Peapack Gladstone Financial Corp: Form 10-Q for the period ended Jun 30, 2020

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, 2019, 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 2020 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 value in our investment portfolio;
• impact on our business from a pandemic event on our business, operations, customers, allowance for loan losses and capital levels;
• higher than expected increases in our allowance for loan and lease losses;
• higher than expected increases in loan and lease losses or 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 inability to retain key employees;
• demands for loans and deposits in our market areas;
• adverse changes in securities markets;
• changes in accounting policies and practices; and
• other unexpected material adverse changes in our operations or earnings.

Further, given its ongoing and dynamic nature, it is difficult to predict the full impact of the COVID-19 outbreak on our business. The extent of such impact will depend on future developments, which are highly uncertain, including when the coronavirus can be controlled and abated and when and how the economy may be reopened. As the result of the COVID-19 pandemic and the related adverse local and national economic consequences, we could be subject to any of the following risks, any of which could have a material, adverse effect on our business, financial condition, liquidity, and results of operations:

• demand for our products and services may decline, making it difficult to grow assets and income;
• if the economy is unable to substantially reopen, and high levels of unemployment continue for an extended period of time, loan delinquencies, problem assets, and foreclosures may increase, resulting in increased charges and reduced income;
• collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase;
• our allowance for loan losses may have to be increased if borrowers experience financial difficulties, which will adversely affect our net income;
• the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us;
• as the result of the decline in the Federal Reserve Board’s target federal funds rate to near 0%, the yield on our assets may decline to a greater extent than the decline in our cost of interest-bearing liabilities, reducing our net interest margin and spread and reducing net income;
• a material decrease in net income or a net loss over several quarters could result in a decrease in the rate of our quarterly cash dividend;
• our wealth management revenues may decline with continuing market turmoil;
• a worsening of business and economic conditions or in the financial markets could result in an impairment of certain intangible assets, such as goodwill;
• the unanticipated loss or unavailability of key employees due to the outbreak, which could harm our ability to operate our business or execute our business strategy, especially as we may not be successful in finding and integrating suitable successors;
• we may face litigation, regulatory enforcement and reputation risk as a result of our participation in the PPP and the risk that the SBA may not fund some or all PPP loan guaranties;
• our cyber security risks are increased as the result of an increase in the number of employees working remotely; and
• FDIC premiums may increase if the agency experience additional resolution costs.

Moreover, our operations depend on the management skills of our executive officers and directors, many of whom have held officer and director positions with us for many years. The unanticipated loss or unavailability of key employees due to the pandemic could hinder our ability to operate our business or execute our business strategy.

Except as may be required by applicable law or regulation, the Company undertakes no duty to update any forward-looking statements to conform the statement to actual results or change in the Company’s expectations. 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, 2019 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/(loss), 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.

EXECUTIVE SUMMARY: The following table presents certain key aspects of our performance for the three months ended June 30, 2020 and 2019.

(Dollars in thousands, except per share data)

1. The June 2020 quarter included a provision for loan and lease losses of $4.9 million. The increase in the provision for loan and lease losses was primarily due to the current environment created by the COVID-19 pandemic.

2. The June 2020 quarter included a full quarter of wealth management fee income and expense related to Point View, which was acquired effective September 1, 2019.

The following table presents certain key aspects of our performance for the six months ended June 30, 2020 and 2019.

(Dollars in thousands, except per share data)

(1) The six months ended June 30, 2020 included a provision for loan and lease losses of $24.9 million. The increase in the provision for loan and lease losses was primarily due to the current environment created by the COVID-19 pandemic.

(2) The six months ended June 30, 2020 included wealth management fee income and expense related to Point View, which was acquired effective September 1, 2019.

(3) The 2020 year included a $3.2 million tax benefit related to the carryback of tax NOLs to prior years when the Federal tax rate was 14% higher.

