EDGAR 10-K Filing

Company CIK: 920427
Filing Year: 2021
Filename: 920427_10-K_2021_0000920427-21-000011.json

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ITEM 1. BUSINESS
Item 1. Business:
a) General
Unity Bancorp, Inc., ("we", "us", "our", the "Company" or "Registrant"), is a bank holding company incorporated under the laws of the State of New Jersey to serve as a holding company for Unity Bank (the “Bank”). The Company has also elected to become a financial holding company pursuant to regulations of the Board of Governors of the Federal Reserve system (the "FRB"). The Company was organized at the direction of the Board of Directors of the Bank for the purpose of acquiring all of the capital stock of the Bank. Pursuant to the New Jersey Banking Act of 1948 (the "Banking Act"), and pursuant to approval of the shareholders of the Bank, the Company acquired the Bank and became its holding company on December 1, 1994. The primary activity of the Company is ownership and supervision of the Bank. The Company also owns 100 percent of the common equity of Unity (NJ) Statutory Trust II. The trust has issued $10.3 million of preferred securities to investors. The Company also serves as a holding company for its wholly-owned subsidiary, Unity Risk Management, Inc. Unity Risk Management, Inc. is a captive insurance company that insures risks to the Bank and the Company not covered by the traditional commercial insurance market.
The Bank received its charter from the New Jersey Department of Banking and Insurance on September 13, 1991 and opened for business on September 16, 1991. The Bank is a full-service commercial bank, providing a wide range of business and consumer financial services through its main office in Clinton, New Jersey and sixteen additional New Jersey branches located in Edison, Emerson, Flemington, Highland Park, Linden, Middlesex, North Plainfield, Phillipsburg, Scotch Plains, Somerset, Somerville, South Plainfield, Ramsey, Union, Washington and Whitehouse. In addition, the Bank has two Pennsylvania branches located in Bethlehem and Forks Township. The Bank’s primary service area encompasses the Route 22/Route 78 corridors between the Bethlehem, Pennsylvania office and its Linden, New Jersey branch, as well as Bergen County, New Jersey.
The principal executive offices of the Company are located at 64 Old Highway 22, Clinton, New Jersey 08809, and the telephone number is (800) 618-2265. The Company’s website address is www.unitybank.com.
Business of the Company
The Company’s primary business is ownership and supervision of the Bank. The Company, through the Bank, conducts a traditional and community-oriented commercial banking business and offers services, including personal and business checking accounts, time deposits, money market accounts and regular savings accounts. The Company structures its specific services and charges in a manner designed to attract the business of the small and medium sized business and professional community, as well as that of individuals residing, working and shopping in its service area. The Company engages in a wide range of lending activities and offers commercial, Small Business Administration (“SBA”), consumer, mortgage, home equity and personal loans.
During 2020, the Company participated in the SBA’s Paycheck Protection Program (“PPP”) created under the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”). The PPP provided funds to guarantee forgivable loans originated by depository institutions to eligible small businesses through the SBA’s 7(a) loan guaranty program. These loans are 100% federally guaranteed (principal and interest). An eligible business could apply under the PPP during the applicable covered period and receive a loan up to 2.5 times its average monthly “payroll costs” limited to a loan amount of $10.0 million. The proceeds of the loan could be used for payroll (excluding individual employee compensation over $100,000 per year), mortgage, interest, rent, insurance, utilities and other qualifying expenses. PPP loans have: (a) an interest rate of 1.0%, (b) a two-year loan term (or five-year loan term for loans made after June 5, 2020) to maturity; and (c) principal and interest payments deferred until the date on which the SBA remits the loan forgiveness amount to the borrower’s lender or, alternatively, notifies the lender no loan forgiveness is allowed. If the borrower did not submit a loan forgiveness application to the lender within 10 months following the end of the 24-week loan forgiveness covered period (or the 8-week loan forgiveness covered period with respect to loans made prior to June 5, 2020 if such covered period is elected by the borrower), the borrower would begin paying principal
and interest on the PPP loan immediately after the 10-month period. The Company originated $143.0 million in PPP loans and as of December 31, 2020 it has $118.3 million in PPP loans outstanding.
On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits and Venues Act (the “Economic Aid Act”) became law. Among other things, the Economic Aid Act extended the PPP through March 31, 2021 and allocated additional funds for new PPP loans, to be guaranteed by the SBA. The extension included an authorization to make new PPP loans to existing PPP loan borrowers, and to make loans to parties that did not previously obtain a PPP loan. The Company is participating in the newly extended PPP, and will originate loans under the extended program. Loans originated under the extended PPP will have substantially the same terms as existing PPP loans.
Service Areas
The Company’s primary service area is defined as the neighborhoods served by the Bank’s offices. The Bank’s main office, located in Clinton, NJ, in combination with its Flemington and Whitehouse offices, serves the greater area of Hunterdon County. The Bank’s North Plainfield, Somerset and Somerville offices serve those communities located in the northern, eastern and central parts of Somerset County and the southernmost communities of Union County. The Bank’s Scotch Plains, Linden, and Union offices serve the majority of the communities in Union County and the southwestern communities of Essex County. The offices in Middlesex, South Plainfield, Highland Park, and Edison extend the Company’s service area into Middlesex County. The Bank’s Phillipsburg and Washington offices serve Warren County. The Bank’s Emerson and Ramsey offices serve Bergen County. The Bank’s Forks Township and Bethlehem offices serve Northampton County, Pennsylvania.
Competition
The Company is located in an extremely competitive area. The Company’s service area is also serviced by national banks, major regional banks, large thrift institutions and a variety of credit unions. In addition, since passage of the Gramm-Leach-Bliley Financial Modernization Act of 1999 (the “Modernization Act”), securities firms and insurance companies have been allowed to acquire or form financial institutions, thereby increasing competition in the financial services market. Most of the Company’s competitors have substantially more capital, and therefore greater lending limits than the Company. The Company’s competitors generally have established positions in the service area and have greater resources than the Company with which to pay for advertising, physical facilities, personnel and interest on deposited funds. The Company relies on the competitive pricing of its loans, deposits and other services, as well as its ability to provide local decision-making and personal service in order to compete with these larger institutions.
Employees and Human Capital
At December 31, 2020, the Company employed 202 full-time and 8 part-time employees. None of the Company’s employees are represented by any collective bargaining units. The Company believes that its relations with its employees are good. . We believe our ability to attract and retain employees is a key to our success. Accordingly, we strive to offer competitive salaries and employee benefits to all employees and monitor salaries in our market areas. In addition, the principal purposes of our equity incentive plans are to attract, retain and motivate selected employees, consultants and directors through the granting of stock-based compensation awards.
SUPERVISION AND REGULATION
General Supervision and Regulation
Bank holding companies and banks are extensively regulated under both federal and state law, and these laws are subject to change. As an example, in the summer of 2010, Congress passed, and the President signed, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) (discussed below). These laws and regulations are intended to protect depositors, not stockholders. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in the applicable law or regulation may have a material effect on the business and prospects of
the Company and the Bank. Management of the Company is unable to predict, at this time, the impact of future changes to laws and regulations.
General Bank Holding Company Regulation
General: As a bank holding company registered under the Bank Holding Company Act of 1956, as amended, (the "BHCA"), the Company is subject to the regulation and supervision of the FRB. The Company is required to file with the FRB annual reports and other information regarding its business operations and those of its subsidiaries. Under the BHCA, the Company’s activities and those of its subsidiaries are limited to banking, managing or controlling banks, furnishing services to or performing services for its subsidiaries or engaging in any other activity which the FRB determines to be so closely related to banking or managing or controlling banks as to be properly incident thereto. In addition, as a financial holding company, the Company may engage in a broader scope of activities. See "Financial Holding Company Status".
The BHCA requires, among other things, the prior approval of the FRB in any case where a bank holding company proposes to; (i) acquire all or substantially all of the assets of any other bank; (ii) acquire direct or indirect ownership or control of more than 5% of the outstanding voting stock of any bank (unless it owns a majority of such bank’s voting shares); or (iii) merge or consolidate with any other bank holding company. The FRB will not approve any acquisition, merger or consolidation that would have a substantially anti-competitive effect, unless the anti-competitive impact of the proposed transaction is clearly outweighed by a greater public interest in meeting the convenience and needs of the community to be served. The FRB also considers capital adequacy and other financial and managerial resources and future prospects of the companies and the banks concerned, together with the convenience and needs of the community to be served, when reviewing acquisitions or mergers.
The BHCA also generally prohibits a bank holding company, with certain limited exceptions, from; (i) acquiring or retaining direct or indirect ownership or control of more than 5% of the outstanding voting stock of any company which is not a bank or bank holding company; or (ii) engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or performing services for its subsidiaries, unless such non-banking business is determined by the FRB to be so closely related to banking or managing or controlling banks as to be properly incident thereto. In making such determinations, the FRB is required to weigh the expected benefits to the public such as greater convenience, increased competition or gains in efficiency, against the possible adverse effects such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices.
The BHCA was substantially amended through the Modernization Act. The Modernization Act permits bank holding companies and banks, which meet certain capital, management and Community Reinvestment Act standards, to engage in a broader range of non-banking activities. In addition, bank holding companies, which elect to become financial holding companies, may engage in certain banking and non-banking activities without prior FRB approval. Finally, the Modernization Act imposes certain privacy requirements on all financial institutions and their treatment of consumer information. The Company has elected to become a financial holding company. See "Financial Holding Company Status" below.
There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the Federal Deposit Insurance Corporation (the “FDIC”) Deposit Insurance Fund in the event the depository institution becomes in danger of default. Under regulations of the FRB, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such policy. The FRB also has the authority under the BHCA to require a bank holding company to terminate any activity or to relinquish control of a non-bank subsidiary upon the FRB’s determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company.
Capital Adequacy Guidelines
In December 2010 and January 2011, the Basel Committee on Banking Supervision (the “Basel Committee”) published the final reforms on capital and liquidity generally referred to as “Basel III.” In July 2013, the FRB, the FDIC and the Comptroller of the Currency adopted final rules (the “New Rules”), which implement certain provisions of Basel III and the Dodd-Frank Act. The New Rules replaced the existing general risk-based capital rules of the various banking agencies with a single, integrated regulatory capital framework. The New Rules require higher capital cushions and more stringent criteria for what qualifies as regulatory capital. The New Rules were effective for the Bank and the Company on January 1, 2015.
Under the New Rules, the Company and the Bank are required to maintain the following minimum capital ratios, expressed as a percentage of risk-weighted assets:
● Common Equity Tier 1 Capital Ratio of 4.5% (the “CET1”);
● Tier 1 Capital Ratio (CET1 capital plus “Additional Tier 1 capital”) of 6.0%; and
● Total Capital Ratio (Tier 1 capital plus Tier 2 capital) of 8.0%.
In addition, the Company and the Bank are subject to a leverage ratio of 4% (calculated as Tier 1 capital to average consolidated assets as reported on the consolidated financial statements).
The New Rules also require a “capital conservation buffer.” As of January 1 2019, the Company and the Bank are required to maintain a 2.5% capital conservation buffer, which is composed entirely of CET1, on top of the minimum risk-weighted asset ratios described above, resulting in the following minimum capital ratios:
● CET1 of 7%;
● Tier 1 Capital Ratio of 8.5%; and
● Total Capital Ratio of 10.5%.
The purpose of the capital conservation buffer is to absorb losses during periods of economic stress. Banking institutions with a CET1, Tier 1 Capital Ratio and Total Capital Ratio above the minimum set forth above but below the capital conservation buffer will face constraints on their ability to pay dividends, repurchase equity and pay discretionary bonuses to executive officers, based on the amount of the shortfall.
The New Rules provide for several deductions from and adjustments to CET1. For example, mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in common equity issued by nonconsolidated financial entities must be deducted from CET1 to the extent that any one of those categories exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1.
Under the New Rules, banking organizations such as the Company and the Bank may make a one-time permanent election regarding the treatment of accumulated other comprehensive income items in determining regulatory capital ratios. Effective as of January 1, 2015, the Company and the Bank elected to exclude accumulated other comprehensive income items for purposes of determining regulatory capital.
While the New Rules generally require the phase-out of non-qualifying capital instruments such as trust preferred securities and cumulative perpetual preferred stock, holding companies with less than $15 billion in total consolidated assets as of December 31, 2009, such as the Company, may permanently include non-qualifying instruments that were issued and included in Tier 1 or Tier 2 capital prior to May 19, 2010 in Additional Tier 1 or Tier 2 capital until they redeem such instruments or until the instruments mature.
The New Rules prescribe a standardized approach for calculating risk-weighted assets. Depending on the nature of the assets, the risk categories generally range from 0% for U.S. Government and agency securities, to 600% for certain equity exposures, and result in higher risk weights for a variety of asset categories. In addition, the New Rules provide
more advantageous risk weights for derivatives and repurchase-style transactions cleared through a qualifying central counterparty and increase the scope of eligible guarantors and eligible collateral for purposes of credit risk mitigation.
Consistent with the Dodd-Frank Act, the New Rules adopt alternatives to credit ratings for calculating the risk-weighting for certain assets.
On September 17, 2019, the federal banking agencies issued a final rule providing simplified capital requirements for certain community banking organizations (banks and holding companies) with less than $10 billion in total consolidated assets, implementing provisions of The Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”). Under the rule, a qualifying community banking organization would be eligible to elect the community bank leverage ratio framework, or continue to measure capital under the existing Basel III requirements set forth in the New Rules. The community bank capital rule took effect January 1, 2020, and qualifying community banking organizations may elect to opt into the new community bank leverage ratio (“CBLR”) in their call report for the first quarter of 2020 or any quarter thereafter.
A qualifying community banking organization (“QCBO”) is defined as a bank, a savings association, a bank holding company or a savings and loan holding company with:
● a leverage capital ratio of greater than 9.0%;
● total consolidated assets of less than $10.0 billion;
● total off-balance sheet exposures (excluding derivatives other than credit derivatives and unconditionally cancelable commitments) of 25% or less of total consolidated assets; and
● total trading assets and trading liabilities of 5% or less of total consolidated assets.
A QCBO opting into the CBLR must maintain a CBLR of 9.0%, subject to a two quarter grace period to come back into compliance, provided that the QCBO maintains a leverage ratio of more than 8.0% during the grace period. A QCBO failing to satisfy these requirements must comply with the Basel III requirements as implemented by the New Rules. The numerator of the CBLR is Tier 1 capital, as calculated under the New Rule. The denominator of the CBLR is the QCBO’s average assets, calculated in accordance with the QCBO’s Call Report instructions and less assets deducted from Tier 1 capital. On April 6, 2020, the federal banking regulators, implementing the applicable provisions of the CARES Act, modified the CBLR framework so that: (i) beginning in the second quarter 2020 and until the end of the year, a banking organization that has a leverage ratio of 8% or greater and meets certain other criteria may elect to use the CBLR framework; and (ii) community banking organizations will have until January 1, 2022, before the CBLR requirement is re-established at greater than 9%. Under the interim rules, the minimum CBLR will be 8% beginning in the second quarter and for the remainder of calendar year 2020, 8.5% for calendar year 2021, and 9% thereafter. Commencing with the first quarter of 2020, the Bank elected to comply with the CBLR, rather than the capital requirements specified in the New Rules. At December 31, 2020, the Bank’s CBLR was 9.80%.
Pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), each federal banking agency has promulgated regulations, specifying the levels at which an insured depository institution such as the Bank would be considered “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized,” and providing for certain mandatory and discretionary supervisory actions based on the capital level of the institution. To qualify to engage in financial activities under the Gramm-Leach-Bliley Act, all depository institutions must be “well capitalized.”
The New Rules also revised the regulations implementing these provisions of FDICIA, to change the capital levels applicable to each designation. Under the New Rules, an institution will be classified as “well capitalized” if it (i) has a total risk-based capital ratio of at least 10.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 8.0 percent, (iii) has a Tier 1 leverage ratio of at least 5.0 percent, (iv) has a common equity Tier 1 capital ratio of at least 6.5 percent, and (v) meets certain other requirements. An institution will be classified as “adequately capitalized” if it (i) has a total risk-based capital ratio of at least 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 6.0 percent, (iii) has a Tier 1 leverage ratio of at least 4.0 percent, (iv) has a common equity Tier 1 capital ratio of at least 4.5 percent, and (v) does not meet the definition of “well capitalized.” An institution will be classified as “undercapitalized” if it (i) has a total risk-based capital ratio of less than 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 6.0 percent,
(iii) has a Tier 1 leverage ratio of less than 4.0 percent, or (iv) has a common equity Tier 1 capital ratio of less than 4.5 percent. An institution will be classified as “significantly undercapitalized” if it (i) has a total risk-based capital ratio of less than 6.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 4.0 percent, (iii) has a Tier 1 leverage ratio of less than 3.0 percent, or (iv) has a common equity Tier 1 capital ratio of less 3.0 percent. An institution will be classified as “critically undercapitalized” if it has a tangible equity to total assets ratio that is equal to or less than 2.0 percent. An insured depository institution may be deemed to be in a lower capitalization category if it receives an unsatisfactory examination rating.
General Bank Regulation
As a New Jersey-chartered commercial bank, the Bank is subject to the regulation, supervision, and control of the New Jersey Department of Banking and Insurance (the “Department”). As an FDIC-insured institution, the Bank is subject to regulation, supervision and control of the FDIC, an agency of the federal government. The regulations of the FDIC and the Department affect virtually all activities of the Bank, including the minimum level of capital that the Bank must maintain, the ability of the Bank to pay dividends, the ability of the Bank to expand through new branches or acquisitions and various other matters.
Insurance of Deposits: The Dodd-Frank Act has caused significant changes in the FDIC’s insurance of deposit accounts. Among other things, the Dodd-Frank Act permanently increased the FDIC deposit insurance limit to $250 thousand per depositor.
On February 7, 2011 the FDIC announced the approval of the assessment system mandated by the Dodd-Frank Act. Dodd-Frank required that the base on which deposit insurance assessments are charged be revised from one based on domestic deposits to one based on assets. The FDIC’s rule to base the assessment on average total consolidated assets minus average tangible equity instead of domestic deposits lowered assessments for many community banks with less than $10 billion in assets and reduced the Company’s costs.
Dividend Rights: Under the Banking Act, a bank may declare and pay dividends only if, after payment of the dividend, the capital stock of the bank will be unimpaired and either the bank will have a surplus of not less than 50% of its capital stock or the payment of the dividend will not reduce the bank’s surplus. Unless and until the Company develops other lines of business, payments of dividends from the Bank will remain the Company’s primary source of income and the primary source of funds for dividend payments to the shareholders of the Company.
Dodd-Frank Wall Street Reform and Consumer Protection Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), enacted on July 21, 2010, significantly changed the bank regulatory landscape and has impacted and will continue to impact the lending, deposit, investment, trading and operating activities of insured depository institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new rules and regulations. The Dodd-Frank Act, among other things:
● capped debit card interchange fees for institutions with $10 billion in assets or more at $0.21 plus 5 basis points times the transaction amount, a substantially lower rate than the average rate in effect prior to adoption of the Dodd-Frank Act;
● provided for an increase in the FDIC assessment for depository institutions with assets of $10 billion or more, increases in the minimum reserve ratio for the Deposit Insurance Fund ("DIF") from 1.15% to 1.35% and changes the basis for determining FDIC premiums from deposits to assets;
● permanently increased the deposit insurance coverage to $250 thousand and allowed depository institutions to pay interest on checking accounts;
● created a new Consumer Financial Protection Bureau (“CFPB”) that has rulemaking authority for a wide range of consumer financial protection laws that apply to all banks and has broad authority to enforce these laws;
● provided for new disclosure and other requirements relating to executive compensation and corporate governance;
● changed standards for Federal preemption of state laws related to federally-chartered institutions and their subsidiaries;
● provided mortgage reform provisions regarding a customer’s ability to repay, restricting variable rate lending by requiring the ability to repay to be determined for variable rate loans by using the maximum rate that will apply during the first five years of a variable rate loan term, and making more loans subject to provisions for higher cost loans, new disclosures, and certain other revisions; and
● created a financial stability oversight council that will recommend to the FRB increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity.
The Dodd-Frank Act also imposes new obligations on originators of residential mortgage loans, such as the Bank. Among other things, the Dodd-Frank Act requires originators to make a reasonable and good faith determination based on documented information that a borrower has a reasonable ability to repay a particular mortgage loan over the long term. If the originator cannot meet this standard, the mortgage may be unenforceable. The Dodd-Frank Act contains an exception from this ability-to-repay rule for “Qualified Mortgages”. The CFPB has established specific underwriting criteria for a loan to qualify as a Qualified Mortgage. The criteria generally exclude loans that (1) are interest-only, (2) have excessive upfront points or fees, or (3) have negative amortization features, balloon payments, or terms in excess of 30 years. The underwriting criteria also impose a maximum debt to income ratio of 43%, based upon documented and verifiable information. If a loan meets these criteria and is not a “higher priced loan” as defined in FRB regulations, the CFPB rule establishes a safe harbor preventing a consumer from asserting the failure of the originator to establish the consumer’s ability to repay. However, a consumer may assert the lender’s failure to comply with the ability-to-repay rule for all residential mortgage loans other than Qualified Mortgages, and may challenge whether a loan in fact qualified as a Qualified Mortgage.
Although the majority of residential mortgages historically originated by the Bank would be considered Qualified Mortgages, the Bank has and may continue to make residential mortgage loans that would not qualify. As a result of such rules, the Bank might experience increased compliance costs, loan losses, litigation related expenses and delays in taking title to real estate collateral, if these loans do not perform and borrowers challenge whether the Bank satisfied the ability-to-repay rule upon originating the loan.
The requirements of the Dodd-Frank Act and other regulatory reforms continue to be implemented. It is difficult to predict at this time what specific impact certain provisions and yet-to-be-finalized rules and regulations will have on us, including any regulations promulgated by the CFPB. Financial reform legislation and rules could have adverse implications on the financial industry, the competitive environment, and our ability to conduct business. Management will have to apply resources to ensure compliance with all applicable provisions of regulatory reforms, including the Dodd-Frank Act and any implementing rules, which may increase our costs of operations and adversely impact our earnings.
Financial Holding Company Status
The Company has elected to become a financial holding company. Financial holding companies may engage in a broader scope of activities than a bank holding company. In addition, financial holding companies may undertake certain activities without prior FRB approval.
A financial holding company may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature or incidental or complementary to activities that are financial in nature. "Financial in nature" activities include:
● securities underwriting, dealing and market making;
● sponsoring, mutual funds and investment companies;
● insurance underwriting and insurance agency activities;
● merchant banking; and
● activities that the FRB determines to be financial in nature or incidental to a financial activity or which are complementary to a financial activity and do not pose a safety and soundness risk.
A financial holding company that desires to engage in activities that are financial in nature or incidental to a financial activity but not previously authorized by the FRB must obtain approval from the FRB before engaging in such activity. Also, a financial holding company may seek FRB approval to engage in an activity that is complementary to a financial activity, if it shows, among other things, that the activity does not pose a substantial risk to the safety and soundness of its insured depository institutions or the financial system.
A financial holding company generally may acquire a company (other than a bank holding company, bank or savings association) engaged in activities that are financial in nature or incidental to activities that are financial in nature without prior approval from the FRB. Prior FRB approval is required, however, before the financial holding company may acquire control of more than 5% of the voting shares or substantially all of the assets of a bank holding company, bank or savings association. In addition, under the FRB’s merchant banking regulations, a financial holding company is authorized to invest in companies that engage in activities that are not financial in nature, as long as the financial holding company makes its investment with the intention of limiting the duration of the investment, does not manage the company on a day-to-day basis, and the company does not cross-market its products or services with any of the financial holding company’s controlled depository institutions.
If any subsidiary bank of a financial holding company ceases to be "well-capitalized" or "well-managed" and fails to correct its condition within the time period that the FRB specifies, the FRB has authority to order the financial holding company to divest its subsidiary banks. Alternatively, the financial holding company may elect to limit its activities and the activities of its subsidiaries to those permissible for a bank holding company that is not a financial holding company. If any subsidiary bank of a financial holding company receives a rating under the CRA of less than "satisfactory", then the financial holding company is prohibited from engaging in new activities or acquiring companies other than bank holding companies, banks or savings associations until the rating is raised to "satisfactory" or better.

