Item 1. Business
General
Beneficial Bancorp, Inc. (the “Company”) is a Maryland corporation that was incorporated in August 2014 to be the successor to Beneficial Mutual Bancorp, Inc. (“Beneficial Mutual Bancorp”) upon completion of the second-step conversion of Beneficial Bank (the “Bank”) from the two-tier mutual holding company structure to the stock holding company structure. Beneficial Savings Bank MHC was the former mutual holding company for Beneficial Mutual Bancorp prior to completion of the second-step conversion. In conjunction with the second-step conversion, Beneficial Savings Bank MHC merged into Beneficial Mutual Bancorp (and ceased to exist), and Beneficial Mutual Bancorp merged into the Company, with the Company as the surviving entity. The second-step conversion was completed on January 12, 2015, at which time the Company sold, for gross proceeds of $503.8 million, a total of 50,383,817 shares of common stock at $10.00 per share, including 2,015,352 shares purchased by the Bank’s employee savings and stock ownership plan. As part of the second-step conversion, each of the existing 29,394,417 outstanding shares of Beneficial Mutual Bancorp common stock owned by persons other than Beneficial Savings Bank MHC was converted into 1.0999 of a share of Company common stock. Upon the completion of the second-step conversion, the Bank changed its legal name from Beneficial Mutual Savings Bank to Beneficial Bank.
The consolidated financial statements include the accounts of the Company, the Bank, a Pennsylvania chartered savings bank, and the Bank’s subsidiaries. The Company owns 100% of the issued and outstanding common stock of the Bank. The Bank offers a variety of consumer and commercial banking services to individuals, businesses, and nonprofit organizations through 61 offices throughout the Philadelphia and Southern New Jersey area. The Bank is supervised and regulated by the Pennsylvania Department of Banking and Securities and the Federal Deposit Insurance Corporation (the “FDIC”). The Company is regulated by the Board of Governors of the Federal Reserve System. The deposits of the Bank are insured up to the applicable legal limits by the Deposit Insurance Fund of the FDIC.
Beneficial Bancorp’s business activities are the ownership of Beneficial Bank’s capital stock. Beneficial Bancorp does not own or lease any property but instead uses the premises, equipment and other property of Beneficial Bank with the payment of appropriate rental fees, as required by applicable law and regulations, under the terms of an expense allocation agreement. Accordingly, the information set forth in this Annual Report, including the consolidated financial statements and related financial data, relates primarily to Beneficial Bank.
Beneficial Bank was founded in 1853. Since we were founded, we have served the financial needs of our depositors and the local community as a community-minded, customer service-focused institution. We offer traditional financial services to consumers and businesses in our market areas. We attract deposits from the general public and use those funds to originate a variety of loans, including commercial real estate loans, commercial business loans, equipment financing and leasing, one- to four-family real estate loans, consumer loans, home equity loans and construction loans.
Pending Merger with WSFS Financial Corporation
On August 8, 2018, WSFS Financial Corporation (“WSFS”) and the Company issued a joint press release announcing that WSFS and the Company have entered into an Agreement and Plan of Reorganization (the “Merger Agreement”) pursuant to which the Company will merge with and into WSFS, with WSFS as the surviving entity (the “Merger”). Under the terms of the Merger Agreement, which has been approved by the boards of directors and stockholders of both companies, stockholders of Beneficial will receive 0.3013 shares of WSFS common stock and $2.93 in cash for each share of Beneficial common stock. The transaction is subject to customary closing conditions and is expected to close during the first quarter of 2019.
Acquisition History
In 2007, in connection with the closing of our initial public offering, Beneficial Mutual Bancorp acquired FMS Financial Corporation and its wholly owned subsidiary, Farmers & Mechanics Bank. The acquisition of FMS Financial Corporation and Farmers & Mechanics Bank, which had 31 branch offices in Burlington, Camden and Gloucester Counties in New Jersey, substantially enhanced our market share and solidified Beneficial Bank’s position as the largest Philadelphia-based bank operating solely in the greater Philadelphia metropolitan area. In 2012, Beneficial Mutual Bancorp acquired SE Financial Corp. and its wholly owned subsidiary, St. Edmond’s Federal Savings Bank. The acquisition increased our market share in southeastern Pennsylvania, specifically in Philadelphia and Delaware Counties. Additionally, the acquisition provided Beneficial Bank with new branches in Roxborough, Pennsylvania and Deptford, New Jersey.
On April 14, 2016, the Company completed the acquisition of Conestoga Bank. Pursuant to the terms of the Stock Purchase Agreement, dated October 21, 2015, between the Company, Conestoga Bancorp, Inc. (“Conestoga”) and Conestoga Bank, the Company acquired Conestoga’s ownership interest in Conestoga Bank for a cash payment of $105.0 million and subsequently merged Conestoga Bank with and into Beneficial Bank. The results of Conestoga Bank’s operations are included in the Company’s unaudited condensed Consolidated Statements of Income for the period beginning on April 15, 2016, the date of the acquisition, through December 31, 2018. The acquisition of Conestoga Bank increased the Company’s market share in southeastern Pennsylvania and provided Beneficial Bank with new branches in Blue Bell, Chester Springs, Feasterville, Media, Wayne and Philadelphia, Pennsylvania.
In 2017, the Company formed Neumann Finance Company (“Neumann”), a majority owned subsidiary equipment leasing company, named after the Bank’s pioneering founder, Saint John Neumann. Neumann is focused on providing financing products and services to businesses nationwide and targets various equipment categories including technology, software, office, medical and other areas.
Market Area
We are headquartered in Philadelphia, Pennsylvania. We currently operate 38 full-service banking offices in Bucks, Chester, Delaware, Montgomery and Philadelphia Counties, Pennsylvania and 23 full-service banking offices in Burlington, Gloucester, and Camden Counties, New Jersey. We operate two lending offices in Montgomery and Delaware Counties, Pennsylvania. We also operate one leasing office in Chester County, Pennsylvania. We regularly evaluate our network of banking offices to optimize the penetration in our market area. We will occasionally open or consolidate banking offices.
Philadelphia is the eighth largest metropolitan region in the United States and home to 66 colleges and universities. Traditionally, the economy of the Philadelphia metropolitan area was driven by the manufacturing and distribution sectors. However, the region has evolved into a more diverse economy geared toward information and service-based businesses. Currently, the leading employment sectors in the region are (1) educational and health services; (2) transportation, trade and utilities services; (3) professional and business services; and (4) due to the region’s numerous historic attractions, leisure and hospitality services. The region’s leading employers include Jefferson Health System, the University of Pennsylvania Health System, Merck & Company, Inc. and Comcast Corporation. The Philadelphia metropolitan area has also evolved into one of the major corporate centers in the United States due to its geographic location, access to transportation, significant number of educational facilities to supply technical talent and available land for corporate and industrial development. The Philadelphia metropolitan area is currently home to 14 Fortune 500 companies, including AmerisourceBergen, Comcast, PPL, DuPont, Aramark and Lincoln National.
According to a 2017 census estimate, the population of our eight-county primary retail market area totaled approximately 5.4 million. Overall, the eight counties that comprise our primary retail market area provide attractive long-term growth potential by demonstrating relatively strong household income and wealth growth trends relative to national and state-wide projections. The unemployment rate, seasonally adjusted, for the Philadelphia metropolitan area totaled 4.1% in December 2018, which was higher than the national unemployment rate of 3.9% in December 2018.
Competition
We face significant competition for the attraction of deposits and origination of loans. Our most direct competition for deposits has historically come from the many banks, thrift institutions and credit unions operating in our market area and, to a lesser extent, from other financial service companies such as brokerage firms and insurance companies. We also face competition for investors’ funds from money market funds, mutual funds and other corporate and government securities.
Our competition for loans comes primarily from the competitors referenced above and other regional and local community banks, thrifts and credit unions and from other financial service providers, such as mortgage companies and mortgage brokers. Competition for loans also comes from the increasing number of non-depository financial service companies participating in the mortgage market, such as insurance companies, securities companies and specialty finance companies. We have also seen an increasing number of FINTECH companies that are focused on consumer and small business lending that are not subject to the same regulatory oversight as banks. These companies have introduced a number of technology solutions threatening to disrupt traditional lending channels.
We expect competition to remain intense in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Technological advances, for example, have lowered barriers to entry, allowed banks to expand their geographic reach by providing services over the internet and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks. Competition for deposits and the origination of loans could limit our growth in the future.
Lending Activities
We offer a variety of loans and leases including commercial, residential and consumer loan products. Our commercial loan and lease portfolio includes business loans, small business leases, commercial real estate loans and commercial construction loans. Our residential loan portfolio includes one- to four-family residential real estate loans. Our consumer loan portfolio primarily includes home equity loans and lines of credit, automobile loans, personal, and educational loans.
We intend to continue to emphasize commercial and small business lending and remain focused on commercial real estate lending. We will continue to proactively monitor and manage existing credit relationships. We continue to invest in our credit risk management and lending staff and processes to position Beneficial Bank for future growth. Specifically, we have hired additional lenders with significant experience in our market area to expand our commercial real estate and commercial and industrial lending efforts.
Commercial Real Estate Loans. At December 31, 2018, commercial real estate loans totaled $1.54 billion, or 39.6% of our total loan and lease portfolio. This portfolio is comprised of loans for the acquisition (purchase), financing and/or refinancing of commercial real estate and the financing of income-producing real estate. Income-producing real estate includes real estate held for lease to third parties and nonresidential real estate. These loans are generally non-owner-occupied properties in which 50% or more of the primary source of repayment is derived from rental income from unaffiliated third parties. The commercial real estate portfolio includes loans to finance
office buildings, apartment buildings, shopping centers, hotels, motels, dormitories, nursing homes, assisted-living facilities, mini-storage warehouse facilities and similar non-owner-occupied properties.
We offer both fixed and adjustable rate commercial real estate loans. We originate a variety of commercial real estate loans generally for terms of up to 10 years and with payments generally based on an amortization schedule of up to 25 years. Our fixed rate loans are typically based on either the Federal Home Loan Bank of Pittsburgh’s borrowing rate or U.S. Treasury rate and generally most are fixed with a rate reset after a five-year period.
When making commercial real estate loans, we consider the financial statements and tax returns of the borrower, the borrower’s payment history of its debt, the debt service capabilities of the borrower, the projected cash flows of the real estate, leases for any of the tenants located at the collateral property and the value of the collateral.
As of December 31, 2018, our largest commercial real estate loan was a $67.2 million loan for an upscale hotel in Avalon, New Jersey. The loan is well collateralized and was performing in accordance with its original terms at December 31, 2018.
Commercial Business Loans. At December 31, 2018, commercial business loans totaled $615.2 million, or 15.8% of our total loan and lease portfolio.
This portfolio is comprised of loans to individuals, sole proprietorships, partnerships, corporations, and other business enterprises, whether secured or unsecured, single-payment or installment, for commercial, industrial and professional purposes as well as owner-occupied real estate loans. Owner-occupied real estate loans are loans where the primary source of repayment is the cash flow generated by the occupying business. Proceeds from these loans may finance the acquisition or construction of business premises or may be used for other business purposes such as working capital. In many cases, the owner of the occupying business owns the building in a separate entity and leases it to the business. In an owner-occupied property, more than 50% of the primary source of repayment is derived from the affiliated entity. Properties such as hospitals, golf courses, recreational facilities, and car washes are considered owner-occupied unless leased to an unaffiliated party.
We offer lines of credit, intermediate term loans and long-term loans primarily to assist businesses in achieving their growth objectives and/or working or long-term capital needs. The interest rates for these loans are typically based on LIBOR, bank prime, U.S. Treasury or Federal Home Loan Bank of Pittsburgh borrowing rate. These loans are usually secured by business assets, including but not limited to, accounts receivable, inventory, equipment and real estate. Many of these loans include the personal guarantees of the owners or business owners.
When making commercial business loans, we review financial information of the borrowers and guarantors. We apply a due diligence process that includes a review of the borrowers’ and/or guarantors’ payment history, an understanding of the business and its industry, an assessment of the management capabilities, an analysis of the financial capacity, financial condition and cash flows of the borrower, an assessment of the collateral and when applicable a review of the guarantors’ financial capacity and condition.
Commercial business loans include shared national credits, which are participations in loans or loan commitments of at least $20.0 million that are shared by three or more banks. Effective January 1, 2018, the federal banking agencies have changed the aggregate loan commitment threshold for inclusion in the shared national credit program from $20 million to $100 million. Included in our shared national credit portfolio are purchased participations and assignments in leveraged lending transactions. Leveraged lending transactions are generally used to support a merger- or acquisition-related transaction, to back a recapitalization of a company’s balance sheet or to refinance debt. When considering a participation in the leveraged lending market, we will participate only in first lien senior secured term loans that are highly rated (investment grade) by the rating agencies and that trade in active secondary markets. Even though we intend to hold these loans in our portfolio, we actively monitor the secondary market for these types of loans to ensure that we maintain flexibility to sell such loans in the event of deteriorating credit quality. To further minimize risk, based on our current capital levels and loan portfolio, we have limited the total amount of leveraged loans to $150.0 million with no single obligor exceeding $15.0 million while maintaining single industry concentrations below 30%. We may reevaluate these limits in future periods.
Shared national credit loans are typically variable rate with terms ranging from one to seven years. At December 31, 2018, shared national credits totaled $139.5 million, which included $83.4 million of leveraged lending transactions. All of these loans were classified as pass rated as of December 31, 2018 as all payments are current and the loans are performing in accordance with their contractual terms.
At December 31, 2018, our largest commercial business loan was a $19.8 million term loan to a telecommunications provider located in Bala Cynwyd, Pennsylvania. The loan was performing in accordance with its original terms at December 31, 2018.
Commercial Small Business Leases. At December 31, 2018, commercial small business leases totaled $139.9 million, or 3.6% of our total loan and lease portfolio.
This portfolio is comprised of small business finance leases. Primary production has been focused on equipment for medical and veterinary businesses with smaller ticket leases with shorter terms. The average small business lease amount and lease term was $21 thousand and 4.7 years as of December 31, 2018.
When making commercial small business leases, we review financial information of the borrowers and guarantors. We apply a due diligence process that includes a review of the borrowers’ and/or guarantors’ payment history, an understanding of the business and its industry, an assessment of the management capabilities, an analysis of the financial capacity, financial condition and cash flows of the borrower, an assessment of the collateral and when applicable a review of the guarantors’ financial capacity and condition.
Construction Loans. At December 31, 2018, commercial construction loans totaled $188.5 million, or 4.8% of our total loan and lease portfolio.
We offer commercial and residential construction loans to commercial real estate and residential construction developers in our market area. We offer loans secured by real estate, with original maturities of 60 months or less, made to finance land development costs incurred before erecting new structures (i.e., the process of improving land including laying sewers, water pipes, etc.) or the on-site construction of industrial, commercial, residential, or farm buildings. Commercial construction loans include loans secured by real estate which are used to acquire and improve developed and undeveloped property as well as used to alter or demolish existing structures to allow for new development.
We generally limit the number of model homes and homes built on speculation, and scheduled draws against executed agreements of sales as conditions of the commercial construction loans.
Commercial real estate and residential construction loans are typically based upon the prime rate as published in The Wall Street Journal and/or LIBOR. Commercial real estate loans for developed real estate and for real estate acquisition and development are originated generally with loan-to-value ratios up to 75%, while loans for the acquisition of land are originated with a maximum loan to value ratio of 65%.
When making commercial and residential construction loans, we consider the financial statements of the borrower, the borrower’s payment history, the projected cash flows from the proposed real estate collateral, and the value of the collateral. In general, our real estate construction loans are guaranteed by the borrowers. We consider the financial statements and tax returns of the guarantors, along with the guarantors’ payment history, when underwriting a commercial construction loan.
At December 31, 2018, our largest commercial construction loan was a $22.4 million participation loan for the construction of a luxury apartment complex located in King of Prussia, Pennsylvania. The loan is well collateralized and was performing in accordance with its original terms at December 31, 2018.
One- to Four-Family Residential Loans. At December 31, 2018, one- to four-family residential loans totaled $968.9 million, or 24.9% of our total loan and lease portfolio.
We offer fixed-rate and adjustable-rate residential mortgage loans. We offer fixed-rate mortgage loans with terms of up to 30 years. Approximately 95.4% of our outstanding residential mortgage loans were fixed rate loans at December 31, 2018. We also offer adjustable-rate mortgage loans with interest rates and payments that adjust annually after an initial fixed period of one, three or five years. Interest rates and payments on our adjustable-rate loans generally are adjusted to a rate equal to a percentage above the U.S. Treasury Security Index or LIBOR. Our adjustable-rate single-family residential real estate loans generally have a cap of 2% on any increase or decrease in the interest rate at any adjustment date, and a maximum adjustment limit of 5% on any such increase or decrease over the life of the loan. Our adjustable-rate loans require that any payment adjustment resulting from a change in the interest rate be sufficient to result in full amortization of the loan by the end of the loan term and, thus, do not permit any of the increased payment to be added to the principal amount of the loan, creating negative amortization.
Borrower demand for adjustable-rate loans compared to fixed-rate loans is a function of the level of interest rates, the expectations of changes in the level of interest rates, and the difference between the interest rates and loan fees offered for fixed-rate mortgage loans as compared to the interest rates and loan fees for adjustable-rate loans. At December 31, 2018, floating or adjustable rate mortgage loans totaled approximately $44.3 million and fixed rate mortgage loans totaled approximately $924.6 million. The loan fees, interest rates and other provisions of mortgage loans are determined by us on the basis of our own pricing criteria and competitive market conditions.
While one- to four-family residential real estate loans are normally originated with up to 30-year terms, such loans typically remain outstanding for substantially shorter periods because borrowers often prepay their loans in full either upon sale of the property pledged as security or upon refinancing the original loan. Therefore, average loan maturity is a function of, among other factors, the level of purchase and sale activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans. We do not offer loans with negative amortization or interest-only loans.
It is our general policy not to make high loan-to-value loans (defined as loans with a loan-to-value ratio of 80% or more) without private mortgage insurance. However, we do offer loans with loan-to-value ratios of up to 100% under a special low-income loan program, which consisted of $15.6 million in loans as of December 31, 2018. The maximum loan-to-value ratio we generally permit is 95% with private mortgage insurance, although occasionally we do originate loans with loan-to-value ratios as high as 97% under special loan programs, including our first-time home owner loan program. The balance of one- to four-family residential loans with an original loan-to-value equal to 97% or more was $8.0 million as of December 31, 2018. We require all properties securing mortgage loans to be appraised by an independent appraiser approved by our board of directors. We require title insurance on all first mortgage loans. Borrowers must obtain hazard insurance, and flood insurance is required for loans on properties located in a flood zone.
Home Equity Loans and Equity Lines of Credit. At December 31, 2018, home equity loans and equity lines of credit totaled $201.5 million, or 5.2% of our total loan and lease portfolio.
We offer consumer home equity loans and equity lines of credit that are secured by one- to four-family residential real estate, where Beneficial Bank may be in a first or second lien position. We generally offer home equity loans and lines of credit with a maximum combined loan-to-value ratio of 80%. We require flood insurance on all home equity loans and equity lines of credit. Home equity loans have fixed-rates of interest and are originated with terms of generally up to 15 years with some exceptions up to 20 years. Home equity lines of credit have adjustable rates and are based upon the prime rate as published in The Wall Street Journal. Home equity lines of credit can have repayment schedules of both principal and interest or interest only paid monthly. We hold a first mortgage position on approximately 60.0% of the homes that secured our home equity loans and lines of credit at December 31, 2018.
The procedures for underwriting consumer home equity and equity lines of credit include an assessment of the applicant’s payment history on other debts and ability to meet existing obligations and payments on the proposed loan. Although the applicant’s creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral to the proposed loan amount.
Consumer Personal Loans. At December 31, 2018, consumer personal loans totaled $13.5 million, or 0.3% of our total loan and lease portfolio.
We offer a variety of consumer personal loans, including loans for recreational vehicles, unsecured personal loans and lines of credit. Our consumer loans secured by passbook accounts and certificates of deposit held at Beneficial Bank are based upon the prime rate as published in The Wall Street Journal with terms up to four years. We will offer such loans up to 100% of the principal balance of the certificate of deposit or balance in the passbook account. We also offer unsecured loans and lines of credit with terms up to five years. Our unsecured loans and lines of credit bear a substantially higher interest rate than our secured loans and lines of credit. For more information on our loan commitments, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity Risk.”
Consumer Education Loans. At December 31, 2018, consumer education loans totaled $131.0 million, or 3.4% of our total loan and lease portfolio. Our consumer education loans are unsecured but are generally 98% government guaranteed. These loans are serviced by the Pennsylvania Higher Education Assistance Agency and Navient (formerly Sallie Mae). Our consumer education loan portfolio was previously purchased. We do not except to purchase or originate more of these types of loans. Thus, we expect this portfolio to decrease as these loans continue to be paid down.
Automobile Loans. At December 31, 2018, automobile loans that we originated totaled $94.5 million, or 2.4% of our total loan and lease portfolio. These loans are secured by new and used automobiles. The majority of the loans in this portfolio are indirect automobile loans. These loans have fixed interest rates and generally have terms up to 84 months. These loans have loan-to-value ratios of up to 120% of the purchase price of the vehicle depending upon the credit history of the borrower and other factors. During 2017, we discontinued offering indirect auto loans as other lending channels provided higher levels of profitability and returns on capital.
Credit Risks.
Commercial Real Estate Loans. Loans secured by commercial real estate generally have larger balances and involve a greater degree of risk than one- to four-family residential mortgage loans. Of primary concern in commercial real estate lending is the borrower’s creditworthiness and the feasibility and cash flow potential of the property that secures the loan. Additional considerations include: location, market and geographic concentrations, loan to value ratio, strength of guarantors and quality of tenants. Payments on loans secured by income properties often depend on successful operation and management of the properties. As a result, repayment of such loans may be subject to a greater extent than residential real estate loans to adverse conditions in the real estate market or the economy. To monitor cash flows on income properties, we require borrowers and loan guarantors, if any, to provide annual financial statements on commercial real estate loans and rent rolls where applicable. In reaching a decision on whether to make a commercial real estate loan, we consider and review a global cash flow analysis of the borrower, when applicable, and consider the net operating income of the property, the borrower’s expertise, credit history and profitability and the value of the underlying property. We have generally required that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before debt service to debt service) of at least 1.2x and a loan to value no greater than 75%. An environmental report is obtained when the possibility exists that hazardous materials may have existed on the site, or the site may have been impacted by adjoining properties that handled hazardous materials.
Commercial Business Loans. Unlike commercial real estate loans, which generally are made on the basis of the cash flow of the property that secures the loan, and are secured by real property, the value of which tends to be more easily ascertainable, commercial business loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans may depend substantially on the success of the business itself. Further, any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value. Our commercial business loans also include owner-occupied commercial real estate where the cash flow supporting the loan is derived from the owners underlying business.
Commercial Small Business Leases. Commercial small business leases are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial small business leases may depend substantially on the success of the business itself. Further, any collateral securing such leases may depreciate over time, may be difficult to appraise and may fluctuate in value. However, these leases tend to be significantly smaller than commercial real estate and commercial business loans with shorter average terms.
Construction Loans. Loans made to facilitate construction are primarily short-term loans used to finance the construction of an owner-occupied residence or income producing assets. Generally, upon stabilization or upon completion and issuance of a certificate of occupancy, these loans convert to permanent loans with long-term amortization. Payments during construction consist of an interest-only period funded generally by borrower equity. As these loans represent higher risk, each project is monitored for progress throughout the life of the loan, and loan funding occurs through borrower draw requests. These requests are compared to agreed-upon project milestones and progress is verified by independent inspectors engaged by us.
Construction financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property’s value at completion of construction or development and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the dwelling. If the estimate of value proves to be inaccurate, we may be confronted, at or before the maturity of the loan, with a project having a value which is insufficient to assure full repayment.
Residential Real Estate Loans. Loans made for the purchase of one- to four- family residential loans generally are made on the basis of the borrower’s ability to make repayment from his or her employment or other income and are secured by real property with ascertainable fair values. Because these loans tend to carry a fixed interest rate and have terms as long as 30 years, the Company can be adversely impacted if interest rates increase. While we anticipate that adjustable-rate loans will better offset the adverse effects of an increase in interest rates as compared to fixed-rate mortgages, the increased mortgage payments required of adjustable-rate loan borrowers in a rising interest rate environment could cause an increase in delinquencies and defaults. The marketability of the underlying property also may be adversely affected in a high interest rate environment. Although adjustable-rate mortgage loans help make our asset base more responsive to changes in interest rates, the extent of this interest sensitivity is limited by the annual and lifetime interest rate adjustment limits on such loans.
Consumer Home Equity and Equity Lines of Credit. Consumer home equity loans and equity lines of credit are loans secured by one- to four-family residential real estate, where we may be in a first or second lien position. In each instance, the value of the property is determined and the loan is made against identified equity in the market value of the property. When a residential mortgage is not present on the property, a first lien position is secured against the property. In cases where a mortgage is present on the property, a second lien position is established, subordinated to the mortgage. As these subordinated liens represent higher risk, loan collection becomes more influenced by various factors, including job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.
Consumer and Automobile Loans. Unlike consumer home equity loans, these loans are either unsecured or secured by rapidly depreciating assets such as boats or motor homes. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and a small remaining deficiency often does not warrant further substantial collection efforts against the borrower. Consumer loan collections depend on the borrower’s continuing financial stability, and, therefore, are likely to be adversely affected by various factors, including job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.
Automobile loans may entail greater risk than residential mortgage loans, as they are secured by assets that depreciate rapidly. Repossessed collateral for a defaulted automobile loan may not provide an adequate source of repayment for the outstanding loan and a small remaining deficiency often does not warrant further substantial collection efforts against the borrower. Automobile loan collections depend on the borrower’s continuing financial stability, and therefore are likely to be adversely affected by various factors, including job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.
Consumer Education Loans. These consumer loans are unsecured but generally 98% government guaranteed. Consumer education loan collections depend on the efforts of the Pennsylvania Higher Education Assistance Agency and Navient (formerly Sallie Mae) and are dependent on the borrower’s continuing financial stability. Therefore, these loans are likely to be adversely affected by various factors including job loss, divorce, illness or personal bankruptcy. As a result of the government guarantee, we will ultimately be unaffected materially by delinquencies in the portfolio.
Loan Originations and Purchases. Loan originations come from a number of sources. The primary sources of loan originations are existing customers, advertising and referrals from customers and other business contacts, including attorneys, accountants and other professionals, and walk-in traffic.
We also purchase loans and enter into loan participations with other financial institutions to supplement our lending portfolio. There were no purchases of participations in loan portfolios originated by other financial institutions during the years ended December 31, 2017 and 2018. Loan participations totaled $563.0 million at December 31, 2018 and are primarily comprised of commercial real estate and commercial and industrial loans. A portion of our participation loans are shared national credits, which are participations in loans or loan commitments of at least $20.0 million that are shared by three or more banks. Effective January 1, 2018, the federal banking agencies have changed the aggregate loan commitment threshold for inclusion in the shared national credit program from $20 million to $100 million. As of December 31, 2018 and December 31, 2017, the balance of Beneficial Bank’s outstanding purchased shared national credits was $139.5 million and $199.5 million, respectively. See “-Lending Activities-Commercial Business Loans.” Loan participations
are subject to the same credit analysis and loan approvals as loans we originate. We are permitted to review all of the documentation relating to any loan in which we participate. However, for participation loans, we do not service the loan and, thus, are subject to the policies and practices of the lead lender with regard to monitoring delinquencies, pursuing collections and instituting foreclosure proceedings.
Loan Approval Procedures and Authority Our lending activities follow written, non-discriminatory, underwriting standards and loan origination procedures established by management and approved by the board of directors. Beneficial Bank’s board of trustees has granted loan approval authority to certain officers or groups of officers up to prescribed limits, based on an officer’s experience and tenure. Generally, all commercial loans greater than $10.0 million must be approved by the Senior Loan Committee, which is comprised of personnel from the Credit, Finance and Lending departments. Generally, all commercial loans greater than $50.0 million must be approved by the director loan committee of the Bank’s board of trustees, which is comprised of five non-employee trustees. In addition, leveraged lending transactions must be approved by the Senior Loan Committee and the director loan committee of the Bank’s board of trustees.
Loans to One Borrower. The maximum amount that we may lend to one borrower and the borrower’s related entities is limited, by regulation, to generally 15% of our stated capital and reserves. At December 31, 2018, our regulatory limit on loans to one borrower was $143.3 million. Beneficial Bank’s internal lending limits are lower than the levels permitted by regulation and at December 31, 2018, the total exposure with our largest lending relationship was $78.6 million, which is the total of the amount outstanding and committed for a group of three commercial real estate loans and one commercial construction loan. These loans were performing in accordance with their original terms at December 31, 2018.
Loan Commitments. We issue commitments for fixed and adjustable-rate mortgage loans conditioned upon the occurrence of certain events. Commitments to originate mortgage loans are legally binding agreements to lend to our customers. Generally, our loan commitments expire after 60 days.
Delinquent Loans and Leases. We identify loans and leases that may need to be charged-off as a loss by reviewing all delinquent loans and leases, classified loans and other loans that management may have concerns about collectability. For individually reviewed loans, the borrower’s inability to make payments under the terms of the loan as well as a shortfall in collateral value may result in a write down to management’s estimate of net realizable value. The collateral or cash flow shortfall on all secured loans is charged-off when the loan becomes 90 days delinquent or in the case of unsecured loans the entire balance is charged-off when the loan becomes 90 days delinquent. For more information on how Beneficial Bank addresses credit risk, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Risk Management.”
Deposit Activities and Other Sources of Funds
General. Deposits, borrowings and loan and investment repayments are the major sources of our funds for lending and other investment purposes. Scheduled loan and investment repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and market conditions.
Deposit Accounts. Deposits are primarily attracted from within our market area through the offering of a broad selection of deposit instruments, including non-interest-bearing demand deposits (such as individual checking accounts), interest-bearing demand accounts (such as NOW, municipal and money market accounts), savings accounts and certificates of deposit.
Our three primary categories of deposit customers consist of retail or individual customers, businesses and municipalities. Our business banking and municipal deposit products include a commercial checking account and a checking account specifically designed for small businesses. Additionally, we offer cash management, including remote deposit, lockbox service and sweep accounts.
Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of our deposit accounts, we consider the rates offered by our competition, the rates on borrowings, brokered deposits, our liquidity needs, profitability to us, and customer preferences and concerns. We generally review our deposit mix and pricing bi-weekly. Our deposit pricing strategy has generally been to offer competitive rates on all types of deposit products.
Certificate of Deposit Account Registry Service (CDARS). Our participation in this program enables our customers to invest balances in excess of the FDIC deposit insurance limit into other banks within the CDARS network while maintaining their relationship with us. We work with our customers to obtain the most favorable rates and combine all accounts for convenience onto one statement.
Brokered Certificates of Deposit. We will use brokered certificates of deposit to extend the maturity of our deposits and limit interest rate risk in our deposit portfolio. We generally limit our use of brokered certificates of deposit to 10% or less of total deposits. At December 31, 2018, our brokered certificates of deposits totaled $210.2 million and represented approximately 5.0% of total deposits.
Borrowings. We have the ability to utilize advances from the Federal Home Loan Bank of Pittsburgh to supplement our liquidity. As a member, we are required to own capital stock in the Federal Home Loan Bank of Pittsburgh and are authorized to apply for advances on the security of such stock and certain mortgage loans and other assets, provided certain standards related to creditworthiness have been met. Advances are made under several different programs, each having its own interest rate and range of maturities. We also have the ability to utilize overnight repurchase agreements and securities sold under agreements to repurchase, along with the Federal Reserve
Bank’s discount window and Federal Funds lines with correspondent banks to supplement our supply of investable funds and to meet deposit withdrawal requirements. To secure our borrowings, we generally pledge securities and/or loans. The types of securities pledged for borrowings include, but are not limited to, government-sponsored enterprises (“GSE”) notes and government agency mortgage-backed securities. The types of loans pledged for borrowings include, but are not limited to, one- to four-family real estate mortgage loans. At December 31, 2018, we had combined maximum borrowing capacity from the Federal Home Loan Bank of Pittsburgh and the Federal Reserve Bank of Philadelphia of $2.2 billion.
Personnel
As of December 31, 2018, we had 720 full-time employees and 15 part-time employees, none of whom is represented by a collective bargaining unit. We believe our relationship with our employees is good.
Subsidiaries
Beneficial Advisors, LLC, which is wholly owned by Beneficial Bank, is a Pennsylvania limited liability company formed in 2000 to offer wealth management services and investment and insurance related products, including, but not limited to, fixed- and variable-rate annuities and the sale of mutual funds and securities through a third-party broker dealer. We decided to cease the operations of Beneficial Advisors, LLC effective the first quarter of 2018. This entity is currently inactive.
Neumann Corporation, which was formed in 1990, is a Delaware investment holding company that holds title to various securities and other investments. Neumann Corporation is 100% owned by Beneficial Bank. At December 31, 2018, Neumann Corporation held $567.7 million in assets.
Neumann Finance Company, which was formed in 2017 to originate small business leases, is a New Jersey corporation. Neumann Finance Company is majority owned (83%) by Beneficial Bank. The Bank concluded that the entity meets the definition of a variable interest entity and that the Bank is the primary beneficiary of the variable interest entity. Accordingly, the investment has been consolidated into the Company’s financial statements as of December 31, 2018. Non-controlling interest at December 31, 2018 was comprised of capital and undistributed losses of the shareholders of Neumann Finance Company, other than the Bank. Non-controlling interest on our consolidated balance sheet at December 31, 2018 totaled $158 thousand. At December 31, 2018, Neumann Finance Company held $13.0 million in assets.
Beneficial Equipment Finance Corporation, formerly BSB Union Corporation, was formed in 1994 to own and lease automobiles. In 2012, BSB Union Corporation obtained approval to engage in equipment leasing activities. Following the acquisition of Conestoga Bank in April 2016, the leasing operations of Beneficial Equipment Finance Corporation became an active subsidiary which originates small business leases primarily medical and veterinarian equipment.
PA Real Property GP, LLC, which is wholly owned by Beneficial Bank, is a special purpose entity formed in 2009 to manage and hold other real estate owned (“OREO”) properties in Pennsylvania until disposition.
NJ Real Property GP, LLC, which is wholly owned by Beneficial Bank, is a special purpose entity formed in 2010 to manage and hold OREO properties in New Jersey until disposition.
DE Real Property Holding, Inc., which is wholly owned by Beneficial Bank, is a special purpose entity formed in 2011 to manage and hold OREO properties in Delaware until disposition.
REGULATION AND SUPERVISION
General
The Bank is a Pennsylvania-chartered savings bank that is subject to extensive regulation, examination and supervision by the Pennsylvania Department of Banking and Securities (“Department”), as its primary regulator, and the FDIC, as its deposit insurer. The Bank is a member of the Federal Home Loan Bank system and, with respect to deposit insurance, of the Deposit Insurance Fund managed by the FDIC. The Bank must file reports with the Department and the FDIC concerning its activities and financial condition, in addition to obtaining regulatory approvals before entering into certain transactions such as mergers with, or acquisitions of, other savings institutions. The Pennsylvania Department of Banking and Securities and/or the FDIC conduct periodic examinations to test the Bank’s safety and soundness and compliance with various regulatory requirements. This regulatory structure gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in the regulatory requirements and policies, whether by the Department, the FDIC, the Federal Reserve Board or Congress, could have a material adverse impact on the Bank and its operations.
Effective as of December 23, 2016, the Company elected to become a financial holding company under the Bank Holding Company Act of 1956, as amended. As a financial holding company, the Company may engage in a broader array of financial activities than previously permitted, such as insurance underwriting and investment banking, and is subject to regulation, examination and supervision by the
Federal Reserve Board. Prior to December 23, 2016, the Company was a bank holding company that was subject to regulation, examination and supervision by the Federal Reserve Board.
Certain of the regulatory requirements that are applicable to the Bank and the Company are described below. This description of statutes and regulations is not intended to be a complete explanation of such statutes and regulations and their effects on the Bank and the Company.
Bank Regulation
Pennsylvania Savings Bank Law. The Pennsylvania Banking Code of 1965, as amended, contains detailed provisions governing the organization, location of offices, rights and responsibilities of directors, officers and employees, as well as corporate powers, savings and investment operations and other aspects of the Bank and its affairs. The Pennsylvania Banking Code delegates extensive rule-making power and administrative discretion to the Pennsylvania Department of Banking and Securities so that the supervision and regulation of state-chartered savings banks may be flexible and readily responsive to changes in economic conditions and in savings and lending practices. Specifically, under the Pennsylvania Banking Code, the Department is given the authority to exercise such supervision over state-chartered savings banks as to afford the greatest safety to creditors, shareholders and depositors, ensure business safety and soundness, conserve assets, protect the public interest and maintain public confidence in such institutions.
The Pennsylvania Banking Code provides, among other powers, that state-chartered savings banks may engage in any activity permissible for a national banking association or federal savings association, subject to regulation by the Department (which shall not be more restrictive than the regulation imposed upon a national banking association or federal savings association, respectively). Before it engages in an activity allowable for a national banking association or federal savings association, a state-chartered savings bank must either obtain prior approval from the Department or provide at least 30 days’ prior written notice to the Department. The authority of the Bank under Pennsylvania law, however, may be constrained by federal law and regulation. See “Investments and Activities” below.
Capital Requirements. Under FDIC regulations, federally insured state-chartered banks that are not members of the Federal Reserve System (“state non-member banks”), such as the Bank, are required to comply with minimum leverage capital requirements. In early July 2013, the FDIC approved revisions to its capital adequacy guidelines and prompt corrective action rules that implement the revised standards of the Basel Committee on Banking Supervision, commonly called Basel III, and address relevant provisions of the Dodd-Frank Act. “Basel III” refers to two consultative documents released by the Basel Committee on Banking Supervision in December 2009, the rules text released in December 2010, and loss absorbency rules issued in January 2011, which include significant changes to bank capital, leverage and liquidity requirements.
The rules include new risk-based capital and leverage ratios, which became effective January 1, 2015, and revised the definition of what constitutes “capital” for purposes of calculating those ratios. The new minimum capital level requirements applicable to Beneficial Bank are: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions. In addition, the rules assign a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The rules also eliminate the inclusion of certain instruments, such as trust preferred securities, from Tier 1 capital. However, instruments issued prior to May 19, 2010 will be grandfathered for companies with consolidated assets of $15.0 billion or less. In addition, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in total capital. Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of common stock will be required to be deducted from capital, subject to a two-year transition period. Finally, Tier 1 capital will include accumulated other comprehensive income (which includes all unrealized gains and losses on available for sale debt and equity securities), subject to a two-year transition period.
The rules also establish a “capital conservation buffer” of 2.5% above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital and would result in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement started to be phased in beginning in January 2016 at 0.625% of risk-weighted assets and were increased by that amount each year until fully implemented in January 2019. An institution would be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that can be utilized for such actions.
The FDIC also has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institution’s capital level is or may become inadequate in light of particular risks or circumstances.
As of December 31, 2018, our current capital levels exceed the required capital amounts to be considered “well capitalized” and we believe they also meet the fully-phased in minimum capital requirements, including the related capital conservation buffers, as required by the Basel III capital rules.
Restrictions on Dividends. The Company’s ability to declare and pay dividends may depend in part on dividends received from the Bank. The Pennsylvania Banking Code regulates the distribution of dividends by savings banks and provides that dividends may be declared and paid only out of accumulated net earnings and may be paid in cash or property other than its own shares. Dividends may
not be declared or paid unless shareholders’ equity is at least equal to contributed capital. The Company paid cash dividends on its common stock totaling $0.49 per share during the year ended December 31, 2018.
Interstate Banking and Branching. Federal law permits a bank, such as the Bank, to acquire an institution by merger in a state other than Pennsylvania unless the other state has opted out of interstate banking and branching. Federal law, as amended by the Dodd-Frank Act, also authorizes de novo branching into another state if the host state allows banks chartered by that state to establish such branches within its borders. The Bank currently has 23 full-service locations in Burlington, Gloucester and Camden counties, New Jersey. At its interstate branches, the Bank may conduct any activity that is authorized under Pennsylvania law that is permissible either for a New Jersey savings bank (subject to applicable federal restrictions) or a New Jersey branch of an out-of-state national bank. The New Jersey Department of Banking and Insurance may exercise certain regulatory authority over the Bank’s New Jersey branches.
Prompt Corrective Regulatory Action. Federal law requires, among other things, that federal bank regulatory authorities take “prompt corrective action” with respect to banks that do not meet minimum capital requirements. For these purposes, the law establishes three categories of capital deficient institutions: undercapitalized, significantly undercapitalized and critically undercapitalized.
