Peapack Gladstone Financial Corp: Form 10-Q for the period ended Jun 30, 2019

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

FORWARD LOOKING STATEMENTS: This Quarterly Report on Form 10-Q may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are not historical facts and include expressions about Management’s confidence and strategies and Management’s expectations about new and existing programs and products, investments, relationships, opportunities and market conditions. These statements may be identified by such forward-looking terminology as “expect”, “look”, “believe”, “anticipate”, “may”, or similar statements or variations of such terms. Actual results may differ materially from such forward-looking statements. Factors that may cause results to differ materially from those contemplated by such forward-looking statements include, among others, those risk factors identified in the Company’s Form 10-K for the year ended December 31, 2018, in addition to/which include the following:

• our inability to successfully grow our business and implement our strategic plan, including an inability to generate revenues to offset the increased personnel and other costs related to the strategic plan;
• the impact of anticipated higher operating expenses in 2019 and beyond;
• our inability to successfully integrate wealth management firm acquisitions;
• our inability to manage our growth;
• our inability to successfully integrate our expanded employee base;
• an unexpected decline in the economy, in particular in our New Jersey and New York market areas;
• declines in our net interest margin caused by the interest rate environment and/or our highly competitive market;
• declines in values in our investment portfolio;
• higher than expected increases in our allowance for loan and lease losses;
• higher than expected increases in the level of nonperforming loans;
• changes in interest rates;
• decline in real estate values within our market areas;
• legislative and regulatory actions (including the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Basel III and related regulations) that may result in increased compliance costs;
• successful cyberattacks against our IT infrastructure and that of our IT and third-party providers;
• higher than expected FDIC insurance premiums;
• adverse weather conditions;
• our inability to successfully generate new business in new geographic markets;
• our inability to execute upon new business initiatives;
• our lack of liquidity to fund our various cash obligations;
• reduction in our lower-cost funding sources;
• our inability to adapt to technological changes;
• claims and litigation pertaining to fiduciary responsibility, environmental laws and other matters;
• our ability to retain key employees;
• demands for loans and deposits in our market areas;
• adverse changes in securities markets;
• changes in accounting policies and practices;
• effects related to a prolonged shutdown of the federal government which could impact SBA and other government lending programs; and
• other unexpected material adverse changes in our operations or earnings.

Except as required by law, the Company assumes no responsibility to update such forward-looking statements in the future. Although we believe that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, levels of activity, performance, or achievements.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES: Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon the Company’s consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to the Company’s Audited Consolidated Financial Statements for the year ended December 31, 2018 contains a summary of the Company’s significant accounting policies.

Management believes that the Company’s policy with respect to the methodology for the determination of the allowance for loan and lease losses involves a higher degree of complexity and requires Management to make difficult and subjective judgments, which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact results of operations. This critical policy and its application are periodically reviewed with the Audit Committee and the Board of Directors.

The provision for loan and lease losses is based upon Management’s evaluation of the adequacy of the allowance, including an assessment of known and inherent risks in the portfolio, giving consideration to the size and composition of the loan portfolio, actual loan loss experience, level of delinquencies, detailed analysis of individual loans for which full collectability may not be assured, the existence and estimated fair value of any underlying collateral and guarantees securing the loans, and current economic and market conditions. Although Management uses the best information available, the level of the allowance for loan and lease losses remains an estimate, which is subject to significant judgment and short-term change. Various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan and lease losses. Such agencies may require the Company to make additional provisions for loan and lease losses based upon information available to them at the time of their examination. Furthermore, the majority of the Company’s loans are secured by real estate in New Jersey and, to a lesser extent, New York City. Accordingly, the collectability of a substantial portion of the carrying value of the Company’s loan portfolio is susceptible to changes in local market conditions and any adverse economic conditions. Future adjustments to the provision for loan and lease losses and allowance for loan and lease losses may be necessary due to economic, operating, regulatory and other conditions beyond the Company’s control.

The Company accounts for its debt securities in accordance with “Accounting Standards Codification (“ASC”) 320, “Investments - Debt Securities” and its equity security in accordance with ASC 321, “Investments – Equity Securities”. All securities are classified as available for sale and are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax with the exception of the Company’s investment in a CRA investment fund which is classified as an equity security. In accordance with ASU 2016-01, “Financial Instruments” unrealized holding gains and losses are marked to market through the income statement.

Management evaluates securities for other-than-temporary impairment on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, Management considers the extent and duration of the unrealized loss and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) other-than-temporary impairment related to credit loss, which must be recognized in the income statement and 2) other-than-temporary impairment related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. No impairment charges were recognized for the six months ended June 30, 2019 and 2018.

EXECUTIVE SUMMARY: The following table presents certain key aspects of our performance for the three months ended June 30, 2019 and 2018.

(Dollars in thousands, except per share data)

(1) The June 2019 quarter included results of operations of Lassus Wherley, acquired effective September 1, 2018.

The following table presents certain key aspects of our performance for the six months ended June 30, 2019 and 2018.

