BRIDGEWATER BANCSHARES, INC. General
The following discussion explains the Company's financial condition and results of operations as of and for the three and nine months endedSeptember 30, 2020 . Annualized results for these interim periods may not be indicative of results for the full year or future periods. The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes presented elsewhere in this report and the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 , filed with theSecurities and Exchange Commission , or theSEC , onMarch 12, 2020 .
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of the safe harbor provisions of theU.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, statements concerning plans, estimates, calculations, forecasts and projections with respect to the anticipated future performance of the Company. These statements are often, but not always, identified by words such as "may", "might", "should", "could", "predict", "potential", "believe", "expect", "continue", "will", "anticipate", "seek", "estimate", "intend", "plan", "projection", "would", "annualized", "target" and "outlook", or the negative version of those words or other comparable words of a future or forward-looking nature. Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Our actual results and financial condition may differ materially from those indicated in the forward-looking statements. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:
the negative effects of the COVID-19 pandemic, including its effects on the
? economic environment, our clients and our operations, as well as any changes to
federal, state or local government laws, regulations or orders in connection
with the pandemic;
? loan concentrations in our portfolio;
? the overall health of the local and national real estate market;
? the ability to successfully manage credit risk;
? business and economic conditions generally and in the financial services
industry, nationally and within our market area;
? the ability to maintain an adequate level of allowance for loan losses;
? new or revised accounting standards, including as a result of the future
implementation of the Current Expected Credit Loss standard;
? the concentration of large loans to certain borrowers;
? the ability to successfully manage liquidity risk;
? the dependence on non-core funding sources and our cost of funds;
? the concentration of large deposits from certain clients;
? the ability to raise additional capital to implement our business plan;
? the ability to implement the Company's growth strategy and manage costs
effectively;
developments and uncertainty related to the future use and availability of some
? reference rates, such as the London Interbank Offered Rate, as well as other
alternative reference rates;
? the composition of our senior leadership team and our ability to attract and
retain key personnel;
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? the occurrence of fraudulent activity, breaches or failures of our information
security controls or cybersecurity-related incidents;
? interruptions involving our information technology and telecommunications
systems or third-party servicers;
? competition in the financial services industry;
severe weather, natural disasters, wide spread disease or pandemics (including
? the COVID-19 pandemic), acts of war or terrorism or other adverse external
events;
? the effectiveness of our risk management framework;
? the commencement and outcome of litigation and other legal proceedings and
regulatory actions against us;
? the impact of recent and future legislative and regulatory changes;
? interest rate risk;
? fluctuations in the values of the securities held in our securities portfolio;
? changes in federal tax law or policy;
? the imposition of tariffs or other governmental policies impacting the value of
products produced by our commercial borrowers;
? potential impairment to the goodwill we recorded in connection with our past
acquisition; and
any other risks described in the "Risk Factors" section of this report and in
the Company's Annual Report on Form 10-K as of
? the
reports filed by the Company with the
The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this report. In addition, past results of operations are not necessarily indicative of future results. Any forward-looking statement made by us in this report is based only on information currently available to us and speaks only as of the date on which it is made. We undertake no obligation to publicly update any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future developments or otherwise.
Overview
The Company is a financial holding company headquartered inSt. Louis Park, Minnesota . The principal sources of funds for loans and investments are transaction, savings, time, and other deposits, and short-term and long-term borrowings. The Company's principal sources of income are interest and fees collected on loans, interest and dividends earned on investment securities and service charges. The Company's principal expenses are interest paid on deposit accounts and borrowings, employee compensation and other overhead expenses. The Company's simple, efficient business model of providing responsive support and unconventional experiences to clients continues to be the underlying principle that drives the Company's profitable growth.
During the third quarter of 2020, the Company opened its newly constructed
office complex in
Information Regarding COVID-19 Impact
Financial Position and Results of Operations. The outbreak of the novel coronavirus, or COVID-19, which was declared a pandemic by theWorld Health Organization onMarch 11, 2020 , has continued to create uncertainty and extraordinary change for the Company, its clients, its communities and the country as a whole. In response to this pandemic, the Company rapidly deployed its business continuity plan and continues to take steps to protect the health and safety of its employees and clients. Given the fluidity of the situation, management cannot estimate the duration and full impact of the COVID-19 pandemic on the economy, financial markets and the Company's financial condition and results of operations. At this point, management does not expect that the Company's financial results in future quarters 35
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will track with the Company's historical performance.
Effects on the Company's Market Area. The Company's primary banking market area is theMinneapolis-St. Paul -Bloomington, MN -WI Metropolitan Statistical Area. InMinnesota , the Governor issued an order onMarch 25, 2020 that, subject to limited exceptions, required individuals to stay at home and non-essential businesses to cease all activities, other than minimum basic operations. This order was lifted as ofMay 18, 2020 , and the state has continued its phased-in approach to reopening, where businesses must operate under certain restrictions based on the nature and industry of the business. Recent increases in COVID-19 infections locally and across the nation have created uncertainty surrounding future restrictions, companies' operations, and the impacts on the economy. Policy and Regulatory Developments. Federal, state and local governments and regulatory authorities have enacted and issued a range of policy responses to the COVID-19 pandemic, including the following:
The
? 0.50% on
current range of 0.00 - 0.25%.
On
and Economic Security Act, or CARES Act, which established a
economic stimulus package, including cash payments to individuals, supplemental
unemployment insurance benefits and a
through the
? Paycheck Protection Program, or PPP. On
billion in funding for PPP loans was authorized, with such funds available for
PPP loans beginning on
financial institutions the option to temporarily suspend certain requirements
under GAAP related to troubled debt restructurings, or TDRs, for a limited
period of time to account for the effects of COVID-19. The Company is applying
this guidance to qualifying loan modifications.
On
Statement on Loan Modifications and Reporting for Financial Institutions,
which, among other things, encouraged financial institutions to work prudently
? with borrowers
obligations because of the effects of COVID-19, and stated that institutions
generally do not need to categorize COVID-19-related modifications as TDRs and
that the agencies will not direct supervised institutions to automatically
categorize all COVID-19 related loan modifications as TDRs.
On
supporting small and midsized business, as well as state and local governments
impacted by COVID-19. The
Lending Program, which established two new loan facilities intended to
facilitate lending to small and midsized businesses: (1) the Main Street New
Loan Facility, or MSNLF, and (2) the Main Street Expanded Loan Facility, or
? MSELF. MSNLF loans are unsecured term loans originated on or after
2020, while MSELF loans are provided as upsized tranches of existing loans
originated before
billion. The
funding to banks offering PPP loans to struggling small businesses. Lenders
participating in the PPP will be able to exclude loans pledged to the facility
from their leverage ratio. OnAugust 3, 2020 , theFFIEC issued a joint statement on Additional Loan
Accommodations Related to COVID-19, which, among other things, encouraged
? financial institutions to consider prudent additional loan accommodation
options when borrowers are unable to meet their obligations due to continuing
financial challenges. Accommodation options should be based on prudent risk
management and consumer protection principles. In addition to the policy responses described above, the federal bank
regulatory agencies, along with their state counterparts, have issued a stream
? of guidance in response to the COVID-19 pandemic and have taken a number of
unprecedented steps to help banks navigate the pandemic and mitigate its
impact. These include, without limitation: requiring banks to focus on business
continuity and pandemic
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planning; adding pandemic scenarios to stress testing; encouraging bank use of
capital buffers and reserves in lending programs; permitting certain regulatory
reporting extensions; reducing margin requirements on swaps; permitting certain
otherwise prohibited investments in investment funds; issuing guidance to
encourage banks to work with customers affected by the pandemic and encourage
loan workouts; and providing credit under the Community Reinvestment Act, or
CRA, for certain pandemic-related loans, investments and public service.
Moreover, because of the need for social distancing measures, the agencies
revamped the manner in which they conducted periodic examinations of their
regulated institutions, including making greater use of off-site reviews. The
its discount window for loans and intraday credit extended by its Reserve Banks
to help households and businesses impacted by the pandemic and announced
numerous funding facilities. The
insurance assessment effects of participating in the PPP and theFederal Reserve's PPP Liquidity Facility and Money Market Mutual Fund Liquidity Facility.
Capital and Liquidity. At
In addition, the Company issued$50.0 million of 5.25% Fixed-to-Floating Rate Subordinated Notes dueJune 2030 in a private placement onJune 19, 2020 . These notes are callable starting in 2025 and qualify for tier 2 capital treatment at the holding company level. The Company injected$25.0 million of capital into the Bank in connection with the subordinated note issuance, which qualifies for tier 1 capital treatment at the bank level. Asset Valuation. During the nine months endedSeptember 30, 2020 , the economic turmoil and market volatility resulting from the COVID-19 pandemic resulted in a substantial decrease in the Company's stock price and market capitalization. The Company believed such decrease was a triggering event requiring an interim goodwill impairment analysis as ofMarch 31, 2020 . The Company performed an interim analysis and determined that goodwill was not more likely than not impaired, resulting in no impairment charge for the period. In the event that all or a portion of goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital or regulatory capital. AtSeptember 30, 2020 , the Company had goodwill of$2.6 million . Active Management of Credit Risk. The Company has modified its internal policies to increase oversight and analysis of all credits, especially in vulnerable industries such as hospitality and restaurants to proactively monitor evolving credit risk. With the change in economic conditions and uncertain duration of the COVID-19 pandemic, the Company's portfolio is expected to be negatively impacted and management anticipates delinquencies and charge-offs could rise in future periods. The Company has not yet experienced charge-offs related to the COVID-19 pandemic, but the continued uncertainty regarding the severity and duration of the pandemic and related economic effects has and will continue to affect the Company's estimate of its allowance for loan losses and resulting provision for loan losses. The Company will continue to monitor credits closely while working with clients to provide relief when appropriate. COVID-19 Related Loan Deferrals and PPP Lending. The Company has developed programs for assisting existing clients through this uncertain time by providing, when appropriate, loan modifications that may include loan payment deferrals or interest-only modifications. As ofSeptember 30, 2020 , the Company had active loan modifications for 87 loans totaling$191.4 million . Of that total, loan modifications to interest-only payments totaled$160.9 million and loans with payment deferrals totaled$30.5 million . In accordance with recent regulatory guidance and the CARES Act, loans modified in response to the COVID-19 pandemic are not considered TDRs. New modification activity has been limited in the third quarter of 2020. In a further effort to assist both existing and new clients, the Company participated in government loan programs through the SBA, primarily the PPP. As ofSeptember 30, 2020 , principal balances originated under the program totaled$181.6 million . The Company has generated fees from the SBA, net of costs, of$5.7 million ,$1.2 million of which was recognized in the nine months endedSeptember 30, 2020 . In the third quarter of 2020, the Company began to shift its efforts to principal forgiveness processing; however, the SBA did not grant forgiveness to any borrowers during the third quarter of 2020. 37 Table of Contents
Processes, Controls, and Business Continuity. The Company's operations are being conducted in material compliance with current federal, state and local government guidelines regarding social distancing, sanitation, and personal hygiene. During the third quarter of 2020, the Company began allowing employees to return to the office in accordance with new health and safety procedures, including increasing physical space between employees, using face coverings, alternating schedules for employees in the workspace and requiring employees with COVID-19 symptoms or exposure to quarantine away from the office. Additional details about the Company's COVID-19 pandemic assistance programs, including relevant disclosures and up-to-date information, are maintained at bwbmn.com. The Company's investments in technology, digital platforms and electronic banking have allowed clients and employees to transact with minimal interruption during this time of uncertainty. Additional team members have been assigned to assist clients over the telephone and work with clients on new enrollments in online banking and other treasury management services. Internally, these investments in technology have enabled increased communication capabilities for departments by use of video conferencing, chat, and other collaborative features.