For the quarter ended June 30, 2020, the Company recorded revenue of $44.60 million, pretax income of $10.68 million, net income of $8.24 million and diluted earnings per share of $0.43, compared to revenue of $42.29 million, pretax income of $14.97 million, net income of $11.55 million and diluted earnings per share of $0.59 for the same three month period last year. The 2020 quarter included increased net interest income, which was offset by an increased provision for loan and lease losses and increased operating expenses (due in part to the wealth management firm acquired September 2019.) The increased provision for loan losses was due to increased qualitative factors associated with the increased unemployment rate and the level of loan payment deferral requests created by the COVID-19 pandemic. In comparing the second quarter of 2020 to the second quarter of 2019, revenue increased by 5%. Net interest income benefitted from an increase in our average interest-earning assets partially offset by a decline in our net interest margin for the quarter ended June 30, 2020. Revenue was also positively affected by an increase in wealth management fee income due to growth in AUM/AUA from existing clients and the acquisition of Point View in September 2019, offset by the decrease in market value of the AUM/AUA over the first quarter of 2020. Capital markets activity (which includes loan level back-to-back swap activities, the SBA lending and sale program and mortgage banking activities) resulted in $1.01 million of revenue for the second quarter of 2020 which decreased $416,000 from $1.43 million for the same period in 2019. Income from these programs are not linear each quarter, as some quarters will be higher than others. The

COVID-19 pandemic along with a declining interest rate environment impacted the Company’s capital markets activity and revenue during the second quarter of 2020.

The Company recorded revenue of $90.86 million, pretax income of $8.71 million, net income of $9.62 million and diluted earnings per share of $0.51 for the six months ended June 30, 2020 compared to revenue of $84.03 million, pretax income of $30.89 million, net income of $22.98 million and diluted earnings per share of $1.18 for the same 2019 period. The 2020 year included increased net interest income and noninterest income offset by increased operating expenses (due in part to the wealth management firm acquired in September 2019) and an increased provision for loan and lease losses. The 2020 year also included a tax benefit of $3.2 million recorded in the first quarter of 2020 caused by the changes in the treatment of tax net operating losses (“NOL”) under the provisions of The Coronavirus Aid, Relief, and Economic Security (“CARES”) Act.

COVID-19 UPDATE: The COVID-19 pandemic has continued to have a devastating effect on businesses both locally and nationally. As a result, Congress passed the CARES Act to provide fast and direct economic assistance to American workers, families and businesses. The CARES Act contains substantial tax and spending provisions including direct financial aid to American families, extensive emergency funding for hospitals and medical providers, and economic stimulus to significant impacted industry sectors. Below are some of the measures the Company has implemented in response to COVID-19.

The Company has an Incident Response Team comprised of senior and departmental leaders that meet frequently to monitor and address the ongoing developments and challenges presented by the COVID-19 pandemic. The following represent responses by Management as a result of COVID-19:

• The Company’s branch offices remain open via drive-thru facilities, ATM access, and on-line banking;
• Management has leveraged technology to support employees that are working remotely;
• Retail client initiatives have been introduced including:

1) 90-day or 180-day payment deferral period (the Company approved deferral requests relating to approximately $913.7 million or 19% of our portfolio as of June 30, 2020).

2) Waiving all late fees for April/May/June;

3) Not reporting payment deferrals or late payments to credit bureaus through June; and

4) Utilized the PPP to assist both clients and community organizations with funding needs related to the pandemic (processed over 2,000 applications with approximately $600 million of approved loans as of June 30, 2020).

The Company has identified several industry sectors within the loan portfolio that are most impacted by COVID-19 and include but are not limited to: manufacturing, transportation, accommodation and food services, retail trade, real estate – retail and arts, entertainment and recreation. Management has performed portfolio reviews related to these sectors in the second quarter of 2020 and will conduct follow up reviews for the third quarter of 2020. Management will continue to monitor these sectors closely and evaluate for potential impact on our ALLL.

The Company will continue to prudently extend credit to our clients. The Company expects COVID-19 to have a significant impact on our operations but cannot determine or estimate the impact at this time.

