0000835324sybt:LoansOriginatedIn2019Memberus-gaap:PerformingFinancingReceivableMembersybt:CommercialAndIndustrialPortfolioSegmentMembersybt:LinesOfCreditMemberus-gaap:SubstandardMember2020-06-30 0000835324us-gaap:StateAndLocalJurisdictionMembersybt:KentuckyDepartmentOfRevenueMember2019-03-012019-03-31
 

 

Table of Contents

UNITED STATES 

SECURITIES AND EXCHANGE COMMISSION 

Washington, D.C. 20549 

 

FORM 10-Q

  

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

  

For the quarterly period ended June 30, 20192020

  

or 

  

Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

  

Commission File Number: 1-13661

  

  

STOCK YARDS BANCORP, INC. 

(Exact name of registrant as specified in its charter)

  

Kentucky

 

61-1137529

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

   

1040 East Main Street, Louisville, Kentucky

 

40206

(Address of principal executive offices)

 

(Zip Code)

  

Registrant’s telephone number, including area code: (502) 582-2571

  

Securities registered pursuant to Section 12(b) of the Act: 

Title of each class

Trading symbol(s)

Name of each exchange on which registered

Common stock, no par value

SYBT

The NASDAQ Stock Market, LLC

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  ☒ Yes   ☐ No

  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  ☒ Yes  ☐ No

  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

 

 

 

 

 

Large accelerated filer ☒ 

 

Accelerated filer ☐

 

Non-accelerated filer ☐

 

Smaller reporting company ☐ 

Emerging growth company ☐

 

 

 

 

 

 

  

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  ☐ Yes  ☒ No

 

The number of shares outstanding of the registrant’s Common Stock, no par value, outstanding as of July 31, 2019,2020, was 22,723,643.22,681,848.

 

1

 

Stock Yards Bancorp, inc. and subsidiary

 

TABLE OF CONTENTS

 

Item

Page

partPart I – financial informationFinancial Information

 
  
 

Item 1. Financial Statements.

4
  
Consolidated Balance Sheets4
Consolidated Statements of Income5
Consolidated Statements of Comprehensive Income6
Consolidated Statements of Changes in Stockholders’ Equity7
Consolidated Statements of Cash Flows9
Footnotes to Consolidated Financial Statements11
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.5258
  
Item 3. Quantitative and Qualitative Disclosures about Market Risk.7594
  
Item 4. Controls and Procedures.7594
  
  
PARTPart II – OTHER INFORMATIONOther Information94
Item 1. Legal Proceedings.94
Item1A. Risk Factors.94
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.96
Item 6. Exhibits.96
  
  
Item 1.     Legal Proceedings76
Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds.76
Item 6.     Exhibits.77
SIGNATURESSignatures97

 

2

 

 

Stock Yards Bancorp, inc. and subsidiary

PART I – FINANCIAL INFORMATION

Glossary of Acronyms and TermsGLOSSARY OF ABBREVIATIONS AND ACRONYMS

 

The following listing provides a comprehensive reference of common acronyms and termsabbreviations identified in alphabetical order below are used throughout the document:this Report on Form 10-Q:

 

Acronym

or Term

Definition

Acronym

or Term

Definition

Acronym

or Term

Definition

ACH

 

DefinitionAutomatic Clearing House

ETR

Effective Tax Rate

NIM

Net Interest Margin (FTE)

AFS

 

Available for saleSale

 

HELOCEVP 

 

Home equity line of creditExecutive Vice President

NPV

Net Present Value

AllowanceAPIC

Additional paid-in capital

FASB

Financial Accounting Standards Board

Net Interest Spread

Net Interest Spread (FTE)

ACL

 

Allowance for loan and lease lossesCredit Losses

 

HTMFDIC

 

Held to maturityFederal Deposit Insurance Corporation

NM

Not Meaningful

AOCI

Accumulated Other Comprehensive Income

FFP

Federal Funds Purchased

OAEM

Other Assets Especially Mentioned

ASC

 

Accounting Standards Codification

 

KingFFS

 

King Bancorp, Inc.Federal Funds Sold

OCI

Other Comprehensive Income

ASU

 

Accounting Standards Update

 

KSBTFFTR

 

King Bancorp Statutory Trust IFederal Funds Target Rate

OREO

Other Real Estate Owned

ATM

Automated Teller Machine

FHA

Federal Housing Authority

PPP

Paycheck Protection Program

AUM

 

Assets under managementUnder Management

 

LIBORFHC

 

London Interbank Offering RateFinancial Holding Company

PV

Present Value

Bancorp / the Company

 

Stock Yards Bancorp, Inc.

 

LoansFHLB

 

Loans and leasesFederal Home Loan Bank of Cincinnati

PCD

Purchased with Credit Deteriorated

Bank / SYB

 

Stock Yards Bank & Trust Co.Company 

 

MSAFHLMC

 

Metropolitan statistical areaFederal Home Loan Mortgage Corporation 

PCI

Purchased Credit Impaired

BOLI

 

Bank owned life insuranceOwned Life Insurance

 

MSRFICA

 

Mortgage servicing rightFederal Insurance Contributions Act

Prime

The Wall Street Journal Prime Interest Rate

BPSBP

 

Basis point =Point - 1/100th100th of one percent

 

NAFNMA

 

Not applicableFederal National Mortgage Association

Provision

Provision for Credit Losses

C&D

 

Construction and developmentDevelopment

 

OAEMFRB

 

Other assets especially mentionedFederal Reserve Bank

PSU

Performance Stock Unit

CARES Act

Coronavirus Aid, Relief and Economic Security Act

FTE

Fully Tax Equivalent

ROA

Return on Average Assets

C&I

 

Commercial and industrialIndustrial

 

OCIGAAP

 

Other comprehensive incomeUnited States Generally Accepted Accounting Principles

ROE

Return on Average Equity

CD

Certificate of Deposit

GLB Act

Gramm-Leach-Bliley Act

RSA

Restricted Stock Award

CDI

Core Deposit Intangible

GNMA

Government National Mortgage Association

RSU

Restricted Stock Unit

CECL

 

Current Expected Credit LossesLoss (ASC-326)

 

OREOHB

 

Other real estate ownedHouse Bill

SAB

Staff Accounting Bulletin

CEO

 

Chief Executive Officer

 

OTTIHELOC

 

Other than temporarily impaired

COSO

CommitteeHome Equity Line of Sponsoring Organizations

PCI

Purchased credit impaired

CRA

Community Reinvestment Act of 1977

Provision

Provision for loan and lease losses

CRE

Commercial real estate

PSU

Performance stock unit

Dodd-Frank Act

Dodd-Frank Wall Street Reform and Consumer Protection Act

ROA

Return on average assets

EPS

Earnings per share

ROE

Return on average equity

EVP

Executive Vice President

RSA

Restricted stock award

FASB

Financial Accounting Standards Board

RSU

Restricted stock unit

FDIC

Federal Deposit Insurance CorporationCredit

 

SAR

 

Stock appreciate rightAppreciation Right

FHACFO

 

Federal housing AdministrationChief Financial Officer

ITM

Interactive Teller Machine

 

SEC

 

Securities and Exchange Commission

FHLBCOVID-19

 

Federal Home Loan BankCoronavirus Disease - 2019

KBST

King Bancorp Statutory Trust I

 

SSUAR

 

Securities sold under agreementsSold Under Agreements to repurchaseRepurchase

FHLMCCRA

 

Federal Home Loan Mortgage CorporationCommunity Reinvestment Act

 

TBOCKSB

 

THEKing Bancorp, Inc. and King Southern Bank of Oldham County

FNMA

 

Federal National Mortgage AssociationSBA

Small Business Administration

CRE

Commercial Real Estate

LIBOR

London Interbank Offered Rate

 

TCE

 

Tangible common equityCommon Equity

FRBDodd-Frank Act

 

Federal Reserve BankThe Dodd-Frank Wall Street Reform and Consumer Protection Act

Loans

Loans and Leases

 

TDR

 

Troubled Debt Restructuring

GAAPDTA

 

U.S. Generally Accepted Accounting PrinciplesDeferred Tax Asset

MBS

Mortgage Backed Securities

TPS

Trust Preferred Securities

DTL

Deferred Tax Liability

MSA

Metropolitan Statistical Area

 

VA

 

U.S. Department of Veterans Affairs

GNMADCF

 

Government National Discounted Cash Flow

MSRs

Mortgage AssociationServicing Rights

 

WM&T

 

Wealth Management and Trust

EPS

Earnings Per Share

NASDAQ

The NASDAQ Stock Market, LLC

 

3

 

 

Stock Yards Bancorp, inc. and subsidiaryPART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

Item 1.   Financial Statements

CONSOLIDATED BALANCE SHEETS

June 30, 2020 (unaudited) and December 31, 2019 (in thousands, except per share data)

CONSOLIDATED BALANCE SHEETS

June 30, 2019 (unaudited) and December 31, 2018

 

(In thousands, except share data)

        
 

June 30,

 

December 31,

  

June 30,

 

December 31,

 

 

2019

  

2018

  

2020

  

2019

 
Assets                

Cash and due from banks

 $51,264  $51,892  $46,362  $46,863 

Federal funds sold and interest bearing due from banks

  64,775   147,047   178,032   202,861 

Cash and cash equivalents

 116,039  198,939 

Total cash and cash equivalents

 224,394  249,724 
 

Mortgage loans held for sale

 3,922  1,675  17,364  8,748 

Securities available for sale

 423,579  436,995 

Available for sale debt securities (amortized cost of $472,797 in 2020 and $469,313 in 2019, respectively

 485,249  470,738 

Federal Home Loan Bank stock, at cost

 11,316  10,370  11,284  11,284 

Loans and leases

 2,763,880  2,548,171 

Allowance for loan and lease losses

  26,416   25,534 

Net loans and leases

 2,737,464  2,522,637 

Loans

 3,464,077  2,845,016 

Allowance for credit losses

  47,708   26,791 

Net loans

 3,416,369  2,818,225 
  

Premises and equipment, net

 65,069  44,764  56,832  58,618 

Bank owned life insurance

 32,631  32,273  32,912  32,557 

Accrued interest receivable

 9,633  8,360  13,535  8,534 

Goodwill

 12,826  682  12,513  12,513 

Core deposit intangible

 2,461  1,057  2,122  2,285 

Other assets

  48,883   45,172   61,959   50,971 

Total assets

 $3,463,823  $3,302,924  $4,334,533  $3,724,197 
  

Liabilities

                

Deposits:

          

Non-interest bearing

 $777,652  $711,023  $1,205,253  $810,475 

Interest bearing

  2,105,801   2,083,333   2,521,903   2,323,463 

Total deposits

 2,883,453  2,794,356  3,727,156  3,133,938 
  

Securities sold under agreements to repurchase

 33,809  36,094  42,722  31,895 

Federal funds purchased

 12,012  10,247  8,401  10,887 

Federal Home Loan Bank advances

 84,279  48,177  61,432  79,953 

Accrued interest payable

 1,008  762  471  640 

Other liabilities

  59,897   46,788   74,120   60,587 

Total liabilities

  3,074,458   2,936,424   3,914,302   3,317,900 
  

Commitments and contingent liabilities (note 15)

    

Commitments and contingent liabilities (Footnote 10)

    
  

Stockholders’ equity

                

Preferred stock, no par value. Authorized 1,000,000 shares; no shares issued or outstanding

        

Common stock, no par value. Authorized 40,000,000 shares; issued and outstanding 22,721,027 and 22,749,139 shares in 2019 and 2018, respectively

 36,596  36,689 

Common stock, no par value. Authorized 40,000,000 shares; issued and outstanding 22,667,000 and 22,604,000 shares in 2020 and 2019, respectively

 36,415  36,207 

Additional paid-in capital

 37,776  36,797  39,425  35,714 

Retained earnings

 313,927  298,156  335,575  333,699 

Accumulated other comprehensive income (loss)

  1,066   (5,142)

Accumulated other comprehensive income

  8,816   677 

Total stockholders’ equity

  389,365   366,500   420,231   406,297 

Total liabilities and stockholders’ equity

 $3,463,823  $3,302,924  $4,334,533  $3,724,197 

See accompanying notes to unaudited consolidated financial statements.

4

CONSOLIDATED STATEMENTS OF INCOME (unaudited)

For the three and sixmonths ended June 30, 2020 and 2019(in thousands, except per share data)

  

Three months ended

  

Six months ended

 
  

June 30,

  

June 30,

 
  

2020

  

2019

  

2020

  

2019

 

Interest income:

                

Loans, including fees

 $34,099  $33,447  $67,848  $65,018 

Federal funds sold and interest bearing due from banks

  88   830   619   1,563 

Mortgage loans held for sale

  125   43   186   80 

Securities available for sale:

                

Taxable

  2,136   2,546   4,602   5,114 

Tax-exempt

  58   130   133   277 

Total interest income

  36,506   36,996   73,388   72,052 

Interest expense:

                

Deposits

  2,607   5,652   6,569   10,718 

Securities sold under agreements to repurchase

  8   28   24   53 

Federal funds purchased and other short-term borrowing

  2   64   31   124 

Federal Home Loan Bank advances

  361   424   790   645 

Subordinated debentures

     26      26 

Total interest expense

  2,978   6,194   7,414   11,566 

Net interest income

  33,528   30,802   65,974   60,486 

Provision for credit losses

  5,550      11,100   600 

Net interest income after provision

  27,978   30,802   54,874   59,886 

Non-interest income:

                

Wealth management and trust services

  5,726   5,662   11,944   11,101 

Deposit service charges

  800   1,260   2,083   2,438 

Debit and credit card income

  2,063   2,168   4,043   3,912 

Treasury management fees

  1,249   1,202   2,533   2,359 

Mortgage banking income

  1,622   760   2,468   1,210 

Net investment product sales commissions and fees

  391   364   857   720 

Bank owned life insurance

  176   184   355   362 

Other

  595   624   875   1,130 

Total non-interest income

  12,622   12,224   25,158   23,232 

Non-interest expenses:

                

Compensation

  11,763   12,715   23,996   24,516 

Employee benefits

  2,871   2,807   6,038   5,362 

Net occupancy and equipment

  2,089   1,967   3,970   3,816 

Technology and communication

  1,947   1,848   3,960   3,621 

Debit and credit card processing

  603   631   1,259   1,218 

Marketing and business development

  465   903   1,025   1,528 

Postage, printing and supplies

  442   410   883   816 

Legal and professional

  628   1,523   1,251   2,057 

FDIC insurance

  330   248   459   486 

Amortization of investments in tax credit partnerships

  53   52   89   104 

Capital and deposit based taxes

  1,225   967   2,255   1,871 

Credit loss expense for off-balance sheet exposures

  1,475   -   1,850   - 

Other

  993   1,382   1,799   2,670 

Total non-interest expenses

  24,884   25,453   48,834   48,065 

Income before income tax expense

  15,716   17,573   31,198   35,053 

Income tax expense

  2,348   1,030   4,598   2,869 

Net income

 $13,368  $16,543  $26,600  $32,184 

Net income per share, basic

 $0.59  $0.73  $1.18  $1.42 

Net income per share, diluted

 $0.59  $0.72  $1.17  $1.40 

Weighted average outstanding shares:

                

Basic

  22,560   22,689   22,538   22,675 

Diluted

  22,739   22,949   22,737   22,948 

See accompanying notes to unaudited consolidated financial statements.

5

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)

For the three and six months ended June 30, 2020 and 2019(in thousands)

  

Three months ended

  

Six months ended

 
  

June 30,

  

June 30,

 
  

2020

  

2019

  

2020

  

2019

 

Net income

 $13,368  $16,543  $26,600  $32,184 

Other comprehensive income:

                

Change in unrealized gain on AFS debt securities

  3,086   5,021   11,027   8,446 

Change in fair value of derivatives used in cash flow hedge

  28   (321)  (318)  (530)

Total other comprehensive income, before income tax expense

  3,114   4,700   10,709   7,916 

Tax effect

  750   1,121   2,570   1,708 

Total other comprehensive income, net of tax

  2,364   3,579   8,139   6,208 

Comprehensive income

 $15,732  $20,122  $34,739  $38,392 

 

See accompanying notes to unaudited consolidated financial statements.

 

4
6

 

 

CONSOLIDATED STATEMENTS OF INCOME  (Unaudited)

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (unaudited)

For the three and six months ended June 30, 2020 and 2019 (in thousands, except per share data)

For the three and six months ended June 30, 2019 and 2018

 

  

Three months ended

  

Six months ended

 

(In thousands, except per share data)

 

June 30,

  

June 30,

 
  

2019

  

2018

  

2019

  

2018

 

Interest income:

                

Loans and leases

 $33,419  $29,456  $64,963  $56,518 

Federal funds sold and interest bearing due from banks

  830   163   1,563   431 

Mortgage loans held for sale

  43   44   80   79 

Securities available for sale

                

Taxable

  2,546   2,105   5,114   4,243 

Tax-exempt

  130   236   277   477 

Total interest income

  36,968   32,004   71,997   61,748 

Interest expense:

                

Deposits

  5,652   2,674   10,718   4,751 

Securities sold under agreements to repurchase

  28   30   53   67 

Federal funds purchased and other short-term borrowing

  64   397   124   483 

Federal Home Loan Bank advances

  424   229   645   464 

Subordinated debentures

  26      26    

Total interest expense

  6,194   3,330   11,566   5,765 

Net interest income

  30,774   28,674   60,431   55,983 

Provision for loan and lease losses

     1,235   600   1,970 

Net interest income after provision

  30,774   27,439   59,831   54,013 

Non-interest income:

                

Wealth management and trust services

  5,662   5,344   11,101   10,844 

Deposit service charges

  1,336   1,447   2,583   2,858 

Debit and credit card income

  2,168   1,689   3,912   3,197 

Treasury management fees

  1,202   1,113   2,359   2,160 

Mortgage banking income

  796   746   1,278   1,322 

Net investment product sales commissions and fees

  364   397   720   801 

Bank owned life insurance

  184   191   362   378 

Other

  551   508   1,010   784 

Total non-interest income

  12,263   11,435   23,325   22,344 

Non-interest expenses:

                

Compensation

  12,715   11,703   24,516   22,673 

Employee benefits

  2,908   2,512   5,550   5,145 

Net occupancy and equipment

  1,976   1,811   3,834   3,629 

Technology and communication

  1,848   1,685   3,621   3,315 

Debit and credit card processing

  631   579   1,218   1,145 

Marketing and business development

  903   805   1,528   1,451 

Postage, printing, and supplies

  410   400   816   791 

Legal and professional

  1,523   504   2,057   997 

FDIC insurance

  248   238   486   480 

Amortization/impairment of investments in tax credit partnerships

  52   58   104   58 

Capital and deposit based taxes

  967   862   1,871   1,714 

Other

  1,283   979   2,502   1,765 

Total non-interest expenses

  25,464   22,136   48,103   43,163 

Income before income tax expense

  17,573   16,738   35,053   33,194 

Income tax expense

  1,030   3,159   2,869   6,211 

Net income

 $16,543  $13,579  $32,184  $26,983 

Net income per share, basic

 $0.73  $0.60  $1.42  $1.19 

Net income per share, diluted

 $0.72  $0.59  $1.40  $1.17 

Weighted average common shares:

                

Basic

  22,689   22,625   22,675   22,601 

Diluted

  22,949   22,967   22,948   22,959 
                  

Accumulated

     
  

Common stock

  

Additional

      

other

  

Total

 
  

Shares

      

paid-in

  

Retained

  

comprehensive

  

stockholders'

 
  

outstanding

  

Amount

  

capital

  

earnings

  

income (loss)

  

equity

 
                         

Balance, January 1, 2019

  22,749  $36,689  $36,797  $298,156  $(5,142) $366,500 
                         

Activity for three months ended March 31, 2019:

                        

Net income

           15,641      15,641 

Other comprehensive income

              2,629   2,629 

Stock compensation expense

        863         863 

Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations

  74   245   2,254   (4,452)     (1,953)

Cash dividends declared, $0.25 per share

           (5,686)     (5,686)
                         

Balance, March 31, 2019

  22,823  $36,934  $39,914  $303,659  $(2,513) $377,994 
                         
                         

Activity for three months ended June 30, 2019:

                        
                         

Net income

           16,543      16,543 

Other comprehensive income

              3,579   3,579 

Stock compensation expense

        993         993 

Common stock repurchased

  (107)  (357)  (3,308)        (3,665)

Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations

  5   19   182   (363)     (162)

Cash dividends declared, $0.26 per share

           (5,917)     (5,917)

Shares cancelled

        (5)  5       
                         

Balance, June 30, 2019

  22,721  $36,596  $37,776  $313,927  $1,066  $389,365 

 

See accompanying notes to unaudited consolidated financial statements.

 

5
7

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (unaudited)

For the three and six months ended June 30, 2020 and 2019 (in thousands, except per share data)

For the three and six months ended June 30, 2019 and 2018

 

  

Three months ended

  

Six months ended

 
  

June 30,

  

June 30,

 

(In thousands)

 

2019

  

2018

  

2019

  

2018

 
             

Net income

 $16,543  $13,579  $32,184  $26,983 

Other comprehensive income:

                

Change in unrealized gain (loss) on available for sale debt securities

  5,021   (1,618)  8,446   (6,325)

Change in fair value of derivatives used in cash flow hedges

  (321)  99   (530)  491 

Total other comprehensive income (loss), before income tax

  4,700   (1,519)  7,916   (5,834)

Tax effect

  1,121   (319)  1,708   (1,226)

Total other comprehensive income (loss), net of tax

  3,579   (1,200)  6,208   (4,608)

Comprehensive income

 $20,122  $12,379  $38,392  $22,375 
                  

Accumulated

     
  

Common stock

  

Additional

      

other

  

Total

 
  

Shares

      

paid-in

  

Retained

  

comprehensive

  

stockholders'

 
  

outstanding

  

Amount

  

capital

  

earnings

  

income

  

Total

 
                         

Balance, January 1, 2020

  22,604  $36,207  $35,714  $333,699  $677  $406,297 
                         

Activity for three months ended March 31, 2020:

                        

Impact of adoption of ASC 326

           (8,823)     (8,823)

Net income

           13,232      13,232 

Other comprehensive income

              5,775   5,775 

Stock compensation expense

        817         817 

Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations

  62   203   1,858   (3,546)     (1,485)

Cash dividends declared, $0.27 per share

           (6,111)     (6,111)

Shares cancelled

  (1)  (2)  (22)  24       
                         

Balance, March 31, 2020

  22,665  $36,408  $38,367  $328,475  $6,452  $409,702 
                         

Activity for three months ended June 30, 2020:

                        

Net income

           13,368      13,368 

Other comprehensive income

              2,364   2,364 

Stock compensation expense

        976         976 

Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations

  2   8   96   (163)     (59)

Cash dividends declared, $0.27 per share

           (6,120)     (6,120)

Shares cancelled

     (1)  (14)  15       

Balance, June 30, 2020

  22,667  $36,415  $39,425  $335,575  $8,816  $420,231 

 

See accompanying notes to unaudited consolidated financial statements.

 

6
8

 

 

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

For the six months ended June 30, 2020 and 2019(in thousands)

For the six months ended June 30, 2019  with quarterly subtotals

 

                  

Accumulated

     
  

Common stock

  

Additional

      

other

  

Total

 
  

Number of

      

paid-in

  

Retained

  

comprehensive

  

stockholders'

 

(In thousands, except per share data)

 

shares

  

Amount

  

capital

  

earnings

  

income (loss)

  

equity

 
                         

Balance, January 1, 2019

  22,749  $36,689  $36,797  $298,156  $(5,142) $366,500 
                         

Activity for three months ended March 31, 2019:

                     
                         

Net income

           15,641      15,641 
                         

Net change in accumulated other comprehensive income (loss)

              2,629   2,629 
                         

Stock compensation expense

        863         863 
                         

Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations upon award

  74   245   2,254   (4,452)     (1,953)
                         

Cash dividends declared, $0.25 per share

           (5,686)     (5,686)
                         

Balance, March 31, 2019

  22,823  $36,934  $39,914  $303,659  $(2,513) $377,994 
                         

Activity for three months ended June 30, 2019:

                     
                         

Net income

           16,543      16,543 
                         

Net change in accumulated other comprehensive income (loss)

              3,579   3,579 
                         

Stock compensation expense

        993         993 
                         

Common stock repurchased

  (107)  (357)  (3,308)        (3,665)
                         

Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations upon award

  5   19   182   (363)     (162)
                         

Cash dividends declared, $0.26 per share

           (5,917)     (5,917)
                         

Shares cancelled

        (5)  5       
                         

Balance, June 30, 2019

  22,721  $36,596  $37,776  $313,927  $1,066  $389,365 
  

2020

  

2019

 

Operating activities:

        

Net income

 $26,600  $32,184 

Adjustments to reconcile net income to net cash provided by operating activities:

        

Provision for credit losses

  11,100   600 

Depreciation, amortization and accretion, net

  2,815   1,679 

Deferred income tax benefit

  (1,947)  (3,959)

Gain on sales of mortgage loans held for sale

  (2,593)  (719)

Origination of mortgage loans held for sale

  (103,509)  (38,081)

Proceeds from sale of mortgage loans held for sale

  97,486   36,553 

Bank owned life insurance income

  (355)  (362)

(Gain)/loss on the disposal of premises and equipment

  (209)  6 

Gain on the sale of other real estate owned

     (63)

Stock compensation expense

  1,793   1,856 

Excess tax (benefit) expense from share-based compensation arrangements

  3   (392)

Net change in accrued interest receivable and other assets

  (14,245)  (3,429)

Net change in accrued interest payable and other liabilities

  11,741   (3,974)

Net cash provided by operating activities

  28,680   21,899 

Investing activities:

        

Purchases of available for sale debt securities

  (192,713)  (373,761)

Proceeds from sales of acquired available for sale debt securities

     12,427 

Proceeds from maturities and paydowns of available for sale debt securities

  189,047   396,367 

Proceeds from redemption of Federal Home Loan Bank stock

     591 

Proceeds from redemption of Federal Reserve Bank stock

     490 

Proceeds from redemption of interest bearing due from banks

     1,761 

Net change in traditional loans

  12,616   (49,280)

Net change in PPP loans

  (630,082)   

Purchases of premises and equipment

  (2,526)  (3,321)

Proceeds from disposal of premises and equipment

  1,222   45 

Proceeds from surrender of acquired bank owned life insurance

     3,431 

Proceeds from bank owned life insurance mortality benefit

     909 

Other investment activities

  (646)  (1,532)

Proceeds from sales of other real estate owned

     868 

Cash for acquisition, net of cash acquired

     (24,684)

Net cash used in investing activities

  (623,082)  (35,689)

Financing activities:

        

Net change in deposits

  593,179   (36,464)

Net change in securities sold under agreements to repurchase and federal funds purchased

  8,341   (2,086)

Proceeds from Federal Home Loan Bank advances

  60,000   60,000 

Repayments of Federal Home Loan Bank advances

  (78,629)  (67,250)

Repayment of acquired bank holding company line of credit

     (2,300)

Redemption of acquired bank subordinated debentures

     (3,609)

Repurchase of common stock

     (3,665)

Share repurchases related to compensation plans

  (1,544)  (2,115)

Cash dividends paid

  (12,275)  (11,621)

Net cash provided by (used in) financing activities

  569,072   (69,110)

Net change in cash and cash equivalents

  (25,330)  (82,900)

Cash and cash equivalents at beginning of period

  249,724   198,939 

Cash and cash equivalents at end of period

 $224,394  $116,039 

 

See accompanying notes to unaudited consolidated financial statements.

(continued)

 

7
9

 

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (continued)

For the six months ended June 30, 2020 and 2019(in thousands)

For the six months ended June 30, 2018 with quarterly subtotals

 

                  

Accumulated

     
  

Common stock

  

Additional

      

other

  

Total

 
  

Number of

      

paid-in

  

Retained

  

comprehensive

  

stockholders'

 

(In thousands, except per share data)

 

shares

  

Amount

  

capital

  

earnings

  

loss

  

Total

 
                         

Balance, January 1, 2018

  22,679  $36,457  $31,924  $267,193  $(1,930) $333,644 
                         

Activity for three months ended March 31, 2018:

                     
                         

Net income

           13,404      13,404 
                         

Net change in accumulated other comprehensive loss

              (3,408)  (3,408)
                         

Reclassification adjustment under Accounting Standards Update 2018-02

           506   (506)   
                         

Stock compensation expense

        823         823 
                         

Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations upon award

  52   174   205   (1,914)     (1,535)
                         

Cash dividends declared, $0.23 per share

           (5,226)     (5,226)
                         

Shares cancelled

  (1)  (4)  (35)  39       
                         

Balance, March 31, 2018

  22,730  $36,627  $32,917  $274,002  $(5,844) $337,702 
                         

Activity for three months ended June 30, 2018:

                     
                         

Net income

           13,579      13,579 
                         

Net change in accumulated other comprehensive loss

              (1,200)  (1,200)
                         

Stock compensation expense

        1,212         1,212 
                         

Repurchase of common stock

                  
                         

Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations upon award

  17   57   618   (1,226)     (551)
                         

Cash dividends declared, $0.23 per share

           (5,227)     (5,227)
                         

Shares cancelled

  (1)  (4)  (32)  36       
                         

Balance, June 30, 2018

  22,746  $36,680  $34,715  $281,164  $(7,044) $345,515 
  

2020

  

2019

 

Supplemental cash flow information:

        

Interest paid

 $7,583  $5,382 

Income taxes paid, net of refunds

  418   11,320 

Cash paid for operating lease liabilities

  790   694 

Supplemental non-cash activity:

        

Unfunded commitments in tax credit investments

 $5,503  $3,477 

Initial recognition of right-of-use lease assets

     16,747 

Initial recognition operating lease liabilities

     18,067 

Loans transferred to OREO

      
         

Liabilities assumed in conjunction with acquisition

        

Fair value of assets acquired

 $  $204,613 

Cash paid in acquisition

     28,000 

Liabilities assumed

 $  $176,613 

 

See accompanying notes to unaudited consolidated financial statements.

 

8
10

CONSOLIDATED STATEMENTS OF CASHFLOWS (Unaudited)

For the six months ended June 30, 2019 and 2018

(In thousands)

 2019  2018 

Operating activities:

        

Net income

 $32,184  $26,983 

Adjustments to reconcile net income to net cash provided by operating activities:

        

Provision for loan and lease losses

  600   1,970 

Depreciation, amortization and accretion, net

  1,679   2,680 

Deferred income tax (benefit) expense

  (3,959)  40 

Gain on sales of mortgage loans held for sale

  (719)  (769)

Origination of mortgage loans held for sale

  (38,081)  (37,803)

Proceeds from sale of mortgage loans held for sale

  36,553   39,483 

Bank owned life insurance income

  (362)  (378)

Loss (gain) on the disposal of premises and equipment

  6   (14)

Gain on the sale of other real estate

  (63)  (109)

Stock compensation expense

  1,856   2,035 

Excess tax benefits from share-based compensation arrangements

  (392)  (525)

Net change in accrued interest receivable and other assets

  (3,429)  2,236 

Net change in accrued interest payable and other liabilities

  (3,974)  247 

Net cash provided by operating activities

  21,899   36,076 

Investing activities:

        

Purchases of securities available for sale

  (373,761)  (399,911)

Proceeds from sales of securities

  12,427    

Proceeds from maturities and paydowns of securities available for sale

  396,367   392,855 

Purchase of Federal Home Loan Bank stock

     (2,724)

Proceeds from redemptions of Federal Home Loan Bank stock

  591    

Proceeds from redemption of Federal Reserve Bank stock

  490    

Proceeds from redemption of interest bearing due from banks

  1,761    

Net change in loans

  (49,280)  (170,843)

Purchases of premises and equipment

  (3,321)  (2,694)

Proceeds from disposal of premises and equipment

  45   230 

Proceeds from surrender of acquired bank bank owned life insurance

  3,431    

Proceeds from bank owned life insurance mortality benefit

  909    

Other investment activities

  (1,532)  (2,542)

Proceeds from sale of foreclosed assets

  868   2,860 

Cash for acquisition, net of cash acquired

  (24,684)   

Net cash used in investing activities

  (35,689)  (182,769)

Financing activities:

        

Net change in deposits

  (36,464)  (37,834)

Net change in securities sold under agreements to repurchase and federal funds purchased

  (2,086)  113,443 

Proceeds from Federal Home Loan Bank advances

  60,000   60,000 

Repayments of Federal Home Loan Bank advances

  (67,250)  (60,637)

Repayment of acquired bank holding company line of credit

  (2,300)   

Redemption of acquired bank subordinated debentures

  (3,609)   

Common stock repurchases

  (5,780)  (2,086)

Cash dividends paid

  (11,621)  (10,441)

Net cash provided by (used in) financing activities

  (69,110)  62,445 

Net change in cash and cash equivalents

  (82,900)  (84,248)

Cash and cash equivalents at beginning of period

  198,939   139,248 

Cash and cash equivalents at end of period

 $116,039  $55,000 

(continued)

CONSOLIDATED STATEMENTS OF CASHFLOWS (continued) (Unaudited)

For the six months ended June 30, 2019 and 2018

(In thousands)

 2019  2018 

Supplemental cash flow information:

        

Cash paid during the period for:

        

Income tax payments, net of refunds

 $5,382  $1,800 

Cash paid for interest

  11,320   5,497 

Supplemental non-cash activity:

        

Initital recognition of right-of-use lease assets

 $16,747  $ 

Initital recognition operating lease liabilities

  18,067    

Transfers from loans to real estate acquired in settlement of loans

     471 
         

Liabilities assumed in conjunction with King Bancorp acquisition:

        

Fair value of assets acquired

 $204,613  $ 

Cash paid in acqusition

  28,000    

Liabilities assumed

 $176,613  $ 

See accompanying notes to unaudited consolidated financial statements.

 

NOTESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

 

(1)

Basis of Presentation and Summary of Significant Accounting Policies

 

BasisNature of PresentationOperationsStock Yards Bancorp, Inc. (“Bancorp” or “the Company”) is a FHC headquartered in Louisville, Kentucky. The accompanying consolidated financial statements include the accounts of Stock Yards Bancorp, Inc.its wholly owned subsidiary, SYB (“Holding Company”), and its wholly-owned subsidiary, Stock Yards Bank & Trust Company (“Bank”)the Bank). All significant inter-company transactions and accounts have been eliminatedEstablished in consolidation. All companies are collectively referred to as “Bancorp” or the “Company.”

As a result of its acquisition of King, Bancorp, Inc. on May 1, 2019, Bancorp became the 100% successor owner of King Bancorp Statutory Trust I (“KBST”), an unconsolidated finance subsidiary. As permitted under the terms of KBST’s governing documents, Bancorp redeemed the trust-preferred securities at the par amount of approximately $3.6 million on June 17, 2019.

The Bank, chartered in 1904, SYB is a Louisville, Kentucky-based, state-chartered non-member financial institution that provides services in the Louisville, Kentucky, Indianapolis, Indiana and Cincinnati, Ohio Metropolitan Statistical Areas (“MSAs”)MSAs through 4243 full service banking center locations.

As a result of its acquisition on May 1, 2019, Bancorp became the 100% successor owner of KBST, an unconsolidated finance subsidiary. As permitted under the terms of the governing documents, Bancorp redeemed the TPS at the par amount of approximately $4 million in June 2019.

As of June 30, 2019, Bancorp wasis divided into two reportable segments: Commercial Banking and Wealth Management & Trust (“WM&T”):&T:

Commercial Banking provides a full range of loan and deposit products to individual consumers and businesses in all its markets through commercial lending, retail lending, mortgage banking, deposit services, treasury management services, private banking, online banking, mobile banking, private banking, commercial lending, treasury management services, merchant services, international banking, correspondent banking and other banking services. The Bank also offers securities brokerage services via its banking center network through an arrangement with a third party broker-dealer. broker-dealer in the Commercial Banking segment. 

WM&T with over $3 billion in assets under management (“AUM”), provides custom-tailored financial planning, investment management, company retirement plan management, retirement planning, and trust and estate services in all markets in which Bancorp operates. The magnitude of WM&T revenue distinguishes Bancorp from other community banks of similar asset size.

Principles of Consolidation and Basis of PresentationThe accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”)GAAP for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, the financial statements do not include all the information and footnotes required by GAAP for complete financial statements.

In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for fair presentation have been included. Intercompany transactions have been eliminated. These condensed consolidated financial statements should be read in conjunction with Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2019. Operating results for the three and six months month periods ended June 30, 20192020 are not necessarily indicative of the results that may be expected for the year ending December 31,2020.2019. For further information, refer

Critical Accounting Policies and Estimates – Certain accounting estimates are important to the portrayal of Bancorp’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances which could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy, including pandemic-related changes, and changes in the financial condition of borrowers.

Bancorp’s accounting policies are fundamental to understanding management’s discussion and analysis of our results of operations and financial condition. At December 31, 2019, the significant accounting policy considered the most critical in preparing Bancorp’s consolidated financial statements is the determination of the ACL on loans. See the section titled “Critical Accounting Policies and notes thereto includedEstimates in Bancorp’s2019 Annual Report on Form 10-K for the year endedadditional detail.

On January 1, 2020, Bancorp adopted ASC 326Financial Instruments – Credit Losses, which created material changes to Bancorp’s existing critical accounting policy that existed at December 31, 2018.2019. Effective Certain reclassifications have been madeJanuary 1, 2020 through June 30, 2020, the significant accounting policy considered the most critical in preparing Bancorp’s consolidated financial statements is the determination of the ACL on loans.

The ACL on loans is established through credit loss expense charged to current earnings. The amount maintained in the prior year financial statementsACL reflects management’s estimate of the net amount not expected to conformbe collected on the loan portfolio at the balance sheet date. The ACL is comprised of specific reserves assigned to certain loans that do not share general risk characteristics and general reserves on pools of loans that do share general risk characteristics. Factors contributing to the determination of specific reserves include the creditworthiness of the borrower and more specifically, changes in the expected future receipt of principal and interest payments and/or in the value of pledged collateral. A reserve is recorded when the carrying amount of the loan exceeds the discounted estimated cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral-dependent loans. For purposes of establishing the general reserve, Bancorp stratifies the loan portfolio into homogeneous groups of loans that possess similar loss potential characteristics and calculates the net amount expected to be collected over the life of the loans to estimate the credit losses in the loan portfolio. Bancorp’s methodologies for estimating the ACL on loans consider available relevant information about the collectability of cash flows, including information about past events, current year classifications.conditions, and reasonable and supportable forecasts.

 

Significant Accounting Policies - In preparing the unaudited consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of related revenues and expenses during the reporting period. Actual results could differ from those estimates. A description of significant accounting policies is presented in Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2018.2019.

Debt SecuritiesBancorp determines the classification of debt securities at the time of purchase. Debt securities that management has the positive intent and ability to hold to maturity are classified as held to maturity and recorded at amortized cost. Debt securities not classified as held to maturity are classified as AFS and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in AOCI, net of tax. All debt securities were classified as AFS at June 30, 2020 and December 31, 2019.

Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific-identification method. Amortization of premiums and discounts are recognized in interest income over the period to maturity using the interest method, except for premiums on callable debt securities, which are amortized to their earliest call date.

Bancorp has made a policy election to exclude accrued interest from the amortized cost basis of debt securities and reports accrued interest separately in the consolidated balance sheets. A debt security is placed on non-accrual status at the time any principal or interest payments become more than 90 days delinquent or if full collection of interest or principal becomes uncertain. Accrued interest for a security placed on non-accrual is reversed against interest income. There was no accrued interest related to AFS debt securities reversed against interest income for the three and six-month periods ended June 30, 2020 and 2019.

 

CriticalACLAFSDebt Securities Accounting Policies - An allowance has been establishedFor AFS debt securities in an unrealized loss position, Bancorp evaluates the securities to providedetermine whether the decline in the fair value below the amortized cost basis (impairment) is due to credit-related factors or non-credit related factors. Any impairment that is not credit-related is recognized in AOCI, net of tax. Credit-related impairment is recognized as an a ACL on AFS debt securities on the balance sheet, limited to the amount by which the amortized cost basis exceeds the fair value, with a corresponding adjustment to earnings. Accrued interest receivable is excluded from the estimate of credit losses. Both the ACL and the adjustment to net income may be reversed if conditions change. However, if Bancorp intends to sell an impaired AFS debt security or more likely than not will be required to sell such a security before recovering its amortized cost basis, the entire impairment amount would be recognized in earnings with a corresponding adjustment to the security’s amortized cost basis. Because the security’s amortized cost basis is adjusted to fair value, there is no ACL in this situation.

In evaluating AFS debt securities in unrealized loss positions for probableimpairment and the criteria regarding its intent or requirement to sell such securities, Bancorp considers the extent to which fair value is less than amortized cost, whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuers’ financial condition, among other factors. There were no credit related factors underlying unrealized losses on loansAFS debt securities at June 30, 2020 and December 31, 2019.

Changes in the ACL on AFS debt securities are recorded as expense. Losses are charged against the ACL when management believes the uncollectability of an AFS debt security is confirmed or when either of the criteria regarding intent or requirement to sell is met.

LoansLoans that may not be fully repaid. The allowancemanagement has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at amortized cost basis, which is increased by provisions charged to expense and decreased by charge-offs,the unpaid principal balance outstanding, net of recoveries. Loans are typically charged off when management deems them uncollectibleunearned income, deferred loan fees and after underlying collateralcosts, premiums and discounts associated with acquisition date fair value adjustments on acquired loans and any direct partial charge-offs. Bancorp has been liquidated; however, collection efforts continuemade a policy election to exclude accrued interest from the amortized cost basis of loans and future recoveries may occur. Periodically, loans are partially charged off toreport accrued interest separately from the net realizable value based upon evaluation of related underlying collateral, including Bancorp’s expectation of resolution.loan balance in the consolidated balance sheets.

 

Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income over the remaining life of the loan without anticipating prepayments.

 

The allowance methodology is driven by risk ratings, historical losses, and qualitative factors. The levelLoans are considered past due or delinquent when the contractual principal and/or interest due in accordance with the terms of the loan agreement or any portion thereof remains unpaid after the due date of the scheduled payment. Loans are classified as non-accrual when, in the opinion of management, collection of principal or interest is doubtful. The accrual of interest income on loans is typically discontinued at the time the loan is June 30, 2019 90allowance reflected days delinquent unless the loan is well-secured and in process of collection, or if full collection of interest or principal becomes uncertain. Consumer loans are typically charged off no later than 120 days past due. All interest accrued but not received for a numberloan placed on non-accrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Under the cost-recovery method, interest income is not recognized until the loan balance is reduced to zero. Under the cash-basis method, interest income is recorded when the payment is received in cash. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Acquired loans are recorded at fair value at the date of acquisition based on a DCF methodology that considers various factors including credit quality metrics which were generally consistent with prior periods,the type of loan and expansionrelated collateral, classification status, fixed or variable interest rate, term of the historical look-back period from 32 to 36 quarters in March of 2019. This expansion of the historical period was applied to all classesloan and segments of the portfolio. Expansion of the look-back period for historical loss rates used in the quantitative allocation caused review of the overall methodology for qualitative factors to ensure we were appropriately capturing riskwhether or not addressed in the quantitative historical loss rate. Management believes extension of the look-back period is appropriate to ensure capture of the impact ofloan was amortizing, and a full economic cycle and more accurately represents the current leveldiscount rate reflecting Bancorp’s assessment of risk inherent in the cash flow estimates. Certain larger purchased loans are individually evaluated while certain purchased loans are grouped together according to similar risk characteristics and are treated in aggregate when applying various valuation techniques. These cash flow evaluations are inherently subjective, as they require material estimates, all of which may be susceptible to significant change.

Prior to January 1, 2020, loans acquired in a business combination that had evidence of deterioration of credit quality since origination and for which it was probable, at acquisition, that Bancorp would be unable to collect all contractually required payments receivable were considered PCI. PCI loans were individually evaluated and recorded at fair value at the date of acquisition with no initial ACL based on a DCF methodology that considered various factors including the type of loan portfolio. Basedand related collateral, classification status, fixed or variable interest rate, term of loan and whether or not the loan was amortizing, and a discount rate reflecting Bancorp’s assessment of risk inherent in the cash flow estimates. The difference between the DCFs expected at acquisition and the investment in the loan, or the “accretable yield,” was recognized as interest income on a level-yield method over the life of the loan. Contractually required payments for interest and principal that exceed the DCFs expected at acquisition, or the “non-accretable difference,” were not recognized on the look-back period extension, the allowance level increased approximately $2.0 million forbalance sheet and did 2019.not Key indicators of loan quality continued to trend at levels consistent with prior periods, however management recognizes that dueresult in any yield adjustments, loss accruals or valuation allowances. Increases in expected cash flows, including prepayments, subsequent to the cyclicalinitial investment were recognized prospectively through adjustment of the yield on the loan over its remaining life. Decreases in expected cash flows were recognized as impairment. ACLs on PCI loans reflected only losses incurred post-acquisition (meaning the PV of all cash flows expected at acquisition that ultimately were not to be received).

Subsequent to January 1, 2020, loans acquired in a business combination that have experienced more-than-insignificant deterioration in credit quality since origination are considered PCD loans. At the acquisition date, an estimate of expected credit losses is made for groups of PCD loans with similar risk characteristics and individual PCD loans without similar risk characteristics. This initial ACL is allocated to individual PCD loans and added to the purchase price or acquisition date fair values to establish the initial amortized cost basis of the PCD loans. As the initial ACL is added to the purchase price, there is no credit loss expense recognized upon acquisition of a PCD loan. Any difference between the unpaid principal balance of PCD loans and the amortized cost basis is considered to relate to non-credit factors and results in a discount or premium. Discounts and premiums are recognized through interest income on a level-yield method over the life of the loans. Approximately $1.6 million in PCI loans were converted to PCD on January 1, 2020.

For acquired loans not deemed PCD at acquisition, the differences between the initial fair value and the unpaid principal balance are recognized as interest income on a level-yield basis over the lives of the related loans. At the acquisition date, an initial ACL on loans is estimated and recorded as credit loss expense.

The subsequent measurement of expected credit losses for all acquired loans is the same as the subsequent measurement of expected credit losses for originated loans.

ACLLoans – Under the current CECL model, the ACL on loans represents a valuation allowance estimated at each balance sheet date in accordance with GAAP that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loan portfolio.

Bancorp estimates the ACL on loans based on the underlying assets’ amortized cost basis, which is the amount at which the receivable is originated or acquired, adjusted for applicable accretion or amortization of premium, discount, and net deferred fees or costs, collection of payment, and charge-offs. In the event that collection of principal becomes uncertain, Bancorp has policies in place to reverse accrued interest in a timely manner. Therefore, Bancorp has made a policy election to exclude accrued interest from the measurement of ACL.

Expected credit losses are reflected in the ACL through a charge to provision. When Bancorp deems all or a portion of a financial asset to be uncollectible, the appropriate amount is written-off and the ACL is reduced by the same amount. Bancorp applies judgment to determine when a financial asset is deemed uncollectible; however, generally speaking, an asset will be considered uncollectible no later than when all efforts at collection have been exhausted and the collateral, if any, has been liquidated. Subsequent recoveries, if any, are credited to the ACL when received.

Bancorp’s methodologies for estimating the ACL consider available relevant information about the collectability of cash flows, including information about past events, current conditions and reasonable and supportable forecasts. The methodologies apply historical loss information, adjusted for asset-specific characteristics, economic conditions at the measurement date, and forecasts about future economic conditions expected to exist through the contractual lives of the financial assets that are reasonable and supportable, to the identified pools of financial assets with similar risk characteristics for which the historical loss experience was observed. Bancorp’s methodologies may revert to historical loss information on a straight-line basis over a number quarters when it can no longer develop reasonable and supportable forecasts.

Loans are predominantly segmented by FDIC Call Report Codes into loan pools that have similar risk characteristics, similar collateral type and are assumed to pose consistent risk of loss to Bancorp. Bancorp has identified the following pools of financial assets with similar risk characteristics for measuring expected credit losses:

Commercial real estate – owner occupied – Includes non-farm non-residential real estate loans for a variety of commercial property types and purposes, and is typically secured by commercial office or industrial buildings, warehouses or retail buildings where the owner of the building occupies the property. The primary source of repayment is the cash flow from the ongoing operations and activities conducted by the party (or affiliate) who owns the property. Repayment terms vary considerably; interest rates are fixed or variable and are structured for full, partial, or no amortization of principal.

Commercial real estate – non-owner occupied – Includes investment real estate loans secured by similar collateral as above. The primary source of income for this loan type is typically rental income associated with the property. These loans generally involve a greater degree of credit risk, as these borrowers are more sensitive to adverse economic conditions. This category also includes apartment or multifamily residential buildings (secured by five or more dwelling units).

Construction and land development — Consists of loans to finance the ground up construction, improvement and/or carrying for sale after the completion of construction of owner occupied and non-owner occupied residential and commercial properties and loans secured by raw or improved land. The repayment of C&D loans is generally dependent upon the successful completion of the improvements by the builder for the end user, the leasing of the property, or sale of the property to a third party. Repayment of land secured loans are dependent upon the successful development and sale of the property, the sale of the land as is, or the outside cash flow of the owners to support the retirement of the debt. Bancorp’s construction loans may convert to real estate-secured once construction is completed or principal amortization payments begin, assuming the borrower retains financing with the Bank.

Commercialand Industrial — Represents loans for C&I purposes to sole proprietorships, partnerships, corporations and other business enterprises, where secured (other than those that meet the definition of a “loan secured by real estate”) or unsecured, single payment or installment. This category includes loans originated for financing capital expenditures, non-real estate loans guaranteed by the SBA and non-real estate related construction loans in addition to loans secured by accounts receivable, inventory and other business assets such as equipment. Bancorp originates these loans for a variety of purposes across a various industries. This category also includes loans to commercial banks in the U.S. This portfolio has been segregated between term loans and revolving lines of credits based on the varied characteristics of these individual loan structures.

Residential real estate— Includes non-revolving (closed-end) first and junior liens secured by residential real estate primarily in Bancorp’s market areas. This portfolio has been segregated between owner occupied and non-owner occupied status, as the investment nature of the lendinglatter poses additional credit risks to Bancorp.

Home equity lines of credit – Similar to the above, however these are revolving (open-ended) lines of credit that predominantly represent junior liens.

Consumer — Represents loans to individuals for household, family and other personal expenditures that may be secured or unsecured. This includes pre-arranged overdraft plans, secured automobile loans and other consumer-purposed loans.

Leases— Represents a variety of leasing options to businesses to acquire equipment.

Commercial Credit Cards — Represents revolving loans to businesses to manage operating cash flows.

