ITEM 1. BUSINESS
Northwest Bancshares, Inc.
Northwest Bancshares, Inc., a Maryland corporation, was incorporated in September 2009 to be the successor corporation to Northwest Bancorp, Inc., the former stock holding company for Northwest Bank, upon completion of the mutual-to-stock conversion of Northwest Bancorp, MHC. The terms “Northwest”, “the Company”, “we”, “us” and “our” refer to Northwest Bancshares, Inc.
The conversion was completed December 18, 2009 when the Company sold 68,878,267 shares of common stock at $10.00 per share in the related offering. Concurrent with the completion of the offering, shares of Northwest Bancorp, Inc. common stock owned by public stockholders were exchanged for shares of Northwest Bancshares, Inc.’s common stock. We also issued 1,277,565 shares of common stock and contributed $1.0 million in cash from the offering proceeds to Northwest Charitable Foundation, a charitable foundation that we established for the benefit of the communities in which Northwest Bank operates. As of December 31, 2019, the Company had 106,859,088 shares outstanding and a market capitalization of approximately $1.777 billion.
Our executive offices are located at 100 Liberty Street, Warren, Pennsylvania 16365. Our telephone number at this address is (814) 726-2140.
The Company’s website (www.northwest.com) contains a direct link to Northwest Bancshares, Inc.’s filings with the Securities and Exchange Commission, including copies of annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these filings, if any. Information on our website shall not be considered a part of this report. Copies of our filings may be obtained, without charge, by written request to Shareholder Relations, P.O. Box 128, Warren, Pennsylvania 16365.
Northwest Bank
Northwest Bank is a Pennsylvania-chartered stock savings bank headquartered in Warren, Pennsylvania, which is located in northwestern Pennsylvania. Northwest Bank is a community-oriented financial institution offering personal and business banking solutions, investment management and trust services and insurance products. Northwest Bank’s mutual savings bank predecessor was founded in 1896.
As of December 31, 2019, Northwest Bank operated 181 community-banking locations throughout its market area in central and western Pennsylvania, western New York and eastern Ohio. Northwest Bank also offers investment management and trust services and employee benefits and property and casualty insurance. Our principal lending activities are the origination of loans secured by first mortgages on owner-occupied, one-to four-family residences, shorter term consumer loans, and commercial business and commercial real estate loans.
Our principal sources of funds are personal and business deposits, borrowed funds and the principal and interest payments on loans and marketable securities. Our principal source of income is interest received on loans and marketable securities. Our principal expenses are the cost of employee compensation and benefits and the interest paid on deposits and borrowed funds.
Northwest Bank’s principal executive office is located at 100 Liberty Street, Warren, Pennsylvania 16365, and its telephone number at that address is (814) 726-2140.
Market Area and Competition
We are headquartered in northwestern Pennsylvania and have expanded primarily through acquisitions, into the southwestern and central regions of Pennsylvania, as well as western New York and northeastern Ohio. As of December 31, 2019, we operated 122 community banking locations in Pennsylvania, 22 community banking offices in Ohio and 37 community banking offices in New York. All of the aforementioned market areas are served by a number of competing financial institutions. As a result, we encounter strong competition both in attracting deposits and in originating loans. Our most direct competition for deposits comes from other banks, brokerage houses and credit unions in our market areas. We expect continued competition from these financial institutions in the foreseeable future. With the continued acceptance of internet banking by our customers and consumers generally, competition for deposits has increased from institutions operating outside of our market area as well as from insurance companies.
The following description of our market area is based upon information obtained from SNL Securities, the Bureau of Labor Statistics, The Federal Housing Financial Agency and the Mortgage Bankers Association.
Pennsylvania Market Area. Our retail branch network within the state of Pennsylvania encompasses 28 counties. Our western Pennsylvania market has a diverse economy driven by healthcare and education industries, service businesses, technology companies and small manufacturing operations. Our southeastern Pennsylvania market is primarily driven by service businesses but also serves as a bedroom community to the cities of Baltimore, Maryland and Philadelphia, Pennsylvania.
Pennsylvania is a stable banking market with a total population of approximately 12.8 million and total households of approximately 5.1 million as of December 31, 2019. The Pennsylvania markets in which we operate our retail branches contain approximately half of Pennsylvania’s population and a similar percentage of households. These markets have experienced a 2.4% decrease in population between 2010 and 2019. As of December 31, 2019, the market's average median household income had increased over the last year by 5.5%, to $57,533, compared to the national median income level of $66,010. The household income growth rate in Pennsylvania of 9.6%, is projected to be slightly below the national average growth rates during the next five years of 9.9%. As of December 31, 2019, the market's unemployment rate was 4.5%, slightly higher the state of Pennsylvania rate of 4.0% and the national average of 3.9%.
As of September 30, 2019, the House Price Index for the last four quarters in the state of Pennsylvania increased by 5.2%, compared to an increase in the national average of 4.9%. Nationally, foreclosures have receded from their record highs to the lowest levels since the fourth quarter of 2006. As of September 30, 2019, the foreclosure rate for mortgage loans on one-to-four unit residential properties in the state of Pennsylvania was one in every 874 housing units, compared to the national average of one in every 946 housing units.
Western New York Market Area. Our retail branch network of 37 community banking offices in New York encompasses five counties in the western portion of the state. This market has a diverse economy driven by healthcare and education industries, service businesses, technology companies and small manufacturing operations.
Our New York market area has a total population of approximately 2.1 million and total households of approximately 871,000 as of December 31, 2019. This area has experienced a decrease in population between 2010 and 2019, of 2.44%. The average median household income in this market increased by 4.5% over the last year to $59,785 as of December 31, 2019, compared to the national median income level of $66,010. As of December 31, 2019, the unemployment rate for our New York market area was 4.6%, compared to the national average of 3.9%.
As of September 30, 2019, the House Price Index for the last four quarters in our New York market increased by 3.4%, compared to an increase in the national average of 4.9%. As of September 30, 2019, the foreclosure rate for mortgage loans on one-to-four unit residential properties in the state of New York was one in every 945 housing units, compared to the national average of one in every 946 housing units.
Northeastern Ohio Market Area. Our branch network includes five counties in northeastern Ohio, including the Cleveland metro area. The major employment sectors in this market are similar to the contiguous market in western Pennsylvania.
Our Ohio market area has a total population of approximately 2.4 million and total households of approximately 1.0 million as of December 31, 2019. This area has experienced an increase in population between 2010 and 2019, of 2.5%. The median household income for our Ohio market increased 0.6% over the last year to $59,270 as of December 31, 2019, compared to the national median income level of $66,010. As of December 31, 2019, the unemployment rate for our Ohio market was 3.74%, compared to the national average of 3.9%.
As of September 30, 2019, the House Price Index for the last four quarters in our Ohio market area increased by 5.6%, compared to an increase in the national average of 4.9%. As of September 30, 2019, the foreclosure rate for mortgage loans on one-to-four unit residential properties in the state of Ohio was one in every 701 housing units, compared to the national average of one in every 946 housing units.
Lending Activities
General. Our principal lending activities are the origination of fixed and adjustable-rate loans collateralized by one-to four-family residential real estate, shorter term consumer loans and loans collateralized by multi-family residential and commercial real estate as well as commercial business loans. Generally, we focus our lending activities in the geographic areas where we maintain offices.
In an effort to manage interest rate risk, we have sought to make our interest-earning assets more interest rate sensitive by originating adjustable-rate loans, such as adjustable-rate residential mortgage loans and home equity lines of credit, and by originating short-term and medium-term fixed-rate consumer loans. In recent years we have emphasized the origination of commercial real estate loans and commercial business loans, which generally have adjustable-rates of interest and shorter maturities than one-to four-family residential real estate loans. Because we originate a substantial amount of long-term fixed-rate mortgage loans collateralized by one-to four-family residential real estate, when possible, we originate and underwrite loans according to standards that allow us to sell them into the secondary mortgage market for purposes of managing interest-rate risk and liquidity. The sale of mortgage loans supports our strategy to grow the consumer and commercial loan portfolios faster than our portfolio of long-term fixed-rate residential mortgage loans. We
currently sell low-yielding fixed-rate residential mortgage loans with maturities of more than 15 years, and on a more limited basis, those with maturities of 15 years or less, while retaining all adjustable-rate residential mortgage loans. With the build out of our Columbus, Ohio mortgage fulfillment center, our intention is to sell more loans into the secondary market servicing released. We also retain servicing on some of the mortgage loans we sell which generates monthly service fee income. We generally retain in our portfolio all consumer loans that we originate while we periodically sell participations in the multi-family residential, commercial real estate or commercial business loans that we originate in an effort to reduce the concentration of certain individual credits and the risk associated with certain businesses, industries or geographies.
Residential Mortgage Loans. We offer residential mortgage loans with terms typically ranging from 15 to 30 years, with either fixed or adjustable interest rates. Our mortgage loans are amortized on a monthly basis with both principal and interest due monthly. Originations of fixed-rate residential mortgage loans versus adjustable-rate residential mortgage loans are monitored on an ongoing basis. The percentage of adjustable-rate residential mortgage originations to total originations is affected significantly by the level of market interest rates, customer preference, our interest rate sensitivity and liquidity position, as well as loan products offered by our competitors. Therefore, even when our strategy is to increase the origination of adjustable-rate residential mortgage loans, market conditions may be such that there is greater demand for fixed-rate mortgage loans. Adjustable-rate residential mortgage loans totaled $34.8 million, or 0.4%, of our gross loan portfolio at December 31, 2019.
Our fixed-rate residential mortgage loan products offer fixed-rates for up to 30 years. Whenever possible, our fixed-rate residential mortgages are originated and underwritten according to secondary mortgage market guidelines in order to manage credit risk, as well as interest rate risk and liquidity risk. Our adjustable-rate residential mortgage loans offer initial interest rate adjustment periods of five and seven years, terms up to 30 years and adjustments based on changes in designated market indices.
Regulations limit the amount that a savings bank may lend relative to appraised values of real estate securing the loans, as determined by an appraisal at the time of loan origination. Such regulations permit a maximum loan-to-value of 95% for residential properties and 80% for all other real estate secured loans. We generally limit the maximum loan-to-value on both fixed- and adjustable-rate residential mortgage loans without private mortgage insurance, to 80% of the lesser of appraised values or purchase prices of real estate serving as collateral for our mortgage loans. Limited special financing programs allow for insured loans with loan-to-value ratios of up to 97%, and uninsured loans with loan-to-value ratios up to 100%. The appraisal process is managed by Northwest Appraisal Services, and appraisals are performed by in-house appraiser staff or by appraisers deemed qualified by our chief appraiser. We require fire and casualty insurance, as well as a title guaranty regarding good title, on all properties securing our residential mortgage loans. We also require flood insurance for loans secured by properties located within special flood hazard areas.
Included in our $2.860 billion portfolio of residential mortgage loans are construction loans of $12.9 million, or 0.1% of our gross loan portfolio. We offer fixed-rate and adjustable-rate residential construction-to-permanent loans primarily for the construction of owner-occupied one-to four-family residences in our market area to builders or owners who have a contract for construction. Construction loans are originated with terms of up to 30 years with an allowance of up to one year for construction. Advances are made as construction is completed, and interest is charged on the total amount of credit extended. At the end of the construction period, repayment terms convert to fully amortizing payments, with both principal and interest due monthly. Construction lending generally involves a greater degree of credit risk than permanent residential mortgage lending, as repayment of construction loans is often dependent upon the successful completion of construction projects. Construction delays or the inability of borrowers to sell properties once construction is completed may impair borrowers’ ability to repay loans. Private mortgage insurance is required for construction loans with loan-to-value ratios in excess of 80%, and the maximum loan-to-value ratio for construction loans is 95% of the lower of cost to build or as-completed appraised value.
In addition, we originate loans within our market area that are secured by individual unimproved or improved lots. Land loans for the construction of owner-occupied residential real estate properties are currently offered with fixed-rates for terms of up to ten years. The maximum loan-to-value ratio for these loans is 80% of the as-completed appraised value.
Our residential mortgage loans customarily include due-on-sale clauses, which are provisions giving us the right to declare loans immediately due and payable in the event, among other things, borrowers sell or otherwise dispose of underlying real properties serving as collateral for loans.
Home Equity Loans. Generally, our home equity loans are secured by the borrower’s principal residence with a maximum loan-to-value ratio, including the principal balances of both the first and second mortgage loans, of 90% or less. We generally underwrite home equity loans and lines of credit in a manner similar to our underwriting of residential mortgage loans.
Home equity loans are offered on a fixed-rate basis with amortized terms of up to 20 years. Principal and interest is due monthly. At December 31, 2019, our fixed-rate home equity loans totaled $839.2 million, or 9.5% of gross loans.
Home equity lines of credit are offered on an adjustable-rate basis with terms of up to 25 years, including a draw period of 10 years each. Although home equity lines of credit require interest-only payments during draw periods, they are underwritten using amortizing principal and interest payments based on current rates of equivalent fixed-rate products. The disbursed portion of home equity lines of credit totaled $503.7 million, or 5.7% of gross loans, with $687.3 million remaining undisbursed as of December 31, 2019.
Other Consumer Loans. The principal types of other consumer loans we offer are direct and indirect automobile loans, sales finance loans, unsecured personal loans, credit card loans, and loans secured by deposit accounts. These loans are typically offered with maturities of ten years or less.
The underwriting standards we employ for consumer loans include a determination of the applicant’s credit history and an assessment of ability to meet existing obligations and payments on the proposed loan. The stability of the applicant’s monthly income may be determined by verification of gross monthly income from primary employment, and additionally, from any verifiable secondary income. Creditworthiness of the applicant is of primary consideration; however, the underwriting process also includes a comparison of the value of the collateral in relation to the proposed loan amount.
Consumer loans entail greater credit risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly, such as automobiles, mobile homes, boats, recreation vehicles, appliances and furniture. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In particular, amounts realizable on the sale of repossessed automobiles may be significantly reduced based upon the condition of the automobiles and the lack of demand for used automobiles. At December 31, 2019, other consumer loans totaled $1.093 billion, or 12.4% of gross loans.
Commercial Real Estate Loans. Our multi-family commercial real estate loans are secured by multi-family residences, such as rental properties. Our commercial real estate loans are secured by nonresidential properties such as hotels, commercial offices, medical buildings, manufacturing facilities and retail establishments. At December 31, 2019, a significant portion of our multi-family commercial real estate and commercial real estate loans were secured by properties located within our market area. Our largest multi-family commercial real estate loan relationship at December 31, 2019 had an aggregate total exposure of $25.9 million. This loan was performing in accordance with its terms as of December 31, 2019. Our largest commercial real estate loan relationship at December 31, 2019 had an aggregate total exposure of $117.9 million and was secured by ten commercial real estate properties including student housing, retail, office and commercial development. These loans were performing in accordance with their terms as of December 31, 2019. Multi-family commercial and commercial real estate loans are offered with both adjustable and fixed interest rates. The terms of each multi-family residential and commercial real estate loan are negotiated on a case-by-case basis. We generally originate multi-family commercial and commercial real estate loans in amounts up to 80% of the appraised value of the property collateralizing the loan. At December 31, 2019, commercial real estate loans loans totaled $2.754 billion, or 31.3% of gross loans.
Loans secured by multi-family commercial and commercial real estate generally involve a greater degree of credit risk than residential mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties, and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family commercial and commercial real estate is typically dependent upon the successful operation of the related real estate property. If the cash flow from the project is reduced, the borrower’s ability to repay the loan may be impaired.
Commercial Loans. We offer commercial loans to finance various activities in our market area, some of which are secured in part by additional real estate collateral. At December 31, 2019, our largest commercial loan relationship had an aggregate total exposure of $34.7 million, and was secured with business assets. This loan was performing in accordance with its terms as of December 31, 2019.
Commercial business loans are offered with both fixed and adjustable interest rates. Underwriting standards we employ for commercial business loans include a determination of the applicant’s ability to meet existing obligations and payments on the proposed loan from operating cash flows generated by the applicant’s business. The financial strength of each applicant is also assessed through a review of financial statements provided by the applicant.
We originate commercial loans through our network of Small Business and Commercial Loan Officers located in our areas. In addition, our Commercial Finance group originates loans where multiple banks may be involved in the credit facilities. These loans are made to companies operating in our market area. Many of these companies carry public debt ratings.
Commercial loans generally have higher interest rates than residential loans, but they also may involve a higher risk of default since their repayment is generally dependent on the successful operation of the borrower’s business. We strive to obtain personal guarantees from the borrower or a third party as a condition to originating commercial loans. At December 31, 2019, commercial loans loans totaled $718.1 million, or 8.2% of gross loans.
Loan Originations, Solicitation, Processing and Commitments. Upon receiving a retail loan application, we obtain a credit report and employment verification to verify specific information relating to the applicant’s employment, income, and credit standing. In the case of a real estate loan, either an in-house appraiser, or an approved external appraiser, appraises the real estate intended to secure the proposed loan. A loan processor checks the loan document file for accuracy and completeness, and verifies the information provided.
For our personal loans, including residential mortgage loans, home equity loans and lines of credit, automobile loans, credit cards and other unsecured loans, we have implemented a credit approval process based on a laddered individual loan authority system. Real estate secured loans are underwritten centrally by our underwriting team. Non-real estate loans are underwritten by local loan officers who are granted various levels of authority based on their lending experience and expertise. These authority levels are reviewed by the Credit Committee on at least an annual basis.
Aggregate credit exposures over $750,000 are underwritten by Credit Administration. Our commercial loan policy assigns individual lending limits for our various commercial loan officers and dual authority consisting of an individual from Commercial Lending and Credit Administration. Lending authorities are established by the Credit Committee. The Senior Loan Committee may approve extensions of credit in excess of the maximum dual authority. The Credit Committee meets quarterly to review the assigned lending limits and to monitor our lending policies, loan activity, economic conditions and concentrations of credit.
Our general policy is to make no loans either individually or in the aggregate to one customer in excess of $30.0 million. Under certain circumstances, for instance well-qualified customers or customers with multiple individually qualified projects, this limit may be exceeded subject to the approval of the Senior Loan Committee. Loans exceeding $5.0 million or unusual loan requests are reviewed with the Risk Management Committee of the Board of Directors at each quarterly meeting. In addition, the Chief Credit Officer has the authority to require that the Board of Directors review any loan that has been approved by the Senior Loan Committee with which the Chief Credit Officer has specific concerns. Fire and casualty insurance is required at the time the loan is made and throughout the term of the loan, and flood insurance is required as determined by regulation. After a loan is approved, a loan commitment letter is promptly issued to the borrower. At December 31, 2019, we had commitments to originate $234.1 million of loans.
The commitment letter specifies the terms and conditions of the proposed loan including the amount, interest rate, amortization period, maturity, a description of the required collateral and required insurance coverage. Property searches are requested, as needed, on all loans secured by real property.
Loan Origination Fees and Cost. We defer loan origination fees received from borrowers and costs to originate loans and amortize such amounts as an adjustment of yield over the life of the loan by using the level yield method. Deferred loan fees and costs are recognized as part of interest income immediately upon prepayment or the sale of the related loan. At December 31, 2019, we had $41.7 million of net deferred loan origination fees. Loan origination fees vary with the volume and type of loans and commitments originated and purchased, principal repayments, and competitive conditions in the marketplace.
Loan origination cost was $15.5 million, $11.2 million and $11.6 million for the years ended December 31, 2019, 2018 and 2017, respectively.
Loans-to-One Borrower. As of December 31, 2019, the largest aggregate amount loaned to one borrower, or related borrowers, totaled $117.9 million in exposure and was secured by student housing, retail, office and commercial development. Our second largest lending relationship totaled $90.5 million in exposure and was secured by hotel, retail, office, multi-family, charter school, self-storage, and restaurant. Our third largest lending relationship totaled $81.8 million in exposure and was secured by student housing, medical, senior housing, office, industrial, and retail. Our fourth largest commercial relationship totaled $72.0 million in exposure and was secured by student housing. Our fifth largest commercial relationship totaled $51.2 million in exposure and was secured by hotel and office. All of these loans were performing in accordance with their terms at December 31, 2019.
Investment Activities
Our Board of Directors has primary responsibility for establishing and overseeing our investment policy. The Board of Directors has delegated authority to implement the investment policy to our Chief Financial Officer. The investment policy is reviewed at least annually, and any changes to the policy are subject to approval by the Board of Directors. The overall objectives of the investment policy are to maintain a portfolio of high quality and diversified investments, to provide liquidity, and to control interest rate risk while providing an acceptable return. The investment portfolio is also used to provide collateral for qualified deposits and borrowings, to provide additional earnings when loan production is low, and to reduce our tax liability. The policy dictates that investment decisions give consideration to the safety of principal, liquidity requirements and potential returns. All purchase and sale transactions are reported to the Board of Directors on a monthly basis.
Our investment policy does not permit the purchase of complex securities and derivatives as defined in federal banking regulations and other high-risk securities, nor does it permit additional investments in non-agency mortgage-backed securities, pooled trust preferred securities, or single issuer trust preferred securities.
At the time of purchase, we designate a security as either held-to-maturity or available-for-sale based upon our ability and intentions. Securities available-for-sale are carried at fair value and securities held-to-maturity are carried at amortized cost. A periodic review and evaluation of the available-for-sale and held-to-maturity securities portfolios is conducted to determine if the fair value of any security has declined below its carrying value and whether such decline is other-than-temporary. If impairment exists, credit related impairment losses are recorded in earnings while noncredit related impairment losses are recorded in accumulated other comprehensive income (for available-for-sale securities). The fair values of our securities are based on published or securities dealers’ market values, when available. See note 5 to the Consolidated Financial Statements for a detailed analysis and description of our investment portfolio and valuation techniques.
We purchase debentures and mortgage-backed securities that generally are issued by the Federal Home Loan Bank ("FHLB"), Fannie Mae ("FNMA"), Freddie Mac ("FHLMC") or Ginnie Mae ("GNMA"). Historically, we have invested in mortgage-backed securities to achieve positive interest rate spreads with minimal administrative expense and to lower our credit risk as a result of the guarantees provided by FHLMC, FNMA or GNMA.
Sources of Funds
General. Deposits are the primary funding source for lending and other investing purposes. In addition to deposits, we derive funds from the amortization, prepayment and sale of loans and mortgage-backed securities, the maturity of investment securities, operations and, if needed, borrowings. Scheduled loan principal repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments and sales are influenced significantly by general interest rates and market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds from other sources or on a longer term basis for general business purposes, including to manage interest rate risk.
Deposits. Personal and business deposits are generated from our market area by offering a broad selection of deposit instruments including checking accounts, savings accounts, money market deposit accounts, term certificate accounts and individual retirement accounts. While we accept deposits of $250,000 or more, we do not offer premium rates for such deposits. We accept brokered deposits through the CDARS program, but generally do not solicit funds outside our market area. As of December 31, 2019, we had deposits through the CDARS program with an aggregate balance of $4.1 million. Deposit account terms vary according to the minimum balance required, the period of time during which the funds must remain on deposit, and the interest rate, among other factors. We regularly execute changes in our deposit rates based upon general market interest rates, competition, and liquidity requirements.
Borrowings. We may utilize borrowings to supplement our supply of lendable funds and to meet deposit withdrawal requirements. Borrowings from the Federal Home Loan Bank of Pittsburgh typically are collateralized by a portion of our real estate loans. In addition to the Federal Home Loan Bank of Pittsburgh, we have borrowing facilities with the Federal Reserve Bank, two correspondent banks and we borrow funds, in the form of corporate repurchase agreements, from municipalities, corporations and school districts.
The Federal Home Loan Bank of Pittsburgh functions as a central bank providing credit for Northwest Bank and other member financial institutions. As a member, Northwest Bank is required to own capital stock in the Federal Home Loan Bank of Pittsburgh and is authorized to apply for borrowings on the security of certain of its real estate loans, provided certain standards related to creditworthiness have been met. Borrowings are made pursuant to several different programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of borrowings are based either on a fixed percentage of a member institution’s net worth or on the Federal Home Loan Bank of Pittsburgh’s assessment of the institution’s creditworthiness.
Subsidiary Activities
Northwest Bancshares, Inc.’s sole direct consolidated subsidiary is Northwest Bank. Northwest Bancshares, Inc. also owns all of the common stock of five statutory business trusts: Northwest Bancorp Capital Trust III, a Delaware statutory business trust, Northwest Bancorp Statutory Trust IV, a Connecticut statutory business trust, LNB Trust II, a Delaware statutory business trust, Union National Capital Trust I and Union National Capital Trust II, both Delaware statutory business trusts (the “Trusts”). At December 31, 2019, the Trusts have issued a total of $118.9 million of trust preferred securities. The Trusts are not consolidated with Northwest Bancshares, Inc. At December 31, 2019, Northwest Bancshares, Inc.’s investment in the Trusts totaled $3.7 million, and the Trusts had assets of $121.8 million, net of discounts due to fair value adjustments made at the time of acquisition of Union Community Bank.
At December 31, 2019, Northwest Bank had four active wholly-owned subsidiaries; Great Northwest Corporation, Allegheny Services, Inc., Northwest Capital Group, Inc. and The Bert Company. For financial reporting purposes all of these companies are included in the Consolidated Financial Statements of Northwest Bancshares, Inc.
Great Northwest Corporation holds equity investments in government-assisted, low-income housing projects in various locations throughout our market area. At December 31, 2019, Northwest Bank had an equity investment in Great Northwest Corporation of $12.7 million. For the year ended December 31, 2019, Great Northwest Corporation had net income of $753,000, generated primarily from federal low-income housing tax credits.
Allegheny Services, Inc. is a Delaware investment company that holds mortgage loans originated through our wholesale lending operation as well as municipal bonds. At December 31, 2019, Northwest Bank had an equity investment in Allegheny Services, Inc. of $841.4 million, and for the year ended December 31, 2019, Allegheny Services, Inc. had net income of $22.4 million.
Northwest Capital Group, Inc.’s principal activity is to own, operate and ultimately divest of properties that were acquired in foreclosure. At December 31, 2019, Northwest Bank had an equity investment of $11.7 million in Northwest Capital Group, Inc., with a $20,000 net loss reported for the year ended December 31, 2019.
The Bert Company (doing business as Northwest Insurance Services) is an employee benefits and property and casualty insurance agency specializing in commercial and personal insurance as well as retirement benefit plans. At December 31, 2019, Northwest Bank had an equity investment of $12.1 million in The Bert Company and for the year ended December 31, 2019, The Bert Company had net income of $783,000.
Northwest Bank strategically ceased operating several business lines in prior periods.
Northwest Advisors, Inc., a federally registered investment advisor, which provided investment management programs and investment portfolio planning services, ceased operations and became inactive during 2018. At December 31, 2019, Northwest Bank had an equity investment in Northwest Advisors, Inc. of $1.7 million.
Northwest Settlement Agency, LLC ceased writing new title insurance business during the fourth quarter of 2016 and ceased operations and became inactive during 2017. At December 31, 2019, Northwest Bank had an equity investment in Northwest Settlement Agency, LLC of $3.9 million.
On July 14, 2017, Northwest Consumer Discount Company, Inc. became inactive as all consumer finance offices were closed. At December 31, 2019, Northwest Bank had an equity investment in Northwest Consumer Discount Company of $44.3 million.
Federal regulations require insured institutions to provide 30 days advance notice to the Federal Deposit Insurance Corporation (“FDIC”) before establishing or acquiring a subsidiary or conducting a new activity in a subsidiary. The insured institution must also provide the FDIC such information as may be required by applicable regulations and must conduct the activity in accordance with the rules and orders of the FDIC. In addition to other enforcement and supervision powers, the FDIC may determine after notice and opportunity for a hearing that the continuation of a savings bank’s ownership of or relation to a subsidiary constitutes a serious risk to the safety, soundness or stability of the savings bank, or is inconsistent with the purposes of federal banking laws. Upon the making of such a determination, the FDIC may order the savings bank to divest the subsidiary or take other actions.
Personnel
As of December 31, 2019, we had 2,084 full-time and 249 part-time employees. None of our employees are represented by a collective bargaining group. We believe we have a good working relationship with our employees.
SUPERVISION AND REGULATION
General
As a savings and loan holding company, we are required to comply with the rules and regulations of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”), and are also required to file certain reports with and are subject to examination by the Federal Reserve Board. We are also subject to the rules and regulations of the Securities and Exchange Commission under the federal securities laws.
Northwest Bank is a Pennsylvania-chartered stock savings bank and our deposit accounts are insured up to applicable limits by the FDIC’s Deposit Insurance Fund (the "DIF"). Northwest Bank is subject to extensive regulation by the Department of Banking and Securities of the Commonwealth of Pennsylvania (the “Department of Banking”), as its chartering agency, and by the FDIC, as the insurer
of its deposit accounts. Northwest Bank must file reports with the Department of Banking and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions including acquisitions of other financial institutions. Northwest Bank is examined periodically by the Department of Banking and the FDIC to test Northwest Bank’s compliance with various laws and regulations. This regulation and supervision, as well as federal and state law, establishes a comprehensive framework of activities in which Northwest Bank may engage and is intended primarily for the protection of the DIF and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and with their 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 these laws or regulations, whether by the Department of Banking or the FDIC, could have a material adverse impact on the Company, Northwest Bank and their respective operations. Additionally, when the consolidated assets of a financial institution and its holding company exceed $10 billion, the financial institution becomes subject to additional statutory and regulatory requirements that will result in additional costs. This includes enhanced risk management and corporate governance processes, stress-testing based on scenarios specified by the federal regulatory agencies and examination for compliance with federal financial consumer protection laws by the Consumer Financial Protection Bureau rather than the FDIC. As of December 31, 2019, our consolidated assets were $10.494 billion.