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, 2019 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, 2019 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 table 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 $2.5 million, or 8 percent, for the second quarter of 2020 to $32.4 million from net interest income of $29.9 million for the same quarter in 2019. The net interest margin was 2.27 percent and 2.64 percent for the three months ended June 30, 2020 and 2019, respectively, a decrease of 37 basis points. Net interest income, on a fully tax-equivalent basis, increased $4.2 million, or 7 percent, for the first six months ended June 30, 2020 to $64.7 million from net interest income of $60.5 million for the same period in 2019. The net interest margin was 2.41 percent and 2.67 percent for the six months ended June 30, 2020 and 2019, respectively, a decrease of 26 basis points. As shown above, the Company’s reported NIM declined 37 basis points compared to the June 30, 2019 quarter, while core NIM declined only 24 basis points compared to the June 30, 2019 quarter. As a commercial bank, the Company is asset sensitive with a large portion of its commercial loan portfolio tied to one-month LIBOR. The decline in the core NIM was a function of the precipitous decline in one-month LIBOR in the second quarter.

The growth in net interest income for the three and six months ended June 30, 2020 was due to increases in the average balance of interest-earning assets and a decrease in the average cost of interest-bearing liabilities, offset by an increase in the average balance of interest-bearing liabilities and by a decrease in the average yield on interest-earning assets. The Company continues to be impacted by competitive pressures in attracting new loans and deposits, as well as retaining deposits.

Future net interest income will be benefitted from interest and fees from PPP loans. As of June 30, 2020, the Company had $521.6 million of PPP loans, with net deferred fees of $11.1 million that will be amortized to net interest income over the life of the loans, which have a stated maturity of two to five years. However, these loans may be eligible for loan forgiveness by the SBA at an earlier date, which would accelerate the amortization of the net deferred fees.

Future net interest income will also be benefitted by the repricing of the Company’s time certificates of deposit (“CDs”). Over the six-month period of July to December 2020, approximately $300 million of CDs with an average rate of approximately 1.50% will mature.

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

(In thousands)

(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.

(C) Includes PPP loans of $596 million for the three and six months ended June 30, 2020.

The Company manages its origination levels in conjunction with anticipated paydowns and payoffs. 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. C&I loan originations declined by $44.6 million and $142.9 million for the three and six months ended June 30, 2020, respectively. Multi-family originations also declined by $46.6 million to $12.0 million for the three months ended June 30, 2020 as compared to the prior year. The decreases in originations were due to the Company’s focused efforts on PPP production and loan deferral requests during the second quarter of 2020. Residential mortgage loans increased by $23.9 million and $44.2 million for the three and six months ended June 30, 2020, respectively. The increase was primarily due to an increased demand by residential customers reflective of the low interest rate environment and the ability of the Company to sell these mortgages in the secondary market to generate non-interest income.

At June 30, 2020, December 31, 2019 and June 30, 2019, 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 table reflects 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)

53

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 $42.1 million for the second quarter of 2020 compared to $45.2 million for the same quarter of 2019, reflecting a decrease of $3.2 million, or 7 percent. Interest income on interest-earning assets, on a fully tax-equivalent basis, totaled $88.0 million for the six months ended June 30, 2020 compared to $90.4 million for the same period of 2019, reflecting a decrease of $2.4 million, or 3 percent. The decrease in both the three and six months ended June 30, 2020, as compared to the comparable periods in 2019 reflects a decrease in the average yield on interest-earnings assets, offset by an increase in the average balance of interest-earning assets.