Bancorp measures expected credit losses for its loan portfolio segments as follows:

Loan Portfolio Segment

ACL Methodology

Commercial real estate - non-owner occupied

Discounted cash flow

Commercial real estate - owner occupied

Discounted cash flow

Commercial and industrial - term

Static pool

Commercial and industrial - line of credit

Static pool

Residential real estate - owner occupied

Discounted cash flow

Residential real estate - non-owner occupied

Discounted cash flow

Construction and land development

Static pool

Home equity lines of credit

Static pool

Consumer

Static pool

Leases

Static pool

Credit cards - commercial

Static pool

Discounted Cash flowMethod – The DCF methodology is used to develop cash flow projections at the instrument level wherein payment expectations are adjusted for estimated prepayment speeds, curtailments, time to recovery, probability of default and loss given default. The modeling of expected prepayment speeds, curtailment rates and time to recovery are based on historical internal data.

Bancorp uses regression analysis of historical internal and peer data to determine suitable loss drivers to utilize when modeling lifetime probability of default and loss given default. This analysis also determines how expected probability of default and loss given default will react to forecasted levels of the loss drivers. For all loan pools utilizing the DCF method, management utilizes the forecasted Seasonally Adjusted National Civilian Unemployment Rate as its primary loss driver, as this was determined to best correlate to historical losses.

With regard to the DCF model and the adoption of CECL on January 1, 2020, management determined that four quarters represented a reasonable and supportable forecast period with reversion back to a historical loss rate over eight quarters on a straight-line basis.

The combination of adjustments for credit expectations (default and loss) and timing expectations (prepayment, curtailment, and time to recovery) produces an expected cash flow stream at the instrument level. Instrument effective yield is calculated, net of the impacts of prepayment assumptions and the instrument expected cash flows are then discounted at that effective yield to produce an instrument-level NPV of expected cash flows. An ACL is established for the difference between the instrument’s NPV and amortized cost basis.

Static Pool Method – The static pool methodology is utilized for the loan portfolio segments that typically have shorter durations. For each of these loan segments, Bancorp applies an expected loss ratio based on historical losses adjusted as appropriate for qualitative factors. Qualitative loss factors are based on management's judgment of company, market, industry or business thesespecific data, changes in underlying loan composition of specific portfolios, trends will likely normalizerelating to credit quality, delinquency, non-performing and adversely rated loans and reasonable and supportable forecasts of economic conditions.

Collateral Dependent Loans – Loans that do not share risk characteristics are evaluated on an individual basis. For collateral dependent loans where Bancorp has determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and Bancorp expects repayment of the financial asset to be provided substantially through the operation of the business or sale of the collateral, the ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the asset as of the measurement date. When repayment is expected to be from the operation of the collateral, expected credit losses are calculated as the amount by which the amortized cost basis of the financial asset exceeds the NPV of expected cash flows from the operation of the collateral. When repayment is expected to be from the sale of the collateral, expected credit losses are calculated as the amount by which the amortized costs basis of the financial asset exceeds the fair value of the underlying collateral less estimated cost to sell. The ACL may be zero if the fair value of the collateral at the measurement date exceeds the amortized cost basis of loan. Bancorp’s estimate of the ACL reflects losses expected over the long term. Additional informationremaining contractual life of the loan and the contractual term does not consider extensions, renewals or modifications.

A loan that has been modified or renewed is considered a TDR when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) concessions are made for the borrower's benefit that would not otherwise be considered for a borrower or transaction with similar credit risk characteristics. TDRs are evaluated individually to determine the required ACL. TDRs performing in accordance with their modified contractual terms for a reasonable period may be included in Bancorp’s existing pools based on the underlying risk characteristics of the loan to measure the ACL.

Off-Balance Sheet Credit Exposures – Financial instruments include off-balance sheet credit instruments, such as commitments to originate loans and commercial letters of credit issued to meet customer-financing needs. Bancorp’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the contractual amount of those instruments. Such financial instruments are recorded when they are funded.

Bancorp records an ACL on off-balance sheet credit exposures, unless the commitments to extend credit are unconditionally cancelable, through a charge to credit loss expense for off-balance sheet credit exposures included in other non-interest expense in Bancorp’s consolidated statements of income. The ACL on off-balance sheet credit exposures is estimated by loan portfolio segment at each balance sheet date under the current CECL model using the same methodologies as portfolio loans, taking into consideration the likelihood that funding will occur and is included in other liabilities on Bancorp’s consolidated balance sheets.

Recently Adopted Accounting StandardsBancorp adopted ASC 326,Financial Instruments – Credit Losses,” on January 1, 2020 using the modified retrospective approach. Results for the periods subsequent to January 1, 2020 are presented under ASC 326, while prior period amounts continue to be reported in accordance with previously applicable GAAP. Bancorp recorded a net reduction of retained earnings of $8.8 million upon adoption. The transition adjustment included an increase in the ACL on loans of $8.2 million and an increase in the ACL on off-balance sheet credit exposures of $3.5 million, net of the total corresponding DTA increase of $2.9 million.

Bancorp adopted ASC 326 using the prospective transition approach for loans purchased with PCD that were previously classified as PCI and accounted for under ASC 310-30. In accordance with the standard, management did not reassess whether PCI loans met the criteria of PCD loans as of the adoption date. On January 1, 2020, non-accretable yield marks of $1.6 million related to formerly classified PCI loans were reclassified between the amortized cost basis of loans and corresponding ACL.

The following table summarizes the impact of the adoption of ASC 326:

  

January 1, 2020

 

(in thousands)

 

As reported under

ASC 326

  

Pre-ASC 326

Adoption

  

Impact of Adoption

(1)

 
             

Allowance for credit losses on loans:

            
             

Commercial real estate - non-owner occupied

 $8,333  $5,235  $3,098 

Commercial real estate - owner occupied

  6,219   3,327   2,892 

Total commercial real estate

  14,552   8,562   5,990 
             

Commercial and industrial - term

  7,147   6,782   365 

Commercial and industrial - line of credit

  4,129   5,657   (1,528)

Total commercial and industrial

  11,276   12,439   (1,163)
             

Residential real estate - owner occupied

  2,713   1,527   1,186 

Residential real estate - non-owner occupied

  1,376   947   429 

Total residential real estate

  4,089   2,474   1,615 
             

Construction and land development

  5,161   2,105   3,056 

Home equity lines of credit

  842   728   114 

Consumer

  398   100   298 

Leases

  233   237   (4)

Credit cards - commercial

  96   146   (50)

Total allowance for credit losses on loans

 $36,647  $26,791  $9,856 
             

Total allowance for credit losses on off-balance sheet exposures

 $3,850  $350  $3,500 

(1)

– The impact of the ASC 326 adoption on the ACL on loans reflects $8.2 million related to the transition from the incurred loss ACL model to the CECL ACL model and $1.6 million related to the transition from PCI to PCD methodology as defined in the standard.

In August 2018, the FASB issued ASU No.2018-13, Fair Value Measurement (Topic 820): “Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement.” The amendments in this update modify the disclosure requirements for fair value measurements by removing, modifying, or adding certain disclosures. The update is effective for interim and annual periods in fiscal years beginning after December 15, 2019, with early adoption permitted for the removed disclosures and delayed adoption until the fiscal year 2020 permitted for the new disclosures. The removed and modified disclosures will be adopted on a retrospective basis, and the new disclosures will be adopted on a prospective basis. The adoption did not have a material effect on Bancorp’s consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment.” This ASU simplifies the accounting for goodwill impairment by requiring impairment charges to be based on the first step in the previous two-step impairment test. Under the new guidance, if a reporting unit’s carrying amount exceeds its fair value, an entity will record an impairment charge based on that difference. The impairment charge will be limited to the amount of goodwill allocated to that reporting unit. The standard eliminates the prior requirement to calculate a goodwill impairment charge using Step 2, which requires an entity to calculate any impairment charge by comparing the implied fair value of goodwill with its carrying amount. ASU 2017-04 was effective for Bancorp on January 1, 2020 and it did not have a material impact on Bancorp’s financial statements.

In August 2018, the FASB issued ASU 2018-15, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40) - Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” This ASU aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by these amendments. ASU 2018-15 was effective for Bancorp on January 1, 2020 and did not have a material impact on Bancorp’s financial statements.

In March 2020, interagency guidance was issued regarding loan modifications and reporting for financial institutions working with customers affected by COVID-19. The interagency statement was effective immediately and affected accounting for loan modifications. Under ASC 310-40,Receivables – Troubled Debt Restructurings by Creditors,” a restructuring of debt constitutes a TDR if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to such relief, are not to be considered TDRs. This includes short-term (e.g., six months) modifications such as full payment and principal only deferrals. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program was implemented. This interagency guidance in addition to deferral guidance included in the CARES Act could have a material impact on Bancorp’s methodologyfinancial statements; however, this impact cannot be quantified at this time.

In March 2020, the FASB issued ASU No.2020-04, Reference Rate Reform (Topic 848): “Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” The amendments in this update provide optional guidance for a limited period to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. It provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments in this update are effective for all entities as of March 12, 2020 through December 31, 2022. Bancorp is currently evaluating the adequacyimpact of the allowance can be read inthis ASU on Bancorp’s Annual Report on Form 10-K.consolidated financial statements.

 

Accounting Standards Updates (“ASUs”)

The following ASU was issued prior to June 30, 2019 and is considered relevant to Bancorp’s financial statements. Generally, if an issued-but-issued but not-yet-effective yet effective ASU with an expected immaterial impact to Bancorp has been disclosed in prior SEC filings, it will not be re-disclosed.

In April 2019, June 2016, the Financial Accounting Standards Board (“FASB”)FASB issued ASU No.20162019-04,Codification Improvements to Financial Instruments -13,Measurement of Credit Losses on(ASC 326), Derivatives and Hedging (ASC 815), and Financial Instruments (ASC 825), (“CECL”). This” The amendments in the ASU significantly changesimprove the way entities recognize impairment of many financial assetsCodification by requiring immediate recognition of estimatedeliminating inconsistencies and providing clarifications. The amended guidance in this ASU related to the credit losses expected to occur over their remaining life. The guidance iswill be effective for annualBancorp’s for fiscal years and interim reporting periods beginning after December 15, 2019.2022. Bancorp expects to recognize a one-time cumulative-effect adjustment to the allowance on January 1, 2020. Interagency guidance issued in December 2018 allows for a three year phase-in of the cumulative-effect adjustment for regulatory capital reporting.

As a result of this ASU, Bancorp could experience an increase in its allowance. Bancorp has formed a committee to oversee its transition to the CECL methodology. Bancorp has devoted internal resources and purchased a third party software solution to analyze, compute and report upon the CECL disclosure requirements. In addition, Bancorp has analyzed loan-level data and is determining its CECL loan segmentation and initial segment calculation methodologies.  Bancorp is currently exploring regression techniques and has begun to run forecasting scenarios.

Recently Adopted Accounting Standards

Bancorp adoptedevaluating the impact of the ASU2016-02,Leases and related amendments using an alternative transition method, effective January 1, 2019 and upon adoption recorded $17 million of right-of-use lease assets and $18 million of operating lease liabilities on its balance sheet as of June 30, 2019. Prior periods have not been restated. The right-of-use lease asset and operating lease liability are recorded in premises and equipment and other liabilities, respectively, on the Company’s consolidated balance sheet. Bancorp elected all applicable practical expedients, including the option to expense short-term leases, which are defined as leases with a term of one year or less. Bancorp also elected not to separate lease components from non-lease components.

The adoption of this ASU did not have a meaningful impact on Bancorp's performance metrics, including regulatory capital ratios and return on average assets.  Additionally, Bancorp does not believe that the adoption of this ASU by its clients will have a significant impact on Bancorp's ability to underwrite credit when client financial statements are presented inclusive of the requirements of this ASU. See the note titled “Leases” for additional information on lease activities.statements.

 

 

 

(2)

Acquisition of King Bancorp, Inc.

 

On May 1, 2019, Bancorp completed its acquisition of King Bancorp, Inc, and its wholly-owned subsidiary King Southern Bank (“King”),KSB, for $28 million in cash. The acquisition expands the Company’sexpanded Bancorp’s market area into nearby Nelson County, Kentucky, while growing its customer base in Louisville, Kentucky.

 

The following table provides a summary of the fair value of the assets acquired and liabilities assumed by Bancorp as of the acquisition date. As provided for under GAAP, Effective March 31, 2020, management has up to 12 months following the date of acquisition to finalizefinalized the fair values of the acquired assets and assumed liabilities. liabilities in advance of 12 months post acquisition date, as allowed by GAAP.

The following table provides a summary of the assets acquired and liabilities assumed as recorded by the acquiree, the previously reported preliminary fair value adjustments necessary to adjust those acquired assets and theassumed liabilities to fair value, final recast adjustments to those previously reported preliminary fair values, shown inand the following table continue to be evaluatedfinal fair values of those assets and liabilities as recorded by management and may be subject to further adjustment.Bancorp.

  

May 1, 2019

 
  

As Recorded

  

Fair Value

   

Recast

   

As Recorded

 

(in thousands)

 

by KSB

  

Adjustments (1)

   

Adjustments

   

by Bancorp

 

Assets acquired:

                  
                   

Cash and due from banks

 $3,316  $   $   $3,316 

Interest bearing due from banks

  1,761           1,761 

Available for sale debt securities

  12,404   23 

a

      12,427 

Federal Home Loan Bank stock, at cost

  1,517           1,517 

Federal Reserve Bank stock, at cost

  490           490 

Loans

  165,744   (1,597)

b

  (118)

b

  164,029 

Allowance for credit losses

  (1,812)  1,812 

b

       

Net loans

  163,932   215    (118)   164,029 

Premises and equipment, net

  4,358   (1,328)

c

  431 

c

  3,461 

Bank owned life insurance

  3,431           3,431 

Core deposit intangible

     1,519 

d

      1,519 

Other real estate owned

  325   (325)

e

       

Other assets and accrued interest receivable

  867   (36)

f

      831 

Total assets acquired

 $192,401  $68   $313   $192,782 
                   

Liabilities assumed:

                  
                   

Deposits:

                  

Non-interest bearing

 $24,939  $   $   $24,939 

Interest bearing

  100,839   (252)

g

      100,587 

Total deposits

  125,778   (252)       125,526 
                   

Federal funds purchased

  1,566           1,566 

Federal Home Loan Bank advances

  43,718   (419)

h

      43,299 

Subordinated note

  3,609           3,609 

Holding Company line of credit

  2,300           2,300 

Other liabilities and accrued interest payable

  313           313 
                   

Total liabilities assumed

  177,284   (671)       176,613 
                   

Net assets acquired

 $15,117  $739   $313   $16,169 
                   

Cash consideration paid

                (28,000)
                   

Goodwill

               $11,831 

 

Acquisition of King Bancorp, Inc.

Summary of Assets Aquired and Liabilities Assumed

  

May 1, 2019

 
  

As Recorded

  

Fair Value

   

As Recorded

 

(In thousands)

 

by King

  

Adjustments (1)

   

by Bancorp

 

Assets aquired:

             
              

Cash and due from banks

 $3,316  $   $3,316 

Interest bearing due from banks

  1,761       1,761 

Available for sale securities

  12,404   23 

a

  12,427 

Loans

  165,744   (1,597)

b

  164,147 

Allowance for loan and lease losses

  (1,812)  1,812 

b

  - 

Loans, net

  163,932   215    164,147 

Federal Home Loan Bank stock, at cost

  1,517       1,517 

Federal Reserve Bank stock, at cost

  490       490 

Premises and equipment, net

  4,358   (1,328)

c

  3,030 

Core deposit intangible

     1,519 

d

  1,519 

Bank owned life insurance

  3,431       3,431 

Other real estate owned

  325   (325)

e

   

Other assets and accrued interest receivable

  867   (36)

f

  831 
              

Total assets acquired

 $192,401  $68   $192,469 
              

Liabilities assumed:

             
              

Deposits

             

Non-interest bearing

 $24,939  $   $24,939 

Interest bearing

  100,839   (252)

g

  100,587 

Total deposits

  125,778   (252)   125,526 
              

Federal funds purchased

  1,566       1,566 

Federal Home Loan Bank advances

  43,718   (419)

h

  43,299 

Subordinated Note

  3,609       3,609 

Holding Company line of credit

  2,300       2,300 

Other liabilities and accrued interest payable

  313       313 
              

Total liabilities assumed

  177,284   (671)   176,613 
              

Net assets acquired

 $15,117  $739   $15,856 
              

Cash consideration paid

           (28,000)
              

Goodwill

          $12,144 

(1)  –

Bancorp’s acquisitionSee the following page for explanations of King closed on May 1, 2019. Accordingly, theindividual fair value adjustments shown are preliminary estimates of the purchase accounting adjustments. Management is continuing to evaluate each of these fair value adjustments and may revise one or more of such fair value adjustments in future periods based on this continuing evaluation. To the extent that any of these preliminary fair value adjustments are revised in future periods, the resultant fair values and the amount of goodwill recorded by the Company will change.

 

 

Explanation of the above pre-ASC 326fair value adjustments:

 

 

a.

Reflects the fair value adjustment based on Bancorp’s evaluation of the acquired investment portfolio.

 

b.

Reflects the fair value adjustment based on Bancorp’s evaluation of the acquired loan portfolio and to eliminate King’sthe acquiree’s recorded allowance. ACL.

 

c.

Reflects the fair value adjustment based on Bancorp’s evaluation of the premises and equipment acquired.

 

d.

Reflects the fair value adjustment for the core deposit intangibleCDI asset recorded as a result of the acquisition.

 

e.

Reflects the fair value adjustment based upon Bancorp’s evaluation of the foreclosed real estate acquired.

 

f.

Reflects the write-off of a miscellaneous other asset.

 

g.

Reflects the fair value adjustment based on the Company’sBancorp’s evaluation of the assumed time deposits.

 

h.

Reflects the fair value adjustment based upon Bancorp’s evaluation of the assumed FHLB advances.

Goodwill of approximately $12 million, which is the excess of the acquisition consideration over the fair value of net assets acquired, is expected to be recorded in the King acquisition and is the result of expected operational synergies and other factors. This goodwill is all attributable to the Company’s Commercial Banking segment and is not expected to be deductible for tax purposes. To the extent that management revises any of the above fair value adjustments as a result of its continuing evaluation, the amount of goodwill recorded in the King acquisition will change. As a result of the King transaction, and based upon the proximity to existing branch locations, Bancorp expects to sell three acquired branch buildings in the third quarter of 2019, while retaining the associated customer relationships. These branches are considered held available for sale as of June 30, 2019. If consummated, goodwill will be adjusted in that period.

Revenue attributed to King totaled $1.6 million for the three and six months ended June 30, 2019. Prior year pro-forma financial statements were not presented due to the immateriality of the transaction.

 

Goodwill of approximately $12 million, which is the excess of the acquisition consideration over the fair value of net assets acquired, was recorded and is the result of expected operational synergies and other factors. This goodwill was entirely attributable to Bancorp’s Commercial Banking segment and deductible for tax purposes.

Based upon the proximity to existing branch locations, Bancorp closed and ultimately sold three acquired full service branch locations in 2019, while retaining the associated customer relationships. Goodwill was recast in 2019 based on these sales.

Pro forma financial information as of the acquisition was not considered material.

 

 

(3)

Available for Sale Debt Securities

 

All of Bancorp’s debt securities are classified as available for sale.AFS. Amortized cost, unrealized gains and losses and fair value of securities follow:

 

(In thousands)

 

Amortized

  

Unrealized

    

June 30, 2019

 cost  

Gains

  

Losses

  Fair value  
                 

Government sponsored enterprise obligations

 $266,579  $1,755  $(319) $268,015 

Mortgage backed securities - government agencies

  131,447   938   (787)  131,598 

Obligations of states and political subdivisions

  23,854   118   (6)  23,966 
                 

Total securities available for sale

 $421,880  $2,811  $(1,112) $423,579 
                 

December 31, 2018

                

Government sponsored enterprise obligations

  264,234   156   (3,351)  261,039 

Mortgage backed securities - government agencies

  149,748   282   (3,753)  146,277 

Obligations of states and political subdivisions

  29,760   107   (188)  29,679 
                 

Total securities available for sale

 $443,742  $545  $(7,292) $436,995 

(in thousands)

 

 

  

Unrealized

  

Allowance

    

June 30, 2020

 

Amortized

cost

  

Gains

  

Losses

  

for Credit

Losses

  Fair value 
                     

Obligations of states and political subdivisions

 $  $  $  $  $ 

Government sponsored enterprise obligations

  199,838   4,788   (215)     204,411 

Mortgage backed securities - government agencies

  262,565   7,702   (13)     270,254 

Obligations of states and political subdivisions

  10,394   190         10,584 
                     

Total available for sale debt securities

 $472,797  $12,680  $(228) $  $485,249 
                     

December 31, 2019

                    
                     

Obligations of states and political subdivisions

 $49,887  $10  $  $  $49,897 

Government sponsored enterprise obligations

  208,933   1,189   (178)     209,944 

Mortgage backed securities - government agencies

  193,574   1,243   (956)     193,861 

Obligations of states and political subdivisions

  16,919   117         17,036 
                     

Total available for sale debt securities

 $469,313  $2,559  $(1,134) $  $470,738 

 

At June 30, 20192020 and December 31, 2018,2019, there were no holdings of debt securities of any one issuer, other than the U.S. government and its agencies, in an amount greater than 10% of stockholders’ equity.

 

There were no0 gains or losses on sales or calls of securities for the three-month and six month-month periods ending June 30, 20192020 orand 2018.2019. Securities owned by King,acquired in the May 1, 2019 acquisition totaling $12.4$12 million, were sold immediately following the acquisition with no0 gain or loss realized in the income statement.

 

Accrued interest on AFS debt securities totaled $1.5 million and $1.6 million at June 30, 2020 and December 31, 2019, respectively, and was included in the consolidated balance sheets.

A summary of AFS debt securities available for sale by contractual maturity as of June 30, 2020 follows:

 

(In thousands)

 

Amortized cost

  

Fair value

 

(in thousands)

 

Amortized cost

  

Fair value

 
  

Due within 1 year

 $132,158  $132,133  $75,092  $75,164 

Due after 1 year but within 5 years

 56,040  56,033  31,457  32,114 

Due after 5 years but within 10 years

 7,157  7,232  3,972  4,145 

Due after 10 years

 95,078  96,583  99,711  103,572 

Mortgage backed securities - government agencies

  131,447   131,598   262,565   270,254 

Total securities available for sale

 $421,880  $423,579  $472,797  $485,249 

 

 

Actual maturities may differ from contractual maturities because some issuers have the right to call or prepay obligations with or without prepayment penalties. The investment portfolio includes agency mortgage backed securities,MBS’s, which are guaranteed by agencies such as Federal Home Loan Mortgage Corporation (“FHLMC”), Federal National Mortgage Association (“FNMA”),FHLMC, FNMA and Government National Mortgage Association (“GNMA”).GNMA. These securities differ from traditional debt securities primarily in that they may have uncertain principal payment dates and are priced based on estimated prepayment rates on the underlying collateral.

 

Securities with a carrying value of $336.5$395 million and $355.1$403 million were pledged at June 30, 20192020 and December 31, 2018,2019, respectively, to secure accounts of commercial depositors in cash management accounts, public deposits,funds and uninsured cash balances for WM&T accounts.

 

 

SecuritiesAFS debt securities with unrealized losses atloss position for which an ACL has June 30, 2019 notand December 31, 2018, been recorded, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position follows:follow:

 

(In thousands)

 

Less than 12 months

  

12 months or more

  

Total

 
                   
  

Fair

  

Unrealized

  

Fair

  

Unrealized

  

Fair

  

Unrealized

 

June 30, 2019

 

value

  

losses

  

value

  

losses

  

value

  

losses

 
                         

Government sponsored enterprise obligations

 $  $  $57,505  $(319) $57,505  $(319)

Mortgage-backed securities - government agencies

        82,088   (787)  82,088   (787)

Obligations of states and political subdivisions

        6,485   (6)  6,485   (6)
                         

Total temporarily impaired securities

 $  $  $146,078  $(1,112) $146,078  $(1,112)
                         

December 31, 2018

                        

Government sponsored enterprise obligations

  96,740   (38)  149,320   (3,313)  246,060   (3,351)

Mortgage-backed securities - government agencies

  3,108   (5)  120,848   (3,748)  123,956   (3,753)

Obligations of states and political subdivisions

  814   (1)  17,639   (187)  18,453   (188)
                         

Total temporarily impaired securities

 $100,662  $(44) $287,807  $(7,248) $388,469  $(7,292)
  

Less than 12 months

  

12 months or more

  

Total

 
          

(in thousands)

 

Fair

  

Unrealized

  

Fair

  

Unrealized

  

Fair

  

Unrealized

 

June 30, 2020

 

value

  

losses

  

value

  

losses

  

value

  

losses

 
                         

Government sponsored enterprise obligations

 $19,614  $(149) $5,548  $(66) $25,162  $(215)

Mortgage-backed securities - government agencies

  16,358   (13)        16,358   (13)
                         

Total

 $35,972  $(162) $5,548  $(66) $41,520  $(228)
                         

December 31, 2019

                        

Government sponsored enterprise obligations

 $16,503  $(107) $11,492  $(71) $27,995  $(178)

Mortgage-backed securities - government agencies

  81,664   (496)  32,453   (460)  114,117   (956)
                         

Total

 $98,167  $(603) $43,945  $(531) $142,112  $(1,134)

 

 

Applicable dates for determining when securities are in an unrealized loss position are June 30, 20192020 and December 31, 2018.2019. As such, it is possible that a security had a market value lower than its amortized cost on other days during the past twelve12 months, but is not in the “Less than 12 months” category above.

 

For AFS debt securities in an unrealized loss position, Bancorp evaluates the securities to determine whether the decline in the fair value below the amortized cost basis (impairment) is due to credit-related factors or non-credit related factors. Any impairment that is not credit-related is recognized in AOCI, net of tax. Credit-related impairment is recognized as an a ACL on AFS debt securities on the balance sheet, limited to the amount by which the amortized cost basis exceeds the fair value, with a corresponding adjustment to earnings. Accrued interest receivable is excluded from the estimate of credit losses. Both the ACL and the adjustment to net income may be reversed if conditions change. However, if Bancorp intends to sell an impaired AFS debt security or more likely than not will be required to sell such a security before recovering its amortized cost basis, the entire impairment amount would be recognized in earnings with a corresponding adjustment to the security’s amortized cost basis. Because the security’s amortized cost basis is adjusted to fair value, there is no ACL in this situation.

In evaluating AFS debt securities in unrealized loss positions for impairment and the criteria regarding its intent or requirement to sell such securities, Bancorp considers the extent to which fair value is less than amortized cost, whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuers’ financial condition, among other factors. Unrealized losses on Bancorp’s investment securities portfolio have not been recognized as an expense because the securities are of high credit quality, and the decline in fair values is dueattributable to changes in the prevailing interest rate environment since the purchase date. Fair value is expected to recover as securities reach maturity and/or the interest rate environment returns to conditions similar to when these securities were purchased. These investments consistconsisted of 619 and 11754 separate investment positions as of June 30, 20192020 and December 31, 2018,2019, respectively. Because management doesThere were notno intend to sell thecredit related factors underlying unrealized losses on AFS debt securities and it is not likely that Bancorp will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, Bancorp does not consider these securities to be other-than-temporarily impaired at June 30, 2020 and December 31, 2019.

 

The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value are not necessarily favorable, or that there is a general lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other-than-temporary, the value of the security is reduced and a corresponding charge to earnings is recognized for the anticipated credit losses.

Federal Home Loan Bank of Cincinnati (“FHLB”)FHLB stock isrepresents an investment held by Bancorp whichthat is not readily marketable and is carried at cost adjusted for identified impairment.impairment, if any. Impairment is evaluated on an annual basis in the fourth quarter.quarter and more often if market conditions warrant. Bancorp has never recorded FHLB stock impairment. Holdings of FHLB stock are required for access to FHLB advances.

 

 

 

(4)

Loans and leasesAllowance for Credit Losses on Loans

 

Composition of loans by class as reported under ASC 326 follows:

(in thousands)

 

June 30, 2020

  

December 31, 2019

 
         

Commercial real estate - non-owner occupied

 $815,464  $746,283 

Commercial real estate - owner occupied

  472,457   474,329 

Total commercial real estate

  1,287,921   1,220,612 
         

Commercial and industrial - term

  510,384   457,298 

Commercial and industrial - term - PPP

  630,082    

Commercial and industrial - lines of credit

  254,096   381,502 

Total commercial and industrial

  1,394,562   838,800 
         

Residential real estate - owner occupied

  215,891   217,606 

Residential real estate - non-owner occupied

  139,121   134,995 

Total residential real estate

  355,012   352,601 
         

Construction and land development

  255,447   255,816 

Home equity lines of credit

  103,672   103,854 

Consumer

  43,758   47,467 

Leases

  14,843   16,003 

Credits cards - commercial

  8,862   9,863 

Total loans (1)

 $3,464,077  $2,845,016 

(1) Total loans are presented inclusive of premiums, discounts, and net of deferredloan origination fees and costs,costs.

For historical comparative purposes, the composition of loans by loan portfolio class pre-ASC 326 adoption follows:

 

(In thousands)

 

June 30, 2019

  

December 31, 2018

 

(in thousands)

 

December 31, 2019

 
  

Commercial and industrial

 $860,085  $833,524  $870,511 

Construction and development, excluding undeveloped land(1)

 222,632  225,050  213,822 

Undeveloped land

 35,169  30,092  46,360 
  

Real estate mortgage:

        

Commercial investment

 696,421  588,610  736,618 

Owner occupied commercial

 452,719  426,373  473,783 

1-4 family residential

 338,957  276,017  334,358 

Home equity - first lien

 46,012  49,500  48,620 

Home equity - junior lien

  67,948   70,947   73,477 

Subtotal: Real estate mortgage

 1,602,057  1,411,447  1,666,856 
 

Consumer

  43,937   48,058   47,467 

Total loans(2)

 $2,763,880  $2,548,171 

Total loans (1)

 $2,845,016 

 

(1) Consists of land acquired for development by the borrower, but for which no development has yet taken place.

(2) Total loans are presented inclusive of premiums, discounts, and net of loan origination fees and costs.

 

Accrued interest on loans, which is excluded from the amortized cost of loans, totaled $12 million and $7 million at June 30, 2020 and December 31,2019, respectively, and was included in the consolidated balance sheets.

Loans with carrying amounts of $1.9 billion and $1.6 billion at June 30, 2020 and December 31, 2019, respectively, were pledged to secure FHLB borrowing capacity.

 

Loans to directors and their related interests, including loans to companies for which directors are principal owners and executive officers, totaled $53.7$46 million and $52.7$43 million as of June 30, 20192020 and December 31, 2018,2019, respectively.

 

 

The following table summarizes loans acquired in the King Bancorp’s May 1, 2019 acquisition, based upon valuation method:as recasted:

 

  

May 1, 2019

 
  

Contractual

  

Non-accretable

  

Accretable

  

Acquisition-day

 

(In thousands)

 

receivable

  

amount

  

amount

  

fair value

 
                 

Commercial and industrial

 $8,249  $  $(23) $8,226 

Construction and development

  10,764      43   10,807 

Raw Land

  7,974      43   8,017 

Real estate mortgage:

                

Commercial real estate

  84,219      (408)  83,811 

1-4 family residential

  50,556      322   50,878 

Home equity - first lien

  196      3   199 

Home equity - junior lien

  679      5   684 

Subtotal: Real estate mortgage

  135,650      (78)  135,572 
                 

Consumer

  1,528      (3)  1,525 
                 

Total loans ASC 310-20

  164,165      (18)  164,147 
                 

Commercial and industrial

                

Construction and development

            

Raw Land

            

Real estate mortgage:

                

Commercial real estate

  1,351   (1,351)      

1-4 family residential

  228   (228)      

Home equity - first lien

            

Home equity - junior lien

            

Subtotal: Real estate mortgage

  1,579   (1,579)      
                 

Consumer

            
                 

Total loans ASC 310 purchased- credit-impaired loans

  1,579   (1,579)      
                 

Total loans

 $165,744  $(1,579) $(18) $164,147 
  

May 1, 2019

 
  

Contractual

  

Non-accretable

  

Accretable

  

Acquisition-day

 

(in thousands)

 

Receivable

  

Yield

  

Yield

  

Fair Value

 
                 

Commercial and industrial

 $8,249  $  $(23) $8,226 

Construction and land development

  18,738      86   18,824 

Real estate mortgage:

                

Commercial real estate

  84,219      (456)  83,763 

Residential real estate

  50,556      322   50,878 

Home equity lines of credit

  875      8   883 

Subtotal: Real estate mortgage

  135,650      (126)  135,524 
                 

Consumer

  1,528      (73)  1,455 
                 

Total loans acquired under ASC 310-20

  164,165      (136)  164,029 
                 

Commercial and industrial

            

Construction and land development

            

Real estate mortgage:

                

Commercial real estate

  1,351   (1,351)      

Residential real estate

  228   (228)      

Home equity lines of credit

            

Subtotal: Real estate mortgage

  1,579   (1,579)      
                 

Consumer

            
                 

Total purchased credit impaired loans acquired under ASC 310-30

  1,579   (1,579)      
                 

Total loans

 $165,744  $(1,579) $(136) $164,029 

 

Purchased-Credit-Impaired (“PCI”) Loans

 

The Bank acquired PCI loans onrelated to its May 1, 2019in its King and 2013 acquisitions. At acquisition and during the year ended December 31, 2012 in the TBOC acquisition. PCIdate, these loans arewere accounted for under ASC 310-30. On January 1, 2020, Bancorp adopted ASC 326 using the prospective transition approach for loans purchased with credit deterioration that were previously classified as PCI and accounted for under ASC 310-30. In accordance with the standard, management did not reassess whether PCI loans met the criteria of PCD loans as of the adoption date. On January 1, 2020, non-accretable yield marks of $1.6 million related to formerly classified PCI loans were reclassed between the amortized cost basis of loans and corresponding ACL.

Bancorp’s estimate of the ACL on loans reflects losses expected over the remaining contractual life of the assets. The contractual term does not consider extensions, renewals or modifications. The activity in the ACL related to loans follows (2020 is presented in accordance with ASC 326 and 2019 in accordance with ASC 310):

(in thousands)

Three Months Ended June 30, 2020

 

Beginning

Balance

  

Impact of

Adopting

ASC 326

  

Initial ACL on

Loans Purchased

with Credit

Deterioration

  

Provision for

Credit Losses

  

Charge-offs

  

Recoveries

  

Ending

Balance

 
                             

Commercial real estate - non-owner occupied

 $13,435  $-  $-  $5,403  $-  $1  $18,839 

Commercial real estate - owner occupied

  6,509   -   -   197   -   -   6,706 

Total commercial real estate

  19,944   -   -   5,600   -   1   25,545 
                             

Commercial and industrial - term

  7,990   -   -   (651)  -   -   7,339 

Commercial and industrial - lines of credit

  3,866   -   -   (624)  -   -   3,242 

Total commercial and industrial

  11,856   -   -   (1,275)  -   -   10,581 
                             

Residential real estate - owner occupied

  2,702   -   -   162   (18)  2   2,848 

Residential real estate - non-owner occupied

  1,419   -   -   175   -   -   1,594 

Total residential real estate

  4,121   -   -   337   (18)  2   4,442 
                             

Construction and land development

  5,185   -   -   423   -   -   5,608 

Home equity lines of credit

  623   -   -   209   -   -   832 

Consumer

  198   -   -   134   (80)  110   362 

Leases

  159   -   -   64   -   -   223 

Credit cards - commercial

  57   -   -   58   -   -   115 

Total net loan (charge-offs) recoveries

 $42,143  $-  $-  $5,550  $(98) $113  $47,708 

(in thousands)

Six Months Ended June 30, 2020

 

Beginning

Balance

  

Impact of

Adopting

ASC 326

  

Initial ACL on

Loans Purchased

with Credit

Deterioration

  

Provision for

Credit Losses

  

Charge-offs

  

Recoveries

  

Ending

Balance

 
                             

Commercial real estate - non-owner occupied

 $5,235  $2,946  $152  $10,503  $-  $3  $18,839 

Commercial real estate - owner occupied

  3,327   1,542   1,350   487   -   -   6,706 

Total commercial real estate

  8,562   4,488   1,502   10,990   -   3   25,545 
                             

Commercial and industrial - term

  6,782   365   -   185   -   7   7,339 

Commercial and industrial - lines of credit

  5,657   (1,528)  -   (887)  -   -   3,242 

Total commercial and industrial

  12,439   (1,163)  -   (702)  -   7   10,581 
                             

Residential real estate - owner occupied

  1,527   1,087   99   151   (18)  2   2,848 

Residential real estate - non-owner occupied

  947   429   -   218   -   -   1,594 

Total residential real estate

  2,474   1,516   99   369   (18)  2   4,442 
                             

Construction and land development

  2,105   3,056   -   447   -   -   5,608 

Home equity lines of credit

  728   114   -   (10)  -   -   832 

Consumer

  100   264   34   (3)  (254)  221   362 

Leases

  237   (4)  -   (10)  -   -   223 

Credit cards - commercial

  146   (50)  -   19   -   -   115 

Total net loan (charge-offs) recoveries

 $26,791  $8,221  $1,635  $11,100  $(272) $233  $47,708 

(in thousands)

Three Months Ended June 30, 2019

 

Beginning

Balance

  

Provision for

Credit Losses

  

Charge-offs

  

Recoveries

  

Ending

Balance

 
                     

Real estate mortgage

 $12,001  $10  $(13) $32  $12,030 

Commercial and industrial

  11,762   92   -   4   11,858 

Construction and development

  1,884   (74)  -   -   1,810 

Undeveloped land

  662   (61)  -   -   601 

Consumer

  155   33   (148)  77   117 
  $26,464  $-  $(161) $113  $26,416 

(in thousands)

Six Months Ended Six June 30, 2019

 

Beginning

Balance

  

Provision for

Credit Losses

  

Charge-offs

  

Recoveries

  

Ending

Balance

 
                     

Real estate mortgage

 $10,681  $1,310  $(13) $52  $12,030 

Commercial and industrial

  11,965   (210)  (3)  106   11,858 

Construction and development

  1,760   (153)  -   203   1,810 

Undeveloped land

  752   (151)  -   -   601 

Consumer

  376   (196)  (244)  181   117 
  $25,534  $600  $(260) $542  $26,416 

Upon adoption of ASC 326 on January 1, 2020, Bancorp recorded an increase of $8.2 million to the ACL on loans and a corresponding decrease to retained earnings, net of the DTA impact. In addition, non-accretable yield marks of $1.6 million related to formerly classified PCI loans were re-classed between the amortized cost basis of loans and corresponding ACL. The adjustment upon adoption of ASC 326 raised the ACL on loans balance to $37 million on January 1, 2020. In addition to CECL adoption, the ACL on the first and second quarters of 2020 was significantly impacted by Bancorp’s national unemployment forecast adjustments within the CECL model, changes in the loan mix and the addition of a large specific reserve during the second quarter of 2020.

Bancorp measures expected credit losses of financial assets on a collective (pool) basis, when the financial assets share similar risk characteristics. Depending on the nature of the pool of financial assets with similar risk characteristics, Bancorp has measured its portfolio classes as follows:

Loan Portfolio Segment

ACL Methodology

Commercial real estate - non-owner occupied

Discounted cash flow

Commercial real estate - owner occupied

Discounted cash flow

Commercial and industrial - term

Static pool

Commercial and industrial - line of credit

Static pool

Residential real estate - owner occupied

Discounted cash flow

Residential real estate - non-owner occupied

Discounted cash flow

Construction and land development

Static pool

Home equity lines of credit

Static pool

Consumer

Static pool

Leases

Static pool

Credit cards - commercial

Static pool

The static pool methodology is utilized for the loan portfolio segments that typically have shorter durations. For each of these loan segments, Bancorp applies an expected loss ratio based on historical losses adjusted as appropriate for qualitative factors. Qualitative loss factors are based on management's judgment of company, market, industry or business specific data, changes in underlying loan composition of specific portfolios, trends relating to credit quality, delinquency, non-performing and adversely rated loans, and reasonable and supportable forecasts of economic conditions.

When developing the ACL CECL model for loan pools utilizing the DCF method, Bancorp utilized regression analysis of historical internal and peer data to identify a suitable loss driver to utilize when modeling lifetime probability of default and loss given default. Such regression analysis was used to measure how the expected probability of default and loss given default would react to changes in forecasted levels of the loss driver. Based on this regression analysis, management determined that the forecasted Seasonally Adjusted National Civilian Unemployment Rate best correlated to Bancorp’s historical losses and elected to use this rate as the primary loss driver to be consistently applied across all applicable loan segments over a reasonable and supportable forecast period.

Upon adoption of ASC 326 on January 1, 2020, management determined that four quarters represented a reasonable and supportable national unemployment forecast period with reversion back to Bancorp’s historical loss rate over eight quarters on a straight-line basis. This resulted in an $8.2 million initial increase in the ACL on loans with the offset to retained earnings.

Subsequent to January 1, 2020, based on the economic crisis caused by COVID-19 and measures taken to protect public health such as stay-at-home orders and mandatory closures of businesses, economic activity halted significantly and job losses surged. As such, national unemployment has fluctuated widely over the last several months as follows:

Jun 20

May 20

Apr 20

Mar 20

Feb 20

Jan 20

Dec 19

National Unemployment Rate

11.10%13.30%14.70%4.40%3.50%3.60%3.50%

As of March 31, 2020, based on the evolving pandemic, Bancorp elected to forecast for only one quarter of national unemployment (versus the four quarters used as of January 1, 2020) and modified its forecast to reflect a significant increase in unemployment (utilizing the highest unemployment rate in Bancorp’s observed history) reverting back to the long-term average in the third quarter of 2020, with the loss driver remaining significantly worse compared to recent trends. The impact of the increased national unemployment forecast was muted by an adjustment in qualitative factors attributed to the massive federal stimulus programs enacted at the end of the first quarter in response to the pandemic. The forecasted increase in national unemployment coupled with the qualitative factor adjustments resulted in approximately $4.2 million of the total provision expense recorded for the three months ended March 31, 2020.

For all loan pools utilizing the DCF method, management utilizes the forecasted Seasonally Adjusted National Civilian Unemployment Rate as its primary loss driver, as this was determined to best correlate to historical losses. During the second quarter, for the first time during 2020, the FRB released a forecasted Seasonally Adjusted National Civilian Unemployment Rate for the 12 months endedDecember 31, 2020, 2021 and 2022 as follows:

  

2020

  

2021

  

2022

 
             

Upper end of range

  14.0%  12.0%  8.0%

Median

  9.3%  6.5%  5.5%

Lower end of range

  7.0%  4.5%  4.0%

As of June 30, 2020, based on the above and the continuation of the economic crisis, Bancorp elected to forecast for one quarter of national unemployment utilizing actual unemployment in June then stepping down to a blended rate based on the above FRB median forecast over the next four quarters before reverting back to the long-term average. Similar to the first quarter of 2020, the impact of the increased unemployment forecast was muted by an adjustment in qualitative factors attributed to the massive federal stimulus programs that have been enacted. The forecasted increase in unemployment coupled with the qualitative factor adjustments resulted in approximately $4.6 million of the total provision expense recorded for the three months ended June 30, 2020 and $8.8 million for the six months ended June 30, 2020.

Outstanding loans (excluding PPP loans) increased $92 million during the firstthree months of 2020 and contracted $103 million during the second quarter of 2020, as outstanding C&I lines of credit were reduced by $114 million. The overall net change in the loan mix contributed to $1.3 million of additional provision expense for the three months ended March 31, 2020. During the second quarter of 2020, the loan contraction (mainly C&I lines of credit) led to a $1.0 million reduction in the required ACL on loans.

The pandemic has had a material impact on Bancorp’s ACL on loans calculations for both March 31, 2020 and June 30, 2020. While Bancorp has not yet experienced any credit quality issues such as charge-offs related to the pandemic, the ACL calculation for loans and resulting provision were significantly impacted by changes in forecasted economic conditions. Should the forecast for economic conditions worsen, Bancorp could experience further increases in its required ACL and record additional provision expense. While the execution of Bancorp’s payment deferral program has assisted the ratio of past due loans to total loans at March 31, 2020 and June 30, 2020, it is possible that asset quality could worsen at future measurement periods if the effects of the pandemic are prolonged.

In connection with the adoption of ASC 326, Bancorp analyzed its unused lines of credit and recorded credit loss expense for off-balance sheet exposures (non-interest expense) totaling $375,000 and $1.5 million during the first and second quarters of 2020. The second quarter increase directly correlates to the increased availability due to C&I line of credit pay downs. At June 30, 2020, approximately $6 million was accrued within other liabilities related to off balance sheet exposures.

During the three months ended June 30, 2020, a large CRE relationship was placed on non-accrual status and received a $2 million specific reserve allocation within the ACL on loans. The borrower did not receive PPP funds, the loan was current at the time of non-accrual classification, and no payments related to the loan have been deferred.

The following table presents the amortized cost basis and ACL allocated for collateral dependent loans in accordance with ASC 326, which are individually evaluated to determine expected credit losses:

(in thousands)

June 30, 2020

 

Real Estate

  

Accounts

Receivable /

Equipment

  

Other

  

Total

  

ACL

Allocation

 
                     

Commercial real estate - non-owner occupied

 $10,569  $-  $-  $10,569  $2,255 

Commercial real estate - owner occupied

  3,014   -   -   3,014   1,351 

Total commercial real estate

  13,583   -   -   13,583   3,606 
                     

Commercial and industrial - term

  -   9   18   27   18 

Commercial and industrial - lines of credit

  -   -   -   -   - 

Total commercial and industrial

  -   9   18   27   18 
                     

Residential real estate - owner occupied

  445   -   -   445   99 

Residential real estate - non-owner occupied

  225   -   -   225   - 

Total residential real estate

  670   -   -   670   99 
                     

Construction and land development

  -   -   -   -   - 

Home equity lines of credit

  -   -   -   -   - 

Consumer

  -   -   26   26   26 

Leases

  -   -   -   -   - 

Credit cards - commercial

  -   -   -   -   - 

Total collateral dependent loans

 $14,253  $9  $44  $14,306  $3,749 

There have been no significant changes to the types of collateral securing Bancorp’s collateral dependent loans.

The following table presents loans individually and collectively evaluated for impairment and the respective ACL allocation as of December 31, 2019, as determined in accordance with ASC 310 prior to the adoption of ASC 326:

  

Loans

  

ACL

 

(in thousands)

December 31, 2019

 

Loans individually

evaluated for

impairment

  

Loans collectively

evaluated for

impairment

  

Loans acquired

with deteriorated

credit quality

  

Total loans

  

Loans individually

evaluated for

impairment

  

Loans collectively

evaluated for

impairment

  

Loans acquired

with deteriorated

credit quality

  

Total ACL

 
                                 

Commercial and industrial

 $8,223  $862,288  $  $870,511  $1,150  $11,672  $  $12,822 

Construction and development, excluding undeveloped land

     213,822      213,822      1,319      1,319 

Undeveloped land

     46,360      46,360      786      786 

Real estate mortgage

  3,307   1,663,549      1,666,856   13   11,751      11,764 

Consumer

     47,467      47,467      100      100 
                                 

Total

 $11,530  $2,833,486  $  $2,845,016  $1,163  $25,628  $  $26,791 

The following table presents information pertaining to impaired loans as of December 31, 2019 and the three and six months periods ended June 30, 2019, as determined in accordance with ASC 310:

  

As of

  

Three months ended

  

Six months ended

 
  

December 31, 2019

  

June 30, 2019

  

June 30, 2019

 
                             
      

Unpaid

      

Average

  

Interest

  

Average

  

Interest

 
  

Recorded

  

principal

  

Related

  

recorded

  

income

  

recorded

  

income

 

(in thousands)

 

investment

  

balance

  

ACL

  

investment

  

recognized

  

investment

  

recognized

 
                             

Impaired loans with no related ACL

                            

Commercial and industrial

 $174  $174  $  $144  $  $160  $ 

Construction and development, excluding undeveloped land

                 106    

Undeveloped land

                 158    
                             

Real estate mortgage

                            

Commercial investment

  741   741      311      254    

Owner occupied commercial

  2,278   2,736      1,455      1,165    

1-4 family residential

  124   124      779      773    

Home equity - junior lien

  151   151      462      356    

Subtotal: Real estate mortgage

  3,294   3,752      3,007      2,548    
                             

Subtotal

 $3,468  $3,926  $  $3,151  $  $2,972  $ 
                             

Impaired loans with an ACL

                            

Commercial and industrial

 $8,049  $8,049  $1,150  $24  $  $26  $1 

Real estate mortgage 1-4 family residential

  13   13   13   14      14    

Subtotal: Real estate mortgage

  13   13   13   14      14    
                             

Subtotal

 $8,062  $8,062  $1,163  $38  $  $40  $1 
                             

Total impaired loans:

                            

Commercial and industrial

 $8,223  $8,223  $1,150  $168  $  $186  $1 

Construction and development, excluding undeveloped land

                 106    

Undeveloped land

                 158    
                             

Real estate mortgage

                            

Commercial investment

  741   741      311      254    

Owner occupied commercial

  2,278   2,736      1,455      1,165    

1-4 family residential

  137   137   13   793      787    

Home equity - junior lien

  151   151      462      356    

Subtotal: Real estate mortgage

  3,307   3,765   13   3,021      2,562    
                             

Total

 $11,530  $11,988  $1,163  $3,189  $  $3,012  $1 

Differences between recorded investment amounts and unpaid principal balance amounts less related ACL are due to partial charge-offs which have occurred over the lives of certain loans.