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ITEM 1A. RISK FACTORS
Item 1A. Risk Factors:
Our business, financial condition, results of operations and the trading price of our securities can be materially and adversely affected by many events and conditions including the following:
Pandemic events may have a material adverse effect on our operations and our financial condition.
The outbreak of disease on a regional, national or global level, such as the spread of the COVID-19 coronavirus, has a material adverse effect on commerce, which may, in turn impact our lines of business.
Our operations are significantly affected by the general economic conditions of New Jersey, Eastern Pennsylvania and the specific local markets in which we operate. The Central and Northern New Jersey and Eastern Pennsylvania markets served by the Registrant have been significantly impact by the Coronavirus epidemic and governmental actions to mitigate the epidemic, such as stay at home orders and business shutdowns. Our real estate portfolio consists primarily of loans secured by properties located in Bergen, Hunterdon, Middlesex, Somerset, Union and Warren counties in New Jersey, and Northampton County in Pennsylvania. A decline in the economies of these counties, which we consider to be our primary market area, could have a material adverse effect on our business, financial condition, results of operations, and prospects.
The coronavirus outbreak may also have an adverse effect on our customers directly or indirectly. These effects could include disruptions or restrictions in our customers’ supply chains or employee productivity, closures of customers’ facilities, decreases in demand for customers’ products and services or in other economic activities. Their businesses may be adversely affected by quarantines and travel restrictions in areas most affected by COVID-19. If our customers are adversely affected, our condition and results of operations could be adversely affected.
The COVID-19 epidemic may also affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans and/or result in loss of revenue. A decline in local
economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are geographically diverse. Many of the loans in our portfolio are secured by real estate. Deterioration in the real estate markets where collateral for a mortgage loan is located could negatively affect the borrower’s ability to repay the loan and the value of the collateral securing the loan. Real estate values are affected by various other factors, including changes in general or regional economic conditions and governmental rules or policies. If we are required to liquidate a significant amount of collateral during a period of reduced real estate values, our financial condition and profitability could be adversely affected. Adverse changes in the regional and general economy could reduce our growth rate, impair our ability to collect loans and generally have a negative effect on our financial condition and results of operations.
Including the potential effects of the COVID-19 outbreak on the Company’s loan portfolios, the ongoing and dynamic nature of the pandemic and the resultant, potentially severe and long-lasting, economic dislocations, it is difficult to predict the full impact of the COVID-19 outbreak on our business. The extent of such impact will depend on future developments, which are highly uncertain, including when the coronavirus can be controlled and abated and when and how the economy may be reopened. As the result of the COVID-19 pandemic and the related adverse local and national economic consequences, we could be subject to any of the following risks, any of which could have a material, adverse effect on our business, financial condition, liquidity, and results of operations:
● Demand for our products and services may decline, making it difficult to grow assets and income;
● If the economy is unable to substantially reopen, and high levels of unemployment continue for an extended period of time, loan delinquencies, problem assets, and foreclosures may increase, resulting in increased charges and reduced income;
● Collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase;
● Our allowance for loan losses may have to be increased if borrowers experience financial difficulties beyond loan deferral and forbearance periods, which will adversely affect our net income;
● The net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us;
● As the result of the decline in the Federal Reserve Board’s target federal fund rate to near 0%, the yield on our assets may decline to a greater extent than the decline in our cost of interest-bearing liabilities, reducing our net interest margin and spread and reducing net income; and
● Federal Deposit Insurance Corporation premiums may increase if the agency experiences additional resolution costs.
Moreover, our future success and profitability substantially depends on the management skills of our executive officers and directors, many of whom have held officer and director positions with us for many years. The unanticipated loss or unavailability of key employees due to the outbreak could harm our ability to operate our business or execute our business strategy. We may not be successful in finding and integrating suitable successors in the event of key employee loss or unavailability.
Any one or a combination of the factors identified above could negatively impact our business, financial condition and results of operations and prospects.
The Company and its bank subsidiary are subject to regulatory enforcement orders requiring improvement in compliance functions and remedial actions.
In recent years, a combination of financial reform legislation and heightened scrutiny by banking regulators have significantly increased expectations regarding what constitutes an effective risk and compliance management infrastructure. On July 6, 2020, Unity Bank executed a Stipulation and Consent to the Issuance of a Consent Order (the “Order”) countersigned by the Federal Deposit Insurance Corporation (the "FDIC"). On July 6, 2020 the Bank also agreed to an Acknowledgement and Consent of FDIC Consent Order with the Commissioner of Banking and Insurance for the State of New Jersey (the “Commissioner”), which makes the Consent Order binding as between the Bank and the Commissioner. On July 15, 2020, the Commissioner adopted the Acknowledgement. The Bank consented to the issuance of the Consent Order without admitting any charges of unsafe or unsound banking practices or violations of law or regulation. The Consent Order arises from a routine safety and soundness examination of the Bank by the FDIC.
Under the terms of the Order, the Bank is required to, among other things, increase board supervision of its BSA/AML program, review and improve its written BSA/AML compliance program, review and improve its BSA risk assessment, review and improve its system of internal controls to assure and monitor compliance with the BSA, provide for independent testing of its BSA compliance, provide additional resources and training to staff to ensure BSA compliance, review its compliance with Office of Foreign Assets Control regulations, retain a firm acceptable to the FDIC and the New Jersey Department of Banking and Insurance ("NJDOBI") to undertake a review of all accounts and transaction activity to determine that appropriate reporting was undertaken, establish a board oversight committee consisting of independent directors and provide quarterly reporting to the FDIC and NJDOBI.
The board of directors and management of the Bank began proactively taking steps to address identified matters promptly following the FDIC examination, and will continue to work with the FDIC to address such matters.
However, the provisions of the Order will remain in effect until modified, terminated, suspended or set aside by the FDIC, and we can give no assurance that the FDIC and NJDOBI will find the steps that we have taken satisfactory and when, or if, the Order will be lifted. Based upon quotes received from third party vendors to date and management’s current understanding of the work to be performed to comply with the Consent Order, we currently estimate that the costs to comply with the Consent Order will approximate $1.8 million. However, if additional review or remediation work is required to fully comply with the provisions of the Consent Order, the Bank could incur additional expense.
While the Bank intends to take such actions as may be necessary to enable it to comply with the Consent Order, there can be no assurance that the Bank will be able to fully comply with the provisions of the Consent Order, that its efforts to comply with the Consent Order will not have adverse effects on the operations and financial condition of the Bank, or that the Bank would not be subject to other regulatory enforcement actions in the future. In addition, while the Consent Order is in place, the Bank’s ability to expend through acquisitions or additional branches may be curtailed.
We have been and may continue to be adversely affected by national financial markets and economic conditions, as well as local conditions.
Our business and results of operations are affected by the financial markets and general economic conditions in the United States, including factors such as the level and volatility of interest rates, inflation, home prices, unemployment and under-employment levels, bankruptcies, household income, consumer spending, investor confidence and the strength of the U.S. economy. The deterioration of any of these conditions can adversely affect our securities and loan portfolios, our level of charge-offs and provision for credit losses, our capital levels, liquidity and our results of operations.
In addition, we are affected by the economic conditions within our New Jersey and Pennsylvania trade areas. Unlike larger banks that are more geographically diversified, we provide banking and financial services primarily to customers in the seven counties in the New Jersey market and one county in Pennsylvania in which we have branches, so any decline in the economy of New Jersey or eastern Pennsylvania could have an adverse impact on us.
Our loans, the ability of borrowers to repay these loans, and the value of collateral securing these loans are impacted by economic conditions. Our financial results, the credit quality of our existing loan portfolio, and the ability to generate new loans with acceptable yield and credit characteristics may be adversely affected by changes in prevailing economic conditions, including declines in real estate values, changes in interest rates, adverse employment conditions and the monetary and fiscal policies of the federal government. We cannot assure you that positive trends or developments discussed in this annual report will continue or that negative trends or developments will not have a significant adverse effect on us.
A significant portion of our loan portfolio is secured by real estate, and events that negatively impact the real estate market could hurt our business.
A significant portion of our loan portfolio is secured by real estate. As of December 31, 2020, approximately 87 percent of our loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the
time the credit is extended. Weakness in the real estate market in our primary market areas could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality. Any future declines in home prices in the New Jersey and Pennsylvania markets we serve also may result in increases in delinquencies and losses in our loan portfolios. Stress in the real estate market, combined with any weakness in economic conditions and any future elevated unemployment levels could drive losses beyond that which is provided for in our allowance for loan losses. In that event, our earnings could be adversely affected.
There is a risk that the SBA will not honor their guarantee.
The Company has historically been a participant in various SBA lending programs which guarantee up to 90% of the principal on the underlying loan. There is a risk that the SBA will not honor its guarantee if a loan is not underwritten and administered to SBA guidelines. The Company follows the underwriting guidelines of the SBA; however our ability to manage this will depend on our ability to continue to attract, hire and retain skilled employees who have knowledge of the SBA program.
There is a risk that we may not be repaid in a timely manner, or at all, for loans we make.
The risk of nonpayment (or deferred or delayed payment) of loans is inherent in commercial banking. Such nonpayment, or delayed or deferred payment of loans to the Company, if they occur, may have a material adverse effect on our earnings and overall financial condition. Additionally, in compliance with applicable banking laws and regulations, the Company maintains an allowance for loan losses created through charges against earnings. As of December 31, 2020, the Company’s allowance for loan losses was $23.1 million, or 1.42 percent of our total loan portfolio and 242.83 percent of our nonperforming loans. The Company’s marketing focus on small to medium size businesses may result in the assumption by the Company of certain lending risks that are different from or greater than those which would apply to loans made to larger companies. We seek to minimize our credit risk exposure through credit controls, which include evaluation of potential borrowers’ available collateral, liquidity and cash flow. However, there can be no assurance that such procedures will actually reduce loan losses.
Our allowance for loan losses may not be adequate to cover actual losses.
Like all financial institutions, we maintain an allowance for loan losses to provide for loan defaults and nonperformance. Our allowance for loan losses may not be adequate to cover actual losses, and future provisions for loan losses could materially and adversely affect the results of our operations. Risks within the loan portfolio are analyzed on a continuous basis by management and, periodically, by an independent loan review function and by the Audit Committee. A risk system, consisting of multiple-grading categories, is utilized as an analytical tool to assess risk and the appropriate level of loss reserves. Along with the risk system, management further evaluates risk characteristics of the loan portfolio under current economic conditions and considers such factors as the financial condition of the borrowers, past and expected loan loss experience and other factors management feels deserve recognition in establishing an adequate reserve. This risk assessment process is performed at least quarterly and, as adjustments become necessary, they are realized in the periods in which they become known. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be beyond our control, and these losses may exceed current estimates. State and federal regulatory agencies, as an integral part of their examination process, review our loans and allowance for loan losses and may require an increase in our allowance for loan losses. Although we believe that our allowance for loan losses is adequate to cover probable and reasonably estimated losses, we cannot assure you that we will not further increase the allowance for loan losses or that our regulators will not require us to increase this allowance. Either of these occurrences could adversely affect our earnings.
In June 2016, the Financial Accounting Standards Board issued ASU 2016-13. ASU 2016-13 significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. ASU 2016-13 will replace the incurred loss model under existing guidance with a current expected credit loss (“CECL”) model for instruments measured at amortized cost, and require entities to record allowances for available-for-sale debt securities rather than reduce the carrying amount, as they do today under the other-than-temporary impairment model. ASU 2016-13 also simplifies the accounting model for purchased credit-
impaired debt securities and loans. While ASU 2016-13 does not require any particular method for determining the CECL allowance, it does specify the allowance should be based on relevant information about past events, including historical loss experience, current portfolio and market conditions, and reasonable and supportable forecasts for the duration of each respective loan. Because our methodology for determining CECL allowances may differ from the methodologies employed by other companies, our CECL allowances may not be comparable with the CECL allowances reported by other companies. In addition, other than a few narrow exceptions, ASU 2016-13 requires that all financial instruments subject to the CECL model have some amount of reserve to reflect the GAAP principal underlying the CECL model that all loans, debt securities, and similar assets have some inherent risk of loss, regardless of credit quality, subordinate capital, or other mitigating factors. Accordingly, we expect that the adoption of the CECL model will materially affect how we determine our allowance for loan losses and could require us to increase our allowance and recognize provisions for loan losses earlier in the lending cycle. Moreover, the CECL model may create more volatility in the level of our allowance for loan losses. If we are required to materially increase our level of allowance for loan losses for any reason, such increase could adversely affect our business, financial condition and results of operations. ASU 2016-13 is effective for fiscal years beginning after December 15, 2022.
We are subject to interest rate risk and variations in interest rates may negatively affect our financial performance.
Net interest income, the difference between interest earned on our interest-earning assets and interest paid on interest-bearing liabilities, represents a significant portion of our earnings. Both increases and decreases in the interest rate environment may reduce our profits. Interest rates are subject to factors which are beyond our control, including general economic conditions, competition and policies of various governmental and regulatory agencies, such as the FRB. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investment securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, including the held to maturity and available for sale securities portfolios, and (iii) the average duration of our interest-earning assets. This also includes the risk that interest-earning assets may be more responsive to changes in interest rates than interest-bearing liabilities, or vice versa (repricing risk), the risk that the individual interest rates or rate indexes underlying various interest-earning assets and interest-bearing liabilities may not change in the same degree over a given time period (basis risk), and the risk of changing interest rate relationships across the spectrum of interest-earning asset and interest-bearing liability maturities (yield curve risk).
The banking business is subject to significant government regulations.
We are subject to extensive governmental supervision, regulation and control. These laws and regulations are subject to change, and may require substantial modifications to our operations or may cause us to incur substantial additional compliance costs. These laws and regulations are designed to protect depositors and the public, but not our shareholders. In addition, future legislation and government policy could adversely affect the commercial banking industry and our operations. Such governing laws can be anticipated to continue to be the subject of future modification. Our management cannot predict what effect any such future modifications will have on our operations. In addition, the primary focus of Federal and state banking regulation is the protection of depositors and not the shareholders of the regulated institutions.
For example, the Dodd-Frank Act has resulted in substantial new compliance costs, and may restrict certain sources of revenue. The Dodd-Frank Act was signed into law on July 21, 2011. Generally, the Act is effective the day after it was signed into law, but different effective dates apply to specific sections of the law, many of which will not become effective until various Federal regulatory agencies have promulgated rules implementing the statutory provisions. Uncertainty remains as to the ultimate impact of the Dodd-Frank Act, which could have a material adverse impact either on the financial services industry as a whole, or on our business, results of operations and financial condition. The Dodd-Frank Act, among other things:
● capped debit card interchange fees for institutions with $10 billion in assets or more at $0.21 plus 5 basis points times the transaction amount, a substantially lower rate than the average rate in effect prior to adoption of the Dodd-Frank Act;
● provided for an increase in the FDIC assessment for depository institutions with assets of $10 billion or more, increases the minimum reserve ratio for the DIF from 1.15% to 1.35% and changes the basis for determining FDIC premiums from deposits to assets;
● permanently increased the deposit insurance coverage to $250 thousand and allowed depository institutions to pay interest on checking accounts;
● created a new CFPB that has rule making authority for a wide range of consumer financial protection laws that apply to all banks and has broad authority to enforce these laws;
● provided for new disclosure and other requirements relating to executive compensation and corporate governance;
● changed standards for Federal preemption of state laws related to federally-chartered institutions and their subsidiaries;
● provided mortgage reform provisions regarding a customer’s ability to repay, restricting variable rate lending by requiring the ability to repay to be determined for variable rate loans by using the maximum rate that will apply during the first five years of a variable rate loan term, and making more loans subject to provisions for higher cost loans, new disclosures, and certain other revisions; and
● created a financial stability oversight council that will recommend to the FRB increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity.
These provisions, as well as any other aspects of current or proposed regulatory or legislative changes to laws applicable to the financial industry, may impact the profitability of our business activities and may change certain of our business practices, including the ability to offer new products, obtain financing, attract deposits, make loans, and achieve satisfactory interest spreads, and could expose us to additional costs, including increased compliance costs. These changes also may require us to invest significant management attention and resources to make any necessary changes to operations in order to comply, and could therefore also materially and adversely affect our business, financial condition and results of operations.
We are subject to changes in accounting policies or accounting standards.
Understanding our accounting policies is fundamental to understanding our financial results. Some of these policies require the use of estimates and assumptions that may affect the value of assets or liabilities and financial results. We have identified our accounting policies regarding the allowance for loan losses, security valuations and impairments, goodwill and income taxes to be critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain. Under each of these policies, it is possible that materially different amounts would be reported under different conditions, using different assumptions, or as new information becomes available.
From time to time, the FASB and the SEC change their guidance governing the form and content of our external financial statements. In addition, accounting standard setters and those who interpret U.S. generally accepted accounting principles (“U.S. GAAP”), such as the FASB, SEC, banking regulators and our outside auditors, may change or even reverse their previous interpretations or positions on how these standards should be applied. Such changes are expected to continue. Changes in U.S. GAAP and changes in current interpretations are beyond our control, can be hard to predict and could materially impact how we report our financial results and condition. In certain cases, we could be required to apply a new or revised guidance retroactively or apply existing guidance differently (also retroactively) which may result in our 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 will negatively impact our results of operations.
Declines in value may adversely impact the investment portfolio.
As of December 31, 2020, we had approximately $45.6 million and $2.0 million in available for sale and equity investment securities, respectively. We may be required to record impairment charges in earnings related to credit losses on our investment securities if they suffer a decline in value that is considered other-than-temporary. Additionally, (a) if we intend to sell a security or (b) it is more likely than not that we will be required to sell the security prior to recovery
of its amortized cost basis, we will be required to recognize an other-than-temporary impairment charge in the statement of income equal to the full amount of the decline in fair value below amortized cost. Factors, including lack of liquidity, absence of reliable pricing information, adverse actions by regulators, or unanticipated changes in the competitive environment could have a negative effect on our investment portfolio and may result in other-than-temporary impairment on our investment securities in future periods.
Liquidity risk.
Liquidity risk is the potential that we will be unable to meet our obligations as they come due because of an inability to liquidate assets or obtain adequate funding on 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.
Liquidity is derived primarily from retail deposit growth and retention; principal and interest payments on loans; principal and interest payments on investment securities; sale, maturity and prepayment of investment securities; net cash provided from operations and access to other funding sources.
Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to persistent weakness, or downturn, in the economy or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not necessarily specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole.
We are in competition with many other banks, including larger commercial banks which have greater resources than us.
The banking industry within the State of New Jersey is highly competitive. The Company’s principal market area is also served by branch offices of large commercial banks and thrift institutions. In addition, the Gramm-Leach-Bliley Financial Modernization Act permits other financial entities, such as insurance companies and securities firms, to acquire or form financial institutions, thereby further increasing competition. A number of our competitors have substantially greater resources than we do to expend upon advertising and marketing, and their substantially greater capitalization enables them to make much larger loans. Our success depends a great deal upon our judgment that large and mid-size financial institutions do not adequately serve small businesses in our principal market area and upon our ability to compete favorably for such customers. In addition to competition from larger institutions, we also face competition for individuals and small businesses from small community banks seeking to compete as “hometown” institutions. Most of these smaller institutions have focused their marketing efforts on the smaller end of the small business market we serve.
The Company has also been active in competing for New Jersey governmental and municipal deposits. At December 31, 2020, the Company held approximately $142.6 million in governmental and municipal deposits. The governor of New Jersey has proposed that the state form and own a bank in which governmental and municipal entities would deposit their excess funds, with the state owned bank then financing small businesses and municipal projects in New Jersey. Although this proposal is in the very early stages and no legislation has been introduced in the state legislature, should this proposal be adopted and a state owned bank formed, it could impede the Company’s ability to attract and retain governmental and municipal deposits, thereby impairing the Company’s liquidity.
Future offerings of common stock may adversely affect the market price of our stock.
In the future, if our or the Bank’s capital ratios fall below the prevailing regulatory required minimums, we or the Bank could be forced to raise additional capital by making additional offerings of common stock or preferred stock. Additional
equity offerings may dilute the holdings of our existing shareholders or reduce the market price of our common stock, or both.
We cannot predict how changes in technology will impact our business.
The financial services market, including banking services, is increasingly affected by advances in technology, including developments in:
● telecommunications;
● data processing;
● automation;
● Internet-based banking;
● Tele-banking; and
● debit cards/smart cards
Our ability to compete successfully in the future will depend on whether we can anticipate and respond to technological changes. To develop these and other new technologies, we will likely have to make additional capital investments. Although we continually invest in new technology, we cannot assure you that we will have sufficient resources or access to the necessary proprietary technology to remain competitive in the future.
The Company’s information systems may experience an interruption or breach in security.
The Company relies heavily on communications and information systems to conduct its business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in the Company’s customer-relationship management, general ledger, deposit, loan and other systems.
We are further exposed to the risk that our external vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by their respective employees as us) and to the risk that our (or our vendors’) business continuity and data security systems prove to be inadequate. We maintain a system of comprehensive policies and a control framework designed to monitor vendor risks including, among other things, (i) changes in the vendor’s organizational structure or internal controls, (ii) changes in the vendor’s financial condition, (iii) changes in the vendor’s support for existing products and services and (iv) changes in the vendor’s strategic focus. In addition, we maintain cyber liability insurance to mitigate against any loss incurred.
While the Company has policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of its information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur; or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of the Company’s information systems could damage the Company’s reputation, result in a loss of customer business, subject the Company to additional regulatory scrutiny or expose the Company to civil litigation and possible financial liability; any of which could have a material adverse effect on the Company’s financial condition and results of operations.
Our business strategy could be adversely affected if we are not able to attract and retain skilled employees and manage our expenses.
We expect to continue to experience growth in the scope of our operations and, correspondingly, in the number of our employees and customers. We may not be able to successfully manage our business as a result of the strain on our management and operations that may result from this growth. Our ability to manage this growth will depend upon our ability to continue to attract, hire and retain skilled employees. Our success will also depend on the ability of our officers and key employees to continue to implement and improve our operational and other systems, to manage multiple, concurrent customer relationships and to hire, train and manage our employees.
Hurricanes or other adverse weather events could negatively affect our local economies or disrupt our operations, which would have an adverse effect on our business or results of operations.
Hurricanes and other weather events can disrupt our operations, result in damage to our properties and negatively affect the local economies in which we operate. In addition, these weather events may result in a decline in value or destruction of properties securing our loans and an increase in delinquencies, foreclosures and loan losses.
The Company may be adversely affected by changes in U.S. tax laws.
Our business may be adversely affected by changes in tax laws. For example, changes in tax laws contained in the Tax Cuts and Jobs Act ("Tax Act"), enacted in December 2017, include a number of provisions that will have an impact on the banking industry, borrowers and the market for single-family residential real estate. Changes include (i) a lower limit on the deductibility of mortgage interest on single-family residential mortgage loans, (ii) the elimination of interest deductions for home equity loans, (iii) a limitation on the deductibility of business interest expense and (iv) a limitation on the deductibility of property taxes and state and local income taxes.
The recent changes in the tax laws may have an adverse effect on the market for, and valuation of, residential properties, and on the demand for such loans in the future, and could make it harder for borrowers to make their loan payments. In addition, these recent changes may also have a disproportionate effect on taxpayers in states with high residential home prices and high state and local taxes, such as New Jersey. If home ownership becomes less attractive, demand for mortgage loans could decrease. The value of the properties securing loans in the loan portfolio may be adversely impacted as a result of the changing economics of home ownership, which could require an increase in the provision for loan losses, which would reduce profitability and could have a material adverse effect on the Company’s business, financial condition and results of operations.
In addition, the incoming Biden administration has discussed raising corporate income tax rates. Any increase in our federal income tax rates could adversely impact our results of operations.
New Jersey legislative changes may increase our tax expense.
In 2019, the New Jersey legislature adopted legislation that will increase our state income tax liability and could increase our overall tax expense. The legislation imposed a temporary surtax on corporations earning New Jersey allocated income in excess of $1 million at a rate of 2.5% for tax years beginning on or after January 1, 2018 through December 31, 2019, and at 1.5% for tax years beginning on or after January 1, 2020 through December 31, 2021. However, in 2020, this surtax was extended through December 31, 2023, at the 2.5% level. The legislation also requires combined filing for members of an affiliated group for tax years beginning on or after January 1, 2019, changing New Jersey’s current status as a separate return state, and limits the deductibility of dividends received. These changes are not temporary.
Reforms to and uncertainty regarding LIBOR may adversely affect the business.
In 2017, a committee of private-market derivative participants and their regulators convened by the Federal Reserve, the Alternative Reference Rates Committee, or “ARRC”, was created to identify an alternative reference interest rate to replace LIBOR. The ARRC announced Secured Overnight Financing Rate, or “SOFR”, a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities, as its preferred alternative to LIBOR. The Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced its intention to stop persuading or compelling banks to submit rates for the calculation of LIBOR to the administrator of LIBOR after 2021. Subsequently, the Federal Reserve Bank announced final plans for the production of SOFR, which resulted in the commencement of its published rates by the Federal Reserve Bank of New York on April 2, 2018. Whether or not SOFR attains market traction as a LIBOR replacement tool remains in question and the future of LIBOR at this time is uncertain. The uncertainty as to the nature and effect of such reforms and actions and the political discontinuance of LIBOR may adversely affect the value of and return on the Company’s financial assets and liabilities that are based on or are linked to LIBOR, the Company’s results of operations or financial condition. In addition, these reforms may also
require extensive changes to the contracts that govern these LIBOR based products, as well as the Company’s systems and processes.
LIBOR is used as a reference rate for many of our transactions, which means it is the base on which relevant interest rates are determined. Transactions include those in which we lend and borrow money, and enter into derivatives to manage our or our customers’ risk. Risks related to transitioning instruments to a new reference rate or to how LIBOR is calculated and its availability include impacts on the yield on loans or securities held by us, amounts paid on securities we have issued, or amounts received and paid on derivative instruments we have entered into. The value of loans, securities, or derivative instruments tied to LIBOR and the trading market for LIBOR-based securities could also be impacted upon its discontinuance or if it is limited.
While we expect LIBOR to continue to be available in substantially its current form until the end of 2021 or shortly before that, it is possible that LIBOR quotes will become unavailable prior to that point. This could result, for example, if sufficient banks decline to make submissions to the LIBOR administrator. In that case, the risks associated with the transition to an alternative reference rate will be accelerated and magnified. These risks may also be increased due to the shorter time for preparing for the transition.

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ITEM 1B. UNRESOLVED STAFF COMMENTS
Item 1B. Unresolved Staff Comments: None

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ITEM 2. PROPERTIES
Item 2. Properties:
The Company presently conducts its business through its main office located at 64 Old Highway 22, Clinton, New Jersey, and its nineteen branch offices. The Company is currently leasing additional back office space in Clinton, New Jersey, in a building adjacent to its main office. The Company’s facilities are adequate to meet its needs.
The following table sets forth certain information regarding the Company’s properties from which it conducts business as of December 31, 2020.
Location
Leased or Owned
Date Leased or Acquired
Lease Expiration
2020 Annual Rental Fee
North Plainfield, NJ
Owned
-
$
-
Linden, NJ
Owned
-
-
Whitehouse, NJ
Owned
-
-
Union, NJ
Leased
75,000
Scotch Plains, NJ
Owned
-
-
Flemington, NJ
Owned
-
-
Forks Township, PA
Leased
63,930
Middlesex, NJ
Owned
-
-
Somerset, NJ
Leased
132,117
Washington, NJ
Owned
-
-
Highland Park, NJ
Owned
-
-
South Plainfield, NJ
Owned
-
-
Edison, NJ
Owned
-
-
Clinton, NJ
Owned
-
-
Somerville, NJ
Owned
-
-
Emerson, NJ
Owned
-
-
Ramsey, NJ
Leased
61,963
Phillipsburg, NJ
Leased
60,000
Clinton, NJ
Leased
29,231
Bethlehem, PA
Leased
$
78,477

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ITEM 3. LEGAL PROCEEDINGS
Item 3. Legal Proceedings:
From time to time, the Company is subject to legal proceedings and claims in the ordinary course of business. The Company currently is not aware of any such legal proceedings or claims that it believes will have, individually or in the aggregate, a material adverse effect on the business, financial condition, or operating results of the Company.

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ITEM 4. MINE SAFETY DISCLOSURE
Item 4. Mine Safety Disclosures: N/A
Item 4A. Executive Officers of the Registrant:
The following table sets forth certain information as of December 31, 2020, regarding each executive officer of the Company who is not also a director.
Name, Age and Position
Officer Since
Principal Occupation During Past Five Years
John Kauchak, 67, Chief Operating Officer and Executive Vice President of the Company and Bank
Previously, Mr. Kauchak was the head of Deposit Operations for Unity Bank from 1996. to 2002.
Janice Bolomey, 52, Chief Administrative Officer and Executive Vice President of the Company and Bank
Previously, Ms. Bolomey was Director of Sales for Unity Bank from 2002 to 2013.
Laureen S. Cook, 52, Interim Principal Financial Officer and Senior Vice President of the Company and Bank
Previously, Ms. Cook was Chief Accounting Officer from July to September 2020, Interim Principal Accounting and Financial Officer from January to May 2020 and Controller for Unity Bank from 2004.
PART II

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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities:
(a) Market Information
The Company’s Common Stock is quoted on the NASDAQ Global Market under the symbol “UNTY.”
(b) Repurchase Plan
On July 16, 2019, the Company authorized the repurchase of up to 525 thousand shares, or approximately 5 percent of its outstanding common stock. The amount and timing of purchases is dependent upon a number of factors, including the price and availability of the Company’s shares, general market conditions and competing alternate uses of funds. The new plan replaces the Company’s prior share repurchase program, which has since been terminated. As of December 31, 2020, the Company had repurchased a total of 504,525 shares, leaving 20,475 shares remaining to be repurchased under the plan. There were no shares repurchased during 2019 or 2018. The table below sets forth information regarding our repurchases during the year:
Maximum
Total Number of
Number of
Total
Shares Purchased
Shares that May
Number of
as Part of Publicly
Yet be Purchased
Shares
Average Price
Announced Plans
Under the Plans
Period
Purchased
Paid per Share
or Programs
or Programs
Jan 1, 2020 through March 31, 2020
10,540
$
16.24
10,540
514,460
April 1, 2020 through June 30, 2020
200,809
13.99
200,809
313,651
July 1, 2020 through September 30, 2020
161,554
13.22
161,554
152,097
October 1, 2020 through December 31, 2020
131,622
17.48
131,622
20,475
On February 4, 2021, the Company authorized the repurchase of up to 725 thousand shares, or approximately 7.5 percent of its outstanding common stock. The timing and amount of purchases will be dictated by a number of factors, including the trading price of the Company’s common stock.

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ITEM 6. SELECTED FINANCIAL DATA
Item 6. Selected Financial Data:
The information under the caption, “Selected Consolidated Financial Data,” in the Company’s Annual Report to Shareholders for the year ended December 31, 2020, is incorporated by reference herein.