Average interest-earning assets totaled $5.71 billion for the second quarter of 2020, an increase of $1.17 billion, or 26 percent, from the same period of 2019. Average interest-earning assets totaled $5.37 billion for the six months ended June 30, 2020, an increase of $836.9 million, or 18 percent, from the same period of 2019. The increase in the average balance of interest-earning assets for the three and six months ended June 30, 2020, as compared to the comparable periods in 2019 reflects an increase in the average balance of loans, particularly, in the average balance of C&I and commercial mortgage portfolios. The average balance of the C&I loan portfolio increased $621.4 million to $2.04 billion, or 44 percent, for the second quarter of 2020, as compared to $1.42 billion for the three months ended June 30, 2019. The average balance of the C&I loan portfolio increased $499.9 million, or 36 percent, to $1.90 for the six months ended June 30, 2020 as compared to $1.40 billion the same period in 2019. The increase in this portfolio for the three and six months ended June 30, 2020 was primarily attributable to the Company’s participation in the PPP program, in which the Company originated $596 million during the second quarter of 2020. The Company has also supported growth in the C&I portfolio through: the addition of seasoned bankers including a new EVP, Head of Commercial Banking, in 2019 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. The average balance of the commercial mortgage portfolio increased $297.2 million to $2.08 billion, or 17 percent, from $1.79 billion for the second quarter of 2019. The average balance of the commercial mortgage portfolio was $2.02 billion for the six months ended June 30, 2020 an increase of $214.4 million, or 12 percent, from the same period in 2019. The increase in the commercial mortgage portfolio for the three and six months ended June 30, 2020 were to maintain the size of the portfolio in anticipation of maturities in the portfolio in the latter part of 2020. These increases were partially offset by decreases in the average balance of the residential mortgage portfolio of $37.9 million, or 7 percent, and $37.2 million, or 7 percent to $530.1 million and $532.6 million for the three and six months ended June 30, 2020, respectively, when compared to the same periods in 2019. 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 $447.4 million for the second quarter of 2020 compared to $409.0 million for the same quarter of 2019, reflecting an increase of $38.4 million, or 9 percent.

The average balance of investment securities totaled $434.9 million for the six months ended June 30, 2020 as compared to $407.0 million for the same period of 2019 reflecting an increase of $27.9 million, or 7 percent. The increase in the average balance of investment securities was due to the re-purchase of securities to maintain the size of the portfolio in anticipation of maturities for the third and four quarters of 2020. Interest-earning deposits totaled $497.8 million for the three months ended June 30, 2020 when compared to $241.1 million for the same period in 2019, reflecting an increase of $256.6 million or 106 percent. Interest-earning deposits increased to $374.7 million for the six months ended June 30, 2020 when compared to $239.2 million for the same period in 2019 reflecting an increase of $135.5 million or 57 percent. The increase in interest-earning deposits for the three and six months ended June 30, 2020 was primarily to increase the Company’s balance sheet liquidity in the event of significant depositor withdrawals and/or significant borrower draws on existing unused credit lines due to the current environment created by the COVID-19 pandemic.

For the quarters ended June 30, 2020 and 2019, the average yields earned on interest-earning assets were 2.95 percent and 3.99 percent, respectively, a decrease of 104 basis points. The six months ended June 30, 2020 had a decrease of 71 basis points on the average yields earned on interest-earning assets to 3.28 percent from 3.99 percent when compared to the same period of 2019. The decrease in average yields on loans for the three and six month periods was due to a declining rate environment. The one-month London Interbank Offered Rate (“LIBOR”) declined by approximately 150 basis points from the beginning of the year. The Federal Open Market Committee also reduced the target Federal Funds rate to 0 percent to 0.25 percent in March 2020 due to the economic disruption caused by COVID-19. With the transformation to a commercial bank balance sheet and business model, the Company’s interest rate sensitivity models indicate the Company is asset sensitive as of June 30, 2020, and that net interest income would improve in both a rising rate environment and a falling rate environment as our adjustable rate assets have little room to re-price in this low rate environment. In the short term, we will most likely see a decline in net interest income in the event of a change in interest rates as the full effect of rate decreases on our adjustable rate assets occurred in the middle of the second quarter of 2020.

For the second quarter of 2020, the average balance of interest-bearing deposits was $3.94 billion, an increase of $521.3 million, or 15 percent, from $3.41 billion for the same period of 2019. Interest-bearing deposits totaled $3.85 billion for the six months ended June 30, 2020 which is an increase of $413.5 million or 12 percent, from the same 2019 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; a focus on providing high-touch client service; new deposit relationships related to PPP; and a full array of treasury management products that support core deposit growth. The growth was partially offset by a decline of $23.2 million of listing service deposits from June 30, 2019 as the Company has chosen not to participate in such programs for the foreseeable future, so maturing listing service deposits are not replaced with new listing service deposits.