Under the current prompt corrective action capital guidelines, an institution is deemed to be “well capitalized” if it has (1) a common equity Tier 1 capital ratio of 6.5%; (2) a Tier 1 capital ratio of 8%; (3) a total capital ratio of 10%; and (4) a Tier 1 leverage ratio of 5%. An institution is deemed to be “adequately capitalized” if it has (1) a common equity Tier 1 capital ratio of 4.5%; (2) a Tier 1 capital ratio of 6%; (3) a total capital ratio of less than 4.5%; and (4) a Tier 1 leverage ratio of 4%. An institution is deemed to be “undercapitalized” if it has (1) a common equity Tier 1 capital ratio of less than 4.5%; (2) a Tier 1 capital ratio of less than 6%; (3) a total capital ratio of less than 8%; and (4) a Tier 1 leverage ratio of less than 4%. An institution is deemed to be “significantly undercapitalized” if it has (1) a common equity Tier 1 capital ratio of less than 3%; (2) a Tier 1 capital ratio of less than 4%; (3) a total capital ratio of less than 6%; and (4) a Tier 1 leverage ratio of less than 3%. An institution is considered to be “critically undercapitalized” if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2%. As of December 31, 2018, the Company and the Bank met the conditions to be classified as a “well capitalized” institution.
“Undercapitalized” banks must adhere to growth, capital distribution (including dividend) and other limitations and are required to submit a capital restoration plan. No institution may make a capital distribution, including payment as a dividend, if it would be “undercapitalized” after the payment. A bank’s compliance with such plans is required to be guaranteed by its parent holding company in an amount equal to the lesser of 5% of the institution’s total assets when deemed undercapitalized or the amount needed to comply with regulatory capital requirements. If an “undercapitalized” bank fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.” “Significantly undercapitalized” banks must comply with one or more of a number of additional restrictions, including but not limited to an order by the FDIC to sell sufficient voting stock to become adequately capitalized, requirements to reduce assets and cease receipt of deposits from correspondent banks or dismiss directors or officers, and restrictions on interest rates paid on deposits, compensation of executive officers and capital distributions by the parent holding company. “Critically undercapitalized” institutions must comply with additional sanctions including, subject to a narrow exception, the appointment of a receiver or conservator within 270 days after it obtains such status.
Investments and Activities. Under federal law, all state-chartered banks insured by the FDIC have generally been limited to activities as principal and equity investments of the type and in the amount authorized for national banks, notwithstanding state law. The Federal Deposit Insurance Corporation Improvement Act and the FDIC permit exceptions to these limitations. For example, state chartered banks may, with FDIC approval, continue to exercise grandfathered state authority to invest in common or preferred stocks listed on a national securities exchange and in the shares of an investment company registered under federal law. The Bank received grandfathering authority from the FDIC to invest in listed stocks and/or registered shares. The maximum permissible investment is 100% of Tier 1 capital, as specified by the FDIC’s regulations, or the maximum amount permitted by Pennsylvania Banking Law, whichever is less. Such grandfathering authority may be terminated upon the FDIC’s determination that such investments pose a safety and soundness risk to the Bank or if the Bank converts its charter or undergoes a change in control. In addition, the FDIC is authorized to permit such institutions to engage in other state authorized activities or investments (other than non-subsidiary equity investments) that meet all applicable capital requirements if it is determined that such activities or investments do not pose a significant risk to the Deposit Insurance Fund. As of December 31, 2018, the Bank held no marketable equity securities under such grandfathering authority.
Transactions with Related Parties. Federal law limits the Bank’s authority to lend to, and engage in certain other transactions with (collectively, “covered transactions”) its “affiliates” (e.g., any company that controls or is under common control with an institution). The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the savings institution. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type specified by federal law. The purchase of low quality assets from affiliates is generally prohibited. Transactions with affiliates must generally be on terms and under circumstances, that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliates. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank or financial holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary.
The Sarbanes-Oxley Act of 2002 generally prohibits loans by the Bank to its executive officers and directors. However, the law contains a specific exception for loans by the Bank to its executive officers and directors in compliance with federal banking laws. Under such laws, the Bank’s authority to extend credit to executive officers, directors and 10% shareholders (“insiders”), as well as entities such persons control, is limited. The law limits both the individual and aggregate amount of loans the Bank may make to insiders based, in part, on the Bank’s capital position and requires certain board approval procedures to be followed. Such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. There
is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. Loans to executives are subject to further limitations based on the type of loan involved.
Enforcement. The FDIC has extensive enforcement authority over insured savings banks, including the Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease and desist orders and to remove directors and officers. In general, these enforcement actions may be initiated in response to violations of laws and regulations and unsafe or unsound practices.
Standards for Safety and Soundness. As required by statute, the federal banking agencies have adopted Interagency Guidelines prescribing Standards for Safety and Soundness. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the FDIC determines that a savings institution fails to meet any standard prescribed by the guidelines, the FDIC may require the institution to submit an acceptable plan to achieve compliance with the standard.
Insurance of Deposit Accounts. The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. The deposit insurance per account owner is currently $250,000.
Under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors, with less risky institutions paying lower assessments. An institution’s assessment rate depends upon the category to which it is assigned. In 2011, the FDIC approved a final rule that implemented changes to the deposit insurance assessment system mandated by the Dodd-Frank Act. Under the final rule, assessment base for payment of FDIC premiums was changed from a deposit level base to an asset level base consisting of average tangible assets less average tangible equity.
The FDIC may adjust rates uniformly from one quarter to the next, except that no adjustment can deviate more than three basis points from the base scale without notice and comment rulemaking. No institution may pay a dividend if in default of the FDIC assessment.
The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and our results of operations. Management cannot predict what insurance assessment rates will be in the future.
On June 30, 2016, the Deposit Insurance Fund’s designated reserve ratio rose to 1.17% from 1.13% on March 31, 2016. FDIC regulations provided for three changes to deposit insurance assessments the quarter after the designated reserve ratio reaches or surpasses 1.15%. As a result, effective July 1, 2016, (1) the range of initial assessment rates for all institutions declined based on final rules approve by the FDIC in February 2011 and April 2016; (2) surcharges on insured depository institutions with total consolidated assets of $10 billion or more (large banks) began to be assessed by the FDIC; and (3) a revised method to calculate risk-based assessment rates for established small banks became applicable pursuant to a final rule approved by the FDIC in April 2016. The surcharge on large banks, which equals 4.5 basis points of the institution’s deposit insurance assessment base, was in effect for assessments billed after the designated reserve ratio reaches 1.15% and would continue until it reaches 1.35%. On September 30, 2018, the deposit insurance fund reserve ratio reached 1.36%. As a result, Beneficial Bank was awarded an assessment credit for the portion of its assessment that contributed to the growth in the reserve ratio from 1.15% to 1.35%. This credit will be applied when the reserve ratio is at least 1.38%.
Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the Pennsylvania Department of Banking and Securities. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank system, which consists of 11 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central credit facility primarily for member institutions. At December 31, 2018, Beneficial Bank had a maximum borrowing capacity from the Federal Home Loan Bank of Pittsburgh of $2.0 billion of which it had $515.0 million in outstanding advances. The balance remaining of $1.5 billion is our unused borrowing capacity with the Federal Home Loan Bank at December 31, 2018. Beneficial Bank, as a member of the Federal Home Loan Bank of Pittsburgh, is required to acquire and hold shares of capital stock in that Federal Home Loan Bank. Beneficial Bank was in compliance with requirements for the Federal Home Loan Bank of Pittsburgh with an investment of $23.2 million at December 31, 2018.
Community Reinvestment Act. Under the Community Reinvestment Act, as implemented by FDIC regulations, a state non-member bank has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate-income neighborhoods. The Community Reinvestment Act neither establishes specific lending requirements or programs for financial institutions nor limits an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community. The Community Reinvestment Act requires the FDIC, in connection with its examination of an institution, to assess the institution’s record of meeting the credit needs of its community and to consider such record when it evaluates applications made by such institution. The Community Reinvestment Act requires public disclosure of an institution’s Community Reinvestment Act rating. The Bank’s latest Community Reinvestment Act rating received from the FDIC was “outstanding.”
Bank Secrecy Act and Anti-Money Laundering. Federal laws and regulations impose obligations on U.S. financial institutions, including banks and broker/dealer subsidiaries, to implement and maintain appropriate policies, procedures and controls which are reasonably designed to prevent, detect and report instances of money laundering and the financing of terrorism and to verify the identity of their customers. In addition, these provisions require the federal financial institution regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and bank holding company acquisitions. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing could have serious legal and reputational consequences for the institution.
Office of Foreign Assets Control Regulation. The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. These are typically known as the “OFAC” rules based on their administration by the U.S. Treasury Department Office of Foreign Assets Control (“OFAC”). The OFAC-administered sanctions targeting countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “U.S. persons” engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g. property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences.
Other Regulations. Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank’s operations are also subject to federal laws applicable to credit transactions, such as the:
· Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
· Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
· Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
· Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies;
· Fair Debt Collection Practices Act, governing the manner in which consumer debts may be collected by collection agencies; and
· Rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.
The operations of the Bank also are subject to the:
· Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;
· Electronic Funds Transfer Act and Regulation E promulgated thereunder, which establishes the rights, liabilities and responsibilities of consumers who use electronic fund transfer (EFT) services and financial institutions that offer these services; its primary objective is the protection of individual consumers in their dealings with these services;
· Check Clearing for the 21st Century Act (also known as “Check 21”), which allows banks to create and receive “substitute checks” (paper reproduction of the original check), and discloses the customers rights regarding “substitute checks” pertaining to these items having the “same legal standing as the original paper check”;
· Title III of The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (referred to as the “USA PATRIOT Act”), and related regulations that require savings associations operating in the United States to develop new anti-money laundering compliance programs (including a customer identification program that must be incorporated into the anti-money laundering compliance program), due diligence policies and controls to ensure the detection and reporting of money laundering;
· The Gramm-Leach-Bliley Act, which prohibits a financial institution from disclosing non-public personal information about a consumer to non-affiliated third parties, unless the institution satisfies various notice and opt-out requirements;
· The Fair and Accurate Reporting Act of 2003, as an amendment to the Fair Credit Reporting Act, as noted previously, which includes provisions to help reduce identity theft by providing procedures for the identification, detection, and response to patterns, practices, or specific activities-known as “red flags”; and
· Truth in Savings Act, which establishes the requirement for clear and uniform disclosure of terms and conditions regarding interest and fees to help promote economic stability, competition between depository institutions, and allow the consumer to
make informed decisions.
Holding Company Regulation
General. As a financial holding company, the Company is subject to examination, regulation and periodic reporting under the Bank Holding Company Act of 1956, as amended, as administered by the Federal Reserve Board. As a result, prior Federal Reserve Board approval would be required for the Company to acquire direct or indirect ownership or control of any voting securities of any bank or bank or financial holding company if, after such acquisition, it would, directly or indirectly, own or control more than 5% of any class of voting shares of the bank or bank holding company. In addition to the approval of the Federal Reserve Board, before any bank acquisition can be completed, prior approval may also be required to be obtained from other agencies having supervisory jurisdiction over the bank to be acquired.
A bank or financial holding company is generally prohibited from engaging in, or acquiring, direct or indirect control of more than 5% of the voting securities of any company engaged in non-banking activities. One of the principal exceptions to this prohibition is for activities found by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the principal activities that the Federal Reserve Board has determined by regulation to be so closely related to banking are: (1) making or servicing loans; (2) performing certain data processing services; (3) providing discount brokerage services; (4) acting as fiduciary, investment or financial advisor; (5) leasing personal or real property; (6) making investments in corporations or projects designed primarily to promote community welfare; and (7) acquiring a savings and loan association.
The Company is also subject to the Federal Reserve Board’s capital adequacy guidelines for bank and financial holding companies (on a consolidated basis) substantially similar to those of the FDIC for the Bank.
A financial holding company is generally required to give the Federal Reserve Board prior written notice of any purchase or redemption of then outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the company’s consolidated net worth. The Federal Reserve Board may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, Federal Reserve Board order or directive, or any condition imposed by, or written agreement with, the Federal Reserve Board. The Federal Reserve Board has adopted an exception to this approval requirement for well-capitalized bank and financial holding companies that meet certain other conditions.
The Federal Reserve Board has issued a policy statement regarding the payment of dividends by bank or financial holding companies. In general, the Federal Reserve Board’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank or financial holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. The Federal Reserve Board’s policies also require that a bank or financial holding company serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. Under the prompt corrective action laws, the ability of a bank or financial holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions.
Under the Federal Deposit Insurance Act, depository institutions are liable to the FDIC for losses suffered or anticipated by the FDIC in connection with the default of a commonly controlled depository institution or any assistance provided by the FDIC to such an institution in danger of default. This law would have potential applicability if the Company ever held as a separate subsidiary a depository institution in addition to the Bank.
The Company and the Bank will be affected by the monetary and fiscal policies of various agencies of the United States Government, including the Federal Reserve System. In view of changing conditions in the national economy and in the money markets, it is impossible for management to accurately predict future changes in monetary policy or the effect of such changes on the business or financial condition of the Company or the Bank.
The status of the Company as a registered financial holding company under the Bank Holding Company Act does not exempt it from certain federal and state laws and regulations applicable to corporations generally, including, without limitation, certain provisions of the federal securities laws.
Under the Change in Bank Control Act, a notice must be submitted to the Federal Reserve Board if any person (including a company), or group acting in concert, seeks to acquire direct or indirect “control” of a bank or financial holding company or savings association. Under certain circumstances, a change of control may occur, and prior notice is required, upon the acquisition of 10% or more of the outstanding voting stock of the company or institution, unless the Federal Reserve Board has found that the acquisition will not result in a change of control. Under the Change in Control Act, the Federal Reserve Board generally has 60 days from the filing of a complete
notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the acquisition. Any company that acquires control would then be subject to regulation as a bank company.
Federal Securities Laws
The Company’s common stock is registered with the Securities and Exchange Commission under the Securities Exchange Act. As a result, the Company is required to file quarterly and annual reports with the Securities and Exchange Commission and is subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act.
Federal Income Taxation
General. We report our income on a calendar year basis using the accrual method of accounting. The Tax Cuts and Jobs Act was enacted on December 22, 2017 and lowered the federal corporate tax rate in 2018 to 21% from 35%. Under ASC 740, the effects of changes in tax rates and laws on deferred tax balances are recorded as a component of income tax expense related to continuing operations for the period in which the law was enacted, even if the assets and liabilities related to items of accumulated other comprehensive income. The Company re-measured its net deferred tax assets at the current 21% federal corporate tax rate and, as a result, the Company recorded $13.1 million of additional income tax expense during the year ended December 31, 2017.
The federal income tax laws apply to us in the same manner as to other corporations with some exceptions, including particularly our reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to us. The 2016 and 2017 tax years remain subject to examination by the Internal Revenue Service. For 2018, the Company’s maximum federal income tax rate was 21%. The Company’s maximum federal income tax rate will be 21% in 2018 and future periods.
Beneficial Bancorp and Beneficial Bank have entered into a tax allocation agreement. Because Beneficial Bancorp owns 100% of the issued and outstanding capital stock of Beneficial Bank, Beneficial Bancorp and Beneficial Bank are members of an affiliated group within the meaning of Section 1504(a) of the Internal Revenue Code, of which group Beneficial Bancorp is the common parent corporation. As a result of this affiliation, Beneficial Bank may be included in the filing of a consolidated federal income tax return with Beneficial Bancorp and, if a decision to file a consolidated tax return is made, the parties have agreed to compensate each other for their individual share of the consolidated tax liability and/or any tax benefits provided by them in the filing of the consolidated federal income tax return.
Bad Debt Reserves. For fiscal years beginning before June 30, 1996, thrift institutions that qualified under certain definitional tests and other conditions of the Internal Revenue Code were permitted to use certain favorable provisions to calculate their deductions from taxable income for annual additions to their bad debt reserve. A reserve could be established for bad debts on qualifying real property loans, generally secured by interests in real property improved or to be improved, under the percentage of taxable income method or the experience method. The reserve for non-qualifying loans was computed using the experience method. Federal legislation enacted in 1996 repealed the reserve method of accounting for bad debts and the percentage of taxable income method for tax years beginning after 1995 and required savings institutions to recapture or take into income certain portions of their accumulated bad debt reserves as of December 31, 1987. Approximately $1.4 million of income tax related to our accumulated bad debt reserves would not be recognized unless Beneficial Bank makes a “non-dividend distribution” to Beneficial Bancorp as described below.
Distributions. If Beneficial Bank makes “non-dividend distributions” to Beneficial Bancorp, the distributions will be considered to have been made from Beneficial Bank’s un-recaptured tax bad debt reserves, including the balance of its reserves as of December 31, 1987, to the extent of the “non-dividend distributions,” and then from Beneficial Bank’s supplemental reserve for losses on loans, to the extent of those reserves, and an amount based on the amount distributed, but not more than the amount of those reserves, will be included in Beneficial Bank’s taxable income. Non-dividend distributions include distributions in excess of Beneficial Bank’s current and accumulated earnings and profits, as calculated for federal income tax purposes, distributions in redemption of stock, and distributions in partial or complete liquidation. Dividends paid out of Beneficial Bank’s current or accumulated earnings and profits will not be so included in Beneficial Bank’s taxable income.
The amount of additional taxable income triggered by a non-dividend is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Therefore, if Beneficial Bank makes a non-dividend distribution to Beneficial Bancorp, approximately one and one-quarter times the amount of the distribution not in excess of the amount of the reserves would be includable in income for federal income tax purposes, assuming a 21% federal corporate income tax rate. Beneficial Bank does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserves.
State, City and Local Taxation
Beneficial Bank is a savings bank conducting business in Pennsylvania (PA), New Jersey (NJ) and Philadelphia (PHL), and is subject to tax under the Pennsylvania Mutual Thrift Institutions Tax (“MTIT”) Act, New Jersey’s Corporation Business Tax, and the City of Philadelphia Business Privilege Tax. The MTIT is a tax upon separately stated net book income, determined in accordance with generally accepted accounting principles with certain adjustments. The MTIT tax rate is 11.5%. Net operating losses, if any, can be carried forward a maximum of three years for MTIT purposes. New Jersey’s Corporation Business Tax is calculated based on separate company apportioned taxable income, where taxable income is determined based on federal taxable income, subject to certain state adjustments and modifications. The New Jersey corporate income tax rate is 9.0%. On July 1, 2018, New Jersey signed into law Assembly Bill 4202, which significantly revises New Jersey’s Corporation Business Tax laws. Assembly Bill 4202 imposes a surtax on Corporation Business
Tax taxpayers of 2.5% for the tax years 2018 and 2019 and 1.5% for the tax years 2020 and 2021. For tax years beginning on or after January 1, 2019, combined unitary filing is required. Net operating losses may be carried forward for twenty years following the tax year for which they were first reported. The City of Philadelphia Business Privilege Tax is a tax upon net income (6.35%) or taxable gross receipts (.14%) imposed on persons carrying on or exercising for gain or profit certain business activities within Philadelphia. For regulated industry taxpayers, the tax is the lesser of the tax on net income or the tax on gross receipts. The tax years 2015 through 2017 remain subject to examination by various state and local taxing authorities.
Beneficial Equipment Finance Corporation (“BEFC”) is a corporation that is in the business of leasing small equipment and fixed assets. As a result of its leasing transactions, BEFC files as a separate company in several state and local jurisdictions and Beneficial Bancorp and its affiliates file in several unitary jurisdictions. These state and local jurisdictions have net operating loss carry forward periods between three and twenty years. Additionally, Beneficial Bank has other subsidiaries that file in Pennsylvania, Maryland and Delaware. These jurisdictions allow for net operating loss carryforwards that can be carried forward for twenty years.
Executive Officers
Our executive officers are elected annually by the board of directors and serve at the board’s discretion. The following individuals currently serve as executive officers of the Company and the Bank:
Below is information regarding our executive officers. Each executive officer has held his or her current position for the period indicated below. Ages presented are as of December 31, 2018.
Gerard P. Cuddy has served as President and Chief Executive Officer since 2006. From May 2005 to November 2006, Mr. Cuddy was a senior lender at Commerce Bank. From 2002 to 2005, Mr. Cuddy served as a Senior Vice President of Fleet/Bank of America. Before his service with Fleet/Bank of America, Mr. Cuddy held senior management positions with First Union National Bank and Citigroup. Age 59.
Joseph V. Canosa was named Executive Vice President in February 2018. Mr. Canosa joined Beneficial Bank in 2014 as a Senior Credit Officer and was appointed Chief Credit Officer in 2016. Before that time, Mr. Canosa served as Senior Vice President and Senior Credit Officer of Sun National Bank. Age 57.
Thomas D. Cestare joined Beneficial Bank as Executive Vice President and Chief Financial Officer of Beneficial Bank in July 2010. Before joining Beneficial Bancorp and Beneficial Bank, Mr. Cestare served as Executive Vice President and Chief Accounting Officer of Sovereign Bancorp. Mr. Cestare is a certified public accountant who was a partner with the public accounting firm of KPMG LLP before joining Sovereign Bancorp in 2005. Age 50.
Pamela M. Cyr has served as Executive Vice President and Chief Retail Banking Officer since June 2012. Ms. Cyr is the former President and Chief Executive Officer of SE Financial Corp. Age 51.
Martin F. Gallagher has served as Executive Vice President and Chief Lending Officer of Beneficial Bank since February 2015. Mr. Gallagher joined Beneficial in 2011 to build the Bank’s commercial lending business while enhancing the Bank’s overall credit approach. He was named Chief Credit Officer in 2012, overseeing credit, portfolio management, and special assets/workout. Before that time, Mr. Gallagher managed and developed commercial banking portfolios for Bryn Mawr Trust Company and National Penn Bank. Age 62.
Joanne R. Ryder has served as Executive Vice President and Chief Administration Officer since April 2015. Ms. Ryder joined Beneficial Bank in July 2007 and was named Executive Vice President and Director of Brand & Strategy in January 2012. Before that time, Ms. Ryder served as Vice President, Field Marketing Manager at Commerce Bank. Age 44.
Item 1A.
Item 1A. RISK FACTORS
Completion of our previously announced merger with WSFS Financial Corporation is subject to certain conditions, and if these conditions are not satisfied or waived, the Merger will not be completed.
We currently expect our previously announced business combination with WSFS to be completed during the first quarter of 2019. However, the obligations of WSFS and us to complete the Merger are subject to the satisfaction or waiver (if permitted) of a number of conditions. The satisfaction of all of the required conditions could delay the completion of the Merger for a significant period of time or prevent it from occurring. Any delay in completing the Merger could cause the combined company not to realize some or all of the benefits that the combined company expects to achieve if the Merger is successfully completed within its expected timeframe. Further, there can
be no assurance that the conditions to the closing of the Merger will be satisfied or waived or that the merger will be completed.
Failure to complete our previously announced merger with WSFS Financial Corporation could negatively impact our stock price and our future business and financial results.
If our proposed merger with WSFS is not completed for any reason, our ongoing business may be adversely affected and, without realizing any of the benefits of having completed the Merger, we would be subject to a number of risks, including the following:
· We are subject to certain restrictions on the conduct of our business prior to completing the Merger, which may adversely affect our abilities to execute certain of our business strategies;
· We may experience negative reactions from the financial markets, including negative impacts on our stock price or from our customers, regulators and employees;
· We have incurred and will continue to incur certain costs and fees associated with the Merger and other transactions contemplated by the Merger Agreement; and
· Matters relating to the Merger (including integration planning) have required substantial commitments of time and resources by our management, which would otherwise have been devoted to day-to-day operations and other opportunities that may have been beneficial to us as an independent company.
In addition, we could be subject to litigation related to any failure to complete the Merger or related to any enforcement proceeding commenced against us to perform our obligations under the Merger Agreement. If the Merger is not completed, these risks may adversely affect our business, financial condition, results of operations and stock price.
Our business is subject to interest rate risk and variations in interest rates may negatively affect our financial performance.
Changes in the interest rate environment may reduce profits. The primary source of our income is the differential or “spread” between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities. As prevailing interest rates change, net interest spreads are affected by the difference between the maturities and re-pricing characteristics of interest-earning assets and interest-bearing liabilities. At December 31, 2018, we were asset sensitive and would benefit from an increase in interest rates. In the event of a 200 basis point increase in interest rates, we would expect to experience a 5.0% increase in net interest income. Because the prospective effects of hypothetical interest rate changes are based on a number of assumptions, these computations should not be relied upon as indicative of actual results.
In addition, loan volume and yields are affected by market interest rates on loans, and rising interest rates generally are associated with a lower volume of loan originations. An increase in the general level of interest rates may also adversely affect the ability of certain borrowers to pay the interest on and principal of their obligations. Accordingly, changes in levels of market interest rates could materially adversely affect our net interest spread, asset quality, loan origination volume and overall profitability. In addition, our deposits are subject to increases in interest rates and as interest rates rise we may lose these deposits if we do not pay competitive interest rates, which may affect our liquidity and profits.
Our emphasis on commercial loans may expose us to increased lending risks.
At December 31, 2018, $1.54 billion, or 39.6%, of our loan portfolio consisted of commercial real estate loans, $615.2 million, or 15.8%, of our loan portfolio consisted of commercial business loans, and $188.5 million, or 4.8%, of our loan portfolio consisted of commercial construction loans, including loans for the acquisition and development of property. At December 31, 2018, we had a total of 51 land acquisition and development loans totaling $149.3 million included primarily in commercial real estate and commercial construction loans, which consist of 23 residential land acquisition and development loans totaling $86.0 million and 28 commercial land acquisition and development loans totaling $63.3 million. We are committed to growing our commercial banking business and, over the past few years, we have hired additional lenders with significant experience in our market area to expand our commercial real estate and commercial and industrial lending efforts. We expect to continue to look for additional qualified lenders to further accelerate our commercial loan growth.
Commercial real estate loans and commercial business loans generally expose a lender to a greater risk of loss than one- to four-family residential loans. Repayment of commercial real estate and commercial business loans generally is dependent, in large part, on sufficient income from the property or business to cover operating expenses and debt service. Commercial real estate loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one- to four-family residential mortgage loans. Changes in economic conditions that are out of the control of the borrower and lender could impact the value of the security for the loan, the future cash flow of the affected property, or the marketability of a construction project with respect to loans originated for the acquisition and development of property. Additionally, any decline in real estate values may be more pronounced with respect to commercial real estate properties than residential properties. Also, many of our multi-family and commercial real estate and commercial business borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a residential mortgage loan. Further, unlike residential mortgages or multi-family and commercial real estate loans, commercial and industrial loans may be secured by collateral other than real estate, such as inventory and accounts receivable, the value of which may be more difficult to appraise and may be more susceptible to fluctuation in value at default.
Commercial business loans include shared national credits, which are participations in loans or loan commitments of at least $20.0 million that are shared by three or more banks. Effective January 1, 2018, the federal banking agencies have changed the aggregate loan commitment threshold for inclusion in the shared national credit program from $20 million to $100 million. Included in our shared national credit portfolio are purchased participations and assignments in leveraged lending transactions. Leveraged lending transactions are generally used to support a merger- or acquisition-related transaction, to back a recapitalization of a company’s balance sheet or to refinance debt. When considering a participation in the leveraged lending market, we will participate only in first lien senior secured term loans that are highly rated (investment grade) by the rating agencies and that trade in active secondary markets. Even though we intend to hold these loans in our portfolio, we actively monitor the secondary market for these types of loans to ensure that we maintain flexibility to sell such loans in the event of deteriorating credit quality. To further minimize risk, based on our current capital levels and loan portfolio, we have limited the total amount of leveraged loans to $150.0 million with no single obligor exceeding $15.0 million while maintaining single industry concentrations below 30%. However, we may reevaluate these limits in future periods. At December 31, 2018, shared national credits totaled $139.5 million, which included $83.4 million of leveraged lending transactions.
Strong competition within our market area could hurt our profits and slow growth.
We face substantial competition in originating loans, both commercial and consumer. This competition comes principally from other banks, savings institutions, mortgage banking companies and other lenders. Many of our competitors enjoy advantages that we do not, including greater financial resources and higher lending limits, a wider geographic presence, more accessible branch office locations, the ability to offer a wider array of services or more favorable pricing alternatives, as well as lower origination and operating costs. This competition could reduce our net income by decreasing the number and size of loans that we originate and the interest rates we may charge on these loans.
In attracting business and consumer deposits, we face substantial competition from other insured depository institutions such as banks, savings institutions and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds. Many of our competitors enjoy advantages that we do not, including greater financial resources, more aggressive marketing campaigns, better brand recognition and more branch locations. These competitors may offer higher interest rates than we do, which could decrease the deposits that we attract or require us to increase our rates to retain existing deposits or attract new deposits. Increased deposit competition could adversely affect our ability to generate the funds necessary for lending operations. As a result, we may need to seek other sources of funds that may be more expensive to obtain and could increase our cost of funds.
Our banking and non-banking subsidiaries also compete with non-bank providers of financial services, such as brokerage firms, consumer finance companies, credit unions, insurance agencies, on-line banks, financial technology companies and governmental organizations, which may offer more favorable terms. Some of our non-bank competitors are not subject to the same extensive regulations that govern our banking operations. As a result, such non-bank competitors may have advantages over our banking and non-banking subsidiaries in providing certain products and services. Technological change is influencing how individuals and firms conduct their financial affairs and changing the delivery channels for financial services, with the result that the Company may have to contend with a broader range of competitors including many that are not located within the geographic footprint of its banking office network. This competition may reduce or limit our margins on banking and non-banking services, reduce our market share, and adversely affect our earnings and financial condition.
In addition, our performance is largely dependent on the talents and efforts of highly skilled individuals. Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly skilled personnel for all areas of our organization. Competition in our industry for qualified employees is intense, and we are aware that certain of our competitors have directly targeted our employees. Our continued ability to compete effectively depends on our ability to attract new employees and to retain and motivate our existing employees.
Our emphasis on residential mortgage loans and home equity loans exposes us to lending risks, and the geographic concentration of our loan portfolio and lending activities makes us vulnerable to a downturn in the local economy.
At December 31, 2018, $968.9 million, or 24.9% of our loan portfolio, consisted of one- to four-family residential real estate loans and $201.5 million, or 5.2% of our loan portfolio, consisted of home equity loans and lines of credit. One- to four-family residential mortgage lending is generally sensitive to regional and local economic conditions that significantly impact the ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict. Declines in real estate values could cause some of our residential mortgages and home equity loans to be inadequately collateralized, which would expose us to a greater risk of loss if we seek to recover on defaulted loans by selling the real estate collateral. Real estate values are affected by various factors, including supply and demand, changes in general or regional economic conditions, interest rates, governmental rules or policies and natural disasters. Future weakness in economic conditions also could result in reduced loan demand and a decline in loan originations. In particular, a significant decline in real estate values would likely lead to a decrease in new multi-family, commercial real estate, residential mortgage, and home equity loan originations and increased delinquencies and defaults in our real estate loan portfolio.
A return to recessionary conditions could result in increases in our level of non-performing loans and/or reduce demand for our products and services, which would lead to lower revenue, higher loan losses and lower earnings.
Although economic conditions have improved since the end of the economic recession in June 2009, economic growth has been slower than in past recoveries and the recovery is entering its tenth year which is longer than past recoveries. A return of recessionary conditions and/or continued negative developments in the domestic and international credit markets may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Further declines in real estate values and sales volumes and increases in unemployment levels may result in higher than expected loan delinquencies, increases in our
levels of nonperforming and classified assets and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital, liquidity and financial condition.
If our allowance for loan losses is not sufficient to cover actual loan losses, our results of operations will be negatively impacted.
In determining the amount of the allowance for loan losses, we analyze our loss and delinquency experience by loan categories and we consider the effect of existing economic conditions. In addition, we make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. If the results of our analyses are incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, which would require additions to our allowance and would decrease our net income. Our emphasis on loan growth and on increasing our portfolio of multi-family, commercial business and commercial real estate loans, as well any future credit deterioration, could also require us to increase our allowance further in the future.
In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities may have a material adverse effect on our results of operations and financial condition.
A significant percentage of our assets is invested in securities which typically have a lower yield than our loan portfolio.
Our results of operations are substantially dependent on our net interest income. At December 31, 2018, 27.3% of our assets were invested in investment securities, overnight investments and cash and due from banks. These investments yield substantially less than the loans we hold in our portfolio. While we intend to invest a greater proportion of our assets in loans with the goal of increasing our net interest income, we may not be able to increase originations of loans that are acceptable to us.
We hold goodwill, an intangible asset, that could be classified as impaired in the future. If goodwill is considered to be either partially or fully impaired in the future, our earnings and the book value of goodwill would decrease.
We are required to test our goodwill for impairment on a periodic basis. The impairment testing process considers a variety of factors, including the current market price of our common shares, the estimated net present value of our assets and liabilities and information concerning the terminal valuation of similarly situated insured depository institutions. It is possible that future impairment testing could result in a partial or full impairment of the value of our goodwill. If an impairment determination is made in a future reporting period, our earnings and the book value of goodwill will be reduced by the amount of the impairment.
We may be adversely affected by recent changes in U.S. tax laws and regulations.
Changes in tax laws contained in the Tax Cuts and Jobs Act, which was enacted in December 2017, include a number of provisions that will have an impact on the banking industry, borrowers and the market for residential real estate. Included in this legislation was a reduction of the corporate income tax rate from 35% to 21%. In addition, other changes included: (i) a lower limit on the deductibility of mortgage interest on single-family residential mortgage loans, (ii) the elimination of interest deductions for home equity loans, (iii) a limitation on the deductibility of business interest expense and (iv) a limitation on the deductibility of property taxes and state and local income taxes.
The recent changes in the tax laws may have an adverse effect on the market for, and valuation of, residential properties, and on the demand for such loans in the future, and could make it harder for borrowers to make their loan payments. In addition, these recent changes may also have a disproportionate effect on taxpayers in states with high residential home prices and high state and local taxes, such as Pennsylvania and New Jersey. If home ownership becomes less attractive, demand for mortgage loans could decrease. The value of the properties securing loans in our loan portfolio may be adversely impacted as a result of the changing economics of home ownership, which could require an increase in our provision for loan losses, which would reduce our profitability and could materially adversely affect our business, financial condition and results of operations.
The preparation of our tax returns requires the use of estimates and interpretations of complex tax laws and regulations and is subject to review by taxing authorities.
We are subject to the income tax laws of the U.S., its states and municipalities. These tax laws are complex and subject to different interpretations by the taxpayer and the relevant governmental taxing authorities. In establishing a provision for income tax expense and filing returns, we must make judgments and interpretations about the application of these inherently complex tax laws. Actual income taxes paid may vary from estimates depending upon changes in income tax laws, actual results of operations, and the final audit of tax returns by taxing authorities. Tax assessments may arise several years after tax returns have been filed. We are subject to ongoing tax examinations and assessments in various jurisdictions.
As of December 31, 2018, we had net deferred tax assets totaling $21.7 million. These deferred tax assets can only be realized if we generate taxable income in the future. We regularly evaluate the realizability of deferred tax asset positions. In determining whether a valuation allowance is necessary, we consider estimates of future pre-tax and taxable income and tax planning strategies that would, if necessary, be implemented. We currently maintain a valuation allowance for certain state net operating losses that management believes it is more likely than not that such deferred tax assets will not be realized. We expect to realize our remaining deferred tax assets over the allowable carryforward periods. Therefore, no valuation allowance is deemed necessary against our federal or remaining state deferred tax assets as of December 31, 2018. However, if an unanticipated event occurred that materially changed pre-tax and taxable income in future periods, an increase in the valuation allowance may become necessary and it could be material to our financial statements. Our net deferred tax asset of $21.7 million was determined based on the current enacted federal tax rate of 21%. The
passage of the Tax Cuts and Jobs Act Act in December 2017 lowered the federal corporate tax rate for 2018 to 21% from 35%. The Company re-measured its net deferred tax assets at the current 21% federal corporate tax rate and, as a result, the Company recorded $13.1 million of additional income tax expense during the year ended December 31, 2017. Any possible future reduction in federal tax rates, would reduce the value of our net deferred tax assets and result in immediate write-down of the net deferred tax assets though our statement of operations, the effect of which would be material.
We operate in a highly regulated environment and we may be adversely affected by changes in laws and regulations.
We are subject to extensive regulation, supervision and examination by the FDIC, as insurer of our deposits, and by the Department as our primary regulator. Beneficial Bancorp is subject to regulation and supervision by the Federal Reserve Board. Such regulation and supervision governs the activities in which an institution and its holding company may engage and are intended primarily for the protection of the insurance fund and the depositors and borrowers of Beneficial Bank rather than for holders of our common stock. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may increase our costs of operations and have a material impact on our operations.
We are now subject to more stringent capital requirements, which may adversely impact our return on equity, or constrain us from paying dividends or repurchasing shares.
In July 2013, the Federal Deposit Insurance Corporation and the Federal Reserve Board approved new rules that amended the regulatory risk-based capital rules applicable to Beneficial Bank and Beneficial Bancorp. The final rules implement the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act.
The rules include new risk-based capital and leverage ratios, which became effective on January 1, 2015, and revise the definition of what constitutes “capital” for purposes of calculating those ratios. The new minimum capital level requirements applicable to the Company and the Bank are: (1) a new common equity Tier 1 capital ratio of 4.5%; (2) a Tier 1 capital ratio of 6% (increased from 4%); (3) a total capital ratio of 8% (unchanged from current rules); and (4) a Tier 1 leverage ratio of 4% for all institutions. The rules eliminate the inclusion of certain instruments, such as trust preferred securities, from Tier 1 capital. Instruments issued prior to May 19, 2010 will be grandfathered for companies with consolidated assets of $15 billion or less. The rules also establish a “capital conservation buffer” of 2.5% above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital and would result in the following minimum ratios: (1) a common equity Tier 1 capital ratio of 7.0%, (2) a Tier 1 capital ratio of 8.5%, and (3) a total capital ratio of 10.5%. The new capital conservation buffer requirement started to be phased in beginning in January 2016 at 0.625% of risk-weighted assets and were increased by that amount each year until fully implemented in January 2019. An institution is subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.
The application of more stringent capital requirements for Beneficial Bank and Beneficial Bancorp could, among other things, result in lower returns on equity, require the raising of additional capital, and result in regulatory actions constraining us from paying dividends or repurchasing shares if we were to be unable to comply with such requirements.
Our framework for managing risks may not be effective in mitigating risk and loss.
Our risk management framework seeks to mitigate risk and loss. We have established processes and procedures intended to identify, measure, monitor, report and analyze the types of risk to which we are subject, including liquidity risk, interest rate risk, credit risk, market risk and reputational risk, among others. However, as with any risk management framework, there are inherent limitations to our risk management strategies and there may exist, or develop in the future, risks that we have not anticipated or identified. If our risk management framework proves to be ineffective, we could suffer unexpected losses and could be materially adversely affected.
Loss of, or failure to adequately safeguard, confidential or proprietary information may adversely affect our operations, net income or reputation.
We regularly collect, process, transmit and store significant amounts of confidential information regarding our customers, employees and others and concerning our own business, operations, plans and strategies. In some cases, this confidential or proprietary information is collected, compiled, processed, transmitted or stored by third parties on our behalf.
Information security risks have generally increased in recent years because of the proliferation of new technologies and the increased sophistication and activities of perpetrators of cyber-attacks and mobile phishing. Mobile phishing, a means for identity thieves to obtain sensitive personal information through fraudulent e-mail, text or voice mail, is an emerging threat targeting the customers of popular financial entities. A failure in or breach of our operational or information security systems, or those of our third-party service providers, as a result of cyber-attacks or information security breaches or due to employee error, malfeasance or other disruptions could adversely affect our business, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and/or cause losses.
If this confidential or proprietary information were to be mishandled, misused or lost, we could be exposed to significant regulatory consequences, reputational damage, civil litigation and financial loss.
Although we employ a variety of physical, procedural and technological safeguards to protect this confidential and proprietary information from mishandling, misuse or loss, these safeguards do not provide absolute assurance that mishandling, misuse or loss of the information
will not occur, and that if mishandling, misuse or loss of the information did occur, those events will be promptly detected and addressed. Similarly, when confidential or proprietary information is collected, compiled, processed, transmitted or stored by third parties on our behalf, our policies and procedures require that the third party agree to maintain the confidentiality of the information, establish and maintain policies and procedures designed to preserve the confidentiality of the information, and permit us to confirm the third party’s compliance with the terms of the agreement. Although we believe that we have adequate information security procedures and other safeguards in place, as information security risks and cyber threats continue to evolve, we may be required to expend additional resources to continue to enhance our information security measures and/or to investigate and remediate any information security vulnerabilities.
The failure of other companies to adequately provide key components of our business infrastructure could adversely affect our operations and revenues.