Set forth below is a brief description of certain regulatory requirements that are applicable to Northwest Bank and Northwest Bancshares, Inc. The description below is limited to certain material aspects of the statutes and regulations addressed, and is not intended to be a complete description of such statutes and regulations and their effects on Northwest Bank and Northwest Bancshares, Inc.
Pennsylvania Savings Bank Law
The Pennsylvania Banking Code of 1965, as amended (the “Banking Code”) contains detailed provisions governing the organization, operations, corporate powers, savings and investment authority, branching rights and responsibilities of directors, officers and employees of Pennsylvania savings banks. A Pennsylvania savings bank may locate or change the location of its principal place of business and establish an office anywhere in, or adjacent to, Pennsylvania, with the prior approval of the Department of Banking. The Banking Code delegates extensive rulemaking power and administrative discretion to the Department of Banking in its supervision and regulation of state-chartered savings banks.
Although the Department of Banking may accept the examinations and reports of the FDIC in lieu of its own examination, the current practice is for the Department of Banking to conduct joint examinations with the FDIC. The Department of Banking may order any savings bank to discontinue any violation of law or unsafe or unsound business practice and may direct any director, officer, or employee of a savings bank engaged in a violation of law, unsafe or unsound practice or breach of fiduciary duty to show cause at a hearing before the Department of Banking why such person should not be removed. Legislation enacted in 2012 clarified the Department of Banking’s examination and enforcement authority over subsidiaries of Pennsylvania institutions and authorized the assessment of civil money penalties of up to $25,000 under certain circumstances for violations of laws or orders related to the institution or unsafe or unsound practices or breaches of fiduciary duties. The Department of Banking may also appoint a receiver or conservator for an institution in appropriate cases.
Federal Deposit Insurance
The FDIC currently maintains the Deposit Insurance Fund ("DIF"), which was created in 2006 through the merger of the Bank Insurance Fund and the Savings Association Insurance Fund. The deposit accounts of our subsidiary bank are insured by the DIF to the maximum amount provided by law. This insurance is backed by the full faith and credit of the United States Government.
As insurer, the FDIC is authorized to conduct examinations of and to require reporting by DIF-insured institutions. It also may prohibit any DIF-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the DIF. The FDIC also has the authority to take enforcement actions against insured institutions.
The FDIC charges insured depository institutions premiums to maintain the DIF. Under the FDIC’s original risk-based assessment system, insured institutions were assigned a risk category based on supervisory evaluations, regulatory capital levels and certain other factors. An institution’s rate depended upon the category to which it is assigned, and certain adjustments specified by FDIC regulations. Institutions deemed less risky pay lower FDIC assessments.
Assessments for most institutions are now based on financial measures and supervisory ratings derived from statistical modeling estimating the probability of failure within three years. In conjunction with the DIF reserve ratio achieving 1.15%, the assessment range was reduced for most banks and savings associations of less than $10 billion in total assets to 1.5 basis points from 30 basis points (inclusive of possible adjustments), effective July 1, 2016. The Dodd-Frank Act specified that banks with greater than $10 billion in assets be required to bear the burden of raising the reserve ratio from 1.15% to 1.35%. Such institutions were subject to an annual surcharge of 4.5 basis points of total assets exceeding $10 billion. The FDIC indicated that the 1.35% ratio was exceeded in November 2018. The
Dodd-Frank Act eliminated the 1.5% maximum fund ratio, instead leaving it to the discretion of the FDIC, and the FDIC has exercised that discretion by establishing a long-range fund ratio of 2%.
Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged or is engaging in unsafe and 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 written agreement entered into with the FDIC. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
Capital Requirements
Federal regulations require federally insured depository institutions to meet several minimum capital standards: a common equity Tier 1 capital to risk-based assets ratio of 4.5%, a Tier 1 capital to risk-based assets ratio of 6.0%, a total capital to risk-based assets of 8.0%, and a 4.0% Tier 1 capital to total assets leverage ratio.
In determining the amount of risk-weighted assets for purposes of calculating risk-based capital ratios, all assets, including certain off-balance sheet assets (e.g., recourse obligations, direct credit substitutes, residual interests) are multiplied by a risk weight factor assigned by the regulations based on the risks believed inherent in the type of asset. Higher levels of capital are required for asset categories believed to present greater risk. Common equity Tier 1 capital is generally defined as common stockholders’ equity and retained earnings. Tier 1 capital is generally defined as common equity Tier 1 and additional Tier 1 capital. Additional Tier 1 capital includes certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries. Total capital includes Tier 1 capital (common equity Tier 1 capital plus additional Tier 1 capital) and Tier 2 capital. Tier 2 capital is comprised of capital instruments and related surplus, meeting specified requirements, and may include cumulative preferred stock and long-term perpetual preferred stock, mandatory convertible securities, intermediate preferred stock and subordinated debt. Also included in Tier 2 capital is the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and, for institutions that have exercised an opt-out election regarding the treatment of Accumulated Other Comprehensive Income, up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations. In assessing an institution’s capital adequacy, the FDIC takes into consideration not only these numeric factors but qualitative factors as well, and has the authority to establish higher capital requirements for individual institutions where deemed necessary.
Any institution that fails any of the regulatory capital requirements is subject to enforcement action by the FDIC. Such action may include a capital directive, a cease and desist order, civil money penalties, restrictions on an institution’s operations, termination of federal deposit insurance, and the appointment of a conservator or receiver. Such action, through enforcement proceedings or otherwise, may require a variety of corrective measures. The regulations limit capital distributions and certain discretionary bonus payments to management if the institution does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets above the amount necessary to meet its minimum risk-based capital requirements. The capital conservation buffer requirement was phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and increased each year until fully implemented at 2.5% on January 1, 2019.
The following table shows the Basel III regulatory capital levels that must be maintained to avoid limitations on capital distributions and discretionary bonus payments, effective January 1, 2020.
Northwest Bank is also subject to capital guidelines of the Department of Banking. Although not adopted in regulation form, the Department of Banking requires 6% leverage capital and 10% risk-based capital. The components of leverage and risk-based capital are substantially the same as those defined by the FDIC.
Prompt Corrective Action
Federal law requires, among other things, that federal bank regulators take “prompt corrective action” with respect to institutions that do not meet minimum capital requirements. For this purpose, the law establishes five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Under applicable regulations, an institution is deemed to be “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, a leverage ratio of 5.0% or greater and a common equity Tier 1 ratio of 6.5% or greater. An institution is “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, a leverage ratio of 4.0% or greater and a common equity Tier 1 ratio of 4.5% or greater. An institution is “undercapitalized” if it has a total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based capital ratio of less than 6.0%, a leverage ratio of less than 4.0% or a common equity Tier 1 ratio of less than 4.5%. An institution is deemed to be “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 4.0%, a leverage ratio of less than 3.0% or a common equity Tier 1 ratio of less than 3.0%. 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 2.0%. Institutions that fall into an “undercapitalized” category are subject to a variety of mandatory and discretionary supervisory actions, including a restriction on capital distributions and the requirement to file a capital restoration plan with the regulators. Performance under the capital restoration plan must be guaranteed by the parent holding company up to the lesser of the amount of the capital deficiency when deemed undercapitalized or 5% of the institution’s total assets. Federal regulations also specify circumstances under which a federal banking agency may reclassify a well capitalized institution as adequately capitalized, and may require an adequately capitalized institution to comply with supervisory actions as if it were in the next lower category (except that the Federal Deposit Insurance Corporation may not reclassify a significantly undercapitalized institution as critically undercapitalized). As of December 31, 2019, Northwest Bank was well-capitalized for this purpose.
Loans-to-One Borrower Limitation
In accordance with the Banking Code, a Pennsylvania chartered savings bank, with certain limited exceptions, may lend to a single or related group of borrowers on an “unsecured” basis an amount equal to 15% of its capital accounts, the aggregate of capital, surplus, undivided profits, capital securities and reserve for loan losses. The Credit Committee has established an internal lending limit, either individually or in the aggregate to one customer, of $20.0 million. Under certain circumstances, for instance well qualified customers or customers with multiple individually qualified projects, this limit may be exceeded subject to the approval of the Senior Loan Committee. As of December 31, 2019 we had no credit relationships that equal or exceed our $20.0 million internal limit.
Activities and Investments of Insured State-Chartered Banks
Federal law generally limits the activities and equity investments of state-chartered banks insured by the FDIC to those that are permissible for national banks. Under regulations dealing with equity investments, an insured state bank generally may not, directly or indirectly, acquire or retain any equity investment of a type, or in an amount, that is not permissible for a national bank. An insured state bank is not prohibited from, among other things: (i) acquiring or retaining a majority interest in a subsidiary; (ii) investing as a limited partner in a partnership the sole purpose of which is direct or indirect investment in the acquisition, rehabilitation, or new construction of a qualified housing project, provided that such limited partnership investments may not exceed 2% of the bank’s total assets; (iii) acquiring up to 10% of the voting stock of a company that solely provides or reinsures liability insurance for directors, trustees or officers, or blanket bond group insurance coverage for insured depository institutions; and (iv) acquiring or retaining the voting shares of a depository institution if certain requirements are met. Activities of state banks and their subsidiaries are generally limited to those permissible for national banks. Exceptions include where the bank meets applicable regulatory capital requirements and the FDIC determines that the proposed activity does not pose a significant risk to the deposit insurance fund.
The USA PATRIOT Act
The USA Patriot Act gives the federal government powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. The USA Patriot Act also requires the federal banking agencies to take into consideration the effectiveness of controls designed to combat money-laundering activities in determining whether to approve a merger or other acquisition application of a member institution. Accordingly, if we engage in a merger or other acquisition, our controls designed to combat money laundering would be considered as part of the application process. We have established policies, procedures and systems designed to comply with these regulations.
Holding Company Regulation
General. Federal law allows a state savings bank, such as Northwest Bank, to elect to be treated as a savings association for purposes of the savings and loan company provisions of the Home Owners’ Loan Act of 1933, as amended, provided that it qualifies as a “Qualified Thrift Lender.” Such election results in its holding company being regulated as a savings and loan holding company by the Federal Reserve Board rather than as a bank holding company. Northwest Bank has made such an election. Therefore, Northwest
Bancshares, Inc. is a savings and loan holding company within the meaning of the Home Owners’ Loan Act of 1933, as amended. As such, we are registered as a savings and loan holding company with the Federal Reserve Board and are subject to Federal Reserve Board regulations, examinations, supervision and reporting requirements. In addition, the Federal Reserve Board has enforcement authority over the Company and any non-savings institution subsidiaries of the Company. Among other things, this authority permits the Federal Reserve Board to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution.
Permissible Activities. The business activities of Northwest Bancshares, Inc. are generally limited to those activities permissible for financial holding companies under Section 4(k) of the Bank Holding Company Act of 1956, as amended, or for multiple savings and loan holding companies. A financial holding company may engage in activities that are financial in nature, including underwriting equity securities and insurance as well as activities that are incidental to financial activities or complementary to financial activities. The Dodd-Frank Act and Federal Reserve Board regulations specify that a savings and loan holding company may only engage in financial holding company activities if it meets the qualitative criteria necessary for a bank holding company to engage in such activities and files an election with the Federal Reserve Board. Northwest Bancshares, Inc. has not chosen to be regulated as a financial holding company as of this time. A multiple savings and loan holding company is generally limited to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the Federal Reserve Board, and certain additional activities authorized by Federal Reserve Board regulations.
Federal law prohibits a savings and loan holding company, including Northwest Bancshares, Inc., directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of another savings institution or holding company thereof, without prior written approval of the Federal Reserve Board. It also prohibits, with certain exceptions, the acquisition or retention of more than 5% of a non-subsidiary company engaged in activities that are not closely related to banking or financial in nature, or acquiring or retaining control of an institution that is not federally insured. In evaluating applications by holding companies to acquire savings institutions, the Federal Reserve Board must consider, among other factors, the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the federal deposit insurance fund, the convenience and needs of the community and competitive factors.
The Federal Reserve Board is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions:
(i)
the approval of interstate supervisory acquisitions by savings and loan holding companies; and
(ii)
the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisition.
The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
Qualified Thrift Lender Test. To be regulated as a savings and loan holding company (rather than as a bank holding company), Northwest Bank must qualify as a Qualified Thrift Lender. To qualify as a Qualified Thrift Lender, Northwest Bank must be a “domestic building and loan association,” as defined in the Internal Revenue Code, or comply with the Qualified Thrift Lender test. Under the Qualified Thrift Lender test, a savings institution is required to maintain at least 65% of its “portfolio assets” (total assets less: (1) specified liquid assets up to 20% of total assets; (2) intangibles, including goodwill; and (3) the value of property used to conduct business) in certain “qualified thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed and related securities) in at least nine months out of each 12-month period. As of December 31, 2019, Northwest Bank met the Qualified Thrift Lender test.
Capital Requirements. Savings and loan holding companies had not historically been subjected to consolidated regulatory capital requirements. However, the Dodd-Frank Act required the Federal Reserve Board to establish, for all depository institution holding companies, minimum consolidated capital levels that are as stringent as those required for the insured depository subsidiaries. Consolidated regulatory capital requirements identical to those applicable to the subsidiary depository institutions apply to savings and loan holding companies (of greater than $3 billion in consolidated assets). As is the case with institutions themselves, the capital conservation buffer was phased in between 2016 and 2019. Northwest Bancshares, Inc. was in compliance with the holding company capital requirements and the capital conservation buffer at December 31, 2019.
Source of Strength/Capital Distributions. The Dodd-Frank Act extended to savings and loan holding companies the Federal Reserve Board’s “source of strength” doctrine, which has long applied to bank holding companies. The Federal Reserve Board has promulgated regulations implementing the “source of strength” policy, which requires holding companies to act as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress.
The Federal Reserve Board has issued a policy statement regarding capital distributions by bank holding companies that it has made applicable to savings and loan holding companies as well. In general, the policy provides that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s
capital needs, asset quality and overall financial condition. The ability of a holding company to pay dividends may be restricted if a subsidiary depository institution becomes undercapitalized. Regulatory guidance provides for prior regulatory consultation with respect to dividends in certain circumstances, such as where the company’s net income for the past four quarters, net of dividends previously paid over that period, is insufficient to fully fund the dividend or the company’s overall rate of earnings retention is inconsistent with the company’s capital needs and overall financial condition. The guidance similarly provides for regulatory review of stock repurchases or redemptions under certain circumstances. These regulatory policies could affect our ability to pay dividends or otherwise engage in capital distributions, including stock repurchases.
As a subsidiary of a savings and loan holding company, Northwest Bank must notify the Federal Reserve Board thirty days before declaring any dividend to the Company. The dividend notice may be objected to under certain circumstances, such as where the dividend raises safety or soundness concerns, the dividend would cause the savings bank to be undercapitalized or the dividend would violate a law, regulation, regulatory condition or enforcement order.
Federal Securities Laws
Our common stock is registered with the SEC under Section 12(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We are also subject to the proxy rules, tender offer rules, insider trading restrictions, annual and periodic reporting, and other requirements of the Exchange Act.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 was enacted to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies, and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally applies to all companies that file or are required to file periodic reports with the Securities and Exchange Commission, under the Securities Exchange Act of 1934.
As directed by the Sarbanes-Oxley Act, our Chief Executive Officer and Chief Financial Officer are required to certify that our quarterly and annual reports do not contain any untrue statement of a material fact. The rules adopted by the Securities and Exchange Commission under the Sarbanes-Oxley Act have several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of our internal control over financial reporting; they have made certain disclosures to our auditors and the audit committee of the board of directors about our internal control over financial reporting; and they have included information in our quarterly and annual reports about their evaluation and whether there have been changes in our internal control over financial reporting or in other factors that could materially affect internal control over financial reporting.
FEDERAL AND STATE TAXATION
Federal Taxation. For federal income tax purposes, Northwest Bancshares, Inc. files a consolidated federal income tax return with its wholly-owned subsidiaries on a calendar year basis. The applicable federal income tax expense or benefit is properly allocated to each subsidiary based upon taxable income or loss calculated on a separate company basis.
We account for income taxes using the asset and liability method which accounts for deferred income taxes by applying the enacted statutory rates in effect at the balance sheet date to differences between the book basis and the tax basis of assets and liabilities. The resulting deferred tax liabilities and assets are adjusted to reflect changes in tax laws.
On December 22, 2017, H.R.1, commonly known as the Tax Cuts and Jobs Act (the “Act”), was signed into law. The Act includes many provisions that will affect our income tax expense, including reducing our federal tax rate from 35.0% to 21.0% effective January 1, 2018. As a result of the rate reduction, we were required to re-measure, through income tax expense in the period of enactment, our deferred tax assets and liabilities using the enacted rate at which we expect them to be recovered or settled. The re-measurement of our net deferred tax liability resulted in a 2017 income tax benefit of $3.1 million.
State Taxation. As a Maryland business corporation, Northwest Bancshares, Inc. is required to file annual tax returns with the State of Maryland. In addition, Northwest Bancshares, Inc. is subject to Pennsylvania’s corporate net income tax. Dividends received from Northwest Bank qualify for a 100% dividends received deduction and are not subject to corporate net income tax.
Northwest Bank is subject to Pennsylvania’s mutual thrift institutions tax based on Northwest Bank’s net income determined in accordance with generally accepted accounting principles, with certain adjustments. The tax rate under the mutual thrift institutions tax is 11.5%. Interest on Pennsylvania and federal obligations is excluded from net income. An allocable portion of interest expense incurred to carry the tax-free obligations is disallowed as a deduction. Northwest Bank is also subject to taxes in the other states in which it conducts business. These taxes are apportioned based upon the volume of business conducted in those states as a percentage of the whole. Because a majority of Northwest Bank’s affairs are conducted in Pennsylvania, taxes paid to other states are not material.
The subsidiaries of Northwest Bank are subject to a Pennsylvania corporate net income tax and are also subject to other applicable taxes in the states where they conduct business.
ITEM 1A.
ITEM 1A. RISK FACTORS
In addition to factors discussed in the description of our business and elsewhere in this report, the following are factors that could adversely affect our future results of operations and financial condition.
A worsening of economic conditions in our market area could reduce demand for our products and services and/or result in increases in our level of non-performing loans, which could adversely affect our operations, financial condition and earnings.
Our performance is significantly impacted by the general economic conditions in our primary markets in Pennsylvania, New York and Ohio. At December 31, 2019, 49.6% of our loan portfolio was secured by properties located in Pennsylvania, with a large portion of the rest of our loans secured by real estate located in New York and Ohio. Local economic conditions have a significant impact on the ability of our borrowers to repay loans and the value of the collateral securing loans.
A deterioration in economic conditions could result in the following consequences, any of which could have a material adverse affect on our business, financial condition, liquidity and results of operations:
•
demand for our products and services may decline;
•
loan delinquencies, problem assets and foreclosures may increase;
•
collateral for loans, especially real estate, may decline in value, in turn reducing customers’ future borrowing power, and reducing the value of assets and collateral associated with existing loans; and
•
the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us.
In addition, deflationary pressures, while possibly lowering our operating costs, could have a significant negative effect on our borrowers, especially our business borrowers, and the values of underlying collateral securing loans, which could negatively affect our financial performance.
Changes in laws and regulations and the cost of compliance with new laws and regulations may adversely affect our operations and our income.
The Company and Northwest Bank are subject to extensive regulation, supervision and examination by the Federal Reserve Board, the Department of Banking and the FDIC. These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the ability to impose restrictions on Northwest Bank’s operations, reclassify assets, determine the adequacy of Northwest Bank’s allowance for loan losses and determine the level of deposit insurance premiums assessed. The laws and regulations applicable to us are subject to frequent change and interpretations. Any change in these regulations and oversight, whether in the form of regulatory policy, new regulations or legislation or additional deposit insurance premiums could have a material impact on our operations.
The potential exists for additional federal or state laws and regulations, or changes in policy, affecting lending and funding practices and liquidity standards. Moreover, bank regulatory agencies have been active in responding to concerns and trends identified in examinations, and have issued many formal enforcement orders requiring capital ratios in excess of regulatory requirements. Bank regulatory agencies, such as the Federal Reserve Board, the Department of Banking, the Consumer Financial Protection Bureau and the FDIC, govern the activities in which we may engage, primarily for the protection of depositors, and not for the protection or benefit of potential investors. In addition, new laws and regulations may increase our costs of regulatory compliance and of doing business, and otherwise affect our operations. New laws and regulations may significantly affect the markets in which we do business, the markets for and value of our loans and investments, the fees we can charge and our ongoing operations, costs and profitability.
The corporate governance provisions in our articles of incorporation and bylaws, and the corporate governance provisions under Maryland law, may prevent or impede the holders of our common stock from obtaining representation on our Board of Directors and may impede takeovers of the Company that our board might conclude are not in the best interest of us or our stockholders.
Provisions in our articles of incorporation and bylaws may prevent or impede holders of our common stock from obtaining representation on our Board of Directors and may make takeovers of Northwest Bancshares, Inc. more difficult. As a result, our stockholders may not have the opportunity to participate in such a transaction, which could provide a premium over the prevailing price of our common stock. The provisions that may discourage takeover attempts or make them more difficult include that our Board of Directors is divided into three staggered classes. A classified board makes it more difficult for stockholders to change a majority of the
directors because it generally takes at least two annual elections of directors for this to occur. Our articles of incorporation include a provision that no person will be entitled to vote any shares of our common stock in excess of 10% of our outstanding shares of common stock. This limitation does not apply to the purchase of shares by a tax-qualified employee stock benefit plan established by us. In addition, our articles of incorporation and bylaws restrict who may call special meetings of stockholders and how directors may be removed from office. Additionally, in certain instances, the Maryland General Corporation Law requires a supermajority vote of our stockholders to approve a merger or other business combination with a large stockholder, if the proposed transaction is not approved by a majority of our directors.
Changes in interest rates could adversely affect our results of operations and financial condition.
While we strive to control the impact of changes in interest rates on our net income, our results of operations and financial condition could be significantly affected by changes in interest rates. Our results of operations depend substantially on our net interest income, which is the difference between the interest income we earn on our interest-earning assets, such as loans and investment securities, and the interest expense we pay on our interest-bearing liabilities, such as deposits, borrowings and trust preferred securities. Because it is difficult to perfectly match the maturities and cash flows from our financial assets and liabilities our net income could be adversely impacted by changes in the level of interest rates or the slope of the Treasury yield curve.
Changes in interest rates may also affect the average life of loans and mortgage-related securities. Decreases in interest rates can result in increased prepayments of loans and mortgage-related securities, as borrowers refinance to reduce their borrowing costs. Under these circumstances, we are subject to reinvestment risk to the extent that we are unable to reinvest the cash received from such prepayments at rates that are comparable to the rates on existing loans and investment securities. Additionally, increases in interest rates may decrease loan demand and make it more difficult for borrowers to repay adjustable rate loans. Also, increases in interest rates may extend the life of fixed rate assets, which would restrict our ability to reinvest in higher yielding alternatives, and may result in customers withdrawing certificates of deposit early so long as the early withdrawal penalty is less than the interest they could receive as a result of the higher interest rates.
Changes in interest rates also affect the current fair value of our interest-earning investment securities portfolio. Generally, the value of securities moves inversely with changes in interest rates. At December 31, 2019, the fair value of our investment and mortgage-backed securities portfolio totaled $838.1 million. Net unrealized losses on these securities totaled $4.6 million at December 31, 2019.
Any increase in market interest rates may reduce our mortgage banking income. We generate revenues primarily from gains on the sale of mortgage loans to investors, and from the amortization of deferred mortgage servicing rights. We recognized noninterest income of $3.8 million on mortgage banking activities during the year ended December 31, 2019. We also earn interest on loans held for sale while awaiting delivery to our investors. In a rising or higher interest rate environment, our mortgage loan originations may decrease, resulting in fewer loans that are available for sale. This would result in a decrease in interest income and a decrease in revenues from loan sales. In addition, our results of operations are affected by the amount of noninterest expense associated with mortgage banking activities, such as salaries and employee benefits, occupancy, equipment, data processing and other operating costs. During periods of reduced loan demand, our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in mortgage loan origination activity.
At December 31, 2019, our interest rate risk analysis indicated that the market value of our equity would decrease by 6.3% if there was an instant parallel 200 basis point increase in market interest rates. See “Item 7A. Quantitative and Qualitative Disclosures About Market Risk.”
We are a community bank and our ability to maintain our reputation is critical to the success of our business and the failure to do so may materially adversely affect our performance.
We are a community bank, and our reputation is one of the most valuable components of our business. A key component of our business strategy is to rely on our reputation for customer service and knowledge of local markets to expand our presence by capturing new business opportunities from existing and prospective customers in our current market and contiguous areas. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering superior service to our customers and caring about our customers and associates. If our reputation is negatively affected by the actions of our employees, by our inability to conduct our operations in a manner that is appealing to current or prospective customers, or otherwise, our business and operating results may be adversely affected.
If the allowance for loan losses is not sufficient to cover actual loan losses, our earnings could decrease.
Our customers may not repay their loans according to the original terms, and the collateral, if any, securing the payment of these loans may be insufficient to pay any remaining loan balance. We may experience significant loan losses, which may have a material
adverse effect on operating results. We make various assumptions and judgments about the collectability of the loan portfolio, including the creditworthiness of borrowers and the value of the real estate and other assets serving as collateral for the repayment of loans. If our assumptions prove to be incorrect, the allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in additions to the allowance. Material additions to the allowance would materially decrease net income.
Our emphasis on originating commercial real estate and commercial loans is one of the more significant factors in evaluating the allowance for loan losses. As we continue to increase the amount of such loans, increased provisions for loan losses may be necessary, which would decrease our earnings.
The FASB has adopted a new accounting standard that will be effective for our first fiscal year after December 15, 2019. This standard, referred to as Current Expected Credit Loss ("CECL"), will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for loan losses. This will change the current method of providing allowances for loan losses that are probable, which will require us to increase our allowance for loan losses, and to greatly increase the types of data we would need to collect and review to determine the appropriate level of the allowance for loan losses. We are currently evaluating the impact this standard will have on our results of operations and financial position.
Management has created a formal working group to govern the implementation of these amendments, consisting of key stakeholders from finance, risk, credit and accounting. The working group meets periodically to discuss the progress of implementation, monitor the established timeline and discuss latest hot topics and industry trends. We have engaged a third party to assist in the development of certain portfolio-level estimation methodologies and have chosen, and are in the process of implementing, a third-party software platform provider and have completed a preliminary current expected credit loss estimation. This estimation includes the quantitative and qualitative components of the calculation which incorporates a forecasting component of certain economic variables. We are currently working to finalize our documentation around the CECL methodology and designing and updating processes, internal controls and financial statement disclosures. The CECL model was also reviewed and validated by an independent consultant during the fourth quarter of 2019 and recommendations will be reviewed and implemented prior to adoption. While the impact of the ASU 2016-13 will depend upon the state of the economy and the nature of our portfolios, among other items at the date of adoption, we currently expect the adoption of ASU 2016-13 will result in a combined 15% to 35% increase in our allowance for loan losses and our reserves for unfunded commitments with a cumulative effect adjustment, net of deferred taxes, to equity. The adoption of ASU 2016-13 is not expected to have a significant impact on our regulatory capital ratios.
Bank regulators periodically review our allowance for loan losses and may require an increase to the provision for loan losses or 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 or financial condition.
Our commercial loan portfolio is increasing and the inherently higher risk of loss may lead to additional provisions for loan losses or charge-offs, which would negatively impact earnings and capital.
Commercial loans generally expose a lender to greater risk of non-payment and loss than one- to four-family residential mortgage loans because repayment of the loans often depends on the successful operation of the business and the income stream of the borrowers. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one- to four-family residential mortgage loans. Also, many of our commercial 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 one- to four-family residential mortgage loan. Commercial business loans expose us to additional risk since they typically are dependent on the borrower’s ability to make repayments from the cash flows of the business and are secured by non-real estate collateral that may depreciate over time. Further, our commercial business 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, control or collect and may be more susceptible to fluctuation in value at the time of default.
We could record future losses on our investment securities portfolio.
A number of factors or combinations of factors could require us to conclude in one or more future reporting periods that an unrealized loss that exists with respect to these and other securities constitutes an impairment that is other-than-temporary, which could result in material losses to us. These factors include, but are not limited to, failure by the issuer to make scheduled interest payments, an increase in the severity of the unrealized loss on a particular security, an increase in the continuous duration of the unrealized loss without an improvement in value or changes in market conditions and/or industry or issuer specific factors that would render us unable to forecast a full recovery in value. In addition, the fair values of securities could decline if the overall economy and the financial condition of some of the issuers deteriorates and there remains limited liquidity for these securities.
See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Balance Sheet Analysis-Securities” for a discussion of our securities portfolio and the unrealized losses related to the portfolio, as well as the “Marketable Securities” and “Disclosures about Fair Value of Financial Instruments” footnotes to the audited financial statements.
Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions.
The USA PATRIOT and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury’s Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions or affect our ability to pursue further acquisition opportunities. During the last year, several banking institutions have received large fines for non-compliance with these laws and regulations. While we have developed policies and procedures designed to assist in compliance with these laws and regulations, these policies and procedures may not be effective in preventing violations of these laws and regulations.
