10-Q 1 tm2025015-1_10q.htm FORM 10-Q

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-Q

 

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2020

 

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from          to

 

Commission File Number 001-38290

 

Sterling Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

Michigan   38-3163775
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification Number)

 

One Towne Square, Suite 1900

Southfield, Michigan 48076

(248) 355-2400

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

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

 

Title of each class Trading Symbol(s) Name of each exchange on which registered
Common stock, no par value per share SBT The NASDAQ Stock Market LLC (NASDAQ
Capital Market)

 

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

 

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

 

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

 

Large accelerated filer ¨   Accelerated filer x   Non-accelerated filer ¨   Smaller reporting company x
            Emerging growth company x

 

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

 

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

 

As of September 30, 2020, there were 49,977,209 shares of the Registrant’s Common Stock outstanding.

 

 

 

 

 

STERLING BANCORP, INC.

FORM 10-Q

INDEX

 

PART I — FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)  
  Condensed Consolidated Balance Sheets as of March 31, 2020 and December 31, 2019 2
  Condensed Consolidated Statements of Income for the three months ended March 31, 2020 and 2019 3
  Condensed Consolidated Statements of Comprehensive Income for the three months ended March 31, 2020 and 2019 4
  Condensed Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2020 and 2019 5
  Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2020 and 2019 6
  Notes to the Condensed Consolidated Financial Statements (Unaudited) 7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 32
Item 3. Quantitative and Qualitative Disclosures about Market Risk 50
Item 4. Controls and Procedures 52
     
PART II — OTHER INFORMATION
Item 1. Legal Proceedings 53
Item 1A. Risk Factors 54
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 55
Item 6. Exhibits 56
Exhibit Index   56
SIGNATURES   57

 

1

 

 

Sterling Bancorp, Inc.

Condensed Consolidated Balance Sheets (Unaudited)

(dollars in thousands)

  

PART 1. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

 

   March 31,   December 31, 
   2020   2019 
Assets          
Cash and due from banks  $389,984   $77,819 
Interest-bearing time deposits with other banks   1,025    1,025 
Investment securities   159,168    152,544 
Mortgage loans held for sale   3,776    1,337 
Loans, net of allowance for loan losses of $42,613 and $21,730   2,799,645    2,891,530 
Accrued interest receivable   13,221    13,718 
Mortgage servicing rights, net   7,976    9,765 
Leasehold improvements and equipment, net   9,081    9,198 
Operating lease right-of-use assets   17,802    18,715 
Federal Home Loan Bank stock, at cost   22,950    22,950 
Cash surrender value of bank-owned life insurance   32,070    31,917 
Deferred tax asset, net   18,113    12,095 
Other assets   2,564    2,271 
       Total assets  $3,477,375   $3,244,884 
           
Liabilities and Shareholders' Equity          
Liabilities:          
   Noninterest-bearing deposits  $68,650   $77,563 
   Interest-bearing deposits   2,576,643    2,417,877 
       Total deposits   2,645,293    2,495,440 
   Federal Home Loan Bank borrowings   329,000    229,000 
   Subordinated notes, net   65,218    65,179 
Operating lease liabilities   18,959    19,868 
   Accrued expenses and other liabilities   90,230    102,783 
       Total liabilities   3,148,700    2,912,270 
           
Shareholders' equity:          
   Preferred stock,  authorized 10,000,000 shares; no shares issued and outstanding        
   Common stock, no par value, authorized 500,000,000 shares; issued and outstanding          
     50,067,738 shares at March 31, 2020 and 49,944,473 shares at December 31, 2019, respectively   80,807    80,889 
   Additional paid-in capital   13,319    13,210 
   Retained earnings   233,790    238,319 
   Accumulated other comprehensive income   759    196 
       Total shareholders' equity   328,675    332,614 
       Total liabilities and shareholders' equity  $3,477,375   $3,244,884 

 

See accompanying notes to condensed consolidated financial statements.

 

2

 

 

Sterling Bancorp, Inc.

Condensed Consolidated Statements of Income (Unaudited)

(dollars in thousands, except per share amounts)

 

   Three Months Ended
March 31,
 
   2020   2019 
Interest income          
    Interest and fees on loans  $39,525   $41,722 
    Interest and dividends on investment securities and restricted stock   1,034    1,227 
    Other interest   434    236 
      Total interest income   40,993    43,185 
           
Interest expense          
   Interest on deposits   10,364    10,656 
   Interest on Federal Home Loan Bank borrowings   810    1,055 
   Interest on subordinated notes   1,177    1,174 
      Total interest expense   12,351    12,885 
           
Net interest income   28,642    30,300 
Provision (recovery) for loan losses   20,853    (1,014)
Net interest income after provision (recovery) for loan losses   7,789    31,314 
           
Non-interest income          
   Service charges and fees   117    104 
   Investment management and advisory fees   313    340 
   Gain on sale of investment securities   233     
   Gain on sale of mortgage loans held for sale   269    38 
   Gain on sale of portfolio loans       2,442 
   Unrealized gains on equity securities   80    49 
   Net servicing income (loss)   (911)   325 
   Income on cash surrender value of bank-owned life insurance   328    310 
   Other   100    220 
       Total non-interest income   529    3,828 
           
Non-interest expense          
   Salaries and employee benefits   6,753    7,267 
   Occupancy and equipment   2,118    2,237 
   Professional fees   3,312    962 
   Advertising and marketing   273    439 
   FDIC assessments   19    255 
   Data processing   335    308 
   Other   1,425    1,654 
      Total non-interest expense   14,235    13,122 
           
Income (loss) before income taxes   (5,917)   22,020 
Income tax expense (benefit)   (1,887)   6,337 
Net income (loss)  $(4,030)  $15,683 
           
Income (loss) per share, basic and diluted  $(0.08)  $0.30 
           
Weighted average common shares outstanding:          
    Basic   49,837,662    52,554,446 
    Diluted   49,837,662    52,562,820 

 

See accompanying notes to condensed consolidated financial statements.

 

3

 

 

Sterling Bancorp, Inc.

Condensed Consolidated Statements of Comprehensive Income (Unaudited)

(dollars in thousands)

 

   Three Months Ended 
   March 31, 
   2020   2019 
Net income (loss)  $(4,030)  $15,683 
Other comprehensive income, net of tax:          
Unrealized gains on investment securities, arising during the period, net of tax effect of $284 and $41, respectively        731           106   
Reclassification adjustment for gains included in net income of $233 and $-, respectively, included in gain on sale of investment securities, net of tax effect of $65 and $-, respectively           (168   )           —    
Total other comprehensive income   563    106 
Comprehensive income (loss)  $(3,467)  $15,789 

 

See accompanying notes to condensed consolidated financial statements.

 

4

 

 

Sterling Bancorp, Inc.

Condensed Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

(dollars in thousands, except per share amounts)

 

                   Accumulated     
           Additional       Other   Total 
   Common Stock   Paid-in   Retained   Comprehensive   Shareholders' 
   Shares   Amount   Capital   Earnings   Income (Loss)   Equity 
Balance at January 1, 2019   53,012,283   $111,238   $12,713   $211,115   $(9)  $335,057 
Net income               15,683        15,683 
Repurchases of shares of common stock (Note 10)   (1,212,574)   (11,544)               (11,544)
Stock-based compensation   71,144        126            126 
Other comprehensive income                   106    106 
Dividends distributed ($0.01 per share)               (526)       (526)
Balance at March 31, 2019   51,870,853   $99,694   $12,839   $226,272   $97   $338,902 
                               
Balance at January 1, 2020   49,944,473   $80,889   $13,210   $238,319   $196   $332,614 
Net loss               (4,030)       (4,030)
Repurchases of shares of common stock (Note 10)   (10,912)   (82)               (82)
Stock-based compensation   134,177        109            109 
Other comprehensive income                   563    563 
Dividends distributed ($0.01 per share)               (499)       (499)
Balance at March 31, 2020   50,067,738   $80,807   $13,319   $233,790   $759   $328,675 

 

See accompanying notes to condensed consolidated financial statements.

 

5

 

 

Sterling Bancorp, Inc.

Condensed Consolidated Statements of Cash Flows (Unaudited)

(dollars in thousands)

 

   Three Months Ended
March 31,
 
   2020   2019 
Cash Flows From Operating Activities          
Net income (loss)  $(4,030)  $15,683 
Adjustments to reconcile net income to net cash provided by operating activities:          
       Provision (recovery) for loan losses   20,853    (1,014)
       Deferred income taxes   (6,237)   143 
       Gain on sale of investment securities   (233)    
       Unrealized gains on equity securities   (80)   (49)
       Accretion on investment securities, net   (128)   (441)
       Depreciation and amortization on leasehold improvements and equipment   398    391 
       Amortization of intangible asset       113 
       Origination, net of principal payments, mortgage loans held for sale   (16,855)   (3,166)
       Proceeds from sale of mortgage loans held for sale   14,578    4,152 
       Gain on sale of mortgage loans held for sale   (269)   (38)
       Gain on sale of portfolio loans       (2,442)
       Increase in cash surrender value of bank-owned life insurance, net of premiums   (153)   (152)
       Valuation allowance adjustments and amoritzation of mortgage servicing rights   1,896    721 
       Stock-based compensation   109    126 
       Other   39    36 
       Change in operating assets and liabilities:          
            Accrued interest receivable   497    (217)
            Other assets   662    1,432 
            Accrued expenses and other liabilities   (13,504)   5,336 
                    Net cash provided by (used in) operating activities   (2,457)   20,614 
           
Cash Flows From Investing Activities          
Maturities and principal receipts of investment securities   47,272    45,124 
Sales of investment securities   23,044     
Purchases of investment securities   (75,717)   (46,640)
Net decrease (increase) in loans   71,032    (74,766)
Proceeds from the sale of portfolio loans       49,891 
Purchase of leasehold improvements and equipment   (281)   (582)
                   Net cash provided by (used in) investing activities   65,350    (26,973)
           
Cash Flows From Financing Activities          
Net increase (decrease) in deposits   149,853    (16,118)
Proceeds from advances from Federal Home Loan Bank   100,000    1,021,000 
Repayments of advances from Federal Home Loan Bank       (981,000)
Net change in line of credit with Federal Home Loan Bank       51 
Repurchase of shares of common stock   (82)   (11,544)
Dividends paid to shareholders   (499)   (526)
                 Net cash provided by financing activities   249,272    11,863 
   Net change in cash and due from banks   312,165    5,504 
  Cash and due from banks at beginning of period   77,819    52,526 
  Cash and due from banks at end of period  $389,984   $58,030 
           
Supplemental cash flows information          
  Cash paid:          
     Interest  $9,993   $12,278 
     Income taxes   102     
  Noncash investing and financing activities:          
    Transfers of residential real estate loans to mortgage loans held for sale       48,260 
    Transfers of residential real estate loans from mortgage loans held for sale       103 
    Right-of-use assets obtained in exchange for new operating lease liabilities   42    513 

 

See accompanying notes to condensed consolidated financial statements.

 

6

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

Note 1—Nature of Operations and Basis of Presentation

 

Nature of Operations

 

Sterling Bancorp, Inc. (the “Company”) is a unitary thrift holding company that was incorporated in 1989 and the parent company of its wholly owned subsidiary, Sterling Bank and Trust, F.S.B. (the “Bank”). The Company’s business is conducted through the Bank, which was formed in 1984. The Bank originates residential and commercial real estate loans, construction loans, commercial lines of credit, and other consumer loans and provides deposit products, consisting primarily of checking, savings and term certificate accounts. The Bank operates through a network of 30 branches of which 26 branches are located in San Francisco and Los Angeles, California with the remaining branches located in New York, New York, Southfield, Michigan and the greater Seattle market.

 

The Company is headquartered in Southfield, Michigan and its operations are in the financial services industry. Management evaluates the performance of its business based on one reportable segment, community banking.

 

The Company is subject to regulation, examination and supervision by the Board of Governors of the Federal Reserve (“Federal Reserve”). The Bank is a federally chartered stock savings bank which is subject to regulation, supervision and examination by the Office of the Comptroller of the Currency (“OCC”) of the U.S. Department of Treasury and the Federal Deposit Insurance Corporation (“FDIC”) and is a member of the Federal Home Loan Bank (“FHLB”) system.

