What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-11-04 compared with 2020-08-05 · 241 added, 220 removed, 469 unchanged (50% of the section changed)

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changes in governmental monetary and fiscal policies as well as other legislative and regulatory changes, including with respect to SBA or USDA lending programs and investment tax credits;

changes in political and economic conditions;

changes in political and economic conditions, including as a result of the 2020 federal elections;

the impact of heightened regulatory scrutiny of financial products and services, primarily led by the Consumer Financial Protection Bureau and various state agencies;

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Offsetting these revenues are the cost of funding sources, provision for loan and lease credit losses, any costs related to foreclosed assets and other operating costs such as salaries and employee benefits, travel, professional services, advertising and marketing and tax expense.

The Company also has less routinely generated gains and losses arising from its financial technology investments.

Recent Developments

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Financial position and results of operations

Relating to our June 30, 2020 financial condition and results of operations, COVID-19 had a significant impact on the allowance for credit losses (“ACL”) on loans and leases, loans carried at fair value, loan servicing asset revaluation, net gains on sales of loans and net interest income.

While the Company has not yet experienced any charge-offs related to COVID-19, the ACL and loan fair value calculation and resulting provision for loan and lease credit losses and net loss on loans accounted for under the fair value option were significantly impacted by changes in forecasted economic conditions.

Given that forecasted economic scenarios continued to be negative with substantial uncertainty since the pandemic was declared in early March combined with effects surfacing in certain pandemic-at-risk verticals and the risk that payments being made by the SBA for borrowers under its programs may be skewing actual indications of ability to repay, the need for additional credit related reserves increased significantly by the end of the second quarter.

Relating to our September 30, 2020 financial condition and results of operations, COVID-19 continued to have a cumulative impact on the allowance for credit losses (“ACL”) on loans and leases, loans carried at fair value, loan servicing asset revaluation, net gains on sales of loans and net interest income, however observed improvement in economic forecasts and broader markets did begin to slow and in some cases somewhat reverse pandemic effects recorded earlier in the year.

With improving economic forecasts, the ACL and resulting provision for loan and lease credit losses were most significantly impacted by charge-offs related to COVID-19 while the loan fair value calculation and net gain on loans accounted for under the fair value were positively affected.

With the ongoing monitoring of effects surfacing in certain pandemic-at-risk verticals combined with the risk that payment deferrals and those being made by the SBA for borrowers under its programs may be skewing actual indications of ability to repay, total credit related reserves continued to grow but at a slower pace due to the above mentioned improving economic forecasts during the third quarter.

Refer to the discussion of the ACL and loans at fair value in Notes 5 and 9, respectively, of the unaudited condensed consolidated financial statements as well as further discussion below in MD&A.

Also impacted by deteriorating market conditions was the Company’s valuation of the loan servicing asset as discussed in Note 7 of the unaudited condensed consolidated financial statements and net gains on sales of loans, both of which are further discussed below in MD&A.

The secondary market improved at the end of the second quarter which offset earlier negative COVID-19 adjustments for loans carried at fair value and the loan servicing asset valuation.

In the second quarter the net interest margin was negatively impacted by significant rate cuts in response to stimulus efforts combined with heightened levels of liquidity at the Company as a part of pandemic preparedness, while the Paycheck Protection Program (the “PPP”) lending had a positive impact on net interest margin, as discussed more fully below in MD&A.

Should economic conditions worsen, the Company could experience further increases in the required ACL and negative fair value marks and record additional credit or market related loss expense.

It is also possible that the Company’s asset quality measures could worsen at future measurement periods if the effects of COVID-19 are prolonged.

While there are current signs of recovery in the secondary market pricing, the income from gain on sale of loans in future periods could be reduced due to COVID-19.

Impacts began to be felt in the latter part of March and early April with loan sales executed at that time as secondary markets conditions began to weaken.

At this time, the Company is unable to project the materiality of such an impact but recognizes the breadth of the economic impact is likely to impact gains in future periods.

Also impacted by improving market conditions was the Company’s valuation of the loan servicing asset as discussed in Note 7 of the unaudited condensed consolidated financial statements and net gains on sales of loans, both of which are further discussed below in MD&A.

The secondary market continued to improve during the third quarter which also began to somewhat offset earlier negative COVID-19 adjustments for loans carried at fair value and the loan servicing asset valuation.

In the third quarter the net interest margin continued to be negatively impacted by significant rate cuts in response to stimulus efforts combined with heightened levels of liquidity at the Company as a part of pandemic preparedness, however improvements began to emerge as the deposit portfolio started to reprice and a substantial portion of excess liquidity was utilized to fund significant loan demand, while Paycheck Protection Program (“PPP”) lending had a positive impact on net interest margin as discussed more fully below in MD&A.

Should economic conditions worsen, the Company could experience further increases in the allowance for credit losses (“ACL”) and negative fair value marks and record additional credit or market related loss expense.

It is also possible that the Company’s asset quality measures could worsen at future measurement periods if there is a significant resurgence of COVID-19 cases or the pandemic’s effects are prolonged.

While there are positive signs of recovery in the secondary market pricing, the income from gain on sale of loans in future periods could be reduced due to COVID-19.

Negative impacts began to be felt in the latter part of March and early April 2020 with loan sales executed at that time as secondary markets conditions began to weaken.

At this time, the Company is unable to project the materiality of such impacts but anticipates that the breadth of the economic impact would likely impact gains in future periods.

Interest income could be further reduced due to COVID-19.

In keeping with guidance from banking regulators, the Company has and continues to actively work with COVID-19 affected borrowers to help defer their payments, interest, and fees.

In addition to regulatory relief on deferrals from banking regulators, six months of payment relief are also available from the SBA for certain loans guaranteed by that agency.

In accordance with guidance from banking regulators, the Company has worked and continues to work with COVID-19 affected borrowers to help defer their payments, interest, and fees.

In addition to regulatory relief on deferrals from banking regulators, six months of payment relief is also available from the SBA for certain loans guaranteed by that agency pursuant to the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”).

While interest and fees will still accrue to interest, should eventual credit losses on these loans with deferred payments emerge, interest income and fees accrued would need to be reversed.

In such a scenario, interest income in future periods could be negatively impacted.

At this time, we are unable to project the materiality of such an impact, but recognize the breadth of the economic impact may affect our borrowers’ ability to repay in future periods.

At this time, we are unable to project the materiality of such an impact but anticipate that the breadth of the economic impact may affect our borrowers’ ability to repay in future periods.

Capital and liquidity

As of June 30, 2020, all of the Company’s capital ratios, and the Bank’s capital ratios, were in excess of all regulatory requirements.

As of September 30, 2020, all of the Company’s capital ratios, and the Bank’s capital ratios, were in excess of all regulatory requirements.

While the Company believes that capital is sufficient to withstand an extended economic recession brought about by COVID-19, reported and regulatory capital ratios could be adversely impacted by further credit losses.

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Wholesale funding markets have remained open to the Company, but rates for short term funding have recently been volatile and the secondary market for guaranteed loans has shown reactionary and varying responses to the changing economic environment.

In addition to increased levels of loan sales, the Company also increased its levels of deposits and borrowings in the first half of the year, as discussed further in MD&A.

The Company increased its levels of deposits and borrowings in the first nine months of the year, as discussed further in MD&A.

If funding costs are elevated for an extended period of time, it could have an adverse effect on the Company’s net interest margin.

If an extended recession causes large numbers of the Company’s deposit customers to withdraw their funds, the Company might become more reliant on volatile or more expensive sources of funding.

The Federal Reserve has created the Paycheck Protection Program L iquidity Facility (“P P P L F”) to help provide financing for the origination of PPP loans .

The Federal Reserve created the Paycheck Protection Program L iquidity Facility (“P P P L F”) to help provide financing for the origination of PPP loans .

The P P P LF extends loans to banks that have loaned money to small businesses under the PPP, discussed in more detail below.

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Borrowings under the P P P LF bear interest at a rate of 0.35% , and there are no fees paid by the Company.

As of June 30 , 2020 , the Company had borrowed $ 1.

As of September 30 , 2020 , the Company had borrowed $ 1.

7 4 b illion from the P P PLF .

Lending operations and accommodations to borrowers

With the passage of the PPP, administered by the SBA, the Company has actively interpreted and implemented new loan programs and systems using its technology platform while participating in assisting its customers and other small businesses in need of resources through the program.

With the establishment of the PPP administered by the SBA, the Company has implemented new loan programs and systems using its technology platform while participating in assisting its customers and other small businesses in need of resources through the program.

PPP loans earn interest at 1% and currently have a two-year or five-year contractual term depending on the origination date.

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The Company expects that some portion of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program.

As of June 30, 2020, the Company has secured funding from the SBA for 10,847 PPP loans representing $1.74 billion in originations.

As of September 30, 2020, the Company secured funding from the SBA for approximately 11,000 PPP loans representing $1.76 billion in originations.

Loans funded through the PPP are fully guaranteed by the SBA, subject to the terms and conditions of the program.

Should those circumstances change, the Company could be required to record additional credit loss expense through earnings.

With the passage of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) on March 27, 2020 , the SBA will be making six months of principal and interest payments on all fully disbursed SBA 7(a) and SBA Express loans in regular servicing status that close by September 27, 2020 .

In addition, with regulatory guidance to work with borrowers during this unprecedented situation, the Company has also mobilized to provide a payment deferral program when needed by customers that are adversely affected by the pandemic.

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In accordance with interagency guidance issued in March 2020, these short-term deferrals are not considered troubled debt restructurings.

At June 30, 2020 the Company estimated that as a percentage to total loans and leases at amortized cost, excluding PPP, 60% of its loans were receiving the six months of payments from the SBA and that 9% of its loans had a payment deferral in place.

On June 5, 2020, the Paycheck Protection Program Flexibility Act (the “new Act”) was signed into law, and made significant changes to the PPP to provide additional relief for small businesses.

At September 30, and June 30, 2020, the Company estimated that as a percentage to total loans and leases at amortized cost, excluding PPP loans, 63% and 60%, respectively, of its loans were receiving the six months of payments from the SBA and that 2% and 9%, respectively, of its loans had a payment deferral in place.

On October 2, 2020, the SBA began approving PPP forgiveness applications and remitting forgiveness payments to PPP lenders for PPP borrowers.

As of November 3, 2020, the Company has processed and submitted $77.5 million, or 4% of gross PPP loans by dollar amount, to the SBA for forgiveness.