The Company believes it is positioned to continue these business continuity measures for the foreseeable future; however, no assurances can be provided as circumstances may change depending on the duration of the pandemic.
Critical Accounting Policies and Estimates
The consolidated financial statements of the Company are prepared based on the application of certain accounting policies, the most significant of which are described in Note 1 of the notes to the consolidated financial statements included as a part of the Company's Annual Report on Form 10-K. Certain of these policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or subject to variation and may significantly affect the reported results and financial position for the current period or in future periods. The use of estimates, assumptions, and judgments are necessary when financial assets and liabilities are required to be recorded or adjusted to reflect fair value. Assets carried at fair value inherently result in more financial statement volatility. Fair values and information used to record valuation adjustments for certain assets and liabilities are based on either quoted market prices or are provided by other independent third-party sources, when available. When such information is not available, management estimates valuation adjustments. Changes in underlying factors, assumptions or estimates in any of these areas could have a material impact on the future financial condition and results of operations of the Company. Management has discussed each critical accounting policy and the methodology for the identification and determination of critical accounting policies with the Company's Audit Committee. The JOBS Act permits the Company an extended transition period for complying with new or revised accounting standards affecting public companies. The Company has elected to take advantage of this extended transition period, which means that the financial statements included in this report, as well as any financial statements filed in the future, will not be subject to all new or revised accounting standards generally applicable to public companies for the transition period for so long as the Company remains an emerging growth company or until the Company affirmatively and irrevocably opts out of the extended transition period under the JOBS Act.
The following is a discussion of the critical accounting policies and significant estimates that require the Company to make complex and subjective judgements.
Allowance for Loan Losses
The allowance for loan losses, sometimes referred to as the "allowance," is
established through a provision for loan losses which is charged to expense.
Loan losses are charged against the allowance when management determines all or
a portion of the loan balance to be uncollectible. Subsequent recoveries, if
any, are credited to the allowance for cash received on previously charged-off
amounts. If the allowance is considered inadequate to absorb future loan losses
on existing loans for any reason, including but not limited to, increases in the
size of the loan portfolio, increases in charge-offs or changes in the risk
characteristics of the loan portfolio, then the provision for loan losses is
increased.
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A loan is considered impaired when, based on current information and events, it
is probable that the Company will be unable to collect all amounts due according
to the original contractual terms of the loan agreement. The collection of all
amounts due according to original contractual terms means that both the
contractual interest and principal payments of a loan will be collected as
scheduled in the loan agreement. An impaired loan is measured based on the
present value of expected future cash flows discounted at the loan's effective
interest rate, or, as a practical expedient, at the loan's observable market
price, or the fair value of the underlying collateral, reduced by costs to sell
on a discounted basis, is used if a loan is collateral dependent.
Investment Securities Impairment
Periodically, the Company may need to assess whether there have been any events or economic circumstances to indicate that a security on which there is an unrealized loss is impaired on an other than temporary basis. In any such instance, the Company would consider many factors, including the length of time and the extent to which the fair value has been less than the amortized cost basis, the market liquidity for the security, the financial condition and the near-term prospects of the issuer, expected cash flows, and the intent and ability to hold the investment for a period of time sufficient to recover the temporary loss. Securities on which there is an unrealized loss that is deemed to be other than temporary are written down to fair value, with the write-down recorded as a realized loss in securities gains (losses). The fair values of investment securities are generally determined by various pricing models. The Company evaluates the methodologies used to develop the resulting fair values. The Company performs a semi-annual analysis on the pricing of investment securities to ensure that the prices represent reasonable estimates of fair value. The procedures include initial and ongoing reviews of pricing methodologies and trends. The Company seeks to ensure prices represent reasonable estimates of fair value through the use of broker quotes, current sales transactions from the portfolio and pricing techniques, which are based on the net present value of future expected cash flows discounted at a rate of return market participants would require. As a result of this analysis, if the Company determines there is a more appropriate fair value, the price is adjusted accordingly.
Fair Value of Financial Instruments
The fair value of a financial instrument is defined as the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants in the market in which the reporting
entity transacts business. A framework has been established for measuring the
fair value of financial instruments that considers the attributes specific to
particular assets or liabilities and includes a three-level hierarchy for
determining fair value based on the transparency of inputs to each valuation as
of the measurement date. The Company estimates the fair value of financial
instruments using a variety of valuation methods. When financial instruments are
actively traded and have quoted market prices, quoted market prices are used for
fair value and are classified as Level 1. When financial instruments, such as
investment securities and derivatives, are not actively traded, the Company
determines fair value based on various sources and may apply matrix pricing with
observable prices for similar instruments where a price for the identical
instrument is not observable. The fair values of these financial instruments,
which are classified as Level 2, are determined by pricing models that consider
observable market data such as interest rate volatilities, London Interbank
Offered Rate, or LIBOR, yield curve, credit spreads, prices from external market
data providers and/or nonbinding broker-dealer quotations. When observable
inputs do not exist, the Company estimates fair value based on available market
data, and these values are classified as Level 3. Imprecision in estimating fair
values can impact the carrying value of assets and liabilities and the amount of
revenue or loss recorded.
Deferred Tax Asset
The Company uses the asset and liability method of accounting for income taxes
as prescribed by GAAP. Under this method, deferred tax assets and liabilities
are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax basis. If currently available information
indicates it is "more likely than not" that the deferred tax asset will not be
realized, a valuation allowance is established. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. Accounting for deferred income taxes is a critical
accounting estimate because the Company exercises
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significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. Management's determination of the realization of deferred tax assets is based upon management's judgment of various future events and uncertainties, including the timing and amount of future income, reversing temporary differences which may offset, and the implementation of various tax plans to maximize realization of the deferred tax asset. These judgments and estimates are inherently subjective and reviewed on a continual basis as regulatory and business factors change. Any reduction in estimated future taxable income may require the Company to record a valuation allowance against the deferred tax assets. A valuation allowance would result in additional income tax expense in such period, which would negatively affect
earnings.
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Operating Results Overview
The following table summarizes certain key financial results for the periods
indicated:
As of and for the Three Months Ended
September 30, June 30, March 31, December 31, September 30,
2020 2020 2020 2019 2019
Per Common Share DataBasic Earnings Per Share $ 0.25$ 0.26 $ 0.26 $ 0.30 $ 0.27 Diluted Earnings Per Share 0.25 0.26 0.25 0.29 0.27 Book Value Per Share 9.25 8.92 8.61 8.45 8.20 Tangible Book Value Per Share (1) 9.13 8.80 8.49 8.33 8.08 Basic Weighted Average Shares Outstanding 28,683,855
28,676,441 28,791,494 28,833,576 28,820,144 Diluted Weighted Average Shares Outstanding
29,174,601 29,165,157 29,502,245 29,561,103 29,497,961 Shares Outstanding at Period End
28,710,775 28,837,560 28,807,375 28,973,572 28,781,162
Selected Performance Ratios
Return on Average Assets (Annualized) 1.05 % 1.17 % 1.29 % 1.53 % 1.43 %
Pre-Provision Net Revenue Return on Average
Assets (Annualized)(1) 1.94 2.00 2.11 2.09 2.08
Return on Average Common Equity (Annualized) 10.84 11.98 11.94 14.16 13.31
Return on Average Tangible Common Equity
(Annualized) (1) 10.98 12.14 12.10 14.37 13.52
Yield on Interest Earning Assets 4.30 4.45 4.90 5.01 4.98
Yield on Total Loans, Gross 4.73 4.85 5.17 5.33 5.32
Cost of Interest Bearing Liabilities 1.50 1.58 1.84 1.96 2.04 Cost of Total Deposits 0.87 0.99 1.27 1.34 1.42 Net Interest Margin (2) 3.28 3.38 3.59 3.65 3.56 Efficiency Ratio (1) 42.3 48.6 44.4 49.6 45.6
Adjusted Efficiency Ratio (1) 41.7 40.4 44.1 44.3 42.9 Noninterest Expense to Average Assets (Annualized) 1.42 1.64 1.69 1.87 1.66 Adjusted Noninterest Expense to Average Assets (Annualized) (1) 1.40 1.37 1.68 1.67 1.56 Loan to Deposit Ratio 99.4 97.8 105.4 104.9 102.4 Core Deposits to Total Deposits 77.1 75.7 78.6 80.7 79.9 Tangible Common Equity to Tangible Assets (1) 9.46 9.23 10.13 10.65 10.43
(1) Represents a non-GAAP financial measure. See "Non-GAAP Financial Measures"
for further details.
(2) Amounts calculated on a tax-equivalent basis using the statutory federal tax
rate of 21%.
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Selected Financial Data
The following tables summarize certain selected financial data as of and for the
periods indicated:
September 30, June 30, March 31, December 31, September 30,
(dollars in thousands) 2020 2020 2020 2019 2019
Selected Balance Sheet Data
Total Assets $ 2,774,564 $ 2,754,463 $ 2,418,730 $ 2,268,830 $ 2,232,339
Total Loans, Gross 2,259,228 2,193,778 2,002,817 1,912,038 1,846,218
Allowance for Loan Losses 31,381 27,633 24,585 22,526 22,124Goodwill and Other Intangibles 3,344 3,391
3,439 3,487 3,535
Deposits 2,273,044 2,242,051 1,900,127 1,823,310 1,802,236
Tangible Common Equity (1) 262,088 253,799 244,704 241,307 232,524
Total Shareholders' Equity 265,432 257,190 248,143 244,794 236,059
Average Total Assets -
Quarter-to-Date 2,711,755 2,622,272 2,317,040 2,221,370 2,168,909
Average Common Equity -
Quarter-to-Date 263,195 255,109 250,800 240,188 232,590
(1) Represents a non-GAAP financial measure. See "Non-GAAP Financial Measures"
for further details.