Third party vendors provide key components of our business infrastructure such as internet connections, network access and core processing systems. While we have selected these third-party vendors carefully and our agreements include requirements regarding the levels of their service quality, we ultimately do not control their actions. Any problems caused by these third parties, including those that result from their failure to provide services for any reason or their poor performance of services, could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. Replacing these third-party vendors could also entail significant delay and expense.
Item 1B.
Item 1B. UNRESOLVED STAFF COMMENTS
None.
Item 2.
Item 2. PROPERTIES
We conduct our business through our headquarters located at 1818 Market Street, Philadelphia, PA and 61 branch offices located in Bucks, Chester, Delaware, Montgomery and Philadelphia Counties in Pennsylvania and Burlington, Camden and Gloucester Counties in New Jersey. We own 31 properties and lease the other 30 properties. In Pennsylvania, we serve our customers through our four offices in Bucks County, seven offices in Delaware County, nine offices in Montgomery County, 15 offices in Philadelphia County and three offices in Chester County. In New Jersey, we serve our customers through our 18 offices in Burlington County, four offices in Camden County and one office in Gloucester County. We operate a leasing office in Chester County, Pennsylvania and Philadelphia, Pennsylvania. All branches and offices are adequate for business operation.
Item 3.
Item 3. LEGAL PROCEEDINGS
The Company and its directors had been named in a lawsuit filed in Maryland state circuit court regarding compensation levels of directors in connection with equity awards granted in the second quarter of 2016 under the Company’s 2016 Omnibus Incentive Plan. The defendants believed the lawsuit, alleging breach of fiduciary duty and unjust enrichment under Maryland law, is without merit and vigorously defended it. During the quarter ended December 31, 2018, this lawsuit was settled with the plaintiffs.
On October 15, 2018, one purported Company stockholder filed a putative class action lawsuit against Beneficial and the members of the Company’s Board of Directors in the United States District Court for the Southern District of New York, captioned Dappollone v. Beneficial Bancorp, Inc., et al., Docket No. 1:18-cv-09395. The plaintiff, on behalf of himself and similarly situated Company stockholders, generally alleged that the defendants violated Sections 14(a) and 20(a) of the Exchange Act and Rule 14a-9 promulgated thereunder by disclosing materially incomplete and misleading information about the Merger to Company stockholders. The plaintiff sought injunctive relief, unspecified damages and an award of attorneys’ fees and expenses.
On October 19, 2018, another purported Company stockholder filed a putative derivative and class action lawsuit against the Company, the members of the Company’s Board of Directors and Wilmington Savings Fund Society, FSB, in the Circuit Court for Baltimore City, Maryland, on behalf of himself and similarly situated Beneficial stockholders, and derivatively on behalf of Beneficial, captioned Parshall v. Farnesi et al., Case No. The plaintiff generally alleged that the Beneficial board of directors breached its fiduciary obligations by approving the terms of the Merger, including allegedly inadequate merger consideration and certain deal protection devices, and making materially incomplete disclosures about the merger to Company stockholders. The plaintiff sought injunctive relief, unspecified damages, and an award of attorneys’ fees and expenses.
On October 31, 2018, three other purported Company stockholders filed separate lawsuits against the Company and the members of the Company’s Board of Directors in the District Court for the District of Maryland, captioned Wolenter v. Beneficial Bancorp, Inc. et al. (Case No. 1:18-cv-03379-JKB), Karp v. Beneficial Bancorp, Inc. et. al. (Case No. 1:18-cv-03381-ELH), and Bushanksy v. Beneficial Bancorp, Inc. et al. (Case No. 1:18-cv-03382-DKC). The plaintiffs each generally alleged that the registration statement filed with the SEC on September 27, 2018 contained materially misleading omissions or misrepresentations in violation of Section 14(a) and Section 20(a) of the Exchange Act. The plaintiffs each sought injunctive relief, unspecified damages, and an award of attorneys’ fees and expenses.
On November 29, 2018, the Company filed with the SEC a Current Report on Form 8-K making additional disclosures to supplement the disclosures in the allegedly misleading proxy statement disclosures set forth in the five complaints relating to the Merger. Each plaintiff agreed that the Form 8-K mooted his or her disclosure claims, and accordingly each of the five lawsuits related to the Merger was voluntarily dismissed in January 2019
Beneficial Bancorp and Beneficial Bank are involved in routine legal proceedings in the ordinary course of business. Such routine legal proceedings, in the aggregate, are believed by management to be immaterial to our financial condition, results of operations and cash flows.
Item 4.
Item 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
Item 5.
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company’s common stock is listed on the Nasdaq Global Select Market (“Nasdaq”) under the trading symbol “BNCL.” As of February 26, 2019, the Company had approximately 2,766 holders of record of common stock.
Stock Performance Graph
The following graph provided by SNL Financial compares the cumulative total return of the Company’s common stock with the cumulative total return of the SNL Mid-Atlantic Thrift Index and the Index for the Nasdaq Stock Market (U.S. Companies, all Standard Industrial Classification, (“SIC”)). The graph assumes $100 was invested on December 31, 2012, the first day of trading of the Company’s common stock. Cumulative total return assumes reinvestment of all dividends. The performance graph is being furnished solely to accompany this report pursuant to Item 201(e) of Regulation S-K, and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is not to be incorporated by reference into any filing of the Company, whether made before or after the date hereof, regardless of any general incorporation language in such filing.
Purchases of Equity Securities
On July 21, 2016, the Company adopted a second stock repurchase program for up to 10% of its outstanding common stock, or 7,770,978 shares. During the year ended December 31, 2018, the Company purchased 945,400 shares under the second stock repurchase plan.
The Company did not repurchase any shares of its common stock during the three months ended December 31, 2018.
Item 6.
Item 6. SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
* - Noncontrolling interest relates to the majority owned subsidiary equipment leasing company, Neumann Finance Company, formed during the year ended December 31, 2017.
(1) Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost on average interest-bearing liabilities.
(2) Represents net interest income as a percent of average interest-earning assets.
(3) Represents other non-interest expenses divided by the sum of net interest income and non-interest income.
(4) Ratios are for Beneficial Bank.
(5) Non-performing loans and assets include accruing government guaranteed student loans past due 90 days or more.
(6) During 2016, the increase in the number of offices was primarily due to the addition of nine branches as part of the acquisition of Conestoga Bank.
Item 7.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Note on Forward-Looking Statements
This section contains certain “forward-looking statements” within the meaning of the federal securities laws. These statements are not historical facts, but rather are statements based on the Company’s current expectations regarding its business strategies, intended results and future performance. Forward-looking statements are preceded by terms such as “expects,” “believes,” “anticipates,” “intends” and similar expressions.
Management’s ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors that could affect actual results include, but are not limited to, our ability to complete our previously announced business combination with WSFS Financial Corporation, interest rate trends, the general economic climate in our market area, as well as nationwide, our ability to control costs and expenses, competitive products and pricing, loan delinquency rates and changes in federal and state legislation and regulation and tax laws. These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements. The Company assumes no obligation to update any forward-looking statements.
Executive Summary
On August 8, 2018, WSFS Financial Corporation (“WSFS”) and the Company issued a joint press release announcing that WSFS and the Company have entered into an Agreement and Plan of Reorganization pursuant to which the Company will merge with and into WSFS, with WSFS as the surviving entity. Under the terms of the agreement, which has been unanimously approved by the boards of directors of both companies, stockholders of Beneficial will receive 0.3013 shares of WSFS common stock and $2.93 in cash for each share of Beneficial common stock. The transaction is subject to customary closing conditions and is expected to close during the first quarter of 2019.
Our profitability is generally a function of the revenues we earn from our interest-bearing assets less the cost of our interest-bearing liabilities plus revenues we receive from non-interest income less our provision for loan losses and non-interest expenses.
Our primary source of revenue is net interest income. Net interest income, which comprises 86.2% of our revenue for the year ended December 31, 2018, is the difference between the income we earn on our loans and investments and the interest we pay on our deposits and borrowings. Changes in levels of interest rates affect our net interest income.
A secondary source of revenue is non-interest income, which is income we receive from providing products and services. Traditionally, the majority of our non-interest income has come from service charges (mostly on deposit accounts), interchange income, mortgage banking and SBA income and from fee income from our insurance and wealth management services. We discontinued our wealth management services during the first quarter of 2018 and we sold the assets and liabilities of our insurance agency subsidiary during the three months ended September 30, 2018.
Provision for loan losses is the expense we incur to cover the estimated inherent losses in our portfolio at each reporting period.
The non-interest expense represents our operating costs and consists of salaries and employee benefits expenses, the cost of our equity plans, occupancy expenses, depreciation, amortization and maintenance expenses and other miscellaneous expenses, such as loan and owned real estate expenses, advertising, insurance, professional services and printing and supplies expenses. Our largest non-interest expense is salaries and employee benefits, which consist primarily of salaries and wages paid to our employees, payroll taxes, and expenses for health insurance, retirement plans and other employee benefits.
During the year ended December 31, 2017, the Company formed Neumann Finance Company (“Neumann”), a majority owned subsidiary equipment leasing company, named after the Bank’s pioneering founder, Saint John Neumann. Neumann focuses on providing financing products and services to businesses nationwide and targets various equipment categories including technology, software, office, medical and other areas.
We recorded net income of $47.8 million, or $0.65 per diluted share, for the year ended December 31, 2018 compared to net income of $23.9 million, or $0.32 per diluted share, for the year ended December 31, 2017. Net income for the year ended December 31, 2017 included a one- time $13.1 million charge, or $0.18 per diluted share, of additional income tax expense related to the enactment of the Tax Cuts and Jobs Act and its impact on the re-measurement of our net deferred tax assets due to the reduction in the corporate income tax rate for 2018 to 21% from 35%.
Our business results for during 2018 were favorably impacted by a rise in interest rates. Net interest margin totaled 3.29% for the year ended December 31, 2018 compared to 3.12% for the year ended December 31, 2017. The increase in net interest income was primarily due to an increase in yields on the investment and loan portfolios following recent Federal Reserve Bank federal funds rate increases. During the year ended December 31, 2018, the net interest margin was positively impacted 9 basis points by loan prepayment income compared to 7 basis points during the year ended December 31, 2017.
During the quarter ended September 30, 2018, we entered into an asset purchase agreement with a third party to sell the net assets of Beneficial Insurance Services, LLC. In connection with that sale, Beneficial received net proceeds of $14.1 million and realized a net
gain of $3.3 million as the sale proceeds exceeded our carrying amount for Beneficial Insurance Services including goodwill and intangible assets. Goodwill and intangible assets that related to Beneficial Insurance Services decreased $10.2 million during the quarter ended September 30, 2018 as a result of the sale. For the nine months ending September 30, 2018, non-interest income and non-interest expense includes $4.6 million and $4.6 million, respectively, related to Beneficial Insurance Services. These non-interest income and non-interest expense items related to Beneficial Insurance Services will not occur in future periods.
Loans decreased $139.5 million, or 3.5%, to $3.89 billion at December 31, 2018, from $4.03 billion at December 31, 2017. During the year ended December 31, 2018, our residential real estate portfolio increased $25.3 million, or 2.7%. However, this growth was offset by a $54.7 million decrease in our total commercial portfolio and an $110.1 million decrease in our total consumer loan portfolio. We continue to experience a number of large commercial loan payoffs as projects are completed and sold and financing is obtained from non-bank sources. The decrease in our consumer loan portfolio was due primarily to a $63.1 million decrease in indirect auto loans resulting from our planned run-off of this portfolio segment. As previously disclosed, we decided to exit the indirect auto lending business in the first quarter of 2017.
Asset quality metrics continued to remain strong with non-performing assets to total assets, excluding government guaranteed student loans, of 0.38% as of December 31, 2018, compared to 0.36% at December 31, 2017. Our allowance for loan losses totaled $43.3 million, or 1.11% of total loans, as of December 31, 2018, compared to $43.3 million, or 1.07% of total loans, as of December 31, 2017.
During the second quarter of 2016, the Company completed its first share repurchase program since completing its mutual-to-stock conversion and related stock offering in January 2015. Under the first program, Beneficial repurchased 8,291,859 shares of its common stock. On July 21, 2016, the Company adopted a second stock repurchase program for up to 10% of its outstanding common stock, or 7,770,978 shares. During the year ended December 31, 2018, the Company purchased 945,400 shares of its common stock under the second stock repurchase plan.
During the year ended December 31, 2018, the Company declared and paid cash dividends totaling $35.7 million. On January 31, 2019, the Company declared a cash dividend of 6 cents per common share, payable on or after February 21, 2019, to common shareholders of record at the close of business on February 11, 2019.
We continue to maintain strong levels of capital and our capital ratios are well in excess of the levels required to be considered well-capitalized under applicable federal regulations for both the Company and the Bank. Our capital levels have remained strong with tangible capital to tangible assets totaling 15.75% at December 31, 2018 compared to 15.33% at December 31, 2017.
We believe in working with our customers to help them save and use credit wisely. We dedicate financial and human capital to support organizations that share our sense of responsibility to do what’s right for the communities we serve. We remain committed to the financial responsibility we have practiced throughout our history, and we are dedicated to providing financial education opportunities to our customers by providing the tools necessary to make wise financial decisions.
Current Interest Rate Environment
Net interest income represents a significant portion of our revenues. For the year ended December 31, 2018, net interest income was $180.4 million, an increase of $10.5 million, or 6.2%, from the year ended December 31, 2017. The increase in net interest income was primarily due to an increase in yields on the investment and loan portfolios following recent Federal Reserve Bank federal funds rate increases. The Company also paid off $25.8 million of a higher cost trust preferred debenture during the first quarter of 2018. Our net interest margin increased to 3.29% for the year ended December 31, 2018, from 3.12% for 2017. During the year ended December 31, 2018, the net interest margin was positively impacted by nine basis points due to loan prepayments compared to a seven basis points positive impact during the year ended December 31, 2017. Due to a slow-down in lending in our markets, the ratio of our total cash and cash equivalents and total investment securities to total assets increased to 27.3% as of December 31, 2018 compared to 24.6% as of December 31, 2017. During 2018, our cash balances increased $294.9 million to $852.5 million. Our loans-to-deposits ratio decreased to 93.3% at December 31, 2018 from 97.2% at December 31, 2017 due to continued loan prepayments and payoffs that outpaced our organic loan growth. Net interest margin in future periods will be impacted by several factors such as, but not limited to, our ability to grow and retain low cost core deposits, the future interest rate environment, loan and investment prepayment rates, loan growth and changes in non-accrual loans.
Critical Accounting Policies
In the preparation of our consolidated financial statements, we have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and that conform to general practices within the banking industry. Our significant accounting policies are described in note 3 to the consolidated financial statements included in this Annual Report.
Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies, which are discussed below, to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Actual results could differ from these judgments and estimates under different conditions, resulting in a change that could have a material impact on the carrying values of our assets and liabilities and our results of operations.
Allowance for Loan and Lease Losses. We consider the allowance for loan and lease losses to be a critical accounting policy. The allowance for loan and lease losses is determined by management based upon portfolio segment, past experience, evaluation of estimated loss and impairment in the loan or lease portfolio, current economic conditions and other pertinent factors. Management also considers risk characteristics by portfolio segments including, but not limited to, renewals and real estate valuations. The allowance for loan losses is maintained at a level that management considers adequate to provide for estimated losses and impairment based upon an evaluation of known and inherent risk in the loan portfolio. Loan impairment is evaluated based on the fair value of collateral or estimated net realizable value. While management uses the best information available to make such evaluations, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluations.
The allowance for loan and lease losses is established through a provision for loan and lease losses charged to expense, which is based upon past loan loss experience and an evaluation of estimated losses in the current loan portfolio, including the evaluation of impaired loans. Determining the amount of the allowance for loan and lease losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are: overall economic conditions; value of collateral; strength of guarantors; loss exposure at default; the amount and timing of future cash flows on impaired loans; and determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change. Management regularly reviews the level of loss experience, current economic conditions and other factors related to the collectability of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan and lease losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, the Federal Deposit Insurance Corporation and the Pennsylvania Department of Banking and Securities, as an integral part of their examination process, periodically review our allowance for loan losses. Such agencies may require us to recognize adjustments to the allowance based on judgments about information available to them at the time of their examination.
Our financial results are affected by the changes in and the level of the allowance for loan and lease losses. This process involves our analysis of complex internal and external variables, and it requires that we exercise judgment to estimate an appropriate allowance for loan losses. As a result of the uncertainty associated with this subjectivity, we cannot assure the precision of the amount reserved, should we experience sizeable loan or lease losses in any particular period. For example, changes in the financial condition of individual borrowers, economic conditions, or the condition of various markets in which collateral may be sold could require us to significantly decrease or increase the level of the allowance for loan and lease losses. Such an adjustment could materially affect net income as a result of the change in provision for credit losses. For example, a change in the estimate resulting in a 10% to 20% difference in the allowance would have resulted in an additional provision for credit losses of $4.3 million to $8.7 million for the year ended December 31, 2018. We also have approximately $30.5 million in non-performing assets consisting of non-performing loans and other real estate owned. Most of these assets are collateral dependent loans where we have incurred significant credit losses to write the assets down to their current appraised value less selling costs. We continue to assess the realizability of these loans and update our appraisals on these loans each year. To the extent the property values continue to decline, there could be additional losses on these non-performing assets which may be material. For example, a 10% decrease in the collateral value supporting the non-performing assets could result in additional credit losses of $3.0 million. In recent periods, we experienced improvement in our asset quality metrics including delinquencies, net charge-offs and non-performing assets. Management considered market conditions in deriving the estimated allowance for loan losses; however, given the continued economic difficulties, the ultimate amount of loss could vary from that estimate.
In June 2016, the FASB issued ASU 2016-13: Financial Instruments -Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. Topic 326 amends guidance on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. For assets held at amortized cost basis, Topic 326 eliminates the probable initial recognition threshold in current GAAP and, instead, requires an entity to reflect its current estimate of all expected credit losses. This update affects entities holding financial assets and net investment in leases that are not accounted for at fair value through net income. The amendments affect loans, debt securities, trade receivables, net investments in leases, off balance sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. The amendments in this update are effective for fiscal years beginning after December 15, 2019. The Company is in the process of evaluating the impact of this guidance but expects that the impact will likely be material to the consolidated financial statements.
For additional discussion related to the determination of the allowance for loan losses, see “-Risk Management-Analysis and Determination of the Allowance for Loan Losses” and the notes to the consolidated financial statements included in this Annual Report.
Income Taxes. We are subject to the income tax laws of the various jurisdictions where we conduct business and estimate income tax expense based on amounts expected to be owed to these various tax jurisdictions. The estimated income tax expense (benefit) is reported in the Consolidated Statements of Operations. The evaluation pertaining to the tax expense and related tax asset and liability balances involves a high degree of judgment and subjectivity around the ultimate measurement and resolution of these matters.
Accrued taxes represent the net estimated amount due to or to be received from tax jurisdictions either currently or in the future and are reported in other assets on our consolidated statements of financial condition. We assess the appropriate tax treatment of transactions and filing positions after considering statutes, regulations, judicial precedent and other pertinent information and maintain tax accruals consistent with our evaluation. Changes in the estimate of accrued taxes occur periodically due to changes in tax rates, interpretations of tax laws, the status of examinations by the tax authorities and newly enacted statutory, judicial and regulatory guidance that could impact the relative merits of tax positions. These changes, when they occur, impact accrued taxes and can materially affect our operating results. We regularly evaluate our uncertain tax positions and estimate the appropriate level of reserves related to each of these positions.
As of December 31, 2018, we had net deferred tax assets totaling $21.7 million. We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If currently available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax assets and liabilities. These judgments require us to make projections of future taxable income. Management believes, based upon current facts, that it is more likely than not that there will be sufficient taxable income in future years to realize the deferred tax assets. The judgments and estimates we make in determining our deferred tax assets are inherently subjective and are reviewed on a continual basis as regulatory and business factors change. Any reduction in estimated future taxable income may require us to record a valuation allowance against our deferred tax assets. A valuation allowance that results in additional income tax expense in the period in which it is recognized would negatively affect earnings. The Company currently maintains a valuation allowance for certain state net operating losses that management believes it is more likely than not that such deferred tax assets will not be realized. Therefore, no valuation allowance is deemed necessary against our remaining federal or remaining state deferred tax assets as of December 31, 2018. Our net deferred tax asset of $21.7 million was determined based on the current enacted federal tax rate of 21%. Any possible future reduction in federal tax rates, would reduce the value of our net deferred tax assets and result in immediate write-down of the net deferred tax assets though our statement of operations, the effect of which would be material.
Balance Sheet Analysis
Total assets were $5.81 billion at December 31, 2018 consistent with the $5.80 billion of total assets at December 31, 2017. Due to a slowdown in loan demand and maintaining our excess liquidity, we experienced a change in the mix of our balance sheet with the loan and investment securities portfolios decreasing and cash and cash equivalents increasing. Cash and cash equivalents increased $294.9 million, or 52.9%, to $852.5 million at December 31, 2018, from $557.6 million at December 31, 2017.
Securities
Investments decreased $137.4 million, or 15.8%, to $733.4 million at December 31, 2018, compared to $870.8 million at December 31, 2017. We continue to focus on maintaining a high-quality investment portfolio that provides a steady stream of cash flows both in the current and in rising interest rate environments.
At December 31, 2018, our investment portfolio, excluding Federal Home Loan Bank (“FHLB”) stock, was $710.2 million, or 12.2% of total assets. At December 31, 2018, 87.7% of the investment portfolio was comprised of mortgage-backed securities issued by Freddie Mac and Fannie Mae and the Government National Mortgage Association (“Ginnie Mae”), including collateralized mortgage obligations (“CMO”) securities issued by Freddie Mac, Fannie Mae, and the Ginnie Mae. At December 31, 2018, our investment portfolio also included 0.3% of municipal bonds, 3.3% of corporate bonds and 0.4% of government-sponsored enterprise (“GSE”) notes. The remaining 8.3% of our investment portfolio consisted of foreign bonds, mutual funds and money market funds.
In order to mitigate the credit risk related to the Company’s held-to-maturity and available-for-sale portfolios, the Company monitors the ratings of its securities. As of December 31, 2018, approximately 92.9% of the Company’s portfolio consisted of direct government obligations, government sponsored enterprise obligations or securities rated AAA by Moody’s and/or S&P. In addition, at December 31, 2018, approximately 3.8% of the investment portfolio was non-agency securities, rated below AAA but rated investment grade by Moody’s, S&P and/or Kroll and approximately 3.3% of the investment portfolio was not rated. Securities not rated consist primarily of private placement municipal bonds, FHLB stock and mutual funds.
The following table sets forth the cost and fair value of investment securities at December 31, 2018, 2017 and 2016.
Mortgage-backed securities are a type of asset-backed security that is secured by a mortgage, or a collection of mortgages. These securities usually pay periodic payments that are similar to coupon payments. Furthermore, the mortgage must have originated from regulated and authorized financial institutions. The contractual cash flows of investments in government sponsored enterprises’ mortgage-backed securities are debt obligations of Freddie Mac and Fannie Mae, both of which are currently under the conservatorship of the Federal Housing Finance Agency. The cash flows related to Ginnie Mae securities are direct obligations of the U.S. Government. Mortgage-backed securities are also known as mortgage pass-throughs. CMOs are a type of mortgage-backed security that create separate pools of pass-through rates for different classes of bondholders with varying cash flow structures, called tranches. The repayments from the pool of pass-through securities are used to retire the bonds in the order specified by the bonds’ prospectuses. At December 31, 2018, we had no investments in a single company or entity (other than United States government sponsored enterprise securities) that had an aggregate book value in excess of 10% of our equity.
At December 31, 2018, December 31, 2017 and December 31, 2016, securities totaling $598.7 million, $634.4 million and $623.4 million, respectively, were in an unrealized loss position and the unrealized losses on these securities totaled $13.2 million, $7.0 million and $9.3 million, respectively. At December 31, 2018 and 2017, the unrealized losses in the portfolio were mainly attributed to GSE mortgage-backed securities and CMOs. The unrealized losses are due to current interest rate levels relative to our cost and not credit quality. As we do not intend to sell the investments, and it is not likely we will be required to sell the investments before recovery, we do not consider the investments to be other than temporarily impaired at December 31, 2018. During the years ended December 31, 2018, and 2017, we did not record any impairment charges for securities.
The following table sets forth the stated maturities and weighted average yields of investment securities at December 31, 2018. Certain securities have adjustable interest rates and may reprice monthly, quarterly, semi-annually or annually within the various maturity ranges. Mutual funds, money market funds and equities are not included in the table based on lack of a maturity date.
Loans
Loans decreased $139.5 million, or 3.5%, to $3.89 billion at December 31, 2018, from $4.03 billion at December 31, 2017. During the year ended December 31, 2018, our residential real estate portfolio increased $25.3 million, or 2.7%. However, this growth was offset by a $54.7 million decrease in our total commercial portfolio and an $110.1 million decrease in our total consumer loan portfolio. We continue to experience a number of large commercial loan payoffs as projects are completed and sold and financing is obtained from non-bank sources. The decrease in our consumer loan portfolio was due primarily to a $63.1 million decrease in indirect auto loans resulting from our planned run-off of this portfolio segment. As previously disclosed, we decided to exit the indirect auto lending business in the first quarter of 2017.
The following table shows the loan portfolio at the dates indicated:
Loan Maturity
The following table sets forth certain information at December 31, 2018 regarding the dollar amount of loan principal repayments becoming due during the periods indicated. The tables do not include any estimate of prepayments that significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below. Demand loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.
The following table sets forth all loans at December 31, 2018 that are due after December 31, 2019, and have either fixed interest rates or floating or adjustable interest rates:
Loan Activity
The following table shows loans originated, purchased and sold during the periods indicated:
Deposits
Our primary source of funds is our deposits, which are comprised of demand deposits, money market and passbook accounts and certificates of deposit.
Deposits increased $22.1 million, or 0.53%, to $4.17 billion at December 31, 2018, from $4.15 billion at December 31, 2017. The increase in deposits was primarily due to increases in interest-earning checking accounts, partially offset by decreases in non-interest bearing deposits, money market accounts and certificate of deposits. The following table sets forth the deposits as a percentage of total deposits for the dates indicated:
We are required to pledge securities to secure municipal deposits. At December 31, 2018 and 2017, we had pledged $79.5 million and $78.1 million, respectively, of securities to secure these deposits.
The following table sets forth the time remaining until maturity for certificate of deposits of $100,000 or more at December 31, 2018:
The following table sets forth the deposit activity for the periods indicated:
Borrowings
We have the ability to utilize advances from the Federal Home Loan Bank of Pittsburgh to supplement our liquidity. As a member, we are required to own capital stock in the Federal Home Loan Bank and are authorized to apply for advances on the security of such stock and certain mortgage loans and other assets, provided certain standards related to creditworthiness have been met. Advances are made under several different programs, each having its own interest rate and range of maturities. We also have the ability to utilize securities sold under agreements to repurchase and overnight repurchase agreements, along with the Federal Reserve Bank’s discount window and Federal Funds lines with correspondent banks to supplement our supply of investable funds and to meet deposit withdrawal requirements. To secure our borrowings, we generally pledge securities and/or loans. The types of securities pledged for borrowings include, but are not limited to, GSE notes and GSE mortgage-backed securities. The types of loans pledged for borrowings include, but are not limited to, one- to four-family real estate mortgage loans. Borrowings decreased $25.4 million to $515.0 million at December 31, 2018. During the year ended December 31, 2018, the Company paid off $25.8 million of a higher cost trust preferred debenture.
The following table sets forth the outstanding borrowings and weighted averages at the dates or for the periods indicated:
Results of Operations for the Years Ended December 31, 2018, 2017, and 2016
Financial Highlights
Net income was $47.8 million for the year ended December 31, 2018 compared to net income of $23.9 million for the year ended December 31, 2017 and net income of $25.5 million for the year ended December 31, 2016. Net income for the year ended December 31, 2017 included a one- time $13.1 million charge, or $0.18 per diluted share, of additional income tax expense related to the enactment of the Tax Cuts and Jobs Act and its impact on the re-measurement of our net deferred tax assets (DTA) due to the reduction in the corporate income tax rate in 2018 to 21% from 35%. Net income for year ended December 31, 2016 included $8.8 million of merger and restructuring charges related to the acquisition of Conestoga Bank (“Conestoga”) and the Bank’s expense management reduction program.
For the year ended December 31, 2018, net interest income was $180.4 million, an increase of $10.5 million, or 6.2%, from $169.9 million for the year ended December 31, 2017. The increase in net interest income was primarily due to an increase in yields on the investment and loan portfolios following recent Federal Reserve Bank federal funds rate increases. Our net interest margin increased to 3.29% for the year ended December 31, 2018, from 3.12% for 2017. During the year ended December 31, 2018, the net interest margin was positively impacted by nine basis points due to loan prepayments compared to a seven basis points positive impact during the year ended December 31, 2017.
As a result of loan growth and net charge-offs, we recorded a $4.6 million, $3.1 million, and $485 thousand provision for loan losses during the years ended December 31, 2018, December 31, 2017, and December 31, 2016, respectively.
For the year ended December 31, 2018, non-interest income totaled $28.9 million, an increase of $105 thousand, or 0.4%, from the year ended December 31, 2017. The increase was primarily due to a $3.3 million net gain on the sale of the assets and liabilities of Beneficial Insurance Services, LLC. This increase to non-interest income was partially offset by a $2.4 million decrease in income from insurance and advisory services during the year ended December 31, 2018 compared to the prior year. The increase was also partially offset by a $518 thousand decrease in mortgage banking and SBA income.
For the year ended December 31, 2018, non-interest expense totaled $141.3 million, an increase of $2.5 million, or 1.8%, from the year ended December 31, 2017. The increase in non-interest expense was primarily due to an increase in salaries and employee benefits of $2.8 million due primarily to the costs associated with the build out of Neumann Finance Company, our majority-owned equipment financing subsidiary, an increase in our minimum wage and annual merit increases. The increase in non-interest expense was also due to $3.1 million of professional fees associated with the previously mentioned pending merger of Beneficial with WSFS Financial Corporation. These increases to non-interest expense were partially offset by a $1.0 million decrease in net losses on other assets due to the $319 thousand gain on the sale of a closed branch during 2018 and $685 thousand of branch closure expenses recorded during the year ended December 31, 2017. These increases to non-interest expense were also partially offset by an $816 thousand decrease in stock-based compensation expense, and an $867 thousand decrease in intangible amortization expense as a result of certain intangible assets reaching the end of their estimated lives.
For the year ended December 31, 2018, we recorded a provision for income taxes of $16.2 million, reflecting an effective tax rate of 25.5%, compared to a provision for income taxes of $32.8 million, reflecting an effective tax rate of 57.8%, for the year ended December 31, 2017. The decrease in the effective tax rate in the year ended December 31, 2018 compared to the same period a year ago is primarily due to the passage of the Tax Cuts and Jobs Act, which was enacted on December 22, 2017 and lowered the federal corporate tax rate for 2018 to 21% from 35%.
Summary Income Statements
The following table sets forth the income summary for the periods indicated:
Net Interest Income
Average Balances and Yields
The following tables present information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting annualized average yields and costs. The yields and costs for the periods indicated are derived by dividing income or expense by the average daily balances of assets or liabilities, respectively, for the periods presented. Loan fees are included in interest income on loans and are not material. Non-accrual loans are included in the average balances only. In addition, yields are not presented on a tax-equivalent basis. Any adjustments necessary to present yields on a tax-equivalent basis are insignificant.
Average Balance Tables
Rate/Volume Analysis
The following table sets forth the effects of changing rates and volumes on our net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. Changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionally based on the changes due to rate and the changes due to volume.
2018 vs. 2017. For the year ended December 31, 2018, the Company reported net interest income of $180.4 million, an increase of $10.5 million, or 6.2%, from the year ended December 31, 2017. Total interest income increased $13.9 million, or 7.0%, to $211.8 million for the year ended December 31, 2018 from $197.9 million for the year ended December 31, 2017. The increase in interest income was primarily due to an increase in yields on the investment and loan portfolios following recent Federal Reserve Bank federal funds rate increases. Loans decreased $139.5 million, or 3.5%, to $3.89 billion at December 31, 2018, from $4.03 billion at December 31, 2017. During the year ended December 31, 2018, our residential real estate portfolio increased $25.3 million, or 2.7%. However, this growth was offset by a $54.7 million decrease in our total commercial portfolio and an $110.1 million decrease in our total consumer loan portfolio. We continue to experience a number of large commercial loan payoffs as projects are completed and sold and financing is obtained from non-bank sources. The decrease in our consumer loan portfolio was due primarily to a $63.1 million decrease in indirect auto loans resulting from our planned run-off of this portfolio segment. As previously disclosed, we decided to exit the indirect auto lending business in the first quarter of 2017. For the year ended December 31, 2018, total interest expense increased $3.4 million, or 12.2%, to $31.4 million from $28.0 million for the year ended December 31, 2017 primarily due to an increase in the cost of deposits driven by the previously discussed federal funds rate increases. The Company also paid off $25.8 million of a higher cost trust preferred debenture during the first quarter of 2018. Our net interest margin increased to 3.29% for the year ended December 31, 2018, from 3.12% for 2017. During the year ended December 31, 2018, the net interest margin was positively impacted by nine basis points due to loan prepayments compared to a seven basis points positive impact during the year ended December 31, 2017. We believe that the current interest rate environment will put pressure on net interest margin in future periods until we continue to grow our loan portfolio and reduce the percentage of our balance sheet assets that are held in lower yielding cash and investments.
2017 vs. 2016. For the year ended December 31, 2017, the Company reported net interest income of $169.9 million, an increase of $19.0 million, or 12.6%, from the year ended December 31, 2016. Total interest income increased $24.1 million, or 13.9%, to $197.9 million for the year ended December 31, 2017 from $173.8 million for the year ended December 31, 2016. The increase in interest income was primarily due to the acquisition of Conestoga Bank and organic loan growth with average loans increasing $437.2 million, or 12.1%, in 2017 compared to 2016. Total loans increased $23.6 million to $4.03 billion at December 31, 2017, from $4.01 billion at December 31, 2016. The increase in loans was primarily due to organic growth in our commercial loan portfolio and residential real estate loan portfolio of $93.4 million (3.8% growth) and $49.1 million (5.5% growth), respectively, partially offset by decreases in our consumer loan portfolio due primarily to a decrease in indirect auto loans resulting from our planned run-off of this portfolio segment. As previously disclosed, we decided to exit the indirect lending business in the first quarter of 2017. In addition to the increase in the average balance of loans, there was an increase in the average interest rate earned on loans to 4.23% in 2017 compared to 4.06% in 2016. For the year ended December 31, 2017, total interest expense increased $5.1 million, or 22.4%, to $28.0 million from $22.9 million for the year ended December 31,
2016 primarily due to an increase in the average balance of deposits driven by the acquisition of Conestoga Bank, as well as an increase in the average balance of borrowings, partially offset by a 24 basis point decrease in the rate on borrowings. During the year ended December 31, 2017, the Federal Reserve Board raised short term interest rates three times resulting in a FED Funds rate on overnight funds of 1.50%. Despite the movement in short term rates, long term rates did not rise by a comparable amount resulting in a flattening of the yield curve (10 year US treasuries were 2.60% at December 31, 2017). We believe that the current interest rate environment will put pressure on net interest margin in future periods until we continue to grow our loan portfolio and reduce the percentage of our balance sheet assets that are held in lower yielding cash and investments.
Provision for Loan Losses
As a result of loan growth and net charge-offs during 2018, 2017 and 2016, we recorded a $4.6 million, $3.1 million and $485 thousand provision for loan losses during the years ended December 31, 2018, December 31, 2017 and December 31, 2016, respectively. The provision for the year ended December 31, 2017 also included a $1.5 million specific valuation allowance for a shared national credit that was downgraded to doubtful and moved to non-accrual status during the first quarter of 2017. During 2018, this non-performing shared national credit was sold and we recorded a loss of $766 thousand. Net charge-offs for the year ended December 31, 2018 were $4.6 million, compared to $3.1 million and $2.7 million for the years ended December 31, 2017 and 2016, respectively. We charge-off any collateral or cash flow deficiency on all classified loans once they are 90 days delinquent. Government guaranteed student loans greater than 90 days delinquent continue to accrue interest as these loans are guaranteed by the government and have little risk of credit loss. The provision for loan losses was determined by management to be an amount necessary to maintain a balance of allowance for loan losses at a level that considers all known and current losses in the loan portfolio as well as potential losses due to unknown factors such as the economic environment. Changes in the provision were based on management’s analysis of various factors such as: estimated fair value of underlying collateral, recent loss experience in particular segments of the portfolio, levels and trends in delinquent loans, and changes in general economic and business conditions.
At December 31, 2018, the allowance for loan losses totaled $43.3 million, or 1.11% of total loans outstanding, compared to $43.3 million, or 1.07% of total loans outstanding, as of December 31, 2017 and $43.3 million, or 1.08% of total loans outstanding, as of December 31, 2016. An analysis of the changes in the allowance for loan losses is presented under “Risk Management-Analysis and Determination of the Allowance for Loan Losses” below.
Non-Interest Income
The following table sets forth a summary of non-interest income for the periods indicated:
2018 vs. 2017. For the year ended December 31, 2018, non-interest income increased $105 thousand, or 0.4%, to $28.9 million from $28.8 million for the year ended December 31, 2017. The increase was primarily due to a $3.3 million net gain on the sale of the assets and liabilities of Beneficial Insurance Services, LLC. This increase to non-interest income was partially offset by a $2.4 million decrease in income from insurance and advisory services during the year ended December 31, 2018 compared to the prior year. The increase was also partially offset by a $518 thousand decrease in mortgage banking and SBA income.
2017 vs. 2016. For the year ended December 31, 2017, non-interest income increased $960 thousand, or 3.5%, to $28.8 million from $27.8 million for the year ended December 31, 2016. The increase was primarily due to a $1.6 million net gain on the sale of $17.8 million of SBA loans recorded during the year ended December 31, 2017, a $765 thousand increase in interchange fees, and a $308 thousand increase in returned check charges, partially offset by a $1.8 million investment gain recorded during the year ended December 31, 2016 from the sale of stock that we held in a financial institution that was acquired.
Non-Interest Expense
The following table sets forth an analysis of non-interest expense for the periods indicated:
2018 vs. 2017. For the year ended December 31, 2018, non-interest expense increased $2.5 million, or 1.8%, to $141.3 million from $138.8 million for the year ended December 31, 2017. The increase in non-interest expense was primarily due to an increase in salaries and employee benefits of $2.8 million due primarily to the costs associated with the build out of Neumann Finance Company, our majority-owned equipment financing subsidiary, an increase in our minimum wage and annual merit increases. The increase in non-interest expense was also due to $3.1 million of professional fees associated with the previously mentioned pending merger of Beneficial with WSFS Financial Corporation. These increases to non-interest expense were partially offset by a $1.0 million decrease in net losses on other assets due to the $319 thousand gain on the sale of a closed branch during 2018 and $685 thousand of branch closure expenses recorded during the year ended December 31, 2017. These increases to non-interest expense were also partially offset by an $816 thousand decrease in stock-based compensation expense, and an $867 thousand decrease in intangible amortization expense as a result of certain intangible assets reaching the end of their estimated lives.
2017 vs. 2016. For the year ended December 31, 2017, non-interest expense decreased $327 thousand, or 0.2%, to $138.8 million from $139.1 million for the year ended December 31, 2016. The decrease in non-interest expense was primarily due to $8.8 million of merger and restructuring charges related to the acquisition of Conestoga and our April 2016 expense management reduction program recorded during the year ended December 31, 2016. This decrease to non-interest expense was partially offset by an increase in salaries and employee benefits of $6.7 million and other expense of $2.0 million due primarily to increases in stock based compensation and board fees associated with equity awards granted under the Company’s 2016 Omnibus Incentive Plan. For the year ended December 31, 2017, our efficiency ratio was 69.93% compared to 77.84% for the year ended December 31, 2016.
Income Tax Expense
2018 vs. 2017. We recorded a provision for income taxes of $16.2 million for 2018, reflecting an effective rate of 25.5%, compared to a provision for income taxes of $32.8 million for 2017, reflecting an effective rate of 57.8%. The decrease in the effective tax rate in the year ended December 31, 2018 compared to the same periods a year ago is primarily due to the passage of the Tax Cuts and Jobs Act, which was enacted on December 22, 2017 and lowered the federal corporate tax rate for 2018 to 21% from 35%.
2017 vs. 2016. We recorded a provision for income taxes of $32.8 million for 2017, reflecting an effective rate of 57.8%, compared to a provision for income taxes of $13.6 million for 2016, reflecting an effective rate of 34.9%. Income tax expense increased $13.1 million, related to the enactment of the Tax Cuts and Jobs Act and its impact on re-measuring our net deferred tax assets (DTA) due to the reduction in the federal corporate income tax rate for 2018 to 21% from 35%.