(Dollars in thousands, except per share data)

(1) The six months ended June 30, 2019 included results of operations of Lassus Wherley, acquired effective September 1, 2018.

For the quarter ended June 30, 2019, the Company recorded net income of $11.6 million and diluted earnings per share of $0.59, compared to $11.9 million and diluted earnings per share of $0.62 for the same three-month period last year.

For the six months ended June 30, 2019, the Company recorded net income of $23.0 million and diluted earnings per share of $1.18, compared to $22.7 million and $1.20 for the same six-month period last year.

The three months ended June 30, 2019, when compared to the same period of 2018, reflected: increased provision for loan and lease losses resulting from the higher level of loan growth and a specific reserve of $1.0 million in the second quarter of 2019 and higher operating expenses for the three months ended June 30, 2019 which included expense related to Lassus Wherley and an increase in salaries and benefits expense due to strategic hiring and normal salary increases, partially offset by greater wealth management fee income (partially due to the acquisition of Lassus Wherley in September 2018).

The six months ended June 30, 2019, when compared to the same period of 2018, reflected: increased net interest income (due to increased loan balances and higher yields on loans partially offset by increased interest expense on our cost of funds); greater wealth management fee income (partially due to the acquisition of Lassus Wherley in September 2018); and a reduced provision for loan and lease losses. These positive effects were partially offset by higher operating expenses for the six months ended June 30, 2019, which included expense related to Lassus Wherley and an increase in salaries and benefits expense due to strategic hiring and normal salary increases.

CONTRACTUAL OBLIGATIONS: For a discussion of our contractual obligations, see the information set forth in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2018 under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Contractual Obligations.”

OFF-BALANCE SHEET ARRANGEMENTS: For a discussion of our off-balance sheet arrangements, see the information set forth in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2018 under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Off-Balance Sheet Arrangements.”

EARNINGS ANALYSIS

NET INTEREST INCOME (“NII”) / NET INTEREST MARGIN (“NIM”) / AVERAGE BALANCE SHEET:

The primary source of the Company’s operating income is net interest income, which is the difference between interest and dividends earned on earning assets and fees earned on loans, and interest paid on interest-bearing liabilities. Earning assets include loans, investment securities, interest-earning deposits and federal funds sold. Interest-bearing liabilities include interest-bearing checking, savings and time deposits, Federal Home Loan Bank advances, subordinated debt and other borrowings. Net interest income is determined by the difference between the average yields earned on earning assets and the average cost of interest-bearing liabilities (“net interest spread”) and the relative amounts of earning assets and interest-bearing liabilities. Net interest margin is calculated as net interest income annualized as a percent of total interest earning assets. The Company’s net interest income, spread and margin are affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows and general levels of nonperforming assets.

The following tables summarize the Company’s net interest income and margin for the periods indicated:

(Dollars in thousands)

Net interest income, on a fully tax-equivalent basis, increased $282 thousand, or 1 percent, for the second quarter of 2019 to $29.9 million from net interest income of $29.6 million for the same quarter in 2018. The net interest margin was 2.64 percent and 2.82 percent for the three months ended June 30, 2019 and 2018, respectively, a decrease of 18 basis points. Net interest income, on a fully tax-equivalent basis, increased $2.1 million, or 4 percent, for the first six months ended June 30, 2019 to $60.5 million from net interest income of $58.4 million for the same period in 2018. The net interest margin was 2.67 percent and 2.79 percent for the six months ended June 30, 2019 and 2018, respectively, a decrease of 12 basis points. The growth in net interest income for both the three and six months ended June 30, 2019 was due to increases in the average balance and yield on the Company’s interest-earning assets, especially the average balance of C&I loans, which typically have higher yields. The increase in interest income was partially offset by increases in interest-bearing liabilities and the Company’s cost of funds for those same periods. The Company continues to be impacted by competitive pressures in attracting new loans and deposits, as well as retaining deposits.

The following table summarizes the loans that the Company closed during the periods indicated:

(In thousands)

46

(A) Includes loans and lines of credit that closed in the period but were not necessarily funded.

(B) Includes equipment finance leases and loans.

(In thousands)

(A) Includes loans and lines of credit that closed in the period but were not necessarily funded.

(B) Includes equipment finance leases and loans.

The Company has managed its balance sheet such that multifamily and 1-4 family residential loans declined as a percentage of the overall loan portfolio and C&I loans became a larger percentage of the overall loan portfolio.

At June 30, 2019, December 31, 2018 and June 30, 2018, the Bank had a concentration in commercial real estate (“CRE”) loans as defined by applicable regulatory guidance.

The following table presents such concentration levels at the following periods:

The Bank believes it addresses the key elements in the risk management framework laid out by its regulators for the effective management of CRE concentration risks.

The following tables reflect the components of the average balance sheet and of net interest income for the periods indicated:

Average Balance Sheet

Unaudited

Three Months Ended

(Dollars in thousands)

(1) Average balances for available for sale securities are based on amortized cost.

(2) Interest income is presented on a tax-equivalent basis using a 21 percent federal tax rate.