For the Three Months Ended
September 30, June 30, March 31, December 31, September 30,
(dollars in thousands) 2020 2020 2020 2019 2019
Selected Income Statement
Data
Interest Income $ 28,493 $ 28,166 $ 27,468 $ 27,419 $ 26,572
Interest Expense 6,814 6,824 7,366 7,491 7,637
Net Interest Income 21,679 21,342 20,102 19,928 18,935Provision for Loan Losses 3,750 3,000 2,100 600 900 Net Interest Income after Provision for Loan Losses 17,929 18,342 18,002
19,328 18,035
Noninterest Income 1,157 1,977 1,719 1,112 946
Noninterest Expense 9,672 10,711 9,746 10,489 9,084Income Before Income Taxes 9,414 9,608 9,975 9,951 9,897 Provision for Income Taxes 2,240 2,010 2,532
1,380 2,092
Net Income $ 7,174 $ 7,598 $ 7,443 $ 8,571 $ 7,805
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Discussion and Analysis of Results of Operations
Net Income
Net income was$7.2 million for the third quarter of 2020, an 8.1% decrease compared to net income of$7.8 million for the third quarter of 2019. Net income per diluted common share for the third quarter of 2020 was$0.25 , a 7.1% decrease compared to$0.27 per diluted common share for the third quarter of 2019. Net income was$22.2 million for the nine months endedSeptember 30, 2020 , a 2.7% decrease compared to net income of$22.8 million for the third quarter of 2019. Net income per diluted common share for the nine months endedSeptember 30, 2020 and 2019 was$0.76 . Net Interest Income The Company's primary source of revenue is net interest income, which is impacted by the level of interest earning assets and related funding sources, as well as changes in the level of interest rates. The difference between the average yield on earning assets and the average rate paid for interest bearing liabilities is the net interest spread. Noninterest bearing sources of funds, such as demand deposits and shareholders' equity, also support earning assets. The impact of the noninterest bearing sources of funds is captured in the net interest margin, which is calculated as net interest income divided by average earning assets. Both the net interest margin and net interest spread are presented on a tax-equivalent basis, which means that tax-free interest income has been adjusted to pretax-equivalent income, assuming a 21% federal tax rate. Management's ability to respond to changes in interest rates by using effective asset-liability management techniques is critical to maintaining the stability of the net interest margin and the momentum of the Company's primary source of earnings. In response to the COVID-19 pandemic, theFederal Open Market Committee , orFOMC , decreased the targeted federal funds rate by a total of 150 basis points inMarch 2020 . This decrease may impact the comparability of net interest income between 2019 and 2020. 43 Table of Contents
Average Balances and Yields
The following tables present, for the three and nine months endedSeptember 30, 2020 and 2019, the average balances of each principal category of assets, liabilities and shareholders' equity, and an analysis of net interest income. The average balances are principally daily averages and, for loans, include both performing and nonperforming balances. Interest income on loans includes the effects of net deferred loan origination fees and costs accounted for as yield adjustments. These tables are presented on a tax-equivalent basis, if applicable. For the Three Months Ended September 30, 2020 September 30, 2019 Average Interest Yield/ Average Interest Yield/ Balance & Fees Rate Balance & Fees Rate (dollars in thousands) Interest Earning Assets: Cash Investments$ 101,787 $ 42 0.16 %$ 73,970 $ 346 1.86 %Investment Securities : Taxable Investment Securities 256,808 1,389 2.15 151,319 1,095 2.87Tax-Exempt Investment Securities (1) 82,579 900 4.33 95,575 1,031 4.28 Total Investment Securities 339,387 2,289 2.68 246,894 2,126 3.42 Paycheck Protection Program Loans (2) 181,397 1,173 2.57 - - - Loans (1)(2) 2,025,410 25,081 4.93 1,805,920 24,220 5.32 Total Loans 2,206,807 26,254 4.73 1,805,920 24,220 5.32
Federal Home Loan Bank Stock 7,901 127 6.38 8,111 96 4.72 Total Interest Earning Assets 2,655,882 28,712 4.30 % 2,134,895 26,788 4.98 % Noninterest Earning Assets 55,873 34,014 Total Assets$ 2,711,755 $ 2,168,909 Interest Bearing Liabilities: Deposits: Interest Bearing Transaction Deposits 306,162 400 0.52 % 250,667 511 0.81 % Savings and Money Market Deposits 501,246 1,106 0.88
453,340 2,080 1.82 Time Deposits 369,975 1,899 2.04 359,329 2,229 2.46 Brokered Deposits 419,744 1,435 1.36 242,600 1,389 2.27
Total Interest Bearing Deposits 1,597,127 4,840 1.21
1,305,936 6,209 1.89 Federal Funds Purchased 152 - 0.33 - - - Notes Payable 11,500 108 3.74 13,500 127 3.73 FHLB Advances 129,457 748 2.30 143,690 908 2.51 Subordinated Debentures 73,649 1,118 6.04 24,699 393 6.31 Total Interest Bearing Liabilities 1,811,885 6,814 1.50 % 1,487,825 7,637 2.04 % Noninterest Bearing Liabilities: Noninterest Bearing Transaction Deposits 615,214 434,021 Other Noninterest Bearing Liabilities 21,461 14,473 Total Noninterest Bearing Liabilities 636,675 448,494 Shareholders' Equity 263,195 232,590 Total Liabilities and Shareholders' Equity$ 2,711,755 $ 2,168,909 Net Interest Income / Interest Rate Spread 21,898 2.80 % 19,151 2.94 % Net Interest Margin (3) 3.28 % 3.56 % Taxable Equivalent Adjustment: Tax-Exempt Investment Securities (219)
(216)
Net Interest Income $ 21,679 $ 18,935 Interest income and average rates for tax-exempt investment securities and (1) loans are presented on a tax-equivalent basis, assuming a federal income tax
rate of 21%.
(2) Average loan balances include nonaccrual loans. Interest income on loans
includes amortization of deferred loan fees, net of deferred loan costs.
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Net interest margin includes the tax equivalent adjustment and represents the (3) annualized results of: (i) the difference between interest income on interest
earning assets and the interest expense on interest bearing liabilities,
divided by (ii) average interest earning assets for the period.
For the Nine Months Ended
September 30, 2020 September 30, 2019
Average Interest Yield/ Average Interest Yield/
Balance & Fees Rate Balance & Fees Rate
(dollars in thousands)
Interest Earning Assets:
Cash Investments $ 80,186 $ 138 0.23 % $ 46,158 $ 604 1.75 %
Investment Securities :Taxable Investment Securities 216,332 4,080 2.52 143,583 3,126 2.91Tax-Exempt Investment Securities (1) 89,674 2,920 4.35 103,032 3,307 4.29 Total Investment Securities 306,006 7,000 3.06 246,615 6,433 3.49 Paycheck Protection Program Loans (2) 107,541 2,046 2.54 - - - Loans (1)(2) 1,997,553 75,301 5.04 1,756,855 69,720 5.31 Total Loans 2,105,094 77,347 4.91 1,756,855 69,720 5.31
Federal Home Loan Bank Stock 9,541 352 4.93 7,906 296 5.00 Total Interest Earning Assets 2,500,827 84,837 4.53 % 2,057,534 77,053 5.01 % Noninterest Earning Assets 50,118 26,303 Total Assets$ 2,550,945 $ 2,083,837 Interest Bearing Liabilities: Deposits: Interest Bearing Transaction Deposits 275,303 1,207 0.58 % 211,784 1,130 0.71 % Savings and Money Market Deposits 518,648 4,338 1.12
433,430 5,784 1.78 Time Deposits 378,133 6,199 2.19 347,731 6,230 2.40 Brokered Deposits 319,615 3,990 1.67 266,976 4,788 2.40
Total Interest Bearing Deposits 1,491,699 15,734 1.41
1,259,921 17,932 1.90 Federal Funds Purchased 8,302 107 1.73 8,923 172 2.58 Notes Payable 12,000 334 3.72 14,000 378 3.61 FHLB Advances 165,088 2,839 2.30 133,097 2,510 2.52 Subordinated Debentures 43,318 1,990 6.14 24,673 1,163 6.30 Total Interest Bearing Liabilities 1,720,407 21,004 1.63 % 1,440,614 22,155 2.06 % Noninterest Bearing Liabilities: Noninterest Bearing Transaction Deposits 554,513 401,973 Other Noninterest Bearing Liabilities 19,632 11,289 Total Noninterest Bearing Liabilities 574,145 413,262 Shareholders' Equity 256,393 229,961 Total Liabilities and Shareholders' Equity$ 2,550,945 $ 2,083,837 Net Interest Income / Interest Rate Spread 63,833 2.90 % 54,898 2.95 % Net Interest Margin (3) 3.41 % 3.57 % Taxable Equivalent Adjustment: Tax-Exempt Investment Securities (710)
(694)
Net Interest Income $ 63,123 $ 54,204 Interest income and average rates for tax-exempt investment securities and (1) loans are presented on a tax-equivalent basis, assuming a federal income tax
rate of 21%.
(2) Average loan balances include nonaccrual loans. Interest income on loans
includes amortization of deferred loan fees, net of deferred loan costs.
Net interest margin includes the tax equivalent adjustment and represents the (3) annualized results of: (i) the difference between interest income on interest
earning assets and the interest expense on interest bearing liabilities,
divided by (ii) average interest earning assets for the period.
Interest Rates and Operating Interest Differential
Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest earning assets and interest bearing liabilities, as well as changes in average interest rates. The
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following table presents the effect that these factors had on the interest earned on interest earning assets and the interest incurred on interest bearing liabilities. The effect of changes in volume is determined by multiplying the change in volume by the previous period's average rate. Similarly, the effect of rate changes is calculated by multiplying the change in average rate by the previous period's volume. The changes not attributable specifically to either volume or rate have been allocated to the changes due to volume. The following tables present the changes in the volume and rate of interest bearing assets and liabilities for the three months endedSeptember 30, 2020 , compared to the three months endedSeptember 30, 2019 , and for the nine months endedSeptember 30, 2020 , compared to the nine months endedSeptember 30, 2019 . Three Months Ended September 30, 2020 Compared with Three Months Ended September 30, 2019 Change Due To: Interest (dollars in thousands) Volume Rate Variance Interest Earning Assets: Cash Investments$ 12 $ (316) $ (304) Investment Securities :
Taxable Investment Securities 568 (274)
294
Tax-Exempt Investment Securities (142) 11
(131)
Total Securities 426 (263)
163
Loans:
Paycheck Protection Program Loans 1,173 -
1,173
Loans 2,656 (1,795) 861
Total Loans 3,829 (1,795) 2,034
Federal Home Loan Bank Stock (3) 34 31
Total Interest Earning Assets $ 4,264 $ (2,340) $ 1,924
Interest Bearing Liabilities:Interest Bearing Transaction Deposits$ 73 $ (184) $ (111) Savings and Money Market Deposits 103 (1,077)
(974)
Time Deposits 49 (379) (330)
Brokered Deposits 603 (557) 46
Total Deposits 828 (2,197) (1,369)
Notes Payable (19) - (19)
FHLB Advances (84) (76) (160)
Subordinated Debentures 742 (17) 725Total Interest Bearing Liabilities 1,467 (2,290)
(823)
Net Interest Income $ 2,797 $ (50) $ 2,747
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Nine Months Ended September 30, 2020
Compared with
Nine Months Ended September 30, 2019
Change Due To: Interest
(dollars in thousands) Volume Rate Variance
Interest Earning Assets:
Cash Investments $ 59 $ (525) $ (466)
Investment Securities :
Taxable Investment Securities 1,374 (420) 954Tax Exempt Investment Securities (432) 45
(387)
Total Securities 942 (375)
567
Loans:
Paycheck Protection Program Loans 2,046 -
2,046
Loans 9,134 (3,553) 5,581
Total Loans 11,180 (3,553) 7,627
Federal Home Loan Bank Stock 60 (4) 56
Total Interest Earning Assets $ 12,241 $ (4,457) $ 7,784
Interest Bearing Liabilities:Interest Bearing Transaction Deposits$ 281 $ (204) $
77
Savings and Money Market Deposits 716 (2,162)
(1,446) Time Deposits 504 (535) (31) Brokered Deposits 660 (1,458) (798) Total Deposits 2,161 (4,359) (2,198) Federal Funds Purchased (8) (57) (65) Notes Payable (55) 11 (44) FHLB Advances 552 (223) 329 Subordinated Debentures 858 (31) 827
Total Interest Bearing Liabilities 3,508 (4,659)
(1,151) Net Interest Income$ 8,733 $ 202$ 8,935
Comparison of Interest Income, Interest Expense, and Net Interest Margin
Third Quarter of 2020 Compared to Third Quarter of 2019
Net interest income was$21.7 million for the third quarter of 2020, an increase of$2.7 million , or 14.5%, compared to$18.9 million for the third quarter of 2019. The increase in net interest income was primarily due to growth in average interest earning assets and lower rates paid on deposits, offset partially by lower rates on interest earning assets. The increase in average interest earning assets was primarily due to continued organic growth in the loan portfolio and most recently, the funding of PPP loans. The Company anticipates that its net interest income will be adversely affected in future periods as a result of the COVID-19 pandemic and the effects of lower interest rates. Net interest margin (on a fully tax-equivalent basis) for the third quarter of 2020 was 3.28%, a 28 basis point decrease from 3.56% in the third quarter of 2019. While the Company is encouraged by the continued reduction in the cost of interest bearing liabilities during the third quarter of 2020, the year-over-year decline in net interest margin was primarily attributed to a meaningful increase in on-balance sheet liquidity in conjunction with the historically low and flat yield curve weighing on subsequent earning asset yields. Furthermore, the Company's participation in the PPP generated strong loan origination volume during the second quarter of 2020; however, the interest rate of 1.00% earned on these loans is significantly lower than the aggregate loan yield, thus impacting the net interest margin during the third quarter
of
2020.
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The core net interest margin, excluding PPP loans and corresponding deposit balances, was 3.33% for the third quarter of 2020. As a result of the low interest rate environment, as well as the impact of the COVID-19 pandemic, the Company expects that its net interest margin will continue to be under pressure in future periods. Average interest earning assets for the third quarter of 2020 increased$521.0 million , or 24.4%, to$2.66 billion , from$2.13 billion for the third quarter of 2019. This increase in average interest earning assets was primarily due to continued organic growth in the loan portfolio and the funding of PPP loans. Average interest bearing liabilities increased$324.1 million , or 21.8%, to$1.81 billion for the third quarter of 2020, from$1.49 billion for the third quarter of 2019. The increase in average interest bearing liabilities was primarily due to an increase in interest bearing deposits and the issuance of subordinated debentures in the second quarter of 2020, offset partially by a decrease in FHLB advances and notes payable. Average interest earning assets produced a tax-equivalent yield of 4.30% for the third quarter of 2020, compared to 4.98% for the third quarter of 2019. The decrease in the yield on interest earning assets was due to the falling interest rate environment which created lower loan and security yields, the impact of PPP loans at a meaningfully lower rate than the aggregate loan portfolio yield, and an increase in cash balances held by the Company due to the uncertain impacts of the COVID-19 pandemic. The average rate paid on interest bearing liabilities was 1.50% for the third quarter of 2020, compared to 2.04% for the third quarter of 2019, which benefitted from the falling interest rate environment. Interest Income. Total interest income on a tax-equivalent basis was$28.7 million for the third quarter of 2020, compared to$26.8 million for the third quarter of 2019. The$1.9 million , or 7.2%, increase in total interest income on a tax-equivalent basis was primarily due to continued organic growth in the loan portfolio and PPP loan income. Interest income on loans, on a tax-equivalent basis, for the third quarter of 2020 was$26.3 million , compared to$24.2 million for the third quarter of 2019. The$2.0 million , or 8.4%, increase was due to a 22.2% increase in the average balance of loans outstanding due to continued organic loan growth, which included$181.4 million of PPP loans. Loan interest income and loan fees remain the primary contributing factors to the changes in yield on interest earning assets. The aggregate loan yield, excluding PPP loans, decreased to 4.93% in the third quarter of 2020, which was 39 basis points lower than 5.32% in the third quarter of 2019. While loan fees have maintained a stable contribution to aggregate loan yield, the historically low and flat yield curve has resulted in a declining core yield on loans in comparison to prior periods.
The following table presents a summary of interest and fees recognized on loans, excluding PPP loans, for the periods indicated as follows:
Three Months Ended
September 30, 2020 June 30, 2020 March 31, 2020 December 31, 2019 September 30, 2019
Interest 4.69 % 4.76 % 4.90 % 5.00 % 5.07 %
Fees 0.24 0.25 0.27 0.33 0.25
Yield on Loans,
Excluding PPP
Loans 4.93 % 5.01 % 5.17 % 5.33 % 5.32 %
Interest Expense. Interest expense on interest bearing liabilities decreased
$823,000 , or 10.8%, to $6.8 million for the third quarter of 2020, compared to
$7.6 million for the third quarter of 2019. The cost of interest bearing
liabilities declined 54 basis points from 2.04% in the third quarter of 2019 to
1.50% in the third quarter of 2020, primarily due to deposit rate cuts
consistent with a lower rate environment and the repricing of time deposits.
Given the strong deposit growth and ample time deposit maturities over the next
12 months, the Company anticipates meaningful deposit repricing opportunities in
future quarters.
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Interest expense on deposits was $4.8 million for the third quarter of 2020,
compared to $6.2 million for the third quarter of 2019. The $1.4 million , or
22.1%, decrease in interest expense on deposits was primarily due to a 68 basis
point decrease in the average rate paid on interest bearing deposits. The
average balance of interest bearing deposits increased $291.2 million , or 22.3%,
to $1.60 billion in the third quarter of 2020, compared to $1.31 billion for the
third quarter of 2019. The increase in the average balance of interest bearing
deposits resulted from growth among all interest bearing deposit types over the
year. The average rate paid on interest bearing deposits decreased from 1.89% in
the third quarter of 2019 to 1.21% in the third quarter of 2020. The decrease in
the average rate paid was primarily due to the decline of market interest rates.
Interest expense on borrowings increased $546,000 to $2.0 million for the third
quarter of 2020, compared to $1.4 million for the third quarter of 2019. This
increase was primarily due to a higher average balance of subordinated
debentures, partially offset by a decrease in FHLB advances. The higher
subordinated debentures balance was due to the issuance of $50.0 million of
subordinated debentures during the second quarter of 2020.
Nine Months Ended
Net interest income was$63.1 million for the nine months endedSeptember 30, 2020 , an increase of$8.9 million , or 16.5%, compared to$54.2 million for the nine months endedSeptember 30, 2019 . The increase in net interest income was primarily attributable to growth in average interest earning assets due to organic growth in the loan portfolio and lower rates paid on deposits due to the falling interest rate environment. The Company anticipates that its net interest income will be adversely affected in future periods as a result of the COVID-19 pandemic and the effects of lower interest rates. Net interest margin (on a fully tax-equivalent basis) for the nine months endedSeptember 30, 2020 was 3.41%, compared to 3.57% for the nine months endedSeptember 30, 2019 , a decrease of 16 basis points. Despite a significant reduction in interest bearing liability costs over the year, the historically low interest rate environment, coupled with a more liquid balance sheet mix, pressured earning asset yields lower and ultimately compressed the net interest margin year-over-year. Average interest earning assets for the nine months endedSeptember 30, 2020 increased$443.3 million , or 21.5%, to$2.50 billion from$2.06 billion for the nine months endedSeptember 30, 2019 . This increase in average interest earning assets was primarily due to continued organic growth in the loan portfolio and the funding of PPP loans. Average interest bearing liabilities increased$280.0 million , or 19.4%, to$1.72 billion for the nine months endedSeptember 30, 2020 , from$1.44 billion for the nine months endedSeptember 30, 2019 . The increase in average interest bearing liabilities was primarily due to increases in interest bearing deposits, FHLB advances and subordinated debentures, offset partially by decreases in federal funds purchased and notes payable. Average interest earning assets produced a tax-equivalent yield of 4.53% for the nine months endedSeptember 30, 2020 , compared to 5.01% for the nine months endedSeptember 30, 2019 . The average rate paid on interest bearing liabilities was 1.63% for the nine months endedSeptember 30, 2020 , compared to 2.06% for the nine months endedSeptember 30, 2019 . Interest Income. Total interest income on a tax-equivalent basis was$84.8 million for the nine months endedSeptember 30, 2020 , compared to$77.1 million for the nine months endedSeptember 30, 2019 . The$7.8 million , or 10.1%, increase in total interest income on a tax-equivalent basis was primarily due to organic growth in the loan portfolio. Interest income on the investment securities portfolio on a fully-tax equivalent basis increased$567,000 , or 8.8%, during the nine months endedSeptember 30, 2020 compared to the nine months endedSeptember 30, 2019 , due to a$59.4 million , or 24.1%, increase in average balances between the periods, which was partially offset by a 43 basis point decrease in the aggregate portfolio yield.
Interest income on loans for the nine months ended
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a 19.8% increase in the average balance of loans outstanding, which was offset partially by a 40 basis point decrease in the average yield on loans, 13 basis points of which was attributed to the origination of PPP loans. The increase in the average balance of loans outstanding was due to organic loan growth. The decrease in yield on the loan portfolio was primarily driven by lower market interest rates and an interest rate of 1.00% earned on PPP loans. Interest Expense. Interest expense on interest bearing liabilities decreased$1.2 million , or 5.2%, to$21.0 million for the nine months endedSeptember 30, 2020 , compared to$22.2 million for the nine months endedSeptember 30, 2019 , due to lower interest rates paid on both deposits and borrowings. Interest expense on deposits decreased to$15.7 million for the nine months endedSeptember 30, 2020 , compared to$17.9 million for the nine months endedSeptember 30, 2019 . The$2.2 million , or 12.3%, decrease in interest expense on deposits was primarily due to a 49 basis point decrease in the average rate paid, even as the average balance of deposits increased 18.4%. The decrease in the average rate paid was primarily due to the impact of lower market interest rates. The increase in the average balance of interest bearing deposits resulted primarily from increases in interest bearing transaction deposits and savings and money market deposits. Interest expense on borrowings increased$1.0 million to$5.3 million for the nine months endedSeptember 30, 2020 , compared to$4.2 million for the nine months endedSeptember 30, 2019 . This increase was primarily due to a higher average balances of FHLB advances and subordinated debentures.
Provision for Loan Losses
The provision for loan losses was$3.8 million for the third quarter of 2020, an increase of$2.9 million , compared to the provision for loan losses of$900,000 for the third quarter of 2019. The provision for loan losses was$8.9 million for the nine months endedSeptember 30, 2020 , an increase of$6.8 million compared to the provision for loan losses of$2.1 million for the nine months endedSeptember 30, 2019 . The increase in the provision for loan losses compared to both prior periods relates primarily to growth of the loan portfolio, economic uncertainties and evolving risks driven by the impact of the COVID-19 pandemic. The Company expects the provision for loan losses to remain at an increased level compared to recent historical periods based on its belief that the credit quality of its loan portfolio will decline, and the likelihood of loan defaults will increase the longer the COVID-19 pandemic persists. The allowance for loan losses to total loans was 1.39% atSeptember 30, 2020 , compared to 1.20% atSeptember 30, 2019 . The allowance for loan losses to total loans, excluding$181.6 million of PPP loans, was 1.51% atSeptember 30, 2020 . As an emerging growth company, the Company is not subject to Accounting Standards Update No. 2016-13 "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses of Financial Instruments," or CECL, untilJanuary 1, 2023 .
The following table presents the activity in the allowance for loan losses for
the three and nine month periods ended
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,(dollars in thousands) 2020 2019 2020 2019 Balance at Beginning of Period $ 27,633$ 21,362 $ 22,526$ 20,031 Provision for Loan Losses 3,750 900 8,850 2,100 Charge-offs (6) (144) (54) (183) Recoveries 4 6 59 176 Balance at End of Period $ 31,381$ 22,124 $ 31,381$ 22,124 50 Table of Contents Noninterest Income Noninterest income was$1.2 million for the third quarter of 2020, an increase of$211,000 from$946,000 for the third quarter of 2019. The increase was primarily due to increased letter of credit fees. Noninterest income was$4.9 million for the nine months endedSeptember 30, 2020 , an increase of$2.1 million , compared to$2.7 million for the nine months endedSeptember 30, 2019 . The increase was primarily due to increased gains on sales of securities and swap fees. The following table presents the major components of noninterest income for the three and nine months endedSeptember 30, 2020 , compared to the three and nine months endedSeptember 30, 2019 : Three Months Ended
Nine Months Ended
September 30, Increase/ September 30, Increase/
(dollars in thousands) 2020 2019 (Decrease) 2020 2019 (Decrease)
Noninterest Income:
Customer Service Fees $ 200 $ 184 $ 16 $ 575 $ 564 $ 11 Net Gain on Sales of Securities 109 58 51 1,473 516 957 Net Gain on Sales of Foreclosed Assets - 69 (69) - 69 (69) Letter of Credit Fees 487 331 156 1,026 790 236 Debit Card Interchange Fees 119 116
3 310 313 (3) Swap Fees - - - 907 - 907 Other Income 242 188 54 562 462 100 Totals$ 1,157 $ 946 $ 211 $ 4,853 $ 2,714 $ 2,139 Noninterest Expense
Third Quarter of 2020 Compared to Third Quarter of 2019
Noninterest expense was$9.7 million for the third quarter of 2020, an increase of$588,000 from$9.1 million for the third quarter of 2019. The increase was primarily driven by a$635,000 increase in salaries and employee benefits as the result of merit increases and increased staff to meet the needs of the Company's growth. The increase was partially offset by a decrease of$385,000 in amortization of tax credit investments and a$245,000 decrease in marketing and advertising expenses due to the COVID-19 pandemic. During the third quarter of 2020, the Company opened its newly constructed office complex inSt. Louis Park, Minnesota . Management expects that occupancy and equipment expenses will increase in future periods related to the operation and depreciation of the building.
Nine Months Ended
Noninterest expense was$30.1 million for the nine months endedSeptember 30, 2020 , an increase of$3.7 million , or 13.9%, from$26.4 million for the nine months endedSeptember 30, 2019 . The increase was primarily driven by a$3.5 million increase in salaries and employee benefits and a$1.4 million one-time FHLB advance prepayment fee. The increase was partially offset by decreased marketing and advertising and amortization of tax credit investments. The Company expects future increases in noninterest expense as the Company continues investing in infrastructure to support balance sheet growth; particularly occupancy and equipment expenses related to the new corporate headquarters. Management remains focused on supporting growth primarily by adding to staff, investing in technology, and by enhancing risk controls. Full-time equivalent employees increased from 158 at the end of the third quarter of 2019 to 180 at the end of the third quarter of 2020. Despite the uncertainty surrounding the COVID-19 pandemic, the Company continues to attract strategic hires in lending, deposit gathering, technology and risk management roles. 51 Table of Contents Efficiency Ratio. The efficiency ratio, a non-GAAP financial measure, reports total noninterest expense, less amortization of intangible assets, as a percentage of net interest income plus total noninterest income, less gains (losses) on sales of securities. Management believes this non-GAAP financial measure provides a meaningful comparison of operational performance and facilitates investors' assessments of business performance and trends in comparison to peers in the banking industry. The Company's efficiency ratio, and its comparability to some peers, is negatively impacted by the amortization of tax credit investments within noninterest expense. The efficiency ratio was 42.3% for the third quarter of 2020, compared to 45.6% for the third quarter of 2019. While the recognition of the tax credits increases operating expenses, and concurrently the efficiency ratio, it directly reduces income tax expense and the effective tax rate. The adjusted efficiency ratio, which excludes the impact of the amortization of tax credit investments and certain non-routine income and expenses, decreased to 41.7% for the third quarter of 2020, compared to 42.9% for the third quarter of 2019. The adjusted efficiency ratio for the nine months endedSeptember 30, 2020 and 2019 was 42.0% and 42.9%, respectively. Management seeks to contain costs whenever prudent, which is evident in the historical stability of the adjusted efficiency ratio. The following table presents the major components of noninterest expense for the three and nine months endedSeptember 30, 2020 , compared to the three and nine months endedSeptember 30, 2019 : Three Months Ended Nine Months Ended September 30, Increase/ September 30, Increase/ (dollars in thousands) 2020 2019
(Decrease) 2020 2019 (Decrease) Noninterest Expense: Salaries and Employee Benefits
$ 6,550 $ 5,915 $ 635 $ 19,352 $ 15,841 $ 3,511 Occupancy and Equipment 894 761 133 2,279 2,202 77 FDIC Insurance Assessment 160 - 160 518 570 (52) Data Processing 267 182 85 734 486 248 Professional and Consulting Fees 492 414 78 1,400 1,253 147 Information Technology and Telecommunications 385 233 152 977 677 300 Marketing and Advertising 94 339 (245) 645 1,208 (563) Intangible Asset Amortization 48 48 - 143 143 - Amortization of Tax Credit Investments 145 530 (385) 592 2,097 (1,505) FHLB Advance Prepayment Fees - -
- 1,430 - 1,430
Other Expense 637 662 (25) 2,059 1,966 93
Totals $ 9,672 $ 9,084 $ 588 $ 30,129 $ 26,443 $ 3,686
Income Tax Expense
The provision for income taxes includes both federal and state taxes.
Fluctuations in effective tax rates reflect the differences in the inclusion or
deductibility of certain income and expenses for income tax purposes and the
recognition of tax credits. The Company's future effective income tax rate will
fluctuate based on the mix of taxable and tax-free investments and loans, the
recognition and availability of tax credit investments, and overall taxable
income.
Income tax expense was $2.2 million for the third quarter of 2020, compared to
$2.1 million for the third quarter of 2019. The effective combined federal and
state income tax rate for the third quarter of 2020 was 23.8%, compared to 21.1%
for the third quarter of 2019. Income tax expense was $6.8 million for the nine
months ended September 30, 2020 , compared to $5.5 million for the nine months
ended September 30, 2019 . The effective combined federal and state income tax
rate for the nine months ended September 30, 2020 and 2019 was 23.4% and 19.5%,
respectively. The higher effective combined rate compared to both prior periods
was primarily due to fewer tax credits being recognized.
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Table of Contents
Financial Condition
Assets
Total assets at
Investment Securities Portfolio
The investment securities portfolio is used to make various term investments and is intended to provide the Company with adequate liquidity, a source of stable income, and at times, serve as collateral for certain types of deposits. Investment balances in the investment securities portfolio are subject to change over time based on funding needs and interest rate risk management objectives. The liquidity levels take into account anticipated future cash flows and are maintained at levels management believes are appropriate to ensure future flexibility in meeting anticipated funding needs. The investment securities portfolio consists primarily of municipal securities,U.S. government agency mortgage backed securities, SBA securities, and corporate securities comprised of subordinated debentures of bank and financial holding companies. In addition, the Company also holdsU.S. treasury securities, asset-backed securities and other debt securities, all with varying contractual maturities. These maturities do not necessarily represent the expected life of the securities as the securities may be called or paid down without penalty prior to their stated maturities. All investment securities are held as available for sale. Securities available for sale were$374.0 million atSeptember 30, 2020 , compared to$289.9 million atDecember 31, 2019 , an increase of$84.1 million or 29.0%. AtSeptember 30, 2020 , municipal securities represented 28.2% of the investment securities portfolio, government agency mortgage-backed securities represented 31.4% of the portfolio, SBA securities represented 11.4% of the portfolio, corporate securities represented 18.3% of the portfolio, asset-backed securities represented 10.5% of the portfolio, and other mortgage-backed securities represented 0.2% of the portfolio.
The following table presents the amortized cost and fair value of securities
available for sale, by type, at
September 30, 2020 December 31, 2019
Amortized Fair Amortized Fair
Cost Value Cost Value
U.S. Treasury Securities $ - $ - $ 4,990 $ 4,998
SBA Securities 42,934 42,507 50,126 49,559
Mortgage-Backed Securities Issued or
Guaranteed by U.S. Agencies (MBS):
Residential Pass-Through:
Guaranteed by GNMA 958 1,015 1,195 1,215
Issued by FNMA and FHLMC 14,864 14,949 3,571 3,543Other Residential Mortgage-Backed Securities 87,954 89,055 46,464 46,695 Commercial Mortgage-Backed Securities 11,658 12,519
12,019 12,213
All Other Commercial MBS 818 821 1,063 1,062
Total MBS 116,252 118,359 64,312 64,728
Municipal Securities 97,294 105,254 99,441 105,743
Corporate Securities 68,043 68,506 49,674 50,176
Asset-Backed Securities 38,846 39,329 14,673 14,673
Total $ 363,369 $ 373,955 $ 283,216 $ 289,877
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Loan Portfolio
The Company focuses on lending to borrowers located or investing in the
Minneapolis-St. Paul -Bloomington, MN -WI Metropolitan Statistical Area across a
diverse range of industries and property types. The Company lends primarily to
commercial customers, consisting of loans secured by nonfarm, nonresidential
properties, multifamily residential properties, land, and non-real estate
business assets. Responsive service, local decision making, and an efficient
turnaround time from application to closing have been significant factors in
growing the loan portfolio.
The Company manages concentrations of credit exposure through a risk management
program which implements formalized processes and procedures specifically for
managing and mitigating risk within the loan portfolio. The processes and
procedures include board and management oversight, commercial real estate
exposure limits, portfolio monitoring tools, management information systems,
market reports, underwriting standards, internal and external loan review, and
stress testing.
The Company originated net loan exposures of $405.6 million , for the third
quarter of 2020, compared to $302.0 million for the third quarter of 2019. Net
loan exposures include principal advances and unfunded commitments on newly
originated loans, net of loan participations sold. Total gross loans increased
$347.2 million , or 18.2%, to $2.26 billion at September 30, 2020 , compared to
$1.91 billion at December 31, 2019 and increased $413.0 million , or 22.4%, from
$1.85 billion at September 30, 2019 . The increase in both periods included PPP
loans funded primarily in the second quarter of 2020. The 1-4 family mortgage,
multifamily, and commercial real estate, or CRE, nonowner occupied categories
contributed most significantly to the $165.6 million of loan growth, excluding
PPP loans, in the nine months ended September 30, 2020 . As of
September 30, 2020 , 1-4 family mortgage loans increased $25.5 million , or 9.8%,
multifamily loans increased $70.8 million , or 13.7%, and nonowner occupied CRE
loans increased $67.5 million , or 11.4%, when compared to December 31, 2019 .
Collectively, the Company's annualized loan growth for the nine months ended
September 30, 2020 , excluding PPP loans, was 11.6%.
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Table of Contents
The following table presents the dollar and percentage composition of the loan portfolio by category, at the dates indicated:
September 30, 2020 June 30, 2020
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
(dollars in
thousands)
Commercial $ 287,254 12.7 % $ 302,536 13.8 % $ 299,425 15.0 % $ 276,035 14.5 % $ 291,723 15.8 %
Paycheck
Protection
Program 181,596 8.0 180,228 8.2 - - - - - -Construction
and Land Development 175,882 7.8 191,768 8.7 183,350 9.2 196,776 10.3 216,054 11.7 Real Estate Mortgage: 1 - 4 Family Mortgage 286,089 12.7 289,456 13.2
272,590 13.6 260,611 13.6 254,782 13.8 Multifamily
585,814 25.9 522,491 23.8 536,380 26.8 515,014 26.9 456,257 24.7 CRE Owner Occupied
75,963 3.4 73,539 3.4 75,207 3.8 66,584 3.5 71,209 3.9 CRE Nonowner Occupied
660,058 29.2 627,651 28.6 631,541 31.4 592,545 31.0 551,992 29.9
Total Real
Estate Mortgage
Loans 1,607,924 71.2 1,513,137 69.0 1,515,718 75.6 1,434,754 75.0 1,334,240 72.3
Consumer and
Other 6,572 0.3 6,109 0.3 4,324 0.2 4,473 0.2 4,201 0.2
Total Loans,
Gross 2,259,228 100.0 % 2,193,778 100.0 % 2,002,817 100.0 % 1,912,038 100.0 % 1,846,218 100.0 %
Allowance for
Loan Losses (31,381) (27,633) (24,585) (22,526) (22,124)
Net Deferred
Loan Fees (10,367) (10,287) (5,336) (5,512) (5,788)
Total Loans,
Net $ 2,217,480 $ 2,155,858 $ 1,972,896 $ 1,884,000 $ 1,818,306
The Company's primary focus historically has been on real estate mortgage
lending, which constituted 77.4% of the portfolio, excluding PPP loans, as of
September 30, 2020 . The composition of the portfolio has remained consistent
with prior periods and the Company does not expect any significant changes in
the foreseeable future in the composition of the loan portfolio or in the
emphasis on real estate lending.
As of September 30, 2020 , investor CRE loans totaled $1.42 billion , consisting
of $660.1 million of loans secured by nonowner occupied CRE, $585.8 million of
loans secured by multifamily residential properties and $175.9 million of
construction and land development loans. Investor CRE loans represented 68.4% of
the total gross loan portfolio, excluding PPP loans, and 441.2% of the Bank's
total risk-based capital at September 30, 2020 , compared to 516.6% at December
31, 2019 .
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The following table presents time to contractual maturity and sensitivity to
interest rate changes for the loan portfolio at September 30, 2020 and
December 31, 2019 :
As of September 30, 2020
Due in One Year More Than One
(dollars in thousands) or Less Year to Five Years After Five Years
Commercial $ 134,014 $ 116,056 $ 37,184Paycheck Protection Program - 181,596 - Construction and Land Development 91,295
62,656 21,931
Real Estate Mortgage:
1 - 4 Family Mortgage 62,528 184,165 39,396
Multifamily 61,365 239,031 285,418
CRE Owner Occupied 15,560 17,409 42,994
CRE Nonowner Occupied 130,685 282,935 246,438Total Real Estate Mortgage Loans 270,138
723,540 614,246
Consumer and Other 2,992 2,821 759
Total Loans, Gross $ 498,439 $ 1,086,669 $ 674,120
Interest Rate Sensitivity:
Fixed Interest Rates $ 199,251 $ 841,868 $ 285,364
Floating or Adjustable Rates 299,188
244,801 388,756
Total Loans, Gross $ 498,439 $ 1,086,669 $ 674,120
As of December 31, 2019
Due in One Year More Than One
(dollars in thousands) or Less Year to Five Years After Five Years
Commercial $ 121,383 $ 119,575 $ 35,077
Construction and Land Development 132,221
53,194 11,361
Real Estate Mortgage:
1 - 4 Family Mortgage 53,707 170,116 36,788
Multifamily 117,406 168,770 228,838
CRE Owner Occupied 4,078 25,286 37,220
CRE Nonowner Occupied 114,533 234,599 243,413Total Real Estate Mortgage Loans 289,724
598,771 546,259
Consumer and Other 1,589 2,420 464
Total Loans, Gross $ 544,917 $ 773,960 $ 593,161
Interest Rate Sensitivity:
Fixed Interest Rates $ 184,370 $ 545,855 $ 197,151
Floating or Adjustable Rates 360,547
228,105 396,010
Total Loans, Gross $ 544,917 $ 773,960 $ 593,161
Asset Quality
The Company emphasizes credit quality in the originating and monitoring of the
loan portfolio, and success in underwriting is measured by the levels of
classified and nonperforming assets and net charge-offs. Federal regulations and
internal policies require the use of an asset classification system as a means
of managing and reporting problem and potential problem assets. The Company has
incorporated an internal asset classification system, substantially consistent
with federal banking regulations, as a part of the credit monitoring system.
Federal banking regulations set forth a classification scheme for problem and
potential problem assets as "substandard," "doubtful" or "loss" assets. An asset
is considered "substandard" if it is inadequately protected by the current net
worth and paying capacity of the obligor or of the collateral pledged, if any.
"Substandard" assets include those characterized by the "distinct possibility"
that the financial institution will sustain "some loss" if the deficiencies are
not corrected. Assets classified as "doubtful" have all of the weaknesses
inherent in those classified "substandard" with the added characteristic that
the weaknesses present make "collection or liquidation in full," on the basis of
currently existing facts, conditions, and values, "highly questionable and
improbable." Assets classified as "loss" are those considered "uncollectible"
and of such little value
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that their continuance as assets without the establishment of a specific loss
reserve is not warranted. Assets which do not currently expose the insured
institution to sufficient risk to warrant classification in one of the
aforementioned categories but possess weaknesses are required to be designated
"watch."
The following table presents information on loan classifications at
September 30, 2020 . The Company had no assets classified as doubtful or loss.
Risk Category
(dollars in thousands) Watch Substandard Total
Commercial $ 20,267 $ 432 $ 20,699
Construction and Land Development 129 156 285
Real Estate Mortgage:
1 - 4 Family Mortgage 1,464 1,773 3,237
Multifamily - - -
CRE Owner Occupied - 1,589 1,589
CRE Nonowner Occupied 29,057 12,111 41,168
Total Real Estate Mortgage Loans 30,521 15,473 45,994
Consumer and Other - 13 13
Totals $ 50,917 $ 16,074 $ 66,991 The Company has increased oversight and analysis of all segments within the loan portfolio in response to the COVID-19 pandemic, especially in vulnerable industries such as hospitality and restaurants, to proactively monitor evolving credit risk. Although the Company has not yet seen direct impacts to the asset quality metrics, such as delinquencies and charge-offs, throughSeptember 30, 2020 , management believes the economic uncertainty that exists may begin to negatively impact these metrics in future quarters. Management actively evaluates loan classifications and as a result of the COVID-19 pandemic, watchlist and adversely classified assets as ofSeptember 30, 2020 increased when compared toDecember 31, 2019 . AtSeptember 30, 2020 , watchlist loans were$50.9 million , compared to$5.3 million atDecember 31, 2019 . AtSeptember 30, 2020 , substandard loans were$16.1 million , compared to$2.7 million atDecember 31, 2019 . As the COVID-19 pandemic continues to evolve, the length and extent of the economic contraction may dictate further watchlist or adverse classifications in the loan portfolio. In response to the COVID-19 pandemic, the Company is offering loan modifications, when appropriate, to borrowerswho were current and otherwise not past due as ofDecember 31, 2019 . These include modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment. In accordance with interagency regulatory guidance and the CARES Act, qualifying loans modified in response to the COVID-19 pandemic are not considered TDRs. New modification activity has been limited in the third quarter of 2020.
The following table presents a rollforward of loan modification activity, by
modification type, from
(dollars in thousands) Interest-Only Payment Deferral Total Principal Balance - June 30, 2020$ 175,307 $ 117,703$ 293,010 Modification Expired (45,392) (90,108) (135,500) Second Modification Granted 18,909 2,909 21,818 New Modifications 10,502 - 10,502 Net Principal Advances (Payments) 1,559
(8) 1,551
Principal Balance -
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The following table presents a summary of active loan modifications, by loan
segment and modification type, at
Interest-Only Payment Deferral Total
(dollars in thousands) Amount # of Loans Amount # of Loans Amount # of Loans
Commercial $ 11,705 21 $ 414 2 $ 12,119 23
Construction and Land Development - - -
- - -
Real Estate Mortgage:
1 - 4 Family Mortgage 5,589 10 - - 5,589 10
Multifamily 42,273 6 - - 42,273 6
CRE Owner Occupied 1,646 4 1,502 3 3,148 7
CRE Nonowner Occupied 99,672 35 28,580 6 128,252 41
Consumer and Other - - - - - -
Totals $ 160,885 76 $ 30,496 11 $ 191,381 87
Modifications have been granted on a case-by-case basis based on specific needs
and circumstances affecting each borrower. Interest-only modifications have been
primarily granted for three to six month periods, but range up to twelve months.
Payment deferral modifications have been granted for three to six month periods.
The Company has 52 modified loans totaling $99.8 million set to expire in
October 2020 . As of October 22, 2020 , based on lender and client surveys, the
Company estimates that $73.6 million will return to regular payment status,
bringing loan modification balances as a percent of total loans, excludingPPP loans, to 5.6%. Nonperforming Assets Nonperforming loans include loans accounted for on a nonaccrual basis and loans 90 days past due and still accruing. Nonperforming assets consist of nonperforming loans plus foreclosed assets (i.e., real or personal property acquired through foreclosure). Nonaccrual loans totaled$433,000 and$461,000 as ofSeptember 30, 2020 andDecember 31, 2019 , respectively, a decrease of$28,000 . There were no loans 90 days past due and still accruing as ofSeptember 30, 2020 orDecember 31, 2019 . There were no foreclosed assets as ofSeptember 30, 2020 orDecember 31, 2019 . The following table presents a summary of nonperforming assets, by category, at the dates indicated: September 30, December 31, (dollars in thousands) 2020 2019 Nonaccrual Loans: Commercial $ 7 $ 7
Construction andLand Development
156 176 Real Estate Mortgage: 1 - 4 Family Mortgage 270 278 Total Nonaccrual Loans $ 433 $ 461 Total Nonperforming Loans $ 433 $ 461
Total Nonperforming Assets (1) $ 433 $ 461 Total Restructured Accruing Loans 664 276
Total Nonperforming Assets and Restructured Accruing Loans $ 1,097 $
737
Nonaccrual Loans to Total Loans 0.02 % 0.02 %
Nonperforming Loans to Total Loans 0.02 0.02
Nonperforming Assets to Total Loans Plus Foreclosed Assets (1)
0.02 0.02
Nonperforming Assets and Restructured Accruing Loans to Total Loans Plus Foreclosed Assets
0.05 0.04
(1) Nonperforming assets are defined as nonaccrual loans and loans greater than
90 days past due still accruing plus foreclosed assets.
The balance of nonperforming assets can fluctuate due to changes in economic
conditions. The Company has established a policy to discontinue accruing
interest on a loan (that is, place the loan on nonaccrual status) after it has
become 90 days delinquent as to payment of principal or interest, unless the
loan is considered to be well-collateralized and is actively in the process of
collection. In addition, a loan will be placed on nonaccrual status before it
becomes 90 days delinquent unless management believes that the collection of
interest is expected. Interest previously accrued but
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uncollected on such loans is reversed and charged against current income when the receivable is determined to be uncollectible. If management believes that a loan will not be collected in full, an increase to the allowance for loan losses is recorded to reflect management's estimate of any potential exposure or loss. Generally, payments received on nonaccrual loans are applied directly to principal. Gross income that would have been recorded on nonaccrual loans during the three and nine months endedSeptember 30, 2020 was$4,000 and$36,000 , respectively.
Allowance for Loan Losses
The allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. The Company maintains an allowance for loan losses at a level management considers adequate to provide for known and probable incurred losses in the portfolio. The level of the allowance is based on management's evaluation of estimated losses in the portfolio, after consideration of risk characteristics of the loans and prevailing and anticipated economic conditions. Loan charge-offs (i.e., loans judged to be uncollectible) are charged against the reserve and any subsequent recovery is credited to the reserve. The Company analyzes risks within the loan portfolio on a continual basis. A risk system, consisting of multiple grading categories for each portfolio class, is utilized as an analytical tool to assess risk and appropriate reserves. In addition to the risk system, management further evaluates risk characteristics of the loan portfolio under current and anticipated economic conditions, including the economic distress caused by the COVID-19 pandemic, and considers such factors as the financial condition of the borrower, past and expected loss experience, and other factors which management feels deserve recognition in establishing an appropriate reserve. These estimates are reviewed at least quarterly, and as adjustments become necessary, they are recognized in the periods in which they become known. Although management strives to maintain an allowance it deems adequate, future economic changes, deterioration of borrowers' creditworthiness, and the impact of examinations by regulatory agencies all could cause changes to the allowance for loan losses. AtSeptember 30, 2020 , the allowance for loan losses was$31.4 million , an increase of$8.9 million from$22.5 million atDecember 31, 2019 . Net charge-offs totaled$2,000 during the third quarter of 2020 and$138,000 during the third quarter of 2019. Net charge-offs (recoveries) totaled$(5,000) for the nine months endedSeptember 30, 2020 and$7,000 for the nine months endedSeptember 30, 2019 . The allowance for loan losses as a percentage of total loans was 1.39% as ofSeptember 30, 2020 and 1.18% as ofDecember 31, 2019 . The allowance for loan losses to total loans, excluding$181.6 million of PPP loans, was 1.51% as ofSeptember 30, 2020 . Based on current economic indicators, the Company increased the economic factors within the allowance for loan losses evaluation, primarily in response to the impacts of the COVID-19 pandemic. The Company expects that the allowance for loan losses as a percent of total loans will increase in future periods based on its belief that the credit quality of its loan portfolio will decline, and loan defaults will increase as a result of the COVID-19 pandemic. 59 Table of Contents
The following presents a summary of the activity in the allowance for loan loss reserve for the periods indicated:
Three Months Ended Nine Months Ended
September 30, September 30,
(dollars in thousands) 2020 2019 2020 2019
Balance, Beginning of Period $ 27,633 $ 21,362 $ 22,526 $ 20,031
Charge-offs:
Commercial 5 141 39 160
Consumer and Other 1 3 15 23
Total Charge-offs 6 144 54 183
Recoveries:
Commercial 1 2 5 5Construction and Land Development - -
- 1
Real Estate Mortgage:
1 - 4 Family Mortgage 3 3 51 165
Consumer and Other - 1 3 5
Total Recoveries 4 6 59 176Net Charge-offs (Recoveries) 2 138
(5) 7
Provision for Loan Losses 3,750 900 8,850 2,100
Balance at End of Period $ 31,381 $ 22,124 $ 31,381 $ 22,124
Gross Loans, End of Period 2,259,228 1,846,218 2,259,228 1,846,218
Average Loans 2,206,807 1,805,920 2,105,094 1,756,855
Net Charge-offs (Recoveries)
(Annualized) to Average Loans - % 0.03 % - % - %
Allowance to Total Gross Loans 1.39 % 1.20 % 1.39 % 1.20 %
Allowance to Total Gross Loans,
Excluding PPP Loans 1.51 % N/A 1.51 % N/A
The following table presents a summary of the allocation of the allowance for loan losses by loan portfolio segment for the periods indicated:
September 30, December 31,
2020 2019
(dollars in thousands) Amount Percent Amount Percent
Commercial $ 5,303 16.9 % $ 3,058 13.6 %
Paycheck Protection Program 91 0.3 - -Construction and Land Development 2,236 7.1 2,202
9.8 Real Estate Mortgage: 1 - 4 Family Mortgage 3,709 11.8 2,839 12.6 Multifamily 8,319 26.5 5,824 25.9 CRE Owner Occupied 1,104 3.5 792 3.5 CRE Nonowner Occupied 9,500 30.3 6,972 30.9 Total Real Estate Mortgage Loans 22,632 72.1 16,427 72.9 Consumer and Other 176 0.6 85 0.4 Unallocated 943 3.0 754 3.3
Total Allowance for Loan Losses
Deposits
The principal sources of funds for the Company are deposits, consisting of
demand deposits, money market accounts, savings accounts, and certificates of
deposit. The following table details the dollar and percentage composition of
the deposit portfolio, by category, at the dates indicated:
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September 30, 2020 June 30, 2020 March 31, 2020 December 31, 2019 September30, 2019 (dollars in thousands) Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent Noninterest Bearing Transaction Deposits$ 685,773 30.2 %$ 648,869 28.9 %$ 476,217 25.1 %$ 447,509 24.5 %$ 478,493 26.5 % Interest Bearing Transaction Deposits 322,253 14.2 285,386 12.7 255,483 13.4 264,627 14.5 243,889 13.5 Savings and Money Market Deposits 498,397 21.9 516,543 23.0 514,113 27.1 516,785 28.3 470,518 26.1 Time Deposits 363,897 16.0 382,187 17.1 393,340 20.7 360,027 19.8 363,308 20.2 Brokered Deposits 402,724 17.7 409,066 18.3 260,974 13.7 234,362 12.9 246,028 13.7 Total Deposits$ 2,273,044 100.0 %$ 2,242,051 100.0 %$ 1,900,127 100.0 %$ 1,823,310 100.0 %$ 1,802,236 100.0 % Total deposits atSeptember 30, 2020 were$2.27 billion , an increase of$449.7 million , or 24.7%, compared to total deposits of$1.82 billion atDecember 31, 2019 , and an increase of$470.8 million , or 26.1%, over total deposits of$1.80 billion atSeptember 30, 2019 . Noninterest bearing transaction deposits were$685.8 million atSeptember 30, 2020 , compared to$447.5 million atDecember 31, 2019 , and$478.5 million atSeptember 30, 2019 . Noninterest bearing deposits comprised 30.2% of total deposits atSeptember 30, 2020 , compared to 24.5% atDecember 31, 2019 , and 26.5% atSeptember 30, 2019 . The growth in noninterest bearing transaction deposits was a result of both successful new client acquisition initiatives and pandemic-related accumulation of liquidity in existing client accounts. The Company estimates approximately$30.0 million of the noninterest bearing transaction deposit growth in 2020 was due to remaining PPP loan funds. The Company expects that deposit levels will fluctuate in future periods as a result of the distressed and uncertain economic conditions relating to the COVID-19 pandemic. The Company relies on increasing the deposit base to fund loans and other asset growth. The Company is in a highly competitive market and competes for local deposits by offering attractive products with competitive rates. The Company expects to have a higher average cost of funds for local deposits compared to competitor banks due to the lack of an extensive branch network. The Company's strategy is to offset the higher cost of funding with a lower level of operating expense. When appropriate, the Company utilizes alternative funding sources such as brokered deposits. AtSeptember 30, 2020 , total brokered deposits were$402.7 million , an increase of$168.4 million , or 71.8%, compared to total brokered deposits of$234.4 million atDecember 31, 2019 . Brokered deposits increased as a result of a change in mix of wholesale funding sources due to favorable funding costs offered compared to other wholesale funding alternatives and to expand on-balance sheet liquidity in this uncertain environment. Furthermore, the brokered deposit market provides flexibility in structure, optionality and efficiency not afforded in traditional, retail deposit channels. The following table presents the average balance and average rate paid on each of the following deposit categories for the three months endedSeptember 30, 2020 andSeptember 30, 2019 : As of and for the As of and for the Three Months Ended Three Months Ended September 30, 2020 September 30, 2019 Average Average Average Average (dollars in thousands) Balance Rate Balance Rate
Noninterest Bearing Transaction Deposits$ 615,214 - %$ 434,021 - % Interest Bearing Transaction Deposits 306,162 0.52 250,667 0.81 Savings and Money Market Deposits 501,246 0.88
453,340 1.82
Time Deposits < $250,000 242,048 2.08 238,556 2.35
Time Deposits >$250,000 127,927 1.98 120,773 2.69
Brokered Deposits 419,744 1.36 242,600 2.27
Total Deposits $ 2,212,341 0.87 % $ 1,739,957 1.42 %
Borrowed Funds
Federal Funds Purchased
In addition to deposits, the Company utilizes overnight borrowings to meet the daily liquidity needs of clients and fund loan growth. The following table summarizes overnight borrowings, which consist of federal funds purchased
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from correspondent banks on an overnight basis at the prevailing overnight
market rates and the weighted average interest rates paid for the periods
presented:
As of and for the As of and for the As of and for the
Three Months Ended Three Months Ended Three Months Ended
(dollars in thousands) September 30, 2020 December 31, 2019 September 30, 2019
Outstanding at Period-End $ - $ - $ -
Average Amount Outstanding 152 3,011 -
Maximum Amount Outstanding at any
Month-End - 6,000 -
Weighted Average Interest Rate:
During Period 0.33 % 1.82 % - %
End of Period 0.30 % 2.63 % - %
Other Borrowings
At September 30, 2020 , other borrowings outstanding consisted of FHLB advances
of $127.5 million and notes payable of $11.5 million . During the second quarter
of 2020, the Company paid off $25.0 million of fixed rate FHLB advances with an
average cost of 2.89% and incurred a loss on extinguishment of debt of $1.4
million . The Company's borrowing capacity at the FHLB is determined based on
collateral pledged, generally consisting of loans. The Company had additional
borrowing capacity under this credit facility of $250.8 million and $209.8
million at September 30, 2020 and December 31, 2019 , respectively, based on
collateral amounts pledged.
Additionally, the Company has borrowing capacity from other sources. As of
September 30, 2020 , the Bank was eligible to use the Federal Reserve discount
window for borrowings. Based on assets pledged as collateral as of the
applicable date, the Bank's borrowing availability was approximately
$73.1 million and $113.2 million at September 30, 2020 and December 31, 2019 ,
respectively. As of September 30, 2020 and December 31, 2019 , the Company had no
outstanding advances.
As part of the CARES Act, the Federal Reserve Bank offered secured borrowings to
banks who originated PPP loans through the Paycheck Protection Program Liquidity
Facility, or PPPLF. As of September 30, 2020 , the Company had not pledged any
PPP loans to borrow funds under this facility. The facility is available through
December 31, 2020 , unless the Federal Reserve Board and the Department of the
Treasury determine to extend the facility.
The Company has a swap agreement with an unaffiliated third party in order to hedge interest rate risk associated with the notes payable. This agreement provides for the Company to make payments at a fixed rate in exchange for receiving payments at a variable rate determined by the one-month LIBOR.
Subordinated Debentures
OnJune 19, 2020 , the Company issued$50.0 million of subordinated debentures at an initial fixed interest rate of 5.25% which is payable semi-annually. BeginningJuly 1, 2025 , the interest rate converts to a variable interest rate equal to the three-month term SOFR, plus 5.13%, which is payable quarterly. The subordinated debentures mature onJuly 1, 2030 . The subordinated debentures, net of issuance costs, were$48.9 million atSeptember 30, 2020 . OnOctober 13, 2020 , the Company completed an offer to exchange up to$50.0 million total principal amount of the subordinated debentures for substantially identical subordinated debentures registered under the Securities Act of 1933, in satisfaction of the Company's obligations under a registration rights agreement entered into with the initial purchasers of the subordinated debentures.$47.0 million of the$50.0 million of the subordinated debentures were exchanged in the exchange offer. OnJuly 12, 2017 , the Company issued$25.0 million of subordinated debentures at an initial fixed interest rate of 5.875% which is payable semi-annually. BeginningJuly 15, 2022 , the interest rate converts to a variable interest rate equal to the three-month LIBOR plus 3.88%. The subordinated debentures mature onJuly 15, 2027 . The subordinated 62
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debentures, net of issuance costs, were
All of the subordinated debentures qualify for Tier 2 regulatory capital treatment at the Company level for the first five years, under applicable regulatory guidelines.
Contractual Obligations
The following table presents supplemental information regarding total
contractual obligations at
Within One to Three to After
(dollars in thousands) One Year Three Years Five Years Five Years TotalDeposits Without a Stated Maturity$ 1,664,123 $ -
$ - $ -$ 1,664,123 Time Deposits 365,231 125,851 117,839 - 608,921 Notes Payable 11,500 - - - 11,500 FHLB Advances 15,000 39,000 68,500 5,000 127,500
Subordinated Debentures - - - 75,000 75,000 Commitment to Fund Tax Credit Investments 2,394 - - - 2,394 Operating Lease Obligations 488 652
653 886 2,679
Totals $ 2,058,736 $ 165,503 $ 186,992 $ 80,886 $ 2,492,117 During the third quarter, the Company opened its newly constructed office
complex in
The Company believes that it will be able to meet all contractual obligations as they come due through the maintenance of adequate cash levels. The Company expects to maintain adequate cash levels through earnings, loan and securities repayments and maturity activity and continued deposit gathering activities. As described above, the Company has in place various borrowing mechanisms for both short-term and long-term liquidity needs.
Shareholders' Equity
Shareholders' equity atSeptember 30, 2020 was$265.4 million , an increase of$20.6 million , or 8.4%, over shareholders' equity of$244.8 million atDecember 31, 2019 , primarily due to$22.2 million of net income and$509,000 increase in unrealized gains in the securities portfolio, partially offset by$3.3 million of stock repurchases in the first and third quarter of 2020 under the Company's stock repurchase program. Stock Repurchase Program. OnJanuary 22, 2019 , the Company adopted a stock repurchase program. Under the repurchase program, the Company was initially authorized to repurchase up to$15.0 million of its common stock in open market transactions or through privately negotiated transactions at the Company's discretion. OnJuly 23, 2019 , the Company's Board of Directors approved a$10.0 million increase to the Company's stock repurchase program, increasing the authorization to repurchase common stock under the program from a total of$15.0 million to a total of$25.0 million . Subsequent toSeptember 30, 2020 , onOctober 27, 2020 , the Company's Board of Directors approved a$15.0 million increase to the Company's stock repurchase program, increasing the authorization to repurchase common stock under the program from a total of$25.0 million to$40.0 million and extending the program untilOctober 27, 2022 . In response to the pandemic and the related economic and market uncertainty, the Company stopped repurchasing shares under the program onMarch 16, 2020 . Strong earnings and capital growth coupled with better asset quality visibility as loan modifications expired, supported management's decision to resume repurchases under the Company's stock repurchase program late in the third quarter of 2020. The Company remains committed to maintaining strong capital levels while enhancing shareholder value as it strategically executes its stock repurchase program in this fluid economic environment. During the three months endedSeptember 30, 2020 , the Company repurchased 137,984 shares of its common stock, representing less than 1% of the Company's outstanding shares. Shares were
repurchased
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during this period at a weighted average price of$9.39 for a total of$1.3 million . During the nine months endedSeptember 30, 2020 , the Company repurchased 315,848 shares of its common stock, representing approximately 1% of the Company's outstanding shares. Shares were repurchased at a weighted average price of$10.59 for a total of 3.3 million. All shares repurchased under the stock repurchase program were converted to authorized but unissued shares. AtSeptember 30, 2020 , the remaining amount that could be used to repurchase shares under the stock repurchase program was$6.7 million .Regulatory Capital . The Company and the Bank are subject to various regulatory capital requirements administered by federal banking regulators. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by federal banking regulators that, if undertaken, could have a direct material effect on the Company's and Bank's business. Under applicable regulatory capital rules, the Company and Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank must also meet certain specific capital guidelines under the prompt corrective action framework. The capital amounts and classification are subject to qualitative judgments by the federal banking regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of common equity Tier 1 capital, Tier 1 capital and total capital to risk-weighted assets and of Tier 1 capital to average consolidated assets (referred to as the "leverage ratio"), as defined under the applicable regulatory capital rules. Management believes the Company and the Bank met all capital adequacy requirements to which they were subject as ofSeptember 30, 2020 . The regulatory capital ratios for the Company and the Bank to meet the minimum capital adequacy standards and for the Bank to be considered well capitalized under the prompt corrective action framework are set forth in the following tables. The Company's and the Bank's actual capital amounts and ratios are as of the dates indicated. Minimum Required
For Capital Adequacy To be Well Capitalized
For Capital
Adequacy
Actual Purposes Conservation Buffer Action Regulations
September 30, 2020 Amount Ratio Amount Ratio Amount Ratio Amount Ratio
(dollars in thousands)
Company (Consolidated):
Total Risk-Based Capital $ 359,597 15.45 % $ 186,206 8.00 % $ 244,396 10.50 % N/A N/A
Tier 1 Risk-Based Capital 256,805 11.03 139,655 6.00 197,844 8.50 N/A N/A
Common Equity Tier 1 Capital 256,805 11.03 104,741 4.50 162,931 7.00 N/A N/A
Tier 1 Leverage Ratio 256,805 9.83 104,543 4.00 104,543 4.00 N/A N/A
Bank:
Total Risk-Based Capital $ 322,276 13.85 % $ 186,104 8.00 % $ 244,262 10.50 % $ 232,630 10.00 %
Tier 1 Risk-Based Capital 293,164 12.60 139,578 6.00 197,736 8.50 186,104 8.00
Common Equity Tier 1 Capital 293,164 12.60 104,684 4.50 162,841 7.00 151,210 6.50
Tier 1 Leverage Ratio 293,164 11.24 104,350 4.00 104,350 4.00 130,437 5.00
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Minimum Required For Capital Adequacy To be Well Capitalized
For Capital
Adequacy
Actual Purposes Conservation Buffer Action Regulations
December 31, 2019 Amount Ratio Amount Ratio Amount Ratio Amount Ratio
(dollars in thousands)
Company (Consolidated):
Total Risk-Based Capital $ 269,613 12.98 % $ 166,163 8.00 % $ 218,089 10.50 % N/A N/A
Tier 1 Risk-Based Capital 236,533 11.39 124,623 6.00 176,549 8.50 N/A N/A
Common Equity Tier 1 Capital 236,533 11.39 93,467 4.50 145,393 7.00 N/A N/A
Tier 1 Leverage Ratio 236,533 10.69 88,498 4.00 88,498 4.00 N/A N/A
Bank:
Total Risk-Based Capital $ 252,501 12.16 % $ 166,137 8.00 % $ 218,055 10.50 % $ 207,671 10.00 %
Tier 1 Risk-Based Capital 243,461 11.72 124,603 6.00 176,521 8.50 166,137 8.00
Common Equity Tier 1 Capital 243,461 11.72 93,452 4.50 145,370 7.00 134,986 6.50
Tier 1 Leverage Ratio 243,461 11.01 88,455 4.00 88,455 4.00 110,569 5.00
The Company and the Bank are subject to the rules of the Basel III regulatory
capital framework and related Dodd-Frank Wall Street Reform and Consumer
Protection Act. The rules require a capital conservation buffer of 2.5% that was
added to the minimum requirements for capital adequacy purposes. A banking
organization with a conservation buffer of less than the required amount is
subject to limitations on capital distributions, including dividend payments,
stock repurchases and certain discretionary bonus payments to executive
officers. At September 30, 2020 , the ratios for the Company and the Bank were
sufficient to meet the conservation buffer.
In 2019, the federal banking agencies issued a final rule to provide an optional
simplified measure of capital adequacy for qualifying depository institutions
and depository institution holding companies, titled the community bank leverage
ratio, or CBLR framework. Generally, under the CBLR framework, qualifying
depository institutions and depository institution holding companies that have
less than $10 billion in total consolidated assets and that meet other
qualifying criteria, including a leverage ratio (equal to tier 1 capital divided
by average total consolidated assets) of greater than 9% (subsequently reduced
to 8% as a COVID-19 relief measure), are eligible to opt into the CBLR
framework. Qualifying organizations that elect to use the CBLR framework and
that maintain a leverage ratio of greater than 9% will be considered to have met
the well capitalized ratio requirements for purposes of the FDIC's prompt
corrective action framework. The final rule was effective on January 1, 2020 .
The Company has elected not to opt into the CBLR framework and will continue to
compute regulatory capital ratios based on the Basel III Capital Rules discussed
above.
Off-Balance Sheet Arrangements
In the normal course of business, the Company enters into various transactions
to meet the financing needs of clients, which, in accordance with GAAP, are not
included in the consolidated balance sheets. These transactions include
commitments to extend credit, standby letters of credit, and commercial letters
of credit, which involve, to varying degrees, elements of credit risk and
interest rate risk in excess of the amounts recognized in the consolidated
balance sheets. Most of these commitments mature within two years and the
standby letters of credit are expected to expire without being drawn upon. All
off-balance sheet commitments are included in the determination of the amount of
risk-based capital that the Company and the Bank are required to hold.
The Company's exposure to credit loss in the event of non-performance by the
other party to the financial instrument for commitments to extend credit,
standby letters of credit, and commercial letters of credit is represented by
the contractual or notional amount of those instruments. The Company decreases
its exposure to losses under these commitments by subjecting them to credit
approval and monitoring procedures. The Company assesses the credit risk
associated with certain commitments to extend credit and establishes a liability
for probable credit losses.
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The following table presents credit arrangements and financial instruments whose
contract amounts represent credit risk as of September 30, 2020 and
December 31, 2019 :
September 30, 2020 December 31, 2019
Fixed Variable Fixed Variable
(dollars in thousands)
Unfunded Commitments Under Lines of Credit $ 196,552 $ 409,442 $ 181,622 $ 319,340
Letters of Credit 12,911 72,990 17,503 61,722
Totals $ 209,463 $ 482,432 $ 199,125 $ 381,062
Liquidity
Liquidity is the Company's capacity to meet cash and collateral obligations at a reasonable cost. Maintaining an adequate level of liquidity depends on the Company's ability to efficiently meet both expected and unexpected cash flows and collateral needs without adversely affecting either daily operations or financial condition. The Bank's Asset Liability Management, or ALM, Committee, which is comprised of members of senior management, is responsible for managing commitments to meet the needs of customers while achieving the Company's financial objectives. The ALM Committee meets regularly to review balance sheet composition, funding capacities, and current and forecasted loan demand. The Company manages liquidity by maintaining adequate levels of cash and other assets from on- and off-balance sheet arrangements. Specifically, on-balance sheet liquidity consists of cash and due from banks and unpledged investment securities available for sale, which are referred to as primary liquidity. In regards to off-balance sheet capacity, the Company maintains available borrowing capacity under secured borrowing lines with the FHLB and theFederal Reserve Bank of Minneapolis , as well as unsecured lines of credit for the purpose of overnight funds with various correspondent banks, which the Company refers to as secondary liquidity. In addition, the Bank is a member of the American Financial Exchange, or AFX, through which it may either borrow or lend funds on an overnight or short-term basis with a group of approved commercial banks. The availability of funds changes daily. As ofSeptember 30, 2020 , the Company had no borrowings outstanding through the AFX. The Bank has also established additional borrowing capacity through theFederal Reserve Bank's PPPLF, where it can pledge PPP loans to borrow an equal amount of funds. As ofSeptember 30, 2020 , the Company had no borrowings outstanding through this facility and$181.6 million of PPP loans available to pledge. The facility is available throughDecember 31, 2020 .
The following tables provide a summary of primary and secondary liquidity levels as of the dates indicated:
Primary Liquidity-On-Balance SheetSeptember 30, 2020
December 31, 2019 (Dollars in thousands) Cash and Cash Equivalents $ 91,510 $ 31,935
Securities Available for Sale 373,955 289,877 Total Primary Liquidity $ 465,465 $ 321,812 Ratio of Primary Liquidity to Total Deposits 20.5 % 17.6 %
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