As of December 31, 2018 and 2017, the Company had net deferred tax assets totaling $21.7 million and $23.0 million, respectively. Deferred tax assets can only be realized if the Company generates taxable income in the future. The Company regularly evaluates the realizability of deferred tax asset positions. In determining whether a valuation allowance is necessary, the Company considers the level of taxable income in prior years to the extent that carrybacks are permitted under current tax laws, as well as estimates of future pre-tax and taxable income and tax planning strategies that would, if necessary, be implemented. The Company currently maintains a valuation allowance for certain state net operating losses that management believes it is more likely than not that such deferred tax assets will not be realized. The Company expects to realize the remaining deferred tax assets over the allowable carryforward periods. Therefore, no valuation allowance is deemed necessary against its remaining federal or state deferred tax assets as of December 31, 2018 and 2017. However, if an unanticipated event occurred that materially changed pre-tax book income and taxable income in future periods, an increase in the valuation allowance may become necessary and it could be material to the Company’s financial statements.
Risk Management
Overview. Managing risk is an essential part of successfully managing a financial institution. Our most prominent risk exposures are credit risk, interest rate risk and market risk. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or investment when it is due. Interest rate risk is the potential reduction of interest income as a result of changes in interest rates. Market risk arises from fluctuations in interest rates that may result in changes in the values of financial instruments, such as available-for-sale securities that are accounted for at fair value. Other risks that we face are operational risk, liquidity risk and reputation risk. Operational risk includes risks related to fraud, regulatory compliance, processing errors, technology, cyber-security and disaster recovery. Liquidity risk is the possible inability to fund obligations to depositors, lenders or borrowers. Reputation risk is the risk that negative publicity or press, whether true or not, could cause a decline in our customer base or revenue.
Credit Risk Management. The objective of our credit risk management strategy is to quantify and manage credit risk and to limit the risk of loss resulting from an individual customer default. Our credit risk management strategy focuses on conservatism, diversification within the loan portfolio and monitoring. Our lending practices include conservative exposure limits and underwriting, documentation and collection standards. Our credit risk management strategy also emphasizes diversification on an industry and customer level as well as regular credit examinations and monthly management reviews of large credit exposures and credits experiencing deterioration of credit quality. Underwriting activities are centralized. Our credit risk review function provides objective assessments of the quality of underwriting and documentation, the accuracy of risk grades and the charge-off, non-accrual and reserve analysis process. Our credit review process and overall assessment of required allowances is based on quarterly assessments of the probable estimated losses inherent in the loan portfolio. We use these assessments to identify potential problem loans within the portfolio, maintain an adequate reserve and take any necessary charge-offs. Further, we have strengthened our oversight of problem assets through the formation of a special assets committee. The committee, which consists of our Chief Credit Officer, Chief Financial Officer and other members of senior management, increase the frequency with which classified and watch list credits are reviewed and aggressively acts to resolve problem assets.
When a borrower fails to make a required payment, we take a number of steps to have the borrower cure the delinquency and restore the loan to current status. Generally, our collection department follows the guidelines for servicing loans as prescribed by the appropriate investor, state or federal law. Collection activities include, but are not limited to, phone calls to borrowers and collection letters, which include a late charge notice based on the contractual requirements of the specific loan. Additional calls and notices are mailed in compliance with state and federal regulations including, but not limited to, the Fair Debt Collection Practices Act. After the 90th day of delinquency, or on a different date as allowable by state law, the collection department will forward the account to counsel and begin the foreclosure proceedings. If a foreclosure action is instituted and the loan is not in at least the early stages of a workout by the scheduled sale date, the real property securing the loan generally is sold at a foreclosure sale. If we determine that there is a possibility of a settlement, pay-off or reinstatement, the foreclosure sale may be postponed. If there is a failure to cure the delinquency, the foreclosure sale would proceed.
We charge-off the collateral or cash flow deficiency on all loans once they become 90 days delinquent. Generally, all consumer loans are charged-off once they become 90 days delinquent except for education loans as they are guaranteed by the government and there is little risk of loss. In addition to the individual review of larger commercial loans that exhibit probable or observed credit weaknesses, the commercial credit review process includes the use of an enhanced risk grading system. This risk grading system is consistent with Basel II expectations and allows for precision in the analysis of commercial credit risk. Historical portfolio performance metrics, current economic conditions and delinquency monitoring are factors used to assess the credit risk in our homogenous commercial, residential and consumer loan portfolio.
Analysis of Non-performing, Troubled Debt Restructurings and Classified Assets. We consider repossessed assets and loans that are 90 days or more past due, except guaranteed student loans, to be non-performing assets. Generally, all loans are placed on non-accrual status when they become 90 days delinquent at which time the accrual of interest ceases and any collateral deficiency is charged-off. Typically, payments received on a non-accrual loan are applied to the outstanding principal balance of the loan.
Real estate that we acquire as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate owned until it is sold. When property is acquired, it is recorded at the lower of its cost or fair market value less estimated costs to sell. Holding costs and declines in fair value after acquisition of the property result in charges against income.
We consider a loan a troubled debt restructuring, or “TDR,” when the borrower is experiencing financial difficulty and we grant a concession that we would not otherwise consider but for the borrower’s financial difficulties. A TDR includes a modification of debt terms
or assets received in satisfaction of the debt (which may include foreclosure or deed in lieu of foreclosure) or a combination of types. We evaluate selective criteria to determine if a borrower is experiencing financial difficulty including the ability of the borrower to obtain funds from sources other than Beneficial Bank at market rates. We consider all TDRs that are on non-accrual status to be impaired loans. We will not consider the loan a TDR if the loan modification was made for customer retention purposes and the modification is consistent with prevailing market conditions.
Once a loan has been classified as a TDR and has been put on non-accrual status, it will only be put back on accruing status when certain criteria are met. Our policy for returning a loan to accruing status requires the preparation of a well-documented credit evaluation, which includes the following:
· A review of the borrower’s current financial condition in which the borrower must demonstrate sufficient cash flows to support the repayment of all principal and interest including any amounts previously charged-off;
· An updated appraisal or home valuation, which must demonstrate sufficient collateral value to support the debt;
· Sustained performance based on the restructured terms for at least six consecutive months;
· Approval by the special assets committee, which consists of senior management including the Chief Credit Officer and the Chief Financial Officer.
The following table sets forth information with respect to our non-performing assets at the dates indicated.
(1) Includes $8.2 million, $8.4 million, $1.1 million, $731 thousand, and $1.1 million of TDRs on non-accrual status as of December 31, 2018, 2017, 2016, 2015, and 2014, respectively.
(2) Education loans are 98% government guaranteed.
Non-performing assets decreased $4.4 million to $30.5 million, or 0.52% of total assets, at December 31, 2018 from $34.9 million, or 0.60% of total assets, at December 31, 2017. The decrease is primarily due to the sale of one large commercial non-performing loan totaling $7.6 million during 2018. We had a specific loan loss reserve of $1.5 million for this loan. The actual loss for the loan was $766 thousand. This was offset by an increase in non-accrual commercial real estate loans due primarily to one large relationship. This loan has been charged down to the appraised value of the collateral securing the loan. In 2018, we experienced a decrease in the balance of government guaranteed student loans that are greater than 90 days delinquent. The decrease in past due government guaranteed loans is due to the timing of loans coming out of deferment status as of the reporting dates. Net charge-offs for the year ended December 31, 2018 were $4.6 million compared to $3.1 million for the year ended December 31, 2017. We charge-off the collateral or cash flow deficiency on all classified loans once they are 90 days delinquent. Non-performing assets at December 31, 2018 included $8.6 million, or 28.2%, of government guaranteed student loans where we have little risk of credit loss. We continue to rigorously review our loan portfolio to ensure that the collateral values remain sufficient to support the outstanding balances.
Interest income that would have been recorded for the years ended December 31, 2018 and 2017, had non-accrual loans been current according to their original terms, amounted to approximately $1.2 million and $1.3 million, respectively. There was no interest income recorded on non-accrual loans during the years ended December 31, 2018 and 2017, respectively.
The tables below include impaired loans and the average impaired loan balance as of December 31, 2018 and 2017.
Impaired Loans
As of December 31, 2018
(Dollars in thousands)
Impaired Loans
As of December 31, 2017
(Dollars in thousands)
Federal regulations require us to review and classify our assets on a regular basis. In addition, the Federal Deposit Insurance Corporation has the authority to identify problem assets and, if appropriate, require them to be classified. Our credit review process includes a risk classification of all commercial and residential loans that includes pass, special mention, substandard and doubtful. A loan is classified as pass when payments are current and it is performing under the original contractual terms. A loan is classified as special mention when the borrower exhibits potential credit weakness or a downward trend which, if not checked or corrected, will weaken the asset or inadequately protect Beneficial Bank’s position. While potentially weak, the borrower is currently marginally acceptable; no loss of principal or interest is envisioned. A loan is classified as substandard when the borrower has a well-defined weakness or weaknesses that jeopardize the orderly liquidation of the debt. A substandard loan is inadequately protected by the current net worth and paying capacity of the obligor, normal repayment from this borrower is in jeopardy, and there is a distinct possibility that a partial loss of interest and/or
principal will occur if the deficiencies are not corrected. A loan is classified as doubtful when a borrower has all weaknesses inherent in a substandard loan with the added provision that: (1) the weaknesses make collection of debt in full on the basis of currently existing facts, conditions and values highly questionable and improbable; (2) serious problems exist to the point where a partial loss of principal is likely; and (3) the possibility of loss is extremely high, but because of certain important, reasonably specific pending factors that may work to the advantage and strengthening of the assets, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens and additional refinancing plans. We charge-off the collateral deficiency on all loans classified as substandard. In all cases, loans are placed on non-accrual when 90 days past due or earlier if collection of principal or interest is considered doubtful.
The following table summarizes classified assets of all portfolio types at the dates indicated:
For all loans classified as substandard and doubtful, we generally charge-off the collateral deficiency on all collateral dependent classified loans that are 90 days past due. During the first quarter of 2017, one shared national credit for $9.6 million was downgraded to doubtful and changed to non-accrual status based on the results of a shared national credit examination performed by regulators. This loan continued to make payments in 2017 and, at December 31, 2017, had an $8.0 million outstanding balance. Management had established a $1.5 million specific valuation allowance to cover risk associated with this loan as of December 31, 2017. During the year ended December 31, 2018, this loan was sold and the actual loss for the loan was $766 thousand.
Analysis and Determination of the Allowance for Loan Losses. The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. We evaluate the need to establish allowances against losses on loans on a quarterly basis. When additional allowances are necessary, a provision for loan losses is charged to earnings. As of December 31, 2018 and 2017, our methodology for assessing the appropriateness of the allowance for loan losses consists of: (1) a specific valuation allowance on identified problem loans; and (2) a general valuation allowance on the remainder of the loan portfolio. The allowance for loan losses methodology includes review of the nine interagency qualitative factors that are assessed to adjust the allowance based on the incremental risk of drivers not adequately reflected in the quantitative component of the allowance. The appropriate allowance level is estimated based upon factors and trends identified by the Company at the time the consolidated financial statements are prepared. Management continuously evaluates its allowance methodology to reflect changes in the portfolio and current economic conditions.
Specific Allowance. Management regularly monitors the condition of borrowers and assesses both internal and external factors in determining whether any relationships have deteriorated considering factors such as historical loss experience, trends in delinquency and non-performing loans, changes in risk composition and underwriting standards, the experience and ability of staff and regional and national economic conditions and trends.
Our Chief Credit Officer supervises the workout department and identifies, manages and works through non-performing assets. Our credit officers and workout group identify and manage potential problem loans for our commercial loan portfolios. Changes in management, financial and operating performance, company behavior, industry factors and external events and circumstances are evaluated on an ongoing basis to determine whether potential impairment is evident and additional analysis is needed. For our commercial loan portfolios, risk ratings are assigned to each individual loan to differentiate risk within the portfolio and are reviewed on an ongoing basis by credit risk management and revised, if needed, to reflect the borrowers’ current risk profiles and the related collateral positions. The risk ratings consider factors such as financial condition, debt capacity and coverage ratios, market presence and quality of management. When a credit’s risk rating is downgraded to a certain level, the relationship must be reviewed and detailed reports completed that document risk management strategies for the credit going forward, and the appropriate accounting actions to take in accordance with generally accepted accounting principles in the United States. When credits are downgraded beyond a certain level, our workout department becomes responsible for managing the credit risk.
Risk rating actions are generally reviewed formally by one or more credit committees depending on the size of the loan and the type of risk rating action being taken. Our commercial, consumer and residential loans are monitored for credit risk and deterioration considering factors such as delinquency, loan to value ratios, and credit scores.
When problem loans are identified that are secured with collateral, management examines the loan files to evaluate the nature and type of collateral supporting the loans. Management documents the collateral type, date of the most recent valuation, and whether any liens exist, to determine the value to compare against the committed loan amount. If a loan is identified as impaired and is collateral dependent, an updated appraisal is obtained to provide a baseline in determining the property’s fair market value. We also consider costs to sell the property and use the appraisal less selling costs to determine if a charge-off is required for the collateral dependent problem loan. If the
collateral value is subject to significant volatility (due to location of asset, obsolescence, etc.) an appraisal is obtained more frequently. In-house revaluations are typically performed on a quarterly basis and updated appraisals are obtained annually, if determined necessary.
When we determine that the value of an impaired loan is less than its carrying amount, we recognize impairment through a charge-off to the allowance. We perform these assessments on at least a quarterly basis. For commercial loans, a charge-off is recorded when management determines we will not collect 100% of a loan based on the fair value of the collateral, less costs to sell the property, or the net present value of expected future cash flows. Charge-offs are recorded on a monthly basis and partially charged-off loans continue to be evaluated on a monthly basis. The collateral deficiency on consumer loans and residential loans are generally charged-off when deemed to be uncollectible or delinquent 90 days or more, whichever comes first, unless it can be clearly demonstrated that repayment will occur regardless of the delinquency status. Examples that would demonstrate repayment include a loan that is secured by adequate collateral and is in the process of collection, a loan supported by a valid guarantee or insurance, or a loan supported by a valid claim against a solvent estate.
Although we determine the amount of each element of the allowance separately, the entire allowance for loan losses is available to absorb losses in the loan portfolio. We generally charge-off the collateral or discounted cash flow deficiency on all loans at 90 days past due. During the first quarter of 2017, one shared national credit for $9.6 million was downgraded to doubtful and changed to non-accrual status based on the results of a shared national credit examination performed by regulators. This loan continued to make payments in 2017 and, at December 31, 2017, had an $8.0 million outstanding balance. Management had established a $1.5 million specific valuation allowance to cover risk associated with this loan as of December 31, 2017. During the year ended December 31, 2018, this loan was sold and the actual loss for the loan was $766 thousand.
General Allowance. Additionally, we reserve for certain inherent, but undetected, losses that are probable within the loan portfolio. This is due to several factors, such as, but not limited to, inherent delays in obtaining information regarding a customer’s financial condition or changes in their unique business conditions and economic trends. While this analysis is conducted at least quarterly, we have the ability to revise the allowance factors whenever necessary to address improving or deteriorating credit quality trends or specific risks associated with a given loan pool classification.
A comprehensive analysis of the allowance for loan losses is performed on a quarterly basis. The factors supporting the allowance for loan losses do not diminish that the entire allowance for loan losses is available to absorb losses in the loan portfolio. Our principal focus, therefore, is on the appropriateness of the total allowance for loan losses.
The allowance for loan losses is subject to review by banking regulators. Our primary bank regulators regularly conduct examinations of the allowance for loan losses and make assessments regarding their adequacy and the methodology employed in their determination. Our regulators may require the allowance for loan losses to be increased based on their review of information available to them at the time of their examination.
The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated:
Commercial Loans. The allowance for the commercial portfolio totaled $41.3 million at December 31, 2018 compared to $39.1 million at December 31, 2017. The allowance for loan losses related to the commercial portfolio was 1.66% of commercial loans at December 31, 2018 compared to 1.60% of commercial loans at December 31, 2017. We continue to experience low levels of delinquencies, commercial criticized and classified loans, and net charge-offs. We believe the commercial reserves are adequate given the continued improvement in credit quality metrics during the year ended December 31, 2018.
Residential Loans. The allowance for the residential loan portfolio was $810 thousand, or 0.08% of residential loans, at December 31, 2018 compared to $838 thousand, or 0.09% of residential loans, at December 31, 2017. We continue to experience consistently low levels of net charge-offs and delinquencies within this portfolio with annual loss rates of 0.09% and 0.02% during the year ended December 31, 2018 and 2017, respectively. We believe the balance of residential reserves is appropriate given the continued low net charge-off levels.
Consumer Loans. The allowance for the consumer loan portfolio was $1.2 million, or 0.27% of consumer loans, at December 31, 2018 compared to $1.8 million, or 0.32% of consumer loans, at December 31, 2017. The decrease in the allowance for loan losses within this portfolio is primarily due to a decline in the balance of consumer loans and continued low levels of delinquencies. For the year ended December 31, 2018, delinquent consumer loans totaled $22.9 million compared to $33.5 million as of December 31, 2017. We believe the balance of consumer reserves is appropriate given continued low levels of delinquencies.
Specific Allowance. Management determined that no specific allowance was necessary as of December 31, 2018. As of December 31, 2017, management established a $1.5 million specific valuation allowance to cover the risk associated with one shared national credit for $8.0 million that was downgraded to doubtful and changed to non-accrual status during the year. This loan was sold during the year ended December 31, 2018. The actual loss for this loan was $766 thousand.
The appropriate allowance level is estimated based upon factors and trends identified by Beneficial Bancorp at the time the consolidated financial statements are prepared. Management continuously evaluates its allowance methodology.
The allowance for loan losses is maintained at levels that management considers appropriate to provide for losses based upon an evaluation of known and inherent risks in the loan portfolio. Management’s evaluation takes into consideration the risks inherent in the loan portfolio, past loan loss experience, specific loans with loss potential, geographic and industry concentrations, delinquency trends, economic conditions, the level of originations and other relevant factors. While management uses the best information available to make such evaluations, future adjustments to the allowance for credit losses may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, the existing allowance for loan losses may not be sufficient should the quality of loans deteriorate as a result of the factors described above. Any material increase in the allowance for loan losses may adversely affect our financial condition and results of operations.
The following table sets forth an analysis of the activity in the allowance for loan losses for the periods indicated:
Interest Rate Risk Management. Interest rate risk is defined as the exposure to current and future earnings, and capital that arises from adverse movements in interest rates. Depending on a bank’s asset/liability structure, adverse movements in interest rates could be either rising or falling interest rates. For example, a bank with predominantly long-term fixed-rate loans, and short-term deposits could have an adverse earnings exposure to a rising rate environment. Conversely, a short-term or variable-rate asset base funded by longer-term liabilities could be negatively affected by falling rates. This is referred to as re-pricing or maturity mismatch risk.
Interest rate risk also arises from changes in the slope of the yield curve (yield curve risk), from imperfect correlations in the adjustment of rates earned and paid on different instruments with otherwise similar re-pricing characteristics (basis risk), and from interest rate related options embedded in our assets and liabilities (option risk).
Our goal is to manage our interest rate risk by determining whether a given movement in interest rates affects our net income and the market value of our portfolio equity in a positive or negative way, and to execute strategies to maintain interest rate risk within established limits. The results at December 31, 2018 indicate an acceptable level of risk.
Model Simulation Analysis. We view interest rate risk from two different perspectives. The traditional accounting perspective, which defines and measures interest rate risk as the change in net interest income and earnings caused by a change in interest rates, provides
the best view of short-term interest rate risk exposure. We also view interest rate risk from an economic perspective, which defines and measures interest rate risk as the change in the market value of portfolio equity caused by changes in the values of assets and liabilities, which fluctuate due to changes in interest rates. The market value of portfolio equity, also referred to as the economic value of equity, is defined as the present value of future cash flows from existing assets, minus the present value of future cash flows from existing liabilities.
These two perspectives give rise to income simulation and economic value simulation, each of which presents a unique picture of our risk of any movement in interest rates. Income simulation identifies the timing and magnitude of changes in income resulting from changes in prevailing interest rates over a short-term time horizon (usually one year). Economic value simulation reflects the interest rate sensitivity of assets and liabilities in a more comprehensive fashion, reflecting all future time periods. It can identify the quantity of interest rate risk as a function of the changes in the economic values of assets and liabilities, and the equity of Beneficial Bancorp. Both types of simulation assist in identifying, measuring, monitoring and controlling interest rate risk and are employed by management to ensure that variations in interest rate risk exposure will be maintained within policy guidelines.
Our asset/liability management committee (“ALCO”) produces reports on a quarterly basis, which compare baseline (no interest rate change) current positions showing forecasted net income, the economic value of equity and the duration of individual asset and liability classes, and of equity. Duration is defined as the weighted average time to the receipt of the present value of future cash flows. These baseline forecasts are subjected to a series of interest rate changes, to demonstrate or model the specific impact of the interest rate scenario tested on income, equity and duration. The model, which incorporates all asset and liability rate information, simulates the effect of various interest rate movements on income and equity value. The reports identify and measure our interest rate risk exposure present in our current asset/liability structure. If the results produce quantifiable interest rate risk exposure beyond our limits, then the testing will have served as a monitoring mechanism to allow us to initiate asset/liability strategies designed to reduce and therefore control interest rate risk.
The tables below set forth an approximation of our interest rate risk exposure. The simulation uses projected repricing of assets and liabilities at December 31, 2018 and December 31, 2017. The primary interest rate exposure measurement applied to the entire balance sheet is the effect on net interest income of a change in market interest rates of plus or minus 200 basis points over a one year time horizon, and the effect on economic value of equity of a change in market interest rates of plus or minus 200 basis points for all projected future cash flows. Various assumptions are made regarding the prepayment speed and optionality of loans, investments and deposits, which are based on analysis and market information. The assumptions regarding optionality, such as prepayments of loans and the effective maturity of non-maturity deposit products, are documented periodically through evaluation under varying interest rate scenarios.
Because the prospective effects of hypothetical interest rate changes are based on a number of assumptions, these computations should not be relied upon as indicative of actual results. While we believe such assumptions to be reasonable, assumed prepayment rates may not approximate actual future prepayment activity on mortgage-backed securities, collateralized mortgage obligations and loans. Further, the computation does not reflect any actions that management may undertake in response to changes in interest rates. Management periodically reviews the rate assumptions based on existing and projected economic conditions.
As of December 31, 2018 (Dollars in thousands):
As of December 31, 2017 (Dollars in thousands):
As of December 31, 2018, based on the scenarios above, net interest income at risk would be positively affected over a one-year time horizon in a rising interest rate environment and negatively affected in a declining interest rate environment. The economic value at risk would be negatively affected over a one-year time horizon in both a rising and a declining interest rate environment. As of December 31, 2017, based on the scenarios above, net interest income at risk would be positively affected over a one-year time horizon in a rising interest rate environment and negatively affected in a declining interest rate environment. The economic value at risk would be negatively
affected over a one-year time horizon in both a rising and a declining interest rate environment. The current historically low interest rate environment reduces the reliability of the measurement of a 200 basis point decline in interest rates, as such a decline would result in negative interest rates. We have established an interest rate floor of zero percent for measuring interest rate risk. Such a floor in our income simulation results in a reduction in our net interest margin as more of our liabilities than our assets are impacted by the zero percent floor. In addition, economic value of equity is also reduced in a declining rate environment due to the negative impact to deposit premium values.
Overall, our December 31, 2018 results indicate that we are adequately positioned with limited net interest income and economic value at risk and that all interest rate risk results continue to be within our policy guidelines.
Liquidity Risk
Liquidity risk is the risk of being unable to meet obligations as they come due at a reasonable funding cost. We mitigate this risk by attempting to structure our balance sheet prudently and by maintaining diverse borrowing resources to fund potential cash needs. For example, we structure our balance sheet so that we fund less liquid assets, such as loans, with stable funding sources, such as retail deposits, long-term debt, wholesale deposits, and capital. We assess liquidity needs arising from asset growth, maturing obligations, and deposit withdrawals, considering operations in both the normal course of business and times of unusual events. In addition, we consider our off-balance sheet arrangements and commitments that may impact liquidity in certain business environments.
Our ALCO measures liquidity risks, sets policies to manage these risks, and reviews adherence to those policies at its quarterly meetings. For example, we manage the use of short-term unsecured borrowings as well as total wholesale funding through policies established and reviewed by our ALCO. In addition, the director risk committee of our board of directors sets liquidity limits and reviews current and forecasted liquidity positions at each of its regularly scheduled meetings.
We have contingency funding plans that assess liquidity needs that may arise from certain stress events such as rapid asset growth and financial market disruptions. Our contingency plans also provide for continuous monitoring of net borrowed funds dependence and available sources of contingent liquidity. These sources of contingent liquidity include cash and cash equivalents, capacity to borrow at the Federal Reserve discount window and the Federal Home Loan Bank system, fed funds purchased from other banks and the ability to sell, pledge or borrow against unencumbered securities in our investment portfolio. As of December 31, 2018, the potential liquidity from these sources totaled $3.2 billion, which is an amount we believe currently exceeds any contingent liquidity needs.
Uses of Funds. Our primary uses of funds include the extension of loans and credit, the purchase of investment securities, working capital, and debt and capital management. In addition, contingent uses of funds may arise from events such as financial market disruptions.
We regularly adjust our investments in liquid assets based upon our assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities, (4) repayment of borrowings and (5) the objectives of our asset/liability management program. Excess liquid assets are invested generally in short to intermediate-term U.S. Government agency obligations.
Sources of Funds. Our most liquid assets are cash and cash equivalents. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At December 31, 2018, cash and cash equivalents totaled $852.5 million, including overnight investments of $792.2 million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $285.6 million at December 31, 2018. On December 31, 2018, we had $515.0 million in Federal Home Loan Bank advances outstanding. In addition, if Beneficial Bank requires funds beyond its ability to generate them internally, it can borrow funds under an overnight advance program up to Beneficial Bank’s maximum borrowing capacity based on its ability to collateralize such borrowings.
Our primary sources of funds include a large, stable deposit base. Core deposits, primarily gathered from our retail branch network, are our largest and most cost-effective source of funding. Core deposits totaled $3.33 billion at December 31, 2018, compared to $3.28 billion at December 31, 2017. In addition, we use brokered certificates of deposit as a funding source of our asset base. The Company primarily relies on its retail and commercial deposit base to fund the balance sheet as these deposits are typically a lower cost and more stable funding source than brokered deposits. However, the Company also utilizes brokered certificates of deposit to fund a portion of the balance sheet subject to policy limits approved by the Company’s Board of Directors. As of December 31, 2018 and December 31, 2017, the Company had $210.2 million, or 3.6% of total assets, and $285.6 million, or 4.9% of total assets, of brokered certificates of deposit, respectively. For the years ended December 31, 2018 and December 31, 2017, the cost of brokered certificates of deposit totaled 1.53% and 1.56%, respectively.
The Company utilizes different terms for the brokered certificates of deposit to minimize the refinancing risk that exists in any given year. The Company has structured its brokered certificates of deposit to mature over a five-year period. The following table summarizes the outstanding balance of brokered certificates of deposit by calendar year of maturity for the period presented:
The Company may be restricted in its ability to accept, renew or roll over brokered deposits, depending on its capital classification. Only “well-capitalized” banks are permitted to accept, renew or roll over brokered deposits. The FDIC may, on a case-by-case basis, permit banks that are adequately capitalized to accept brokered deposits if the FDIC determines that acceptance of such deposits would not constitute an unsafe or unsound banking practice with respect to the bank. Undercapitalized banks generally may not accept, renew or roll over brokered deposits. Should the Bank be restricted from the brokered deposit market, we could replace these deposits with a diversified base of wholesale funding sources. These uncommitted sources may include fed funds purchased from other banks, securities sold under agreements to repurchase, and FHLB advances.
As of December 31, 2018 and December 31, 2017, aggregate wholesale funding totaled $724.0 million and $790.9 million, respectively. In addition, at December 31, 2018, we had arrangements to borrow up to $2.2 billion from the FHLB of Pittsburgh and the Federal Reserve Bank of Philadelphia. On December 31, 2018, we had $515.0 million of advances outstanding with the FHLB of Pittsburgh. During the year ended December 31, 2017, we executed a $200.0 million forward starting interest rate swap at 2.24% to lock in lower funding costs for a $200.0 million borrowing that matures in 2019.
A significant use of our liquidity is the funding of loan originations. At December 31, 2018, Beneficial Bank had $758.3 million in loan and lease commitments outstanding, which consisted of $588 thousand, $328 thousand and $6.4 million in commercial loan commitments, consumer loan commitments, and commercial small business lease commitments, respectively, $243.8 million in commercial construction and other advances, $480.4 million in commercial and consumer unused lines of credit, and $26.8 million in standby letters of credit. Another significant use of Beneficial Bank’s liquidity is the funding of deposit withdrawals. Certificates of deposit due within one year of December 31, 2018 totaled $433.2 million, or 52.4% of certificates of deposit. The large percentage of certificates of deposit that mature within one year reflects customers’ hesitancy to invest their funds for long periods in the current low interest rate environment. If these maturing deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit, brokered deposits and borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before December 31, 2018. We have the ability to attract and retain deposits by adjusting the interest rates offered.
The following tables present certain of our contractual obligations at December 31, 2018:
Our primary investing activities are the origination of loans and the purchase of securities. Our primary financing activities consist of activity in deposit accounts and borrowings. Deposit flows are affected by the overall level of interest rates, the interest rates and products
offered by us and our local competitors and other factors. We generally manage the pricing of our deposits to be competitive. Occasionally, we offer promotional rates on certain deposit products to attract deposits.
Beneficial Bancorp is a separate legal entity from Beneficial Bank and must provide for its own liquidity in addition to its operating expenses. Beneficial Bancorp’s primary source of income is dividends received from Beneficial Bank. The amount of dividends that Beneficial Bank may declare and pay to Beneficial Bancorp is generally restricted under Pennsylvania law to the retained earnings of Beneficial Bank. At December 31, 2018, Beneficial Bancorp (stand-alone) had liquid assets of $130.4 million. During the year ended December 31, 2018, the Company used cash of $20.3 million to repurchase stock and $35.7 million to pay cash dividends to shareholders.
Capital Management. We are subject to various regulatory capital requirements administered by the Federal Deposit Insurance Corporation, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At December 31, 2018, we exceeded all of our regulatory capital requirements. We are considered “well capitalized” under regulatory guidelines. See note 17 in the notes to the consolidated financial statements included in this Annual Report.
At December 31, 2018, Beneficial Bank’s ratio of Tier 1 capital to risk-weighted assets equaled 19.63%, well above the ratio necessary to be considered well capitalized under applicable federal regulations. We strive to manage our capital for maximum shareholder benefit. While the significant increase in equity that resulted from our second-step conversion completed on January 12, 2015 adversely impacted our return on equity, our financial condition and results of operations have been enhanced by the capital from the offering, resulting in increased net interest-earning assets and net income. Further, our strong capital position leaves us well-positioned to meet our customers’ needs and to execute on our growth strategies both organically and through acquisitions. We will also use capital management tools, such as common share repurchases, to improve our capital position.
On July 21, 2016, the Company adopted a second stock repurchase program for up to 10% of its outstanding common stock, or 7,770,978 shares. During the year ended December 31, 2018, the Company purchased 945,400 shares under the second stock repurchase plan.
The Company paid cash dividends on its common stock totaling $0.49 per share during the year ended December 31, 2018. On January 31, 2019, the Company declared a cash dividend of 6 cents per common share, payable on or after February 21, 2019, to common shareholders of record at the close of business on February 11, 2019.
Off-Balance Sheet Arrangements. In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in our consolidated financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit. For information about our loan commitments and unused lines of credit, see note 22 to the consolidated financial statements. For the year ended December 31, 2018, we did not engage in any off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.
Derivative Financial Instruments. The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. These derivatives are not designated as hedges and are not speculative. Rather, these derivatives result from a service the Company provides to certain customers. As the interest rate swaps associated with this program do not meet the hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. As of December 31, 2018, the Company had interest rate swaps with an aggregate notional amount of $164.3 million related to this program. During the year ended December 31, 2018, the Company recognized a net loss of $43 thousand compared to a net loss of $39 thousand during the year ended December 31, 2017 and a net gain of $798 thousand during the year ended December 31, 2016, related to interest rate swap agreements that are included as a component of services charges and other non-interest income in the Company’s consolidated statements of income. The increase in income associated with our interest rate swap agreements during 2016 can be attributed to a $493 thousand swap fee earned on a commercial real estate loan.
Additionally, during the year ended December 31, 2017, the Company entered into an interest rate swap with a separate financial institution with the objective to add stability to interest income and expense and to manage its exposure to interest rate movements associated with its FHLB borrowings. This interest rate swap has a $200.0 million notional value and is designated as a cash flow hedge and involves the receipt of variable rate amounts from a counterparty in exchange for the Company making fixed interest payments.
For this interest rate swap that is designated as a cash flow hedge, the effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income (outside of earnings), net of tax, and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings. The Company assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged transactions. The Company did not recognize any hedge ineffectiveness in earnings during the years ended December 31, 2018 and December 31, 2017.
Recent Accounting Pronouncements
For a discussion of the impact of recent accounting pronouncements, see note 3 in the notes to the consolidated financial statements included in this Annual Report.
Effect of Inflation and Changing Prices
The consolidated financial statements and related consolidated financial data presented in this report have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution’s performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services because such prices are affected by inflation to a larger extent than interest rates.
Consolidated Summary of Quarterly Earnings (Unaudited)
(Dollars in thousands, except per share amounts)
The following table presents summarized quarterly data for 2018 and 2017:
(1) Earnings per share is computed independently for each period. The sum of the individual quarters may not equal the annual earnings per share.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is incorporated herein by reference to the section captioned “Management’s Discussion and Analysis of Results of Operations and Financial Condition.”
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is included herein beginning on page.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
Item 9A.
Item 9A. CONTROLS AND PROCEDURES
The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”): (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. In addition, based on that evaluation, no change in the Company’s internal control over financial reporting occurred during the quarter or year ended December 31, 2018 that has materially affected, or is reasonably likely to affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
The management of Beneficial Bancorp, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting. The internal control process has been designed under our supervision to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles.
Management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018, utilizing the framework established in the 2013 Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2018 is effective.
Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that accurately and fairly reflect, in reasonable detail, transactions and dispositions of assets; and provide reasonable assurances that: (1) transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles; (2) receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and (3) unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the Company’s financial statements are prevented or timely detected.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
KPMG LLP, an independent registered public accounting firm, has audited the Company’s consolidated financial statements as of and for the year ended December 31, 2018, and the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018, as stated in their reports, which are included herein.
/s/ Gerard P. Cuddy
/s/ Thomas D. Cestare
Gerard P. Cuddy
Thomas D. Cestare
President and Chief Executive Officer
Executive Vice President and Chief Financial Officer
Item 9B.
Item 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Board of Directors
The Company’s Board of Directors currently consists of nine members. The Board is divided into three classes with three-year staggered terms, with approximately one-third of the directors elected each year.
Information regarding the Company’s directors is provided below. Unless otherwise stated, each individual has held his or her current occupation for the last five years. The age indicated in each director’s biography is as of December 31, 2018. There are no family relationships among the directors or executive officers. The indicated period for service as a director includes service as a trustee of the Bank.
Edward G. Boehne served as the President of the Federal Reserve Bank of Philadelphia from 1981 to 2000. Mr. Boehne is a Senior Economic Advisor for Haverford Trust Company, an asset management company. He is also a director of Toll Brothers, Inc. (NYSE: TOL) and the privately held companies of Haverford Trust Company. Age 78. Trustee of Beneficial Bank since 2000 and director of Beneficial Bancorp since its formation in 2014.
Mr. Boehne’s asset management background provides the Board of Directors with substantial management and leadership experience with respect to an industry that complements the financial services provided by Beneficial Bank. In addition, as a director of a corporation listed on the New York Stock Exchange, Mr. Boehne offers the Board of Directors significant public company oversight experience.
Karen Dougherty Buchholz is Senior Vice President, Administration, Comcast Corporation, one of the nation’s leading providers of entertainment, information and communications products and services. Age 51. Trustee of Beneficial Bank since 2009 and director of Beneficial Bancorp since its formation in 2014.
As an executive of Comcast Corporation, Ms. Buchholz provides the Board of Directors with extensive public company oversight and leadership experience. In addition, Ms. Buchholz is affiliated with several local civic and charitable organizations and offers the Board of Directors significant business and management level experience from a setting outside of the financial services industry.
Gerard P. Cuddy has served as our President and Chief Executive Officer since 2006. From May 2005 to November 2006, Mr. Cuddy was a senior lender at Commerce Bank. From 2002 to 2005, Mr. Cuddy served as a Senior Vice President of Fleet/Bank of America. Before his service with Fleet/Bank of America, Mr. Cuddy held senior management positions with First Union National Bank and Citigroup. Age 59. Trustee of Beneficial Bank since 2006 and director of Beneficial Bancorp since its formation in 2014.
Mr. Cuddy’s extensive experience in the local banking industry and involvement in business and civic organizations in the communities in which Beneficial Bank serves affords the Board of Directors valuable insight regarding the business and operation of Beneficial Bank. Mr. Cuddy’s knowledge of Beneficial Bancorp’s and Beneficial Bank’s business and history, combined with his success and strategic vision, position him well to continue to serve as our President and Chief Executive Officer.
Michael J. Donahue is a retired partner of KPMG LLP, the global accounting and consulting firm where he held various leadership roles including Group Executive Vice President and Chief Operating Officer of KPMG Consulting (later renamed BearingPoint, NYSE: BE, NASDAQ: KCIN), the $3.6 billion consulting and systems integration firm. Mr. Donahue also served as the managing partner, technology solutions, for the global consulting business and as a member of the Board of Directors of KPMG LLP (US), KPMG Consulting KK (Japan) and as Chairman of the Supervisory Board of KPMG Consulting AG (Germany, Austria and Switzerland). While Chief Operating Officer, Mr. Donahue managed the initial public offering process and led a global expansion program, completing 34 merger and acquisition transactions which added $1.1 billion of annual revenue. Age 60. Trustee of Beneficial Bank and director of Beneficial Bancorp since 2015.
Mr. Donahue has significant Board experience having served on the board of directors for 17 corporations (12 private, five publicly-held). Mr. Donahue’s experience has ranged from large global company boards to emerging growth company boards. In addition to serving on the Board of Directors of Beneficial, Mr. Donahue presently serves as an independent director of two privately-
held firms: Mobiquity, a Massachusetts-based mobile technology and services company; and SiteSpect, a web marketing and optimization software business located in Boston. He also recently served as a director of Preferred Sands, a Pennsylvania-based energy services company.
Mr. Donahue provides the Board of Directors with significant technology strategy and information systems experience across a wide range of industries. In addition, Mr. Donahue offers the Board of Directors significant public company oversight experience.
Frank A. Farnesi is a retired partner of KPMG LLP. In October 2012, Mr. Farnesi was named Chairman of the Board of Beneficial Bank. He is also a former director of RAIT Investment Trust (NYSE: RAS) and a former Trustee of Faith in the Future Foundation. Mr. Farnesi is a Board Leadership Fellow of the National Association of Corporate Directors (NACD). Age 71. Trustee of Beneficial Bank since 2004 and director of Beneficial Bancorp since its formation in 2014.
As a former partner with a certified public accounting firm, Mr. Farnesi provides the Board of Directors with critical experience regarding accounting and financial matters.
Donald F. Gayhardt, Jr. has served as the Chief Executive Officer of Curo Group Holdings Corporation, a publicly traded financial services company, since January 2012 and as Chairman of the Board of Music Training Center Holdings, LLC, a music education company, since May 2009. Before that, Mr. Gayhardt held positions of President, Chief Financial Officer and Secretary as well as a member of the Board of Directors of Dollar Financial Corp., a financial services company located in Berwyn, Pennsylvania. Age 54. Trustee of Beneficial Bank since 2009 and director of Beneficial Bancorp since its formation in 2014.
As a former Chief Financial Officer of Dollar Financial Corp., Mr. Gayhardt provides the Board of Directors with critical experience regarding accounting and financial matters. Mr. Gayhardt’s extensive experience in the local banking industry and involvement in business and civic organizations in the communities in which Beneficial Bank serves affords the Board of Directors valuable insight regarding the business and operation of Beneficial Bank.
Elizabeth H. Gemmill served as the President of the Warwick Foundation, a private family foundation, which dissolved in 2012. She is also a director of Universal Display Corporation (Nasdaq: OLED). In addition, Ms. Gemmill is a Board Leadership Fellow of the National Association of Corporate Directors (NACD). Age 73. Trustee of Beneficial Bank since 2005 and director of Beneficial Bancorp since its formation in 2014.