(3) Loans are stated net of unearned income and include nonaccrual loans.

(4) Net interest income on a tax-equivalent basis as a percentage of total average interest-earning assets.

Average Balance Sheet

Unaudited

Six Months Ended

(Dollars in thousands)

(1) Average balances for available for sale securities are based on amortized cost.

(2) Interest income is presented on a tax-equivalent basis using a 21 percent federal tax rate.

(3) Loans are stated net of unearned income and include nonaccrual loans.

(4) Net interest income on a tax-equivalent basis as a percentage of total average interest-earning assets.

The effect of volume and rate changes on net interest income (on a tax-equivalent basis) for the periods indicated are shown below:

Interest income on interest-earning assets, on a fully tax-equivalent basis, totaled $45.2 million for the second quarter of 2019 compared to $40.1 million for the same quarter of 2018, reflecting an increase of $5.2 million, or 13 percent. Interest income on interest-earning assets, on a fully tax-equivalent basis, totaled $90.4 million for the six months ended June 30, 2019 compared to $77.5 million for the same quarter of 2018, reflecting an increase of $12.9 million, or 17 percent. Average interest-earning assets totaled $4.54 billion for the second quarter of 2019, an increase of $331.4 million, or 8 percent, from the same period of 2018. The average balance of the C&I loan portfolio increased $369.8 million, or 35 percent, from the second quarter of 2018, to $1.42 billion for the same quarter of 2019. Average interest-earning assets totaled $4.54 billion for the six months ended June 30, 2019, an increase of $348.7 million, or 8 percent, from the same period of 2018. The average balance of the C&I loan portfolio increased $389.8 million, or 39 percent, to $1.40 for the six months ended June 30, 2019 as compared to the same period in 2018. The increase in this portfolio for both the three and six months ended June 30, 2019 was attributed to: the addition of seasoned bankers including a new EVP, Head of Commercial Banking, and an equipment finance team in 2017; a continued focus on client service and value-added aspects of the lending process; and a continued focus on markets outside of the immediate branch service area, including markets around the Teaneck and Princeton, New Jersey private banking offices. These increases were partially offset by decreases in the average balance of the commercial mortgage portfolio (which includes multifamily mortgage loans) of $200.1 million, or 10 percent, and $194.4 million, or 10 percent to $1.79 billion and $1.80 billion for the three and six months ended June 30, 2019 when compared to the same periods in 2018. The Company continued to manage its balance sheet such that lower yielding, primarily fixed rate multifamily loans declined as a percentage of the overall loan portfolio and higher yielding, primarily floating rate or short duration C&I loans became a larger percentage of the overall loan portfolio. The average balance of investment securities totaled $409.0 million for the second quarter of 2019 compared to $382.2 million for the same quarter of 2018 reflecting an increase of $26.8 million, or 7 percent. The average balance of investment securities totaled $407.0 million for the six months ended June 30, 2019 as compared to $373.1 million for the same period of 2018 reflecting an increase of $33.9 million, or 9 percent. Interest-earning deposits totaled $241.1 million for the three months ended June 30, 2019 when compared to $94.8 million for the same period in 2018 reflecting an increase of $146.4 million or 154 percent. Interest-earning deposits increased to $239.2 million for the six months ended June 30, 2019 when compared to $97.1 million for the same period in 2018 reflecting an increase of $142.1 million or 146 percent. The increase for the three and six months ended June 30, 2019 was primarily due to certain loan originations and fundings shifting from the end of the second quarter of 2019 into the third quarter.

For the quarters ended June 30, 2019 and 2018, the average rates earned on interest-earning assets were 3.99 percent and 3.81 percent, respectively, an increase of 18 basis points. The six months ended June 30, 2019 had an increase of 29 basis points on the average rates earned on interest-earning assets to 3.99 percent from 3.70 percent when compared to the same period of 2018. The increase in average rates on loans for both periods was due to an increase in market rates and a shift from lower yielding commercial mortgages into higher yielding commercial loans (C&I and equipment financings) and a sale of $131.3 million of multifamily mortgage loans during the fourth quarter of 2018.

For the second quarter of 2019, the average balance of interest-bearing deposits was $3.41 billion, an increase of $418.5 million, or 14 percent, from the average balance for the same period of 2018. Interest-bearing deposits totaled $3.43 billion for the six months ended June 30, 2019 which is an increase of $381.3 million or 12 percent, from the same 2018 period. The growth in customer deposits (excluding brokered CDs and brokered interest-bearing demand deposits, but including reciprocal funds discussed below) has come from an increase in retail deposits from our branch network; focus on providing high-touch client service; and a full array of treasury management products that support core deposit growth. The growth is partially offset by a decline of $38.1 million of listing service deposits as the Company has chosen not to participate in going forward, so maturing listing service deposits are not replaced with new listing service deposits.