On September 5, 2020, the Paycheck Protection Program Flexibility Act (the “new Act”) was signed into law, and made significant changes to the PPP to provide additional relief for small businesses.

The new Act increased flexibility for small businesses that have been unable to rehire employees due to lack of employee availability, or have been unable to operate as normal due to COVID-19 related restrictions.

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For PPP recipients who do not apply for forgiveness, the loan deferral period is 10 months after the applicable forgiveness period ends.

While all industries have and will continue to experience adverse impacts as a result of COVID-19, the Company has exposures in the following verticals considered to be “at-risk” of significant impact as of June 30, 2020:

hotels, wine and craft beverage, educational services, entertainment centers, fitness centers, and quick service restaurants each comprising $178.9 million or 8.1%, $101.6 million or 4.6%, $80.4 million or 3.6%, $56.8 million or 2.6%, $22.8 million or 1.0%, and $12.3 million or 0.6% of total unguaranteed loans and leases (all at amortized cost, inclusive of loans carried at fair value), respectively.

While most industries have and will continue to experience adverse impacts as a result of COVID-19, the Company has $414.4 million in total unguaranteed exposure in six verticals considered to be “at-risk” of significant impact:

hotels, wine and craft beverage, educational services, entertainment centers, fitness centers, and quick service restaurants, each comprising $129.1 million or 5.4%, $98.8 million or 4.1%, $88.8 million or 3.7%, $55.3 million or 2.3%, $25.6 million or 1.1%, and $16.8 million or 0.7% of total unguaranteed loans and leases (all at amortized cost, inclusive of loans carried at fair value) as of September 30, 2020, respectively.

The Company continues to work with customers directly affected by COVID-19 and is prepared to offer short-term assistance in accordance with regulatory guidelines.

As a result of the uncertain economic environment caused by COVID-19, the Company is engaging in more frequent communication with borrowers to better understand their situation and the challenges faced and circumstances evolve, which the Company anticipates will allow it to respond proactively as needs and issues arise.

As a result of the uncertain economic environment caused by COVID-19, the Company is engaging in more frequent communication with borrowers in an effort to better understand their situation and the challenges faced and circumstances evolve, which the Company anticipates will enable it to respond proactively as needs and issues arise.

Results of Operations

Performance Summary

Three months ended June 30, 2020 compared with three months ended June 30, 2019

For the three months ended June 30, 2020, the Company reported net earnings of $3.8 million, or $0.09 per diluted share, compared to net earnings of $4.9 million, or $0.12 per diluted share, for the second quarter of 2019.

This decrease in net income was largely due to continued risks and uncertainties related to the COVID-19 pandemic with significant impacts to t he Company’s credit reserves and fair value adjustments , as outlined below:

The provision for loan and lease credit losses increased $6.5 million, or 191.9%;

The net loss on loans accounted for under the fair value option increased $3.8 million, or 139.0%.

Outside of the continued effects of COVID-19, which was intensified by the adoption of new current expected credit losses model (“CECL”) in the first quarter of 2020, salaries and employee benefits increased $8.8 million, or 40.0%, as the Company continued to invest in its workforce to support growth and a variety of initiatives including $7.2 million in expense for a performance bonus pool that was available to all employees other than executive officers .

The primary factors partially offsetting the decrease in net income for the three months ended June 30, 2020 were:

Increase in net interest income of $7.0 million, or 20.5%, predominately driven by significant growth in total loan and lease portfolios which was accentuated by the origination of $1.74 billion in PPP loans during the second quarter of 2020;

Net gains on sales of loans increased $4.7 million, or 77.8%, due largely to a higher volume of loans sold in the second quarter of 2020.

The volume in guaranteed loan sales in the second quarter of 2020 increased to $154.5 million, in line with the Company’s balance sheet strategy, compared to $71.9 million in the second quarter of 2019;

Other noninterest income increased $3.6 million, or 410.0%, primarily as the result of $2.5 million in revenue resulting from the sale of services from co-developed technology for processing PPP loans.

Six months ended June 30, 2020 compared with six months ended June 30, 2019

For the six months ended June 30, 2020, the Company reported a net loss of $3.8 million, or $(0.10) per diluted share, as compared to net earnings of $7.3 million, or $0.18 per diluted share, for the six months ended June 30, 2019.

This decrease in net income was largely the due to continuation of the above-mentioned risks and uncertainties related to the COVID-19 pandemic during the first half of 2020, as reflected below:

The provision for loan and lease credit losses increased $15.3 million, or 237.6%;

The net loss on loans accounted for under the fair value option increased $16.6 million, or 340.6%.

Outside of COVID-19 effects on the first half of 2020, salaries and employee benefits increased $15.0 million, or 34.2%, as the Company continued to invest in its workforce to support growth and a variety of initiatives, as discussed more fully above .

The primary factors partially offsetting the net loss for the six months ended June 30, 2020 were:

Increase in net interest income of $16.5 million, or 25.6%, predominately driven by significant growth in total loan and lease portfolios which was accentuated by the origination of $1.74 billion in PPP loans during the second quarter of 2020;

Net gains on sales of loans increased $11.6 million, or 113.5% largely due to higher sale volumes in the first quarter to strengthen the Company’s capital and liquidity profile in preparation for pandemic uncertainties.

The volume in guaranteed loan sales in the first half of 2020 increased to $317.3 million compared to $134.9 million in the first half of 2019;

Other noninterest income increased $2.

7 million, or 79.3%, primarily as the result of $2.5 million in revenue resulting from the sale of services from co-developed technology for processing PPP loans ;

Income tax benefit increased $7.3 million primarily as a result of a $3.7 million estimated benefit related to the enactment of the CARES Act which allows the carryback of certain net operating losses for five years combined with the Company’s overall net pretax loss in the first half of 2020.

Three months ended September 30, 2020 compared with three months ended September 30, 2019

For the three months ended September 30, 2020, the Company reported net income of $33.8 million, or $0.81 per diluted share, compared to net income of $3.9 million, or $0.09 per diluted share, for the third quarter of 2019.

This increase in net income is largely due to the following items:

Increase in net interest income of $13.8 million, or 36.9%, predominately driven by significant growth in total loan and lease portfolios which was accentuated by the origination of $1.76 billion in PPP loans during the second and third quarters of 2020;

A net increase in the loan servicing asset revaluation of $7.2 million, increasing from a negative valuation of $5.2 million during the third quarter of 2019 to a positive valuation adjustment of $2.1 million during the third quarter of 2020;

Net gains on sales of loans increased $5.3 million, or 70.9%;

The net gain on loans accounted for under the fair value option increased $2.3 million, or 208.8%;

Equity security investments gains increased $11.4 million, or 339.9%, largely due to a $13.7 million non-cash gain resulting from the increase in the observable fair market value of the Company’s investment in Greenlight Financial Technology, Inc.

(“Greenlight”) arising from orderly transactions in Greenlight’s securities;

Also enhancing net income were operational adaptations due to the impact of the COVID-19 pandemic that reduced travel, advertising and marketing expense.

The total decrease for these expense categories was $2.4 million, or 75.0%.

The valuation of loans and loan servicing assets were favorably impacted by greater stability and improvement of market conditions that began to emerge in the third quarter.

The primary factors partially offsetting the net income for the third quarter of 2020 were:

An increase in the provision for loan and lease credit losses of $6.3 million, or 159.4%;

Increased income tax expense of $9.3 million, primarily due to the above discussed increase in net income.

Nine months ended September 30, 2020 compared with nine months ended September 30, 2019

For the nine months ended September 30, 2020, the Company reported net income of $30.0 million, or $0.73 per diluted share, as compared to net income of $11.2 million, or $0.27 per diluted share, for the nine months ended September 30, 2019.

This increase in net income was largely the due to the following items:

Increase in net interest income of $30.4 million, or 29.7%, predominately driven by significant growth in total loan and lease portfolios which was also accentuated by the origination of $1.76 billion in PPP loans during the second and third quarters of 2020;

A net increase in the loan servicing asset revaluation of $8.2 million, increasing from a negative valuation of $12.4 million during the third quarter of 2019 to a negative valuation adjustment of $4.2 million at the end of the third quarter of 2020;

Net gains on sales of loans increased $16.9 million, or 95.6%;

Equity security investments gains increased $11.3 million, or 325.6%, largely due to the above discussed $13.7 million non-cash gain arising from the Company’s Greenlight investment;

Management fee income earned by the Company’s wholly-owned subsidiary, Canapi Advisors, increased $4.0 million;

Other noninterest income increased $3.4 million due principally due to revenue resulting from the sale of services from co-developed technology for processing PPP loans combined with financial planning fees from Live Oak Private Wealth, the Bank’s wholly-owned subsidiary;

Also enhancing year to date net income were operational adaptations due to the impact of the COVID-19 pandemic that reduced travel, advertising, and marketing expense.

The total decrease for these expense categories was $4.0 million, or 45.1%.

As mentioned above, the valuation of the loan servicing assets was favorably impacted by greater stability and improvement of market conditions that began to emerge during the third quarter.

The primary factors partially offsetting the net income for the first nine months of 2020 were:

An increase in the provision for loan and lease credit losses of $21.6 million, or 207.8%;

The net gain on the valuation adjustment for loans accounted for under the fair value option decreased $14.3 million, or 239.3%, to a net loss of $8.3 million;

Increased salaries and employee benefits of $16.5 million, or 24.8%, as the Company continued to invest in its workforce to support growth and a variety of initiatives including $7.2 million in expense in the second quarter of 2020 for a performance bonus pool that was available to all employees other than executive officers .

The increase in the provision for loan and lease credit losses and loss on loans carried at fair value in the first nine months of the year was largely due to continued risks and uncertainties related to the COVID-19 pandemic which was intensified by the adoption of new current expected credit losses model (“CECL”) in the first quarter of 2020.

The combination of these items had significant impacts to the Company’s credit reserves and fair value adjustments.

Net Interest Income and Margin

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Due to the nature of a branchless bank and the relatively low overhead required for deposit gathering, the rates that the Bank offers are generally above the industry average.

Three months ended June 30, 2020 compared with three months ended June 30, 2019

For the three months ended June 30, 2020, net interest income increased $7.0 million, or 20.5%, to $40.9 million compared to $33.9 million for the three months ended June 30, 2019.

The increase was principally due to the significant growth in the held for investment loan and lease portfolio reflecting the Company's ongoing initiative to grow recurring revenue sources and strengthen liquidity.