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations:
The purpose of this analysis is to provide the reader with information relevant to understanding and assessing the Company’s results of operations for each of the past three years and financial condition for each of the past two years. In order to fully appreciate this analysis, the reader is encouraged to review the consolidated financial statements and accompanying notes thereto appearing under Item 8 of this report, and statistical data presented in this document.
Overview
Unity Bancorp, Inc. (the “Parent Company”) is a bank holding company incorporated in New Jersey and is registered under the Bank Holding Company Act of 1956, as amended. Its wholly-owned subsidiary, Unity Bank (the “Bank” or, when consolidated with the Parent Company, the “Company”) is chartered by the New Jersey Department of Banking and Insurance. The Bank provides a full range of commercial and retail banking services through the Internet and its nineteen branch offices located in Bergen, Hunterdon, Middlesex, Somerset, Union and Warren counties in New Jersey, and Northampton County in Pennsylvania. These services include the acceptance of demand, savings, and time deposits and the extension of consumer, real estate, Small Business Administration ("SBA") and other commercial credits.
Results of Operations
Net income totaled $23.6 million, or $2.19 per diluted share for the year ended December 31, 2020, compared to $23.7 million, or $2.14 per diluted share for the year ended December 31, 2019.
Highlights for the year include:
● Net income before tax increased 2.7 percent to $31.1 million from $30.3 million in the prior year.
● Net interest income increased $6.8 million or 11.9 percent to $64.4 million from $57.6 million in the prior year, due to SBA PPP loans, commercial loan growth and a reduction in the cost of funds.
● Net interest margin decreased 10 basis points to 3.85 percent compared to 3.95 percent in the prior year. The decrease was a direct result of interest rate cuts by the Federal Reserve Board in response to COVID-19.
● Noninterest income was $12.9 million, a $3.4 million increase compared to $9.5 million in the prior year, primarily due to increased gains on mortgage loan sales.
● Noninterest expense totaled $39.3 million, an increase of $4.6 million when compared to $34.7 million in the prior year. The increase was primarily due to increased consulting expenses incurred in connection with compliance with our Consent Order with the FDIC and NJDOBI and increased compensation due to increased mortgage commissions.
● The effective tax rate increased to 24.0 percent compared to 22.0 percent in the prior year.
● A 14.2 percent increase in total loans driven by a 79.7 percent increase in SBA loans, which reflects $118.3 million from the funding of SBA PPP loans, a 9.8 percent increase in commercial loans and a 6.8 percent increase in consumer loans.
● A 24.6 percent increase in total deposits with a 64.3 percent increase in noninterest-bearing demand deposits and a 28.3 percent increase in interest-bearing demand deposits.
The Company’s performance ratios for the past three years are listed in the following table:
For the years ended December 31,
Net income per common share - Basic (1)
$
2.21
$
2.18
$
2.04
Net income per common share - Diluted (2)
$
2.19
$
2.14
$
2.01
Return on average assets
1.35
%
1.54
%
1.53
%
Return on average equity (3)
14.20
%
15.86
%
17.10
%
Efficiency ratio (4)
50.80
%
52.00
%
53.07
%
(1) Defined as net income divided by weighted average shares outstanding.
(2) Defined as net income divided by the sum of weighted average shares and the potential dilutive impact of the exercise of outstanding options.
(3) Defined as net income divided by average shareholders’ equity.
(4) The efficiency ratio is a non-GAAP measure of operational performance. It is defined as noninterest expense divided by the sum of net interest income plus noninterest income less any gains or losses on securities.
COVID-19
On March 13, 2020, the Coronavirus Disease (“COVID-19”) pandemic was declared a national emergency by the President of the United States. The spread of COVID-19 has negatively impacted the national and local economy, disrupted supply chains and increased unemployment levels. In response to the COVID-19 pandemic, many businesses have been faced with restrictions in an effort to prioritize public health. The initial temporary closure and gradual reopening of many businesses and the implementation of social distancing and stay-at-home policies has and will continue to impact many of the Company’s customers. COVID-19 continues to aggressively spread globally and in the United States.
The Company is committed to supporting its customers, employees and communities during this difficult time and has adapted to the changing environment. We have taken and continue taking steps to protect the health and safety of our employees and to work with our customers experiencing economic consequences from the epidemic. The Company has and is working with its loan customers to provide short term payment deferrals and to waive certain fees. These accommodations are likely to have a negative impact on the Company’s results of operations during the duration of the
epidemic, and, depending on how quickly the businesses of our customers rebound after the emergency, could lead to an increase in nonperforming assets.
The full impact of the pandemic is unknown and rapidly evolving. The outbreak is having a significant adverse impact on certain industries the Company serves, including retail, accommodations, and restaurants and food services. While most states have re-opened, it is under limited capacities and under other social-distancing restrictions, which have resulted in lower commercial activity and consumer spending. This decrease in commercial activity may result in our customers' inability to meet their loan obligations to us. In addition, the economic pressures and uncertainties related to the COVID-19 pandemic have resulted in changes in consumer spending behaviors, which may negatively impact the demand for loans and other services we offer. Because of the significant uncertainties related to the ultimate duration of the COVID-19 pandemic and its effects on our customers and prospects, and on the local and national economy, there can be no assurances as to how the crisis may ultimately affect the Company's loan portfolio, and business as a whole. The extent of such impact will depend on future developments, which are highly uncertain, including when the coronavirus can be controlled and abated and whether the gradual reopening of businesses will result in a meaningful increase in economic activity. As such, the Company could be subject to certain risks, any of which could have a material, adverse effect on our business, financial condition, liquidity, and results of operations.
CARES Act
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was signed into law. It contains substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic. The CARES Act includes a range of other provisions designed to support the U.S. economy and mitigate the impact of COVID-19 on financial institutions and their customers, including through the authorization of various relief programs and measures that the U.S. Department of the Treasury, the Small Business Administration, the Federal Reserve Board (“FRB”) and other federal banking agencies have implemented or may implement.
The CARES Act provides assistance to small businesses through the establishment of the Paycheck Protection Program ("PPP"). The PPP generally provides small businesses with funds to pay up to 24 weeks of payroll costs, including certain benefits. The funds are provided in the form of loans that may be fully or partially forgiven when used for payroll costs, interest on mortgages, rent, and utilities. The payments on these loans will be deferred for up to six months. Loans made after June 5, 2020, mature in five years, and loans made prior to June 5, 2020, mature in two years but can be extended to five years if the lender agrees. Forgiveness of the PPP loans is based on the employer maintaining or quickly rehiring employees and maintaining salary levels. Most small businesses with 500 or fewer employees are eligible. Applications for the PPP loans started on April 3, 2020 and the application period was extended to August 8, 2020, and then reopened pursuant to the terms of the Economic Aid Act discussed below. As an existing SBA 7(a) lender, the Company has opted to participate in the program.
The Company approved 1,224 applications and provided fundings of approximately $143.0 million. The Company has $118.3 million of PPP loans remaining on our balance sheet as of December 31, 2020 and believes that the majority of these loans will be forgiven by the SBA.
Economic Aid Act
On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues (“Economic Aid”) Act was signed into law. It provides additional assistance to the hardest-hit small businesses, nonprofits, and venues that are struggling to recover from the impact of the COVID-19 pandemic. The Economic Aid Act provides funding for a second round of PPP loans for small businesses and nonprofits experiencing significant revenue losses, makes programmatic improvements to PPP, funds grants to shuttered venues, and enacts emergency enhancements to other SBA lending programs.
The PPP now allows certain eligible borrowers that previously received a PPP loan to apply for a Second Draw PPP Loan with the same general loan terms as their First Draw PPP Loan, and for borrowers that did not initially receive a PPP loan to apply for one. Most small businesses with 300 or fewer employees that can demonstrate at least a 25% reduction in gross receipts between comparable quarters in 2019 and 2020 are eligible. Applications for PPP loans under the Economic Aid Act started on January 13, 2021 and are available until March 31, 2021. The Company is participating in the re-opened PPP loan process.
Deferrals
On March 22, 2020, the federal bank regulatory agencies issued an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus.” This guidance encourages financial institutions to work prudently with borrowers that may be unable to meet their contractual obligations because of the effects of COVID-19. The guidance goes on to explain that, in consultation with the FASB staff, the federal bank regulatory agencies concluded that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current as of the implementation date of a relief program are not TDRs. Section 4013 of the CARES Act also addresses COVID-19 related modifications and specifies that COVID-19 related modifications on loans that were current as of December 31, 2019, are not TDRs.
In March 2020, the Company proactively communicated with its customers to address their financial needs. The Company worked closely with its customers to educate and guide them on their options for financial assistance, including disaster loans, the PPP and payment relief through deferrals and waived fees. As a result of our proactive approach to provide financial assistance to our customers, loans have been modified through payment deferrals and are not categorized as TDRs, in accordance with regulatory guidance and the CARES Act. The table below summarizes the loans that are in deferral as of December 31, 2020:
(In thousands)
Total loan portfolio balance
Unpaid principal balance of full deferrals
Unpaid principal balance of principal only deferrals
Unpaid principal balance on deferral
% total deferrals to total loans
SBA loans held for sale
$
9,335
$
-
$
-
$
-
0.00
%
SBA loans held for investment
39,587
2,461
3,023
7.64
SBA PPP loans
118,257
-
-
-
0.00
Commercial loans
839,788
4,921
22,647
27,568
3.28
Residential mortgage loans
467,586
1,952
-
1,952
0.42
Consumer loans
153,264
-
-
-
0.00
Total loans
$
1,627,817
$
7,435
$
25,108
$
32,543
2.00
%
Consent Order
In July 2020, Unity Bank agreed to the issuance of a Consent Order by the Federal Deposit Insurance Corporation (“FDIC”) and agreed to an Acknowledgement and Consent of the FDIC Consent Order with the Commissioner of Banking and Insurance for the State of New Jersey. The Consent Order requires the Bank to strengthen its Bank Secrecy Act (“BSA”)/anti-money laundering (“AML”) program, and to address related matters. The Bank hired a consulting firm to assist management in effectively addressing all matters pertaining to the order. Although the Bank believes it is complying with all requirements of the Consent Order, we can give no assurance that the FDIC and the NJDOBI will agree that the Bank is fully complying or that the Bank will not incur material additional expense in complying with the Consent Order.
Net Interest Income
The primary source of the Company’s operating income is net interest income, which is the difference between interest and dividends earned on earning assets and fees earned on loans, and interest paid on interest-bearing liabilities. Earning assets include loans to individuals and businesses, investment securities, interest-earning deposits and federal funds sold.
Interest-bearing liabilities include interest-bearing checking, savings and time deposits, Federal Home Loan Bank ("FHLB") advances and other borrowings. Net interest income is determined by the difference between the yields earned on earning assets and the rates paid on interest-bearing liabilities (“net interest spread”) and the relative amounts of earning assets and interest-bearing liabilities. The Company’s net interest spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand, deposit flows and general levels of nonperforming assets.
COVID-19 has and will continue to adversely affect economic activity globally, nationally and locally. Following the COVID-19 outbreak, market interest rates have declined significantly, with the 10-year Treasury bond falling below 1.00% on March 3, 2020 for the first time. Additionally, the Federal Open Market Committee reduced the target federal funds rate to 0% to 0.25% on March 16, 2020. These reductions in interest rates and other effects of the COVID-19 outbreak may adversely affect the Company's financial condition and results of operations.
2020 compared to 2019
Tax-equivalent net interest income amounted to $64.4 million in 2020, an increase of $6.8 million from $57.6 million in 2019. The Company’s net interest margin decreased 10 basis points to 3.85 percent in 2020, compared to 3.95 percent in 2019. The net interest spread was 3.48 percent, a decrease of 6 basis points from 3.54 percent in 2019.
During 2020, tax-equivalent interest income was $78.9 million, an increase of $3.2 million or 4.3 percent when compared to 2019. This increase was driven primarily by the increase in the average volume of loans:
● Of the $3.2 million increase in interest income on a tax-equivalent basis, $8.6 million was due to the increased volume of earning assets, partially offset by a $5.4 million decrease in yields on average interest-earning assets.
● The yield on interest-earning assets decreased 47 basis points to 4.71 percent in 2020 when compared to 2019.
● The average volume of interest-earning assets increased $214.4 million to $1.7 billion in 2020 compared to $1.5 billion in 2019. This was due primarily to a $197.2 million increase in average loans, primarily SBA, PPP, commercial, residential mortgage and consumer loans, and a $25.2 million increase in average federal funds and interest-bearing deposits, partially offset by a $8.0 million decrease in average investment securities.
Total interest expense was $14.5 million in 2020, a decrease of $3.6 million or 19.8 percent compared to 2019. This decrease was driven by the decreased rates on interest-bearing deposits, partially offset by an increase in the average volume of interest-bearing deposits:
● Of the $3.6 million decrease in interest expense, $4.8 million was due to decreased rates on interest-bearing liabilities, partially offset by an increase of $1.2 million in the volume of average interest-bearing liabilities.
● The average cost of interest-bearing liabilities decreased 41 basis points to 1.23 percent in 2020 when compared to 2019. The cost of interest-bearing deposits and borrowed funds and subordinated debentures decreased 41 basis points and 35 basis points, respectively, in 2020.
● Interest-bearing liabilities averaged $1.2 billion in 2020, an increase of $75.7 million or 6.9 percent, compared to 2019. The increase in interest-bearing liabilities was primarily due to an overall increase in time, savings, and interest-bearing demand deposits.
2019 compared to 2018
Tax-equivalent net interest income amounted to $57.6 million in 2019, an increase of $3.8 million from $53.8 million in 2018. The Company’s net interest margin decreased 2 basis points to 3.95 percent in 2019, compared to 3.97 percent in 2018. The net interest spread was 3.54 percent, a decrease of 11 basis points from 3.65 percent in 2018.
During 2019, tax-equivalent interest income was $75.7 million, an increase of $8.4 million or 12.5 percent when compared to 2018. This increase was driven primarily by the increase in the average volume of loans:
● Of the $8.4 million increase in interest income on a tax-equivalent basis, $5.2 million of the increase was due primarily to the increased volume of earning assets and $3.2 million of the increase was due to an increase in yields on average interest-earning assets.
● The yield on interest-earning assets increased 21 basis points to 5.18 percent in 2019 when compared to 2018.
● The average volume of interest-earning assets increased $105.3 million to $1.5 billion in 2019 compared to $1.4 billion in 2018. This was due primarily to a $105.4 million increase in average loans, primarily residential mortgage, commercial and consumer loans, and a $2.6 million increase in average federal funds, interest-bearing deposits and repos, partially offset by a $2.0 million decrease in average investment securities.
Total interest expense was $18.1 million in 2019, an increase of $4.5 million or 33.6 percent compared to 2018. This increase was driven by the increased rates on interest-bearing deposits and volume of time deposits, partially offset by a decrease in the average volume of borrowed funds and subordinated debentures compared to a year ago:
● Of the $4.5 million increase in interest expense, $3.0 million was due to increased rates on interest-bearing liabilities and $1.6 million was due to an increase in the volume of average interest-bearing liabilities.
● The average cost of interest-bearing liabilities increased 32 basis points to 1.64 percent in 2019 when compared to 2018. The cost of interest-bearing deposits and borrowed funds and subordinated debentures increased 36 basis points and 14 basis points, respectively, in 2019
● Interest-bearing liabilities averaged $1.1 billion in 2019, an increase of $72.1 million or 7.0 percent, compared to 2018. The increase in interest-bearing liabilities was primarily due to an increase in average time deposits.
The following table reflects the components of net interest income, setting forth for the periods presented herein: (1) average assets, liabilities and shareholders’ equity, (2) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (4) net interest spread, and (5) net interest income/margin on average earning assets. Rates/yields are computed on a fully tax-equivalent basis, assuming a federal income tax rate of 21 percent.
Consolidated Average Balance Sheets
(Dollar amounts in thousands, interest amounts and interest rates/yields on a fully tax-equivalent basis)
For the years ended December 31,
Average
Average
balance
Interest
Rate/Yield
balance
Interest
Rate/Yield
ASSETS
Interest-earning assets:
Federal funds sold and interest-bearing deposits
$
68,507
$
0.38
%
$
43,305
$
2.09
%
Federal Home Loan Bank ("FHLB") stock
6,145
5.39
6,066
6.35
Securities:
Taxable
52,714
1,695
3.22
59,459
1,926
3.24
Tax-exempt
3,118
2.44
4,394
2.94
Total securities (A)
55,832
1,771
3.17
63,853
2,055
3.22
Loans:
SBA loans
50,354
3,144
6.24
48,686
3,780
7.76
SBA PPP loans
93,733
3,120
3.33
-
-
-
Commercial loans
790,093
40,002
5.06
715,301
37,577
5.25
Residential mortgage loans
463,155
22,255
4.81
449,003
22,483
5.01
Consumer loans
146,738
8,049
5.49
133,918
8,487
6.34
Total loans (B)
1,544,073
76,570
4.96
1,346,908
72,327
5.37
Total interest-earning assets
$
1,674,557
$
78,930
4.71
%
$
1,460,132
$
75,673
5.18
%
Noninterest-earning assets:
Cash and due from banks
22,571
25,761
Allowance for loan losses
(19,812)
(16,058)
Other assets
73,948
69,987
Total noninterest-earning assets
76,707
79,690
Total assets
$
1,751,264
$
1,539,822
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing demand deposits
$
178,358
$
1,344
0.75
%
$
155,176
$
1,386
0.89
%
Savings deposits
438,996
2,463
0.56
424,486
4,906
1.16
Time deposits
448,688
8,784
1.96
409,406
9,460
2.31
Total interest-bearing deposits
1,066,042
12,591
1.18
989,068
15,752
1.59
Borrowed funds and subordinated debentures
112,264
1,889
1.68
113,511
2,303
2.03
Total interest-bearing liabilities
$
1,178,306
$
14,480
1.23
%
$
1,102,579
$
18,055
1.64
%
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits
389,255
273,338
Other liabilities
17,163
14,755
Total noninterest-bearing liabilities
406,418
288,093
Total shareholders' equity
166,540
149,150
Total liabilities and shareholders' equity
$
1,751,264
$
1,539,822
Net interest spread
$
64,450
3.48
%
$
57,618
3.54
%
Tax-equivalent basis adjustment
(15)
(25)
Net interest income
$
64,435
$
57,593
Net interest margin
3.85
%
3.95
%
(A) Yields related to securities exempt from federal and state income taxes are stated on a fully tax-equivalent basis. They are reduced by the nondeductible portion of interest expense, assuming a federal tax rate of 21 percent in 2020, 2019 and 2018 and 35 percent in prior years and applicable state rates.
(B) The loan averages are stated net of unearned income, and the averages include loans on which the accrual of interest has been discontinued.
Average
Average
Average
balance
Interest
Rate/Yield
balance
Interest
Rate/Yield
balance
Interest
Rate/Yield
$
40,700
$
1.90
%
$
70,139
$
1.21
%
$
71,265
$
0.30
%
6,786
6.81
6,230
5.94
5,241
4.67
60,734
1,907
3.14
66,107
2,029
3.07
61,053
1,698
2.78
5,104
2.84
6,225
3.86
7,649
4.01
65,838
2,052
3.12
72,332
2,269
3.14
68,702
2,005
2.92
60,321
4,338
7.19
59,293
3,805
6.42
56,834
3,181
5.60
-
-
-
-
-
-
-
-
-
668,144
33,886
5.07
571,001
28,150
4.93
510,614
25,256
4.95
396,731
18,837
4.75
319,074
14,650
4.59
273,612
12,205
4.46
116,311
6,943
5.97
102,898
5,296
5.15
84,222
4,021
4.77
1,241,507
64,004
5.16
1,052,266
51,901
4.93
925,282
44,663
4.83
$
1,354,831
$
67,291
4.97
%
$
1,200,967
$
55,391
4.61
%
$
1,070,490
$
47,127
4.40
%
24,598
23,321
24,409
(14,640)
(13,033)
(12,841)
65,770
58,481
50,103
75,728
68,769
61,671
$
1,430,559
$
1,269,736
$
1,132,161
$
145,846
$
0.55
%
$
142,184
$
0.41
%
$
116,840
$
0.40
%
435,789
4,277
0.98
414,708
2,827
0.68
344,858
1,808
0.52
314,224
5,903
1.88
219,847
3,278
1.49
261,225
3,670
1.40
895,859
10,976
1.23
776,739
6,681
0.86
722,923
5,949
0.82
134,664
2,540
1.89
135,730
2,772
2.04
114,853
2,818
2.45
$
1,030,523
$
13,516
1.32
%
$
912,469
$
9,453
1.04
%
$
837,776
$
8,767
1.04
%
261,976
237,207
199,554
9,903
7,090
8,895
271,879
244,297
208,449
128,157
112,970
85,936
$
1,430,559
$
1,269,736
$
1,132,161
$
53,775
3.65
%
$
45,938
3.57
%
$
38,360
3.36
%
(28)
(81)
(103)
$
53,747
$
45,857
$
38,257
3.97
%
3.83
%
3.58
%
The rate volume table below presents an analysis of the impact on interest income and expense resulting from changes in average volume and rates over the periods presented. Changes that are not solely due to volume or rate variances have been allocated proportionally to both, based on their relative absolute values. Amounts have been computed on a tax-equivalent basis, assuming a federal income tax rate of 21 percent.
For the years ended December 31,
2020 versus 2019
2019 versus 2018
Increase (decrease) due to change in:
Increase (decrease) due to change in:
(In thousands on a tax-equivalent basis)
Volume
Rate
Net
Volume
Rate
Net
Interest income:
Federal funds sold and interest-bearing deposits
$
$
(995)
$
(648)
$
$
$
FHLB stock
(59)
(54)
(47)
(30)
(77)
Securities
(253)
(31)
(284)
(62)
Loans
8,524
(4,281)
4,243
5,245
3,078
8,323
Total interest income
$
8,623
$
(5,366)
$
3,257
$
5,188
$
3,194
$
8,382
Interest expense:
Demand deposits
$
$
(233)
$
(42)
$
$
$
Savings deposits
(2,608)
(2,444)
(116)
Time deposits
(1,524)
(675)
2,027
1,530
3,557
Total interest-bearing deposits
1,204
(4,365)
(3,161)
1,966
2,810
4,776
Borrowed funds and subordinated debentures
(25)
(389)
(414)
(419)
(237)
Total interest expense
1,179
(4,754)
(3,575)
1,547
2,992
4,539
Net interest income - fully tax-equivalent
$
7,444
$
(612)
$
6,832
$
3,641
$
$
3,843
Decrease in tax-equivalent adjustment
Net interest income
$
6,842
$
3,846
Provision for Loan Losses
The provision for loan losses totaled $7.0 million for 2020, $2.1 million in 2019 and $2.1 million in 2018. The increase in provision for loan losses in 2020 was primarily due to the increased risk of loan defaults as a result of COVID-19. The company may incur elevated provisions until restrictions on businesses have been loosened and they can fully open.
Each period’s loan loss provision is the result of management’s analysis of the loan portfolio and reflects changes in the size and composition of the portfolio, the level of net charge-offs, delinquencies, current economic conditions and other internal and external factors impacting the risk within the loan portfolio. Additional information may be found under the captions “Financial Condition - Asset Quality” and “Financial Condition - Allowance for Loan Losses and Unfunded Loan Commitments.” The current provision is considered appropriate based upon management’s assessment of the adequacy of the allowance for loan losses.
Noninterest Income
The following table shows the components of noninterest income for the past three years:
For the years ended December 31,
(In thousands)
Branch fee income
$
1,046
$
1,502
$
1,519
Service and loan fee income
1,742
1,965
2,130
Gain on sale of SBA loans held for sale, net
1,642
1,680
Gain on sale of mortgage loans, net
6,344
2,090
1,719
BOLI income
Net security gains (losses)
(199)
Gain on sale of premises and equipment
-
-
Other income
1,466
1,346
1,207
Total noninterest income
$
12,946
$
9,539
$
9,031
2020 compared to 2019
Noninterest income was $12.9 million for 2020, a $3.4 million increase compared to $9.5 million for 2019. This increase was primarily due to increased gains on sales of mortgages.
Changes in noninterest income reflect:
● Branch fee income decreased $456 thousand to $1.0 million when compared to 2019, primarily due to a decrease in overdraft fees and transactions as a result of COVID-19.
● Service and loan fee income, which consists of prepayment fees, application fees and servicing fees, decreased $223 thousand in 2020, primarily due to lower loan late charges from waived fees for customers during the COVID-19 pandemic.
● Net gains on the sale of SBA loans increased $733 thousand in 2020 as a result of higher premiums on loan sales. In 2020, $18.2 million in SBA loans were sold compared to $14.9 million in the prior year.
● Gains on sales of mortgage loans increased $4.2 million in 2020 as a result of a volume increase. During the year, $290.8 million in residential mortgage loans were sold at a gain of $6.3 million compared to $120.2 million in loans sold at a gain of $2.1 million during the prior year.
● BOLI income increased $25 thousand from prior year.
● Gains on sales of securities totaled $322 thousand in 2020, compared to $52 thousand in 2019. In 2020, these gains were partially offset by $229 thousand from the decrease in the market value of equity securities, as compared to an increase of $321 thousand in 2019.
● There were no gains on sale of premises and equipment in 2020. The 2019 gain in premises and equipment was primarily due to the sale of our Union, NJ branch building.
● Other income increased $120 thousand, primarily due to an increase in wire transfer fee income.
2019 compared to 2018
Noninterest income was $9.5 million for 2019, a $508 thousand increase compared to $9.0 million for 2018. This increase was primarily due to market fluctuations on our equity securities and increased gains on sales of mortgages.
Changes in noninterest income reflect:
● Branch fee income decreased $17 thousand to $1.5 million when compared to 2018.
● Service and loan fee income, which consists of prepayment fees, applications fees and servicing fees, decreased $165 thousand in 2019.
● Net gains on the sale of SBA loans decreased $771 thousand to $909 thousand in 2019 due to a decrease in the volume of SBA loans sales. In 2019, $14.9 million in SBA loans were sold compared to $22.3 million in the prior year. The Company elected not to sell SBA loans during the third quarter of 2019.
● During 2019, $120.2 million in residential mortgage loans were sold at a gain of $2.1 million compared to $80.7 million in loans sold at a gain of $1.7 million during the prior year.
● BOLI income decreased $387 thousand from prior year, primarily due to a $291 thousand death benefit in the third quarter of 2018.
● Net security gains totaled $373 thousand in 2019 compared to losses of $199 thousand in 2018. Approximately $321 thousand of these gains resulted from an increase in the market value of equity securities, compared to a decrease of $195 thousand in 2018. Gains on sales of securities totaled $52 thousand in 2019, compared to losses of $4 thousand in 2018.
● Gain on sale of premises and equipment totaled $766 thousand in 2019 versus none in 2018. The increase was primarily due to the $768 thousand gain on the sale of our Union, NJ branch building in September 2019.
● Other income, which includes check card related income and miscellaneous service charges totaled $1.3 million and $1.2 million in 2019 and 2018, respectively.
Noninterest Expense
The following table presents a breakdown of noninterest expense for the past three years:
For the years ended December 31,
(In thousands)
Compensation and benefits
$
23,124
$
20,666
$
20,119
Processing and communications
3,155
2,924
2,788
Furniture and equipment
2,606
2,894
2,348
Occupancy
2,543
2,650
2,739
BSA expenses
1,800
-
-
Professional services
1,144
1,061
Advertising
1,358
1,411
Director fees
Other loan expenses
Deposit insurance
Loan collection & OREO expenses (recoveries)
(361)
Other expenses
1,699
1,877
1,782
Total noninterest expense
$
39,262
$
34,717
$
33,421
2020 compared to 2019
Noninterest expense totaled $39.3 million for the year ended December 31, 2020, an increase of $4.6 million when compared to $34.7 million in 2019. The majority of this increase is attributed to increased compensation due to mortgage commissions paid on a higher origination volume and expenses related to enhancing our BSA program and complying with our Consent Order with the FDIC and NJDOBI.
Changes in noninterest expense reflect:
● Compensation and benefits expense, the largest component of noninterest expense, increased $2.5 million for the year ended December 31, 2020, when compared to 2019. The yearly increase is primarily due to increased mortgage commissions on a higher origination volume.
● Processing and communications, which includes items processed and electronic banking fees, increased $231 thousand for the year ended December 31, 2020 when compared to 2019, primarily due to data processing expenses.
● Furniture and equipment expense, which includes network and software maintenance, decreased $288 thousand in 2020.
● Occupancy expense decreased $107 thousand in 2020 when compared to 2019.
● BSA expenses were $1.8 million in 2020 due to consulting expenses in connection with BSA/AML remediation related to the Bank’s Consent Order.
● Professional service fees increased $83 thousand in 2020, primarily due to higher external audit and tax expenses.
● Advertising expenses decreased $452 thousand for the year ended December 31, 2020, versus 2019 primarily due to decreased community relations expenses and marketing event related expenses due to the impact of COVID-19.
● Director fees increased $101 thousand in 2020 when compared to 2019.
● Other loan expenses, which consist of expenses such as appraisals, filings and credit reports, increased $350 thousand in 2020, when compared to 2019.
● Deposit insurance expense increased $373 thousand in 2020 when compared to 2019 primarily due to a $279 FDIC assessment credit in 2019.
● Loan collection and OREO expenses increased $174 thousand in 2020, primarily due to increased property tax expenses on OREO properties.
● Other expenses decreased $178 thousand in 2020 when compared to 2019, primarily due to lower officer and employee expenses.
2019 compared to 2018
Noninterest expense totaled $34.7 million for the year ended December 31, 2019, an increase of $1.3 million when compared to $33.4 million in 2018. The majority of this increase is attributed to increased compensation and mortgage commissions paid on a higher origination volume and the continued investment in our technology infrastructure through software upgrades.
Changes in noninterest expense reflect:
● Compensation and benefits expense, the largest component of noninterest expense, increased $547 thousand for the year ended December 31, 2019, when compared to 2018. The yearly increase is primarily due to increased salary expenses and year-end bonuses paid to employees.
● Occupancy expense decreased $89 thousand in 2019 when compared to 2018.
● Processing and communications increased $136 thousand for the year ended December 31, 2019 when compared to 2018, primarily due to increased electronic banking expenses.
● Furniture and equipment expense increased $546 thousand in 2019, due to investment in software and equipment to remain efficient, secure and competitive technologically.
● Professional service fees increased $127 thousand in 2019, primarily due to higher consulting expenses.
● Loan collection and OREO expenses increased $402 thousand in 2019, primarily due to a $317 thousand settlement related to an OREO property in the third quarter of 2018.
● Other loan expenses, which consist of expenses such as appraisals, filings and credit reports, increased $64 thousand in 2019, when compared to 2018.
● Deposit insurance expense decreased $481 thousand in 2019 when compared to 2018 primarily due to an FDIC assessment credit of $279 thousand during the second half of 2019.
● Advertising expenses decreased $53 thousand for the year ended December 31, 2019, versus 2018.
● Director fees remained relatively flat in 2019 when compared to 2018.
● Other expenses increased $95 thousand in 2019, primarily due to higher officer and employee expenses.
Income Tax Expense
For 2020, the Company reported income tax expense of $7.5 million for an effective tax rate of 24.0%, compared to an income tax expense of $6.7 million and an effective tax rate of 22.0% in 2019 and an income tax expense of $5.4 million and an effective tax rate of 19.7% in 2018.
On July 1, 2018, New Jersey’s Assembly Bill 4202 was signed into law. The bill, effective January 1, 2018, imposed a temporary surtax on corporations earning New Jersey allocated income in excess of $1 million at a rate of 2.5% for tax years beginning on or after January 1, 2018 through December 31, 2019, and at a rate of 1.5% for years beginning on or after January 1, 2020, through December 31, 2021. In addition, New Jersey adopted mandatory unitary combined reporting for its Corporation Business Tax, which became effective for periods on or after January 1, 2019.
On September 29, 2020, New Jersey’s Assembly Bill 4721 was signed into law. The bill, retroactively effective January 1, 2020, extends the 2.5% corporate income surtax until December 31, 2023. The Division of Taxation will waive any underpayment penalties on 2020 estimated tax payments related to the retroactive increase. In addition, if the federal corporate tax rate is increased to a rate of at least 35% of taxable income, the surtax will be suspended.
For additional information on income taxes, see Note 16 to the Consolidated Financial Statements.
Financial Condition
Total assets increased $240.0 million or 14.0%, to $2.0 billion at December 31, 2020, compared to $1.7 billion at December 31, 2019. This increase was primarily due to an increase of $195.5 million in net loans, reflecting $118.3 million from the funding of PPP loans, strong commercial growth, and $61.3 million in cash and cash equivalents, partially offset by a decrease of $19.0 million in investments.
Total deposits increased $307.8 million, primarily due to increases of $179.9 million in noninterest-bearing demand deposits, $48.5 million in savings deposits, $45.1 million in interest-bearing demand deposits, and $34.4 million in time deposits. Borrowed funds decreased $83.0 million to $200.0 million at December 31, 2020 due to a $63.0 million decrease in overnight borrowings and the maturity of a $20.0 million FHLB adjustable rate advance.
Total shareholders’ equity increased $13.2 million from year end 2019, primarily due to net income from operations, less dividends paid on our common stock. Net income was $23.6 million for the year ended December 31, 2020, a decrease of $9.0 thousand from the prior year. Other changes in shareholder’s equity included stock-based transactions of $1.6 million, offset by another comprehensive loss net of tax of $1.3 million, common stock dividends of $3.3 million paid in 2020 and treasury stock purchases of $7.4 million.
These fluctuations are discussed in further detail in the section that follow.
Securities
The Company’s securities portfolio consists of available for sale (“AFS”) debt securities and equity investments. The investment securities portfolio is maintained for asset-liability management purposes, as well as for liquidity and earnings purposes.
AFS debt securities are investments carried at fair value that may be sold in response to changing market and interest rate conditions or for other business purposes. Activity in this portfolio is undertaken primarily to manage liquidity and interest rate risk, to take advantage of market conditions that create economically attractive returns and as an additional source of earnings. AFS debt securities consist primarily of obligations of U.S. Government sponsored entities, obligations of state and political subdivisions, mortgage-backed securities, and corporate and other securities.
AFS debt securities totaled $45.6 million at December 31, 2020, a decrease of $18.7 million or 29.0 percent, compared to $64.3 million at December 31, 2019. This net decrease was the result of:
● $14.9 million in principal payments, maturities and called bonds,
● $6.6 million in sales net of realized gains, which consisted of two corporate bonds, three mortgage-backed securities, one tax-exempt municipal security, and one taxable municipal security,
● $695 thousand of depreciation in the market value of the portfolio. At December 31, 2020, the portfolio had a net unrealized loss of $304 thousand compared to a net unrealized gain of $392 thousand at
December 31, 2019. These net unrealized losses and gains are reflected net of tax in shareholders’ equity as accumulated other comprehensive income, and
● $241 thousand in net amortization, partially offset by
● An increase of $3.8 million from the purchase of two corporate bonds and three municipal tax-exempt securities.
The weighted average life of AFS debt securities, adjusted for prepayments, amounted to 4.6 years and 4.9 years at December 31, 2020 and 2019, respectively.
Equity securities are investments carried at fair value that may be sold in response to changing market and interest rate conditions or for other business purposes. Activity in this portfolio is undertaken primarily to manage liquidity and interest rate risk, to take advantage of market conditions that create economically attractive returns and as an additional source of earnings. Equity securities consist of Community Reinvestment Act ("CRA") investments and the equity holdings of financial institutions.
Equity securities totaled $2.0 million at December 31, 2020, a decrease of $335 thousand or 14.6 percent, compared to $2.3 million at December 31, 2019. This net decrease was the result of:
● $224 thousand in market value adjustments throughout the year, and
● $111 thousand in sales net of realized gains from the sale of one community bank holding.
The average balance of taxable securities amounted to $52.7 million in 2020 compared to $59.5 million in 2019. The average yield earned on taxable securities decreased 2 basis points to 3.22 percent in 2020, from 3.24 percent in 2019. The average balance of tax-exempt securities amounted to $3.1 million in 2020 compared to $4.4 million in 2019. The average yield earned on tax-exempt securities decreased 52 basis points to 2.42 percent in 2020, from 2.94 percent in 2019.
Securities with a carrying value of $1.6 million and $4.0 million at December 31, 2020 and December 31, 2019, respectively, were pledged to secure other borrowings, collateralize hedging instruments and for other purposes required or permitted by law.
Approximately 48 percent of the total investment portfolio had a fixed rate of interest at December 31, 2020, compared to 64 percent in 2019.
For additional information on securities, see Note 3 to the Consolidated Financial Statements.
Loans
The loan portfolio, which represents the Company’s largest asset group, is a significant source of both interest and fee income. The portfolio consists of SBA, commercial, residential mortgage and consumer loans. Each of these segments is subject to differing levels of credit and interest rate risk.
Total loans increased $202.3 million or 14.2 percent to $1.6 billion at December 31, 2020, compared to $1.4 billion at year-end 2019. The increase was primarily driven by the funding of SBA Paycheck Protection Program (“PPP”) loans. As of December 31, 2020, the Company had PPP loans totaling $118.3 million. Commercial and consumer loans increased $74.8 million and $9.7 million respectively, partially offset by a decrease of $374 thousand and $120 thousand in SBA and residential loans.
The following table sets forth the classification of loans by major category, including unearned fees, deferred costs and excluding the allowance for loan losses at December 31st for the past five years:
% of
% of
% of
% of
% of
(In thousands, except percentages)
Amount
total
Amount
total
Amount
total
Amount
total
Amount
total
Ending balance:
SBA loans held for investment
$
39,587
2.4
%
$
35,767
2.5
%
$
39,333
3.0
%
$
43,999
3.8
%
$
42,492
4.4
%
SBA PPP loans
118,257
7.3
-
-
-
-
-
-
-
-
Commercial loans
839,788
51.6
765,032
53.7
694,102
53.2
628,865
53.7
535,515
55.6
Residential mortgage loans
467,586
28.7
467,706
32.8
436,056
33.4
365,145
31.2
289,093
29.7
Consumer loans
153,264
9.4
143,524
10.1
123,904
9.5
109,855
9.4
91,541
9.4
Total loans held for investment
1,618,482
99.4
1,412,029
99.1
1,293,395
99.1
1,147,864
98.1
958,641
98.5
SBA loans held for sale
9,335
0.6
13,529
0.9
11,171
0.9
22,810
1.9
14,773
1.5
Total loans
$
1,627,817
100.0
%
$
1,425,558
100.0
%
$
1,304,566
100.0
%
$
1,170,674
100.0
%
$
973,414
100.0
%
Average loans increased $197.2 million or 14.6 percent from $1.3 billion in 2019, to $1.5 billion in 2020. The increase in average loans was due to increases in average PPP, commercial, residential mortgages, consumer and SBA loans. The yield on the overall loan portfolio decreased 41 basis points to 4.96 percent for the year ended December 31, 2020, compared to 5.37 percent for the prior year.
SBA 7(a) loans, on which the SBA historically has provided guarantees of up to 90 percent of the principal balance, are considered a higher risk loan product for the Company than its other loan products. These loans are made for the purposes of providing working capital, financing the purchase of equipment, inventory or commercial real estate. Generally, an SBA 7(a) loan has a deficiency in its credit profile that would not allow the borrower to qualify for a traditional commercial loan, which is why the SBA provides the guarantee. The deficiency may be a higher loan to value (“LTV”) ratio, lower debt service coverage (“DSC”) ratio or weak personal financial guarantees. In addition, many SBA 7(a) loans are for start up businesses where there is no historical financial information. Finally, many SBA borrowers do not have an ongoing and continuous banking relationship with the Bank, but merely work with the Bank on a single transaction. The guaranteed portion of the Company’s SBA loans is generally sold in the secondary market with the nonguaranteed portion held in the portfolio as a loan held for investment.
SBA 7(a) loans held for sale, carried at the lower of cost or market, amounted to $9.3 million at December 31, 2020, a decrease of $4.2 million from $13.5 million at December 31, 2019. SBA 7(a) loans held for investment amounted to $39.6 million at December 31, 2020, an increase of $3.8 million from $35.8 million at December 31, 2019. The yield on SBA 7(a) loans, which is generally floating and adjusts quarterly to the Prime Rate, was 6.24 percent for the year ended December 31, 2020, compared to 7.76 percent in the prior year.
The guarantee rates on SBA 7(a) loans range from 50 percent to 90 percent, with the majority of the portfolio having a guarantee rate of 75 percent at origination. The guarantee rates are determined by the SBA and can vary from year to year depending on government funding and the goals of the SBA program. The carrying value of SBA loans held for sale represents the guaranteed portion to be sold into the secondary market. The carrying value of SBA loans held for investment represents the unguaranteed portion, which is the Company’s portion of SBA loans originated, reduced by the guaranteed portion that is sold into the secondary market. Approximately $98.9 million and $93.6 million in SBA loans were sold but serviced by the Company at December 31, 2020 and December 31, 2019, respectively, and are not included on the Company’s balance sheet. There is no direct relationship or correlation between the guarantee percentages and the level of charge-offs and recoveries on the Company’s SBA 7(a) loans. Charge-offs taken on SBA 7(a) loans effect the unguaranteed portion of the loan. SBA loans are underwritten to the same credit standards irrespective of the guarantee percentage.
The CARES Act provides assistance to small businesses through the establishment of the PPP. The PPP generally provides eligible small businesses with funds to pay up to 24 weeks of payroll costs, including certain benefits. The funds are provided in the form of loans that may be fully or partially forgiven when used for payroll costs, interest on mortgages, rent, and utilities. The payments on these loans will be deferred for up to six months. Loans made after June 5, 2020, mature in five years, and loans made prior to June 5, 2020, mature in two years and can be extended to five years if the lender agrees. Forgiveness of the PPP loans is based on the employer maintaining or quickly rehiring employees and maintaining salary levels. Applications for the PPP loans started on April 3, 2020 and the application
period was extended through August 8, 2020. The Economic Aid Act provided additional funding for the PPP, and the application period was reopened. As an existing SBA 7(a) lender, the Company opted to participate in the program. Applications for PPP loans under the Economic Aid Act started on January 13, 2021 and are available until March 31, 2021.
Commercial loans are generally made in the Company’s marketplace for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. These loans amounted to $839.8 million at December 31, 2020, an increase of $74.8 million from year end 2019. The yield on commercial loans was 5.06 percent for 2020, compared to 5.25 percent for the same period in 2019. The SBA 504 program, which consists of real estate backed commercial mortgages where the Company has the first mortgage and the SBA has the second mortgage on the property, is included in the Commercial loan portfolio. Generally, the Company has a 50 percent LTV ratio on SBA 504 program loans at origination.
Residential mortgage loans consist of loans secured by 1 to 4 family residential properties. These loans amounted to $467.6 million at December 31, 2020, a decrease of $120.0 thousand from year end 2019. Sales of mortgage loans totaled $290.8 million for 2020. Approximately $13.2 million of the loans sold were from portfolio, with the remainder consisting of new production. Approximately $29.7 million and $36.9 million in residential loans were sold but serviced by the Company at December 31, 2020 and December 31, 2019, respectively, and are not included on the Company’s balance sheet. The yield on residential mortgages was 4.81 percent for 2020, compared to 5.01 percent for 2019. Residential mortgage loans maintained in portfolio are generally to individuals that do not qualify for conventional financing. In extending credit to this category of borrowers, the Bank considers other mitigating factors such as credit history, equity and liquid reserves of the borrower. As a result, the residential mortgage loan portfolio of the Bank includes fixed and adjustable rate mortgages with rates that exceed the rates on conventional fixed-rate mortgage loan products but are not considered high priced mortgages.