Average rates paid on total interest-bearing deposits were 1.54 percent and 1.06 percent for the second quarters of 2019 and 2018, respectively, an increase of 48 basis points. Average rates paid on total interest-bearing deposits were 1.49 percent and 0.98 percent for the six months ended June 30, 2019 and 2018, respectively, an increase of 51 basis points. The increase in the average rate paid on deposits was principally due to growth in higher costing certificates of deposit and money market accounts and competitive pressures in attracting new deposits.

For the second quarter of 2019, the average balance of borrowings was $105.0 million, a decrease of $116.3 million when compared to the same period in 2018. For the six months ended June 30, 2019, the average balance of borrowings was $105.4 million, a decrease of $48.8 million when compared to the same period in 2018.

The Company is a participant in the Reich & Tang Demand Deposit Marketplace (“DDM”) program and the Promontory Program. The Company uses these deposit sweep services to place customer funds into interest-bearing demand (checking) accounts issued by other participating banks. Customer funds are placed at one or more participating banks to ensure that each deposit customer is eligible for the full amount of FDIC insurance. As a program participant, the Company receives reciprocal amounts of deposits from other participating banks. Such reciprocal deposit balances are included in the Company’s interest-bearing checking balances. The average balance of reciprocal deposits was $436.1 million and $434.9 million for the three and six months ended June 30, 2019 compared to $375.3 million and $373.8 million for the three and six months ended June 30, 2018.

The average balance of brokered interest-bearing demand deposits was $180.0 million for the three and six months ended June 30, 2019 and 2018, respectively, and are matched to the Company’s existing $180.0 million of interest rate swaps, transacted previously as part of the Company’s interest rate risk management program.

INVESTMENT SECURITIES AVAILABLE FOR SALE: Investment securities available for sale are purchased, sold and/or maintained as a part of the Company’s overall balance sheet, liquidity and interest rate risk management strategies. These securities are carried at estimated fair value, and unrealized changes in fair value are recognized as a separate component of shareholders’ equity, net of income taxes. Realized gains and losses are recognized in income at the time the securities are sold. Equity securities are carried at fair value with unrealized gains and losses recorded in non-interest income.

At June 30, 2019, the Company had investment securities available for sale with a fair value of $378.8 million compared with $377.9 million at December 31, 2018. A net unrealized gain (net of income tax) of $898 thousand and a net unrealized loss (net of income tax) of $3.0 million were included in shareholders’ equity at June 30, 2019 and December 31, 2018, respectively.

The Company has one equity security (a CRA investment security) with a fair value of $4.8 million at June 30, 2019 compared with $4.7 million at December 31, 2018. The Company recorded a $128 thousand unrealized gain on the Consolidated Statements of Income for the six months ended June 30, 2019 as compared to an unrealized loss of $114 thousand for the six months ended June 30, 2018. Such security has been owned for years for CRA purposes, but under Accounting Standards Update (“ASU”) 2016-01, “Financial Instruments”, equity securities require a quarterly mark to market through the income statement effective January 1, 2018.

The carrying value of investment securities available for sale as of June 30, 2019 and December 31, 2018 are shown below:

(In thousands)

The following table presents the contractual maturities and yields of debt securities available for sale, stated at fair value, as of June 30, 2019:

(1) Shown using stated final maturity.

(2) Yields presented on a fully tax-equivalent basis.

Federal funds sold and interest-earning deposits are an additional part of the Company’s liquidity and interest rate risk management strategies. The combined average balance of these investments during the six months ended June 30, 2019 was $239.3 million compared to $103.2 million for the year ended December 31, 2018. The increase represented excess cash as deposit growth exceeded loan growth.

OTHER INCOME: The following table presents other income, excluding income from wealth management, which is summarized and discussed subsequently:

(In thousands)

(In thousands)

For the quarter ended June 30, 2019, income from the sale of newly originated residential mortgage loans was $132 thousand compared to $79 thousand for the same period in 2018. For the six months ended June 30, 2019 and 2018, income from the sale of newly originated residential mortgage loans was $179 thousand and $173 thousand, respectively. Such income is a result of the volume of residential mortgage loans originated for sale in the respective periods.

The second quarter of 2019 included $721 thousand of loan level, back-to-back swap income compared to $900 thousand in the same quarter of 2018. The six months ended June 30, 2019 included $991 thousand of loan level, back-to-back swap income compared to $1.2 million for the same period of 2018. The program provides a borrower with a degree of interest rate protection on a variable rate loan, while still providing an adjustable rate to the Company, thus helping to manage the Company’s interest rate risk, while contributing to income.

The second quarter of 2019 included $573 thousand of income, on sales of $5.7 million, related to the Company’s SBA lending and sale program compared to $814 thousand of income, on sales of $8.1 million, for the same quarter in 2018. The six months ended June 30, 2019 included $992 thousand of income, on sales of $9.9 million, related to the Company’s SBA lending and sale program compared to $845 thousand of income, on sales of $8.4 million, for the same period in 2018.

Income from the back-to-back swap and SBA programs are dependent on volume, and thus are not linear from quarter to quarter, as some quarters will be higher than others.