We are subject to the Community Reinvestment Act and fair lending laws, and failure to comply with these laws could lead to material penalties.
The Community Reinvestment Act (“CRA”), the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations impose nondiscriminatory lending requirements on financial institutions. A successful regulatory challenge to an institution’s performance under the CRA or fair lending laws and regulations could result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on mergers and acquisitions activity and restrictions on expansion. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. Such actions could have a material adverse effect on our business, financial condition and results of operations.
The Federal Reserve Board may require us to commit capital resources to support Northwest Bank.
Federal law requires that a holding company act as a source of financial and managerial strength to its subsidiary bank and to commit resources to support such subsidiary bank. Under the “source of strength” doctrine, the Federal Reserve Board may require a holding company to make capital injections into a troubled subsidiary bank and may charge the holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank. A capital injection may be required at times when the holding company may not have the resources to provide it and therefore may be required to borrow the funds or raise capital. Any loans by a holding company to its subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a holding company’s bankruptcy, the bankruptcy trustee will assume any commitment by the holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank. Moreover, bankruptcy law provides that claims based on any such commitment will be entitled to a priority of payment over the claims of the institution’s general unsecured creditors, including the holders of its note obligations. Thus, any borrowing that must be done by the Company to make a required capital injection becomes more difficult and expensive and could have an adverse effect on our business, financial condition and results of operations.
If our intangible assets, including goodwill, are either partially or fully impaired in the future, it would decrease earnings.
We are required to test our goodwill and other identifiable intangible assets for impairment on an annual basis and more regularly if indicators of impairment exist. The impairment testing process considers a variety of factors, including the current market price of our common stock, the estimated net present value of our assets and liabilities and information concerning the terminal valuation of similar insured depository institutions. Future impairment testing may result in a partial or full impairment of the value of our goodwill or other identifiable intangible assets, or both. If an impairment determination is made in a future reporting period, our earnings and the book value of these intangible assets will be reduced by the amount of the impairment. However, the recording of such an impairment loss would have no impact on the tangible book value of our shares of common stock or our regulatory capital levels.
Strong competition may limit growth and profitability.
Competition in the banking and financial services industry is intense. We compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, fintech companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. Many of these competitors (whether regional or national institutions) have substantially greater resources and lending limits than we have and may offer certain services that we do not or cannot provide. In addition, some have competitive advantages such as the credit union exemption from paying Federal income tax. Our profitability depends upon our ability to successfully compete in our market areas.
Future legislative or regulatory actions responding to perceived financial and market problems could impair our ability to foreclose on collateral.
There have been proposals made by members of Congress and others that would reduce the amount distressed borrowers are otherwise contractually obligated to pay under their mortgage loans and limit an institution’s ability to foreclose on mortgage collateral. Were proposals such as these, or other proposals limiting our rights as a creditor, to be implemented, we could experience increased credit losses or increased expense in pursuing our remedies as a creditor.
Legal and regulatory proceedings and related matters could adversely affect us or the financial services industry in general.
We, and other participants in the financial services industry upon whom we rely to operate, have been and may in the future become involved in legal and regulatory proceedings. Most of the proceedings we consider to be in the normal course of our business are typical for the industry; however, it is inherently difficult to assess the outcome of these matters, and other participants in the financial services industry or we may not prevail in any proceeding or litigation. There could be substantial cost and management diversion in such litigation and proceedings, and any adverse determination could have a materially adverse effect on our business, brand or image, or our financial condition and results of our operations.
Monetary policies and regulations of the Federal Reserve Board could adversely affect our business, financial condition and results of operations.
In addition to being affected by general economic conditions, our earnings and growth are affected by the policies of the Federal Reserve Board. An important function of the Federal Reserve Board is to regulate the money supply and credit conditions. Among the instruments used by the Federal Reserve Board to implement these objectives are open market purchases and sales of U.S. government securities, adjustments of the discount rate and changes in banks’ reserve requirements against bank deposits. These instruments are used in varying combinations to influence overall economic growth and the distribution of credit, bank loans, investments and deposits. Their use also affects interest rates charged on loans or paid on deposits.
The monetary policies and regulations of the Federal Reserve Board have had a significant effect on the operating results of financial institutions in the past and are expected to continue to do so in the future. The effects of such policies upon our business, financial condition and results of operations cannot be predicted.
The level of our commercial real estate loan portfolio may subject us to additional regulatory scrutiny.
The FDIC and the other federal bank regulatory agencies have promulgated joint guidance on sound risk management practices for financial institutions with concentrations in commercial real estate lending. Under the guidance, a financial institution that, like us, is actively involved in commercial real estate lending should perform a risk assessment to identify concentrations. A financial institution may have a concentration in commercial real estate lending if, among other factors, (i) total reported loans for construction, land acquisition and development, and other land represent 100% or more of total capital, or (ii) total reported loans secured by multi-family and non-farm residential properties, loans for construction, land acquisition and development and other land, and loans otherwise sensitive to the general commercial real estate market, including loans to commercial real estate related entities, represent 300% or more of total capital. Based on these factors, we have a concentration in multi-family and commercial real estate lending, as such loans represent 516.9% of total bank capital as of December 31, 2019. The particular focus of the guidance is on exposure to commercial real estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely to be at greater risk to conditions in the commercial real estate market (as opposed to real estate collateral held as a secondary source of repayment or as an abundance of caution). The purpose of the guidance is to guide banks in developing risk management practices and capital levels commensurate with the level and nature of real estate concentrations. The guidance states that management should employ heightened risk management practices including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing. While we believe we have implemented policies and procedures with respect to our commercial real estate loan portfolio consistent with this guidance, bank regulators could require us to implement additional policies and procedures consistent with their interpretation of the guidance that may result in additional costs to us or that may result in a curtailment of our multi-family and commercial real estate lending that would adversely affect our loan originations and profitability.
Our exposure to municipalities may lead to operating losses.
Our municipal bond portfolio may be impacted by the effects of economic stress on state and local governments. At December 31, 2019, we had $26.0 million invested in debt obligations of states, municipalities and political subdivisions (collectively referred to as our municipal bond portfolio). We also had $175.7 million of loans outstanding to municipalities and political subdivisions. Widespread concern currently exists regarding the stress on state and local governments emanating from: (i) declining revenues; (ii) large unfunded liabilities to government workers; and (iii) entrenched cost structures. Debt-to-gross domestic product ratios for the majority of states have been deteriorating due to, among other factors, declines in federal monetary assistance provided as the United States is currently experiencing the largest deficit in its history. This concern has led to speculation about the potential for a significant deterioration in the municipal bond market, which could materially affect our results of operations, financial condition and liquidity. We may not be able to mitigate the exposure in our municipal portfolio if state and local governments are unable to fulfill their obligations. The risk of widespread
issuer defaults may also increase if there are changes in legislation that permit states, or additional municipalities and political subdivisions, to file for bankruptcy protection or if there are judicial interpretations that, in a bankruptcy or other proceeding, lessen the value of any structural protections.
If our government banking deposits were lost within a short period of time, this could negatively impact our liquidity and earnings.
As of December 31, 2019, we held $455.8 million of deposits from municipalities throughout Pennsylvania, New York and Ohio. These deposits may be more volatile than other deposits. If a significant amount of these deposits were withdrawn within a short period of time, it could have a negative impact on our short-term liquidity and have an adverse impact on our earnings.
The financial services sector represents a significant concentration within our investment portfolio.
Within our investment portfolio, we have a significant amount of corporate debt and mortgage-backed securities issued by companies in the financial services sector. Given current market conditions, this sector has an enhanced level of credit risk.
Risks associated with system failures, interruptions, or breaches of security could negatively affect our earnings.
Information technology systems are critical to our business. We use various technology systems to manage our customer relationships, general ledger, deposits, and loans. We have established policies and procedures to prevent or limit the impact of system failures, interruptions, and security breaches, but such events may still occur or may not be adequately addressed if they do occur. In addition, any compromise of our systems could deter customers from using our products and services. Although we rely on security systems to provide security and authentication necessary to effect the secure transmission of data, these precautions may not protect our systems from compromises or breaches of security.
Our business is subject to the Gramm-Leach-Bliley Act which, among other things: (i) imposes certain limitations on our ability to share nonpublic personal information about our customers with nonaffiliated third parties; (ii) requires that we provide certain disclosures to customers about our information collection, sharing and security practices and afford customers the right to “opt out” of any information sharing by us with nonaffiliated third parties (with certain exceptions); and (iii) requires that we develop, implement and maintain a written comprehensive information security program containing appropriate safeguards based on our size and complexity, the nature and scope of our activities, and the sensitivity of customer information we process, as well as plans for responding to data security breaches. Ensuring that our collection, use, transfer and storage of personal information complies with all applicable laws and regulations can increase our costs. Despite the defensive measures we take to manage our internal technological and operational infrastructure, threats may originate externally from third parties such as foreign governments, organized crime and other hackers, and outsource or infrastructure-support providers and application developers, or may originate internally from within our organization. Furthermore, we may not be able to ensure that all of our clients, suppliers, counterparties and other third parties have appropriate controls in place to protect the confidentiality of the information that they exchange with us, particularly where such information is transmitted by electronic means.
In addition, we outsource a significant amount of our data processing to certain third-party providers. If these third-party providers encounter difficulties, or if we have difficulty communicating with them, our ability to adequately process and account for transactions could be affected, and our business operations could be adversely affected. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.
The occurrence of any system failures, interruption, or breach of security could damage our reputation and result in a loss of customers and business, could subject us to additional regulatory scrutiny, or could expose us to litigation and possible financial liability. Any of these events could have a material adverse effect on our financial condition and results of operations.
Our risk management framework may not be effective in mitigating risk and reducing the potential for significant losses.
Our risk management framework is designed to minimize risk and loss to us. We seek to identify, measure, monitor, report and control our exposure to risk, including strategic, market, liquidity, credit, interest rate, compliance and operational risks. While we use a broad and diversified set of risk monitoring and mitigation techniques, these techniques are inherently limited because they cannot anticipate the existence or future development of currently unanticipated or unknown risks. Recent economic conditions and heightened legislative and regulatory scrutiny of the financial services industry, among other developments, have increased our level of risk. Accordingly, we could suffer losses as a result of our failure to properly anticipate and manage these risks.
Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.
Our loans to businesses and individuals and our deposit relationships and related transactions are subject to exposure to the risk of loss due to fraud and other financial crimes. Nationally, reported incidents of fraud and other financial crimes have increased. We have also experienced losses due to apparent fraud and other financial crimes. While we have policies and procedures designed to prevent such losses, losses may still occur.
Acquisitions may disrupt our business and dilute stockholder value.
We regularly evaluate merger and acquisition opportunities with other financial institutions and financial services companies. As a result, negotiations may take place and future mergers or acquisitions involving cash, debt, or equity securities may occur at any time. We would seek acquisition partners that offer us either significant market presence or the potential to expand our market footprint and improve profitability through economies of scale or expanded services.
Acquiring other banks, businesses, or branches may have an adverse effect on our financial results and may involve various other risks commonly associated with acquisitions, including, among other things:
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difficulty in estimating the value of the target company;
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payment of a premium over book and market values that may dilute our tangible book value and earnings per share in the short and long term;
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potential exposure to unknown or contingent liabilities of the target company;
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exposure to potential asset quality problems of the target company;
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potential volatility in reported income associated with goodwill impairment losses;
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difficulty and expense of integrating the operations and personnel of the target company;
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inability to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits of the acquisition;
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potential disruption to our business;
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potential diversion of our management’s time and attention;
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the possible loss of key employees and customers of the target company; and
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potential changes in banking or tax laws or regulations that may affect the target company.
Acquisitions may not enhance our cash flows, business, financial condition, results of operations or prospects as expected and such acquisitions may have an adverse effect on our results of operations, particularly during periods in which the acquisitions are being integrated into our operations.
Our continued pace of growth may require us to raise additional capital in the future, but that capital may not be available when it is needed.
We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate that we will have sufficient capital resources to satisfy our capital requirements for the foreseeable future. We may at some point, however, need to raise additional capital to support our continued growth. If we raise capital through the issuance of additional shares of our common stock or other securities, it would dilute the ownership interests of existing stockholders and may dilute the per share book value of our common stock. New investors may also have rights, preferences and privileges senior to our current stockholders, which may adversely impact our current stockholders. Also, the need to raise additional capital may force our management to spend more time in managerial and financing-related activities than in operational activities.
Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside of our control, and on our financial performance. Accordingly, we may not be able to raise additional capital, if needed, with favorable terms. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired.
New lines of business or new products and services may subject us to additional risks.
From time to time, we may implement new lines of business or offer new products and services within existing lines of business. In addition, we will continue to make investments in research, development, and marketing for new products and services. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services we may invest significant time and resources. Initial timetables for the development and introduction of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. Furthermore, if customers do not perceive our new offerings as providing significant value, they may fail to accept our new products and services. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, the burden on management and our information technology of introducing any new line of business and/or new product or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage
these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on our business, financial condition and results of operations.
Provisions of the Dodd-Frank Act that are applicable to savings banks and their holding companies with $10 billion or more in assets may decrease our fee income and increase our operating costs or otherwise have a material effect on our business, financial condition or results of operations.
The Dodd-Frank Act resulted in several new requirements for banking institutions with $10 billion or more in assets. As of December 31, 2019, we had consolidated assets of $10.494 billion. These provisions, subject to a phase-in period, may significantly increase our compliance or operating costs or otherwise have a significant impact on our business, financial condition and results of operations. Such provisions include:
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The Dodd-Frank Act created the Consumer Financial Protection Bureau (the “CFPB”), which has broad powers to supervise and enforce consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. Currently, the Pennsylvania Department of Banking and the FDIC examine Northwest Bank for compliance with consumer protection laws. However, the CFPB has examination and enforcement authority over all banks with more than $10 billion in assets, and accordingly will assume examination and enforcement authority over us, subject to a phase in period.
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Interchange fees for electronic debt transactions by a payment card issuer would be limited to $0.21 plus five basis points times the value of the transaction, plus up to $0.01 for fraud prevention costs. This would lower significantly our interchange or “swipe” revenue. We estimate this decrease in interchange fee income to be approximately $8.0 million, before tax for the year end December 31, 2020.
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The Dodd-Frank Act established 1.35% as the minimum Deposit Insurance Fund reserve ratio and the FDIC has adopted a plan under which it will meet the statutory minimum fund reserve ratio of 1.35% by September 30, 2020. The Dodd-Frank Act requires the FDIC to offset the effect of the increase in the statutory minimum fund reserve ratio to 1.35% from the former statutory minimum of 1.15% on institutions with assets less than $10 billion. We will not be entitled to benefit from the offset.
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The Dodd-Frank Act requires a publicly traded savings and loan holding company with $10 billion or more in assets to establish and maintain a risk committee responsible for oversight of enterprise-wide risk management practices, which must be commensurate with the bank’s structure, risk profile, complexity, activities and size.
It is difficult to predict the overall compliance cost of these provisions. However, compliance with these provisions would likely require additional staffing, engagement of external consultants and other operating costs that could have a material adverse effect on our future financial condition and results of operations.
Our business strategy includes growth, and our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively.
Our business strategy includes growth in assets, deposits and the scale of our operations. Achieving our growth targets will require us to attract customers that currently bank at other financial institutions in our market, thereby increasing our share of the market. Our ability to successfully grow will depend on a variety of factors, including our ability to attract and retain experienced bankers, the continued availability of desirable business opportunities, the competitive responses from other financial institutions in our market area and our ability to manage our growth. Growth opportunities may not be available or we may not be able to manage our growth successfully. If we do not manage our growth effectively, our financial condition and operating results could be negatively affected.
Uncertainties associated with increased loan originations may result in errors in our judgment of collectability, which may lead to additional provisions for loan losses or charge-offs, which would negatively affect our operations.
Increasing loan originations would likely require us to lend to borrowers with which we have limited experience. Accordingly, we would not have a significant payment history pattern with which to judge future collectability. Further, newly originated loans have not been subjected to unfavorable economic conditions. As a result, it may be difficult to predict the future performance of newly originated loans. These loans may have delinquency or charge-off levels above our recent historical experience, which could adversely affect our future performance.
Our funding sources may prove insufficient to replace deposits at maturity and support our future growth.
We must maintain sufficient funds to respond to the needs of depositors and borrowers. As a part of our liquidity management, we use a number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments. As we continue to grow, we are likely to become more dependent on these sources, which may include Federal Home Loan Bank advances, proceeds from the sale of loans, federal funds purchased and brokered certificates of deposit. Adverse operating results or changes in industry conditions could lead to difficulty or an inability to access these additional funding sources. Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. If we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our operating margins and profitability would be adversely affected.
Changes in card network rules or standards could adversely affect our business.
In order to provide our debit card and cash management solutions, we are members of the Visa network. As such, we are subject to card network rules that could subject us to a variety of fines or penalties that may be assessed on us. The termination of our membership or any changes in card network rules or standards, including interpretation and implementation of existing rules or standards, could increase the cost of operating our merchant services business or limit our ability to provide debit card and cash management solutions to or through our customers, and could have a material adverse effect on our business, financial condition and results of operations.
Changes in card network fees could impact our operations.
From time to time, the card networks increase the fees (known as interchange fees) that they charge to acquirers and that we charge to our merchants. It is possible that competitive pressures will result in us absorbing a portion of such increases in the future, which would increase our costs, reduce our profit margin and adversely affect our business and financial condition. In addition, the card networks require certain capital requirements. An increase in the required capital level would further limit our use of capital for other purposes.
Our business could suffer if there is a decline in the use of debit cards as a payment mechanism or if there are adverse developments with respect to the financial services industry in general.
As the financial services industry evolves, consumers may find debit financial services to be less attractive than traditional or other financial services. Consumers might not use debit card financial services for any number of reasons, including the general perception of our industry. If consumers do not continue or increase their usage of debit cards, including making changes in the way debit cards are loaded, our operating revenues and debit card deposits may remain at current levels or decline. Any projected growth for the industry may not occur or may occur more slowly than estimated. If consumer acceptance of debit financial services does not continue to develop or develops more slowly than expected or if there is a shift in the mix of payment forms, such as cash, credit cards, and debit cards, away from our products and services, it could have a material adverse effect on our financial position and results of operations.
Changes in management’s estimates and assumptions may have a material impact on our Consolidated Financial Statements and our financial condition or operating results.
In preparing this annual report as well as periodic reports we are required to file under the Securities Exchange Act of 1934, including our Consolidated Financial Statements, our management is and will be required under applicable rules and regulations to make estimates and assumptions as of a specified date. These estimates and assumptions are based on management’s best estimates and experience as of that date and are subject to substantial risk and uncertainty. Materially different results may occur as circumstances change and additional information becomes known. Areas requiring significant estimates and assumptions by management include our valuation of investment securities, our determination of our income tax provision and goodwill, and our evaluation of the adequacy of our allowance for loan losses.
We could be adversely affected by the soundness of other financial institutions and other third parties we rely on.
Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks and other institutional customers. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when our collateral cannot be foreclosed upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due. Furthermore, successful operation of our debit card and cash management solutions business depends on the soundness of third party processors, clearing agents and others that we rely on to conduct our merchant business. Any losses resulting from such third parties could adversely affect our business, financial condition and results of operations.
We are subject to environmental liability risk associated with lending activities.
A significant portion of our loan portfolio is secured by real estate, and we could become subject to environmental liabilities with respect to one or more of these properties. During the ordinary course of business, we may foreclose on and take title to properties securing defaulted loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous conditions or toxic substances are found on these properties, we may be liable for remediation costs, as well as for personal injury and property damage, civil fines and criminal penalties regardless of when the hazardous conditions or toxic substances first affected any particular property. Environmental laws may require us to incur substantial expenses to address unknown liabilities and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures to perform an environmental review before initiating any foreclosure action on nonresidential real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on us.
We are required to transition from the use of the LIBOR interest rate index in the future.
We have certain loans indexed to LIBOR to calculate the loan interest rate. The continued availability of the LIBOR index is not guaranteed after 2021. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR. The implementation of a substitute index or indices for the calculation of interest rates under our loan agreements with our borrowers may incur significant expenses in effecting the transition, may result in reduced loan balances if borrowers do not accept the substitute index or indices, and may result in disputes or litigation with customers over the appropriateness or comparability to LIBOR of the substitute index or indices, which could have an adverse effect on our results of operations.
A protracted government shutdown may result in reduced loan originations and related gains on sale and could negatively affect our financial condition and results of operations.
During any protracted federal government shutdown, we may not be able to close certain loans and we may not be able to recognize non-interest income on the sale of loans. Some of the loans we originate are sold directly to government agencies, and some of these sales may be unable to be consummated during the shutdown. In addition, we believe that some borrowers may determine not to proceed with their home purchase and not close on their loans, which would result in a permanent loss of the related non-interest income. A federal government shutdown could also result in reduced income for government employees or employees of companies that engage in business with the federal government, which could result in greater loan delinquencies, increases in our nonperforming, criticized and classified assets and a decline in demand for our products and services.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
As of December 31, 2019, we conducted our business through our main office located in Warren, Pennsylvania, 115 other full-service offices and six free-standing drive-through locations throughout our market area in central and western Pennsylvania, 35 full-service offices and two free-standing drive-through location in western New York and 21 full-service offices and one free-standing drive-through location in eastern Ohio. At December 31, 2019, our premises and equipment had an aggregate net book value of approximately $147.4 million.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Northwest Bancshares, Inc. and its subsidiaries are subject to various legal actions arising in the normal course of business. In the opinion of management, the resolution of these legal actions is not expected to have a material adverse effect on our financial condition and/or results of operations. See note 20 in the notes to the Consolidated Financial Statements.
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
Our common stock is listed on the Nasdaq Global Select Market under the symbol “NWBI.” As of February 21, 2020, we had 22 registered market makers, 12,532 stockholders of record (excluding the number of persons or entities holding stock in street name through various brokerage firms), and 106,934,228 shares outstanding.
Payment of dividends on our shares of common stock is subject to determination and declaration by the Board of Directors and will depend upon a number of factors, including capital requirements, regulatory limitations on the payment of dividends, our results of operations and financial condition, tax considerations and general economic conditions. No assurance can be given that dividends will continue to be declared or, if declared, what the amount of dividends will be. See "Item 1. Business Supervision and Regulation - Holding Company Regulation - Source of Strength/Capital Distributions” for additional information regarding our ability to pay dividends.
There were no sales of unregistered securities during the quarter ended December 31, 2019. Additionally, there were no repurchases of shares of common stock during the quarter ended December 31, 2019.
On December 13, 2012, the board of directors approved a program that authorizes the repurchase of approximately 5,000,000 shares. This program does not have expiration date. During the quarter ended December 31, 2019, we did not repurchase any shares and there are a maximum of 4,834,089 shares that can be purchased under the repurchase program.
Stock Performance Graph
The following stock performance graph compares (a) the cumulative total return on our common stock between December 31, 2014 and December 31, 2019, (b) the cumulative total return on stocks included in the Total Return Index for the Nasdaq Stock Market (US) over such period, and (c) the cumulative total return on stocks included in the Nasdaq Bank Index over such period. Cumulative return assumes the reinvestment of dividends, and is expressed in dollars based on an assumed investment of $100.
There can be no assurance that our stock performance will continue in the future with the same or similar trend depicted in the graph. We will not make or endorse any predictions as to future stock performance.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN
Among Northwest Bancshares, Inc., the NASDAQ Composite Index, and the NASDAQ Bank Index
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Selected Financial and Other Data
The summary financial information presented below is derived in part from the Company’s Consolidated Financial Statements. The following is only a summary and should be read in conjunction with the Consolidated Financial Statements and notes included elsewhere in this document. The information at December 31, 2019 and 2018 and for the years ended December 31, 2019, 2018 and 2017 is derived in part from the audited Consolidated Financial Statements that appear in this document. The information at December 31, 2017, 2016 and 2015, and for the years ended December 31, 2016 and 2015, is derived in part from audited Consolidated Financial Statements that do not appear in this document.
(1)
Represents net income divided by average assets.
(2)
Represents net income divided by average equity.
(3)
Represents average yield on interest-earning assets less average cost of interest-bearing liabilities (shown on an fully taxable equivalent "FTE" basis).
(4)
Represents net interest income as a percentage of average interest-earning assets (shown on a FTE basis).
(5)
2016 includes $37.0 million FHLB prepayment penalty, $12.2 million restructuring/acquisition expense and $5.1 million ESOP termination expense.
(6) 2017 includes $4.4 million restructuring/acquisition expense.
(7) 2017 includes $17.2 million gain on sale of offices.
(8) 2018 includes $1.0 million restructuring/acquisition expense.
(9) 2019 includes $4.2 million restructuring/acquisition expense.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Our principal business consists of collecting deposits and making loans secured by various types of collateral, including real estate and other assets in the markets in which we are located. Attracting and maintaining deposits is affected by a number of factors, including interest rates paid on competing deposits and other investments offered by other financial and non-financial institutions, account maturities, fee structures, and levels of personal income and savings. Lending activities are affected by the demand for funds and thus are influenced by interest rates, the number and quality of lenders and regional economic conditions. Sources of funds for lending activities include deposits, borrowings, repayments on loans, cash flows from investment and mortgage-backed securities and income provided from operations.
Our earnings depend primarily on net interest income, which is the difference between interest earned on our interest-earning assets, consisting primarily of loans and investment securities, and the interest paid on interest-bearing liabilities, consisting primarily of deposits, borrowed funds, and trust-preferred securities. Net interest income is a function of our interest rate spread, which is the difference between the average yield earned on our interest-earning assets and the average rate paid on our interest-bearing liabilities, as well as a function of the average balance of interest-earning assets compared to the average balance of interest-bearing liabilities. Also contributing to our earnings is noninterest income, which consists primarily of service charges and fees on loan and deposit products and services, fees related to insurance and investment management and trust services, and net gains and losses on the sale of assets. Net interest income and noninterest income are offset by provisions for loan losses, general administrative and other expenses, including employee compensation and benefits and occupancy and processing costs, as well as by state and federal income tax expense.
Our net income was $110.4 million, or $1.04 per diluted share, for the year ended December 31, 2019 compared to $105.5 million, or $1.02 per diluted share, for the year ended December 31, 2018 and $94.5 million, or $0.92 per diluted share, for the year ended December 31, 2017. The loan loss provision was $22.7 million for the year ended December 31, 2019 compared to $20.3 million for the year ended December 31, 2018 and $19.8 million for the year ended December 31, 2017.
Critical Accounting Policies
Certain accounting policies are important to the understanding of our financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances, including, but without limitation, changes in interest rates, performance of the economy, financial condition of borrowers and laws and regulations. The following are the accounting policies we believe are critical.
Allowance for Loan Losses. We recognize that losses will be experienced on loans and that the risk of loss varies with the type of loan, the creditworthiness of the borrower, general economic conditions and the quality of the collateral for the loan. We maintain an allowance for losses inherent in the loan portfolio. The allowance for loan losses represents management’s estimate of probable losses based on all available information. The allowance for loan losses is based on management’s evaluation of the collectability of the loan portfolio, including past loan loss experience, known and inherent losses, information about specific borrower situations, estimated collateral values, and current economic conditions. The loan portfolio is reviewed regularly by management in its determination of the allowance for loan losses. The methodology for assessing the appropriateness of the allowance includes a review of historical losses, peer group comparisons, industry data and economic conditions. As an integral part of their examination process, regulatory agencies periodically review our allowance for loan losses and may require us to make additional provisions for estimated losses based upon judgments different from those of management. In establishing the allowance for loan losses, loss factors are applied to various pools of outstanding loans. Loss factors are derived using our historical loss experience and may be adjusted for factors that affect the collectability of the portfolio as of the evaluation date. Commercial loans over $1.0 million that are criticized are evaluated individually to determine the required allowance for loan losses and to evaluate the potential impairment. Although management believes that it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of loans deteriorate as a result of the factors discussed previously. Any material increase in the allowance for loan losses may adversely affect our financial condition and results of operations. The allowance is based on information known at the time of the review. Changes in factors underlying the assessment could have a material impact on the amount of the allowance that is necessary and the amount of provision to be charged against earnings. Such changes could impact future results. For further information related to our allowance for loan losses, see note 1(f) of the notes to the Consolidated Financial Statements.
Valuation of Investment Securities. Our investment securities are classified as either held-to-maturity or available-for-sale. Held-to-maturity securities are carried at amortized cost, while available-for-sale securities are carried at fair value. Unrealized gains or losses on available-for-sale securities, net of deferred taxes, are reported in other comprehensive income. Fair values are determined as described in note 17 of the notes to the Consolidated Financial Statements. Semi-annually (at May 31 and November 30), we validate the prices received from third parties by comparing them to prices provided by a different independent pricing service. We have reviewed the detailed valuation methodologies provided to us by our pricing services. Additional information related to our investment securities can be found in note 1(d) of the notes to the Consolidated Financial Statements.
We conduct a quarterly review of all investment securities to determine if any declines in fair value are other than temporary. In making this determination, we consider the period of time the securities have been in an unrealized loss position, the percentage decline in comparison to the securities’ amortized cost, the financial condition of the issuer, if applicable, and the delinquency or default rates of underlying collateral. We consider our intent to sell the investment securities evaluated and the likelihood that we will not have to sell the investment securities before recovery of their cost basis. If impairment exists, credit related impairment losses are recorded in earnings while noncredit related impairment losses are recorded in accumulated other comprehensive income, net of income taxes. Any future deterioration in the fair value of an investment security, or the determination that the existing unrealized loss of an investment security is other-than-temporary, may have a material adverse affect on future earnings.