Consumer loans consist of home equity loans, construction loans and loans for the purpose of financing the purchase of consumer goods, home improvements, and other personal needs, and are generally secured by the personal property being purchased. These loans amounted to $153.3 million at December 31, 2020, an increase of $9.7 million from December 31, 2019. The yield on consumer loans was 5.49 percent for 2020, compared to 6.34 percent for 2019.
There are no concentrations of loans to any borrowers or group of borrowers exceeding 10 percent of the total loan portfolio and no foreign loans in the portfolio.
In the normal course of business, the Company may originate loan products whose terms could give rise to additional credit risk. Interest-only loans, loans with high LTV ratios, construction loans with payments made from interest reserves and multiple loans supported by the same collateral (e.g. home equity loans) are examples of such products. However, these products are not material to the Company’s financial position and are closely managed via credit controls that mitigate their additional inherent risk. Management does not believe that these products create a concentration of credit risk in the Company’s loan portfolio. The Company does not have any option adjustable rate mortgage loans.
The majority of the Company’s loans are secured by real estate. Declines in the market values of real estate in the Company’s trade area impact the value of the collateral securing its loans. This could lead to greater losses in the event of defaults on loans secured by real estate. At December 31, 2020 approximately 87 percent of the Company’s loan portfolio was secured by real estate compared to 94 percent at December 31, 2019.
The following table shows the maturity distribution or repricing of the loan portfolio and the allocation of fixed and floating interest rates at December 31, 2020:
December 31, 2020
(In thousands)
One year or less
One to five years
Over five years
Total
SBA loans
$
43,230
$
4,629
$
1,063
$
48,922
SBA PPP loans
-
118,257
-
118,257
Commercial loans
SBA 504 loans
3,781
14,963
19,681
Commercial other
26,603
51,095
40,583
118,281
Commercial real estate
69,461
455,044
105,917
630,422
Commercial real estate construction
1,428
36,031
33,945
71,404
Total
$
144,503
$
680,019
$
182,445
$
1,006,967
Amount of loans with maturities or repricing dates greater than one year:
Fixed interest rates
$
322,898
Floating or adjustable interest rates
539,566
Total
$
862,464
For additional information on loans, see Note 4 to the Consolidated Financial Statements.
Troubled Debt Restructurings
Troubled debt restructurings (“TDRs”) occur when a creditor, for economic or legal reasons related to a debtor’s financial condition, grants a concession to the debtor that it would not otherwise consider. These concessions typically include reductions in interest rate, extending the maturity of a loan, other modifications of payment terms, or a combination of modifications. Deferrals complying with the terms of the CARES Act and regulatory guidance (i.e., deferrals of up to six months to borrowers impacted by COVID-19 pandemic, where the borrower was current at either December 31, 2019 or prior to the deferral being granted) are not considered TDR’s.
When the Company modifies a loan, management evaluates the loan for any possible impairment using either the discounted cash flows method, where the value of the modified loan is based on the present value of expected cash flows, discounted at the contractual interest rate of the original loan agreement, or by using the fair value of the collateral less selling costs. If management determines that the value of the modified loan is less than the recorded investment in the loan, impairment is recognized by segment or class of loan, as applicable, through an allowance estimate or charge-off to the allowance. This process is used, regardless of loan type, and for loans modified as TDRs that subsequently default on their modified terms.
At December 31, 2020, there was one loan totaling $663 thousand that was classified as a TDR and deemed impaired, compared to one such loan totaling $705 thousand at December 31, 2019. The TDR was a commercial real estate loan which was modified in 2017 to reduce the principal balance. The loan remains in accrual status since it continues to perform in accordance with the restructured terms. Restructured loans that are placed in nonaccrual status may be removed after six months of contractual payments and the borrower showing the ability to service the debt going forward.
For additional information on TDRs, see Note 4 to the Consolidated Financial Statements.
Asset Quality
Inherent in the lending function is credit risk, which is the possibility a borrower may not perform in accordance with the contractual terms of their loan. A borrower’s inability to pay their obligations according to the contractual terms can create the risk of past due loans and, ultimately, credit losses, especially on collateral deficient loans. The Company minimizes its credit risk by loan diversification and adhering to strict credit administration policies and procedures. Due diligence on loans begins when we initiate contact regarding a loan with a borrower. Documentation,
including a borrower’s credit history, materials establishing the value and liquidity of potential collateral, the purpose of the loan, the source of funds for repayment of the loan, and other factors, are analyzed before a loan is submitted for approval. The loan portfolio is then subject to on-going internal reviews for credit quality, as well as independent credit reviews by an outside firm.
The risk of loss is difficult to quantify and is subject to fluctuations in collateral values, general economic conditions and other factors. In some cases, these factors have also resulted in significant impairment to the value of loan collateral. The Company values its collateral through the use of appraisals, broker price opinions, and knowledge of its local market.
Nonperforming assets consist of nonperforming loans and OREO. Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being delinquent for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt. When a loan is classified as nonaccrual, interest accruals discontinue and all past due interest previously recognized as income is reversed and charged against current period income. Generally, until the loan becomes current, any payments received from the borrower are applied to outstanding principal, until such time as management determines that the financial condition of the borrower and other factors merit recognition of a portion of such payments as interest income. Loans past due 90 days or more and still accruing interest are not included in nonperforming loans. Loans past due 90 days or more and still accruing generally represent loans that are well secured and in process of collection.
The following table sets forth information concerning nonperforming assets and loans past due 90 days or more and still accruing interest at December 31st for the past five years:
(In thousands, except percentages)
Nonperforming by category:
SBA loans held for investment (1)
$
2,473
$
1,164
$
1,560
$
$
1,168
Commercial loans
1,325
1,076
Residential mortgage loans
5,217
3,936
4,211
1,669
2,672
Consumer loans
3,045
2,458
Total nonperforming loans
$
12,060
$
5,649
$
6,873
$
2,994
$
7,237
OREO
-
1,723
1,050
Total nonperforming assets
$
12,060
$
7,372
$
6,929
$
3,420
$
8,287
Past due 90 days or more and still accruing interest:
Commercial loans
-
-
-
-
Residential mortgage loans
-
-
Consumer loans
-
-
-
-
Total past due 90 days or more and still accruing interest
$
$
$
$
$
-
Nonperforming loans to total loans
0.74
%
0.40
%
0.53
%
0.26
%
0.74
%
Nonperforming loans and TDRs to total loans (2)
0.78
0.45
0.58
0.32
0.74
Nonperforming assets to total loans and OREO
0.74
0.52
0.53
0.29
0.85
Nonperforming assets to total assets
0.62
0.43
0.44
0.23
0.70
(1) Guaranteed SBA loans included above
$
$
$
$
$
(2) Nonperforming TDRs included above
-
-
-
-
(2) Performing TDRs
-
Nonperforming loans were $12.1 million at December 31, 2020, a $6.5 million increase from $5.6 million at year end 2019. Since year end 2019, nonperforming loans in the consumer, SBA, residential and commercial segments increased. The increase in nonperforming consumer loans was primarily due to three consumer construction loans totaling $1.7 million and four home equity loans totaling $1.3 million. Included in nonperforming loans at December 31, 2020 are approximately $371 thousand of loans guaranteed by the SBA, compared to $59 thousand at December 31, 2019. In addition, there were $449 thousand in loans past due 90 days or more and still accruing interest at December 31, 2020, compared to $930 thousand at December 31, 2019.
The Company did not have any OREO property at December 31, 2020, compared to $1.7 million at year end 2019. During 2020, the Company charged off $225 thousand on two OREO properties. The Company sold four properties, resulting in net recoveries of $68 thousand.
The Company also monitors potential problem loans. Potential problem loans are those loans where information about possible credit problems of borrowers causes management to have doubts as to the ability of such borrowers to comply with loan repayment terms. These loans are categorized by their non-passing risk rating and performing loan status. Potential problem loans totaled $36.7 million at December 31, 2020, an increase of $29.3 million from $7.4 million at December 31, 2019.
For additional information on asset quality, see Note 4 to the Consolidated Financial Statements.
Allowance for Loan Losses and Reserve for Unfunded Loan Commitments
Management reviews the level of the allowance for loan losses on a quarterly basis. The standardized methodology used to assess the adequacy of the allowance includes the allocation of specific and general reserves. Specific reserves are made to individual impaired loans, which have been defined to include all nonperforming loans and TDRs. The general reserve is set based upon a representative average historical net charge-off rate adjusted for certain environmental factors such as: delinquency and impairment trends, charge-off and recovery trends, volume and loan term trends, risk and underwriting policy trends, staffing and experience changes, national and local economic trends, industry conditions and credit concentration changes.
When calculating the five-year historical net charge-off rate, the Company weights the past three years more heavily as it believes they are more indicative of future charge-offs. All of the environmental factors are ranked and assigned a basis points value based on the following scale: low, low moderate, moderate, high moderate and high risk. The factors are evaluated separately for each type of loan. For example, commercial loans are broken down further into commercial and industrial loans, commercial mortgages, construction loans, etc. Each type of loan is risk weighted for each environmental factor based on its individual characteristics.
According to the Company’s policy, a loss (“charge-off”) is to be recognized and charged to the allowance for loan losses as soon as a loan is recognized as uncollectable. All credits which are 90 days past due must be analyzed for the Company’s ability to collect on the credit. Once a loss is known to exist, the charge-off approval process is immediately expedited.
The allowance for loan losses totaled $23.1 million at December 31, 2020, compared to $16.4 million at December 31, 2019, with resulting allowance to total loan ratios of 1.42 percent and 1.15 percent, respectively. Net charge-offs amounted to $290 thousand for 2020, compared to $1.2 million for 2019.
The following table is a summary of the changes to the allowance for loan losses for the past five years, including net charge-offs to average loan ratios for each major loan category:
For the years ended December 31,
(In thousands, except percentages)
Balance, beginning of period
$
16,395
$
15,488
$
13,556
$
12,579
$
12,759
Provision for loan losses charged to expense
7,000
2,100
2,050
1,650
1,220
Less: Chargeoffs
SBA loans held for investment
Commercial loans
Residential mortgage loans
-
Consumer loans
-
Total chargeoffs
1,242
1,463
Add: Recoveries
SBA loans held for investment
Commercial loans
Residential mortgage loans
-
-
-
Consumer loans
-
Total recoveries
Net charge-offs
1,193
1,400
Balance, end of period
$
23,105
$
16,395
$
15,488
$
13,556
$
12,579
Selected loan quality ratios:
Net (recoveries) chargeoffs to average loans:
SBA loans held for investment
(0.04)
%
1.05
%
0.47
%
0.29
%
0.92
%
Commercial loans
0.02
0.07
-
0.02
0.15
Residential mortgage loans
0.04
0.05
-
0.01
0.04
Consumer loans
-
(0.01)
(0.11)
0.32
0.03
Total loans
0.02
0.09
0.01
0.06
0.15
Allowance to total loans
1.42
1.15
1.19
1.16
1.29
Allowance to nonperforming loans
191.59
%
290.23
%
225.35
%
452.77
%
173.82
%
The following table sets forth, for each of the major lending categories, the amount of the allowance for loan losses allocated to each category and the percentage of total loans represented by such category, as of December 31st of the past five years. The allocated allowance is the total of identified specific and general reserves by loan category. The allocation is not necessarily indicative of the categories in which future losses may occur. The total allowance is available to absorb losses from any segment of the portfolio.
% of
% of
% of
% of
% of
loans
loans
loans
loans
loans
Reserve
to total
Reserve
to total
Reserve
to total
Reserve
to total
Reserve
to total
(In thousands, except percentages)
amount
loans
amount
loans
amount
loans
amount
loans
amount
loans
Balance applicable to:
SBA loans held for investment
$
1,301
9.7
%
$
1,079
2.5
%
$
1,655
3.0
%
$
1,471
3.8
%
$
1,576
4.4
%
Commercial loans
14,992
51.6
9,722
53.7
8,705
53.2
7,825
53.7
7,302
55.0
Residential mortgage loans
5,318
28.7
4,254
32.8
3,900
33.4
3,130
31.2
2,593
29.7
Consumer loans
1,494
9.4
1,340
10.1
1,228
9.5
1,130
9.4
9.4
Unallocated
-
-
-
-
-
-
-
-
-
Total loans held for investment
23,105
99.4
16,395
99.1
15,488
99.1
13,556
98.1
12,579
98.5
SBA loans held for sale
-
0.6
-
0.9
-
0.9
-
1.9
-
1.5
Total loans
$
23,105
100.0
%
$
16,395
100.0
%
$
15,488
100.0
%
$
13,556
100.0
%
$
12,579
100.0
%
In addition to the allowance for loan losses, the Company maintains a reserve for unfunded loan commitments that is maintained at a level that management believes is adequate to absorb estimated probable losses. Adjustments to the reserve are made through other expense and applied to the reserve which is maintained in other liabilities. At December 31, 2020, a $288 thousand commitment reserve was reported on the balance sheet as an “other liability”, compared to a $273 thousand commitment reserve at December 31, 2019.
For additional information on the allowance for loan losses and reserve for unfunded loan commitments, see Note 5 to the Consolidated Financial Statements.
Deposits
Deposits, which include noninterest-bearing demand deposits, interest-bearing demand deposits, savings deposits and time deposits, are the primary source of the Company’s funds. The Company offers a variety of products designed to attract and retain customers, with primary focus on building and expanding relationships. The Company continues to focus on establishing a comprehensive relationship with business borrowers, seeking deposits as well as lending relationships.
The following table shows period-end deposits and the concentration of each category of deposits for the past three years:
(In thousands, except percentages)
Amount
% of total
Amount
% of total
Amount
% of total
Ending balance:
Noninterest-bearing demand deposits
$
459,677
29.5
%
$
279,793
22.4
%
$
270,152
22.4
%
Interest-bearing demand deposits
204,236
13.1
159,175
12.7
155,121
12.8
Savings deposits
455,449
29.2
406,954
32.6
425,398
35.2
Time deposits
438,597
28.2
404,192
32.3
357,016
29.6
Total deposits
$
1,557,959
100.0
%
$
1,250,114
100.0
%
$
1,207,687
100.0
%
2020 compared to 2019
Total deposits increased $307.8 million to $1.6 billion at December 31, 2020, from $1.3 billion at December 31, 2019. This increase in deposits was due to increases of $179.9 million in noninterest-bearing demand deposits, $48.5 million in savings deposits, $45.1 million in interest-bearing demand deposits, and $34.4 million in time deposits.
The Company’s deposit composition at December 31, 2020, consisted of 29.5 percent noninterest-bearing demand deposits, 29.2 percent savings deposits, 28.2 percent time deposits, and 13.1 percent interest-bearing demand deposits. The change in the composition of the portfolio from December 31, 2019 reflects a 7.1 percent increase in noninterest-bearing demand deposits and a 0.4 percent increase in interest-bearing demand deposits, offset by a 4.1 percent decrease in time deposits and a 3.4 percent decrease in savings deposits.
2019 compared to 2018
Total deposits increased $42.4 million to $1.3 billion at December 31, 2019, from $1.2 billion at December 31, 2018. This increase in deposits was due to increases of $47.2 million in time deposits, $9.6 million in noninterest-bearing demand deposits and $4.1 million in interest-bearing demand deposits, partially offset by a decrease of $18.4 million in savings deposits, respectively.
The Company’s deposit composition at December 31, 2019, consisted of 32.6 percent savings deposits, 32.3 percent time deposits, 22.4 percent noninterest-bearing demand deposits and 12.7 percent interest-bearing demand deposits. The change in the composition of the portfolio from December 31, 2018 reflects a 2.7 percent increase in time deposits, offset by a 1.4 percent decrease in savings deposits and a 1.3 percent decrease in interest-bearing demand deposits.
The following table shows average deposits and the concentration of each category of deposits for the past three years:
For the years ended December 31,
(In thousands, except percentages)
Amount
% of total
Amount
% of total
Amount
% of total
Average balance:
Noninterest-bearing demand deposits
$
389,255
26.7
%
$
273,338
21.7
%
$
261,993
22.6
%
Interest-bearing demand deposits
178,358
12.3
155,177
12.3
145,846
12.6
Savings deposits
438,996
30.2
424,485
33.6
435,789
37.6
Time deposits
448,688
30.8
409,406
32.4
314,224
27.2
Total deposits
$
1,455,297
100.0
%
$
1,262,406
100.0
%
$
1,157,852
100.0
%
For additional information on deposits, see Note 8 to the Consolidated Financial Statements.
Borrowed Funds and Subordinated Debentures
Borrowed funds consist or previously consisted primarily of adjustable and fixed rate advances from the Federal Home Loan Bank of New York. These borrowings are used as a source of liquidity or to fund asset growth not supported by deposit generation. Residential mortgages and commercial loans collateralize the borrowings from the FHLB.
Borrowed funds and subordinated debentures totaled $210.3 million and $293.3 million at December 31, 2020 and December 31, 2019, respectively, and are broken down in the following table:
(In thousands)
December 31, 2020
December 31, 2019
FHLB borrowings:
Fixed rate advances
$
40,000
$
40,000
Adjustable rate advances
30,000
50,000
Overnight advances
130,000
193,000
Subordinated debentures
10,310
10,310
Total borrowed funds and subordinated debentures
$
210,310
$
293,310
Borrowed funds decreased $83.0 million from prior year-end due to a $63.0 million decrease in FHLB overnight borrowings and a $20.0 million decrease in FHLB adjustable rate advances during the year ended December 31, 2020.
FHLB Borrowings
At December 31, 2020 and December 31, 2019, the Company had $40.0 million in fixed rate advances. The terms of this transaction are as follows:
● A $40.0 million FHLB borrowing with a maturity date of August 22, 2024, at a rate of 1.810%.
At December 31, 2020, the $30.0 million FHLB adjustable rate (“ARC”) advances consisted of one $20.0 million advance and one $10.0 million advance. At December 31, 2019, the $50.0 million FHLB ARC advances consisted of two $20.0 million advances and one $10.0 million advance. These ARC advances roll over every six months. The Company has opted to hedge rates in a fluctuating rate environment. Each ARC advance has a swap instrument which modifies the borrowing to a 5 year fixed rate borrowing. The terms of these transactions are as follows:
● A $20.0 million ARC FHLB borrowing with a maturity date of January 6, 2021, at a rate of 3 month LIBOR plus 0.165%. The swap instrument modifies the borrowing to a 5 year fixed rate borrowing at 1.212% and matures on July 5, 2021.
● A $10.0 million ARC FHLB borrowing with a maturity date of February 18, 2021, at a rate of 3 month LIBOR plus 0.130%. The swap instrument modifies the borrowing to a 5 year fixed rate borrowing at 1.232% that matures on February 16, 2021.
At December 31, 2020, there were FHLB overnight borrowings of $130.0 million at a rate of 0.340%, compared to $193.0 million at a rate of 1.810% at December 31, 2019.
In December 2020, the FHLB issued a $12.0 million municipal deposit letter of credit in the name of Unity Bank naming the NJ Department of Banking and Insurance as beneficiary, to secure municipal deposits as required under New Jersey law.
At December 31, 2020, the Company had $286.1 million of additional credit available at the FHLB. Pledging additional collateral in the form of 1 to 4 family residential mortgages, commercial loans and investment securities can increase the line with the FHLB.
Subordinated Debentures
On July 24, 2006, Unity (NJ) Statutory Trust II, a statutory business trust and wholly-owned subsidiary of the Parent Company, issued $10.0 million of floating rate capital trust pass through securities to investors due on July 24, 2036. The subordinated debentures are redeemable in whole or part, prior to maturity but after July 24, 2011. The floating interest rate on the subordinated debentures is three-month LIBOR plus 159 basis points and reprices quarterly. The floating interest rate was 1.835% at December 31, 2020 and 3.518% at December 31, 2019. At December 31, 2020 and 2019, the subordinated debentures had a swap instrument which modified the borrowing to a 3 year fixed rate borrowing at 3.435%.
For additional information on borrowed funds and subordinated debentures, see Note 9 to the Consolidated Financial Statements.
Market Risk
Based on the Company’s business, the two largest risks facing the Company are market risk and credit risk. Market risk for the Company is primarily limited to interest rate risk, which is the impact that changes in interest rates would have on future earnings. The Company’s Risk Management Committee (“RMC”) manages this risk. The principal objectives of RMC are to establish prudent risk management guidelines, evaluate and control the level of interest rate risk in balance sheet accounts, determine the level of appropriate risk given the business focus, operating environment, capital, and liquidity requirements, and actively manage risk within Board-approved guidelines. The RMC reviews the maturities and repricing of loans, investments, deposits and borrowings, cash flow needs, current market conditions, and interest rate levels.
The Company uses various techniques to evaluate risk levels on both a short and long-term basis. One of the monitoring tools is the “gap” ratio. A gap ratio, as a percentage of assets, is calculated to determine the maturity and repricing mismatch between interest rate-sensitive assets and interest rate-sensitive liabilities. A gap is considered positive when the amount of interest rate-sensitive assets repricing exceeds the amount of interest rate-sensitive liabilities repricing in a designated time period. A positive gap should result in higher net interest income with rising interest rates, as the amount of the assets repricing exceeds the amount of liabilities repricing. Conversely, a gap is considered negative when the amount of interest rate-sensitive liabilities exceeds interest rate-sensitive assets, and lower rates should result in higher net interest income.
Repricing of mortgage-related securities is shown by contractual amortization and estimated prepayments based on the most recent 3-month constant prepayment rate. Callable agency securities are shown based upon their option-adjusted spread modified duration date (“OAS”), rather than the next call date or maturity date. The OAS date considers the coupon on the security, the time to the next call date, the maturity date, market volatility and current rate levels. Fixed rate loans are allocated based on expected amortization.
The following table sets forth the gap ratio at December 31, 2020. Assumptions regarding the repricing characteristics of certain assets and liabilities are critical in determining the projected level of rate sensitivity. Certain savings and interest checking accounts are less sensitive to market interest rate changes than other interest-bearing sources of funds. Core
deposits such as interest-bearing demand, savings and money market deposits are allocated based on their expected repricing in relation to changes in market interest rates.
Six
More than
More than
More than
More than
months
one year
three years
five years
ten years
Under six
through
through
through
through
and not
(In thousands, except percentages)
months
one year
three years
five years
ten years
repricing
Total
Assets:
Cash and due from banks
$
-
$
-
$
-
$
-
$
-
$
22,750
$
22,750
Federal funds sold and interest-bearing deposits
194,842
-
1,719
-
-
-
196,561
Federal Home Loan Bank stock
-
-
-
-
-
10,594
10,594
Securities
20,658
3,366
12,820
5,569
2,182
2,976
47,571
Loans
464,259
190,534
485,885
289,760
82,023
115,356
1,627,817
Allowance for loan losses
-
-
-
-
-
(23,105)
(23,105)
Other assets
-
-
-
-
-
76,726
76,726
Total assets
$
679,759
$
193,900
$
500,424
$
295,329
$
84,205
$
205,297
$
1,958,914
Liabilities and shareholders’ equity:
Noninterest-bearing demand deposits
$
-
$
-
$
-
$
-
$
-
$
459,677
$
459,677
Savings and interest-bearing demand deposits
308,584
-
97,254
125,819
128,028
-
659,685
Time deposits
209,632
112,581
77,859
28,256
10,269
-
438,597
Borrowed funds and subordinated debentures
110,000
20,000
-
80,000
-
210,310
Other liabilities
-
-
-
-
-
16,734
16,734
Shareholders’ equity
-
-
-
-
-
173,911
173,911
Total liabilities and shareholders’ equity
$
628,216
$
132,581
$
175,113
$
234,075
$
138,297
$
650,632
$
1,958,914
Gap
51,543
61,319
325,311
61,254
(54,092)
(445,335)
Cumulative gap
51,543
112,862
438,173
499,427
445,335
-
Cumulative gap to total assets
2.6
%
5.8
%
22.4
%
25.5
%
22.7
%
-
At December 31, 2020, there was a six-month asset-sensitive gap of $51.5 million and a one-year asset-sensitive gap of $112.9 million, as compared to a six-month asset-sensitive gap of $4.6 million and a one-year asset-sensitive gap of $23.7 million at December 31, 2019. The six-month and one-year cumulative gap to total assets ratios were within the Board-approved guidelines of +/- 20 percent.
Other models are also used in conjunction with the static gap table, which is not able to capture the risk of changing spread relationships over time, the effects of projected growth in the balance sheet or dynamic decisions such as the modification of investment maturities as a rate environment unfolds. For these reasons, a simulation model is used, where numerous interest rate scenarios and balance sheets are combined to produce a range of potential income results. Net interest income is managed within guideline ranges for interest rates rising or falling by 200 basis points. Results outside of guidelines require action by the RMC to correct the imbalance. Simulations are typically created over a 12 to 24 month time horizon. At December 31, 2020, these simulations show that with a 200 basis point rate increase over a 12 month period, net interest income would decrease by approximately $1.1 million, or 1.6 percent. A 200 basis point rate decline over a 12 month period would increase net interest income by approximately $552 thousand or 0.8 percent. These variances in net interest income are within the Board-approved guidelines of +/- 10 percent.
Finally, to measure the impact of longer-term asset and liability mismatches beyond two years, the Company utilizes Modified Duration of Equity and Economic Value of Portfolio Equity (“EVPE”) models. The modified duration of
equity measures the potential price risk of equity to changes in interest rates. A longer modified duration of equity indicates a greater degree of risk to rising interest rates. Because of balance sheet optionality, an EVPE analysis is also used to dynamically model the present value of asset and liability cash flows, with rate shocks of 200 basis points. The economic value of equity is likely to be different as interest rates change. Results falling outside prescribed ranges require action by the RMC. The Company’s variance in the economic value of equity with rate shocks of 200 basis points is an increase of 4.1 percent in a rising rate environment and a decrease of 7.5 percent in a falling rate environment at December 31, 2020. At December 31, 2019, the Company’s variance in the economic value of equity with rate shocks of 200 basis points is a decline of 1.8 percent in a rising rate environment and a decrease of 1.9 percent in a falling rate environment. The variance in the EVPE at December 31, 2020 and 2019 were within the Board-approved guidelines in place at the time of +/- 20 percent.
Liquidity
Consolidated Bank Liquidity
Liquidity measures the ability to satisfy current and future cash flow needs as they become due. A bank’s liquidity reflects its ability to meet loan demand, to accommodate possible outflows in deposits and to take advantage of interest rate opportunities in the marketplace. The Company’s liquidity is monitored by management and the Board of Directors which reviews historical funding requirements, the current liquidity position, sources and stability of funding, marketability of assets, options for attracting additional funds, and anticipated future funding needs, including the level of unfunded commitments. The goal is to maintain sufficient asset-based liquidity to cover potential funding requirements in order to minimize dependence on volatile and potentially unstable funding markets.
The principal sources of funds at the Bank are deposits, scheduled amortization and prepayments of investment and loan principal, sales and maturities of investment securities, additional borrowings and funds provided by operations. While scheduled loan payments and maturing investments are relatively predictable sources of funds, deposit inflows and outflows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. The Consolidated Statement of Cash Flows provides detail on the Company’s sources and uses of cash, as well as an indication of the Company’s ability to maintain an adequate level of liquidity. As the Consolidated Bank comprises the majority of the assets of the Company, the Consolidated Statement of Cash Flows is indicative of the Consolidated Bank’s activity. At December 31, 2020, the balance of cash and cash equivalents was $219.3 million, an increase of $61.3 million from December 31, 2019. A discussion of the cash provided by and used in operating, investing and financing activities follows.
Operating activities provided $33.7 million and $33.2 million in net cash for the years ended December 31, 2020 and 2019. The primary sources of funds were net income from operations and adjustments to net income, such as the proceeds from the sale of mortgage and SBA loans held for sale, partially offset by originations of mortgage and SBA loans held for sale.
Investing activities used $186.8 million and $133.1 million in net cash for the years ended December 31, 2020 and 2019, respectively. Cash was primarily used to fund new loans, primarily PPP loans, and purchase FHLB stock, partially offset by cash inflows from proceeds from the redemption of FHLB stock.
● Securities. The Consolidated Bank’s available for sale investment portfolio amounted to $45.6 million and $64.3 million at December 31, 2020 and December 31, 2019, respectively. This excludes the Parent Company’s securities discussed under the heading “Parent Company Liquidity” below. Projected cash flows from securities over the next twelve months are $13.3 million.
● Loans. The SBA loans held for sale portfolio amounted to $9.3 million and $13.5 million at December 31, 2020 and December 31, 2019, respectively. Sales of these loans provide an additional source of liquidity for the Company.
● Outstanding Commitments. The Company was committed to advance approximately $288.4 million to its borrowers as of December 31, 2020, compared to $272.8 million at December 31, 2019. At December 31, 2020, $114.2 million of these commitments expire within one year, compared to $119.2 million at December 31, 2019. The Company had $4.5 million and $4.8 million in standby letters of credit at
December 31, 2020 and December 31, 2019, respectively, which are included in the commitments amount noted above. The estimated fair value of these guarantees is not significant. The Company believes it has the necessary liquidity to honor all commitments. Many of these commitments will expire and never be funded.
Financing activities provided $214.3 million and $112.4 million in net cash for the years ended December 31, 2020 and 2019, respectively, primarily due to an increase in the Company’s deposits and borrowings, partially offset by the Company’s repayment of borrowings.
● Deposits. As of December 31, 2020, deposits included $142.6 million of Government deposits, as compared to $123.3 million at year end 2019. These deposits are generally short in duration and are very sensitive to price competition. The Company believes that the current level of these types of deposits is appropriate. Included in the portfolio were $127.6 million of deposits from eleven municipalities with account balances in excess of $5.0 million. The withdrawal of these deposits, in whole or in part, would not create a liquidity shortfall for the Company.
● Borrowed Funds. Total FHLB borrowings amounted to $200.0 million and $283.0 million as of December 31, 2020 and 2019, respectively. As a member of the Federal Home Loan Bank of New York, the Company can borrow additional funds based on the market value of collateral pledged. At December 31, 2020, pledging provided an additional $286.1 million in borrowing potential from the FHLB. In addition, the Company can pledge additional collateral in the form of 1 to 4 family residential mortgages, commercial loans or investment securities to increase this line with the FHLB.
Parent Company Liquidity
The Parent Company’s cash needs are funded by dividends paid and rental payments on corporate headquarters by the Bank. Other than its investment in the Bank, Unity Risk Management Inc., and Unity Statutory Trust II, the Parent Company does not actively engage in other transactions or business. Only expenses specifically for the benefit of the Parent Company are paid using its cash, which typically includes the payment of operating expenses, cash dividends on common stock and payments on trust preferred debt.
At December 31, 2020, the Parent Company had $640 thousand in cash and cash equivalents and $1.0 million in investment securities valued at fair market value, compared to $2.3 million in cash and cash equivalents and $1.4 million in investment securities at December 31, 2019.
Off-Balance Sheet Arrangements and Contractual Obligations
The following table shows the amounts and expected maturities or payment periods of off-balance sheet arrangements and contractual obligations as of December 31, 2020:
One year
One to
Three to
Over five
(In thousands)
or less
three years
five years
years
Total
Off-balance sheet arrangements:
Standby letters of credit
$
3,875
$
$
-
$
$
4,533
Contractual obligations:
Time deposits
322,213
77,859
28,256
10,269
438,597
Borrowed funds and subordinated debentures
160,000
-
40,000
10,310
210,310
Purchase obligations
1,662
2,037
-
-
3,699
Total off-balance sheet arrangements and contractual obligations
$
487,750
$
79,955
$
68,256
$
21,178
$
657,139
Standby letters of credit represent guarantees of payment issued by the Bank on behalf of a client that is used as "payment of last resort" should the client fail to fulfill a contractual commitment with a third party. Standby letters of credit are typically short-term in duration, maturing in one year or less.
Time deposits have stated maturity dates. For additional information on time deposits, see Note 8 to the Consolidated Financial Statements.
Borrowed funds and subordinated debentures include adjustable rate borrowings from the Federal Home Loan Bank and subordinated debentures. The borrowings have defined terms and under certain circumstances are callable at the option of the lender. For additional information on borrowed funds and subordinated debentures, see Note 9 to the Consolidated Financial Statements.
Purchase obligations represent legally binding and enforceable agreements to purchase goods and services from third parties and consist primarily of contractual obligations under data processing and ATM service agreements.
Capital Adequacy
A significant measure of the strength of a financial institution is its capital base. Shareholders’ equity increased $13.2 million to $173.9 million at December 31, 2020 compared to $160.7 million at December 31, 2019, primarily due to net income of $23.6 million. Other items impacting shareholders’ equity included $7.4 million in treasury stock purchased at cost, $3.3 million in dividends paid on common stock, $1.6 million from the issuance of common stock under employee benefit plans and $1.3 million in accumulated other comprehensive loss net of tax. The issuance of common stock under employee benefit plans includes nonqualified stock options and restricted stock expense related entries, employee option exercises and the tax benefit of options exercised.
For additional information on shareholders’ equity, see Note 13 to the Consolidated Financial Statements.
On September 17, 2019, the federal banking agencies issued a final rule providing simplified capital requirements for certain community banking organizations (banks and holding companies) with less than $10 billion in total consolidated assets, implementing provisions of The Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”). Under the rule, a qualifying community banking organization would be eligible to elect the community bank leverage ratio framework, or continue to measure capital under the existing Basel III requirements. The new rule, effective beginning January 1, 2020, allowed qualifying community banking organizations (“QCBO”) to opt into the new community bank leverage ratio (“CBLR”) in their call report beginning in the first quarter of 2020.
A QCBO is defined as a bank, a savings association, a bank holding company or a savings and loan holding company with:
● A leverage capital ratio of greater than 9.0%;
● Total consolidated assets of less than $10.0 billion;
● Total off-balance sheet exposures (excluding derivatives other than credit derivatives and unconditionally cancelable commitments) of 25% or less of total consolidated assets; and
● Total trading assets and trading liabilities of 5% or less of total consolidated assets.
On April 6, 2020, the federal banking regulators, implementing the applicable provisions of the CARES Act, modified the CBLR framework so that: (i) beginning in the second quarter 2020 and until the end of the year, a banking organization that has a leverage ratio of 8% or greater and meets certain other criteria may elect to use the CBLR framework; and (ii) community banking organizations will have until January 1, 2022, before the CBLR requirement is re-established at greater than 9%. Under the interim rules, the minimum CBLR will be 8% beginning in the second quarter and for the remainder of calendar year 2020, 8.5% for calendar year 2021, and 9% thereafter. The numerator of the CBLR is Tier 1 capital, as calculated under present rules. The denominator of the CBLR is the QCBO’s average assets, calculated in accordance with the QCBO’s Call Report instructions less assets deducted from Tier 1 capital.
The Bank has opted into the CBLR and is therefore not be required to comply with the Basel III capital requirements. As of December 31, 2020, the Bank’s CBLR was 9.80% and the Company’s CBLR was 10.09%.
The following table shows the CBLR ratio for the Company and the Bank at December 31, 2020, and the capital ratios for the Company and Bank under Basel III requirements at December 31, 2019:
Company
Bank
Required for capital adequacy purposes
To be well-capitalized under prompt corrective action regulations
At December 31, 2020:
CBLR
10.09
%
9.80
%
8.00
%
8.00
%
At December 31, 2019:
Leverage ratio
10.59
%
10.15
%
4.00
%
5.00
%
CET1
11.59
%
11.81
%
4.50
%
(1)
6.50
%
Tier I risk-based capital ratio
12.32
%
11.81
%
6.00
%
(1)
8.00
%
Total risk-based capital ratio
13.06
%
12.58
%
8.00
%
(1)
10.00
%
(1) Excludes capital conservation buffer at December 31, 2019.
For additional information on regulatory capital, see Note 18 to the Consolidated Financial Statements.
Forward-Looking Statements
This report contains certain forward-looking statements, either expressed or implied, which are provided to assist the reader in understanding anticipated future financial performance. These statements involve certain risks, uncertainties, estimates and assumptions by management.
Factors that may cause actual results to differ from those results expressed or implied, include, but are not limited to those listed under “Item 1A - Risk Factors” in this Annual Report; the impact of the COVID-19 pandemic, the overall economy and the interest rate environment; the ability of customers to repay their obligations; the adequacy of the allowance for loan losses; competition; significant changes in tax, accounting or regulatory practices and requirements; and technological changes. Although management has taken certain steps to mitigate the negative effect of the aforementioned items, significant unfavorable changes could severely impact the assumptions used and have an adverse effect on future profitability.
Critical Accounting Policies and Estimates
“Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based upon the Company’s Consolidated Financial Statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to the Company’s Audited Consolidated Financial Statements for the year ended December 31, 2020, contains a summary of the Company’s significant accounting policies. Management believes the Company’s policies with respect to the methodology for the determination of the allowance for loan losses, valuation of deferred tax and servicing assets, the carrying value of loans held for sale and other real estate owned, the valuation of securities and the determination of other-than-temporary impairment for securities and fair value disclosures involve a higher degree of complexity and require management to make difficult and subjective judgments, which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact results of operations. These critical policies are periodically reviewed with the Audit Committee and the Board of Directors.
Other-Than-Temporary Impairment
The Company has a process in place to identify debt securities that could potentially incur credit impairment that is other-than-temporary. This process involves monitoring late payments, pricing levels, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concern warrants such evaluation. This evaluation considers relevant facts and circumstances in evaluating whether a credit or interest rate-related impairment of a security is other-than-temporary. Relevant facts
and circumstances considered include: (1) the extent and length of time the fair value has been below cost; (2) the reasons for the decline in value; (3) the financial position and access to capital of the issuer, including the current and future impact of any specific events and (4) for fixed maturity securities, the intent to sell a security or whether it is more likely than not the security will be required to be sold before the recovery of its amortized cost which, in some cases, may extend to maturity and for equity securities, the ability and intent to hold the security for a forecasted period of time that allows for the recovery in value.
Management assesses its intent to sell or whether it is more likely than not that it will be required to sell a security before recovery of its amortized cost basis less any current-period credit losses. For debt securities that are considered other-than-temporarily impaired with no intent to sell and no requirement to sell prior to recovery of its amortized cost basis, the amount of the impairment is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income. For debt securities where management has the intent to sell, the amount of the impairment is reflected in earnings as realized losses.
The present value of expected future cash flows is determined using the best estimate cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security. The methodology and assumptions for establishing the best estimate cash flows vary depending on the type of security. The asset-backed securities cash flow estimates are based on bond specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity and prepayment speeds and structural support, including subordination and guarantees. The corporate bond cash flow estimates are derived from scenario-based outcomes of expected corporate restructurings or the disposition of assets using bond specific facts and circumstances including timing, security interests and loss severity.
For additional information on other-than-temporary impairment, see Note 3 to the Consolidated Financial Statements.
Servicing Assets
Servicing assets represent the estimated fair value of retained servicing rights, net of servicing costs, at the time loans are sold. Servicing assets are amortized in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on stratifying the underlying financial assets by date of origination and term. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Any impairment, if temporary, would be reported as a valuation allowance.
For additional information on servicing assets, see Note 4 to the Consolidated Financial Statements.
Allowance for Loan Losses and Unfunded Loan Commitments
The allowance for loan losses is maintained at a level management considers adequate to provide for probable loan losses as of the balance sheet date. The allowance is increased by provisions charged to expense and is reduced by net charge-offs.
The level of the allowance is based on management’s evaluation of probable losses in the loan portfolio, after consideration of prevailing economic conditions in the Company’s market area, the volume and composition of the loan portfolio, and historical loan loss experience. The allowance for loan losses consists of specific reserves for individually impaired credits and TDRs and reserves for nonimpaired loans based on historical loss factors and reserves based on general economic factors and other qualitative risk factors such as changes in delinquency trends, industry concentrations or local/national economic trends. This risk assessment process is performed at least quarterly, and, as adjustments become necessary, they are realized in the periods in which they become known.
Although management attempts to maintain the allowance at a level deemed adequate to provide for probable losses, future additions to the allowance may be necessary based upon certain factors including changes in market conditions and underlying collateral values. In addition, various regulatory agencies periodically review the adequacy of the
Company’s allowance for loan losses. These agencies may require the Company to make additional provisions based on judgments about information available at the time of the examination.
The Company maintains an allowance for unfunded loan commitments that is maintained at a level that management believes is adequate to absorb estimated probable losses. Adjustments to the allowance are made through other expenses and applied to the allowance which is maintained in other liabilities.
For additional information on the allowance for loan losses and unfunded loan commitments, see Note 5 to the Consolidated Financial Statements.
Income Taxes
The Company accounts for income taxes according to the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using the enacted tax rates applicable to taxable income for the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. If tax reform results in a decline in the corporate tax rates the Company would have to write-down its deferred tax asset.
Valuation reserves are established against certain deferred tax assets when it is more likely than not that the deferred tax assets will not be realized. Increases or decreases in the valuation reserve are charged or credited to the income tax provision.
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that ultimately would be sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. The evaluation of a tax position taken is considered by itself and not offset or aggregated with other positions. Tax positions that meet the more likely than not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest and penalties associated with unrecognized tax benefits would be recognized in income tax expense on the income statement.
For additional information on income taxes, see Note 16 to the Consolidated Financial Statements.