The following tables present the aging of contractually past due loans by portfolio class (2020 is presented in accordance with ASC 326 and 2019 in accordance with ASC 310):

(in thousands)

     

30-59 days

  

60-89 days

  

90 or more

  

Total

  

Total

 

June 30, 2020

 

Current

  

Past Due

  

Past Due

  

Days Past Due

  

Past Due

  

Loans

 
                         

Commercial real estate - non-owner occupied

 $814,610  $121  $35  $698  $854  $815,464 

Commercial real estate - owner occupied

  469,529   256      2,672   2,928   472,457 

Total commercial real estate

  1,284,139   377   35   3,370   3,782   1,287,921 
                         

Commercial and industrial - term

  1,140,384   59   14   9   82   1,140,466 

Commercial and industrial - line of credit

  253,645   41   310   100   451   254,096 

Total commercial and industrial

  1,394,029   100   324   109   533   1,394,562 
                         

Residential real estate - owner occupied

  214,681   603   290   317   1,210   215,891 

Residential real estate - non-owner occupied

  138,823      24   274   298   139,121 

Total residential real estate

  353,504   603   314   591   1,508   355,012 
                         

Construction and land development

  255,399         48   48   255,447 

Home equity lines of credit

  103,672               103,672 

Consumer

  43,727   30   1      31   43,758 

Leases

  14,843               14,843 

Credit cards - commercial

  8,862               8,862 

Total

 $3,458,175  $1,110  $674  $4,118  $5,902  $3,464,077 

              

90 or more

         
              

Days Past Due

         

(in thousands)

     

30-59 days

  

60-89 days

  

(includes all

  

Total

  

Total

 

December 31, 2019

 

Current

  

Past Due

  

Past Due

  

non-accrual)

  

Past Due

  

Loans

 
                         

Commercial and industrial

 $861,860  $253  $194  $8,204  $8,651  $870,511 

Construction and development, excluding undeveloped land

  213,766   6   50      56   213,822 

Undeveloped land

  46,360               46,360 
                         

Real estate mortgage:

                        

Commercial investment

  735,387   94      1,137   1,231   736,618 

Owner occupied commercial

  470,951   467   86   2,279   2,832   473,783 

1-4 family residential

  332,718   1,368   33   239   1,640   334,358 

Home equity - first lien

  48,441   179         179   48,620 

Home equity - junior lien

  72,995   196   100   186   482   73,477 

Subtotal: Real estate mortgage

  1,660,492   2,304   219   3,841   6,364   1,666,856 
                         

Consumer

  47,379   84   4      88   47,467 
                         

Total

 $2,829,857  $2,647  $467  $12,045  $15,159  $2,845,016 

The following table presents the amortized cost basis of non-performing loans and the amortized cost basis of loans on non-accrual status for which there was no related ACL losses of June 30, 2020:

          

Past Due 90-Days-

 

(In thousands)

 

Non-accrual

  

Total

  

or-More and Still

 

June 30, 2020

 

with no ACL

  

Non-accrual

  

Accruing Interest

 
             

Commercial real estate - non-owner occupied

 $213  $10,569  $- 

Commercial real estate - owner occupied

  1,663   3,014   - 

Total commercial real estate

  1,876   13,583   - 
             

Commercial and industrial - term

  9   9   - 

Commercial and industrial - lines of credit

  -   -   - 

Total commercial and industrial

  9   9   - 
             

Residential real estate - owner occupied

  306   445   - 

Residential real estate - non-owner occupied

  225   225   - 

Total residential real estate

  531   670   - 
             

Construction and land development

  -   -   48 

Home equity lines of credit

  -   -   - 

Consumer

  -   -   - 

Leases

  -   -   - 

Credit cards - commercial

  -   -   - 

Total

 $2,416  $14,262  $48 

For the three and six month periods ended June 30, 2020 and 2019, the amount of accrued interest income previously recorded as revenue and subsequently reversed due to the change in accrual status was immaterial.

For the three and six month periods ended June 30, 2020 and 2019,no interest income was recognized on loans on non-accrual status.

The following table presents the recorded investment in non-performing loans by portfolio class as of December 31, 2019:

December 31, 2019 (in thousands)

 

Non-accrual

  

Past Due 90-Days-or-

More and Still

Accruing Interest

 
         

Commercial and industrial

 $8,202  $ 

Construction and development, excluding undeveloped land

      

Undeveloped land

      
         

Real estate mortgage:

        

Commercial investment

  740   396 

Owner occupied commercial

  2,278    

1-4 family residential

  123   104 

Home equity - first lien

      

Home equity - junior lien

  151   35 

Subtotal: Real estate mortgage

  3,292   535 

Consumer

      
         

Total

 $11,494  $535 

Loan Risk Ratings

Consistent with regulatory guidance, Bancorp categorizes loans into credit risk rating categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information and current economic trends. Pass-rated loans include all risk-rated loans other than those classified as OAEM, substandard, and doubtful, which are defined below:

OAEM Loans classified as OAEM have potential weaknesses requiring management's heightened attention. These potential weaknesses may result in deterioration of repayment prospects for the loan or of Bancorp's credit position at some future date.

Substandard – Loans classified as substandard are inadequately protected by the paying capacity of the obligor or of collateral pledged, if any. Loans so classified have well-defined weaknesses that jeopardize ultimate repayment of the debt. Default is a distinct possibility if the deficiencies are not corrected.

Substandard non-performing – Loans classified as substandard non-performing have all the characteristics of substandard loans and have been placed on non-accrual status or have been accounted for as TDRs. Loans are placed on non-accrual status when prospects for recovering both principal and accrued interest are considered doubtful or when a default of principal or interest has existed for 90 days or more.

Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or repayment in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

Management considers the guidance in ASC 310-20 when determining whether a modification, extension, or renewal of loan constitutes a current period origination. Current period renewals of credit are re-underwritten at the point of renewal and considered current period originations for purposes of the table below. As of June 30, 2020, the risk rating of loans based on year of origination is as follows:

  

Term Loans Amortized Cost Basis by Origination Year

             
                          

Revolving

  

Revolving

     
                          

loans

  

loans

     

(in thousands)

                         

amortized

  

converted

     

June 30, 2020

 

2020

  

2019

  

2018

  

2017

  

2016

  

Prior

  

cost basis

  

to term

  

Total

 
                                     

Commercial real estate - non-owner occupied:

                                    

Risk rating

                                    

Pass

 $174,017  $171,037  $106,905  $126,594  $95,310  $96,646  $13,982  $11,989  $796,480 

OAEM

  61   -   -   -   1,578   52   472   -   2,163 

Substandard

  4,200   2,051   -   -   -   1   -   -   6,252 

Substandard non-performing

  9,727   -   -   614   -   228   -   -   10,569 

Doubtful

  -   -   -   -   -   -   -   -   - 

Total Commercial real estate non-owner occupied

 $188,005  $173,088  $106,905  $127,208  $96,888  $96,927  $14,454  $11,989  $815,464 
                                     

Commercial real estate - owner occupied:

                                    

Risk rating

                                    

Pass

 $102,192  $109,160  $91,659  $53,309  $44,522  $49,472  $7,144  $851  $458,309 

OAEM

  -   62   967   825   252   76   -   -   2,182 

Substandard

  -   6,997   1,363   105   127   360   -   -   8,952 

Substandard non-performing

  -   -   20   500   -   2,151   -   343   3,014 

Doubtful

  -   -   -   -   -   -   -   -   - 

Total Commercial real estate owner occupied

 $102,192  $116,219  $94,009  $54,739  $44,901  $52,059  $7,144  $1,194  $472,457 
                                     

Commercial and industrial - term:

                                    

Risk rating

                                    

Pass

 $768,510  $110,924  $111,287  $51,862  $43,348  $26,536  $-  $7,755  $1,120,222 

OAEM

  -   928   11,679   160   83   17   -   -   12,867 

Substandard

  5,249   1,853   -   -   189   77   -   -   7,368 

Substandard non-performing

  -   -   -   -   9   -   -   -   9 

Doubtful

  -   -   -   -   -   -   -   -   - 

Total Commercial and industrial - term

 $773,759  $113,705  $122,966  $52,022  $43,629  $26,630  $-  $7,755  $1,140,466 
                                     

Commercial and industrial - lines of credit

                                    

Risk rating

                                    

Pass

 $13,460  $29,646  $4,191  $2,956  $364  $-  $193,105  $-  $243,722 

OAEM

  -   -   -   -   -   -   783   -   783 

Substandard

  -   -   -   -   -   -   9,591   -   9,591 

Substandard non-performing

  -   -   -   -   -   -   -   -   - 

Doubtful

  -   -   -   -   -   -   -   -   - 

Total Commercial and industrial - lines of credit

 $13,460  $29,646  $4,191  $2,956  $364  $-  $203,479  $-  $254,096 

(continued)

(continued)

 

Term Loans Amortized Cost Basis by Origination Year

             
                          

Revolving

  

Revolving

     
                          

loans

  

loans

     

(in thousands)

                         

amortized

  

converted

     

June 30, 2020

 

2020

  

2019

  

2018

  

2017

  

2016

  

Prior

  

cost basis

  

to term

  

Total

 
                                     

Residential real estate - owner occupied

                                    

Risk rating

                                    

Pass

 $35,591  $43,994  $29,055  $26,881  $32,877  $46,720  $-  $195  $215,313 

OAEM

  -   -   -   -   -   -   -   -   - 

Substandard

  16   -   -   118   -   -   -   -   134 

Substandard non-performing

  -   -   -   101   38   205   -   100   444 

Doubtful

  -   -   -   -   -   -   -   -   - 

Total Residential real estate - owner occupied

 $35,607  $43,994  $29,055  $27,100  $32,915  $46,925  $-  $295  $215,891 
                                     

Residential real estate - non-owner occupied

                                    

Risk rating

                                    

Pass

 $43,459  $27,037  $29,437  $12,618  $11,728  $12,740  $-  $158  $137,177 

OAEM

  -   1,600   -   -   -   88   -   -   1,688 

Substandard

  -   -   31   -   -   -   -   -   31 

Substandard non-performing

  -   -   -   -   -   225   -   -   225 

Doubtful

  -   -   -   -   -   -   -   -   - 

Total Residential real estate - non-owner occupied

 $43,459  $28,637  $29,468  $12,618  $11,728  $13,053  $-  $158  $139,121 
                                     

Construction and land development

                                    

Risk rating

                                    

Pass

 $55,195  $97,608  $66,746  $23,159  $1,249  $2,764  $6,842  $1,883  $255,446 

OAEM

  -   -   -   -   -   -   -   -   - 

Substandard

  -   -   -   -   1   -   -   -   1 

Substandard non-performing

  -   -   -   -   -   -   -   -   - 

Doubtful

  -   -   -   -   -   -   -   -   - 

Total Construction and land development

 $55,195  $97,608  $66,746  $23,159  $1,250  $2,764  $6,842  $1,883  $255,447 
                                     

Home equity lines of credit

                                    

Risk rating

                                    

Pass

 $-  $-  $-  $-  $-  $-  $103,672  $-  $103,672 

OAEM

  -   -   -   -   -   -   -   -   - 

Substandard

  -   -   -   -   -   -   -   -   - 

Substandard non-performing

  -   -   -   -   -   -   -   -   - 

Doubtful

  -   -   -   -   -   -   -   -   - 

Total Home equity lines of credit

 $-  $-  $-  $-  $-  $-  $103,672  $-  $103,672 
                                     

Consumer

                                    

Risk rating

                                    

Pass *

 $3,680  $5,697  $4,042  $498  $525  $1,506  $27,638  $145  $43,731 

OAEM

  -   -   -   -   -   -   -   -   - 

Substandard

  -   26   -   -   -   -   -   -   26 

Substandard non-performing

  -   -   -   -   -   1   -   -   1 

Doubtful

  -   -   -   -   -   -   -   -   - 

Total Consumer

 $3,680  $5,723  $4,042  $498  $525  $1,507  $27,638  $145  $43,758 

* - Revolving loans include $506,000 in overdrawn demand deposit balances.

(continued)

(continued)

 

Term Loans Amortized Cost Basis by Origination Year

             
                          

Revolving

  

Revolving

     
                          

loans

  

loans

     

(in thousands)

                         

amortized

  

converted

     

June 30, 2020

 

2020

  

2019

  

2018

  

2017

  

2016

  

Prior

  

cost basis

  

to term

  

Total

 
                                     

Leases

                                    

Risk rating

                                    

Pass

 $1,692  $2,238  $2,495  $1,774  $3,272  $2,502  $-  $-  $13,973 

OAEM

  -   -   34   -   -   4   -   -   38 

Substandard

  -   -   -   -   832   -   -   -   832 

Substandard non-performing

  -   -   -   -   -   -   -   -   - 

Doubtful

  -   -   -   -   -   -   -   -   - 

Total Consumer

 $1,692  $2,238  $2,529  $1,774  $4,104  $2,506  $-  $-  $14,843 
                                     

Credit cards - commercial

                                    

Risk rating

                                    

Pass

 $-  $-  $-  $-  $-  $-  $8,862  $-  $8,862 

OAEM

  -   -   -   -   -   -   -   -   - 

Substandard

  -   -   -   -   -   -   -   -   - 

Substandard non-performing

  -   -   -   -   -   -   -   -   - 

Doubtful

  -   -   -   -   -   -   -   -   - 

Total Consumer

 $-  $-  $-  $-  $-  $-  $8,862  $-  $8,862 
                                     

Total loans

                                    

Risk rating

                                    

Pass

 $1,197,796  $597,341  $445,817  $299,651  $233,195  $238,886  $361,245  $22,976  $3,396,907 

OAEM

  61   2,590   12,680   985   1,913   237   1,255   -   19,721 

Substandard

  9,465   10,927   1,394   223   1,149   438   9,591   -   33,187 

Substandard non-performing

  9,727   -   20   1,215   47   2,810   -   443   14,262 

Doubtful

  -   -   -   -   -   -   -   -   - 

Total Loans

 $1,217,049  $610,858  $459,911  $302,074  $236,304  $242,371  $372,091  $23,419  $3,464,077 

Bancorp considers the performance of the loan portfolio and its impact on the ACL. For certain loan classes, such as credit cards, credit quality is evaluated based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the recorded investment in commercial credit cards based on payment activity:

  

June, 30

 

(in thousands)

 

2020

 
     

Credit cards - commercial

    

Performing

 $8,862 

Non-performing

   

Total credit cards - commercial

 $8,862 

Internally assigned risk ratings of loans by loan portfolio class classification category as of December 31, 2019 follows:

(in thousands)

             

Substandard

      

Total

 

December 31, 2019

 

Pass

  

OAEM

  

Substandard

  

Non-performing

  

Doubtful

  

Loans

 
                         

Commercial and industrial

 $840,105  $704  $21,500  $8,202  $  $870,511 

Construction and development, excluding undeveloped land

  213,822               213,822 

Undeveloped land

  46,360               46,360 
                         

Real estate mortgage:

                        

Commercial investment

  722,747   6,459   6,275   1,137      736,618 

Owner occupied commercial

  460,981   1,375   9,050   2,377      473,783 

1-4 family residential

  332,294   1,701   122   241      334,358 

Home equity - first lien

  48,620               48,620 

Home equity - junior lien

  73,273      17   187      73,477 

Subtotal: Real estate mortgage

  1,637,915   9,535   15,464   3,942      1,666,856 
                         

Consumer

  47,429      38         47,467 
                         

Total

 $2,785,631  $10,239  $37,002  $12,144  $  $2,845,016 

Troubled Debt Securities AcquiredRestructurings

Detail of outstanding TDRs included in total non-performing loans follows:

  

June 30, 2020

  

December 31, 2019

 
      

Specific

  

Additional

      

Specific

  

Additional

 
      

reserve

  

commitment

      

reserve

  

commitment

 

(in thousands)

 

Balance

  

allocation

  

to lend

  

Balance

  

allocation

  

to lend

 
                         

Commercial and industrial - term

 $19  $19  $  $21  $21  $ 

Residential real estate

           13   13    

Consumer

  26   26             
                         

Total TDRs

 $45  $45  $  $34  $34  $ 

In March 2020, the FASB issued ASU No.2020-04, Reference Rate Reform (Topic 848): “Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” The amendments in this update provide optional guidance for a limited period to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. It provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments in this update are effective for all entities as of March 12, 2020 through December 31, 2022. Bancorp is currently evaluating the impact of this ASU on the Company’s consolidated financial statements.

In accordance with DeterioratedSection 4013 of the CARES Act and in response to requests from borrowers who experienced business or personal cash flow interruptions related to the pandemic, Bancorp executed a payment deferral program. Depending on the demonstrated need of the customer, Bancorp deferred either the full loan payment or the interest only portion of respective loan payments for 90 or 180 days.  As of June 30, 2020, Bancorp executed 1,100 of full payment deferrals (predominantly three months) on outstanding loan balances of $502 million - representing 18% of the loan portfolio (excluding PPP loans). Approximately 85% of the total deferrals processed (in terms of dollars) occurred in the month of April, with the subsequent pace slowing significantly. Pursuant to the CARES Act, these loan deferrals were not classified as TDRs and not included in non-performing loan statistics. Subsequent to the end of the second quarter and through July, a significant portion of the deferred loan portfolio returned to full paying status. As of July 31, 2020, Bancorp estimates that 10% of the total loan portfolio (excluding PPP loans) remained in full payment deferment status. Bancorp is monitoring loan modification expirations daily and anticipates the potential for more customers to return to full payment status over the next two months as their initial deferral period ends.

During the three and six month periods ended June 30, 2020 and 2019, there were 0 loans modified as TDRs and there were no payment defaults of existing TDRs within 12 months following the modification. Default is determined at 90 or more days past due, charge-off, or foreclosure.

At June 30, 2020 and December 31, 2019, Bancorp had $177,000 and $239,000, respectively, in residential real estate loans for which formal foreclosure proceedings were in process.

Purchased Credit Quality.Impaired Loans (Prior to the Adoption of ASC 326)

 

Management utilized the following criteria in determining which loans were classified as PCI criterialoans for theits May 1, 2019King acquisition:

●     Loans assigned a non-accretable mark

●     Loans classified by management as substandard, doubtful or loss

●     Loans classified as non-accrual when acquired

●     Loans past due 90 days or more when acquired

●     Loans for which management assigned a non-accretable mark

 

The following table reconcilesBank acquired $1.6 million in PCI loans in connection with its 2019 acquisition. Under ASC 310-30, the non-accretable amount attributed to these loans equaled the contractually required principal at acquisition date and carrying amountsas of all PCI loans:

In thousands

 

June 30, 2019

  

December 31, 2018

 
         

Contractually-required principal

 $1,864  $432 

Non-accretable amount

  (1,577)   

Accretable amount

  (57)  (68)

Carrying value of loans

 $230  $364 

June 30, 2020.

 

The following table presents a rollforwardroll forward of the accretable amount on allof PCI loans:loans acquired in its 2013 acquisition:

 

 

Three months ended

 

Six months ended

  

Three months ended

 

Six months ended

 
 

June 30,

  

June 30,

 

(In thousands)

 

2019

  

2018

  

2019

  

2018

 

(in thousands)

 

June 30, 2019

  

June 30, 2019

 
  

Balance, beginning of period

 $(62) $(95) $(68) $(106) $(62) $(68)

Transfers between non-accretable and accretable

            

Net accretion into interest income on loans, including loan fees

 5  10  11  21   5   11 

Generated from acquisition of King

            

Balance, end of period

 $(57) $(85) $(57) $(85) $(57) $(57)

 

Consistent with regulatory guidance, Bancorp categorizes loans into credit risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends. Pass-rated loans included all risk-rated loans other than those classified as other assets especially mentioned, substandard, and doubtful, which are defined below:

Other assets especially mentioned (“OAEM”): Loans classified as OAEM have potential weaknesses that deserve management's close attention. These potential weaknesses may result in deterioration of repayment prospects for the loan or of Bancorp's credit position at some future date.

Substandard: Loans classified as substandard are inadequately protected by the paying capacity of the obligor or of collateral pledged, if any. Loans so classified have well-defined weaknesses that jeopardize ultimate repayment of the debt. Default is a distinct possibility if the deficiencies are not corrected.

Substandard non-performing: Loans classified as substandard non-performing have all the characteristics of substandard loans and have been placed on non-accrual status or have been accounted for as troubled debt restructurings. Loans are placed on non-accrual status when prospects for recovering both principal and accrued interest are considered doubtful or when a default of principal or interest has existed for 90 days or more.

Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or repayment in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

19
37

Internally assigned risk grades of loans by loan portfolio class classification category follows:

(In thousands)

             

Substandard

      

Total

 

June 30, 2019

 

Pass

  

OAEM

  

Substandard

  

non-performing

  

Doubtful

  

loans

 
                         

Commercial and industrial

 $817,645  $23,907  $18,241  $292  $  $860,085 

Construction and development, excluding undeveloped land

  222,632               222,632 

Undeveloped land

  35,169               35,169 
                         

Real estate mortgage:

                        

Commercial investment

  687,304   4,202   4,213   702      696,421 

Owner occupied commercial

  429,070   17,757   4,228   1,664      452,719 

1-4 family residential

  336,312   1,686   159   800      338,957 

Home equity - first lien

  46,012               46,012 

Home equity - junior lien

  67,236   224   18   470      67,948 

Subtotal: Real estate mortgage

  1,565,934   23,869   8,618   3,636      1,602,057 
                         

Consumer

  43,937               43,937 
                         

Total

 $2,685,317  $47,776  $26,859  $3,928  $  $2,763,880 
                         
                         

December 31, 2018

                        
                         

Commercial and industrial

 $803,073  $11,516  $18,703  $232  $  $833,524 

Construction and development, excluding undeveloped land

  220,532   4,200      318      225,050 

Undeveloped land

  29,618         474      30,092 
                         

Real estate mortgage:

                        

Commercial investment

  586,543   1,815   15   237      588,610 

Owner occupied commercial

  411,722   9,030   4,500   1,121      426,373 

1-4 family residential

  273,537   1,544   162   774      276,017 

Home equity - first lien

  49,500               49,500 

Home equity - junior lien

  70,437   249   19   242      70,947 

Subtotal: Real estate mortgage

  1,391,739   12,638   4,696   2,374      1,411,447 
                         

Consumer

  48,058               48,058 
                         

Total

 $2,493,020  $28,354  $23,399  $3,398  $  $2,548,171 

 

The following table presents the activity in the allowance by loan portfolio class:

  

Type of loan

     
      

Construction

                 
      

and development,

                 

Three months ended

 

Commercial

  

excluding

                 
  

and

  

undeveloped

  

Undeveloped

  

Real estate

         

(In thousands)

 

industrial

  

land

  

land

  

mortgage

  

Consumer

  

Total

 
                         

Balance, April 1, 2019

 $11,762  $1,884  $662  $12,001  $155  $26,464 

Provision (credit)

  92   (74)  (61)  10   33   - 

Charge-offs

           (13)  (148)  (161)

Recoveries

  4         32   77   113 

Balance, June 30, 2019

 $11,858  $1,810  $601  $12,030  $117  $26,416 

      

Construction

                 
      

and development,

                 
  

Commercial

  

excluding

                 
  

and

  

undeveloped

  

Undeveloped

  

Real estate

         

(In thousands)

 

industrial

  

land

  

land

  

mortgage

  

Consumer

  

Total

 
                         

Balance, April 1, 2018

 $10,638  $2,020  $482  $10,707  $356  $24,203 

Provision (credit)

  2,008   (82)  19   (795)  85   1,235 

Charge-offs

  (530)           (117)  (647)

Recoveries

  2         2   78   82 

Balance, June 30, 2018

 $12,118  $1,938  $501  $9,914  $402  $24,873 

  

Type of loan

     
      

Construction

                 
      

and development,

                 

Six months ended

 

Commercial

  

excluding

                 
  

and

  

undeveloped

  

Undeveloped

  

Real estate

         

(In thousands)

 

industrial

  

land

  

land

  

mortgage

  

Consumer

  

Total

 
                         

Balance, January 1, 2019

 $11,965  $1,760  $752  $10,681  $376  $25,534 

Provision (credit)

  (210)  (153)  (151)  1,310   (196)  600 

Charge-offs

  (3)        (13)  (244)  (260)

Recoveries

  106   203      52   181   542 

Balance, June 30, 2019

 $11,858  $1,810  $601  $12,030  $117  $26,416 

      

Construction

                 
      

and development,

                 
  

Commercial

  

excluding

                 
  

and

  

undeveloped

  

Undeveloped

  

Real estate

         

(In thousands)

 

industrial

  

land

  

land

  

mortgage

  

Consumer

  

Total

 
                         

Balance, January 1, 2018

 $11,276  $1,724  $521  $11,012  $352  $24,885 

Provision (credit)

  2,769   214   (20)  (1,104)  111   1,970 

Charge-offs

  (1,939)           (236)  (2,175)

Recoveries

  12         6   175   193 

Balance, June 30, 2018

 $12,118  $1,938  $501  $9,914  $402  $24,873 

The considerations by Bancorp in computing its allowance are determined based on the various risk characteristics of each loan segment. Relevant risk characteristics are as follows:

Commercial and industrial: Loans in this category are made to businesses. Generally these loans are secured by assets of the business and repayment is expected from cash flows of the business. A decline in the strength of the business or a weakened economy and resultant decreased consumer and/or business spending may have an effect on the credit quality in this loan category.

Construction and development, excluding undeveloped land: Loans in this category primarily include owner-occupied and investment construction loans and commercial development projects. In most cases, construction loans require only interest to be paid during the construction period. Upon completion or stabilization, the construction loans generally convert to permanent financing in the real estate mortgage segment, requiring principal amortization. Repayment of development loans is derived from sale of lots or units. Credit risk is affected by construction delays, cost overruns, market conditions and availability of permanent financing; to the extent such permanent financing is not being provided by Bancorp.

Undeveloped land: Loans in this category are secured by land acquired for development by the borrower, but for which no development has yet taken place. Credit risk is primarily dependent upon the financial strength of the borrower, but can also be affected by market conditions and time to sell lots at an adequate price in the future. Credit risk is also affected by availability of permanent financing, including to the end user, to the extent such permanent financing is not being provided by Bancorp.  

Real estate mortgage: Loans in this category are made to and secured by owner-occupied residential real estate, owner-occupied real estate used for business purposes, and income-producing investment properties. Underlying properties are generally located in Bancorp's primary market areas. A decline in the strength of the borrower or a weakened economy may have an effect on the credit quality of this type of loan. For owner occupied residential and owner-occupied commercial real estate, repayment is dependent on financial strength of the borrower. For income-producing investment properties, repayment is dependent on financial strength of tenants, and to a lesser extent the borrowers’ financial strength, once the project is stabilized. Cash flows of income producing investment properties may be adversely impacted by a downturn in the economy as reflected by increased vacancy rates, which in turn, will have an effect on credit quality and property values. Overall health of the economy, including unemployment rates and real estate prices, has an effect on credit quality in this loan category.

Consumer: Loans in this category may be either secured or unsecured and repayment is dependent on credit quality of the individual borrower and, if applicable, adequacy of collateral securing the loan. Therefore, overall health of the economy, including unemployment rates, as well as home and securities prices, will have a significant effect on credit quality in this loan category.

Impaired loans include non-accrual loans and accruing loans accounted for as troubled debt restructurings (“TDRs”), which continue to accrue interest. Non-performing loans include the balance of impaired loans plus any loans over 90 days past due and still accruing interest.

The following table presents the recorded investment in non-accrual loans:

(In thousands)

 

June 30, 2019

  

December 31, 2018

 
         

Commercial and industrial

 $96  $192 

Construction and development, excluding undeveloped land

     318 

Undeveloped land

     474 
         

Real estate mortgage:

        

Commercial investment

  305   138 

Owner occupied commercial

  1,444   586 

1-4 family residential

  715   760 

Home equity - first lien

      

Home equity - junior lien

  470   143 

Subtotal: Real estate mortgage

  2,934   1,627 

Consumer

      

Total non-accrual loans

 $3,030  $2,611 

In the course of working with borrowers, Bancorp may elect to restructure the contractual terms of certain loans. TDRs occur when, for economic, legal, or other reasons related to a borrower’s financial difficulties, Bancorp grants a concession to the borrower that it would not otherwise consider. Bancorp did not recognize new TDRs, nor did any TDRs default, in the three and six months periods ended June 30, 2019 and 2018. Detail of outstanding TDRs follows:

  

June 30, 2019

  

December 31, 2018

 

(In thousands)

     

Specific

  

Additional

      

Specific

  

Additional

 
      

reserve

  

commitment

      

reserve

  

commitment

 

TDRs

 

Balance

  

allocation

  

to lend

  

Balance

  

allocation

  

to lend

 
                         

Commercial and industrial

 $23  $23  $  $28  $28  $ 

1-4 family residential

  14   14      14   14    
                         

Total TDRs

 $37  $37  $  $42  $42  $ 

As of June 30, 2019 formal foreclosure proceedings were in process on 1-4 family residential mortgage loans with a total recorded investment of $795 thousand, as compared with $528 thousand as of December 31, 2018.

The following tables present the balance in the recorded investment in loans and allowance for loans by portfolio loan class and based on impairment evaluation method:

(In thousands)

 

Loans

  

Allowance

 
                         

June 30, 2019

 

Loans individually

evaluated for

impairment

  

Loans collectively

evaluated for

impairment

  

Loans acquired

with deteriorated

credit quality

  

Total loans

  

Loans individually

evaluated for

impairment

  

Loans collectively

evaluated for

impairment

  

Loans acquired

with deteriorated

credit quality

  

Total allowance

 
                                 

Commercial and industrial

 $119  $859,966  $  $860,085  $23  $11,835  $  $11,858 

Construction and development, excluding undeveloped land

     222,632      222,632      1,810      1,810 

Undeveloped land

     35,169      35,169      601      601 

Real estate mortgage

  2,948   1,599,109      1,602,057   14   12,016      12,030 

Consumer

     43,937      43,937      117      117 
                                 

Total

 $3,067  $2,760,813  $  $2,763,880  $37  $26,379  $  $26,416 
                                 

(In thousands)

 

Loans

  

Allowance

 
                         

December 31, 2018

 

Loans individually

evaluated for

impairment

  

Loans collectively

evaluated for

impairment

  

Loans acquired

with deteriorated

credit quality

  

Total loans

  

Loans individually

evaluated for

impairment

  

Loans collectively

evaluated for

impairment

  

Loans acquired

with deteriorated

credit quality

  

Total allowance

 
                                 

Commercial and industrial

 $220  $833,304  $  $833,524  $28  $11,937  $  $11,965 

Construction and development, excluding undeveloped land

  318   224,732      225,050      1,760      1,760 

Undeveloped land

  474   29,618      30,092      752      752 

Real estate mortgage

  1,641   1,409,806      1,411,447   14   10,667      10,681 

Consumer

     48,058      48,058      376      376 
                                 

Total

 $2,653  $2,545,518  $  $2,548,171  $42  $25,492  $  $25,534 

The following tables present loans individually evaluated for impairment by loan portfolio class:

  

As of

  

Three months ended

  

Six months ended

 
  

June 30, 2019

  

June 30, 2019

  

June 30, 2019

 
                             
      

Unpaid

      

Average

  

Interest

  

Average

  

Interest

 
  

Recorded

  

principal

  

Related

  

recorded

  

income

  

recorded

  

income

 

(In thousands)

 

investment

  

balance

  

allowance

  

investment

  

recognized

  

investment

  

recognized

 
                             

Impaired loans with no related allowance:

                            

Commercial and industrial

 $96  $96  $  $144  $  $160  $ 

Construction and development, excluding undeveloped land

                 106    

Undeveloped land

                 158    
                             

Real estate mortgage

                            

Commercial investment

  306   306      311      254    

Owner occupied commercial

  1,444   1,882      1,455      1,165    

1-4 family residential

  715   715      779      773    

Home equity - first lien

     -                

Home equity - junior lien

  469   469      462      356    

Subtotal: Real estate mortgage

  2,934   3,372      3,007      2,548    
                             

Consumer

                     

Subtotal

 $3,030  $3,468  $  $3,151  $  $2,972  $ 
                             

Impaired loans with an allowance:

                            

Commercial and industrial

 $23  $23  $23  $24  $  $26  $1 

Construction and development, excluding undeveloped land

                     

Undeveloped land

                     
                             

Real estate mortgage

                            

Commercial investment

                     

Owner occupied commercial

                     

1-4 family residential

  14   14   14   14      14    

Home equity - first lien

                     

Home equity - junior lien

                     

Subtotal: Real estate mortgage

  14   14   14   14      14    
                             

Consumer

                     

Subtotal

 $37  $37  $37  $38  $  $40  $1 
                             

Total:

                            

Commercial and industrial

 $119  $119  $23  $168  $  $186  $1 

Construction and development, excluding undeveloped land

                 106    

Undeveloped land

                 158    
                             

Real estate mortgage

                            

Commercial investment

  306   306      311      254    

Owner occupied commercial

  1,444   1,882      1,455      1,165    

1-4 family residential

  729   729   14   793      787    

Home equity - first lien

           -      -    

Home equity - junior lien

  469   469      462      356    

Subtotal: Real estate mortgage

  2,948   3,386   14   3,021      2,562    
                             

Consumer

                     

Total impaired loans

 $3,067  $3,505  $37  $3,189  $  $3,012  $1 

  

As of

  

Three months ended

  

Six months ended

 
  

December 31, 2018

  

June 30, 2018

  

June 30, 2018

 
                             
      

Unpaid

      

Average

  

Interest

  

Average

  

Interest

 
  

Recorded

  

principal

  

Related

  

recorded

  

income

  

recorded

  

income

 

(In thousands)

 

investment

  

balance

  

allowance

  

investment

  

recognized

  

investment

  

recognized

 
                             

Impaired loans with no related allowance:

                            

Commercial and industrial

 $192  $707  $  $225  $  $531  $ 

Construction and development, excluding undeveloped land

  318   489      525      571    

Undeveloped land

  474   506      474      474    
                             

Real estate mortgage

                            

Commercial investment

  138   138      -      17    

Owner occupied commercial

  586   1,023      2,335      2,667    

1-4 family residential

  760   760      1,350      1,446    

Home equity - first lien

     -      -      -    

Home equity - junior lien

  143   143      17      22    

Subtotal: Real estate mortgage

  1,627   2,064      3,702      4,152    
                             

Consumer

           46      30    

Subtotal

 $2,611  $3,766  $  $4,972  $  $5,758  $ 
                             

Impaired loans with an allowance:

                            

Commercial and industrial

 $28  $28  $28  $3,074  $  $2,061  $ 

Construction and development, excluding undeveloped land

                     

Undeveloped land

           48      32    
                             

Real estate mortgage

                            

Commercial investment

                     

Owner occupied commercial

           1,645      1,097    

1-4 family residential

  14   14   14   14      14    

Home equity - first lien

                     

Home equity - junior lien

                     

Subtotal: Real estate mortgage

  14   14   14   1,659      1,111    
                             

Consumer

                     

Subtotal

 $42  $42  $42  $4,781  $  $3,204  $ 
                             

Total:

                            

Commercial and industrial

 $220  $735  $28  $3,299  $  $2,592  $ 

Construction and development, excluding undeveloped land

  318   489      525      571    

Undeveloped land

  474   506      522      506    
                             

Real estate mortgage

                            

Commercial investment

  138   138      -      17    

Owner occupied commercial

  586   1,023      3,980      3,764    

1-4 family residential

  774   774   14   1,364      1,460    

Home equity - first lien

           -      -    

Home equity - junior lien

  143   143      17      22    

Subtotal: Real estate mortgage

  1,641   2,078   14   5,361      5,263    
                             

Consumer

           46      30    

Total impaired loans

 $2,653  $3,808  $42  $9,753  $  $8,962  $ 

Differences between recorded investment amounts and unpaid principal balance amounts less related allowance are due to partial charge-offs which have occurred over the lives of certain loans.

The following table presents the aging of the recorded investment in loans by portfolio class:

                          

Recorded

 

(In thousands)

             

90 or more

          

investment

 
              

days past due

          

> 90 days

 
      

30-59 days

  

60-89 days

  

(includes all

  

Total

  

Total

  

and

 

June 30, 2019

 

Current

  

past due

  

past due

  

non-accrual)

  

past due

  

loans

  

accruing

 
                             

Commercial and industrial

 $858,853  $572  $391  $269  $1,232  $860,085  $173 

Construction and development, excluding undeveloped land

  222,632               222,632    

Undeveloped land

  35,169               35,169    
                             

Real estate mortgage:

                            

Commercial investment

  692,612   1   3,107   701   3,809   696,421   396 

Owner occupied commercial

  450,140   643   272   1,664   2,579   452,719   220 

1-4 family residential

  336,548   749   873   787   2,409   338,957   72 

Home equity - first lien

  45,963   49         49   46,012    

Home equity - junior lien

  67,408   70      470   540   67,948    

Subtotal: Real estate mortgage

  1,592,671   1,512   4,252   3,622   9,386   1,602,057   688 
                             

Consumer

  43,901   9   27      36   43,937    
                             

Total

 $2,753,226  $2,093  $4,670  $3,891  $10,654  $2,763,880  $861 
                             

December 31, 2018

                            
                             

Commercial and industrial

 $832,923  $197  $200  $204  $601  $833,524  $12 

Construction and development, excluding undeveloped land

  224,732         318   318   225,050    

Undeveloped land

  29,552   66      474   540   30,092    
                             

Real estate mortgage:

                            

Commercial investment

  586,884   1,382   107   237   1,726   588,610   99 

Owner occupied commercial

  421,143   2,732   1,377   1,121   5,230   426,373   535 

1-4 family residential

  274,547   374   336   760   1,470   276,017    

Home equity - first lien

  49,321   179         179   49,500    

Home equity - junior lien

  70,467   182   56   242   480   70,947   99 

Subtotal: Real estate mortgage

  1,402,362   4,849   1,876   2,360   9,085   1,411,447   733 
                             

Consumer

  48,058               48,058    
                             

Total

 $2,537,627  $5,112  $2,076  $3,356  $10,544  $2,548,171  $745 

 

(5)

Goodwill and Intangible Assets

 

Goodwill recorded onand intangible assets consist of the acquisition date of an entity,following:

(in thousands)

 

June 30, 2020

  

December 31, 2019

 
         

Goodwill

 $12,513  $12,513 

Core deposit intangibles

  2,122   2,285 

Mortgage servicing rights

  1,888   1,372 

Goodwill represents $12.1$11.8 million related to the May 1, 2019 King acquisition and $682 thousand$682,000 related to the 1996 purchase of a bank in southern Indiana. As providedSee the footnote titled “Acquisition for under GAAP, further details. Related to the May 2019 acquisition, effective March 31, 2020, management has up to 12 months following the date of acquisition to finalizefinalized the fair values of the acquired assets and assumed liabilities. During this measurement period, Bancorpliabilities ahead of the may 12record subsequent adjustments to goodwill for provisional amounts recorded at the acquisition date. months as allowed by GAAP.

 

The goodwill balance at June 30, 2019 relates entirely to the Commercial Banking segment of Bancorp. GAAP requires that goodwill and intangible assets with indefinite useful lives not be amortized, but instead be tested for impairment at least annually. Impairment exists when a reporting unit’s carrying value of goodwill exceeds its fair value. Bancorp’s annual goodwill impairment test is conducted as of December 31September 30 of each year or more often as situations dictate. At December 31, 2018,September 30, 2019, Bancorp’s Commercial Banking reporting unit had positive equity and Bancorp elected to perform a qualitative assessment to determine if it was more-likely-than-not that the fair value of the reporting unit exceeded its carrying value, including goodwill. The qualitative assessment indicated that it was not more-likely-than-not that the carrying value of the reporting unit exceeded its fair value. Therefore, Bancorp did not complete the two-step impairment test as of DecemberSeptember 30, 2019. As of March 31, 2018.2020 and June 30, 2020, consistent with market volatility and uncertain economic conditions resulting from the COVID-19 pandemic, interim impairment testing was conducted and indicated that it was not more-likely-than-not that the carrying value of the reporting unit exceeded its fair value.

 

Changes in the carrying value of goodwill follows:

 

 

Three months ended

 

Six months ended

  

Three months ended

 

Six months ended

 
 

June 30,

  

June 30,

  

June 30,

  

June 30,

 

(In thousands)

 

2019

  

2018

  

2019

  

2018

 

(in thousands)

 

2020

  

2019

  

2020

  

2019

 

Balance at beginning of period

 $682  $682  $682  $682  $12,513  $682  $12,513  $682 

Goodwill acquired

 12,144    12,144      12,144    12,144 

Recast adjustments

        

Impairment

                        

Balance at end of period

 $12,826  $682  $12,826  $682  $12,513  $12,826  $12,513  $12,826 

 

 

The CompanyBancorp recorded core deposit intangibleCDI assets of $1.5 million and $2.5 million in association with its May 1, 2019 King and 2013 TBOC acquisitions, respectively.acquisitions. See the footnote titled “Acquisition for further details.

 

Details regarding the King acquisition are discussed in the Acquisitions footnote. Changes in the net carrying amount of core deposit intangibles follow:CDIs follows:

 

 

Three months ended

 

Six months ended

  

Three months ended

 

Six months ended

 
 

June 30,

  

June 30,

  

June 30,

  

June 30,

 

(In thousands)

 

2019

  

2018

  

2019

  

2018

 

(in thousands)

 

2020

  

2019

  

2020

  

2019

 

Balance at beginning of period

 $1,015  $1,182  $1,056  $1,225  $2,203  $1,015  $2,285  $1,056 

Core deposit intangible acquired

 1,519    1,519      1,519    1,519 

Amortization

  (73)  (43)  (114)  (86)  (81)  (73)  (163)  (114)
            

Balance at end of period

 $2,461  $1,139  $2,461  $1,139  $2,122  $2,461  $2,122  $2,461 

 

 

Mortgage servicing rights (“MSRs”),MSRs, a component of other assets, are initially recognized at fair value when mortgage loans are sold with servicing retained. The MSRs are amortized in proportion to and over the period of estimated net servicing income, considering appropriate prepayment assumptions. MSRs are evaluated quarterly for impairment by comparing carrying value to fair value. EstimatedFair value is based on a valuation model that calculates the PV of estimated net servicing income. The model incorporates assumptions that market participants would use in estimating future net servicing income.

The estimated fair valuesvalue of MSRs at both June 30, 20192020 and December 31, 20182019 were $2.9 million $3 million. There was 0 valuation allowance for MSRs as of June 30, 2020 and $3.6 million, respectively.December 31, 2019, as fair value exceeded carrying value.

Changes in the net carrying amount of MSRs follows:

  

Three months ended

  

Six months ended

 
  

June 30,

  

June 30,

 

(in thousands)

 

2020

  

2019

  

2020

  

2019

 

Balance at beginning of period

 $1,446  $1,070  $1,372  $1,022 

Additions for mortgage loans sold

  511   134   641   214 

Amortization

  (69)  (36)  (125)  (68)

Impairment

            

Balance at end of period

 $1,888  $1,168  $1,888  $1,168 

 

Total outstanding principal balances of loans serviced for others were $325.1$349 million and $327.9$327 million at June 30, 2019,2020 and December 31, 2018,2019, respectively.

 

28
39


Changes in the net carrying amount of MSRs follows:

  

Three months ended

  

Six months ended

 
  

June 30,

  

June 30,

 

(In thousands)

 

2019

  

2018

  

2019

  

2018

 

Balance at beginning of period

 $1,070  $861  $1,022  $875 

Additions for mortgage loans sold

  134   74   214   95 

Amortization

  (36)  (37)  (68)  (72)
                 

Balance at end of period

 $1,168  $898  $1,168  $898 

 

 

(6)

Income Taxes

Components of income tax expense (benefit) from operations follow:

  

Three months ended

  

Six months ended

 
  

June 30,

  

June 30,

 

(in thousands)

 

2020

  

2019

  

2020

  

2019

 

Current income tax expense:

                

Federal

 $4,363  $3,772  $6,205  $6,498 

State

  209   189   340   330 

Total current income tax expense

  4,572   3,961   6,545   6,828 
                 

Deferred income tax expense (benefit):

                

Federal

  (1,798)  224   (1,146)  789 

State

  (427)  (3,155)  (803)  (4,768)

Total deferred income tax expense (benefit)

  (2,225)  (2,931)  (1,949)  (3,979)

Change in valuation allowance

  1      2   20 

Total income tax expense

 $2,348  $1,030  $4,598  $2,869 

An analysis of the difference between the statutory and ETR from operations follows:

  

Three months ended

  

Six months ended

 
  

June 30,

  

June 30,

 
  

2020

  

2019

  

2020

  

2019

 

U.S. federal statutory income tax rate

  21.0

%

  21.0

%

  21.0

%

  21.0

%

Tax credits

  (5.9)  (0.7)  (5.9)  (0.7)

Kentucky state income tax enactments

  (1.7)  (14.1)  (1.9)  (10.7)

Change in cash surrender value of life insurance

  (2.0)  (0.6)  (0.4)  (0.9)

State income taxes, net of federal benefit

  0.6   0.8   0.8   0.8 

Excess tax benefit from stock-based compensation arrangements

  (0.4)  (0.4)  -   (1.1)

Tax exempt interest income

  (0.2)  (0.3)  (0.3)  (0.3)

Other, net

  3.5   0.2   1.4   0.1 

Effective tax rate

  14.9

%

  5.9

%

  14.7

%

  8.2

%

Current state income tax expense represents tax owed to the state of Indiana. Kentucky and Ohio state bank taxes are currently based on capital levels and are recorded as other non-interest expense.

The ETR at June 30, 2020 includes one-half of the anticipated full year impact of a large historic tax credit project scheduled to be placed in service later in 2020.

 

In March 2019, the Kentucky Legislature passed HB354 requiring financial institutions to transition from a capital based franchise tax to the Kentucky corporate income tax beginning in 2021. Historically, the franchise tax, a component of non-interest expenses, was assessed at 1.1% of net capital and averaged $2.5 million annually over the prior two year-end periods. The Kentucky corporate income tax will be assessed at 5% of Kentucky taxable income and will be included as a component of current and deferred state income tax expense. Associated with this change, predominantly during the first quarter of 2019, Bancorp established a Kentucky state deferred tax assetDTA related to existing temporary differences estimated to reverse after the effective date of the law change. Bancorp recorded a corresponding state tax benefit, net of federal tax impact of $1.3 million, or approximately $0.06 per diluted share for the first quarter 2019. While this is positive in the short-term, Bancorp anticipates an unfavorable impact of approximately $200 thousand$200,000 per year beginning in 2021.

 

In April 2019, the Kentucky legislatureLegislature passed HB458 allowing banks and their holding companiesentities filing a combined Kentucky income return to be combined together for Kentuckyshare certain tax return filings.attributes, including net operating loss carryforwards. The combined filing beginning in 2021will allow Bancorp’s holding company net operating lossesloss carryforwards to offset against net revenue generated by Thethe Bank up to 50% of the Bank’s Kentucky taxable income and reduce Bancorp’s tax liability. Bancorp recorded sa state tax benefit, associated with this changenet of federal tax impact of $2.4 million, predominantly in the second quarter of 2019, or approximately $0.11 per diluted share for the three2019. and six month periods ended June 30, 2019.

Components ofThe losses are expected to be utilized when Bancorp begins filing a combined Kentucky income tax expense (benefit) from operations follow:

  

Three months ended

  

Six months ended

 
  

June 30,

  

June 30,

 

(In thousands)

 

2019

  

2018

  

2019

  

2018

 

Current income tax expense:

                

Federal

 $3,772  $3,426  $6,498  $5,862 

State

  189   182   330   310 

Total current income tax expense

  3,961   3,608   6,828   6,172 
                 

Deferred income tax expense (benefit) :

                

Federal

  224   (421)  789   46 

State

  (3,155)  (28)  (4,768)  (7)

Total deferred income tax expense

  (2,931)  (449)  (3,979)  39 

Change in valuation allowance

        20    

Total income tax expense

 $1,030  $3,159  $2,869  $6,211 

An analysis ofreturn. A valuation allowance is maintained for the difference between statutory and effective income tax rates follows:

  

Three months ended

  

Six months ended

 
  

June 30,

  

June 30,

 
  

2019

  

2018

  

2019

  

2018

 

U.S. federal statutory income tax rate

  21.0

%

  21.0

%

  21.0

%

  21.0

%

Kentucky state income tax enactments

  (14.1)     (10.7)   

Excess tax benefits from stock-based compensation arrangements

  (0.4)  (1.2)  (1.1)  (1.5)

Increase in cash surrender value of life insurance

  (0.6)�� (1.2)  (0.9)  (0.6)

Tax credits

  (0.7)  (0.7)  (0.7)  (0.5)

Tax exempt interest income

  (0.3)  (0.5)  (0.3)  (0.5)

State income taxes, net of federal benefit

  0.8   0.7   0.8   0.7 

Other, net

  0.2   0.8   0.1   0.1 

Effective income tax rate

  5.9

%

  18.9

%

  8.2

%

  18.7

%

Currently, state income tax expense represents tax owed to the state of Indiana. Kentucky and Ohio state bank taxes are currently based on capital levels, and are recorded as other non-interest expense. See comment above regarding recent changesloss that will expire in Kentucky tax law.2020.

 

GAAP provides guidance on financial statement recognition and measurement of tax positions taken, or expected to be taken, in tax returns. If recognized, tax benefits would reduce tax expense and accordingly, increase net income. The amount of unrecognized tax benefits may increase or decrease in the future for various reasons, including adding amounts for current year tax positions, expiration of open income tax returns due to statutes of limitation, changes in management’s judgment about the level of uncertainty, the status of examination,examinations, litigation and legislative activity and the addition or elimination of uncertain tax positions. As of June 30, 20192020 and December 31, 2018,2019, the gross amount of unrecognized tax benefits was immaterial to the consolidated financial statements of the Company.Bancorp. Federal and state income tax returns are subject to examination for the years after 2015.

 

 

(7)

Deposits

 

The composition of the Bank’s deposits follows:

 

(In thousands)

 

June 30, 2019

  

December 31, 2018

 

(in thousands)

 

June 30, 2020

  

December 31, 2019

 
  

Non-interest bearing demand deposits

 $777,652  $711,023  $1,205,253  $810,475 
  

Interest bearing deposits:

          

Interest bearing demand

 824,324  892,867  1,147,357  979,595 

Savings

 171,471  155,007  196,655  169,622 

Money market

 675,221  688,744  761,256  742,029 
  

Time deposits of $250 thousand or more

 71,952  55,182  76,954  81,412 

Other time deposits(1)

  362,833   291,533   339,681   350,805 

Total time deposits

 434,785  346,715  416,635  432,217 
  

Total interest bearing deposits

 2,105,801  2,083,333  2,521,903  2,323,463 
          

Total deposits

 $2,883,453  $2,794,356  $3,727,156  $3,133,938 

 

(1)     Includes $30 million in brokered deposits as of both June 30, 2020 and December 31, 2019.

Includes $29.8 million in brokered deposits as of both June 30, 2019 and December 31, 2018.

 

Deposits totaling $125.5$126 million were acquired on May 1, 2019, associated with the Kingan acquisition.

 

 

(8)

Securities Sold Under Agreements to Repurchase

 

SSUAR represent a funding source of Bancorp and are primarily used by commercial customers in conjunction with collateralized corporate cash management accounts. Such repurchase agreements are considered financing agreements and mature within one business day from the transaction date. At June 30, 2019,2020, all of these financing arrangements had overnight maturities and were secured by government sponsored enterprise obligations and government agency mortgage-backed securities whichthat were owned and controlled by Bancorp.