This increase over the prior year was primarily a product of the aforementioned origination of $1.74 billion in PPP loans in the second quarter of 2020 with $8.7 million in interest income coming from recognition of net deferred fees combined with a 1% annualized interest rate.

Accordingly, average interest earning assets increased by $2.73 billion, or 74.6%, to $6.40 billion for the three months ended June 30, 2020, compared to $3.66 billion for the three months ended June 30, 2019, while the yield on average interest earning assets decreased 185 basis points to 4.19%.

The cost of funds on interest bearing liabilities for the three months ended June 30, 2020 decreased 76 basis points to 1.65%, and the average balance of interest bearing liabilities increased by $2.78 billion, or 78.8%, over the same period in 2019.

The increase in average interest bearing liabilities was largely driven by strategically heightened levels of liquidity related to COVID-19 risks and uncertainties and funding for PPP loans.

As indicated in the rate/volume table below, increased interest earning asset volume more than offset lower yields outpacing the higher volume and lower levels of cost declines for interest bearing liabilities, resulting in increased interest income of $11.7 million and increased interest expense of $4.7 million for the three months ended June 30, 2020 compared to the three months ended June 30, 2019.

For the three months ended June 30, 2019 compared to the three months ended June 30, 2020, net interest margin decreased from 3.71% to 2.56%, respectively, principally due to the Company’s interest earning assets repricing more rapidly from lower fed funds rates than its interest bearing liabilities, combined with above mentioned impacts of PPP related activities and heightened liquidity.

Six Months Ended June 30, 2020 compared with six months ended June 30, 2019

For the six months ended June 30, 2020, net interest income increased $16.5 million, or 25.6%, to $81.1 million compared to $64.5 million for the six months ended June 30, 2019.

This increase was principally due to the significant growth in the combined held for sale and held for investment loan and lease portfolios along with higher investment security holdings reflecting the Company's ongoing initiative to grow recurring revenue sources and strengthen liquidity.

This increase over the first half of 2019 was also enhanced by the above mentioned origination of PPP loans in the second quarter.

Accordingly, a verage interest earning assets increased by $1.93 billion, or 54.7%, to $5.47 billion for the six months ended June 30, 2020, compared to $3.53 billion for the six months ended June 30, 2019, while the yield on average interest earning assets decreased 122 basis points to 4.78%.

The cost of funds on interest bearing liabilities for the six months ended June 30, 2020 decreased 54 basis points to 1.85%, and the average balance of interest bearing liabilities increased by $1.93 billion, or 56.5%, over the same period in 2019.

The increase in average interest bearing liabilities was also largely impacted by strategically heightened levels of liquidity in the first half of 2020 related to COVID-19 risks and uncertainties and funding sources for PPP loans.

As indicated in the rate/volume table below, the increase in interest earning assets and corresponding yields outpaced the higher volume and decreased cost of interest bearing liabilities, resulting in increased interest income of $25.2 million and increased interest expense of $8.7 million for the six months ended June 30, 2020 compared to the six months ended June 30, 2019.

For the six months ended June 30, 2019 compared to the six months ended June 30, 2020, net interest margin decreased from 3.68% to 2.97%, respectively, principally due to lower fed funds rates impacting the yield on interest earning assets more rapidly than the cost of interest bearing liabilities in the first half of 2020, combined with the above mentioned impacts of PPP related activities and heightened levels of liquidity.

Three months ended September 30, 2020 compared with three months ended September 30, 2019

For the three months ended September 30, 2020, net interest income increased $13.8 million, or 36.9%, to $51.4 million compared to $37.5 million for the three months ended September 30, 2019.

The increase was principally due to the significant growth in the held for investment loan and lease portfolios reflecting the Company's ongoing initiative to grow recurring revenue sources and strengthen its liquidity profile.

This increase over the prior year was further enhanced by the aforementioned origination of $1.76 billion in PPP loans in the second and third quarters of 2020 with $13.6 million in interest income coming from amortization of net deferred fees combined with a 1% annualized interest rate.

Accordingly, average interest earning assets increased by $3.39 billion, or 85.4%, to $7.36 billion for the three months ended September 30, 2020, compared to $3.97 billion for the three months ended September 30, 2019, while the yield on average interest earning assets decreased 206 basis points to 4.05%.

The cost of funds on interest bearing liabilities for the three months ended September 30, 2020 decreased 117 basis points to 1.27%, and the average balance of interest bearing liabilities increased by $3.59 billion, or 93.7%, over the same period in 2019.

The increase in average interest bearing liabilities was largely driven by strategically heightened levels of liquidity related to COVID-19 risks and uncertainties combined with funding for significant loan originations discussed above, including the PPPLF.

As indicated in the rate/volume table below, increased interest earning asset volume more than offset lower yields, outpacing the higher volume and lower levels of cost declines of interest bearing liabilities, resulting in increased interest income of $14.0 million and increased interest expense of $139 thousand for the three months ended September 30, 2020 compared to the three months ended September 30, 2019.

For the three months ended September 30, 2019 compared to the three months ended September 30, 2020, net interest margin decreased from 3.75% to 2.77%, respectively, due to lower fed funds rates impacting the yield on interest earning assets more significantly than interest earning liabilities, combined with the above mentioned impacts of PPP related activities and heightened levels of liquidity.

Nine Months Ended September 30, 2020 compared with nine months ended September 30, 2019

For the nine months ended September 30, 2020, net interest income increased $30.4 million, or 29.7%, to $132.4 million compared to $102.1 million for the nine months ended September 30, 2019.

This increase was principally due to the significant growth in the held for investment loan and lease portfolios reflecting the Company's ongoing initiative to grow recurring revenue sources and strengthen liquidity.

This increase over the first nine months of 2019 was further enhanced by the above mentioned origination of PPP loans in the second and third quarters of 2020.

Accordingly, average interest earning assets increased by $2.42 billion, or 65.8%, to $6.10 billion for the nine months ended September 30, 2020, compared to $3.68 billion for the nine months ended September 30, 2019, while the yield on average interest earning assets decreased 156 basis points to 4.48%.

The cost of funds on interest bearing liabilities for the nine months ended September 30, 2020 decreased 80 basis points to 1.61%, and the average balance of interest bearing liabilities increased by $2.49 billion, or 69.9%, over the same period in 2019.

The increase in average interest bearing liabilities was largely impacted by strategically heightened levels of liquidity in the first nine months of 2020 related to COVID-19 risks and uncertainties and funding sources for significant loan originations.

As indicated in the rate/volume table below, the increase in interest earning asset volume more than offset lower yields, outpacing the higher volume and lower levels of cost declines of interest bearing liabilities, resulting in increased interest income of $39.2 million and increased interest expense of $8.9 million for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019.

For the nine months ended September 30, 2019 compared to the nine months ended September 30, 2020, net interest margin decreased from 3.71% to 2.89%, respectively, principally due to lower fed funds rates impacting the yield on interest earning assets more rapidly than the cost of interest bearing liabilities in the first nine months of 2020, combined with the above mentioned impacts of PPP related activities and heightened levels of liquidity.

Average Balances and Yields.

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Loan fees are included in interest income on loans.

Three Months Ended June 30,

Three Months Ended September 30,

Interest earning assets:

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Average loan and lease balances include non-accruing loans and leases.

Six Months Ended June 30,

Nine Months Ended September 30,

Interest earning assets:

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For purposes of this table, increases or decreases attributable to changes in both rate and volume that cannot be segregated have been allocated proportionally based on the changes due to rate and the changes due to volume.

Three Months Ended June 30,

Six Months Ended June 30,

Three Months Ended September 30,

Nine Months Ended September 30,

Increase (Decrease) Due to

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The Company believes that its focus on compliance with regulations and guidance from the SBA and USDA are key factors to managing this risk.

For the second quarter of 2020, the provision for loan and lease credit losses was $10.0 million compared to $3.4 million for the same period in 2019, an increase of $6.5 million.

For the first half of 2020, the provision for loan and lease credit losses was $21.8 million compared to $6.4 million for the same period in 2019, an increase of $15.3 million.

For the third quarter of 2020, the provision for loan and lease credit losses was $10.3 million compared to $4.0 million for the same period in 2019, an increase of $6.3 million.

For the first nine months of 2020, the provision for loan and lease credit losses was $32.0 million compared to $10.4 million for the same period in 2019, an increase of $21.6 million.

The Company adopted the new current expected credit losses (“CECL”) standard effective January 1, 2020 and accordingly determined to use forecasted levels of unemployment as a primary economic variable in forecasting future expected losses.

The majority of the provision for the second quarter of 2020 was due to the effects of the COVID-19 pandemic, while approximately $15.5 million of the first half of 2020 provision was estimated to be based upon the severity of ongoing developments resulting from the COVID-19 pandemic.

Loans and leases held for investment at historical cost were $3.82 billion as of June 30, 2020, increasing by $2.45 billion, or 178.7%, compared to June 30, 2019.

This growth was largely fueled by $1.74 billion in PPP loan originations in the second quarter of 2020.

Excluding PPP loan originations and net unearned fees on those loans, the balance in loans and leases held for investment at historical cost was $2.13 billion at June 30, 2020, an increase of $758.2 million, or 55.4%, over June 30, 2019.

This growth, outside of PPP activity in the second quarter of 2020, was fueled by continued origination volumes combined with retention of substantially more loans on the balance sheet.

Net charge-offs for loans and leases carried at historical cost were $ 1 .

8 million , or 0.

21 % of average quarterly loans and leases held for investment , carried at historical cost, on an annualized basis , for the three months ended June 3 0 , 2020 , compared to $ 121 thousand , or 0 .0 4 %, for the three months ended June 3 0 , 2019 .

N et charge-offs for loans and leases carried at historical cost for the second quarter of 2020 was 0.

2 5 % of average quarterly loans and leases held for investment , excluding PPP loans, on an annualized basis .

For the six months ended June 30, 2020, net charge-offs totaled $4.

6 million compared to $34 thousand for the six months ended June 30, 2019, an increase of $4.5 million, or 13 , 3 70.6 %.

The increase in net charge-offs largely consisted of a number of loans in the Government Contracting, Healthcare, Family Entertainment, and Independent Pharmacies verticals .

Net charge-offs are a key element of historical experience in the Company's estimation of the allowance for credit losses on loan s and lease s .

In addition, nonperforming loans and leases not guaranteed by the SBA or USDA, excluding $6.4 million and $7.7 million accounted for under the fair value option at June 30, 2020 and 2019, respectively, totaled $13.1 million, which was 0.34% of the held for investment loan and lease portfolio carried at historical cost at June 30, 2020, compared to $6.5 million, or 0.48% of loans and leases held for investment at June 30, 2019.