---

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 7A. Quantitative and Qualitative Disclosures About Market Risk:
For information regarding Quantitative and Qualitative Disclosures about Market Risk, see Part II, Item 7, "Management’s Discussion and Analysis of Financial Condition and Results of Operations - Market Risk."

---

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Item 8. Financial Statements and Supplementary Data:
Consolidated Balance Sheets
(In thousands)
December 31, 2020
December 31, 2019
ASSETS
Cash and due from banks
$
22,750
$
21,106
Federal funds sold and interest-bearing deposits
196,561
136,910
Cash and cash equivalents
219,311
158,016
Securities:
Debt securities available for sale (amortized cost of $45,921 in 2020 and $63,883 in 2019)
45,617
64,275
Equity securities with readily determinable fair values (amortized cost of $2,112 in 2020 and $2,218 in 2019)
1,954
2,289
Total securities
47,571
66,564
Loans:
SBA loans held for sale
9,335
13,529
SBA loans held for investment
39,587
35,767
SBA PPP loans
118,257
-
Commercial loans
839,788
765,032
Residential mortgage loans
467,586
467,706
Consumer loans
153,264
143,524
Total loans
1,627,817
1,425,558
Allowance for loan losses
(23,105)
(16,395)
Net loans
1,604,712
1,409,163
Premises and equipment, net
20,226
21,315
Bank owned life insurance ("BOLI")
26,514
26,323
Deferred tax assets
9,183
5,559
Federal Home Loan Bank ("FHLB") stock
10,594
14,184
Accrued interest receivable
10,429
6,984
Other real estate owned ("OREO")
-
1,723
Goodwill
1,516
1,516
Prepaid expenses and other assets
8,858
7,595
Total assets
$
1,958,914
$
1,718,942
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Deposits:
Noninterest-bearing demand
$
459,677
$
279,793
Interest-bearing demand
204,236
159,175
Savings
455,449
406,955
Time, under $100,000
264,671
195,446
Time, $100,000 to $250,000
95,595
126,192
Time, $250,000 and over
78,331
82,553
Total deposits
1,557,959
1,250,114
Borrowed funds
200,000
283,000
Subordinated debentures
10,310
10,310
Accrued interest payable
Accrued expenses and other liabilities
16,486
14,354
Total liabilities
1,785,003
1,558,233
Shareholders’ equity:
Common stock, no par value, 12,500 shares authorized, 10,961 shares issued and 10,456 shares outstanding in 2020; 10,881 shares issued and outstanding in 2019
91,873
90,113
Retained earnings
90,669
70,442
Treasury stock, at cost (505 shares in 2020)
(7,442)
-
Accumulated other comprehensive (loss) income
(1,189)
Total shareholders’ equity
173,911
160,709
Total liabilities and shareholders’ equity
$
1,958,914
$
1,718,942
The accompanying notes to the Consolidated Financial Statements are an integral part of these statements.
Consolidated Statements of Income
For the years ended December 31,
(In thousands, except per share amounts)
INTEREST INCOME
Federal funds sold, interest-bearing deposits and repos
$
$
$
FHLB stock
Securities:
Taxable
1,695
1,926
1,907
Tax-exempt
Total securities
1,756
2,030
2,024
Loans:
SBA loans
3,144
3,780
4,338
SBA PPP loans
3,120
-
-
Commercial loans
40,002
37,577
33,886
Residential mortgage loans
22,255
22,483
18,837
Consumer loans
8,049
8,487
6,943
Total loans
76,570
72,327
64,004
Total interest income
78,915
75,648
67,263
INTEREST EXPENSE
Interest-bearing demand deposits
1,344
1,386
Savings deposits
2,463
4,907
4,277
Time deposits
8,784
9,459
5,903
Borrowed funds and subordinated debentures
1,889
2,303
2,540
Total interest expense
14,480
18,055
13,516
Net interest income
64,435
57,593
53,747
Provision for loan losses
7,000
2,100
2,050
Net interest income after provision for loan losses
57,435
55,493
51,697
NONINTEREST INCOME
Branch fee income
1,046
1,502
1,519
Service and loan fee income
1,742
1,965
2,130
Gain on sale of SBA loans held for sale, net
1,642
1,680
Gain on sale of mortgage loans, net
6,344
2,090
1,719
BOLI income
Net security gains (losses)
(199)
Gain on sale of premises and equipment
-
-
Other income
1,466
1,346
1,207
Total noninterest income
12,946
9,539
9,031
NONINTEREST EXPENSE
Compensation and benefits
23,124
20,666
20,119
Processing and communications
3,155
2,924
2,788
Furniture and equipment
2,606
2,894
2,348
Occupancy
2,543
2,650
2,739
BSA expenses
1,800
-
-
Professional services
1,144
1,061
Advertising
1,358
1,411
Director fees
Other loan expenses
Deposit insurance
Loan collection and OREO expenses (recoveries)
(361)
Other expenses
1,699
1,877
1,782
Total noninterest expense
39,262
34,717
33,421
Income before provision for income taxes
31,119
30,315
27,307
Provision for income taxes
7,475
6,662
5,388
Net income
$
23,644
$
23,653
$
21,919
Net income per common share - Basic
$
2.21
$
2.18
$
2.04
Net income per common share - Diluted
$
2.19
$
2.14
$
2.01
Weighted average common shares outstanding - Basic
10,709
10,845
10,726
Weighted average common shares outstanding - Diluted
10,814
11,029
10,916
The accompanying notes to the Consolidated Financial Statements are an integral part of these statements.
Consolidated Statements of Comprehensive Income
For the year ended December 31, 2020
Income tax
Before tax
expense
Net of tax
(In thousands)
amount
(benefit)
amount
Net income
$
31,119
7,475
$
23,644
Other comprehensive income
Debt securities available for sale:
Unrealized holding losses on securities arising during the period
(603)
(181)
(422)
Less: reclassification adjustment for gains on securities included in net income
Total unrealized losses on securities available for sale
(696)
(201)
(495)
Adjustments related to defined benefit plan:
Amortization of prior service cost
Total adjustments related to defined benefit plan
Net unrealized losses from cash flow hedges:
Unrealized holding losses on cash flow hedges arising during the period
(1,264)
(359)
(905)
Total unrealized losses on cash flow hedges
(1,264)
(359)
(905)
Total other comprehensive loss
(1,877)
(535)
(1,343)
Total comprehensive income
$
29,242
$
6,941
$
22,301
For the year ended December 31, 2019
Income tax
Before tax
expense
Net of tax
(In thousands)
amount
(benefit)
amount
Net income
$
30,315
6,662
23,653
Other comprehensive income
Debt securities available for sale:
Unrealized holding gains on securities arising during the period
1,814
1,332
Less: reclassification adjustment for gains on securities included in net income
Total unrealized gains on securities available for sale
1,441
1,037
Adjustments related to defined benefit plan:
Amortization (accretion) of prior service cost
(53)
Total adjustments related to defined benefit plan
(53)
Net unrealized losses from cash flow hedges:
Unrealized holding losses on cash flow hedges arising during the period
(1,195)
(333)
(862)
Total unrealized losses on cash flow hedges
(1,195)
(333)
(862)
Total other comprehensive income
Total comprehensive income
$
30,644
$
6,680
$
23,964
For the year ended December 31, 2018
Income tax
Before tax
expense
Net of tax
(In thousands)
amount
(benefit)
amount
Net income
$
27,307
$
5,388
$
21,919
Other comprehensive income
Investment securities available for sale:
Unrealized holding losses on securities arising during the period
(756)
(225)
(531)
Less: reclassification adjustment for losses on securities included in net income
(183)
(38)
(145)
Total unrealized losses on securities available for sale
(573)
(187)
(386)
Adjustments related to defined benefit plan:
Amortization (accretion) of prior service cost
(90)
Total adjustments related to defined benefit plan
(90)
Net unrealized gains from cash flow hedges:
Unrealized holding gains (losses) on cash flow hedges arising during the period
(123)
Total unrealized gains (losses) on cash flow hedges
(123)
Total other comprehensive loss
(465)
(137)
(328)
Total comprehensive income
$
26,842
$
5,251
$
21,591
The accompanying notes to the Consolidated Financial Statements are an integral part of these statements.
Consolidated Statements of Changes in Shareholders’ Equity
Accumulated
other
Total
Common stock
Retained
comprehensive
Treasury
Shareholders’
(In thousands, except per share amounts)
Shares
Amount
earnings (2)
income (loss)
stock
equity
Balance, December 31, 2017
10,615
$
86,782
$
31,117
$
$
-
$
118,105
Net income
21,919
21,919
Other comprehensive loss, net of tax
(328)
(328)
Dividends on common stock ($0.27 per share)
(2,910)
(2,803)
Common stock issued and related tax effects (1)
1,595
1,595
Retained earnings impact due to adoption of ASU 2016-01 (3)
(40)
-
Tax rate adjustment to AOCI (4)
(75)
-
Balance, December 31, 2018
10,780
88,484
50,161
(157)
-
138,488
Net income
23,653
23,653
Other comprehensive income, net of tax
Dividends on common stock ($0.31 per share)
(3,372)
(3,255)
Common stock issued and related tax effects (1)
1,512
1,512
Balance, December 31, 2019
10,881
90,113
70,442
-
160,709
Net income
23,644
23,644
Other comprehensive loss, net of tax
(1,343)
(1,343)
Dividends on common stock ($0.32 per share)
(3,417)
(3,298)
Common stock issued and related tax effects (1)
1,641
1,641
Treasury stock purchased, at cost
(505)
(7,442)
(7,442)
Balance, December 31, 2020
10,456
$
91,873
$
90,669
$
(1,189)
$
(7,442)
$
173,911
(1) Includes the issuance of common stock under employee benefit plans, which includes nonqualified stock options and restricted stock expense related entries, employee option exercises and the tax benefit of options exercised.
(2) 2017 includes the impact of implementing ASU 2016-09, “Compensation - Stock Compensation (Topic 718),” which resulted in a cumulative-effect adjustment of $498 thousand to retained earnings.
(3) As a result of ASU 2016-01, "Financial Instruments Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities", the Company reclassed $40 thousand of gains (losses) on available for sale equity securities from accumulated other comprehensive income to retained earnings.
(4) As a result of ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income", the Company reclassed $75 thousand from accumulated other comprehensive income to retained earnings.
The accompanying notes to the Consolidated Financial Statements are an integral part of these statements.
Consolidated Statements of Cash Flows
For the twelve months ended December 31,
(In thousands)
OPERATING ACTIVITIES:
Net income
$
23,644
$
23,653
$
21,919
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses
7,000
2,100
2,050
Net amortization of purchase premiums and discounts on securities
Depreciation and amortization
1,909
1,619
1,937
SBA PPP deferred fees and costs
2,947
-
-
Deferred income tax benefit
(3,090)
(299)
(1,262)
Net security (gains) losses
(322)
(52)
Stock compensation expense
1,412
1,271
1,053
Gain on sale of OREO
(68)
(16)
(169)
Valuation writedowns on OREO
-
-
Gain on sale of mortgage loans, net
(5,594)
(2,143)
(1,390)
Gain on sale of SBA loans held for sale, net
(1,642)
(909)
(1,680)
Origination of mortgage loans sold
(290,808)
(120,173)
(80,729)
Origination of SBA loans held for sale
(13,998)
(10,246)
(9,510)
Proceeds from sale of mortgage loans, net
296,402
122,316
82,119
Proceeds from sale of SBA loans held for sale, net
19,826
15,768
23,939
BOLI income
(613)
(588)
(975)
Gain on sale of premises and equipment
-
(766)
-
Net change in other assets and liabilities
(3,726)
1,480
1,064
Net cash provided by operating activities
33,745
33,204
38,590
INVESTING ACTIVITIES
Purchase of equity securities
-
-
(1,133)
Purchases of securities available for sale
(3,802)
(13,084)
(579)
Purchases of FHLB stock, at cost
(76,915)
(90,644)
(72,115)
Maturities and principal payments on securities held to maturity
-
1,393
Maturities and principal payments on debt securities available for sale
15,205
5,441
5,396
Proceeds from sales of securities available for sale
6,635
5,606
-
Proceeds from sales of equity securities
-
Proceeds from redemption of FHLB stock
80,505
87,255
74,183
Proceeds from sale of OREO
1,566
Net increase in SBA PPP loans
(121,182)
-
-
Net increase in loans
(88,770)
(128,876)
(147,223)
Proceeds from BOLI
-
Purchase of BOLI
-
(1,025)
-
Proceeds from sale of premises and equipment
-
1,821
-
Purchases of premises and equipment
(559)
(709)
(1,507)
Net cash used in investing activities
(186,784)
(133,115)
(140,653)
FINANCING ACTIVITIES
Net increase in deposits
307,845
42,427
164,550
Proceeds from new borrowings
160,000
283,000
210,000
Repayments of borrowings
(243,000)
(210,000)
(275,000)
Proceeds from exercise of stock options
Fair market value of shares withheld to cover employee tax liability
(222)
(213)
-
Dividends on common stock
(3,298)
(3,255)
(2,802)
Purchase of treasury stock
(7,442)
-
-
Net cash provided by financing activities
214,334
112,412
97,324
Increase (decrease) in cash and cash equivalents
61,295
12,501
(4,739)
Cash and cash equivalents, beginning of period
158,016
145,515
150,254
Cash and cash equivalents, end of period
$
219,311
$
158,016
$
145,515
SUPPLEMENTAL DISCLOSURES
Cash:
Interest paid
$
14,687
$
18,006
$
13,546
Income taxes paid
11,112
8,222
5,941
Noncash investing activities:
Transfer of securities held to maturity to available for sale
-
14,221
-
Establishment of lease liability and right-of-use asset
3,234
-
Transfer of SBA loans held for sale to held to maturity
2,633
-
-
Capitalization of servicing rights
Transfer of loans to OREO
-
2,151
The accompanying notes to the Consolidated Financial Statements are an integral part of these statements
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Overview
The accompanying Consolidated Financial Statements include the accounts of Unity Bancorp, Inc. (the “Parent Company”) and its wholly-owned subsidiary, Unity Bank (the “Bank” or when consolidated with the Parent Company, the “Company”). All significant intercompany balances and transactions have been eliminated in consolidation.
Unity Bancorp, Inc. is a bank holding company incorporated in New Jersey and registered under the Bank Holding Company Act of 1956, as amended. Its wholly-owned subsidiary, the Bank, is chartered by the New Jersey Department of Banking and Insurance. The Bank provides a full range of commercial and retail banking services through nineteen branch offices located in Bergen, Hunterdon, Middlesex, Somerset, Union and Warren counties in New Jersey and Northampton County in Pennsylvania. These services include the acceptance of demand, savings, and time deposits and the extension of consumer, real estate, Small Business Administration (“SBA”) and other commercial credits.
Unity Bank has nine wholly-owned subsidiaries: Unity Investment Services, Inc., AJB Residential Realty Enterprises, Inc., AJB Commercial Realty, Inc., MKCD Commercial, Inc., JAH Commercial, Inc., UB Commercial LLC, ASBC Holdings LLC, Unity Property Holdings 1, Inc., and Unity Property Holdings 2, Inc. Unity Investment Services, Inc. is used to hold and administer part of the Bank’s investment portfolio. The other subsidiaries hold, administer and maintain the Bank’s other real estate owned (“OREO”) properties. Unity Investment Services, Inc. has one subsidiary, Unity Delaware Investment 2, Inc., which has one subsidiary, Unity NJ REIT, Inc. Unity NJ REIT, Inc. was formed in 2013 to hold loans.
The Company has two wholly-owned subsidiaries: Unity (NJ) Statutory Trust II and Unity Risk Management, Inc. For additional information on Unity (NJ) Statutory Trust II, see Note 9 to the Consolidated Financial Statements. Unity Risk Management, Inc. is the Company’s captive insurance company that insures risks to the Bank not insured by the traditional commercial insurance market.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Amounts requiring the use of significant estimates include the allowance for loan losses, valuation of deferred tax and servicing assets, the carrying value of loans held for sale and other real estate owned, the valuation of securities and the determination of other-than-temporary impairment for securities and fair value disclosures. Actual results could differ from those estimates.
Risks and Uncertainties
On March 11, 2020, the world Health Organization declared the outbreak of COVID-19 a global pandemic. The COVID-19 pandemic has adversely affected local, national and global economic activity. Actions taken to help mitigate the spread of COVID-19 include restrictions on travel, localized quarantines, and government-mandated closures of certain businesses. The spread of the outbreak has caused significant disruptions to the U.S. economy and has disrupted banking and other financial activity in the areas in which the Company operates.
On March 3, 2020, the Federal Open Market Committee reduced the targeted federal funds interest rate range by 50 basis points to 1.00 percent to 1.25 percent. This range was further reduced to 0 percent to 0.25 percent on March 16, 2020. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted to, among other provisions, provide emergency assistance for individuals, families and businesses affected by the COVID-19 pandemic. These reductions in interest rates and other effects of the COVID-19 pandemic may materially and
adversely affect the Company's financial condition and results of operations in future periods. It is unknown how long the adverse conditions associated with the COVID-19 pandemic will last and what the complete financial effect will be to the Company. It is possible that estimates made in the financial statements could be materially and adversely impacted as a result of these conditions.
On July 27, 2017, the U.K. Financial Conduct Authority, which regulates LIBOR, announced that it will no longer persuade or compel banks to submit rates for the calculation of LIBOR to the LIBOR administrator after 2021. The announcement also indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. Consequently, at this time, it is not possible to predict whether and to what extent banks will continue to provide LIBOR submissions to the LIBOR administrator or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. Similarly, it is not possible to predict whether LIBOR will continue to be viewed as an acceptable benchmark for certain loans and liabilities including our subordinated notes, what rate or rates may become accepted alternatives to LIBOR or the effect of any such changes in views or alternatives on the values of the loans and liabilities, whose interest rates are tied to LIBOR. Uncertainty as to the nature of such potential changes, alternative reference rates, the elimination or replacement of LIBOR, or other reforms may adversely affect the value of, and the return on our loans, and our investment securities.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold and interest-bearing deposits.
Securities
The Company classifies its securities into three categories, available for sale, held to maturity and equity investments.
Securities that are classified as available for sale are stated at fair value. Unrealized gains and losses on securities available for sale are generally excluded from results of operations and are reported as other comprehensive income, a separate component of shareholders’ equity, net of taxes. Securities classified as available for sale include securities that may be sold in response to changes in interest rates, changes in prepayment risks or for asset/liability management purposes. The cost of securities sold is determined on a specific identification basis. Gains and losses on sales of securities are recognized in the Consolidated Statements of Income on the date of sale.
Securities are classified as held to maturity based on management’s intent and ability to hold them to maturity. Such securities are stated at cost, adjusted for unamortized purchase premiums and discounts using the level yield method.
If transfers between the available for sale and held to maturity portfolios occur, they are accounted for at fair value and unrealized holding gains and losses are accounted for at the date of transfer. For securities transferred to available for sale from held to maturity, unrealized gains or losses as of the date of the transfer are recognized in other comprehensive income (loss), a separate component of shareholders’ equity. For securities transferred into the held to maturity portfolio from the available for sale portfolio, unrealized gains or losses as of the date of transfer continue to be reported in other comprehensive income (loss), and are amortized over the remaining life of the security as an adjustment to its yield, consistent with amortization of the premium or accretion of the discount.
Equity securities are investments carried at fair value that may be sold in response to changing market and interest rate conditions or for other business purposes. Activity in this portfolio is undertaken primarily to manage liquidity and interest rate risk, to take advantage of market conditions that create economically attractive returns and as an additional source of earnings. These securities were transferred from available for sale and reclassified into equity securities on the balance sheet as a result of the adoption of ASU 2016-01 in January 2018. Periodic net gains and losses on equity investments are recognized in the income statement as realized gains and losses.
For additional information on securities, see Note 3 to the Consolidated Financial Statements.
Other-Than-Temporary Impairment
The Company has a process in place to identify debt securities that could potentially incur credit impairment that is other-than-temporary. This process involves monitoring late payments, pricing levels, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concern warrants such evaluation. This evaluation considers relevant facts and circumstances in evaluating whether a credit or interest rate-related impairment of a security is other-than-temporary. Relevant facts and circumstances considered include: (1) the extent and length of time the fair value has been below cost; (2) the reasons for the decline in value; (3) the financial position and access to capital of the issuer, including the current and future impact of any specific events and (4) for fixed maturity securities, the intent to sell a security or whether it is more likely than not the Company will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity and for equity securities, our ability and intent to hold the security for a forecasted period of time that allows for the recovery in value.
For debt securities that are considered other-than-temporarily impaired where management has no intent to sell and the Company has no requirement to sell prior to recovery of its amortized cost basis, the amount of the impairment is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income. For debt securities where management has the intent to sell, the amount of the impairment is reflected in earnings as realized losses.
The present value of expected future cash flows is determined using the best estimate cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security. The methodology and assumptions for establishing the best estimate cash flows vary depending on the type of security. The asset-backed securities cash flow estimates are based on bond specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity and prepayment speeds and structural support, including subordination and guarantees. The corporate bond cash flow estimates are derived from scenario-based outcomes of expected corporate restructurings or the disposition of assets using bond specific facts and circumstances including timing, security interests and loss severity.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Loans
Loans Held for Sale
Loans held for sale represent the guaranteed portion of SBA loans, other than loans originated under the Paycheck Protection Program, and are reflected at the lower of aggregate cost or market value. The Company originates loans to customers under an SBA program that historically has provided for SBA guarantees of up to 90 percent of each loan. The Company generally sells the guaranteed portion of its SBA loans to a third party and retains the servicing, holding the nonguaranteed portion in its portfolio. The net amount of loan origination fees on loans sold is included in the carrying value and in the gain or loss on the sale. When sales of SBA loans do occur, the premium received on the sale and the present value of future cash flows of the servicing assets are recognized in income. All criteria for sale accounting must be met in order for the loan sales to occur; see details under the “Transfers of Financial Assets” heading above.
Servicing assets represent the estimated fair value of retained servicing rights, net of servicing costs, at the time loans are sold. Servicing assets are amortized in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on stratifying the underlying financial assets by date of origination and term. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Any impairment, if temporary, would generally be reported as a valuation allowance.
Serviced loans sold to others are not included in the accompanying Consolidated Balance Sheets. Income and fees collected for loan servicing are credited to noninterest income when earned, net of amortization on the related servicing assets.
For additional information on servicing assets, see Note 4 to the Consolidated Financial Statements.
Loans Held for Investment
Loans held for investment are stated at the unpaid principal balance, net of unearned discounts and deferred loan origination fees and costs. In accordance with the level yield method, loan origination fees, net of direct loan origination costs, are deferred and recognized over the estimated life of the related loans as an adjustment to the loan yield. Interest is credited to operations primarily based upon the principal balance outstanding.
Loans are reported as past due when either interest or principal is unpaid in the following circumstances: fixed payment loans when the borrower is in arrears for two or more monthly payments; open end credit for two or more billing cycles; and single payment notes if interest or principal remains unpaid for 30 days or more.
Nonperforming loans consist of loans that are not accruing interest as a result of principal or interest being delinquent for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt (nonaccrual loans). When a loan is classified as nonaccrual, interest accruals are discontinued and all past due interest previously recognized as income is reversed and charged against current period earnings. Generally, until the loan becomes current, any payments received from the borrower are applied to outstanding principal until such time as management determines that the financial condition of the borrower and other factors merit recognition of a portion of such payments as interest income. Loans may be returned to an accrual status when the ability to collect is reasonably assured and when the loan is brought current as to principal and interest.
Loans are charged off when collection is sufficiently questionable and when the Company can no longer justify maintaining the loan as an asset on the balance sheet. Loans qualify for charge-off when, after thorough analysis, all possible sources of repayment are insufficient. These include: 1) potential future cash flows, 2) value of collateral, and/or 3) strength of co-makers and guarantors. All unsecured loans are charged off upon the establishment of the loan’s nonaccrual status. Additionally, all loans classified as a loss or that portion of the loan classified as a loss is charged off. All loan charge-offs are approved by the Board of Directors.
Troubled debt restructurings ("TDRs") occur when a creditor, for economic or legal reasons related to a debtor’s financial condition, grants a concession to the debtor that it would not otherwise consider. These concessions typically include reductions in interest rate, extending the maturity of a loan, or a combination of both. Interest income on accruing TDRs is credited to operations primarily based upon the principal amount outstanding, as stated in the paragraphs above.
The Company evaluates its loans for impairment. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Company has defined impaired loans to be all TDRs and nonperforming loans individually evaluated for impairment. Impairment of a loan is measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, or as a practical expedient, based on a loan’s observable market price or the fair value of collateral, net of estimated costs to sell, if the loan is collateral-dependent. If the value of the impaired loan is less than the recorded investment in the loan, the Company establishes a valuation allowance, or adjusts existing valuation allowances, with a corresponding charge to the provision for loan losses.
For additional information on loans, see Note 4 to the Consolidated Financial Statements.
Allowance for Loan Losses and Reserve for Unfunded Loan Commitments
The allowance for loan losses is maintained at a level management considers adequate to provide for probable loan losses as of the balance sheet date. The allowance is increased by provisions charged to expense and is reduced by net charge-offs.
The level of the allowance is based on management’s evaluation of probable losses in the loan portfolio, after consideration of prevailing economic conditions in the Company’s market area, the volume and composition of the loan portfolio, and historical loan loss experience. The allowance for loan losses consists of specific reserves for individually impaired credits and TDRs, reserves for nonimpaired loans based on historical loss factors adjusted for general economic factors and other qualitative risk factors such as changes in delinquency trends, industry concentrations or local/national economic trends. This risk assessment process is performed at least quarterly, and, as adjustments become necessary, they are realized in the periods in which they become known.
Although management attempts to maintain the allowance at a level deemed adequate to provide for probable losses, future additions to the allowance may be necessary based upon certain factors including changes in market conditions and underlying collateral values. In addition, various regulatory agencies periodically review the adequacy of the Company’s allowance for loan losses. These agencies may require the Company to make additional provisions based on their judgments about information available at the time of the examination.
The Company maintains a reserve for unfunded loan commitments at a level that management believes is adequate to absorb estimated probable losses. Adjustments to the reserve are made through other expenses and applied to the reserve which is classified as other liabilities.
For additional information on the allowance for loan losses and reserve for unfunded loan commitments, see Note 5 to the Consolidated Financial Statements.
Premises and Equipment, net
Land is carried at cost. All other fixed assets are carried at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. The useful life of buildings is not to exceed 30 years; furniture and fixtures is generally 10 years or less, and equipment is 3 to 5 years. Leasehold improvements are depreciated over the life of the underlying lease.
For additional information on premises and equipment, see Note 6 to the Consolidated Financial Statements.
Bank Owned Life Insurance
The Company purchased life insurance policies on certain members of management. Bank owned life insurance is recorded at its cash surrender value or the amount that can be realized.
Federal Home Loan Bank Stock
Federal law requires a member institution of the Federal Home Loan Bank system to hold stock of its district FHLB according to a predetermined formula. The stock is carried at cost. Management reviews the stock for impairment based on the ultimate recoverability of the cost basis in the stock. The stock’s value is determined by the ultimate recoverability of the par value rather than by recognizing temporary declines. Management considers such criteria as the significance of the decline in net assets, if any, of the FHLB, the length of time this situation has persisted, commitments by the FHLB to make payments required by law or regulation, the impact of legislative and regulatory changes on the customer base of the FHLB and the liquidity position of the FHLB.
Accrued Interest Receivable
Accrued interest receivable consists of amounts earned on investments and loans. The Company recognizes accrued interest receivable as it is earned.
Other Real Estate Owned
Other real estate owned is recorded at the fair value, less estimated costs to sell at the date of acquisition, with a charge to the allowance for loan losses for any excess of the loan carrying value over such amount. Subsequently, OREO is carried at the lower of cost or fair value, as determined by current appraisals. Certain costs that increase the value or extend the useful life in preparing properties for sale are capitalized to the extent that the appraisal amount exceeds the carry value, and expenses of holding foreclosed properties are charged to operations as incurred.
Goodwill
The Company accounts for goodwill and other intangible assets in accordance with FASB ASC Topic 350, “Intangibles - Goodwill and Other,” which allows an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Based on a qualitative assessment, management determined that the Company’s recorded goodwill totaling $1.5 million, which resulted from the 2005 acquisition of its Phillipsburg, New Jersey branch, is not impaired as of December 31, 2020.
Appraisals
The Company requires current real estate appraisals on all loans that become OREO or in-substance foreclosure, 1-4 family residential and consumer mortgage loans above $400,000, commercial credit facilities above $500,000 when supported by real property or nonperforming loans with properties that are securing credit. Prior to each balance sheet date, the Company values impaired collateral-dependent loans and OREO based upon a third party appraisal, broker’s price opinion, drive by appraisal, automated valuation model, updated market evaluation, or a combination of these methods. The amount is discounted for the decline in market real estate values for any known damage or repair costs, and for selling and closing costs. The amount of the discount is dependent upon the method used to determine the original value. The original appraisal is generally used when a loan is first determined to be impaired. When applying the discount, the Company takes into consideration when the appraisal was performed, the collateral’s location, the type of collateral, any known damage to the property and the type of business. Subsequent to entering impaired status and the Company determining that there is a collateral shortfall, the Company will generally, depending on the type of collateral, order a third party appraisal, broker’s price opinion, automated valuation model or updated market evaluation. Subsequent to receiving the third party results, the Company will discount the value 6 to 10 percent for selling and closing costs.
Derivative Instruments and Hedging Activities
The Company utilizes derivative instruments in the form of interest rate swaps to hedge its exposure to interest rate risk in conjunction with its overall asset and liability risk management process. In accordance with accounting requirements, the Company formally designates all of its hedging relationships as either fair value hedges, intended to offset the changes in the value of certain financial instruments due to movements in interest rates, or cash flow hedges, intended to offset changes in the cash flows of certain financial instruments due to movement in interest rates, and documents the strategy for undertaking the hedge transactions, and its method of assessing ongoing effectiveness. The Company’s derivative instruments currently consist of cash flow hedges.
We recognize all derivative instruments at fair value as either Other assets or Other liabilities on the Consolidated Balance Sheet and the related cash flows in the Operating Activities section of the Consolidated Statement of Cash Flows.
For derivatives designated cash flow hedges (i.e., hedging the exposure to variability in expected future cash flows), the gain or loss on the derivative is reported in other comprehensive income and is reclassified into earnings in the same periods during which the hedged transaction affects earnings.
Derivative instruments qualify for hedge accounting treatment only if they are designated as such on the date on which the derivative contract is entered and are expected to be, and are, effective in substantially reducing interest rate risk arising from the assets and liabilities identified as exposing the Company to risk. Those derivative financial instruments that do not meet the hedging criteria discussed below would be classified as undesignated derivatives and would be recorded at fair value with changes in fair value recorded in income.
The Company discontinues hedge accounting when (a) it determines that a derivative is no longer effective in offsetting changes in cash flows of a hedged item; (b) the derivative expires or is sold, terminated or exercised; (c) probability exists that the forecasted transaction will no longer occur; or (d) management determines that designating the derivative as a hedging instrument is no longer appropriate. In all cases in which hedge accounting is discontinued and a derivative remains outstanding, the Company will carry the derivative at fair value in the Consolidated Financial Statements, recognizing changes in fair value in current period income in the consolidated statement of income.
For additional information on derivative instruments and hedging activities, see Note 9 to the Consolidated Financial Statements.
Income Taxes
The Company follows Financial Accounting Standards Board Accounting Standards Codification ("FASB ASC") Topic 740, “Income Taxes,” which prescribes a threshold for the financial statement recognition of income taxes and provides criteria for the measurement of tax positions taken or expected to be taken in a tax return. ASC 740 also includes guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition of income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using the enacted tax rates applicable to taxable income for the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation reserves are established against certain deferred tax assets when it is more likely than not that the deferred tax assets will not be realized. Increases or decreases in the valuation reserve are charged or credited to the income tax provision.
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that ultimately would be sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. The evaluation of a tax position taken is considered by itself and not offset or aggregated with other positions. Tax positions that meet the more likely than not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.
Interest and penalties associated with unrecognized tax benefits are recognized in income tax expense on the income statement.
For additional information on income taxes, see Note 16 to the Consolidated Financial Statements.
Net Income Per Share
Basic net income per common share is calculated as net income available to common shareholders divided by the weighted average common shares outstanding during the reporting period.
Diluted net income per common share is computed similarly to that of basic net income per common share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if all potentially dilutive common shares, principally stock options, were issued during the reporting period utilizing the Treasury stock method. However, when a net loss rather than net income is recognized, diluted earnings per share equals basic earnings per share.
For additional information on net income per share, see Note 17 to the Consolidated Financial Statements.
Stock-Based Compensation
The Company accounts for its stock-based compensation awards in accordance with FASB ASC Topic 718, “Compensation - Stock Compensation,” which requires recognition of compensation expense related to stock-based compensation awards over the period during which an employee is required to provide service for the award. Compensation expense is equal to the fair value of the award, net of estimated forfeitures, and is recognized over the vesting period of such awards.
For additional information on the Company’s stock-based compensation, see Note 19 to the Consolidated Financial Statements.
Fair Value
The Company follows FASB ASC Topic 820, “Fair Value Measurement and Disclosures,” which provides a framework for measuring fair value under generally accepted accounting principles.
For additional information on the fair value of the Company’s financial instruments, see Note 20 to the Consolidated Financial Statements.
Other Comprehensive Income
Other comprehensive income consists of the change in unrealized gains (losses) on SERP, securities available for sale and swap related items that were reported as a component of shareholders’ equity, net of tax.
For additional information on other comprehensive income, see Note 12 to the Consolidated Financial Statements.
Advertising
The Company expenses the costs of advertising in the period incurred.
Dividend Restrictions
Banking regulations require maintaining certain capital levels that may limit the dividends paid by the Bank to the holding company or by the holding company to the shareholders.
Operating Segments
While management monitors the revenue streams of its various products and services, operating results and financial performance are evaluated on a company-wide basis. The Company’s management uses consolidated results to make operating and strategic decisions. Accordingly, there is only one reportable segment.
Recent Accounting Pronouncements
ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." ASU 2016-13 was issued to replace the incurred loss impairment methodology in current GAAP with an expected credit loss methodology and requires consideration of a broader range of information to determine credit loss estimates. Financial assets measured at amortized cost will be presented at the net amount expected to be collected by using an allowance for credit losses. Purchased credit impaired loans will receive an allowance account at the acquisition date that represents a component of the purchase price allocation. Credit losses relating to available-for-sale debt securities will be recorded through an allowance for credit losses, with such allowance limited to the amount by which fair value is below amortized cost. For public business entities, ASU 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019.
In May 2019, FASB issued ASU 2019-05, "Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief." ASU 2019-05 was issued to address concerns with the adoption of ASU 2016-13. ASU 2019-05 gives entities the ability to irrevocably elect the fair value option in Subtopic 825-10 for certain existing financial assets upon transition to ASU 2016-03. Financial assets that are eligible for this fair value election are those that qualify under Subtopic 825-10 and are within the scope of Subtopic 326-10, "Financial Instruments - Credit Losses - Measured at Amortized Costs." An exception to this is held-to-maturity debt securities, which do not qualify for this transition election. The effective date for the amendment is the same as the effective date in ASU 2016-03. In November 2019, FASB issued ASU 2019-10, "Financial Instruments - Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates." ASU 2019-10 was issued to defer the effective dates for certain guidance in its Accounting Standard Codification ("ASC") for certain entities. The amendments in this update amend the mandatory effective dates for ASC 326, "Financial Instruments - Credit Losses", for entities eligible to be smaller reporting companies as defined by the SEC for fiscal years beginning after December 15, 2022, including interim reporting periods within that reporting period. The Company is currently evaluating the impact of the adoption of ASU 2016-13 on its consolidated financial statements.
In November 2019, FASB issued ASU 2019-11, "Codification Improvements to Topic 326, Financial Instruments - Credit Losses." ASU 2019-11 was issued to address issues raise by stakeholders during the implementation of ASU 2016-13. ASU 2019-11 provides transition relief when adjusting the effective interest rate for troubled debt restructurings ("TDRs") that exist as of the adoption date, extends the disclosure relief in ASU 2019-04 to disclose accrued interest receivable balances separately from the amortized cost basis to additional disclosures involving amortized cost basis, and provides clarification regarding application of the guidance in paragraph 326-20-35-6 for financial assets secured by collateral maintenance provisions that provides a practical expedient to measure the estimate of expected credit losses by comparing the amortized cost basis of a financial asset and the fair value of collateral securing the financial asset as of the reporting date. The effective date and transition requirements for the amendment are the same as the effective date and transition requirements in ASU 2016-13.
ASU 2017-04, "Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment." ASU 2017-04 was issued in an effort to simplify accounting in a new standard. The amendments in this update require that an entity perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. The amendment states that an entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, but the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. For public business entities, ASU 2017-04 is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performing on testing dates after January 1, 2017. The Company adopted this standard as of January 1, 2020. The adoption of this ASU did not have an impact on the Company’s consolidated financial statements since the fair values of our reporting units were not lower than their respective carrying amounts at the time of our goodwill impairment analysis.
ASU 2018-14, “Compensation - Retirement Benefits - Defined Benefit Plans - General (Subtopic 715-20): Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans.” ASU 2018-14 removes, adds and clarifies certain disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. For public business entities, ASU 2018-14 is effective for interim and annual periods beginning after December 15, 2020.
ASU 2019-12, "Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes." ASU 2019-12 removes the exception to the incremental approach for intraperiod tax allocation when there is a loss from continuing operations and income or a gain from other items and removes the exception to the interim period income tax accounting when a year-to-date loss exceeds the anticipated loss for the year. ASU 2019-12 also simplifies the accounting for income taxes by requiring that an entity recognize a franchise tax that is partially based on income as an income-based tax, that an entity evaluate when a step up in the tax basis of goodwill should be considered part of the business combination in which the book goodwill originally was recognized, and that an entity reflect the effect of an enacted change in tax laws or rates in the annual effective tax rate computation in the interim period that includes the enactment date. For public business entities, ASU 2019-12 is effective for interim and annual periods beginning after December 15, 2020.
ASU 2020-01, "Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815): Clarifying the Interactions between Topic 321, Topic 323, and Topic 815 (a consensus of the Emerging Issues Task Force)." ASU 2020-01 clarifies that the observable price changes in orderly transactions that should be considered when applying the measurement alternative in accordance with ASC 321 include transactions that require it to either apply or discontinue the equity method of accounting under ASC 323. ASU 2020-01 also addresses questions about how to apply the guidance in Topic 815, “Derivatives and Hedging,” for certain forward contracts and purchased options to purchase securities that, upon settlement or exercise, would be accounted for under the equity method of accounting. The ASU clarifies that, for the purpose of applying ASC 815-10-15-141(a), an entity should not consider whether, upon the settlement of the forward contract or exercise of the purchased option, the underlying securities would be accounted for under the equity method in ASC 323 or the fair value option in accordance with the financial instruments guidance in Topic 825, “Financial Instruments.” For public business entities, ASU 2020-01 is effective for interim and annual periods beginning after December 15, 2020.
ASU 2020-03, "Codification Improvement to Financial Instruments." ASU 2020-03 clarifies that all entities are required to provide the fair value option disclosures in paragraphs 825-10-50-24 through 50-32 of the FASB’s Accounting Standards Codification (ASC). ASU 2020-03 also clarifies that the contractual term of a net investment in a lease determined in accordance with ASC 842, “Leases,” should be the contractual term used to measure expected credit losses under ASC 326, “Financial Instruments - Credit Losses.” ASU 2020-03 also addresses amendments to ASC 860-20, “Transfers and Servicing - Sales of Financial Assets,” clarify that when an entity regains control of financial assets sold, an allowance for credit losses should be recorded in accordance with ASC 326. The effective date and transition requirements for the amendment are the same as the effective date and transition requirements in ASU 2016-13.
ASU 2020-04, "Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting." ASU 2020-04 provides temporary optional guidance intended to ease the burden of reference rate reform on financial reporting. The guidance provides optional expedients and exceptions for applying existing guidance to contract modifications, hedging relationships and other transactions that are expected to be affected by reference rate reform and meet certain scope guidance. ASU 2020-04 provides various optional expedients, including the following, for hedging relationships affected by reference rate reform, if certain criteria are met:
● An entity can change certain critical terms of the hedging instrument or hedged item or transaction without having to dedesignate the relationship.
● For fair value hedging relationships in which the designated interest rate is LIBOR or another rate that is expected to be discontinued, an entity may change the hedged risk to another permitted benchmark rate without dedesignating the relationship.
● For cash flow hedging relationships in which the designated hedged risk is LIBOR or another rate that is expected to be discontinued, an entity may assert that the occurrence of the hedged forecasted transaction remains probable.
● Certain qualifying conditions for the shortcut method and other methods that assume perfect effectiveness may be disregarded.
In addition, ASU 2020-04 permits an entity to make a one-time election to sell, transfer, or both sell and transfer debt securities classified as held to maturity that reference a rate affected by reference rate reform and that were classified as held to maturity before January 1, 2020. ASU 2020-04 was effective upon its issuance on March 12, 2020. However, it
cannot be applied to contract modifications that occur after December 31, 2022. With certain exceptions, the ASU also cannot be applied to hedging relationships entered into or evaluated after that date.
ASU 2020-06, “Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity's Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity's Own Equity.” ASU 2020-06 was issued to address the complexities of its guidance for certain financial instruments with characteristics of liabilities and equity, including:
● Removing the accounting models that require beneficial conversion features or cash conversion features associated with convertible instruments to be recognized as a separate component of equity.
● Adding certain disclosure requirements for convertible instruments.
● Amending the guidance for the derivatives scope exception for contracts in an entity’s own equity.
● Simplifying the diluted earning per share calculation for certain situations.
For public business entities, ASU 2020-06 is effective for interim and annual periods beginning after December 15, 2021.
ASU 2020-10, “Codification Improvements.” ASU 2020-10 was issued to make changes to clarify the Codification, corrects unintended application of guidance, and makes minor improvements to the Codification that are not expected to have a significant effect on current accounting practice. The transition and effective date guidance in this ASU is based on the facts and circumstances of each amendment.
Revenue Recognition
ASC 606, Revenue from Contracts with Customers ("ASC 606"), establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the entity’s contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services recognized as performance obligations are satisfied.
The majority of our revenue-generating transactions are not subject to ASC 606, including revenue generated from financial instruments, such as our loans, letters of credit, derivatives and investment securities, as well as revenue related to our mortgage servicing activities, as these activities are subject to other GAAP discussed elsewhere within our disclosures. Descriptions of our revenue-generating activities that are within the scope of ASC 606, which are presented in our income statements as components of non-interest income are as follows:
● Service charges on deposit accounts - these represent general service fees for monthly account maintenance and activity- or transaction based fees and consist of transaction-based revenue, time-based revenue (service period), item-based revenue or some other individual attribute-based revenue. Revenue is recognized when our performance obligation is completed which is generally monthly for account maintenance services or when a transaction has been completed (such as a wire transfer). Payment for such performance obligations are generally received at the time the performance obligations are satisfied.
● Other non-interest income primarily includes items such as letter of credit fees, bank owned life insurance income, dividends on FHLB and FRB stock and other general operating income, none of which are subject to the requirements of ASC 606.
Subsequent Events
The Company has evaluated all events or transactions that occurred through the date the Company issued these financial statements. During this period, the Company did not have any material recognizable or non-recognizable subsequent events.
2. Restrictions on Cash
Federal law requires depository institutions to hold reserves in the form of vault cash or, if vault cash is insufficient, in the form of a deposit maintained with a Federal Reserve Bank. The dollar amount of a depository institution’s reserve
requirement is determined by applying the reserve ratios specified in the FRB’s Regulation D to an institution’s reservable liabilities. In response to COVID-19, on March 15, 2020, the FRB announced the reduction of the reserve requirement ratios to zero percent, effective March 26, 2020. This action eliminated the reserve requirement for depository institutions to help support lending to households and businesses. At December 31, 2019, the Company had $25.5 million of reserves to meet its reserve requirements.