As a director of Universal Display Corporation, Ms. Gemmill is the Lead Director and provides the Board of Directors with critical experience regarding public company oversight matters.
Thomas J. Lewis served as President and Chief Executive Officer of Thomas Jefferson University Hospitals, Inc. from 1996 to 2012. He is also a director of The Food Trust, which is a nonprofit organization. Mr. Lewis is a Board Governance Fellow of the National Association of Corporate Directors (NACD). Age 66. Trustee of Beneficial Bank since 2005 and director of Beneficial Bancorp since its formation in 2014.
Mr. Lewis’ background offers the Board of Directors management and oversight experience, specifically within the region in which Beneficial Bank conducts its business.
Roy D. Yates is a Professor of Electrical and Computer Engineering at Rutgers University in Piscataway, New Jersey and is a former Chairman of the Board of FMS Financial Corporation. Age 56. Trustee of Beneficial Bank since 2007 and director of Beneficial Bancorp since its formation in 2014.
As the former Chairman of FMS Financial Corporation, Mr. Yates provides the Board of Directors with critical experience regarding public company oversight matters. In addition, Mr. Yates’ academic and engineering background provides the Board of Directors with experience from a setting outside of the financial services industry.
Executive Officers
For information relating to officers of the Company, the section captioned “Business-Executive Officers of the Registrant” in Part I, Item 1 of this Annual Report on Form 10-K is incorporated by reference.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires the Company’s executive officers and directors, and persons who own more than 10% of any registered class of the Company’s equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission. Executive officers, directors and greater than 10% stockholders are required by regulation to furnish the Company with copies of all Section 16(a) reports they file.
Based solely on its review of the copies of the reports it has received and written representations provided to the Company from the individuals required to file the reports, the Company believes that each of its executive officers and directors has complied with applicable reporting requirements for transactions in Company common stock during the year ended December 31, 2018.
Audit Committee Financial Expert
The Audit Committee, which is comprised of Donald F. Gayhardt (Chair), Michael J. Donahue, Elizabeth H. Gemmill and Thomas J. Lewis, assists the Board of Directors in its oversight of Beneficial Bancorp’s accounting, auditing, internal control structure and financial reporting matters, the quality and integrity of Beneficial Bancorp’s financial reports and Beneficial Bancorp’s compliance with applicable laws and regulations. The committee is also responsible for engaging Beneficial Bancorp’s independent registered public accounting firm and monitoring its conduct and independence. The Board of Directors has designated Donald F. Gayhardt, Jr. as an audit committee financial expert under the rules of the Securities and Exchange Commission. Mr. Gayhardt is independent under the listing requirements of the Nasdaq Stock Market applicable to audit committee members.
Code of Ethics and Business Conduct
Beneficial Bancorp has adopted a Code of Ethics and Business Conduct that is designed to ensure that the Company’s directors and employees meet the highest standards of ethical conduct. The Code of Ethics and Business Conduct, which applies to all employees and directors, addresses conflicts of interest, the treatment of confidential information, general employee conduct and compliance with applicable laws, rules and regulations. In addition, the Code of Ethics and Business Conduct is designed to deter wrongdoing and promote honest and ethical conduct, the avoidance of conflicts of interest, full and accurate disclosure and compliance with all applicable laws, rules and regulations. A copy of the Code of Ethics and Business Conduct is available in the Corporate Governance portion of the Investor Relations section of our website (www.thebeneficial.com).
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Report of the Compensation Committee
The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis included in this Item 11 that is required by the rules established by the Securities and Exchange Commission. Based on such review and discussion, the Compensation Committee has recommended to the Board of Directors that the Compensation Discussion and Analysis be included in this document. See “-Compensation Discussion and Analysis.”
Compensation Committee of the Board of Directors of
Beneficial Bancorp, Inc.
Thomas J. Lewis, Chairman
Edward G. Boehne
Donald F. Gayhardt, Jr.
Elizabeth H. Gemmill
Compensation Discussion and Analysis
Overview
This Compensation Discussion and Analysis (“CD&A”) is intended to assist shareholders in understanding our decision-making process and philosophy for compensating our named executive officers in 2018. The following executive officers, who constitute our “named executive officers”, include our Chief Executive Officer, Chief Financial Officer and our next three most highly compensated individuals who served as an executive officer at the end of 2018:
Gerard P. Cuddy
President and Chief Executive Officer
Thomas D. Cestare
Executive Vice President and Chief Financial Officer
Joanne R. Ryder
Executive Vice President and Chief Administration Officer
Martin F. Gallagher, Jr.
Executive Vice President and Chief Lending Officer
Joseph V. Canosa
Executive Vice President and Chief Credit Officer
This CD&A should be read together with the compensation tables for our named executive officers that may be found below under the caption “-Executive Compensation” in Item 11 of this Annual Report on Form 10-K.
The Compensation Committee routinely reviews the Company’s compensation practices to remain market competitive and to ensure that these practices are aligned with our compensation philosophy and objectives, regulatory requirements and evolving best practices. Key highlights of the program include:
· We maintain a clawback policy for bonus and other incentive compensation paid to executive officers, which mitigates risk-taking behavior.
· Our directors and named executive officers are required to hold our common stock at specified minimum levels, which recognizes the importance of aligning their interests with those of stockholders.
· Our President and Chief Executive Officer is required to hold Company common stock valued at three times his annual base salary, and all other named executive officers are required to hold common stock valued at one times his or her annual base salary.
· The Compensation Committee reviews all incentive compensation programs with respect to risk-taking behavior, with the guiding principle being the safety and soundness of the Company and the Bank as paramount to all compensation incentives.
· Our annual incentive awards and long-term performance-based pay reflect and reinforce our pay for performance philosophy.
· We provide limited executive perquisites.
Executive Summary
2018 Financial and Strategic Highlights
During 2018 we continued to make progress towards our strategic goals. Most significantly, on August 7, 2018, the Company entered into an Agreement and Plan of Reorganization with WSFS Financial Corporation (“WSFS”), pursuant to which the Company will merge with and into WSFS (the “Merger Agreement”). Under the terms of the agreement, which has been unanimously approved by the boards of directors and shareholders of both companies, stockholders of Beneficial will receive 0.3013 shares of WSFS common stock and $2.93 in cash for each share of Beneficial common stock. The transaction is subject to customary closing conditions and is expected to close during the first quarter of 2019.
In addition to the transactions contemplated by the Merger Agreement, our management team was also focused in 2018 on improving the Company’s financial performance. Our top priorities were to:
· Improve our overall returns and profitability levels;
· Manage our expense base and improve our efficiency ratio;
· Maintain strong asset quality;
· Divest our insurance operations; and
· Start up a new equipment finance company.
Some of our financial and strategic highlights for 2018 include:
· We recorded net income of $47.8 million, or $0.65 per diluted share, for the year ended December 31, 2018, compared to net income of $23.9 million, or $0.32 per diluted share, for the year ended December 31, 2017;
· Our return on assets improved to 0.81% compared to 0.41% in the prior year
· Net interest margin totaled 3.38% for the year ended December 31, 2018, compared to 3.12% for the year ended December 31, 2017;
· Net interest income increased $10.5 million, or 6.2%, for the year ended December 31, 2018, compared to the year ended December 31, 2017;
· Our non-performing assets to total assets ratio decreased to 0.52% at December 31, 2018, compared to 0.60% at December 31, 2017, and our non-performing assets decreased $4.4 million to $30.5 million at December 31, 2018 from $34.9 million at December 31, 2017;
· During the year ended December 31, 2018 we divested and recorded a $3.3 million net gain on the sale of substantially all of the assets and liabilities of Beneficial Insurance Services, LLC, a former consolidated wholly owned subsidiary of the Bank; and
· In 2018, we launched Neumann Finance, a majority owned subsidiary that originates equipment leases to small businesses.
2018 Key Developments in Executive Compensation
Throughout 2018, our named executive officers focused on strategic initiatives that included the proposed merger with WSFS, as well as managing our capital, increasing profitability, reducing non-performing assets, differentiating the Bank from our competitors, and using new delivery channels to optimize our branch network. Our compensation decisions for 2018 reflected the contributions of our named executive officers to our solid financial performance and achievement of our strategic objectives, including the negotiation of the Merger Agreement.
Adjusting Base Salaries
Following annual performance reviews in the first the quarter of 2018, the Compensation Committee made adjustments to the base salaries for each of our named executive officers. During 2018, Mr. Cuddy, Mr. Cestare, Ms. Ryder, and Mr. Gallagher each received a 2% increase in base salary and Mr. Canosa received a 5% salary increase. See - “Base Salary” for further discussion of our named executive officers’ base salaries. See also, “-Executive Compensation-Summary Compensation Table” for actual base salaries paid in 2018.
Payments under the Company’s Short-Term Cash-Based Incentive Plan
Our Management Incentive Plan (“MIP”) paid out at stretch levels in 2018. See “-Short-Term Cash-Based Incentive Compensation” for additional information on the MIP. See also “-Executive Compensation-Summary Compensation Table” for the actual amounts earned by our named executive officers in 2018.
Issuing Annual Equity Grants
Consistent with our pay for performance philosophy, all of our named executive officers received grants of restricted stock in January 2018 under our long-term incentive program that was designed in connection with the adoption of the Beneficial Bancorp, Inc. 2016 Omnibus Plan. Consistent with past practices, the committee chose to use restricted stock exclusively as it creates alignment with shareholders whether the stock price increases or decreases. Mr. Cuddy, Mr. Cestare, Ms. Ryder, Mr. Gallagher, and Mr. Canosa received annual equity awards of 25,853 shares, 10,517 shares, 7,291 shares, 6,808 shares, and 4,955 shares, respectively. These annual equity awards were based on each named executive officer’s target equity incentive opportunity as a percent of salary as established under the new plan. Forty percent of each award was granted in time-vested shares that vest ratably over three years and the remaining sixty percent was granted in shares that cliff vest based on the bank’s performance at the end of the three-year performance period. See the section titled “-Long-Term Equity-Based Incentive Compensation” for additional information on our equity program. See also, “-Executive Compensation-Grants of Plan Based Awards” for the equity awards granted to our named executive officers in 2018.
Best Practices
In support of our pay for performance philosophy, as well as to ensure our compensation program is supported by good corporate governance practices, we have adopted the following best practices:
· Performance vesting on the majority of equity awards;
· A clawback policy;
· Stock ownership guidelines;
· No tax gross-ups in our executive agreements; and
· Comprehensive risk oversight.
Additional information on each of these governance practices is discussed in this CD&A.
Shareholder Say-on-Pay Vote
As required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), we held an advisory vote on the approval of the compensation of our named executive officers at our 2018 annual stockholders meeting and 96.04% of the shares voted were voted in favor of the proposal. The Compensation Committee considers this approval level to be a strong validation of our compensation philosophy and executive compensation program.
Compensation Philosophy
The Company’s 2018 executive compensation program was designed to offer competitive cash and equity compensation and benefits that attract, motivate and retain highly qualified and talented executives who assist in maximizing the Company’s strategic initiatives, financial performance and earnings growth. The Company’s 2018 executive compensation program focused on aligning the interests of its executive officers with stockholders by rewarding performance against established corporate financial targets, and by motivating strong executive leadership and superior individual performance. The 2018 executive compensation program allocated total compensation between long-term and short-term compensation and between cash and non-cash compensation by including competitive base salaries, executive perquisites, an annual cash incentive plan and stock awards. The compensation paid to each named executive officer in 2018 was based on the executive officer’s level of job responsibility, corporate financial performance and an assessment of his or her individual performance. Our pay for performance philosophy is supported by comprehensive risk oversight by our Board of Directors.
Role of the Compensation Committee
The Compensation Committee is accountable for developing our executive compensation philosophy and making compensation decisions relating to our named executive officers. The committee monitors the success of our program in achieving the objectives of our compensation philosophy. The Compensation Committee is also responsible for the administration of our compensation programs and policies, including the administration of our cash- and stock-based incentive programs.
The Compensation Committee operates under a written charter that establishes its responsibilities. A copy of the Compensation Committee’s charter can be found on the Company’s website at www.thebeneficial.com. The Compensation Committee reviews the charter annually to ensure that the scope of the charter is consistent with the Compensation Committee’s expected role. Under the charter, the Compensation Committee is charged with general responsibility for the oversight and administration of our compensation program. The charter vests in the Compensation Committee the sole responsibility for determining the compensation of the Chief Executive Officer based on the Compensation Committee’s evaluation of his performance. The charter also authorizes the Compensation Committee to engage consultants and other professionals without management approval to the extent deemed necessary to discharge its responsibilities.
During 2018, the Compensation Committee met one time and this meeting included an executive session attended by Compensation Committee members without management present. The members of the Compensation Committee during 2018 were Thomas J. Lewis (Chairman), Edward G. Boehne, Donald F. Gayhardt Jr. and Elizabeth H. Gemmill. Mr. Farnesi, in his role of Chairman of the Board, attended meetings as a non-voting member.
Role of Management
Our Chief Executive Officer, in conjunction with members of the Compensation Committee and the Human Resources Department, develops recommendations regarding the appropriate mix and level of compensation for our named executive officers (other than himself). The recommendations consider the objectives of our compensation philosophy and the range of compensation programs authorized by the Compensation Committee. The Chief Executive Officer meets with the Compensation Committee to discuss the compensation recommendations for the other named
executive officers. Our Chief Executive Officer does not participate in Compensation Committee discussions relating to his own compensation.
Use of Peer Group Data
The Compensation Committee considers information about the practices of the Company’s peers and other comparable companies, as well as evolving market practices when it makes compensation decisions. The committee considers the compensation levels and arrangements of similarly situated executives in addition to other factors in connection with its decision-making process. Duties, responsibilities, and tenure with the Company are also considered in the committee’s compensation decisions. The peer group noted below was developed by the Compensation Committee using objective parameters that reflected banks of similar asset sizes (i.e., between one-half and two times the Company’s asset size) and location (i.e. financial institutions from Connecticut, Delaware, Massachusetts, Maryland, New Jersey, New York, and Pennsylvania).
The Compensation Committee reviews the peer group on an annual basis and updates the peer group as appropriate to ensure that the peer group continues to consist of financial institutions with business models and demographics similar to the Company. The financial institutions that make up our peer group may change depending on acquisitions, growth and/or changes in the business focus of the Company or our peer institutions. Overall, our goal is to have approximately 18 to 24 comparative banks in our peer group to provide a market perspective for executive total compensation.
Below is a list of the institutions that made up our peer group. The peer group’s assets range between $4.1 billion and $10.7 billion.
Elements of Executive Compensation and 2018 Compensation Decisions
Our 2018 compensation program for our named executive officers reflects our compensation philosophy and uses a full range of pay components to achieve our objectives.
When making compensation determinations for our named executive officers, the Compensation Committee focuses on salaries and incentive compensation that are generally competitive at the 50th percentile of the market at target levels of performance. The allocation of base salary and performance-based compensation (short-term cash incentives and equity awards) varies depending upon the role of a named executive officer in our organization and his or her individual performance.
Base Salary
The base salary of each named executive officer is reviewed on an annual basis in connection with the executive’s performance review. Decisions regarding salary adjustments take into account an executive’s current base salary, market practice and the role/contribution of the executive. Our goal is to maintain salary levels for the named executive officers at levels consistent with base pay received by those in comparable positions in the market. We obtain market information from a variety of sources, including peer proxy and survey data gathered by the Compensation Consultant. See “-Use of Peer Group Data.” We also evaluate salary levels at the time of promotion or other change in responsibilities or as a result of specific commitments we made when an officer was hired. Individual performance, role and responsibilities and retention risk are also considered as part of our annual assessment.
Short-Term Cash-Based Incentive Compensation
Our short-term cash-based incentive compensation plan or MIP, was designed in 2018 to recognize and reward plan participants for their contribution to our success through the payment of cash awards.
The MIP is administered by the Compensation Committee with the assistance of the Bank’s Human Resources Department.
The table below shows the 2018 incentive opportunities for our named executive officers under the MIP (expressed as a percentage of base salary), as well as the 2018 results.
The efforts and leadership of our named executive officers were critical to our ability execute a merger agreement with WSFS and to continue to improve the financial performance of the bank and retain our key employees and customers. In 2018, the execution of the Company’s strategic initiatives and the negotiation of the Merger Agreement resulted in 2018 MIP payouts at stretch levels to Messrs. Cuddy, Cestare, Gallagher, Canosa and Ms. Ryder.
See “-Executive Compensation-Grant of Plan Based Awards” for the cash incentive opportunities for each of our named executive officers in 2018.
Long-Term Equity-Based Incentive Compensation. The objectives of our 2018 long term incentive (“LTI”) program were to:
· align the interests of senior management with those of shareholders by increasing their ownership in the Company;
· incentivize senior management to grow the bank without encouraging them to take undue risk; and
· demonstrate to our shareholders that we are focused on growing the bank and linking the compensation of our executives to our organizational performance.
2018 Annual Equity Award. All of our named executive officers received an annual grant of restricted stock under the LTI program in January 2018. Each officer’s target award was calculated by multiplying their target incentive opportunity by their base salary. The table below shows the target equity incentive opportunities for our officers under the 2018 LTI Program.
Forty percent of the 2018 calculated target award was comprised of time-vested shares and the remaining 60% of the 2018 calculated target award was performance-based using ROAA, TSR and NPA/Total Assets as the performance metrics.
See “-Executive Compensation-Grants of Plan Based Awards” for the equity awards granted to our named executive officers in 2018.
Stock Compensation Grant and Award Practices; Timing Issues
Our Compensation Committee considers whether to make equity awards to officers and directors on an annual basis and in connection with new hires and promotions. The Compensation Committee considers the recommendations of our chief executive officer and other executive officers with respect to awards contemplated for their subordinates. The Compensation Committee is solely responsible for the development of the schedule of equity awards made to our chief executive officer and the other named executive officers.
The Compensation Committee’s process is independent of any consideration of the timing of the release of material non-public information, including with respect to the determination of grant dates or stock option exercise prices. Similarly, we have never timed the release of material non-public information to affect the value of executive compensation. The release of such information reflects long-established timetables for the disclosure of material non-public information such as earnings reports or, with respect to other events reportable under federal securities laws, the applicable requirements of such laws with respect to timing of disclosure. The Compensation Committee’s decisions are reviewed and ratified by the full Board of Directors.
The terms and conditions of the annual grant of equity awards made in January 2018 were determined in accordance with the 2016 Omnibus Plan and the policies established by the Compensation Committee.
All stock options and stock awards granted under the equity plans become 100% vested upon an award recipient’s death, disability or a change in control. See “-Executive Compensation-Outstanding Equity Awards at Fiscal Year End” for detail on the outstanding equity awards granted to our named executive officers as of December 31, 2018.
Our equity plans provide that the Compensation Committee may grant stock options with an exercise price only at or above fair market value, which is defined as the closing sales price of our common stock on the Nasdaq Global Select Market on the date of grant.
Retirement Benefits; Employee Welfare Benefits
All of our named executive officers are eligible to participate in the tax-qualified retirement plans available to all eligible Beneficial Bank employees. This includes the employee savings and stock ownership plan and, for those executives employed by Beneficial Bank before June 30, 2008, the Employees’ Pension and Retirement Plan of Beneficial Bank (the “Pension Plan”). The Pension Plan was frozen effective June 30, 2008 in connection with the restructuring of our retirement program. Our employee savings and stock ownership plan allows eligible employees, including the named executive officers, to supplement their retirement savings with elective deferral contributions that we match at specified levels. The employee savings and stock ownership plan also provides for additional discretionary employer contributions based on a percentage of participant compensation, subject to the Internal Revenue Code contribution limits.
In addition to our tax-qualified retirement plans, we also maintain two non-qualified supplemental retirement arrangements for certain named executive officers. These supplemental retirement plans assist the Company in attracting and retaining executive talent. The Compensation Committee periodically reviews the plans with due consideration given to prevailing market practice, overall compensation philosophy and cost to the Company. Mr. Cuddy is a participant in the Beneficial Bank Supplemental Pension and Retirement Plan, which provides him with a benefit that would have been payable under the Pension Plan, prior to the plan freeze but for certain Internal Revenue Code limits on compensation and benefits. See “-Executive Compensation-Pension Benefits-Supplemental Pension and Retirement Plan” for a detailed description of the arrangement and contributions made on behalf of Mr. Cuddy in 2018. The Company also maintains an elective deferred compensation plan that allows the Bank to provide restorative payments to participants who experience a shortfall in retirement benefits under the employee savings and stock ownership plan due to Internal Revenue Code limits on compensation that reduce benefits for highly compensated executives under tax-qualified retirement plans. The Compensation Committee has designated each of our named executive officers as participants in the Elective Deferred Compensation Plan.
In addition to retirement programs, we provide our employees with coverage under medical, life insurance and disability plans on terms consistent with industry practice. All benefits offered to the named executive officers are provided at the same coverage level and cost as those offered to all Bank employees.
Employment and Executive Change in Control Severance Agreements
Chief Executive Officer/Chief Financial Officer
During 2018, we maintained employment agreements with Messrs. Cuddy and Cestare. The employment agreements ensure the stability of our management team and outline the terms and conditions of employment for these executives. The terms and conditions of our employment agreements are consistent with the agreements provided to executive officers in the banking industry and reflect best practices, such as the exclusion of tax gross-ups. See “-Executive Compensation-Employment Agreements” and “-Executive Compensation-Potential Post-Termination Payments” for a detailed discussion of the terms of the employment agreements and the benefits and payments provided upon termination of service for Messrs. Cuddy and Cestare under the employment agreements.
Other Named Executive Officers
We maintained executive change in control severance agreements with Ms. Ryder, Mr. Gallagher and Mr. Canosa during 2018. These agreements provide financial protection if an executive’s employment is terminated in connection with a change in control. See “-Executive Compensation-Change in Control Severance Agreements” and “-Executive Compensation-Potential Post-Termination Payments” for a detailed discussion of the terms of the change in control severance agreements and the benefits and payments provided upon termination of service for Ms. Ryder, Mr. Gallagher and Mr. Canosa under the executive change in control severance agreements. We do not provide tax gross ups under the change in control severance agreements.
In November 2018, as contemplated by the Merger Agreement, Mr. Canosa entered into an arrangement with the Company and WSFS that entitled Mr. Canosa to a lump sum cash payment of $704,546 on or before December 31, 2018.
Tax and Accounting Considerations
In consultation with our advisors, we evaluate the tax and accounting treatment of each of our compensation programs at the time of adoption and on an annual basis to ensure an understanding of the financial impact of the program. Our analysis includes a detailed review of recently adopted and pending changes in tax and accounting requirements. As part of our review, we consider modifications and/or alternatives to existing programs to take advantage of favorable changes in the tax or accounting environment or to avoid adverse consequences. To preserve maximum flexibility in the design and implementation of our compensation program, we have not adopted a formal policy that requires that all compensation be tax deductible. However, to the greatest extent possible, it is our intent to structure our compensation programs in a tax efficient manner. When making grants under the 2016 Omnibus Plan, the Compensation Committee considers the tax implications of the awards. All stock options granted under our equity plans, since their implementation, have been non-statutory stock options.
Perquisites
We annually review the perquisites that we make available to our named executive officers. The primary perquisites for senior managers include an automobile allowance and certain club dues. See “-Executive Compensation- Summary Compensation Table” for detailed information on the perquisites provided to our named executive officers.
Stock Ownership Requirements
Our stock ownership guidelines are robust and continue to reflect current corporate governance trends. We require our President and Chief Executive Officer to own or acquire shares of Company stock having a fair market value equal to three times his base salary. All other named executive officers are expected to own or acquire Company common stock having a fair market value equal to one times each officer’s base salary. Each named executive officer’s individual stock ownership requirement is based on his or her salary as of March 17, 2011 or, for new executives, as of his or her date of hire, and will not change due to a change in base salary or fluctuation in the Company’s stock prices. However, the Corporate Governance Committee, may, from time to time, re-evaluate or revise the guidelines for corporate reasons. Non-employee directors of the Company are expected to own or acquire shares of Company common stock having a fair market value equal to ten times the annual retainer received by each director for services rendered as a director of the Company as of March 17, 2011. All individuals subject to the stock ownership and retention policy had five years from appointment as a named executive officer or director (whichever is applicable) or March 17, 2016, whichever was later, to satisfy the stock ownership guidelines. Shares counted towards the ownership requirements include shares of Company common stock purchased in the open market, owned out-right by an individual, or members of his or her immediate family residing in the same household, whether held individually or jointly, restricted stock granted under the Company’s equity plans, shares held in trust or by a family limited partnership and shares acquired through the employee savings and stock ownership plan. Failure to meet, or in unique circumstances to show sustained progress toward meeting, the stock ownership guidelines may result in a reduction in future long-term incentive grants and/or payment of future annual incentives in the form of stock. All executive officers and directors are in compliance with the stock ownership requirement. Once stock ownership goals are achieved, the ownership requirement amount must be maintained for as long as an individual is subject to the stock ownership guidelines. In addition to stock ownership requirements, the Company also established a mandatory holding period of six months for stock acquired under the Company’s 2008 Equity Incentive Plan and 2016 Omnibus Plan.
Clawback Policy
Our stock-based and cash-based incentive plans provide that if our Board of Directors determines that a named executive officer alters, inflates or inappropriately manipulates the performance/financial results of the Company or violates recognized ethical business standards, the Board of Directors will, to the extent permitted by applicable law, seek recoupment from that named executive officer of any portion of performance-based compensation (cash or stock) paid to the named executive officer. We also have adopted a clawback policy that incorporates the plan provisions and further states that if a named executive officer engages in fraud or willful misconduct that causes or otherwise contributes to the need for a material restatement of our financial results, the Board of Directors will direct the Compensation Committee to review all performance-based compensation awarded to or earned by that named executive officer during the three-year period before the fiscal periods materially affected by the restatement. If, in the Compensation Committee’s view, the performance-based compensation would have been lower if it had been based on the restated results, the Board of Directors will, to the extent permitted by applicable law, seek recoupment from that named executive officer of any portion of such performance-based compensation as it deems appropriate after a review of all relevant facts and circumstances. The Compensation Committee will monitor our clawback policy as further guidance is released by the U.S. Securities and Exchange Commission as part of the Dodd-Frank Act.
Risk Assessment
At the direction of the Compensation Committee, the Company reviews its compensation and benefit programs to determine if the programs create undesired or unintentional risk of a material nature. The 2018 risk assessment included: a review of program policies and practices; program analysis to identify risk and risk control related to the programs; and determinations as to the sufficiency of risk identification, the balance of potential risk to potential reward, risk control, and the support of the programs and their risks to the Company’s strategy. The results of the 2018 risk assessment concluded that our compensation policies and practices do not encourage excessive risk-taking, are compatible with effective internal controls and are supported by the oversight and administration of the Compensation Committee with regard to executive compensation programs.
Executive Compensation
Summary Compensation Table
The following tables provides information concerning the total compensation awarded, earned or paid to the principal executive officer and principal financial officer of Beneficial Bancorp and our three other most highly compensated executives during the year ended December 31, 2018. These officers are referred to as the “named executive officers” in this proxy statement.
(1) Reflects the grant date aggregate fair value calculated in accordance with FASB ASC Topic 718 on outstanding restricted stock awards for each of the named executive officers. The amounts were calculated based on Beneficial Bancorp’s stock price as of the date of grant as follows: (i) $16.60 for all restricted stock awards granted on January 25, 2018, (ii) $18.00 for all restricted stock awards granted on January 26, 2017, and (iii) $12.69 for all restricted stock awards granted on January 28, 2016 and $13.63 for all restricted stock awards granted on June 9, 2016. For the performance-based portion of the 2018 awards, the grant date fair value reflects the number of shares that are expected to vest based on the probable outcome of the performance results (i.e., target level of performance). The grant date fair value of the restricted stock awards granted in 2018, assuming maximum level of performance for the performance-based portion of the awards, was $557,909 for Mr. Cuddy, $226,955 for Mr. Cestare, $157,335 for Ms. Ryder, $146,910 for Mr. Gallagher, and $106,921 for Mr. Canosa. For the performance-based portion of the 2017 awards, the grant date fair value reflects the number of shares that are expected to vest based on the probable outcome of the performance results (i.e., target level of performance). The grant date fair value of the restricted stock awards granted in 2017, assuming maximum level of performance for the performance-based portion of the awards, was $531,342 for Mr. Cuddy, $220,329 for Mr. Cestare, $144,324 for Ms. Ryder and $142,641 for Mr. Gallagher.
(2) The pension value decreased by $4,141 in 2018 as a result of an increase in the discount rate during the year and not in the total pension benefit to be received in the future. Amounts during the years ended December 31, 2017 and 2016 represent the actuarial change in pension
value in Mr. Cuddy’s under the Beneficial Bank Consolidated Pension Plan and the Beneficial Bank Supplemental Pension and Retirement Plan. See “Pension Benefits” below for a further discussion of these arrangements.
(3) Amounts reported in the “All Other Compensation” column for 2018 include the details in the table below.
(a) Represents Beneficial Bancorp’s 2018 contribution to the Elective Deferred Compensation Plan.
(b) Includes the value of executive’s personal use of a company-owned automobile and club membership fees.
Grants of Plan Based Awards
2008 Equity Incentive Plan. Beneficial Bancorp maintained the 2008 Equity Incentive Plan to further its commitment to performance-based compensation and to provide participants with an opportunity to have an equity interest in Beneficial Bancorp. Upon the adoption of the 2016 Omnibus Plan, the 2008 Equity Incentive Plan was terminated and no additional awards can be granted under this plan. However, outstanding awards under the 2008 Equity Incentive Plan will continue in effect in accordance with their terms.
2016 Omnibus Plan. At the annual meeting of stockholders held on March 11, 2016, stockholders of the Company approved Beneficial Bancorp, Inc. 2016 Omnibus Plan (“2016 Equity Plan”). This plan provided for the issuance of 3,500,000 shares of common stock (4.4% of our issued and outstanding). Individuals may receive awards of Beneficial Bancorp common stock (restricted or performance awards) and grants of options to purchase shares of Beneficial Bancorp common stock at a specified exercise price during a specified time period. The Compensation Committee believes that executive stock ownership provides a significant incentive in building stockholder value by further aligning the interests of our executives with stockholders and such compensation is directly linked to the performance of Beneficial Bancorp common stock. The granting of equity awards are designed to provide additional incentives to management in order to retain such persons whose efforts will facilitate the long-term growth and profitability of the Company. The following table provides information concerning restricted stock awards granted to the named executive officers in 2018 under the Beneficial Bancorp, Inc. 2016 Omnibus Plan.
(1) For all named executive officers, the number of performance-based restricted shares that could be earned is determined based on the Company’s Return on Average Assets, Total Shareholder Return, and NPAs/Total Assets in 2017-2019. The earned shares will cliff vest following the completion of the 3-year performance period.
(2) For all named executive officers, time-based restricted shares vest in three equal annual installments on the anniversary of the date of the award.
(3) Sets forth the grant date fair value of stock awards calculated in accordance with FASB ASC Topic 718. The grant date fair value of all restricted stock awards is equal to the number of performance-based shares that could be earned at target level performance plus the number of time-based shares multiplied by $16.60, the closing price for Beneficial Bancorp’s common stock on the date of grant. For further information see note 20 to the notes to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.
The 2016 Equity Plan will expire on March 11, 2026 (the tenth anniversary of the shareholder approval) or sooner, if the maximum number of shares available for issuance under the plan have been issued or if the Board of Directors terminates the plan. The plan is administered by Beneficial Bancorp’s Compensation Committee.
Management Incentive Plan. The following table sets forth the threshold, target and maximum award that may be earned by each named executive officer under our 2018 MIP. See “Compensation Discussion and Analysis-Short-Term Cash-Based Incentive Compensation” for detailed information on Beneficial Bancorp and individual performance measures that must be achieved for an eligible named executive officer to receive an award under the plan.
(1) The “Summary Compensation Table” shows the actual awards earned by our named executive officers under the 2018 MIP.
The 2018 MIP is designed to recognize and reward executives for their individual and collective contributions to the success of Beneficial Bancorp and Beneficial Bank. The plan focuses on performance measures that are critical to the profitability and growth of Beneficial Bancorp and its affiliates. See “Compensation Discussion and Analysis-Short-Term Cash-Based Incentive Compensation” for detailed information on the plan and Beneficial Bancorp and individual performance measures used by the Compensation Committee to determine payouts under the 2018 MIP.
Outstanding Equity Awards at Fiscal Year End
The following table provides information concerning unexercised options and stock awards that have not vested for each named executive officer outstanding as of December 31, 2018.
(1) Options vest in five equal annual installments beginning one year from the date of grant.
(2) Shares vest according to the following schedule: shares are subject to a three-year cliff vesting schedule whereby no shares vest on the first and second anniversaries of the award, 60% of the shares vest on the third anniversary of the award and 20% of the shares each vest on the fourth and fifth anniversaries of the award.
(3) Shares vest in three equal annual installments on the anniversary of the date of the award.
(4) Shares subject to performance-vesting. Anywhere between 0% and 150% of the target award will vest based on the bank’s performance under pre-established metrics relative to a pre-established group of peers. No performance-vesting shares will vest until the bank’s performance has been assessed at the end of the three-year performance period
(5) Based upon Beneficial Bancorp’s closing stock price of $14.29 on December 31, 2018.
Stock Vested
The following table provides information concerning the vesting of stock awards for each named executive officer, on an aggregate basis, during 2018.
(1) The value realized upon vesting is equal to the closing market price of the Company on the date of vesting multiplied by the number of shares acquired. The amount reported is the aggregate of shares vesting from multiple grants of restricted stock.
Pension Benefits
The following table sets forth the actuarial present value of Mr. Cuddy’s accumulated benefit under our tax-qualified and non tax-qualified defined benefit plans, along with the number of years of credited service under the respective plans. No distributions were made under the plans in 2017. Beneficial Bank froze the Employees’ Pension and Retirement Plan of Beneficial Bank effective June 30, 2008. Messrs. Cestare and Gallagher and Ms. Ryder and Cyr are not participants in the Beneficial Bank tax-qualified and non-qualified defined benefit plans.
(1) Represents the number of years of credited service used only to determine the benefits under the pension plan and the supplemental pension plan. Years of credited service were frozen at June 30, 2008.
(2) The present value of accumulated benefit assumes normal retirement (age 65), the election of a single life form of pension and is based on a 4.24% discount rate for the pension plan and 3.95% for the supplemental pension plan.
Consolidated Pension Plan. The Employees’ Pension and Retirement Plan of Beneficial Bank was frozen effective June 30, 2008. The frozen plan provides that an active participant may retire on or after the date the participant attains age 65 and upon retirement, after twenty-five accrual years of service as a participant, receive a monthly pension in the form of a straight life annuity equal to 50% of his or her average monthly compensation. If the participant’s service is less than 25 years, his or her pension will be adjusted by the ratio of service to 25 years. After attainment of age 55 and the completion of five years of service, an active participant may elect early retirement. Upon early retirement a participant will be entitled to receive his or her accrued pension commencing on his or her normal retirement date or, if
the participant desires, he or she may elect to receive a reduced pension, which can commence on the first day of the month concurrent with or next following the participant’s early retirement date. If the employment of an active participant is terminated because of total and permanent disability, the participant will be entitled to receive a disability pension equal to the participant’s accrued pension, without actuarial reduction, commencing on the date the participant terminates employment due to disability and continuing until his death or until recovery from his total and permanent disability, if before age 65.
Participants generally have no vested interest in retirement plan benefits before the completion of five years of service. Following the completion of five years of vesting service, or in the event of a participant’s attainment of age 65 (or the fifth anniversary of participation in the plan, if later), death or termination of employment due to disability, a participant will become 100% vested in his or her accrued benefit under the retirement plan. The retirement plan provides that a participant may receive, subject to certain spousal consent requirements, his or her pension benefit in any of the following forms: (1) a life annuity, (2) a reduced life annuity for the participant’s life with 120 monthly payments guaranteed if the participant dies before receiving the 120 payments, (3) a 100%, 75% or 50% joint and survivor annuity, or (4) a lump sum distribution if the value of the accrued pension benefit is less than $5,000.
Supplemental Pension and Retirement Plan. The Supplemental Pension and Retirement Plan of Beneficial Bank provides benefits that would have been payable to certain officers under the Beneficial Bank Consolidated Pension Plan but for certain Internal Revenue Service limitations. Upon termination of employment with Beneficial Bank a participant is eligible to receive benefits under the Supplemental Pension and Retirement Plan equal to the excess, if any, of (1) the benefits that would have been payable to the participant commencing on the first day of the month coincident with or next following the attainment of age 65 under the Pension Plan in the form of a single life annuity, but for the limitations imposed by the Internal Revenue Code, based on a participant’s compensation and service with Beneficial Bank through June 30, 2008, over (2) the accrued benefits actually payable under the Pension Plan commencing on the first day of the month coincident with or next following the attainment of age 65 in the form of a single life annuity. If a participant dies before the commencement of benefits under the Pension Plan and if the participant’s spouse or beneficiary is entitled to a survivor’s benefit under the Pension, the spouse or beneficiary shall receive a benefit under the Supplemental Pension and Retirement Plan.
Nonqualified Deferred Compensation
The following table discloses contributions made under the Beneficial Bank Elective Deferred Compensation Plan, a non-qualified defined contribution plan, for each named executive officer in 2018, along with the earnings and balances on each executive’s account as of December 31, 2018.
Potential Post-Termination Payments
Payments Made Upon Termination for Cause. Under the terms of the employment agreements with Messrs. Cuddy and Cestare, if either of the executives is terminated for cause, he will receive his base salary through the date of termination and retain the rights to any vested benefits subject to the terms of the plan or arrangement under which those benefits are provided. In addition, a termination for cause will also result in the forfeiture of all unvested stock awards
(time-based and performance) and vested stock options that have not been exercised. Further, participants in Beneficial Bank’s 2018 MIP will forfeit all rights to incentive opportunities as a result of termination for cause.
Payments Made Upon Termination Without Cause or for Good Reason. Under the terms of the employment agreements with Messrs. Cuddy and Cestare, if Beneficial Bank or Beneficial Bancorp terminates either executive’s employment for reasons other than for cause or a change in control, or if either executive resigns from Beneficial Bank or Beneficial Bancorp after specified circumstances set forth in the agreements that would constitute constructive termination, the employment agreements provide that the executive or, if the executive dies, his beneficiary, would be entitled to receive two times the sum of the executive’s (1) current base salary and (2) the average of the bonus paid (including performance bonuses paid under the 2018 MIP) by the Company and/or Bank for the three year’s preceding the executive’s termination of employment. The severance benefit would be paid ratably over a two-year period. In addition, the executive would be entitled to receive, for the 24-month period following his termination date, medical, dental and life insurance coverage. If Beneficial Bank or Beneficial Bancorp terminates its employment relationship with Messrs. Cuddy and Cestare, during the term of their employment agreements for reasons other than cause or a change in control, the executive must adhere to a one-year non-competition restriction.
If any named executive officer terminates employment without cause or for good reason he or she will forfeit all unvested stock awards, performance awards and stock options.
Participants in Beneficial Bank’s 2018 MIP must be employed by Beneficial Bank on the date the benefits are distributed. Therefore, if a participant terminates employment without cause or for good reason before payment under the 2018 MIP, all rights to plan benefits are forfeited.
Payments Made Upon Disability. The employment agreements provide each executive with a disability benefit equal to two-thirds of the executive’s bi-weekly rate of base salary as of his termination date. An executive will cease to receive disability payments upon the earlier of: (1) the date the executive returns to full-time employment; (2) the death of the executive; (3) the executive’s attainment of age 65; or (4) the date the employment agreement would have expired had the executive’s employment not terminated by reason of the executive’s disability. In addition, the executive would continue to be covered, to the greatest extent possible, under all benefit plans in which the executive participated before his or her disability as if he or she were actively employed by us. Disability payments are reduced by any disability benefits paid to an executive under any policy or program maintained by Beneficial Bank.
If any named executive officer terminates employment due to disability, he or she will vest 100% in all unvested stock awards and stock options.
If a participant in Beneficial Bank’s 2018 MIP terminates his or her service with Beneficial Bank due to a disability, his or her award will be prorated based on the period of active employment with Beneficial Bank.
Payments Made Upon Death. Under the employment agreements, each executive’s estate is entitled to receive any salary and bonus accrued but unpaid as of the date of the executive’s death.
If a participant in Beneficial Bank’s 2018 MIP dies, his or her estate will receive the prorated portion of the participant’s award as of his or her date of death.