 

Basis of Presentation

 

The condensed consolidated balance sheet as of March 31, 2020, and the condensed consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for the three months ended March 31, 2020 and 2019 are unaudited. The unaudited condensed consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and reflect all adjustments, in the opinion of management, of a normal recurring nature that are necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented. The financial data and other financial information disclosed in these notes to the condensed consolidated financial statements related to these periods are also unaudited. The results of operations for the three months ended March 31, 2020 are not necessarily indicative of the results that may be expected for the year ended December 31, 2020 or for any future annual or interim period. The consolidated balance sheet at December 31, 2019 included herein was derived from the audited financial statements as of that date. The accompanying unaudited consolidated financial statements and notes thereto should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

 

Note 2—New Accounting Standards

 

Recently Issued Accounting Guidance Not Yet Adopted

 

In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which is intended to improve financial reporting by requiring recording of credit losses on loans and other financial instruments on a more timely basis. The guidance will replace the current incurred loss accounting model with an expected loss approach and requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. The guidance requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, which clarifies the scope of the credit losses standard and addresses issues related to accrued interest receivable balances and recoveries, among other things. In May 2019, the FASB issued ASU 2019-05, Financial Instruments—Credit Losses (Topic 326): Targeted Transition Relief. The amendments provide entities with an option to irrevocably elect the fair value option for certain financial assets previously measured at amortized cost basis, upon adoption of Topic 326. In November 2019, the FASB issued ASU 2019-10, Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates. This update deferred the effective dates of Topic 326 to January 1, 2023 for certain entities including smaller reporting companies (as defined by the U.S. Securities and Exchange Commission (the “SEC”)). The Company, as a smaller reporting company as of the relevant measuring period, qualifies for this extension.

 

7

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

At this time, the Company has formed a cross-functional implementation team consisting of individuals from credit, finance and information systems. The implementation team has been working with a software vendor to assist in implementing required changes to credit loss estimation models and processes. The historical data set for model development has been finalized, and the credit loss estimation models are in the process of being developed and tested. The Company expects to recognize a cumulative effect adjustment to the opening balance of retained earnings as of the beginning of the first reporting period in which ASU No. 2016-13 is effective. The Company has not yet determined the magnitude of any such one-time cumulative adjustment or of the overall impact of ASU No. 2016-13 on its consolidated financial statements.

 

Note 3—Summary of Significant Accounting Policies

 

Principles of Consolidation

 

The accompanying condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The condensed consolidated financial statements include the results of the Company and its wholly-owned subsidiary. All significant intercompany accounts and transactions have been eliminated in consolidation.

 

Use of Estimates

 

The preparation of the condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Due to the inherent uncertainty involved in making estimates, actual results reported in the future periods may be based upon amounts that could differ from those estimates.

 

During 2020, economies throughout the world have been severely disrupted because of the outbreak of the novel coronavirus (“COVID-19”). The Company’s primary market areas of California, the greater Seattle market, and New York became part of several epicenters of the COVID-19 pandemic. Banking and financial services have been designated essential businesses and the Bank’s operations are continuing, subject to certain modifications to business practices imposed to safeguard the health and wellness of the Bank’s customers and employees, and to comply with applicable government directives. As of March 31, 2020, the impact of the outbreak of COVID-19 was continuing to unfold. As a result, many of management’s estimates and assumptions required increased judgement and carried a higher degree of variability and volatility. As events continue to evolve and additional information becomes available, management’s estimates may change materially in future periods.

 

Concentration of Credit Risk

 

The loan portfolio consists primarily of residential real estate loans which are collateralized by real estate. At March 31, 2020 and December 31, 2019, residential real estate loans accounted for 83% and 85%, respectively, of the loan portfolio. In addition, most of these residential loans and other commercial loans have been made to individuals and businesses in the state of California which are dependent on the area economy for their livelihoods and servicing of their loan obligation. At March 31, 2020 and December 31, 2019, approximately 88% and 89%, respectively, of the loan portfolio was originated in California.

 

Starting December 9, 2019, the Bank suspended its Advantage Loan Program and announced that it permanently discontinued this program on March 6, 2020. This Program was a material component of the Bank’s total loan originations. Loans under the Advantage Loan Program totaled $1,791,863, or 76% of residential loan portfolio, as of March 31, 2020, and $1,942,657, or 78% of residential loan portfolio, as of December 31, 2019.

 

8

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

Note 4—Investment Securities

 

Debt Securities

 

The following tables summarize the amortized cost and fair value of debt securities available for sale at March 31, 2020 and December 31, 2019 and the corresponding amounts of gross unrealized gains and losses:

 

   March 31, 2020 
   Amortized   Gross   Unrealized   Fair 
   Cost   Gain   Loss   Value 
Available for sale:                    
U.S. Treasury securities  $95,949   $917   $   $96,866 
Mortgage-backed securities   15,157    4        15,161 
Collateralized mortgage obligations   41,458    226    (67)   41,617 
Collateralized debt obligations   215        (26)   189 
Total  $152,779   $1,147   $(93)  $153,833 

 

   December 31, 2019 
   Amortized   Gross Unrealized   Fair 
   Cost   Gain   Loss   Value 
Available for sale:                    
U.S. Treasury securities  $122,634   $170   $(1)  $122,803 
Mortgage-backed securities   23,028    76        23,104 
Collateralized mortgage obligations   1,138    45        1,183 
Collateralized debt obligations   216        (17)   199 
Total  $147,016   $291   $(18)  $147,289 

 

All of the Company’s mortgage-backed securities and the majority of the Company's collateralized mortgage obligations are issued and/or guaranteed by a U.S. government agency (Government National Mortgage Association) or a U.S. government-sponsored enterprise (Federal Home Loan Mortgage Corporation or Federal National Mortgage Association).

 

No securities of any single issuer, other than debt securities issued by the U.S. government, government agency and government-sponsored enterprises, were in excess of 10% of total shareholders’ equity as of March 31, 2020 and December 31, 2019.

 

For the three months ended March 31, 2020, the proceeds from sales of debt securities available for sale were $23,044. The Company recorded gross realized gains of $235 and gross realized losses of $(2).

 

The amortized cost and fair value of debt securities available for sale issued by U.S. Treasury at March 31, 2020 are shown by contractual maturity. Mortgage-backed securities, collateralized mortgage obligations and collateralized debt obligations are disclosed separately in the table below as the expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

 

   Amortized
Cost
   Fair
Value
 
U.S. Treasury securities          
Due less than one year  $76,095   $76,654 
Due after one year through five years   19,854    20,212 
Mortgage-backed securities   15,157    15,161 
Collateralized mortgage obligations   41,458    41,617 
Collateralized debt obligations   215    189 
Total  $152,779   $153,833 

 

9

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

The table summarizes debt securities available for sale, at fair value, with unrealized losses at March 31, 2020 and December 31, 2019 aggregated by major security type and length of time the individual securities have been in a continuous unrealized loss position, as follows:

 

   March 31, 2020 
   Less than 12 Months   12 Months or More   Total 
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
 
Collateralized mortgage obligations  $1,016   $(67)  $   $   $1,016   $(67)
Collateralized debt obligations           189    (26)   189    (26) 
Total  $1,016   $(67)  $189   $(26)  $1,205   $(93)

 

   December 31, 2019 
   Less than 12 Months   12 Months or More   Total 
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
 
U.S. Treasury securities  $5,011   $(1)  $   $   $5,011   $(1)
Collateralized debt obligations           199    (17)   199    (17)
Total  $5,011   $(1)  $199   $(17)  $5,210   $(18)

 

As of March 31, 2020, the debt securities portfolio consisted of 14 debt securities, with three debt securities in an unrealized loss position. For debt securities in an unrealized loss position, management has both the intent and ability to hold these investments until the recovery of the decline; thus, the impairment was determined to be temporary. Non-agency collateralized mortgage obligations with a carrying value of $1,016 had an unrealized loss of $67 due to a temporary dislocation of the market for non-Agency mortgages and the corresponding effect on non-Agency securitizations as a result of the COVID-19 pandemic. These investments have historically been in a gain position, and is expected to recover within the coming months. All interest and dividends are considered taxable.

 

A collateralized debt obligation with a carrying value of $189 and $199 at March 31, 2020 and December 31, 2019, respectively, was rated high quality at inception, but it was subsequently rated by Moody’s as Ba1, which is defined as “speculative.” The issuers of the underlying investments (the collateral) of the collateralized debt obligation are primarily banks. Management uses in-house and third party other-than-temporary impairment evaluation models to compare the present value of expected cash flows to the previous estimate to ensure there are no adverse changes in cash flows during the period. The other-than-temporary impairment model considers the structure and term of the collateralized debt obligations and the financial condition of the underlying issuers. Assumptions used in the model include expected future default rates and prepayments. The collateralized debt obligation remained classified as available for sale and represented $26 and $17 of the unrealized losses reported at March 31, 2020 and December 31, 2019, respectively.

 

Equity Securities

 

Equity securities consist of an investment in a qualified community reinvestment act investment fund, which is a publicly-traded mutual fund, and an investment in Pacific Coast Banker’s Bank, a thinly traded, restricted stock. At March 31, 2020 and December 31, 2019, equity securities totaled $5,335 and $5,255, respectively. Equity securities with readily determinable fair values are stated at fair value with realized and unrealized gains and losses reported in income.

 

10

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

At March 31, 2020 and December 31, 2019, equity securities with readily determinable fair values were $5,089 and $5,009, respectively. The following is a summary of unrealized and realized gains and losses recognized in the condensed consolidated statements of income during the three months ended March 31, 2020 and 2019:

 

   Three Months Ended
March 31,
 
   2020   2019 
Net gains recorded during the period on equity securities  $80   $49 
Less: net gains (losses) recorded during the period on equity securities sold during the period        
Unrealized gains recorded during the period on equity securities held at the reporting date  $80   $49 

 

The Company has elected to account for its investment in a thinly traded, restricted stock using the measurement alternative for equity securities without readily determinable fair values. The investment was reported at $246 at both March 31, 2020 and December 31, 2019.

 

Note 5—Loans

 

Major categories of loans were as follows:

 

   March 31,   December 31, 
   2020   2019 
Residential real estate  $2,345,328   $2,476,866 
Commercial real estate   279,508    240,081 
Construction   198,115    178,376 
Commercial lines of credit   19,271    17,903 
Other consumer   36    34 
Total loans   2,842,258    2,913,260 
Less: allowance for loan losses   (42,613)   (21,730)
Loans, net  $2,799,645   $2,891,530 

 

Loans with carrying values of $1,157,536 and $933,747 were pledged as collateral on FHLB borrowings at March 31, 2020 and December 31, 2019, respectively.

 

The table presents the activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2020 and 2019:

 

Three Months Ended March 31, 2020  

Residential

Real Estate

  Commercial
Real Estate
  Construction   Commercial
Lines of
Credit
  Other
Consumer
  Unallocated   Total
Allowance for loan losses:                            
Beginning balance   $ 12,336   $ 5,243   $ 3,822   $ 328   $ 1   $   $ 21,730
Provision for loan losses   6,808   5,999   7,616   40     390   20,853
Charge offs              
Recoveries   10   19   1         30
Total ending balance   $ 19,154   $ 11,261   $ 11,439   $ 368   $ 1   $ 390   $ 42,613

 

11

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

Three Months Ended March 31, 2019 

Residential

Real Estate

   Commercial
Real Estate
   Construction   Commercial
Lines of
Credit
   Other
Consumer
   Unallocated   Total 
Allowance for loan losses:                                   
Beginning balance  $13,826   $2,573   $3,273   $1,058   $1   $1,119   $21,850 
Provision (recovery) for loan losses   (343)   (253)   (558)   (58)       198    (1,014)
Charge offs               (176)           (176)
Recoveries   5    31    2                38 
Total ending balance  $13,488   $2,351   $2,717   $824   $1   $1,317   $20,698 

 

 

The following tables present the balance in the allowance for loan losses and the recorded investment by portfolio segment and based on impairment method as of March 31, 2020 and December 31, 2019:

 

March 31, 2020  Residential
Real Estate
   Commercial
Real Estate
   Construction   Commercial
Lines of
Credit
   Other
Consumer
   Unallocated   Total 
Allowance for loan losses:                                   
Ending allowance balance attributable to loans:                                                      
Individually evaluated for impairment  $42   $   $   $5   $   $   $47 
Collectively evaluated for impairment   19,112    11,261    11,439    363    1    390    42,566 
Total ending allowance balance  $19,154   $11,261   $11,439   $368   $1   $390   $42,613 
Loans:                                   
Loans individually evaluated for impairment  $211   $1,079   $26,846   $1,373   $   $   $29,509 
Loans collectively evaluated for impairment   2,345,117    278,429    171,269    17,898    36        2,812,749 
Total ending loans balance  $2,345,328   $279,508   $198,115   $19,271   $36   $   $2,842,258 