Nonperforming loans and leases carried at historical cost which are not guaranteed by the SBA or USDA were 0.62% of the historical cost portion of the held for investment loan and lease portfolio, excluding PPP loans, at June 30, 2020.

The majority of the provision for the third quarter of 2020 was due to the impact of charge-offs on fifteen hotel loans exceeding the existing allowance for credit losses (“ACL”) on those loans, of which ten were sold before quarter end.

This charge-off created a shortfall in ACL of $6.4 million which was replenished through the quarter end provision for loan and lease credit losses.

See below discussion of charge-offs for more information.

Approximately $21.9 million of the first nine months of 2020 provision was estimated to be based upon the severity of the COVID-19 pandemic.

Loans and leases held for investment at historical cost were $4.19 billion as of September 30, 2020, increasing by $2.60 billion, or 163.3%, compared to September 30, 2019.

This growth was largely fueled by $1.76 billion in PPP loan originations in the second and third quarters of 2020.

Excluding PPP loan originations and net unearned fees on those loans, the balance in loans and leases held for investment at historical cost was $2.48 billion at September 30, 2020, an increase of $888.2 million, or 55.8%, over September 30, 2019.

This growth, outside of PPP activity in the third quarter of 2020, was fueled by robust origination volumes combined with retention of substantially more loans on the balance sheet.

Net charge-offs for loans and leases carried at historical cost were $ 10.1 million , or 1.03 % of average quarterly loans and leases held for investment , carried at historical cost, on an annualized basis , for the three months ended September 3 0 , 2020 , compared to $ 840 thousand , or 0.2 3 %, for the three months ended September 3 0 , 2019 .

Net charge-offs for loans and leases carried at historical cost for the third quarter of 2020 were 1.81% of average quarterly loans and leases held for investment, excluding PPP loans, on an annualized basis.

The increase in net charge-offs during the third quarter of 2020 was principally driven by the reclassification of fifteen hotel loans, discussed above, from held for investment to held for sale.

These loans aggregating $81.2 million in net investment were reclassified as available for sale due to negative trends observed from management’s ongoing analysis of COVID-19 impacts and were marked to the lower of cost or fair value upon reclassification with the write down of $9.8 million reflected in charge-offs.

The existing ACL on these loans at the time of charge-off was $3.4 million with the remaining $6.4 million requiring an additional provision for loan and lease losses.

At September 30, 2020, the Company had completed the sale of ten of these loans with only five still held for sale with an aggregate net investment balance of $25.7 million ;

however, these unsold loans have been written down to an agreed upon price.

For the nine months ended September 30, 2020, net charge-offs totaled $14.7 million compared to $874 thousand for the nine months ended September 30, 2019, an increase of $13.9 million, or 1,585.01%.

The increase in net charge-offs for the first nine months of 2020 compared to the same period of 2019 largely consisted of the above discussed hotel loans combined with a number of loans in the Government Contracting, Healthcare, Family Entertainment, and Independent Pharmacies verticals.

Net charge-offs are a key element of historical experience in the Company's estimation of the allowance for credit losses on loans and leases.

In addition, nonperforming loans and leases not guaranteed by the SBA or USDA, excluding $7.5 million and $8.2 million accounted for under the fair value option at September 30, 2020 and 2019, respectively, totaled $20.2 million, which was 0.48% of the held for investment loan and lease portfolio carried at historical cost at September 30, 2020, compared to $7.8 million, or 0.49% of loans and leases held for investment at September 30, 2019.

Nonperforming loans and leases carried at historical cost which are not guaranteed by the SBA or USDA were 0.81% of the historical cost portion of the held for investment loan and lease portfolio, excluding PPP loans, at September 30, 2020.

Noninterest Income

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Net (loss) gain on loans accounted for under the fair value option is also significantly impacted by changes in market rates, prepayment speeds and inherent credit risk.

Other less common elements of noninterest income include nonrecurring gains and losses on investments.

Other less common elements of noninterest income include less routine gains and losses on investments.

The following table shows the components of noninterest income and the dollar and percentage changes for the periods presented.

Three Months Ended June 30,

Three Months Ended September 30,

2020/2019 Increase (Decrease)

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Net gains on sales of loans

Net (loss) gain on loans accounted for under the fair

Net gain (loss) on loans accounted for under the fair

Equity method investments income (loss)

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Total noninterest income

Six Months Ended June 30,

Nine Months Ended September 30,

2020/2019 Increase (Decrease)

3 unchanged sentences

Net gains on sales of loans

Net (loss) gain on loans accounted for under the fair

Net gain (loss) on loans accounted for under the fair

Equity method investments income (loss)

6 unchanged sentences

Total noninterest income

For the three months ended June 30, 2020, noninterest income increased by $7.8 million, or 53.0%, compared to the three months ended June 30, 2019.

The increase from the prior year is primarily the result of the aforementioned increase in net gains on sales of loans combined with a $3.6 million increase in other noninterest income largely comprised of $2.5 million in revenue resulting from the sale of services from co-developed technology for processing PPP loans.

Other items contributing to the increase in noninterest income were a lower net loss on the loan servicing asset revaluation of $1.7 million and management fee income earned by Canapi Advisors, the Company’s investment advisor subsidiary, increasing by $1.1 million.

Offsetting the increases in noninterest income for the second quarter of 2020 was the aforementioned net negative valuation adjustment related to loans measured at fair value which increased by $3.9 million.

For the six months ended June 30, 2020, noninterest income increased by $187 thousand, or 0.7%, compared to the six months ended June 30, 2019.

The slight increase from the prior year is also primarily the result of the aforementioned increase in net gains on sales of loans combined with a $2.7 million increase in other noninterest income largely comprised of $2.5 million in revenue resulting from the sale of services from co-developed technology for processing PPP loans.

Other items contributing to the increase in noninterest income were a lower net loss on the loan servicing asset revaluation of $1.0 million and management fee income earned by Canapi Advisors, the Company’s investment advisor subsidiary, increasing by $2.8 million.

Offsetting the increases in noninterest income for the first half of 2020 was the aforementioned net negative valuation adjustment related to loans measured at fair value which increased by $16.6 million and decreased loan servicing revenue of $1.4 million.

For the three months ended September 30, 2020, noninterest income increased by $31.6 million, or 204.9%, compared to the three months ended September 30, 2019.

The increase from the prior year is primarily the result of the aforementioned increase in net gains on equity securities of $11.4 million combined with a net increase in the loan servicing asset revaluation of $7.2 million, a $5.3 million increase in net gains on sales of loans and a $2.3 million increase in net gains on loans accounted for under the fair value option.

As previously discussed, the $11.4 million increase in net gains in equity securities was largely due to a $13.7 million non-cash gain resulting from the increase in the observable fair market value of the Company’s investment in Greenlight arising from orderly transactions.

In assessing the effect of transactions at Greenlight giving rise to this gain, the Company reevaluated its ownership percentage and other factors to reassess the existence of significant influence and determined that this investment should continue to be accounted for as an equity security.

Other items contributing to the increase in noninterest income were management fee income earned by Canapi Advisors, the Company’s investment advisor subsidiary, increasing by $1.2 million.

For the nine months ended September 30, 2020, noninterest income increased by $ 31.8 million , or 73.3 %, compared to the nine months ended September 30, 2019.

The increase from the prior year is primarily the result of a $16.9 million increase in net gains on sales of loans combined with net gains on equity securities discussed above, a net increase in the loan servicing asset revaluation of $8.2 million, management fee income earned by Canapi Advisors increasing by $4.0 million and a $ 3.4 million increase in other noninterest income largely comprised of $2.5 million in revenue resulting from the sale of services from co-developed technology for processing PPP loans and financial planning fees earned by Live Oak Private Wealth .

Other items contributing to the increase in noninterest income were a $1.8 million in increase gains a sale of investments available for sale .

Offsetting the increases in noninterest income for the first half of 2020 was the aforementioned net loss on the valuation adjustment related to loans measured at fair value which increased by $ 14.3 million and decreased loan servicing revenue of $1.4 million.

The following table reflects loan and lease production, sales of guaranteed loans and the aggregate balance in guaranteed loans sold.

These components are key drivers of the Company's noninterest income.

Three months ended September 30,

Three months ended June 30,

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guaranteed loans sold (1)

Six Months Ended June 30,

Nine Months Ended September 30,

For years ended December 31,

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Revenues associated with the servicing of loans are recognized over the expected life of the loan through the income statement, and the servicing asset is reduced as this revenue is recognized.

For the quarter ended June 30, 2020, loan servicing revenue decreased $372 thousand, or 5.27%, to $6.7 million as compared to the quarter ended June 30, 2019.

For the six months ended June 30, 2020, loan servicing revenue decreased $1.4 million, or 9.4% to $13.1 million as compared to the six months ended June 30, 2019.

The lower servicing revenue for the second quarter and first half of 2020 has been a result of the declining balance of the serviced portfolio.

At June 30, 2020, the outstanding balance of guaranteed loans sold in the secondary market was $2.84 billion compared to $2.87 billion at June 30, 2019.

For the quarter ended September 30, 2020, loan servicing revenue decreased $28 thousand, or 0.41%, to $6.8 million as compared to the quarter ended September 30, 2019.

For the nine months ended September 30, 2020, loan servicing revenue decreased $1.4 million, or 6.5% to $19.9 million as compared to the nine months ended September 30, 2019.

The lower servicing revenue for the third quarter and first nine months of 2020 has been a result of a downward trend in the balance of the serviced portfolio which began to reverse direction in the second quarter of 2020.

At September 30, 2020, the outstanding balance of guaranteed loans sold in the secondary market was $2.88 billion compared to $2.80 billion at September 30, 2019.

Loan Servicing Revaluation:

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The revaluation considers the amortization of the portfolio, current market conditions for loan sale premiums, and current prepayment speeds.

For the three months ended June 30, 2020, there was a net negative loan servicing revaluation adjustment of $1.6 million compared to a net negative adjustment of $3.2 million for the three months ended June 30, 2019.

For the six months ended June 30, 2020, there was a net negative loan servicing revaluation adjustment of $6.3 million compared to a net negative adjustment of $7.3 million for the six months ended June 30, 2019.The lower revaluation amount for the second quarter and first half of 2020 as compared to the corresponding period of 2019 was primarily a result of improving market conditions.