The Company recorded a $69 thousand and $128 thousand mark to market gain on its equity security investment for the three and six months ended June 30, 2019, respectively, compared to a $36 thousand and $114 thousand mark to market loss on its equity security investment for the three and six months ended June 30, 2018, respectively, as a result of the adoption of Accounting Standards Update (“ASU”) 2016-01, “Financial Instruments” on January 1, 2018.

Other income was $740 thousand for the quarter ended June 30, 2019 compared to $639 thousand for the same quarter in 2018. The six months ended June 30, 2019 included $1.3 million in other income compared to $1.0 million for the same period of 2018. The increase in other income was primarily due to increased fees associated with loans, as well as income related to our corporate advisory program for both the three and six months ended June 30, 2019.

OPERATING EXPENSES: The following table presents the components of operating expenses for the periods indicated:

(In thousands)

(In thousands)

Increased operating expenses in the three-month and six-month periods ended June 30, 2019 were principally attributable to: an increase in compensation and employee benefits of $1.7 million to $17.5 million for the second quarter of 2019 and $4.3 million to $34.7 million for the six months ended June 30, 2019, which includes expense related to the Lassus Wherley acquisition completed on September 1, 2018; ongoing operating expenses including amortization of intangibles; hiring in line with the Company’s strategic plan; and normal salary increases. These increases were partially offset by a decrease in FDIC expense, provision for OREO, and professional and legal fees.

PRIVATE WEALTH MANAGEMENT DIVISION: This division includes: investment management services provided for individuals and institutions; personal trust services, including services as executor, trustee, administrator, custodian and guardian, and other financial planning, tax preparation and advisory services. Officers from the Private Wealth Management Division are available to provide wealth management, trust and investment services at the Bank’s headquarters in Bedminster, at private banking locations in Morristown, Princeton and Teaneck, New Jersey and at the Bank’s subsidiaries, PGB Trust & Investments of Delaware in Greenville, Delaware, MCM, in Gladstone, New Jersey, Quadrant, in Fairfield, New Jersey and Lassus Wherley in New Providence, New Jersey and Bonita Springs, Florida.

The following table presents certain key aspects of the Bank’s Private Wealth Management Division performance for the three and six months ended June 30, 2019 and 2018.

(In thousands)

(In thousands)

The market value of the assets under management and/or administration (“AUM”) of the Private Wealth Management Division was $6.6 billion at June 30, 2019, reflecting an increase of 16 percent from $5.7 billion at June 30, 2018. The increase in AUM was due to the acquisition of one registered investment advisory firm (“RIA”) and organic growth. Effective September 1, 2018, the Bank acquired Lassus Wherley, an RIA, based in New Providence, NJ, which contributed approximately $550 million of AUM at the time of acquisition. Organic growth, which includes equity market appreciation, contributed an additional $325 million in AUM.

In the June 2019 quarter, the Private Wealth Management Division generated $9.6 million in fee income compared to $8.1 million for the June 2018 quarter, reflecting an 18 percent increase. For the six months ended June 30, 2019, the Private Wealth Management Division generated $18.7 million in fee income compared to $16.5 million for the same period in 2018, reflecting a 14 percent increase. The growth in fee income was due to the acquisition noted above, as well as continued new business, partially offset by normal levels of disbursements and outflows.

The Company continues to incorporate wealth management into conversations it has with the Company’s clients across all business lines. The Company has expanded its wealth management team and intends to continue to grow organically and through acquisition.

Operating expenses relative to the Private Wealth Management Division reflected increases due to the Lassus Wherley acquisition, overall growth in the business, new hires and select third party expenditures. Remaining expenses are in line with the Company’s Strategic Plan, particularly the hiring of key management and revenue-producing personnel. Generally, revenue and profitability related to the new personnel will lag expenses by several quarters.

The Private Wealth Management Division currently generates adequate revenue to support the salaries, benefits and other expenses of the Division. Management believes that the Bank generates adequate liquidity to support the expenses of the Private Wealth Management Division should it be necessary.

NONPERFORMING ASSETS: OREO, loans past due in excess of 90 days and still accruing, and nonaccrual loans are considered nonperforming assets.

The following table sets forth asset quality data on the dates indicated:

(Dollars in thousands)

(1) Nonperforming loans/assets do not include performing TDRs.

PROVISION FOR LOAN AND LEASE LOSSES: The provision for loan and lease losses was $1.2 million and $300 thousand for the second quarters of 2019 and 2018, respectively. For the six months ended June 30, 2019 and 2018, the provision for loan losses was $1.3 million and $1.6 million, respectively. The increase in the provision for loan and lease losses was primarily due to the higher level of loan growth and a specific reserve of $1.0 million associated with a casual commercial dining relationship in the second quarter of 2019 as compared to the same period in 2018. The loan portfolio grew by $131.9 million during the second quarter of 2019 as compared to $14.6 million for the second quarter of 2018. The provision for loan and lease losses was lower for the six months ended June 30, 2019 due to a specific reserve of $1.3 million associated with a commercial real estate loan recorded during the first six months of 2018. The amount of the loan loss provision and the level of the allowance for loan and lease losses are based upon several factors including Management’s evaluation of probable losses inherent in the portfolio, after consideration of appraised collateral values, financial condition and past credit history of the borrowers, as well as prevailing economic conditions. Commercial credits generally carry a higher risk profile compared to some of the other credits, which is reflected in Management’s determination of the adequacy of the allowance for loan and lease losses.