 

December 31, 2019  Residential
Real Estate
   Commercial
Real Estate
   Construction   Commercial
Lines yof
Credit
   Other
Consumer
   Unallocated   Total 
Allowance for loan losses:                                   
Ending allowance balance attributable to loans:                                   
Individually evaluated for impairment  $43   $   $   $5   $           —   $      —   $48 
Collectively evaluated for impairment   12,293    5,243    3,822    323    1        21,682 
Total ending allowance balance  $12,336   $5,243   $3,822   $328   $1   $   $21,730 
Loans:                                   
Loans individually evaluated for impairment  $215   $1,100   $17,112   $1,377   $   $   $19,804 
Loans collectively evaluated for impairment   2,476,651    238,981    161,264    16,526    34        2,893,456 
Total ending loans balance  $2,476,866   $240,081   $178,376   $17,903   $34   $   $2,913,260 

  

12

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

The following tables present information related to impaired loans by class of loans as of and for the periods indicated:

 

   At March 31, 2020   At December 31, 2019 
    Unpaid
Principal
Balance
    Recorded
Investment
    Allowance
for Loan
Losses
    Unpaid
Principal
Balance
    Recorded
Investment
    Allowance
for Loan
Losses
 
With no related allowance for loan losses recorded:                              
Residential real estate, first mortgage  $121   $95   $   $125   $98   $ 
Commercial real estate, retail   1,292    1,079        1,308    1,100     
Construction   26,889    26,846        17,156    17,112     
Commercial lines of credit, private banking   1,245    1,242        1,245    1,245     
Subtotal   29,547    29,262        19,834    19,555     
With an allowance for loan losses recorded:                              
Residential real estate, first mortgage   116    116    42    116    117    43 
Commercial lines of credit, private banking   131    131    5    132    132    5 
Subtotal   247    247    47    248    249    48 
Total  $29,794   $29,509   $47   $20,082   $19,804   $48 

  

In the above tables, the unpaid principal balance is not reduced for partial charge offs. Also, the recorded investment excludes accrued interest receivable on loans which was not significant.

 

   Three Months Ended March 31, 
   2020   2019 
   Average
Recorded
Investment
   Interest
Income
Recognized
   Cash Basis
Interest
Recognized
   Average
Recorded
Investment
   Interest
Income
Recognized
   Cash Basis
Interest
Recognized
 
With no related allowance for loan losses recorded:                              
Residential real estate, first mortgage  $96   $      —   $      —   $107   $      —   $      — 
Commercial real estate:                              
Retail   1,089    15    10    1,165    15    10 
Multifamily               1,080    12    8 
Offices               1,516    25    17 
Construction   26,653    466    269    9,325    146    97 
Commercial lines of credit:                              
Private banking   1,243    21    14             
C&I lending               100    2    1 
Subtotal   29,081    502    293    13,293    200    133 
With an allowance for loan losses recorded:                              
Residential real estate, first mortgage   117    1    1    120    1    1 
Commercial lines of credit, private banking   131    2    1    139    2    1 
Subtotal   248    3    2    259    3    2 
Total  $29,329   $505   $295   $13,552   $203   $135 

 

Also presented in the above table is the average recorded investment of the impaired loans and the related amount of interest recognized during the time within the period that the impaired loans were impaired. When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on nonaccrual status, all payments are applied to principal under the cost recovery method. When the ultimate collectability of the total principal of an impaired loan is not in doubt and the loan is on nonaccrual status, contractual interest is credited to interest income when received under the cash basis method. The average balances are calculated based on the month-end balances of the loans for the period reported.

 

13

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of March 31, 2020 and December 31, 2019:

 

   March 31, 2020   December 31, 2019 
   Nonaccrual   Loans Past
Due Over
90 Days Still
Accruing
   Nonaccrual   Loans Past
Due Over
90 Days Still
Accruing
 
Residential real estate:                    
Residential first mortgage  $15,768   $48   $14,482   $50 
Residential second mortgage   505        210     
Commercial real estate:                    
Retail   35        40     
Total  $16,308   $48   $14,732   $50 

 

The following tables present the aging of the recorded investment in past due loans as of March 31, 2020 and December 31, 2019 by class of loans:

 

March 31, 2020  30 - 59
Days
Past Due
   60 - 89
Days
Past Due
   Greater
than
89 Days
Past Due
   Total
Past Due
   Loans Not
Past Due
   Total 
Residential real estate:                        
Residential first mortgage  $29,528   $12,668   $15,816   $58,012   $2,262,732   $2,320,744 
Residential second mortgage   477    127    505    1,109    23,475    24,584 
Commercial real estate:                              
Retail           35    35    17,995    18,030 
Multifamily   979            979    92,293    93,272 
Offices                   27,822    27,822 
Hotels/Single room occupancy hotels   13,538            13,538    59,949    73,487 
Industrial                   14,089    14,089 
Other                   52,808    52,808 
Construction   20,214            20,214    177,901    198,115 
Commercial lines of credit:                              
Private banking                   10,874    10,874 
C&I lending                   8,397    8,397 
Other consumer                   36    36 
Total  $64,736   $12,795   $16,356   $93,887   $2,748,371   $2,842,258 

 

14

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

December 31, 2019  30 - 59
Days
Past Due
   60 - 89
Days
Past Due
   Greater
than
89 Days
Past Due
   Total
Past Due
   Loans Not
Past Due
   Total 
Residential real estate:                              
Residential first mortgage  $36,112   $5,112   $14,532   $55,756   $2,396,800   $2,452,556 
Residential second mortgage   97    295    210    602    23,708    24,310 
Commercial real estate:                              
Retail           40    40    6,089    6,129 
Multifamily                   64,873    64,873 
Offices                   28,048    28,048 
Hotel/ Single room occupancy hotels   5,605            5,605    76,165    81,770 
Industrial                   14,150    14,150 
Other                   45,111    45,111 
Construction   15,008            15,008    163,368    178,376 
Commercial lines of credit:                              
Private banking                   11,914    11,914 
C&I lending   1,249            1,249    4,740    5,989 
Other consumer                   34    34 
Total  $58,071   $5,407   $14,782   $78,260   $2,835,000   $2,913,260 

 

The Company considers the performance of the loan portfolio and its impact on the allowance for loan losses. For residential real estate and other consumer loans, the Company also evaluates credit quality based on the aging status of the loan, which is presented above, and by payment activity. The Company reviews the status of nonperforming loans which include loans 90 days past due and still accruing and nonaccrual loans.

 

As a response to COVID-19, the Company has offered forbearance under the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act to customers facing COVID-19 related financial difficulties. The Company is not adjusting the aging of loans for customers granted a payment deferral in response to COVID-19. These loans remain in the aging category that was applicable at the time of payment deferral. Interest continues to accrue on these loans.

 

Troubled Debt Restructurings

 

At March 31, 2020 and December 31, 2019, the balance of outstanding loans identified as troubled debt restructurings was $24,563 and $13,708, respectively. The allocated portion of the allowance for loan losses with respect to these loans was $47 and $48 at March 31, 2020 and December 31, 2019, respectively. There were no loans identified as troubled debt restructurings that subsequently defaulted.

 

During the three months ended March 31, 2020, the Bank modified the terms of two construction loans and one private banking loan with an extension of the maturity dates at the contract's existing rate of interest, which is lower than the current market rate for new debt with similar risk. The total outstanding recorded investments were $10,863 both before and after modification. During the three months ended March 31, 2019, the Bank modified the terms of a construction loan by providing for an extension of the maturity dates at the contract’s existing rate of interest, which is lower than the current market rate for new debt with similar risk. The outstanding recorded investment was $1,046 both before and after modification. The effect of the modification on the allowance for loan losses was not significant.

 

The terms of certain other loans have been modified during the three months ended March 31, 2020 and 2019 that did not meet the definition of a troubled debt restructuring. These other loans that were modified were not considered significant.

 

Certain provisions of the CARES Act encourage financial institutions to practice prudent efforts to work with borrowers impacted by COVID-19. Under these provisions, a modification deemed to be COVID-19 related would not be considered a troubled debt restructuring if the loan was not more than 30 days past due as of December 31, 2019 and the deferral was executed between March 1, 2020 and the earlier of 60 days after the date of termination of the COVID-19 national emergency or December 31, 2020. The banking regulators issued similar guidance, which also clarified that a COVID-19 related modification should not be considered a troubled debt restructuring if the borrower was current on payments at the time the underlying loan modification program was implemented and if the modification is considered to be short-term. Under these terms, the Company had implemented a COVID-19 forbearance program that generally provides for principal and interest forbearance for 120 days to residential and commercial borrowers and these loans were not considered troubled debt restructurings. As of March 31, 2020, the Company had received approximately 150 forbearance requests under this program with an aggregate loan balance of $70,288, the vast majority of which were in the process of review as of that date. As of September 30, 2020, the Company approved 245 forbearance requests on loans totaling $114,989. Of these, 116 loans, totaling $69,828 have completed the agreed-upon deferment period and have returned to normal debt service. There are 62 loans that remain in payment deferral totaling $75,161.

 

15

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

Foreclosure Proceedings

 

At March 31, 2020 and December 31, 2019, the recorded investment of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process is $8,132 and $1,643, respectively.

 

Credit Quality

 

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes homogeneous loans such as residential real estate and other consumer loans and non-homogeneous loans, such as commercial lines of credit, construction and commercial real estate loans. This analysis is performed at least quarterly. The Company uses the following definitions for risk ratings:

 

Pass: Loans are of satisfactory quality.

 

Special Mention: Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company’s credit position at some future date.

 

Substandard: Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

 

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

 

16

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

At March 31, 2020 and December 31, 2019, the risk rating of loans by class of loans was as follows:

 

March 31, 2020   Pass   Special
Mention
  Substandard   Doubtful   Total  
Residential real estate:                      
Residential first mortgage   $ 2,304,928   $   $ 15,459   $ 357   $ 2,320,744  
Residential second mortgage   24,079     505     24,584  
Commercial real estate:                      
Retail    16,118    833   1,079      18,030  
Multifamily    84,601    7,118    1,553      93,272  
Offices    24,343     3,479      27,822  
Hotels/ Single room occupancy hotels    28,205   15,355   29,927      73,487  
Industrial    5,888     8,201      14,089  
Other    45,468    916    6,424      52,808  
Construction   163,679   14,539   19,897     198,115  
Commercial lines of credit:                      
Private banking   9,632    1,242        10,874  
C&I lending   7,015    1,382        8,397  
Other consumer loans   36         36  
Total   $ 2,713,992   $ 41,385   $ 86,524   $ 357   $ 2,842,258  

 

December 31, 2019   Pass   Special
Mention
  Substandard   Doubtful   Total  
Residential real estate:                      

Residential first mortgage   $ 2,438,024   $   $ 14,077   $ 455   $ 2,452,556  
Residential second mortgage   24,100     210     24,310  
Commercial real estate:                      
Retail   4,195   834    1,100      6,129  
Multifamily   56,164   7,150    1,559     64,873  
Offices   24,484   645    2,919      28,048  
Hotels/ Single room occupancy hotels   60,074   18,189    3,507      81,770  
Industrial   5,894   8,256   —        14,150  
Other   37,693   920    6,498       45,111  
Construction   156,339   7,008   15,029     178,376  
Commercial lines of credit:                      
Private banking   10,669   1,245       11,914  
C&I lending    4,013     1,976     5,989  
Other consumer   34         34  
Total   $ 2,821,683   $ 44,247   $ 46,875   $ 455   $ 2,913,260  

 

During the three months ended March 31, 2019, the Bank sold pools of residential real estate mortgages for $49,891 to third-party investors. The transactions resulted in full de-recognition of the mortgages (i.e. transferred assets) from the condensed consolidated balance sheets and recognition of gain on sale of portfolio loans of $2,442. After the sales, the Bank’s only continuing involvement in the transferred assets is to act as servicer or subservicer of the mortgages. For more information on repurchase exposures, see Note 16Commitments and Contingencies.