Payments Made Upon a Change in Control. Following a change in control of Beneficial Bank or Beneficial Bancorp, under the terms of the employment agreements with Messrs. Cuddy and Cestare, if either executive voluntarily terminates with Good Reason, as such term is defined in the executive’s employment agreement (upon circumstances discussed in the agreement), or involuntarily terminates employment, the executive or, if the executive dies, the executive’s beneficiary, would be entitled to receive a lump sum severance payment equal to three times the sum of the executive’s: (1) base salary and (2) the average of the bonus paid (including performance bonuses paid under the 2018 MIP) by the Company and/or Bank for the three years preceding the executive’s termination of employment. In addition, the executive would also be entitled to continued medical, dental and life insurance coverage for the executive and his dependents for 36 months following termination of employment. Mr. Cuddy would also be entitled to continue a club membership for 36 months following his termination of employment at no cost to him.
Under the terms of the executive change in control severance agreement with Ms. Ryder, Mr. Gallagher or Ms. Cyr, if within twelve months of a change in control, any of the executives is involuntarily terminated or voluntarily terminates employment with Beneficial Bancorp as a result of not being offered a Comparable Position (as defined in the agreements) he or she would be entitled to receive a lump sum severance payment equal to three times the sum of his or her: (1) base salary and (2) most recent bonus paid (including performance bonuses paid under the 2018 MIP) by Beneficial Bancorp and/or Beneficial Bank. In addition, each executive would also be entitled to continued medical, dental and life insurance coverage for 36 months following termination of employment.
Section 280G of the Internal Revenue Code provides that severance payments that equal or exceed three times an individual’s base amount are deemed to be “excess parachute payments” if they are contingent upon a change in control. An individual’s base amount is equal to an average of the individual’s Form W-2 compensation for the five years preceding the year a change in control occurs (or such lesser number of years if the individual has not been employed for five years). Individuals receiving excess parachute payments are subject to a 20% excise tax on the amount of the payment in excess of the base amount, and the employer may not deduct such amount for federal tax purposes. The employment agreements and executive change in control severance agreements provide for a “best net benefits” approach in the event that severance benefits under the agreements or otherwise result in “excess parachute payments” under Section 280G of the Internal Revenue Code of 1986, as amended. The best net benefits approach reduces an executive’s payments and benefits to avoid triggering the excise tax if the reduction would result in a greater after-tax amount to the executive officer compared to the amount the executive officer would receive net of the excise tax if no reduction were made.
If the executives terminate employment in connection with a change in control, they will vest 100% in all unvested equity awards.
Payments Upon Retirement. In addition to the tax-qualified retirement benefits and non-qualified retirement benefits set forth in “-Pension Benefits” above, participants in the 2018 MIP who retire from Beneficial Bank will receive a prorated payout based on the period of the participant’s active employment only.
All payments under the Elective Deferred Compensation Plan will be made in accordance with the form and timing elections made at the time of each executive’s deferral election.
Potential Post-Termination Benefits Tables. The amount of compensation payable to each named executive officer upon termination for cause, termination upon an event of termination, change in control followed by termination of employment, disability, death and retirement is shown below. The amounts shown assume that such termination was effective as of December 31, 2018, and thus include amounts earned through such time and are estimates of the amounts that would be paid out to the executives upon their termination. The amounts do not include the executive’s account balances in Beneficial Bank’s tax-qualified retirement plans to which each executive has a non-forfeitable interest. The amounts shown relating to unvested options and awards are based on the fair market value of Beneficial Bancorp’s common stock on December 31, 2018, which was $14.29. The actual amounts to be paid out can only be determined at the time of such executive’s separation from service with Beneficial Bancorp.
The following table provides the amount of compensation payable to Mr. Cuddy in each of the circumstances listed below.
(1) Represents the value of club membership fees for 36 months following termination of employment in connection with a change in control.
(2) Represents the cash payment due under the executive’s employment agreement. Assumes such payment would be paid ratably over a two-year period.
(3) Assumes 2018 MIP payment was made on December 31, 2018.
(4) Benefits have been calculated based on the date the agreement would have expired had the executive’s employment not terminated due to disability.
(5) The amount shown does not reflect adjustments that may be made by the executive if said payment was deemed an “excess parachute payment” under Section 280G of the Internal Revenue Code.
The following table provides the amount of compensation payable to Mr. Cestare in each of the circumstances listed below.
(1) Represents the cash payment due under the executive’s employment agreement. Assumes such payment would be paid ratably over a two-year period.
(2) Assumes 2018 MIP payment was made on December 31, 2018.
(3) Benefits have been calculated based on the date the agreement would have expired had the executive’s employment not terminated due to disability.
(4) The amount shown does not reflect adjustments that may be made by the executive if said payment was deemed an “excess parachute payment” under Section 280G of the Internal Revenue Code.
The following table provides the amount of compensation payable to Ms. Ryder in each of the circumstances listed.
(1) The amount shown does not reflect adjustments that may be made by the executive if said payment was deemed an “excess parachute payment” under Section 280G of the Internal Revenue Code.
(2) Assumes 2018 MIP payment was made on December 31, 2018.
The following table provides the amount of compensation payable to Mr. Gallagher in each of the circumstances listed below.
(1) The amount shown does not reflect adjustments that may be made by the executive if said payment was deemed an “excess parachute payment” under Section 280G of the Internal Revenue Code.
(2) Assumes 2018 MIP payment was made on December 31, 2018.
The following table provides the amount of compensation payable to Mr. Canosa in each of the circumstances listed below.
(1) The amount shown does not reflect adjustments that may be made by the executive if said payment was deemed an “excess parachute payment” under Section 280G of the Internal Revenue Code.
(2) Assumes 2018 MIP payment was made on December 31, 2018.
Chief Executive Officer’s Pay Ratio
We believe our executive compensation program is consistent and internally equitable to motivate our employees to perform in ways that enhance shareholder value. We are committed to internal pay equity, and the Compensation Committee monitors the relationship between the pay of our executive officers and the pay of our non-executive employees. The Compensation Committee reviewed a comparison of our Chief Executive Officer’s compensation for 2018 to that of all other Company employees for the same period. The calculation of annual total compensation of all employees was determined in the same manner as the “Total Compensation” shown for our CEO in the “Summary Compensation Table.” Pay elements that were included in the annual total compensation for each employee that was used in determining the median employee for the purposes of the calculation were:
· salary received during the twelve months ended December 31, 2018;
· annual incentive payment received for performance during 2018;
· grant date fair value of restricted and performance stock awards granted during 2018;
· employer contribution to employee savings and stock ownership plan and elective deferred compensation plan made during the first nine months of 2018, annualized;
· dividends paid on unvested restricted awards during 2018; and
· personal use of a company-owned automobile and club membership fees during 2018.
We determined the compensation of our median employee (our “Median Employee”) by: (i) calculating the compensation described above for each of our employees, (ii) ranking the compensation of all employees except for the Chief Executive Officer from lowest to highest, and (iii) determining the employee whose compensation represents the median compensation of all employees other than the CEO.
The annual compensation for our CEO was $2,014,998 for fiscal year 2018, and for the Median Employee it was $50,798 for fiscal year 2018. The resulting ratio of our CEO’s pay to the pay of our Median Employee for fiscal year 2018 is 40 to 1.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Security Ownership of Certain Beneficial Owners and Management
The following table provides information as of February 22, 2019 about the persons known to us to be the beneficial owners of more than 5% of Beneficial Bancorp, Inc.’s outstanding common stock. A person may be considered to beneficially own any shares of common stock over which he or she has, directly or indirectly, sole or shared voting or investing power.
(1) Based on 74,700,184 shares of Beneficial Bancorp common stock outstanding as of February 22, 2019.
(2) Based solely on a Schedule 13G/A filed with the U.S. Securities and Exchange Commission on February 14, 2019. The Company’s articles of incorporation generally provide that record holders of the Company’s common stock who beneficially own, either directly or indirectly, in excess of 10% of the Company’s outstanding shares are not entitled to any vote with respect to those shares held in excess of the 10% limit. However, a majority of the Company’s disinterested directors may approve a shareholder acquiring and voting in excess of 10% of the Company’s outstanding shares before the shareholder acquires shares in excess of the 10% limit. In December 2016, the Company’s Board of Directors authorized T. Rowe Price Associates, Inc. (“T. Rowe Price”) to acquire up to 15% of the Company’s outstanding common stock effective January 12, 2018, provided that (i) T. Rowe Price will use its best efforts to provide that any such shares owned in excess of the 10% limit will be voted in proportion to the vote taken on all other shares and (ii) in the event that such efforts to provide for mirrored voting are not successful, T. Rowe Price will not vote any shares in excess of the 10% limit.
(3) Based solely on a Schedule 13G/A filed with the U.S. Securities and Exchange Commission on February 13, 2019.
(4) Based solely on a Schedule 13G filed with the U.S. Securities and Exchange Commission on February 8, 2019.
(5) Based solely on a Schedule 13G/A filed with the U.S. Securities and Exchange Commission on February 4, 2019.
(6) Based solely on a Schedule 13G filed with the U.S. Securities and Exchange Commission on February 12, 2019.
The following table provides information about the shares of Beneficial Bancorp common stock that may be considered to be owned by each director of Beneficial Bancorp, each executive officer named in the summary compensation table and by all directors and executive officers of Beneficial Bancorp as a group as of February 22, 2019. A person may be considered to own any shares of common stock over which he or she has, directly or indirectly, sole or shared voting or investment power. Unless otherwise indicated, each of the named individuals has sole voting and
investment power with respect to the shares shown. The number of shares beneficially owned by all directors and executive officers as a group totaled 4.6% of our common stock at February 22, 2019.
* Represents less than 1% of outstanding common stock at February 22, 2019.
(1) This column includes the following:
(2) Includes 33,478 shares held by Mr. Yates’ son.
Change in Control
The Company has entered into an Agreement and Plan of Reorganization, dated as of August 7, 2018 and amended as of November 1, 2018 (the “Merger Agreement”), with WSFS Financial Corporation (“WSFS”), pursuant to which the Company will merge with and into WSFS in accordance with the terms of the Merger Agreement.
Aside from the transactions contemplated by the Merger Agreement, management of the Company knows of no arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the Company.
Equity Compensation Plan Information
The following table sets forth information as of December 31, 2018 about Company common stock that may be issued under the Company’s equity compensation plans. All plans were approved by the Company’s stockholders.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
Transactions with Related Persons
The Sarbanes-Oxley Act of 2002 generally prohibits loans by Beneficial Bancorp to its executive officers and directors. However, the Sarbanes-Oxley Act contains a specific exemption from such prohibition for loans by Beneficial Bank to its executive officers and directors in compliance with federal banking regulations. Federal regulations require that all loans or extensions of credit to executive officers and directors of insured financial institutions must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and must not involve more than the normal risk of repayment or present other unfavorable features. Beneficial Bank is therefore prohibited from making any new loans or extensions of credit to executive officers and directors at different rates or terms than those offered to the general public. Notwithstanding this rule, federal regulations permit Beneficial Bank to make loans to executive officers and directors at reduced interest rates if the loan is made under a benefit program generally available to all other employees and does not give preference to any executive officer or director over any other employee, although Beneficial Bank does not currently have such a program in place.
Pursuant to Beneficial Bancorp’s Audit Committee charter, the Audit Committee periodically reviews, no less frequently than quarterly, a summary of Beneficial Bancorp’s transactions with directors and executive officers of Beneficial Bancorp and with firms that employ directors, as well as any other related person transactions, to recommend to the disinterested members of the Board of Directors that the transactions are fair, reasonable and within our policy and should be ratified and approved. Also, in accordance with banking regulations and its policy, the Board of Directors reviews all loans made to a director or executive officer in an amount that, when aggregated with the amount of all other loans to such person and his or her related interests, exceed the greater of $25,000 or 5% of Beneficial Bancorp’s capital and surplus (up to a maximum of $500,000) and such loan must be approved in advance by a majority of the disinterested members of the Board of Directors. Additionally, pursuant to Beneficial Bancorp’s Code of Ethics and Business Conduct, all executive officers and directors of Beneficial Bancorp must disclose any existing or potential conflicts of interest to the President and Chief Executive Officer of Beneficial Bancorp. Such potential conflicts of interest include, but are not limited to: (1) Beneficial Bancorp conducting business with or competing against an organization in which a family member of an executive officer or director has an ownership or employment interest; and (2) the ownership of more than 5% of the outstanding securities or 5% of total assets of any business entity that does business with or is in competition with Beneficial Bancorp.
The aggregate amount of loans by Beneficial Bank to its executive officers and directors and their affiliates was $233 thousand at December 31, 2018. As of that date, these loans were performing according to their original terms. The outstanding loans made to our directors and executive officers and their affiliates were made in the ordinary course of business, were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable loans with persons not related to Beneficial Bank, and did not involve more than the normal risk of collectability or present other unfavorable features.
Director Independence
The Company’s Board of Directors currently consists of nine members. The Board of Directors has determined that each of the Company’s directors is independent under the listing requirements of the Nasdaq Stock Market, Inc., except for Gerard P. Cuddy, who is our President and Chief Executive Officer. Mr. Cuddy is not independent because he is employed by the Company. In determining the independence of its directors, the Board of Directors considered transactions, relationships and arrangements between the Company and its directors the details of which are not required to be disclosed in this Item 13 under the heading “- Transactions with Related Persons.”
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Audit Fees
The following table sets forth the fees billed to the Company for the fiscal years ended December 31, 2018 and 2017 by KPMG LLP.
(1) Includes professional services rendered for the audit of the Company’s annual consolidated financial statements and review of consolidated financial statements included in Quarterly Reports on Form 10-Q, or services normally provided in connection with statutory and regulatory filings (i.e., attest services required by the Federal Deposit Insurance Corporation Improvement Act or Section 404 of the Sarbanes-Oxley Act), including out-of-pocket expenses.
(2) Includes fees for certain agreed upon procedures related to KSOP audit matters.
(3) 2018 includes fees related to the adoption of tax reform laws. 2017 includes fees related to the formation of Neumann Finance.
Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of the Independent Registered Public Accounting Firm.
The Audit Committee is responsible for appointing, setting the compensation and overseeing the work of the independent registered public accounting firm. In accordance with its charter, the Audit Committee approves, in advance, all audit and permissible non-audit services to be performed by the independent auditor. Such approval process ensures that the external auditor does not provide any non-audit services to the Company that are prohibited by law or regulation.
In addition, the Audit Committee has established a policy regarding pre-approval of all audit and permissible non-audit services provided by the independent registered public accounting firm. Requests for services by the independent registered public accounting firm for compliance with the auditor services policy must be specific as to the particular services to be provided. The request may be made with respect to either specific services or a type of service for predictable or recurring services. During the year ended December 31, 2018, all services were approved, in advance, by the Audit Committee in compliance with these procedures.
PART IV
Item 15.
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(1) The financial statements required in response to this item are incorporated herein by reference from Item 8 of this Annual Report on Form 10-K.
(2) All financial statement schedules are omitted because they are not required or applicable, or the required information is shown in the consolidated financial statements or the notes thereto.
(3) Exhibits
No.
Description
3.1
Articles of Incorporation of Beneficial Bancorp, Inc. (1)
3.2
Bylaws of Beneficial Bancorp, Inc. (2)
4.0
Stock Certificate of Beneficial Bancorp, Inc. (3)
10.1
Amended and Restated Employment Agreement between Beneficial Bancorp, Inc., Beneficial Bank and Gerard P. Cuddy *(4)
10.2
Amended and Restated Employment Agreement between Beneficial Bancorp, Inc., Beneficial Bank and Thomas D. Cestare * (5)
10.3
Amended and Restated Executive Officer Change in Control Severance Agreement between Beneficial Bank and Martin F. Gallagher * (6)
10.4
Amended and Restated Executive Officer Change in Control Severance Agreement between Beneficial Bank and Joanne Ryder * (7)
10.5
Amended and Restated Executive Officer Change in Control Severance Agreement between Beneficial Bank and Pamela M. Cyr * (8)
10.6
Supplemental Pension and Retirement Plan of Beneficial Bank * (9)
10.7
Second Amendment to the Beneficial Bank Board of Managers Non-Vested Deferred Compensation Plan * (10)
10.8
Beneficial Bancorp, Inc. 2008 Equity Incentive Plan * (11)
10.9
Beneficial Bancorp, Inc. 2016 Omnibus Incentive Plan * (12)
10.10
Beneficial Bank Board of Trustees’ Non-Vested Deferred Compensation Plan * (13)
10.11
Beneficial Bank Stock-Based Deferral Plan * (14)
10.12
Severance Pay Plan for Eligible Employees of Beneficial Bank * (15)
10.13
Amended and Restated Beneficial Bank Elective Deferred Compensation Plan * (16)
10.14
Executive Officer Change in Control Severance Agreement between Beneficial Bank and Joseph Canosa* (17)
21.0
Subsidiary information is incorporated herein by reference to “Part I, Item 1 - Subsidiaries”
23.1
Consent of KPMG LLP
31.1
Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31.2
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32.0
Section 1350 Certification of Chief Executive Officer and Chief Financial Officer
101.0
The following materials from the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Statements of Financial Condition, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statement of Changes in Stockholders’ Equity, (v) the Consolidated Statements of Cash Flows and (vi) the Notes to the Consolidated Financial Statements
* Management contract or compensatory plan, contract or arrangement.
(1) Incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1 (File No. 333-198282), as amended, initially filed with the Securities and Exchange Commission on August 21, 2014.
(2) Incorporated by reference to Exhibit 3.2 to the Company’s Registration Statement on Form S-1 (File No. 333-198282), as amended, initially filed with the Securities and Exchange Commission on August 21, 2014.
(3) Incorporated by reference to Exhibit 4.0 to the Company’s Registration Statement on Form S-1 (File No. 333-198282), as amended, initially filed with the Securities and Exchange Commission on August 21, 2014.
(4) Incorporated by reference to Exhibit 10.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 (File No. 001-36806) filed with the Securities and Exchange Commission on February 26, 2016.
(5) Incorporated by reference to Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 (File No. 001-36806) filed with the Securities and Exchange Commission on February 26, 2016.
(6) Incorporated by reference to Exhibit 10.3 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 (File No. 001-36806) filed with the Securities and Exchange Commission on February 26, 2016.
(7) Incorporated by reference to Exhibit 10.4 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 (File No. 001-36806) filed with the Securities and Exchange Commission on February 26, 2016.
(8) Incorporated by reference to Exhibit 10.5 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 (File No. 001-36806) filed with the Securities and Exchange Commission on February 26, 2016.
(9) Incorporated by reference to Exhibit 10.7 to the Company’s Registration Statement on Form S-1 (File No. 333-198282), as amended, initially filed with the Securities and Exchange Commission on August 21, 2014.
(10) Incorporated by reference to Exhibit 10.9 to the Company’s Registration Statement on Form S-1 (File No. 333-198282), as amended, initially filed with the Securities and Exchange Commission on August 21, 2014.
(11) Incorporated by reference to Exhibit 10.10 to the Company’s Registration Statement on Form S-1 (File No. 333-198282), as amended, initially filed with the Securities and Exchange Commission on August 21, 2014.
(12) Incorporated by reference to Appendix A to the Company’s Definitive Proxy Materials on Schedule 14A (File No. 001-36806) filed with the Securities and Exchange Commission on March 11, 2016.
(13) Incorporated by reference to Exhibit 10.8 to the Company’s Registration Statement on Form S-1 (File No. 333-198282), as amended, initially filed with the Securities and Exchange Commission on August 21, 2014.
(14) Incorporated by reference to Exhibit 10.11 to the Company’s Registration Statement on Form S-1 (File No. 333-198282), as amended, initially filed with the Securities and Exchange Commission on August 21, 2014.
(15) Incorporated by reference to Exhibit 10.12 to the Company’s Registration Statement on Form S-1 (File No. 333-198282), as amended, initially filed with the Securities and Exchange Commission on August 21, 2014.
(16) Incorporated by reference to Exhibit 10.13 to the Company’s Registration Statement on Form S-1 (File No. 333-198282), as amended, initially filed with the Securities and Exchange Commission on August 21, 2014.
(17) Incorporated by reference to Exhibit 10.14 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 (File No. 001-36806) filed with the Securities and Exchange Commission on February 26, 2016.
Item 16. FORM 10-K SUMMARY
None.
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Beneficial Bancorp, Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated statements of financial condition of Beneficial Bancorp, Inc. and subsidiaries (the Company) as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2018, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 26, 2019 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ KPMG LLP
We have served as the Company’s auditor since 2012.
Philadelphia, Pennsylvania
February 26, 2019
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Beneficial Bancorp, Inc.:
Opinion on Internal Control Over Financial Reporting
We have audited Beneficial Bancorp, Inc. and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated statements of financial condition of the Company as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2018, and the related notes (collectively, the consolidated financial statements), and our report dated February 26, 2019 expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ KPMG LLP
Philadelphia, Pennsylvania
February 26, 2019
BENEFICIAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands, except share and per share amounts)
As of December 31, 2018 and 2017
See accompanying notes to consolidated financial statements.
BENEFICIAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except share and per share amounts)
For the Years Ended December 31, 2018, 2017 and 2016
See accompanying notes to consolidated financial statements.
BENEFICIAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
For the Years Ended December 31, 2018, 2017 and 2016
See accompanying notes to the consolidated financial statements.
BENEFICIAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(Dollars in thousands, except share amounts)
For the Years Ended December 31, 2018, 2017 and 2016
See accompanying notes to consolidated financial statements
BENEFICIAL BANCORP, INC. AND SUBSIDIAIRIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
For the Years Ended December 31, 2018, 2017 and 2016
See accompanying notes to consolidated financial statements.
BENEFICIAL BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2018, 2017 and 2016
(All dollar amounts are presented in thousands, except per share data)
1. PENDING MERGER WITH WSFS FINANCIAL CORPORATION
On August 8, 2018, WSFS Financial Corporation (“WSFS”) and the Company issued a joint press release announcing that WSFS and the Company have entered into an Agreement and Plan of Reorganization pursuant to which the Company will merge with and into WSFS, with WSFS as the surviving entity. Under the terms of the agreement, which has been unanimously approved by the boards of directors of both companies, stockholders of Beneficial will receive 0.3013 shares of WSFS common stock and $2.93 in cash for each share of Beneficial common stock. The transaction is subject to customary closing conditions and is expected to close during the first quarter of 2019.
Net income for the year ended December 31, 2018 includes $3.1 million of professional fees associated with the pending merger of Beneficial with WSFS.
2. NATURE OF OPERATIONS
The Company is a Maryland corporation and owns 100% of the outstanding common stock of the Bank, a Pennsylvania chartered savings bank. The Bank offers a variety of consumer and commercial banking services to individuals, businesses, and nonprofit organizations through 61 offices throughout the Philadelphia and Southern New Jersey area. The Bank is supervised and regulated by the Department and the FDIC. The Company is regulated by the Federal Reserve Board. The deposits of the Bank are insured up to the applicable legal limits by the Deposit Insurance Fund of the FDIC.
The Company that was incorporated in August 2014 to be the successor to Beneficial Mutual Bancorp upon completion of the second-step conversion of the Bank from the two-tier mutual holding company structure to the stock holding company structure. Beneficial Savings Bank MHC was the former mutual holding company for Beneficial Mutual Bancorp prior to completion of the second-step conversion. In conjunction with the second-step conversion, each of Beneficial Savings Bank MHC and Beneficial Mutual Bancorp ceased to exist. The second-step conversion was completed on January 12, 2015, at which time the Company sold, for gross proceeds of $503.8 million, a total of 50,383,817 shares of common stock at $10.00 per share, including 2,015,352 shares purchased by the Bank’s employee savings and stock ownership plan. As part of the second-step conversion, each of the existing 29,394,417 outstanding shares of Beneficial Mutual Bancorp common stock owned by persons other than Beneficial Savings Bank MHC was converted into 1.0999 of a share of Company common stock. As a result of the second-step conversion, all share information prior to January 12, 2015 has been subsequently revised to reflect the 1.0999 exchange ratio.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Basis of Presentation - The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. Specifically, the financial statements include the accounts of the Bank, the Company’s wholly owned subsidiary, and the Bank’s wholly owned subsidiaries. The Bank’s wholly owned subsidiaries are: (i) Beneficial Advisors, LLC (currently inactive), (ii) Neumann Corporation, a Delaware corporation formed to manage certain investments, (iii) Beneficial Equipment Finance Corporation, a business equipment leasing company and (iv) Neumann Finance Company, a majority owned subsidiary, formed to originate small business leases. Additionally, the Company has subsidiaries that hold other real estate acquired in foreclosure or transferred from the commercial real estate loan portfolio. All significant intercompany accounts and transactions have been eliminated. The various services and products support each other and are interrelated. Management makes significant operating decisions based upon the analysis of the entire Company and financial performance is evaluated on a company-wide basis. Accordingly, the various financial services and products offered are aggregated into one reportable operating segment: community banking as under guidance in the Financial Accounting Standards Board (the “FASB”) Accounting Standards Codification (“ASC” or “codification”) Topic 280 for Segment Reporting.
Use of Estimates in the Preparation of Financial Statements - These consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. The significant estimates include the allowance for loan losses, goodwill, other intangible assets, income taxes, postretirement benefits, and the fair value of investment securities. Actual results could differ from those estimates and assumptions.
Investment Securities - The Company classifies and accounts for debt and equity securities as follows:
Held-to-Maturity - Debt securities that management has the positive intent and ability to hold to maturity are classified as “held-to-maturity” and are recorded at amortized cost. Premiums are amortized and discounts are accreted using the interest method over the estimated remaining term of the underlying security.
Available-for-Sale - Debt securities that will be held for indefinite periods of time, including equity securities with readily determinable fair values, that may be sold in response to changes to market interest or prepayment rates, needs for liquidity, and changes in the availability
of and the yield of alternative investments, are classified as “available-for-sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported net of tax in other comprehensive income. Realized gains and losses on the sale of investment securities are recorded as of trade date and reported in the consolidated statements of income and determined using the adjusted cost of the specific security sold.
The Company determines whether any unrealized losses are temporary in accordance with guidance under FASB ASC Topic 320 for Investments - Debt and Equity Securities. The evaluation is based upon factors such as the creditworthiness of the issuers/guarantors, the underlying collateral, if applicable, and the continuing performance of the securities. Management also evaluates other facts and circumstances that may be indicative of an other-than-temporary impairment (“OTTI”) condition. This includes, but is not limited to, an evaluation of the type of security, length of time and extent to which the fair value has been less than cost, and near-term prospects of the issuer.
In accordance with accounting guidance for equity securities, the Company evaluates its securities portfolio for other-than-temporary impairment throughout the year. Each investment that has an estimated fair value less than the book value is reviewed on a quarterly basis by management. Management considers at a minimum the following factors that, both individually or in combination, could indicate that the decline is other-than-temporary: (1) the length of time and the extent to which the fair value has been less than book value, (2) the financial condition and the near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Among other factors that are considered in determining the Company’s intent and ability to maintain an investment is a review of the capital adequacy, interest rate risk profile and liquidity position of the Company. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other-than-temporary are reflected in earnings as realized losses.
Accounting guidance for debt securities requires the Company to assess whether the loss existed by considering whether (1) the Company has the intent to sell the security, (2) it is more likely than not that it will be required to sell the security before recovery, or (3) it does not expect to recover the entire amortized cost basis of the security. The guidance requires the Company to bifurcate the impact on securities where impairment in value was deemed to be other than temporary between the component representing credit loss and the component representing loss related to other factors. The portion of the fair value decline attributable to credit loss must be recognized through a charge to earnings. The difference between the fair market value and the credit loss is recognized in other comprehensive income.
The Company invests in Federal Home Loan Bank of Pittsburgh (“FHLB”) stock as required to support borrowing activities, as detailed in Note 15 to these consolidated financial statements. Although FHLB stock is an equity interest in a FHLB, it does not have a readily determinable fair value because its ownership is restricted and it lacks a market. FHLB stock can be sold back only at its par value of $100 per share and only to the FHLBs or to another member institution. The Company evaluates this investment for impairment on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. The Company reports its investment in FHLB stock at cost in the consolidated statements of financial condition. The Company reviews FHLB stock for impairment based on guidance from FASB ASC Topic 320 for Investments - Debt and Equity Securities and FASB ASC Topic 942 for Financial Services - Depository and Lending and has concluded that its investment is not impaired.
Loans and Leases - The Company’s loan and lease portfolio consists of commercial loans and leases, residential loans and consumer loans. Commercial loans and leases include commercial real estate loans, commercial construction loans, commercial business loans, shared national credits and small business commercial leases. Residential loans include residential mortgage loans secured primarily by first liens on one-to four-family residential properties. Consumer loans consist primarily of home equity loans and lines of credit, personal loans, automobile loans and education loans. Loan balances are stated at their principal balances, net of unamortized fees and costs.
Interest on loans is calculated based upon the principal amount outstanding. Loan fees and certain direct loan origination costs are deferred and recognized as a yield adjustment over the life of the loans using the interest method.
Generally, loans are placed on non-accrual status when the loan becomes 90 days delinquent and any collateral or discounted cash flow deficiency is charged-off. Unsecured consumer loans are typically charged-off when they become 90 days past due. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Government guaranteed student loans greater than 90 days continue to accrue interest as they are government guaranteed with little risk of credit loss.
When a loan is determined to be impaired, it is placed on non-accrual status and all interest that had been accrued and not collected is reversed against interest income. Payments received on non-accrual loans are applied to principal balances until paid in full and then to interest income. The Bank’s policy for returning a loan to accruing status requires the preparation of a well-documented credit evaluation which includes the following:
· A review of the borrower’s current financial condition in which the borrower must demonstrate sufficient cash flow to support the repayment of all principal and interest including any amounts previously charged-off;
· An updated appraisal or home valuation which must demonstrate sufficient collateral value to support the debt;
· Sustained performance based on the restructured terms for at least six consecutive months;
· Approval by the Special Assets Committee which consists of the Chief Credit Officer, the Chief Financial Officer and other members of senior management.
Allowance for Loan and Lease Losses - The allowance for loan and lease losses is determined by management based upon portfolio segment, past experience, evaluation of estimated loss and impairment in the loan portfolio, current economic conditions and other pertinent factors. Management also considers risk characteristics by portfolio segments including, but not limited to, renewals and real estate valuations. The allowance for loan and lease losses is maintained at a level that management considers appropriate to provide for estimated losses and impairment based upon an evaluation of known and inherent risk in the loan portfolio. Loan impairment is evaluated based on the fair value of collateral or estimated net realizable value. While management uses the best information available to make such evaluations, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluations. The allowance for loan and lease losses is established through a provision for loan losses charged to expense which is based upon past loan and loss experience and an evaluation of estimated losses in the current loan portfolio, including the evaluation of impaired loans. In addition, the FDIC and the Department, as an integral part of their examination process, periodically review our allowance for loan and lease losses and may require us to increase our provision for loan losses or recognize further loan charge-offs.
Under the accounting guidance FASB ASC Topic 310 for Receivables, a loan is considered to be impaired when, based upon current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan. An insignificant delay or insignificant shortfall in amount of payments does not necessarily result in the loan being identified as impaired. When all or a portion of the loan is deemed uncollectible, the uncollectible portion is charged-off. The measurement is based either on the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if the loan is collateral-dependent. Impairment losses are included in the provision for loan losses.
Troubled Debt Restructurings - The Company considers a loan a TDR when the borrower is experiencing financial difficulty and the Company has granted a concession that it would not otherwise consider but for the borrower’s financial difficulties. A TDR includes a modification of debt terms or assets received in satisfaction of the debt (which may include foreclosure or deed in lieu of foreclosure) or a combination of types. The Company evaluates selective criteria to determine if a borrower is experiencing financial difficulty including the ability of the borrower to obtain funds from sources other than the Bank at market rates. The Company considers all TDR loans that are on non-accrual status to be impaired loans. The Company evaluates all TDR loans for impairment on an individual basis in accordance with ASC 310. We will not consider a loan a TDR if the loan modification was a result of a customer retention program.
Loans Acquired With Deteriorated Credit Quality - The Company accounts for loans acquired with deteriorated credit quality in accordance with the provisions included in FASB ASC 310-30 Loans and Debt Securities Acquired with Deteriorated Credit Quality. For these loans, the Company determined that there is evidence of deterioration in credit quality since the origination of the loan and that it was probable, at the acquisition date, that the Company will be unable to collect all contractually required payments receivable. These loans are recorded at fair value, at the acquisition date, reflecting the present value of the amounts expected to be collected. Subsequently, the Company evaluates loans acquired with deteriorated credit quality individually for further impairment on a quarterly basis.
Loans Acquired Without Deteriorated Credit Quality - The Company accounts for loans acquired without deteriorated credit quality in accordance with the provisions included in FASB ASC 310-20 Receivables. These loans are recorded at fair value, at the acquisition date, and are subsequently reviewed on a quarterly basis to evaluate whether the remaining fair value mark is sufficient to cover expected losses over the remaining life of the loan portfolios.
Mortgage Banking Activities - The Company originates mortgage loans held for investment and for sale. At origination, mortgage loans are identified as either held for sale or held for investment. Mortgage loans held for sale are carried at the lower of cost or market, determined on a net aggregate basis.
The Company originates residential mortgage loans for sale primarily to institutional investors, such as Fannie Mae. The Company retains the mortgage servicing rights (“MSRs”) for the loans sold to Fannie Mae. The Company elected the fair value measurement method to value its existing MSRs at fair value in accordance with ASC 860-50. Under the fair value measurement method, the Company measures its MSRs at fair value at each reporting date and reports changes in the fair value of its MSRs in earnings in the period in which the changes occur.
SBA Loan Servicing - The Company sells guaranteed portion of certain Small Business Administration (“SBA”) loans to third parties and retains servicing rights and receives servicing fees. All such transfers are accounted for as sales. While the Company may retain a portion of certain sold SBA loans, its continuing involvement in the portion of the loan that was sold is limited to certain servicing responsibilities. When the contractual servicing fees on loans sold with servicing retained are expected to be more than adequate compensation to a servicer for performing the servicing, a capitalized servicing asset is recognized. The Company accounts for the transfers and servicing of financial assets in accordance with ASC 860, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities.
Bank Premises and Equipment - Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is calculated using a straight-line method over the estimated useful lives of 10 to 40 years for buildings and three to 20 years for furniture, fixtures and equipment. Leasehold improvements are amortized using the straight-line method over the terms of the respective leases or the useful lives of the respective assets, whichever is less.
Real Estate Owned - Real estate owned includes properties acquired by foreclosure or deed in-lieu of foreclosure and premises no longer used in operations. These assets are initially recorded at the lower of carrying value of the loan or estimated fair value less selling costs at the time of foreclosure and at the lower of the new cost basis or fair value less selling costs thereafter. Losses arising from foreclosure transactions are charged against the allowance for loan losses. The amounts recoverable from real estate owned could differ materially from the amounts used in arriving at the net carrying value of the assets at the time of foreclosure because of future market factors beyond the control of the Company. Costs relating to the development and improvement of real estate owned properties are capitalized to the extent realizable and supported by the fair value of the property less selling costs and other costs relating to holding the property that are charged to expense. Real estate owned is periodically evaluated for impairment and reductions in carrying value are recognized in the Company’s consolidated statements of operations as “classified loan and other real estate owned related expense.”
Income Taxes - Deferred income taxes are recognized for the tax consequences of “temporary differences” by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. A deferred tax liability is recognized for temporary differences that will result in taxable amounts in future years. A deferred tax asset is recognized for temporary differences that will result in deductible amounts in future years and for carryforwards. A valuation allowance is recognized if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized.
The Company accounts for uncertain tax positions in accordance with FASB ASC Topic 740 for Income Taxes. The guidance clarifies the accounting and reporting for income taxes where interpretation of the tax law may be uncertain. The FASB prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of income tax uncertainties with respect to positions taken or expected to be taken in income tax returns. The uncertain tax liability for uncertain tax positions was zero at December 31, 2018 and December 31, 2017.
The passage of the Tax Cuts and Jobs Act on December 22, 2017 lowered the federal corporate tax rate for 2018 to 21% from 35%. Under ASC 740, the effects of changes in tax rates and laws on deferred tax balances are recorded as a component of income tax expense related to continuing operations for the period in which the law was enacted, even if the assets and liabilities related to items of accumulated other comprehensive income. The Company re-measured its net deferred tax assets at the current 21% federal corporate tax rate and, as a result, the Company recorded a one-time charge of $13.1 million of income tax expense during the year ended December 31, 2017. In addition, the FASB issued an accounting standards update that permits entities to reclassify tax effects stranded in accumulated other comprehensive income as a result of tax reform to retained earnings. As of December 31, 2017, the Company had $5.0 million of tax effects stranded in accumulated OCI as a result of the passage of the Tax Cuts and Jobs Act. The Company reclassified the amount stranded in accumulated OCI to retained earnings during the year ended December 31, 2018.
Goodwill and Other Intangibles - Net assets of companies acquired in purchase transactions are recorded at fair value at the date of acquisition and, as such, the historical cost basis of individual assets and liabilities are adjusted to reflect their fair value. Finite lived intangibles are amortized on an accelerated or straight-line basis over the period benefited. In accordance with FASB ASC Topic 350 for Intangibles - Goodwill and Other, goodwill is not amortized but is reviewed for potential impairment on an annual basis, or if events or circumstances indicate a potential impairment, at the reporting unit level. The Company’s review for impairment includes an assessment of qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value, including goodwill. If it is determined that it is more likely than not that the fair value of a reporting unit is less than its carrying value, including goodwill, the first step of the two-step quantitative goodwill impairment test is performed, which compares the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired. However, if the carrying amount of the reporting unit exceeds its fair value, an additional procedure must be performed. That additional procedure compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. An impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value.
Other intangible assets subject to amortization are evaluated for impairment in accordance with applicable accounting guidance. An impairment loss will be recognized if the carrying amount of the intangible asset is not recoverable and exceeds fair value. The carrying amount of the intangible is considered not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use of the asset. The other intangibles are amortizing intangibles, which primarily consist of core deposit intangibles which are amortized over an estimated useful life of ten years.
Cash Surrender Value of Life Insurance - The Company funds the purchase of insurance policies on the lives of certain officers and employees of the Company. The Company has recognized any change in cash surrender value of life insurance in non-interest income in the Company’s consolidated statements of operations. The Company has recognized insurance costs in non-interest expense in the Company’s consolidated statements of operations.
Comprehensive Income - The Company presents a separate financial statement of comprehensive income that includes amounts from transactions and other events excluded from the Company’s consolidated statements of operations and recorded directly to retained earnings.
Pension and Other Postretirement Benefits - The Company currently provides certain postretirement benefits to qualified retired employees. These postretirement benefits principally pertain to health insurance coverage and life insurance. The cost of such benefits is accrued during the years the employee provides service. The Bank has noncontributory defined benefit pension plans covering many of its employees. Additionally, the Company sponsors nonqualified supplemental employee retirement plans for certain participants. The
benefits associated with these arrangements and plans are earned over a service period, and the Company estimates the amount of expense applicable to each plan or contract. The estimated obligations for the plans and contracts are reflected as liabilities on the Company’s consolidated statements of condition.
Employee Savings and Stock Ownership Plan (“KSOP”) - The Company accounts for its KSOP based on guidance set forth in FASB ASC Topic 715 for Compensation - Retirement Benefits. Shares are released to participants proportionately as the loan is repaid. If the Company declares a dividend, the dividends on the allocated shares would be recorded as dividends and charged to retained earnings. Dividends declared on common stock held by the KSOP and not allocated to the account of a participant can be used to repay the loan. Allocation of shares to the KSOP participants is contingent upon the repayment of the loan to the Company.
Stock Based Compensation - The Company accounts for stock awards and stock options granted to employees and directors based on guidance set forth in FASB ASC Topic 718 for Compensation - Stock Compensation. The Company recognizes the related expense for the options and awards over the service period using the straight-line method.
Earnings Per Share - The Company uses the two-class method to calculate earnings per share as the unvested restricted stock issued under the Company’s equity incentive plans are participating shares with nonforfeitable rights to dividends. Under the two-class method, earnings per common share are computed by dividing the sum of distributed earnings to common shareholders and undistributed earnings allocated to common shareholders by the weighted average number of common shares outstanding for the period. In applying the two-class method, undistributed earnings are allocated to both common shares and participating securities based on the number of weighted average shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if options on common shares had been exercised, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options, and are determined using the treasury stock method. The effects of options to issue common stock are excluded from the computation of diluted earnings per share in periods in which the effect would be antidilutive.
Cash and Cash Equivalents - For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash and balances due from banks, interest bearing deposits and federal funds sold.
Recent Accounting Pronouncements
In February 2016, the FASB issued its new lease accounting guidance in ASU 2016-02: Leases (Topic 842). Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (i) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (ii) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Public business entities should apply the amendments in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted for all public business entities upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The Company anticipates recording a right-of-use asset and lease liability in the range of $66.0 million and $69.0 million, respectively, upon adoption of the provisions of this update. The right-of-use asset and lease liability will be included in other assets and other liabilities, respectively, on the Company’s consolidated statement of condition. In addition, the Company elected the optional transition method and intends to recognize a $4.2 million cumulative-effect adjustment related to the straight-line rent asset on the balance sheet as of December 31, 2018 to the opening balance of retained earnings during the first quarter of 2019. The Company does not anticipate a significant impact to its consolidated statements of income as a result of the adoption of the provisions of this update.
In July 2018, the FASB issued ASU 2018-11: Leases (Topic 842): Targeted Improvements. The amendments in this update provide entities with an additional (and optional) transition method to adopt the new leases standard. Under this new transition method, an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Consequently, an entity’s reporting for the comparative periods presented in the financial statements in which it adopts the new leases standard will continue to be in accordance with current GAAP (Topic 840, Leases). An entity that elects this additional (and optional) transition method must provide the required Topic 840 disclosures for all periods that continue to be in accordance with Topic 840. The amendments do not change the existing disclosure requirements in Topic 840. The amendments in this update also provide lessors with a practical expedient, by class of underlying asset, to not separate nonlease components from the associated lease component and, instead, to account for those components as a single component if the nonlease components otherwise would be accounted for under the new revenue guidance (Topic 606). If the nonlease component or components associated with the lease component are the predominant component of the combined component, an entity is required to account for the combined component in accordance with Topic 606. Otherwise, the entity must account for the combined component as an operating lease in accordance with Topic 842.
In October 2018, the FASB issued ASU 2018-16: Derivatives and Hedging (Topic 815)-Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes. During the hedge accounting project that led to the issuance of Update 2017-12, the Federal Reserve Board and the Federal Reserve Bank of New York
(Fed) requested that the OIS rate based on SOFR be considered eligible as a U.S. benchmark interest rate for purposes of applying hedge accounting under Topic 815. Similar to the OIS rate based on the Fed Funds Effective Rate, which is a swap rate based on the underlying overnight Fed Funds Effective Rate, the OIS rate based on SOFR will be a swap rate based on the underlying overnight SOFR rate. The Fed and Alternative Reference Rate Committee (ARRC) expressed the importance of including the OIS rate based on SOFR as a benchmark rate for hedge accounting purposes in facilitating broader use of the underlying SOFR rate in the marketplace. The amendments in this update permit use of the OIS rate based on SOFR as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815 in addition to the UST, the LIBOR swap rate, the OIS rate based on the Fed Funds Effective Rate, and the SIFMA Municipal Swap Rate. The Company plans to adopt the provisions of this update and the provisions of ASU 2017-12 on January 1, 2019. While the Company continues to assess all potential impacts of the standard, the Company currently expects adoption to have an immaterial impact to the consolidated financial statements.
In August 2018, the FASB issued ASU 2018-15: Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. The amendments in this update align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by the amendments in this update. The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The Company evaluated the amendments of this update and does not anticipate an impact to the consolidated financial statements.
Also in August 2018, the FASB issued ASU 2018-14: Compensation-Retirement Benefits-Defined Benefit Plans-General (Subtopic 715-20)-Disclosure Framework-Changes to the Disclosure Requirements for Defined Benefit Plans. The Board is issuing the amendments in this update as part of the disclosure framework project. The disclosure framework project’s objective and primary focus are to improve the effectiveness of disclosures in the notes to financial statements by facilitating clear communication of the information required by generally accepted accounting principles that is most important to users of each entity’s financial statements. The amendments in this update modify the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans by removing disclosures that no longer are considered cost beneficial, clarifying the specific requirements of disclosures, and adding disclosure requirements identified as relevant. The amendments in this update are effective for fiscal years ending after December 15, 2020 for public business entities. Early adoption is permitted. The Company evaluated the amendments of this update and anticipates an impact in the period of adoption to the Pension and Other Postretirement Benefit Plans footnote included in the consolidated financial statements.
Also in August 2018, the FASB issued ASU 2018-13: Fair Value Measurement (Topic 820)-Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement. The Board is issuing the amendments in this update as part of the disclosure framework project. The disclosure framework project’s objective and primary focus are to improve the effectiveness of disclosures in the notes to financial statements by facilitating clear communication of the information required by generally accepted accounting principles that is most important to users of each entity’s financial statements. The amendments in this update modify the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement, based on the concepts in the Concepts Statement, including the consideration of costs and benefits. The amendments in this update are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. The Company evaluated the amendments of this update and anticipates an impact in the period of adoption to the Fair Value of Financial Instruments footnote included in the consolidated financial statements.
In June 2018, the FASB issued ASU 2018-07: Compensation-Stock Compensation (Topic 718)-Improvements to Nonemployee Share-Based Payment Accounting. The amendments in this update expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. An entity should apply the requirements of Topic 718 to nonemployee awards except for specific guidance on inputs to an option pricing model and the attribution of cost (that is, the period of time over which share-based payment awards vest and the pattern of cost recognition over that period). The amendments specify that Topic 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations by issuing share-based payment awards. The amendments also clarify that Topic 718 does not apply to share-based payments used to effectively provide (1) financing to the issuer or (2) awards granted in conjunction with selling goods or services to customers as part of a contract accounted for under Topic 606, Revenue from Contracts with Customers. The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. The Company has historically applied the provisions of Topic 718 to its accounting for share-based payment awards to the Company’s Board of Directors. As a result, the Company does not anticipate an impact to the consolidated financial statements.
In February 2018, the FASB issued ASU 2018-02: Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The amendments in this update allow for a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the passage of the Tax Cuts and Jobs Act. The amendments in this update also require certain disclosures about stranded tax effects. Upon adoption of the ASU, an entity will be required to disclose a description of the accounting policy for releasing income tax effects from accumulated other comprehensive income. The amendments in this update are effective for all entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption of the amendments in this update is permitted, including adoption in any interim period, (1) for public business entities for reporting periods for which financial statements have not yet been issued and (2) for all
other entities for reporting periods for which financial statements have not yet been made available for issuance. The amendments in this update should be applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized. As of December 31, 2018, the Company had $5.0 million of tax benefits stranded in accumulated OCI as a result of the passage of the Tax Cuts and Jobs Act. The Company complied with the amendments in this update and reclassified the amount stranded in accumulated OCI to retained earnings in the first quarter of 2018.
In August 2017, the FASB issued ASU 2017-12: Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The purpose of this updated guidance is to better align a company’s financial reporting for hedging activities with the economic objectives of those activities. ASU 2017-12 is effective for public business entities for fiscal years beginning after December 15, 2018, with early adoption, including adoption in an interim period, permitted. The Company plans to adopt ASU 2017-12 on January 1, 2019. ASU 2017-12 requires a modified retrospective transition method in which the Company will recognize the cumulative effect of the change on the opening balance of each affected component of equity in the statement of financial position as of the date of adoption. While the Company continues to assess all potential impacts of the standard, the Company currently expects adoption to have an immaterial impact to the consolidated financial statements.
In May 2017, the FASB issued ASU 2017-09: Compensation -Stock Compensation (Topic 718): Scope of Modification Accounting. The Board is issuing this update to provide clarity and reduce both (1) diversity in practice and (2) cost and complexity when applying the guidance in Topic 718, Compensation-Stock Compensation, to a change to the terms or conditions of a share-based payment award. The amendments in this update affect any entity that changes the terms or conditions of a share-based payment award. The amendments in this update provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. The amendments in this update are effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. To date, the Company has not changed the terms or conditions of a share-based payment award. As a result, there was no impact to the Company’s consolidated financial statements.
In March 2017, the FASB issued ASU 2017-08: Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. This Accounting Standards update amends guidance on the amortization period of premiums on certain purchased callable debt securities. Specifically, the amendments shorten the amortization period of premiums on certain purchased callable debt securities to the earliest call date. The amendments affect all entities that hold investments in callable debt securities that have an amortized cost basis in excess of the amount that is repayable by the issuer at the earliest call date. For public business entities, the amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company does not currently hold any callable debt securities with a premium. As a result, the Company does not anticipate an impact to the consolidated financial statements.
Also in March 2017, the FASB issued ASU 2017-07: Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. Topic 715, Compensation-Retirement Benefits, requires an entity to present net periodic pension cost and net periodic postretirement benefit cost as a net amount that may be capitalized as part of an asset where appropriate. Users have communicated that the service cost component generally is analyzed differently from the other components of net periodic pension cost and net periodic postretirement benefit cost. To improve the consistency, transparency, and usefulness of financial information for users, the amendments in this update require that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The amendments in this update are effective for public business entities for annual periods beginning after December 15, 2017, including interim periods within those annual periods. The Company’s current accounting treatment and presentation of net periodic pension cost and net periodic postretirement benefit cost is consistent with the provisions in ASU-2017. The Company adopted the amendments in this update during the year ended December 31, 2018 and noted no impact to the consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04: Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. To simplify the subsequent measurement of goodwill, this update eliminates Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, under the amendments in this update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. An entity should apply the amendments in this Update on a prospective basis. A public business entity that is a U.S. Securities and Exchange Commission (SEC) filer should adopt the amendments in this update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not anticipate a material impact to the consolidated financial statements at this time.
In June 2016, the FASB issued ASU 2016-13: Financial Instruments -Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. Topic 326 amends guidance on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. For assets held at amortized cost basis, Topic 326 eliminates the probable initial recognition threshold in current GAAP and, instead, requires an entity to reflect its current estimate of all expected credit losses. For available for sale debt securities, credit losses should be measured in a manner similar to current GAAP, however Topic 326 will require that credit losses be presented
as an allowance rather than as a write-down. This update affects entities holding financial assets and net investment in leases that are not accounted for at fair value through net income. The amendments affect loans, debt securities, trade receivables, net investments in leases, off balance sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. The amendments in this update are effective for fiscal years beginning after December 15, 2019. The Company is in the process of evaluating the impact of this guidance but expects that the impact will likely be material to the consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09 - Revenue from Contracts with Customers (Topic 606) and subsequent updates. This ASU clarifies the principles for recognizing revenue and develops a common standard for U.S. GAAP and International Financial Reporting Standards. The ASU establishes a core principle that requires an entity to identify the contract(s) with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract and recognize revenue when (or as) the entity satisfies a performance obligation. The ASU provides for improved disclosure requirements that require entities to disclose sufficient of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The Company adopted the guidance effective January 1, 2018 using the modified retrospective method. The Company’s revenue is the sum of net interest income and non-interest income. The scope of the guidance excludes nearly all net interest income as well as many other revenues for financial assets and liabilities including loans, leases, securities, and derivatives. The Company completed its review and determined that the majority of non-interest income revenue streams are within the scope of the new standard. Non-interest income streams that are out of scope of the new standard include BOLI, sales of investment securities, mortgage banking activities, and certain items within service charges and other income. Management reviewed contracts related to service charges on deposits, investment advisory commissions and fee income, insurance commission and fee income and certain items within other service charges and other income. The Company evaluated the impact of this ASU on the Company’s various revenue streams and, upon adoption on January 1, 2018 and going forward, does not anticipate a material impact to the consolidated financial statements. The Company has included applicable disclosures regarding revenue recognition within Note 4 of these consolidated financial statements.
4. NON-INTEREST INCOME
During the year ended December 31, 2018, the Company adopted ASU 2014-09 - Revenue from Contracts with Customers (Topic 606) and all subsequent ASUs that modified Topic 606. The Company has included the following table regarding the Company’s non-interest income for the periods presented.
The Company recognizes revenue as it is earned and noted no impact to its revenue recognition policies as a result of the adoption of ASU 2014-09. The following is a discussion of key revenues within the scope of the new revenue guidance:
· Insurance commission income - Insurance revenue is earned through commissions on insurance sales and earned at a point in time. 2018 only includes insurance commission income through September 30, 2018, the date Beneficial Insurance LLC’s assets were sold to a third party.
· Debit card interchange fee income - Card processing fees consist of interchange fees from consumer debit card networks and other card related services. Interchange rates are set by the card network. Interchange fees are based on purchase volumes and other factors and are recognized as transactions occur.
· Service charges on deposit accounts - Revenue from service charges on deposit accounts is earned through cash management, wire transfer, and other deposit-related services; as well as overdraft, non-sufficient funds, account management and other deposit-related fees. Revenue is recognized for these services either over time, corresponding with deposit accounts’ monthly cycle, or at a point in time for transactional related services and fees. These revenues are included in returned check charges and other service charges in the table above.
5. CHANGES IN AND RECLASSIFICATIONS OUT OF ACCUMULATED OTHER COMPREHENSIVE INCOME LOSS
The following tables present the changes in the balances of each component of accumulated other comprehensive income (“AOCI”) for the year ended December 31, 2018. All amounts are presented net of tax.
The following table presents reclassifications out of AOCI by component for the year ended December 31, 2018:
For the Year Ended December 31, 2018
(Dollars in thousands)
(1) These accumulated other comprehensive income (loss) components are included in the computation of net periodic pension cost. See Note 19 - Pension and Other Postretirement Benefits for additional details.
The following table presents the changes in the balances of each component of AOCI for the year ended December 31, 2017. All amounts are presented net of tax.
The following table presents reclassifications out of AOCI by component for the year ended December 31, 2017:
For the Year Ended December 31, 2017
(Dollars in thousands)
(1) These accumulated other comprehensive income (loss) components are included in the computation of net periodic pension cost. See Note 19 - Pension and Other Postretirement Benefits for additional details.
The following table presents the changes in the balances of each component of AOCI for the year ended December 31, 2016. All amounts are presented net of tax.
The following table presents reclassifications out of AOCI by component for the year ended December 31, 2016:
For the Year Ended December 31, 2016
(Dollars in thousands)
(1) These accumulated other comprehensive income (loss) components are included in the computation of net periodic pension cost. See Note 19 - Pension and Other Postretirement Benefits for additional details.
6. EARNINGS PER SHARE
The following table presents a calculation of basic and diluted earnings per share for the years ended December 31, 2018, 2017, and 2016. Earnings per share is computed by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding. The difference between common shares issued and basic average common shares outstanding, for purposes of calculating basic earnings per share, is a result of subtracting unallocated employee stock ownership plan (“KSOP”) shares and unvested restricted stock shares. Since the Company paid dividends during the years ended December 31, 2018, 2017, and 2016, the Company was required to use the two-class method to calculate earnings per share as the unvested restricted stock issued under the Company’s equity incentive plans are participating shares with nonforfeitable rights to dividends. Under the two-class method, earnings per common share are computed by dividing the sum of distributed earnings to common shareholders and undistributed earnings allocated to common shareholders by the weighted average number of common shares outstanding for the period. In applying the two-class method, undistributed earnings are allocated to both common shares and participating securities based on the number of weighted average shares outstanding during the period. Net earnings per share for both common shares and participating securities is the same for the years ended December 31, 2018, 2017, and 2016. See Note 22 to these consolidated financial statements for further discussion of stock grants.
Anti-dilutive shares are common stock equivalents with weighted average exercise prices in excess of the weighted average market value for the periods presented. For the years ended December 31, 2018 and 2017, there were no outstanding options that were anti-dilutive. For the year ended December 31, 2016, there were 2,750 outstanding options that were anti-dilutive and therefore excluded from the earnings per share calculation.
7. CASH AND DUE FROM BANKS
The Bank is required to maintain average reserve balances in accordance with federal requirements. Cash and due from banks in the consolidated statements of financial condition include $20.0 million and $22.1 million at December 31, 2018 and 2017, respectively, relating to this requirement. As of December 31, 2017, cash and due from banks includes fiduciary funds of $422 thousand relating to insurance services. As of December 31, 2018, there were no fiduciary funds included in cash and due from banks because the Company sold the majority of the assets and liabilities of Beneficial Insurance Services, LLC during the quarter ended September 30, 2018.
8. INVESTMENT SECURITIES
The amortized cost and estimated fair value of investments in debt and equity securities at December 31, 2018, and 2017 are as follows:
During the year ended December 31, 2018, the Bank received proceeds from the sale of $253 thousand of mutual funds that resulted in a loss of $4 thousand. During the year ended December 31, 2017, the Bank received proceeds from the sale of $795 thousand of mutual funds that resulted in a loss of $7 thousand. During 2016, the Company sold its investment in stock held in a financial institution that was acquired and recorded a $1.8 million gain and also received proceeds from the sale of $356 thousand of mutual funds that resulted in a loss of $14 thousand.
The following tables provide information on the gross unrealized losses and fair market value of the Company’s investments with unrealized losses that are not deemed to be other than temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2018 and 2017:
Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis or as economic or market concerns warrant such evaluation. The Company determines whether the unrealized losses are temporary in accordance with guidance under FASB ASC Topic 320 for Investments - Debt and Equity Securities. The evaluation is based upon factors such as the creditworthiness of the issuers/guarantors, the underlying collateral, if applicable, and the continuing performance of the securities. Management also evaluates other facts and circumstances that may be indicative of an OTTI condition. This includes, but is not limited to, an evaluation of the type of security, length of time and extent to which the fair value has been less than cost, and near-term prospects
of the issuer. The likelihood of recovering the Company’s investment, whether the Company has the intent to sell the investment or that it is more likely than not that the Company will be required to sell the investment before recovery is also used to determine the nature of the decline in market value of the securities.
The Company records the credit portion of OTTI through earnings based on the credit impairment estimates generally derived from cash flow analyses. The remaining unrealized loss, due to factors other than credit, is recorded in other comprehensive income (“OCI”). The Company had an unrealized loss of $11.6 million related to its GSE mortgage-backed securities as of December 31, 2018. Additionally, the Company had an unrealized loss of $1.3 million on GSE & Agency collateralized mortgage obligations, an unrealized loss of $55 thousand on GSE` Notes, an unrealized loss of $135 thousand on corporate securities and an unrealized loss of $5 thousand on mutual funds as of December 31, 2018.
Mortgage-Backed Securities
The Company’s investments that were in a loss position for greater than 12 months included GSE mortgage-backed securities with an unrealized loss of 2.2% as of December 31, 2018. The Company’s investment that was in a loss position for less than 12 months included one GSE mortgage-backed security with an unrealized loss of 1.1% as of December 31, 2018. The unrealized loss is due to current interest rate levels relative to the Company’s cost. Because the unrealized losses are due to current interest rate levels relative to the Company’s cost and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell these investments before recovery of its amortized cost, which may be at maturity, the Company does not consider these investments to be other-than temporarily impaired at December 31, 2018.
Collateralized Mortgage Obligations (CMOs)
The Company’s investments that were in a loss position for greater than 12 months included GSE & Agency CMOs with an unrealized loss of 2.3% as of December 31, 2018. The Company’s investment that was in a loss position for less than 12 months included one GSE CMO with an unrealized loss of 0.2%. The unrealized loss is due to current interest rate levels relative to the Company’s cost. Because the unrealized losses are due to current interest rate levels relative to the Company’s cost and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell these investments before recovery of its amortized cost, which may be at maturity, the Company does not consider these investments to be other-than temporarily impaired at December 31, 2018.
US GSE & Agency Notes
The Company’s investments that were in a loss position for greater than 12 months included GSE Notes with an unrealized loss of 2.0% as of December 31, 2018. The unrealized loss is due to current interest rate levels relative to the Company’s cost. Because the unrealized losses are due to current interest rate levels relative to the Company’s cost and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell these investments before recovery of its amortized cost, which may be at maturity, the Company does not consider these investments to be other-than temporarily impaired at December 31, 2018.
Corporate Securities
The Company’s investments that were in a loss position for less than 12 months included Corporate Securities with an unrealized loss of 1.2% as of December 31, 2018. The unrealized loss is due to current interest rate levels relative to the Company’s cost. Because the unrealized loss is due to current interest rate levels relative to the Company’s cost and not credit quality, and because the Company does not intend to sell the investment and it is not more likely than not that the Company will be required to sell this investment before recovery of its amortized cost, which may be at maturity, the Company does not consider this investment to be other-than temporarily impaired at December 31, 2018.
The following table sets forth the stated maturities of the investment securities at December 31, 2018 and 2017. Maturities for mortgage-backed securities are dependent upon the rate environment and prepayments of the underlying loans. For purposes of this table they are presented separately.
At December 31, 2018 and December 31, 2017, $79.5 million and $78.1 million, respectively, of securities were pledged to secure municipal deposits. At both December 31, 2018 and December 31, 2017, the Company had no securities pledged as collateral on interest rate swaps.
9. LOANS
Major classifications of loans at December 31, 2018 and 2017 are summarized as follows:
During the years ended December 31, 2018 and December 31, 2017, the Company recorded a $1.2 million and $1.6 million net gain on the sale of $19.4 million and $17.8 million, respectively, of guaranteed Small Business Administration (“SBA”) loans that is included in “mortgage banking and SBA income” on the consolidated statements of income. As of December 31, 2018 and December 31, 2017, the Bank retained the $5.7 million and $5.6 million, respectively, outstanding unguaranteed portion of the loans and the related servicing rights for the loans and receives a 1.0% servicing fee from the purchaser of the loans.
Included in the balance of residential loans are approximately $152 thousand and $245 thousand of loans held for sale at December 31, 2018, and December 31, 2017, respectively. These loans are carried at the lower of cost or estimated fair value, on an aggregate basis. Residential loans held for sale are loans originated by the Bank to be sold to a third party under contractual obligation to purchase the loans from the Bank. For the years ended December 31, 2018 and December 31, 2017, the Bank sold residential mortgage loans with an unpaid principal balance of approximately $8.7 million and $17.6 million, respectively, and recorded mortgage banking income of approximately $525 thousand and $734 thousand, respectively. The Bank retained the related servicing rights for the loans that were sold to Fannie Mae and receives a 25 basis point servicing fee from the purchaser of the loans.
Commercial business loans include shared national credits, which are participations in loans or loan commitments of at least $20.0 million that are shared by three or more banks. Effective January 1, 2018, the federal banking agencies have changed the aggregate loan commitment threshold for inclusion in the shared national credit program from $20 million to $100 million. Included in the shared national credit portfolio are purchased participations and assignments in leveraged lending transactions. Leveraged lending transactions are generally used to support a merger- or acquisition-related transaction, to back a recapitalization of a company’s balance sheet or to refinance debt. When considering a participation in the leveraged lending market, the Company will participate only in first lien senior secured term loans that are highly rated (investment grade) by the rating agencies and that trade in active secondary markets. The Company actively monitors the secondary market for these types of loans to ensure that it maintains flexibility to sell such loans in the event of deteriorating credit quality. To further minimize risk and based on our current capital levels and loan portfolio, the Company has limited the total amount of leveraged loans to $150.0 million with no single obligor exceeding $15.0 million while maintaining single industry concentrations below 30%. The Company may reevaluate these limits in future periods.
The shared national credit loans are typically variable rate with terms ranging from one to seven years. At December 31, 2018, shared national credits totaled $139.5 million, which included $83.4 million of leveraged lending transactions. All shared national credits were classified as pass rated as of December 31, 2018 as all payments are current and the loans are performing in accordance with their contractual terms. As of December 31, 2017, management had established a $1.5 million specific valuation allowance to cover risk associated with an $8.0 million non-performing shared national credit that was sold during the year ended December 31, 2018. The actual loss for the loan was $766 thousand.
The Company’s accounting policies for shared national credits, including our charge off and reserve policy, are consistent with the significant accounting policies disclosed in our financial statements for our total loan portfolio. The Company underwrites all shared national credits consistent with our underwriting guidelines. All shared national credits are subject to annual reviews where the risk rating of the loan is evaluated. Additionally, the Company obtains quarterly financial information and performs a financial analysis on a regular basis to ensure that the borrower can comply with the financial terms of the loan. The information used in the analysis is provided by the borrower through the agent bank.
In the ordinary course of business, the Company has granted loans to executive officers and directors and their affiliates amounting to $233 thousand and $255 thousand at December 31, 2018 and 2017, respectively. The amounts of payoffs and repayments with respect to such loans during the years ended December 31, 2018, and 2017 totaled $22 thousand and $8 thousand, respectively.
Allowance for Loan Losses
The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. The Company evaluates the appropriateness of the allowance for loan losses balance on loans on a quarterly basis. When additional allowances are necessary, a provision for loan losses is charged to earnings and, when less allowances are necessary, a credit is taken. As of December 31, 2018, the Company’s methodology for assessing the appropriateness of the allowance for loan losses consists of: (1) a specific valuation allowance on identified problem loans; and (2) a general valuation allowance on the remainder of the loan portfolio. The appropriate allowance level is estimated based upon factors and trends identified by the Company at the time the consolidated financial statements are prepared. Management continuously evaluates its allowance methodology.
The Company generally charges-off the collateral or discounted cash flow deficiency on all loans at 90 days past due, except government guaranteed student loans, and all loans rated substandard or worse that are 90 days past due. No specific valuation allowance was maintained as of December 31, 2018. At December 31, 2017, the Company maintained a $1.5 million specific valuation allowance for the previously mentioned shared national credit.
The following tables set forth the activity in the allowance for loan losses by portfolio for the years ended December 31, 2018, 2017 and 2016:
(1) Acquired credit impaired loans are evaluated on an individual basis.
(2) Acquired non-credit impaired loans are evaluated collectively, excluding loans that have subsequently moved to non-accrual status which are individually evaluated for impairment.
(1) Acquired credit impaired loans are evaluated on an individual basis.
(2) Acquired non-credit impaired loans are evaluated collectively, excluding loans that have subsequently moved to non-accrual status which are individually evaluated for impairment.
(1) Acquired credit impaired loans are evaluated on an individual basis.
(2) Acquired non-credit impaired loans are evaluated collectively, excluding loans that have subsequently moved to non-accrual status which are individually evaluated for impairment.
The provision for loan losses charged to expense is based upon past loan loss experience and an evaluation of estimated losses in the current loan portfolio, including the evaluation of impaired loans under FASB ASC Topic 310 for Loans and Debt Securities. Under FASB ASC Topic 310 for Receivables, for all loan segments a loan is considered to be impaired when, based upon current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan. An insignificant delay or insignificant shortfall in amount of payments does not necessarily result in the loan being identified as impaired. When all or a portion of the loan is deemed uncollectible, the uncollectible portion is charged-off. The measurement is based either on the fair value of the collateral if the loan is collateral dependent, the liquidation value, or the present value of expected future cash flows discounted at the loan’s effective interest rate. Most of the Company’s commercial loans are collateral dependent and therefore the Company uses the value of the collateral to measure the loss. Any collateral or discounted cash flow deficiency for loans that are 90 days past due are charged-off. Impairment losses are included in the provision for loan losses. Large groups of homogeneous loans are collectively evaluated for impairment, except for those loans restructured under a troubled debt restructuring.
Classified Loans
The Bank’s credit review process includes a risk classification of all commercial and residential loans that includes pass, special mention, substandard and doubtful. The classification of a loan may change based on changes in the creditworthiness of the borrower. The description of the risk classifications are as follows:
A loan is classified as pass when payments are current and it is performing under the original contractual terms. A loan is classified as special mention when the borrower exhibits potential credit weakness or a downward trend which, if not checked or corrected, will weaken the asset or inadequately protect the Bank’s position. While potentially weak, the borrower is currently marginally acceptable; no loss of principal or interest is envisioned. A loan is classified as substandard when the borrower has a well-defined weakness or weaknesses that jeopardize the orderly liquidation of the debt. A substandard loan is inadequately protected by the current net worth and paying capacity of the obligor, normal repayment from this borrower is in jeopardy, and there is a distinct possibility that a partial loss of interest
and/or principal will occur if the deficiencies are not corrected. A loan is classified as doubtful when a borrower has all weaknesses inherent in a loan classified as substandard with the added provision that: (1) the weaknesses make collection of debt in full on the basis of currently existing facts, conditions and values highly questionable and improbable; (2) serious problems exist to the point where a partial loss of principal is likely; and (3) the possibility of loss is extremely high, but because of certain important, reasonably specific pending factors which may work to the advantage and strengthening of the assets, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens and additional refinancing plans. In all cases, loans are placed on non-accrual when 90 days past due or earlier if collection of principal or interest is considered doubtful. The Company charges-off the collateral or discounted cash flow deficiency on all non-accrual loans.
The following tables set forth the amounts and percentage of the portfolio of classified asset categories for the commercial and residential loan portfolios at December 31, 2018 and December 31, 2017:
Commercial and Residential Loans
Credit Risk Internally Assigned
Commercial and Residential Loans
Credit Risk Internally Assigned
During the year ended December 31, 2017, one shared national credit for $8.0 million was downgraded to doubtful and changed to non-accrual status based on the results of a shared national credit examination performed by regulators. Management established a $1.5 million specific valuation allowance to cover risk associated with this loan as of December 31, 2017. This loan was sold during the year ended December 31, 2018 and the actual loss on this loan was $766 thousand.
The Bank’s credit review process is based on payment history for all consumer loans. The collateral deficiency on consumer loans is charged-off when they become 90 days delinquent with the exception of education loans which are guaranteed by the U.S. government. Non-performing consumer loans include loans on non-accrual status and education loans that are greater than 90 days delinquent. The following tables set forth the consumer loan risk profile based on payment activity as of December 31, 2018 and December 31, 2017:
Consumer and Residential Loans
Credit Risk Internally Assigned
Consumer and Residential Loans
Credit Risk Internally Assigned
Loan Delinquencies and Non-accrual Loans
The Company monitors the past due and non-accrual status of loans in determining the loss classification, impairment status and in determining the allowance for loan losses. Generally, all loans past due 90 days are put on non-accrual status. Education loans greater than 90 days delinquent continue to accrue interest as they are U.S. government guaranteed with little risk of credit loss.
The following tables provide information about delinquent and non-accrual loans in the Company’s portfolio at the dates indicated:
Analysis of Past Due and Non-accrual Financing Receivables
As of December 31, 2018
(1) Non-accruing loans do not include $1.5 million of loans acquired with deteriorated credit quality, which have been recorded at their fair value at acquisition.
Analysis of Past Due and Non-accrual Financing Receivables
As of December 31, 2017
(1) Non-accruing loans do not include $6.6 million of loans acquired with deteriorated credit quality, which have been recorded at their fair value at acquisition.
Troubled Debt Restructured Loans
The Bank determines whether a restructuring of debt constitutes a troubled debt restructuring (“TDR”) in accordance with guidance under FASB ASC Topic 310 Receivables. The Bank considers a loan a TDR when the borrower is experiencing financial difficulty and the Bank grants a concession that they would not otherwise consider but for the borrower’s financial difficulties. A TDR includes a modification of debt terms or assets received in satisfaction of the debt (including a foreclosure or a deed in lieu of foreclosure) or a combination of types. The Bank evaluates selective criteria to determine if a borrower is experiencing financial difficulty, including the ability of the borrower to obtain funds from sources other than the Bank at market rates. The Bank considers all TDR loans as impaired loans and, generally, they are put on non-accrual status. The Bank will not consider the loan a TDR if the loan modification was made for customer retention purposes and the modification reflects prevailing market conditions. The Bank’s policy for returning a loan to accruing status requires the preparation of a well-documented credit evaluation which includes the following:
· A review of the borrower’s current financial condition in which the borrower must demonstrate sufficient cash flow to support the repayment of all principal and interest including any amounts previously charged-off;
· An updated appraisal or home valuation which must demonstrate sufficient collateral value to support the debt;
· Sustained performance based on the restructured terms for at least six consecutive months; and
· Approval by the Special Assets Committee which consists of the Chief Credit Officer, the Chief Financial Officer and other members of senior management.
The following table summarizes loans whose terms were modified in a manner that met the definition of a TDR as of December 31, 2018, 2017, and 2016. The Company had no accruing TDRs which were modified during the year ended December 31, 2018. The Company had two accruing TDRs and three accruing TDRs in the amount of $1.5 million and $1.9 million, which were modified during the years ended December 31, 2017 and 2016, respectively.
The following tables summarize information about TDRs as of and for the years ended December 31, 2018, 2017 and 2016:
Impaired Loans
Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures the extent of the impairment in accordance with guidance under FASB ASC Topic 310 for Receivables. The fair value of impaired loans is estimated using one of several methods, including collateral value, liquidation value or discounted cash flows. However, collateral value is predominantly used to assess the fair value of an impaired loan. Those impaired loans not requiring an allowance represent loans for which the fair value of the collateral or expected repayments exceed the recorded investments in such loans.
Components of Impaired Loans
Impaired Loans
For the Year Ended December 31, 2018
Impaired Loans
For the Year Ended December 31, 2017
The impaired loans table above includes accruing TDRs in the amount of $1.5 million that were modified during 2017 and are performing in accordance with their modified terms. The interest income disclosed above relates to accruing TDRs.
Impaired Loans
For the Year Ended December 31, 2016
The impaired loans table above includes $1.9 million of accruing TDRs that were modified during 2016 and are performing in accordance with their modified terms. The interest income disclosed above relates to accruing TDRs.
Generally, the Company will charged-off the collateral or discounted cash flow deficiency on all impaired loans. The Company determined that no specific valuation allowance for any impaired loans was required as of December 31, 2018. The Company determined that a $1.5 million specific valuation allowance for the previously mentioned shared national credit was required as of December 31, 2017. Interest income that would have been recorded for the year ended December 31, 2018 and 2017, had impaired loans been current according to their original terms, amounted to $1.2 million and $1.3 million, respectively.
10. ACCRUED INTEREST RECEIVABLE
The following table provides information on accrued interest receivable at December 31, 2018 and 2017.
11. BANK PREMISES AND EQUIPMENT
Premises and equipment at December 31, 2018 and 2017:
Depreciation and amortization expense amounted to $5.8 million and $6.1 million for the years ended December 31, 2018 and 2017, respectively.
12. GOODWILL AND OTHER INTANGIBLES
The goodwill and other intangible assets arising from acquisitions is accounted for in accordance with the accounting guidance in FASB ASC Topic 350 for Intangibles - Goodwill and Other. As of December 31, 2018, the other intangibles consisted of $1.3 million of core deposit intangibles, which are amortized over an estimated useful life of ten years.
During the year ended December 31, 2018, the Company entered into an asset purchase agreement with a third party to sell the net assets of Beneficial Insurance Services, LLC and exit that business. In connection with that sale, the Company received net proceeds of $14.1 million and realized a net gain of $3.3 million as the sale proceeds exceeded the carrying amount for Beneficial Insurance Services including goodwill and intangible assets. Goodwill and intangible assets that related to Beneficial Insurance Services decreased $10.2 million during the year ended December 31, 2018 as a result of the sale.
During 2018, management reviewed qualitative factors for the bank unit including financial performance, market changes and general economic conditions and noted there was not a significant change in any of these factors as compared to 2017. Accordingly, it was determined that it was more likely than not that the fair value of banking unit continued to be in excess of its carrying amount as of December 31, 2018.
Goodwill and other intangibles at December 31, 2018 and December 31, 2017 are summarized as follows:
The following tables summarize amortizing intangible assets at December 31, 2018 and 2017:
Aggregate amortization expense was $696 million and $1.6 million for the years ended December 31, 2018 and 2017, respectively. Amortization expense for the next five years and thereafter is expected to be as follows:
13. OTHER ASSETS
The following table provides selected information on other assets at December 31, 2018 and 2017:
During the year ended December 31, 2017, the Company recorded a one- time $14.1 million reduction in the valuation of its net deferred tax assets related to the enactment of the Tax Cuts and Jobs Act and its impact on the re-measurement of our net deferred tax assets due to the reduction in the corporate income tax rate in 2018 to 21% from 35%.
The Company follows the authoritative guidance under ASC 860-50 - Servicing Assets and Liabilities to account for its servicing rights. The Company has elected the fair value measurement method to value its servicing assets at fair value in accordance with ASC 860-50. Under the fair value measurement method, the Company measures its loan servicing rights at fair value at each reporting date and reports changes in the fair value of its loan servicing rights in earnings in the period in which the changes occur. See Note 25 to these consolidated financial statements.
14. DEPOSITS
Deposits consisted of the following major classifications at December 31, 2018 and 2017:
Time deposit accounts outstanding at December 31, 2018 mature as follows:
The aggregate amounts of certificates of deposit accounts in denominations of $100 thousand or more totaled $223.3 million, $182.6 million and $176.0 million at December 31, 2018, December 31, 2017 and 2016, respectively. The FDIC has permanently raised deposit insurance per account owner to $250 thousand for all types of accounts.
15. BORROWED FUNDS
A summary of borrowings is as follows:
Advances from the FHLB that bear fixed interest rates with remaining periods until maturity are summarized as follows:
The Bank is a member of the FHLB system, which consists of 11 regional Federal Home Loan Banks. The FHLB provides a central credit facility primarily for member institutions. At December 31, 2018, the Bank had a maximum borrowing capacity from the FHLB of Pittsburgh of $2.0 billion of which we had $515.0 million in outstanding advances. The balance remaining of $1.5 billion is our unused borrowing capacity with the FHLB of Pittsburgh at December 31, 2018. The Bank, as a member of the FHLB of Pittsburgh, is required to acquire and hold shares of capital stock in that FHLB. The Bank was in compliance with requirements for FHLB of Pittsburgh with an investment of $23.2 million at December 31, 2018.
The weighted average interest rates of the borrowings during the years ended December 31, 2018 and 2017 were as follows:
As of December 31, 2018, the Bank also has a $173.4 million borrowing capacity with the Federal Reserve Bank. The Company pledges loans to secure its borrowing capacity at the Federal Reserve Bank of Philadelphia. Loans totaling $254.7 million and $193.6 million were pledged to secure borrowings at December 31, 2018 and 2017, respectively. There were no outstanding borrowings with the Federal Reserve Bank at December 31, 2018 and 2017.
At December 31, 2018 and 2017, the Bank had no outstanding repurchase agreements.
During the first quarter of 2018, the Company paid off the statutory trust debenture of $25.4 million that was at a rate of 3.17%.
16. OTHER LIABILITIES
The following table provides selected information on other liabilities at December 31, 2018 and December 31, 2017:
17. REGULATORY CAPITAL REQUIREMENTS
The Bank is subject to various regulatory capital requirements administered by state and federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
The Dodd-Frank Act required the Federal Reserve Board to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves. In early July 2013, the Federal Reserve Board and the Office of the Comptroller of the Currency approved revisions to their capital adequacy guidelines and prompt corrective action rules that implement the revised standards of the Basel Committee on Banking Supervision, commonly called Basel III, and address relevant provisions of the Dodd-Frank Act. “Basel III” refers to two consultative documents released by the Basel Committee on Banking Supervision in December 2009, the rules text released in December 2010, and loss absorbency rules issued in January 2011, which include significant changes to bank capital, leverage and liquidity requirements.
In July 2013, the Federal Deposit Insurance Corporation and the Federal Reserve Board approved a new rule that substantially amended the regulatory risk-based capital rules applicable to Beneficial Bank and Beneficial Bancorp. The final rule implements the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. The rules include new risk-based capital and leverage ratios, which became effective on January 1, 2015, and revised the definition of what constitutes “capital” for purposes of calculating those ratios.
The new minimum capital level requirements applicable to the Company and the Bank are: (1) a new common equity Tier 1 capital ratio of 4.5%; (2) a Tier 1 capital ratio of 6% (increased from 4%); (3) a total capital ratio of 8% (unchanged from current rules); and (4) a Tier 1 leverage ratio of 4% for all institutions. The rules also establish a “capital conservation buffer” of 2.5% above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital and would result in the following minimum ratios: (1) a common equity Tier 1 capital ratio of 7.0%, (2) a Tier 1 capital ratio of 8.5%, and (3) a total capital ratio of 10.5%. The new capital conservation buffer requirement started to be phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase by that amount each year until fully implemented in January 2019. An institution is also subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.
As of December 31, 2018, the Company’s and the Bank’s current capital levels exceed the required capital amounts to be considered “well capitalized” and we believe they also meet the fully-phased in minimum capital requirements, including the related capital conservation buffers, as required by the Basel III capital rules.
The following table summarizes the Company’s compliance with applicable regulatory capital requirements as of December 31, 2018 and December 31, 2017:
The following table summarizes the Bank’s compliance with applicable regulatory capital requirements as of December 31, 2018 and 2017:
18. INCOME TAXES
The Company files a consolidated federal income tax return. The provision for income taxes for the years ended December 31, 2018, 2017, and 2016 includes the following:
A reconciliation from the expected federal income tax expense computed at the statutory federal income tax rate to the actual income tax expense included in the consolidated statements of income is as follows:
Items that give rise to significant portions of the deferred tax accounts at December 31, 2018 and 2017 are as follows:
The passage of the Tax Cuts and Jobs Act on December 22, 2017 lowered the federal corporate tax rate for 2018 to 21% from 35%. Under ASC 740, the effects of changes in tax rates and laws on deferred tax balances are recorded as a component of income tax expense related to continuing operations for the period in which the law was enacted, even if the assets and liabilities related to items of accumulated other comprehensive income. During the quarter ended December 31, 2017, the Company re-measured its net deferred tax assets at the current 21% federal corporate tax rate and, as a result, the Company recorded a one-time charge of $13.1 million of
income tax expense. In addition, the FASB issued an accounting standards update that permits entities to reclassify tax effects stranded in accumulated other comprehensive income as a result of tax reform to retained earnings. As of December 31, 2017, the Company had $5.0 million of tax effects stranded in accumulated OCI as a result of the passage of the Tax Cuts and Jobs Act. The Company reclassified the amount stranded in accumulated OCI to retained earnings during the year ended December 31, 2018.