The allowance for loan and lease losses was $39.8 million as of June 30, 2019, compared to $38.5 million at December 31, 2018. As a percentage of loans, the allowance for loan and lease losses was 0.99 percent for June 30, 2019 and 0.98 percent for December 31, 2018. The specific reserves on impaired loans were $1.2 million at June 30, 2019 compared to $262 thousand as of December 31, 2018. Total impaired loans were $34.9 million and $31.3 million as of June 30, 2019 and December 31, 2018, respectively. The general component of the allowance increased from $38.2 million at December 31, 2018 to $38.5 million at June 30, 2019.

A summary of the allowance for loan and lease losses for the quarterly periods indicated follows:

(Dollars in thousands)

INCOME TAXES: Income tax expense for the three months ended June 30, 2019 was $3.4 million as compared to $3.8 million for the same period in 2018. For the second quarters of 2019 and 2018, income tax expense as a percentage of pre-tax income was 22.9 percent and 24.3 percent, respectively. Income tax expense for the six months ended June 30, 2019 was $7.9 million as compared to $7.0 million for the same period in 2018. For the first six months of 2019 and 2018, income tax expense as a percentage of pre-tax income was 25.6 percent and 23.7 percent, respectively. The increase in income tax expense and the effective rate in the six months ended 2019 was primarily due to the New Jersey surtax and combined reporting rules.

On July 1, 2018, the 2019 New Jersey Budget (“Budget”) was passed, which established a 2.5 percent surtax on businesses that have New Jersey allocated net income in excess of $1.0 million. The surtax was effective as of January 1, 2018 and will continue through 2019. The surtax will adjust to 1.5 percent for 2020 and 2021. In addition, effective for taxable years beginning on or after January 1, 2019, banks will be required to file combined reports of taxable income including their parent holding company. New Jersey issued a tax bulletin in May 2019 for the 2019 calendar tax year which requires entities to report their real estate investment trust, registered investment company and investment company on a separate entity basis. The Bank made an adjustment to income tax expense and deferred tax assets/liabilities in the third quarter of 2018 to reflect the new state tax rate, which became effective on January 1, 2018. The Company’s effective tax rate increased by approximately 2% for the six months ended June 30, 2019 as a result of the New Jersey tax changes. The Company’s effective tax rate for the six months ended June 30, 2018 was also affected by the adoption of ASU 2016-09. The six months ended June 30, 2018 included a $416 thousand reduction in income taxes.

CAPITAL RESOURCES A solid capital base provides the Company with the ability to support future growth and financial strength and is essential to executing the Company’s Strategic Plan – “Expanding Our Reach.” The Company’s capital strategy is intended to provide stability to expand its business, even in stressed environments. Quarterly stress testing is integral to the Company’s capital management process.

The Company strives to maintain capital levels in excess of internal “triggers” and in excess of those considered to be well capitalized under regulatory guidelines applicable to banks. Maintaining an adequate capital position supports the Company’s goal of providing shareholders an attractive and stable long-term return on investment.

Capital for the six months ended June 30, 2019 was benefitted by net income of $23.0 million.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of Total, Common Equity Tier 1 and Tier 1 capital (each as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). At June 30, 2019 and December 31, 2018, all of the Bank’s capital ratios remain above the levels required to be considered “well capitalized” and the Company’s capital ratios remain above regulatory requirements.

To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, common equity Tier I and Tier I leverage ratios as set forth in the table.

As a result of the recently enacted Economic Growth, Regulatory Relief, and Consumer Protection Act, the federal banking agencies are required to develop a “Community Bank Leverage Ratio” (the ratio of a bank’s tangible equity capital to average total consolidated assets) for financial institutions with assets of less than $10 billion. A “qualifying community bank” that exceeds this ratio will be deemed to be in compliance with all other capital and leverage requirements, including the capital requirements to be considered “well capitalized” under Prompt Corrective Action statutes. The federal banking agencies may consider a financial institution’s risk profile when evaluating whether it qualifies as a community bank for purposes of the capital ratio requirement. The federal banking agencies must set the minimum capital for the new Community Bank Leverage Ratio at not less than 8 percent and not more than 10 percent. A financial institution can elect to be subject to this new definition. The Bank’s leverage ratio was 11.54 percent at June 30, 2019.

The Bank’s regulatory capital amounts and ratios are presented in the following table:

(Dollars in thousands)

(A) See footnote on following table

The Company’s regulatory capital amounts and ratios are presented in the following table:

(Dollars in thousands)

(A) As fully phased in on January 1, 2019, the Basel Rules require the Company and the Bank to maintain a 2.5% “capital conservation buffer” on top of the minimum risk-weighted asset ratios. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of (i) CET1 to risk-weighted assets, (ii) Tier 1 capital to risk-weighted assets or (iii) total capital to risk-weighted assets above the respective minimum but below the capital conservation buffer face constraints on dividends, equity repurchases and discretionary bonus payments to executive officers based on the amount of the shortfall. The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and increased by 0.625% on each subsequent January 1, until it reached 2.5% on January 1, 2019.

The Company’s regulatory total risk-based capital ratio was benefitted by the $48.7 million (net) subordinated debt issuance that closed in June 2016. At that time, the Company down-streamed approximately $40.0 million of proceeds to the Bank as capital, benefitting all the Bank’s regulatory capital ratios.

In addition, on December 12, 2017, the Company issued $35.0 million in aggregate principal amount of Fixed-to-Floating Subordinated Notes due December 15, 2027. The Company down-streamed approximately $29.1 million of those proceeds to the Bank as capital.

The Dividend Reinvestment Plan of Peapack-Gladstone Financial Corporation, or the “Reinvestment Plan,” allows shareholders of the Company to purchase additional shares of common stock using cash dividends without payment of any brokerage commissions or other charges. Shareholders may also make voluntary cash payments of up to $200 thousand per quarter to purchase additional shares of common stock, which up to January 30, 2019 were purchased at a 3 percent discount to market. On January 30, 2019, the Company filed a Registration Statement on Form S-3 eliminating the feature in our “Reinvestment Plan” under which participants could purchase shares of our common stock through the Plan at a 3 percent discount to market price. Voluntary share purchases in the “Reinvestment Plan” can be filled from the Company’s authorized but unissued shares and/or in the open market, at the discretion of the Company. During the three months ended June 30, 2019, 694 shares purchased for the “Reinvestment Plan” were purchased in the open market.

On July 25, 2019, the Board of Directors declared a regular cash dividend of $0.05 per share payable on August 22, 2019 to shareholders of record on August 8, 2019.

Management believes the Company’s capital position and capital ratios are adequate. Further, Management believes the Company has sufficient capital to support its planned balance sheet growth for the immediate future. The Company continually assesses other potential sources of capital to support future growth.

LIQUIDITY: Liquidity refers to an institution’s ability to meet short-term requirements including funding of loans, deposit withdrawals and maturing obligations, as well as long-term obligations, including potential capital expenditures. The Company’s liquidity risk management is intended to ensure the Company has adequate funding and liquidity to support its assets across a range of market environments and conditions, including stressed conditions. Principal sources of liquidity include cash, temporary investments, securities available for sale, customer deposit inflows, loan repayments and secured borrowings. Other liquidity sources include loan sales and loan participations.

Management actively monitors and manages the Company’s liquidity position and believes it is sufficient to meet future needs. Cash and cash equivalents, including federal funds sold and interest-earning deposits, totaled $304.0 million at June 30, 2019. In addition, the Company had $378.8 million in securities designated as available for sale at June 30, 2019. These securities can be sold, or used as collateral for borrowings, in response to liquidity concerns. Securities available for sale with a fair value of $338.2 million as of June 30, 2019 were pledged to secure public funds and for other purposes required or permitted by law. In addition, the Company generates significant liquidity from scheduled and unscheduled principal repayments of loans and mortgage-backed securities.

A further source of liquidity is secured borrowing capacity. At June 30, 2019, unused borrowing commitments totaled $1.4 billion from the FHLB and $1.4 billion from the Federal Reserve Bank of New York.

Customer deposits and capital increased by $200.3 million and $24.9 million, respectively, during the first six months of 2019. These increases funded an increase in loans of $101.4 million and the additional on-balance sheet liquidity of $687.7 million of cash, cash equivalents and investment securities at June 30, 2019 as compared to $543.4 million at December 31, 2018.

Brokered interest-bearing demand (“overnight”) deposits were $180.0 million at June 30, 2019. The interest rate paid on these deposits allows the Bank to fund at attractive rates and engage in interest rate swaps to hedge its asset-liability interest rate risk. The Company ensures ample available collateralized liquidity as a backup to these short-term brokered deposits. As of June 30, 2019, the Company had transacted pay fixed, receive floating interest rate swaps totaling $230.0 million in notional amount.

The Company has a Board-approved Contingency Funding Plan in place. This plan provides a framework for managing adverse liquidity stress and contingent sources of liquidity. The Company conducts liquidity stress testing on a regular basis to ensure sufficient liquidity in a stressed environment.

The Company, on an unconsolidated basis, had liquid assets of $8.8 million at June 30, 2019.

Management believes the Company’s liquidity position and sources are adequate.

ASSET/LIABILITY MANAGEMENT: The Company’s Asset/Liability Committee (“ALCO”) is responsible for developing, implementing and monitoring asset/liability management strategies and advising the Board of Directors on such strategies, as well as the related level of interest rate risk. In this regard, interest rate risk simulation models are prepared on a quarterly basis. These models demonstrate balance sheet gaps and predict changes to net interest income and economic/market value of portfolio equity under various interest rate scenarios. In addition, these models, as well as ALCO processes and reporting, are subject to annual independent third-party review.

ALCO is generally authorized to manage interest rate risk through the management of capital, cash flows and duration of assets and liabilities, including sales and purchases of assets, as well as additions of wholesale borrowings and other sources of medium/longer term funding. ALCO is authorized to engage in interest rate swaps as a means of extending the duration of shorter term liabilities.

The following strategies are among those used to manage interest rate risk:

• Actively market C&I loans, which tend to have adjustable-rate features, and which generate customer relationships that can result in higher core deposit accounts;
• Actively market equipment finance leases and loans, which tend to have shorter terms and higher interest rates than real estate lending;
• Manage residential mortgage portfolio originations to adjustable-rate and/or shorter-term and/or “relationship” loans that result in core deposit and/or wealth management relationships;
• Actively market core deposit relationships, which are generally longer duration liabilities;
• Utilize medium to longer term certificates of deposit and/or wholesale borrowings to extend liability duration;
• Utilize interest rate swaps to extend liability duration;
• Utilize a loan level / back-to-back interest rate swap program, which converts a borrower’s fixed rate loan to adjustable rate for the Company;
• Closely monitor and actively manage the investment portfolio, including management of duration, prepayment and interest rate risk;
• Maintain adequate levels of capital; and
• Utilize loan sales, especially longer-term residential sales, and/or loan participations.

The interest rate swap program is administered by ALCO and follows procedures and documentation in accordance with regulatory guidance and standards as set forth in ASC 815 for cash flow hedges. The program incorporates pre-purchase analysis, liability designation, sensitivity analysis, correlation analysis, daily mark-to-market analysis and collateral posting as required. The Board is advised of all swap activity. In all of these swaps, the Company is receiving floating and paying fixed interest rates with total notional value of $230.0 million as of June 30, 2019.

In addition, the Company initiated a loan level / back-to-back swap program in support of its commercial lending business. Pursuant to this program, the Company extends a floating rate loan and executes a floating to fixed swap with the borrower. At the same time, the Company executes a third-party swap, the terms of which fully offset the fixed exposure and, result in a final floating rate exposure for the Company. As of June 30, 2019, $539.1 million of notional value in swaps were executed and outstanding with borrowers under this program.

As noted above, ALCO uses simulation modeling to analyze the Company’s net interest income sensitivity, as well as the Company’s economic value of portfolio equity under various interest rate scenarios. The models are based on the actual maturity and repricing characteristics of rate sensitive assets and liabilities. The models incorporate certain prepayment and interest rate assumptions, which management believes to be reasonable as of June 30, 2019. The models assume changes in interest rates without any proactive change in the balance sheet by management. In the models, the forecasted shape of the yield curve remained static as of June 30, 2019.

In an immediate and sustained 200 basis point increase in market rates at June 30, 2019, net interest income for year 1 would increase approximately 7.6 percent, when compared to a flat interest rate scenario. In year 2 net interest income would increase 14.5 percent, when compared to a flat interest rate scenario.

In an immediate and sustained 100 basis point decrease in market rates at June 30, 2019, net interest income would decline approximately 7.0 percent for year 1 and 14.7 percent for year 2, compared to a flat interest rate scenario.

The table below shows the estimated changes in the Company’s economic value of portfolio equity (“EVPE”) that would result from an immediate parallel change in the market interest rates at June 30, 2019.

(Dollars in thousands)

(1) EVPE is the discounted present value of expected cash flows from assets and liabilities.

(2) Present value of assets represents the discounted present value of incoming cash flows on interest-earning assets.

(3) EVPE ratio represents EVPE divided by the present value of assets.

Certain shortcomings are inherent in the methodologies used in determining interest rate risk. Simulation modeling requires making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the modeling assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the information provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.

Model simulation results indicate the Company is slightly asset sensitive, which indicates the Company’s net interest income should improve slightly in a rising rate environment. Management believes the Company’s interest rate risk position is reasonable.

The Corporation’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of the Corporation’s disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer have concluded that the Corporation’s disclosure controls and procedures are effective as of the end of the period covered by this Quarterly Report on Form 10-Q.

The Corporation’s Chief Executive Officer and Chief Financial Officer have also concluded that there have not been any changes in the Corporation’s internal control over financial reporting during the quarter ended June 30, 2019 that have materially affected, or are reasonable likely to materially affect, the Corporation’s internal control over financial reporting.

The Corporation’s management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures of our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, provides reasonable, not absolute, assurance that the objectives of the control system are met. The design of a control system reflects resource constraints; the benefits of controls must be considered relative to their costs. Because there are inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Corporation have been or will be detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns occur because of simple error or mistake. Controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all future conditions; over time, control may become inadequate because of changes in conditions or deterioration in the degree of compliance with the policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

There were no material changes in the Company’s risk factors during the six months ended June 30, 2019 from the risk factors disclosed in Part I, Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.