 

17

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

Note 6—Mortgage Servicing Rights, net

 

The Bank records servicing assets from the sale of residential real estate mortgage loans to the secondary market for which servicing has been retained. Residential real estate mortgage loans serviced for others are not included in the condensed consolidated balance sheets. The principal balance of these loans at March 31, 2020 and December 31, 2019 are as follows:

 

    March 31,
2020
  December 31,
2019
 
Residential real estate mortgage loan portfolios serviced for:          
FNMA   $ 136,184   $ 130,425  
FHLB   87,753   86,778  
Private investors   610,094   656,035  
Total   $ 834,031   $ 873,238  

 

Custodial escrow balances maintained with these serviced loans were $7,122 and $7,688 at March 31, 2020 and December 31, 2019, respectively.

 

Activity for mortgage servicing rights and the related valuation allowance are as follows:

 

      Three Months Ended
March 31,
 
      2020     2019  
Mortgage servicing rights:              
Beginning of period   $ 10,845   $ 10,733  
Additions   107   843  
Amortization   (650 ) (684 )
End of period   10,302   10,892  
           
Valuation allowance at beginning of period   1,080   100  
Additions (recoveries)   1,246   37  
Valuation allowance at end of period   2,326   137  
           
Mortgage servicing rights, net   $ 7,976   $ 10,755  

 

Servicing fee income, net of amortization of servicing rights and changes in the valuation allowance, was $(911) and $325 for the three months ended March 31, 2020 and 2019, respectively.

 

The fair value of mortgage servicing rights was $8,119 and $10,271 at March 31, 2020 and December 31, 2019, respectively. The fair value of mortgage servicing rights is highly sensitive to changes in underlying assumptions. Changes in prepayment speed assumptions have the most significant impact on the estimate of the fair value of mortgage servicing rights. The fair value at March 31, 2020 was determined using discount rates ranging from 9.5% to 12.0%, prepayment speeds ranging from 7.3% to 47.8%, depending on the stratification of the specific right, and a weighted average default rate of 0.2%. The fair value at December 31, 2019 was determined using discount rates ranging from 9.5% to 12.0%, prepayment speeds ranging from 6.8% to 47.1%, depending on the stratification of the specific right, and a weighted average default rate of 0.2%.

 

At March 31, 2020 and December 31, 2019, the carrying amount of certain individual groupings exceeded their fair values. See Note 13Fair Values of Financial Instruments.

 

Note 7—Deposits

 

Time deposits, included in interest-bearing deposits, were $1,377,610 and $1,154,076 at March 31, 2020 and December 31, 2019, respectively. Time deposits included brokered deposits of $167,751 and $25,000 at March 31, 2020 and December 31, 2019, respectively.

 

18

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

  

Time deposits that meet or exceed the FDIC insurance limit of $250 were $335,218 and $283,457 at March 31, 2020 and December 31, 2019, respectively.

 

Note 8—FHLB Borrowings

 

FHLB borrowings at March 31, 2020 and December 31, 2019 consist of the following:

 

    March 31,
2020
  Interest Rates   December 31,
2019
  Interest Rates  
Long-term fixed rate advances   $ 329,000   0.43%-1.96%   $ 229,000   1.07%-1.96%  

 

FHLB Advances

 

The long-term fixed rate advances have maturity dates ranging from July 2020 to February 2030. Interest on these advances is payable monthly and each advance is payable at its maturity date, and may contain a prepayment penalty if paid before maturity. At March 31, 2020, advances totaling $307,000 were callable by the FHLB as follows: $100,000 in August 2020; $67,000 in September 2021; $90,000 in October 2021; and $50,000 in May 2024. At March 31, 2020, the Bank had additional borrowing capacity of $430,153 from the FHLB.

 

FHLB Overdraft Line of Credit

 

The Bank has established an overdraft line of credit agreement with the FHLB providing maximum borrowings of $50,000. The average amount outstanding during the three months ended March 31, 2020 and 2019 was $5 and $4,133, respectively. Borrowings accrue interest based on a variable rate based on the FHLB’s overnight cost of funds rate, which was 0.53% and 1.99% at March 31, 2020 and December 31, 2019, respectively. The agreement has a one-year term and terminates in October 2020.

 

The FHLB advances and the overdraft line of credit are collateralized by pledged loans totaling $1,157,536 and $933,747 at March 31, 2020 and December 31, 2019, respectively.

 

Other Borrowings

 

The Bank had available unsecured credit lines with other banks totaling $70,000 at both March 31, 2020 and December 31, 2019. There were no borrowings under these credit lines during the three months ended March 31, 2020 or the year ended December 31, 2019.

 

Note 9—Subordinated Notes, net

 

The subordinated notes (the “Notes”) were as follows:

 

    March 31,
2020
  December 31,
2019
 
7.0% fixed to floating rate subordinated notes   $ 65,000   $ 65,000  
Unamortized note premium   458   474  
Unamortized debt issuance costs   (240 ) (295 )
Total   $ 65,218   $ 65,179  

 

The Notes bear interest at 7% per annum, payable semi-annually on April 15 and October 15 in arrears, through April 2021 after which the Notes will have a variable interest rate of the three-month London Interbank Offered Rate (“LIBOR”) rate plus a margin of 5.82%. Premiums and debt issuance costs are amortized over the contractual term of the Notes into interest expense using the effective interest method. Interest expense on these Notes was $1,177 and $1,174 for the three months ended March 31, 2020 and 2019, respectively. The Notes mature in April 2026.

 

On or after April 14, 2021, the Company may redeem the Notes, in whole or in part, at an amount equal to 100% of the outstanding principal amount being redeemed plus accrued interest, in a principal amount with integral multiples of $1. The Notes are not redeemable by the Company prior to April 14, 2021 except in the event that (i) the Notes no longer qualify as Tier 2 Capital, (ii) the interest on the Notes is determined by law to be not deductible for Federal Income Tax reporting or (iii) the Company is considered an investment company pursuant to the Investment Company Act of 1940. The Notes are not subject to redemption by the noteholder.

 

19

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

  

The Notes are unsecured obligations and are subordinated in right of payment to all existing and future indebtedness, deposits and other liabilities of the Company’s current and future subsidiaries, including the Bank’s deposits as well as the Company’s subsidiaries’ liabilities to general creditors and liabilities arising during the ordinary course of business. The Notes may be included in Tier 2 capital for the Company under current regulatory guidelines and interpretations. As long as the Notes are outstanding, the Company is permitted to pay dividends if prior to such dividends, the Bank is considered well capitalized, as defined in Note 14Regulatory Capital Requirements.

 

Note 10—Stock Repurchase Program

 

In late 2018, the board of directors approved the repurchase of up to $50,000 of the Company’s outstanding shares of common stock. The stock repurchase program permits the Company to purchase shares of its common stock from time to time in the open market or in privately negotiated transactions. The program does not have an expiration date. The Company received regulatory approval of its stock repurchase program and publicly announced the program in January 2019. Under this program, the Company is not obligated to repurchase shares of its common stock. The repurchased shares will be canceled and returned to authorized but unissued status.

 

During the three months ended March 31, 2020, the Company repurchased and cancelled 10,912 shares of its common stock for $82, including commissions and fees (average repurchase price of $7.57 per share). Such repurchases of common stock were funded through cash generated from operations. As of March 31, 2020, the Company had $19,568 of common stock purchases remaining that may be made under the program.

 

In March 2020, in connection with the issues giving rise to the internal review of the Advantage Loan Program (the “Internal Review”), the Company suspended the stock repurchase program for at least the near term.

 

Note 11—Stock-based Compensation

 

The board of directors established a 2017 Omnibus Equity Incentive Plan (the “Plan”) which was approved by the shareholders. The Plan provides for the grant of up to 4,237,100 shares of common stock for stock options, stock appreciation rights, restricted stock, restricted stock units and other stock-based awards for issuance to employees, consultants and board of directors of the Company. The stock-based awards are issued at no less than the market price on the date the awards are granted.

 

Stock Options

 

Stock option awards are granted with an exercise price equal to the market price of the Company’s common stock on the date of grant. Stock option awards granted prior to 2020 generally vest in installments of 50% in each of the third and fourth year after the date of grant, while stock options awards granted beginning in 2020 will vest ratably over three years (33% per year) after the date of grant. All stock option awards have a maximum term of ten years.

 

The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option pricing model that uses the assumptions noted below. Estimating the grant date fair values for employee stock options requires management to make assumptions regarding expected volatility of the value of those underlying shares, the risk-free rate over the expected life of the stock options and the date on which share-based payments will be settled. Expected volatilities are based on a weighted average of the Company’s historic volatility and an implied volatility for a group of industry-relevant bank holding companies as of the measurement date. The expected term of options granted is calculated using the simplified method (the midpoint between the end of the vesting period and the end of the maximum term). The risk-free rate for the expected term of the option is based upon U.S. Treasury yield curve in effect at the time of grant. Expected dividend yield represents what the Company anticipates will be declared during the expected term of the options.

 

20

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

On March 2, 2020, the board of directors approved the issuance of options to purchase 67,361 shares of common stock with an exercise price of $7.10 to certain key employees, which are accounted for as equity awards. These options to purchase shares of common stock had a weighted average grant-date fair value of $1.78 per option. The grant-date fair value of each stock option award was estimated using the Black-Scholes option pricing model that uses the assumptions set forth in the following table:

 

Exercise price of options     $7.10  
Risk-free interest rate   0.94 %
Expected term (in years)   6.00  
Expected stock price volatility   26.45 %
Dividend yield   .56 %

 

A summary of the Company’s stock option activity as of and for the three months ended March 31, 2020 is as follows:

 

    Number
of Shares
  Weighted
Average
Exercise
Price
  Weighted
Average
Remaining
Contractual
Term
  Aggregate
Intrinsic
Value
 
            (Years)      
Outstanding at January 1, 2020   142,477   $ 12.29   8.60   $  
Granted   67,361   7.10          
Exercised              
Forfeited/expired   (8,673 ) 11.78          
Outstanding at March 31, 2020   201,165   $ 10.57   8.88   $  

 

The Company recorded stock-based compensation expense associated with stock options of $26 and $32 for the three months ended March 31, 2020 and 2019, respectively. At March 31, 2020, there was $422 of total unrecognized compensation cost related to nonvested stock options granted under the Plan. The cost is expected to be recognized over a weighted-average period of 2.51 years. No options are exercisable at March 31, 2020.

 

Restricted Stock Awards

 

On March 2, 2020, the board of directors approved the issuance of 141,374 restricted stock awards to certain key employees. The restricted stock awards vest ratably over three years (33% per year) after the date of grant. Upon a change in control, as defined in the Plan, the outstanding restricted stock awards will immediately vest. The value of a restricted stock award is based on the market value of the Company’s common stock at the date of grant reduced by the present value of dividends per share expected to be paid during the period the shares are not vested.

 

A summary of the Company’s restricted stock awards activity for the three months ended March 31, 2020 is as follows:

 

    Number
of Shares
  Weighted Average
Grant Date Fair
Value
 
           
Nonvested at January 1, 2020   100,096   $ 11.02  
Granted   141,374   6.98  
Vested      
Forfeited   (7,197 ) 11.35  
Nonvested at March 31, 2020   234,273   $ 8.57  

 

The fair value of the award is recorded as compensation expense on a straight-line basis over the vesting period. The Company recorded stock-based compensation expense associated with restricted stock awards of $83 and $94 for the three months ended March 31, 2020 and 2019, respectively. At March 31, 2020, there was $1,557 of total unrecognized compensation cost related to the nonvested stock granted under the Plan. The cost is expected to be recognized over a weighted-average period of 2.78 years.

 

21

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

Note 12—Income (Loss) Per Share

 

Basic income per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted income per common share further includes any common shares available to be issued upon the exercise of outstanding stock options and restricted stock awards if such inclusions would be dilutive. The Company determines the potentially dilutive common shares using the treasury stock method. The following table presents the computation of income (loss) per share, basic and diluted:

 

 

Three Months Ended

March 31,

  2020   2019
Numerator:      
Net income (loss) $ (4,030)   $ 15,683
           
Denominator:      
Weighted average common shares outstanding, basic 49,837,662   52,554,446
Weighted average effect of potentially dilutive common shares:      
Stock options  
Restricted stock   8,374
Weighted average common shares outstanding, diluted 49,837,662   52,562,820
       
Income (loss) per share:      
Basic $ (0.08)   $ 0.30
Diluted $ (0.08)   $ 0.30

 

For the three months ended March 31, 2020, the effect of 234,273 nonvested restricted shares of common stock and 201,165 options to purchase shares of common stock were excluded in computing diluted income per common share, as the inclusion would be antidilutive. For the three months ended March 31, 2019, the effect of 104,244 nonvested restricted shares of common stock and 177,514 options to purchase shares of common stock were excluded in computing diluted income per common share, as the inclusion would be antidilutive.