For the three months ended September 3 0 , 2020, there was a net positive loan servicing revaluation adjustment of $ 2.1 million compared to a net negative adjustment of $ 5 .2 million for the three months ended September 3 0 , 2019.

For the nine months ended September 30, 2020, there was a net negative loan servicing revaluation adjustment of $ 4.2 million compared to a net negative adjustment of $ 12.4 million for the nine months ended September 30, 2019.

The net positive revaluation amount for the third quarter and lower net negative revaluation first half of 2020 as compared to the corresponding period of 2019 was primarily a result of greater stability and improving market conditions.

Net Gains on Sale of Loans:

For the three months ended June 30, 2020, net gains on sales of loans increased $4.7 million, or 77.8%, compared to the three months ended June 30, 2019.

For the three months ended June 30, 2020, the volume of guaranteed loans sold increased $83.0 million, or 115.4%, to $155.0 million from $71.9 million for the three months ended June 30, 2019.

For the six months ended June 30, 2020, net gains on sales of loans increased $11.6 million, or 113.5%, compared to the six months ended June 30, 2019.

For the six months ended June 30, 2020, the volume of guaranteed loans sold increased $182.4 million, or 135.2%, to $317.3 million from $134.9 million for the six months ended June 30, 2019.

The average net gain on guaranteed loan sales decreased from $80.1 thousand to $66.8 thousand, per million sold, in the second quarters of 2019 and 2020, respectively, and decreased from $71.3 thousand to $65.2 thousand, per million sold, in the first half of 2019 and 2020, respectively.

With this overall decrease in market value due to loan sales earlier in the second quarter combined with the mix of loan sales, the increase in net gains on sales of loans in the second quarter and second half of 2020 is due to a higher volume of loans sold.

Secondary market values continued to recover as the second quarter of 2020 progressed.

The volume of sales in the first quarter of 2020 was heightened to strengthen the Company’s capital and liquidity profile in light of uncertain market conditions while the second quarter of 2020 sales volume is in-line with the Company’s balance sheet strategy.

Also enhancing the increase in net gains on sale of loans in the second quarter of 2020 are $1.1 million in decreased losses from fair value changes in exchange-traded interest rate futures contracts.

For the three months ended September 30, 2020, net gains on sales of loans increased $5.3 million, or 70.9%, compared to the three months ended September 30, 2019.

For the three months ended September 30, 2020, the volume of guaranteed loans sold increased $14.2 million, or 14.2%, to $114.7 million from $100.5 million for the three months ended September 30, 2019.

For the nine months ended September 30, 2020, net gains on sales of loans increased $16.9 million, or 95.6%, compared to the nine months ended September 30, 2019.

For the nine months ended September 30, 2020, the volume of guaranteed loans sold increased $196.6 million, or 83.5%, to $432.0 million from $235.4 million for the nine months ended September 30, 2019.

The average net gain on guaranteed loan sales increased from $80.5 thousand to $110.2 thousand, per million sold, in the third quarters of 2019 and 2020, respectively, and increased from $75.3 thousand to $77.2 thousand, per million sold, in the first nine months of 2019 and 2020, respectively.

With this overall increase in loan sales earlier in the third quarter combined with the mix of loan sales, the increase in net gains on sales of loans in the third quarter and first nine months of 2020 is due to both higher volume of loans sold combined with higher secondary market premiums.

The volume of sales in the first nine months of 2020 was largely a product of heightened efforts to strengthen the Company’s capital and liquidity profile in light of uncertain market conditions while the third quarter of 2020 sales volume is in-line with the Company’s balance sheet strategy.

Also enhancing the increase in net gains on sale of loans in the third quarter and first nine months of 2020 are $1.7 million and $1.3 million, respectively, in decreased losses from fair value changes in exchange-traded interest rate futures contracts.

This decrease in volatility of exchange-traded interest rate futures contracts was the product of the Company preemptively exiting such contracts in the first quarter.

Net (Loss) Gain on Loans Accounted for Under the Fair Value Option :

For the three months ended June 30 , 2020 , the net loss on loans accounted for under the fair value option increased $ 3.9 million, or 139.0 %, compared to the three months ended June 30 , 2019.

For the six months ended June 30, 2020 , the net loss on loans accounted for under the fair value option increased $16.6 million, or 340.6%, compared to the six months ended June 30, 2019.

The carrying amount of loans accounted for under the fair value option at June 30 , 2020 and 2019 was $ 866.7 million ($ 32.1 million classified as held for sale and $ 834.6 million classified as held for investment) and $ 865.7 million ($ 26.6 million classified as held for sale and $ 839.1 million classified as held for investment), respectively, a n in crease of $ 990 thousand , or 0 .1 %.

The first half of 2020 net loss on loans accounted for under the fair value option was estimated to be approximately $ 9.7 million related to the severity of ongoing developments of the COVID-19 pandemic .

The magnitude of COVID-19 related impacts on loan fair value adjustments in the second quarter of 2020 was dampened by improving market conditions for unguaranteed loans.

For the three months ended September 30, 2020, the net gain on loans accounted for under the fair value option increased $2.3 million, or 208.8%, compared to the three months ended September 30, 2019.

For the nine months ended September 30, 2020, the net loss on loans accounted for under the fair value option increased $14.3 million, or 239.3%, compared to the nine months ended September 30, 2019.

The carrying amount of loans accounted for under the fair value option at September 30, 2020 and 2019 was $876.2 million ($30.4 million classified as held for sale and $845.7 million classified as held for investment) and $846.0 million ($14.7 million classified as held for sale and $831.3 million classified as held for investment), respectively, an increase of $30.2 million, or 3.6%.

The first nine months of 2020 net loss on loans accounted for under the fair value option was estimated to be approximately $9.8 million related to the severity of ongoing developments of the COVID-19 pandemic.

The magnitude of COVID-19 related impacts on loan fair value adjustments in the third quarter of 2020 was dampened by improving market conditions for unguaranteed loans.

Noninterest Expense

1 unchanged sentence

The following table shows the components of noninterest expense and the related dollar and percentage changes for the periods presented.

Three Months Ended June 30,

Three Months Ended September 30,

2020/2019 Increase (Decrease)

9 unchanged sentences

Other loan origination and maintenance expense

Renewable energy tax credit investment impairment

FDIC insurance

2 unchanged sentences

Total noninterest expense

Six Months Ended June 30,

Nine Months Ended September 30,

2020/2019 Increase (Decrease)

14 unchanged sentences

Total noninterest expense

Total noninterest expense for the three and six months ended June 3 0 , 2020 in creased $ 8.5 million , or 21.5 %, and $19.8 million, or 25.5%, respectively, compared to the same period s in 201 9 .

The in crease in noninterest expense was largely driven by salaries and employee benefits .

Total noninterest expense for the three and nine months ended September 30, 2020 decreased $87 thousand, or 0.2%, and increased $19.7 million, or 16.4%, respectively, compared to the same periods in 2019.

The increase in noninterest expense for the comparable nine month period was largely driven by salaries and employee benefits.

Changes in various components of noninterest expense are discussed below.

Salaries and employee benefits :

Total personnel expense for the three and six months ended June 30, 2020 increased by $8.8 million, or 40.0%, and $15.0 million, or 34.2%, respectively, compared to the same periods in 2019.

While personnel expense is carefully managed, this increase is principally due to the Company’s commitment to and investment in its workforce to support growth and a variety of initiatives combined with $7.2 million in expense for a performance bonus pool that was available to all employees other than executive officers.

Total full-time equivalent employees increased from 531 at June 30, 2019 to 640 at June 30, 2020.

Salaries and employee benefits expense included $3.3 million and $6.2 million of stock-based compensation for the three and six months ended June 30, 2020, respectively, compared to $2.9 million and $5.8 million for the three and six months ended June 30, 2019, respectively.

Total personnel expense for the three and nine months ended September 30, 2020 increased by $1.5 million, or 6.5%, and $16.5 million, or 24.8%, respectively, compared to the same periods in 2019.

While personnel expense is carefully managed, the quarter over quarter increase is principally due to the Company’s commitment to and investment in its workforce to support growth and a variety of initiatives while the year over year increase was also influenced by $7.2 million in expense for a performance bonus pool that was available to all employees other than executive officers during the second quarter of 2020.

Total full-time equivalent employees increased from 569 at September 30, 2019 to 628 at September 30, 2020.

Salaries and employee benefits expense included $3.3 million and $9.5 million of stock-based compensation for the three and nine months ended September 30, 2020, respectively, compared to $2.9 million and $8.7 million for the three and nine months ended September 30, 2019, respectively.

Expenses related to the employee stock purchase program, stock grants, stock option compensation and restricted stock expense are all considered stock-based compensation.

Travel & Advertising and marketing expenses:

For the three and nine months ended September 30, 2020, travel & advertising and marketing expenses in aggregate decreased $2.4 million, or 75.0%, and $4.0 million, or 45.1%, respectively.

This decrease was the result of certain operational adaptations due to the impact of COVID-19.

Data processing expense :

Total data processing expense for the three and six months ended June 30, 2020 increased by $817 thousand, or 42.0%, and $1.6 million, or 36.2%, respectively, compared to the same periods in 2019.

The increase was predominantly driven by third party costs incurred in internal software development and with additional software subscriptions to help maximize operational efficiencies.

Total data processing expense for the three and nine months ended September 30, 2020 decreased by $63 thousand, or 2.1% and increased by $1.5 million, or 20.4%, respectively, compared to the same period in 2019.

The increase over the first nine months of 2019 was predominantly driven by third party costs incurred in internal software development and with additional software subscriptions to help maximize operational efficiencies.

Equipment expense:

For the three and six months ended June 30, 2020, equipment expense increased $413 thousand, or 9.7%, and $1.7 million, or 22.8%, respectively, compared to the same periods in 2019.

Primary factors contributing to this increase were the depreciation of technology and infrastructure investments to support the Company’s growth initiatives.

Other loan origination and maintenance expense:

For the three and six months ended June 30, 2020, other loan origination and maintenance expense increased $784 thousand, or 45.9%, and $1.6 million, or 47.8%, respectively, compared to the same periods in 2019 due to increased levels of SBA loans.

For the three and nine months ended September 30, 2020, equipment expense decreased $47 thousand, or 1.1%, and increased $1.7 million, or 14.1%, respectively, compared to the same periods in 2019.

Primary factors contributing to this increase over the first nine months of 2019 were the depreciation of technology and infrastructure investments to support the Company’s growth initiatives.