As of December 31, 2018, the Company had net deferred tax assets totaling $21.7 million. These deferred tax assets can only be realized if the Company generates sufficient taxable income in the future. If it cannot, a valuation allowance is established. The Company regularly evaluates the reliability of deferred tax asset positions. In determining whether a valuation allowance is necessary, the Company considers the level of taxable income in prior years to the extent that carry backs are permitted under current tax laws, as well as estimates of future pre-tax and taxable income and tax planning strategies that would, if necessary, be implemented. The Company currently maintains a valuation allowance for certain state net operating losses that management believes it is more likely than not that such deferred tax assets will not be realized. The Company expects to realize the remaining deferred tax assets over the allowable carry back and/or carry forward periods. Therefore, no valuation allowance is deemed necessary against its remaining federal or remaining state deferred tax assets as December 31, 2018. However, if an unanticipated event occurs that materially changes pre-tax and taxable income in future periods, an increase in the valuation allowance may become necessary and it could be material to the Company’s financial statements.
As of December 31, 2018, the Company had state and local net operating loss carryovers of $17.1 million resulting in deferred tax assets of $775 thousand. These state and local net operating loss carryovers begin to expire after December 31, 2018 if not utilized. A valuation allowance of $564 thousand for these deferred tax assets had been recorded as of December 31, 2018 as management believes it is more likely than not that such deferred tax assets will not be realized.
During the years ended December 31, 2018 and 2017, $370 thousand in net deferred tax liabilities and $727 thousand of net deferred tax assets, respectively, were recorded as adjustments to other comprehensive income tax accounts.
The Company accounts for uncertain tax positions in accordance with FASB ASC Topic 740 for Income Taxes. The guidance clarifies the accounting and reporting for income taxes where interpretation of the tax law may be uncertain. The FASB prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of income tax uncertainties with respect to positions taken or expected to be taken in income tax returns. The uncertain tax liability for uncertain tax positions was zero at December 31, 2018 and December 31, 2017. The tax years 2016 and 2017 remain subject to examination by the IRS. The 2015 through 2017 tax years remain subject to examination by various state and local taxing authorities. For 2018, the Bank’s maximum federal income tax rate was 21%.
The Company recognizes, when applicable, interest and penalties related to unrecognized tax positions in the provision for income taxes in the consolidated statement of income. No interest or penalties were incurred during the years ended December 31, 2018 and 2017.
Pursuant to accounting guidance, the Company is not required to provide deferred taxes on its tax loan loss reserve as of December 31, 1987. As of December 31, 2018 and 2017, the Company had unrecognized deferred income taxes of approximately $1.7 million with respect to this reserve. This reserve could be recognized as taxable income and create a current and/or deferred tax liability using the income tax rates then in effect if one of the following occur: (1) the Bank’s retained earnings represented by this reserve are used for distributions in liquidation or for any other purpose other than to absorb losses from bad debts; (2) the Bank fails to qualify as a Bank, as provided by the Internal Revenue Code; or (3) there is a change in federal tax law.
19. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS
The Bank has noncontributory defined benefit pension plans covering many of its employees. Additionally, the Company sponsors nonqualified supplemental employee retirement plans for certain participants. The Bank also provides certain postretirement benefits to qualified former employees. These postretirement benefits principally pertain to certain health and life insurance coverage. Information relating to these employee benefits program are included in the tables that follow.
Effective June 30, 2008, the defined pension benefits for Bank employees were frozen at the current levels. Additionally, the Bank enhanced its 401(k) Plan and combined it with its Employee Stock Ownership Plan to fund employer contributions. See Note 20 to these consolidated financial statements.
During 2014, the Company adopted the new mortality tables reflecting longer life expectancy published by the Society of Actuaries on October 27, 2014. These revised tables resulted in an increase in our pension plan’s projected benefit obligation of approximately $5.7 million as of December 31, 2014. In 2018, this scale was updated to MP-2018.
During 2016, the Company revised its method for estimating the service cost and interest cost components of the net periodic benefit cost. Previously, these were estimated using a single weighted-average discount rate derived from the Citigroup Above Median Curve, the yield curve used to measure the benefit obligation. Now, the service cost and interest cost are estimated more precisely by discounting the projected cash flows with their corresponding spot rates on the Citigroup Above Median Curve. The Company has accounted for this as a change in accounting estimate affected by a change in accounting principle and have therefore accounted for it prospectively. This change in estimate reduced the net periodic benefit cost by $656 thousand in 2016.
The following tables present a reconciliation of beginning and ending balances of benefit obligations and assets at December 31, 2018 and 2017:
The following table presents a reconciliation of the funded status of the pension and postretirement benefits at December 31, 2018 and 2017:
The Company’s pension benefits funding policy is to contribute annually an amount, as determined by consulting actuaries and approved by the Retirement Plan Committee, which can be deducted for federal income tax purposes, if required. During 2018, $252 thousand was contributed to the pension plans under the Bank’s funding policy compared to $293 thousand during 2017.
The following table presents the amounts recognized in accumulated other comprehensive income for pension and postretirement benefits at December 31, 2018 and 2017.
The Company’s total accumulated pension benefit obligations at December 31, 2018 and December 31, 2017 were $91.0 million and $101.9 million, respectively. The accumulated pension obligation equals the projected benefit obligation as a result of the freeze in pension benefits effective June 30, 2008.
Significant assumptions used to calculate the net periodic pension cost and obligation as of December 31, 2018, 2017, and 2016 are as follows:
The components of net pension cost are as follows:
As of December 31, 2018, the health care trend initial rate was 7.00 percent for all participants, which is projected to reach an ultimate trend rate of 5.00 percent as of December 31, 2027 and remain level thereafter.
The impact of a 1.0 percent increase and decrease in assumed health care cost trend for each future year would be as follows:
The estimated net loss for the pension benefits that will be amortized from accumulated other comprehensive income into net periodic pension costs over the next fiscal year is $2.5 million. There is no estimated transition that will be amortized from accumulated other comprehensive income into periodic pension cost over the next fiscal year. The net loss and prior service cost for postretirement benefits that will be amortized from accumulated other comprehensive income into periodic pension cost over the next fiscal year are $63 thousand and ($73) thousand, respectively.
Future benefit payments for all pension and postretirement plans are estimated to be paid as follows:
(Dollars in thousands)
The fair values of all pension and postretirement plan assets at December 31, 2018 and 2017 by asset category are as follows:
As of December 31, 2018 and 2017, pension and postretirement plan assets were comprised of investments in equity and fixed income mutual funds. The Bank’s consolidated pension plan investment policy provides that assets are to be managed over a long-term investment horizon to ensure that the chances and duration of investment losses are carefully weighed against the long-term potential for asset appreciation. The primary objective of managing a plan’s assets is to improve the plan’s funded status. A secondary financial objective is, where possible, to minimize pension expense volatility. The Company’s pension plan allocates assets based on the plan’s funded status to risk management and return enhancement asset classes. The risk management class is comprised of a long duration fixed income fund while the return enhancement class consists of equity and other fixed income funds. Asset allocation ranges are generally 40% to 80% for risk management and 20% to 60% for return enhancement when the funded status is less than 110%, and 50% to 90% in risk management and 10% to 50% for return enhancement when the funded status reaches 110%, subject to the discretion of the Bank’s Retirement Plan Committee. Also, a small portion is maintained in cash reserves when appropriate. Weighted average asset allocations in plan assets at December 31, 2018 and December 31, 2017 were as follows:
The Company provides life insurance benefits to eligible employees under an endorsement split-dollar life insurance program. At December 31, 2018 and 2017, $21.4 million and $20.9 million, respectively, in cash surrender value relating to this program was recognized in “other assets” in the Company’s consolidated statements of financial condition. The Company recognizes a liability for future benefits applicable to endorsement split-dollar life insurance arrangements that provide death benefits postretirement. These liabilities totaled $2.7 million and $4.9 million at December 31, 2018 and 2017, respectively, and are included in the postretirement tables above.
20. EMPLOYEE SAVINGS AND STOCK OWNERSHIP PLAN
In connection with its initial public offering, the Company implemented an Employee Stock Ownership Plan (“ESOP”), which provides retirement benefits for substantially all full-time employees who were employed at the date of the initial public offering and are at least 21 years of age. Other salaried employees will be eligible after they have completed one year of service and have attained the age of 21. The Company makes annual contributions to the ESOP equal to the ESOP’s debt service or equal to the debt service less the dividends received by the ESOP on unallocated shares. Shares purchased by the ESOP were acquired using funds provided by two loans from the Company and accordingly the cost of those shares is shown as a reduction of stockholders’ equity. As previously discussed, 2,015,352
shares were purchased by the Plan to be used to fund future contributions into the Plan in conjunction with the second step conversion. In connection with the purchase of the shares during the second-step stock offering on January 12, 2015, the Plan borrowed $20.2 million from the Bancorp at a fixed interest rate of 3.25% with a thirty-year term to fund the purchase of 2,015,352 shares. As of July 1, 2008, the ESOP was merged with the Company’s 401(k) plans to form the Employee Savings and Stock Ownership Plan (“KSOP”). The Company accounts for the KSOP based on guidance from FASB ASC Topic 718 for Compensation - Stock Compensation. Shares are released as the loan is repaid.
The balance of the 2008 loan to the KSOP as of December 31, 2018 was $10.8 million compared to $13.0 million as of December 31, 2017. The balance of the 2015 loan to the KSOP as of December 31, 2018 was $18.5 million compared to $18.9 million as of December 31, 2017. All full-time employees and certain part-time employees are eligible to participate in the KSOP if they meet prescribed service criteria. Shares will be allocated and released based on the KSOP’s plan document. While the KSOP is one plan, the two separate components of the 401(k) Plan and ESOP remain. Under the KSOP, the Company makes basic contributions and matching contributions. The Bank makes additional contributions for certain employees based on age and years of service. The Company may also make discretionary contributions under the KSOP. Each participant’s account is credited with shares of the Company’s stock or cash based on compensation earned during the year in which the contribution was made.
Dividends declared on common stock held by the ESOP which have not been allocated to the account of a participant can be used to repay the loan. During the year ended December 31, 2018, the Company used dividends declared of $1.3 million to repay the loans compared to $711 thousand for the year ended December 31, 2017. Allocation of shares to the participants is contingent upon the repayment of a loan to the Company. The allocated shares in the KSOP related to the 2008 loan were 2,763,627 and 2,566,075 as of December 31, 2018 and December 31, 2017, respectively. The allocated shares in the KSOP related to the 2015 loan were 266,481 and 199,301 as of December 31, 2018 and December 31, 2017, respectively. The suspense shares available related to the 2008 loan were 783,300 as of December 31, 2018 and 980,852 as of December 31, 2017. The suspense shares available related to the 2015 loan were 1,748,871 as of December 31, 2018 and 1,816,051 as of December 31, 2017. The suspense shares are the shares that are unearned and are available to be allocated. The market values of the unearned shares were $36.2 million and $46.0 million as of December 31, 2018 and 2017, respectively. The Company recorded a related expense of approximately $4.3 million, $4.2 million and $3.8 million, respectively, for contributions to the KSOP for years ended December 31, 2018, 2017 and 2016.
21. STOCK BASED COMPENSATION
Stock-based compensation is accounted for in accordance with FASB ASC Topic 718 for Compensation - Stock Compensation. The Company establishes fair value for its equity awards to determine their cost. The Company recognizes the related expense for employees over the appropriate vesting period, or when applicable, service period, using the straight-line method. However, consistent with the guidance, the amount of stock-based compensation recognized at any date must at least equal the portion of the grant date value of the award that is vested at that date. As a result, it may be necessary to recognize the expense using a ratable method.
Under the 2016 Omnibus Incentive Plan (“the 2016 Plan”), the Company has granted 2,626,706 of restricted stock awards to employees, officers and directors, of which 225,349 have been forfeited as of December 31, 2018. The net impact to the Company’s outstanding additional paid in capital as of December 31, 2018 was a reduction of $29.7 million as well as a reduction in the balance of treasury stock. The restricted stock awards granted to directors vest generally over a 12 to 31 month period and the restricted stock awards granted to employees and officers vest over a three year period. Restricted stock awards include performance awards granted to certain officers of the Company that will vest only if the Company exceeds threshold goals related to credit quality, return on average assets and total shareholder return. Upon the adoption of the 2016 Plan, the Company’s 2008 Equity Incentive Plan (“EIP”) was terminated. However, outstanding awards under the 2008 EIP remain in effect in accordance with their original terms.
Compensation expense related to the stock awards is recognized ratably over the vesting period in an amount which totals the market price of the Company’s stock at the grant date. The expense recognized for the years ended December 31, 2018, 2017 and 2016 totaled $13.3 million, $13.7 million and $7.6 million, respectively.
The following table summarizes the non-vested stock award activity for the year ended December 31, 2018:
The following table summarizes the non-vested stock award activity for the year ended December 31, 2017:
The fair value of the 989,486 shares that vested during the year ended December 31, 2018 was $16.3 million. The fair value of the 904,019 shares that vested during the year ended December 31, 2017 was $14.4 million.
The 2008 EIP authorized the grant of options to officers, employees, and directors of the Company to acquire shares of common stock with an exercise price equal to the fair value of the common stock at the grant date. Options expire ten years after the date of grant, unless terminated earlier under the option terms. Options are granted at the then fair market value of the Company’s stock. The options were valued using the Black-Scholes option pricing model. During the year ended December 31, 2018 and 2017, the Company did not grant any options. All options require the participant’s continued service. The options generally vest and are exercisable over five years. Compensation expense for the options totaled $582 thousand for the year ended December 31, 2018 compared to $945 thousand and $1.4 million for the year ended December 31, 2017 and 2016, respectively.
A summary of option activity as of December 31, 2018 and changes during the twelve month period is presented below:
A summary of option activity as of December 31, 2017 and changes during the twelve month period is presented below:
The weighted average remaining contractual term was approximately 4.15 years and the aggregate intrinsic value was $6.9 million for options outstanding as of December 31, 2018. The weighted average remaining contractual term was approximately 4.47 years and the aggregate intrinsic value was $11.8 million for options outstanding as of December 31, 2017. The weighted average remaining contractual term was approximately 4.74 years and the aggregate intrinsic value was $25.4 million for options outstanding as of December 31, 2016. As of December 31, 2018, exercisable options totaled 1,259,910 with an average weighted exercise price of $9.25 per share, a weighted average remaining contractual term of approximately 3.97 years, and an aggregate intrinsic value of $6.4 million. As of December 31, 2017, exercisable options totaled 1,309,807 with an average weighted exercise price of $9.39 per share, a weighted average remaining
contractual term of approximately 3.96 years, and an aggregate intrinsic value of $9.2 million. As of December 31, 2016, exercisable options totaled 2,069,854 with an average weighted exercise price of $9.46 per share, a weighted average remaining contractual term of approximately 3.94 years, and an aggregate intrinsic value of $18.5 million.
As of December 31, 2018, there was $196 thousand of total unrecognized compensation cost related to options and $7.3 million in unrecognized compensation cost related to non-vested stock awards granted. As of December 31, 2017, there was $784 thousand of total unrecognized compensation cost related to options and $18.2 million in unrecognized compensation cost related to non-vested stock awards granted. The average weighted lives for the option expense were 0.81 and 1.43 years as of December 31, 2018 and December 31, 2017, respectively. The average weighted lives for the stock award expense were 1.14 and 1.61 years at December 31, 2018 and December 31, 2017, respectively.
22. COMMITMENTS AND CONTINGENCIES
The Company leases a number of offices as part of its regular business operations. Rental expense under such leases aggregated $6.3 million, $6.1 million and $5.8 million for the years ended December 31, 2018, 2017 and 2016, respectively.
At December 31, 2018, the Company was committed under non-cancelable operating lease agreements for minimum rental payments to lessors as follows:
In the normal course of business, there are various outstanding commitments and contingent liabilities, such as commitments to extend credit, which are not reflected in the consolidated financial statements. The Company has established specific reserves related to loan commitments that are not material to the Company.
At December 31, 2018 and 2017, the Company had outstanding commitments to purchase or originate new loans or leases aggregating approximately $7.3 million and $29.4 million, respectively, and commitments to customers on available lines of credit of $480.4 million and $443.1 million, respectively, commitments to fund commercial construction and other advances of $243.8 million and $159.3 million, respectively, and standby letters of credit of $26.8 million and $29.4 million, respectively. Commitments are issued in accordance with the same policies and underwriting procedures as settled loans. The Bank had a reserve for its commitments and contingencies of $119 thousand and $124 thousand at December 31, 2018 and December 31, 2017, respectively.
The Company and its directors had been named in a lawsuit filed in Maryland state circuit court regarding compensation levels of directors in connection with equity awards granted in the second quarter of 2016 under the Company’s 2016 Omnibus Incentive Plan. The defendants believed the lawsuit, alleging breach of fiduciary duty and unjust enrichment under Maryland law, was without merit and vigorously defended it. During the quarter ended December 31, 2018, this lawsuit was settled with the plaintiffs.
Periodically, there have been other various claims and lawsuits against the Bank, such as claims to enforce liens, condemnation proceedings on properties in which it holds security interests, claims involving the making and servicing of real property loans and other issues incident to its business. The Bank is not a party to any pending legal proceedings that it believes would have a material adverse effect on its financial condition, results of operations or cash flows.
23. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company follows authoritative guidance under FASB ASC Topic 820 for Fair Value Measurements and Disclosures which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The definition of fair value under ASC 820 is the exchange price. The guidance clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability. The definition focuses on the price that would be received to sell the asset or paid to transfer the liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price). The guidance emphasizes that fair value is a market-based measurement, not an entity-specific measurement.
Fair value is based on quoted market prices, when available. If listed prices or quotes are not available, fair value is based on fair value models that use market participant or independently sourced market data which include: discount rate, interest rate yield curves, credit risk, default rates and expected cash flow assumptions. In addition, valuation adjustments may be made in the determination of fair value. These fair value adjustments may include amounts to reflect counter party credit quality, creditworthiness, liquidity and other unobservable inputs that are applied consistently over time. These adjustments are estimated and, therefore, subject to significant management judgment, and at times, may be necessary to mitigate the possibility of error or revision in the model-based estimate of the fair value
provided by the model. The methods described above may produce fair value calculations that may not be indicative of the net realizable value. While the Company believes its valuation methods are consistent with other financial institutions, the use of different methods or assumptions to determine fair values could result in different estimates of fair value. FASB ASC Topic 820 for Fair Value Measurements and Disclosures describes three levels of inputs that may be used to measure fair value:
Level 1 Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include debt securities, equity securities and derivative contracts that are traded in an active exchange market as well as certain U.S. Treasury securities that are highly liquid and actively traded in over-the-counter markets.
Level 2 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 for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include debt securities with quoted market prices that are traded less frequently than exchange traded assets and liabilities. The values of these items are determined using pricing models with inputs observable in the market or can be corroborated from observable market data. This category generally includes U.S. Government and agency mortgage-backed debt securities, corporate debt securities and derivative contracts.
Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
Those assets which will continue to be measured at fair value on a recurring basis are as follows at December 31, 2018:
Those assets which will continue to be measured at fair value on a recurring basis are as follows at December 31, 2017:
Level 1 Valuation Techniques and Inputs
Included in this category are money market funds, mutual funds and certificates of deposit. To estimate the fair value of these securities, the Company utilizes observable quotations for the indicated security.
Level 2 Valuation Techniques and Inputs
The majority of the Company’s investment securities are reported at fair value utilizing Level 2 inputs. Prices of these securities are obtained through independent, third-party pricing services. Prices obtained through these sources include market derived quotations and matrix pricing and may include both observable and unobservable inputs. Fair market values take into consideration data such as dealer quotes, new issue pricing, trade prices for similar issues, prepayment estimates, cash flows, market credit spreads and other factors. The Company reviews the output from the third-party providers for reasonableness by considering the pricing consistency among securities with similar characteristics, where available, and comparing values with other pricing sources available to the Company. In general, the Level 2 valuation process uses the following significant inputs in determining the fair value of the different classes of investments:
U.S. Government Sponsored Enterprise (GSE) and Agency Notes. Pricing evaluations are based on obtaining relevant trade data, benchmark quotes and spreads and incorporating this information into the evaluation process. Evaluations are generated on a price, yield or spread basis as determined by the observed market data. Spreads and yields are calculated continuously throughout the day, as well as “end of day”.
Ginnie Mae Guaranteed Mortgage Certificates. Pricing evaluations are based on issuer type, coupon and maturity. The Pool specific evaluation model takes into account pool level information supplied directly by the agency. For adjustable rate mortgages, the model takes into account indices, margin, periodic and life caps, next coupon adjustment date and the convertibility of the bond.
GSE CMOs. For pricing evaluations, the pricing service, obtains and applies available direct market color (trades, covers, bids, offers and price talk) along with market color for similar bonds and GSE CMOs in general (including market research). Evaluations of tranches (non-volatile and volatile) are based on ICE Data Services interpretation of accepted market modeling, trading, and pricing conventions.
GSE Mortgage-backed Securities. Included in this category are Fannie Mae and Freddie Mac fixed rate residential mortgage backed securities and Fannie Mae and Freddie Mac Adjustable Rate residential mortgage backed securities. Pricing evaluations are based on issuer type, coupon and maturity. The Pool specific evaluation model takes into account pool level information supplied directly by the GSE. For adjustable rate mortgages, the model takes into account indices, margin, periodic and life caps, next coupon adjustment date and the convertibility of the bond.
Tax Exempt General Obligation and Municipal Bonds. For pricing, the pricing service’s evaluators collect and analyze market data to determine how it should be applied to bonds within their assigned sectors. Bonds are adjusted throughout the day based on trades and other pertinent market information. The information may be applied to an individual bond’s evaluation as well as extrapolated to other municipal bonds of the same issuer sector and other sectors, when appropriate. Within a given sector, evaluators have the ability to make daily spread adjustments for various attributes that include, but are not limited to, discounts, premiums, credit, alternative minimum tax (AMT), use of proceeds, and callability.
Corporate Securities. Pricing evaluations are based on obtaining relevant trade data, benchmark quotes and spreads and incorporating this information into the evaluation process. Evaluations are generated on a price, yield or spread basis as determined by the observed market data. Spreads and yields are calculated continuously throughout the day, as well as “end of day”.
Equities. For a regular price on listed securities (NYSE, NASDAQ, AMEX), ICE Data Services uses the last trade on any exchange where the security trades during regular trading hours. If the issue does not trade, the last bid from any exchange is used. If there is no trade or bid, the last trade or bid from the previous day is used, or the last day where there was a bid or trade, going back up to 90 days, is used. If there were no bids or trades in the last 90 days, an error message is returned by ICE Data Services.
Level 3 Valuation Techniques and Inputs
Servicing Rights. The Company determines the fair value of its servicing rights by estimating the amount and timing of future cash flows associated with the servicing rights and discounting the cash flows using market discount rates. The valuation includes the application of certain assumptions made by management of the Company, including prepayment projections, and prevailing assumptions used in the marketplace at the time of the valuation.
The table below presents all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2018 and 2017.
Level 3 Investments Only
Level 3 Investments Only
The Company also has assets that, under certain conditions, are subject to measurement at fair value on a non-recurring basis. These include assets that are measured at the lower of cost or market value and had a fair value below cost at the end of the period as summarized below. A loan is impaired when, based on current information, the Company determines that it is probable that the Company will be unable to collect amounts due according to the terms of the loan agreement. The Company’s impaired loans are measured based on the estimated fair value of the collateral if the loans are collateral dependent or based on a discounted cash flow analysis if the loans are not collateral dependent. Assets measured at fair value on a nonrecurring basis are as follows:
In accordance with FASB ASC Topic 825 for Financial Instruments, Disclosures about Fair Value of Financial Instruments, the Company is required to disclose the fair value of financial instruments. The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a distressed sale. Fair value is best determined using observable market prices; however for many of the Company’s financial instruments no quoted market prices are readily available. In instances where quoted market prices are not readily available, fair value is determined using present value or other techniques appropriate for the particular instrument. These techniques involve some degree of judgment, and as a result, are not necessarily indicative of the amounts the Company would realize in a current market exchange. Different assumptions or estimation techniques may have a material effect on the estimated fair value.
The following table sets forth the carrying and estimated fair value of the Company’s financial assets and liabilities for the periods indicated:
Cash and Cash Equivalents - For cash and cash equivalents, the carrying amount is a reasonable estimate of fair value.
Securities Available for Sale and Held to Maturity - The fair value of investment securities, mortgage-backed securities and collateralized mortgage obligations is based on quoted market prices, dealer quotes, yield curve analysis, and prices obtained from independent pricing services.
FHLB Stock - The fair value of FHLB stock is estimated at its carrying value and redemption price of $100 per share.
Loans and Leases, Net - The fair value of loans and leases is estimated by discounting the future cash flows using the current rate at which similar loans and leases would be made to borrowers with similar credit and for the same remaining maturities. Additionally, to be consistent with the requirements under FASB ASC Topic 820 for Fair Value Measurements and Disclosures, the loans and leases were valued at a price that represents the Company’s exit price or the price at which these instruments would be sold or transferred.
Loans Held for Sale - The fair value of loans held for sale is estimated using the current rate at which similar loans would be made to borrowers with similar credit risk and the same remaining maturities. Loans held for sale are carried at the lower of cost or estimated fair value.
Servicing Rights - The Company determines the fair value of its servicing rights by estimating the amount and timing of future cash flows associated with the servicing rights and discounting the cash flows using market discount rates. The valuation included the application of certain assumptions made by management of the Bank, including prepayment projections, and prevailing assumptions used in the marketplace at the time of the valuation.
Interest Rate Swaps and Other Contracts - The Company’s valuation methodology for OTC derivatives includes an analysis of discount cash flows based on OIS rates. Fully collateralized trades are discounted using OIS with no additional economic adjustments to arrive at fair value. Uncollateralized or partially-collateralized trades are also discounted at OIS, but include appropriate economic adjustments for funding costs (i.e., a LIBOR-OIS basis adjustment to approximate uncollateralized cost of funds) and credit risk.
Accrued Interest Receivable/Payable - The carrying amounts of interest receivable/payable approximate fair value.
Deposits - The fair value of checking and money market deposits and savings accounts is the amount reported in the consolidated financial statements. The carrying amount of checking, savings and money market accounts is the amount that is payable on demand at the reporting date. The fair value of time deposits is generally based on a present value estimate using rates currently offered for deposits
of similar remaining maturity.
Borrowed Funds - The fair value of borrowed funds is based on a present value estimate using rates currently offered.
Commitments to Extend Credit and Letters of Credit - The majority of the Company’s commitments to extend credit and letters of credit carry current market interest rates if converted to loans and are not included in the table above. Because commitments to extend credit and letters of credit are generally unassignable by either the Company or the borrower, they only have value to the Company and the borrower. The estimated fair value approximates the recorded net deferred fee amounts, which are not significant.
The fair value estimates presented herein are based on pertinent information available to management as of December 31, 2018 and December 31, 2017. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these consolidated financial statements since December 31, 2018 and December 31, 2017 and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.
24. RELATED PARTY TRANSACTIONS
At December 31, 2018 and 2017, certain directors, executive officers, principal holders of the Company’s common stock, associates of such persons, and affiliated companies of such persons were indebted, including undrawn commitments to lend, to the Bank in the aggregate amount of $233 thousand and $255 thousand, respectively. Please refer to Note 9 for further information.
There were no commitments to lend to related parties at December 31, 2018 and 2017. The commitments are in the form of loans and guarantees for various business and personal interests. This indebtedness was incurred in the ordinary course of business on substantially the same terms, including interest rate and collateral, as those prevailing at the time of comparable transactions with unrelated parties. This indebtedness does not involve more than the normal risk of repayment or present other unfavorable features.
None of the Company’s affiliates, officers, directors or employees have an interest in or receive remuneration from any special purpose entities or qualified special purpose entities which the Company transacts business.
The Company maintains a written policy and procedures covering related party transactions. These procedures cover transactions such as employee-stock purchase loans, personal lines of credit, residential secured loans, overdrafts, letter of credit and increases in indebtedness. Such transactions are subject to the Bank’s normal underwriting and approval procedures. Prior to the loan closing, the Bank’s Senior Loan Committee must approve and determine whether the transaction requires approval from or a post notification be sent to the Company’s Board of Directors.
25. SERVICING RIGHTS
The Company sells certain residential mortgage loans and the guaranteed portion of certain Small Business Administration (“SBA”) loans to third parties and retains servicing rights and receives servicing fees. All such transfers are accounted for as sales. When the Company sells a residential mortgage loan, it does not retain any portion of that loan and its continuing involvement in such transfers is limited to certain servicing responsibilities. While the Company may retain a portion of certain sold SBA loans, its continuing involvement in the portion of the loan that was sold is limited to certain servicing responsibilities. When the contractual servicing fees on loans sold with servicing retained are expected to be more than adequate compensation to a servicer for performing the servicing, a capitalized servicing asset is recognized. The Company accounts for the transfers and servicing of financial assets in accordance with ASC 860, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities.
Residential Mortgage Loans
The Company has elected the fair value measurement method to value its mortgage servicing rights (“MSRs”). Under the fair value measurement method, the Company records its MSRs on its consolidated statements of financial condition as a component of other assets at fair value with changes recorded as a component of mortgage banking income in the Company’s consolidated statements of income for each period. As of December 31, 2018 and December 31, 2017, the Company serviced $124.6 million and $132.5 million of residential mortgage loans, respectively. Servicing loans for others consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors, and processing foreclosures. During the years ended December 31, 2018, 2017 and 2016, the Company recognized $325 thousand, $338 thousand, and $350 thousand of servicing fee income, respectively. The Company had
fiduciary responsibility for related escrow and custodial funds aggregating approximately $1.9 and $2.0 million at December 31, 2018 and 2017, respectively.
The following is an analysis of the activity in the Company’s residential MSRs for the years ended December 31, 2018, 2017 and 2016:
The Company uses assumptions and estimates in determining the fair value of MSRs. These assumptions include prepayment speeds, discount rates, escrow earnings rates and other assumptions. The assumptions used in the valuation were based on input from buyers, brokers and other qualified personnel, as well as market knowledge. At December 31, 2018, the key assumptions used to determine the fair value of the Company’s MSRs included a lifetime constant prepayment rate equal to 6.60%, a discount rate equal to 10.25% and an escrow earnings credit rate equal to 3.02%. At December 31, 2017, the key assumptions used to determine the fair value of the Company’s MSRs included a lifetime constant prepayment rate equal to 7.92%, a discount rate equal to 9.63% and an escrow earnings credit rate equal to 2.13%.
The sensitivity of the current fair value of the residential MSRs to immediate 10% and 20% favorable and unfavorable changes in key economic assumptions are included in the following table for the periods indicated:
The sensitivity calculations above are hypothetical and should not be considered to be predictive of future performance. As indicated, changes in fair value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the change
in assumption to the change in fair value may not be linear. Also, in this table, the effect of an adverse variation in a particular assumption on the fair value of the mortgage servicing rights is calculated without changing any other assumption; while in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments), which may magnify or counteract the effect of the change.
SBA Loans
The Company has elected the fair value measurement method to value its SBA loan servicing rights. Under the fair value measurement method, the Company records its SBA loan servicing asset on its consolidated statements of financial condition as a component of other assets at fair value with changes recorded as a component of other non-interest income in the Company’s consolidated statements of income for each period. As of December 31, 2018 and December 31, 2017 the Company serviced $59.3 million and $50.9 million of SBA loans, respectively. During the years ended December 31, 2018, 2017, and 2016, the Company recognized $546 thousand, $466 thousand, and $287 thousand of servicing fee income, respectively. At December 31, 2018 and December 31, 2017, SBA loan servicing rights totaled $1.0 million and $785 thousand, respectively, and were included in “other assets” in the Company’s consolidated statements of financial condition.
The following is an analysis of the activity in the Company’s SBA loan servicing rights for the years ended December 31, 2018 and 2017:
The Company uses assumptions and estimates in determining the fair value of SBA servicing rights. These assumptions include prepayment speeds, discount rates, escrow earnings rates and other assumptions. The assumptions used in the valuation were based on input from buyers, brokers and other qualified personnel, as well as market knowledge. At December 31, 2018, the key assumptions used to determine the fair value of the Company’s SBA servicing rights included a lifetime constant prepayment rate equal to 9.84%, a discount rate equal to 13.75% and servicing expenses per loan of $1 thousand. At December 31, 2017, the key assumptions used to determine the fair value of the Company’s SBA servicing rights included a lifetime constant prepayment rate equal to 8.85%, a discount rate equal to 13.13% and servicing expenses per loan of $1 thousand.
At December 31, 2018 and 2017, the sensitivity of the current fair value of the SBA servicing rights to immediate 10% and 20% favorable and unfavorable changes in key economic assumptions are included in the following table.
The sensitivity calculations above are hypothetical and should not be considered to be predictive of future performance. As indicated, changes in fair value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of an adverse variation in a particular assumption on the fair value of the SBA servicing rights is calculated without changing any other assumption; while in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments), which may magnify or counteract the effect of the change.
26. DERIVATIVE FINANCIAL INSTRUMENTS
Interest rate swaps and risk participation agreements
The Company is a party to derivative financial instruments in the normal course of business to meet the needs of commercial banking customers. These financial instruments have been limited to interest rate swap agreements, which are entered into with counterparties that meet established credit standards and, where appropriate, contain master netting and collateral provisions protecting the party at risk. The Company believes that the credit risk inherent in all of the derivative contracts is minimal based on the credit standards and the netting and collateral provisions of the interest rate swap agreements.
The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. These derivatives are not designated as hedges and are not speculative. Rather, these derivatives result from a service the Company provides to certain customers, which the Company implemented during the first quarter of 2012. As the interest rate swaps associated with this program do not meet the hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. As of December 31, 2018, the Company had 26 interest rate swaps with an aggregate notional amount of $164.3 million related to this program. During the year ended December 31, 2018, the Company recognized a net loss of $43 thousand compared to a net loss of $39 thousand for the year ended December 31, 2017 and a net gain of $798 thousand for the year ended December 31, 2016 related to interest rate swap agreements that are included as a component of services charges and other non-interest income in the Company’s consolidated statements of income.
Under certain circumstances, when the Company purchases a portion of a commercial loan that has an existing interest rate swap, it enters a Risk Participation Agreement with the counterparty and assumes the credit risk of the loan customer related to the swap. The Company has entered into risk participation agreements with a notional value of $7.8 million and a fair value of $3 thousand as of December 31, 2018. During the year ended December 31, 2018, the Company recognized a net gain of $1 thousand compared to a net gain of $5 thousand for the year ended December 31, 2017 and a net gain of $51 thousand for the year ended December 31, 2016 related to the risk participation agreements that are included as a component of services charges and other non-interest income in the Company’s consolidated statements of income.
The table below presents the fair value of the Company’s derivative financial instruments not designated as hedging instruments as well as their classification on the consolidated statements of condition as of December 31, 2018 and December 31, 2017:
As of December 31, 2018
(1) Included in other assets in our Consolidated Statements of Financial Condition.
(2) Included in other liabilities in our Consolidated Statements of Financial Condition.
As of December 31, 2017
(1) Included in other assets in our Consolidated Statements of Financial Condition.
(2) Included in other liabilities in our Consolidated Statements of Financial Condition.
The following displays offsetting interest rate swap assets and liabilities for the dates presented:
Offsetting of Derivative Assets
Offsetting of Derivative Liabilities
(1) - Balance includes accrued interest receivable/payable and credit valuation adjustments.
Offsetting of Derivative Assets
Offsetting of Derivative Liabilities
(1) - Balance includes accrued interest receivable/payable and credit valuation adjustments.
The Company has agreements with certain of its derivative counterparties that provide that if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations. The Company also has agreements with certain of its derivative counterparties that provide that if the Company fails to maintain its status as a well or adequately capitalized institution, then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations under the agreements.
As of December 31, 2018 and December 31, 2017, the termination value of the interest rate swaps in a liability position was $2.8 million and $1.8 million, respectively. The Company has minimum collateral posting thresholds with its counterparty. The Company was not required to post collateral on interest rate swaps as of December 31, 2018 and December 31, 2017. Additionally, as of December 31, 2018 the counterparties posted collateral on interest rate swaps in the amount of $843 thousand, compared to $1.3 million in 2017. If the Company had breached any of these provisions at December 31, 2018 it would have been required to settle its obligation under the agreement at the termination value and could have been required to pay any additional amounts due in excess of amounts previously posted as collateral with the counterparty. The Company had not breached any provisions at December 31, 2018.
Cash Flow Hedges of Interest Rate Risk
The Company’s objectives in using interest rate derivatives designated as cash flow hedges are to add stability to interest expense on borrowings and to manage its exposure to interest rate movements. To accomplish these objectives, the Company has entered into one
forward starting interest rate swap with a notional amount of $200.0 million with a commercial bank effective April 1, 2019 and maturing April 1, 2024 as part of its interest rate risk management strategy. This interest rate swap is designated as a cash flow hedge and involves the receipt of variable rate amounts from the counterparty in exchange for the Company making fixed interest payments.
For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income (outside of earnings), net of tax, and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings. The Company assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged transactions. The Company did not recognize any hedge ineffectiveness in earnings during the period ended December 31, 2018.
The table below presents the fair value of the Company’s derivative financial instruments designated as hedging instruments as well as their classification on the consolidated statements of condition as of December 31, 2018 and December 31, 2017:
(1) Included in other assets in our Consolidated Statements of Financial Condition.
(1) Included in other assets in our Consolidated Statements of Financial Condition.
At December 31, 2018, the counterparty posted collateral on the cash flow hedge in the amount of $2.9 million.
The Company estimated that none of the existing gains that are reported in accumulated other comprehensive income at December 31, 2018 and December 31, 2017 are expected to be reclassified into earnings within the next twelve months.
The table below presents the pre-tax net gains of the Company’s cash flow hedge for the period ended December 31, 2018 and December 31, 2017 and where they were recorded in our Consolidated Statements of Financial Condition.
27. PARENT COMPANY FINANCIAL INFORMATION
Beneficial Bancorp, Inc.
CONDENSED STATEMENTS OF FINANCIAL CONDITION - PARENT COMPANY ONLY
Beneficial Bancorp, Inc.
CONDENSED STATEMENTS OF OPERATIONS - PARENT COMPANY ONLY
Beneficial Bancorp, Inc.
CONDENSED STATEMENTS OF COMPREHENSIVE INCOME - PARENT COMPANY ONLY
See accompanying notes to the consolidated financial statements.
Beneficial Bancorp, Inc.
CONDENSED STATEMENTS OF CASH FLOW - PARENT COMPANY ONLY
28. SUBSEQUENT EVENTS
On January 31, 2019, the Company declared a cash dividend of 6 cents per common share, payable on or after February 21, 2019, to common shareholders of record at the close of business on February 11, 2019.
WSFS Financial Corporation and Beneficial Bancorp, Inc. announced that, in connection with their proposed combination, Beneficial’s banking subsidiary, Beneficial Bank, will sell five New Jersey banking offices with approximately $193 million of deposits to another financial institution. The transaction is subject to the close of the WSFS and Beneficial combination (currently anticipated in the first quarter of 2019), the receipt of customary regulatory approvals, and satisfaction of certain closing conditions.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Name
Title
Date
/s/ Gerard P. Cuddy
President, Chief Executive Officer
and Director
(principal executive officer)
February 26, 2019
Gerard P. Cuddy
/s/ Thomas D. Cestare
Executive Vice President and Chief
Financial Officer
(principal financial and accounting officer)
February 26, 2019
Thomas D. Cestare
/s/ Frank A. Farnesi
Chairman of the Board
February 26, 2019
Frank A. Farnesi
/s/ Edward G. Boehne
Director
February 26, 2019
Edward G. Boehne
/s/ Karen Dougherty Buchholz
Director
February 26, 2019
Karen Dougherty Buchholz
/s/ Michael J. Donahue
Director
February 26, 2019
Michael J. Donahue
/s/ Donald F. Gayhardt, Jr.
Director
February 26, 2019
Donald F. Gayhardt, Jr.
/s/ Elizabeth H. Gemmill
Director
February 26, 2019
Elizabeth H. Gemmill
/s/ Thomas J. Lewis
Director
February 26, 2019
Thomas J. Lewis
/s/ Roy D. Yates
Director
February 26, 2019
Roy D. Yates