 

Note 13—Fair Values of Financial Instruments

 

Financial instruments include assets carried at fair value, as well as certain assets and liabilities carried at cost or amortized cost but disclosed at fair value in these condensed consolidated financial statements. Fair value is defined as the exit price, the price that would be received for an asset or paid to transfer a liability in the most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date under current market conditions. The inputs to valuation techniques used to measure fair value are prioritized into a three-level hierarchy. The hierarchy gives the highest priority to quoted prices in active markets for identical assets and liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

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

 

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

 

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

The following methods and significant assumptions are used to estimate fair value:

 

22

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

Investment Securities

 

The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar investment securities (Level 2). For investment securities where quoted prices or market prices of similar investment securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Discounted cash flows are calculated using spread to LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the analysis. Rating agency and industry research reports as well as defaults and deferrals on individual investment securities are reviewed and incorporated into the calculations.

 

Mortgage Servicing Rights

 

Fair value of mortgage servicing rights is initially determined at the individual grouping level based on an internal valuation model that calculates the present value of estimated future net servicing income. On a quarterly basis, mortgage servicing rights are evaluated for impairment based upon third party valuations obtained. As disclosed in Note 5, the valuation model utilizes interest rate, prepayment speed, and default rate assumptions that market participants would use in estimating future net servicing income (Level 3).

 

Assets Measured at Fair Value on a Recurring Basis

 

The table below presents the assets measured at fair value on a recurring basis categorized by the level of inputs used in the valuation of each asset at March 31, 2020 and December 31, 2019:

 

        Fair Value Measurements at
March 31, 2020
 
    Total   Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
  Significant
Other
Observable
Inputs
(Level 2)
  Significant
Unobservable
Inputs
(Level 3)
 
Financial Assets                  
Available for sale debt securities:                  
U.S. Treasury securities   $ 96,866   $ 96,866   $   $  
Mortgage-backed securities   15,161     15,161    
Collateralized mortgage obligations   41,617     41,617    
Collateralized debt obligations   189       189  
Equity securities   5,089   5,089      

 

        Fair Value Measurements at
December 31, 2019
 
    Total   Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
  Significant
Other
Observable
Inputs
(Level 2)
  Significant
Unobservable
Inputs
(Level 3)
 
Financial Assets                  
Available for sale debt securities:                  
U.S. Treasury securities   $ 122,803   $ 122,803   $   $  
Mortgage-backed securities   23,104     23,104    
Collateralized mortgage obligations   1,183     1,183    
Collateralized debt obligations   199       199  
Equity securities   5,009   5,009      

 

The table below presents a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at March 31, 2020 and 2019:

 

23

 

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

   Fair Value Measurements Using Significant
Unobservable Inputs (Level 3)
 
   Collateralized Debt Obligations 
   March 31, 2020   March 31, 2019 
Balance of recurring Level 3 assets at beginning of period  $199   $297 
Total gains or losses (realized/unrealized):          
Included in income-realized        
Included in other comprehensive income (loss)   (9)   (6)
Principal maturities/settlements   (1)   (1)
Sales        
Transfers in and/or out of Level 3        
Balance of recurring Level 3 assets at end of period  $189   $290 

  

Unrealized losses on Level 3 investments for collateralized debt obligations was $26 and $17 at March 31, 2020 and December 31, 2019, respectively. In addition to the amounts included in income as presented in the table above, interest income recorded on collateralized debt obligations was $2 and $4 for the three months ended March 31, 2020 and 2019, respectively.

 

The fair value of the collateralized debt obligations is obtained from third party pricing information. It is determined by calculating discounted cash flows using LIBOR curves plus spreads that adjust for credit risk and illiquidity. The Company also performs an internal analysis that considers the structure and term of the collateralized debt obligations and the financial condition of the underlying issuers to corroborate the information used from the independent third party.

 

Assets Measured at Fair Value on a Non-Recurring Basis

 

From time to time, the Bank may be required to measure certain other assets at fair value on a nonrecurring basis in accordance with U.S. GAAP. These adjustments to fair value usually result from the application of lower of cost or fair value accounting or write-downs of individual assets. For assets measured at fair value on a nonrecurring basis which were still held in the condensed consolidated balance sheet at March 31, 2020 and December 31, 2019, the following table provides the level of valuation assumptions used to determine each adjustment and the related carrying value:

 

   Fair Value Measurements at March 31, 2020 
   Fair Value   Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
Mortgage servicing rights  $7,466   $   $   $7,466 

 

   Fair Value Measurements at December 31, 2019 
   Fair Value   Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
Mortgage servicing rights  $7,949   $   $   $7,949 

 

 24 

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

The following table presents quantitative information about Level 3 fair value measurements for the financial instruments measured at fair value on a nonrecurring basis at March 31, 2020 and December 31, 2019:

 

   Quantitative Information about Level 3 Fair Value Measurements at March 31, 2020 
   Fair Value   Valuation Technique  Unobservable Inputs  Range
(Weighted Average) (1)
 
Mortgage servicing rights  $7,466   Discounted cash flow  Discount rate   

9.5% - 12.0%

(11.7%)

 
           Prepayment speed   

7.8% - 47.8%

(22.5%)

 
           Default rate   

0.1% - 0.3%

(0.2%)

 

 

 

(1) The range and weighted average for an asset category consisting of a single investment represents the significant unobservable input used in the fair value of the investment.

 

   Quantitative Information about Level 3 Fair Value Measurements at December 31, 2019 
   Fair Value   Valuation Technique  Unobservable Inputs 

Range

(Weighted Average) (1)

 
Mortgage servicing rights  $7,949   Discounted cash flow  Discount rate   

9.5% - 12.0%

(11.9%)

 
           Prepayment speed   

7.2% - 47.1%

(21.3%)

 
           Default rate   

0.1% - 0.3%

(0.2%)

 

 

 

(1) The range and weighted average for an asset category consisting of a single investment represents the significant unobservable input used in the fair value of the investment.

 

Fair Value of Financial Instruments

 

The carrying amounts and estimated fair values of financial instruments not carried at fair value at March 31, 2020 and December 31, 2019, are as follows:

 

   Fair Value Measurements at March 31, 2020 
   Carrying
Amount
   Fair
Value
   Level 1   Level 2   Level 3 
Financial Assets                         
Cash and due from banks  $391,009   $391,009   $391,009   $   $ 
Interest-bearing time deposits with other banks   1,025    1,031        1,031     
Mortgage loans held for sale   3,776    3,890        3,890     
Loans, net   2,799,645    2,840,329            2,840,329 
                          
Financial Liabilities                         
Time deposits   1,377,610    1,383,282        1,383,282     
Federal Home Loan Bank borrowings   329,000    344,961        344,961     
Subordinated notes, net   65,218    59,150        59,150     

 

 25 

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

   Fair Value Measurements at December 31, 2019 
   Carrying
Amount
   Fair
Value
   Level 1   Level 2   Level 3 
Financial Assets                         
Cash and due from banks  $77,819   $77,819   $77,819   $   $ 
Interest-bearing time deposits with other banks   1,025    1,025    1,025         
Mortgage loans held for sale   1,337    1,368        1,368     
Loans, net   2,891,530    2,978,846            2,978,846 
                          
Financial Liabilities                         
Time deposits   1,154,076    1,161,490        1,161,490     
Federal Home Loan Bank borrowings   229,000    227,333        227,333     
Subordinated notes, net   65,179    65,650        65,650     

 

Note 14—Regulatory Capital Requirements

 

The Bank is subject to the capital adequacy requirements of the OCC. The Company, as a thrift holding company, is subject to the capital adequacy requirements of the Federal Reserve. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Prompt corrective action provisions are not applicable to thrift holding companies. Failure to meet minimum capital requirements can initiate regulatory action that could have a direct material effect on the condensed consolidated financial statements.

 

Prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition.

 

Under the Basel III rules, the Company must hold a capital conservation buffer over the adequately capitalized risk-based capital ratios. At present, in order to avoid the imposition of restrictions on capital distributions and discretionary bonus payments, the Company in required to maintain a capital conservation buffer of at least 2.50%. The net unrealized gain or loss on investment securities is not included in regulatory capital. Banking organizations are required to maintain a minimum total capital ratio of 10.5%, a minimum Tier 1 capital ratio of 8.5% and a minimum common equity Tier 1 capital ratio of 7.0%, respectively (in each case accounting for the required capital conservation buffer). Management believes that at March 31, 2020, the Company and the Bank meet all regulatory capital requirements to which they are subject.

 

The holding company contributed $50,000 of capital into the Bank during the three months ended March 31, 2020. At March 31, 2020 and December 31, 2019, the Bank exceeded all capital requirements to be categorized as well-capitalized and the Company exceeded the applicable capital adequacy requirements as presented below. The Company and the Bank’s actual and minimum required capital amounts and ratios, with such regulatory minimums not including the capital conservation buffer, at March 31, 2020 and December 31, 2019 are as follows:

 

   Actual   For Capital
Adequacy Purposes
   To be Well
Capitalized
 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
March 31, 2020                              
Total adjusted capital to risk-weighted assets                              
Consolidated  $413,905    21.15%  $156,553    8.00%   N/A    N/A 
Bank   396,945    20.37    155,911    8.00   $194,889    10.00%
Tier 1 (core) capital to risk-weighted assets                              
Consolidated   327,917    16.76    117,415    6.00    N/A    N/A 
Bank   372,307    19.10    116,933    6.00    155,809    8.00 
Common Equity Tier 1 (CET1)                              
Consolidated   327,917    16.76    88,061    4.50    N/A    N/A 
Bank   372,307    19.10    87,700    4.50    126,595    6.50 
Tier 1 (core) capital to adjusted tangible assets                              
Consolidated   327,917    9.95    131,795    4.00    N/A    N/A 
Bank   372,307    11.31    131,681    4.00    164,337    5.00 

 

 26 

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

   Actual   For Capital
Adequacy Purposes
   To be Well
Capitalized
 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
December 31, 2019                              
Total adjusted capital to risk-weighted assets                              
Consolidated  $419,327    21.49%  $156,081    8.00%   N/A      N/A   
Bank   346,985    17.82    155,809    8.00   $194,761    10.00%
Tier 1 (core) capital to risk-weighted assets                              
Consolidated   332,418    17.04    117,061    6.00    N/A      N/A   
Bank   325,255    16.70    116,857    6.00    155,809    8.00 
Common Equity Tier 1 (CET1)                              
Consolidated   332,418    17.04    87,796    4.50    N/A      N/A   
Bank   325,255    16.70    87,643    4.50    126,595    6.50 
Tier 1 (core) capital to adjusted tangible assets                              
Consolidated   332,418    10.11    131,471    4.00    N/A    N/A 
Bank   325,255    9.90    131,469    4.00    164,337    5.00 

 

Dividend Restrictions

 

As noted above, banking regulations require the Bank to maintain certain capital levels and may limit the dividends paid by the bank to the holding company or by the holding company to its shareholders. The Company’s principal source of funds for dividend payments is dividends received from the Bank and banking regulations limit the dividends that may be paid. Approval by regulatory authorities is required if the total capital distributions for the applicable calendar year exceed the sum of the Bank’s net income for that year to date plus the Bank’s retained net income for the preceding two years, or the Bank would not be at least adequately capitalized following the distribution.

 

The Qualified Thrift Lender (“QTL”) test requires that a minimum of 65% of assets be maintained in “qualified thrift investments”, including mortgage loans, housing- and real estate-related finance and other specified areas. If the QTL test is not met, limits are placed on growth, branching, new investments, FHLB Advances and dividends, or the Bank must convert to a commercial bank charter. Management believes that the QTL test has been met. Also, pursuant to the terms of the subordinated note agreements, the Company may pay dividends if it is “well capitalized” as defined by regulatory guidelines.

 

At March 31, 2020, the Bank has the ability to pay aggregate dividends of approximately $79,036 to the Company without prior regulatory approval.

 

Note 15—Related Party Transactions

 

From time to time, the Company makes charitable contributions to a foundation for which certain members of the boards of directors of the Company and Bank, and who are also related to the Company’s controlling shareholders, serve as trustees. The Company paid $225 to the foundation during both the three months ended March 31, 2020 and 2019.

 

 27 

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

The Bank provides monthly data processing and programming services to entities controlled by the Company’s controlling shareholders. Aggregate fees received for such services amounted to $27 during both the three months ended March 31, 2020 and 2019.