 

Information concerning SSUAR follows:

 

(Dollars in thousands)

 

June 30, 2019

  

December 31, 2018

 

(dollars in thousands)

 

June 30, 2020

  

December 31, 2019

 

Outstanding balance at end of period

 $33,809  $36,094  $42,722  $31,895 

Weighted average interest rate at end of period

 0.31

%

 0.24

%

 0.08

%

 0.22

%

 

 

 

Three months ended

 

Six months ended

  

Three months ended

 

Six months ended

 
 

June 30,

  

June 30,

  

June 30,

  

June 30,

 

(Dollars in thousands)

 

2019

  

2018

  

2019

  

2018

 

(dollars in thousands)

 

2020

  

2019

  

2020

  

2019

 
 

Average outstanding balance during the period

 $39,969  $61,993  $38,755  $66,609  $41,517  $39,969  $37,465  $38,755 

Average interest rate during the period

 0.28

%

 0.21

%

 0.28

%

 0.20  0.08

%

 0.28

%

 0.13

%

 0.28

%

Maximum outstanding at any month end during the period

 $43,160  $60,801  $43,160  $74,725  $42,722  $43,160  $42,722  $43,160 

 

 

 

(9)

Federal Home Loan BankFHLB Advances

 

Bancorp had outstanding 5849 separate advances totaling $84.3$61 million outstanding as of June 30, 2019,2020 as compared with 1457 separate advances totaling $48.2$80 million as of December 31, 2018.2019. As a result of the King2019 acquisition, Bancorp assumed 46 advances totaling $43.3$43 million, with maturities ranging from 2019extending to 2028. These advances were discounted to fair value as of the acquisition date. See the acquisition footnote titled “Acquisitionfor further details. As of June 30, 2019,2020, for 1610 advances totaling $51$38 million, all of which are non-callable, interest payments are due monthly, with principal due at maturity. For the remaining advances, principal and interest payments are due monthly based on an amortization schedule.

 

The following is a summary of the contractual maturities and average effective rates of outstanding advances:

 

(In thousands)

 

June 30, 2019

  

December 31, 2018

 

Maturity

     

Weighted average

      

Weighted average

 

Year

 

Advance

  

Fixed Rate

  

Advance

  

Fixed Rate

 

2019

 $30,850   2.42

%

 $30,000   2.54

%

2020

  20,390   2.38   1,691   2.23 

2021

  2,561   2.46   215   2.12 

2023

  579   1.01       

2024

  2,131   2.36   2,240   2.36 

2025

  4,192   2.42   4,626   2.42 

2026

  8,470   1.95   8,185   1.99 

2027

  8,771   1.75       

2028

  6,335   2.38   1,220   1.49 
                 

Total

 $84,279   2.28

%

 $48,177   2.39

%

(dollars in thousands)

 

June 30, 2020

  

December 31, 2019

 

Maturity

     

Weighted average

      

Weighted average

 

Year

 

Advance

  

Fixed Rate

  

Advance

  

Fixed Rate

 

2020

 $37,533   0.67

%

 $50,004   1.99

%

2021

  2,281   2.57   2,400   2.52 

2022

            

2023

  360   1.01   456   1.00 

2024

  1,479   2.36   2,023   2.36 

2025

  3,055   2.43   3,774   2.41 

2026

  5,625   1.95   8,156   1.96 

2027

  6,323   1.75   7,445   1.73 

2028

  4,776   2.33   5,695   2.32 
                 

Total

 $61,432   1.22

%

 $79,953   2.02

%

 

FHLB advances are collateralized by certain commercialCRE and residential real estate mortgage loans under a blanket mortgage collateral pledge agreementagreements, as well as Bancorp’s PPP loan portfolio and FHLB stock. Bancorp views these advances to beas an effective lower-costing alternative to brokered deposits to fund loan growth. At June 30, 2019,2020 and December 31, 2018,2019, the amount of available credit from the FHLB totaled $484.0$806 million and $537.0$599 million, respectively. Bancorp also had $80 million and $105 million in federal fundsFFP lines available from correspondent banks at both June 30, 2019,2020 and December 31, 2018.2019,

respectively, with the decrease resulting from the closing of an inactive correspondent relationship during the second quarter.

 

42

(10)

Other Comprehensive Income (Loss)

The following tables illustrate activity within the balances in accumulated other comprehensive income (“OCI”) by component:

 

 

Net unrealized

  

Net unrealized

  

Minimum

     
  

gains (losses)

  

gains (losses)

  

pension

     

Three months ended June 30, 2019

 

on securities

  

on cash

  

liability

     

(In thousands)

 

available for sale

  

flow hedges

  

adjustment

  

Total

 
                 

Balance, beginning of period

 $(2,536) $234  $(211) $(2,513)

Net current period other comprehensive income (loss)

  3,827   (248)     3,579 

Balance, end of period

 $1,291  $(14) $(211) $1,066 
                 

Three months ended June 30, 2018

                

Balance, beginning of period

 $(5,995) $544  $(393) $(5,844)

Net current period other comprehensive income (loss)

  (1,279)  79      (1,200)

Balance, end of period

 $(7,274) $623  $(393) $(7,044)


32

  

Net unrealized

  

Net unrealized

  

Minimum

     
  

gains (losses)

  

gains (losses)

  

pension

     

Six months ended June 30, 2019

 

on securities

  

on cash

  

liability

     

(In thousands)

 

available for sale

  

flow hedges

  

adjustment

  

Total

 
                 

Balance, beginning of period

 $(5,330) $408  $(220) $(5,142)

Net current period other comprehensive income (loss)

  6,621   (422)  9   6,208 

Balance, end of period

 $1,291  $(14) $(211) $1,066 
                 

Six months ended June 30, 2018

                

Balance, beginning of period

 $(1,781) $193  $(342) $(1,930)

Net current period other comprehensive income (loss)

  (4,997)  389     $(4,608)

Reclassification adjustment for adoption of ASU 2018-02

  (496)  41   (51)  (506)

Balance, end of period

 $(7,274) $623  $(393) $(7,044)

 

 

(11)

Preferred Stock

Bancorp has a class of preferred stock (no par value; 1,000,000 shares authorized), the relative rights, preferences and other terms of which or any series within the class will be determined by the Board of Directors prior to any issuance. None of this stock has been issued to date.

(12)

Net Income Per Share

The following table reflects, for the three months ended June 30, 2019 and 2018, net income (numerator) and average shares outstanding (denominator) for basic and diluted net income per share computations:

  

Three months ended

  

Six months ended

 
  

June 30,

  

June 30,

 

(In thousands, except per share data)

 

2019

  

2018

  

2019

  

2018

 

Net income

 $16,543  $13,579  $32,184  $26,983 
                 

Weighted average shares outstanding - basic

  22,689   22,625   22,675   22,601 

Dilutive securities

  260   342   273   358 

Weighted average shares outstanding- diluted

  22,949   22,967   22,948   22,959 
                 

Net income per share, basic

 $0.73  $0.60  $1.42  $1.19 

Net income per share, diluted

  0.72   0.59   1.40   1.17 

33

Stock appreciation rights (“SARs”) excluded from the earnings per share calculation because their impact was antidilutive follows:

  

Three

  

Six

 
  

months ended

  

months ended

 

(In thousands)

 

June 30,

  

June 30,

 
  

2019

  

2018

  

2019

  

2018

 

Antidilutive SARs

  200   93   200   93 

These shares while antidilutive, could however, be dilutive to earnings per share (“EPS”) in the future.

(13)

Defined Benefit Plan

Bancorp sponsors an unfunded, non-qualified, defined benefit retirement plan for three key officers (one current and two retired), and has no plans to increase the number of or benefits to participants. All participants are fully vested. Actuarially determined pension costs are expensed and accrued over the service period, and benefits are paid from Bancorp’s assets. Bancorp maintains life insurance policies, for which it is the beneficiary, on participants and certain former executives. Income from these policies is utilized to offset costs of benefits. Net periodic benefit cost was immaterial for all respective periods.

(14)

Stock-Based Compensation

The fair value of all stock-based awards granted, net of estimated forfeitures, is recognized as compensation expense over the respective service period.

At Bancorp's 2015 Annual Meeting of Shareholders, shareholders approved the 2015 Omnibus Equity Compensation Plan and authorized the shares available from the expiring 2005 plan for future awards under the 2015 plan. In 2018 shareholders approved an additional 500 thousand shares for issuance under the plan. As of June 30, 2019, there were 505 thousand shares available for future awards.

Stock OptionsBancorp had no stock options outstanding as of June 30, 2019 and December 31, 2018.

SARs SARs granted have a vesting schedule of 20% per year and expire 10 years after the grant date unless forfeited due to employment termination.

Fair values of SARs are estimated at the date of grant using the Black-Scholes option pricing model, a leading formula for calculating such value. This model requires the input of assumptions, changes to which can materially affect the fair value estimate. The following assumptions were used in SAR valuations at the grant date in each year:

  

2019

  

2018

 
         

Dividend yield

  2.54%  2.56%

Expected volatility

  20.39%  20.17%

Risk free interest rate

  2.52%  2.96%

Expected life of SARs (in years)

  7.2   7.0 

Dividend yield and expected volatility are based on historical information for Bancorp corresponding to the expected life of SARs granted. Expected volatility is the volatility of the underlying shares for the expected term on a monthly basis. The risk free interest rate is the implied yield currently available on U.S. Treasury issues with a remaining term equal to the expected life of the awards. The expected life of SARs is based on past experience of similar-life SARs. Bancorp evaluates historical exercise and post-vesting termination behavior when determining the expected life.

34

Restricted stock awards (“RSAs”) – RSAs granted to officers vest over 5 years. For all grants prior to 2015, grantees are entitled to dividend payments during the vesting period. For grants in 2015 and forward, forfeitable dividends are deferred until shares are vested. Fair value of RSAs is equal to the market value of the shares on the date of grant.

Grants of performance stock units (“PSUs”) – PSUs vest based upon service and a 3-year performance period, which begins January 1 of the first year of the performance period. Because grantees are not entitled to dividend payments during the performance period, the fair value of these PSUs is estimated based upon the market value of the underlying shares on the date of grant, adjusted for non-payment of dividends. Grants require a 1 year post-vesting holding period and the fair value of such grants incorporates a liquidity discount related to the holding period of 4.1%, 4.3% and 5.1% for 2019,2018, and 2017, respectively.

Grants of restricted stock units (“RSUs”) – RSUs are only granted to non-employee directors, are time-based and vest 12 months after grant date. Because grantees are entitled to deferred dividend payments at the end of the vesting period, fair value of the RSUs equals market value of underlying shares on the date of grant.

Bancorp utilized cash of $272 thousand during the firstsix months of 2019 for the purchase of shares upon the vesting of RSUs. This compares with cash used of $155 thousand during the firstsix months of 2018 for the purchase of shares.

In the first quarter of 2019, Bancorp awarded 9,834 RSUs to non-employee directors of Bancorp with a grant date fair value of $330 thousand.

35

Bancorp has recognized stock-based compensation expense for SARs, RSAs, and PSUs within compensation expense, and RSUs for directors within other non-interest expense, as follows:

  

Three months ended June 30, 2019

 

(In thousands)

 

Stock

Appreciation

Rights

  

Restricted

Stock Awards

  

Restricted

Stock Units

  

Performance

Stock Units

  

Total

 
                     

Expense

 $86  $306  $83  $518  $993 

Deferred tax benefit

  (18)  (65)  (17)  (109)  (209)

Total net expense

 $68  $241  $66  $409  $784 

  

Three months ended June 30, 2018

 

(In thousands)

 

Stock

Appreciation

Rights

  

Restricted

Stock Awards

  

Restricted

Stock Units

  

Performance

Stock Units

  

Total

 
                     

Expense

 $77  $275  $62  $798  $1,212 

Deferred tax benefit

  (16)  (58)  (13)  (167)  (254)

Total net expense

 $61  $217  $49  $631  $958 

  

Six months ended June 30, 2019

 

(In thousands)

 

Stock

Appreciation

Rights

  

Restricted

Stock Awards

  

Restricted

Stock Units

  

Performance

Stock Units

  

Total

 
                     

Expense

 $170  $599  $164  $923  $1,856 

Deferred tax benefit

  (36)  (126)  (34)  (194)  (390)

Total net expense

 $134  $473  $130  $729  $1,466 

  

Six months ended June 30, 2018

 

(In thousands)

 

Stock

Appreciation

Rights

  

Restricted

Stock Awards

  

Restricted

Stock Units

  

Performance

Stock Units

  

Total

 
                     

Expense

 $150  $551  $124  $1,210  $2,035 

Deferred tax benefit

  (32)  (116)  (26)  (253)  (427)

Total net expense

 $118  $435  $98  $957  $1,608 

36

As of June 30, 2019, Bancorp has $7.4 million of unrecognized stock-based compensation expense estimated to be recorded as follows:

(In thousands)

Year ended

 

Stock

Appreciation

Rights

  

Restricted

Stock Awards

  

Restricted

Stock Units

  

Performance

Stock Units

  

Total

 
                     

Remainder of 2019

 $175  $599  $166  $999  $1,939 

2020

  306   1,049   2   1,325   2,682 

2021

  248   830      466   1,544 

2022

  193   559         752 

2023

  118   308         426 

2024

  11   25         36 

Total estimated expense

 $1,051  $3,370  $168  $2,790  $7,379 

The following table summarizes SARs activity and related information:

                       

Weighted

 
           

Weighted

      

Weighted

  

average

 
           

average

  

Aggregate

  

average

  

remaining

 
      

Exercise

  

exercise

  

intrinsic

  

fair

  

contractual

 

(In thousands, except per share data)

 

SARs

  

price

  

price

  

value(1)

  

value

  

life (in years)

 
                          
Outstanding, January 1, 2018  704  $14.02-$40.00  $19.51  $12,923  $3.47   5.1 

Granted

  100  35.90-39.32   37.75      6.07     

Exercised

  (73) 14.02-19.37   15.32   1,654   3.43     

Forfeited

     -    -           
Outstanding, December 31, 2018  731  $14.02-$40.00  $22.42  $8,422  $3.82   5.2 
                          
Outstanding, January 1, 2019  731  $14.02-$40.00  $22.42  $8,422  $3.82     

Granted

  53  36.65-38.18   37.01      6.24     

Exercised

  (47) 14.02-22.96   17.16   830   3.62     

Forfeited

     -    -           
Outstanding, June 30, 2019  737  $14.02-$40.00  $23.79  $9,505  $4.01   5.0 
                          
                          
Vested and exercisable   525  $14.02-$40.00  19.20  8,975  3.38   3.5 

Unvested

  212  22.96-40.00   35.14   530   5.58   8.5 
Outstanding, June 30, 2019  737  $14.02-$40.00  23.79  9,505  4.01   5.0 
                          
Vested at June 30, 2019  79  $19.37-$40.00  $27.39  $740  $4.55     

(1) - Intrinsic value for SARs is defined as the amount by which the current market price of the underlying stock exceeds the exercise or grantprice.

37

The following table summarizes activity for RSAs granted to officers:

      

Grant date

 
      

weighted

 

(In thousands, except per share data)

 

RSAs

  

average cost

 
         

Unvested at January 1, 2018

  119  $27.62 

Shares awarded

  40   35.89 

Restrictions lapsed and shares released

  (44)  23.62 

Shares forfeited

  (5)  31.35 

Unvested at December 31, 2018

  110  $32.09 
         

Unvested at January 1, 2019

  110  $32.09 

Shares awarded

  39   34.88 

Restrictions lapsed and shares released

  (39)  28.70 

Shares forfeited

      

Unvested at June 30, 2019

  110  $34.32 


 

Expected shares to be awarded for PSUs granted to executive officers of Bancorp, the three-year performance period for which began January 1 of the award year are as follows:

  

Vesting

      

Expected

 

Grant

 

period

  

Fair

  

shares to

 

year

 

in years

  

value

  

be awarded

 

2017

  3  $35.66   61,893 

2018

  3   31.54   71,932 

2019

  3   32.03   43,602 

(15)

Commitments and Contingent Liabilities

 

As of June 30, 20192020 and December 31, 2018,2019, Bancorp had various commitments outstanding that arose in the normal course of business such as unused commitments or lines of credit and commitments made to lend in the future, which are properly not reflected in the consolidated financial statements. Total off balance sheet commitments to extend credit follows:

 

(In thousands)

 

June 30, 2019

  

December 31, 2018

 

Commercial and Industrial

 $381,824  $309,920 

Construction - Commercial

  224,641   163,314 

Construction - Residential

  15,631   16,050 

Home Equity

  154,030   147,907 

Credit Cards

  21,222   20,003 

Overdrafts

  21,777   21,751 

Letters of credit

  23,359   20,891 

Other

  43,572   33,369 

Future loan commitments

  213,687   101,399 
         

Total off balance sheet commitments to extend credit

 $1,099,743  $834,604 

(in thousands)

 

June 30, 2020

  

December 31, 2019

 

Commercial and industrial

 $501,632  $416,195 

Construction and development

  229,676   240,503 

Home equity

  167,409   155,920 

Credit cards

  30,789   26,439 

Overdrafts

  34,149   32,715 

Letters of credit

  22,352   24,193 

Other

  44,782   40,083 

Future loan commitments

  207,847   236,885 
         

Total off balance sheet commitments to extend credit

 $1,238,636  $1,172,933 

 

Commitments to extend credit are an agreement to lend to a customer either unsecured or secured, as long as collateral is available as agreed upon and there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Bancorp uses the same credit and collateral policies in making commitments and conditional guarantees as for on-balance sheet instruments. Bancorp evaluates each customer’s creditworthiness on a case by casecase-by-case basis. The amount of collateral obtained is based on management’s credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, securities, equipment and real estate. However, should the commitments be drawn upon and should our customers default on their resulting obligation to us, our maximum exposure to credit loss, without consideration of collateral, is represented by the contractual amount of those instruments.

At June 30, 20192020 and December 31, 2018,2019, Bancorp had accrued $350 thousand$6 million and $350,000, respectively, in other liabilities for its estimate of inherent risks related to unfunded credit commitments.

38

ASC 326 on January 1, 2020, Bancorp’s ACL on off-balance sheet exposures was increased from $350,000 at December 31, 2019 to $3.9 million ($2.6 million net of the DTA) with the offset recorded to retained earnings on a tax-effected basis, with no impact on earnings.

 

Standby letters of credit and financial guarantees written are conditional commitments issued by Bancorp to guarantee the performance of a customer to a first party.party beneficiary. Those guarantees are primarily issued to support customer commercial transactions. Standby letters of credit generally have maturities of 1one to 2two years.

Certain commercial customers require confirmation of Bancorp’s letters of credit by other banks since Bancorp does not have a rating by a national rating agency. Terms of the agreements range from one month to a year with certain agreements requiring between one and six months’ notice to cancel. If an event of default on all contracts had occurred at June 30, 2020, Bancorp would have been required to make payments of approximately $2.2 million, or the maximum amount payable under those contracts. No payments have ever been required because of default on these contracts. These agreements are normally secured by collateral acceptable to Bancorp, which limits credit risk associated with the agreements.

 

As of June 30, 2019,2020, in the normal course of business, there were pending legal actions and proceedings in which claims for damages are asserted. Management, after discussion with legal counsel, believes the ultimate result of these legal actions and proceedings will not have a material adverse effect on the consolidated financial position or results of operations of Bancorp.

 

 

(1611)

Assets and Liabilities Measured and Reported at Fair Value

 

Fair value represents the exchange price that would be received for an asset or paid to transfer a liability (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. There are three levels of inputs that may be used to measure fair values:

 

Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 1: Valuation is based upon quoted (unadjusted) prices for identical instruments traded in active markets.

Level 2: Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3: Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions would reflect internal estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques could include pricing models, discounted cash flows and other similar techniques.

 

Authoritative guidance requires maximization of use ofLevel 2 – Significant other observable inputs and minimization of use ofother than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3 – Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in fair value measurements. Where there exists limited or no observable market data, Bancorp derives its own estimates by generally considering characteristics of the asset/liability, the current economic and competitive environment and other factors. For this reason, results cannot be determined with precision and may not be realized onpricing an actual sale or immediate settlement of the asset or liability.

 

At June 30, 2019 and December 31, 2018, Bancorp’s securities available for sale portfolio and interest rate swaps were recorded atThe methods of determining the fair value on a recurring basis.

All available for sale securities are priced using standard industry models or matrices with various assumptions such as yield curves, volatility, prepayment speeds, default rates, time value, credit rating and market prices for similar instruments. These assumptions are observable in the market place and can be derived from or supported by observable data. These measurements are classified as Level 2.

Fair value measurements for interest rate swaps are based on benchmark forward yield curves and other relevant observable market data. For purposes of potential valuation adjustments to derivative positions, Bancorp evaluates the credit risk of its counterparties as well as its own credit risk. To date, Bancorp has not realized any losses due to counterparty’s inability to perform and the change in value of derivative assets and liabilities attributable to credit risk waspresented in this note are consistent with the methodologies disclosed in Bancorp’s not2019 significant during the reporting period. Interest rate swaps are valued using primarily LevelAnnual Report on Form 210 inputs.-K.

 

Mortgage servicing rights, impaired loans and OREO are recorded at fair value on a non-recurring basis, generally in the application of lower of cost or market adjustments or write-downs of specific assets.

39

Carrying values of assets measured at fair value on a recurring basis follows:

(In thousands)

 

Fair value at June 30, 2019

 

Assets

 

Total

  

Level 1

  

Level 2

  

Level 3

 

Securities available for sale:

                

Government sponsored enterprise obligations

 $268,015  $  $268,015  $ 

Mortgage backed securities - government agencies

  131,598      131,598    

Obligations of states and political subdivisions

  23,966      23,966    
                 

Total Securities available for sale

  423,579      423,579    
                 

Interest rate swaps

  1,813      1,813    
                 

Total assets

 $425,392  $  $425,392  $ 
                 

Liabilities

                
                 

Interest rate swaps

 $1,849  $  $1,849  $ 

(In thousands)

 

Fair value at December 31, 2018

 

Assets

 

Total

  

Level 1

  

Level 2

  

Level 3

 

Securities available for sale:

                

Government sponsored enterprise obligations

 $261,039  $  $261,039  $ 

Mortgage backed securities - government agencies

  146,277      146,277    

Obligations of states and political subdivisions

  29,679      29,679    
                 

Total Securities available for sale

  436,995      436,995    
                 

Interest rate swaps

  1,035      1,035    
                 

Total assets

 $438,030  $  $438,030  $ 
                 

Liabilities

                
                 

Interest rate swaps

 $543  $  $543  $ 

For the securities portfolio, Bancorp monitors the valuation technique used by pricing agencies to ascertain when transfers between levels have occurred. The nature of other assets and liabilities measured at fair value is such that transfers in and out of any level are expected to be rare. For the three and six months ended June 30, 2019, there were no transfers between Levels 1,2, or 3.

Bancorp had nofinancial instruments classified within Level 3 of the valuation hierarchy for assetsAssets and liabilities measured at fair value on a recurring basis at June 30, 2019 or December 31, 2018.are summarized as follows:

 

  

Fair Value Measurements Using

  

Total

 

June 30, 2020 (in thousands)

 

Level 1

  

Level 2

  

Level 3

  

Fair Value

 

Assets:

                

Available for sale debt securities:

                

Government sponsored enterprise obligations

 $  $204,411  $  $204,411 

Mortgage backed securities - government agencies

     270,254      270,254 

Obligations of states and political subdivisions

     10,584      10,584 
                 

Total available for sale debt securities

     485,249      485,249 
                 

Interest rate swaps

     9,895      9,895 
                 

Total assets

 $  $495,144  $  $495,144 
                 

Liabilities:

                

Interest rate swaps

 $  $10,283  $  $10,283 

  

Fair Value Measurements Using

  

Total

 

December 31, 2019 (in thousands)

 

Level 1

  

Level 2

  

Level 3

  

Fair Value

 

Assets:

                

Available for sale debt securities:

                

U.S. Treasury and other U.S. government obligations

 $49,897  $  $  $49,897 

Government sponsored enterprise obligations

     209,944      209,944 

Mortgage backed securities - government agencies

     193,861      193,861 

Obligations of states and political subdivisions

     17,036      17,036 
                 

Total available for sale debt securities

  49,897   420,841      470,738 
                 

Interest rate swaps

     2,696      2,696 
                 

Total assets

 $49,897  $423,537  $  $473,434 
                 

Liabilities:

                

Interest rate swaps

 $  $2,767  $  $2,767 

There were no transfers into or out of Level 3 of the fair value hierarchy during 2020 or 2019.

 

Discussion of assetsAssets measured at fair value on a non-recurring basis are summarized as follows:

 

                  

Losses recorded

     
                  

Three months

  

Six months

 
  

Fair Value Measurements Using

  

Total

  

ended

  

ended

 

June 30, 2020 (in thousands)

 

Level 1

  

Level 2

  

Level 3

  

Fair Value

  

June 30, 2020

  

June 30, 2020

 
                         

Collateral dependent loans

 $  $  $8,434  $8,434  $  $ 

Other real estate owned

        493   493       

Mortgage Servicing Rights – On at least a quarterly basis, MSRs are evaluated for impairment based upon the fair value of the MSRs as compared to carrying amount. Fair value is based on a valuation model that calculates the present value of estimated net servicing income. The model incorporates assumptions that market participants would use in estimating future net servicing income. These measurements are classified as Level 3. At June 30, 2019 and December 31, 2018, there was novaluation allowance for the mortgage servicing rights, as the fair value exceeded the cost. Accordingly, the MSRs are not included in the following tabular disclosure for June 30, 2019 or December 31, 2018.

                  

Losses recorded

     
                  

Three months

  

Six months

 
  

Fair Value Measurements Using

  

Total

  

ended

  

ended

 

December 31, 2019 (in thousands)

 

Level 1

  

Level 2

  

Level 3

  

Fair Value

  

June 30, 2019

  

June 30, 2019

 
                         

Impaired loans

 $  $  $7,253  $7,253  $  $ 

Other real estate owned

        493   493       

 

Impaired loans - Collateral-dependent impaired loans generally reflect partial charge-downs to their respective fair value, which is commonly based on recent real estate appraisals or other sources of valuations based upon the underlying collateral. Also, fair value is calculated as the carrying value of loans with a specific valuation allowance, less the specific valuation allowance. Fair value of impaired loans was primarily measured based on the value of collateral securing these loans. Impaired loans are classified within Level 3 of the fair value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory, and/or accounts receivable. Bancorp determines the value of real estate collateral based on independent appraisals performed by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraised values are discounted for costs to sell and may be discounted further based on management’s historical knowledge, changes in market conditions from the date of the most recent appraisal, and/or management’s expertise and knowledge of the customer and the customer’s business. Such discounts by management are subjective and are typically significant unobservable inputs for determining fair value. For other assets, Bancorp relies on both internal and third party assessments of asset value, based on information provided by the borrower, following methodologies similar to those described for real estate. As of June 30, 2019, total impaired collateral dependent loans charged down to their fair value and impaired loans with a valuation allowanceThere were $389 thousand, and the specific allowance totaled $37 thousand, resulting in a fair value of $352 thousand, compared with total collateral dependent loans charged down to their fair value and impaired loans with a valuation allowance of $967 thousand, and the specific allowance allocation totaling $42 thousand, resulting in a fair value of $925 thousand at December 31, 2018. Losses represent charge offs and changes in specific allowances for the periods indicated.

Other real estate owned (“OREO”) - Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals performed by external parties which use judgments and assumptions that are property-specific and sensitive to changes in the overall economic environment. Appraisals may be further discounted based on management’s historical knowledge and/or changes in market conditions from the date of the most recent appraisal. Many of these inputs are not observable and, accordingly, these measurements are classified as Level 3. For OREO in the following table, fair value is the carrying value of only parcels of OREO which have a carrying value equal to appraised value. Losses represent write-downs which occurred during the period indicated. At June 30, 2019 and December 31, 2018, carrying value of all other real estate owned was $563 thousand and $1.0 million, respectively.

41

Below are the carrying values of assets0 liabilities measured at fair value on a non-recurring basis.

(In thousands)

 

Fair value at June 30, 2019

  

Losses recorded:

 
                  

Three months

  

Six months

 
                  

ended

  

ended

 
  

Total

  

Level 1

  

Level 2

  

Level 3

  

June 30, 2019

  

June 30, 2019

 

Impaired loans

 $352  $  $  $352  $  $ 

Other real estate owned

  239         239       

(In thousands)

 

Fair value at December 31, 2018

  

Losses recorded:

 
                  

Three months

  

Six months

 
                  

ended

  

ended

 
  

Total

  

Level 1

  

Level 2

  

Level 3

  

June 30, 2018

  

June 30, 2018

 

Impaired loans

 $925  $  $  $925  $304  $1,419 

Other real estate owned

  239         239       

basis at June 30, 2020 and December 31,2019.

 

For Level 3 assets measured at fair value on a non-recurring basis, as of June 30, 2019 and December 31, 2018, the significant unobservable inputs used in the fair value measurements are presented below.

 

June 30, 2019

 
  

Fair

 

Valuation

 

Unobservable

 

(weighted

 

(Dollars in thousands)

 

value

 

technique

 

inputs

 

average)

 
            

Impaired loans - collateral dependent

 $352 

Appraisal

 

Appraisal discounts

  10.0

%

Other real estate owned

  239 

Appraisal

 

Appraisal discounts

  22.0 
  

June 30, 2020

 

(dollars in thousands)

 

Fair Value

 

Valuation Technique

 

Unobservable Inputs

 

Weighted Average

 
            

Collateral dependent loans

 $8,434 

Appraisal

 

Appraisal discounts

  7.2

%

Other real estate owned

  493 

Appraisal

 

Appraisal discounts

  17.1 

  

December 31, 2019

 

(dollars in thousands)

 

Fair Value

 

Valuation Technique

 

Unobservable Inputs

 

Weighted Average

 
            

Impaired loans - collateral dependent

 $7,253 

Appraisal

 

Appraisal discounts

  60.3

%

Other real estate owned

  493 

Appraisal

 

Appraisal discounts

  17.1 

 

 

December 31, 2018

 
  

Fair

 

Valuation

 

Unobservable

 

(weighted

 

(Dollars in thousands)

 

value

 

technique

 

inputs

 

average)

 
            

Impaired loans - collateral dependent

 $925 

Appraisal

 

Appraisal discounts

  9.9

%

Other real estate owned

  1,018 

Appraisal

 

Appraisal discounts

  12.2 

Collateral Dependent Loans with an ACL (Impaired Loans with Specific Reserves prior to the adoption of ASC 326): For collateral-dependent loans where Bancorp has determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and the Company expects repayment of the loan to be provided substantially through the operation or sale of the collateral, the ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the loan as of the measurement date. For real estate loans, fair value of the loan’s collateral is determined by third party appraisals, which are then adjusted for the estimated selling and closing costs related to liquidation of the collateral. For this asset class, the actual valuation methods (income, comparable sales, or cost) vary based on the status of the project or property. For example, land is generally based on the comparable sales method while construction and improved real estate is based on the income and/or comparable sales methods. The unobservable inputs may vary depending on the individual assets with noone of the three methods being the predominant approach. Bancorp reviews the third party appraisal for appropriateness and adjusts the value downward to consider selling and closing costs, which typically range from 8% to 10% of the appraised value. For non-real estate loans, fair value of the loan’s collateral may be determined using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation and management’s expertise and knowledge of the client and client’s business.

 

42
45

(17)

Disclosure of Financial Instruments Not Reported at Fair Value

 

GAAP requires disclosureOther Real Estate Owned: OREO is primarily comprised of real estate acquired in partial or full satisfaction of loans. OREO is recorded at its estimated fair value less estimated selling and closing costs at the date of transfer, with any excess of the related loan balance over the fair value less expected selling costs charged to the ACL. Subsequent changes in fair value are reported as adjustments to the carrying amount and are recorded against earnings. Bancorp outsources the valuation of OREO with material balances to third party appraisers. For this asset class, the actual valuation methods (income, sales comparable, or cost) vary based on the status of the project or property. For example, land is generally based on the sales comparable method while construction and improved real estate is based on the income and/or sales comparable methods. The unobservable inputs may vary depending on the individual assets with noone of the three methods being the predominant approach. Bancorp reviews the third party appraisal for appropriateness and adjusts the value downward to consider selling and closing costs, which typically range from 8% to 10% of the appraised value.

The estimated fair values of Bancorp’s financial assets and liabilities, including those financial assets and financial liabilities that areinstruments not measured and reported at fair value on a recurring basis or nonrecurring basis. Carrying amounts, estimated fair values, and placement in the fair value hierarchy of Bancorp’s financial instruments are asnon-recurring basis follows:

 

(In thousands)

 

Carrying

                 

June 30, 2019

 

amount

  

Fair value

  

Level 1

  

Level 2

  

Level 3

 
                     

Assets

                    

Cash and cash equivalents

 $116,039  $116,039  $116,039  $  $ 

Mortgage loans held for sale

  3,922   4,023      4,023    

Federal Home Loan Bank stock

  11,316   11,316      11,316    

Loans, net

  2,737,464   2,749,157         2,749,157 

Accrued interest receivable

  9,633   9,633   9,633       
                     

Liabilities

                    

Non-interest bearing deposits

  777,652   777,652   777,652       

Transaction deposits

  1,671,016   1,671,016      1,671,016    

Time deposits

  434,785   436,451      436,451    

Securities sold under agreement to repurchase

  33,809   33,809      33,809    

Federal funds purchased

  12,012   12,012      12,012    

FHLB advances

  84,279   84,505      84,505    

Accrued interest payable

  1,008   1,008   1,008       

(in thousands)

 

Carrying

      

Fair Value Measurements Using

 

June 30, 2020

 

amount

  

Fair value

  

Level 1

  

Level 2

  

Level 3

 
                     

Assets

                    

Cash and cash equivalents

 $224,394  $224,394  $224,394  $  $ 

Mortgage loans held for sale

  17,364   18,008      18,008    

Federal Home Loan Bank stock

  11,284   11,284      11,284    

Loans, net

  3,416,369   3,454,659         3,454,659 

Accrued interest receivable

  13,535   13,535   13,535       
                     

Liabilities

     ��              

Non-interest bearing deposits

 $1,205,253  $1,205,253  $  $1,205,253  $ 

Transaction deposits

  2,105,268   2,105,268      2,105,268    

Time deposits

  416,635   422,131      422,131    

Securities sold under agreement to repurchase

  42,722   42,722      42,722    

Federal funds purchased

  8,401   8,401      8,401    

Federal Home Loan Bank advances

  61,432   63,436      63,436    

Accrued interest payable

  471   471   471       

 

 

(In thousands)

 

Carrying

                 

December 31, 2018

 

amount

  

Fair value

  

Level 1

  

Level 2

  

Level 3

 
                     

Assets

                    

Cash and cash equivalents

 $198,939  $198,939  $198,939  $  $ 

Mortgage loans held for sale

  1,675   1,743      1,743    

Federal Home Loan Bank stock

  10,370   10,370      10,370    

Loans, net

  2,522,637   2,508,587         2,508,587 

Accrued interest receivable

  8,360   8,360   8,360       
                     

Liabilities

                    

Non-interest bearing deposits

  711,023   711,023   711,023       

Transaction deposits

  1,736,618   1,736,618      1,736,618    

Time deposits

  346,715   345,273      345,273    

Securities sold under agreement to repurchase

  36,094   36,094      36,094    

Federal funds purchased

  10,247   10,247      10,247    

FHLB advances

  48,177   47,227      47,227    

Accrued interest payable

  762   762   762       

Limitations

(in thousands)

 

Carrying

      

Fair Value Measurements Using

 

December 31, 2019

 

amount

  

Fair value

  

Level 1

  

Level 2

  

Level 3

 
                     

Assets

                    

Cash and cash equivalents

 $249,724  $249,724  $249,724  $  $ 

Mortgage loans held for sale

  8,748   8,923      8,923    

Federal Home Loan Bank stock

  11,284   11,284      11,284    

Loans, net

  2,818,225   2,841,767         2,841,767 

Accrued interest receivable

  8,534   8,534   8,534       
                     

Liabilities

                    

Non-interest bearing deposits

 $810,475  $810,475  $  $810,475  $ 

Transaction deposits

  1,891,246   1,891,246      1,891,246    

Time deposits

  432,217   434,927      434,927    

Securities sold under agreement to repurchase

  31,895   31,895      31,895    

Federal funds purchased

  10,887   10,887      10,887    

Federal Home Loan Bank advances

  79,953   80,906      80,906    

Accrued interest payable

  640   640   640       

 

Fair value estimates are made at a specific point in time based on relevant market information and information about financial instruments. Because no market exists for a significant portion of Bancorp’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. Therefore, calculated fair value estimates in many instances cannot be substantiated by comparison to independent markets and, in many cases, may not be realizable in a current sale of the instrument. Changes in assumptions could significantly affectimpact estimates.

 

 

 

(1812)

Other Comprehensive Income (Loss)

The following table illustrates activity within the balances of AOCI by component:

(in thousands)

 

Net unrealized gains (losses) on available for sale debt securities

  

Net unrealized gains (losses) on cash flow hedges

  

Minimum pension liability adjustment

  

Total

 

Three months ended June 30, 2020

                

Balance, March 31, 2020

 $7,123  $(302) $(369) $6,452 

Net current period other comprehensive income (loss)

  2,343   21      2,364 

Balance, June 30, 2020

 $9,466  $(281) $(369) $8,816 
                 

Three months ended June 30, 2019

                

Balance, March 31, 2019

 $(2,536) $234  $(211) $(2,513)

Net current period other comprehensive income (loss)

  3,827   (248)     3,579 

Balance, June 30, 2019

 $1,291  $(14) $(211) $1,066 

(in thousands)

 

Net unrealized gains (losses) on available for sale debt securities

  

Net unrealized gains (losses) on cash flow hedges

  

Minimum pension liability adjustment

  

Total

 

Six months ended June 30, 2020

                

Balance, January 1, 2020

 $1,085  $(39) $(369) $677 

Net current period other comprehensive income (loss)

  8,381   (242)     8,139 

Balance, June 30, 2020

 $9,466  $(281) $(369) $8,816 
                 

Six months ended June 30, 2019

                

Balance, January 1, 2019

 $(5,330) $408  $(220) $(5,142)

Net current period other comprehensive income (loss)

  6,621   (422)  9   6,208 

Balance, June 30, 2019

 $1,291  $(14) $(211) $1,066 

(13)

Preferred Stock

Bancorp has one class of preferred stock (0 par value; 1,000,000 shares authorized), the relative rights, preferences and other terms of the class or any series within the class will be determined by the Board of Directors prior to any issuance. None of this stock has been issued to date.

(14)

Net Income Per Share

The following table reflects net income (numerator) and average shares outstanding (denominator) for basic and diluted net income per share computations:

  

Three months ended

  

Six months ended

 
  

June 30,

  

June 30,

 

(in thousands, except per share data)

 

2020

  

2019

  

2020

  

2019

 

Net income

 $13,368  $16,543  $26,600  $32,184 
                 

Weighted average shares outstanding - basic

  22,560   22,689   22,538   22,675 

Dilutive securities

  179   260   199   273 

Weighted average shares outstanding- diluted

  22,739   22,949   22,737   22,948 
                 

Net income per share - basic

 $0.59  $0.73  $1.18  $1.42 

Net income per share - diluted

  0.59   0.72   1.17   1.40 

Certain SARs that were excluded from the EPS calculation because their impact was antidilutive were as follows:

  

Three months ended

  

Six months ended

 

(in thousands)

 

June 30,

  

June 30,

 
  

2020

  

2019

  

2020

  

2019

 

Antidilutive SARs

  248   200   248   200 

(15)

Stock-Based Compensation

The fair value of all stock-based awards granted, net of estimated forfeitures, is recognized as compensation expense over the respective service period.

At Bancorp's 2015 Annual Meeting of Shareholders, shareholders approved the 2015 Omnibus Equity Compensation Plan and authorized the shares available from the expiring 2005 plan for future awards under the 2015 plan. In 2018, shareholders approved an additional 500,000 shares for issuance under the plan. As of June 30, 2020, there were 397,000 shares available for future awards. The 2005 Stock Incentive Plan expired in April 2015 and SARs granted under this plan expire as late as 2025. The 2015 Stock Incentive Plan has no defined expiration date.

SAR Grants SARs granted have a vesting schedule of 20% per year and expire ten years after the grant date unless forfeited due to employment termination.

Fair values of SARs are estimated at the date of grant using the Black-Scholes option-pricing model, a leading formula for calculating such value. This model requires the input of assumptions, changes to which can materially impact the fair value estimate. The following assumptions were used in SAR valuations at the grant date in each year:

Assumptions

 

2020

  

2019

 
         

Dividend yield

  2.51%  2.52%

Expected volatility

  20.87%  20.40%

Risk free interest rate

  1.25%  2.55%

Expected life (in years)

  7.1   7.2 

Dividend yield and expected volatility are based on historical information for Bancorp corresponding to the expected life of SARs granted. Expected volatility is the volatility of underlying shares for the expected term calculated on a monthly basis. The risk free interest rate is the implied yield currently available on U.S. Treasury issues with a remaining term equal to the expected life of the awards. The expected life of SARs is based on actual experience of past like-term SARs. Bancorp evaluates historical exercise and post-vesting termination behavior when determining the expected life.

RSA Grants – RSAs granted to officers vest over five years. For all grants prior to 2015, grantees are entitled to dividend payments during the vesting period. For grants in 2015 and forward, forfeitable dividends are deferred until shares are vested. Fair value of RSAs is equal to the market value of the shares on the date of grant.

PSU Grants – PSUs vest based upon service and a three-year performance period, which begins January 1 of the first year of the performance period. Because grantees are not entitled to dividend payments during the performance period, the fair value of these PSUs is estimated based upon the market value of the underlying shares on the date of grant, adjusted for non-payment of dividends. Grants require a one-year post-vesting holding period and the fair value of such grants incorporates a liquidity discount related to the holding period of 4.4% and 4.1% for 2020 and 2019.

RSU Grants – RSUs are only granted to non-employee directors, are time-based and vest 12 months after grant date. Because grantees are entitled to deferred dividend payments at the end of the vesting period, fair value of the RSUs equals market value of underlying shares on the date of grant.

In the first quarters of 2020 and 2019, Bancorp awarded 6,570 and 9,834 RSUs to non-employee directors of Bancorp with a grant date fair value of $270,000 and $247,000, respectively.

Bancorp utilized cash of $224,000 and $272,000 during the firstsix months of 2020 and 2019, respectively, for the purchase of shares upon the vesting of RSUs.

Bancorp has recognized stock-based compensation expense for SARs, RSAs and PSUs within compensation expense and RSUs for directors within other non-interest expense, as follows:

  

Three months ended June 30, 2020

 

(in thousands)

 

Stock

Appreciation

Rights

  

Restricte

Stock Awards

  

Restricted

Stock Units

  

Performance

Stock Units

  

Total

 
                     

Expense

 $87  $317  $67  $505  $976 

Deferred tax benefit

  (18)  (67)  (14)  (106)  (205)

Total net expense

 $69  $250  $53  $399  $771 

  

Three months ended June 30, 2019

 

(in thousands)

 

Stock

Appreciation

Rights

  

Restricte

Stock Awards

  

Restricted

Stock Units

  

Performance

Stock Units

  

Total

 
                     

Expense

 $86  $306  $83  $518  $993 

Deferred tax benefit

  (18)  (65)  (17)  (109)  (209)

Total net expense

 $68  $241  $66  $409  $784 

  

Six months ended June 30, 2020

 

(in thousands)

 

Stock

Appreciation

Rights

  

Restricted

Stock Awards

  

Restricted

Stock Units

  

Performance

Stock Units

  

Total

 
                     

Expense

 $177  $643  $135  $838  $1,793 

Deferred tax benefit

  (37)  (135)  (28)  (177)  (377)

Total net expense

 $140  $508  $107  $661  $1,416 

  

Six months ended June 30, 2019

 

(in thousands)

 

Stock

Appreciation

Rights

  

Restricted

Stock Awards

  

Restricted

Stock Units

  

Performance

Stock Units

  

Total

 
                     

Expense

 $170  $599  $164  $923  $1,856 

Deferred tax benefit

  (36)  (126)  (34)  (194)  (390)

Total net expense

 $134  $473  $130  $729  $1,466 

Detail of unrecognized stock-based compensation expense follows:

(in thousands)

Year ended

 

Stock

Appreciation

Rights

  

Restricted

Stock Awards

  

Restricted

Stock Units

  

Performance

Stock Units

  

Total

 
                     

Remainder of 2020

 $176  $636  $135  $1,182  $2,129 

2021

  304   1,090   1   952   2,347 

2022

  249   823      490   1,562 

2023

  174   580         754 

2024

  68   305         373 

2025

  9   29         38 

Total estimated expense

 $980  $3,463  $136  $2,624  $7,203 

The following table summarizes SARs activity and related information:

                      

Weighted

 
          

Weighted

      

Weighted

  

average

 
          

average

  

Aggregate

  

average

  

remaining

 
     

Exercise

  

exercise

  

intrinsic

  

fair

  

contractual

 

(in thousands, except per share data)

 

SARs

 

price

  

price

  

value(1)

  

value

  

life (in years)

 
                         

Outstanding, January 1, 2019

  731 $14.02-$40.00  $22.42  $8,422  $3.83   5.2 

Granted

  53 36.65-38.18   37.01   213   6.24     

Exercised

  (143)14.02-22.96   15.99   3,025   3.47     

Forfeited

                   

Outstanding, December 31, 2019

  641 $14.02-$40.00  $25.06  $10,250  $4.10   5.3 
                         

Outstanding, January 1, 2020

  641 $14.02-$40.00  $25.06  $10,250  $4.10   5.3 

Granted

  48 37.30-37.30   37.30   140   5.80     

Exercised

  (12)14.02-15.84   15.19   279   3.09     

Forfeited

                   

Outstanding, June 30, 2020

  677 $15.24-$40.00  $26.10  $9,550  $4.24   5.2 
                         

Vested and exercisable

  485 $15.24-$40.00  $21.87  $8,887  $3.62   3.9 

Unvested

  192 24.56-40.00   36.76   663   5.81   8.3 

Outstanding, June 30, 2020

  677 $15.24-$40.00  $26.10  $9,550  $4.24   5.2 
                         

Vested at June 30, 2020

  57 $22.96-$40.00  $30.80  $537  $5.02     

(1) - Intrinsic value for SARs is defined as the amount by which the current market price of the underlying stock exceeds the exercise or grantprice.

The following table summarizes activity for RSAs granted to officers:

      

Grant date

 
      

weighted

 

(in thousands, except per share data)

 

RSAs

  

average cost

 
         

Unvested at January 1, 2019

  110  $32.09 

Shares awarded

  40   34.88 

Restrictions lapsed and shares released

  (40)  28.74 

Shares forfeited

  (2)  35.36 

Unvested at December 31, 2019

  108  $34.31 
         

Unvested at January 1, 2020

  108  $34.31 

Shares awarded

  36   39.30 

Restrictions lapsed and shares released

  (38)  32.13 

Shares forfeited

  (1)  36.70 

Unvested at June 30, 2020

  105  $36.81 

Shares expected to be awarded for PSUs granted to executive officers of Bancorp, the three-year performance period for which began January 1 of the award year, are as follows:

  

Vesting

      

Expected

 

Grant

 

period

  

Fair

  

shares to

 

year

 

in years

  

value

  

be awarded

 

2018

 3  $31.54   71,932 

2019

 3   32.03   43,603 

2020

 3   32.27   45,577 

(16)

Derivative Financial Instruments

 

Periodically, Bancorp enters into interest rate swap transactions with borrowers who desire to hedge exposure to rising interest rates, while at the same time entering into an offsetting interest rate swap, with substantially matching terms, with another approved independent counterparty. These are undesignated derivative instruments and are recognized on the balance sheet at fair value. Because of matching terms of offsetting contracts and collateral provisions mitigating any non-performance risk, changes in fair value subsequent to initial recognition have an insignificant effect on earnings. Exchanges of cash flows related to undesignated interest rate swap agreements for the firstsix months of 2019were offsetting and therefore had no effect on Bancorp’s earnings or cash flows.

 

Interest rate swap agreements derive their value from underlying interest rates. These transactions involve both credit and market risk. Notional amounts are amounts on which calculations, payments and the value of the derivative 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. Bancorp is exposed to credit-related losses in the event of nonperformancenon-performance by counterparties to these agreements. Bancorp mitigates the credit risk of its financial contracts through credit approvals, limits, collateral and monitoring procedures, and does not expect any counterparties to fail their obligations.

 

44

At June 30, 2019 and December 31, 2018, Bancorp had outstanding undesignated interest rate swap contracts as follows:

 

(Dollars in thousands)

 

Receiving

  

Paying

 
 

June 30,

 

December 31,

 

June 30,

 

December 31,

  

Receiving

  

Paying

 
 

June 30,

 

December 31,

 

June 30,

 

December 31,

 

(dollars in thousands)

 

2020

  

2019

  

2020

  

2019

 
 

2019

  

2018

  

2019

  

2018

  

Notional amount

 $60,607  $55,505  $60,607  $55,505  $103,526  $99,000  $103,526  $99,000 

Weighted average maturity (years)

 7.4  8.0  7.4  8.0  7.9  8.2  7.9  8.2 

Fair value

 $1,813  $519  $1,835  $543  $9,895  $2,696  $9,914  $2,767 

 

 

In 2015, Bancorp entered into an interest rate swap to hedge cash flows of a $20 million rolling fixed-rate three-month FHLB borrowing. The swap began December 9, 2015 and matures December 6, 2020. In 2016, Bancorp entered into an interest rate swap to hedge cash flows of a $10 million rolling fixed-rate three-month FHLB borrowing. The swap began December 6, 2016 and endsmatures December 6, 2021. For purposes of hedging, rolling fixed rate advances are considered to be floating rate liabilities. Interest rate swaps involve exchange of Bancorp’s floating rate interest payments for fixed rate swap payments on underlying principal amounts. These swaps were designated and qualified, for cash-flow hedge accounting. For derivative instruments that are designated and qualify as cash flow hedging instruments, the effective portion of gains or losses is reported as a component of other comprehensive income,OCI, and is subsequently reclassified into earnings as an adjustment to interest expense in periods infor which the hedged forecasted transaction affectsimpacts earnings.