In addition, the Company’s contract with its current electronic funds transfer (“EFT”) provider requires a predetermined balance be maintained in a settlement account controlled by the provider equal to the Company’s average daily net settlement position multiplied by four days. The required balance was $156 thousand as of December 31, 2020 and 2019. This balance can be adjusted periodically to reflect actual transaction volume and seasonal factors.
As of December 31, 2020, Unity Risk Management, Inc. had a total cash balance of $2.0 million, compared to $1.9 million at December 31, 2019.
3. Securities
This table provides the major components of debt securities available for sale (“AFS”) and equity securities with readily determinable fair values ("equity securities") at amortized cost and estimated fair value at December 31, 2020 and December 31, 2019:
December 31, 2020
December 31, 2019
Gross
Gross
Gross
Gross
Amortized
unrealized
unrealized
Estimated
Amortized
unrealized
unrealized
Estimated
(In thousands)
cost
gains
losses
fair value
cost
gains
losses
fair value
Available for sale:
U.S. Government sponsored entities
$
2,000
$
$
-
$
2,003
$
5,751
$
$
(2)
$
5,753
State and political subdivisions
2,935
-
2,969
4,992
(12)
5,154
Residential mortgage-backed securities
16,765
-
17,410
27,698
(106)
27,964
Corporate and other securities
24,221
(1,118)
23,235
25,442
(268)
25,404
Total debt securities available for sale
$
45,921
$
$
(1,118)
$
45,617
$
63,883
$
$
(388)
$
64,275
Equity securities:
Total equity securities
$
2,112
$
-
$
(158)
$
1,954
$
2,218
$
$
(71)
$
2,289
This table provides the remaining contractual maturities and yields of securities within the investment portfolios. The carrying value of securities at December 31, 2020 is distributed by contractual maturity. Mortgage-backed securities and other securities, which may have principal prepayment provisions, are distributed based on contractual maturity. Expected maturities will differ materially from contractual maturities as a result of early prepayments and calls.
After one through
After five through
Total carrying
Within one year
five years
ten years
After ten years
value
(In thousands, except percentages)
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Available for sale at fair value:
U.S. Government sponsored entities
$
2,003
1.48
%
$
-
-
%
$
-
-
%
$
-
-
%
$
2,003
1.48
%
State and political subdivisions
2,051
2.85
1.90
-
-
2.74
2,969
2.73
Residential mortgage-backed securities
2,662
1.16
10,862
2.58
5.44
3,713
2.68
17,410
2.42
Corporate and other securities
5,544
4.57
8,055
4.51
5,236
3.00
4,400
3.14
23,235
3.92
Total debt securities available for sale
$
12,260
3.04
%
$
19,200
3.38
%
$
5,409
3.08
%
$
8,748
2.92
%
$
45,617
3.16
%
Equity Securities at fair value:
Total equity securities
$
-
-
%
$
-
-
%
$
-
-
%
$
1,954
2.55
%
$
1,954
2.55
%
The fair value of securities with unrealized losses by length of time that the individual securities have been in a continuous unrealized loss position at December 31, 2020 and December 31, 2019 are as follows:
December 31, 2020
Less than 12 months
12 months and greater
Total
Total
number in a
Estimated
Unrealized
Estimated
Unrealized
Estimated
Unrealized
(In thousands, except number in a loss position)
loss position
fair value
loss
fair value
loss
fair value
loss
Available for sale:
Corporate and other securities
4,793
(20)
9,157
(1,098)
13,950
(1,118)
Total temporarily impaired securities
$
4,793
$
(20)
$
9,157
$
(1,098)
$
13,950
$
(1,118)
December 31, 2019
Less than 12 months
12 months and greater
Total
Total
number in a
Estimated
Unrealized
Estimated
Unrealized
Estimated
Unrealized
(In thousands, except number in a loss position)
loss position
fair value
loss
fair value
loss
fair value
loss
Available for sale:
U.S. Government sponsored entities
$
-
$
-
$
1,995
$
(2)
$
1,995
$
(2)
State and political subdivisions
-
-
1,013
(12)
1,013
(12)
Residential mortgage-backed securities
3,707
(27)
4,996
(79)
8,703
(106)
Corporate and other securities
3,366
(13)
3,735
(255)
7,101
(268)
Total temporarily impaired securities
$
7,073
$
(40)
$
11,739
$
(348)
$
18,812
$
(388)
Unrealized Losses
The unrealized losses in each of the categories presented in the tables above are discussed in the paragraphs that follow:
U.S. government sponsored entities and state and political subdivision securities: The unrealized losses on investments in these types of securities were caused by the increase in interest rate spreads or the increase in interest rates at the long end of the Treasury curve. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the par value of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity, the Company did not consider these investments to be other-than temporarily impaired as of December 31, 2020 or December 31, 2019.
Residential and commercial mortgage-backed securities: The unrealized losses on investments in mortgage-backed securities were caused by increases in interest rate spreads or the increase in interest rates at the long end of the Treasury curve. The majority of contractual cash flows of these securities are guaranteed by the Federal National Mortgage Association (FNMA), the Government National Mortgage Association (GNMA) and the Federal Home Loan Mortgage Corporation (FHLMC). It is expected that the securities would not be settled at a price significantly less than the par value of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity, the Company did not consider these investments to be other-than-temporarily impaired as of December 31, 2020 or December 31, 2019.
Corporate and other securities: Included in this category are corporate and other debt securities. The unrealized losses on corporate and other debt securities were due to widening credit spreads. The Company evaluated the prospects of the issuers and forecasted a recovery period; and as a result determined it did not consider these investments to be other-than-temporarily impaired as of December 31, 2020 or December 31, 2019. The contractual terms do not allow the securities to be settled at a price less than the par value. Because the Company does not intend to sell the securities and it is not more likely than not that the Company will be required to sell the securities before recovery of its amortized cost basis, which may be at maturity, the Company did not consider these securities to be other-than-temporarily impaired as of December 31, 2020 or December 31, 2019.
Realized Gains and Losses
Gross realized gains and losses on securities for the past three years are detailed in the table below:
For the years ended December 31,
(In thousands)
Available for sale:
Realized gains
$
$
$
-
Realized losses
-
-
(4)
Total debt securities available for sale
(4)
Net gains on sales of securities
$
$
$
(4)
The net realized gains are included in noninterest income in the Consolidated Statements of Income as net security gains. There were $317 thousand of gross realized gains in 2020, compared to $35 thousand of gross realized gains in 2019 and no gross realized gains in 2018. There were no gross realized losses in 2020 or 2019, compared to $4 thousand in 2018.
● The net gain during 2020 is attributed to the sale of two corporate bonds with a total book value of $2.7 million and resulting gains of $77 thousand, three mortgage-backed securities with a total book value of $2.8 million and resulting gains of $57 thousand, one taxable municipal security with a book value of $456 thousand and resulting gains of $140 thousand, one tax-exempt municipal security with a book value of $381 thousand and resulting gains of $27 thousand, and the call of three tax-exempt municipal securities with a total book value of $1.8 million and resulting gains of $16 thousand.
● The net gain during 2019 is attributed to the sale of two commercial mortgage-backed securities with a total book value of $3.5 million and resulting gains of $64 thousand offset by the sale of two agency securities with a total book value of $2.1 million and resulting losses of $29 thousand.
● The net loss during 2018 is attributed to the partial call of one tax-exempt municipal security with a book value of $174 thousand which resulted in a loss of $4 thousand.
Equity Securities
Included in this category are Community Reinvestment Act ("CRA") investments and the equity holdings of financial institutions. Equity securities are defined to include (a) preferred, common and other ownership interests in entities including partnerships, joint ventures and limited liability companies and (b) rights to acquire or dispose of ownership interest in entities at fixed or determinable prices.
The following is a summary of the gains and losses recognized in net income on equity securities for the past two years:
For the year ended December 31,
(In thousands)
Net (losses) gains recognized during the period on equity securities
$
(229)
$
Net gains recognized during the period on equity securities sold during the period
Unrealized (losses) gains recognized during the reporting period on equity securities still held at the reporting date
$
(224)
$
Pledged Securities
Securities with a carrying value of $1.6 million and $4.0 million at December 31, 2020 and December 31, 2019, respectively, were pledged to secure Government deposits, secure other borrowings and for other purposes required or permitted by law.
4. Loans
The following table sets forth the classification of loans by class, including unearned fees, deferred costs and excluding the allowance for loan losses for the past two years:
(In thousands)
December 31, 2020
December 31, 2019
SBA loans held for investment
$
39,587
$
35,767
SBA PPP loans
118,257
-
Commercial loans
SBA 504 loans
19,681
26,726
Commercial other
118,280
112,014
Commercial real estate
630,423
578,643
Commercial real estate construction
71,404
47,649
Residential mortgage loans
467,586
467,706
Consumer loans
Home equity
62,549
69,589
Consumer construction
87,164
72,497
Consumer other
3,551
1,438
Total loans held for investment
$
1,618,482
$
1,412,029
SBA loans held for sale
9,335
13,529
Total loans
$
1,627,817
$
1,425,558
Loans are made to individuals as well as commercial entities. Specific loan terms vary as to interest rate, repayment, and collateral requirements based on the type of loan requested and the credit worthiness of the prospective borrower. Credit risk tends to be geographically concentrated in that a majority of the loan customers are located in the markets serviced by the Bank. Loan performance may be adversely affected by factors impacting the general economy or conditions specific to the real estate market such as geographic location and/or property type. A description of the Company’s different loan segments follows:
SBA Loans: SBA 7(a) loans, on which the SBA has historically provided guarantees of up to 90 percent of the principal balance, are considered a higher risk loan product for the Company than its other loan products. The guaranteed portion of the Company’s SBA loans is generally sold in the secondary market with the nonguaranteed portion held in the portfolio as a loan held for investment. SBA loans are for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. Loans are guaranteed by the businesses’ major owners. SBA loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was signed into law. It contains substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic. The CARES Act includes a range of other provisions designed to support the U.S. economy and mitigate the impact of COVID-19 on financial institutions and their customers, including through the authorization of various relief programs and measures that the U.S. Department of the Treasury, the Small Business Administration, the Federal Reserve Board (“FRB”) and other federal banking agencies have implemented or may implement.
The CARES Act provides assistance to small businesses through the establishment of the SBA Paycheck Protection Program (“PPP”). The PPP generally provides eligible small businesses with funds to pay up to 24 weeks of payroll costs, including certain benefits. The funds are provided in the form of loans that may be fully or partially forgiven when used for payroll costs, interest on mortgages, rent, or utilities. The payments on these loans will be deferred for up to six months. Loans made after June 5, 2020, mature in five years, and loans made prior to June 5, 2020, mature in two years but can be extended to five years if the lender agrees. Forgiveness of the PPP loans is based on the borrower maintaining or quickly rehiring employees and maintaining salary levels. Applications for the PPP loans started on April 3, 2020 and were extended through August 8, 2020. The Economic Aid to Hard-Hit Small Businesses, Nonprofits and Venues Act (the “Economic Aid Act”) became law on December 27, 2020. Among other things, the Economic Aid Act extended the PPP through March 31, 2021 and allocated additional funds for new PPP loans, to be guaranteed by the SBA. The
extension included an authorization to make new PPP loans to existing PPP loan borrowers, and to make loans to parties that did not previously obtain a PPP loan. Loans originated under the extended PPP will have substantially the same terms as existing PPP loans. As an existing SBA 7(a) lender, the Company opted to participate in the program.
Commercial Loans: Commercial credit is extended primarily to middle market and small business customers. Commercial loans are generally made in the Company’s market place for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. The SBA 504 program consists of real estate backed commercial mortgages where the Company has the first mortgage and the SBA has the second mortgage on the property. Loans will generally be guaranteed in full or for a meaningful amount by the businesses’ major owners. Commercial loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided. Generally, the Company has a 50 percent loan to value ratio on SBA 504 program loans at origination.
Residential Mortgage and Consumer Loans: The Company originates mortgage and consumer loans including principally residential real estate, home equity lines and loans and consumer construction lines. The Company originates qualified mortgages which are generally sold in the secondary market and nonqualified mortgages which are generally held for investment. Each loan type is evaluated on debt to income, type of collateral and loan to collateral value, credit history and Company relationship with the borrower.
Inherent in the lending function is credit risk, which is the possibility a borrower may not perform in accordance with the contractual terms of their loan. A borrower’s inability to pay their obligations according to the contractual terms can create the risk of past due loans and, ultimately, credit losses, especially on collateral deficient loans. The Company minimizes its credit risk by loan diversification and adhering to credit administration policies and procedures. Due diligence on loans begins when the Company initiates contact regarding a loan with a borrower. Documentation, including a borrower’s credit history, materials establishing the value and liquidity of potential collateral, the purpose of the loan, the source of funds for repayment of the loan, and other factors, are analyzed before a loan is submitted for approval. The loan portfolio is then subject to on-going internal reviews for credit quality, as well as independent credit reviews by an outside firm.
The Company’s extension of credit is governed by the Credit Risk Policy which was established to control the quality of the Company’s loans. These policies and procedures are reviewed and approved by the Board of Directors on a regular basis.
Credit Ratings
For SBA 7(a), and commercial loans, management uses internally assigned risk ratings as the best indicator of credit quality. A loan’s internal risk rating is updated at least annually and more frequently if circumstances warrant a change in risk rating. The Company uses a 1 through 10 loan grading system that follows regulatory accepted definitions.
Pass: Risk ratings of 1 through 6 are used for loans that are performing, as they meet, and are expected to continue to meet, all of the terms and conditions set forth in the original loan documentation, and are generally current on principal and interest payments. These performing loans are termed “Pass”.
Special Mention: Criticized loans are assigned a risk rating of 7 and termed “Special Mention”, as the borrowers exhibit potential credit weaknesses or downward trends deserving management’s close attention. If not checked or corrected, these trends will weaken the Bank’s collateral and position. While potentially weak, these borrowers are currently marginally acceptable and no loss of interest or principal is anticipated. As a result, special mention assets do not expose an institution to sufficient risk to warrant adverse classification. Included in “Special Mention” could be turnaround situations, such as borrowers with deteriorating trends beyond one year, borrowers in start up or deteriorating industries, or borrowers with a poor market share in an average industry. "Special Mention" loans may include an element of asset quality, financial flexibility, or below average management. Management and ownership may have limited depth or experience. Regulatory agencies have agreed on a consistent definition of “Special Mention” as an asset with potential weaknesses which, if left uncorrected, may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. This definition is intended to ensure that the “Special Mention” category is
not used to identify assets that have as their sole weakness credit data exceptions or collateral documentation exceptions that are not material to the repayment of the asset.
Substandard: Classified loans are assigned a risk rating of an 8 or 9, depending upon the prospect for collection, and deemed “Substandard”. A risk rating of 8 is used for borrowers with well-defined weaknesses that jeopardize the orderly liquidation of debt. The loan is inadequately protected by the current paying capacity of the obligor or by the collateral pledged, if any. Normal repayment from the borrower is in jeopardy, although no loss of principal is envisioned. There is a distinct possibility that a partial loss of interest and/or principal will occur if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified “Substandard”.
A risk rating of 9 is used for borrowers that have all the weaknesses inherent in a loan with a risk rating of 8, with the added characteristic that the weaknesses make collection of debt in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Serious problems exist to the point where partial loss of principal is likely. The possibility of loss is extremely high, but because of certain important, reasonably specific pending factors that may work to strengthen the assets, the loans’ classification as estimated losses is deferred until a more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures; capital injection; perfecting liens on additional collateral; and refinancing plans. Partial charge-offs are likely.
Loss: Once a borrower is deemed incapable of repayment of unsecured debt, the risk rating becomes a 10, the loan is termed a “Loss”, and charged-off immediately. Loans to such borrowers are considered uncollectible and of such little value that continuance as active assets of the Bank is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off these basically worthless assets even though partial recovery may be affected in the future.
For residential mortgage and consumer loans, management uses performing versus nonperforming as the best indicator of credit quality. Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being delinquent for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt. These credit quality indicators are updated on an ongoing basis, as a loan is placed on nonaccrual status as soon as management believes there is sufficient doubt as to the ultimate ability to collect interest on a loan.
The tables below detail the Company’s loan portfolio by class according to their credit quality indicators discussed in the paragraphs above as of December 31, 2020:
December 31, 2020
SBA & Commercial loans - Internal risk ratings
(In thousands)
Pass
Special mention
Substandard
Total
SBA loans held for investment
$
36,818
$
$
2,244
$
39,587
SBA PPP loans
118,257
-
-
118,257
Commercial loans
SBA 504 loans
19,681
-
-
19,681
Commercial other
109,672
5,533
3,075
118,280
Commercial real estate
603,482
25,206
1,735
630,423
Commercial real estate construction
71,404
-
-
71,404
Total commercial loans
804,239
30,739
4,810
839,788
Total SBA and commercial loans
$
959,314
$
31,264
$
7,054
$
997,632
Residential mortgage & Consumer loans - Performing/Nonperforming
(In thousands)
Performing
Nonperforming
Total
Residential mortgage loans
$
462,369
$
5,217
$
467,586
Consumer loans
Home equity
61,254
1,295
62,549
Consumer construction
85,414
1,750
87,164
Consumer other
3,551
-
3,551
Total consumer loans
150,219
3,045
153,264
Total residential mortgage and consumer loans
$
612,588
$
8,262
$
620,850
The tables below detail the Company’s loan portfolio by class according to their credit quality indicators discussed in the paragraphs above as of December 31, 2019:
December 31, 2019
SBA & Commercial loans - Internal risk ratings
(In thousands)
Pass
Special mention
Substandard
Total
SBA loans held for investment
$
34,202
$
1,115
$
$
35,767
SBA PPP loans
-
-
-
-
Commercial loans
SBA 504 loans
24,878
1,808
26,726
Commercial other
107,220
3,361
1,433
112,014
Commercial real estate
576,326
1,559
578,643
Commercial real estate construction
47,649
-
-
47,649
Total commercial loans
756,073
5,927
3,032
765,032
Total SBA and commercial loans
$
790,275
$
7,042
$
3,482
$
800,799
Residential mortgage & Consumer loans - Performing/Nonperforming
(In thousands)
Performing
Nonperforming
Total
Residential mortgage loans
$
463,770
$
3,936
$
467,706
Consumer loans
Home equity
69,589
-
69,589
Consumer construction
72,497
-
72,497
Consumer other
1,418
1,438
Total consumer loans
143,504
143,524
Total residential mortgage and consumer loans
$
607,274
$
3,956
$
611,230
Nonperforming and Past Due Loans
Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being delinquent for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt. Loans past due 90 days or more and still accruing interest are not included in nonperforming loans and generally represent loans that are well secured and in process of collection. The risk of loss is difficult to quantify and is subject to fluctuations in collateral values, general economic conditions and other factors. The Company values its collateral through the use of appraisals, broker price opinions, and knowledge of its local market.
The following tables set forth an aging analysis of past due and nonaccrual loans as of December 31, 2020 and December 31, 2019:
December 31, 2020
90+ days
30-59 days
60-89 days
and still
Nonaccrual
Total past
(In thousands)
past due
past due
accruing
(1)
due
Current
Total loans
SBA loans held for investment
$
$
1,280
$
-
$
2,473
$
4,545
$
35,042
$
39,587
SBA PPP loans
-
-
-
-
-
118,257
118,257
Commercial loans
SBA 504 loans
-
-
-
-
-
19,681
19,681
Commercial other
-
117,627
118,280
Commercial real estate
3,109
1,971
-
1,059
6,139
624,284
630,423
Commercial real estate construction
1,047
-
-
-
1,047
70,357
71,404
Residential mortgage loans
3,232
2,933
5,217
11,644
455,942
467,586
Consumer loans
Home equity
-
1,295
1,875
60,674
62,549
Consumer construction
-
1,750
2,666
84,498
87,164
Consumer other
-
-
3,547
3,551
Total loans held for investment
8,882
7,182
12,060
28,573
1,589,909
1,618,482
SBA loans held for sale
-
-
-
8,738
9,335
Total loans
$
9,479
$
7,182
$
$
12,060
$
29,170
$
1,598,647
$
1,627,817
(1) At December 31, 2020, nonaccrual loans included $371 thousand of loans guaranteed by the SBA.
December 31, 2019
90+ days
30-59 days
60-89 days
and still
Nonaccrual
Total past
(In thousands)
past due
past due
accruing
(1)
due
Current
Total loans
SBA loans held for investment
$
1,048
$
-
$
-
$
1,164
$
2,212
$
33,555
$
35,767
SBA PPP loans
-
-
-
-
-
-
-
Commercial loans
SBA 504 loans
-
1,808
-
-
1,808
24,918
26,726
Commercial other
-
-
111,627
112,014
Commercial real estate
-
-
578,215
578,643
Commercial real estate construction
-
-
-
-
-
47,649
47,649
Residential mortgage loans
4,383
1,676
3,936
10,925
456,781
467,706
Consumer loans
Home equity
1,446
-
-
1,624
67,965
69,589
Consumer construction
-
-
-
72,384
72,497
Consumer other
-
-
-
1,418
1,438
Total loans held for investment
7,163
3,775
5,649
17,517
1,394,512
1,412,029
SBA loans held for sale
-
-
-
-
-
13,529
13,529
Total loans
$
7,163
$
3,775
$
$
5,649
$
17,517
$
1,408,041
$
1,425,558
(1) At December 31, 2019, nonaccrual loans included $59 thousand of loans guaranteed by the SBA.
Impaired Loans
The Company has defined impaired loans to be all nonperforming loans and troubled debt restructurings. Management considers a loan impaired when, based on current information and events, it is determined that the Company will not be able to collect all amounts due according to the loan contract.
The following tables provide detail on the Company’s loans individually evaluated for impairment with the associated allowance amount, if applicable, as of December 31, 2020 and December 31, 2019:
December 31, 2020
Unpaid
principal
Recorded
Specific
(In thousands)
balance
investment
reserves
With no related allowance:
SBA loans held for investment (1)
$
1,799
$
1,698
$
-
Commercial loans
Commercial real estate
1,462
1,462
-
Total commercial loans
1,462
1,462
-
Residential mortgage loans
4,080
3,975
-
Consumer loans:
Home equity
1,295
1,295
-
Consumer construction
1,750
1,750
-
Consumer other
-
-
-
Total impaired loans with no related allowance
10,386
10,180
-
With an allowance:
SBA loans held for investment (1)
Commercial loans
Commercial other
3,160
3,160
3,106
Commercial real estate
1,730
1,080
Total commercial loans
4,890
4,240
3,682
Residential mortgage loans
1,242
1,242
Consumer loans:
Home equity
-
-
-
Consumer construction
-
-
-
Consumer other
-
-
-
Total impaired loans with a related allowance
6,566
5,886
4,107
Total individually evaluated impaired loans:
SBA loans held for investment (1)
2,233
2,102
Commercial loans
Commercial other
3,160
3,160
3,106
Commercial real estate
3,192
2,542
Total commercial loans
6,352
5,702
3,682
Residential mortgage loans
5,322
5,217
Consumer loans:
Home equity
1,295
1,295
-
Consumer construction
1,750
1,750
-
Consumer other
-
-
-
Total individually evaluated impaired loans
$
16,952
$
16,066
$
4,107
(1) Balances are reduced by amount guaranteed by the SBA of $371 thousand at December 31, 2020.
December 31, 2019
Unpaid
principal
Recorded
Specific
(In thousands)
balance
investment
reserves
With no related allowance:
SBA loans held for investment (1)
$
1,224
$
1,064
$
-
Commercial loans
Commercial real estate
-
Total commercial loans
-
Total impaired loans with no related allowance
1,437
1,277
-
With an allowance:
SBA loans held for investment (1)
Commercial loans
Commercial other
Commercial real estate
Total commercial loans
1,521
1,021
Total impaired loans with a related allowance
1,678
1,062
Total individually evaluated impaired loans:
SBA loans held for investment (1)
1,381
1,105
Commercial loans
Commercial other
Commercial real estate
Total commercial loans
1,734
1,234
Total individually evaluated impaired loans
$
3,115
$
2,339
$
(1) Balances are reduced by amount guaranteed by the SBA of $59 thousand at December 31, 2019.
The following table presents the average recorded investments in impaired loans and the related amount of interest recognized during the time period in which the loans were impaired for the years ended December 31, 2020, 2019 and 2018. The average balances are calculated based on the month-end balances of impaired loans. When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on nonaccrual status, all payments are applied to principal under the cost recovery method, therefore no interest income is recognized. The interest recognized on impaired loans noted below represents accruing troubled debt restructurings only and nominal amounts of income recognized on a cash basis for well-collateralized impaired loans.
For the years ended December 31,
Interest
Interest
Interest
income
income
income
Average
recognized
Average
recognized
Average
recognized
recorded
on impaired
recorded
on impaired
recorded
on impaired
(In thousands)
investment
loans
investment
loans
investment
loans
SBA loans held for investment (1)
$
1,674
$
$
$
$
1,063
$
Commercial loans
SBA 504 loans
-
-
-
-
Commercial other
-
Commercial real estate
1,232
1,258
2,092
Commercial real estate construction
-
-
-
-
-
Residential mortgage loans
5,409
4,671
-
-
Consumer loans
Home equity
-
-
Consumer construction
-
-
-
-
-
Consumer other
-
-
-
-
-
Total
$
9,449
$
$
6,940
$
$
3,167
$
(1) Balances are reduced by the average amount guaranteed by the SBA of $719 thousand, $124 thousand and $85 thousand for years ended December 31, 2020, 2019 and 2018, respectively.
Troubled Debt Restructurings
The Company’s loan portfolio includes certain loans that have been modified as a troubled debt restructuring (“TDR”). TDRs occur when a creditor, for economic or legal reasons related to a debtor’s financial condition, grants a concession to the debtor that it would not otherwise consider, unless it results in a delay in payment that is insignificant. These concessions typically include reductions in interest rate, extending the maturity of a loan, other modifications of payment terms, or a combination of modifications. Under the CARES Act and regulatory guidance issued in regards to the COVID-19 pandemic, loan payment deferrals for periods of up to 180 days granted to borrowers adversely effected by the pandemic are not considered TDRs if the borrower was current on its loan payments at year end 2019 or until the deferral was granted. When the Company modifies a loan, management evaluates for any possible impairment using either the discounted cash flows method, where the value of the modified loan is based on the present value of expected cash flows, discounted at the contractual interest rate of the original loan agreement, or by using the fair value of the collateral less selling costs if the loan is collateral-dependent. If management determines that the value of the modified loan is less than the recorded investment in the loan, impairment is recognized by segment or class of loan, as applicable, through an allowance estimate or charge-off to the allowance. This process is used, regardless of loan type, and for loans modified as TDRs that subsequently default on their modified terms.
The company had one performing TDR with a balance of $663 thousand and $705 thousand as of December 31, 2020 and December 31, 2019, respectively, which was included in the impaired loan numbers as of such dates. The loan remains in accrual status since it continues to perform in accordance with the restructured terms.
To date, the Company’s TDRs consisted of interest rate reductions, interest only periods, principal balance reductions, and maturity extensions. There were no loans modified as a TDR within the previous 12 months that subsequently
defaulted at some point during the years ended December 31, 2020 or 2019. In this case, the subsequent default is defined as 90 days past due or transferred to nonaccrual status.
Other Loan Information
Servicing Assets:
Loans sold to others and serviced by the Company are not included in the accompanying Consolidated Balance Sheets. The total amount of such loans serviced, but owned by third party investors, amounted to approximately $128.5 million and $130.6 million at December 31, 2020 and 2019, respectively. At December 31, 2020 and 2019, the carrying value, which approximates fair value, of servicing assets was $1.9 million and $2.0 million, respectively, and is included in Other Assets. The fair value of SBA servicing assets was determined using a discount rate of 15%, constant prepayment speeds ranging from 15% to 18%, and interest strip multiples ranging from 2.08% to 3.80%, depending on each individual credit. The fair value of mortgage servicing assets was determined using a discount rate of 12% and the present value of excess servicing over 7 years. A summary of the changes in the related servicing assets for the past three years follows:
For the years ended December 31,
(In thousands)
Balance, beginning of year
$
2,026
$
2,375
$
1,800
Servicing assets capitalized
Amortization of expense
(891)
(992)
(364)
Balance, end of year
$
1,857
$
2,026
$
2,375
In addition, the Company had a $1.3 million discount related to the retained portion of the unsold SBA loans at December 31, 2020 and 2019, respectively.
Officer and Director Loans:
In the ordinary course of business, the Company may extend credit to officers, directors or their associates. These loans are subject to the Company’s normal lending policy. An analysis of such loans, all of which are current as to principal and interest payments, is as follows:
(In thousands)
December 31, 2020
December 31, 2019
Balance, beginning of year
$
17,841
$
22,429
New loans and advances
Loan repayments
(5,817)
(4,661)
Balance, end of year
$
12,082
$
17,841
Loan Portfolio Collateral:
The majority of the Company’s loans are secured by real estate. Declines in the market values of real estate in the Company’s trade area impact the value of the collateral securing its loans. This could lead to greater losses in the event of defaults on loans secured by real estate. At December 31, 2020, and December 31, 2019 approximately 87% and 94% of the Company’s loan portfolio was secured by real estate.
5. Allowance for Loan Losses and Reserve for Unfunded Loan Commitments
Allowance for Loan Losses
The Company has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. At a minimum, the adequacy of the allowance for loan losses is reviewed by management on a quarterly basis. For purposes of determining the allowance for loan losses, the Company has segmented the loans in its portfolio by loan type. Loans are segmented into the following pools: SBA 7(a),
commercial, residential mortgages, and consumer loans. Certain portfolio segments are further broken down into classes based on the associated risks within those segments and the type of collateral underlying each loan. Commercial loans are divided into the following five classes: commercial real estate, commercial real estate construction, unsecured business line of credit, commercial other, and SBA 504. Consumer loans are divided into two classes as follows: home equity and other.
The standardized methodology used to assess the adequacy of the allowance includes the allocation of specific and general reserves. The same standard methodology is used, regardless of loan type. Specific reserves are made to individual impaired loans and troubled debt restructurings (see Note 1 for additional information on this term). The general reserve is set based upon a representative average historical net charge-off rate adjusted for the following environmental factors: delinquency and impairment trends, charge-off and recovery trends, changes in the volume of restructured loans, volume and loan term trends, changes in risk and underwriting policy trends, staffing and experience changes, national and local economic trends, industry conditions and credit concentration changes. Within the five-year historical net charge-off rate, the Company weights the past three years more because it believes they are more indicative of future losses. All of the environmental factors are ranked and assigned a basis points value based on the following scale: low, low moderate, moderate, high moderate and high risk. Each environmental factor is evaluated separately for each class of loans and risk weighted based on its individual characteristics.
● For SBA 7(a) and commercial loans, the estimate of loss based on pools of loans with similar characteristics is made through the use of a standardized loan grading system that is applied on an individual loan level and updated on a continuous basis. The loan grading system incorporates reviews of the financial performance of the borrower, including cash flow, debt-service coverage ratio, earnings power, debt level and equity position, in conjunction with an assessment of the borrower’s industry and future prospects. It also incorporates analysis of the type of collateral and the relative loan to value ratio.
● For residential mortgage and consumer loans, the estimate of loss is based on pools of loans with similar characteristics. Factors such as credit score, delinquency status and type of collateral are evaluated. Factors are updated frequently to capture the recent behavioral characteristics of the subject portfolios, as well as any changes in loss mitigation or credit origination strategies, and adjustments to the reserve factors are made as needed.
According to the Company’s policy, a loss (“charge-off”) is to be recognized and charged to the allowance for loan losses as soon as a loan is recognized as uncollectable. All credits which are 90 days past due must be analyzed for the Company’s ability to collect on the credit. Once a loss is known to exist, the charge-off approval process is immediately expedited. This charge-off policy is followed for all loan types.
The allocated allowance is the total of identified specific and general reserves by loan category. The allocation is not necessarily indicative of the categories in which future losses may occur. The total allowance is available to absorb losses from any segment of the portfolio. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in methodologies for estimating allocated and general reserves in the portfolio.
The following tables detail the activity in the allowance for loan losses by portfolio segment for the past three years:
For the year ended December 31, 2020
SBA held
for
(In thousands)
investment
Commercial
Residential
Consumer
Total
Balance, beginning of period
$
1,079
$
9,722
$
4,254
$
1,340
$
16,395
Charge-offs
(26)
(669)
(200)
-
(895)
Recoveries
-
-
Net recoveries (charge-offs)
(147)
(200)
-
(290)
Provision for loan losses charged to expense
5,417
1,264
7,000
Balance, end of period
$
1,301
$
14,992
$
5,318
$
1,494
$
23,105
For the year ended December 31, 2019
SBA held
for
(In thousands)
investment
Commercial
Residential
Consumer
Total
Balance, beginning of period
$
1,655
$
8,705
$
3,900
$
1,228
$
15,488
Charge-offs
(535)
(501)
(205)
(1)
(1,242)
Recoveries
-
Net (charge-offs) recoveries
(512)
(485)
(205)
(1,193)
Provision for (credit to) loan losses charged to expense
(64)
1,502
2,100
Balance, end of period
$
1,079
$
9,722
$
4,254
$
1,340
$
16,395
For the year ended December 31, 2018
SBA held
for
(In thousands)
investment
Commercial
Residential
Consumer
Total
Balance, beginning of period
$
1,471
$
7,825
$
3,130
$
1,130
$
13,556
Charge-offs
(354)
(10)
-
(22)
(386)
Recoveries
Net (charge-offs) recoveries
(282)
(118)
Provision for (credit to) loan losses charged to expense
(33)
2,050
Balance, end of period
$
1,655
$
8,705
$
3,900
$
1,228
$
15,488
The following tables present loans and their related allowance for loan losses, by portfolio segment, as of December 31st for the past two years:
December 31, 2020
SBA held
for
(In thousands)
investment
Commercial
Residential
Consumer
Total
Allowance for loan losses ending balance:
Individually evaluated for impairment
$
$
3,682
$
$
-
$
4,107
Collectively evaluated for impairment
11,310
5,217
1,494
18,998
Total
$
1,301
$
14,992
$
5,318
$
1,494
$
23,105
Loan ending balances:
Individually evaluated for impairment
$
2,102
$
5,702
$
5,217
$
3,045
$
16,066
Collectively evaluated for impairment
155,742
834,086
462,369
150,219
1,602,416
Total
$
157,844
$
839,788
$
467,586
$
153,264
$
1,618,482
December 31, 2019
SBA held
for
(In thousands)
investment
Commercial
Residential
Consumer
Total
Allowance for loan losses ending balance:
Individually evaluated for impairment
$
$
$
-
$
-
$
Collectively evaluated for impairment
1,038
9,349
4,254
1,340
15,981
Total
$
1,079
$
9,722
$
4,254
$
1,340
$
16,395
Loan ending balances:
Individually evaluated for impairment
$
1,105
$
1,234
$
-
$
-
$
2,339
Collectively evaluated for impairment
34,662
763,798
467,706
143,524
1,409,690
Total
$
35,767
$
765,032
$
467,706
$
143,524
$
1,412,029
Changes in Methodology:
The Company did not make any changes to its allowance for loan losses methodology in the current period.
Reserve for Unfunded Loan Commitments
In addition to the allowance for loan losses, the Company maintains a reserve for unfunded loan commitments at a level that management believes is adequate to absorb estimated probable losses. Adjustments to the reserve are made through other expense and applied to the reserve which is classified as other liabilities. At December 31, 2020, a $288 thousand commitment reserve was reported on the balance sheet as an “other liability”, compared to a $273 thousand commitment reserve at December 31, 2019. There were no losses on unfunded loan commitments during 2020 or 2019.
6. Premises and Equipment
The detail of premises and equipment as of December 31st for the past two years is as follows:
(In thousands)
December 31, 2020
December 31, 2019
Land and buildings
$
23,588
$
23,466
Furniture, fixtures and equipment
11,593
11,164
Leasehold improvements
2,376
2,376
Gross premises and equipment
37,557
37,006
Less: Accumulated depreciation
(17,331)
(15,691)
Net premises and equipment
$
20,226
$
21,315
Amounts charged to noninterest expense for depreciation of premises and equipment amounted to $1.6 million and $1.7 million in 2020 and 2019, respectively.
7. Other Assets
The detail of other assets as of December 31st for the past two years is as follows:
(In thousands)
December 31, 2020
December 31, 2019
Right-of-use assets
$
2,365
$
2,792
Escrow advances
Servicing assets:
Mortgage servicing asset
1,106
SBA servicing asset
Mortgage gains receivable
Prepaid expenses
Prepaid insurance
Net receivable due from SBA
Unrealized gains on interest rate swap agreements
-
Other
Total other assets
$
8,858
$
7,595
8. Deposits
The following table details the maturity distribution of time deposits as of December 31st for the past two years:
More than
More than
three
six months
Three
months
through
More than
months or
through six
twelve
twelve
(In thousands)
less
months
months
months
Total
At December 31, 2020:
Less than $100,000
$
83,479
$
43,763
$
60,482
$
76,947
$
264,671
$100,000 or more
26,567
55,823
52,099
39,437
173,926
At December 31, 2019:
Less than $100,000
$
40,789
$
14,207
$
59,338
$
81,112
$
195,446
$100,000 or more
31,799
17,633
72,444
86,869
208,745
The following table presents the expected maturities of time deposits over the next five years:
(In thousands)
Thereafter
Total
Balance maturing
$
322,213
$
51,772
$
26,087
$
6,591
$
21,665
$
10,269
$
438,597
Time deposits with balances of $250 thousand or more totaled $78.3 million and $82.6 million at December 31, 2020 and 2019, respectively.
9. Borrowed Funds and Subordinated Debentures
The following table presents the period-end and average balances of borrowed funds and subordinated debentures for the past three years with resultant rates:
(In thousands)
Amount
Rate
Amount
Rate
Amount
Rate
FHLB borrowings and repurchase agreements:
At December 31,
$
200,000
0.77
%
$
283,000
1.74
%
$
210,000
2.31
%
Year-to-date average
101,954
1.49
103,201
1.85
121,970
1.78
Maximum outstanding
270,000
283,000
238,000
Repurchase agreements:
At December 31,
$
-
-
%
$
-
-
%
$
-
-
%
Year-to-date average
-
-
-
-
2,384
3.67
Maximum outstanding
-
-
15,000
Subordinated debentures:
At December 31,
$
10,310
3.33
%
$
10,310
3.33
%
$
10,310
2.40
%
Year-to-date average
10,310
3.33
10,310
3.50
10,310
2.40
Maximum outstanding
10,310
10,310
10,310
The following table presents the expected maturities of borrowed funds and subordinated debentures over the next five years:
(In thousands)
Thereafter
Total
FHLB borrowings
$
160,000
$
-
$
-
$
40,000
$
-
$
-
$
200,000
Subordinated debentures
-
-
-
-
-
10,310
10,310
Total borrowings
$
160,000
$
-
$
-
$
40,000
$
-
$
10,310
$
210,310
FHLB Borrowings
FHLB borrowings at December 31, 2020 included a $130.0 million overnight line of credit advance, compared to $193.0 million at December 31, 2019. FHLB borrowings at December 31, 2020 also consisted of one $40.0 million fixed rate advance, one $20.0 million advance and one $10.0 million advance. Comparatively, FHLB borrowings at December 31, 2019 consisted of one $40.0 million fixed rate advance, two $20.0 million advances and one $10.0 million advance. The terms of these transactions at year end 2020 are as follows:
● A $130.0 million FHLB overnight line of credit advance issued on December 31, 2020 was at a rate of 0.340% and was repaid on January 4, 2021.
● A $10.0 million FHLB advance that was issued on August 18, 2020 and has an adjustable interest rate equal to 3 month LIBOR plus 0.130% that matured on February 18, 2021. This borrowing was swapped to a 5 year fixed rate borrowing at 1.232%.
● A $20.0 million FHLB advance that was issued on July 6, 2020 and has an adjustable interest rate equal to 3 month LIBOR plus 0.165% that matured on January 6, 2021. This borrowing was swapped to a 5 year fixed rate borrowing at 1.212%.
● A $40.0 million FHLB advance that was issued on August 22, 2019 and has a fixed interest rate at 1.810% that matures on August 22, 2024.
Subordinated Debentures
At December 31, 2020 and 2019, the Company was a party in the following subordinated debenture transactions:
● On July 24, 2006, Unity (NJ) Statutory Trust II, a statutory business trust and wholly-owned subsidiary of Unity Bancorp, Inc., issued $10.0 million of floating rate capital trust pass through securities to investors due
on July 24, 2036. The subordinated debentures are redeemable in whole or part, prior to maturity but after July 24, 2011. The floating interest rate on the subordinated debentures is the three-month LIBOR plus 159 basis points and reprices quarterly. The floating interest rate was 1.835% at December 31, 2020 and 3.518% at December 31, 2019. At December 31, 2020 and 2019, the subordinated debentures had a swap instrument which modified the borrowing to a 3 year fixed rate borrowing at 3.435%.
● In connection with the formation of the statutory business trust, the trust also issued $465 thousand of common equity securities to the Company, which together with the proceeds stated above were used to purchase the subordinated debentures, under the same terms and conditions. At December 31, 2020 and 2019, $310 thousand of the common equity securities remained.
The capital securities in the above transaction have preference over the common securities with respect to liquidation and other distributions and qualify as Tier I capital. Under the terms of the Dodd-Frank Wall Street Reform and Consumer Protection Act, these securities will continue to qualify as Tier 1 capital as the Company has less than $10 billion in assets. In accordance with FASB ASC Topic 810, “Consolidation,” the Company does not consolidate the accounts and related activity of Unity (NJ) Statutory Trust II because it is not the primary beneficiary. The additional capital from this transaction was used to bolster the Company’s capital ratios and for general corporate purposes, including among other things, capital contributions to the Bank.
The Company has the ability to defer interest payments on the subordinated debentures for up to 5 years without being in default. Due to the redemption provisions of these securities, the expected maturity could differ from the contractual maturity.
Derivative Financial Instruments and Hedging Activities
Derivative Financial Instruments
The Company has derivative financial instruments in the form of interest rate swap agreements, which derive their value from underlying interest rates. These transactions involve both credit and market risk. The notional amounts are amounts on which calculations, payments, and the value of the derivatives are based. Notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid, if any. Such difference, which represents the fair value of the derivative instrument, is reflected on the Company’s balance sheet as other assets or other liabilities.
The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to any derivative agreement. The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures, and does not expect any counterparties to fail their obligations. The Company deals only with primary dealers.
Derivative instruments are generally either negotiated OTC contracts or standardized contracts executed on a recognized exchange. Negotiated OTC derivative contracts are generally entered into between two counterparties that negotiate specific agreement terms, including the underlying instrument, amount, exercise prices and maturity.
Risk Management Policies - Hedging Instruments
The primary focus of the Company’s asset/liability management program is to monitor the sensitivity of the Company’s net portfolio value and net income under varying interest rate scenarios to take steps to control its risks. On a quarterly basis, the Company evaluates the effectiveness of entering into any derivative agreement by measuring the cost of such an agreement in relation to the reduction in net portfolio value and net income volatility within an assumed range of interest rates.
Interest Rate Risk Management - Cash Flow Hedging Instruments
The Company has variable rate debt as a source of funds for use in the Company’s lending and investment activities and for other general business purposes. These debt obligations expose the Company to variability in interest payments due
to changes in interest rates. If interest rates increase, interest expense increases. Conversely, if interest rates decrease, interest expense decreases. Management believes it is prudent to limit the variability of a portion of its interest payments and, therefore hedges its variable-rate interest payments. To meet this objective, management enters into interest rate swap agreements whereby the Company receives variable interest rate payments and makes fixed interest rate payments during the contract period.
The Company had a total of 5 interest rate swaps designated as cash flow hedging instruments with a notional amount of $80.0 million at December 31, 2020, compared to 4 with a notional amount of $60.0 million at December 31, 2019. At December 31, 2020, the Company had $1.5 million in cash collateral pledged for these derivatives which was included in federal funds sold and interest-bearing deposits, compared to none at December 31, 2019. A summary of the Company’s outstanding interest rate swap agreements used to hedge variable rate debt at December 31, 2020 and 2019, respectively is as follows:
(In thousands, except percentages and years)
December 31, 2020
December 31, 2019
Notional amount
$
80,000
$
60,000
Fair value
$
(1,026)
$
Weighted average pay rate
1.19
%
1.42
%
Weighted average receive rate
0.89
%
2.19
%
Weighted average maturity in years
2.20
1.25
Number of contracts
During the twelve months ended December 31, 2020 and 2019, the Company received variable rate LIBOR payments from and paid fixed rates in accordance with its interest rate swap agreements. The unrealized gains relating to interest rate swaps are recorded as a derivative asset and are included in Prepaid expenses and other assets in the Company’s Balance Sheet, and the unrealized losses are recorded as a derivative liability and are included in Accrued expenses and other liabilities. Changes in the fair value of interest rate swaps designated as hedging instruments of the variability of cash flows associated with long-term debt are reported in other comprehensive (loss) income. The following table presents the net losses recorded in other comprehensive income and the consolidated financial statements relating to the cash flow derivative instruments at December 31, 2020, 2019, and 2018 respectively:
For the years ended December 31,
(In thousands)
(Loss) gain recognized in OCI on derivatives
$
(1,264)
$
(1,195)
$
(Loss) gain reclassified from AOCI into interest expense
$
(319)
$
-
$
-
During the next twelve months, the Company estimates that $514 thousand will be reclassified as an increase in interest expense.
10. Leases and Commitments
Leases
The Company follows ASU 2016-02, "Leases (Topic 842)," which revised certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. ASU 2016-02 requires that a lessee recognize the assets and liabilities on its balance sheet that arise from all leases with a term greater than 12 months. The core principle requires the lessee to recognize a liability to make lease payments and a "right-of-use" asset.
Operating leases in which we are the lessee are recorded as right-of-use ("ROU") assets and lease liabilities and are included in Prepaid expenses and other assets and Accrued expenses and other liabilities, respectively, on our Consolidated Balance Sheets. We do not currently have any finance leases in which we are the lessee.
Operating lease ROU assets represent our right to use an underlying asset during the lease term and operating lease liabilities represent our obligation to make lease payments arising from the lease. ROU assets and lease liabilities are
recognized at lease commencement based on the present value of the remaining lease payments using a discount rate that represents our incremental borrowing rate. The incremental borrowing rate was calculated for each lease by taking a variable rate FHLB ARC product (based on Libor plus a spread) and then swapping it to a fixed rate borrowing by adding a fixed mid swap rate for the desired term. The borrowing rate for each lease is unique based on the lease term. Operating lease expense, which is comprised of amortization of the ROU asset and the implicit interest accreted on the operating lease liability, is recognized on a straight-line basis over the lease term, and is recorded in Occupancy expense in the Consolidated Statements of Income.
The Bank’s leases relate primarily to bank branches, office space and equipment with remaining lease terms of generally 1 to 10 years. Certain lease arrangements contain extension options which typically range from 1 to 5 years at the then fair market rental rates. As these extension options are not generally considered reasonably certain of exercise, they are not included in the lease term.
Certain real estate leases have lease payments that adjust based on annual changes in the Consumer Price Index ("CPI"). The leases that are dependent upon CPI are initially measured using the index or rate at the commencement date and are included in the measurement of the lease liability.
Operating lease ROU assets totaled $2.4 million at December 31, 2020, compared to $2.8 million at December 31, 2019. Operating lease liabilities totaled $2.4 million, compared to $2.8 million at December 31, 2019.
The table below summarizes our net lease cost:
For the years ended December 31,
(In thousands)
Operating lease cost
$
$
Net lease cost
$
$
The table below summarizes the cash and non-cash activities associated with our leases:
For the years ended December 31,
(In thousands)
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases
$
$
ROU assets obtained in exchange for new operating lease liabilities
$
$
3,295
The table below summarizes other information related to our operating leases:
(In thousands, except percentages and years)
December 31, 2020
December 31, 2019
Weighted average remaining lease term in years
5.96
6.76
Weighted average discount rate
5.45
%
5.47
%
Operating lease right-of-use assets
$
2,365
$
2,792
The table below summarizes the maturity of remaining lease liabilities:
(In thousands)
December 31, 2020
$
2026 and thereafter
Total lease payments
$
2,840
Less: Interest
(424)
Present value of lease liabilities
$
2,416
As of December 31, 2020, the Corporation had not entered into any material leases that have not yet commenced.
Commitments to Borrowers
Commitments to extend credit are legally binding loan commitments with set expiration dates. They are intended to be disbursed, subject to certain conditions, upon the request of the borrower. The Company was committed to advance approximately $288.4 million to its borrowers as of December 31, 2020, compared to $272.8 million at December 31, 2019. At December 31, 2020, $114.2 million of these commitments expire within one year, compared to $119.2 million a year earlier. At December 31, 2020, the Company had $4.5 million in standby letters of credit compared to $4.8 million at December 31, 2019. The estimated fair value of these guarantees is not significant. The Company believes it has the necessary liquidity to honor all commitments.
Litigation
The Company may, in the ordinary course of business, become a party to litigation involving collection matters, contract claims and other legal proceedings relating to the conduct of its business. In the best judgment of management, based upon consultation with counsel, the consolidated financial position and results of operations of the Company will not be affected materially by the final outcome of any pending legal proceedings or other contingent liabilities and commitments.
11. Other Liabilities
The detail of other liabilities as of December 31st for the past two years is as follows:
(In thousands)
December 31, 2020
December 31, 2019
Accrued expenses
$
8,437
$
7,372
Deferred compensation
2,513
1,804
Lease liabilities
2,416
2,824
Unrealized losses on interest rate swap agreements
1,026
Loan expense advances
Reserve for commitments
Other
1,064
Total other liabilities
$
16,486
$
14,354
12. Accumulated Other Comprehensive Income (Loss)
The following table shows the changes in other comprehensive income (loss) for the past three years:
For the year ended December 31, 2020
Adjustments
Net unrealized
Accumulated
Net unrealized
related to
gains (losses)
other
gains (losses) on
defined benefit
from cash flow
comprehensive
(In thousands)
securities
plan
hedges
income (loss)
Balance, beginning of period (1)
$
$
(295)
$
$
Other comprehensive loss before reclassifications
(422)
-
(1,224)
(1,646)
Less amounts reclassified from accumulated other comprehensive income (loss)
(57)
(319)
(303)
Period change
(495)
(905)
(1,343)
Balance, end of period (1)
$
(179)
$
(238)
$
(737)
$
(1,154)
For the year ended December 31, 2019
Adjustments
Net unrealized
Accumulated
Net unrealized
related to
gains (losses)
other
(losses) gains on
defined benefit
from cash flow
comprehensive
(In thousands)
securities
plan
hedges
(loss) income
Balance, beginning of period (1)
$
(721)
$
(431)
$
1,030
$
(122)
Other comprehensive income (loss) before reclassifications
1,332
-
(862)
Less amounts reclassified from accumulated other comprehensive income (loss)
(136)
-
Period change
1,037
(862)
Balance, end of period (1)
$
$
(295)
$
$
(1) AOCI does not reflect the net reclassification of $35 thousand to Retained Earnings as a result of ASU 2016-01, "Financial Instruments Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities" & ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income".
For the year ended December 31, 2018
Adjustments
Accumulated
Net unrealized
related to
Net unrealized
other
losses on
defined benefit
gains from cash
comprehensive
(In thousands)
securities
plan
flow hedges
income (loss)
Balance, beginning of period
$
(335)
$
(341)
$
$
Other comprehensive (loss) income before reclassifications
(531)
-
(383)
Less amounts reclassified from accumulated other comprehensive (loss) income
(145)
-
(55)
Period change
(386)
(90)
(328)
Balance, end of period
$
(721)
$
(431)
$
1,030
$
(122)
13. Shareholders’ Equity
Shareholders’ equity increased $13.2 million to $173.9 million at December 31, 2020 compared to $160.7 million at December 31, 2019, primarily due to net income of $23.6 million. Other items impacting shareholders’ equity included treasury stock purchases of $7.4 million, $3.3 million in dividends paid on common stock, $1.6 million from the issuance of common stock under employee benefit plans and $1.3 million in accumulated other comprehensive loss net of tax. The issuance of common stock under employee benefit plans includes nonqualified stock options and restricted stock expense related entries, employee option exercises and the tax benefit of options exercised.
Repurchase Plan
On July 16, 2019, the Company authorized the repurchase of up to 525 thousand shares, or approximately 5 percent of its outstanding common stock. The new plan replaces the Company’s prior share repurchase program. 505 thousand shares were repurchased at an average price of $14.70 during the twelve months ended December 31, 2021, leaving 20,475 shares remaining to be repurchased under the plan. The amount and timing of additional purchases, if any, will be dependent upon a number of factors including the Company’s capital needs, the performance of its loan portfolio, the need for additional provisions for loan losses, whether related to the COVID-19 pandemic or otherwise, the market price of the Company’s stock and the general impact of the COVID-19 pandemic on the economy. There were no shares repurchased during 2019 or 2018. The table below sets forth information regarding our repurchases during the year:
Maximum
Total Number of
Number of
Total
Shares Purchased
Shares that May
Number of
as Part of Publicly
Yet be Purchased
Shares
Average Price
Announced Plans
Under the Plans
Period
Purchased
Paid per Share
or Programs
or Programs
Jan 1, 2020 through March 31, 2020
10,540
$
16.24
10,540
514,460
April 1, 2020 through June 30, 2020
200,809
13.99
200,809
313,651
July 1, 2020 through September 30, 2020
161,554
13.22
161,554
152,097
October 1, 2020 through December 31, 2020
131,622
17.48
131,622
20,475
14. Other Income
The components of other income for the past three years are as follows:
For the years ended December 31,
(In thousands)
ATM and check card fees
$
$
$
Wire transfer fees
Safe deposit box fees
Other
Total other income
$
1,466
$
1,346
$
1,207
15. Other Expenses
The components of other expenses for the past three years are as follows:
For the years ended December 31,
(In thousands)
Travel, entertainment, training and recruiting
$
$
$
Insurance
Stationery and supplies
Retail losses
Other
Total other expenses
$
1,699
$
1,877
$
1,782
16. Income Taxes
On July 1, 2018, New Jersey’s Assembly Bill 4202 was signed into law. The bill, effective January 1, 2018, imposed a temporary surtax on corporations earning New Jersey allocated taxable income in excess of $1 million at a rate of 2.5 percent for tax years beginning on or after January 1, 2018, through December 31, 2019, and at 1.5 percent for tax years beginning on or after January 1, 2020, through December 31, 2021. In addition, effective for periods on or after January 1, 2019, New Jersey requires mandatory unitary combined reporting of certain affiliates for its Corporation Business Tax.
On September 29, 2020, an amendment to the surtax was signed into law, retroactively increasing the rate back up to 2.5% for tax years beginning on January 1, 2020, and extending through December 31, 2023.
The components of the provision for income taxes for the past three years are as follows:
For the years ended December 31,
(In thousands)
Federal - current provision
$
7,828
$
5,478
$
5,507
Federal - deferred benefit
(2,043)
(285)
(799)
Total federal provision
5,785
5,193
4,708
State - current provision
2,737
1,483
1,143
State - deferred benefit
(1,047)
(14)
(463)
Total state provision
1,690
1,469
Total provision for income taxes
$
7,475
$
6,662
$
5,388
Reconciliation between the reported income tax provision and the amount computed by multiplying income before taxes by the statutory Federal income tax rate for the past three years is as follows:
For the years ended December 31,
(In thousands, except percentages)
Federal income tax provision at statutory rate
$
6,535
$
6,366
$
5,734
Increases (Decreases) resulting from:
Stock option and restricted stock
(93)
(185)
(434)
Bank owned life insurance
(129)
(123)
(205)
Tax-exempt interest
(13)
(22)
(25)
Meals and entertainment
Captive insurance premium
(193)
(209)
(200)
State income taxes, net of federal income tax effect
1,335
1,161
Other, net
(345)
(39)
Provision for income taxes
$
7,475
$
6,662
$
5,388
Effective tax rate
24.0
%
22.0
%
19.7
%
Deferred income taxes are provided for temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities. The components of the net deferred tax asset at December 31, 2020 and 2019 are as follows:
(In thousands)
December 31, 2020
December 31, 2019
Deferred tax assets:
Allowance for loan losses
$
6,540
$
4,605
SERP
1,088
1,006
Stock-based compensation
Deferred compensation
Depreciation
Interest rate swaps
-
State net operating loss
EVP retirement plan
Net unrealized security losses
-
Commitment reserve
Other
Gross deferred tax assets
10,820
7,584
Valuation allowance
(209)
(140)
Total deferred tax assets
10,611
7,444
Deferred tax liabilities:
Goodwill
Prepaid insurance
Deferred loan costs
Deferred servicing fees
Bond accretion
Net unrealized security gains
-
Interest rate swaps
-
Other
Total deferred tax liabilities
1,428
1,885
Net deferred tax asset
$
9,183
$
5,559
The Company computes deferred income taxes under the asset and liability method. Deferred income taxes are recognized for tax consequences of “temporary differences” by applying enacted statutory tax rates to differences between the financial reporting and the tax basis of existing assets and liabilities. A deferred tax liability is recognized for all temporary differences that will result in future taxable income. A deferred tax asset is recognized for all temporary differences that will result in future tax deductions subject to reduction of the asset by a valuation allowance.
The Company had a $209 thousand and $140 thousand valuation allowance for deferred tax assets related to its state net operating loss carry-forward deferred tax asset at December 31, 2020 and 2019, respectively. The Company’s state net operating loss carry-forwards totaled approximately $2.6 million and $2.0 million at December 31, 2020 and 2019, respectively, and expire between 2030 and 2037.
Included as a component of deferred tax assets is an income tax expense (benefit) related to unrealized gains (losses) on securities available for sale, a supplemental retirement plan (“SERP”) and interest rate swaps. The after-tax component of each of these is included in other comprehensive income (loss) in shareholders’ equity. The after-tax component related to securities available for sale was an unrealized loss of $215 thousand for 2020, compared to an unrealized gain of $280 thousand in 2019. The after-tax component related to the SERP was an unrealized loss of $238 thousand for 2020, compared to $295 thousand in 2019. The after-tax component related to the interest rate swaps was an unrealized loss of $736 thousand for 2020, compared to an unrealized gain of $168 thousand in the prior year.
The Company follows FASB ASC Topic 740, “Income Taxes,” which prescribes a threshold for the financial statement recognition of income taxes and provides criteria for the measurement of tax positions taken or expected to be taken in a tax return. ASC 740 also includes guidance on derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition of income taxes. The Company did not recognize or accrue any interest or penalties related to income taxes during the years ended December 31, 2020 and 2019. The Company does not have an accrual for uncertain tax positions as of December 31, 2020 or 2019, as deductions taken and benefits accrued are based on widely understood administrative practices and procedures and are based on clear and unambiguous tax law. Tax returns for all years 2017 and thereafter are subject to future examination by tax authorities.
17. Net Income per Share
The following is a reconciliation of the calculation of basic and diluted net income per share for the past three years:
For the years ended December 31,
(In thousands, except per share amounts)
Net income
$
23,644
$
23,653
$
21,919
Weighted average common shares outstanding - Basic
10,709
10,845
10,726
Plus: Potential dilutive common stock equivalents
Weighted average common shares outstanding - Diluted
10,814
11,029
10,916
Net income per common share - Basic
$
2.21
$
2.18
$
2.04
Net income per common share - Diluted
2.19
2.14
2.01
Stock options and common stock excluded from the income per share calculation as their effect would have been anti-dilutive
18. Regulatory Capital
On September 17, 2019, the federal banking agencies issued a final rule providing simplified capital requirements for certain community banking organizations (banks and holding companies) with less than $10 billion in total consolidated assets, implementing provisions of The Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”). Under the proposal, a qualifying community banking organization would be eligible to elect the community bank leverage ratio framework, or continue to measure capital under the existing Basel III requirements. The new rule, effective beginning January 1, 2020, allowed qualifying community banking organizations (“QCBO”) to opt into the new community bank leverage ratio (“CBLR”) in their call report beginning in the first quarter of 2020.
A QCBO is defined as a bank, a savings association, a bank holding company or a savings and loan holding company with:
● A leverage capital ratio of greater than 9.0%;
● Total consolidated assets of less than $10.0 billion;
● Total off-balance sheet exposures (excluding derivatives other than credit derivatives and unconditionally cancelable commitments) of 25% or less of total consolidated assets; and
● Total trading assets and trading liabilities of 5% or less of total consolidated assets.
On April 6, 2020, the federal banking regulators, implementing the applicable provisions of the CARES Act, modified the CBLR framework so that: (i) beginning in the second quarter 2020 and until the end of the year, a banking organization that has a leverage ratio of 8% or greater and meets certain other criteria may elect to use the CBLR framework; and (ii) community banking organizations will have until January 1, 2022, before the CBLR requirement is re-established at greater than 9%. Under the interim rules, the minimum CBLR will be 8% beginning in the second quarter and for the remainder of calendar year 2020, 8.5% for calendar year 2021, and 9% thereafter. The numerator of the CBLR is Tier 1 capital, as calculated under present rules. The denominator of the CBLR is the QCBO’s average assets, calculated in accordance with the QCBO’s Call Report instructions less assets deducted from Tier 1 capital.
The Bank has opted into the CBLR and will therefore not be required to comply with the Basel III capital requirements. As of December 31, 2020, the Bank’s CBLR was 9.80% and the Company’s CBLR was 10.09%.
The following table shows the CBLR ratio for the Company and the Bank at December 31, 2020, and the capital ratios for the Company and Bank under Basel III requirements at December 31, 2019:
Company
Bank
Required for capital adequacy purposes
To be well-capitalized under prompt corrective action regulations
At December 31, 2020:
CBLR
10.09
%
9.80
%
8.00
%
8.00
%
At December 31, 2019:
Leverage ratio
10.59
%
10.15
%
4.00
%
5.00
%
CET1
11.59
%
11.81
%
4.50
%
(1)
6.50
%
Tier I risk-based capital ratio
12.32
%
11.81
%
6.00
%
(1)
8.00
%
Total risk-based capital ratio
13.06
%
12.58
%
8.00
%
(1)
10.00
%
(1) Excludes capital conservation buffer at December 31, 2019.
19. Employee Benefit Plans
Stock Option Plans
The Company has incentive and nonqualified option plans, which allow for the grant of options to officers, employees and members of the Board of Directors. Grants under the Company’s incentive and nonqualified option plans generally vest over 3 years and must be exercised within 10 years of the date of grant. Transactions under the Company’s stock option plans for 2020, 2019 and 2018 are summarized in the following table:
Weighted
Weighted
average
average
remaining
Aggregate
exercise
contractual
intrinsic
Shares
price
life in years
value
Outstanding at December 31, 2017
504,573
$
8.31
5.7
$
5,772,843
Options granted
203,000
20.15
Options exercised
(115,962)
4.97
Options forfeited
(7,433)
15.47
Options expired
-
-
Outstanding at December 31, 2018
584,178
$
13.00
7.1
$
4,574,680
Options granted
96,000
21.31
Options exercised
(60,534)
7.49
Options forfeited
(5,333)
19.38
Options expired
-
-
Outstanding at December 31, 2019
614,311
$
14.78
6.9
$
4,783,402
Options granted
151,500
19.80
Options exercised
(63,011)
7.16
Options forfeited
(30,000)
19.50
Options expired
-
-
Outstanding at December 31, 2020
672,800
$
16.42
6.8
$
1,952,568
Exercisable at December 31, 2020
402,142
$
13.87
5.6
$
1,907,768
On April 25, 2019, The Company adopted the 2019 Equity Compensation Plan providing for grants of up to 500,000 shares to be allocated between incentive and non-qualified stock options, restricted stock awards, performance units and deferred stock. The Plan replaced all previously approved and established equity plans then currently in effect. As of December 31, 2020, 192,500 options and 43,150 shares of restricted stock have been awarded from the plan leaving 264,350 shares available for future grants.
The fair values of the options granted during 2020, 2019 and 2018 were estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
For the years ended December 31,
Number of options granted
151,500
96,000
203,000
Weighted average exercise price
$
19.80
$
21.31
$
20.15
Weighted average fair value of options
$
6.12
$
6.20
$
6.04
Expected life in years (1)
8.50
8.23
7.17
Expected volatility (2)
32.69
%
27.05
%
26.60
%
Risk-free interest rate (3)
1.28
%
2.21
%
2.61
%
Dividend yield (4)
1.64
%
1.37
%
1.23
%
(1) The expected life of the options was estimated based on historical employee behavior and represents the period of time that options granted are expected to be outstanding.
(2) The expected volatility of the Company’s stock price was based on the historical volatility over the period commensurate with the expected life of the options.
(3) The risk-free interest rate is the U.S. Treasury rate commensurate with the expected life of the options on the date of grant.
(4) The expected dividend yield is the projected annual yield based on the grant date stock price.
Upon exercise, the Company issues shares from its authorized but unissued common stock to satisfy the options. The following table presents information about options exercised during 2020, 2019 and 2018:
For the years ended December 31,
Number of options exercised
63,011
60,534
115,962
Total intrinsic value of options exercised
$
564,314
$
792,446
$
1,949,853
Cash received from options exercised
451,420
453,326
576,119
Tax deduction realized from options
177,675
238,407
548,104
The following table summarizes information about stock options outstanding and exercisable at December 31, 2020:
Options outstanding
Options exercisable
Weighted average
Weighted
Weighted
Options
remaining contractual
average
Options
average
Range of exercise prices
outstanding
life (in years)
exercise price
exercisable
exercise price
$0.00 - $6.00
44,000
1.5
$
5.65
44,000
$
5.65
$6.01 - $12.00
148,267
4.4
8.97
148,267
8.97
$12.01 - $18.00
92,533
7.2
15.86
57,533
15.61
$18.01 - $24.00
388,000
8.3
20.62
152,342
20.35
Total
672,800
6.8
$
16.42
402,142
$
13.87
FASB ASC Topic 718, “Compensation - Stock Compensation,” requires an entity to recognize the fair value of equity awards as compensation expense over the period during which an employee is required to provide service in exchange for such an award (vesting period). Compensation expense related to stock options and the related income tax benefit for the years ended December 31, 2020, 2019 and 2018 are detailed in the following table:
For the years ended December 31,
Compensation expense
$
744,091
$
606,626
$
478,733
Income tax benefit
215,042
175,315
134,572
As of December 31, 2020, unrecognized compensation costs related to nonvested share-based compensation arrangements granted under the Company’s stock option plans totaled approximately $839 thousand. That cost is expected to be recognized over a weighted average period of 1.7 years.
Restricted Stock Awards
Restricted stock is issued under the 2019 Equity Compensation Plan to reward employees and directors and to retain them by distributing stock over a period of time. Restricted stock awards granted to date vest over a period of 4 years and are recognized as compensation to the recipient over the vesting period. The awards are recorded at fair market
value at the time of grant and amortized into salary expense on a straight line basis over the vesting period. The following table summarizes nonvested restricted stock activity for the year ended December 31, 2020:
Average grant
Shares
date fair value
Nonvested restricted stock at December 31, 2019
108,740
$
19.18
Granted
27,250
17.12
Cancelled
(6,062)
19.86
Vested
(41,956)
17.58
Nonvested restricted stock at December 31, 2020
87,972
$
19.26
Restricted stock awards granted during the years ended December 31, 2020, 2019 and 2018 were as follows:
For the years ended December 31,
Number of shares granted
27,250
46,050
47,550
Average grant date fair value
$
17.12
$
20.84
$
20.77
Compensation expense related to the restricted stock for the years ended December 31, 2020, 2019 and 2018 is detailed in the following table:
For the years ended December 31,
Compensation expense
$
667,241
$
664,484
$
574,236
Income tax benefit
$
192,833
$
192,036
$
161,418
As of December 31, 2020, there was approximately $1.0 million of unrecognized compensation cost related to nonvested restricted stock awards granted under the Company’s stock incentive plans. That cost is expected to be recognized over a weighted average period of 2.3 years.
401(k) Savings Plan
The Bank has a 401(k) savings plan covering substantially all employees. Under the Plan, an employee can contribute up to 80 percent of their salary on a tax deferred basis. The Bank may also make discretionary contributions to the Plan. The Bank contributed $675 thousand, $648 thousand and $601 thousand to the Plan in 2020, 2019 and 2018, respectively.
Deferred Fee Plan
The Company has a deferred fee plan for Directors and eligible management. Directors of the Company have the option to elect to defer up to 100 percent of their respective retainer and Board of Director fees, and each eligible member of management has the option to elect to defer 100 percent of their total compensation. Director and officer deferred fees totaled $591 thousand in 2020, $379 thousand in 2019 and $297 thousand in 2018, and the interest paid on deferred balances totaled $132 thousand in 2020, $107 thousand in 2019 and $67 thousand in 2018. The fees distributed on the deferred balances totaled $14 thousand in 2020, 2019 and 2018.
Benefit Plans
In addition to the 401(k) savings plan which covers substantially all employees, in 2015 the Company established an unfunded supplemental defined benefit plan to provide additional retirement benefits for the President and Chief Executive Officer (“CEO”) and unfunded, non-qualified deferred retirement pans for certain other key executives.
On June 4, 2015, the Company approved the Supplemental Executive Retirement Plan (“SERP”) pursuant to which the President and CEO is entitled to receive certain supplemental nonqualified retirement benefits. The retirement benefit under the SERP is an amount equal to sixty percent (60%) of the average of the President and CEO’s base salary for the
thirty-six (36) months immediately preceding executive’s separation from service after age 66, adjusted annually thereafter by two percent (2%). The total benefit is to be made payable in fifteen annual installments. The future payments are estimated to total $6.6 million. A discount rate of four percent (4%) was used to calculate the present value of the benefit obligation.
The President and CEO commenced vesting to this retirement benefit on January 1, 2014, and it will vest an additional three percent (3%) each year until fully vested on January 1, 2024. In the event that the President and CEO’s separation from service from the Company were to occur prior to full vesting, the President and CEO would be entitled to and shall be paid the vested portion of the retirement benefit calculated as of the date of separation from service. Notwithstanding the foregoing, upon a Change in Control, and provided that within 6 months following the Change in Control the President and CEO is involuntarily terminated for reasons other than “cause” or the President and CEO resigns for “good reason”, as such is defined in the SERP, or the President and CEO voluntarily terminates his employment after being offered continued employment in a position that is not a “Comparable Position”, as such is also defined in the SERP, the President and CEO shall become one hundred percent (100%) vested in the full retirement benefit.
No contributions or payments have been made for the year 2020, 2019 or 2018. The following table summarizes the components of the net periodic pension cost of the defined benefit plan recognized during the years ended December 31, 2020, 2019 and 2018:
For the years ended December 31,
(In thousands)
Service cost (1)
$
$
$
1,460
Interest cost
Amortization of prior service cost
Net periodic benefit cost
$
$
$
1,644
(1) On September 27, 2018, the Company approved a change in calculation of the Retirement Benefit resulting in an additional $1.1 million in current expense.
The following table summarizes the changes in benefit obligations of the defined benefit plan recognized during the years ended December 31, 2020, 2019 and 2018:
For the years ended December 31,
(In thousands)
Benefit obligation, beginning of year
$
3,572
$
2,748
$
1,187
Service cost (1)
1,460
Interest cost
Benefit obligation, end of period
$
3,845
$
3,572
$
2,748
(1) On September 27, 2018, the Company approved a change in calculation of the Retirement Benefit resulting in an additional $1.1 million in current expense.
On October 22, 2015, the Company entered into an Executive Incentive Retirement Plan (the “Plan”) with key executive officers. The Plan has an effective date of January 1, 2015.
The Plan is an unfunded, nonqualified deferred compensation plan. For any Plan Year, a guaranteed annual Deferral Award percentage of seven and one half percent (7.5%) of the participant’s annual base salary shall be credited to each Participant’s Deferred Benefit Account. A discretionary annual Deferral Award equal to seven and one half percent (7.5%) of the participant’s annual base salary may be credited to the Participant’s account in addition to the guaranteed Deferral Award, if the Bank exceeds the benchmarks set forth in the Annual Executive Bonus Matrix. The total Deferral Award shall never exceed fifteen percent (15%) of the participant’s base salary for any given Plan Year. Each Participant shall be one hundred percent (100%) vested in all Deferral Awards as of the date they are awarded.
As of December 31, 2020, the Company had total expenses of $86 thousand, compared to $115 thousand in 2019 and $88 thousand in 2018. The Plan is reflected on the Company’s balance sheet as accrued expenses.
Certain members of management are also enrolled in a split-dollar life insurance plan with a post retirement death benefit of $250 thousand. Total expenses related to this plan were $5 thousand, $5 thousand and $18 thousand in 2020, 2019 and 2018, respectively.
20. Fair Value
Fair Value Measurement
The Company follows FASB ASC Topic 820, “Fair Value Measurement and Disclosures,” which requires additional disclosures about the Company’s assets and liabilities that are measured at fair value. Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. In determining fair value, the Company uses various methods including market, income and cost approaches. Based on these approaches, the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable inputs. The Company utilizes techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities carried at fair value will be classified and disclosed as follows:
Level 1 Inputs
● Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
● Generally, this includes debt and equity securities and derivative contracts that are traded in an active exchange market (i.e. New York Stock Exchange), as well as certain U.S. Treasury, U.S. Government and sponsored entity agency mortgage-backed securities that are highly liquid and are actively traded in over-the-counter markets.
Level 2 Inputs
● Quoted prices for similar assets or liabilities in active markets.
● Quoted prices for identical or similar assets or liabilities in inactive markets.
● Inputs other than quoted prices that are observable, either directly or indirectly, for the term of the asset or liability (i.e., interest rates, yield curves, credit risks, prepayment speeds or volatilities) or “market corroborated inputs.”
● Generally, this includes U.S. Government and sponsored entity mortgage-backed securities, corporate debt securities and derivative contracts.
Level 3 Inputs
● Prices or valuation techniques that require inputs that are both unobservable (i.e. supported by little or no market activity) and that are significant to the fair value of the assets or liabilities.
● These assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
Fair Value on a Recurring Basis
The following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis:
Debt Securities Available for Sale
The fair value of available for sale ("AFS") debt securities is the market value based on quoted market prices, when available, or market prices provided by recognized broker dealers (Level 1). If listed prices or quotes are not available, fair value is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).
As of December 31, 2020, the fair value of the Company’s AFS debt securities portfolio was $45.6 million. Approximately 38 percent of the portfolio was made up of residential mortgage-backed securities, which had a fair value of $17.4 million at December 31, 2020. Approximately $17.2 million of the residential mortgage-backed securities are guaranteed by the Government National Mortgage Association ("GNMA"), the Federal National Mortgage Association ("FNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC"). The underlying loans for these securities are residential mortgages that are geographically dispersed throughout the United States.
Most of the Company’s AFS debt securities were classified as Level 2 assets at December 31, 2020. The valuation of AFS debt securities using Level 2 inputs was primarily determined using the market approach, which uses quoted prices for similar assets or liabilities in active markets and all other relevant information. It includes model pricing, defined as valuing securities based upon their relationship with other benchmark securities.
Included in the Company’s AFS debt securities are two corporate bonds which are classified as Level 3 assets at December 31, 2020, which were previously classified as Level 2 assets. The valuation of these corporate bonds is determined using broker quotes, third-party vendor prices, or other valuation techniques, such as discounted cash flow techniques. Market inputs used in the other valuation techniques or underlying third-party vendor prices or broker quotes include benchmark and government bond yield curves, credit spreads, and trade execution data.
The following table presents a reconciliation of the Level 3 available for sale debt securities measured at fair value on a recurring basis for the years ended December 31, 2020 and 2019:
For the year ended December 31,
(In thousands)
Balance at beginning of period (1)
$
6,238
$
-
Purchases/additions
-
-
Sales/reductions
(1,005)
-
Realized
-
-
Unrealized
(833)
-
Balance at end of period
$
4,400
$
-
(1) Includes AFS debt securities classified as Level 2 at December 31, 2019, which were transferred to Level 3 during the period ended December 31, 2020.
Equity Securities with Readily Determinable Fair Values
The fair value of equity securities is the market value based on quoted market prices, when available, or market prices provided by recognized broker dealers (Level 1). If listed prices or quotes are not available, fair value is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).
As of December 31, 2020, the fair value of the Company’s equity securities portfolio was $2.0 million.
All of the Company’s equity securities were classified as Level 2 assets at December 31, 2020. The valuation of securities using Level 2 inputs was primarily determined using the market approach, which uses quoted prices for similar assets or liabilities in active markets and all other relevant information.
There were no changes in the inputs or methodologies used to determine fair value during the period ended December 31, 2020, as compared to the period ended December 31, 2019.
Loans Held for Sale
Fair value for loans held for sale is derived from quoted market prices for similar loans, in which case they are characterized as Level 2 assets in the fair value hierarchy.
Interest Rate Swap Agreements
The fair value of interest rate swap agreements is the market value based on quoted market prices, when available, or market prices provided by recognized broker dealers (Level 1). If listed prices or quotes are not available, fair value is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).
The Company’s derivative instruments are classified as Level 2 assets, as the readily observable market inputs to these models are validated to external sources, such as industry pricing services, or are corroborated through recent trades, dealer quotes, yield curves, implied volatility or other market-related data.
The tables below present the balances of assets measured at fair value on a recurring basis as of December 31st for the past two years:
Fair Value Measurements at December 31, 2020 Using
Quoted Prices in
Assets/Liabilities
Active Markets
Significant Other
Significant
Measured at Fair
for Identical
Observable
Unobservable
(In thousands)
Value
Assets (Level 1)
Inputs (Level 2)
Inputs (Level 3)
Measured on a recurring basis:
Assets:
Debt securities available for sale:
U.S. Government sponsored entities
$
2,003
$
-
$
2,003
$
-
State and political subdivisions
2,969
-
2,969
-
Residential mortgage-backed securities
17,410
-
17,410
-
Corporate and other securities
23,235
-
18,835
4,400
Total debt securities available for sale
$
45,617
$
-
$
41,217
$
4,400
Equity securities with readily determinable fair values
1,954
-
1,954
-
Total equity securities
$
1,954
$
-
$
1,954
$
-
Loans held for sale
10,712
-
10,712
-
Total loans held for sale
$
10,712
-
$
10,712
-
Interest rate swap agreements
(1,026)
-
(1,026)
-
Total swap agreements
$
(1,026)
$
-
$
(1,026)
$
-
Fair value Measurements at December 31, 2019 Using
Quoted Prices in
Assets/Liabilities
Active Markets
Significant Other
Significant
Measured at Fair
for Identical
Observable
Unobservable
(In thousands)
Value
Assets (Level 1)
Inputs (Level 2)
Inputs (Level 3)
Measured on a recurring basis:
Assets:
Debt securities available for sale:
U.S. Government sponsored entities
$
5,753
$
-
$
5,753
$
-
State and political subdivisions
5,154
-
5,154
-
Residential mortgage-backed securities
27,964
-
27,964
-
Corporate and other securities
25,404
-
25,404
-
Total debt securities available for sale
$
64,275
$
-
$
64,275
$
-
Equity securities with readily determinable fair values
2,289
-
2,289
-
Total equity securities
$
2,289
$
-
$
2,289
$
-
Loans held for sale
14,862
-
14,862
-
Total loans held for sale
$
14,862
-
$
14,862
-
Interest rate swap agreements
-
-
Total swap agreements
$
$
-
$
$
-
Fair Value on a Nonrecurring Basis
The following tables present the assets and liabilities subject to fair value adjustments (impairment) on a non-recurring basis carried on the balance sheet by caption and by level within the hierarchy (as described above):
Fair Value Measurements at December 31, 2020 Using
Quoted Prices
Significant
in Active
Other
Significant
Net (Credit)
Assets/Liabilities
Markets for
Observable
Unobservable
Provision
Measured at Fair
Identical Assets
Inputs
Inputs
During
(In thousands)
Value
(Level 1)
(Level 2)
(Level 3)
Period
Measured on a non-recurring basis:
Financial assets:
OREO
$
-
$
-
$
-
$
-
$
(225)
Impaired collateral-dependent loans
11,959
-
-
11,959
3,693
Fair Value Measurements at December 31, 2019 Using
Quoted Prices
Significant
in Active
Other
Significant
Assets/Liabilities
Markets for
Observable
Unobservable
Net Credit
Measured at Fair
Identical Assets
Inputs
Inputs
During
(In thousands)
Value
(Level 1)
(Level 2)
(Level 3)
Period
Measured on a non-recurring basis:
Financial assets:
OREO
$
1,723
$
-
$
-
$
1,723
$
(231)
Impaired collateral-dependent loans
1,925
-
-
1,925
(253)
Certain Assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following is a description of the valuation methodologies used for instruments measured at fair value on a nonrecurring basis:
Appraisal Policy
All appraisals must be performed in accordance with the Uniform Standards of Professional Appraisal Practice ("USPAP"). Appraisals are certified to the Company and performed by appraisers on the Company’s approved list of appraisers. Evaluations are completed by a person independent of Company management. The content of the appraisal depends on the complexity of the property. Appraisals are completed on a "retail value" and an "as is value."
OREO
The fair value of OREO is determined using appraisals, which may be discounted based on management’s review and changes in market conditions (Level 3 Inputs).
Impaired Collateral-Dependent Loans
The fair value of impaired collateral-dependent loans is derived in accordance with FASB ASC Topic 310, "Receivables." Fair value is determined based on the loan’s observable market price or the fair value of the collateral. Partially charged-off loans are measured for impairment based upon an appraisal for collateral-dependent loans. When an updated appraisal is received for a nonperforming loan, the value on the appraisal is discounted in the manner discussed above. If there is a deficiency in the value after the Company applies these discounts, management applies a specific reserve and the loan remains in nonaccrual status. The receipt of an updated appraisal would not qualify as a reason to put a loan back into accruing status. The Company removes loans from nonaccrual status generally when the borrower makes three months of contractual payments and demonstrates the ability to service the debt going forward. Charge-offs are determined based upon the loss that management believes the Company will incur after evaluating collateral for impairment based upon the valuation methods described above and the ability of the borrower to pay any deficiency.
The valuation allowance for impaired loans is included in the allowance for loan losses in the consolidated balance sheets. At December 31, 2020, the valuation allowance for impaired loans was $4.1 million, an increase of $3.7 million from $414 thousand at December 31, 2019.
Fair Value of Financial Instruments
FASB ASC Topic 825, “Financial Instruments,” requires the disclosure of the estimated fair value of certain financial instruments, including those financial instruments for which the Company did not elect the fair value option. These estimated fair values as of December 31, 2020 and December 31, 2019 have been determined using available market information and appropriate valuation methodologies. Considerable judgment is required to interpret market data to develop estimates of fair value. The estimates presented are not necessarily indicative of amounts the Company could realize in a current market exchange. The use of alternative market assumptions and estimation methodologies could have had a material effect on these estimates of fair value. The methodology for estimating the fair value of financial assets and liabilities that are measured on a recurring or nonrecurring basis are discussed above.
The following methods and assumptions were used to estimate the fair value of other financial instruments for which it is practicable to estimate that value:
Cash and Cash Equivalents
For these short-term instruments, the carrying value is a reasonable estimate of fair value.
Securities
The fair value of securities is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).
SBA Loans Held for Sale
The fair value of SBA loans held for sale is estimated by using a market approach that includes significant other observable inputs.
Loans
The fair value of loans is estimated by discounting the future cash flows using current market rates that reflect the interest rate risk inherent in the loan, except for previously discussed impaired loans.
FHLB Stock
Federal Home Loan Bank stock is carried at cost. Carrying value approximates fair value based on the redemption provisions of the issues.
Servicing Assets
Servicing assets do not trade in an active, open market with readily observable prices. The Company estimates the fair value of servicing assets using discounted cash flow models incorporating numerous assumptions from the perspective of a market participant including market discount rates and prepayment speeds.
Accrued Interest
The carrying amounts of accrued interest approximate fair value.
Deposit Liabilities
The fair value of demand deposits and savings accounts is the amount payable on demand at the reporting date (i.e. carrying value). The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using current market rates.
Borrowed Funds and Subordinated Debentures
The fair value of borrowings is estimated by discounting the projected future cash flows using current market rates.
Standby Letters of Credit
At December 31, 2020, the Bank had standby letters of credit outstanding of $4.5 million, as compared to $4.8 million at December 31, 2019. The fair value of these commitments is nominal.
The table below presents the carrying amount and estimated fair values of the Company’s financial instruments not previously presented as of December 31st for the past two years:
December 31, 2020
December 31, 2019
Fair value
Carrying
Estimated
Carrying
Estimated
(In thousands)
level
amount
fair value
amount
fair value
Financial assets:
Cash and cash equivalents
Level 1
$
219,311
$
219,311
$
158,016
$
158,016
Securities (1)
Level 2
47,571
47,571
66,564
66,564
SBA loans held for sale
Level 2
9,335
10,712
13,529
14,862
Loans, net of allowance for loan losses (2)
Level 2
1,595,377
1,613,593
1,395,634
1,398,997
FHLB stock
Level 2
10,594
10,594
14,184
14,184
Servicing assets
Level 3
1,857
1,857
2,026
2,026
Accrued interest receivable
Level 2
10,429
10,429
6,984
6,984
OREO
Level 3
-
-
1,723
1,723
Financial liabilities:
Deposits
Level 2
1,557,959
1,561,502
1,250,114
1,252,082
Borrowed funds and subordinated debentures
Level 2
210,310
212,358
293,310
292,766
Accrued interest payable
Level 2
(1) Includes corporate securities that are considered Level 3 and reported separately in the table under the “Fair Value on a Recurring Basis” heading. These securities had book values of $5.3 million and market values of $4.4 million.
(2) Includes impaired loans that are considered Level 3 and reported separately in the tables under the “Fair Value on a Nonrecurring Basis” heading. Collateral-dependent impaired loans, net of specific reserves totaled $12.0 million and $1.9 million at December 31, 2020 and 2019.
Limitations
Fair value estimates are made at a point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on- and off-statement of condition financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the effect of fair value estimates have not been considered in the above estimates.
21. Condensed Financial Statements of Unity Bancorp, Inc.
(Parent Company Only)
Balance Sheets
December 31,
December 31,
(In thousands)
ASSETS
Cash and cash equivalents
$
$
2,308
Equity securities
1,003
1,355
Investment in subsidiaries
181,113
164,881
Premises and equipment, net
3,823
3,849
Other assets
Total assets
$
186,631
$
173,360
LIABILITIES AND SHAREHOLDERS’ EQUITY
Loan due to subsidiary bank
$
2,209
$
2,304
Other liabilities
Subordinated debentures
10,310
10,310
Shareholders’ equity
173,911
160,709
Total liabilities and shareholders’ equity
$
186,631
$
173,360
Statements of Income
For the year ended December 31,
(In thousands)
Dividend from Bank
$
8,200
$
3,300
$
2,890
Dividend from Nonbank subsidiary
-
-
Gain on sales of securities
-
Other income
Total income
9,245
3,771
3,315
Interest expenses
Market value depreciation (appreciation) on equity securities
(293)
Other expenses
Total expenses
Income before provision for income taxes and equity in undistributed net income of subsidiary
8,391
3,447
2,632
(Provision) benefit for income taxes
(22)
(14)
Income before equity in undistributed net income of subsidiary
8,413
3,369
2,646
Equity in undistributed net income of subsidiaries
15,231
20,284
19,273
Net income
$
23,644
$
23,653
$
21,919
Statements of Cash Flows
For the year ended December 31,
(In thousands)
OPERATING ACTIVITIES
Net income
$
23,644
$
23,653
$
21,919
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed net income of subsidiaries
(15,231)
(20,284)
(19,273)
Gain on sales of securities
(5)
(17)
-
Net change in other assets and other liabilities
Net cash provided by operating activities
8,693
3,858
3,023
INVESTING ACTIVITIES
Purchase of land and building
(87)
(64)
-
Purchases of securities
-
-
(1,133)
Proceeds from sales of securities
-
Net cash provided by (used in) investing activities
(1,133)
FINANCING ACTIVITIES
Proceeds from exercise of stock options
Repayment of advances from subsidiaries
(96)
(91)
(87)
Purchase of treasury stock
(7,442)
-
-
Cash dividends paid on common stock
(3,298)
(3,255)
(2,802)
Net cash used in financing activities
(10,385)
(2,893)
(2,313)
(Decrease) increase in cash and cash equivalents
(1,668)
1,099
(423)
Cash and cash equivalents, beginning of period
2,308
1,209
1,632
Cash and cash equivalents, end of period
$
$
2,308
$
1,209
SUPPLEMENTAL DISCLOSURES
Interest paid
$
$
$
Quarterly Financial Information (Unaudited)
The following quarterly financial information for the years ended December 31, 2020, 2019 and 2018 is unaudited. However, in the opinion of management, all adjustments, which include normal recurring adjustments necessary to present fairly the results of operations for the periods, are reflected.
(In thousands, except per share data)
March 31
June 30
September 30
December 31
Total interest income
$
19,585
$
19,278
$
19,764
$
20,288
Total interest expense
4,341
3,753
3,437
2,949
Net interest income
15,244
15,525
16,327
17,339
Provision for loan losses
1,500
2,500
2,000
1,000
Net interest income after provision for loan losses
13,744
13,025
14,327
16,339
Total noninterest income
2,545
2,811
3,336
4,254
Total noninterest expense
9,323
9,177
10,037
10,725
Income before provision for income taxes
6,966
6,659
7,626
9,868
Provision for income taxes
1,598
1,488
1,866
2,523
Net income
$
5,368
$
5,171
$
5,760
$
7,345
Net income per common share - Basic
$
0.49
$
0.48
$
0.54
$
0.70
Net income per common share - Diluted
0.49
0.47
0.54
0.69
(In thousands, except per share data)
March 31
June 30
September 30
December 31
Total interest income
$
18,500
$
18,781
$
19,055
$
19,312
Total interest expense
4,284
4,571
4,651
4,549
Net interest income
14,216
14,210
14,404
14,763
Provision for loan losses
Net interest income after provision for loan losses
13,716
13,860
13,654
14,263
Total noninterest income
2,020
2,411
2,710
2,398
Total noninterest expense
8,476
8,791
8,729
8,721
Income before provision for income taxes
7,260
7,480
7,635
7,940
Provision for income taxes
1,520
1,646
1,676
1,820
Net income
$
5,740
$
5,834
$
5,959
$
6,120
Net income per common share - Basic
$
0.53
$
0.54
$
0.55
$
0.56
Net income per common share - Diluted
0.52
0.53
0.54
0.55
(In thousands, except per share data)
March 31
June 30
September 30
December 31
Total interest income
$
15,640
$
16,369
$
17,194
$
18,060
Total interest expense
2,768
3,225
3,627
3,896
Net interest income
12,872
13,144
13,567
14,164
Provision for loan losses
Net interest income after provision for loan losses
12,372
12,594
13,067
13,664
Total noninterest income
2,286
2,312
2,479
1,954
Total noninterest expense
8,194
8,158
8,801
8,268
Income before provision for income taxes
6,464
6,748
6,745
7,350
Provision for income taxes
1,235
1,351
1,255
1,547
Net income
$
5,229
$
5,397
$
5,490
$
5,803
Net income per common share - Basic
$
0.49
$
0.50
$
0.51
$
0.54
Net income per common share - Diluted
0.48
0.49
0.50
0.53
Selected Consolidated Financial Data
At or for the years ended December 31,
(In thousands, except percentages)
Selected Results of Operations
Interest income
$
78,915
$
75,648
$
67,263
$
55,310
$
47,024
Interest expense
14,480
18,055
13,516
9,453
8,767
Net interest income
64,435
57,593
53,747
45,857
38,257
Provision for loan losses
7,000
2,100
2,050
1,650
1,220
Noninterest income
12,946
9,539
9,031
8,270
11,060
Noninterest expense
39,262
34,717
33,421
30,044
27,631
Provision for income taxes
7,475
6,662
5,388
9,540
7,257
Net income
23,644
23,653
21,919
12,893
13,209
Per Share Data
Net income per common share - Basic
$
2.21
$
2.18
$
2.04
$
1.22
$
1.40
Net income per common share - Diluted
2.19
2.14
2.01
1.20
1.38
Book value per common share
16.63
14.77
12.85
11.13
10.14
Market value per common share
17.55
22.57
20.76
19.75
15.70
Cash dividends declared on common shares
0.32
0.31
0.27
0.23
0.18
Selected Balance Sheet Data
Assets
$
1,958,914
$
1,718,942
$
1,579,157
$
1,455,496
$
1,189,906
Loans
1,627,817
1,425,558
1,304,566
1,170,674
973,414
Allowance for loan losses
(23,105)
(16,395)
(15,488)
(13,556)
(12,579)
Securities
47,571
66,564
63,732
69,800
61,547
Deposits
1,557,959
1,250,114
1,207,687
1,043,137
945,723
Borrowed funds and subordinated debentures
210,310
293,310
220,310
285,310
131,310
Shareholders’ equity
173,911
160,709
138,488
118,105
106,291
Common shares outstanding
10,456
10,881
10,780
10,615
10,477
Performance Ratios
Return on average assets
1.35
%
1.54
%
1.53
%
1.02
%
1.17
%
Return on average equity
14.20
15.86
17.10
11.47
15.37
Average equity to average assets
9.51
9.69
8.96
8.85
7.59
Efficiency ratio
50.80
52.00
53.07
55.57
56.51
Dividend payout
14.61
14.49
13.43
18.33
13.04
Net interest spread
3.48
3.54
3.65
3.57
3.36
Net interest margin
3.85
3.95
3.97
3.83
3.58
Asset Quality Ratios
Allowance for loan losses to loans
1.42
%
1.15
%
1.19
%
1.16
%
1.29
%
Allowance for loan losses to nonperforming loans
191.59
290.23
225.35
452.77
173.82
Nonperforming loans to total loans
0.74
0.40
0.53
0.26
0.74
Nonperforming assets to total loans and OREO
0.74
0.52
0.53
0.29
0.85
Nonperforming assets to total assets
0.62
0.43
0.44
0.23
0.70
Net charge-offs to average loans
0.02
0.09
0.01
0.06
0.15
Capital Ratios - Company
CBLR
10.09
%
N/A
%
N/A
%
N/A
%
N/A
%
Leverage Ratio
N/A
10.59
9.90
9.37
9.73
Common Equity Tier 1 risk-based capital ratio
N/A
11.59
11.40
10.81
11.49
Tier 1 risk-based capital ratio
N/A
12.32
12.24
11.75
12.58
Total risk-based capital ratio
N/A
13.06
13.49
12.87
13.84
Capital Ratios - Bank
CBLR
9.80
%
N/A
%
N/A
%
N/A
%
N/A
%
Leverage Ratio
N/A
10.15
9.52
9.03
9.50
Common Equity Tier 1 risk-based capital ratio
N/A
11.81
11.80
11.33
12.23
Tier 1 risk-based capital ratio
N/A
11.81
11.80
11.33
12.23
Total risk-based capital ratio
N/A
12.58
13.05
12.50
13.48
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors
Unity Bancorp, Inc. and Subsidiaries
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Unity Bancorp, Inc. and Subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes to the consolidated financial statements (collectively, 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 each of the three years in the period ended December 31, 2020, 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 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. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
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.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or is required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the account or disclosures to which it relates.
Allowance for Loan Losses - Qualitative Factors
The allowance for loan losses as of December 31, 2020 was $23.1 million. As described in Notes 1 and 5 to the consolidated financial statements, the allowance for loan losses is established through a provision for loan losses and represents an amount which, in management’s judgement, will be adequate to absorb losses on existing loans. The allowance consists of specific and general components in the amounts of $4.1 million and $19.0 million, respectively. Specific reserves are made to individual impaired loans, which have been defined to include all nonperforming loans and troubled debt restructurings. The general reserve is set based upon a historical net charge-off rate adjusted for the following environmental factors: delinquency and impairment trends, charge-off and recovery trends, changes in the
volume of restructured loans, volume and loan term trends, changes in risk and underwriting policy trends, staffing and experience changes, national and local economic trends, industry conditions and credit concentration changes. The evaluation of the qualitative factors requires a significant amount of judgement by management and involves a high degree of subjectivity.
We identified the qualitative factor component of the allowance for loan losses as a critical audit matter as auditing the underlying qualitative factors required significant auditor judgment as amounts determined by management rely on analysis that is highly subjective and includes significant estimation uncertainty.
Our audit procedures related to the qualitative factors included the following, among others:
● We obtained an understanding of the relevant controls related to management’s assessment and review of the qualitative factors, and tested such controls for design and operating effectiveness, including controls over management’s establishment, review and approval of the qualitative factors and the data used in determining the qualitative factors.
● We obtained an understanding of how management developed the estimates and related assumptions, including:
o Testing completeness and accuracy of key data inputs used in forming assumptions or calculations and testing the reliability of the underlying data on which these factors are based by comparing information to source documents and external information sources.
o Evaluating the reasonableness of the qualitative factor established by management, including the directional consistency and magnitude, as compared to the underlying internal or external information sources.
/s/ RSM US LLP
We have served as the Company’s auditor since 2007.
New York, New York
March 25, 2021

---

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure:
None.

---

ITEM 9A. CONTROLS AND PROCEDURES
Item 9A. Controls and Procedures:
(a) Evaluation of disclosure controls and procedures:
Based on their evaluation, as of the end of the period covered by this Annual Report on Form 10-K, our Chief Executive Officer and Interim Principal Financial and Accounting Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
(b) Management’s Report on Internal Control Over Financial Reporting:
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f) under the Securities Exchange Act of 1934. Under the supervision and with the participation of the principal executive officer and the principal financial officer, management conducted an evaluation of the effectiveness of our control over financial reporting based on the 2013 framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our evaluation under the framework, management has concluded that our internal control over financial reporting was effective as of December 31, 2020.
(c) Changes in internal controls:
There were not any significant changes in internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

---

ITEM 9B. OTHER INFORMATION
Item 9B. Other Information:
None
PART III

---

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Item 10. Directors, Executive Officers and Corporate Governance; Compliance with Section 16(a) of the Exchange Act:
The information concerning the directors and executive officers of the Company under the caption “Election of Directors,” and the information under the captions, “Delinquent Section 16(a) Reports,” and "Governance of the Company," in the Proxy Statement for the Company’s 2021 Annual Meeting of Shareholders, is incorporated by reference herein. It is expected that such Proxy Statement will be filed with the Securities and Exchange Commission no later than April 30, 2021.
Also, certain information regarding executive officers is included under the section captioned “Executive Officers” in Item 4A of this Annual Report on Form 10-K.

---

ITEM 11. EXECUTIVE COMPENSATION
Item 11. Executive Compensation:
The information concerning executive compensation under the caption, “Executive Compensation,” in the Proxy Statement for the Company’s 2021 Annual Meeting of Shareholders, is incorporated by reference herein. It is expected that such Proxy Statement will be filed with the Securities and Exchange Commission no later than April 30, 2021.

---

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters:
The information concerning the security ownership of certain beneficial owners and management under the caption, “Security Ownership of Certain Beneficial Owners and Management,” in the Proxy Statement for the Company’s 2021 Annual Meeting of Shareholders is incorporated by reference herein. It is expected that such Proxy Statement will be filed with the Securities and Exchange Commission no later than April 30, 2021.
Securities Authorized for Issuance under Equity Compensation Plans
The following table provides information with respect to the equity securities that are authorized for issuance under the Company’s equity compensation plans as of December 31, 2020.
Equity Compensation Plan Information
Number of securities
Number of securities
remaining available
to be issued upon
Weighted-average
for issuance under
exercise of
exercise price of
equity compensation
outstanding options,
outstanding options,
plans (excluding
warrants and rights
warrants and rights
securities reflected in
(A)
(B)
column (A)) (C) (1)
Equity compensation stock option plans approved by security holders
672,800
$
16.42
264,350
Equity compensation plans approved by security holders (Restricted stock plan)
87,972
-
-
Equity compensation plans not approved by security holders
N/A
N/A
N/A
Total
760,772
$
14.52
264,350
(1) Represents securities available for issuance under the 2019 Equity Compensation Plan to be allocated between incentive and non-qualified stock options, restricted stock awards, performance units and deferred stock.

---

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item 13. Certain Relationships and Related Transactions and Director Independence:
The information concerning certain relationships and related transactions under the caption, “Interest of Management and Others in Certain Transactions; Review, Approval or Ratification of Transactions with Related Persons,” in the Proxy Statement for the Company’s 2021 Annual Meeting of Shareholders is incorporated by reference herein. It is
expected that such Proxy Statement will be filed with the Securities and Exchange Commission no later than April 30, 2021.

---

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Item 14. Principal Accountant Fees and Services:
The information concerning principal accountant fees and services, as well as related pre-approval policies, under the caption, “Independent Registered Public Accounting Firm,” in the Proxy Statement for the Company’s 2021 Annual Meeting of Shareholders is incorporated by reference herein. It is expected that such Proxy Statement will be filed with the Securities and Exchange Commission no later than April 30, 2021.
PART IV

---

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Item 15. Exhibits and Financial Statement Schedules:
a) DOCUMENTS:
1. The following Consolidated Financial Statements and Supplementary Data of the Company and subsidiaries are filed as part of this annual report:
● Consolidated Balance Sheets as of December 31, 2020 and 2019
● Consolidated Statements of Income for the years ended December 31, 2020, 2019 and 2018
● Consolidated Statements of Comprehensive Income for the years ended December 31, 2020, 2019 and 2018
● Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2020, 2019 and 2018
● Consolidated Statements of Cash Flows for the years ended December 31, 2020, 2019 and 2018
● Notes to Consolidated Financial Statements
● Report of Independent Registered Public Accounting Firm
2. All Financial Statement Schedules are omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.
b) EXHIBITS:
Exhibit
Number
Description of Exhibits
3(i)
Certificate of Incorporation of the Company, as amended (1)
3(ii)
Bylaws of the Company (4)
4(i)
Form of Stock Certificate (4)
4(vi)
Description of the Registrant’s Securities
10(i)
1998 Stock Option Plan (2)
10(ii)
Amended and Restated Employment Agreement dated June 4, 2015 with James A. Hughes (10), as amended by Amendment Agreement dates February, 6 2020 (18)
10(iii)
Retention Agreement dated September 18, 2017 with John Kauchak (8), as amended by Amendment Agreement dates February, 6 2020 (18)
10(iv)
Retention Agreement dated September 18, 2017 with Janice Bolomey (8), as amended by Amendment Agreement dates February, 6 2020 (18)
10(v)
Change in Control Agreement dated July 23, 2020 with Laureen Cook (15)
10(vi)
2002 Stock Option Plan (3)
10(vii)
2006 Stock Option Plan (5)
10(viii)
2011 Stock Option Plan and 2011 Stock Bonus Plan (6)
10(ix)
2013 Stock Bonus Plan (7)
10(x)
2015 Stock Option Plan (9)
10(xi)
Amended and Restated Supplemental Executive Retirement Plan dated October 25, 2018 with James A. Hughes (13)
10(xii)
Executive Incentive Retirement Plan dated October 22, 2015 (11)
10(xiii)
2017 Stock Option Plan (12)
10(xiv)
2019 Equity Compensation Plan (14)
10(xv)
Acknowledgment and Consent of FDIC Consent Order between Commissioner of Banking and Insurance and Unity Bank (16)
10(xvi)
Consent Order with the Federal Deposit Insurance Corporation (17)
10(xvii)
Form of Indemnification Agreement entered into on January 23, 2020 by and among the Registrant, Unity Bank and each of their respective Directors (19)
Subsidiaries of the Registrant
23.1
Consent of RSM US LLP
31.1
Certification of President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of President, Chief Executive Officer, and Chief Financial Officer pursuant to Section 906
101.INS
Inline XBRL Instance Document
101.SCH
Inline XBRL Taxonomy Extension Schema Document
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF
Inline XBRL Taxonomy Extension Definitions Linkbase Document
Cover Page Interactive Data File (formatted as inline XBRL and contained as Exhibit 101)
(1) Previously filed with the Securities and Exchange Commission as an Exhibit to the Current Report on Form 8-K filed on July 22, 2002 and incorporated by reference herein.
(2) Previously filed with the Securities and Exchange Commission as an Exhibit to the Proxy Statement for the Annual Meeting of Shareholders filed on March 30, 1998.
(3) Previously filed with the Securities and Exchange Commission as an Exhibit to the Proxy Statement for the Annual Meeting of Shareholders filed on April 10, 2002.
(4) Previously filed with the Securities and Exchange Commission as an Exhibit to the Current Report on Form 8-K filed February 24, 2017.
(5) Previously filed with the Securities and Exchange Commission as an Exhibit to the Proxy Statement for the Annual Meeting of Shareholders filed on May 4, 2006.
(6) Previously filed with the Securities and Exchange Commission as an Exhibit to Form S-8 filed on May 26, 2011 and incorporated by reference herein.
(7) Previously filed with the Securities and Exchange Commission as an Exhibit to Form S-8 filed on July 12, 2013 and incorporated by reference herein.
(8) Previously filed with the Securities and Exchange Commission as an Exhibit to the Current Report on Form 8-K filed October 10, 2017.
(9) Previously filed with the Securities and Exchange Commission as an Exhibit to Form S-8 filed on May 22, 2015 and incorporated by reference herein.
(10) Previously filed with the Securities and Exchange Commission as an Exhibit to Form 8-K filed on June 5, 2015 and incorporated by reference herein.
(11) Previously filed with the Securities and Exchange Commission as an Exhibit to Form 8-K filed on October 27, 2015 and incorporated by reference herein.
(12) Previously filed with the Securities and Exchange Commission as an Exhibit to Form S-8 filed on May 22, 2017 and incorporated by reference herein.
(13) Previously filed with the Securities and Exchange Commission as an Exhibit to Form 8-K filed on October 30, 2018 and incorporated by reference herein.
(14) Previously filed with the Securities and Exchange Commission as an Exhibit to Form S-8 filed on June 4, 2019 and incorporated by reference herein.
(15) Previously filed with the Securities and Exchange Commission as an Exhibit to Form 8-K filed on July 24, 2020 and incorporated by reference herein.
(16) Previously filed with the Securities and Exchange Commission as an Exhibit to Form 8-K filed on July 16, 2020 and incorporated by reference herein.
(17) Previously filed with the Securities and Exchange Commission as an Exhibit to Form 8-K filed on July 14, 2020 and incorporated by reference herein.
(18) Previously filed with the Securities and Exchange Commission as an Exhibit to Form 8-K filed on February 6, 2020 and incorporated by reference herein.
(19) Previously filed with the Securities and Exchange Commission as an Exhibit to Form 8-K filed on January 28, 2020 and incorporated by reference herein.
c) Not applicable