FDIC insurance:

For the three and six months ended June 30, 2020, FDIC insurance increased $1.0 million, or 146.2%, and $1.9 million, or 142.2%, respectively, compared to the same periods in 2019 due to higher required premiums.

Travel & Advertising and marketing expenses:

For the three and six months ended June 30, 2020, travel & advertising and marketing expenses in aggregate decreased $2.2 million, or 69.2%, and $1.6 million, or 28.4%, respectively.

This decrease was the result of certain activities being paused due to the impact of COVID-19.

For the three and nine months ended September 30, 2020, FDIC insurance increased $2.0 million and $3.9 million, respectively, compared to the same periods in 2019 due to higher required premiums largely related to increased levels of assets.

Income Tax Expense

For the three months ended June 30, 2020, income tax expense increased by $812 thousand compared to the same period in 2019, and the Company’s effective tax rates were 28.1% and 11.8%, respectively.

The increase in the second quarter of 2020 over the second quarter of 2019 is primarily due to the absence of expected tax credits during 2020.

For the six months ended June 30, 2020, the Company had an income tax benefit of $(6.3) million with an effective tax rate of (62.2)% while the first half of 2019 had income tax expense of $979 thousand with an effective tax rate of 11.8%.

The negative effective tax rate d uring the first half of 2020 was a result of a discrete, estimated income tax benefit of $3.7 million related to the enactment of the CARES Act on March 27, 2020.

For the three months ended September 30, 2020, income tax expense increased by $9.3 million compared to the same period in 2019, and the Company’s effective tax rates were 25.7% and 37.8%, respectively.

The increase in income tax expense in the third quarter of 2020 over the third quarter of 2019 is primarily due to a significant increase in income before taxes.

The higher effective tax rate in the third quarter of 2019 was the result of forecasted reductions in the targeted solar panel leasing activity for the remainder of that year .

For the nine months ended September 30, 2020, the Company had income tax expense of $5.4 million with an effective tax rate of 15.3% while the first nine months of 2019 had income tax expense of $3.3 million with an effective tax rate of 23.0%.

The lower effective tax rate for the first nine months of 2020 was a result of a discrete, estimated income tax benefit of $3.7 million related to the enactment of the CARES Act on March 27, 2020.

The CARES Act allows taxpayers to carryback certain net operating losses to each of the five taxable years preceding the taxable year of such losses.

As a result, the Company will be allowed to carryback its 2018 net operating loss which had been utilized and measured under the prior law using a 21% corporate income tax rate to pre-2018 taxable years during which the corporate income tax rate was 35%.

The remaining income tax benefit in the first half of 2020 was predominantly driven by the Company’s overall net pretax loss.

Based upon current projections, the effective tax rate for the remainder of 2020 is expected to be approximately 26.0% to 28.0%;

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Discussion and Analysis of Financial Condition

June 30, 2020 vs.

September 30, 2020 vs.

December 31, 2019

Total assets at June 30, 2020 were $8.21 billion, an increase of $3.40 billion, or 70.6%, compared to total assets of $4.81 billion at December 31, 2019.

Total assets at September 30, 2020 were $8.09 billion, an increase of $3.28 billion, or 68.2%, compared to total assets of $4.81 billion at December 31, 2019.

The growth in total assets was principally driven by the following:

Cash and cash equivalents, comprised of cash and due from banks and federal funds sold, increased $1.13 billion as a product of increased levels of borrowings, deposits and loan sales arising from strategically heightened levels of liquidity related to COVID-19 risks and uncertainties and funding for PPP loans originated in the second quarter;

Cash and cash equivalents, comprised of cash and due from banks and federal funds sold, increased $413.4 million as a product of increased levels of borrowings, deposits and loan sales arising from strategically heightened levels of liquidity related to COVID-19 risks and uncertainties and funding for PPP and other loans originated in the second and third quarters;

Increased investment securities available-for-sale of $225.7 million.

This increase in investment securities was due to availability of excess surplus liquidity, discussed above related to pandemic readiness, accelerating 2020 investment growth in accordance with the Company’s asset-liability and liquidity management plan;

Growth in loans and leases held for sale and held for investment of $2.03 billion resulting from strong origination activity in the first half of 2020, largely comprised of $1.74 billion in PPP loans.

Cash and cash equivalents, comprised of cash and due from banks and federal funds sold, was $1.35 billion at June 30, 2020, an increase of $1.13 billion, or 508.9%, compared to $221.4 million at December 31, 2019.

As mentioned above, this increase reflects the impact of strategically heightened levels of liquidity related to COVID-19 risks and uncertainties and funding for PPP loans during the second quarter.

Total investment securities increased $239.7 million during the first six months of 2020, from $540.0 million at December 31, 2019, to $779.8 million at June 30, 2020, an increase of 44.4%.

The Company increased its investment securities position during the first half of 2020 largely as a part of improving returns on excess liquidity and meeting annual investment asset-liability plans, as discussed above.

At June 30, 2020, the investment portfolio was comprised of U.S.

treasury, U.S.

Growth in loans and leases held for sale and held for investment of $2.63 billion resulting from strong origination activity in the first nine months of 2020, largely comprised of $1.76 billion in PPP loans.

Additionally, the Company originated a record of $948.8 million loans and leases in the third quarter of 2020 excluding PPP loans.

Cash and cash equivalents, comprised of cash and due from banks and federal funds sold, was $ 634.8 m illion at September 30 , 2020 , a n in crease of $ 413.4 m illion, or 186.7 %, compared to $ 221.4 million at December 31, 2019 .

As mentioned above, this in crease reflects the impact of strategically heightened levels of liquidity related to COVID-19 risks and uncertainties and funding for PPP and other loans during the second and third quarter s .

Total investment securities increased $225.7 million during the first nine months of 2020, from $540.0 million at December 31, 2019, to $765.8 million at September 30, 2020, an increase of 41.8%.

The Company increased its investment securities position during the first nine months of 2020 largely as a part of improving returns on excess liquidity and meeting annual investment asset-liability plans, as discussed above.

At September 30, 2020, the investment portfolio was comprised of U.S.

government agency, U.S.

government-sponsored entity mortgage-backed securities and municipal bonds.

Loans and leases held for investment increased $2.02 billion, or 77.0%, during the first six months of 2020, from $2.63 billion at December 31, 2019, to $4.65 billion at June 30, 2020.

The increase was primarily the result of $1.74 billion in PPP loan originations combined with $930.8 million in other loan originations in the first half of 2020 .

Premises and equipment, net, decreased $10.0 million, or 3.6%, during the first six months of 2020 which was primarily driven by increased levels of depreciation of facilities and infrastructure to accommodate Company growth and solar panels to meet leasing obligations in prior periods.

Other assets increased $23.8 million, or 15.3%, from $156.1 million at December 31, 2019 to $180.0 million at June 30, 2020.

This increase was due to a variety of items, principally comprised of a $7.7 million increase in accrued interest receivable driven by higher levels of interest earning assets combined with $4.6 million in increased receivables from the SBA for guarantee recoveries, $4.1 million in new intangibles added as a result of the acquisition of Jolley Asset Management, LLC (as discussed more fully in Note 1.

Basis of Presentation under the subheading Business Combination), $2.5 million in additional receivables for co-developed technology PPP loan processing services and $2.3 million in capitalized software development and implementation costs.

Total deposits were $5.87 billion at June 30, 2020, an increase of $1.65 billion, or 38.9%, from $4.23 billion at December 31, 2019.

The increase in deposits was largely driven by the planned origination of PPP loans and following the defensive strategy to build liquidity during the first quarter of 2020 due to the uncertainty of the effects of COVID-19.

Borrowings increased to $1.72 billion at June 30, 2020 from $14 thousand at December 31, 2019.

This increase was related to $1.72 billion in new borrowings through the PPPLF in the second quarter of 2020.

Loans and leases held for sale increased $223.8 million, or 23.2%, during the first nine months of 2020, from $966.4 million at December 31, 2019, to $1.19 billion at September 30, 2020.

The increase was primarily the result of strong loan originations, excluding PPP loans, in the third quarter of 2020 combined with declining levels of loan sales in the same period.

Loans and leases held for investment increased $2.41 billion, or 91.7%, during the first nine months of 2020, from $2.63 billion at December 31, 2019, to $5.04 billion at September 30, 2020.

The increase was primarily the result of the above mentioned loan originations in 2020.

Premises and equipment, net, decreased $25.4 million, or 9.1%, during the first nine months of 2020 which was primarily driven by increased levels of depreciation of facilities and infrastructure to accommodate Company growth and solar panels to meet leasing obligations in prior periods combined with the decision to sell an aircraft carried at $10.1 million.

The decision to sell this aircraft resulted in it being reclassified out of premises and equipment to other assets as a held for sale asset carried at the lower of cost or market value.

Upon reclassification to held for sale the Company recognized an impairment charge of $1.0 million to mark the aircraft to its estimated fair value.

Other assets increased $48.8 million, or 31.2%, from $156.1 million at December 31, 2019 to $204.9 million at September 30, 2020.

This increase was due to a variety of items, principally comprised of the earlier discussed $13.7 million increase in the carrying value of the Company’s investment in Greenlight, a $12.2 million increase in accrued interest receivable driven by higher levels of interest earning assets, the above discussed aircraft reclassification, $6.6 million in increased receivables from the SBA for guarantee recoveries, $4.1 million in new intangibles added as a result of the acquisition of Jolley Asset Management, LLC (as discussed more fully in Note 1.

Basis of Presentation under the subheading Business Combination) and $2.5 million in additional receivables for co-developed technology PPP loan processing services.

Total deposits were $5.71 billion at September 30, 2020, an increase of $1.48 billion, or 35.0%, from $4.23 billion at December 31, 2019.

The increase in deposits was largely driven by the planned origination of PPP and other loans combined with the defensive strategy to build liquidity during the first quarter of 2020 due to the uncertainty of the effects of COVID-19.

Borrowings increased to $1.75 billion at September 30, 2020 from $14 thousand at December 31, 2019.

This increase was related to $1.74 billion in new borrowings through the PPPLF in the second and third quarters of 2020.

These PPPLF borrowings were used to help fund PPP loans and complement the defensive strategy to build liquidity which commenced in the first quarter of 2020 due to the uncertainty of the effects of COVID-19.

Shareholders’ equity at June 30, 2020 was $548.4 million as compared to $532.4 million at December 31, 2019.

The book value per share was $13.53 at June 30, 2020 compared to $13.20 at December 31, 2019.

Average equity to average assets was 9.2% for the six months ended June 30, 2020 compared to 12.2% for the year ended December 31, 2019.