 

The Company leases certain storage and office space from entities owned by the Company’s controlling shareholders. Amounts paid under such leases totaled $60 and $59 during the three months ended March 31, 2020 and 2019, respectively. The Company also subleases certain office space to entities owned by the Company’s controlling shareholders. Amounts received under such subleases totaled $69 and $68 during the three months ended March 31, 2020 and 2019, respectively.

 

Note 16—Commitments and Contingencies

 

Financial Instruments with Off-Balance Sheet Risk

 

The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit which are not reflected in the condensed consolidated financial statements.

 

Unfunded Commitments to Extend Credit

 

A commitment to extend credit, such as a loan commitment, credit line and overdraft protection, is a legally binding agreement to lend funds to a customer, usually at a stated interest rate and for a specific purpose. Such commitments have fixed expiration dates and generally require a fee. The extension of a commitment gives rise to credit risk. The actual liquidity requirements or credit risk that the Bank will experience is expected to be lower than the contractual amount of commitments to extend credit because a significant portion of those commitments are expected to expire without being drawn upon. Certain commitments are subject to loan agreements containing covenants regarding the financial performance of the customer that must be met before the Bank is required to fund the commitment. The Bank uses the same credit policies in making commitments to extend credit as it does in making loans.

 

The commitments outstanding to make loans include primarily residential real estate loans that are made for a period of 90 days or less. At March 31, 2020, outstanding commitments to make loans consisted of fixed rate loans of $49,123 with interest rates ranging from 2.375% to 4.50% and maturities ranging from 15 years to 30 years and variable rate loans of $38,640 with varying interest rates (ranging from 3.375% to 6.75% at March 31, 2020) and maturities ranging from 15 to 30 years.

 

Unused Lines of Credit

 

The Bank also issues unused lines of credit to meet customer financing needs. At March 31, 2020, the unused lines of credit include residential second mortgages of $20,283, construction loans of $212,448, commercial lines of credit of $11,716 and consumer loans of $401. These unused lines of credit consisted of fixed rate loans of $438 with interest rates ranging from 5.25% to 18.0% and maturities ranging from three months to 7 years and variable rate loans of $244,410 with varying interest rates (ranging from 3.25% to 8.5%) and maturities ranging from one month to 15 years.

 

Standby Letters of Credit

 

Standby letters of credit are issued on behalf of customers in connection with construction contracts between the customers and third parties. Under standby letters of credit, the Bank assures that the third parties will receive specified funds if customers fail to meet their contractual obligations. The credit risk to the Bank arises from its obligation to make payment in the event of a customer’s contractual default. The maximum amount of potential future payments guaranteed by the Bank is limited to the contractual amount of these letters. Collateral may be obtained at exercise of the commitment. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.

 

 28 

 

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

The following is a summary of the total amount of unfunded commitments to extend credit and standby letters of credit outstanding at March 31, 2020 and December 31, 2019:

 

  

March 31,

2020

   December 31, 2019 
Commitments to make loans  $87,762   $76,927 
Unused lines of credit   244,848    220,553 
Standby letters of credit   24    24 

 

Legal Proceedings

 

The Bank is currently under formal investigation by the OCC and continues to be subject to a publicly available formal agreement with the OCC, dated June 18, 2019 (the “OCC Agreement”), relating primarily to certain aspects of its Bank Secrecy Act/Anti-Money Laundering compliance program as well as the Bank’s credit administration. The OCC Agreement generally requires that the Bank enhance its policies and procedures to ensure compliance with BSA/AML laws and regulations and ensure effective controls over residential loan underwriting. Specifically, the OCC Agreement requires the Bank to: (i) establish a compliance committee to monitor and oversee the Bank’s compliance with the provisions of OCC Agreement; (ii) develop a revised customer due diligence and enhanced due diligence program; (iii) develop a revised suspicious activity monitoring program; (iv) engage an independent, third-party consultant to review and provide a written report on the Bank’s suspicious activity monitoring; (v) develop revised policies and procedures to ensure effective BSA/AML model risk management for the Bank’s automated suspicious activity monitoring system, which must be validated by a qualified, independent third party; (vi) ensure that the Bank’s BSA Department maintains sufficient personnel; and (vii) develop revised policies and procedures to ensure effective controls over loan underwriting. In addition to these requirements, while the OCC Agreement remains in effect, the Bank is subject to certain restrictions on expansion activities, such as growth through acquisition or branching to supplement organic growth of the Bank. Further, any failure to comply with the requirements of the OCC Agreement could result in further enforcement actions, the imposition of material restrictions on the activities of the Bank, or the assessment of fines or penalties. The Bank established a Compliance Committee to monitor and assure compliance with the OCC Agreement, oversee the completion of an independent review of account and transaction activity to be conducted by a third party vendor, and engage a third party to conduct a model validation for its BSA/AML monitoring software.

 

The Bank is fully cooperating with the OCC investigation and implementing the items necessary to achieve compliance with the obligations in the OCC Agreement. A finding by the OCC that the Bank failed to comply with the OCC Agreement or adverse findings in the OCC investigation could result in additional regulatory scrutiny, constraints on the Bank’s business, or other formal enforcement action. Any of those events could have a material adverse effect on our future operations, financial condition, growth, or other aspects of our business. The Bank has incurred significant costs in its efforts to comply with the OCC Agreement and respond to the OCC investigation, which are reflected in the Company’s results of operations for the first quarter of 2020.

 

 29 

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

The Bank also has received grand jury subpoenas from the United States Department of Justice (the “DOJ”) beginning in 2020 requesting the production of documents and information in connection with an investigation that appears to be focused on the Bank’s residential lending practices and related issues. The Bank is fully cooperating with this ongoing investigation. Adverse findings in the DOJ investigation could result in material losses due to damages, penalties, costs, and/or expenses imposed on the Company, which could have a material adverse effect on our future operations, financial condition, growth, or other aspects of our business. The Bank expects to incur significant costs in its efforts to comply with the DOJ investigation in 2020.

 

In addition, the Company, certain of its current and former officers and directors, and other parties have been named as defendants in a shareholder class action captioned Oklahoma Police Pension and Retirement System v. Sterling Bancorp, Inc., et al., Case No. 5:20-cv-10490-JEL-EAS, filed on February 26, 2020 in the United States District Court for the Eastern District of Michigan. The plaintiffs filed an amended complaint on July 2, 2020. This action alleges violations of the federal securities laws, primarily with respect to disclosures concerning the Banks residential lending practices that were made in the Companys registration statement and prospectus for its initial public offering, in subsequent press releases, in periodic and other filings with the SEC, and during earnings calls. The Company filed a motion to dismiss the amended complaint with the court on September 22, 2020. The Company intends to vigorously defend this and any related actions.

 

On December 9, 2019, the Company announced it had voluntarily suspended its Advantage Loan Program in connection with an internal review of the program (the “Internal Review”). The primary focus of the Internal Review, which has been led by outside legal counsel under the direction of a special committee of independent directors (the “Special Committee”), has involved the origination of residential mortgage loans under the Advantage Loan Program and related matters. Results from the Special Committee’s Internal Review have indicated that certain employees engaged in misconduct in connection with the origination of a significant number of such loans, including with respect to verification of income, the amount of income reported for borrowers, reliance on third parties, and related documentation. As a result, the Company has permanently discontinued the Advantage Loan Program. While the Internal Review is substantially complete, the Company expects it to remain open during the pendency of the government investigations discussed herein, and it is possible additional work will be required in connection with the Internal Review.

 

As of December 31, 2019, the Company established a liability of $25,000 for contingent losses based on additional information obtained during the course of the Internal Review and significant judgments by management. The Company has maintained the same level of liability for contingent losses at March 31, 2020. The outcome of the pending investigations and litigation is uncertain. There can be no assurance (i) that the Company will not incur material losses due to damages, penalties, costs and/or expenses as a result of such investigations and litigation, (ii) that the accrual for contingent losses will be sufficient to cover such losses, or (iii) that such losses will not materially exceed such accrual and have a material impact on the Company’s financial condition or results of operations.

 

In addition, on July 28, 2020, the Company received a demand letter from two law firms representing a purported stockholder of the Company alleging facts and claims substantially the same as many of the alleged facts and claims in the class action lawsuit. The demand letter requests that the board of directors take action to (1) recover damages the Company has purportedly sustained as a result of alleged breaches of fiduciary duties by certain of its officers and directors; (2) recover for the benefit of the Company the amounts by which certain of its officers and directors purportedly were unjustly enriched; and (3) correct alleged deficiencies in the Company's internal controls. The demand letter states that, if the board of directors has not taken the actions demanded within 90 days after the receipt of the letter, or in the event the board of directors refuses to take the actions demanded, the purported stockholder will commence a stockholder derivative action on behalf of the Company seeking appropriate relief. The board of directors has recently established a demand review committee to evaluate the matters raised in the demand letter and to determine the actions, if any, that should be taken by the Company with respect to those matters. The Company has responded to the demand letter advising the purported shareholder of the appointment of the demand review committee. There can be no assurance as to whether any litigation will be commenced by or against the Company with respect to the claims set forth in the demand letter or that, if any such litigation is commenced, it will not have a material impact on our financial condition or results of operations.

 

Mortgage Loan Repurchase Liability

 

During the period 2015 through 2019, the Company sold portfolio loans originated under the Advantage Loan Program to private investors in the secondary market. The Company also sells conventional residential mortgage loans (which excludes Advantage Loan Program loans) in the secondary market primarily to Federal National Mortgage Association (“Fannie Mae”) on an ongoing basis. In connection with these loans sold, the Company makes customary representations and warranties about various characteristics of each loan. The Company may be required pursuant to the terms of the applicable mortgage loan purchase and sale agreements to repurchase any previously sold loan or indemnify (make whole) the investor for which the representation or warranty of the Company proves to be inaccurate, incomplete or misleading. In the event of a repurchase, the Company is typically required to pay the unpaid principal balance, the proportionate premium received when selling the loans and certain expenses. Historically, any repurchases due to a breach of any such representations and warranties have been de minimis.

 

 30 

 

 

STERLING BANCORP, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited) - Continued

(dollars in thousands, except per share amounts)

 

The Bank recorded a total mortgage repurchase liability of $7,823 at December 31, 2019 primarily related to probable losses on the sold Advantage Loan Program loan portfolio taking into account the results of the Internal Review. The Bank has maintained the same level of mortgage repurchase liability at March 31, 2020. The repurchase liability is included in accrued expenses and other liabilities in the condensed consolidated balance sheets. The unpaid principal balance of residential mortgage loans sold that were subject to potential repurchase obligations for breach of representations and warranties totaled $713,427 and $759,568 at March 31, 2020 and December 31, 2019, respectively.

 

The repurchase liability reflects management’s estimate of losses based on a combination of factors. The Company’s estimation process requires management to make subjective and complex judgements about matters that are inherently uncertain, such as future repurchase demand expectations, economic factors, and findings from the Internal Review. The actual repurchase losses could vary significantly from the recorded repurchase liability, depending on the outcome of various factors, including those previously discussed.

 

Note 17—Subsequent Events

 

Repurchases of Mortgage Loans

 

In May 2020, the Company negotiated the repurchases of two pools of Advantage Loan Program loans sold to the secondary market with a total outstanding unpaid principal balance of $38,704. The Company recognized a loss of $136 in other non-interest expense in connection with this repurchase. These loans were previously sold to such third-party investors with servicing retained and were considered to be performing at the acquisition date.

 

In addition, to avoid the uncertainty of audits and inquiries by third-party investors in Advantage Loan Program loans sold to the secondary market, beginning at the end of the second quarter of 2020, the Company commenced making offers to each of those investors to repurchase 100% of our sold Advantage Loan Program loan portfolio.

 

In July 2020, three third-party investors accepted the above mentioned offer, from which the Company repurchased three pools of Advantage Loan Program loans sold with a total outstanding unpaid principal balance of $19,251. The Company recognized a loss of $135 in other non-interest expense and charged a loss of $433 against mortgage repurchase liability in connection with this repurchase. These loans were previously sold to such third-party investors with servicing retained and were considered to be performing at the acquisition date.

 

Executive Transition

 

The Company experienced significant executive transitions in late 2019 continuing through the first half of 2020. On May 7, 2020, Thomas Lopp resigned from each of his positions with the Company, including Chairman, President and Chief Executive Officer, and the board of directors appointed Stephen Huber as interim Chief Executive Officer in addition to his existing role as Chief Financial Officer. On May 29, 2020, Michael Montemayor was terminated from his positions as President of Commercial and Retail Banking and Chief Lending Officer. Effective June 3, 2020, the Company and the Bank appointed Thomas M. O’Brien as Chairman, President and Chief Executive Officer of the Company and the Bank, respectively. Mr. Huber continued in his role as Chief Financial Officer following the appointment of Mr. O’Brien.

 

Stock-based Compensation

 

Effective June 3, 2020, the Company and the Bank appointed Thomas M. O’Brien as Chairman, President and Chief Executive Officer of the Company and the Bank, respectively. In connection with Mr. O’Brien entering into an Employment Agreement with the Company on May 31, 2020, on June 5, 2020 the Company granted Mr. O’Brien options to purchase 300,000 shares of common stock with an exercise price of $4.00 per share. The options vest 1/3 on January 1, 2021, 1/3 on the first anniversary of the date of grant, and 1/3 on January 1, 2022 subject to his remaining employed on the vesting date; provided that the unvested portion of the Option would vest immediately in full upon Mr. O’Brien’s termination of employment due to “death” or “disability” and would vest immediately in full upon a “change of control” (each, as defined in Mr. O’Brien’s Employment Agreement). In the event of termination of employment other than termination for “cause” (as defined in Mr. O’Brien’s Employment Agreement), if the Option is exercisable at the time of such termination of employment, it will remain exercisable for three years following termination, provided that Mr. O’Brien remains in compliance with certain terms contained in his Employment Agreement. The Company is required to cause such equity awards to be registered with the SEC as soon as practicable following the Company’s eligibility to do so. The options have a maximum term of ten years. The unrecognized compensation cost associated with Mr. O'Brien's stock options was $354 at the time of grant. The cost is expected to be recognized over a weighted-average period of 1.05 years.

 

Subsequent to March 31, 2020, a total of 93,029 nonvested restricted stock awards and 123,238 options to purchase shares of common stock have been forfeited due to the termination or resignation of employees and loan officers, whether in connection with the Internal Review or otherwise. 

 

 31 

 

 

  

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following management’s discussion and analysis of financial condition and results of operations (“MD&A”) should be read in conjunction with the unaudited condensed consolidated financial statements, related notes, and other financial information appearing elsewhere in this Quarterly Report on Form 10-Q and the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2019, which was filed with the SEC on October 6, 2020.

 

Unless we state otherwise or the context otherwise requires, references in this Quarterly Report on Form 10-Q to “Sterling,” “we,” “our,” “us” or “the Company” refer to Sterling Bancorp, Inc., a Michigan corporation, and its subsidiaries, including Sterling Bank & Trust, F.S.B., which we sometimes refer to as “Sterling Bank,” “the Bank” or “our Bank.”

 

Forward-Looking Statements

 

This Quarterly Report on Form 10-Q contains certain statements that are, or may be deemed to be, “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, regarding the Company’s plans, expectations, thoughts, beliefs, estimates, goals, and outlook for the future that are intended to be covered by the protections provided under the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect our current views with respect to, among other things, future events and our financial performance. These statements are often, but not always, made through the use of words or phrases such as “may,” “might,” “should,” “could,” “predict,” “potential,” “believe,” “expect,” “attribute,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “goal,” “target,” “outlook,” “aim,” “would,” “annualized” and “outlook,” or the negative version of those words or other comparable words or phrases of a future or forward-looking nature. These forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. Accordingly, we caution you that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions, estimates and uncertainties that are difficult to predict. Although we believe that the expectations reflected in these forward-looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements.

 

The following factors, among others, could cause actual future results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

 

The result of the internal review in connection with our Advantage Loan Program and related matters;

 

The impact of the permanent discontinuation of our Advantage Loan Program;

 

Terminations, resignations and departures of top loan producers and other key employees;

 

The results of investigations of us by the OCC, the DOJ, or other governmental agency;

 

The costs of litigation, including settlements and judgments;

 

Compliance with the OCC Agreement;

 

New legislation, regulation, or governmental policy affecting the financial services industry;

 

Adverse effects which may arise in connection with the material weaknesses in our internal control over financial reporting or our failure to promptly remediate them;

 

The outbreak of the COVID-19 pandemic, or an outbreak of other highly infectious or contagious diseases;

 

Market volatility;

 

32

 

 

Potential future losses in connection with certain representations and warranties we have made with respect to mortgages that we have sold into the secondary market;

 

Our ability to comply with The Nasdaq Stock Market LLC (“Nasdaq”) listing requirements, including our ability to timely file our future periodic reports with the SEC;

 

Our concentration in residential mortgage loans;

 

Our geographic concentration of loans and operations in California;

 

Strong competition within our market areas with respect to our products and pricing;

 

Our ability to attract deposits and other sources of liquidity;

 

The value of our mortgage servicing rights;

 

Operational risks resulting from a high volume of financial transactions and increased reliance on technology;

 

Failure to obtain external financing on favorable terms, or at all, in the future;

 

Changes in the state of the general economy and the financial markets;

 

The credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs;

 

The overall quality of the composition of our loan and securities portfolios;

 

Legislative and regulatory changes, including the implementation of the Dodd–Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), changes in banking, securities and tax laws and regulations and their application by our regulators and changes in the scope and cost of FDIC insurance and other coverages;

 

Inflation, interest rate, market and monetary shifts, including uncertainty relating to the calculation and transition from LIBOR;

 

Changes in the financial performance and/or condition of our borrowers;

 

Adverse changes in securities markets, including such changes to the valuation of our securities portfolio;

 

Changes in accounting policies and practices, as may be adopted by the FASB;

 

Changes in estimates of future loan loss reserves based upon the periodic review thereof under relevant regulatory and accounting requirements;

 

The effects of, and changes in, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System (“FRB” or "Federal Reserve");

 

Tax matters, including changes in corporate tax rates and any disagreements with taxing authorities;

 

Changes in consumer and business spending, borrowing and saving habits and demand for financial services in our market area;

 

Fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas;

 

The effect of gentrification or adverse political developments on minority and immigrant individuals, which is one of our historical markets;

 

The inability of key third-party providers, customers, and counterparties to provide accurate and complete information and perform their obligations to us;

 

33

 

 

Our operational, technological, and organizational infrastructure, including whether our enterprise risk management framework effectively mitigates risk and loss and whether we can keep pace with technological change;

 

Our employees’ adherence to our internal policies and procedures;

 

Adverse international conditions and their effect on our customers;

 

Other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services and the other risks described elsewhere herein or in the documents incorporated by reference herein and our other filings with the SEC;

 

The Seligman family’s ability to influence our operations and control the outcome of matters submitted for shareholder approval;

 

Our ability to continue to pay dividends; and

 

Our success at managing the risks involved in the foregoing.

 

The foregoing factors should not be construed as an exhaustive list and should be read in conjunction with other cautionary statements that are included in the items set forth under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2019. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. Accordingly, you should not place undue reliance on any such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise except as required by law. New risks and uncertainties arise from time to time, and it is not possible for us to predict those events or how they may affect us. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

 

34

 

 

Executive Summary

 

The following overview should be read in conjunction with our MD&A in its entirety.

 

Company Overview

 

We are a unitary thrift holding company headquartered in Southfield, Michigan and our primary business is the operation of our wholly owned subsidiary, Sterling Bank. Through Sterling Bank, we offer a range of loan products to the residential and commercial markets, as well as retail banking services.

 

Historical Business Strategy

 

During the quarter ended March 31, 2020, we continued to pursue our historical strategy of originating residential mortgage loans both for retention in our portfolio and sale to the secondary market, as well as growing our commercial real estate and construction lending portfolios. During the year ended December 31, 2019, our Advantage Loan Program generated approximately 77% of our residential mortgage loan production. However, as discussed further below, in the fourth quarter of 2019, our board of directors became aware of significant compliance issues in connection with the origination of residential mortgage loans under the Advantage Loan Program, which ultimately led to the voluntary suspension, and then permanent discontinuation, of the Advantage Loan Program.

 

Formal Agreement, Internal Review and Permanent Discontinuation of Advantage Loan Program

 

On December 9, 2019, the Company announced it had voluntarily suspended its Advantage Loan Program in connection with an internal review of the program (the “Internal Review”). The primary focus of the Internal Review, which has been led by outside legal counsel under the direction of a special committee of independent directors (the “Special Committee”), has involved the origination of residential mortgage loans under the Advantage Loan Program and related matters. Results from the Special Committee’s Internal Review have indicated that certain employees engaged in misconduct in connection with the origination of a significant number of such loans, including with respect to verification of income, the amount of income reported for borrowers, reliance on third parties, and related documentation. As a result, the Company has permanently discontinued the Advantage Loan Program.

 

In connection with the Internal Review, a significant number of officers and employees have been terminated or resigned, including the top loan producers within the Advantage Loan Program. In addition, to avoid the uncertainty of audits and inquiries by third party investors in Advantage Loan Program loans sold to the secondary market, beginning at the end of the second quarter of 2020, we commenced making offers to each of those investors to repurchase 100% of our sold Advantage Loan Program loans. While the Internal Review is substantially complete, the Company expects it to remain open during the pendency of the government investigations discussed below, and it is possible additional work will be required in connection with the Internal Review.

 

The Company experienced significant executive transitions in late 2019 continuing through the first half of 2020. On October 17, 2019, the Company announced the retirement of its then-Chairman and Chief Executive Officer, Gary Judd, with such retirement to be effective November 30, 2019. On October 15, 2019, the board of directors appointed Thomas Lopp, the Company’s then-President, Chief Financial Officer and Chief Operating Officer, to assume the role of Chief Executive Officer and Chairman effective upon Mr. Judd’s retirement. The board of directors also appointed Stephen Huber as Chief Financial Officer, also effective November 30, 2019. On May 7, 2020, Mr. Lopp resigned from each of his positions with the Company and the board of directors appointed Mr. Huber as interim Chief Executive Officer. On May 29, 2020, Michael Montemayor was terminated from his positions as President of Commercial and Retail Banking and Chief Lending Officer. Christine Meredith was hired by the Bank in the role of Senior Vice President and Chief Risk Office with a starting date of February 3, 2020. Since October 1, 2019, more than 100 officers and employees have been terminated or have resigned, including more than 35 loan officers, whether in connection with the Internal Review or otherwise.

 

The Bank is currently under formal investigation by the OCC, is responding to grand jury subpoenas from the DOJ and continues to be subject to a publicly available formal agreement with the OCC, dated June 18, 2019 (the “OCC Agreement”), relating primarily to certain aspects of its BSA/AML compliance program as well as the Bank’s credit administration. The OCC Agreement generally requires that the Bank enhance its policies and procedures to ensure compliance with BSA/AML laws and regulations and ensure effective controls over residential loan underwriting. The Bank established a Compliance Committee to monitor and assure compliance with the OCC Agreement, oversee the completion of  an independent review of account and transaction activity to be conducted by a third party vendor, and engage a third party to conduct a model validation for its BSA/AML monitoring software.

 

35

 

 

The Bank is fully cooperating with the OCC investigation and implementing the items necessary to achieve compliance with the obligations in the OCC Agreement. A finding by the OCC that the Bank failed to comply with the OCC Agreement or adverse findings in the OCC investigation could result in additional regulatory scrutiny, constraints on the Bank’s business, or other formal enforcement action. Any of those events could have a material adverse effect on our future operations, financial condition, growth, or other aspects of our business. The Bank has incurred significant costs in its efforts to comply with the OCC Agreement and respond to the OCC investigation, which are reflected in our results of operations for the quarter ended March 31, 2020.

 

The Bank also has received grand jury subpoenas from the DOJ requesting the production of documents and information in connection with an investigation that appears to be focused on the Bank’s residential lending practices and related issues. The Bank is fully cooperating with this ongoing investigation.

 

In addition, the Company, certain of its current and former officers and directors, and other parties have been named as defendants in a shareholder class action captioned Oklahoma Police Pension and Retirement System v. Sterling Bancorp, Inc., et al., Case No. 5:20-cv-10490-JEL-EAS, filed on February 26, 2020 in the United States District Court for the Eastern District of Michigan. The plaintiffs filed an amended complaint on July 2, 2020. This action alleges violations of the federal securities laws, primarily with respect to disclosures concerning the Bank’s residential lending practices that were made in the Company’s registration statement and prospectus for its initial public offering, in subsequent press releases, in periodic and other filings with the SEC, and during earnings calls. The Company filed a motion to dismiss the amended complaint with the court on September 22, 2020. The Company intends to vigorously defend this and any related actions.

 

The Company has incurred significant legal expenses in 2020 in connection with the government investigations and in defending the litigation. For further information regarding these matters, see “Part II, Item 1. Legal Proceedings.”

 

The Strategy for 2020 and Beyond

 

Effective June 3, 2020, the Company and the Bank hired Thomas M. O’Brien as Chairman, President and Chief Executive Officer of the Company and the Bank, respectively. Prior to being hired, Mr. O’Brien provided consulting services to the board of directors of the Bank under a consulting agreement since March 2020. An accomplished leader in the financial services industry with over 44 years of industry experience, Mr. O'Brien will report to the boards of directors of the Company and the Bank. Mr. Huber continued in his role as Chief Financial Officer following the appointment of Mr. O'Brien.

 

The current focus of the Company is to work hard to resolve its outstanding compliance and regulatory issues, government investigations and third party litigation, develop a strong culture of compliance, re-establish strong credit metrics for new lending initiatives, hire new key business development and operations personnel, and establish a new path forward to service our customers’ needs and build investor confidence. This renewal effort will be complicated by the impact of COVID-19 and its impact on the national economy and the markets in which we focus our products and services. While the Company will continue to work on initiatives to diversify its overall loan production and to review new residential loan products, the implementation of any new loan products takes time and may be subject to the prior review and approval of applicable bank regulatory authorities. Accordingly, the permanent discontinuation of the Advantage Loan Program will likely have an adverse impact on our results of operations as repayments from our residential loan portfolio will need to be invested in lower yielding assets until new loan programs can commence.

 

Impact of COVID-19

 

The COVID-19 pandemic, which was declared a national emergency in the United States in March 2020, continues to create extensive disruptions to the global economy and financial markets and to businesses and the lives of individuals throughout the world. Federal and state governments are taking unprecedented actions to contain the spread of the disease, including quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal stimulus, and legislation designed to deliver monetary aid and other relief to businesses and individuals impacted by the pandemic. Although in various locations certain activity restrictions have been relaxed with some level of success, in many states and localities the number of individuals diagnosed with COVID-19 has increased significantly, which is causing a freezing or, in certain cases, a reversal of previously announced relaxation of activity restrictions and is prompting the need for additional aid and other forms of relief.

 

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The governmental and social response to the COVID-19 pandemic has resulted in an unprecedented slow-down in economic activity and a related increase in unemployment. Since the outbreak of COVID-19 in the United States, more than 50 million people nationwide have filed claims for unemployment, and stock markets have declined in value and in particular, bank stocks have significantly declined in value. As of the end of June 2020, the national unemployment rate was 11.1%. Although an improvement from the 14.7% national unemployment rate observed in April 2020, the current rate of unemployment is substantially higher than the 3.6% national unemployment rate observed in January 2020 prior to the outbreak of COVID-19 in the United States. Further, the Federal Pandemic Unemployment Compensation, which under Section 2104 of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) allows for additional payments to covered individuals of up to $600 per week, expired as of July 31, 2020 and it is uncertain whether this benefit will be renewed by Congress.

 

The COVID-19 pandemic, and related efforts to contain it, have caused significant disruptions in the functioning of the financial markets and have increased economic and market uncertainty and volatility. To help address these issues, the Federal Open Market Committee (“FOMC”) has reduced the benchmark federal funds rate to a target range of 0% to 0.25%, and the yields on 10 and 30-year treasury notes have declined to historic lows. At its June and July meetings, the FOMC continued its commitment to this approach, indicating that the target federal funds rate would remain at current levels until the economy is in position to achieve the FOMC’s maximum-employment and price-stability goals. In addition, in order to support the flow of credit to households and businesses, the FRB indicated that it will continue to increase its holdings of U.S. Treasury securities and agency residential and commercial mortgage-backed securities to sustain proper functioning of the financial markets.

 

Congress and various state governments and federal agencies have taken actions to require lenders to provide forbearance and other relief to borrowers (e.g., waiving late payment and other fees). The federal banking agencies have encouraged financial institutions to prudently work with affected borrowers and recently passed legislation has provided relief from reporting loan classifications due to modifications related to the COVID-19 pandemic. More specifically, through Section 4022 of the CARES Act, Congress provided relief to borrowers with federally-backed one-to-four family mortgage loans experiencing a financial hardship due to COVID-19 by allowing such borrowers to request forbearance, regardless of delinquency status, for up to 360 days. Such relief will be available until the earlier of December 31, 2020 and the date of termination of the national emergency declaration. Section 4022 of the CARES Act also prohibits servicers of federally-backed mortgage loans from initiating foreclosures during the 60-day period beginning March 18, 2020. In addition, under Section 4023 of the CARES Act, until the earlier of December 31, 2020 and the date of termination of the national emergency declaration, borrowers with federally-backed multifamily mortgage loans whose payments were current as of February 1, 2020, but who have since experienced financial hardship due to COVID-19, may request a forbearance for up to 90 days. Borrowers receiving such forbearance may not evict or charge late fees to tenants for its duration.

 

Additionally, in many states in which we do business or in which our borrowers and loan collateral are located, temporary bans on evictions and foreclosures have been enacted through a mix of executive orders, regulations, and judicial orders. Certain such relief orders have since expired, although several states, including New York and New Jersey, have extended their temporary orders and may continue to do so indefinitely. In addition, in New York, Governor Andrew Cuomo signed legislation on June 17, 2020 that expands mortgage forbearance available for those experiencing financial hardship during the crisis caused by the COVID-19 pandemic. The legislation applies to those who have mortgages with state-regulated financial institutions and is intended to be an expansion of the CARES Act’s mortgage forbearance provisions. The legislation provides up to one year of forbearance if the borrower’s hardship persists and provides flexible payment options.

 

Certain industries have been particularly hard-hit by the COVID-19 pandemic, including the travel and hospitality industry, the restaurant industry and the retail industry. In addition, the spread of COVID-19 has caused us to modify our business practices, including employee travel, employee work locations, and cancellation of physical participation in meetings, events and conferences. We have many employees working remotely and we may take further actions as may be required by government authorities or that we determine are in the best interests of our employees, customers and business partners.

 

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We continue to actively monitor developments related to COVID-19 and its impact to our business, customers, employees, counterparties, vendors, and service providers. During the first quarter of 2020, the most notable financial impacts to our results of operations was a higher provision for loan losses primarily reflecting the substantial increase in economic uncertainty and the resultant potential for increased credit losses in future periods as a consequence of the COVID-19 pandemic.

 

In response to the COVID-19 pandemic, we have taken several actions to offer various forms of support to our customers and employees that have experienced impacts from this development. We are actively working with customers impacted by the economic downturn, offering payment deferrals and other loan modifications. Our COVID-19 Hardship Forbearance Program provides a 120-day deferral of principal and interest payments for residential mortgages. Interest will continue to accrue at the note rate. At the end of the forbearance period, the borrower’s accrued but unpaid interest will be added to their outstanding principal balance, while keeping the principal and interest payment at the amount determined in accordance with the terms of their note, thus extending the loan’s maturity date. The terms for commercial loan forbearances are reviewed and determined on a case by case basis. As of March 31, 2020, the Company had received approximately 150 forbearance requests under this program with an aggregate loan balance of $70,288, the vast majority of which were in the process of review as of that date.

 

During this volatile time, we remain focused on our capital and liquidity. Our regulatory capital ratios remained well above the levels required to be considered well capitalized for regulatory purposes with a Common Equity Tier 1 ratio for the Company of 16.97% and a ratio of Tier 1 Capital to adjusted tangible assets of 10.07%. See “Liquidity and Capital Resources.” We have a liquid balance sheet, with access to funding sources, as necessary. As a mortgage servicer, we are required to advance principal and interest on loans under forbearance for a period of up to four months and tax and insurance payments until the owners of the loans make us whole. Although the servicing advances for loans in forbearance have not been significant, should the demand for loan forbearance continue to increase as a result of the effects of COVID-19, our liquidity position could be negatively impacted.

 

The duration and severity of the effect of COVID-19 on economic, market and business conditions remain uncertain. We are subject to heightened business, operational, market, credit and other risks related to the COVID-19 pandemic, which may have an adverse effect on our business, financial condition and results of operations.

 

Overview of Quarterly Performance

 

As of March 31, 2020, the Company had total consolidated assets of $3.48 billion, total consolidated deposits of $2.65 billion and total consolidated shareholders’ equity of $328.7 million.

 

We incurred a net loss of $4.0 million for the three months ended March 31, 2020, or $(0.08) per diluted share, compared to a net income of $15.7 million for the three months ended March 31, 2019, or $0.30 per diluted share. Cash and due from banks increased to $390.0 million at March 31, 2020 from $77.8 million at December 31, 2019, reflecting increased cash flows from loan payments and the discontinuation of our Advantage Loan Program combined with the lack of an alternative loan product to effectively reinvest such proceeds during the quarter. The decrease in net income was primarily attributable to a significant increase in the provision for loan losses, as well as an increase in professional fees related to the government investigations and litigation and a decrease in gain on sale of portfolio loans due to the absence of portfolio loan sales during the quarter. The increase in the provision for loan losses reflects our evaluation of the current and expected impacts on our loan portfolios from the COVID-19 pandemic and risk-rating downgrades of certain commercial real estate and construction loans. The decrease in net income was partially offset by an income tax benefit as a result of the decrease in pre-tax income. Our net interest margin declined to 3.57% for the three months ended March 31, 2020 from 3.86% for the same period in 2019, reflecting the prevailing lower interest rate environment in which we were originating new portfolio loans and the reinvestment of substantial loan payments into lower-yielding interest-earning assets.

 

Critical Accounting Policies and Estimates

 

Our condensed consolidated financial statements are prepared in accordance with U.S. GAAP and with general practices within the financial services industry. Application of these principles requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under current circumstances. These assumptions form the basis for our judgments about the carrying values of assets and liabilities that are not readily available from independent, objective sources. We evaluate our estimates on an ongoing basis. Use of alternative assumptions may have resulted in significantly different estimates. Actual results may differ from these estimates.

 

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During the three months ended March 31, 2020, there were no significant changes to our accounting policies that we believe are critical to an understanding of our financial condition and results of operations, which critical accounting policies are disclosed in our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, as filed with the SEC on October 6, 2020.

 

Financial Condition

 

The Company’s total assets were $3.48 billion at March 31, 2020 compared to $3.24 billion at December 31, 2019. Total loans, net of allowance for loan losses, decreased slightly to $2.80 billion as compared to $2.89 billion at December 31, 2019. The investment securities portfolio increased $6.6 million, or 4%, to $159.2 million at March 31, 2020 from $152.5 million at December 31, 2019. Deposits increased $149.9 million, or 6%, to $2.65 billion at March 31, 2020. Borrowings, excluding subordinated notes, increased $100.0 million, or 44%, to $329.0 million at March 31, 2020.

 

Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio by type of loan at the dates indicated.

 

   At March 31, 2020   At December 31, 2019 
   Amount   %   Amount   % 
   (Dollars in thousands) 
Real estate:                    
Residential real estate  $2,345,328    82%  $2,476,866    85%
Commercial real estate   279,508    10%   240,081    8%
Construction   198,115    7%   178,376    6%
Total real estate   2,822,951    99%   2,895,323    99%
Commercial lines of credit   19,271    1%   17,903    1%
Other consumer   36    %   34    %
Total loans   2,842,258    100%   2,913,260    100%
Allowance for loan losses   (42,613)        (21,730)     
Loans, net  $2,799,645        $2,891,530      

 

The following table sets forth our fixed and adjustable-rate loans in our loan portfolio at March 31, 2020:

 

   Fixed   Adjustable   Total 
   (In thousands) 
Real estate:               
Residential real estate  $34,414   $2,310,914   $2,345,328 
Commercial real estate   43,267    236,241    279,508 
Construction       198,115    198,115 
Commercial lines of credit   333    18,938    19,271 
Other consumer   36        36 
Total  $78,050   $2,764,208   $2,842,258 

 

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The table set forth below contains the repricing dates of adjustable rate loans included within our loan portfolio as of March 31, 2020:

 

March 31, 2020  Residential
Real Estate
   Commercial
Real Estate
   Construction   Commercial
Lines of Credit
   Other
Consumer
   Total 
   (In thousands) 
Amounts to adjust in:                              
6 months or less  $346,201   $18,952   $198,115   $18,938   $   $582,206 
More than 6 months through 12 months   406,309    20,580                426,889 
More than 12 months through 24 months   520,665    30,915