Goodwill. Goodwill is not subject to regular amortization but instead is required to be tested for impairment at least annually and possibly more frequently if certain events occur or changes in circumstances arise. In testing goodwill for impairment, we have the option to first assess 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. If, after assessing the totality of events and circumstances, we determine it is not more likely than not that the fair value of a reporting unit is less than its carrying value, then performing the impairment test would be unnecessary. However, if we conclude otherwise, it would then be required to perform the quantitative impairment test. In the quantitative impairment test, the fair value of each reporting unit is compared to its carrying amount in order to determine if impairment is indicated. If the estimated fair value exceeds the carrying amount, the reporting unit is not deemed to be impaired. If the estimated fair value is below the carrying value of the reporting unit, the difference is the amount of impairment. Determining the fair value of a reporting unit requires a high degree of subjective judgment, including developing cash flow projections, selecting appropriate discount rates, identifying relevant market comparables, incorporating general economic and market conditions and selecting an appropriate control premium.
Future changes in the economic environment or the operations of the reporting units could cause changes to these variables, which could give rise to declines in the estimated fair value of goodwill. Declines in fair value could result in impairment being identified. We have established June 30 of each year as the date for conducting our annual goodwill impairment assessment. Quarterly, we evaluate if there are any triggering events that would require an update to our previous assessment. The variables are selected as of June 30 and the valuation model is run to determine the fair value of the reporting unit. We have determined that goodwill was not impaired as of June 30, 2019.
As of December 31, 2019, we have determined that goodwill is not impaired and there were no changes in our operations that would cause us to update the goodwill impairment test performed as of June 30, 2019.
Deferred Income Taxes. We use the asset and liability method of accounting for income taxes. Using 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 current 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 be applied 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 liabilities and assets. These judgments require us to make projections of future taxable income. The judgments and estimates we make in determining our deferred tax assets, which are inherently subjective, are reviewed on an ongoing basis as regulatory and business factors change. A reduction in estimated future taxable income could require us to record a valuation allowance. Changes in levels of valuation allowances could result in increased income tax expense, and could negatively affect earnings.
Pension Benefits. Pension expense and obligations depend on assumptions used in calculating such amounts. These assumptions include discount rates, anticipated salary increases, interest costs, expected return on plan assets, mortality rates, and other factors. In accordance with U.S. generally accepted accounting principles, actual results that differ from the assumptions are amortized over average future service and, therefore, generally affect recognized expense. While management believes that the assumptions used are appropriate, differences in actual experience or changes in assumptions may affect our pension obligations and future expense.
In determining the projected benefit obligations for pension benefits at December 31, 2019 and 2018, we used a discount rate of 3.14% and 4.15%, respectively. We use the Citigroup Pension Liability Index rates matching the duration of our benefit payments as of the measurement date, December 31, to determine the discount rate.
Recently Issued Accounting Standards
The following accounting standard updates issued by the Financial Accounting Standards Board have not yet been adopted.
In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments", which eliminates the probable initial recognition threshold for credit losses and instead requires that all financial assets (or group of financial assets) measured at amortized cost be presented at the net amount expected to be collected inclusive of the entity’s current estimate of all lifetime expected credit losses. This guidance also applies to certain off-balance-sheet credit exposures such as unfunded commitments and non-derivative financial guarantees. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial assets in order to present the net carrying value at the amount expected to be collected on the financial asset. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. The income statement under this guidance will reflect the initial recognition of current expected credit losses for newly recognized assets, as well as any increases or decreases of expected credit losses that have occurred during the period. This guidance retains many currently-existing disclosures related to the credit quality of an entity’s assets and the related allowance for credit losses amended to reflect the change to an expected credit loss methodology, as well as enhanced disclosures to provide information to users at a more disaggregated level. Upon adoption, ASU 2016-13 provides for a modified retrospective transition by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is effective, except for debt securities for which other-than-temporary impairment has previously been recognized. For these debt securities, a prospective transition is provided in order to maintain the same amortized cost prior to and subsequent to the effective date of the ASU. This guidance is effective for annual reporting periods beginning after December 15, 2019, and interim periods within those annual periods with early adoption permitted for fiscal years beginning after December 15, 2018, and interim periods within those annual periods.
Management has created a formal working group to govern the implementation of these amendments, consisting of key stakeholders from finance, risk, credit and accounting. The working group meets periodically to discuss the progress of implementation, monitor the established timeline and discuss latest hot topics and industry trends. We have engaged a third party to assist in the development of certain portfolio-level estimation methodologies and have chosen, and are in the process of implementing, a third-party software platform provider and have completed a preliminary current expected credit loss estimation. This estimation includes the quantitative and qualitative components of the calculation which incorporates a forecasting component of certain economic variables. We are currently working to finalize our documentation around the CECL methodology and designing and updating processes, internal controls and financial statement disclosures. The CECL model was also reviewed and validated by an independent consultant during the fourth quarter of 2019 and recommendations will be reviewed and implemented prior to adoption. While the impact of adopting ASU 2016-13 will depend upon the state of the economy, the nature of our portfolios, the model calibration and remaining implementation steps, among other items at the date of adoption, we currently expect the adoption of ASU 2016-13 could result in a combined 15% to 35% increase in our allowance for loan losses and our reserves for unfunded commitments.
The adoption of ASU 2016-13 is not expected to have a significant impact on our regulatory capital ratios. We plan to phase-in the transitional amounts impacting regulatory capital over a three-year period with 25% of the impact in the first year, 50% in the second year, 75% in the third year and the full impact beginning in the fourth year.
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.” This guidance removes, modifies and adds disclosure requirements for fair value measurements. This guidance is effective for annual periods beginning after December 15, 2019, including interim periods within those years, with early adoption permitted for any removed or modified disclosure requirements. Transition is on a prospective basis for the new and modified disclosures, and on a retrospective basis for disclosures that have been eliminated. We do not expect this guidance to have a material impact on our financial statements.
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.” This guidance removes and adds disclosure requirements for defined benefit pension or other post-retirement plans. This guidance is effective for annual periods beginning after December 15, 2020, with early adoption permitted, and requires retrospective adoption for all periods presented. We do not expect this guidance to have a material impact on our financial statements.
In August 2018, the FASB issued ASU 2018-15, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40) - Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” This guidance aligns the requirements for capitalization of implementation costs incurred in a hosting arrangement that is a service contract with the existing guidance for internal-use software. This guidance is effective for annual periods beginning after December 15, 2019, including interim periods within those years, with early adoption permitted. Transition can either be on a retrospective basis or a prospective basis on all implementation costs incurred after the date of adoption. We will apply this guidance on a prospective basis upon adoption and do not expect it to have a material impact on our financial statements.
In December 2019, the FASB issued ASU 2019-12, "Income Taxes - Simplifying the Accounting for Income Taxes." This guidance simplifies the accounting for income taxes by eliminating certain exceptions to the guidance in ASC 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition for deferred tax liabilities for outside basis differences. ASU 2019-12 also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. This guidance is effective for annual periods beginning after December 15, 2020, including interim periods within those years, with early adoption permitted. We do not expect this guidance to have a material impact on our financial statements.
Balance Sheet Analysis
Assets. Total assets at December 31, 2019 were $10.494 billion, an increase of $886.1 million, or 9.2%, from $9.608 billion at December 31, 2018. This increase in assets was due primarily to an increase in net loans receivable of $754.5 million. A discussion of significant changes follows.
Cash and cash equivalents. Cash and cash equivalents decreased by $7.9 million, or 11.5%, to $60.8 million at December 31, 2019, from $68.8 million at December 31, 2018. This decrease was a result of funding gross loan growth of $757.2 million, partially offset by increases in deposits of $697.8 million and borrowings of $11.9 million.
Investment securities. Investment securities increased by $13.7 million, or 1.7%, to $837.9 million at December 31, 2019, from $824.2 million at December 31, 2018. This increase was a result of using the cash flow generated from these portfolios to purchase higher yielding investment securities.
The following table sets forth certain information regarding the amortized cost and fair value of our available-for-sale investment securities portfolio and mortgage-backed securities portfolio at the dates indicated.
The following table sets forth certain information regarding the amortized cost and fair value of our held-to-maturity investment securities portfolio and mortgage-backed securities portfolio at the dates indicated.
The following table sets forth information regarding the issuers and the carrying value of our mortgage-backed securities at the dates indicated.
Investment Portfolio Maturities and Yields. The following table sets forth the scheduled maturities, carrying values, amortized cost, market values and weighted average yields for our investment securities and mortgage-backed securities portfolios at December 31, 2019. Adjustable-rate mortgage-backed securities are included in the period in which interest rates are next scheduled to adjust.
Further information and analysis of our investment portfolio, including tables with information related to gross unrealized gains and losses on available-for sale and held-to-maturity investment securities and tables showing the fair value and gross unrealized losses on investment securities aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position are located in note 5 of the notes to the Consolidated Financial Statements.
Loans Receivable. Net loans receivable increased by $754.5 million, or 9.4%, to $8.751 billion at December 31, 2019, from $7.996 billion at December 31, 2018. This increase was due primarily to the addition of $407.8 million, at fair value, of loans related to the acquisition of Union Community Bank ("UCB") as well as organic growth of $346.7 million over the last twelve months.
Set forth below are selected data related to the composition of our loan portfolio by type of loan as of the dates indicated.
(1) Consists primarily of secured and unsecured personal loans.
The following table sets forth the maturity of our loan portfolio at December 31, 2019. Demand loans and loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less. Adjustable and floating-rate loans are included in the period in which they contractually mature, and fixed-rate loans are included in the period in which the contractual repayment is due.
The following table sets forth at December 31, 2019, the dollar amount of all fixed-rate and adjustable-rate loans due one year or more after December 31, 2019. Adjustable and floating-rate loans are included in the table based on the contractual due date of the loan.
Deposits. Total deposits increased by $697.8 million, or 8.8%, to $8.592 billion at December 31, 2019 from $7.894 billion at December 31, 2018 primarily due to the addition of $479.4 million, at fair value, related to the UCB acquisition. In addition, legacy total deposits increased by $218.4 million, or 2.8%. Contributing to this increase, our legacy interest-bearing demand deposits increased by $398.3 million, or 27.4%, to $1.854 billion at December 31, 2019 from $1.455 billion at December 31, 2018 as well as our legacy time deposits increased by $44.1 million, or 3.1%. Legacy money market deposit accounts also increased by $120.5 million, or 7.3%, to $1.782 billion at December 31, 2019 from $1.662 billion at December 31, 2018. Partially offsetting these increases was a decrease in legacy noninterest-bearing demand deposits of $263.8 million, or 15.2%, to $1.472 billion at December 31, 2019 from $1.736 billion at December 31, 2018. Additionally, legacy savings deposits decreased by $80.7 million, or 4.9%, to $1.555 billion at December 31, 2019 from $1.636 billion at December 31, 2018 as a result of recent increased market interest rate competition for interest rate sensitive customers.
The following table sets forth the dollar amount of deposits in the various types of accounts we offered at the dates indicated.
(1) Represents percentage of total deposits.
(2) Represents weighted average nominal rate at year end.
The following table sets forth the dollar amount of deposits in each state by branch location as of December 31, 2019.
The following table indicates the amount of our certificates of deposit of $100,000 or more by time remaining until maturity at December 31, 2019.
Borrowings. Borrowings increased by $11.9 million, or 5.1%, to $246.3 million at December 31, 2019 from $234.4 million at December 31, 2018, in order to fund internal loan growth.
The following table sets forth information concerning our borrowings at the dates and for the periods indicated.
Shareholders’ equity. Total shareholders’ equity at December 31, 2019 was $1.353 billion, an increase of $95.6 million, or 7.6%, from $1.258 billion at December 31, 2018. This increase in equity was primarily the result of net income of $110.4 million as well as the impact of $43.3 million from the issuance of common stock for the Union Community Bank acquisition in the second quarter of 2019. This increase was partially offset by the payment of cash dividends of $76.2 million.
Average Balance Sheets
The following tables set forth average balance sheets, average yields, on a FTE basis, and average costs, and certain other information at and for the periods indicated. All average balances are daily average balances. Non-accrual loans are included in the computation of average balances. The yields set forth below include the effect of deferred fees and discounts and premiums that are amortized or accreted to interest income or expense. The average yield for loans receivable and investment securities are calculated on a fully-taxable equivalent basis.
(1)
Average gross loans receivable includes loans held as available-for-sale and loans placed on nonaccrual status.
(2)
Interest income includes accretion/amortization of deferred loan fees/expenses, which was not material.
(3)
Interest income on tax-free loans is presented on a FTE basis including adjustments, as indicated.
(4)
Average balances do not include the effect of unrealized gains or losses on securities held as available-for-sale.
(5)
Interest income on tax-free investment securities is presented on a FTE basis including adjustments, as indicated.
(6)
Average balances include the effect of unrealized gains or losses on securities held as available-for-sale.
(7)
Average balances include FHLB borrowings and collateralized borrowings.
(8)
Average cost of deposits were 0.58%, 0.39% and 0.29%, respectively.
(9)
Net interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(10)
Net interest margin represents net interest income as a percentage of average interest-earning assets.
(11)
Shown on a FTE basis. GAAP basis yields for the years ended December 31, 2019, 2018 and 2017 were - Loans: 4.61%, 4.52% and 4.44%, respectively, Investment securities: 2.06%, 1.72% and 1.65%, respectively, Interest-earning assets: 4.42%, 4.29% and 4.10%, respectively. GAAP basis net interest rate spreads were 3.61%, 3.72% and 3.68%, respectively, and GAAP basis net interest margins were 3.82%, 3.86% and 3.78%, respectively.
Rate/Volume Analysis
The following table presents, on a FTE basis, the changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities for the year ended December 31, 2019 compared to 2018 and for the year ended December 31, 2018 compared to 2017. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to: (1) changes in volume multiplied by the prior year rate; (2) changes in rate multiplied by the prior year volume; and (3) the total increase or decrease. Changes not solely attributable to rate or volume have been allocated proportionately to the change due to volume and the change due to rate.
Comparison of Results of Operations for the Years Ended December 31, 2019 and 2018
General. Net income for the year ended December 31, 2019 was $110.4 million, or $1.04 per diluted share, an increase of $4.9 million, or 4.7%, from $105.5 million, or $1.02 per diluted share, for the year ended December 31, 2018. The increase in net income resulted from an increase in net interest income of $21.8 million, or 6.4% and noninterest income of $7.7 million, or 8.4%. Partially offsetting these increases was an increase in provision for loan losses of $2.3 million, or 11.4%, an increase in noninterest expense of $20.0 million, or 7.2%, and an increase in income tax expense of $2.3 million, or 7.9%.
Net income for the year ended December 31, 2019 represents returns on average equity and average assets of 8.36% and 1.07%, respectively, compared to 8.61% and 1.11% for the year ended December 31, 2018. A discussion of significant changes follows.
Interest Income. Total interest income increased by $41.6 million, or 11.1%, to $417.4 million for the year ended December 31, 2019 from $375.8 million for the year ended December 31, 2018. This increase is the result of an increase in the average balance of interest earning assets of $675.3 million, or 7.7%, to $9.438 billion for the year ended December 31, 2019 from $8.763 billion for the year ended December 31, 2018 and an increase in the average yield on interest-earning assets to 4.44% for the year ended December 31, 2019 from 4.30% for the year ended December 31, 2018.
Interest income on loans receivable increased by $38.2 million, or 10.7%, to $394.8 million for the year ended December 31, 2019 from $356.6 million for the year ended December 31, 2018. This increase in interest income on loans receivable is attributed to increases in the average balance and average yield on loans receivable. The average balance increased by $671.0 million, or 8.5%, to $8.555 billion for the year ended December 31, 2019 from $7.884 billion for the year ended December 31, 2018. This increase is due primarily to the addition of $407.8 million, at fair value, of loans related to the UCB acquisition and organic loan growth of $349.4 million. Additionally, the average yield on loans receivable increased to 4.63% for the year ended December 31, 2019 from 4.54% for the year ended December 31, 2018. The average loan yield was positively affected by increases in market interest rates over the past year before the Federal Reserve started its recent interest rate easing strategy.
Interest income on mortgage-backed securities increased by $2.9 million, or 21.0%, to $16.7 million for the year ended December 31, 2019 from $13.8 million for the year ended December 31, 2018. This increase is the result of increases in both the average balance and average yield. The average balance of mortgage-backed securities increased by $53.2 million, or 9.1%, to $639.8 million for the year ended December 31, 2019 from $586.6 million for the year ended December 31, 2018. The average yield on mortgage-backed securities increased to 2.61% for the year ended December 31, 2019 from 2.35% for the year ended December 31, 2018 due to the purchase of fixed-rate mortgage-backed securities, including the UCB portfolio, with yields higher than the existing Northwest portfolio.
Interest income on investment securities remained relatively flat, increase by $103,000, or 2.5%, to $4.2 million for the year ended December 31, 2019 from $4.1 million for the year ended December 31, 2018. This increase is the result of an increase in the average yield on investment securities to 2.17% for the year ended December 31, 2019 from 1.84% for the year ended December 31, 2018, due primarily to the addition of higher yielding investments, including municipal bonds, from the UCB acquisition. Partially offsetting this increase was a decrease in the average balance of investment securities of $35.2 million, or 14.6%, to $205.8 million for the year ended December 31, 2019 from $241.0 million for the year ended December 31, 2018, which was primarily due to the maturity or call of government agency securities.
Dividends on FHLB stock increased by $604,000, or 133.6%, to $1.1 million for the year ended December 31, 2019 from$452,000 for the year ended December 31, 2018. This increase is the result of increases in both the average balance and average yield. The average balance on FHLB stock increased by $4.1 million, or 39.8%, to $14.5 million for the year ended December 31, 2019 from $10.4 million for the year ended December 31, 2018. Additionally, the average yield on FHLB stock increased to 7.29% for the year ended December 31, 2019 from 4.37% for the year ended December 31, 2018. Required FHLB stock holdings fluctuate with, among other things, the utilization of our borrowing capacity as well as capital requirements established by the FHLB.
Interest income on interest-earning deposits decreased by $235,000, or 28.1%, to $600,000 for the year ended December 31, 2019 from $835,000 for the year ended December 31, 2018. This decrease is attributable to a decrease in the average balance of interest-earning deposits. The average balance decreased by $17.8 million, or 43.3%, to $23.3 million for the year ended December 31, 2019 from $41.1 million for the year ended December 31, 2018, due to the utilization of excess cash to fund loan growth. Partially offsetting this decrease was an increase in the average yield on interesting-earning deposits to 2.54% for the year ended December 31, 2019 from 2.00% for the year ended December 31, 2018, as a result of previous increases in the targeted Federal Funds rate by the Federal Reserve Board before declining in the second half of 2019.
Interest Expense. Interest expense increased by $19.8 million, or 53.2%, to $56.9 million for the year ended December 31, 2019 from $37.1 million for the year ended December 31, 2018. This increase in interest expense was due to both an increase in the average balance of interest-bearing liabilities and the increase in the average cost of interest-bearing liabilities. The average balance increased by $486.9 million, or 7.5%, to $6.968 billion for the year ended December 31, 2019 from $6.481 billion for the year ended December 31, 2018. This increase was primarily due to the UCB acquisition, which included $479.4 million in deposits. Additionally, the average yield on interest-bearing liabilities increased to 0.82% for the year ended December 31, 2019 from 0.57% for the year ended December 31, 2018. This increase resulted from increases in the interest rates paid on deposits and borrowed funds in response to increases in market interest rates.
Net Interest Income. Net interest income increased by $21.8 million, or 6.4%, to $360.5 million for the year ended December 31, 2019 from $338.6 million for the year ended December 31, 2018. This increase is attributable to the factors discussed above. Our interest-bearing deposit costs rose greater than yields on interest-earning assets reducing both our interest rate spread and net interest margin. Our interest rate spread decreased to 3.62% for the year ended December 31, 2019 from 3.73% for the year ended December 31, 2018 and our net interest margin also decreased to 3.84% for the year ended December 31, 2019 from 3.88% for the year ended December 31, 2018.
Provision for Loan Losses. We analyze the allowance for loan losses as described in note 1(f) of the notes to the Consolidated Financial Statements. The provision for loan losses increased by $2.3 million, or 11.4%, to $22.7 million for the year ended December 31, 2019 from $20.3 million for the year ended December 31, 2018. This increase is due primarily to a downgrade of an $11.5 million commercial loan resulting in a loan loss reserve on this relationship of approximately $7.4 million. Partially offsetting this increase was a decrease in total nonaccrual loans by $3.4 million, or 4.7%, to $68.9 million, or 0.78% of total loans, at December 31, 2019 from $72.3 million, or 0.90% of total loans, at December 31, 2018. In addition, total loan delinquency decreased to $119.4 million, or 1.36% of total loans at December 31, 2019 from $121.5 million, or 1.51% of total loans at December 31, 2018.
In determining the amount of the current period provision, we considered current economic conditions, including unemployment levels, bankruptcy filings, and changes in real estate values, and assessed the impact of these factors on the quality of our loan portfolio and historical loss factors. We analyze the allowance for loan losses as described in the section entitled “Allowance for Loan Losses.” The provision that is recorded is sufficient, in our judgment, to bring this reserve to a level that reflects the losses inherent in our loan portfolio relative to loan mix, economic conditions and historical loss experience as of December 31, 2019.
Noninterest Income. Noninterest income increased by $7.7 million, or 8.4%, to $99.4 million for the year ended December 31, 2019 from $91.7 million for the year ended December 31, 2018. This increase is primarily attributable to a $3.2 million, or 540.8%, increase in mortgage banking income to $3.8 million for the year ended December 31, 2019 from $596,000 for the year ended December 31, 2018, as a result of expanding our secondary market sales capabilities. Service charges and fees also increased $2.3 million, or 4.5%, to $53.1 million for the year ended December 31, 2019 from $50.8 million for the year ended December 31, 2018, primarily due to additional fees collected on deposit accounts due to a recent change in fee structure while also being positively impacted by transaction volume. We recognized a gain of $1.7 million during the current year on the sale of approximately $98.2 million of one-to-four family mortgage loans from our portfolio. Also, trust and other financial services income increased by $1.2 million, or 7.1%, to $17.8 million for the year ended December 31, 2019 from $16.6 million for the year ended December 31, 2018, due primarily to new brokerage production. Slightly offsetting these increases was a decrease of $1.4 million, or 24.1%, in income on bank owned life insurance to $4.4 million for the year ended December 31, 2019 from $5.8 million for the year ended December 31, 2018 due to death benefits received in the prior year.
Noninterest Expense. Noninterest expense increased by $20.0 million, or 7.2%, to $296.1 million for the year ended December 31, 2019 from $276.1 million for the year ended December 31, 2018. All noninterest expense categories, with the exception of federal deposit insurance premiums, marketing expense, and real estate owned expense, increased compared to last year. Most of these increases resulted from the UCB acquisition as well as the pending MutualFirst Financial, Inc. acquisition scheduled to close in the second quarter of 2020. The largest driver of the overall increase was a $10.7 million, or 7.0%, increase in compensation and employee benefits expense to $163.1 million for the year ended December 31, 2019 from $152.4 million for the year ended December 31, 2018, due to both internal growth in compensation and staff as well as the addition of UCB employees. Also contributing to the increase was an increase in processing expenses of $3.4 million, or 8.7%, to $42.5 million for the year ended December 31, 2019 from $39.0 million for the year ended December 31, 2018, primarily due to our continued efforts to invest in technology and infrastructure as well as improvements to our mortgage and commercial loan origination platforms. Acquisition expense increased by $3.2 million, or 311.0%, to $4.2 million for the year ended December 31, 2019 from $1.0 million for the year ended December 31, 2018 due both to costs incurred as part of the UCB acquisition as well as initial expenses incurred as a result of the MutualFirst Financial, Inc. acquisition. Professional services expenses also increased by $1.7 million, or 15.9% primarily as a result of the continued consulting engagements related to the implementation of ASU 2016-13 - Financial Instruments - Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments as well as a deposit consulting engagement focused on product, price and promotion. Additionally, other noninterest expense increased by $2.7 million or 23.5%, to $14.0 million for the year ended December 31, 2019 from $11.3 million for the year ended December 31, 2018, due to both an increase in pension related servicing costs and an increase in litigation expenses. Slightly offsetting these increases was a decrease in FDIC premiums of $2.1 million, or 75.1%, due to an FDIC assessment credit received during the current year as a result of the deposit insurance fund becoming fully funded as well as a decrease in marketing expense of $1.4 million, or 17.0%, due primarily to our debit card reward program being discontinued.
Income Taxes. The provision for income taxes increased by $2.3 million, or 7.9%, to $30.7 million for the year ended December 31, 2019 from $28.4 million for the year ended December 31, 2018. This increase in income tax expense is primarily the result of the $7.2 million, or 5.4%, increase in pretax income to $141.1 million for the year ended December 31, 2019 from $133.9 million for the year ended December 31, 2018. In addition, our effective tax rate for the year ended December 31, 2019 was 21.7% compared to 21.2% for the year ended December 31, 2018.
Comparison of Results of Operations for the Years Ended December 31, 2018 and 2017
General. Net income for the year ended December 31, 2018 was $105.5 million, or $1.02 per diluted share, an increase of $11.0 million, or 11.7%, from $94.5 million, or $0.92 per diluted share, for the year ended December 31, 2017. The increase in net income resulted from an increase in net interest income of $7.9 million, or 2.4% and decreases in noninterest expense of $9.5 million, or 3.3%, and income tax expense of $13.0 million, or 31.4%. Partially offsetting these factors was a decrease in noninterest income of $18.8 million or 17.0%, and an increase in provision for loan losses of $581,000, or 2.9%.
Net income for the year ended December 31, 2018 represents returns on average equity and average assets of 8.61% and 1.11%, respectively, compared to 7.95% and 0.99% for the year ended December 31, 2017. A discussion of significant changes follows.
Interest Income. Total interest income increased by $16.9 million, or 4.7%, to $375.8 million for the year ended December 31, 2018 from $358.9 million for the year ended December 31, 2017. This increase is the result of an increase in the average balance of interest earning assets of $17.7 million, or 0.20%, to $8.763 billion for the year ended December 31, 2018 from $8.745 billion for the year ended December 31, 2017 and an increase in the average yield on interest-earning assets to 4.30% for the year ended December 31, 2018 from 4.14% for the year ended December 31, 2017.
Interest income on loans receivable increased by $16.6 million, or 4.9%, to $356.6 million for the year ended December 31, 2018 from $340.0 million for the year ended December 31, 2017. This increase in interest income on loans receivable is attributed to increases in the average balance and average yield of loans receivable. The average balance increased by $219.7 million, or 2.9%, to $7.884 billion for the year ended December 31, 2018 from $7.664 billion for the year ended December 31, 2017. This increase is due
primarily to $258.0 million of organic loan growth during 2018, as we continue our focus on expanding our commercial banking and indirect consumer portfolios, as well as a reduction in the sale of residential mortgage loans into the secondary market. Additionally, the average yield on loans receivable increased to 4.54% for the year ended December 31, 2018 from 4.46% for the year ended December 31, 2017. The average loan yield was positively affected by an increase in rates on adjustable rate loans in response to increases in short-term rates by the Federal Reserve.
Interest income on mortgage-backed securities increased by $2.4 million, or 21.5%, to $13.8 million for the year ended December 31, 2018 from $11.3 million for the year ended December 31, 2017. This increase is the result of increases in both the average balance and average yield. The average balance of mortgage-backed securities increased by $22.9 million, or 4.1%, to $586.6 million for the year ended December 31, 2018 from $563.7 million for the year ended December 31, 2017. The increase in the average balance was due to the purchase of higher yielding mortgage-backed securities with the cash flow from our investment securities. The average yield on mortgage-backed securities increased to 2.35% for the year ended December 31, 2018 from 2.01% for the year ended December 31, 2017 due to both an increase in short-term market interest rates that positively impacted the yield of adjustable rate mortgage-backed securities and the purchase of fixed rate mortgage-backed securities with yields higher than the existing portfolio.
Interest income on investment securities decreased by $1.7 million, or 28.2%, to $4.1 million for year ended December 31, 2018 from $5.8 million for the year ended December 31, 2017. This decrease is the result of a decrease in the average balance of investment securities of $109.9 million, or 31.3%, to $241.0 million for the year ended December 31, 2018 from $350.9 million for the year ended December 31, 2017 which was primarily due to the maturity or call of municipal and government agency securities. Partially offsetting this decrease was an increase in the average yield on investment securities to 1.84% for the year ended December 31, 2018 from 1.96% for the year ended December 31, 2017, due primarily to an increase in short-term market interest rates.
Dividends on FHLB stock increased by $202,000, or 80.8%, to $452,000 for the year ended December 31, 2018 from $250,000 for the year ended December 31, 2017. This increase is the result of increases in both the average balance and average yield. The average balance on FHLB stock increased by $2.2 million, or 26.5%, to $10.4 million for the year ended December 31, 2018 from $8.2 million for the year ended December 31, 2017. Additionally, the average yield on FHLB stock increased to 4.37% for the year ended December 31, 2018 from 3.05% for the year ended December 31, 2017. Required FHLB stock holdings fluctuate with, among other things, the utilization of our borrowing capacity as well as capital requirements established by the FHLB.
Interest income on interest-earning deposits decreased by $664,000, or 44.3%, to $835,000 for the year ended December 31, 2018 from $1.5 million for the year ended December 31, 2017. This decrease is attributable to a decrease in the average balance of interest-earning deposits. The average balance decreased by $117.2 million, or 74.0%, to $41.1 million for the year ended December 31, 2018 from $158.2 million for the year ended December 31, 2017, due to the utilization of excess cash to fund loan growth. Partially offsetting this decrease was an increase in the average yield on interesting-earning deposits to 2.00% for the year ended December 31, 2018 from 0.93% for the year ended December 31, 2017, as a result of recent increases in the targeted Federal Funds rate by the Federal Reserve Board.
Interest Expense. Interest expense increased by $9.1 million, or 32.3%, to $37.1 million for the year ended December 31, 2018 from $28.1 million for the year ended December 31, 2017. This increase in interest expense was due to an increase in the average cost of interest-bearing liabilities to 0.57% for the year ended December 31, 2018 from 0.42% for the year ended December 31, 2017. This increase resulted from increases in the interest rates paid on deposits and borrowed funds in response to increases in market interest rates. Partially offsetting this increase in cost was a decrease in the average balance of interest bearing liabilities of $183.8 million, or 2.8%, to $6.481 billion for the year ended December 31, 2018 from $6.665 billion for the year ended December 31, 2017. This decrease is due primarily to the sale of our three Maryland offices in May 2017 with deposits of $211.7 million as well as intensified competition for rate sensitive customers. In addition, our efforts to grow noninterest-bearing checking accounts have been successful, increasing the average balance by $154.3 million, or 9.9%, to $1.711 billion for the year ended December 31, 2018 from $1.557 billion for the year ended December 31, 2017.
Net Interest Income. Net interest income increased by $7.9 million, or 2.4%, to $338.6 million for the year ended December 31, 2018 from $330.8 million for the year ended December 31, 2017. This increase is attributable to the factors discussed above. As a result of loan growth and the continued change in our deposit mix toward lower cost accounts, both our interest rate spread and net interest margin increased. Net interest rate spread increased to 3.73% for the year ended December 31, 2018 from 3.72% for the year ended December 31, 2017 while net interest margin increased to 3.88% for the year ended December 31, 2018 from 3.82% for the year ended December 31, 2017.
Provision for Loan Losses. We analyze the allowance for loan losses as described in note 1(f) of the notes to the Consolidated Financial Statements. The provision for loan losses increased by $581,000, or 2.9%, to $20.3 million for the year ended December 31, 2018 from $19.8 million for the year ended December 31, 2017. This increase is due primarily to a $4.6 million write-down on one commercial real estate loan. Additionally, total nonaccrual loans increased by $7.8 million, or 12.1%, to $72.3 million, or 0.90% of total loans, at December 31, 2018 from $64.5 million, or 0.83% of total loans, at December 31, 2017. Total loan delinquency increased to
$121.5 million, or 1.51% of total loans at December 31, 2018 from $117.5 million, or 1.51% of total loans at December 31, 2017. Partially offsetting these trends was a reduction in loans risk rated substandard by $53.7 million, or 22.7%, to $184.1 million at December 31, 2018 from $237.8 million at December 31, 2017 as well as the recalculation of the quantitative and qualitative factors used to determine the allowance for loan losses.
In determining the amount of the current period provision, we considered current economic conditions as of December 31, 2018, including unemployment levels, bankruptcy filings, and changes in real estate values, and assessed the impact of these factors on the quality of our loan portfolio and historical loss factors. We analyze the allowance for loan losses as described in the section entitled “Allowance for Loan Losses.” The provision that was recorded was sufficient, in our judgment, to bring this reserve to a level that reflects the losses inherent in our loan portfolio relative to loan mix, economic conditions and historical loss experience as of December 31, 2018.
Noninterest Income. Noninterest income decreased by $18.8 million, or 17.0%, to $91.7 million for the year ended December 31, 2018 from $110.5 million for the year ended December 31, 2017. This decrease is primarily attributable to the $17.2 million gain on the sale of our three Maryland offices in May 2017. Additionally, trust and other financial services income decreased by $1.4 million, or 7.8%, to $16.6 million for the year ended December 31, 2018 from $18.0 million for the year ended December 31, 2017, due primarily to the sale of our retirement services subsidiary in December 2017. Also, investment securities sold during 2018 resulted in profits of $157,000 compared to a $1.1 million gain during 2017. Mortgage banking income also decreased by $822,000, or 58.0%, to $596,000 for the year ended December 31, 2018 from $1.4 million for the year ended December 31, 2017, as a result of a reduction in the sale of residential mortgage loans into the secondary market. Positively impacting noninterest income was an increase in service charges and fees of $1.1 million, or 2.2%, to $50.8 million for the year ended December 31, 2018 from $49.7 million for the year ended December 31, 2017, due primarily to increased transaction volume. Additionally, other operating income increased by $880,000, or 10.1%, due primarily to the growth in fee income associated with commercial lending activity and fees earned from debit and credit card volume-based incentives.
Noninterest Expense. Noninterest expense decreased by $9.5 million, or 3.3%, to $276.1 million for the year ended December 31, 2018 from $285.6 million for the year ended December 31, 2017. All noninterest expense categories, with the exception of compensation and employee benefits, professional services and other expense, decreased compared to last year. Most of these decreases are a result of the restructuring that occurred during 2017, including a reduction of acquisition and restructuring costs of $3.4 million, or 77.1%, related to the sale of our three Maryland region offices and retirement services business along with the closure of our consumer finance subsidiary. Office operations decreased by $2.2 million, or 13.5% to $14.1 million for the year ended December 31, 2018 from $16.3 million for the year ended December 31, 2017, due to an enhanced fraud monitoring program implemented during 2018. Additionally, marketing expense decreased by $1.2 million, or 12.2%, to $8.4 million for the year ended December 31, 2018 from $9.6 million for the year ended December 31, 2017, primarily due to the timing of checking account acquisition campaigns. Partially offsetting this decrease was an increase in compensation and employee benefits of $99,000, or 0.1%, to $152.4 million for the year ended December 31, 2018 from $152.3 million for the year ended December 31, 2017. This increase is due primarily to normal salary increases as well as increases in the cost of other employee benefits offset by the impact of the restructuring that occurred during 2017. Professional services expenses increased by $305,000, or 3.0% primarily as a result of consulting engagements related to the implementation of ASU 2016-13 - Financial Instruments - Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments, and legal fees associated with the completion of several lawsuits, including the successful conclusion of the Northwest Insurance Services lawsuit. Additionally, other noninterest expense increased by $771,000, or 7.3%, to $11.3 million for the year ended December 31, 2018 from $10.6 million for the year ended December 31, 2017, due primarily to an increase in the reserve for unfunded loan commitments by approximately $800,000.
Income Taxes. The provision for income taxes decreased by $13.0 million, or 31.4%, to $28.4 million for the year ended December 31, 2018 from $41.4 million for the year ended December 31, 2017. This decrease in income tax expense is primarily the result of the enactment of the Tax Cuts and Jobs Act in December 2017, which decreased our corporate tax rate to 21% for the year ended December 31, 2018 from 35% for the year ended December 31, 2017. Additionally, pretax income decreased by $2.0 million, or 1.5%, to $133.9 million for the year ended December 31, 2018 from $135.9 million for the year ended December 31, 2017.
Asset Quality
We actively manage asset quality through our underwriting practices and collection procedures. Our underwriting practices are focused on balancing risk and return while our collection operations focus on diligently working with delinquent borrowers in an effort to minimize losses.
Collection procedures. Our collection procedures for personal loans generally provide that at 15 days delinquent, a notice of late charges is sent and personal contact efforts are attempted by telephone to strengthen the collection process and obtain reasons for the delinquency. Also, plans to establish a payment program are developed. Personal contact efforts are continued throughout the collection process, as necessary. Generally, if a loan becomes 30 days past due, a collection letter is sent and the loan becomes subject to possible legal action if suitable arrangements for payment have not been made. In addition, the borrower is given information which provides access to consumer counseling services to the extent required by the regulations of the Department of Housing and Urban Development
and other applicable authorities. When a loan continues in a delinquent status for 60 days or more, and a payment schedule has not been developed or kept by the borrower, we may send the borrower a notice of intent to foreclose, providing for cure periods of at least 30 days. If not cured, foreclosure proceedings are initiated.
Nonperforming assets. Loans are reviewed on a regular basis and are placed on nonaccrual status when, in the opinion of management, the collection of all contractual principal and/or interest is doubtful. Loans are automatically placed on nonaccrual status when either principal or interest is 90 days or more past due. Interest accrued and unpaid at the time a loan is placed on a nonaccrual status is reversed and charged against interest income.
Real estate acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned until such time that it is sold. When real estate is acquired through foreclosure or by deed in lieu of foreclosure, it is recorded at the lower of the related loan balance or its fair value as determined by an appraisal, less estimated costs of disposal. If the value of the property is less than the principal balance, less any related specific loan loss reserve allocations, the difference is charged against the allowance for loan losses. Any subsequent write-down of real estate owned or loss at the time of disposition is charged against earnings.
Nonaccrual, Past Due, Restructured Loans and Nonperforming Assets. The following table sets forth information with respect to nonperforming assets. Nonaccrual loans are those loans on which the accrual of interest has ceased. Generally, when a loan becomes 90 days past due, we fully reverse all accrued interest thereon and cease to accrue interest thereafter. Exceptions are made for loans that have contractually matured, are in the process of being modified to extend the maturity date and are otherwise current as to principal and interest, and well secured loans that are in process of collection. Loans may also be placed on nonaccrual before they reach 90 days past due if conditions exist that call into question our ability to collect all contractual principal and/or interest. Other nonperforming assets represent property acquired through foreclosure or repossession. Foreclosed property is carried at the lower of its fair value less estimated costs to sell or the principal balance of the related loan.
At December 31, 2019, we expected to collect the carrying value of our purchased credit impaired loans and have determined that we can reasonably estimate their future cash flows including those loans that are 90 days or more delinquent. As a result, we do not consider these loans to be nonaccrual or impaired and continue to recognize interest income on these loans, including the loans’ accretable discount.
(1)
Also included in nonaccrual loans above.
During the year ended December 31, 2019, gross interest income of approximately $4.1 million would have been recorded on loans accounted for on a nonaccrual basis if the loans had been current and in accordance with their original terms throughout the year. We recognized $1.1 million of interest income on nonaccrual and troubled debt restructuring loans during the year ended December 31, 2019.
Classification of Assets. Our policies, consistent with regulatory guidelines, provide for the classification of loans considered to be of lesser quality as “substandard,” “doubtful,” or “loss” assets. An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the financial institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” so that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets that do not expose the savings institution to risk sufficient to warrant classification in one of the aforementioned categories, but which possess some weaknesses, are required to be designated “special mention.” At December 31, 2019, we had 196 loans, with an aggregate principal balance of $123.0 million, designated as special mention.
We regularly review our asset portfolio to determine whether any assets require classification in accordance with applicable regulations. Our largest classified assets generally are also our largest nonperforming assets.
The following table sets forth the aggregate amount of our classified assets at the dates indicated.
Allowance for Loan Losses. Our Board of Directors has adopted an “Allowance for Loan and Lease Losses” (“ALL”) policy designed to provide management with a systematic methodology for determining and documenting the ALL each reporting period. This methodology was developed to provide a consistent process and review procedure to ensure that the ALL is in conformity with GAAP, our policies and procedures and other supervisory and regulatory guidelines.
On an ongoing basis, the Credit Administration department, as well as loan officers, branch managers and department heads, review and monitor the loan portfolio for problem loans. This portfolio monitoring includes a review of the monthly delinquency reports as well as historical comparisons and trend analysis. In addition, a meeting is held every quarter with each region to monitor the performance and status of loans on an internal watch list. On an on-going basis the loan officer, in conjunction with a portfolio manager, grades or classifies problem loans or potential problem loans based upon their knowledge of the lending relationship and other information previously accumulated. This rating is also reviewed independently by our Loan Review department on a periodic basis. Our loan grading system for problem loans is consistent with industry regulatory guidelines which classify loans as “substandard”, “doubtful” or “loss.” Loans that do not expose us to risk sufficient to warrant classification in one of the previous categories, but which possess some weaknesses, are designated as “special mention”. A “substandard” loan is any loan that is 90 days or more contractually delinquent or is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as “doubtful” have all the weaknesses inherent in those classified as “substandard” with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions or values, highly questionable and improbable. Loans classified as “loss” are considered uncollectible so that their continuance as assets without the establishment of a specific loss allowance is not warranted.
Credit relationships that have been classified as substandard or doubtful and are greater than or equal to $1.0 million are reviewed by the Credit Administration department for possible impairment. A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement, including both contractual principal and interest payments.
If such an individual loan is deemed to be impaired, the Credit Administration department determines the proper measure of impairment for each loan based on one of three methods: (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) the loan’s observable market price; or (3) the fair value of the collateral if the loan is collateral dependent, less costs of sale or disposal. If the measurement of the impaired loan is more or less than the recorded investment in the loan, the Credit Administration department adjusts the specific allowance associated with that individual loan accordingly.
If a substandard or doubtful loan is not considered individually for impairment, it is grouped with other loans that possess common characteristics for impairment evaluation and analysis. This segmentation is accomplished by grouping loans of similar product types, risk characteristics and industry concentration into homogeneous pools. Historical loss ratios are analyzed and adjusted based on delinquency trends as well as the current economic, political, regulatory, and interest rate environment and used to estimate the current measure of impairment.
The individual impairment measures along with the estimated loss for each homogeneous pool are consolidated into one summary document. This summary schedule along with the support documentation used to establish this schedule is presented to management’s Allowances for loan losses committee ("ALL Committee") monthly. The ALL Committee reviews and approves the processes and ALL documentation presented. Based on this review and discussion, the appropriate amount of ALL is estimated and any adjustments to reconcile the actual ALL with this estimate are determined. The ALL Committee also considers if any changes to the methodology are needed. In addition to the ALL Committee's, review and approval, a review is performed by the Risk Management Committee of the Board of Directors on a quarterly basis, and annually by Internal Audit.
In addition to the reviews by management’s ALL Committee and the Board of Directors’ Risk Management Committee, regulators from either the FDIC and/or the Pennsylvania Department of Banking and Securities perform an extensive review on at least an annual basis for the adequacy of the ALL and its conformity with regulatory guidelines and pronouncements. Any recommendations or enhancements from these independent parties are considered by management and the ALL Committee and implemented accordingly.
We acknowledge that this is a dynamic process and consists of factors, many of which are external and out of our control, that can change frequently, rapidly and substantially. The adequacy of the ALL is based upon estimates using all the information previously discussed as well as current and known circumstances and events. There is no assurance that actual portfolio losses will not be substantially different than those that were estimated.
We utilize a structured methodology each period when analyzing the adequacy of the allowance for loan losses and the related provision for loan losses, which the ALL Committee assesses regularly for appropriateness. As part of the analysis as of December 31, 2019, we considered the economic conditions in our markets, such as unemployment and bankruptcy levels as well as changes in estimates of real estate collateral values, and no material changes in methodology were determined to be necessary. In addition, we considered the overall trends in asset quality, specific reserves already established for criticized loans, historical loss rates and collateral valuations. The ALL increased by $2.7 million, or 4.9%, to $57.9 million, or 0.66% of total loans at December 31, 2019 from $55.2 million, or 0.69% of total loans, at December 31, 2018. This increase is due primarily to the downgrade of an $11.5 million commercial loan that resulted in a loan loss reserve on this relationship of approximately $7.4 million.
Quarterly, management's Credit Committee reviews the concentration of credit by industry and customer, lending products and activity, competition and collateral values, as well as economic conditions in general and in each of our market areas. The Credit Committee also reviews and discusses delinquency trends, nonperforming asset amounts and ALL levels and ratios compared to our peer group as well as state and national statistics.
We also consider how the levels of non-accrual loans and historical charge-offs have influenced the required amount of ALL. Nonaccrual loans of $68.9 million, or 0.78% of total loans receivable at December 31, 2019, decreased by $3.4 million, or 4.7%, from $72.3 million, or 0.90% of total loans receivable, at December 31, 2018. This decrease is due primarily to the write down of $4.0 million on a residential land development loan and payoffs occurring in the portfolio during 2019. As a percentage of average loans, net charge-offs decreased to 0.23% for the year ended December 31, 2019 compared to 0.28% for the year ended December 31, 2018.
Analysis of the Allowance for Loan Losses. The following table sets forth the analysis of the allowance for loan losses for the periods indicated.
Allocation of Allowance for Loan Losses. The following tables set forth the allocation of allowance for loan losses by loan category at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category.
(1)
Represents percentage of loans in each category to total loans.
Liquidity and Capital Resources
Northwest Bank is required to maintain a sufficient level of liquid assets, as determined by management and defined and reviewed for adequacy by the Federal Deposit Insurance Corporation during their regular examinations. The Federal Deposit Insurance Corporation, however, does not prescribe by regulation a minimum amount or percentage of liquid assets. The Federal Deposit Insurance Corporation allows us to consider any unencumbered, available-for-sale marketable security, whose sale would not impair our capital adequacy, to be eligible for liquidity. Liquidity is monitored through the use of a standard liquidity ratio of liquid assets to borrowings plus deposits. Using this formula, Northwest Bank’s liquidity ratio was 8.57% as of December 31, 2019. We adjust our liquidity level in order to meet funding needs of deposit outflows, repayment of borrowings and loan commitments. We also adjust liquidity as appropriate to meet our asset and liability management objectives. Liquidity needs can also be met by temporarily drawing upon lines-of-credit established for such reasons. As of December 31, 2019, Northwest Bank had $3.3 billion of additional borrowing capacity available with the Federal Home Loan Bank of Pittsburgh, including a $250.0 million overnight line of credit, which had a balance of $153.6 million, as well as $40.8 million of borrowing capacity available with the Federal Reserve Bank and $110.0 million with three correspondent banks.
In addition to deposits, our primary sources of funds are the amortization and repayment of loans and mortgage-backed securities, maturities of investment securities and other short-term investments, and earnings and funds provided from operations. While scheduled principal repayments on loans and mortgage-backed securities are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by general interest rate levels, economic conditions, and competition. We manage the pricing of our deposits to maintain a desired deposit balance. In addition, we invest excess funds in short-term interest earning and other assets, which provide liquidity to meet lending requirements. Short-term interest-earning deposits amounted to $3.1 million at December 31, 2019. For additional information about our cash flows from operating, financing, and investing activities, see the Statements of Cash Flows included in the Consolidated Financial Statements.
A portion of our liquidity consists of cash and cash equivalents, which are a product of our operating, investing, and financing activities. The primary sources of cash during the current year were net income and principal repayments on loans and mortgage-backed securities.
Liquidity management is both a daily and long-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the Federal Home Loan Bank of Pittsburgh and the Federal Reserve Bank of Cleveland, which provide an additional source of funds. At December 31, 2019, Northwest Bank had advances of $153.6 million from the Federal Home Loan Bank of Pittsburgh. We borrow from these sources to reduce interest rate risk and to provide liquidity when necessary.
At December 31, 2019, our customers had $917.2 million of unused lines of credit available and $234.1 million in loan commitments. This amount does not include the unfunded portion of loans in process. Time deposits scheduled to mature in less than one year at December 31, 2019, totaled $909.5 million. We believe that a significant portion of such deposits will remain with us.
Deposits are our primary source of externally generated funds. The level of deposit inflows during any given period is heavily influenced by factors outside of our control, such as consumer savings tendencies, the general level of short-term and long- term market interest rates, as well as higher alternative yields that investors may obtain on competing investments such as money market mutual funds. Financial institutions, such as Northwest Bank, are also subject to deposit outflows. Our net deposits increased by $697.8 million for the year ended December 31, 2019, increased by $67.2 million for the year ended December 31, 2018 and decreased by $55.3 million for the year ended December 31, 2017.
Similarly, the amount of principal repayments on loans and the amount of new loan originations is heavily influenced by the general level of market interest rates, consumer confidence and consumer spending. Funds received from loan maturities and principal payments on loans for the years ended December 31, 2019, 2018 and 2017 were $3.272 billion, $2.726 billion and $2.657 billion, respectively. Loan originations for the years ended December 31, 2019, 2018 and 2017 were $3.718 billion, $3.004 billion and $2.844 billion, respectively. We also sell a portion of the loans we originate as part of our mortgage banking operations, and the cash flows from such sales for the years ended December 31, 2019, 2018 and 2017 were $62.4 million, $4.5 million and $73.1 million, respectively.
We experience significant cash flows from our portfolio of marketable securities as principal payments are received on mortgage-backed securities and as investment securities mature or are called. Cash flow from the repayment of principal and the maturity or call of marketable securities for the years ended December 31, 2019, 2018 and 2017 were $245.8 million, $217.3 million and $220.0 million, respectively.
When necessary, we utilize borrowings as a source of liquidity and as a source of funds for long-term investment when market conditions permit. The net cash flow from the receipt and repayment of borrowings was a net increase of $11.9 million, a net increase of $126.2 million and a net decrease of $34.7 million for the years ended December 31, 2019, 2018 and 2017, respectively.
Northwest Bancshares, Inc. is a separate legal entity from Northwest Bank and must provide for its own liquidity to pay dividends to shareholders, to repurchase its common stock and for other corporate purposes. Northwest Bancshares' primary source of liquidity is the dividend payments it receives from Northwest Bank. The payment of dividends by Northwest Bank is subject to regulatory requirements. At December 31, 2019, Northwest Bancshares, Inc. (on an unconsolidated basis) had liquid assets of $150.9 million.
Other activity with respect to cash flow was the payment of cash dividends on common stock in the amount of $76.2 million, $69.9 million and $65.2 million for the ended December 31, 2019, 2018 and 2017, respectively.
At December 31, 2019, stockholders’ equity totaled $1.353 billion. During 2019, our Board of Directors declared regular quarterly cash dividends totaling $0.72 per share of common stock.
We monitor the capital levels of Northwest Bank to provide for current and future business opportunities and to meet regulatory guidelines for “well capitalized” institutions. Northwest Bank is required by the Pennsylvania Department of Banking and Securities and the FDIC to meet minimum capital adequacy requirements. At December 31, 2019, Northwest Bank exceeded all regulatory minimum capital requirements and is considered to be “well capitalized.” In addition, as of December 31, 2019, we were not aware of any recommendation by a regulatory authority that, if it were implemented, would have a material effect on liquidity, capital resources or operations.
Regulatory Capital Requirements
Northwest Bank is subject to minimum capital requirements established by the Federal Deposit Insurance Corporation. See "Item 1. Business Supervision and Regulation - Capital Requirements and Prompt Corrective Action”. The following table summarizes Northwest Bank’s total shareholders' equity, regulatory capital, total risk-based assets, and leverage and risk-based capital ratios at the dates indicated.
(1)
Tier 2 capital consists of the allowance for loan losses, which is limited to 1.25% of total risk-weighted assets as detailed under the regulations of the FDIC, and 45% of pre-tax net unrealized gains on securities available-for-sale.
Northwest Bank is also subject to capital guidelines of the Pennsylvania Department of Banking. Although not adopted in regulation form, the Department of Banking requires 6% leverage capital and 10% total risk-based capital. See “Item 1. Business - Supervision and Regulation - Capital Requirements and Prompt Corrective Action”.
Contractual Obligations
We are obligated to make future payments according to various contracts. The following table presents the expected future payments of the contractual obligations aggregated by obligation type at December 31, 2019.
(1)
See note 16 to the Consolidated Financial Statements, Employee Benefit Plans, for additional information.
(2)
See note 12 to the Consolidated Financial Statements, Borrowed Funds, for additional information.
(3)
See note 4 to the Consolidated Financial Statements, Premises and Equipment, for additional information.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and notes thereto, presented elsewhere herein, have been prepared in accordance with United States generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time and due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike most industrial companies, nearly all of our assets and liabilities are monetary. As a result, interest rates have a greater impact on our performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services.
Off-Balance Sheet Arrangements
As a financial services provider, we are routinely a party to various financial instruments with off-balance-sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. In addition, we routinely enter into commitments to purchase and sell residential mortgage loans.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Management
The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring an institution’s interest rate sensitivity “gap.” An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or re-price within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or re-pricing within a specific time period and the amount of interest-bearing liabilities maturing or re-pricing within that same time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to positively affect net interest income. Similarly, during a period of falling interest rates, a negative gap would tend to positively affect net interest income while a positive gap would tend to adversely affect net interest income.
Our practice is to reduce our exposure to interest rate risk generally by matching the maturities of our interest rate sensitive assets and liabilities and by increasing the interest rate sensitivity of our interest-earning assets. We purchase adjustable-rate investment securities and mortgage-backed securities, which at December 31, 2019, totaled $80.0 million, and originate adjustable-rate loans, which at December 31, 2019, totaled $3.132 billion or 35.6% of our gross loan portfolio. Of our $9.823 billion of interest-earning assets at December 31, 2019, $3.227 billion, or 32.9%, consisted of assets with adjustable rates of interest. When market conditions are favorable, we also attempt to reduce interest rate risk by lengthening the maturities of our interest-bearing liabilities by using FHLB advances as a source of long-term fixed-rate funds, if necessary, and by promoting longer-term certificates of deposit.
At December 31, 2019, total interest-earning assets maturing or re-pricing within one year exceeded total interest-bearing liabilities maturing or re-pricing in the same period by $57.5 million, representing a positive one-year gap ratio of 0.55%.
The following table sets forth, on a carrying value basis, the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 2019, which are expected to re-price or mature, based upon certain assumptions, in each of the future time periods shown. Except as stated below, the amounts of assets and liabilities shown that re-price or mature during a particular period were determined in accordance with the earlier of the term of re-pricing or the contractual term of the asset or liability. We believe that these assumptions approximate the standards used in the financial services industry and consider them appropriate and reasonable.
We have an Asset/Liability Committee, consisting of members of management, which meets monthly to review market interest rates, economic conditions, the pricing of interest earning assets and interest bearing liabilities and our balance sheet structure. On a quarterly basis, this committee also reviews our interest rate risk position and our cash flow projections.
Our Board of Directors has a Risk Management Committee, which meets quarterly, and reviews interest rate risks and trends, our interest sensitivity position, our liquidity position and the market risk inherent in our investment portfolio.
In an effort to assess interest rate risk, we use a simulation model to determine the effect of immediate incremental increases and decreases in interest rates on net interest income, net income and the market value of our equity. Certain assumptions are made regarding loan prepayments and decay rates of savings and interest-bearing demand deposit accounts. Because it is difficult to accurately project the market reaction of depositors and borrowers, the effect of actual changes in interest rates on these assumptions may differ from simulated results. We have established the following guidelines for assessing interest rate risk:
Net interest income simulation. Given a parallel shift of 100 basis points (“bps”), 200 bps, and 300 bps in interest rates, the estimated net interest income may not decrease by more than 5%, 10%, and 15%, respectively, within a one-year period.
Net income simulation. Given a parallel shift of 100 bps, 200 bps, and 300 bps in interest rates, the estimated net income may not decrease by more than 10%, 20%, and 30%, respectively, within a one-year period.
Market value of equity simulation. The market value of our equity is the present value of our assets and liabilities. Given a parallel shift of 100 bps, 200 bps, and 300 bps in interest rates, the market value of equity may not decrease by more than 15%, 30%, and 35%, respectively, from the computed economic value at current interest rate levels.
The following table illustrates the simulated impact of a parallel 100 bps, 200 bps or 300 bps upward or 100 bps downward movement in interest rates on net interest income, net income, return on average equity, earnings per share, and market value of equity. These analyses were prepared assuming that total interest-earning asset and interest-bearing liability levels at December 31, 2019 remain constant. The impact of the rate movements was computed by simulating the effect of an immediate and sustained shift in interest rates over a twelve-month period from December 31, 2019 levels.
The following table illustrates the simulated impact of a parallel 100 bps, 200 bps or 300 bps upward or 100 bps downward movement in interest rates on net interest income, net income, return on average equity, earnings per share, and market value of equity. These analyses were prepared assuming that total interest-earning asset and interest-bearing liability levels at December 31, 2018 remain constant. The impact of the rate movements was computed by simulating the effect of an immediate and sustained shift in interest rates over a twelve-month period from December 31, 2018 levels.
The figures included in the tables above represent projections that were computed based upon certain assumptions including loan prepayment rates and deposit decay rates. These assumptions are inherently uncertain and, as a result, we cannot precisely predict the impact of changes in interest rates. Actual results may differ significantly due to timing, magnitude and frequency of interest rate changes and changes in market conditions.
When assessing our interest rate sensitivity, analysis of historical trends indicates that loans will prepay at various speeds (or annual rates) depending on the variance between the weighted average portfolio rates and the current market rates. In preparing the table above, the following assumptions were used: (i) adjustable-rate mortgage loans will prepay at an annual rate of 6% to 14%; (ii) fixed-rate mortgage loans will prepay at an annual rate of 5% to 14%, depending on the type of loan; (iii) commercial loans will prepay at an annual rate of 8% to 14%; (iv) consumer loans held by Northwest Bank will prepay at an annual rate of 18% to 24%; and (v) consumer loans that were formerly held by Northwest Consumer Discount Company will prepay at an annual rate of 55% to 70%. In regards to our deposits, it has been assumed that (i) fixed maturity deposits will not be withdrawn prior to maturity; (ii) a significant majority of money market accounts will re-price immediately; (iii) savings accounts will gradually re-price over three years; and (iv) checking accounts will re-price either when the rates on such accounts re-price as interest rate levels change, or when deposit holders withdraw funds from such accounts and select other types of deposit accounts, such as certificate accounts, which may have higher interest rates. For purposes of this analysis, management has estimated, based on historical trends, that $514.1 million, or 26.4%, of our interest-bearing demand accounts and $174.3 million, or 10.9%, of our savings deposits are interest sensitive and may re-price in one year or less, and that the remainder may re-price over longer time periods.
The above assumptions are annual percentages based on remaining balances and should not be regarded as indicative of the actual prepayments and withdrawals that we may experience. Moreover, certain shortcomings are inherent in the analysis presented by the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to re-pricing, they may react in different degrees to changes in market interest rates. Also, interest rates on certain types of assets and liabilities may fluctuate
in advance of or lag behind changes in market interest rates. Additionally, certain assets, such as some adjustable-rate loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. Moreover, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in preparing the table.
In addition, we regularly measure and monitor the market value of our net assets and the changes therein. While fluctuations are expected because of changes in interest rates, we have established policy limits for various interest rate scenarios. Given interest rate shocks of +100 to +300 bps and -100 bps the market value of net assets is not expected to decrease by more than 15% to 35%.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934.
Management, including the principal executive officer and principal financial officer, has assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework (2013). Based on such assessment, management concluded that, as of December 31, 2019, the Company’s internal control over financial reporting is effective based upon those criteria.
KPMG LLP, an independent registered public accounting firm, has audited the Consolidated Financial Statements included in this Report and has issued a report with respect to the effectiveness of the Company’s internal control over financial reporting.
/s/ Ronald J. Seiffert
/s/ William W. Harvey, Jr.
Ronald J. Seiffert
William W. Harvey, Jr.
Chief Executive Officer
Chief Financial Officer
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors
Northwest Bancshares, Inc.:
Opinion on Internal Control Over Financial Reporting
We have audited Northwest Bancshares, Inc. and subsidaries’ (the Company) internal control over financial reporting as of December 31, 2019, 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, 2019, 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, 2019 and 2018, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2019, and the related notes (collectively, the consolidated financial statements), and our report dated March 2, 2020 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
Pittsburgh, Pennsylvania
March 2, 2020
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors
Northwest Bancshares, Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated statements of financial condition of Northwest Bancshares, Inc. and subsidiaries as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2019, 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, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2019, 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, 2019, 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 March 2, 2020 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.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgment. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Assessment of the Allowance for Loan Losses
As discussed in Notes 1f and 6 of the consolidated financial statements, the Company has recorded an allowance for loan losses of $57.9 million as of December 31, 2019 based on incurred losses inherent in the loan portfolio. This recorded balance consists of an allowance for impaired loans, an allowance for homogeneous loans based on historical losses, and an allowance for homogeneous loans based on environmental factors. The allowance for impaired loans is based on individual analysis of all nonperforming loans greater than or equal to $1.0 million. The allowance is measured by the difference between the recorded value of impaired loans and their impaired value. The impaired value is either the present value of the expected future cash flows from the borrower, the market value of the loan, or the fair value of the collateral, less estimated cost to sell. The allowance for homogeneous loans based on historical losses is estimated using historical loss factors based on a rolling three-year average of incurred losses (lookback period), adjusted for a loss emergence period (the estimated period of time from the event of loss to loss realization), applied to homogeneous pools of loans (including impaired loans under $1.0 million) categorized by similar risk characteristics, including credit risk ratings for commercial loans. The allowance for homogeneous loans based on environmental factors augments the historical loss factors.
We identified the assessment of the allowance for loan losses as a critical audit matter because it involved a high degree of subjective auditor judgment, and specialized industry knowledge and experience. This assessment encompassed evaluating the (1) methodologies used to derive the historical loss factors, (2) credit risk ratings for commercial loans, (3) expected cash flows
and collateral values utilized by the Company in measuring the allowance for impaired loans, (4) key factors and assumptions used in the determination of historical loss factors, particularly the loss emergence period, lookback period, and portfolio segmentation, and (5) environmental factors.
The primary procedures we performed to address this critical audit matter included the following. We tested certain internal controls over the (1) development and approval of the allowance methodology, (2) credit risk ratings for commercial loans through the loan review function, (3) expected cash flows or collateral values for impaired loans greater than or equal to $1.0 million, (4) key factors and assumptions used in the determination of historical loss factors, and (5) environmental factors. We tested the Company’s process to develop the allowance for loan losses estimate. We involved credit risk professionals with specialized industry knowledge and experience who assisted in:
-
evaluating the Company’s methodology for the allowance for homogeneous loans, inclusive of the methodology based on historical losses and the methodology based on environmental factors, for compliance with U.S. generally accepted accounting principles,
-
testing individual credit risk ratings for a selection of commercial loans,
-
testing the lookback period assumptions used in calculating the rolling three-year average of incurred losses to evaluate the length of that period,
-
determining whether loans are pooled (segmented) by similar risk characteristics,
-
testing the loss emergence period assumptions by evaluating the methodology used to develop those assumptions and testing the accuracy of those calculations and inputs, and
-
evaluating the framework used to develop the resulting environmental factors and the effect of those factors compared with relevant credit risk factors and consistency with credit trends.
In addition, we tested inputs and assumptions utilized in the determination of expected cash flows and involved valuation professionals with specialized skills and knowledge to test certain collateral values for impaired loans greater than or equal to $1.0 million. Specifically, we tested the sources of the factors and assumptions that the Company used, and considered the relevance and reliability of such factors and assumptions.
/s/ KPMG LLP
We have served as the Company’s auditor since 1963.
Pittsburgh, Pennsylvania
March 2, 2020
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(in thousands, excluding per share data)
See accompanying notes to Consolidated Financial Statements.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, excluding per share data)
See accompanying notes to Consolidated Financial Statements.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
See accompanying notes to Consolidated Financial Statements.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(in thousands, excluding per share data)
See accompanying notes to Consolidated Financial Statements.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
NORTHWEST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(continued)
See accompanying notes to Consolidated Financial Statements.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
(1) Summary of Significant Accounting Policies
(a) Nature of operations
Northwest Bancshares, Inc., a Maryland corporation headquartered in Warren, Pennsylvania, is the federal savings and loan holding company for its wholly owned subsidiary, Northwest Bank. Northwest Bank, a Pennsylvania chartered savings bank, offers personal and business deposit and loan products as well as investment management and insurance services through its 181 banking locations in Pennsylvania, New York, and Ohio.
(b) Principles of consolidation
The Consolidated Financial Statements include the accounts of the Company and its wholly owned subsidiaries after elimination of all intercompany accounts and transactions.
(c) Cash and cash equivalents
For purposes of the statements of financial condition and cash flows, cash and cash equivalents include cash and amounts due from banks, interest-bearing deposits in other financial institutions, federal funds sold, and other short-term investments with original maturities of three months or less.
(d) Investment securities
We classify marketable securities at the time of purchase as held-to-maturity, available-for-sale, or trading. Securities for which management has the intent and ability to hold until maturity are classified as held-to-maturity and are carried at cost, adjusted for amortization of premiums and accretion of discounts on a level yield basis (amortized cost). If it is management’s intent at the time of purchase to hold securities for an indefinite period of time and/or to use such securities as part of its asset/ liability management strategy, the securities are classified as available-for-sale and are carried at fair value, with unrealized gains and losses reported as accumulated other comprehensive income/(loss), a separate component of shareholders’ equity, net of tax. Securities classified as available-for-sale include securities that may be sold in response to changes in interest rates, resultant prepayment risk, or other market factors. Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading and are reported at fair value, with changes in fair value included in earnings. The cost of securities sold is determined on a specific identification basis. We held no securities classified as trading at or during the years ended December 31, 2019 and 2018.
On at least a quarterly basis, we review our investments for other-than-temporary impairment (“OTTI”). An investment security is deemed impaired if the fair value of the investment is less than its amortized cost. If an investment security is determined to be impaired, we evaluate whether the decline in value is other-than-temporary. We consider whether or not we expect to receive all of the contractual cash flows from the investment security based on factors that include, but are not limited to the creditworthiness of the issuer and the historical and projected performance of the underlying collateral. Also, we may evaluate the business and financial outlook of the issuer, as well as broader economic performance indicators. We consider both our intent to sell and the likelihood that we will not have to sell the investment securities before recovery of their cost basis during our evaluation. Impairment that is deemed credit related is recognized in earnings while impairment deemed noncredit related is recorded in accumulated other comprehensive income, if we do not intend to sell nor it is not likely we will be required to sell the investment security. If we intend to sell the investment security or if it is more likely than not that we will be required to sell the investment security, the entire impairment is recorded in earnings.
(e) Loans receivable
Our loan segments consist of Personal Banking and Business Banking loans. Personal Banking loans include residential mortgage, home equity and consumer loans. Business Banking loans include commercial real estate and commercial loans. Originated loans are carried at their unpaid principal balance net of any deferred origination fees or costs and the allowance for loan losses. Interest income on loans is credited to income as earned. Interest earned on loans for which no payments were received during the month is accrued at month end. Accrued interest on loans more than 90 days delinquent is reversed and such loans are placed on nonaccrual status.
All loans are placed on nonaccrual status when principal or interest is 90 days or more delinquent or when there is reasonable doubt that interest or principal will not be collected in accordance with the contractual terms. Interest receipts on all nonaccrual and impaired loans are recognized as interest income when it has been determined that all principal and interest will be collected or are applied
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
to principal when collectability of contractual principal is in doubt. Nonaccrual loans generally are restored to an accrual basis when principal and interest become current and a period of performance has been established in accordance with the contractual terms, typically six months.
A loan is considered to be a troubled debt restructuring loan ("TDR") when the borrower is experiencing financial difficulties and the restructuring constitutes a concession. TDRs may include modifications of terms of loans, receipts of assets from borrowers in partial or full satisfaction of loans, or a combination thereof. TDRs are impaired loans. A modified loan is determined to be a TDR based on the contractual terms as specified by the original loan agreement or the most recent modification. Once classified a TDR, a loan is removed from such classification under three circumstances: (1) the loan is paid off, (2) the loan is charged off, or (3) if, at the beginning of the current fiscal year, the loan has performed in accordance with the modified terms for a minimum of six consecutive months and at the time of modification the loan’s interest rate represented a then current market interest rate for a loan of similar risk.
Loan delinquency is measured based on the number of days since the payment due date. Past due status is measured using the loan’s contractual maturity date.
Loan fees and certain direct loan origination costs are deferred and the net deferred fee or cost is then recognized using the level-yield method over the contractual life of the loan as an adjustment to interest income.
We identify certain residential mortgage loans which will be sold prior to maturity, as loans held-for-sale. These loans are recorded at the lower of amortized cost or fair value less estimated cost to sell. At December 31, 2019 and 2018, there were $7.7 million and no residential mortgage loans classified as held-for-sale, respectively.
Acquired loans are initially measured at fair value with no carryover of the related allowance for loan losses. Determining the fair value of the loans involves estimating the amount and timing of principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest.
The excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable discount and is recognized into interest income over the remaining life of the loan. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable discount. The nonaccretable discount represents estimated future credit losses expected to be incurred over the life of the loan. Subsequent decreases to the expected cash flows require us to evaluate the need for an allowance for loan losses. Subsequent improvements in expected cash flows result in the reversal of a corresponding amount of the nonaccretable discount which we then reclassify as accretable discount that is recognized into interest income over the remaining life of the loan using the interest method. Charge-offs of the principal amount on acquired loans would be first applied to the nonaccretable discount portion of the fair value adjustment.
Acquired loans that met the criteria for nonaccrual of interest prior to the acquisition may be considered performing upon acquisition, regardless of whether the customer is contractually delinquent, if we can reasonably estimate the timing and amount of the expected cash flows on such loans and if we expect to fully collect the new carrying value of the loans. As such, we may no longer consider the loan to be nonaccrual or nonperforming and may accrue interest on these loans, including the impact of any accretable discount. We have determined that we can reasonably estimate future cash flows on our current portfolio of acquired loans that are past due 90 days or more and on which we are accruing interest and we expect to fully collect the carrying value of the loans.
(f) Allowance for loan losses and provision for loan losses
Provisions for estimated loan losses and the amount of the allowance for loan losses are based on losses inherent in the loan portfolio that are both probable and can be reasonably estimated at the date of the financial statements.
We consider a loan to be impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. In evaluating whether a loan is impaired, we consider not only the amount that we expect to collect but also the timing of collection. Generally, if a delay in payment is insignificant (e.g., less than 30 days), a loan is not deemed to be impaired.
Business Banking loans greater than or equal to $1.0 million are reviewed to determine if they should be individually evaluated for impairment. Smaller balance, homogeneous loans (e.g., primarily residential mortgage, home equity and consumer loans) are evaluated collectively for impairment. When a loan is considered to be impaired, the amount of impairment is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s market price, or fair value of the collateral, less estimated cost to sell, if the loan is collateral dependent. Impairment losses are included in the allowance for loan losses. Impaired loans
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
are charged-off or charged down when we believe that the ultimate collectability of a loan is not likely or the collateral value no longer supports the carrying value of the loan.
Interest income on non-performing loans is recognized using the cash basis method. For non-performing loans, interest collected is credited to income in the period of recovery or applied to reduce principal if there is sufficient doubt about the collectability of principal.
The allowance for loan losses is shown as a valuation allowance to loans. The accounting policy for the determination of the adequacy of the allowance by portfolio segment requires us to make numerous complex and subjective estimates and assumptions relating to amounts which are inherently uncertain. The allowance for loan losses is maintained to absorb losses inherent in the loan portfolio as of the balance sheet date. The methodology used to determine the allowance for loan losses is designed to provide procedural discipline in assessing the appropriateness of the allowance for loan losses. Losses are charged against and recoveries are added to the allowance for loan losses.
For Business Banking loans the allowance for loan losses consists of:
•
An allowance for impaired loans;
•
An allowance for homogenous loans based on historical losses; and
•
An allowance for homogenous loans based on environmental factors.
The allowance for impaired loans is based on individual analysis of all nonperforming loans greater than or equal to $1.0 million. The allowance is measured by the difference between the recorded value of impaired loans and their impaired value. The impaired value is either the present value of the expected future cash flows from the borrower, the market value of the loan, or the fair value of the collateral, less estimated costs to sell.
The allowance for homogeneous loans based on historical factors is a rolling three-year average of incurred losses, adjusted for a loss emergence period (the period of time from the event of loss to loss realization), applied to homogenous pools of loans categorized by similar risk characteristics, not including loans evaluated individually for impairment.
The allowance for homogeneous loans based on environmental factors augments the historical loss factors for changes in: economic conditions, lending policies and procedures, the nature and volume of the loan portfolio, management, delinquency trends, loan administration, collateral values, concentrations of credit, and other external factors including legal and regulatory factors.
For Personal Banking loans the allowance for loan losses consists of:
•
An allowance for loans 90 days or more delinquent;
•
An allowance for homogenous loans based on historical losses; and
•
An allowance for homogenous loans based on environmental factors.
The allowance for loans 90 days or more delinquent is based on the loss history of loans that have become 90 days or more delinquent. We apply a historical loss factor to homogeneous pools of loans that are 90 days or more delinquent.
The allowance for homogeneous loans based on historical losses is a rolling three-year average of actual losses incurred, adjusted for a loss realization period, applied to homogenous pools of loans categorized by similar risk characteristics, not including loans that are 90 days or more delinquent.
The allocation of the allowance for loan losses is inherently subjective, and the entire allowance for loan losses is available to absorb loan losses regardless of the nature of the loss.
Personal Banking loans are charged-off or charged down when they become 180 days delinquent, unless the borrower has filed for bankruptcy. Business Banking loans are charged-off or charged down when, in our opinion, they are no longer collectible or when it has been determined that the collateral value no longer supports the carrying value of the loan, for loans that are collateral dependent.
We have not made any material changes to our methodology for the calculation of the allowance for loan losses during the current year.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
(g) Real estate owned
Real estate owned is comprised of property either acquired through foreclosure or voluntarily conveyed by borrowers. These assets are recorded on the date acquired at the lower of the loan balance or fair value of the collateral, less estimated disposition costs, with the fair value being determined by an appraisal. Any initial write-down is charged to the allowance for loan losses. Subsequently, foreclosed assets are valued at the lower of the amount recorded at acquisition date or the current fair value, less estimated disposition costs. Any subsequent write-down or gains or losses realized from the disposition of such property are credited or charged to noninterest income.
(h) Restricted investment in Federal Home Loan Bank stock
Federal law requires a member institution of the Federal Home Loan Bank ("FHLB") system to hold stock of its district FHLB according to a predetermined formula. FHLB stock is carried at cost and evaluated for impairment based on the ultimate recoverability of the par value. FHLB stock can only be purchased, redeemed and transferred at par value. Dividends are reported in interest income in the Consolidated Statements of Income.
(i) Premises and equipment
Premises and equipment are carried at cost, less accumulated depreciation and amortization. Depreciation is accumulated on a straight-line basis over the estimated useful lives of the related assets. Estimated lives range from three to 39 years. Amortization of leasehold improvements is accumulated on a straight-line basis over the terms of the related leases or the useful lives of the related assets, whichever is shorter.
(j) Goodwill
Goodwill is generated from the premium paid for an acquisition and is allocated to reporting units, which are either our reportable segments or one level below. Reporting units are identified based upon analyzing each individual operating segment. A reporting unit is defined as a distinct, separately identifiable component of an operating segment for which complete, discrete financial information is available that management regularly reviews.
Goodwill is not subject to amortization but is tested for impairment at least annually and possibly more frequently if certain events occur or changes in circumstances arise. In testing goodwill for impairment, we have the option to first assess 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. If, after assessing all events and circumstances, we determine it is not more likely than not that the fair value of a reporting unit is less than its carrying value, then performing the two-step impairment test would be unnecessary. However, if we conclude otherwise, it would then be required to perform the first step of the goodwill impairment test and continue to the second step, if necessary. Step 1 requires the fair value of each reporting unit be compared to its carrying amount, including goodwill. Determining the fair value of a reporting unit requires a high degree of subjective judgment, including developing cash flow projections, selecting appropriate discount rates, identifying relevant market comparables, incorporating general economic and market conditions and selecting an appropriate control premium.
We conducted our annual impairment assessment as of June 30, 2019 by first performing a qualitative assessment of goodwill to determine if it was more likely than not that the fair value was less than the carrying value. In performing a qualitative analysis, factors considered include, but are not limited to, macroeconomic conditions, industry and market conditions and overall financial performance. The results of the qualitative assessment for 2019 indicated that it was not more likely than not that the fair value of the reporting unit was less than the carrying value. Consequently, no additional quantitative two-step impairment test was required and no impairment was recorded in 2019. Future events could cause us to conclude that goodwill has become impaired, which would result in recording an impairment loss. There were no changes in our operations that would cause us to update the assessment performed as of June 30, 2019 and 2018. Accordingly, we have determined that goodwill is not impaired as of December 31, 2019 and 2018.
(k) Core deposit and other identifiable intangibles
Through the assistance of an independent third party, we analyze and prepare a core deposit study for all bank acquisitions or other identifiable intangible asset study, such as customer lists, for all non-bank acquisitions. The core deposit study reflects the cumulative present value benefit of acquiring deposits versus an alternative source of funding. The other identifiable intangible asset study reflects the cumulative present value benefit of acquiring the income stream from an existing customer base versus developing new business relationships. Based upon analysis, the amount of the premium related to the core deposits or other identifiable intangibles of the business
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
purchased is calculated along with the estimated life of the intangible. The intangible, which is recorded in other intangible assets, is then amortized to expense on an accelerated basis over an approximate life of typically between seven to eleven years.
(l) Bank-owned life insurance
We own insurance on the lives of a certain group of current and former employees and directors. The policies were purchased to help offset the increase in the costs of various benefit plans, including healthcare, as well as the directors deferred compensation plan. The cash surrender value of these policies is included as an asset on the Consolidated Statements of Financial Condition and any increases in the cash surrender value are recorded as tax-free noninterest income on the Consolidated Statements of Income. In the event of the death of an insured individual covered by these policies, after distribution to the insured’s beneficiaries, if any, we receive a tax-free death benefit, which is recorded as noninterest income.
(m) Deposits
Interest on deposits is accrued and charged to expense monthly and is paid or credited in accordance with the terms of the accounts.
(n) Revenue recognition
Revenue that is not associated with our financial assets and financial liabilities is recognized when performance obligations under the terms of a contract with our customers are satisfied. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods or providing services. The majority of our revenue continues to be recognized at the point in time when the services are provided to our customers.
(o) Pension plans
We maintain multiple noncontributory defined benefit pension plans for substantially all of our employees. The net periodic pension cost has been calculated using service cost, interest cost, expected returns on plan assets and net amortization. The other components of the net periodic benefit cost are included in other expense on the Consolidated Statement of Income and are reported separately from the service costs.
(p) Income taxes
We join with our wholly owned subsidiaries in filing a consolidated federal income tax return. In accordance with an intercompany tax allocation agreement, the applicable federal income tax expense or benefit is allocated to each subsidiary based upon taxable income or loss calculated on a separate company basis. Each subsidiary is responsible for payment of its own federal income tax liability or receives reimbursement of federal income tax benefit. In addition, deferred taxes are calculated and maintained on a separate company basis.
We account for income taxes under the asset and liability method. The objective of the asset and liability method is to establish deferred tax assets and liabilities for temporary differences between the financial reporting and tax basis of our assets and liabilities based on the tax rates expected to be in effect when such amounts are realized or settled. The effect on deferred tax assets and liabilities with regard to a change in tax rates is recognized in the tax provision in the period the change is enacted.
(q) Stock-related compensation
We determine the fair value of each option award, estimated on the grant date, using the Black-Scholes-Merton option-pricing model. The Black-Scholes-Merton option-pricing model uses variables including expected volatilities, expected term, risk-free discount rate and annual rate of quarterly dividends. Expected volatilities are based on historical volatility of the Company’s stock. The expected terms are based upon actual exercise and forfeiture experience of previous option grants. The risk-free rate is based on yields on U.S. Treasury securities of a similar maturity to the expected term of the options. For options outstanding at December 31, 2019, the following assumptions were used to determine the option's fair value: (1) annual rate of quarterly dividends ranging from 3.2% to 4.7% based on historical dividends and market prices; (2) expected volatility of 13.0% to 22.0% based on historical average monthly volatility; (3) risk-free discount rates ranging from 1.7% to 3.1%; and (4) expected lives of seven to ten years based on previous grants. During the year ended December 31, 2019, we awarded 547,410 stock options to employees and 64,800 stock options to directors. During the year ended December 31, 2018, we awarded 831,160 stock options to employees and 64,800 stock options to directors.The options granted in 2019
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
and 2018 vest over a seven-year period, with the first vesting occurring on the grant date. New shares are issued when options are exercised. Option awards are generally granted with an exercise price equal to the closing market price of the Company’s stock on the day before the grant date. Once shares have vested, they are no longer restricted. Compensation expense, in the amount of the fair market value of the common stock at the date of the grant will be recognized pro rata over the periods in which the shares vest. While restricted, the recipients are entitled to all shareholder rights, except that the shares may not be sold, pledged, or otherwise disposed of and are required to be held in a trust.
During the year ended December 31, 2019, we awarded 256,800 restricted shares to employees and 24,300 restricted shares to directors. During the year ended December 31, 2018 we awarded 390,030 restricted shares to employees and 24,300 restricted shares to directors.These common share awards vest over a seven-year period, with the first vesting occurring on the grant date. For additional information regarding grants of stock options and common shares, see note 16.
Stock-based employee compensation expense related to common share awards of $5.7 million, $5.8 million and $3.8 million was included in income before income taxes during the years ended December 31, 2019, 2018 and 2017, respectively. The effect on net income for the years ended December 31, 2019, 2018 and 2017 was a reduction of $4.1 million, $4.2 million and $2.3 million, respectively. Total compensation expense for unvested stock options of $3.5 million has yet to be recognized as of December 31, 2019. The weighted average period over which this remaining stock option expense will be recognized is approximately 3.79 years.
(r) Segment reporting
As a result of the closure of the Northwest Consumer Discount Company in the third quarter 2017, we have determined that we have one reportable segment beginning in the fourth quarter 2017. The Company provides services traditionally offered by full-service community banks, including business and personal deposit accounts and business and personal loans, as well as insurance, brokerage and investment management and trust services. The Company’s non-banking activities are immaterial and, therefore, separate information has not been disclosed.
(s) Derivative financial instruments
We recognize all derivative financial instruments as either assets or liabilities in the balance sheet and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. An entity that elects to use hedge accounting is required, at inception, to establish the method it will use for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. Those methods must be consistent with our approach to managing risk.
At times, we utilize interest rate swap agreements as part of the management of interest rate risk to hedge the interest rate risk on our trust preferred debentures. Amounts receivable or payable are recognized as accrued under the terms of the agreements and the differential is recorded as an adjustment to interest expense. The interest rate swaps are designated as cash flow hedges, with the effective portion of the derivative’s unrealized gain or loss recorded as a component of other comprehensive income which is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the unrealized gain or loss, if any, would be recorded in other expense. For derivatives that are not designated as hedging instruments, any gain or loss is recognized immediately in earnings.
(t) Off-balance-sheet instruments
In the normal course of business, we extend credit in the form of loan commitments, undisbursed lines of credit, and standby letters of credit. These off-balance-sheet instruments involve, to various degrees, elements of credit and interest rate risk not reported in the Consolidated Statement of Financial Condition. We utilize the same underwriting standards for these instruments as other extensions of credit.
(u) Use of estimates
The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amount of revenues and expenses during the reporting period. The estimates and assumptions that we deem important to our financial statements relate to the allowance for loan losses, the accounting treatment and valuation of our investment securities portfolio, the analysis of the carrying value of goodwill, pension and
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
income taxes. These estimates and assumptions are based on management’s best estimates and judgment and we evaluate them using historical experience and other factors, including the current economic environment. We adjust our estimates and assumptions when facts and circumstances dictate. As future events cannot be determined, actual results could differ significantly from our estimates.
(v) Reclassification of prior years’ statements
Certain items previously reported have been reclassified to conform with the current year’s reporting format.
(2) Recently Adopted Accounting Standards
In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-02, Leases (Topic 842), which requires lessees to recognize leases on-balance sheet and disclose key information about leasing arrangements. Accounting Standards Codification ("ASC") Topic 842 establishes a right of use ("ROU") model that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases will be classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement. The Company has elected not to recognize ROU assets and lease liabilities for short-term leases of all classes of underlying assets that have a lease term of 12 months or less and recognizes lease expense for these leases on a straight-line basis over the term of the lease.
On January 1, 2019, the Company adopted ASU 2016-02 using a modified retrospective transition approach as of the effective date, January 1, 2019. As a result, the Company was not required to adjust its comparative period financial information for effects of the standard or make the new required lease disclosures for periods before the date of adoption (i.e. January 1, 2017). The Company has elected to adopt the package of transition practical expedients and, therefore, has not reassessed (1) whether existing or expired contracts contain a lease, (2) lease classification for existing or expired leases or (3) the accounting for initial direct costs that were previously capitalized. The Company also elected the practical expedient to use hindsight for leases existing at the adoption date.
As a result of the adoption of ASU 2016-02, we recognized an operating lease ROU asset of approximately $40.2 million, an operating lease liability of approximately $42.2 million and a cumulative-effect adjustment on retained earnings of $1.2 million on the Consolidated Statements of Financial Condition as of January 1, 2019, with no impact on our Consolidated Statement of Income or Consolidated Statement of Cash Flows compared to the prior lease accounting model.
(3) Acquisition
On March 8, 2019, the Company completed the merger with Donegal Financial Services Corporation ("DFSC"), the holding company for UCB, for total consideration of $85.8 million. The transaction expanded Northwest’s franchise by 12 offices in Lancaster County in eastern Pennsylvania. The result of UCB's operations are included in the Consolidated Statements of Income from the date of acquisition.
Under the terms of the merger agreement, the two shareholders of DFSC, Donegal Mutual Insurance Company and Donegal Group Inc., received payment in the form of 50% cash and 50% stock, or a total of $42.5 million and 2,462,373 shares of common stock of the Company, valued at $43.3 million, based on the $17.58 closing price of the Company's stock on March 8, 2019.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table shows the assets acquired and the liabilities assumed that were recorded at fair value on the date of acquisition:
(1) Amounts are estimates and subject to adjustment. Actual amounts are not expected to differ materially from the amounts shown.
We estimated the fair value of loans acquired from UCB by utilizing a methodology wherein similar loans were aggregated into pools. Cash flows for each pool were determined by estimating future credit losses and the rate of prepayments. Projected monthly cash flows were then discounted to present value based on a market rate for similar loans. There was no carryover of UCB’s allowance for loan losses associated with the loans we acquired as the loans were initially recorded at fair value. Loans acquired with evidence of credit quality deterioration were evaluated and not considered to be significant.
The core deposit intangible asset recognized as part of the UCB merger is being amortized over its estimated useful life of seven years utilizing an accelerated method. The goodwill, which is not amortized for book purposes, was assigned to our Community Banking segment and is not deductible for tax purposes. The fair values of savings and transaction deposit accounts acquired from UCB were assumed to approximate the carrying value as these accounts have no stated maturity and are payable on demand. Certificates of deposit were valued by projecting out the expected cash flows based on the contractual terms of the certificates of deposit. These cash flows were discounted based on a market rate for a certificate of deposit with a corresponding maturity.
Direct costs related to the UCB merger were expensed as incurred and were $3.1 million during the year ended December 31, 2019, which includes technology and communications costs, professional services, marketing and advertising, and other noninterest expenses.
On December 1, 2019, Northwest Insurance Services, a subsidiary of the Company, completed the acquisition of Sundahl & Co. Insurance ("Sundahl"), a property and casualty insurance firm, for total consideration of $3.1 million. The transaction expands and strengthens our presence and insurance offerings in northwestern Pennsylvania. The result of Sundahl's operations are included in the Consolidated Statements of Income from the date of acquisition.
The fair value of total assets acquired from this transaction were $3.8 million, as of the acquisition date, consisting primarily of $2.3 million of customer list intangibles, $1.4 million in goodwill and $154,000 in cash. The fair value of total liabilities assumed as of the acquisition date were $746,000, all of which were considered other liabilities. Expenses incurred as part of the Sundahl acquisition were expensed as incurred and were considered immaterial to the Consolidated Financial Statements.
(4) Leases
At inception, the Company determines if an arrangement contains a lease and whether that lease meets the classification of a finance or operating lease. Operating lease ROU assets represent our right to use an underlying asset during the lease term and operating lease liabilities represent our obligation to make lease payments arising from the lease. ROU assets and operating lease liabilities are recognized at lease commencement based on the present value of the remaining lease payments. ROU assets are further adjusted for lease incentives and initial direct costs.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The Company has operating leases for certain branch and office facilities or land with lease terms up to 35 years. These leases generally contain renewal options for periods ranging from one to ten years. These options are included in the lease term when it is reasonably certain that the options will be exercised.
Some of the Company’s lease arrangements contain lease components (e.g., minimum rent payments) and non-lease components (e.g., common area maintenance, taxes, etc.). The Company elected the option of not separating lease and non-lease components and instead we account for them as a single lease component.
Certain lease agreements include rental payments that are adjusted periodically for an index or rate. The leases are initially measured using the projected adjustment for the index or rate in effect at the commencement date. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.
Generally, the Company cannot practically determine the interest rate implicit in the lease. Therefore, the Company uses its incremental borrowing rate as the discount rate for the lease. The Company’s incremental borrowing rate for a lease is the rate of interest it would have to pay on a collateralized basis to borrow an amount equal to the lease payments under similar terms.
Lease expense for these leases is recognized on a straight-line basis over the lease term, with variable lease payments recognized in the period those payments are incurred. The components of lease cost recognized within our consolidated statements of income were as follows:
Amounts reported in the Consolidated Statements of Financial Condition were as follows:
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
Other information related to leases as of December 31, 2019 were as follows:
Amounts disclosed for ROU assets obtained in exchange for lease obligations include amounts added to the carrying amount of ROU assets resulting from lease modifications and reassessments.
Maturities of lease liabilities by fiscal year for our operating leases are as follows:
Rental expense for the years ended December 31, 2019, 2018 and 2017 was $6.2 million, $5.4 million and $5.6 million, respectively.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
(5) Marketable securities
Marketable securities available-for-sale at December 31, 2019 are as follows:
Marketable securities held-to-maturity at December 31, 2019 are as follows:
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
Marketable securities available-for-sale at December 31, 2018 are as follows:
Marketable securities held-to-maturity at December 31, 2018 are as follows:
The following table presents information regarding the issuers and the carrying values of our mortgage-backed securities at December 31, 2019 and 2018:
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
Marketable securities having a carrying value of $121.8 million at December 31, 2019 were pledged under collateral agreements. During the year ended December 31, 2019, we sold marketable securities classified as available-for-sale for $32.4 million, with gross realized gains of $29,000 and no gross realized losses. During the year ended December 31, 2018, we sold marketable securities classified as available-for-sale for $5.2 million, with gross realized gains of $189,000 and gross realized losses of $37,000. During the year ended December 31, 2017, we sold marketable securities classified as available-for-sale for $36.8 million, with gross realized gains of $1.8 million and gross realized losses of $626,000. During the years ended December 31, 2019, 2018 and 2017, we did not recognize non-cash credit related other-than-temporary-impairment in our investment portfolio.
The following table shows the fair value and gross unrealized losses on investment securities, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position at December 31, 2019:
The following table shows the fair value and gross unrealized losses on investment securities, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position at December 31, 2018:
We perform an assessment to determine whether there have been any events or economic circumstances that indicate a security which has an unrealized loss is impaired other-than-temporarily. The assessment considers many factors including the severity and duration of the impairment; recent events specific to the issuer or industry; and for debt securities, external credit ratings, underlying collateral position and recent downgrades. For asset backed securities, we evaluate current characteristics of each security such as delinquency and foreclosure levels, credit enhancements and projected losses and coverage. It is possible that the underlying collateral of these securities will perform worse than current expectations, which may lead to adverse changes in cash flows on these securities and potential future losses. Events that may trigger material declines in fair values for these securities in the future would be, but are not limited to: deterioration of credit metrics, significantly higher levels of default and severity of loss on the underlying collateral, deteriorating credit enhancement and loss coverage ratios, or further illiquidity. For debt securities, credit related other-than-temporary impairment is recognized in earnings, while noncredit related other-than-temporary impairment on securities not expected to be sold, or otherwise disposed of, is recognized in other comprehensive income. We assert that we do not have the intent to sell these securities and it is more likely than not that we will not have to sell these securities before a recovery of our cost basis. For these reasons, we consider the unrealized losses to be temporary impairment losses. There are approximately 119 positions that are temporarily impaired at December 31, 2019. The aggregate carrying amount of cost-method investments, including both held-to-maturity and available-for-sale, at December 31, 2019 was $837.9 million, of which all were evaluated for impairment. As of December 31, 2019, there were no investment securities for which other-than-temporary impairment charges were recorded in earnings.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The table below shows a cumulative roll forward of credit related impairment losses recognized in earnings for debt securities held and not intended to be sold:
(1)
The beginning balance represents credit losses included in other-than-temporary impairment charges recognized on debt securities in prior periods.
(6) Loans Receivable and Allowance for Loan Losses
Loans receivable at December 31, 2019 and 2018 are summarized in the table below:
(1) Includes $7.7 million and no loans held for sale at December 31, 2019 and 2018, respectively.
(2) Represents loans from our consumer finance subsidiary that was closed in 2017 which are no longer being originated.
As of December 31, 2019, 2018 and 2017, we serviced loans for others approximating $793.1 million, $794.2 million and $887.3 million, respectively. These loans serviced for others are not our assets and are not included in our financial statements.
As of December 31, 2019 and 2018, approximately 50% and 58%, respectively, of our loan portfolio was secured by properties located in Pennsylvania. We do not believe we have significant concentrations of credit risk to any one group of borrowers given our underwriting and collateral requirements.
Loans receivable as of December 31, 2019 and 2018 include $3.090 billion and $2.810 billion, respectively, of adjustable rate loans and $5.948 billion and $5.448 billion, respectively, of fixed rate loans.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table provides information related to the outstanding principal balance and related carrying value of acquired loans for the dates indicated:
The following table provides information related to the changes in the accretable discount, which includes income recognized from contractual cash flows for the dates indicated:
The following table provides information related to purchased credit impaired loans by portfolio segment and by class of financing receivable at and for the year ended December 31, 2019:
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table provides information related to purchased credit impaired loans by portfolio segment and by class of financing receivable at and for the year ended December 31, 2018:
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table provides information related to changes in the allowance for loan losses for the year ended December 31, 2019:
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table provides information related to changes in the allowance for loan losses for the year ended December 31, 2018:
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table provides information related to changes in the allowance for loan losses for the year ended December 31, 2017:
While we use available information to provide for losses, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses. Such agencies may require us to recognize additions to the allowance based on their judgments about information available to them at the time of their examination. Management believes, to the best of their knowledge, that all known losses as of the balance sheet dates have been recorded.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table provides information related to the loan portfolio by portfolio segment and by class of financing receivable as of December 31, 2019:
(1)
Includes $9.0 million of nonaccrual TDRs.
The following table provides information related to the loan portfolio by portfolio segment and by class of financing receivable as of December 31, 2018:
(1)
Includes $15.3 million of nonaccrual TDRs.
A loan is considered to be impaired, when, based on current information and events it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement including both contractual principal and interest payments. This includes non-accrual loans, loans more than 90 days delinquent and still accruing interest, loans for which we perform an impairment review and TDRs. Impairment is measured using one of three methods: (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) the loan’s observable market price; or (3) the fair value of collateral if the loan is collateral dependent, less costs of sale or disposition. If the measure of the impaired loan is less than the recorded investment in the loan, a specific allowance is allocated for the impairment.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table provides information related to the composition of impaired loans by portfolio segment and by class of financing receivable at and for the year ended December 31, 2019:
The following table provides information related to the composition of impaired loans by portfolio segment and by class of financing receivable at and for the year ended December 31, 2018:
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table provides information related to the composition of impaired loans by portfolio segment and by class of financing receivable at and for the year ended December 31, 2017:
The following table provides information related to the evaluation of impaired loans by portfolio segment and by class of financing receivable as of and for the year ended December 31, 2019:
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table provides information related to the evaluation of impaired loans by portfolio segment and by class of financing receivable as of and for the year ended December 31, 2018:
Our loan portfolios include certain loans that have been modified in a TDR, where economic concessions have been granted to borrowers who have experienced financial difficulties. These concessions typically result from our loss mitigation activities and could include: extending the note’s maturity date, permitting interest only payments, reducing the interest rate to a rate lower than current market rates for new debt with similar risk, reducing the principal payment, principal forbearance or other actions. These concessions are applicable to all loan segments and classes. Certain TDRs are classified as nonperforming at the time of restructuring and typically are returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period of at least six consecutive months.
When we modify loans in a TDR, we evaluate any possible impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, the loan’s observable market price or the current fair value of the collateral, less selling costs, for collateral dependent loans. If we determine that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance. In periods subsequent to modification, we evaluate all TDRs, including those that have payment defaults, for possible impairment, in accordance with ASC 310-10. As a result, loans modified in a TDR may have the financial effect of increasing the specific allowance associated with the loan.
Loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future default. If loans modified in a TDR subsequently default, we evaluate the loan for possible further impairment. The allowance may be increased, adjustments may be made in the allocation of the allowance, partial charge-offs may be taken to further write-down the carrying value of the loan, or the loan may be charged-off completely.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table provides a roll forward of troubled debt restructurings for the periods indicated:
The following table provides information related to troubled debt restructurings (including re-modified TDRs) by portfolio segment and by class of financing receivable occurring during the year ended December 31, 2019:
There were no troubled debt restructurings modified within the previous twelve months that have subsequently defaulted.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table provides information related to troubled debt restructurings (including re-modified TDRs) by portfolio segment and by class of financing receivable during the year ended December 31, 2018:
There are no troubled debt restructurings modified within the previous twelve months that have subsequently defaulted.
The following table provides information related to troubled debt restructurings (including re-modified TDRs) by portfolio segment and by class of financing receivable during the year ended December 31, 2017:
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table provides information related to troubled debt restructurings modified within the previous twelve months that have subsequently defaulted during the year ended December 31, 2017:
The following table provides information for troubled debt restructurings (including re-modified TDRs) by type of modification, by portfolio segment and class of financing receivable during occurring the year ended December 31, 2019:
The following table provides information for troubled debt restructurings (including re-modified TDRs) by type of modification, by portfolio segment and class of financing receivable during the year ended December 31, 2018:
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table provides information related to re-modified troubled debt restructurings by portfolio segment and by class of financing receivable for the year ended December 31, 2019:
The following table provides information related to re-modified troubled debt restructurings by portfolio segment and by class of financing receivable for the year ended December 31, 2018:
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table provides information related to loan payment delinquencies as of December 31, 2019:
(1)
Represents acquired loans that were originally recorded at fair value upon acquisition. These loans are considered to be accruing because we can reasonably estimate future cash flows and expect to fully collect the carrying value of these loans. Therefore, we are accreting the difference between the carrying value and their expected cash flows into interest income.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table provides information related to loan delinquencies as of December 31, 2018:
(1)
Represents acquired loans that were originally recorded at fair value upon acquisition. These loans are considered to be accruing because we can reasonably estimate future cash flows and expect to fully collect the carrying value of these loans. Therefore, we are accreting the difference between the carrying value and their expected cash flows into interest income.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
Credit quality indicators: We categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. We analyze business loans individually by classifying the loans by credit risk. Relationships greater than or equal to $1.0 million classified as special mention or substandard are reviewed quarterly for further deterioration or improvement to determine if the loan is appropriately classified. We use the following definitions for risk ratings other than pass:
Special mention - Loans designated as special mention have specific, well-defined risk issues, which create a high level of uncertainty regarding the long-term viability of the business. Loans in this class are considered to have high-risk characteristics. A special mention loan exhibits material negative financial trends due to company-specific or systemic conditions. If these potential weaknesses are not mitigated, they threaten the borrower’s capacity to meet its debt obligations. Special mention loans still demonstrate sufficient financial flexibility to react to and positively address the root cause of the adverse financial trends without significant deviations from their current business strategy. Their potential weaknesses deserve our close attention and warrant enhanced monitoring.
Substandard - Loans classified as substandard are inadequately protected by the current net worth and payment capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected.
Doubtful - Loans classified as doubtful have all the weaknesses inherent in those classified as substandard. In addition, those weaknesses make collection or liquidation in full highly questionable and improbable. A loan classified as doubtful exhibits discernible loss potential, but a complete loss seems very unlikely. The possibility of a loss on a doubtful loan is high, but because of certain important and reasonably specific pending factors that may strengthen the loan, its classification as an estimated loss is deferred until a more exact status can be determined.
Loss - Loans classified as loss are considered uncollectible and of such value that the continuance as a loan is not warranted. A loss classification does not mean that the loan has no recovery or salvage value; instead, it means that it is not practical or desirable to defer writing off all or a portion of a basically worthless loan even though partial recovery may be affected in the future.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table sets forth information about credit quality indicators as of December 31, 2019:
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table sets forth information about credit quality indicators as of December 31, 2018:
Our exposure to credit loss in the event of nonperformance by the other party to off-balance-sheet financial instruments is represented by the contract amount of the financial instrument. We use the same credit policies in making commitments for off-balance-sheet financial instruments as we do for on-balance-sheet instruments. Financial instruments with off-balance-sheet risk as of December 31, 2019 and 2018 are presented in the following table:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral we obtain upon extension of credit is based
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
on management’s credit evaluation of the counterparty. Collateral held varies but generally may include cash, marketable securities, real estate and other property.
Outstanding loan commitments at December 31, 2019 for fixed rate loans were $129.6 million. The interest rates on these commitments approximate market rates at December 31, 2019. Outstanding loan commitments at December 31, 2019 for adjustable rate loans were $104.5 million. The fair values of these commitments are affected by fluctuations in market rates of interest.
We issue standby letters of credit in the normal course of business. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party. We are required to perform under a standby letter of credit when drawn upon by the guaranteed third party in the case of nonperformance by our customer. The credit risk associated with standby letters of credit is essentially the same as that involved in extending loans to customers and is subject to normal credit policies. Collateral may be obtained based on management’s credit assessment of the customer. As of December 31, 2019, the maximum potential amount of future payments we could be required to make under these standby letters of credit is $40.3 million, of which $34.1 million is fully collateralized. A liability (which represents deferred income) of $444,000 and $267,000 has been recognized for the obligations as of December 31, 2019 and 2018, respectively, and there are no recourse provisions that would enable us to recover any amounts from third parties.
Mortgage servicing assets are recognized as separate assets when servicing rights are created through loan originations and the underlying loan is sold. Upon sale, the mortgage servicing right (“MSR”) is established, which represents the then-fair value of future net cash flows expected to be realized for performing the servicing activities. The fair value of the MSRs are estimated by calculating the present value of estimated future net servicing cash flows, taking into consideration actual and expected mortgage loan prepayment rates, discount rates, servicing costs and other economic factors, which are determined based on current market conditions. In determining the fair value of the MSRs, stochastic modeling is performed using variables such as the forward yield curve, prepayment rates, annual service cost, average life expectancy and option adjusted spreads. MSRs are amortized against mortgage banking income in proportion to, and over the period of, the estimated future net servicing income of the underlying mortgage loans. MSRs are recorded in other assets on the Consolidated Statement of Financial Condition.
Capitalized MSRs are evaluated quarterly for impairment based on the estimated fair value of those rights. The MSRs are stratified by certain risk characteristics, primarily loan term and note rate. If impairment exists within a risk stratification tranche, a valuation allowance is established through a charge to income equal to the amount by which the carrying value exceeds the fair value. If it is later determined all or a portion of the temporary impairment no longer exists for a particular tranche, the valuation allowance is reduced or eliminated. We do not directly hedge against realized or potential future impairment losses on our MSRs.
The following table shows changes in MSRs as of and for the years ended December 31, 2019 and 2018:
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
(7) Accrued Interest Receivable
Accrued interest receivable as of December 31, 2019 and 2018 is presented in the following table:
(8) Federal Home Loan Bank Stock
Northwest Bank is a member of the Federal Home Loan Bank ("FHLB") system. As a member, we are required to maintain an investment in the capital stock of the FHLB of Pittsburgh in accordance with their 2015 Capital Plan, at cost, in two subclasses based on the following ranges: Membership stock purchase (Subclass B-1) ranging from 0.05% to 1.0% of the member asset value as defined by the FHLB, currently at 0.10%; and Activity-based stock purchase (Subclass B-2) ranging from 2.0% to 6.0% of outstanding advances, currently at 4.0%; 0.0% to 6.0% of acquired member assets, currently at 4.0%; 0.0% to 4.0% of certain letters of credit, currently at 0.75%; and 0.0% to 6.0% of outstanding advance commitments settling more than 30 days after trade, currently at 0.0%. Our investment in the capital stock of the FHLB of Pittsburgh at December 31, 2019 and December 31, 2018 was $14.7 million and $15.6 million, respectively. We received dividends on capital stock during the years ended December 31, 2019 and 2018 of $1.1 million and $452,000, respectively. Future dividends may be established at different rates for the two subclasses of capital stock.
(9) Premises and Equipment
Premises and equipment at December 31, 2019 and 2018 are summarized by major classification in the following table:
Depreciation and amortization expense for the years ended December 31, 2019, 2018 and 2017 was $11.7 million, $12.1 million and $12.4 million, respectively.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
(10) Goodwill and Other Intangible Assets
The following table provides information for intangible assets subject to amortization for the years ended December 31, 2019 and 2018:
The following information shows the actual aggregate amortization expense for the years ended December 31, 2019, 2018 and 2017 as well as the estimated aggregate amortization expense, based upon current levels of intangible assets, for each of the five succeeding fiscal years:
The following table provides information for the changes in the carrying amount of goodwill:
We have determined that goodwill is not impaired as of December 31, 2019 and 2018. There were no changes in our operations that would cause us to update the goodwill impairment test performed as of June 30, 2019.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
(11) Deposits
Deposit balances at December 31, 2019 and 2018 are shown in the table below:
The aggregate amount of time deposits with a minimum denomination of $100,000 at December 31, 2019 and 2018 was $521.1 million and $460.8 million, respectively.
Generally, deposits in excess of $250,000 are not federally insured. At December 31, 2019 we had $2.211 billion of deposits in accounts exceeding $250,000.
The following table summarizes the contractual maturity of time deposits at December 31, 2019 and 2018:
The following table summarizes the interest expense incurred on the respective deposits for the years ended December 31, 2019, 2018 and 2017:
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
(12) Borrowed Funds
(a) Borrowings
Borrowed funds at December 31, 2019 and 2018 are presented in the following table:
Borrowings from the FHLB of Pittsburgh, if any, are secured by our residential first mortgage and other qualifying loans. Certain of these borrowings are subject to restrictions or penalties in the event of prepayment.
The revolving line of credit with the FHLB of Pittsburgh carries a commitment of $250.0 million. The rate is adjusted daily by the FHLB of Pittsburgh, and any borrowings on this line may be repaid at any time without penalty.
At December 31, 2019 and December 31, 2018, collateralized borrowings due within one year were $92.7 million and $105.8 million, respectively. The collateralized borrowings are collateralized by various securities held in safekeeping by the FHLB of Pittsburgh. The market value of these securities exceeds the value of the collateralized borrowings. The average amount of collateralized borrowings outstanding in the years ended December 31, 2019, 2018 and 2017 was $91.1 million, $102.3 million and $121.0 million, respectively. The maximum amount of collateralized borrowings outstanding during the years ended December 31, 2019, 2018 and 2017 was $101.1 million, $110.3 million and $137.2 million, respectively.
(b) Trust Preferred Securities
Prior to our merger with DFSC, we owned three statutory business trusts: Northwest Bancorp Capital Trust III, a Delaware statutory business trust, Northwest Bancorp Statutory Trust IV, a Connecticut statutory business trust and LNB Trust II, a Delaware statutory business trusts (the Trusts). The trusts exist solely to issue preferred securities to third parties for cash, issue common securities to the Company in exchange for capitalization of the Trusts, invest the proceeds from the sale of trust securities in an equivalent amount of debentures of the Company, and engage in other activities that are incidental to those previously listed. Northwest Bancorp Capital Trust III issued 50,000 cumulative trust preferred securities in a private transaction to a pooled investment vehicle on December 5, 2005 (liquidation value of $1,000 per preferred security or $50,000,000) with a stated maturity of December 30, 2035 and a floating rate of interest, which is reset quarterly, equal to three-month LIBOR plus 1.38%. Northwest Bancorp Statutory Trust IV issued 50,000 cumulative trust preferred securities in a private transaction to a pooled investment vehicle on December 15, 2005 (liquidation value of $1,000 per preferred security or $50,000,000) with a stated maturity of December 15, 2035 and a floating rate of interest, which is reset quarterly, equal to three-month LIBOR plus 1.38%. LNB Trust II had 7,875 cumulative trust preferred securities outstanding (liquidation value of $1,000 per preferred security or $7,875,000) with a stated maturity of June 15, 2037 and a floating rate of interest, which resets quarterly, equal to three-month LIBOR plus 1.48%. As the shareholders of the trust preferred securities are the primary beneficiaries of the Trusts, the Trusts are not consolidated in our financial statements.
The Trusts have invested the proceeds of the offerings in junior subordinated deferrable interest debentures issued by the Company. The structure of these debentures mirrors the structure of the trust preferred securities. Northwest Bancorp Capital Trust III holds $51,547,000 of the Company’s junior subordinated debentures due December 30, 2035 with a floating rate of interest, reset quarterly, of three-month LIBOR plus 1.38%. The rate in effect at December 31, 2019 was 3.34%. Northwest Bancorp Statutory Trust IV holds $51,547,000 of the Company’s junior subordinated debentures due December 15, 2035 with a floating rate of interest, reset quarterly, of three-month LIBOR plus 1.38%. The rate in effect at December 31, 2019 was 3.27%. LNB Trust II holds $8,119,000 of the Company's junior subordinated debentures due June 15, 2037, with a floating rate of interest, reset quarterly, of three-month LIBOR plus 1.48%. The rate in effect at December 31, 2019 was 3.37%.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
As a result of the merger with DFSC, we acquired two additional statutory business trusts: Union National Capital Trust I ("UNCT I") and Union National Capital Trust II ("UNCT II"); both are Delaware statutory business trusts. At December 31, 2019, UNCT I had 8,000 cumulative trust preferred securities outstanding (liquidation value of $1,000 per preferred security or $8,000,000) with a stated maturity of January 23, 2034. These securities carry a floating interest rate, which is reset quarterly, equal to three-month LIBOR plus 2.85%. The rate in effect at December 31, 2019 was 4.79%. At December 31, 2019, UNCT II had 3,000 cumulative trust preferred securities outstanding (liquidation value of $1,000 per preferred security or $3,000,000) with a stated maturity of November 23, 2034. These securities carry a floating interest rate, which is reset quarterly, equal to three-month LIBOR plus 2.00%. The rate in effect at December 31, 2019 was 3.91%. The Trusts have invested the proceeds of the offerings in junior subordinated deferrable interest debentures held by the Company. The structure of these debentures mirrors the structure of the trust-preferred securities. UNCT I holds $8,248,000 of junior subordinated debentures and UNCT II holds $3,093,000 of junior subordinated debentures. These subordinated debentures are the sole assets of the Trusts. As the shareholders of the trust preferred securities are the primary beneficiaries of the Trusts, the Trusts are not consolidated in our financial statements.
Cash distributions on the trust securities are made on a quarterly basis to the extent interest on the debentures is received by the Trusts. We have the right to defer payment of interest on the subordinated debentures at any time, or from time-to-time, for periods not exceeding five years. If interest payments on the subordinated debentures are deferred, the distributions on the trust securities also are deferred. To date there have been no interest deferrals. Interest on the subordinated debentures and distributions on the trust securities is cumulative. Our obligation constitutes a full, irrevocable, and unconditional guarantee on a subordinated basis of the obligations of the trust under the preferred securities.
The Trusts must redeem the preferred securities when the debentures are paid at maturity or upon an earlier redemption of the debentures to the extent the debentures are redeemed. All or part of the debentures may be redeemed at any time. Also, the debentures may be redeemed at any time if existing laws or regulations, or the interpretation or application of these laws or regulations, change causing:
•
the interest on the debentures to no longer be deductible by the Company for federal income tax purposes;
•
the trust to become subject to federal income tax or to certain other taxes or governmental charges;
•
the trust to register as an investment company; or
•
the preferred securities do not qualify as Tier I capital.
We may, at any time, dissolve any of the Trusts and distribute the debentures to the trust security holders, subject to receipt of any required regulatory approval(s).
The following table sets forth a summary of guaranteed capital debt securities and junior subordinated debentures held by the trusts as of December 31, 2019 and 2018:
(1) Net of discounts due to the fair value adjustment made at the time of acquisition.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
(13) Income Taxes
Total income tax was allocated for the years ended December 31, 2019, 2018 and 2017 as follows:
Income tax expense applicable to income before taxes consists of:
A reconciliation of the expected federal statutory income tax rate to the effective rate, expressed as a percentage of pretax income for the years ended December 31, 2019, 2018 and 2017, is as follows:
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2019 and 2018 are presented below:
We have $2.4 million of federal net operating loss carryovers subject to the annual limitation under Internal Revenue Code Section 382 at December 31, 2019. The majority of net operating loss carryovers do not have an expiration date since it was generated after 2018 and is expected to be fully realized.
We recorded a valuation allowance against state deferred tax assets of a Northwest subsidiary since the subsidiary is not expected to utilize its deferred tax assets in the foreseeable future. This valuation allowance is netted against other deferred tax assets in the preceding table.
Other than stated above, we have determined that no valuation allowance is necessary for the deferred tax assets because it is more likely than not that these assets will be realized through future reversals of existing temporary differences and through future taxable income. We will continue to review the criteria related to the recognition of deferred tax assets on a regular basis.
We utilize a comprehensive model to recognize, measure, present and disclose in our financial statements uncertain tax positions that the company has taken or expects to take on a tax return. At December 31, 2019, there were no unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate. We recognize interest accrued and penalties (if any) related to unrecognized tax benefits in income tax expense. During the year ended December 31, 2019, we did not accrue any interest. At December 31, 2019, we had no amount accrued for interest or the payment of penalties.
We are subject to routine audits of our tax returns by the Internal Revenue Service as well as all states in which we conduct business. We are subject to audit by the Internal Revenue Service for the tax periods ended after December 31, 2016 and subject to audit by any state in which we conduct business for the tax periods ended after December 31, 2016. The New York State audit of the Company's 2011 to 2014 tax years was finalized in 2016, resulting in an additional tax liability of $444,000. The Internal Revenue Service audit of the 2013 tax year of LNB was concluded in 2016 and resulted in no additional tax liability.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
Effective January 1, 2018, the Tax Cuts and Jobs Act of 2017 reduced our corporate federal tax rate from 35.0% to 21.0%. As a result, on the enactment date of December 22, 2017, we were required to re-measure, through income tax expense, our deferred tax assets and liabilities using the enacted rate at which we expect them to be recovered or settled. This re-measurement of our net deferred tax liability resulted in prior year 2017 income tax benefit of $3.1 million.
Also on December 22, 2017, the U.S. Securities and Exchange Commission (“SEC”) released Staff Accounting Bulletin No. 118 (“SAB 118”) to address any uncertainty or diversity of views in practice in accounting for the income tax effects of the Act in situations where a registrant does not have the necessary information available, prepared, or analyzed in reasonable detail to complete this accounting in the reporting period that includes the enactment date. SAB 118 allows for a measurement period not to extend beyond one year from the Act’s enactment date to complete the necessary accounting.
We recorded provisional amounts of deferred income taxes using reasonable estimates in three areas where information necessary to complete the accounting was not available, prepared, or analyzed: (i) our deferred tax asset for temporary differences associated with accrued compensation was awaiting final determinations of amounts that will be paid on or before March 15, 2019 and deducted on the 2018 income tax returns;(ii) our deferred tax liability for temporary differences associated with equity investments in partnerships was awaiting receipt of Schedules K-1 from outside preparers, which was necessary to determine our 2018 tax impact from these investments; (iii) we made no adjustments until further analysis can be completed to deferred tax assets representing future deductions for accrued compensation that may be subject to new limitations under Internal Revenue Code Section 162(m) which generally, limits the annual deduction for certain compensation paid to certain employees to $1 million.
(14) Shareholders’ Equity
Retained earnings are partially restricted in connection with regulations related to the insurance of deposit accounts, which requires Northwest to maintain certain statutory reserves. Northwest may not pay dividends on or repurchase any of its common stock if the effect thereof would reduce retained earnings below the level of adequate capitalization as defined by federal and state regulators.
In tax years prior to fiscal 1997, Northwest was permitted, under the Internal Revenue Code ("IRC"), to deduct an annual addition to a reserve for bad debts in determining taxable income, subject to certain limitations. Bad debt deductions for income tax purposes are included in taxable income of later years only if the bad debt reserve is used subsequently for purposes other than to absorb bad debt losses. Because Northwest does not intend to use the reserve for purposes other than to absorb losses, no deferred income taxes have been provided prior to fiscal 1987. Retained earnings at December 31, 2019 and 2018 include approximately $39.1 million representing such bad debt deductions for which no deferred income taxes have been provided.
(15) Earnings Per Share
Basic earnings per common share ("EPS") is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the period, without considering any dilutive items. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in our earnings. All stock options outstanding during the years ended December 31, 2019, 2018 and 2017 were included in the computation of diluted earnings per share because the stock options exercise price was less than the average market price of the common shares of $17.07, $17.20, and $16.64, respectively.
The computation of basic and diluted earnings per share for the years ended December 31, 2019, 2018 and 2017 follows:
(1) Not in thousands.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
(16) Employee Benefit Plans
(a) Pension plans
We maintain noncontributory defined benefit pension plans covering substantially all employees and members of our board of directors. Retirement benefits are based on certain compensation levels, age, and length of service. Contributions are based on an actuarially determined amount to fund not only benefits attributed to service to date but also for those expected to be earned in the future. In addition, we have an unfunded Supplemental Executive Retirement Plan (“SERP”) to compensate those executive participants eligible for the defined benefit pension plan whose benefits are limited by Section 415 of the IRC.
We also sponsor a retirement savings plan in which substantially all employees participate. We provide a matching contribution of 100% of each employee’s contribution to a maximum of 4% of the employee’s compensation.
Total expense for all retirement plans, including defined benefit pension plans, was approximately $6.7 million, $5.8 million and $6.8 million, for the years ended December 31, 2019, 2018 and 2017, respectively.
Components of net periodic pension cost and other amounts recognized in other comprehensive income:
The following table sets forth the net periodic pension cost for the defined benefit pension plans for the years ended December 31, 2019, 2018 and 2017 :
The following table sets forth other changes in the defined benefit pension plans’ plan assets and benefit obligations recognized in other comprehensive income:
The estimated net loss and prior service credit for the defined benefit pension plan that will be amortized from accumulated other comprehensive income into net periodic cost over the next year is $3.6 million and $(2.3) million, respectively.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table sets forth information for the defined benefit pension plans’ funded status at December 31, 2019 and 2018:
The following table sets forth the assumptions used to develop the net periodic pension cost:
The following table sets forth the assumptions used to determine benefit obligations at the end of each period:
The expected long-term rate of return on assets is based on the expected return of each of the asset categories, weighted based on the median of the target allocation for each category. We use the Citigroup Pension Liability Index rates matching the duration of our benefit payments as of the measurement date to determine the discount rate.
The accumulated benefit obligation for the funded defined benefit pension plan was $217.3 million, $175.1 million and $186.9 million at December 31, 2019, 2018 and 2017, respectively. The accumulated benefit obligation for all unfunded defined benefit plans was $5.2 million, $4.8 million and $6.2 million at December 31, 2019, 2018 and 2017, respectively.
The following table sets forth certain information related to our pension plans:
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
We anticipate making a contribution to our defined benefit pension plan of $2.0 million to $4.0 million during the year ending December 31, 2020.
The investment policy as established by the Plan Administrative Committee, to be followed by the Trustee, is to invest assets based on the target allocations shown in the table below. To meet target allocation ranges set forth by the Plan Administrative Committee, periodically, the assets are reallocated by the Trustee. The investment policy is reviewed periodically to determine if the policy should be changed. Pension assets are conservatively invested with the goal of providing market or better returns with below market risks. Assets are invested in a balanced portfolio composed primarily of equities, fixed income, and cash or cash equivalent investments. The Trustee tries to maintain an approximate asset mix position of 20% to 50% bonds and 30% to 60% equities.
A maximum of 10% may be invested in any one stock, including the stock of Northwest Bancshares, Inc. The objective of holding equity securities is to provide capital appreciation consistent with the ownership of the common stocks of medium to large companies. Acceptable bond investments are direct or agency obligations of the U.S. Government or investment grade corporate bonds. The average maturity of the bond portfolio shall not exceed ten years.
The following table sets forth the weighted average asset allocation of defined benefit plans:
All of the assets held by the defined benefit pension plan are measured and recorded at estimated fair value on our balance sheet on a recurring basis as Level 1 and Level 2 assets, as defined by the fair value hierarchy defined in note 17.
The following table sets forth the pension plan assets as of December 31, 2019 and 2018:
The benefits expected to be paid in each year from 2020 to 2024 are $7.7 million, $8.0 million, $8.1 million, $8.0 million and $8.4 million, respectively. The aggregate benefits expected to be paid in the five years from 2025 to 2029 are $46.3 million. The expected benefits to be paid are based on the same assumptions used to measure our benefit obligations at December 31, 2019 and include estimated future employee service.
(b) Post-retirement Healthcare Plan
In addition to pension benefits, we provide post-retirement healthcare benefits for certain employees who were employed as of October 1, 1993 and were at least 55 years of age on that date. We use the accrual method of accounting for post-retirement benefits other than pensions.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
Components of net periodic benefit cost and other amounts recognized in other comprehensive income:
The following table sets forth the net periodic benefit cost for the post-retirement healthcare benefits plan for the years ended December 31, 2019, 2018 and 2017:
The following table sets forth other changes in the post-retirement healthcare plan’s plan assets and benefit obligations recognized in other comprehensive income:
The estimated net loss for the post-retirement healthcare benefit plan that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the year ending December 31, 2020 is $18,000.
The following table sets forth the funded status of the post-retirement healthcare benefit plan at December 31, 2019 and 2018:
The assumptions used to develop the preceding information for post-retirement healthcare benefits are as follows:
(1) Not in thousands.
If the assumed rate of increase in healthcare costs was increased by one percentage point to 5% from the level presented above, the interest cost component of net periodic post-retirement healthcare benefit cost would increase by $4,000 and the accumulated post-retirement benefit obligation for healthcare benefits would increase by $24,000.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table sets forth information for plans with an accumulated benefit obligation in excess of plan assets:
(c) Common stock awards
On April 20, 2011, we established the Northwest Bancshares, Inc. 2011 Equity Incentive Plan with 2,806,233 common shares authorized. From this plan, we awarded employees 353,750 common shares and outside directors 24,300 common shares with a grant date fair value of $15.24 per share (total market value of $5.8 million at issuance). These common shares vest over a ten-year period with the first vesting occurring on the grant date. Total common shares forfeited from the 2011 plan were 539,853, of which, 58,199 shares were forfeited during the year ended December 31, 2019. Forfeited shares may be awarded to other eligible recipients in future grants until the plan termination date in 2021.
On April 18, 2018, we established the Northwest Bancshares, Inc. 2018 Equity Incentive Plan with 1,500,000 common shares. From this plan, we awarded employees 390,030 common shares and outside directors 24,300 common shares with a grant date fair value of $16.59 per share (total market value of $6.9 million at issuance) on May 14, 2018. We also awarded employees 256,800 common shares and outside directors 24,300 common shares with a grant date fair value of $17.27 per share (total market value of $4.9 million at issuance) on May 22, 2019. These common shares vest over a seven-year period with the first vesting occurring on the grant date. Total common shares forfeited from the 2018 plan were 42,610, of which, 32,898 shares were forfeited during the year ended December 31, 2019. Forfeited shares may be awarded to other eligible recipients in future grants until the plan termination date in 2028.
(d) Stock option plans
The Northwest Bancshares, Inc. 2011 Equity Incentive Plan also authorized the granting of 7,015,583 stock options. On May 17, 2017, we granted employees 754,210 stock options and outside directors 64,800 stock options with an exercise price of $15.57 per share. These awarded stock options vest over a ten-year period with the first vesting occurring on the grant date with a ten-year exercise period from the grant date.
The Northwest Bancshares, Inc. 2018 Equity Incentive Plan also authorized the granting of 3,500,000 stock options. On May 14, 2018, we granted employees 831,160 stock options and outside directors 64,800 stock options with an exercise price of $16.59 per share. On May 22, 2019, we granted employees 547,410 stock options and outside directors 64,800 stock options with an exercise price of $17.27 per share. These awarded stock options vest over a seven-year period with the first vesting occurring on the grant date with a ten-year exercise period from the grant date.
The following table summarizes the activity in our option plans during the years ended December 31, 2019, 2018 and 2017 (amounts in this table are not in thousands):
(1)
Weighted average fair value of options at grant date: $1.14, $1.49 and $1.55, respectively.
(2)
The total intrinsic value of options exercised was $5.2 million, $4.8 million and $3.5 million, respectively.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The aggregate intrinsic value of all options expected to vest and fully vested options at December 31, 2019 is $3.2 million and $20.7 million, respectively. The following table summarizes the number of options outstanding, number of options exercisable, and weighted average remaining life of all option grants as of December 31, 2019:
(17) Disclosures About Fair Value of Financial Instruments
We are required to disclose fair value information about financial instruments whether or not recognized in the Consolidated Statement of Financial Condition. Fair value information of certain financial instruments and all nonfinancial instruments is not required to be disclosed. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
Financial assets and liabilities recognized or disclosed at fair value on a recurring basis and certain financial assets and liabilities on a non-recurring basis are accounted for using a three-level hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. This hierarchy gives the highest priority to quoted prices with readily available independent data in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable market inputs (Level 3). When various inputs for measurement fall within different levels of the fair value hierarchy, the lowest level input that has a significant impact on fair value measurement is used.
Financial assets and liabilities are categorized based upon the following characteristics or inputs to the valuation techniques:
•
Level 1 - Financial assets and liabilities for which inputs are observable and are obtained from reliable quoted prices for identical assets or liabilities in actively traded markets. This is the most reliable fair value measurement and includes, for example, active exchange-traded equity securities.
•
Level 2 - Financial assets and liabilities for which values are based on quoted prices in markets that are not active or for which values are based on similar assets or liabilities that are actively traded. Level 2 also includes pricing models in which the inputs are corroborated by market data, for example, matrix pricing.
•
Level 3 - Financial assets and liabilities for which values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. Level 3 inputs include the following:
•
Quotes from brokers or other external sources that are not considered binding;
•
Quotes from brokers or other external sources where it cannot be determined that market participants would in fact transact for the asset or liability at the quoted price;
•
Quotes and other information from brokers or other external sources where the inputs are not deemed observable.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
We are responsible for the valuation process and as part of this process may use data from outside sources in establishing fair value. We perform due diligence to understand the inputs used or how the data was calculated or derived. We also corroborate the reasonableness of external inputs in the valuation process.
The carrying amounts reported in the Consolidated Statement of Financial Condition approximate fair value for the following
financial instruments: cash and cash equivalents, marketable securities available-for-sale, accrued interest receivable, interest rate lock
commitments, forward commitments, interest rate swaps, savings and checking deposits and accrued interest payable.
Marketable Securities
Where available, market values are based on quoted market prices, dealer quotes, and prices obtained from independent pricing services.
Debt securities - available-for-sale - Generally, debt securities are valued using pricing for similar securities, recently executed transactions and other pricing models utilizing observable inputs. The valuation for most debt securities is classified as Level 2. Securities within Level 2 include corporate bonds, municipal bonds, mortgage-backed securities and U.S. government obligations. Certain debt securities which were AAA rated at purchase do not have an active market and as such we have used an alternative method to determine the fair value of these securities. The fair value has been determined using a discounted cash flow model using market assumptions, which generally include cash flow, collateral and other market assumptions. As such, securities which otherwise would have been classified as Level 2 securities if an active market for those assets or similar assets existed are included herein as Level 3 assets.
Debt securities - held-to-maturity - The fair value of debt securities held-to-maturity is determined in the same manner as debt securities available-for-sale.
Loans Receivable
Loans with comparable characteristics including collateral and re-pricing structures are segregated for valuation purposes. Each loan pool is separately valued utilizing a discounted cash flow analysis. Projected monthly cash flows are discounted to present value using a market rate for comparable loans, which is not considered an exit price. Characteristics of comparable loans include remaining term, coupon interest, and estimated prepayment speeds. Delinquent loans are separately evaluated given the impact delinquency has on the projected future cash flow of the loan including the approximate discount or market rate, which is not considered an exit price.
Loans held-for-sale
The estimated fair value of loans held-for-sale is based on market bids obtained from potential buyers.
Loans held for investment
The fair value of the loans held for investment is estimated using a discounted cash flow analysis that utilizes interest rates
currently being offered for similar loans adjusted for liquidity and credit risk.
FHLB Stock
Due to the restrictions placed on the transferability of FHLB stock, it is not practical to determine the fair value.
Deposit Liabilities
The estimated fair value of deposits with no stated maturity, which includes demand deposits, money market, and other savings accounts, is the amount payable on demand. Although market premiums paid for depository institutions reflect an additional value for these low-cost deposits, adjusting fair value for any value expected to be derived from retaining those deposits for a future period of time or from the benefit that results from the ability to fund interest-earning assets with these deposit liabilities is prohibited. The fair value estimates of deposit liabilities do not include the benefit that results from the low-cost funding provided by these deposits compared to the cost of borrowing funds in the market. Fair values for time deposits are estimated using a discounted cash flow calculation that applies contractual cost currently being offered in the existing portfolio to current market rates being offered locally for deposits of similar remaining maturities. The valuation adjustment for the portfolio consists of the present value of the difference of these two cash flows, discounted at the assumed market rate of the corresponding maturity.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
Borrowed Funds
Fixed rate advances are valued by comparing their contractual cost to the prevailing market cost. The carrying amount of repurchase agreements approximates fair value.
Junior Subordinated Debentures
The fair value of junior subordinated debentures is calculated using the discounted cash flows at the prevailing rate of interest.
Interest rate lock commitments and forward commitments
The fair value of interest rate lock commitments is based on the value of underlying loans held-for-sale which is based on quoted prices for similar loans in the secondary market. This value is then adjusted based on the probability of the loan closing (i.e. the “pullthrough”amount, a significant unobservable input). The fair value of forward sale commitments is based on quoted prices from the secondary market based on the settlement date of the contracts.
Cash flow hedges, interest rate and foreign exchange swap agreements
The fair value of interest rate swaps is based upon the present value of the expected future cash flows using the LIBOR swap curve, the basis for the underlying interest rate. To price interest rate swaps, cash flows are first projected for each payment date using the fixed rate for the fixed side of the swap and the forward rates for the floating side of the swap. These swap cash flows are then discounted to time zero using LIBOR zero-coupon interest rates. The sum of the present value of both legs is the fair market value of the interest rate swap. These valuations have been derived from our third party vendor’s proprietary models rather than actual market quotations. The proprietary models are based upon financial principles and assumptions that we believe to be reasonable. The fair value of the foreign exchange swap is derived from proprietary models rather than actual market quotations. The proprietary models are based upon financial principles and assumptions we believe to be reasonable.
Off-Balance Sheet Financial Instruments
These financial instruments generally are not sold or traded, and estimated fair values are not readily available. However, the fair value of commitments to extend credit and standby letters of credit is estimated using the fees currently charged to enter into similar agreements. Commitments to extend credit are generally short-term in nature and, if drawn upon, are issued under current market terms. At December 31, 2019 and 2018, there was no significant unrealized appreciation or depreciation on these financial instruments.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table sets forth the carrying amount and estimated fair value of our financial instruments included in the Consolidated Statement of Financial Condition at December 31, 2019 and 2018:
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
Fair value estimates are made at a point-in-time, based on relevant market data and information about the instrument. The preceding methods and assumptions were used in estimating the fair value of financial instruments at December 31, 2019 and 2018. There were no transfers of financial instruments between Level 1 and Level 2 during the years ended December 31, 2019 and 2018.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table represents assets and liabilities measured at fair value on a recurring basis as of December 31, 2019:
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table represents assets and liabilities measured at fair value on a recurring basis as of December 31, 2018:
The table below presents a reconciliation of all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2019 and 2018:
Certain assets and liabilities are measured at fair value on a nonrecurring basis after initial recognition such as loans held for sale, loans measured for impairment, real estate owned, and mortgage servicing rights.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table represents the fair market measurement for only those nonrecurring assets that had a fair market value below the carrying amount as of December 31, 2019:
The following table represents the fair market measurement for only those nonrecurring assets that had a fair market value below the carrying amount as of December 31, 2018:
Loans measured for impairment - A loan is considered to be impaired as described in note 1(f). We classify impaired loans as nonrecurring Level 3.
Real estate owned - Real estate owned is comprised of property acquired through foreclosure or voluntarily conveyed by borrowers. These assets are recorded on the date acquired at the lower of the related loan balance or fair value, less estimated disposition costs, with the fair value being determined by appraisal. Subsequently, foreclosed assets are valued at the lower of the amount recorded at acquisition date or fair value, less estimated disposition costs. We classify real estate owned as nonrecurring Level 3.
The following table presents additional quantitative information about assets measured at fair value on a recurring and nonrecurring basis and for which we have utilized Level 3 inputs to determine fair value at December 31, 2019:
(1)
Fair value is generally determined through independent appraisals of the underlying collateral, which may include Level 3 inputs that are not identifiable, or by using the discounted cash flow method if the loan is not collateral dependent.
(18) Regulatory Capital Requirements
We and our banking subsidiary are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by the regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices must be met. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
In July 2013, the FDIC and the other federal regulatory agencies issued a final rule that revised their leverage and risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. The rule limits an organization’s capital distributions and certain discretionary bonus payments if the organization does not hold a “capital conservation buffer” consisting of 2.5% of Total Tier 1 and Common Equity Tier 1 ("CET1") capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
Quantitative measures established by regulation to ensure capital adequacy require us and our banking subsidiary to maintain minimum amounts and ratios (set forth in the table below) of Total, Tier 1, and CET1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier I capital to average assets (as defined). As of December 31, 2019 and 2018, we and our banking subsidiary exceeded all capital adequacy requirements to which we were subject.
As of December 15, 2019, the most recent notification from the FDIC categorized Northwest Bank as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized,” the bank must maintain total risk-based, Tier 1 risk-based, CET 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the bank’s categories.
The actual, required, and well capitalized levels as of December 31, 2019 and 2018 were as follows:
(1) Amounts and ratios include the 2019 capital conservation buffer of 2.5% with the exception of Tier 1 capital to average assets. For further information related to the capital conservation buffer, see "Item 1. Business - Supervision and Regulation".
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
(1) Amounts and ratios include the 2018 capital conservation buffer of 1.875% with the exception of Tier 1 capital to average assets. For further information related to the capital conservation buffer, see Item 1. Business - "Supervision and Regulation".
(19) Contingent Liabilities
We and our subsidiaries are subject to a number of asserted and unasserted claims encountered in the normal course of business. Management believes that the aggregate liability, if any, that may result from such potential litigation will not have a material adverse effect on our financial statements. However, we cannot presently determine whether or not any claims against us will have a material adverse effect on our results of operations in any future reporting period.
(20) Legal Proceedings
We establish accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probable and that the amount of loss can be reasonably estimated. As of December 31, 2019, we do not anticipate that the aggregate ultimate liability arising out of any pending or threatened legal proceedings will be material to our Consolidated Financial Statements. Any such accruals are adjusted thereafter as appropriate to reflect changes in circumstances. Due to the inherent subjectivity of assessments and unpredictability of outcomes of legal proceedings, any amounts accrued may not represent the ultimate loss to us from legal proceedings.
During the year-ended December 31, 2018, Northwest and our subsidiary, Northwest Insurance Services (“NWIS”), were involved in a lawsuit against, among others, First National Bank of Pennsylvania (“FNB”) and their insurance subsidiary, First National Insurance Agency, LLC (“FNIA”). All counterclaims against Northwest were discontinued and, in December 2018, a verdict was rendered in favor of NWIS on several of its claims. Post-trial proceedings have continued throughout the current year and, due to the inherent uncertainties with respect to these proceedings, we have not accrued any awards associated with this verdict within our consolidated financial statements as of December 31, 2019.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
(21) Components of Accumulated Other Comprehensive Income
The following table sets forth the components of accumulated other comprehensive loss as of December 31, 2019 and 2018:
The following table shows the changes in accumulated other comprehensive loss by component for the year ended December 31, 2019:
(1)Consists of realized gains on securities (gain on sales of investments, net) of $7, net of tax (income tax expense) of $2.
(2)
Consists of amortization of prior service cost (compensation and employee benefits) of $2,323 and amortization of net loss (compensation and employee benefits) of $(3,492), net of tax (income tax expense) of $334.
The following table shows the changes in accumulated other comprehensive loss by component for the year ended December 31, 2018:
(1)
Consists of realized gains on securities (gain on sales of investments, net) of $215, net of tax (income tax expense) of $60.
(2)
Consists of amortization of prior service cost (compensation and employee benefits) of $2,323 and amortization of net loss (compensation and employee benefits) of $(3,587), net of tax (income tax expense) of $361.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table shows the changes in accumulated other comprehensive loss by component for the year ended December 31, 2017:
(1)
Consists of realized losses on securities (gain on sales of investments, net) of $3,814, net of tax (income tax expense) of $1,488.
(2)
Consists of amortization of prior service cost (compensation and employee benefits) of $2,323 and amortization of net loss (compensation and employee benefits) of $(3,818), net of tax (income tax expense) of $613.
(22) Parent Company Only Financial Statements - Condensed
Statements of Financial Condition
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
Statements of Income
Statements of Cash Flows
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
(23) Derivative Financial Instruments
We are a party to derivative financial instruments in the normal course of business to manage our own exposure to fluctuations in interest rates and to meet the needs of our customers. The primary derivatives that we use are interest rate swaps and caps and foreign exchange contracts, which are entered into with counterparties that meet established credit standards. We believe that the credit risk inherent in all of our derivative contracts is minimal based on our credit standards and the netting and collateral provisions of the interest rate swap agreements.
(a) Derivatives designated in hedging relationships
With the expiration of the $50.0 million in notional of interest rate swap agreements ("swaps") previously designated in hedging relationships, we are no longer a counterparty to any interest rate swap agreements designated as cash flow hedges. Previously, the swaps were intended to protect against the variability of cash flows associated with Northwest Bancorp Capital Trust III and Northwest Bancorp Capital Trust IV. In 2018, the swaps matured without replacement.
(b) Derivatives not designated in hedging relationships
In addition to our derivatives designated in hedge relationships, we act as an interest rate or foreign exchange swap counterparty for certain commercial borrowers in the normal course of servicing our customers, which are accounted for at fair value. We manage our exposure to such interest rate or foreign exchange swaps by entering into corresponding and offsetting interest rate swaps with third parties that mirror the terms of the swaps we have with the commercial borrowers. These positions (referred to as “customer swaps”) directly offset each other and our exposure is the fair value of the derivatives due to changes in credit risk of our commercial borrowers and third parties. Customer swaps are recorded within other assets or other liabilities on the Consolidated Statement of Financial Condition at their estimated fair value. Changes to the fair value of assets and liabilities arising from these derivatives are included, net, in other operating income in the Consolidated Statement of Income.
We enter into interest rate lock commitments for residential mortgage loans which commit us to lend funds to a potential borrower at a specific interest rate within a specified period of time. Interest rate lock commitments that relate to the origination of mortgage loans that will be held-for-sale are considered derivative financial instruments under applicable accounting guidance. Interest rate lock commitments on loans held-for-sale are carried at fair value in other assets on the Consolidated Statement of Financial Condition. Northwest sells loans to the secondary market on a mandatory or best efforts basis. The loans sold on a mandatory basis commit us to deliver a specific principal amount of mortgage loans to an investor at a specified price, by a specified date, or the commitment must be paired off. These forward commitments entered into on a mandatory delivery basis meet the definition of a derivative financial instrument. All closed loans to be sold on a mandatory delivery basis are classified as held-for-sale on the Consolidated Statement of Financial Condition. Changes to the fair value of the interest rate lock commitments and the forward commitments are recorded in mortgage banking income in the Consolidated Statements of Income.
We enter into risk participation agreements with financial institution counterparties for interest rate swaps related to loans in which we are a participant. The risk participation agreements provide credit protection to the financial institution should the borrower fail to perform on its interest rate derivative contract with the financial institution.
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
The following table presents information regarding our derivative financial instruments, at December 31,:
The following table indicates the gain or loss recognized in income on derivatives for the periods indicated:
(24) Selected Quarterly Financial Data - Unaudited
NORTHWEST BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019, 2018 and 2017
(All dollar amounts presented in tables are in thousands, except as indicated)
(25) Subsequent events
The Company previously announced that it has entered into an Agreement and Plan of Merger (the “Merger Agreement”) by and between the Company and MutualFirst Financial, Inc. (“MutualFirst Financial”). Pursuant to the Merger Agreement, MutualFirst Financial will merge with and into the Company, with the Company as the surviving entity. Immediately thereafter, MutualBank, the wholly owned subsidiary of MutualFirst Financial, will merge with and into Northwest Bank, the wholly owned subsidiary of the Company, with Northwest Bank as the surviving entity.
Under the terms of the Merger Agreement, each share of common stock of MutualFirst Financial will be converted into the right to receive 2.4 shares of the Company’s common stock, for total consideration valued at approximately $346 million, or $39.89 per share based on the Company's 15-day volume weighted average closing stock pricing ending on October 23, 2019.
The transaction has been approved by the Boards of Directors of the Company and MutualFirst Financial. Completion of the transaction is subject to customary closing conditions, including the receipt of required regulatory approvals and the approval of stockholders of MutualFirst Financial.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective.
There were no changes made in our internal controls during the quarter ended December 31, 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
See Management’s Report On Internal Control Over Financial Reporting - filed herewith under Part II, Item 8. “Financial Statements and Supplementary Data.”
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Not Applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Directors
The “Proposal I-Election of Directors” section of the Company’s definitive proxy statement for the Company’s 2020 Annual Meeting of Stockholders (the “2020 Proxy Statement”) is incorporated herein by reference.
Executive Officers
The “Proposal I-Election of Directors-Executive Officers who are not Directors” section of the 2020 Proxy Statement is incorporated herein by reference.
Compliance with Section 16(a) of the Exchange Act
The “Proposal I-Election of Directors-Delinquent Section 16(a) Reports” section of the 2020 Proxy Statement is incorporated herein by reference.
Code of Ethics
The “Proposal I-Election of Directors-Code of Ethics” section of the 2020 Proxy Statement is incorporated herein by reference. A copy of the Code of Ethics is available to shareholders on the “Governance Documents” portion of the Investor Relations’ section on the Company’s website at www.northwest.com.
Corporate Governance
Information regarding the audit committee and its composition and the audit committee’s financial expert required by this item is incorporated herein by reference to the section captioned “Proposal I-Election of Directors-Meetings and Committees of the Board of Directors-Audit Committee” section of the 2020 Proxy Statement.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The “Proposal I-Election of Directors-Meetings and Committees of the Board of Directors-Compensation Committee,” “-Compensation Committee Interlocks and Insider Participation,” “-Compensation Committee Report,” “-Compensation Discussion and Analysis,” “-Executive Compensation,” “-Employment Agreements/Change in Control Agreements,” “-Potential Payments to Named Executive Officers,” “-Defined Benefit Plans,” “-Supplemental Executive Retirement Plan,” “-Life Insurance Coverage” and “-Directors’ Compensation” sections of the Company’s 2020 Proxy Statement are incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The “Proposal I-Election of Directors” section of the Company’s 2020 Proxy Statement is incorporated herein by reference.
The Company does not have any equity compensation program that was not approved by stockholders.
Set forth below is certain information as of December 31, 2019 regarding equity compensation plans that have been approved by stockholders.
(1)
Reflects exercise price of options only.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The “Proposal I-Election of Directors-Board Independence” and “Proposal I-Election of Directors-Transactions with Certain Related Persons” sections of the Company’s 2020 Proxy Statement are incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The “Proposal II-Ratification of Appointment of Independent Registered Public Accounting Firm” section of the Company’s 2020 Proxy Statement is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements
The following documents are filed as part of this Form 10-K.
(A)
Management’s Report on Internal Control Over Financial Reporting
(B)
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
(C)
Report of Independent Registered Public Accounting Firm
(D)
Consolidated Statements of Financial Condition at December 31, 2019 and 2018
(E)
Consolidated Statements of Income Years ended December 31, 2019, 2018 and 2017
(F)
Consolidated Statements of Comprehensive Income Years ended December 31, 2019, 2018 and 2017
(G)
Consolidated Statements of Changes in Shareholders’ Equity Years ended December 31, 2019, 2018 and 2017
(H)
Consolidated Statements of Cash Flows Years ended December 31, 2019, 2018 and 2017
(I)
Notes to the Consolidated Financial Statements
(a)(2) Financial Statement Schedules
None.
(a)(3) Exhibits
ITEM 16. FORM 10-K SUMMARY
Not applicable.
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.
NORTHWEST BANCSHARES, INC.
Date: March 2, 2020
By:
/s/ Ronald J. Seiffert
Ronald J. Seiffert, Chairman, President and Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange 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.