 

The following table details the notional and fair value amounts of Bancorp’s derivative positionpositions designated as a cash flow hedge, and the fair values as of June 30, 2019 and December 31, 2018.hedges:

 

(Dollars in thousands)

            

(dollars in thousands)

(dollars in thousands)

            
          

Fair value

           

Fair value

 

Notional

Notional

 

Maturity

 

Receive (variable)

 

Pay fixed

 

assets (liabilities)

 

Notional

 

Maturity

 

Receive (variable)

 

Pay fixed

  

assets (liabilities)

 

amount

amount

 

date

 

index

 

swap rate

  

June 30, 2019

  

December 31, 2018

 

amount

 

date

 

index

 

swap rate

  

June 30, 2020

  

December 31, 2019

 
$10,000 

12/6/2021

 US 3 Month LIBOR

 1.89% $(37) $193 10,000 

12/6/2021

 

US 3 Month LIBOR

 1.89% $(239) $(45)
20,000 

12/6/2020

 US 3 Month LIBOR

  1.79%  23   323 20,000 

12/6/2020

 

US 3 Month LIBOR

  1.79%  (130)  (6)
$30,000     1.82% $(14) $516 30,000      1.82% $(369) $(51)

 

 

 

(1917)

Regulatory Matters

 

Bancorp and the Bank are subject to capital regulations in accordance with Basel III, as administered by banking regulators. Regulatory agencies measure capital adequacy within a framework that makes capital requirements, in part, dependent on the individual risk profiles of financial institutions. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on Bancorp’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Holding CompanyBancorp and the Bank must meet specific capital guidelines that involve quantitative measures of Bancorp’s assets, liabilities and certain off-balance sheet items, as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators regarding components, risk weightings and other factors.

 

Banking regulators have categorized the Bank as well-capitalized. For prompt corrective action, theThe regulations in accordance with Basel III define “well capitalized” as a 6.5% Common Equity Tier 1 Risk-Based Capital ratio, an 8.0% Tier 1 Risk-Based Capital ratio, a 10.0% Total Risk-Based Capital ratio and a 5.0% Tier 1 Leverage ratio. Additionally, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, Bancorp and Bank must hold a capital conservation buffer composed of Common Equity Tier 1 Risk-Based Capital above their minimum risk-based capital requirements. The capital conservation buffer phased in fromset forth by the Basel III regulatory capital framework was 2.5% of risk-weighted assets above the minimum risk based capital ratio requirements at 2016June 30, 2020 toand 2019December 31, 2019. on the following schedule: aThe capital conservation buffer is designed to absorb losses during periods of 0.625% effectiveeconomic stress and requires increased capital levels for the purpose of capital distributions and other payments. Failure to meet the full amount of the buffer will result in restrictions on Bancorp’s ability to make capital distributions, including dividend payments and stock repurchases, and to pay discretionary bonuses to executive officers. At January 1, 2016; 1.25% effective January 1, 2017; 1.875% effective January 1, 2018;June 30, 2020 and a fully phased inDecember 31, 2019, Bancorp’s and the Bank’s risk-based capital exceeded the required capital conservation buffer of 2.5% on January 1, 2019.buffer.

45

 

Bancorp continues to exceed the regulatory requirements to be considered “well-capitalized” for Total Risk Based Capital, Common Equity Tier I Risk Based Capital, Tier I Risk Based Capital and Tier I Leverage Capital.Leverage. Bancorp and the Bank intend to maintain a capital position that meets or exceeds the “well-capitalized”well-capitalized requirements as defined by the FRB and the FDIC, in addition to the Capital Conservation Buffer. There are no conditions or events since June 30, 2020 that management believes have changed Bancorp’s well-capitalized status.

As permitted by the interim final rule issued on March 27, 2020 by the federal banking regulatory agencies, Bancorp elected the option to delay the estimated impact on regulatory capital related to the adoption of ASC 326Financial Instruments – Credit Losses,” or CECL, which was effective January 1, 2020. The initial impact of adoption of ASC 326, as well as 25% of the quarterly increases in the ACL subsequent to adoption of ASC 326 (collectively the “transition adjustments”) were declared to be delayed for two years. After two years, the cumulative amount of the transition adjustments will become fixed and will be phased out of the regulatory capital calculations evenly over a three-year period, with 75% recognized in year three, 50% recognized in year four and 25% recognized in year five. After five years, the temporary regulatory capital benefits will be fully reversed. Had Bancorp elected not to defer the regulatory capital impact of CECL, the post ASC 326 adoption capital ratios of Bancorp and the Bank would have exceeded the well-capitalized level.

Dividends paid by Bancorp are limited to, without prior regulatory approval, current year earnings and earnings less dividends paid during the preceding two years.

 

The following table sets forth consolidated Bancorp’s and the Bank’s risk based capital amounts and ratios:

 

(Dollars in thousands)

 

Actual

 

Minimum for adequately

capitalized

 

Minimum for well

capitalized

 

June 30, 2019

 

Amount

  

Ratio

  

Amount

  

Ratio

  

Amount

  

Ratio

 

(dollars in thousands)

 

Actual

  

Minimum for adequately

capitalized

  

Minimum for well

capitalized

 

June 30, 2020

 

Amount

  

Ratio

  

Amount

  

Ratio

  

Amount

  

Ratio

 
  

Total risk-based capital (1)

              

Consolidated

 $400,314  12.67

%

 $252,821  8.00

%

 

NA

 

NA

  $446,117  13.50

%

 $264,297  8.00

%

 

NA

 

NA

 

Bank

 392,705  12.45  252,265  8.00  $315,331  10.00% 430,654  13.07  263,610  8.00  $329,512  10.00%
  

Common equity tier 1 risk-based capital

              

Consolidated

 373,548  11.82  142,212  4.50  

NA

 

NA

  409,251  12.39  148,667  4.50  

NA

 

NA

 

Bank

 365,939  11.60  141,899  4.50  204,965  6.50  393,788  11.95  148,280  4.50  214,183  6.50 
  

Tier 1 risk-based capital (1)

              

Consolidated

 373,548  11.82  189,616  6.00  

NA

 

NA

  409,251  12.39  198,223  6.00  

NA

 

NA

 

Bank

 365,939  11.60  189,198  6.00  252,265  8.00  393,788  11.95  197,707  6.00  263,610  8.00 
  

Leverage (2)

              

Consolidated

 373,548  10.91  136,955  4.00  

NA

 

NA

  409,251  9.50  172,277  4.00  

NA

 

NA

 

Bank

 365,939  10.70  136,784  4.00  170,980  5.00  393,788  9.15  172,124  4.00  215,155  5.00 

 

 

(Dollars in thousands)

 

Actual

 

Minimum for adequately

capitalized

 

Minimum for well

capitalized

 

December 31, 2018

 

Amount

  

Ratio

  

Amount

  

Ratio

  

Amount

  

Ratio

 

(dollars in thousands)

 

Actual

  

Minimum for adequately

capitalized

 ��

Minimum for well

capitalized

 

December 31, 2019

 

Amount

  

Ratio

  

Amount

  

Ratio

  

Amount

  

Ratio

 
     

Total risk-based capital (1)

                           

Consolidated

 $396,019  13.91

%

 $227,714  8.00

%

 

NA

 

NA

  $418,460  12.85

%

 $260,448  8.00

%

 

NA

 

NA

 

Bank

 385,637  13.56  227,462  8.00  $284,327   10.00% 396,299  12.20  259,823  8.00  $324,778  10.00

%

     

Common equity tier 1 risk-based capital

                           

Consolidated

 370,135  13.00  128,089  4.50  

NA

 

NA

  391,319  12.02  146,502  4.50  

NA

 

NA

 

Bank

 359,753  12.65  127,947  4.50  184,813   6.50  369,158  11.37  146,150  4.50  211,106  6.50 
     

Tier 1 risk-based capital (1)

                           

Consolidated

 370,135  13.00  170,785  6.00  

NA

 

NA

  391,319  12.02  195,336  6.00  

NA

 

NA

 

Bank

 359,753  12.65  170,596  6.00  227,462   8.00  369,158  11.37  194,867  6.00  259,823  8.00 
     

Leverage (2)

                           

Consolidated

 370,135  11.33  130,698  4.00  

NA

 

NA

  391,319  10.60  147,733  4.00  

NA

 

NA

 

Bank

 359,753  11.02  130,569  4.00  163,211   5.00  369,158  10.67  138,392  4.00  172,990  5.00 

 

(1)     Ratio is computed in relation to risk-weighted assets.

(2)     Ratio is computed in relation to average assets.     

NA – Not Applicable

Ratio is computed in relation to risk-weighted assets.

(2)

Ratio is computed in relation to average assets.

NA

Not applicable. Regulatory framework does not define well capitalized for holding companies.

 

 

 

(2018)

Segments

 

Bancorp’s principal activities include commercial banking and WM&T. Commercial banking provides a full range of loan and deposit products to individual consumers and businesses. Commercial banking also includes Bancorp’s mortgage originationbanking and investment products sales activity. WM&T provides custom-tailored financial management services includingplanning, investment management, company retirement plan management, retirement planning, trust and estate administration, and retirement plan services.services in all markets in which Bancorp operates. The magnitude of WM&T revenue distinguishes Bancorp from other community banks of similar asset size.

 

Financial information for each business segment reflects that which is specifically identifiable or allocated based on an internal allocation method. Income taxes are allocated based on the effective federal income tax rate adjusted for any tax exempttax-exempt activity. All tax exempttax-exempt activity and provision for loan losses have been allocated fully to the commercial banking segment. Measurement of performance of business segments is based on the management structure of Bancorp and is not necessarily comparable with similar information for any other financial institution. Information presented is also not necessarily indicative of the segments’ operations if they were independent entities.

 

Principally, all of the net assets of Bancorp are involved in the commercial banking segment. Goodwill of $12.8$12.5 million, of which $682 thousand$682,000 relates to a bank acquisition in 1996 and $12.1$11.8 million resulted fromrelates to the King May 2019 acquisition, has been assigned to the commercial banking segment. Assets assigned to WM&T primarily consist of net premises and equipment.equipment and a receivable related to fees earned that have not been collected.

 

Selected financial information by business segment for the three and six month periods ended June 30, 2019 and 2018follows:

 

     

Wealth

     

Three months ended June 30, 2020

  

Three months ended June 30, 2019

 
 

Commercial

 

Management

     

(In thousands)

 

Banking

  

and Trust

  

Total Company

 

(dollars in thousands)

 

Commercial

Banking

  

WM&T

  

Total

  

Commercial

Banking

  

WM&T

  

Total

 
  

Three months ended June 30, 2019

            

Net interest income

 $30,690  $84  $30,774  $33,443  $85  $33,528  $30,718  $84  $30,802 

Provision

      

Provision for credit losses

 5,550     5,550        

Wealth management and trust services

   5,662  5,662    5,726   5,726    5,662   5,662 

All other non-interest income

 6,601    6,601  6,896     6,896  6,562     6,562 

Non-interest expenses

  22,297   3,167   25,464   21,763   3,121   24,884   22,286   3,167   25,453 

Income before income tax expense

 14,994  2,579  17,573  13,026  2,690   15,716  14,994  2,579   17,573 

Income tax expense

  471   559   1,030   1,764   584   2,348   471   559   1,030 

Net income

 $14,523  $2,020  $16,543  $11,262  $2,106  $13,368  $14,523  $2,020  $16,543 
  

Segment assets

 $3,462,105  $1,718  $3,463,823  4,330,893  $3,640  $4,334,533  3,460,040  $3,783  $3,463,823 
 

Three months ended June 30, 2018

            

Net interest income

 $28,612  $62  $28,674 

Provision

 1,235    1,235 

Wealth management and trust services

   5,344  5,344 

All other non-interest income

 6,091    6,091 

Non-interest expenses

  18,938   3,198   22,136 

Income before income tax expense

 14,530  2,208  16,738 

Income tax expense

  2,644   515   3,159 

Net income

 $11,886  $1,693  $13,579 
 

Segment assets

 $3,321,948  $1,892  $3,323,840 

  

Six months ended June 30, 2020

  

Six months ended June 30, 2019

 
                         

(dollars in thousands)

 

Commercial

Banking

  

WM&T

  

Total

  

Commercial

Banking

  

WM&T

  

Total

 
                         

Net interest income

 $65,804  $170  $65,974  $60,326  $160  $60,486 

Provision for credit losses

  11,100      11,100   600      600 

Wealth management and trust services

     11,944   11,944      11,101   11,101 

All other non-interest income

  13,214      13,214   12,131      12,131 

Non-interest expenses

  42,401   6,433   48,834   41,865   6,200   48,065 

Income before income tax expense

  25,517   5,681   31,198   29,992   5,061   35,053 

Income tax expense

  3,365   1,233   4,598   1,771   1,098   2,869 

Net income

 $22,152  $4,448  $26,600  $28,221  $3,963  $32,184 
                         

Segment assets

  4,330,893  $3,640  $4,334,533   3,460,040  $3,783  $3,463,823 

 

47
55


      

Wealth

     
  

Commercial

  

management

     

(In thousands)

 

Banking

  

and Trust

  

Total Company

 
             

Six months ended June 30, 2019

            

Net interest income

 $60,271  $160  $60,431 

Provision

  600      600 

Wealth management and trust services

     11,101   11,101 

All other non-interest income

  12,224      12,224 

Non-interest expenses

  41,903   6,200   48,103 

Income before income tax expense

  29,992   5,061   35,053 

Income tax expense

  1,771   1,098   2,869 

Net income

 $28,221  $3,963  $32,184 
             

Segment assets

 $3,462,105  $1,718  $3,463,823 
             

Six months ended June 30, 2018

            

Net interest income

 $55,850  $133  $55,983 

Provision

  1,970      1,970 

Wealth management and trust services

     10,844   10,844 

All other non-interest income

  11,500      11,500 

Non-interest expenses

  36,798   6,365   43,163 

Income before income tax expense

  28,582   4,612   33,194 

Income tax expense

  5,210   1,001   6,211 

Net income

 $23,372  $3,611  $26,983 
             

Segment assets

 $3,321,948  $1,892  $3,323,840 

48

 

 

(2119)

Revenue from Contracts with Customers

 

All of Bancorp’s revenue from contracts with customers in the scope of ASC 606 is recognized within non-interest income. The table below presents Bancorp’s sources of non-interest income with items outside the scope of ASC 606 noted as such:

 

 

Three months ended June 30, 2019

  

Three months ended June 30, 2018

  

Three months ended June 30, 2020

  

Three months ended June 30, 2019

 

(Dollars in thousands)

 

Commercial

  

WM&T

  

Total

  

Commercial

  

WM&T

  

Total

 
 

(dollars in thousands)

 

Commercial

Banking

  

WM&T

  

Total

  

Commercial

  

WM&T

  

Total

 

Wealth management and trust services

 $  $5,662  $5,662  $  $5,344  $5,344  $  $5,726  $5,726  $  $5,662  $5,662 

Deposit service charges

 1,336    1,336  1,447    1,447  800     800  1,260     1,260 

Debit and credit card income

 2,168    2,168  1,689    1,689  2,063     2,063  2,168     2,168 

Treasury management fees

 1,202    1,202  1,113    1,113  1,249     1,249  1,202     1,202 

Mortgage banking income(1)

 796    796  746    746  1,622     1,622  760     760 

Net investment product sales commissions and fees

 364    364  397    397  391     391  364     364 

Bank owned life insurance(1)

 184    184  191    191  176     176  184     184 

Other(2)

  551      551   508      508   595      595   624      624 

Total non-interest income

 $6,601  $5,662  $12,263  $6,091  $5,344  $11,435  $6,896  $5,726  $12,622  $6,562  $5,662  $12,224 

 

 

 

Six months ended June 30, 2020

  

Six months ended June 30, 2019

 
 

Six months ended June 30, 2019

  

Six months ended June 30, 2018

  

(Dollars in thousands)

 

Commercial

  

WM&T

  

Total

  

Commercial

  

WM&T

  

Total

  

Commercial

Banking

  

WM&T

  

Total

  

Commercial

  

WM&T

  

Total

 

Wealth management and trust services

 $  $11,101  $11,101  $  $10,844  $10,844  $  $11,944  $11,944  $  $11,101  $11,101 

Deposit service charges

 2,583    2,583  2,858    2,858  2,083     2,083  2,438     2,438 

Debit and credit card income

 3,912    3,912  3,197    3,197  4,043     4,043  3,912     3,912 

Treasury management fees

 2,359    2,359  2,160    2,160  2,533     2,533  2,359     2,359 

Mortgage banking income(1)

 1,278    1,278  1,322    1,322  2,468     2,468  1,210     1,210 

Net investment product sales commissions and fees

 720    720  801    801  857     857  720     720 

Bank owned life insurance(1)

 362    362  378    378  355     355  362     362 

Other(2)

  1,010      1,010   784      784   875      875   1,130      1,130 

Total non-interest income

 $12,224  $11,101  $23,325  $11,500  $10,844  $22,344  $13,214  $11,944  $25,158  $12,131  $11,101  $23,232 

 

(1) Outside of the scope of ASC 606.

(2) Outside of the scope of ASC 606, with the exception of safe deposit fees which were nominal for all periods.

 

Bancorp’s revenue on the consolidated statement of income is categorized by product type, which effectively depicts how the nature, timing and extent of cash flows are affected by economic factors. Revenue sources within the scope of ASC 606 are discussed below:

 

Bancorp earns fees from its deposit customers for transactions-based,transaction-based, account management and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payments fees and ACH fees, are recognized at the time the transaction is executed, as that is when the company fulfills the performance obligation. Account management fees are earned over the course of a month and charged in the month in which the services are provided. Overdraft fees are recognized at the point in time that the overdraft occurs. Deposit service charges are withdrawn from customer’s account balances.

 

Treasury management transaction fees are recognized at the time the transaction is executed, as that is when the company fulfills the performance obligation. Account management fees are earned over the course of a month and charged in the month in which the services are provided. Treasury management fees are withdrawn from customer’scustomers’ account balances.

 

WM&T provides customers fiduciary and investment management services as agreed upon in asset management contracts. The contracts require WM&T to provide a series of distinct services for which fees are earned over time. The contracts are cancellable upon demand with fees typically based upon the asset value of investments. Revenue is accrued and recognized monthly based upon month-end asset values and collected from the customer predominately in the following month except for a small percentage of fees collected quarterly. Incentive compensation related to WM&T activities is considered a cost of obtaining the contract. Contracts between WM&T and clients do not permit performance basedperformance-based fees and accordingly, none of the feesfee income earned by WM&T are performance based.is performance-based. Trust fees receivable were $2.1 million as of both June 30, 20192020 were $2.1 million compared with $1.9 million as ofand December 31, 2018.2019.

49

 

Investment products sales commissions and fees represent the Bank’s share of transaction fees and wrap fees resulting from investment services and programs provided through an agent relationship with a third party broker-dealer. Transaction fees are assessed at the time of the transaction. Those fees are collected and recognized on a monthly basis. Trailing fees are based upon market valuevalues and are assessed, collected and recognized on a quarterly basis. Because the Bank acts as an agent in arranging the relationship between the customer and third party provider, and does not control the services rendered, investment product sales commissions and fees are reported net of related costs, including nominal incentive compensation, and trading activity charges of $257$283,000 and $261 thousand,$258,000 for the six month periods ended June 30, 2019,2020 and 20182019. respectively.

 

Debit and credit card revenue primarily consists of debit and credit card interchange income. Interchange income represents fees assessed within the payment card system for acceptance of card basedcard-based transactions. Interchange fees are assessed as the performance obligation is satisfied, which is at the point in time the card transaction is authorized. Revenue is collected and recognized daily through the payment network settlement process.

 

Bancorp did not establish any contract assets or liabilities as a result of adopting ASC 606, nor were any recognized during the firstsix months of-month period ending 2019.June 30, 2020.

 

Bancorp’s revenue on the consolidated statement

 

 

(2220)

Leases

 

Bancorp has operating leases for various branch locations with terms remainingranging from 3 monthsone month to 1413 years, some of which include options to extend the leases in 5 yearfive-year increments. Options reasonably expected to be exercised are included in determination of the right of useright-of-use asset. Bancorp elected the practical expedient to expense short-term lease expenseobligations associated with leases with original terms of 12 months or less. Bancorp elected not to separate non-lease components from lease components for its operating leases. The right-of-use lease asset and operating lease liability are recorded in others assetspremises and equipment and other liabilities respectively, on the consolidated balance sheet.

50

 

Balance sheet, income statement and cash flow detail regarding operating leases follows:

 

(In thousands)

        
     

(in thousands)

        

Balance Sheet

 

June 30, 2019

      

June 30, 2020

  

December 31, 2019

 
      

Operating lease right-of-use assets

 $16,056  

included in premises and equipment

  $11,547  $12,737 

Operating lease liabilities

 17,373  

included in other liabilities

  12,992  14,369 
       

Weighted average remaining lease term (in years)

 12.42

    

Weighted average remaining lease term

 9.0  9.4 

Weighted average discount rate

 3.61%     3.50% 2.46%
      

Maturities of lease liabilities:

           

One year or less

 $1,949      $986  $1,964 

Year 2

 1,929      1,916  1,915 

Year 3

 1,919      1,930  1,930 

Year 4

 1,955      1,972  1,972 

Year 5

 1,935      1,781  1,781 

Greater than 5 years

  11,870       6,619   6,619 

Total lease payments

 $21,557      $15,204  $16,181 

Less imputed interest

  4,184       2,212   1,812 

Total

 $17,373     

Total lease liabilities

 $12,992  $14,369 

 

 

(In thousands)

 

Three months ended

 

Six months ended

 

(in thousands)

 

Three months ended

 

Three months ended

 

Income Statement

 

June 30, 2019

  

June 30, 2019

  

June 30, 2020

  

June 30, 2019

 
 

Components of lease expense:

      

Operating lease cost

 $489  $997  $473  $489 

Variable lease cost

 24  63  45  24 

Less sublease income

  13   27   25   13 

Total lease cost

 $500  $1,033  $493  $500 
 

 

(in thousands)

 

Six months ended

  

Six months ended

 

Income Statement

 

June 30, 2020

  

June 30, 2019

 

Components of lease expense:

        

Operating lease cost

 $943  $997 

Variable lease cost

  87   63 

Less sublease income

  38   27 

Total lease cost

 $992  $1,033 

 

(In thousands)

 

Six months ended

   

(in thousands)

 

Six months ended

 

Six months ended

 

Cash flow Statement

 

June 30, 2019

     

June 30, 2020

  

June 30, 2019

 
     

Supplemental cash flow information:

          

Operating cash flows from operating leases

 $694     $790  $694 

 

 

As of June 30, 20192020, Bancorp had not entered into any lease agreements that had yet to commence.

 

 

Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations


This item discussesThe consolidated financial statements include the results and operations foraccounts of Stock Yards Bancorp, Inc. (“Holding Company”), and its wholly-ownedwholly owned subsidiary, Stock Yards Bank & Trust Company (“Bank”) forSYB, collectively referred to as “Bancorp” or the three and six months ended June 30, 2019 and compares these periods with the same periods of the previous year.“Company.” All significant inter-company transactions and accounts have been eliminated in consolidation. All companies are collectively referred to as “Bancorp” or the “Company.”

 

As a result of its acquisition of King,Stock Yards Bancorp, Inc. on May 1, 2019, Bancorp becameis a FHC headquartered in Louisville, Kentucky. Established in 1904, SYB is a state-chartered non-member financial institution that provides services in the 100% successor owner of King Bancorp Statutory Trust I (“KBST”), an unconsolidated finance subsidiary. As permitted under the terms of KBST’s governing documents, Bancorp redeemed the trust-preferred securities at the par amount of approximately $3.6 million on June 17, 2019.Louisville, Kentucky, Indianapolis, Indiana and Cincinnati, Ohio MSAs through 42 full service banking center locations.

 

This section presents management’s perspective on our financial condition and results of operations. Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the consolidated financial statements and accompanying notesfootnotes presented in Part 1 Item 1 “Financial Statements.Financial Statements and other information appearing in Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2019. To the extent that this discussion describes prior performance, the descriptions relate only to the periods listed, which may not be indicative of Bancorp’s future financial outcomes. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause results to differ materially from management’s expectations.

 

Stock Yards Bancorp, Inc. is a financial holding company headquartered in Louisville, Kentucky.

The Bank, chartered in 1904, is a state-chartered non-member financial institution that provides services in the Louisville, Kentucky, Indianapolis, Indiana and Cincinnati, Ohio Metropolitan Statistical Areas (“MSAs”) through 43 full service banking center locations.

Cautionary Statement Regarding Forward-Looking Statements 

  

This reportdocument contains statements relating to future results of Bancorp that are considered “forward-looking” as defined by Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The forward-looking statements underare principally, but not exclusively, contained in Part I Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Part II Item 1A “Risk Factors.”

Forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause actual results, performance, or achievements to be materially different from future results, performance, or achievements expressed or implied by the Private Securities Litigation Reform Actstatement. These statements are often, but not always, made through the use of words or phrases such as “anticipate,” “believe,” “can,” “conclude,” “continue,” “could,” “estimate,” “expect,” “foresee,” “goal,” “intend,” “may,” “might,” “outlook,” “possible,” “plan,” “predict,” “project,” “potential,” “seek,” “should,” “target,” “will,” “will likely,” “would,” or other similar expressions. These forward-looking statements are not historical facts and are based on current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control, particularly with regard to developments related to COVID-19. Forward-looking statements detail management’s expectations regarding the future and are based on information known to management only as of the date the statements are made and management undertakes no obligation to update forward-looking statements, except as required by applicable law.

There is no assurance that involveany list of risks and uncertainties. Although Bancorp believes assumptions underlying forward-looking statements contained herein are reasonable, any of these assumptions could be inaccurate.uncertainties or risk factors is complete. Factors that could cause actual results to differ materially from results discussedthose expressed or implied in forward-looking statements include, but are not limited to the following: economic conditions both generally and more specifically in markets in which Bancorp and the Bank operate; competition for Bancorp’s customers fromamong other providers of financial services; government legislation and regulation which change from time to time and over which Bancorp has no control; changes in interest rates; material unforeseen changes in liquidity, results of operations, or financial condition of Bancorp’s customers; and other risks detailed in Bancorp’s filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of Bancorp.things:

 

impact of COVID-19 on Bancorp’s business, including the impact of the actions taken by governmental authorities to try and contain the virus or address the impact of the virus on the U.S. economy (including, without limitation, the CARES Act), and the resulting effect of all of such items on our operations, liquidity and capital position, and on the financial condition of Bancorp’s borrowers and other customers;

changes in or forecasts of future political and economic conditions;

accuracy of assumptions and estimates used in establishing the ACL on loans and other estimates;

impairment of investment securities, goodwill, other intangible assets or DTAs;

ability to effectively navigate an economic slowdown or other economic or market disruption;

changes in laws and regulations or the interpretation thereof;

changes in fiscal, monetary, and/or regulatory policies;

changes in tax polices including but not limited to changes in federal and state statutory rates;

behavior of securities and capital markets, including changes in market volatility and liquidity;

ability to effectively manage capital and liquidity;

long-term and short-term interest rate fluctuations, as well as the shape of the U.S. Treasury yield curve;

the magnitude and frequency of changes to the FFTR implemented by the Federal Open Market Committee of the FRB;

competitive product and pricing pressures;

projections of revenue, expenses, capital expenditures, losses, EPS, dividends, capital structure, etc.;

Acquisition

descriptions of plans or objectives for future operations, products, or services;

changes in the credit quality of Bancorp’s customers and counterparties, deteriorating asset quality and charge-off levels;

changes in technology instituted by Bancorp, its counterparties or competitors;

changes to or the effectiveness of Bancorp’s overall internal control environment;

adequacy of Bancorp’s risk management framework, disclosure controls and procedures and internal control over financial reporting;

changes in applicable accounting standards, including the introduction of new accounting standards;

changes in investor sentiment or consumer spending or savings behavior;

ability to appropriately address social, environmental and sustainability concerns that may arise from business activities;

integration of acquired businesses or future acquisitions;

occurrence of natural or man-made disasters or calamities, including health emergencies, the spread of infectious diseases, pandemics or outbreaks of hostilities, and Bancorp’s ability to deal effectively with disruptions caused by the foregoing;

ability to maintain the security of its financial, accounting, technology, data processing and other operational systems and facilities;

ability to withstand disruptions that may be caused by any failure of its operational systems or those of third parties;

ability to effectively defend itself against cyberattacks or other attempts by unauthorized parties to access information of Bancorp or its customers or to disrupt systems; and

other risks and uncertainties reported from time to time in Bancorp’s filings with the SEC, including Part II Item 1A “Risk Factors.”

Acquisition of King Bancorp, Inc.and its wholly owned subsidiary King Southern Bank

 

On May 1, 2019, Bancorp completed its acquisition of King Bancorp Inc., and its wholly-owned subsidiary King Southern Bank (collectively referred to as “King”),KSB for $28 million in cash. The acquisition expands the Company’sexpanded Bancorp’s market area into nearby Nelson County, Kentucky, while expanding the customer base in Louisville, Kentucky. At May 1, 2019, Kingthe acquiree reported approximately $192 million in total assets, approximately $164 million in loans and approximately $126 million in deposits. As a result of the acquisition, goodwill totaling $11.8 million was recorded during the second quarter of 2019, with nominal recast adjustments posted during the third and fourth quarters of 2019.

 

As a result of the completion of the acquisition, Bancorp incurred pre-tax transaction charges totaling $1.3 million forpredominantly during the three and six months ended June 30,second quarter of 2019. Net income from the King acquisition is expected to bewas accretive to Bancorp’s overall operating results on a quarterly basis going forward.beginning with the third quarter of 2019. Effective March 31, 2020, management finalized the fair values of the acquired assets and assumed liabilities in advance of the 12-month post acquisition date, as allowed by GAAP.

 

Issued but Not Yet Effective Accounting Standards Updates (“ASUs”)In connection with the acquisition, Bancorp became the 100% successor owner of KBST, an unconsolidated finance subsidiary. As permitted under the terms of KBST’s governing documents, Bancorp redeemed the TPS at the par amount of approximately $4 million on June 17, 2019.

Issued but Not Yet Effective Accounting Standards Updates

 

For disclosure regarding the impact to Bancorp’s financial statements of issued-but-not-yet-effective ASUs, see Footnote 1 “Basisthe footnote titled “Basis of Presentation and Summary of Significant Accounting Policies”Policies of Part I Item 1 “Financial Statements.Financial Statements.

 

Business Segment Overview

 

Business Segment Overview

As of June 30, 2019, Bancorp wasis divided into two reportable segments: Commercial Banking and Wealth Management & Trust (“WM&T”):&T:

 

Commercial Banking provides a full range of loan and deposit products to individual consumers and businesses in all its markets through commercial lending, retail lending, mortgage banking, deposit services, treasury management services, private banking, online banking, mobile banking, private banking, commercial lending, treasury management services, merchant services, international banking, correspondent banking and other banking services. The Bank also offers securities brokerage services via its banking center network through an arrangement with a third party broker-dealer.broker-dealer in the Commercial Banking segment. 

 

WM&T with over $3 billion in assets under management (“AUM”), provides custom-tailored financial planning, investment management, company retirement plan management, retirement planning, and trust and estate services in all markets in which Bancorp operates. The magnitude of WM&T revenue distinguishes Bancorp from other community banks of similar asset size.

 

 

Overview – Impact of the COVID-19 Pandemic on Financial Condition and Results of Operations

Summary - Three

The COVID-19 pandemic in the U.S. and Six Months Ended June 30, 2019 Comparedefforts to contain it have had a complex and significant adverse impact on the economy, the banking industry and Bancorp. The impact on future fiscal periods is subject to a high degree of uncertainty.

On March 11, 2020, the World Health Organization declared COVID-19 to be a global pandemic, indicating that almost all public commerce and related business activities must be, to varying degrees, curtailed with the goal of decreasing the rate of new infections. The spread of the outbreak has caused significant disruptions in the U.S. economy and has disrupted banking and other financial activity in the markets in which Bancorp operates. While some industries have been impacted more severely than others, all businesses have been impacted to some degree. This disruption resulted in the initial shuttering of non-essential businesses across most of the country, significant job loss, and aggressive measures by the federal government. While there has been some phased-in re-opening of commerce that began in the second quarter, unemployment levels have remained elevated.

In response to the Threeabove, Congress, the President and Six Months Ended June 30, 2018regulatory agencies took action designed to lessen the economic fallout. Most notably, the CARES Act was signed into law at the end of March. The goal of the CARES Act was to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors.

 

Three months ended June 30, (In thousands, except per share data)

 

2019

  

2018

  

$ Change

  

% Change

 
                 

Net income

 $16,543  $13,579  $2,964   21.8%

Diluted earnings per share

 $0.72  $0.59  $0.13   22.0%

Annualized return on average assets

  1.93%  1.74% 

19 bps

   10.9%

Annualized return on average equity

  17.40%  15.94% 

146 bps

   9.2%

The CARES Act, established the SBA PPP to provide loans for eligible businesses/not-for-profits with the focus on job retention and certain operating expenses. Portions of these loans qualify for forgiveness for payroll costs, mortgage interest, rent and utilities during the 24-week period beginning with the date of the loan. Loans funded through the PPP are fully guaranteed by the U.S. government.

 

The CARES Act permits financial institutions to suspend requirements under GAAP for loan modifications to borrowers affected by COVID-19 and is intended to provide interpretive guidance as to conditions that would constitute a short-term modification that would not meet the definition of a TDR. This includes the following (i) the loan modification is made between March 1, 2020 and the earlier of December 31, 2020 or 60 days after the end of the coronavirus emergency declaration, and (ii) the applicable loan was not more than 30 days past due as of December 31, 2019. Bancorp is applying this guidance to qualifying loan modifications and has implemented modifications meeting these conditions Federal bank regulatory authorities also issued guidance to encourage banks to make loan modifications for borrowers affected by COVID-19 and to assure banks that they will not be criticized by examiners for doing so.

Six months ended June 30, (In thousands, except per share data)

 

2019

  

2018

  

$ Change

  

% Change

 
                 

Net income

 $32,184  $26,983  $5,201   19.3%

Diluted earnings per share

 $1.40  $1.17  $0.23   19.7%

Annualized return on average assets

  1.93%  1.75% 

18 bps

   10.3%

Annualized return on average equity

  17.25%  16.05% 

120 bps

   7.5%

 

OverviewThe PPP directly impacted Bancorp’s financial condition and results of operations for the three and six months ended June 30, 2019 compared with same period in 2018

Bancorp completed the first six months of 2019 with record net income of $32.2 million, a 19.3% increase over the comparable period in 2018. The increase is primarily due to higher net interest income driven by year-over-year average loan growth, higher non-interest income led by WM&T and debit and credit card income, and a lower effective income tax rate resulting from Kentucky tax law changes. Diluted earnings per share for the first six months of 2019 were $1.40, compared to $1.17 for the first six months of 2018.

Key factors affecting Bancorp’s results for the six months ended June 30, 2019 included:

Average loans increased $115.4 million, or 4.7%, year over year as a result of strong loan production and the May 1, 2019 King acquisition, contributing to a 16.6% increase in interest income. Total average deposits increased 9.8% to support loan growth, reflecting strong growth in time deposits and the impact of the King acquisition;

Net interest income increased $4.4 million or 7.9% for the six months ended June 30, 2019, due largely to a $8.4 million increase in interest income earned on loans;

Net interest margin rose 1 basis point compared with the same period of 2018 as interest income stemming from asset growth offset increased interest expense resulting from deposit rate increases;

Credit quality metrics remained sound, including net loan loss recoveries for the first six months of 2019, leading to reduced provision for loan and lease losses (“provision”) of $600 thousand, as compared with $2.0 million for the comparable 2018 period;

WM&T, buoyed by a strong second quarter market and new business generation, achieved 2.4% revenue growth year over year;

Card income and treasury management fees, bolstered by increased volume and usage, continued to stand out as diversifying non-interest revenue streams; and

Bancorp’s effective income tax rate declined to 8.2% for the six months ended June 30, 2019 based on changes made to Kentucky state tax law during the first and second quarters of 2019.  

Net interest income increased $4.4 million, or 7.9%, for the first six months of 2019,2020 as compared with the same period in 2018. Net interest margin increased to 3.85% for the first six months of 2019, compared with 3.84% for the same period of 2018. Increasing average rates earned on interest earning assets, along with the impact of increased volumes of loans and short-term investments contributed to higher interest income for the first six months of 2019, as interest income increased $10.2 million, or 16.6%, over the same period in 2018. Average earning asset growth attributable to the May 1, 2019 King acquisition totaled $56 million for the six-month comparison period. Higher long-term borrowing costs assumed in the King acquisition, along with a shift in deposits from non-interest bearing accounts to interest bearing accounts resulted in an increase in interest expense of $5.8 million. Interest paying liabilities assumed as part of the King acquisition contributed $47.1 million of the total $149.6 million average interest bearing liabilities growth for the six month comparison. The average balance of time deposits increased $144.8 million, or 61.2% in the first six months of 2019, as compared with the same period in 2018, as a result primarily of targeted marketing campaigns initiated in 2018 to support loan growth and add liquidity to the balance sheet. The corresponding cost of time deposits increased from 0.86% for the first six months of 2018 to 1.93% for the same period in 2019.

For the six-month period ended June 30, 2019, Bancorp recorded a $600 thousand provision, compared with $2.0 million for the same period in 2018. The provision represents a charge to earnings necessary to maintain an allowance that, in management’s estimation, is adequate to provide coverage for the inherent losses on outstanding loans. The provision reflects many factors including trends in the portfolio, as well as changes in quantitative and qualitative factors. Reflecting continued strong credit quality metrics, and net recoveries of $282 thousand in the first six months of 2019, the allowance to total loans was 0.96% as of June 30, 2019, compared with 0.96% as of June 30, 2018. In management’s opinion, the allowance remained adequate to cover potential losses within the portfolio.

Total non-interest income for the first six months of 2019 increased $981 thousand, or 4.4%, compared with the same period in 2018. Non-interest income comprised 27.9% of total revenues, defined as net interest income and non-interest income, as compared with 28.5% for the same period in 2018. Bancorp’s WM&T services comprised 47.6% of Bancorp’s non-interest income. Debit and credit card revenue, as a result of increasing transaction volumes and incentives paid by the credit card processor, increased $715 thousand, or 22.4% in the first six months of 2019, as compared with the same period in 2018. Treasury management fees, a steadily growing source of revenue for Bancorp, increased $199 thousand, or 9.2%, in the first half of 2019, as compared with the first half of 2018. These items offset declines of $275 thousand, and $81 thousand, for deposit service charges and investment product sales commissions and fees, respectively, for the first six months of 2019, as compared with 2018.

Total non-interest expense in the first six months of 2019 increased $4.9 million, or 11.4%, compared with the same period in 2018. Increases in compensation, technology and communication, legal and professional fees, and other expenses drove the increase. Costs associated with the King acquisition recognized during 2019 totaled $1.3 million approximately, or $0.05 net income per diluted share, and were spread primarily between compensation and legal and professional fees. Bancorp's efficiency ratio, reflecting the one-time transaction costs associated with the King acquisition recognized in the first six months of 2019 was 57.36%, as compared with 54.98% in the same period in 2018.

Bancorp recorded income tax expense of $2.9 million for the first six months of 2019, compared to $6.2 million for the same period in 2018.  The effective rate for the corresponding six month periods was 8.2% and 18.7%, respectively.  The decrease in the effective tax rate from 2018 to 2019 related primarily to Kentucky state tax law changes as discussed below:follows:

 

 

In March 2019,During the Kentucky Legislature passed HB354 requiring financial institutionssecond quarter of 2020, 3,250 loans totaling $647 million were originated, with the PPP portfolio representing 18% of total loans outstanding at June 30, 2020.

While the PPP was primarily offered to transitionBancorp’s customer base to limit fraud risk, Bancorp added approximately 350 new relationship prospects that have begun the process of migrating over their full commercial banking relationship.

With origination fees ranging between 1% and 5% based on the size of the loan, Bancorp received $20 million in origination fees from a capital based franchise tax to the Kentucky corporate income tax beginning in 2021. Historically, the franchise tax, a component of non-interest expenses, was assessed at 1.1% of net capital and averaged $2.5 million annuallySBA that will be recognized over the prior two year-end periods. The Kentucky corporate income tax will be assessed at 5% of Kentucky taxable income and will be included as a component of current and deferred state income tax expense. Associated with this change, during the first quarter of 2019, Bancorp established a Kentucky state deferred tax asset related to existing temporary differences estimated to reverse after the effective dateterm of the law change. Bancorp recorded a corresponding state tax benefit, net of federal impact of $1.3 million, or approximately $0.06 per diluted share for the first six months of 2019.  While this is positive in the short-term, Bancorp anticipates an unfavorable impact of approximately $200 thousand per year beginning in 2021.loans (predominantly 24 months).

 

 

 

InApproximately $3.4 million in interest and fee income was recognized during the three months ended June 30, 2020. While this had a positive impact to interest income and net interest income, the 1% stated yield on the PPP portfolio negatively impacted the overall loan portfolio yield and NIM.

Based on the 100% SBA guarantee of PPP loans, Bancorp did not reserve for potential losses within the ACL on these loans.

Bancorp experienced a significant increase in deposit balances (both average and ending) directly related to customers who originated PPP loans.

A portion of Bancorp’s customer base paid down existing operating C&I lines of credit in part with excess liquidity resulting from PPP loans, a sign of the strength of certain borrowers.

Bancorp relied on deposit growth in addition to excess cash on hand to fund the PPP loans with no reliance placed on external funding sources. Maintaining excess liquidity related to the PPP loan portfolio contributed to overall NIM compression.

With regard to Bancorp’s compensation expense, the origination of the PPP loans led to elevated levels of deferred salary costs with the offset to deferred loan fees and amortized over the term of the related loans.

Consistent with the historic decline in credit utilization coupled with the adoption of ASC-326, Bancorp incurred a significant increase in reserves for off-balance sheet credit exposures recorded as a component of non-interest expenses.

Bancorp’s leverage ratio, which consists of tier-1 capital divided by adjusted quarterly average assets, was negatively impacted by the outsized balance sheet growth attributed to PPP participation. This will normalize over time, as PPP loans pay-off early or ultimately mature. Bancorp and the Bank remained “well capitalized” in all other capital ratios at June 30, 2020.

Other pandemic-related impacts to Bancorp’s financial condition and results of operations for the three and six months ended June 30, 2020 as follows:

As previously disclosed, on March 16, 2020, the FRB responded to the pandemic by lowering the FFTR to a range of 0% - 0.25% resulting in Prime dropping to 3.25%.

Loan loss provisioning for the second quarter of 2020 was significantly impacted by the economic crisis and corresponding impact on national unemployment forecast adjustments within the CECL model, changes in the loan mix and the addition of a large specific reserve during the second quarter.

Bancorp deferred either the full loan payment or the principal only portion of respective loan payments for 90 or 180 days for some borrowers directly impacted by the pandemic.  As of June 30, 2020, Bancorp executed 1,100 of full payment deferrals (predominantly 3 months) on outstanding loan balances of $502 million - representing 18% of the loan portfolio (excluding PPP loans). Approximately 85% of the total deferrals processed (in terms of dollars) occurred in the month of April, with the subsequent pace slowing significantly. Pursuant to the CARES Act, these loan deferrals were not classified as TDRs and not included in non-performing loan statistics. Subsequent to the end of the second quarter and through the end of July, a significant portion of the deferred loan portfolio returned to full paying status. As of July 31, 2020, Bancorp estimates that 10% of the total loan portfolio (excluding PPP loans) remained in full payment deferment status. Bancorp is monitoring loan modification expirations daily and anticipates the potential for more customers to return to full payment status over the next two months as their initial deferral period ends. While the modifications themselves did not trigger a loan risk rating downgrade, if the impact of COVID-19 continues, borrower operations do not improve or if other negative events occur, such modified loans could transition to potential problem loans or into problem loans.

Deposit balance for both commercial customers who received PPP funding and those that did not were elevated at June 30, 2020 based on the deferment of tax payments.

Consistent with the industry, deposit service charges and debit/credit card income were impacted by pandemic driven changes in customer behavior. This led to among other things, lower transaction volumes and types of spending during April and May with June showing notable improvement for the quarter.

Bancorp did not incur material non-interest expenses related to the execution of its pandemic plan first placed in service in March.

o

During the second quarter of 2020, debit/credit card processing expense declined directionally consistent with the decline in revenue noted above.

o

Marketing and business development expenses include all costs associated with promoting Bancorp, community support, retaining customers and acquiring new business. Marketing and business development expenses decreased sharply during the second quarter corresponding directly with less physical customer interaction as a result of the pandemic.

In tandem with the declaration of the global pandemic, Bancorp invoked its Board approved pandemic plan, which included timely communication to employees, implementing remote work arrangements to the full extent possible, separating individual departments, operating select branch lobbies by appointment only, fully staffing all branch drive-thru lanes, communicating with and encouraging our customers to use Bancorp’s free self-service tools such as ITMs/ATMs, online banking, mobile banking and bill pay and actively promoting social distancing in all aspects of business.

Bancorp has focused first on the well-being of its employees, customers and communities during this time. Preventative health measures were put in place and many employees worked remotely for the majority of the second quarter. Bancorp also established social distancing precautions for all employees in the office and customers visiting branches, preventative cleaning at offices and branches, and eliminated business related travel. Towards the end of the second quarter, Bancorp began returning employees to the office pursuant to new health and safety procedures and in accordance with guidance from the CDC and local authorities, including regular symptom checks, requiring cloth face coverings, increasing physical space between employees, and requiring employees with symptoms associated with COVID-19 or potential exposure to quarantine away from the office. Bancorp implemented business continuity measures as necessary throughout the pandemic including monitoring potential business interruptions. Bancorp has not incurred material expense related to executing the pandemic plan and no material operational or internal control challenges or risks have been identified to date.

Bancorp has taken measures both to support customers affected by the pandemic and to maintain strong asset quality, including:

Assisting business customers through PPP and other government sponsored loan products

Tightening underwriting standards

Monitoring portfolio risk and related mitigation strategies by segments

Limiting originations to higher risk industries and customers including, but not limited to, transportation, travel, hospitality, entertainment, and retail

Proactively contacting customers in order to assess credit situations and needs and develop long-term contingency financial plans

Offering flexible repayment options to current customers and a streamlined loan modification process, when appropriate

Management continues to meet regularly to anticipate and respond to any future pandemic interruptions or developments. Bancorp has not incurred any significant challenges to its ability to maintain its systems and controls in light of the measures taken to prevent the spread of COVID-19 and has not incurred significant resource constraints through the implementation of its business continuity plans and does not anticipate incurring such in the future. Bancorp has not made, and at this time does not expect to make, any material staffing or compensation changes as a result of the pandemic.

Overview Operating Results(FTE)

The following table presents an overview of Bancorp’s financial performance for the three months ended June 30, 2020 and 2019:

Three months ended June 30, (dollars in thousands, except per share data)

 

2020

  

2019

  

$ Change

 

% Change

 
                

Net income

 $13,368  $16,543  $(3,175) -19%

Diluted earnings per share

 $0.59  $0.72  $(0.13) -18%

Annualized return on average assets

  1.25%  1.93% 

(68

) bps -35%

Annualized return on average equity

  12.90%  17.40% 

(450

) bps -26%

Additional discussion follows under the section titled “Results of Operations.”

General highlights for the three months ended June 30, 2020 compared to June 30, 2019:

Net income totaled $13.4 million, resulting in diluted EPS of $0.59, an 18% decline over $0.72 for the same period of 2019, the Kentucky legislature passed HB458 allowing banks and their holding companieslatter of which included a $2.4 million favorable non-recurring tax adjustment related to be combined together fora Kentucky tax return filings beginninglaw change that equated to $0.11 per diluted share in 2021. The combined filing will allow Bancorp’s Holding Companyaddition to significant acquisition deal costs that equated to $0.05 per diluted share.

NIM decreased 54 bps to 3.27% for the three months ended June 30, 2020 compared to 3.81% for the same period in 2019 consistent with the large decline in interest rates led by the FRB, the significant addition of the low yielding PPP loan portfolio and excess balance sheet liquidity; offset by strong average quarter over prior quarter loan growth (excluding PPP loans) and the strategic lowering of stated deposit interest rates and CD offering rates in tandem with the FRB interest rate actions.

Despite the decline in NIM, net operating lossesinterest income increased $2.7 million, or 9%, for the three months ended June 30, 2020 compared to offset against net revenue generated by The Bank and reduce Bancorp’s tax liability. Bancorp recorded a state tax benefitthe same period in 2019 based on the fee income recognized associated with this changethe PPP portfolio and significant benefit from the strategic lowering of $2.4stated deposit rates.

Total loans (excluding PPP loans) contracted $103 million during the second quarter of 2020. C&I loan balances led the decline, falling $119 million. Average loans (excluding PPP loans) increased 8% for the three months ended June 30, 2020 compared to the same period in 2019, driven by strong organic loan growth within Bancorp’s three markets over the previous 12 months in addition to the May 2019 acquisition.

Both ending and quarterly average deposit balances ended at record levels at June 30, 2020, primarily as a result of PPP funding in addition to higher levels of liquidity held by customers attributable to current economic uncertainty.

The quarter ended June 30, 2020 was the second in which Bancorp accounted for credit losses under ASC 326,orCECL. Despite continued minimal net charge-offs and overall strong credit metrics, significant provisioning occurred based on the economic crisis and corresponding impact on national unemployment forecast adjustments within the CECL model, changes in the loan mix and the addition of a large specific reserve during the second quarter totaling $2 million related to one CRE customer. Consistent with the significant decline in line utilization (mainly C&I) experienced in the second quarter of 2020, Bancorp also recorded $1.5 million in additional non-interest expense related to credit exposure for unfunded off-balance sheet commitments. At June 30, 2020, approximately $6 million was accrued within other liabilities related to off balance sheet exposures.

Bancorp’s ACL to total loans was 1.38% at June 30, 2020, compared to 1.43% at March 31, 2020 and 0.94% at December 31, 2019. Bancorp’s ACL to total loans (excluding PPP loans) rose to 1.68% at June 30, 2020.

Non-interest income increased 3% for the three months ended June 30, 2020 compared to the same period in 2019:

o

Despite economic uncertainty and market volatility, WM&T income increased for the quarterly comparison.

o

As noted above, deposit service charges and debit/credit card income were negatively impacted by the pandemic during the quarter.

o

The Treasury Management department was able to overcome the significant decline in pandemic related transaction volume with new product sales and expansion within its customer base. The demand for treasury products has increased during the pandemic, as these products allow customers to operate more efficiently in a decentralized environment.

o

The sustained low interest rate environment led to elevated mortgage refinancing activity and record mortgage banking results.

Bancorp’s efficiency ratio (FTE) for the three months ended June 30, 2020, was 53.87% compared with 59.08% for the same period in 2019, the latter of which included $1.3 million in one-time deal costs associated with an acquisition.

Non-interest expenses remained well-controlled and declined 2% for the three months ended June 30, 2020 compared to the same period in 2019 despite the addition of branches, personnel and increased provisioning for off-balance sheet credit exposures.

The ETR increased to 14.9% for the three months ended June 30, 2020 from 5.9% for the same period in 2019. The second quarter of 2019 reflected a $2.4 million non-recurring state tax adjustment related to Kentucky tax law changes.

The following table presents an overview of Bancorp’s financial performance for the six months ended June 30, 2020 and 2019:

Six months ended June 30, (dollars in thousands, except per share data)

 

2020

  

2019

  

$ Change

 

% Change

 
                

Net income

 $26,600  $32,184  $(5,584) -17%

Diluted earnings per share

 $1.17  $1.40  $(0.23) -16%

Annualized return on average assets

  1.33%  1.93% 

(60

) bps -31%

Annualized return on average equity

  13.04%  17.25% 

(421

) bps -24%

Additional discussion follows under the section titled “Results of Operations.”

General highlights for the six months ended June 30, 2020 compared to June 30, 2019:

The momentum associated with a record 2019 was halted late in the first quarter by the COVID-19 pandemic. Uncertain economic conditions, a substantially lower interest rate environment and government stimulus action have had a significant impact on Bancorp’s results, mainly during the second quarter of 2020 as detailed in the previous section of the document.

Effective January 1, 2020, Bancorp began accounting for credit losses under ASC 326,or approximately $0.11CECL. The adoption of this standard increased the opening balance of the ACL on loans by $8.2 million and reserve for off-balance sheet exposures by $3.5 million as of January 1. The adoption entries reduced Bancorp’s retained earnings on a tax-effected basis of $8.8 million, with no impact on earnings. In addition, on January 1, 2020, the amortized cost basis of the PCD loans were adjusted upwards to reflect the addition of $1.6 million of the ACL on loans.

Net income totaled $26.6 million for the six months ended June 30, 2020, resulting in diluted EPS of $1.17, a 16% decline from the same period in 2019, the latter of which included $3.8 million in non-recurring tax adjustments related to two Kentucky tax law changes that equated to $0.17 per diluted share in addition to significant acquisition deal costs, which equated to $0.05 per diluted share.

The FRB has lowered the FFTR five times since June 30, 2019, resulting in a combined 225 bps decrease in the FFTR over the last 12 months. The most recent of these cuts occurred in mid-March 2020, when the FRB lowered the FFTR to a range of 0% - 0.25% in response to the pandemic - the lowest level seen since late 2015. Bancorp has lowered the stated rate of interest-bearing deposit account types and CD offering rates in tandem with these cuts and further decreases in the interest rate environment.

NIM decreased 38 bps to 3.47% for the six months ended June 30, 2020 compared to 3.85% for the same period in 2019 consistent with the lowering of the FFTR, the PPP portfolio and excess balance sheet liquidity; offset by strong average year over prior year loan growth (excluding PPP loans) and the strategic lowering of stated deposit interest rates and CD offering rates in tandem with FRB interest rate actions.

Despite the decline in NIM, net interest income increased $5.5 million, or 9%, for the six months ended June 30, 2020 compared to the same period in 2019 based on the fee income recognized associated with the PPP portfolio and significant benefit from the strategic lowering of stated deposit rates.

Total loans (excluding PPP loans) contracted $11 million during the first six months of 2020, with the second quarter decline completely reversing the first quarter growth of $92 million fueled by robust and record first quarter production. During 2020, a $67 million increase in the CRE portfolio was offset by a $74 million decline in the C&I portfolio – primarily operating lines of credit.

Despite flat line of credit usage for the first quarter of 2020, usage declined significantly to 39% at June 30, 2020 compared to 48% at June 30, 2019.

Both ending and year to date average deposit balances ended at record levels at June 30, 2020, primarily as a result of PPP funding in addition to higher levels of liquidity held attributable to current economic uncertainty.

Despite continued minimal net charge-offs and overall strong credit metrics, significant provisioning occurred based on the economic crisis and corresponding impact on national unemployment forecast adjustments within the CECL model, changes in the loan mix and the addition of a large specific reserve during the second quarter totaling $2 million related to one CRE relationship. Consistent with the significant decline in line utilization (mainly C&I), Bancorp also recorded $1.9 million in additional non-interest expense related to credit exposure for unfunded off-balance sheet commitments, with $1.5 million of the expense recorded in the second quarter of 2020. At June 30, 2020, approximately $6 million was accrued within other liabilities related to off balance sheet exposures.

Bancorp’s ACL to total loans was 1.38% at June 30, 2020, compared to 0.94% at December 31, 2019. Bancorp’s ACL to total loans (excluding PPP loans) was 1.68% at June 30, 2020.

Non-interest income increased 8%, for the six months ended June 30, 2020 compared to the same period in 2019 led by mortgage banking and WM&T income. The sustained low interest rate environment has continued to incentivize record mortgage refinancing activity and WM&T income was boosted by a large non-recurring estate fee collected in the first quarter of 2020. Card income and treasury management fees also continued to stand out as diversifying revenue streams, representing a combined 26% of total non-interest income.

Bancorp’s efficiency ratio (FTE) for the six months ended June 30, 2020 was 53.53% compared with 57.34% for the same period in 2019, the latter of which included $1.3 million in one-time deal costs associated with an acquisition closed in the prior year.

Non-interest expenses, which have remained well-controlled, increased 2%, for the six months ended June 30, 2020 compared to the same period in 2019 despite the addition of branches, personnel and other expenses related to the May 2019 acquisition and increased provisioning for off-balance sheet credit exposures.

The ETR increased to 14.7% for the six months ended June 30, 2020 from 8.2% for the same period in 2019, the latter of which reflected $4.0 million in non-recurring tax adjustments related to two Kentucky tax law changes.

TCE is a measure of a company’s capital, which is useful in evaluating the quality and adequacy of capital. Bancorp’s ratio of TCE to total tangible assets was 9.39% as of June 30, 2020, compared with 10.55% at December 31, 2019 and 10.85% at June 30, 2019. The fluctuation from December 31, 2019 to June 30, 2020 was driven by asset growth (mainly PPP loans), the change in AOCI and CECL related adjustments. See the section titled “Non-GAAP Financial Measures” for reconcilement of non-GAAP to GAAP measures.

Results of Operations

Net Interest Income - Overview

As is the case with most banks, Bancorp’s primary revenue sources are net interest income and fee income from various financial services provided to customers. Net interest income is the difference between interest income earned on loans, investment securities and other interest earning assets less interest expense on deposit accounts and other interest bearing liabilities. Loan volume and interest rates earned on those loans are critical to overall profitability. Similarly, deposit volume is crucial to funding loans and rates paid on deposits directly impact profitability. New business volume is influenced by economic factors including market interest rates, business spending, consumer confidence and competitive conditions within the marketplace.

Comparative information regarding net interest income follows:

As of and for the three months ended June 30,

         

Variance

 

(dollars in thousands)

 

2020

  

2019

  

2020 / 2019

 
             

Net interest income

 $33,528  $30,802   8.9

%

Net interest spread

  3.10%  3.47%  (37) bps

Net interest margin

  3.27%  3.81%  (54) bps

Average interest earning assets

 $4,124,046  $3,244,941   27.1

%

As of and for the six months ended June 30,

         

Variance

 

(dollars in thousands)

 

2020

  

2019

  

2020 / 2019

 
             

Net interest income

 $65,974  $60,486   9.1

%

Net interest spread

  3.27%  3.52%  (25) bps

Net interest margin

  3.47%  3.85%  (38) bps

Average interest earning assets

 $3,823,598  $3,173,069   20.5

%

The discussion that follows is based on FTE data.

NIM and net interest spread calculations above exclude the sold portion of certain participation loans. These sold loans are on Bancorp’s balance sheet as required by GAAP because Bancorp retains some form of effective control; however, Bancorp receives no interest income on the sold portion. These participation loans sold are excluded from analysis, as Bancorp believes it provides a more accurate depiction of the performance of its loan portfolio.

Bancorp’s loan portfolio is currently composed of approximately 71% fixed and 29% variable rate loans, with the fixed rate portfolio pricing based on a spread to the five-year treasury curve at the time of origination and the variable portion pricing based on an on-going spread to Prime (approximately 60%) or one month LIBOR (approximately 40%). Bancorp’s loan portfolio (excluding PPP loans) at June 30, 2020 was composed of approximately 65% fixed and 35% variable rate loans with the fluctuation in the C&I portfolio driving down variable rate concentration for the quarter.

The FRB has lowered the FFTR five times since June 30, 2019, resulting in a combined 225 bps decrease in the FFTR over the last 12 months. The most recent of these cuts came in mid-March 2020 when the FRB lowered the FFTR to a range of 0% - 0.25% in response to the COVID-19 pandemic, the lowest level seen since late 2015. The following table details the volatility experienced within the interest rate environment over the past several months by comparing period end and quarterly average rates:

  

June 30,

  

March 31,

  

December 31,

  

June 30,

  

March 31,

 
  

2020

  

2020

  

2019

  

2019

  

2019

 
                     

Five-year Treasury note - period end

  0.29%  0.37%  1.69%  1.76%  2.23%

Five-year Treasury note - quarterly average

  0.36%  1.14%  1.61%  2.12%  2.46%

Prime rate - period end

  3.25%  3.25%  4.75%  5.50%  5.50%

Prime rate - quarterly average

  3.25%  4.40%  4.83%  5.50%  5.50%

One-month LIBOR - period end

  0.16%  0.99%  1.79%  2.40%  2.49%

One-month LIBOR - quarterly average

  0.35%  1.40%  2.22%  2.44%  2.50%

Bancorp has lowered the stated rate of interest-bearing deposit account types and CD offering rates in tandem with the above-mentioned FRB interest rate actions and managed to fully offset the decline in loan yields associated with the first two FFTR rate reductions, which occurred in August and September of 2019. The subsequent rate cuts in October 2019, and to a greater extent in March of 2020, have resulted in significant NIM compression, as further deposit rate reductions have not been able to fully off-set the decline in loan yields. As of June 30, 2020, current deposit rates are at or below rates offered during the Great Recession.

The short end of the treasury yield curve at both March 31, 2020 and June 30, 2020 mirrored what was experienced during the Great Recession with the long end, particularly the five-year treasury, dramatically lower. While the curve normalized during the first quarter of 2020, the steep decline/inversion of the treasury curve that began in the second quarter of 2019 has led to intense pricing pressure and stiff competition over this period. With 60% of the variable rate loan portfolio tied to Prime and the majority with floor rates of 4.00%, short-term rates would have to increase over 75 bps for these loans to move above their floor rates given Prime is at 3.25% as of June 30, 2020. Beyond potential ongoing pricing pressure/competition and the absolute low level of rates, the current economic outlook and prospects of a sustained zero-rate environment continues to pose challenges regarding potential ongoing NIM compression.

Net Interest Income – Three months ended June 30, 2020 compared to June 30, 2019

Net interest spread and NIM were 3.10% and 3.27%, for the three months ended June 30, 2020 compared to 3.47% and 3.81% for the same period in 2019. NIM during the three months ended June 30, 2020 was significantly impacted by:

The lowering of the FFTR between August 2019 and mid-March 2020, ending at a range of 0% - 0.25% resulting in Prime dropping to 3.25%.

PPP loan originations during the second quarter of 2020, with significant concentration during the month of April.

The strategic lowering of stated deposit interest rates and CD offering rates over the past 12 months in tandem with FRB interest rate actions.

Strong average loan growth (excluding PPP loans) related to both a prior year acquisition and organic growth.

Excess balance sheet liquidity.

 

The ratioDuring the second quarter of stockholder’s equity to2020, 3,250 PPP loans totaling $647 million were originated, with the portfolio representing 18% of total assets was 11.24% as of June 30, 2019, as compared with 11.10% at December 31, 2018, and 10.40%loans outstanding at June 30, 2018. Total equity increased $22.92020. Origination fees ranged between 1% and 5% based on the size of the loan with the average fee equating to 3.12%. During the three months ended June 30, 2020, Bancorp received $20 million in origination fees from the first six monthsSBA and recognized $2.1 million in fee income. While this had a positive impact to interest and fee income and net interest income, the 1% stated yield on the PPP portfolio negatively impacted the overall loan portfolio (excluding PPP loans) yield and NIM by 27 bps and 11 bps, respectively. With a heavy concentration of 2019, as net incomethese loans originating in April, the average balance of $32.2the portfolio ended at $529 million was offset by dividends declared of $11.6 million and stock repurchases totaling $5.8 million. Bancorp’s ratio of tangible common equity (“TCE”) to total tangible assets was 10.85% as offor the quarter ended June 30, 2019,2020 with a yield of 2.58% - significantly below the 4.31% yield on the loan portfolio (excluding PPP loans) for the three months ended June 30, 2020.

With regard to the PPP, borrowers are eligible for forgiveness from the SBA for the portion of funding received utilized for job retention and certain other expenses, such as payroll costs, mortgage interest, rent and utilities during the 24-week period beginning with the date of the loan. With a significant portion of these loans potentially eligible for full forgiveness there is high likelihood of early pay off prior to maturity (24 months and 60 months for loans that originated post June 5, 2020). Early payoff of such would accelerate recognition of the fee (and to a lesser extent the deferred salary cost) and could have a material positive impact to future operating results.

Average FFS and interest bearing due from bank balances increased significantly for the three months ended June 30, 2020 compared with 11.05% at December 31, 2018, and 10.35% atthe same period in 2019. This excess liquidity contributed to approximately 19 bps of NIM compression for the three months ended June 30, 2018, with the decline attributable to the KSB acquisition. TCE, (a non-U.S. Generally Accepted Accounting Principle (“GAAP”) measure), is a measure of a company's capital which is useful in evaluating the quality and adequacy of capital. See the Non-GAAP Financial Measures section for details on reconcilement to GAAP measures.

Results of Operations2020.

 

Net interest income increased $2.7 million, or 9%, for the three months ended June 30, 2020 compared to the same period of $16.52019, led primarily by increased fee income associated with the PPP loan portfolio and decreased funding costs on deposits.

Total average interest earning assets increased $879 million, or 27%, to $4.1 billion for the three months ended June 30, 2020, with the average rate earned on total interest earning assets contracting 102 bps to 3.56%.

Average loans increased $739 million, or 28%, for the three months ended June 30, 2020 compared to the same period in 2019 with $529 million of this growth attributed to the PPP portfolio. Strong quarter over prior year quarter organic growth across all three markets in addition to the May 2019 acquisition has boosted the loan portfolio (excluding PPP loans) average loans by $210 million over the past 12 months.

Average FFS/interest bearing due from bank balances increased $148 million for the three months ended June 30, 2020 as compared with the same period in 2019, consistent with the increase in deposits.

Total interest income decreased $500,000, or 1%, to $36.6 million for the three months ended June 30, 20192020, as compared to the same period of 2019.

Interest and fee income on loans increased $660,000, or 2%, to $34.1 million, attributed mainly to fee income associated with the PPP portfolio. Despite significant average loan balance (excluding PPP loans) growth, interest income declined $2.7 million, or 8%, consistent with significant interest rate contraction within the loan portfolio over the past 12 months.

With the exception of mortgage loans held for sale, interest income on the remaining interest earning asset portfolio was significantly impacted by the lower interest rate environment over the past 12 months coupled with significant average balance growth.

Total average interest bearing liabilities increased $3.0$375 million, or 21.8%17%, from $13.6 millionto $2.6 billion for the comparable 2018 period. Basic net income per share was $0.73three-month period ended June 30, 2020 compared with the same period in 2019, with the total average cost declining 65 bps to 0.46%.

Average interest bearing deposits increased $388 million, or 18%, for the three months ended June 30, 2020 compared to the same period in 2019, with interest-bearing demand deposits representing $284 million of the increase. Customers who received PPP loans, the proceeds for which were deposited into accounts held at the Bank, have generally been slow in deploying the funds. Further, the economic slow-down and uncertainty surrounding the pandemic has resulted in the customer base maintaining higher levels of liquidity in general, similar to behavior seen during the Great Recession.

Average FHLB advances decreased $9 million, or 12%, for the three months ended June 30, 2020 compared to the same period of 2019, as a portion of the advances assumed in a prior year acquisition have been paid off.

Total interest expense decreased $3.2 million, or 52%, for the second quarterthree months ended June 30, 2020, compared to the same period of 2019, an increaseas a direct result of 21.7% fromstrategic deposit rate reductions implemented in response to the $0.60changing interest rate environment.

Total interest bearing deposit expense decreased $3.0 million, or 54%, representing a 65 bps decrease in the cost of average interest bearing liabilities.

Net Interest Income – Six months ended June 30, 2020 compared to June 30, 2019

Net interest spread and NIM were 3.27% and 3.47%, for the second quarter of 2018. Net income per share on a diluted basis was $0.72 for the second quarter of 2019, an increase of 22.0% from the $0.59six months ended June 30, 2020 compared to 3.53% and 3.85% for the same period in 2018. See Note 12 for additional information related to net income per share.2019. NIM during the six months ended June 30, 2020 was significantly impacted by:

 

Annualized return on average assets and annualized return on average stockholders’ equity were 1.93% and 17.40%, respectively, for the second quarter of 2019, compared with 1.74% and 15.94%, respectively, for the same period in 2018.

The FFTR was lowered 225 bps between August 2019 and mid-March 2020, resulting in Prime dropping to 3.25%. Average Prime has declined significantly to 3.81% for the six months ended June 30, 2020 compared to 5.50% for the same period in 2019.

PPP loan originations

The strategic lowering of stated deposit interest rates and CD offering rates over the past 12 months in tandem with FRB interest rate actions.

Strong average loan (excluding PPP loans) growth related to both a prior year acquisition and organic growth.

Excess balance sheet liquidity that has carried over from the first quarter of 2020 and expanded.

 

NetDuring the first six months of 2020, Bancorp received $20 million in origination fees from the SBA and recognized $2.1 million in fee income. While this had a positive impact to interest and fee income and net interest income, the 1% stated yield on the PPP portfolio negatively impacted the overall loan portfolio yield and NIM by 17 bps and 7 bps, respectively. With a heavy concentration of $32.2these loans originating in April, the average balance of the portfolio ended at $265 million for the six months ended June 30, 2019 increased $5.2 million, or 19.3%, from $27.0 million for2020 with a yield of 2.58% - significantly below the comparable 2018 period. Basic net income per share was $1.42 for4.51% yield on the first six months of 2019, an increase of 19.3% from the $1.19 for the same period of 2018. Net income per share on a diluted basis was $1.40 for the first half of 2019, an increase of 19.7% from the $1.17 for the same period in 2018. See Note 12 for additional information related to net income per share.

Annualized return on average assets and annualized return on average stockholders’ equity were 1.93% and 17.25%, respectively,loan portfolio (excluding PPP loans) for the six months ended June 30, 2019,2020.

Average FFS and interest bearing due from bank balances increased significantly for the six months ended June 30, 2020 compared with 1.75% and 16.05%, respectively, for the same period in 2018.2019. This excess liquidity contributed to approximately 17 bps of NIM compression for the six months ended June 30, 2020.

Net interest income increased $5.5 million, or 9%, for the first six months of 2020 compared to the same period of 2019, led primarily by increased fee income associated with the PPP loan portfolio and decreased funding costs on deposits.

Total average interest earning assets increased $651 million, or 21%, to $3.8 billion for the six months ended June 30, 2020, with the average rate earned on total interest earning assets contracting 73 bps to 3.86%.

Average loans increased $551 million, or 21%, for the six months ended June 30, 2020 compared to the same period in 2019 with $265 million of the growth attributed to the PPP portfolio. In addition to the May 2019 acquisition, Bancorp has experienced strong organic growth across all three markets leading to a $286 million increase in the loan portfolio (excluding PPP loans). Significant average loan balance growth during the first quarter of 2020 was partially reversed with a $24 million decline during the second quarter of 2020.

Average FFS and interest bearing due from bank balances increased $97 million for the six months ended June 30, 2020 as compared with the same period in 2019, consistent with the increase in deposits.

Total interest income increased $1.3 million, or 2%, to $73.5 million for the six months ended June 30, 2020, as compared with the first six months of 2019.

Interest income on loans increased approximately $2.8 million, or 4%, to $67.9 million, attributed mainly to fee income associated with the PPP portfolio. Despite significant average loan (excluding PPP loans) balance growth, interest income declined $551,000, or 1%, consistent with significant interest rate contraction within the loan portfolio over the past 12 months. In addition, NIM and loan yields were positively impacted by a large non-accrual commercial relationship that paid off in the first quarter of 2020, triggering previously unrecognized non-accrual interest of $350,000 to be recognized.

With the exception of mortgage loans held for sale, interest income on the remaining interest earning asset portfolio was significantly impacted by the lower interest rate environment over the past 12 months coupled with significant average balance growth.

Total average interest bearing liabilities increased $332 million, or 15%, to $2.5 billion for the six-month period ended June 30, 2020 as compared with the same period in 2019, with the average cost decreasing 47 bps to 0.59%.

Average interest bearing deposits increased $328 million, or 16%, for the six months ended June 30, 2020 compared to the same period in 2019, with interest-bearing demand deposits representing $205 million of the increase. Customers who received PPP loans, the proceeds for which were deposited into accounts held at the Bank, have generally been slow in deploying the funds. Further, the economic slow-down and uncertainty surrounding the pandemic has resulted in the customer base maintaining higher levels of liquidity in general, similar to behavior seen during the Great Recession.

Average FHLB advances increased $8 million, or 14%, for the six months ended June 30, 2020 compared to the same period of 2019, as a result of advances assumed in the May 2019 acquisition. These advances were retained by Bancorp based upon the favorable rates and terms at the time of acquisition in relation to the execution of Bancorp’s asset liability management strategy. A portion of these advances have either matured or been paid off without penalty during the first six months of 2020.

Total interest expense decreased $4.2 million, or 36%, for the six months ended June 30, 2020, compared to the same period of 2019, as a direct result of strategic deposit rate reductions implemented in response to the changing interest rate environment.

Total interest bearing deposit expense decreased $4.1 million, or 39%, and representing a 49 bps decline in the cost of average interest bearing liabilities.

 

 

NetTotal Company Average Balance Sheets and Interest IncomeRates - Three-Month Comparison

 

The following tables present average balance sheets for the three and six month periods ended June 30, 2019 and 2018 along with the related calculation of tax-equivalent net interest income, net interest margin and net interest spread for the related periods. See the notes following the tables for further explanation.

 

Three months ended June 30,

  

Three months ended June 30,

 
 

 

2019

  

2018

  

2020

  

2019

 
 

 

Average

     

Average

 

Average

     

Average

  

Average

     

Average

 

Average

     

Average

 

(Dollars in thousands)

 

balances

  

Interest

  

rate

  

balances

  

Interest

  

rate

 

(dollars in thousands)

 

Balance

  

Interest

  

Rate

  

Balance

  

Interest

  

Rate

 
                           

Earning assets:

                        

Interest earning assets:

                        

Federal funds sold and interest bearing due from banks

 $137,130  $830  2.43

%

 $36,985  $163  1.77

%

 $285,617  $88  0.12

%

 $137,130  $830  2.43

%

Mortgage loans held for sale

  3,794  43  4.55  2,975  44  5.93  18,010  125  2.79  3,794  43  4.55 

Securities available for sale:

                           

Taxable

  410,201  2,395  2.34  358,637  1,996  2.23  401,750  2,066  2.07  410,201  2,395  2.34 

Tax-exempt

  25,190  162  2.58  42,732  288  2.70   10,618   72  2.73   25,190   162  2.58 

FHLB stock

  10,590  151  5.72  8,925  109  4.90 

Loans, net of unearned income

  2,658,036   33,442  5.05   2,523,450   29,489  4.69 

Total securities

 412,368  2,138  2.09  435,391  2,557  2.36 
                                     

Total earning assets

  3,244,941   37,023  4.58  2,973,704   32,089  4.33 

Federal Home Loan Bank stock

 11,284  70  2.50  10,590  151  5.72 
                    

Less allowance for loan losses

  27,190        24,433      

SBA Paycheck Protection Program (PPP) loans

 529,361  3,392  2.58       

Non-PPP loans

  2,867,406   30,738  4.31   2,658,036   33,470  5.05 

Total loans

 3,396,767  34,130  4.04  2,658,036  33,470  5.05 
  3,217,751       2,949,271                        

Non-earning assets:

              

Total interest earning assets

 4,124,046   36,551  3.56  3,244,941   37,051  4.58 
                  

Less allowance for credit losses

 42,952       27,190      
                

Non-interest earning assets:

                        

Cash and due from banks

  43,955       40,607       43,346       43,955      

Premises and equipment, net

  64,238       42,000       57,206       64,238      

Accrued interest receivable and other assets

  110,231         100,616       
                  

Bank Owned Life Insurance

 32,814       33,038      

Accrued interest receivable and other

  102,970        77,193      

Total assets

 $3,436,175        $3,132,494        $4,317,430       $3,436,175      
               

Interest bearing liabilities:

                                                

Deposits:

                           

Interest bearing demand deposits

 $843,768  $1,408  0.67

%

 $792,193  $839  0.42

%

 $1,128,075  $351  0.13

%

 $843,768  $1,408  0.67

%

Savings deposits

  169,883  109  0.26  158,561  61  0.15  188,931  5  0.01  169,883  109  0.26 

Money market deposits

  689,954  2,079  1.21  657,230  1,206  0.74  760,210  211  0.11  689,954  2,079  1.21 

Time deposits

  409,163   2,056  2.02   238,746   568  0.95   423,099   2,040  1.94   409,163   2,056  2.02 

Total interest bearing deposits

  2,112,768  5,652  1.07  1,846,730  2,674  0.58  2,500,315  2,607  0.42  2,112,768  5,652  1.07 
 

Securities sold under agreements to repurchase

  39,969  28  0.28  61,993  33  0.21  41,517  8  0.08  39,969  28  0.28 

Federal funds purchased and other short term borrowings

  11,774  64  2.18  88,180  394  1.79 

FHLB advances

  72,923  424  2.33  48,929  229  1.88 

Subordinated debt

  1,497   26  6.97         

Federal funds purchased

 8,423  2  0.10  11,774  64  2.18 

Federal Home Loan Bank advances

 63,896  361  2.27  72,923  424  2.33 

Subordinated note

          1,497   26  6.97 
               
               

Total interest bearing liabilities

  2,238,931   6,194  1.11  2,045,832   3,330  0.65   2,614,151   2,978  0.46   2,238,931   6,194  1.11 
                  

Non-interest bearing liabilities:

                                                

Non-interest bearing demand deposits

  754,592       701,642       1,213,136       754,592      

Accrued interest payable and other liabilities

  61,382        43,383      

Accrued interest payable and other

  73,223        61,382      

Total liabilities

  3,054,905       2,790,857       3,900,510       3,054,905      
                                 

Stockholders’ equity

  381,270        341,637        416,920        381,270      
              

Total liabilities and stockholder's equity

 $3,436,175       $3,132,494       $4,317,430       $3,436,175      

Net interest income

     $30,829       $28,759        $33,573       $30,857    

Net interest spread

       3.47

%

      3.68

%

      3.10

%

      3.47

%

Net interest margin

       3.81

%

      3.88

%

      3.27

%

      3.81

%

 

 

Total Company Average Balance Sheets and Interest Rates - Six-Month Comparison

  

Six months ended June 30,

 
  

 

2019

  

2018

 
  

 

Average

      

Average

  

Average

      

Average

 

(Dollars in thousands)

 

balances

  

Interest

  

rate

  

balances

  

Interest

  

rate

 
                         

Earning assets:

                        

Federal funds sold and interest bearing due from banks

 $129,701  $1,563   2.43

%

 $53,991  $431   1.61

%

Mortgage loans held for sale

  2,766   80   5.83   2,539   79   6.27 

Securities available for sale:

                        

Taxable

  410,018   4,806   2.36   365,935   4,024   2.22 

Tax-exempt

  26,480   337   2.57   43,558   583   2.70 

FHLB stock

  10,392   308   5.98   8,310   219   5.31 

Loans, net of unearned income

  2,593,712   65,014   5.05   2,478,305   56,590   4.60 
                         

Total earning assets

  3,173,069   72,108   4.58   2,952,638   61,926   4.23 
                         

Less allowance for loan losses

  26,662           24,746         
   3,146,407           2,927,892         

Non-earning assets:

                        

Cash and due from banks

  42,810           40,298         

Premises and equipment, net

  63,083           41,945         

Accrued interest receivable and other assets

  101,872           101,672         
                         

Total assets

 $3,354,172          $3,111,807         
                         

Interest bearing liabilities:

                        

Deposits:

                        

Interest bearing demand deposits

 $852,347  $2,811   0.67

%

 $804,810  $1,462   0.37

%

Savings deposits

  163,504   205   0.25   156,594   117   0.15 

Money market deposits

  683,767   4,054   1.20   671,883   2,159   0.65 

Time deposits

  381,358   3,648   1.93   236,577   1,013   0.86 

Total interest bearing deposits

  2,080,976   10,718   1.04   1,869,864   4,751   0.51 

Securities sold under agreements to repurchase

  38,755   53   0.28   66,609   67   0.20 

Federal funds purchased and other short term borrowings

  11,602   124   2.16   57,391   483   1.70 

FHLB advances

  60,512   645   2.15   49,087   464   1.91 

Subordinated debt

  752   26   6.97          
                         
                         

Total interest bearing liabilities

  2,192,597   11,566   1.06   2,042,951   5,765   0.57 
                         

Non-interest bearing liabilities:

                        

Non-interest bearing demand deposits

  724,896           685,873         

Accrued interest payable and other liabilities

  60,481           43,866         

Total liabilities

  2,977,974           2,772,690         
                         

Stockholders’ equity

  376,198           339,117         
                         

Total liabilities and stockholder's equity

 $3,354,172          $3,111,807         

Net interest income

     $60,542          $56,161     

Net interest spread

          3.52

%

          3.66

%

Net interest margin

          3.85

%

          3.84

%

  

Six months ended June 30,

 
  

2020

  

2019

 
  

Average

      

Average

  

Average

      

Average

 

(dollars in thousands)

 

Balance

  

Interest

  

Rate

  

Balance

  

Interest

  

Rate

 
                         

Interest earning assets:

                        

Federal funds sold and interest bearing due from banks

 $227,090  $619   0.55

%

 $129,701  $1,563   2.43

%

Mortgage loans held for sale

  11,481   186   3.26   2,766   80   5.83 

Securities available for sale:

                        

Taxable

  417,006   4,461   2.15   410,018   4,806   2.36 

Tax-exempt

  12,519   163   2.62   26,480   337   2.57 

Total securities

  429,525   4,624   2.16   436,498   5,143   2.38 
                         

Federal Home Loan Bank stock

  11,284   141   2.51   10,392   308   5.98 
                         

SBA Paycheck Protection Program (PPP) loans

  264,680   3,392   2.58          

Non-PPP loans

  2,879,538   64,518   4.51   2,593,712   65,069   5.06 

Total loans

  3,144,218   67,910   4.34   2,593,712   65,069   5.06 
                         

Total interest earning assets

  3,823,598   73,480   3.86   3,173,069   72,163   4.59 
                         

Less allowance for credit losses

  40,146           26,662         
                         

Non-interest earning assets:

                        

Cash and due from banks

  43,767           42,810         

Premises and equipment, net

  57,624           63,083         

Bank Owned Life Insurance

  32,725           32,687         

Accrued interest receivable and other

  96,207           69,185         

Total assets

 $4,013,775          $3,354,172         
                         

Interest bearing liabilities:

                        

Deposits:

                        

Interest bearing demand deposits

 $1,057,079  $1,162   0.22

%

 $852,347  $2,811   0.67

%

Savings deposits

  179,503   23   0.03   163,504   205   0.25 

Money market deposits

  747,228   1,203   0.32   683,767   4,054   1.20 

Time deposits

  424,735   4,181   1.98   381,358   3,648   1.93 

Total interest bearing deposits

  2,408,545   6,569   0.55   2,080,976   10,718   1.04 
                         

Securities sold under agreements to repurchase

  37,465   24   0.13   38,755   53   0.28 

Federal funds purchased

  9,375   31   0.66   11,602   124   2.16 

Federal Home Loan Bank advances

  68,918   790   2.31   60,512   645   2.15 

Subordinated note

           752   26   6.97 
                         
                         

Total interest bearing liabilities

  2,524,303   7,414   0.59   2,192,597   11,566   1.06 

Non-interest bearing liabilities:

                        

Non-interest bearing demand deposits

  1,008,302           724,896         

Accrued interest payable and other

  70,859           60,481         

Total liabilities

  3,603,464           2,977,974         
                         

Stockholders’ equity

  410,311           376,198         

Total liabilities and stockholder's equity

 $4,013,775          $3,354,172         

Net interest income

     $66,066          $60,597     

Net interest spread

          3.27

%

          3.53

%

Net interest margin

          3.47

%

          3.85

%

 

 

Notes to the average balanceTotal Company Average Balance Sheets and interest rate tables:Interest Rates - Supplemental Information

 

 

Average loan balances for loans include the principal balance of non-accrualnon-accrual loans, as well as allunearned income such as loan premiums, discounts, fees and costs, and exclude participation loans accountedaccounted for as secured borrowings. Participationarticipation loans averaged $10.$9million and $10 million and $17.1 million, respectively, for the three monththree-month periods ended June 30, 2020 and 2019, and 2018, and $10.2$8 millionand $17.6$10 million respectively for the six monthsix-month periods ended June 30, 20192020 and 2018.2019.

 

 

Interest income on a fully tax equivalentFTE basis includes additional amounts of interest income that would have been earned if investments in certain tax-exempttax-exempt interest earning assets had been made in assets subject to federal taxes yieldingyielding the same after-tax income. Interest income on municipal securities and tax-exempt loanshas been calculatedcalculated on a fully tax equivalentFTE basis using a federal income tax rate of 21% for 20192020 and 2018. 2019. Approximate tax equivalent adjustmentsadjustments to interest income were $5$45 thousand,000 and $8555 thousand, respectively, ,000 for the three month periods ended June 30, 2020 and 2019, , 2019 and 2018, and $92111,000 thousand and $178 thousand$111,000 for the respective six month periods ended June 30, 20192020 and 2018.2019.

 

 

Interest income includes loan fees of $2952.4 million thousand and $29($2.1 million associated with the PPP) 7 thousandand $360,000 for the three months ended June 30, 2020 and 2019, and$2.8 million 2018, respectively, and $$883776 thousand and $514 thousand,000 for the respective six month periodsmonths ended June 30, 20192020 and 20182019.Interest income on loans may be impacted by the level of prepayment fees collected and accretion related to loan purchased.

 

 

Net interest income, the mostmost significant component of the Bank'sBancorp's earnings, represents total interest income less total interest expense. The level of net interest income is determined by mix and volume of interest earning assets, interest bearing deposits and borrowed funds, and changes in interest rates.

NIM represents net interest income on a FTE basis as a percentage of average interest earning assets.

 

 

Net interest spread is the difference between taxable equivalent rates earned on interest earning assets less the cost of interest bearing liabilities.

 

 

Net interest margin represents net interest incomeThe fair market value adjustment on a taxable equivalent basisinvestment securities resulting from ASC 320, Investments – Debt and Equity Securities is included as a percentagecomponent of average interest earningother assets. Net interest margin is impacted by both interest rate spread and the level of non-interest bearing sources of funds, primarily consisting of demand deposits and stockholders’ equity.

 

Net interest spread and net interest margin were 3.47% and 3.81%, respectively, for the second quarter of 2019, and 3.68% and 3.88%, respectively, for the second quarter of 2018. Net interest margin was challenged in the second quarter of 2019 primarily due to the following:

While the Company has not aggressively pursued deposits since mid-2018, nor has it significantly raised rates, it has become more rate sensitive as deposit balances have migrated from non-interest bearing accounts to interest bearing accounts.

Asset yields were impacted by the downward trending of the overall rate environment, as fixed rate loan pricing and LIBOR based loans were impacted.

The second quarter 2018 margin was elevated by prepayment fees collected, with a much lighter impact experienced in the second quarter of 2019.

The King portfolio mix of earning assets and interest bearing liabilities had a slightly negative impact on margin overall.

Fully taxable equivalent net interest income of $30.8 million for the three months ended June 30, 2019 increased $2.1 million, or 7.2%, from $28.8 million for the same period in 2018. Fully taxable equivalent interest income increased $4.9 million or 15.4% for the second quarter of 2019, as compared with the second quarter of 2018, due primarily to increased average loan balances stemming from loan growth fueled by record loan production and the King acquisition, as well as increased rates earned on loans. Wall Street Journal Prime interest rate was 50 to 75 basis points (“bps”) higher for much of the first half of 2019, as compared with 2018, which benefited short-term loan and investment pricing. Taxable securities, and federal funds sold and interest bearing due from banks average balances also increased in the first half of 2019, as compared with 2018, as a result of Bancorp deploying excess liquidity into short-term investments, which earned higher yields year over year. In total, average earning assets increased $271.2 million or 9.1% to $3.2 billion for the three month period ended June 30, 2019, as compared with the same period in 2018, with the average rate on earnings assets increasing 25 bps to 4.58%. Earning assets resulting from the King acquisition averaged $119.6 million, and yielded 5.28% for the three months ended June 30, 2019.

 

58
71

Interest expense increased due primarily to rising deposit costs, growth in interest bearing demand deposits and time deposits, and deposits assumed in the King acquisition. While the Company has not aggressively pursued deposits since mid-2018, nor has it significantly raised rates, deposit balances migrated from non-interest bearing accounts to interest bearing accounts during the period. Average interest bearing liabilities increased $193.0 million, or 9.4%, to $2.2 billion for the three month period ended June 30, 2019, as compared with the same period in 2018. Average interest bearing liabilities resulting from the King acquisition totaled $93.8 million in the second quarter. Growth in average interest bearing deposits was partially offset by declines in securities sold under agreements to repurchase (“SSUARs”). The average cost of interest bearing liabilities increased 46 bps to 1.11% for the second quarter of 2019, as compared with the second quarter of 2018. Bancorp increased rates paid on money market accounts in the first half of 2018 in addition to launching a marketing campaign promoting certificate of deposit accounts. Costs of money market deposit accounts and time deposits increased 47 bps, and 107 bps, respectively, in the second quarter of 2019, as compared with the same period in 2018. The average balance of securities sold under agreements to repurchase (“SSUARs”) decreased $22.0 million, or 35.5%, as customers migrated from lower yielding collateralized products to higher yielding non-collateralized deposits.

Fully taxable equivalent net interest income of $60.5 million for the six months ended June 30, 2019 increased $4.4 million, or 7.8%, from $56.2 million for the same period in 2018. Positive effects of increased average balances on loans, resulting primarily from strong second quarter loan growth coupled with loans added in the King acquisition, and increased balances and rates on other earning assets, were partially offset by the negative effect of increasing rates for all funding sources. Interest earning assets and interest bearing liabilities increased $220.4 million, or 7.5%, and $149.6 million, or 7.3%, respectively, for the six month periods ended June 30, 2019 and June 30, 2018. Net interest spread and net interest margin were 3.52% and 3.85%, respectively, for the first six months of 2019 and 3.66% and 3.84%, respectively, for the first six months of 2018.

Going forward, yield curve inversion could pose a significant challenge if loans were to be originated and repriced at a relatively low five-year portion of the treasury yield curve, while deposits and other funding sources priced or re-priced based upon a higher short end of the curve.

The Federal Reserve Bank (“FRB”) reduced the federal funds rate 25 bps in late July, with the prime lending rate experiencing a corresponding 25 bps decrease. Bancorp’s strategy in response to the rate reduction is to reduce deposit rates in order to fully offset the loss in revenue. Future rate decreases could have a negative impact on net interest margin, as additional reductions in deposit rates may not be sufficient to offset the potential loss in revenue.

 

Asset/Liability Management and Interest Rate Risk

 

Managing interest rate risk is fundamental for the financial services industry. The primary objective of interest rate risk management is to neutralize effects of interest rate changes on net income. By considering both on and off-balance sheet financial instruments, management evaluates interest rate sensitivity with the goal of optimizing net interest income within the constraints of prudent capital adequacy, liquidity needs, market opportunities and customer requirements.

 

Interest Rate Simulation Sensitivity Analysis

 

Bancorp uses an earnings simulation model to estimate and evaluate the impact of an immediate change in interest rates on earnings in a one yearone-year forecast. The simulation model is designed to reflect dynamics of interest earning assets and interest bearing liabilities. By estimating effects of interest rate fluctuations, the model can approximate interest rate risk exposure. This simulation model is used by management to gauge approximate results given a specific change in interest rates at a given point in time. The model is therefore a tool to indicate earnings trends in given interest rate scenarios and may not indicate actual or expected results.

 

The June 30, 20192020 simulation analysis, which shows minimalreflects the mid-March 2020 FRB action to lower the FFTR to near zero. Bancorp’s interest rate simulation sensitivity indicatesanalysis details that increases in interest rates of 100 tobps would have a slightly negative effect on interest income, while an increase in rates of 200 basis pointsbps would have a positive effect on net interest income, and decreasesincome. These results are attributed to over half of 100the variable rate loan portfolio being currently at or near floor rates, as these yields will not increase until short-term rates exceed these floor rates. For example, a significant portion of the variable rate loan portfolio is tied to 200 basis points in interestPrime, with floor rates of 4.00%. Given Prime is at 3.25% as of June 30, 2020, short-term rates would have a negative effect on net interest income. The mix of assets and liabilities acquired in the King transaction slightly increased Bancorp’s exposure to fallingincrease over 75 bps for these loans to move above their floor rates.

The overall minimal increase in net interest income in the rising rate scenarios is primarily due to variable rate loans and short-term investments repricing more quickly than deposits and short-term borrowings. Asset balances subject to immediate repricing cause an estimated decline in net interest income in the down 100 and 200 basis point rate scenarios,bps scenario, as rates on non-maturity deposits cannot be lowered sufficiently to offset declining interest income. These estimates are summarized below.

 

  

Change in Rates

 
   -200   -100  

+100

  

+200

 
  

Basis Points

  

Basis Points

  

Basis Points

  

Basis Points

 

% Change from base net interest income at June 30, 2019

  -10.14%  -1.37%  3.01%  6.03%
  

Change in Rates

 
  -200  -100  

+100

  

+200

 
  

Basis Points

  

Basis Points

  

Basis Points

  

Basis Points

 

% Change from base net interest income at June 30, 2020

 N/A   -3.31%  -0.19%  2.54%

 

 

Approximately 60% of Bancorp’s loan portfolio hasis currently composed of approximately 71% fixed rates with 40% priced at variable rates. Bancorp’sand 29% variable rate loans, are above their floorswith the fixed rate portfolio pricing based on a spread to the five-year treasury curve at the time of origination and will reprice as rates change.the variable portion pricing based on an on-going spread to Prime (approximately 60%) or one month LIBOR (approximately 40%). Bancorp’s loan portfolio (excluding PPPP loans) at June 30, 2020 was composed of approximately 65% fixed and 35% variable rate loans with the fluctuation in the C&I portfolio driving down variable rate percentage for the quarter.

 

UndesignatedPeriodically, Bancorp enters into interest rate swap transactions with borrowers who desire to hedge exposure to rising interest rates, while at the same time entering into an offsetting interest rate swap, with substantially matching terms, with another approved independent counterparty. These are undesignated derivative instruments described in Note 17 to Bancorp’s consolidated financial statementsand are recognized on the consolidated balance sheet at fair value, with changes in fair value recorded in other non-interest income as interest rates fluctuate. Because of matching terms of offsetting contracts, in addition to collateral provisions which mitigate the impact of non-performance risk, changes in fair value subsequent to initial recognition have a minimal effect on earnings, and are therefore not included in the simulation analysis results above. For additional information, see the footnote titled “Assets and Liabilities Measured and Reported at Fair Value.

 

DerivativesIn addition, Bancorp uses derivative financial instruments as part of its interest rate risk management, including interest rate swaps. These interest rate swaps are designated as cash flow hedges as described in Note 18the footnote titled “Derivative Financial Instruments.” For these derivatives, the effective portion of gains or losses is reported as a component of OCI, and is subsequently reclassified into earnings as an adjustment to Bancorp’s consolidated financial statements are recognized oninterest expense in periods in which the consolidated balance sheet at fair value, with changes in fair value due to changes in prevailing interest rates, recorded net of tax in other comprehensive income.hedged forecasted transaction impacts earnings.

 

 

Provision for Loan and LeaseCredit Losses

 

An analysis of the changes in the ACL on loans, including provision, and selected ratios follow:

  

Three months ended

  

Six months ended

 
  

June 30,

  

June 30,

 

(dollars in thousands)

 

2020

  

2019

  

2020

  

2019

 
                 

Beginning balance, prior to the adoption of ASC 326

 $42,143  $26,464  $26,791  $25,534 

Impact of adopting ASC 326

        8,221    

Initial ACL on loans purchased with credit deterioration

        1,635    

Provision for credit losses

  5,550      11,100   600 
                 

Total charge-offs

  (98)  (161)  (272)  (260)

Total recoveries

  113   113   233   542 

Net loan (charge-offs) recoveries

  15   (48)  (39)  282 

ACL at the end of the period

 $47,708  $26,416  $47,708  $26,416 

Average loans

 $3,396,767  $2,658,036  $3,144,218  $2,593,712 

Provision to average loans (1)

  0.16%  0.00%  0.35%  0.02%

Net loan (charge-offs) recoveries to average loans (1)

  0.00%  0.00%  0.00%  0.01%

ACL to average loans

  1.40%  0.99%  1.52%  1.02%

ACL to total loans

  1.38%  0.96%  1.38%  0.96%

(1) Ratios are not annualized

Provision represents the amount of expense that, based on Management’s judgment, is required to maintain the ACL on loans at an appropriate level under the CECL model. The provision reflects resultsdetermination of the amount of the ACL on loans is complex and involves a high degree of judgment and subjectivity. See the footnote titled “Basis of Presentation and Summary of Significant Accounting Policies for detailed discussion regarding Bancorp’s ACL methodology by loan segment.

Upon adoption of ASC 326 on January 1, 2020, Bancorp recorded an allowance methodology that is driven by risk ratings, historicalincrease of $8.2 million to the ACL on loans and a corresponding decrease to retained earnings, net of the DTA impact. In addition, non-accretable yield marks of $1.6 million related to formerly classified PCI loans were re-classed between the amortized cost basis of loans and corresponding ACL. The adjustment upon adoption of ASC 326 raised the ACL on loans balance to $37 million on January 1, 2020.

The ACL on loans totaled $48 million at June 30, 2020 compared to $42 million at March 31, 2020 and $27 million at December 31, 2019, representing an ACL to total loans ratio of 1.38%, 1.43% and 0.94% for the same period ends. The ACL to total loans (excluding PPP loans) was 1.68% at June 30, 2020. Based on the 100% SBA guarantee of the PPP loan portfolio, which totaled $630 million (net of unamortized deferred fees) at June 30, 2020, Bancorp did not reserve for potential losses specific loan loss allocations,for these loans within the ACL.

Despite minimal charge-offs and qualitative factors.overall strong credit metrics, Bancorp recorded provision for credit losses of $0$5.6 million and $600 thousand$11.1 million for the three and six month periods ended June 30, 2019, respectively,2020, as compared with $1.2 million$0 and $2.0 million$600,000 for the same periods in 2018. 2019. As detailed below, provisioning in 2020 has been significantly impacted by the economic crisis and corresponding impact on national unemployment forecast adjustments within the CECL model, changes in the loan mix and the addition of a large specific reserve during the second quarter of 2020.

The forecasted increase in national unemployment coupled with the qualitative factor adjustments resulted in approximately $4.2 million and $4.6 million of the total provision represents a charge to earnings necessary to maintain an allowance that, in management’s evaluation, is adequate to provide coverageexpense recorded for the inherent losses on outstanding loans. Thethree months ended March 31, 2020 and June 30, 2020.

For the three-month period ended March 31, 2019, Bancorp recorded a $600,000 provision reflects many factors including trendsconsistent with a moderate increase in the portfolio, as well as changes in quantitative and qualitative factors. Continued strong credit metricsclassified loans and net recoveries of $282 thousand for the first six months of 2019 resulted in an allowance to total loans of 0.96% as of June 30, 2019, compared with 0.96% as of June 30, 2018.$330,000. In management’s opinion, the allowance remained adequate to cover potential losses within the portfolio.

Key indicators of loan quality remained consistent with the prior year with the exception of increased classified balances, defined as other assets especially mentioned (“OAEM”), substandard, and non-performing loans, which increased $23.4 million during the first half of 2019, as compared with December 31, 2018. The increase was concentrated in OAEM loans, as two commercial relationships, which were well-secured, moved from the Watch category into OAEM. Consistent with Bancorp’s methodology,addition, Bancorp extended the historical look-back period was extendedwithin the incurred loss model from 32 to 36 quarters in the first quarter of 2019 to all classes and segments of the portfolio. Management believes the expansion of the look-back period more accurately representsrepresent the currentthen-current level of risk in the loan portfolio and capturesby capturing the effects of a full economic cycle. Based on the look-back period extension, the allowance levelACL increased approximately $2.0 million for the first three months of 2019. Additional information regarding Bancorp’s methodologyNo provision was recorded for evaluating the adequacy of the allowance can be read in the Company’s Annual Report on Form 10-K.

Non-performing loans, consisting of TDRs, non-accrual loans, and loans over 90 days past due still accruing, increased to $3.9 million atthree months ended June 30, 2019 from $3.4 million at December 31, 2018, while decreasing $3.5 million from $7.4 million at June 30, 2018. Bancorp considers the present asset quality metrics to be exceptional; however, recognizing the cyclical nature of the lending business, this trend is expected to normalize over the long term.

Bancorp’s loan portfolio is diversified with no significant concentrations of credit. Geographically, most loans are extended to borrowers in the metropolitan areas of Louisville, Indianapolis and Cincinnati. The adequacy of the allowance is monitored on an ongoing basis and it is the opinion of management that the balance of the allowance at June 30, 2019 is adequate to absorb probable losses inherent in the loan portfolio as of the financial statement date.2019.

 

61
73

An analysis of the changes in the allowance and selected ratios follows:

(Dollars in thousands)

 

Three months ended June 30,

  

Six months ended June 30,

 
  

2019

  

2018

  

2019

  

2018

 
                 

Balance at the beginning of the period

 $26,464  $24,203  $25,534  $24,885 

Provision

     1,235   600   1,970 

Total charge-offs

  161   647   260   2,175 

Total recoveries

  (113)  (82)  (542)  (193)

Total net loan charge-offs (recoveries)

  48   565   (282)  1,982 

Balance at the end of the period

 $26,416  $24,873  $26,416  $24,873 

Average loans, net of unearned income

 $2,658,036  $2,523,450  $2,593,712  $2,478,305 
                 

Provision to average loans (1)

  0.00%  0.05%  0.02%  0.08%

Net loan charge-offs (recoveries) to average loans (1)

  0.00%  0.02%  (0.01)%  0.08%

Allowance to average loans

  0.99%  0.99%  1.02%  1.00%

Allowance to total loans

  0.96%  0.96%  0.96%  0.96%

(1) Amounts not annualized

Loans are charged off when deemed uncollectible and a loss is identified or after underlying collateral has been liquidated; however, collection efforts may continue and future recoveries may occur. Periodically, loans are partially charged off to net realizable value based upon collateral analysis and collection status. One significant commercial and industrial loan relationship totaling $1.3 million was charged off to its net realizable value in the first quarter of 2018, which resulted in increased net charge offs for the six month period ending June 30, 2018. The increase in the allowance in the second quarter of 2019 as compared with the same period in 2018 was mainly due to qualitative considerations and net recoveries of $282 thousand.

An analysis of net charge-offs (recoveries) by loan portfolio segment follows:

  

Three months

  

Six months

 

(In thousands)

 

ended June 30,

  

ended June 30,

 
  

2019

  

2018

  

2019

  

2018

 
                 

Commercial and industrial

 $(4) $528  $(103) $1,927 

Construction and development, excluding undeveloped land

        (203)   

Undeveloped land

            

Real estate mortgage - commercial investment

  (1)     (1)  (2)

Real estate mortgage - owner occupied commercial

        (20)   

Real estate mortgage - 1-4 family residential

  (17)     (17)   

Home equity

  (1)  (2)  (1)  (4)

Consumer

  71   39   63   61 

Total net loan charge-offs (recoveries)

 $48  $565  $(282) $1,982 

 

Non-interest Income and Non-interest Expenses

 

  

Three months ended June 30,

  

Six months ended June 30,

 
                         

(Dollars in thousands)

 

2019

  

2018

  

$ Change

  

% Change

  

2019

  

2018

  

$ Change

  

% Change

 
                                 

Non-interest income:

                                

Wealth management and trust services

 $5,662  $5,344  $318   6.0

%

 $11,101  $10,844  $257   2.4

%

Deposit service charges

  1,336   1,447   (111)  (7.7)  2,583   2,858   (275)  (9.6)

Debit and credit card income

  2,168   1,689   479   28.4   3,912   3,197   715   22.4 

Treasury management fees

  1,202   1,113   89   8.0   2,359   2,160   199   9.2 

Mortgage banking income

  796   746   50   6.7   1,278   1,322   (44)  (3.3)

Net investment product sales commissions and fees

  364   397   (33)  (8.3)  720   801   (81)  (10.1)

Bank owned life insurance

  184   191   (7)  (3.7)  362   378   (16)  (4.2)

Other

  551   508   43   8.5   1,010   784   226   28.8 

Total non-interest income

 $12,263  $11,435  $828   7.2

%

 $23,325  $22,344  $981   4.4

%

Non-interest expenses:

                                

Compensation

 $12,715  $11,703  $1,012   8.6

%

 $24,516  $22,673  $1,843   8.1

%

Employee benefits

  2,908   2,512   396   15.8   5,550   5,145   405   7.9 

Net occupancy and equipment

  1,976   1,811   165   9.1   3,834   3,629   205   5.6 

Technology and communication

  1,848   1,685   163   9.7   3,621   3,315   306   9.2 

Debit and credit card processing

  631   579   52   9.0   1,218   1,145   73   6.4 

Marketing and business development

  903   805   98   12.2   1,528   1,451   77   5.3 

Postage, printing, and supplies

  410   400   10   2.5   816   791   25   3.2 

Legal and professional

  1,523   504   1,019   202.2   2,057   997   1,060   106.3 

FDIC insurance

  248   238   10   4.2   486   480   6   1.3 

Amortization/impairment of investment in tax credit partnerships

  52   58   (6)  (10.3)  104   58   46   79.3 

Capital and deposit based taxes

  967   862   105   12.2   1,871   1,714   157   9.2 

Other

  1,283   979   304   31.1   2,502   1,765   737   41.8 

Total non-interest expenses

 $25,464  $22,136  $3,328   15.0

%

 $48,103  $43,163  $4,940   11.4

%

  

Three months ended June 30,

  

Six months ended June 30,

 

(dollars in thousands)

 

2020

  

2019

  

$ Change

  

% Change

  

2020

  

2019

  

$ Change

  

% Change

 
                                 

Wealth management and trust services

 $5,726  $5,662  $64   1

%

 $11,944  $11,101  $843   8

%

Deposit service charges

  800   1,260   (460)  (37)  2,083   2,438   (355)  (15)

Debit and credit card income

  2,063   2,168   (105)  (5)  4,043   3,912   131   3 

Treasury management fees

  1,249   1,202   47   4   2,533   2,359   174   7 

Mortgage banking income

  1,622   760   862   113   2,468   1,210   1,258   104 

Net investment product sales commissions and fees

  391   364   27   7   857   720   137   19 

Bank owned life insurance

  176   184   (8)  (4)  355   362   (7)  (2)

Other

  595   624   (29)  (5)  875   1,130   (255)  (23)

Total non-interest income

 $12,622  $12,224  $398   3

%

 $25,158  $23,232  $1,926   8

%

 

Total non-interest income increased $398,000 and $1.9 million for the three and six-month periods ended June 30, 2020 compared to the same periods of 2019. Non-interest income comprised 27.3% and 27.6% of total revenues, defined as net interest income and non-interest income, for the three and six month periods ended June 30, 2020 compared to 28.4% and 27.7% for the same periods in 2019. WM&T services comprised 45.4% and 47.5% of total non-interest income for the three and six-month periods ended June 30, 2020 compared to 46.3% and 47.8% for the same periods of 2019.

 

Non-interest incomeWealth Management and Trust – WM&TServices:

 

The largest component of non-interest income is WM&T revenue. The magnitude of WM&T revenue distinguishes Bancorp from other community banks of similar asset size. Trust assets under managementAUM, stated at market value, totaled $3.2 billion at June 30, 2020, an increase of 4% compared with $3.07 billion at June 30, 2019 a 7.6% increase compared with $2.85 billion at June 30, 2018, and a 11.0% increase4% decline from $2.76$3.32 billion at December 31, 2018. AUM are stated at market value.2019. WM&T revenue which represents approximately 46.2% of non-interest income, increased $318 thousand,$64,000, or 6.0%1%, and $257 thousand,$843,000, or 2.4%8%, respectively, for the three and six month periods ended June 30, 2019,2020, as compared with the same periods of 2019. While stock market volatility associated with the COVID-19 pandemic has had a significant impact on the WM&T department, a large non-recurring estate fee from the first quarter of 2020 served to offset declines in 2018 consistent with increased new business generation and strong market performance for the quarter.market-based fee income.

 

Recurring fees earned for managing accounts are based on a percentage of market value of AUM and are typically assessed on a monthly basis. Recurring fees, which generally comprise over 97%the vast majority of the WM&T revenue, increased $225 thousand,$143,000, or 4.3%3%, and $142 thousand$489,000, or 1.3%4%, respectively, for the three and six month periods ended June 30, 2019,2020, as compared with the same periods in 2018. Some revenues of the2019. A portion of WM&T department,revenue, most notably executor, insurance and some employee benefit plan-related fees, are non-recurring in nature and the timing of these revenues corresponds with the related administrative activities and is also based on the market value of AUM. For this reason, such fees are subject to more period over period fluctuation. Total non-recurring fees decreased $79,000, or 44%, and increased $93 thousand$354,000, or 103.3% and $115 thousand or 59.5%115%, for the respective three and six monthsix-month periods ended June 30, 2019,2020, respectively, as compared with the same time periods of 2018.2019 with the increase for the six-month period attributed to the large estate fee previously noted. Contracts between WM&T and their clients do not permit performance basedperformance-based fees and accordingly, none of the feesfee income earned by WM&T are performance based.performance-based. Management believes the WM&T department will continue to factor significantly in Bancorp’s financial results and provide strategic diversity to revenue streams.

 

 

Trust Assets Under Management by Account Type

                
  

June 30, 2019

  

June 30, 2018

 

(In thousands)

 

Managed

  

Non-

managed (1)

  

Managed

  

Non-

managed (1)

 

Investment advisory accounts

 $1,263,348  $20,251  $1,118,499  $18,121 

Personal trust accounts

  562,655   89,794   561,701   80,723 

Personal individual retirement acounts

  394,429   2,632   360,046   1,802 

Corporate retirement accounts

  48,073   397,708   49,548   394,067 

Foundation and endowment accounts

  216,789   1,247   196,268   - 
                 

Total accounts

 $2,485,294  $511,632  $2,286,062  $494,713 

Custody and safekeeping accounts

     71,402      70,875 
                 
  $2,485,294  $583,034  $2,286,062  $565,588 

Total managed and non-managed assets

 $3,068,328      $2,851,650     

Detail of WM&T Service Income by Account Type:

  

Three months ended June 30,

  

Six months ended June 30,

 

(in thousands)

 

2020

  

2019

  

2020

  

2019

 
                 

Investment advisory

 $2,277  $2,246  $4,699  $4,377 

Personal trust and estate fees

  1,904   1,894   4,090   3,698 

Personal individual retirement

  1,009   931   2,063   643 

Company retirement

  343   316   694   1,821 

Foundation and endowment

  138   140   282   273 

Custody and safekeeping

  27   30   60   61 

Brokerage and insurance services

  9   13   19   38 

Other

  19   92   37   190 
                 

Total WM&T services income

 $5,726  $5,662  $11,944  $11,101 

The preceding table demonstrates that WM&T fee revenue is concentrated within investment advisory and personal trust accounts. WM&T fees are predominantly based on AUM and tailored for individual/company accounts and/or relationships with fee structures customized based on account type and other factors with larger relationships paying a lower percentage of AUM in fees. For example, recurring AUM fee structures are in place for investment management, irrevocable trusts, revocable trusts, individual IRAs and accounts holding only fixed income securities. Company retirement plan services typically consist of a one-time conversion fee with recurring AUM fees to follow. While there are also fee structures for estate settlements, income received is often non-recurring in nature. Fees are agreed upon at the time the account is opened and any subsequent revisions are communicated in writing to the customer. Fees earned are not performance-based nor are they based on investment strategy or transactions.

Assets under Management by Account Type:

AUM (not included on balance sheet) decreased from $3.32 billion at December 31, 2019 to $3.20 billion at June 30, 2020 as follows:

  

June 30, 2020

  

December 31, 2019

 

(in thousands)

 

Managed

  

Non-managed (1)

  

Managed

  

Non-managed (1)

 

Investment advisory

 $1,314,388  $20,179  $1,347,389  $21,759 

Personal trust

  583,775   94,156   617,984   96,506 

Personal individual retirement

  438,146   2,900   437,193   2,799 

Company retirement

  44,161   391,194   45,097   436,188 

Foundation and endowment

  233,948   2,106   231,704   1,343 
                 

Total accounts

 $2,614,418  $510,535  $2,679,367  $558,595 

Custody and safekeeping

     78,981      81,850 
                 
  $2,614,418  $589,516  $2,679,367  $640,445 

Total managed and non-managed assets

 $3,203,934      $3,319,812     

 

(1) Non-managed assets represent those for which WM&T does not have investment discretion.

 

The table above provides information regarding AUM by WM&T. This table demonstrates that asAs of June 30, 2019:

•     Approximately2020 and December 31, 2019, approximately 82% and 81%, respectively, of AUM arewere actively managed.

•     Corporate retirement plan accounts consist primarily of participant directed assets.

•     The amount of custody and safekeeping accounts is insignificant, and

The majority of managed assets are in investment advisory, personal trust and agency accounts. Company retirement plan accounts primarily consist of participant-directed assets and the amount of custody and safekeeping accounts are insignificant.

 

  

June 30,

 

(In thousands)

 

2019

  

2018

 
         

Interest bearing deposits

 $129,561  $95,387 

US Treasury and government agency obligations

  56,083   47,574 

State, county and municipal obligations

  134,268   140,372 

Money market mutual funds

  4,461   7,670 

Equity mutual funds

  603,308   580,199 

Other mutual funds - fixed, balanced, and municipal

  307,068   302,400 

Other notes and bonds

  175,014   142,123 

Common and preferred stocks

  949,410   844,004 

Real estate mortgages

  342   361 

Real estate

  50,001   51,124 

Other miscellaneous assets (1)

  75,778   74,848 
         

Total managed assets

 $2,485,294  $2,286,062 

Managed Trust Assets under Management by Class of Investment:

Managed Trust Assets by Class of Investment

        

(in thousands)

 

June 30, 2020

  

December 31, 2019

 
         

Interest bearing deposits

 $132,316  $145,710 

US Treasury and government agency obligations

  38,023   46,950 

State, county and municipal obligations

  132,344   136,575 

Money market mutual funds

  10,219   7,511 

Equity mutual funds

  612,419   654,569 

Other mutual funds - fixed, balanced, and municipal

  376,187   339,296 

Other notes and bonds

  179,439   182,940 

Common and preferred stocks

  993,485   1,037,695 

Real estate mortgages

  322   332 

Real estate

  51,935   51,059 

Other miscellaneous assets (1)

  87,729   76,730 
         

Total managed assets

 $2,614,418  $2,679,367 

 

(1) Includes client directed instruments including rights, warrants, annuities, insurance policies, unit investment trusts, and oil and gas rights.

 

The table above presents data regarding WM&T managed assets by class of investment. Managed assets are invested in instruments for which market values can be readily determined, the majority of which are sensitive to market fluctuations. This table demonstrates that asfluctuations and consist of June 30, 2019:

The composition of managed assets is divided approximately 62%approximately 61% in equities and 39% in equities and 38% in fixed income securities, and this composition is relatively consistent from period to period, and

WM&T has no proprietary mutual funds.

Fiduciary and Related Trust Services Income

             
  

Three months ended June 30,

  

Six months ended June 30,

 

(In thousands)

 

2019

  

2018

  

2019

  

2018

 
                 

Investment advisory accounts

 $2,246  $2,070  $4,377  $4,149 

Personal trust accounts

  1,894   1,864   3,698   3,782 

Personal individual retirement accounts

  931   869   1,821   1,742 

Corporate retirement accounts

  316   361   643   740 

Foundation and endowment accounts

  140   134   273   285 

Custody and safekeeping accounts

  30   30   61   86 

Brokerage and insurance services

  13   7   38   30 

Other

  92   9   190   30 
                 

Total WM&T services

 $5,662  $5,344  $11,101  $10,844 

The table above provides information regarding fee income earned by Bancorp’s WM&T department. It demonstrates that WM&T fee revenue is earned most significantly from personal trust and investment advisory accounts. Fees are based on AUM and tailored for individual accounts and/or relationships. WM&T uses a fee structure that is tailored based on account type and other factors. For example, fee structures are in place for investment management, irrevocable trusts, revocable trusts, individual retirement accounts (“IRAs”), and accounts holding only fixed income securities. There are also fee structures for estate settlements, which are non-recurring,This composition is relatively consistent from period to period and retirement plan services which typically consist of a one-time conversion fee with recurring AUM fees to follow. All fees are based on the market value of each account and are tiered based on account size, with larger relationships paying a lower percentage of AUM in fees. Fees are agreed upon at the time the account is opened and these and any subsequent revisions are communicated in writing to the customer. Fees earned are not performance based nor are they based on investment strategy or transactions.WM&T has no proprietary mutual funds.

 

Additional sourcesSources of non-interest incomeNon-interest income:

 

Deposit service charges, which consist of non-sufficient funds charges and to a lesser extent, other activity based charges, decreased $111 thousand,$460,000, or 7.7%37%, and $275 thousand,$355,000, or 9.6%15%, respectively,for the three and six-month periods ended June 30, 2020, as compared with the same periods of 2019. Deposit service charge income is heavily driven by customer behavior and transaction volume, which can fluctuate from period to period. Consistent with the industry, Bancorp has experienced a steady decline in fees earned on overdrawn checking accounts over the last several years. This decline was significantly exacerbated for Bancorp and the industry during the second quarter of 2020, with significant declines in transaction volume and paper check presentments. Stimulus checks, extensions of tax payment due dates, more lucrative unemployment compensation, diminished pandemic spend and PPP funding have all impacted consumer behavior. While Bancorp experienced a notable increase in deposit service charge income during June compared to May, Management is not able to predict when, this revenue stream will return to pre-pandemic levels.

Debit and credit card income consists of interchange income, ancillary fees and incentives received from card processors. Debit and credit card revenue decreased $105,000, or 5%, and increased $131,000, or 3%, for the three and six month periods ended June 30, 2019,2020, as compared with the same periods in 2018. Service charge incomeof 2019. The decline for the three-month period is driven byreflective of decreased transaction volume related to the pandemic, as the full effects of state-wide shut downs implemented toward the end of the first quarter in the markets in which can fluctuate from periodBancorp operates were experienced. Interchange income, which lagged significantly in April and May, did show significant improvement in June. In addition to period. Both the quarterly and year-to-date decreases are consistent with the decline in fees earned on overdrawn checking accounts. While management expects this sourcevolume, interchange income has also been impacted by the type of revenue to slowly decline due to anticipated changesspending (i.e. in customer behavior, including reduced check volume, and ongoing regulatory restrictions, the decline is anticipated to be less significant than what was experiencedperson card signature spending versus other forms of card use). The 3% increase in the first half of 2019.

Debit and credit card revenue increased $479 thousand, or 28.4%, and $715 thousand, or 22.4%, for the respective three and six month periods ended June 30, 2019, as compared with the same periods in 2018. The increases in both the three and six month comparisons reflected increased volume resulting from continuedsix-month period is attributed to overall growth in the customer base. Volume, which is dependent on customer behavior and new accounts, is expected to continue to increase. Credit card interchange income increased $184 thousand, or 52.17%, and debit card interchange and ancillary fees increased $295 thousand or 22.0%, inbase over the second quarter of 2019, as compared with the same period in 2018. Second quarter 2019 debit card revenue included a non-recurring fee of $176 thousand from its card processor for reaching activity incentive thresholds. For the first six months of 2019, credit card interchange income increased $328 thousand, or 48.8%, and debit card interchange and ancillary fees increased $387 thousand or 15.3%, as compared with the same period in 2018.past 12 months.

 

Treasury management fees primarily consistsconsist of fees earned for cash management services provided to commercial customers. ThisWhile the pandemic has slowed business spending/activity and international trade, this category has beencontinues to be a consistent, growing source of revenue for Bancorp including increases in the second quarter of 2019 of $89 thousandand increased $47,000, or 8.0%4%, and $199 thousand,$174,000, or 9.2%7%, for the firstthree and six months of 2019,month periods ending June 30, 2020, as compared with the same periods of 2019. Bancorp’s Treasury Management department was able to overcome the significant decline in 2018.pandemic related transaction volume during the second quarter of 2020 with new product sales and expansion of its customer base (partially attributable to the PPP). The demand for Bancorp’s treasury products has increased during the pandemic, as these products allow customers to operate more efficiently in a decentralized environment. Bancorp continues to expect growth inanticipates this income category in 2019will continue to increase based upon an expandingon continued customer base as more existing customers take advantagegrowth and the expanding suite of these services.services offered within the treasury management platform.

 

 

Mortgage banking income primarily includes gains on sales of mortgage loans.loans and loan servicing income offset by MSR amortization. Bancorp’s mortgage banking department originates residential mortgage loans to be sold in the secondary market, primarily to the Federal National Mortgage Association (“FNMA”).FNMA. Interest rates on the mortgage loans sold to FNMA are locked with the borrower and investor prior to closing the loans, thus Bancorp bears no interest rate risk related to loans sold. The departmentBancorp offers conventional, Veterans Administration (“VA”)VA and Federal Housing Authority (“FHA”)FHA financing for purchases and refinances, as well as programs for first-time home buyers.homebuyers. Interest rates on mortgage loans directly impactinfluence the volume of business transacted by the mortgage bankingmortgage-banking department. Mortgage banking revenue increased $50 thousand,$862,000, or 6.7%113%, while decreasing $44 thousand,and $1.3 million, or 3.3%104%, for the respective three and six month periods ended June 30, 2019,2020 as compared with the same periods in 2018. Transaction volume increased in the second quarter of 2019, as declining mortgagesustained low long-term rates resulted in increasedhave incentivized refinancing activity. Including the gain on sale, Bancorp anticipates refinancing activitysold $97 million loans during the first six months of 2020 compared to continue$37 million for the same period in 2019. The current pipeline of mortgage loans remains strong compared to increase intoprior year, however volume could slow, as underlying issues with the third quarter provided mortgage rates continuepandemic develop and the pool of potential clients who have yet to decline.refinance shrinks.

 

Net investment product sales commissions and fees decreased $33 thousand, or 8.3%, and $81 thousand, or 10.1%, respectively, for the quarterly and six month periods ended June 30, 2019, as compared with the same periods in 2018. The decreases correspondare generated primarily to overall brokerage volume, as market volatility has somewhat discouraged investment activity in 2019. Brokerage commissions and fees earned consist primarily ofon stock, bond and mutual fund sales, as well as wrap fees on brokerage accounts. Wrap fees arerepresent charges for investment programs that bundle together a suite of services, such as brokerage, advisory, research and management and are based on a percentage of assets. Bancorp deploys its brokersfinancial advisors primarily through its branch network via an arrangement with a third party broker-dealer, while larger managed accounts are serviced inby Bancorp’s WM&T segment. Net investment product sales commissions and fees increased $27,000, or 7%, and $137,000, or 19%, for the Bank’s WM&T department.three and six month periods ended June 30, 2020, as compared with the same periods of 2019, as market volatility during most of the current year has led to increased client trading activity.

 

Bank owned life insurance (“BOLI”)BOLI assets represent the cash surrender value of life insurance policies on certain key employees who have provided consent for Bancorp to be the beneficiary offor a portion of such policies. The related change in cash surrender value and any death benefits received under the policies are recorded as non-interest income. This income serves to offset the cost of various employee benefits. Income related to BOLI income of $176,000 and $355,000 was recognized for the three and six months ended June 30, 2020, representing nominal changes as compared with the same periods of 2019.

Other non-interest income decreased $7 thousand,$29,000 or 3.7%5%, and $16 thousand,$255,000, or 4.2%23%, respectively, for the three and six month periods ended June 30, 20192020 as compared with the same time periods in 2018, as a result of lower crediting rates on investments.

Other non-interest income increased $43 thousand, or 8.5%,2019. The decline for the second quarter of 2019, as compared with the samesix-month period in 2018, and $226 thousand, or 28.8%,comparison is attributed to a $126,000 incentive for the first six months of 2019, as compared with the same perioda banking center re-location received in 2018. In the first quarter of 2019 Bancorp recognized incomeand a period over period decline in swap fees collected.

Non-interest Expenses

  

Three months ended June 30,

  

Six months ended June 30,

 

(dollars in thousands)

 

2020

  

2019

  

$ Change

  

% Change

  

2020

  

2019

  

$ Change

  

% Change

 
                                 

Compensation

 $11,763  $12,715  $(952)  (7

)%

 $23,996  $24,516  $(520)  (2

)%

Employee benefits

  2,871   2,807   64   2   6,038   5,362   676   13 

Net occupancy and equipment

  2,089   1,967   122   6   3,970   3,816   154   4 

Technology and communication

  1,947   1,848   99   5   3,960   3,621   339   9 

Debit and credit card processing

  603   631   (28)  (4)  1,259   1,218   41   3 

Marketing and business development

  465   903   (438)  (49)  1,025   1,528   (503)  (33)

Postage, printing, and supplies

  442   410   32   8   883   816   67   8 

Legal and professional

  628   1,523   (895)  (59)  1,251   2,057   (806)  (39)

FDIC insurance

  330   248   82   33   459   486   (27)  (6)

Amortization of investments in tax credit partnerships

  53   52   1   2   89   104   (15)  (14)

Capital and deposit based taxes

  1,225   967   258   27   2,255   1,871   384   21 

Credit loss expense for off-balance sheet exposures

  1,475      1,475      1,850      1,850    

Other

  993   1,382   (389)  (28)  1,799   2,670   (871)  (33)

Total non-interest expenses

 $24,884  $25,453  $(569)  (2

)%

 $48,834  $48,065  $769   2

%

 

Non-interestTotal non-interest expenses decreased $569,000, or 2%, and increased $769,000, or 2%, for the three and six-month periods ended June 30, 2020 compared to the same periods of 2019. Compensation and employee benefits comprised 58.8% and 61.5% of Bancorp’s non-interest expenses for the three and six-month periods ended June 30, 2020, compared to 61.0% and 62.2% for the same periods of 2019.

 

Compensation, which includes salaries, incentives, bonuses and stock based compensation, increased $1.0 million,decreased $952,000, or 8.6%7%, and $1.8 million,$520,000, or 8.1%2%, respectively, for the quarterly and six-month periods ended June 30, 2019, as compared with the same periods in 2018. Non-recurring severance and employee retention expenses resulting from the King acquisition totaled $437 thousand for the three and six month periods ended June 30, 2019. Personnel additions related to Bancorp’s growth, including the King acquisition drove the remainder of the increase. At June 30, 2019, Bancorp had 615 full-time equivalent employees including 28 employees added from the King acquisition,2020, as compared with 581the same periods of 2019. The decline for the three-month period ended June 30, 2020 compared to the same period in 2019 was attributed to recording approximately $757,000 of additional deferred salary expense associated with the origination of PPP loans, the offsetting entry for which is deferred loan fees and amortize over the term of the respective loans. This deferred salary expense was partially offset by $194,000 of incentives paid in relation to the operational on boarding of the program. Further, $437,000 of non-recurring severance and employee retention expenses associated with the 2019 acquisition was recorded in the second quarter of 2019. The six-month decrease is attributed to the items noted above in addition to accruing bonus-related expenses at lower levels in 2020 as compared to 2019, the latter of which was elevated due to record performance. Net full time equivalent employees totaled 620 at June 30, 2018.2020, 615 at December 31, 2019 and 615 at June 30, 2019.

 

Employee benefits consists of all personnel relatedpersonnel-related expense not included in compensation, with the most significant items beingrepresenting health insurance, payroll taxes and employee retirement plan contributions. Employee benefits increased $396 thousand,$64,000 or 15.8%2%, and $405 thousand,$676,000, or 7.9%13%, respectively for the three and six month periods ended June 30, 2019,2020, as compared with the same periods in 2018. Increased 401K match contributions,of 2019. The increase for both periods was attributable to higher health insurance claims paid byactivity and additional 401(k) matching contributions. These fluctuations were attributed to the Company, and higher employee recruiting costs resultedoverall increase in the increases. King acquisition related one-time employee benefit expenses totaled $57 thousand for the three and six month periods ended June 30, 2019.full time equivalent employees.

 

Net occupancy and equipment expense increased $165 thousand, or 9.1%,expenses primarily include depreciation, rent, property taxes, utilities and $205 thousand, or 5.6%, respectively, for the three and six month periods ended June 30, 2019, as compared with the same periods in 2018. Bancorp added five branch locations in the King acquisition, which impacted this category beginning in May 2019, adding $80 thousand of additional expense for the three and six month periods ended June 30, 2019. Bancorp expect to divest of three acquired branch locations in Louisville during the third quarter of 2019 due to their proximity to existing Bancorp branches. This category primarily includes rent, depreciation, and maintenance, variances for which were not individually significant.maintenance. Costs of capital asset additions flow through the statement of income over the lives of the assets in the form of depreciation expense.

Technology and communications expense Net occupancy increased $163 thousand,$122,000, or 9.7%6%, and $306,$154,000, or 9.2%4%, respectively, for the three and six month periods ended June 30, 2019,2020, as compared with the same periods in 2018 due largely to increases in computer infrastructure upgradesof 2019. Bancorp added three branch locations associated with the May 2019 acquisition and maintenance costs.  Theseopened one additional branch location during the third quarter of 2019.

Technology and communication expenses include ongoing computer software amortization, equipment depreciation, debit and credit card processing expenses and expenditures related to investments in technology needed to maintain and improve the quality of customer delivery channels, information security and internal resources. King related one-time technologyTechnology expense increased $99,000, or 5%, and communication expenses totaled $104 thousand$339,000, or 9%, for the three and six month periods ended June 30, 2019.    2020 as compared with the same periods of 2019 consistent with expanding customer-facing software and system functionality, as well as increased licensing/maintenance expense. Non-recurring technology expenses associated with the 2019 acquisition totaled $104,000 for the three and six month periods of the prior year.

 

Bancorp outsources processing for debit and commercial credit card operations, which generate significant revenue for the Company. These expenses increase asfluctuate consistent with transaction volume increases, offsetting a portion of corresponding revenue growth.volumes. Debit and credit card processing expense increased $52 thousand,decreased $28,000, or 9.0%4%, and $73 thousand,increased $41,000, or 6.4%3%, for the three month and six monthsix-month periods ended June 30, 2019, respectively, as2020 compared with the same periods of 2019. While the six-month period increase is attributed to growth in 2018, as a result of a growing customer baserespective client bases, the three-month period decrease is tied to the reduction in consumer spending relating to the pandemic and increased transaction volume.correlates with the revenue fluctuation.

 

Marketing and business development expenses include all costs associated with promoting Bancorp, community investment,support, retaining customers and acquiring new business. Marketing and business development expenses increased $98 thousand,decreased $438,000, or 12.2%49%, in the second quarter of 2019, as compared with the second quarter of 2018. Marketing and business development expenses increased $77 thousand,$503,000, or 5.3%33%, for the three and six months endedmonth periods ending June 30, 2020, as compared to the same periods of 2019. The 2019 increases were largely due to increased community support expenses, which can fluctuate between periods due to the nature and timingsharp declines correspond with less physical customer interaction as a result of the pandemic, which has led to less travel and entertainment expense but is expectedin addition to trend to historical annual levels over the remainder of 2019.lower advertising expense.

 

Postage, printing and supplies expensesexpense increased $10 thousand,$32,000, or 2.5%8%, and $25 thousand,$67,000, or 3.2%8%, infor the respective three and six monthsix-month periods ended June 30, 2019,2020, as compared with the same time periods in 2018, primarily dueperiod of 2019, attributed to banking center and customer expansion over the King acquisition.past 12 months.

 

Legal and professional fees increased $1.0 million to $1.5 million for the second quarter of 2019 from $504 thousand in the second quarter of 2018. Legaldecreased $895,000, or 59%, and professional fees increased $1.1 million to $2.1 million for the first half of 2019 from $997 thousand for the first six months of 2018. One-time costs associated with the King acquisition totaled nearly $900 thousand$806,000, or 39%, for the three and six month periods ended June 30, 2020, compared to the same periods of 2019. AdditionalOne-time costs associated with consulting engagements also contributed toa prior year acquisition totaled nearly $900,000 for the period increases.three and six month periods ended June 30, 2019.

 

FDIC insurance expenseincreased $82,000, or 33%, and decreased $27,000, or 6%, for the three and six month periods ended June 30, 2020, as compared to the same periods of 2019. The fluctuation for the three-month period is reflective of balance sheet growth. The six-month period decline was flatattributed to the last portion of the small institution credits from 2019 being used in the first quarter over quarter and year over year. The assessment is calculated byof 2020. As a result of the national FDIC Reserve Ratio reaching 1.38% in 2019, the FDIC released credits to small institutions (less than $10 billion in total consolidated assets). For this reason, Bancorp recorded no FDIC insurance expense for the third and any fluctuation in expense is directly related to changes in Bancorp’s balance sheet.

Amortization/impairment of investments in tax credit partnerships was flat in the second quarterfourth quarters of 2019, as compared withand incurred only a portion of the second quarter of 2018, while increasing slightly year-to-date as compared with the same time period in 2018. Bancorp did not record anyassessed expense in the first quarter of 2018. 2020, as these credits were depleted.

Tax credit partnerships generate federal income tax credits, and for each of Bancorp’s investments in tax credit partnerships, the tax benefit, compared withnet of related expenses, results in a positive effect on net income. Amounts of credits and corresponding expenses can vary widely depending upon timing and magnitude of the investments. SeeAmortization expense associated with these investments saw nominal fluctuations for the Income Taxes section below for details on amortizationthree and income tax impact for these credits.six-month periods ended June 30, 2020, as compared to the same periods of 2019.

 

Other non-interest expensesCapital and deposit based taxes increased $304 thousand,$258,000, or 31.1%27%, and $737 thousand,$384,000, or 41.8%21%, respectively, for the three and six month periods ended June 30, 2019, as2020 compared withto the same periods in 2018.2019 consistent with overall balance sheet growth.

In connection with the adoption of ASC 326, Bancorp analyzed its unused lines of credit and recorded credit loss expense for off balance sheet exposures totaling $375,000 and $1.5 million during the first and second quarters of 2020. The quarterlyincrease related to changes in the mix of unused lines, mainly C&I and year-to-date increases wereunderlying CECL model factors. No such expense was incurred during the first six months of 2019.

Other non-interest expenses decreased $389,000, or 28%, and $871,000, or 33%, for the three and six months periods ended June 30, 2020, as compared to the same periods of 2019. The second quarter of 2019 included elevated losses including a bank robbery. In addition, a bank-owned property was sold during the first quarter of 2020 that resulted in a gain recorded as an offset to non-interest expense.

Income Tax Expense

A comparison of income tax expense and ETR follows:

  

Three months ended June 30,

  

Six months ended June 30,

 

(dollars in thousands)

 

2020

  

2019

  

$ Change

  

% Change

  

2020

  

2019

  

$ Change

  

% Change

 
                                 

Income before income tax expense

 $15,716  $17,573  $(1,857)  (11

)%

 $31,198  $35,053  $(3,855)  (11

)%

Income tax expense

  2,348   1,030   1,318   128   4,598   2,869   1,729   60 

Effective tax rate

  14.9%  5.9%          14.7%  8.2%        

Fluctuations in the ETR are primarily attributed to the following:

 

 

QuarterlyThe ETR at June 30, 2020 includes one-half of the anticipated full year impact of a large historic tax credit project scheduled to be placed in service later in 2020.

 

o

DirectorThe stock based compensation increased $88 thousand.component of the ETR fluctuates consistent with the level of SAR exercise activity, with lower activity experienced in 2020.

 

o

Rewards expense tiedIn March 2019, the Kentucky Legislature passed HB354 requiring financial institutions to Bancorp’s growing credit card program increased $87 thousand.transition from a capital based franchise tax to the Kentucky corporate income tax beginning in 2021. Historically, the franchise tax, a component of non-interest expenses, was assessed at 1.1% of net capital and has averaged $2.5 million annually over the prior two year-end periods. The Kentucky corporate income tax will be assessed at 5% of Kentucky taxable income and will be included as a component of current and deferred state income tax expense. Associated with this change, predominantly during the first quarter of 2019, Bancorp established a Kentucky state DTA related to existing temporary differences estimated to reverse after the effective date of the law change. Bancorp recorded a corresponding state tax benefit, net of federal tax impact of $1.3 million, or approximately $0.06 per diluted share for 2019. While this is positive in the short-term, Bancorp anticipates an unfavorable impact of approximately $200,000 per year beginning in 2021.

 

o

Core deposit intangible amortization increased $30 thousand asIn April 2019, the Kentucky Legislature passed HB458 allowing entities filing a resultcombined Kentucky income return to share certain tax attributed, including net operating loss carryforwards. The combined filing, beginning in 2021, will allow Bancorp’s Holding Company net operating loss carryforwards to offset against net revenue generated by the Bank up to 50% of the King acquisitionBank’s Kentucky taxable income and reduce Bancorp’s tax liability. Bancorp recorded a state tax benefit, net of federal tax impact of $2.4 million, predominantly in the second quarter of 2019, or approximately $0.11 per diluted share for 2019.

 

The CARES Act includes several significant provisions for corporations including increasing the amount of deductible interest under section 163(j), allowing companies to carryback certain net operating losses, and increasing the amount of net operating loss that corporations can use to offset income. These changes did not have a significant impact on Bancorp’s income taxes. 

Bancorp invests in certain partnerships that yield federal income tax credits. Taken as a whole, the tax benefit of these investments exceeds amortization expense, resulting in a positive impact on net income. The timing and magnitude of these transactions may vary widely from period to period.

 

Year-to-date

o

Director compensation increased $221 thousand.

o

Rewards expense tiedFinancial Condition – June 30, 2020 Compared to Bancorp’s growing credit card program increased $140 thousand.

o

Expense related to bad debt collection increased $80 thousand.

o

Fraud related losses increased $76 thousand

o

Gain on sales of other real estate decreased $45 thousand

o

Core deposit intangible amortization increased $28 thousand as a result of the King acquisition.

December 31, 2019

 

Income Taxes

Bancorp recorded income tax expense of $1.0 million and $2.9 million, respectively, for the three and six month periods ended June 30, 2019, compared with $3.2 million and $6.2 million for the same periods in 2018.  The effective rate for the corresponding three and six month periods in 2019 were 5.9% and 8.2%, respectively, and 18.9% and 18.7%, respectively, for 2018  The decrease in the effective tax rate from 2018 to 2019 related primarily to two Kentucky state tax law changes. 

In March 2019, Kentucky State legislation was enacted requiring financial institutions to transition from a bank franchise tax to the Kentucky corporate income tax beginning in 2021.  In April 2019,  an additional Kentucky tax law change was enacted allowing banks and their holding companies to be combined together for Kentucky tax return filings also beginning in 2021.  The combined filing will allow Bancorp’s Holding Company net operating losses to offset against net revenue generated by the Bank and reduce Bancorp’s tax liability. Bancorp recorded significant tax benefits associated with these changes in the first and second quarters of 2019.  During the first six months of 2019, Bancorp recognized a state deferred tax asset and corresponding state income tax benefit of $3.8 million, or approximately $0.16 per diluted share. See the income taxes footnote for more detail.

Commitments

As detailed in the Commitments footnote, Bancorp uses a variety of financial instruments in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit.

Other commitments discussed in Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2018, have not materially changed since that report was filed, relative to qualitative and quantitative disclosures of fixed and determinable contractual obligations.

Financial Condition

Balance SheetOverview

 

Total assets increased $160.9$610 million, or 16%, to $3.5$4.3 billion as ofat June 30, 2019,2020, from $3.3 million$3.7 billion at December 31, 2018. Bancorp acquired assets totaling approximately $1922019. The significant 2020 balance sheet expansion was directly attributable to the second quarter PPP, which drove a $619 million on May 1, 2019increase in connection with the King acquisition.loans. In the first six months of 2019 increases in loans, premises and equipment, and other assets were offset by decreasesaddition, declines in cash and cash equivalents were offset by increases in AFS debt securities, accrued interest receivable and available for sale securities. Grossother assets. The six months ended June 30, 2020 included significantly higher ACL on loans resulting from the adoption of ASC 326 and additional provisioning.

Total liabilities increased $215.7$596 million, or 8.5%18%, including $160.5with a $593 million increase in loans acquired from King. Strong loan productiondeposits driven by the PPP. Increases in the second quarterSSUAR and first six months of 2019 contributed to non-acquisition, or legacy, loan growth of $51.6other liabilities were offset by a $19 million decline in FHLB advances, as matured advances were not replaced.

Cash and Cash Equivalents

Cash and cash equivalents decreased $25 million, or 2.0%10%, ending at $224 million at June 30, 2020, while the average balance for the six months ended June 30, 2019. Cash and cash equivalents decreased $82.92020 compared to the same period in 2019 has increased $97 million, or 41.7%, as excess75%. Bancorp has maintained higher levels of liquidity was usedin 2020 attributable to fund loan growththe PPP and the King acquisition.current economic uncertainty.

AFS Debt Securities available for sale decreased $13.4

AFS debt securities increased $15 million, or 3.1%3%, over the first six months of 2019, as maturing security cash flows were not reinvested but held in the form of short-term liquidity.  This decline was offset somewhat by market value improvement in the portfolio with net unrealized gainsto $485 million at June 30, 20192020. In the current declining interest rate market values have increased, driving an $11 million increase in the market value of $1.7the AFS portfolio at June 30, 2020

Goodwill

At June 30, 2020, Bancorp had $13 million asin goodwill recorded on its balance sheet. Events that may trigger goodwill impairment include deterioration in economic conditions, increased competition, loss of key personnel, and regulatory action. More specifically, a sustained decline in stock price could be considered a triggering event. Similar to other financial institutions, the COVID-19 economic crisis caused volatility to Bancorp’s stock price. Management compared with net unrealized lossesthe fair value of $6.7the commercial banking segment to the carrying value recorded on the balance sheet and other factors, and concluded its goodwill was not impaired. Bancorp’s stock has traded above book value for the entire first and second quarters of 2020.

Other Assets and Other Liabilities

Other assets increased $11 million, or 22%, to $62 million at June 30, 2020, from $51 million at December 31, 2018. Premises and equipment2019. In addition, other liabilities increased $20.3$14 million, or 45.4%22%, primarilyto $74 million at June 30, 2020, from $61 million at December 31, 2019. The increase in both of the result establishingcategories was largely attributed to changes market value changes of interest rate swap transactions maintained for certain loan customers. Bancorp enters into these interest rate swap transactions with borrowers who desire to hedge exposure to rising interest rates, while at the same time entering into an offsetting interest rate swap, with substantially matching terms, with another approved independent counterparty. These are undesignated derivative instruments and are recognized on the balance sheet at fair value via both an asset and a right of use lease asset upon adopting ASU 2016-02, Leases inrelated liability as Bancorp has an agreement with the first quarter of 2019borrower (the asset) and the additioncounterparty (the liability). Because of five King branches. Other assets increased $17.3 million or 36.8% asmatching terms of offsetting contracts and collateral provisions mitigating any non-performance risk, changes in fair value have an offsetting effect on the related asset and liability. For this reason, the market value changes we have seen since the end of last year stemming from the declining interest rate environment have resulted in increases to both the asset and liability associated with these transactions. For additional information, see the footnote titled “Derivative Financial Instruments.

As of June 30, 2019, as compared2020, Bancorp did not have any impairment with December 31, 2018 due primarilyrespect to its other intangible assets (MSRs and CDIs) or other long-lived assets. It is possible that the recognitionlingering effects of $12.1 millionCOVID-19 could cause the occurrence of what management would deem to be a triggering event that could cause Bancorp to perform an intangible asset impairment test and result in goodwill related to the King acquisition.

Total liabilities increased $138.0 million or 4.7% to $3.1 billion as of June 30, 2019, from $2.9 billion as of December 31, 2018. Liabilities assumed in the King acquisition totaled $176.6 million. Total deposits increased $89.1 million, or 3.2%, as $125.5 million in deposits assumed from the King transaction offset expected seasonal decreases in Bancorp’s non-interest bearing deposits, and interest bearing demand deposit accounts.  For the six month period ending June 30, 2019, non-interest bearing demand deposits increased $66.6 million, or 9.4%, while interest bearing deposits increased $22.5 million, or 1.1%. Securities sold under agreements to repurchase (“SSUAR”) decreased $2.3 million, or 6.3%, due to normal cyclical activity, and the continuation of customers migrating to higher-yielding, non-collateralized deposits. Federal funds purchased increased $1.8 million, or 17.2%, period to period, as Bancorp uses short-term lines of credit to manage its overall liquidity position. Federal Home Loan Bank (“FHLB”) advances increased $36.1 million, or 74.9%, as Bancorp retained the fixed rate long term advances that were held at King in connection with overall balance sheet funding. Other liabilities increased $13.1 million, or 28.0%, largely due to the adoption of ASU 2016-02, Leases, in the first quarter of 2019.an impairment charge being recorded.

 

 

Loan Portfolio CompositionLoans

 

Composition of loans, net of deferred fees and costs, by primary loan portfolio class follows:

 

(In thousands)

 

June 30, 2019

  

December 31, 2018

 
         

Commercial and industrial

 $860,085  $833,524 

Construction and development, excluding undeveloped land(1)

  222,632   225,050 

Undeveloped land

  35,169   30,092 
         

Real estate mortgage:

        

Commercial investment

  696,421   588,610 

Owner occupied commercial

  452,719   426,373 

1-4 family residential

  338,957   276,017 

Home equity - first lien

  46,012   49,500 

Home equity - junior lien

  67,948   70,947 

Subtotal: Real estate mortgage

  1,602,057   1,411,447 
         

Consumer

  43,937   48,058 

Total loans(2)

 $2,763,880  $2,548,171 

(In thousands)

 

June 30, 2020

  

December 31, 2019

  

$ Change

  

% Change

 
                 

Commercial real estate - non-owner occupied

 $815,464  $746,283  $69,181   9%

Commercial real estate - owner occupied

  472,457   474,329   (1,872)  0%

Total commercial real estate

  1,287,921   1,220,612   67,309   6%
                 

Commercial and industrial - term

  510,384   457,298   53,086   12%

Commercial and industrial - term - PPP

  630,082   -   630,082   100%

Commercial and industrial - lines of credit

  254,096   381,502   (127,406)  -33%

Total commercial and industrial

  1,394,562   838,800   555,762   66%
                 

Residential real estate - owner occupied

  215,891   217,606   (1,715)  -1%

Residential real estate - non-owner occupied

  139,121   134,995   4,126   3%

Total residential real estate

  355,012   352,601   2,411   1%
                 

Construction and land development

  255,447   255,816   (369)  0%

Home equity lines of credit

  103,672   103,854   (182)  0%

Consumer

  43,758   47,467   (3,709)  -8%

Leases

  14,843   16,003   (1,160)  -7%

Credits cards - commercial

  8,862   9,863   (1,001)  -10%

Total loans (1)

 $3,464,077  $2,845,016  $619,061   22%

 

(1)

Consists Total loans are presented inclusive of land acquired for development by the borrower, but for which no development has yet taken place.

(2)

Unaccreted discounts include accretable and non-accretablepremiums, discounts, and primarily relate to Bancorp's TBOCnet loan origination fees and King acquisitions in 2012,and 2019, respectively.costs

Total loans increased $619 million, or 22%, primarily attributable to the PPP loan portfolio. Total loans (excluding PPP loans) contracted $11 million during the first six months of 2020, with a $67 million increase in CRE loans offset by a $74 million decline in C&I loans. The C&I decline was predominantly attributable to customers who received PPP funds. Despite flat line of credit usage for the first quarter of 2020, usage declined significantly to 39% at June 30, 2020 compared to 47% at December 31, 2019.

As of June 30, 2020, PPP loans of $630 million ($647 million gross of unamortized deferred fees), were outstanding. PPP borrowers are eligible for forgiveness from the SBA for the portion of funding received utilized for job retention and certain other expenses, such as payroll costs, mortgage interest, rent and utilities during the 24-week period beginning with the date of the loan. With a significant portion of these loans potentially eligible for full forgiveness there is high likelihood of early pay off prior to maturity (predominantly 24 months).

In accordance with Section 4013 of the CARES Act and in response to requests from borrowers who experienced business or personal cash flow interruptions related to the pandemic, Bancorp executed a payment deferral program. Depending on the demonstrated need of the customer, Bancorp deferred either the full loan payment or the principal only portion of respective loan payments for 90 or 180 days for some borrowers directly impacted by the pandemic.  As of June 30, 2020, Bancorp executed 1,100 of full payment deferrals (predominantly three months) on outstanding loan balances of $502 million - representing 18% of the loan portfolio (excluding PPP loans). Approximately 85% of the total deferrals processed (in terms of dollars) occurred in the month of April, with the subsequent pace slowing significantly. Pursuant to the CARES Act, these loan deferrals were not classified as TDRs and not included in non-performing loan statistics. Subsequent to the end of the second quarter and through the end of July, a significant portion of the deferred loan portfolio returned to full paying status. As of July 31, 2020, Bancorp estimates that 10% of the total loan portfolio (excluding PPP loans) remained in full payment deferment status. Bancorp is monitoring loan modification expirations daily and anticipates the potential for more customers to return to full payment status over the next two months as their initial deferral period ends.

While all industries have and may continue to experience adverse impacts as a result of COVID-19, Bancorp had exposures (on balance sheet loans and commitments to lend) in the following pandemic sensitive industries as of June 30, 2020:

Industry Segments (dollars in millions)

 

Outstanding

  

% of Total Loans *

 
         

Shopping Centers

 $58   2.0%

Lodging / Hotels

  62   2.2%

Nursing homes / Residential Care

  50   1.8%

Recreation / Entertainment

  56   2.0%

Restaurants / Bars

  30   1.0%

Travel Related

  24   0.8%

* - Total loans exclude PPP loans.

Bancorp anticipates that a significant portion of the Bank’s borrowers in the above industry segments will continue to endure significant economic distress, as long as the current COVID-19 related economic conditions persist. Among other things, this could cause them to draw on their existing lines of credit and/or affect their ability to repay existing indebtedness. These developments, together with economic conditions generally, are also expected to impact the CRE portfolio, particularly with respect to real estate with exposure to these industries, and the value of certain collateral.

Bancorp’s credit exposure is diversified with secured and unsecured loans to individuals and businesses. No specific industry concentration exceeds 10% of loans outstanding. While Bancorp has a diversified loan portfolio, a customer’s ability to honor contracts is somewhat dependent upon the economic stability and/or industry in which that customer does business. Loans outstanding and related unfunded commitments are primarily concentrated within Bancorp’s current market areas, which encompass the Louisville, Indianapolis and Cincinnati MSAs.

 

Bancorp occasionally enters into loan participation agreements with other banks to diversify credit risk. For certain participation loans sold, Bancorp has retained effective control of the loans, typically by restricting the participating institutions from pledging or selling their ownership share of the loan without permission from Bancorp. GAAP requires the participated portion of these loans to be recorded as secured borrowings. These participated loans are included in the commercialC&I, C&D and industrial and real estateCRE mortgage loan portfolio segments with a corresponding liability recorded in other liabilities. At June 30, 20192020 and December 31, 2018,2019, the total participated portionsportion of loans of this nature were $9.9totaled $9 million and $10.5$8 million, respectively.

 

Allowance for Loan and Lease Losses

An allowance has been established to provide for probable losses on loans that may not be fully repaid. The allowance is increased by provisions charged to expense and decreased by charge-offs, net of recoveries. Loans are typically charged off when management deems them uncollectible and after underlying collateral has been liquidated; however, collection efforts continue and future recoveries may occur. Periodically, loans are partially charged off to the net realizable value based upon evaluation of related underlying collateral, including Bancorp’s proclivity for resolution.

The allowance methodology is driven by risk ratings, historical losses, and qualitative factors. The level of the June 30, 2019 allowance reflected a number of factors, including credit quality metrics which were generally consistent with those experienced in the preceding 12 months, and expansion of the historical look-back period from 32 quarters to 36 quarters. This expansion of the historical period was applied to all classes and segments of the portfolio. Expansion of the look-back period for historical loss rates used in the quantitative allocation caused review of the overall methodology for qualitative factors to ensure we were appropriately capturing risk not addressed in the quantitative historical loss rate. Management believes extension of the look-back period is appropriate to ensure capture of the impact of a full economic cycle and more accurately represents the current level of risk inherent in the loan portfolio. Key indicators of loan quality continued to trend at levels consistent with prior periods, however management recognizes that due to the cyclical nature of the lending business, these trends will likely normalize over the long term. Additional information regarding Bancorp’s methodology for evaluating the adequacy of the allowance can be read in Bancorp’s Annual Report on Form 10-K.

As of June 30, 2019 the allowance was $26.4 million, a $882 thousand increase from the December 31, 2018 balance of $25.5 million.  For the comparative periods, the allowance as a percent of year-to-date average loans was 1.02% and 1.01%, respectively.  The allowance as a percent of period end loans, as of each period end, 0.96% and 1.00%, respectively. The allowance balance is reflective of continued strong credit metrics and net recoveries of $282 thousand for the first six months of 2019.  As of June 30, 2019, and December 31, 2018, the allowance remained adequate to cover potential losses in the loan portfolio, in management’s opinion.

Non-performing Loans and Non-performing Assets

 

Information summarizing non-performing loans and assets including non-accrual loans follows:

 

(Dollars in thousands)

 

June 30, 2019

  

December 31, 2018

 

(dollars in thousands)

 

June 30, 2020

  

December 31, 2019

 
  

Non-accrual loans(1)

 $3,030  $2,611  $14,262  $11,494 

Troubled debt restructurings

 37  42  45  34 

Loans past due 90 days or more and still accruing

  861   745   48   535 
  

Total non-performing loans

 3,928  3,398  14,355  12,063 
  

Other real estate owned

  563   1,018   493   493 
  

Total non-performing assets

 $4,491  $4,416  $14,848  $12,556 
  

Non-performing loans as a percentage of total loans

 0.14% 0.13%

Non-performing assets as a percentage of total assets

 0.13% 0.13%

Non-performing loans to total loans

 0.41% 0.42%

Non-performing assets to total assets

 0.34% 0.34%


(1) No TDRs previously accruingNon-performing loans to total loans were transferred to non-accrual during the three and six month periods ending 0.41% at June 30,, 2019. No TDRs were on non-accrual as of June 30, 2019 or 2020 compared to 0.21% at March 31, 2020 and 0.42% at December 31, 2018.2019. Non-performing loans to total loans (excluding PPP loans) were 0.51% at June 30, 2020.

 

In total, non-performing assets as of June 30, 20192020 were comprised of 2631 loans, ranging in amountindividual amounts from $1 thousand$300 to $528 thousand,$10 million, two accruing TDRs,TDR loans and foreclosed real estate held for sale. Foreclosed real estate held at June 30, 2020 and December 31, 2019 included a 1-4 family residential real estate property and a commercial real estateCRE property.

Non-performing loans increased $2 million to $14 million at June 30, 2020 compared to December 31, 2019. During the first quarter of 2020 a large non-accrual C&I relationship totaling $8 million paid off due to sale of the business. During the second quarter of 2020, a large CRE relationship was placed on non-accrual status and allocated a $2 million specific reserve within the ACL on loans. The borrower did not receive PPP funds, the loan was current at the time of non-accrual classification, and no payments related to the loan have been deferred. Other activity in non-performing loans for the first six months of 2020 was driven by additions and removals of smaller credits to and from non-performing loan status.

The following table presents the amortized cost basis of non-performing loans and the amortized cost basis of loans on non-accrual status for which there was no related ACL losses of June 30, 2020:

(in thousands)

 

June 30, 2020

 
     

Commercial real estate - non-owner occupied

 $213 

Commercial real estate - owner occupied

  1,663 

Total commercial real estate

  1,876 
     

Commercial and industrial - term

  9 

Commercial and industrial - lines of credit

   

Total commercial and industrial

  9 
     

Residential real estate - owner occupied

  306 

Residential real estate - non-owner occupied

  225 

Total residential real estate

  531 
     

Construction and land development

   

Home equity lines of credit

   

Consumer

   

Leases

   

Credit cards - commercial

   

Total non-accrual loans

 $2,416 

The following table presents the recorded investment in non-performing loans by portfolio class as of December 31, 2019:

(in thousands)

 

December 31, 2019

 
     

Commercial and industrial

 $8,202 

Construction and development, excluding undeveloped land

   

Undeveloped land

   
     

Real estate mortgage:

    

Commercial investment

  740 

Owner occupied commercial

  2,278 

1-4 family residential

  123 

Home equity - first lien

   

Home equity - junior lien

  151 

Subtotal: Real estate mortgage

  3,292 

Consumer

   

Total non-accrual loans

 $11,494 

Delinquent Loans

Delinquent loans (consisting of all loans 30 days or more past due) totaled $6 million at June 30, 2020 compared to $13 million at March 31, 2020 and $15 million at December 31, 2019. Delinquent loans total loans were 0.17%, 0.44% and 0.53% at June 30, 2020, March 31, 2020 and December 31, 2019. Delinquent loans to total loans (excluding PPP loans) were 0.21% at June 30, 2020.

Allowance for Credit Losses of Loans

The ACL is a valuation allowance for loans estimated at each balance sheet date in accordance with GAAP. When Bancorp deems all or a portion of a loan to be uncollectible, the appropriate amount is written off and the ACL is reduced by the same amount. Subsequent recoveries, if any, are credited to the ACL when received. See the footnote titled “Basis of Presentation and Summary of Significant Accounting Policiesfor discussion of Bancorp’s ACL methodology on loans. Allocations of the ACL may be made for specific loans, but the entire ACL on loans is available for any loan that, in Bancorp’s judgment, should be charged-off.  

 

The following table sets forth the major classificationsACL by category of non-accrual loans:loan:

 

(In thousands)

 

June 30, 2019

  

December 31, 2018

 
         

Commercial and industrial

 $96  $192 

Construction and development, excluding undeveloped land

     318 

Undeveloped land

     474 
         

Real estate mortgage

        

Commercial investment

  305   138 

Owner occupied commercial

  1,444   586 

1-4 family residential

  715   760 

Home equity - first lien

      

Home equity - junior lien

  470   143 

Subtotal: Real estate mortgage

  2,934   1,627 

Consumer

      
         

Total non-accrual loans

 $3,030  $2,611 
  

June 30, 2020

  

December 31, 2019

 

(in thousands)

 

Allocated

Allowance

  

% of Loan

Portfolio (1)

  

ACL to Total

Loans (1)

  

Allocated

Allowance

  

% of Loan

Portfolio

  

ACL to Total

Loans

 
                         

Commercial real estate - non-owner occupied

 $18,839   28%  2.31% $5,235   25%  0.70%

Commercial real estate - owner occupied

  6,706   17%  1.42%  3,327   17%  0.70%

Total commercial real estate

  25,545   45%  1.98%  8,562   42%  0.70%
                         

Commercial and industrial - term (1)

  7,339   17%  1.44%  6,782   16%  1.48%

Commercial and industrial - lines of credit

  3,242   9%  1.28%  5,657   13%  1.48%

Total commercial and industrial

  10,581   26%  1.38%  12,439   29%  1.48%
                         

Residential real estate - owner occupied

  2,848   8%  1.32%  1,527   8%  0.70%

Residential real estate - non-owner occupied

  1,594   5%  1.15%  947   5%  0.70%

Total residential real estate

  4,442   13%  1.25%  2,474   13%  0.70%
                         

Construction and land development

  5,608   9%  2.20%  2,105   9%  0.82%

Home equity lines of credit

  832   4%  0.80%  728   4%  0.70%

Consumer

  362   2%  0.83%  100   2%  0.21%

Leases

  223   1%  1.50%  237   1%  1.48%

Credit cards - commercial

  115   0%  1.30%  146   0%  1.48%

Total net loan (charge-offs) recoveries

 $47,708   100%  1.68% $26,791   100%  0.94%

(1)

Excludes the PPP loan portfolio at June 30, 2020, which was not reserved for based on the 100% SBA guarantee.

Upon adoption of ASC 326 on January 1, 2020, Bancorp recorded an increase of $8.2 million to the ACL on loans and a corresponding decrease to retained earnings, net of the DTA impact. In addition, non-accretable yield marks of $1.6 million related to formerly classified PCI loans were re-classed between the amortized cost basis of loans and corresponding ACL. The adjustment upon adoption of ASC 326 raised the ACL on loans balance to $37 million on January 1, 2020. In addition to the CECL adoption, the ACL on the first and second quarters of 2020 was significantly impacted by national unemployment forecast adjustments within the CECL model, changes in the loan mix and the addition of a large specific reserve during the second quarter of 2020.

 

 

Bancorp measures expected credit losses of financial assets on a collective (pool) basis, when the financial assets share similar risk characteristics. Depending on the nature of the pool of financial assets with similar risk characteristics, Bancorp has measured its portfolio classes as follows:

Loan Portfolio Segment

ACL Methodology

Commercial real estate - non-owner occupied

Discounted cash flow

Commercial real estate - owner occupied

Discounted cash flow

Commercial and industrial - term

Static pool

Commercial and industrial - line of credit

Static pool

Residential real estate - owner occupied

Discounted cash flow

Residential real estate - non-owner occupied

Discounted cash flow

Construction and land development

Static pool

Home equity lines of credit

Static pool

Consumer

Static pool

Leases

Static pool

Credit cards - commercial

Static pool

The static pool methodology is utilized for the loan portfolio segments that typically have shorter durations. For each of these loan segments, Bancorp applies an expected loss ratio based on historical losses adjusted as appropriate for qualitative factors. Qualitative loss factors are based on management's judgment of company, market, industry or business specific data, changes in underlying loan composition of specific portfolios, trends relating to credit quality, delinquency, non-performing and adversely rated loans, and reasonable and supportable forecasts of economic conditions.

When developing the ACL CECL model for loan pools utilizing the DCF method, Bancorp utilized regression analysis of historical internal and peer data to identify a suitable loss driver to utilize when modeling lifetime probability of default and loss given default. Such regression analysis was used to measure how the expected probability of default and loss given default would react to changes in forecasted levels of the loss driver. Based on this regression analysis, management determined that the forecasted Seasonally Adjusted National Civilian Unemployment Rate best correlated to Bancorp’s historical losses and elected to use this rate as the primary loss driver to be consistently applied across all applicable loan segments over a reasonable and supportable forecast period.

Upon adoption of ASC 326 on January 1, 2020, management determined that four quarters represented a reasonable and supportable national unemployment forecast period with reversion back to Bancorp’s historical loss rate over eight quarters on a straight-line basis. This resulted in an $8.2 million initial increase in the ACL on loans with the offset to retained earnings.

Subsequent to January 1, 2020, based on the economic crisis caused by COVID-19 and measures taken to protect public health such as stay-at-home orders and mandatory closures of businesses, economic activity halted significantly and job losses surged. As such, national unemployment has fluctuated widely over the last several months as follows:

  

Jun 20

  

May 20

  

Apr 20

  

Mar 20

  

Feb 20

  

Jan 20

  

Dec 19

 
                             

National Unemployment Rate

  11.10%  13.30%  14.70%  4.40%  3.50%  3.60%  3.50%

As of March 31, 2020, based on the evolving pandemic, Bancorp elected to forecast for only one quarter of national unemployment (versus the four quarters used as of January 1, 2020) and modified its forecast to reflect a significant increase in unemployment (utilizing the highest unemployment rate in Bancorp’s observed history) reverting back to the long-term average in the third quarter of 2020, with the loss driver remaining significantly worse compared to recent trends. The impact of the increased national unemployment forecast was muted by an adjustment in qualitative factors attributed to the massive federal stimulus programs enacted at the end of the first quarter in response to the pandemic. The forecasted increase in national unemployment coupled with the qualitative factor adjustments resulted in approximately $4.2 million of the total provision expense recorded for the three months ended March 31, 2020.

During the second quarter, for the first time during 2020, the FRB released a forecasted Seasonally Adjusted National Civilian Unemployment Rate for the 12 months ended December 31, 2020, 2021 and 2022 as follows:

  

2020

  

2021

  

2022

 
             

Upper end of range

  14.0%  12.0%  8.0%

Median

  9.3%  6.5%  5.5%

Lower end of range

  7.0%  4.5%  4.0%

As of June 30, 2020, based on the above and the continuation of the economic crisis, Bancorp elected to forecast for one quarter of national unemployment utilizing actual June unemployment then stepping down to a blended rate based on the above FRB median forecast over the next four quarters before reverting back to the long-term average. Similar to the first quarter of 2020, the impact of the increased unemployment forecast was muted by an adjustment in qualitative factors attributed to the massive federal stimulus programs that have been enacted. The forecasted increase in unemployment coupled with the qualitative factor adjustments resulted in approximately $4.6 million of the total provision expense recorded for the three months ended June 30, 2020 and $8.8 million for the six months ended June 30, 2020.

Outstanding loans (excluding PPP loans) increased $92 million during the first three months of 2020 and contracted $103 million during the second quarter of 2020, as outstanding C&I lines of credit were reduced by $114 million. The overall net change in the loan mix contributed to $1.3 million of additional provision expense for the three months ended March 31, 2020. During the second quarter of 2020, the loan contraction (mainly C&I lines of credit) led to a $1.0 million reduction in the required ACL on loans.

The pandemic has had a material impact on Bancorp’s ACL on loans calculations for both March 31, 2020 and June 30, 2020. While Bancorp has not yet experienced any credit quality issues such as charge-offs related to the pandemic, the ACL calculation for loans and resulting provision were significantly impacted by changes in forecasted economic conditions. Should the forecast for economic conditions worsen, Bancorp could experience further increases in its required ACL and record additional provision expense. While the execution of Bancorp’s payment deferral program has assisted the ratio of past due loans to total loans at March 31, 2020 and June 30, 2020, it is possible that asset quality could worsen at future measurement periods if the effects of the pandemic are prolonged.

In connection with the adoption of ASC 326, Bancorp analyzed its unused lines of credit and recorded credit loss expense for off-balance sheet exposures (non-interest expense) totaling $375,000 and $1.5 million during the first and second quarters of 2020. The second quarter increase directly correlates to the increased availability due to C&I line of credit pay downs. At June 30, 2020, approximately $6 million was accrued within other liabilities related to off balance sheet exposures.

During the three months ended June 30, 2020, a large CRE relationship was placed on non-accrual status and received a $2 million specific reserve allocation within the ACL on loans. The borrower did not receive PPP funds, the loan was current at the time of non-accrual classification, and no payments related to the loan have been deferred.

Deposits

(in thousands)

 

June 30, 2020

  

December 31, 2019

 
         

Non-interest bearing demand deposits

 $1,205,253  $810,475 
         

Interest bearing deposits:

        

Interest bearing demand

  1,147,357   979,595 

Savings

  196,655   169,622 

Money market

  761,256   742,029 
         

Time deposits of $250 thousand or more

  76,954   81,412 

Other time deposits(1)

  339,681   350,805 

Total time deposits

  416,635   432,217 
         

Total interest bearing deposits

  2,521,903   2,323,463 
         

Total deposits

 $3,727,156  $3,133,938 

(1)     Includes $30 million in brokered deposits as of both June 30, 2020 and December 31, 2019.

Total deposits increased $593 million, or 19%, from December 31, 2019 to June 30, 2020 with non-interest bearing deposits representing $395 million of the increase. Both ending and average deposit balances finished at record levels as of June 30, 2020, as a result of the second quarter PPP and deferred tax payments. Commercial customers who were awarded PPP funding have generally been slow in deploying the funds held on deposit at the Bank. Bancorp has relied on this along with excess cash on hand to fund the PPP loan portfolio. In addition, some maturing certificates of deposit are not being renewed in the current low interest rate environment.

Securities Sold Under Agreements to Repurchase

SSUARs are collateralized by securities and are treated as financings; accordingly, the securities involved with the agreements are recorded as assets and are held by a safekeeping agent and the obligations to repurchase the securities are reflected as liabilities. All securities underlying the agreements are under the Bank’s control.

SSUARs totaled $43 million and $32 million at June 30, 2020 and December 31, 2019, respectively.  The majority of SSUARs are indexed to immediately repricing indices such as the FFTR. The increase in SSUAR is attributed to the trend of customers maintaining higher balances in general during the first half of 2020, presumably a result of current economic uncertainty.

FHLB Advances

In connection with the May 2019 acquisition, Bancorp assumed $43 million FHLB term advances and chose to retain them on balance sheet based upon the then-favorable rate and terms in the overall execution of Bancorp’s asset liability management strategy. Over the past 12 months, these advances have not been replaced as they have matured. In addition, during the second quarter of 2020, Bancorp elected to pay down $10 million of advances without penalty based on the favorable interest rate environment experienced at the time.

Liquidity

 

The role of liquidity management is to ensure funds are available to meet depositors’ withdrawal and borrowers’ credit demands while at the same time maximizing profitability. This is accomplished by balancing changes in demand for funds with changes in supply of suchthose funds. Liquidity is provided by short-term liquid assets that can be converted to cash, investmentAFS debt securities, available for sale, various lines of credit available to Bancorp, and the ability to attract funds from external sources, principally deposits. Management believes it has the ability to increase deposits at any time by offering rates slightly higher than market rate.

Bancorp’s Asset/Liability Committee is comprised of senior management and has direct oversight responsibility for Bancorp’s liquidity position and profile. A combination of reports provided to management details internal liquidity metrics, composition and level of the liquid asset portfolio, timing differences in short-term cash flow obligations, and exposure to contingent draws on Bancorp’s liquidity.

As of June 30 2020, Bancorp had not experienced any significant funding issues related to the PPP or the pandemic in general. A significant portion of the funds borrowed have remained in the form of commercial deposits and have generally been slow to outflow. In addition, the deferment of tax payment deadlines and federal stimulus checks have also contributed to higher than normal deposit balances. If a liquidity issue arose, Bancorp would utilize overnight funds from the FHLB (the lowest costing source), in which Bancorp has available credit in excess of $800 million.

 

Bancorp’s most liquid assets are comprised of cash and due from banks, available for sale marketable investment securities, federal funds soldFFS and AFS debt securities. FFS and interest bearing due from accounts with banks.  Federal funds solddeposits totaled $178 million and interest bearing due from bank accounts totaled $64.8$203 million at June 30, 2019. These investments2020 and December 31, 2019, respectively. FFS normally have overnight maturities andwhile interest-bearing deposits in banks are accessible on demand. These investments are used for general daily liquidity purposes.

Available for sale securities totaled $423.6 The fair value of the AFS debt security portfolio was $485 million and $471 million at June 30, 2020 and December 31, 2019, with $132.1respectively. The portfolio includes maturities of approximately $75 million in securities expected to mature over the next 12 months. Combined with federal funds soldFFS and interest bearing duedeposits from bank accounts, thesebanks, AFS debt securities offer substantial resources to meet either new loan demandgrowth or reductions in Bancorp’s deposit funding base. Bancorp pledges portions of theits investment securities portfolio to secure public fund deposits,funds, cash balances of certain WM&T accounts and SSUAR. At June 30, 2019,2020, total investment securities pledged for these purposes comprised 79.4%81% of the available for sale investmentAFS debt securities portfolio, leaving approximately $87.1$91 million of unpledged AFS debt securities.

 

Bancorp has a significantlarge base of non-maturitycore customer deposits, defined as demand, savings, money market deposit accounts and time deposits less than or equal to $250,000, (excludingdemand, savings, money market deposit accounts and excluding brokered deposits).deposits. At June 30, 2019,2020, such deposits totaled $2.8$3.6 billion and represented 96.5%97% of Bancorp’s total deposits, as compared with $2.7$3.0 billion, or 97.0%96% of total deposits at December 31, 2018.2019. Because these core deposits are less volatile and are often tied to other products of Bancorp through long lasting relationships, they do not put significantplace undue pressure on liquidity. As market conditions continue to improve, theseHowever, many of Bancorp’s individual depositors are currently maintaining historically high balances. These excess balances may decrease, placing pressure onbe more sensitive to market rates, with potential decreases possibly straining Bancorp’s liquidity position.  Bancorp began adding liquidity to the balance sheet in 2018 sheet through targeted certificate of deposit marketing campaigns.  The campaigns generated over $100 million in certificate of deposit growth in 2018. 

 

As of June 30, 2019,2020 and December 31, 2018,2019, Bancorp hadheld brokered deposits totaling $30 million.

 

Included in total deposit balances at June 30, 20192020 is $157.4$234 million of public funds deposits generally comprised of accounts from local government agencies and public school districts in the markets in which Bancorp operates within. As a result of property tax collections in the latter part of each yearoperates. Bancorp consider these accounts provide seasonal excess balances that originate with tax payments and decline leading into the subsequent tax season.  While this excess liquidity is maintained in low-yielding short-term investments and consequently negatively impacts net interest margin, it has a positive impact on net interest income.to be long-term relationships.

 

Other sourcesBancorp is a member of funds available to meet daily needs include the salesFHLB of SSUAR.Cincinnati. As a member of the FHLB, of Cincinnati, Bancorp has access to credit products offered byof the FHLB. Bancorp views these borrowings as a potential low cost alternative to brokered deposits. At June 30, 2020 and December 31, 2019, available credit from the FHLB totaled $484.0$806 million as compared with $537.0and $599 million, asrespectively. The increase in available credit over the first six months of December 31, 2018.2020 is due to pledging a portion of the PPP portfolio, increasing our collateral-based borrowing capacity. See the footnote titled “FHLB Advances” for additional detail.  Additionally, Bancorp had unsecured available federal funds purchasedFFP lines with correspondent banks totaling $105.0$80 million at both June 30, 2019,2020 and $105 million December 31, 2018.  2019. This decrease is the result of closing a relationship with a correspondent bank that was deemed unnecessary as a result of changes in their fee structure.

Over the normal course of business, Bancorp enters into certain forms of off-balance sheet transactions, including unfunded loan commitments and letters of credit. These transactions are managed through Bancorp’s various risk management processes. Management considers both on-balance sheet and off-balance sheet transactions in its evaluation of Bancorp’s liquidity.

 

Bancorp’s principal source of cash revenue is dividends paid to it as the sole shareholder of the Bank. As discussed in the footnote titled “Commitments and Contingent Liabilities,” as of January 1st of any year, the Bank may pay dividends in an amount equal to the Bank’s net income of the prior two years less any dividends paid for the same two years. At June 30, 2019,2020, the Bank couldmay pay upan amount equal to $49.7$53 million in dividends to Bancorp without regulatory approval subject to the ongoing capital requirements of the Bank.

Sources and Uses of Cash

Cash flow is provided primarily through financing activities of Bancorp, which include raising deposits and borrowing funds from institutional sources such as advances from FHLB and FFP, as well as scheduled loan repayments. These funds are primarily used to facilitate investment activities of Bancorp, which include making loans and purchasing securities for the investment portfolio. Another important source of cash is net income of the Bank from operating activities.  For further detail regarding the sources and uses of cash, see the “Consolidated Statements of Cash Flows” in Bancorp’s consolidated financial statements.

Commitments

In the normal course of business, Bancorp is party to activities that contain credit, market and operational risk that are not reflected in whole or in part in Bancorp’s consolidated financial statements. Such activities include traditional off-balance sheet credit-related financial instruments, commitments under operating leases and long-term debt.

Bancorp provides customers with off-balance sheet credit support through loan commitments and standby letters of credit. Unused loan commitments increased $66 million as of June 30, 2020 compared to December 31, 2019 consistent with the pay down activity seen for C&I lines of credit and significantly lower line utilization rates. The Bank paid the Holding Company a $28 million dividend in April,C&I line utilization rate fell from 43% at December 31, 2019 to consummate the acquisition of King and this did not significantly hamper the Bank’s ability to pay future dividends.29% at June 30, 2020.

 

Capital ResourcesCommitments to extend credit are an agreement to lend to a customer as long as collateral is available as agreed upon and there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Bancorp uses the same credit and collateral policies in making commitments and conditional guarantees as for on-balance sheet instruments. Bancorp evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained is based on management’s credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, securities, equipment and real estate. However, should the commitments be drawn upon and should our customers default on their resulting obligation to us, our maximum exposure to credit loss, without consideration of collateral, is represented by the contractual amount of those instruments.

 

At June 30, 2020 and December 31, 2019, Bancorp had accrued $6 million and $350,000, respectively, in other liabilities for its estimate of inherent risks related to unfunded credit commitments. In accordance with the adoption of ASC 326 on January 1, 2020, Bancorp’s ACL on off-balance sheet exposures was increased from $350,000 at December 31, 2019 to $3.9 million ($2.6 million net of the DTA) with the offset recorded to retained earnings on a tax-effected basis, with no impact on earnings. Also, based on periodic analysis of its unused lines of credit, Bancorp recorded $1.9 million in additional off-balance sheet exposure expense for the six months ended June 30, 2020. The increase is related to underlying CECL model factors and a significant decline in line of credit usage related to the pandemic.

Standby letters of credit are conditional commitments issued by Bancorp to guarantee the performance of a customer to a third party beneficiary. Those guarantees are primarily issued to support commercial transactions. Standby letters of credit generally have maturities of one to two years.

In addition to owned banking facilities, Bancorp has entered into long-term leasing arrangements for certain branch facilities. Bancorp also has required future payments for a non-qualified defined benefit retirement plan, long-term debt and the maturity of time deposits.

See the footnote titled “Commitments and Contingent Liabilities” for additional detail.

Capital

At June 30, 2020, stockholders’ equity totaled $389.4$420 million, an increase of $22.9$14 million, or 6.2%3%, since December 31, 2018.  See2019, as 2020 net income of $26.6 million and the Consolidated Statement of Changespositive change in Stockholders’ Equity for further detail of changes in equity since 2018.  One component of equity is accumulated other comprehensive income (loss) which, for Bancorp,AOCI were offset by CECL related adjustments and dividends declared. AOCI consists of net unrealized gains or losses on AFS debt securities available for sale and hedging instruments, as well as a minimum pension liability, each net of income taxes. Accumulated other comprehensive incomeAOCI was $1.1$9 million at June 30, 20192020 compared with a loss of $5.1 million on$677,000 at December 31, 2018. The2019 with the fluctuation in other comprehensive income is reflective ofstemming from the changing interest rate environment during 2019 and corresponding impact upon the valuation of Bancorp’s available for salethe AFS debt securities portfolio. See the Consolidated Statement of Changes in Stockholders’ Equityfor further detail of changes in equity. 

In May 2019, Bancorp’s Board of Directors approved a share repurchase program authorizing the repurchase of up to 1 million shares, or approximately 4% of Bancorp’s total common shares outstanding at the time. The plan, which will expire in May 2021 unless otherwise extended or completed at an earlier date, does not obligate Bancorp to repurchase any specific dollar amount or number of shares prior to the plan’s expiration. During 2019, Bancorp repurchased 259,000 shares at a weighted average price per share of $35.46. In addition to a $28 million dividend to Bancorp during the second quarter of 2019 to consummate the 2019 acquisition, the Bank paid up an $18.5 million dividend during the third quarter of 2019 to support the share repurchase program. Based on recent economic developments and the increased importance of capital preservation, no shares were repurchased in 2020 and Management does not intend to resume repurchasing in the near-term. Approximately 741,000 shares remain eligible for repurchase under the current buy-back plan.

Bank holding companies and their subsidiary banks are required by regulators to meet risk-based capital standards. These standards, or ratios, measure the relationship of capital to a combination of balance sheet and off-balance sheet risks. The value of both balance sheet and off-balance sheet items are adjusted to reflect credit risks. See the footnote titled “Regulatory Matters” for additional detail regarding regulatory capital requirements, as well as capital ratios of Bancorp and the Bank. The Bank exceeds regulatory capital ratios required to be well capitalized. Regulatory framework does not define well capitalized for holding companies. Management considers the effects of growth on capital ratios as it contemplates plans for expansion.

 

 

The following table sets forth consolidated Bancorp’s and the Bank’s risk based capital ratios:

 

  

June 30,

  

December 31,

 
  

2019

  

2018

 
         

Total risk-based capital(1)

        

Consolidated

  12.67

%

  13.91

%

Bank

  12.45   13.56 
         

Common equity tier 1 risk-based capital(1)

        

Consolidated

  11.82   13.00 

Bank

  11.60   12.65 
         

Tier 1 risk-based capital(1)

        

Consolidated

  11.82   13.00 

Bank

  11.60   12.65 
         

Leverage(2)

        

Consolidated

  10.91   11.33 

Bank

  10.70   11.02 

(1)

Under banking agencies risk-based capital guidelines, assets and credit-equivalent amounts of derivatives and off-balance sheet exposures are assigned to broad risk categories. The aggregate dollar amount in each risk category is multiplied by the associated risk weight of the category. Weighted values are added together, resulting inBancorp's total risk-weighted assets. These ratios are computed in relation to average assets.

(2)

Ratio is computed in relation to average assets.

  

June 30,

  

December 31,

 
  

2020

  

2019

 
         

Total risk-based capital(1)

        

Consolidated

  13.50

%

  12.85

%

Bank

  13.07   12.20 
         

Common equity tier 1 risk-based capital(1)

        

Consolidated

  12.39   12.02 

Bank

  11.95   11.37 
         

Tier 1 risk-based capital(1)

        

Consolidated

  12.39   12.02 

Bank

  11.95   11.37 
         

Leverage(2)

        

Consolidated

  9.50   10.60 

Bank

  9.15   10.67 

 

(1)     Under banking agencies’ risk-based capital guidelines, assets and credit-equivalent amounts of derivatives and off-balance sheet exposures are assigned to broad risk categories. The aggregate dollar amount in each risk category is multiplied by the associated risk weight of the category. Weighted values are added together, resulting in Bancorp's total risk-weighted assets. These ratios are computed in relation to average assets.

(2)     Ratio is computed in relation to average assets.

As noted in the table above, Bancorp and the Bank are subjectexperienced a decline in leverage ratio from December 31, 2019 to June 30, 2020. The leverage ratio, which consists of tier-1 capital regulations in accordance with Basel III,divided by adjusted quarterly average assets, was negatively impacted due to the outsized balance sheet growth attributed to PPP participation. This will normalize over time, as administered by banking regulators.  Regulatory agencies measure capital adequacy within a framework that makes capital requirements, in part, dependent on the individual risk profiles of financial institutions. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on Bancorp’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Holding Company and the Bank must meet specific capital guidelines that involve quantitative measures of Bancorp’s assets, liabilities and certain off-balance sheet items, as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators regarding components, risk weightings and other factors.PPP loans pay-off early or ultimately mature.

 

Banking regulators have categorized the Bank as well-capitalized. For prompt corrective action, theThe regulations in accordance with Basel III define “well capitalized” as a 6.5% common equity tierCommon Equity Tier 1 risk-based capitalRisk-Based Capital ratio, an 8.0% tierTier 1 risk-based capitalRisk-Based Capital ratio, a 10.0% total risk-based capitalTotal Risk-Based Capital ratio and a 5.0% leverageTier 1 Leverage ratio.

Additionally, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, Bancorp and Bank must hold a capital conservation buffer composed of common equity tierCommon Equity Tier 1 risk-based capitalRisk-Based Capital above their minimum risk-based capital requirements. The capital conservation buffer phased in from 2016 to 2019 onset forth by the following schedule: 0.625% effective January 1, 2016; 1.25% effective January 1, 2017; 1.875% effective January 1, 2018;Basel III regulatory capital framework was 2.5% of risk-weighted assets above the minimum risk based capital ratio requirements at June 30, 2020 and a fully phased inDecember 31, 2019. The capital conservation buffer is designed to absorb losses during periods of 2.5%economic stress and requires increased capital levels for the purpose of capital distributions and other payments. Failure to meet the full amount of the buffer will result in restrictions on January 1, 2019.Bancorp’s ability to make capital distributions, including dividend payments and stock repurchases, and to pay discretionary bonuses to executive officers. At June 30, 2020 and December 31, 2019, Bancorp’s and SYB’s risk based capital exceeded the required capital conservation buffer.

 

Bancorp continues to exceed the regulatory requirements for total risk-based capital, common equity tierTotal Risk Based Capital, Common Equity Tier I risk-based capital, tierRisk Based Capital, Tier I risk-based capitalRisk Based Capital and leverage capital.Tier I Leverage. Bancorp and the Bank intend to maintain a capital position that meets or exceeds the “well-capitalized” requirements as defined by the FRB and the FDIC, in addition to the Capital Conservation Buffer. There are no conditions or events since June 30, 2020 that management believes have changed Bancorp’s well-capitalized status.

As permitted by the interim final rule issued on March 27, 2020 by the federal banking regulatory agencies, Bancorp elected the option to delay the estimated impact on regulatory capital conservation buffer.related to the adoption of ASC 326 “Financial Instruments – Credit Losses,” or CECL, which was effective January 1, 2020. The initial impact of adoption of ASC 326, as well as 25% of the quarterly increases in the ACL subsequent to adoption of ASC 326 (collectively the “transition adjustments”) were declared to be delayed for two years. After two years, the cumulative amount of the transition adjustments will become fixed and will be phased out of the regulatory capital calculations evenly over a three-year period, with 75% recognized in year three, 50% recognized in year four and 25% recognized in year five. After five years, the temporary regulatory capital benefits will be fully reversed. Had Bancorp not elected to defer the regulatory capital impact of CECL, the post ASC 326 adoption capital ratios of Bancorp and the Bank would have exceeded the well-capitalized level.

 

 

Non-GAAP Financial Measures

Non-GAAP Financial Measures

 

The following table provides a reconciliation of total stockholders’ equity in accordance with GAAP to tangible stockholders’ equity, a non-GAAP disclosure. Bancorp provides the tangible book value per share, a non-GAAP measure, in addition to those defined by banking regulators, because of its widespread use by investors as a means to evaluate capital adequacy.

 

The following table reconciles Bancorp’s calculation of tangible common equity to amounts reported under GAAP:

(In thousands, except per share data)

 

June 30, 2019

  

December 31, 2018

 

(in thousands, except per share data)

 

June 30, 2020

  

December 31, 2019

 
                

Total stockholders' equity - GAAP(a)

 $389,365  $366,500  $420,231  $406,297 

Less: Goodwill

 (12,826) (682) (12,513) (12,513)

Less: Core deposit intangible

  (2,461)  (1,057)  (2,122)  (2,285)

Tangible common equity - Non-GAAP(c)

 $374,078  $364,761  $405,596  $391,499 
  

Total assets - GAAP(b)

 $3,463,823  $3,302,924  $4,334,533  $3,724,197 

Less: Goodwill

 (12,826) (682) (12,513) (12,513)

Less: Core deposit intangible

  (2,461)  (1,057)  (2,122)  (2,285)

Tangible assets - Non-GAAP(d)

 $3,448,536  $3,301,185  $4,319,898  $3,709,399 
  

Total stockholders' equity to total assets - GAAP

 11.24

%

 11.10

%

Tangible common equity to tangible assets - Non-GAAP

 10.85  11.05 

Total stockholders' equity to total assets - GAAP (a/b)

 9.69% 10.91%

Tangible common equity to tangible assets - Non-GAAP (c/d)

 9.39% 10.55%
  

Total shares outstanding(e)

 22,721  22,749   22,667   22,604 
  

Book value per share - GAAP

 $17.14  $16.11 

Tangible common equity per share - Non-GAAP

 16.46  16.03 

Book value per share - GAAP (a/e)

 $18.54  $17.97 

Tangible common equity per share - Non-GAAP (c/e)

 17.89  17.32 

 

 

ACL to total non-PPP loans represents the ACL, divided by total loans less PPP loans. Bancorp believes this non-GAAP ratio is important because it provides a comparable ratio after eliminating PPP loans, which are fully guaranteed by the U.S. SBA and have not been allocated for within the ACL.

(in thousands, except per share data)

 

June 30, 2020

  

December 31, 2019

 
         

Total loans - GAAP (b)

 $3,464,077  $2,845,016 

Less: PPP loans

  (630,082)  - 

Total non-PPP loans - Non-GAAP (c)

 $2,833,995  $2,845,016 
         

Allowance for credit losses (c)

 $47,708  $26,791 
         

Allowance for credit losses to total loans - GAAP (a/b)

  1.38%  0.94%

Allowance for credit losses to total loans - Non-GAAP (a/c)

  1.68%  0.94%

The efficiency ratio, a non-GAAP measure, equals total non-interest expenses divided by the sum of FTE net interest income and non-interest income. The ratio excludes net gains (losses) on sales, calls, and impairment of investment securities, if applicable. In addition to the efficiency ratio, normally presented, Bancorp considers an adjusted efficiency ratio. Bancorp believes excludingit is important because it provides a comparable ratio after eliminating the fluctuation in non-interest expenses related to amortization of investments in tax credit partnerships from non-interest expense in this ratio is important because it provides a meaningful comparison to both prior periods, since amortization expense can fluctuate widely between periods depending upon timing of tax credits, and to other companies who do not invest in these partnerships.

 

Net interest income on a FTE basis includes the additional amount of interest income that would have been earned if investments in certain tax-exempt interest earning assets had been made in assets subject to federal, state and local taxes yielding the same after-tax income.

  

Three months ended June 30,

  

Six months ended June 30,

 

(in thousands, except per share data)

 

2020

  

2019

  

2020

  

2019

 
                 

Total non-interest expenses - GAAP (a)

 $24,884  $25,453  $48,834  $48,065 

Less: Amortization of investments in tax credit partnerships

  (53)  (52)  (89)  (104)

Total non-interest expenses - Non-GAAP (c )

 $24,831  $25,401  $48,745  $47,961 
                 

Total net interest income, fully tax equivalent

 $33,573  $30,857  $66,066  $60,597 

Total non-interest income

  12,622   12,224   25,158   23,232 

Less: Gain/loss on sale of securities

  -   -   -   - 

Total revenue - GAAP (b)

 $46,195  $43,081  $91,224  $83,829 
                 

Efficiency ratio - GAAP (a/b)

  53.87%  59.08%  53.53%  57.34%

Efficiency ratio - Non-GAAP (c/b)

  53.75%  58.96%  53.43%  57.21%

 

The following table reconciles Bancorp’s calculation of adjusted efficiency ratios to the ratio reported under GAAP:

  

Three months ended

  

Six months ended

 
  

June 30,

  

June 30,

 

(Dollars in thousands)

 

2019

  

2018

  

2019

  

2018

 

Non-interest expenses

 $25,464  $22,136  $48,103  $43,163 
                 

Net interest income (tax-equivalent)

  30,829   28,759   60,542   56,161 

Non-interest income

  12,263   11,435   23,325   22,344 

Total revenue

 $43,092  $40,194  $83,867  $78,505 
                 

Efficiency ratio - GAAP

  59.09%  55.07%  57.36%  54.98%

  

Three months ended

  

Six months ended

 
  

June 30,

  

June 30,

 
  

2019

  

2018

  

2019

  

2018

 

Non-interest expenses

 $25,464  $22,136  $48,103  $43,163 

Less: amortization of investments in tax credit partnerships

  (52)  (58)  (104)  (58)

Adjusted non-interest expense

  25,412   22,078   47,999   43,105 
                 

Net interest income (tax-equivalent)

  30,829   28,759   60,542   56,161 

Non-interest income

  12,263   11,435   23,325   22,344 

Total revenue

 $43,092  $40,194  $83,867  $78,505 
                 

Adjusted efficiency ratio - Non-GAAP

  58.97%  54.93%  57.23%  54.91%

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

 

Information required by this item is included in Part I Item 2, “Management’s“Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Item 4.      Controls and Procedures.Procedures.

 

As of the end of the period covered by this report, an evaluation was carried out by Stock Yards Bancorp, Inc.’s management, with the participation of its Chief Executive OfficerCEO and Chief Financial Officer,CFO, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, the Company’s Chief Executive OfficerCEO and Chief Financial OfficerCFO concluded that these disclosure controls and procedures were effective as of the end of the period covered by this report. In addition, no change in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred during the fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II – OTHER INFORMATION

 

Item 1.      Legal Proceedings.Proceedings.

 

In the ordinary course of operations, Bancorp and the Bank are defendants in various legal proceedings. There is no proceeding pending or, threatened litigation, to the knowledge of management, threatened in which an adverse decision could result in a material adverse change in the business or consolidated financial position of Bancorp or the Bank.

 

Item 1A.     Risk Factors.

FACTORS THAT MAY AFFECT FUTURE RESULTS

There have been no material changes in Bancorp’s risk factors from those disclosed in Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2019, with the exception of:

The ongoing COVID-19 pandemic and measures intended to prevent its spread have adversely impacted our business and financial results, and the ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.

The COVID-19 pandemic has created and continues to create extensive disruptions to the global economy and to the lives of individuals throughout the world. Governments, businesses, and the public are taking unprecedented actions to contain the spread of COVID-19 and to mitigate its effects, including self-quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal stimulus, and legislation designed to deliver monetary aid and other relief. While the scope, duration, and full effects of COVID-19 continue to evolve and are not fully known, the pandemic and related efforts to contain it have disrupted global economic activity, adversely affected the functioning of financial markets, impacted interest rates, increased economic and market uncertainty, and disrupted trade and supply chains. If these effects continue for a prolonged period, or result in sustained economic stress or recession, many of the risk factors identified in our 2019 Annual Report on Form-10-K could be exacerbated and such effects could have a material adverse impact on us in a number of ways related to credit, collateral, asset valuations, customer demand, funding, operations, interest rate risk, and human capital, as described in more detail below.

Credit Risk Timely loan repayment and the value of collateral supporting the loans are affected by the strength of our borrower’s business. Concern about the spread of COVID-19 has caused and may continue to cause business shutdowns, limitations on commercial activity and financial transactions, supply chain interruptions, increased unemployment, increased bankruptcies, elevated commercial property vacancy rates, reduced profitability, and overall economic and financial market instability, all of which may cause our customers to be unable to make scheduled loan payments. With regard to unemployment, management utilizes the forecasted Seasonally Adjusted National Civilian Unemployment Rate as its primary loss driver within its ACL model. To the extent the forecast is adjusted upward by the FRB, Bancorp will incur additional provision for credit losses.

If the effects of COVID-19 result in widespread and sustained repayment shortfalls on loans in our portfolio, we could incur significant delinquencies, foreclosures and credit losses, particularly if the available collateral is insufficient to cover our exposure. The future effects of COVID-19 on economic activity could negatively affect the ability of customers to repay their loans, collateral values associated with our existing loans, our ability to maintain loan origination volume, and the future demand for or profitability of our lending and services. Further, in the event of delinquencies, regulatory changes and policies designed to protect borrowers may slow or prevent us from making our business decisions or may result in a delay in our taking certain remediation actions, such as foreclosure. In addition to loans outstanding, we have unfunded commitments to extend credit to customers.

Interest Rate RiskOur net interest income, lending activities, deposits and profitability could be negatively affected by volatility in interest rates caused by uncertainties stemming from COVID-19. In March 2020, the FRB lowered the FFTR to a range from zero to 0.25 percent, citing concerns about the impact of COVID-19 on markets. A prolonged period of extremely volatile and unstable market conditions could increase our funding costs and negatively affect market risk mitigation strategies. Higher income volatility from changes in interest rates and spreads to benchmark indices could cause a loss of future net interest income. Fluctuations in interest rates will affect both the level of income and expense recorded on most of our assets and liabilities and the market value of all interest-earning assets and interest-bearing liabilities, which in turn could have a material adverse effect on our net income, operating results, or financial condition.

Banking institutions have been planning for the transition away from LIBOR in advance of December 31, 2021, the date that LIBOR is generally expected to cease to exist. It remains unclear, however, whether the cessation of LIBOR will be delayed due to COVID-19 or what form any delay may take, and there are no assurances that there will be a delay. It is also unclear what the duration and severity of COVID-19 will be, and whether this will affect LIBOR transition planning. COVID-19 may also slow regulators’ and others’ efforts to develop and implement alternative reference rates, which could make LIBOR transition planning more difficult, particularly if the cessation of LIBOR is not delayed and alternatives do not develop.

Market Risk – Market disruption, whether or not caused directly by COVID-19, could lead to further declines in Bancorp’s stock price and cash flow projections leading to long-lived asset impairment, such as goodwill. While we stress test for various events, Bancorp’s model may not fully take into account a global pandemic event of COVID-19’s scope. Such risks could also result in other-than-temporary impairments and/or reduce other comprehensive income.

Income from WM&T represents a significant portion of non-interest income. AUM are expressed in terms of market value, and a significant portion of fee income is based upon those values. A large majority of WM&T fees are based on market values, which generally fluctuate with overall capital markets. Volatile market conditions caused by COVID-19 could reduce the value of AUM and/or cause clients to withdraw funds.

Operational Risk The spread and the threat of the spread of COVID-19 has caused us to modify our business practices and Bancorp may take further actions, as may be required by government authorities, or as we determine, are in the best interests of our employees, customers and business partners. There is no certainty that such measures will be sufficient to mitigate the risks posed by the virus. We rely on business processes and branch activity that largely depend on people and technology, including access to information technology systems, as well as information, applications, payment systems and other services provided by third parties.

Work-from-home measures introduce additional operational risk, including increased cybersecurity risk. These cyber risks include greater phishing, malware, and other cybersecurity attacks, vulnerability to disruptions of our information technology infrastructure and telecommunications systems for remote operations, increased risk of unauthorized dissemination of confidential information, limited ability to restore the systems in the event of a systems failure or interruption, greater risk of a security breach resulting in destruction or misuse of valuable information, and potential impairment of our ability to perform critical functions, including wiring funds, all of which could expose us to risks of data or financial loss, litigation and liability and could seriously disrupt our operations and the operations of any impacted customers.

Consumers affected by COVID-19 may continue to demonstrate subdued behavior in terms of spending after the crisis is over. For example, consumers may decrease discretionary spending on a permanent or long-term basis, certain industries may take longer to recover (particularly those that rely on travel or large gatherings) as consumers may be hesitant to return to full social interaction, and temporary closures of bank branches could result in consumers becoming more comfortable with technology and devaluing face-to-face interaction. Changes to business practices may be necessary to accommodate changing consumer behaviors.

There are no comparable recent events that provide guidance as to the effect the spread of COVID-19 as a global pandemic may have, and, as a result, the ultimate impact of the outbreak is highly uncertain and subject to change. Bancorp does not yet know the full extent of the impacts on its business, operations or the global economy as a whole. However, the effects could have a material impact on the Company’s results of operations and heighten many of its known risks described in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2019.

Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds

 

The following table shows information relating to the repurchase of shares of common stock by Bancorp during the three months ended June 30, 2019.2020.

 

  

Total number

of shares

purchased(1)

  

Average

price paid

per share

  

Total number of shares

purchased as part of

publicly announced

plans or programs

  

Average

price

paid per

share

  

Maximum number of

shares that may yet be

purchased under the

plans or programs

 
                     
                     

Apr 1 - April 30

  110  $34.35           

May 1 - May 31

  26,260   33.83   26,260   33.83     

June 1 - June 30

  83,770   34.29   81,078   34.25     

Total

  110,140  $34.18   107,338   34.15   892,662 

  

Total number

of shares

purchased(1)

  

Average price

paid per

share

  

Total number of shares purchased as part of publicly announced plans or programs

  

Average

price paid

per share

  

Maximum number of shares that may yet be purchased under the plans or programs

 
                     

April 1 - April 30

    $     $     

May 1 - May 31

                

June 1 - June 30

  1,353   38.27   1,353   38.27     
                     

Total

  1,353  $38.27   1,353  $   741,196 

 

(1)(2)

Activity includes 2,8021,353 shares of stock withheld to pay taxes due upon exercise of stock appreciation rights,SARs and vesting of restricted stock,RSUs and vesting of performance stock units PSUs.

 

Effective May 22, 2019, Bancorp’s Board of Directors approved a share repurchase program authorizing the repurchase of 1,000,0001 million shares, or approximately 4% of the Company’sBancorp’s total common shares outstanding.outstanding at the time. Stock repurchases are expected to be made from time to time on the open market or in privately negotiated transactions, subject to applicable securities law.laws. The plan, which will expire in two yearsMay 2021 unless otherwise extended or completed at an earlier date, does not obligate the Company to repurchase any specific dollar amount or number of shares prior to the plan’s expiration. Based on recent economic developments and the increased importance of capital preservation, no shares were repurchased in 2020 and Management does not expect to resume repurchasing in the near-term. As of June 30, 2019,2020, Bancorp had 892,662741,196 shares that could be repurchased under its current share repurchase program.

 

There were no equity securities of the registrant sold without registration during the quarter covered by this report.

 

 

Item 6.     Exhibits.Exhibits.

 

The following exhibits are filed or furnished as a part of this report:

 

Exhibit

Number

Number

Description of exhibit

31.1

Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act

31.2

Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act

32

Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 902 of the Sarbanes-Oxley Act

101

The following financial statementsmaterials from the Stock Yards Bancorp Inc.’s Form 10-Q Report for the quarterly period ended June 30, 2019
Quarterly Report on Form 10-Q, filed on August 6, 2019,
2020 formatted in Inline Extensible
Business Reporting Language (iXBRL):

(1)

inline XBRL: (i) the Consolidated Balance Sheets,

(2)

(ii) the Consolidated Statements of Income,

(3)

(iii) the Consolidated Statements of Comprehensive Income,

(4)

(iv) the Consolidated Statements of Changes in Stockholders’Shareholders’ Equity,

(5)

(v) the Consolidated Statements of Cash Flows

(6)

and (vi) the Notes to Consolidated Financial StatementsStatements.

104

The cover page from Stock Yards Bancorp Inc.’s Form 10-Q Report for the quarterly period ended June 30, 2020 formatted in inline XBRL and contained in Exhibit 101.

 

 

Signatures

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

STOCK YARDS BANCORP, INC.

(Registrant)

(Registrant)

Date: August 6 , 20197, 2020

By:

By:

/s/ James A. Hillebrand

James A. Hillebrand

ChiefCEO (Principal Executive OfficerOfficer) 

Date: August 6 , 20197, 2020

/s/ T. Clay Stinnett

T. Clay Stinnett, Executive Vice President,EVP, Treasurer and

Treasurer and Chief Financial Officer

CFO  (Principal Financial Officer)

 

78

97