Average rates paid on total interest-bearing deposits were 0.74 percent and 1.54 percent for the second quarters of 2020 and 2019, respectively, a decrease of 80 basis points. Average rates paid on total interest-bearing deposits were 0.97 percent and 1.49 percent for the six months ended June 30, 2020 and 2019, respectively, a decrease of 52 basis points. The decrease in the average rate paid on deposits was principally due to repricing of our deposit base to align with the recent Fed rate decreases.

For the second quarter of 2020, the average balance of borrowings was $330.5 million, an increase of $225.5 million when compared to the same period in 2019. For the six months ended June 30, 2020, the average balance of borrowings was $257.0 million, an increase of $151.5 million when compared to the same period in 2019. The increase in borrowings was principally due to the Company’s participation in the PPPLF as well, for the six months ended June 30, 2020 as a $500.0 million one-month FHLB advance entered in March 2020, which matured in April 2020.

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 $646.3 million and $562.3 million for the three and six months ended June 30, 2020, respectively, compared to $436.1 million and $434.9 million for the same three and six months ended June 30, 2019, respectively.

The average balance of brokered interest-bearing demand deposits was $150.3 million and $165.2 million for the three and six months ended June 30, 2020, respectively, compared to $180.0 million for the three and six months ended June 30, 2019. The Company has transacted $150.0 million of interest rate swaps against these deposits 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 noninterest income.

At June 30, 2020, the Company had investment securities available for sale with a fair value of $539.7 million compared with $390.8 million at December 31, 2019. The increase was due to purchases of residential mortgage-backed securities with excess liquidity as deposits and borrowings exceeded loan growth. A net unrealized gain (net of income tax) of $6.9 million and a net unrealized gain (net of income tax) of $1.0 million were included in shareholders’ equity at June 30, 2020 and December 31, 2019, respectively.

The Company has one equity security (a CRA investment security) with a fair value of $15.2 million at June 30, 2020 compared with $10.8 million at December 31, 2019, with changes in fair value recognized in the Consolidated Statements of Income. The Company recorded a $125,000 and $323,000 unrealized gain on the Consolidated Statements of Income for the three and six months ended June 30, 2020, respectively, as compared to an unrealized gain of $69,000 and $128,000 for the three and six months ended June 30, 2019, respectively.

The carrying value of investment securities available for sale as of June 30, 2020 and December 31, 2019 are shown below:

(In thousands)

56

The following table presents the contractual maturities and yields of debt securities available for sale, stated at fair value, as of June 30, 2020:

(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, 2020 was $374.7 million compared to $223.7 million for the year ended December 31, 2019. The increase represented excess cash as deposit and borrowing growth and cash from maturing securities exceeded loan growth.

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

(In thousands)

57

(In thousands)

The Company recorded total other income, excluding wealth management fee income, of $2.6 million for the second quarter of 2020, reflecting a decrease of $828,000, or 24 percent, compared to the same period in 2019. For the six months ended June 30, 2020 the Company recorded total other income, excluding wealth management fee income, of $7.2 million reflecting an increase of $1.2 million or 20 percent from the same period in 2019. The decrease for the three months ended June 30, 2020 was primarily attributable to capital markets activity (mortgage banking income, fee income related to loan level, back-to-back swaps, and gain on the sale of SBA loans), which decreased by $416,000 as compared to the second quarter of 2019. Capital markets activity with the exception of mortgage banking income activity has been negatively impacted by the COVID-19 pandemic along with the low interest rate environment.

For the quarter ended June 30, 2020, income from the sale of newly originated residential mortgage loans was $550,000 compared to $132,000 for the same period in 2019. For the six months ended June 30, 2020 and 2019, income from the sale of newly originated residential mortgage loans was $842,000 and 179,000, respectively. Such income was a result of an increase in the residential mortgage loan volume during the first six months of 2020 due to the low interest rate environment.