The increase in shareholders’ equity was principally the result of other comprehensive income of $13.6 million and stock-based compensation expense of $6.2 million, partially offset by a net loss of $3.8 million and $2.4 million in dividends.

During the first half of 20 20 , 200,000 shares of Class B common stock (non-voting) were converted to Class A common stock (voting) under a private sale.

Shareholders’ equity at September 30, 2020 was $584.2 million as compared to $532.4 million at December 31, 2019.

The book value per share was $14.40 at September 30, 2020 compared to $13.20 at December 31, 2019.

Average equity to average assets was 8.3% for the nine months ended September 30, 2020 compared to 12.2% for the year ended December 31, 2019.

The increase in shareholders’ equity for the first nine months of 2020 was principally the result of net income of $30.0 million, other comprehensive income of $13.2 million and stock-based compensation expense of $9.5 million, partially offset by $3.6 million in dividends.

During the first nine months of 2020, 450,000 shares of Class B common stock (non-voting) were converted to Class A common stock (voting) under a private sale.

The conversion decreased the value of Class B common stock (non-voting) and increased the value of Class A common stock (voting) by $4.8 million.

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Such concessions would include, but are not limited to, the transfer of assets or the issuance of equity interests by the debtor to satisfy all or part of the debt, modification of the terms of debt or the substitution or addition of debtor(s).

Total nonperforming assets and troubled debt restructurings, including loans measured at fair value, at June 30, 2020 were $134.3 million, which represented a $23.2 million, or 20.9%, increase from December 31, 2019.

These nonperforming assets, at June 30, 2020 were comprised of $90.1 million in nonaccrual loans and leases and $5.7 million in foreclosed assets.

Of the $134.3 million of nonperforming assets and TDRs, $100.9 million carried an SBA guarantee, leaving an unguaranteed exposure of $33.4 million in total nonperforming assets and TDRs at June 30, 2020.

Total nonperforming assets and troubled debt restructurings, including loans measured at fair value, at September 30, 2020 were $145.0 million, which represented a $33.9 million, or 30.5%, increase from December 31, 2019.

These nonperforming assets, at September 30, 2020 were comprised of $99.0 million in nonaccrual loans and leases and $3.3 million in foreclosed assets.

Of the $145.0 million of nonperforming assets and TDRs, $98.5 million carried an SBA guarantee, leaving an unguaranteed exposure of $46.4 million in total nonperforming assets and TDRs at September 30, 2020.

This represents an increase of $19.2 million, or 70.6%, from an unguaranteed exposure of $27.2 million at December 31, 2019.

The following table provides information with respect to nonperforming assets and troubled debt restructurings, excluding loans measured at fair value, at the dates indicated.

June 30, 2020 (1)

September 30, 2020 (1)

December 31, 2019 (1)

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Total nonperforming loans and leases to total loans and leases held for

investment (2)

Total nonperforming loans and leases to total assets (2)

Total nonperforming assets and troubled debt restructurings to total assets (2)

June 30, 2020 (1)

September 30, 2020 (1)

December 31, 2019 (1)

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Excludes loans measured at fair value.

Nonperforming assets and TDRs, excluding loans measured at fair value, at June 30, 2020 were $65.2 million, which represented a $23.3 million, or 55.7%, increase from December 31, 2019.

These nonperforming assets, at June 30, 2020 were comprised of $40.3 million in nonaccrual loans and leases and $5.7 million in foreclosed assets.

Of the $65.2 million of nonperforming assets and TDRs, $45.6 million carried an SBA guarantee, leaving an unguaranteed exposure of $19.6 million in total nonperforming assets and TDRs at June 30, 2020.

The period ended September 30, 2020 excludes one $6.1 million hotel loan classified as held for sale.

The period ended September 30, 2020 excludes one $5.1 million hotel loan classified as held for sale.

Nonperforming assets and TDRs, excluding loans measured at fair value, at September 30, 2020 were $74.4 million, which represented a $32.5 million, or 77.6%, increase from December 31, 2019.

These nonperforming assets, at September 30, 2020 were comprised of $46.7 million in nonaccrual loans and leases and $3.3 million in foreclosed assets.

Of the $74.4 million of nonperforming assets and TDRs, $43.2 million carried an SBA guarantee, leaving an unguaranteed exposure of $31.2 million in total nonperforming assets and TDRs at September 30, 2020.

This represents an increase of $19.0 million, or 155.2%, from an unguaranteed exposure of $12.2 million at December 31, 2019.

See the below discussion related to the change in potential problem and impaired loans and leases for management’s overall observations regarding growth in total nonperforming loans and leases.

As a percentage of the Bank’s total capital, nonperforming loans and leases, excluding loans measured at fair value, represented 8.1% at June 30, 2020, compared to 4.4% at December 31, 2019.

Adjusting the ratio to include only the unguaranteed portion of nonperforming loans and leases at historical cost to reflect management’s belief that the greater magnitude of risk resides in this portion, the ratios at June 30, 2020 and December 31, 2019 were 2.6% and 1.5%, respectively.

As of June 30 , 2020 , and December 31, 2019 , potential problem (also referred to as criticized) and classified loans and leases , excluding loans measured at fair value, totaled $ 146.9 million and $ 12 9 .1 million, respectively.

As a percentage of the Bank’s total capital, nonperforming loans and leases, excluding loans measured at fair value, represented 9.0% at September 30, 2020, compared to 4.4% at December 31, 2019.

Adjusting the ratio to include only the unguaranteed portion of nonperforming loans and leases at historical cost to reflect management’s belief that the greater magnitude of risk resides in this portion, the ratios at September 30, 2020 and December 31, 2019 were 3.9% and 1.5%, respectively.

As of September 30 , 2020 , and December 31, 2019 , potential problem (also referred to as criticized) and classified loans and leases , excluding loans measured at fair value, totaled $ 217.1 million and $ 12 9 .1 million, respectively.

The following is a discussion of these loans and leases .

Risk Grades 5 through 8 represent the spectrum of criticized and classified loans and leases.

At June 30 , 2020 , the portion of criticized and classified loans and leases guaranteed by the SBA or USDA totaled $ 79.0 million resulting in unguaranteed exposure risk of $ 68.0 million, or 4.

9 % of total held for investment unguaranteed exposure carried at historical cost .

At September 30 , 2020 , the portion of criticized and classified loans and leases guaranteed by the SBA or USDA totaled $ 118.7 million resulting in unguaranteed exposure risk of $ 98.4 million, or 6.4 % of total held for investment unguaranteed exposure carried at historical cost .

This compares to the December 31, 2019 portion of criticized and classified loans and leases guaranteed by the SBA or USDA which totaled $ 65.8 million resulting in unguaranteed exposure risk of $ 63.3 million, or 5.

4 % of total held for investment unguaranteed exposure carried at historical cost .

As of June 30 , 2020 , loans and leases carried at historical cost within the following verticals comprise the largest portion of the total potential problem and classified loans and leases :

Healthcare at 20.8%, Wine and Craft Beverage at 15.1% , Hotels at 13.0%, Entertainment Centers at 9.6%, Veterinary at 9.2% , Self Storage at 5 .8% and Educational Services at 5.0%.

As of September 30 , 2020 , loans and leases carried at historical cost within the following verticals comprise the largest portion of the total potential problem and classified loans and leases :

Healthcare at 14.0 %, Wine and Craft Beverage at 13.2 %, Hotels at 12.7 %, Entertainment Centers at 11.7 %, Educational Services at 8.7%, Fitness Centers at 8.3%, Veterinary at 6.3 % and Senior Care at 5.4 %.

As of December 31, 2019, loans and leases carried at historical cost within the following verticals comprise the largest portion of the total potential problem and classified loans and leases :

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Other than Hotels and Government Contracting which are a part of the Company’s Specialty Lending division , all of the above listed verticals are within the Company’s Small Business Banking division.

Two previously impaired Government Contracting relationships were charged off in the first half of 2020 which resulted in a reduction in impaired loans for this vertical.

Two previously impaired Government Contracting relationships were charged off in the first nine months of 2020 which resulted in a reduction in impaired loans for this vertical.

The majority of the increase in potential problem and classified loans and leases was comprised of a relatively small number of borrowers largely concentrated in the Company’s more mature verticals.

Furthermore, the Company believes that its underwriting and credit quality standards have continued to tighten with emphasis on new production in pandemic resilient verticals and increased monitoring of existing loans in pandemic susceptible verticals as the impacts and uncertainties COVID-19 continue to evolve .

With this emphasis, systemic issues which began to emerge during the latter part of 2019 related to higher than expected levels of competition in the Wine and Craft Beverage and Entertainment Center verticals combined with pandemic susceptibility continue to contribute to the increase in criticized and classified loans and leases.

With this emphasis, systemic issues have begun to appear within the Hotel and Entertainment Center verticals due to stress related to the COVID-19 pandemic and contribute d to the increase in criticized and classified loans and leases.

The Bank does not classify loans and leases that experience insignificant payment delays and payment shortfalls as impaired.

The Bank generally considers an “insignificant period of time” from payment delays to be a period of 90 days or less, unless the borrower was not past due at the time of a modification as a part of a COVID-19 assistance program.

In such instances this time period could extend to a period of three months or less.

In such instances this time period could extend to a period of six months or less.

The Bank would consider a modification for a customer experiencing what is expected to be a short-term event that has temporarily impacted cash flow.

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In all cases, credit personnel will review the request to determine if the customer is stressed and how the event has impacted the ability of the customer to repay the loan or lease long term.

To date, the only types of short-term modifications the Bank has given are payment deferral and interest only extensions.

The Bank does not typically alter the rate or lengthen the amortization of the note due to insignificant payment delays.

Short term modifications are not classified as TDRs, because they do not meet the definition set by the applicable accounting standards and the Federal Deposit Insurance Corporation.

At September 30, 2020, the Company had $56.4 million in modified unguaranteed loans and leases for borrowers impacted by the COVID-19 pandemic with $20.9 million of that total occurring in the third quarter.

These modifications were primarily short-term payment deferrals generally no more than six-months in duration and accordingly are not considered troubled debt restructurings.

Management endeavors to be proactive in its approach to identify and resolve problem loans and leases and is focused on working with the borrowers and guarantors of these loans and leases to provide loan and lease modifications when warranted.

Management implements a proactive approach to identifying and classifying loans and leases as special mention (also referred to as criticized), Risk Grade 5.