The second quarter of 2020 included $202,000 of loan level, back-to-back swap income compared to $721,000 for the same quarter of 2019. The six months ended June 30, 2020 included $1.6 million of loan level, back-to-back swap income compared to $991,000 for the same period of 2019. 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 2020 included $258,000 of income, on sales of $2.6 million, related to the Company’s SBA lending and sale program compared to $573,000 of income, on sales of $5.7 million, for the same quarter in 2019. The six months ended June 30, 2020 included $1.3 million of income, on sales of $13.9 million, related to the Company’s SBA lending and sale program compared to $992,000 of income, on sales of $9.9 million, for the same period in 2019.

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 $125,000 and $323,000 mark to market gain on its equity security investment for the three and six months ended June 30, 2020, respectively, compared to a $69,000 and $128,000 mark to market gain on its equity security investment for the three and six months ended June 30, 2019, respectively.

Other income was $482,000 for the quarter ended June 30, 2020 compared to $740,000 for the same quarter in 2019. For the six months ended June 30, 2020 other income was $941,000 compared to $1.3 million for the same period in 2019. The decrease in other income for the three and six months ended June 30, 2020 was primarily due to decreases in commercial lending fees, particularly unused credit line fees, income related to our corporate advisory program, and loan servicing income.

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 period ended June 30, 2020 was principally attributable to: an increase in compensation and employee benefits of $1.6 million to $19.2 million for the second quarter of 2020 and $3.7 million increase to $38.4 million for the six months ended June 30, 2020, which includes expenses related to the Point View acquisition completed on September 1, 2019, hiring in line with the Company’s strategic plan; and normal salary increases; additional premises and equipment expenses, which includes expenses related to Point View; and ongoing operating expenses including amortization of intangibles. Further, the three and six months ended June 30, 2020 included increased medical insurance costs when compared to the same 2019 period. The Company also incurred one-time expenses of $278,000 related to the closure of one branch office. The Company anticipates the branch closure will create future benefit in the form of lower expenses. There was $225,000 of increased marketing expense directly related to the COVID-19 pandemic and the Company’s participation in the PPP program.

PEAPACK PRIVATE: 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 Peapack Private 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, Murphy Capital, in Gladstone, New Jersey, Lassus Wherley, in New Providence, New Jersey and Bonita Springs, Florida and Point View, in Summit, New Jersey.

The market value of the assets under management and/or administration (“AUM/AUA”) of the Peapack Private Wealth Management Division was $7.2 billion at June 30, 2020, reflecting a 4% decline from $7.5 billion at December 31, 2019. AUM/AUA have partially recovered with a 13% increase from $6.4 billion at March 31, 2020. Changes in the market value of the Company’s AUM/AUA are approximately 70% correlated to the changes in value of the S&P index, which declined approximately 20% from December 31, 2019 to March 31, 2020 but experienced a recovery of approximately 18% during the second quarter of 2020.

In the June 2020 quarter, Peapack Private generated $10.0 million in fee income compared to $9.6 million for the June 2019 quarter, reflecting a 4% increase. For the six months ended June 30, 2020, the Private Wealth Management Division generated

$20.0 million in fee income compared to $18.7 million for the same period in 2019, reflecting a 6% increase. The growth in fee income was primarily due to the acquisition of Point View on September 1, 2019. The fees for the first six months of 2020 were negatively impacted by declines in the market value of the Company’s Assets Under Management (AUM) / Assets Under Administration (AUA) as a result of declines in the equity markets created by the COVID-19 pandemic.

Operating expenses relative to Peapack Private reflected increases due to overall growth in the business, new hires and select third party expenditures. The six months ended June 30, 2020 also includes a full six months of expense from Point View. Remaining expenses are in line with the Company’s Strategic Plan, particularly the hiring of key management and revenue-producing personnel.

The Peapack Private Wealth Management Division currently generates adequate revenue to support the salaries, benefits and other expenses of the Division and Management believes it will continue to do so as the Company grows organically and/or by acquisition. Management believes that the Bank generates adequate liquidity to support the expenses of the Peapack 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) Includes a non-owner occupied CRE loan with a balance of $3.5 million at March 31, 2020. This loan was brought fully current in early April. The $6.3 million at September 30, 2019 included one $4.3 million commercial real estate loan that was in process of a rate modification (not a TDR modification). The loan was brought current in early October 2019.

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

PROVISION FOR LOAN AND LEASE LOSSES: The provision for loan and lease losses was $4.9 million and $1.2 million for the second quarters of 2020 and 2019, respectively. For the six months ended June 30, 2020 and 2019, the provision for loan losses was $24.9 million and $1.3 million, respectively. The increased provision for loan and lease losses for the three and six months ended June 30, 2020 was primarily due to the current environment created by the COVID-19 pandemic and was driven principally by increased qualitative factors. The increase in qualitative factors was primarily related to elevated levels of unemployment and approved loan deferral requests. For additional details, see the provision for loan and lease losses table below. The Company’s provision for loan and lease losses and the level of the allowance for loan and lease losses also reflect several other 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, type of and amount of loan growth, asset quality metrics, net charge-off activity, and the composition of the loan portfolio. 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 $66.1 million as of June 30, 2020, compared to $43.7 million at December 31, 2019. As a percentage of loans, the allowance for loan and lease losses was 1.36 percent at June 30, 2020 and 0.99 percent at December 31, 2019. The specific reserves recorded on impaired loans were $4.3 million at June 30, 2020 compared to $2.8 million as of December 31, 2019. Specific reserves at June 30, 2020 were primarily related to a $4.0 million reserve on a senior living facility relationship. Specific reserves declined by $2.0 million during the second quarter of 2020 due to the Company releasing reserves on a casual dining commercial banking relationship and charging-off this amount against the principal balance of the loan. Total impaired loans were $33.7 million and $35.9 million as of June 30, 2020 and December 31, 2019, respectively. The general component of the allowance increased from $40.9 million at December 31, 2019 to $61.7 million at June 30, 2020 due to the reasons noted above.

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

(Dollars in thousands)

(A) The June 30, 2020 ALLL coverage ratios include PPP loans of $521.6 million from total loans

The following table details the Company’s provision for loan and lease losses for the quarter ended June 30, 2020:

(Dollars in thousands)

(A) The June 30, 2020 ALLL ratio include PPP loans of $521.6 million from total loans

The following table details the Company’s provision for loan and lease losses for the six months ended June 30, 2020:

(Dollars in thousands)

(A) The June 30, 2020 ALLL ratio include PPP loans of $521.6 million from total loans

INCOME TAXES: Income tax expense for the three months ended June 30, 2020 was $2.4 million as compared to $3.4 million for the same period in 2019. Income tax benefit for the six months ended June 30, 2020 was $903,000 as compared to income tax expense of $7.9 million for the same period in 2019.

The Company recorded a $3.34 million tax benefit during the first quarter of 2020, principally as a result of a $3.2 million Federal income tax benefit that resulted from a tax NOL carryback. The Company had a $23 million operating loss for tax purposes in 2018 (when the Federal tax rate was 21%) resulting from accelerated tax depreciation. Under the CARES Act, the Company was allowed to carry this NOL back to a period when the Federal tax rate was 35%, generating a permanent tax benefit. The effective tax rate for the three months ended June 30, 2020 was 22.85%, which included a benefit from a New Jersey state credit related to deferred tax liabilities effected by the surtax imposed by New Jersey in 2019. Excluding such benefit, the effective rate for the June 2020 quarter would have been approximately 26.5%.

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 and was in place for 2019. The surtax adjusted to 1.5 percent for 2020 and will continue into 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 requires entities to report their real estate investment trust, registered investment company and investment company on a separate entity basis.

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 was benefitted by net income of $9.6 million for the six months ended June 30, 2020, which was partially offset by the purchase of shares through the Company’s stock repurchase program. Early in the first quarter, the Company purchased 220,222 shares, at an average price of $29.45, for a total cost of $6.5 million.

The Company employs quarterly capital stress testing – adverse case and severely adverse case. In the March 31, 2020 severely, adverse case, no growth scenario, the Bank remains well capitalized over a two-year stress period. With a Pandemic stress overlay, the Bank still remains well capitalized over the two-year stress period.

Quantitative measures established by regulation to ensure capital adequacy require the Company and 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, 2020 and December 31, 2019, 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. The Company’s capital ratios were not affected by our participation in the PPP. The Company pledged its PPP loans as collateral and utilized funding provided by the FRB’s PPPLF. PPP loans funded by the PPPLF are risk-weighted at 0 percent for regulatory risk-based capital ratios and are excluded from average assets in the calculation of the regulatory leverage ratio.

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 set the minimum capital for the Community Bank Leverage Ratio (“CBLR”) at 9 percent, effective January 1, 2020. Under the CARES Act, the Community Bank Leverage Ratio was temporarily lowered to 8 percent. The Bank did not opt into the CBLR and will continue to comply with the requirements under Basel III. The Bank’s leverage ratio was 9.79 percent at June 30, 2020.

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) 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 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. All shares purchased during the quarter ended June 30, 2020 were in the open market.

On July 28, 2020, the Board of Directors declared a regular cash dividend of $0.05 per share payable on August 25, 2020 to shareholders of record on August 11, 2020.

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 $622.8 million at June 30, 2020. In addition, the Company had $539.7 million in securities designated as available for sale at June 30, 2020. 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 $332.3 million as of June 30, 2020 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.

For the quarter ended June 30, 2020, the Company’s balance sheet liquidity was funded by increased client deposits of $608.3 million and $535.8 million in borrowings through the PPPLF. The Company approved loans of approximately $600 million under the PPP. The Federal Reserve has supplied a source of liquidity for the PPP to participating financial institutions through the PPPLF which extends credit to eligible financial institutions, at a rate of 0.35%, that originate PPP loans, taking the loans as collateral at face value. The Company utilized this facility to fund its PPP loans.

As of June 30, 2020, in addition to the $1.2 billion of balance sheet liquidity, the Company also had approximately $1.9 billion of secured funding available from the Federal Home Loan Bank, of which $120.0 million was drawn as of June 30, 2020. Additionally, the Company also had $1.0 billion of secured funding available from the Federal Reserve Discount Window, none of which was drawn.

Brokered interest-bearing demand (“overnight”) deposits were $130.0 million at June 30, 2020. 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, 2020, the Company had transacted pay fixed, receive floating interest rate swaps totaling $270.0 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 believes it has sufficient liquidity given the current environment created by the COVID-19 pandemic.

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.

The interest rate swap program is administered by the 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 $270.0 million as of June 30, 2020.

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, 2020, $868.7 million of notional value in swaps were executed and outstanding with borrowers under this program.

As noted above, the 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, 2020. 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, 2020.

In an immediate and sustained 100 basis point increase in market rates at June 30, 2020, net interest income would increase approximately 9.5 percent for year 1 and 12.7 percent for year 2, compared to a flat interest rate scenario.

In an immediate and sustained 200 basis point increase in market rates at June 30, 2020, net interest income for year 1 would increase approximately 17.3 percent, when compared to a flat interest rate scenario. In year 2 net interest income would increase 23.1 percent, when 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, 2020.

(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.

The Company’s interest rate sensitivity models indicate the Company is asset sensitive as of June 30, 2020, and that net interest income would improve in a both rising rate environment and a falling rate environment. Over the past quarter, the Company has been managing its balance sheet to be closer to interest rate neutral.

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, 2020 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 have been no material changes in risk factors applicable to the Company from those disclosed in “Risk Factors” in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 and Quarterly Report on Form 10-Q for the quarter ended March 31, 2020.