At June 30, 2020, and December 31, 2019, Risk Grade 5 loans and leases, excluding loans measured at fair value, totaled $94.4 million and $89.5 million, respectively.

The increase in Risk Grade 5 loans and leases, exclusive of loans measured at fair value, during the first half of 2020 was principally confined to five verticals:

Entertainment Centers ($9.2 million or 187.7%), Senior Care ($4.0 million or 82.6%), Healthcare ($4.0 million or 81.5%), Veterinary ($3.6 million or 74.2%), General Lending Solutions ($1.4 million or 29.4%), and Funeral Home & Cemetery ($1.1 million or 21.9%).

Largely offsetting the increase in the above Risk Grade 5 loans and leases were decreases in Hotels ($10.5 million or 213.3%) Government Contracting ($3.8 million or 78.4%) and Self Storage ($2.1 million or 43.3%).

Other than Hotels and Government Contracting which are a part of the Company’s Specialty Lending division, all of the above listed verticals are within the Company’s Small Business Banking division.

The decrease in Hotels was due to two relationships moving to risk grade 6 (substandard) while the decrease in Government Contracting was due to loan paydowns which moved loans back to pass grades, and the decrease in Self Storage was due to one relationship being upgraded to a risk grade 4 (acceptable).

At June 30, 2020, approximately 100.0% of loans and leases classified as Risk Grade 5 are performing with no current payments past due more than 30 days.

At September 30, 2020, and December 31, 2019, Risk Grade 5 loans and leases, excluding loans measured at fair value, totaled $151.5 million and $89.5 million, respectively.

The increase in Risk Grade 5 loans and leases, exclusive of loans measured at fair value, during the first nine months of 2020 was principally confined to six verticals:

Fitness Centers ($14.3 million or 23.1%), Entertainment Centers ($12.6 million or 20.4%), Senior Care ($11.8 million or 19.1%), Educational Services ($11.6 million or 18.7%), Wine and Craft Beverage ($7.0 million or 11.3%) and General Lending Solutions ($6.3 million or 10.1%).

Partially offsetting the increase in the above Risk Grade 5 loans and leases were decreases in Hotels ($5.8 million or 9.3%).

Other than Hotels, which are a part of the Company’s Specialty Lending division, all of the above listed verticals are within the Company’s Small Business Banking division.

The decrease in Hotels was largely due to two relationships moving to risk grade 6 (substandard).

At September 30, 2020, approximately 100.0% of loans and leases classified as Risk Grade 5 are performing with no current payments past due more than 30 days.

While the level of nonperforming assets fluctuates in response to changing economic and market conditions, in light of the relative size and composition of the loan and lease portfolio and management’s degree of success in resolving problem assets, management believes that a proactive approach to early identification and intervention is critical to successfully managing a small business loan portfolio.

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Management adjusts historical loss information for differences in current risk characteristics such as portfolio risk grading, delinquency levels, or portfolio mix as well as for changes in environmental conditions such as changes in unemployment rates.

The ACL of $28.2 million at December 31, 2019 increased by $15.8 million, or 56.1%, to $44.1 million at June 30, 2020.

The ACL, as a percentage of loans and leases held for investment at historical cost amounted to 1.2% at June 30, 2020 and 1.6% at December 31, 2019.

Excluding PPP loans and related reserves, the ACL, as a percentage of loans and leases held for investment at historical cost amounted to 2.0% at June 30, 2020.

The ACL of $28.2 million at December 31, 2019 increased by $16.0 million, or 56.6%, to $44.2 million at September 30, 2020.

The ACL, as a percentage of loans and leases held for investment at historical cost amounted to 1.1% at September 30, 2020 and 1.6% at December 31, 2019.

Excluding PPP loans and related reserves, the ACL, as a percentage of loans and leases held for investment at historical cost amounted to 1.8% at September 30, 2020.

As mentioned earlier, the Company adopted the new CECL standard effective January 1, 2020.

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In implementing CECL, the Company accordingly determined to use forecasted levels of unemployment as a primary economic variable in forecasting future expected losses.

Based upon the severity of ongoing developments resulting from the COVID-19 pandemic, the Company’s allowance for credit losses on loans and leases increased significantly, combined with the effects of the above discussed increased levels of criticized and classified loans and leases and charge-offs, as addressed more fully in the Provision for Loan and Lease Credit Losses section of Results of Operations.

Based upon the severity of ongoing developments resulting from the COVID-19 pandemic, combined with the effects of the above discussed increased levels of criticized and classified loans and leases and charge-offs, as addressed more fully in the Provision for Loan and Lease Credit Losses section of Results of Operations, the Company’s allowance for credit losses on loans and leases increased significantly in the first half of the year and subsequently began to contract somewhat during the third quarter of 2020 due to improving economic forecasts.

Actual past due held for investment loans and leases, inclusive of loans measured at fair value, have decreased by $5.7 million since December 31, 2019.

This decrease was due to monthly payments being made by SBA for our SBA 7(a) borrowers.

This decrease was principally due to monthly payments being made by the SBA for our SBA 7(a) borrowers.

Total loans and leases 90 or more days past due increased $18.0 million, or 46.0%, compared to December 31, 2019.

The increase was the result of a $6.9 million increase in the guaranteed portion of past due loans compared to December 31, 2019.

At June 30, 2020 and December 31, 2019, total held for investment unguaranteed loans and leases past due as a percentage of total held for investment unguaranteed loans and leases, inclusive of loans measured at fair value, was 0.9% and 1.7%, respectively.

Total unguaranteed loans and leases past due were comprised of $9.4 million carried at historical cost, an increase of $1.4 million, and $4.1 million measured at fair value, a decrease of $7.6 million as of June 30, 2020 compared to December 31, 2019.

The increase was comprised of a $11.9 million and $6.0 million increase in the unguaranteed and guaranteed portions, respectively, of past due loans compared to December 31, 2019 and was the result of a small number of relationships across eight industries but primarily concentrated within the Entertainment Center and Hotel verticals.

At September 30, 2020 and December 31, 2019, total held for investment unguaranteed loans and leases past due as a percentage of total held for investment unguaranteed loans and leases, inclusive of loans measured at fair value, was 1.0% and 1.7%, respectively.

Total unguaranteed loans and leases past due were comprised of $20.7 million carried at historical cost, an increase of $12.8 million, and $3.8 million measured at fair value, a decrease of $7.8 million as of September 30, 2020 compared to December 31, 2019.

Management continues to actively monitor and work to improve asset quality.

Management believes the ACL of $44.1 million at June 30, 2020 is appropriate in light of the risk inherent in the loan and lease portfolio.

Management believes the ACL of $44.2 million at September 30, 2020 is appropriate in light of the risk inherent in the loan and lease portfolio.

Management’s judgments are based on numerous assumptions about current and expected events that it believes to be reasonable, but which may or may not be valid, including but not limited to factors related to the above mentioned SBA delinquency effect and pandemic-susceptible verticals.

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and (d) availability under lines of credit.

At June 30, 2020, the total amount of these four items was $3.28 billion, or 40.0% of total assets, an increase of $2.09 billion from $1.19 billion, or 24.8% of total assets, at December 31, 2019.

At September 30, 2020, the total amount of these four items was $2.96 billion, or 36.6% of total assets, an increase of $1.77 billion from $1.19 billion, or 24.8% of total assets, at December 31, 2019.

Loans and other assets are funded by loan sales, wholesale deposits and core deposits.

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Additionally, the investment securities portfolio is available for both immediate and secondary liquidity purposes.

At June 30, 2020 , none of the investment securities portfolio was pledged to secure public deposits or pledged to retail repurchase agreements, leaving $ 779.8 million available as lendable collateral.

At September 30, 2020, none of the investment securities portfolio was pledged to secure public deposits or pledged to retail repurchase agreements, leaving $765.8 million available as lendable collateral.

Contractual Obligations

The following table presents the Company’s significant fixed and determinable contractual obligations by payment date as of June 30, 2020.

The following table presents the Company’s significant fixed and determinable contractual obligations by payment date as of September 30, 2020.

The payment amounts represent those amounts contractually due to the recipient.

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Operating lease obligations

As of June 30, 2020, and December 31, 2019, the Company had unfunded commitments to provide capital contributions for on-balance sheet investments in the amount of $16.8 million and $16.9 million, respectively.

As of September 30, 2020, and December 31, 2019, the Company had unfunded commitments to provide capital contributions for on-balance sheet investments in the amount of $14.7 million and $16.9 million, respectively.

Asset/Liability Management and Interest Rate Sensitivity

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One method used to manage interest rate sensitivity is to measure, over various time periods, the interest rate sensitivity positions, or gaps.

As of June 30, 2020, the balance sheet’s total cumulative gap position was slightly liability-sensitive at -1.5%.

The shift to liability-sensitive versus the prior quarter asset-sensitive position is primarily due to the variable, short-term funding added in early in the second quarter of 2020 to provide initial funding for the Payroll Protection Program fixed rate loans.

As of September 30, 2020, the balance sheet’s total cumulative gap position was slightly asset-sensitive at 0.1% .

The shift to asset-sensitive versus the prior quarter liability-sensitive position is primarily due to the deployment of excess liquidity into loans and through reductions in the deposit portfolio.

The interest rate gap method, however, addresses only the magnitude of asset and liability repricing timing differences as of the report date and does not address earnings, market value, changes in account behaviors based on the interest rate environment, nor growth.

Therefore, management uses an earnings simulation model to prepare, on a regular basis, earnings projections based on a range of interest rate scenarios to measure interest rate risk more accurately.

As of June 30, 2020, the Company’s interest rate risk profile under the earnings simulation model method remains asset-sensitive.

As of September 30, 2020, the Company’s interest rate risk profile under the earnings simulation model method remains asset-sensitive.

An asset-sensitive position means that net interest income will generally move in the same direction as interest rates.

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Risk-based capital ratios, which include Tier 1 Capital, Total Capital and Common Equity Tier 1 Capital, are calculated based on regulatory guidance related to the measurement of capital and risk-weighted assets.

Capital amounts and ratios as of June 30, 2020 and December 31, 201 9 , are presented in the table below.

Capital amounts and ratios as of September 30, 2020 and December 31, 2019, are presented in the table below.

Minimum Capital

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Provisions (1)

Consolidated - June 30, 2020

Consolidated - September 30, 2020

Common Equity Tier 1 (to Risk-Weighted Assets)

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Tier 1 Capital (to Average Assets)

Bank - June 30, 2020

Bank - September 30, 2020

Common Equity Tier 1 (to Risk-Weighted Assets)

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis