LEVEL ONE BANCORP, INC. The following discussion explains our financial condition and results of operations as of and for the three and nine months endedSeptember 30, 2021 . The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes presented elsewhere in this report and our Annual Report on Form 10-K for the year endedDecember 31, 2020 , filed with theSEC onMarch 12, 2021 . Annualized results for these interim periods may not be indicative of results for the full year or future periods. In addition to the historical information contained herein, this Form 10-Q includes "forward-looking statements" within the meaning of such term in the Private Securities Litigation Reform Act of 1995. These statements are subject to many risks and uncertainties, including, but not limited to, the effects of the COVID-19 pandemic, including its effects on the economic environment, our customers and our operations, as well as any changes to federal, state or local government laws, regulations or orders in connection with the pandemic; risks related to the pending Merger with First Merchants, including the inability to complete the Merger due to the failure of the Company's shareholders to approve the merger agreement, the failure to satisfy other conditions to completion of the Merger, including receipt of required regulatory and other approvals, the failure of the proposed Merger to close for any other reason, diversion of management's attention from ongoing business operations and opportunities due to the Merger, and the effect of the announcement of the Merger on the Company's customer and employee relationships and operating results; the ability of the Company to implement its strategy and expand its lending operations; changes in interest rates and other general economic, business and political conditions, including changes in the financial markets; changes in business plans as circumstances warrant; changes in benchmark interest rates used to price loans and deposits, including the expected elimination of LIBOR and the development of a substitute; changes in tax laws, regulations and guidance; and other risks detailed from time to time in filings made by the Company with theSEC . Readers should note that the forward-looking statements included herein are not a guarantee of future events, and that actual events may differ materially from those made in or suggested by the forward-looking statements. Forward-looking statements generally can be identified by the use of forward-looking terminology such as "will," "propose," "may," "plan," "seek," "expect," "intend," "estimate," "anticipate," "believe," "continue," or similar terminology. Any forward-looking statements presented herein are made only as of the date of this document, and we do not undertake any obligation to update or revise any forward-looking statements to reflect changes in assumptions, the occurrence of unanticipated events, or otherwise. Critical Accounting Policies Our consolidated financial statements are prepared based on the application of accounting policies generally accepted inthe United States . Our critical accounting policies require reliance on estimates and assumptions, which are based upon historical experience and on various other assumptions that management believes are reasonable under current circumstances, but may prove to be inaccurate or can be subject to variations. Changes in underlying factors, assumptions, or estimates could have a material impact on our future financial condition and results of operations. Our critical accounting policies are set forth in "Note 1 - Basis of Presentation and Summary of Significant Accounting Policies" of the Notes to the Consolidated Financial Statements and "Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the year endedDecember 31, 2020 , which was filed with theSEC onMarch 12, 2021 . There have been no material changes in critical accounting policies or the assumptions and judgments utilized in applying these policies sinceDecember 31, 2020 . OverviewLevel One Bancorp, Inc. is a financial holding company headquartered inFarmington Hills, Michigan , with its primary branch operations in southeastern and westMichigan . Through our wholly owned subsidiary,Level One Bank , we offer a broad range of loan products to the residential and commercial markets, as well as retail and business banking services.Hamilton Court Insurance Company , a wholly owned subsidiary of the Company, provided property and casualty insurance to the Company and the Bank and reinsurance to ten other third-party insurance captives for which insurance may not have been available or economically feasible in the insurance marketplace.Hamilton Court Insurance Company exited the pool resources relationship to which it was previously a member and was dissolved inJanuary 2021 . Our principal business activities have been lending to and accepting deposits from individuals, businesses, municipalities and other entities. We derive income principally from interest charged on loans and leases and, to a lesser extent, from interest and dividends earned on investment securities. We have also derived income from noninterest sources, such as fees received in connection with various lending and deposit services and originations and sales of residential mortgage loans. Our principal expenses include interest expense on deposits and borrowings, operating expenses, such as salaries and employee benefits, occupancy and equipment expenses, data processing costs, professional fees and other noninterest expenses, provisions for loan losses and income tax expense. Recent Developments 41 -------------------------------------------------------------------------------- Third Quarter Common Stock Dividend. OnSeptember 15, 2021 , Level One's Board of Directors declared a third quarter 2021 cash dividend of$0.06 per common share. The dividend was paid onOctober 15, 2021 , to shareholders of record at the close of business onSeptember 30, 2021 . Third Quarter Preferred Stock Dividend. OnOctober 20, 2021 , Level One's Board of Directors declared a quarterly cash dividend of$46.88 per share on its 7.50% Non-Cumulative Perpetual Preferred Stock, Series B. Holders of depositary shares will receive$0.4688 per depositary share. The dividend is payable onNovember 15, 2021 , to shareholders of record at the close of business onOctober 31, 2021 . Impact of COVID-19 Pandemic. The COVID-19 pandemic inthe United States has had, and is expected to continue to have, a complex and significant impact on the economy, the banking industry and the Company. Effects on Our Business. We currently expect that the COVID-19 pandemic, federal, state and local government responses to the pandemic, supply disruptions, labor availability challenges, and the effects of existing and future variants of the disease, such as the Delta variant, may continue to have a significant impact on our business. A substantial portion of the Bank's borrowers in the restaurant and hospitality industries have endured substantial economic distress, and while those challenges have been largely mitigated by the PPP and other governmental assistance, there is still some uncertainty about the ability of these clients to return to cash flow levels necessary to cover their debt service. These developments, together with economic conditions generally, are also expected to impact our commercial real estate portfolio, particularly with respect to real estate with exposure to these industries and the value of certain collateral securing our loans. Level One's Response to the COVID-19 Pandemic. Level One has taken comprehensive steps to help our customers, team members and communities during the COVID-19 pandemic. For our customers, we have provided loan payment deferrals and offered fee waivers, among other actions. Level One was also a participating lender in both the first and second rounds of the PPP. In 2020, the Bank originated 2,208 PPP loans in the aggregate principal amount of$417.0 million . FromJanuary 18, 2021 throughJune 30, 2021 , Level One funded 1,532 new PPP loan applications for$234.3 million , of which 1,187 were for loans$150,000 or below. As ofSeptember 30, 2021 ,$147.6 million of PPP loans were still outstanding. The Bank is actively working with the borrowers of PPP loans to obtain loan forgiveness from the SBA. We are continuing to enable the vast majority of our main office team members to work remotely most days. We have also taken significant actions to help ensure the safety of our team members whose roles require them to come into the office, which include the development, implementation and communication of protocols necessary for those who return. As ofMarch 1, 2021 , we opened branches for walk in services. We continue to evaluate this fluid situation and take additional actions as necessary. Level One also recognizes that some of the most impacted industries are the restaurant and hospitality industries. As ofSeptember 30, 2021 , Level One had less than 4.1% and 0.3% of loan concentrations in the restaurant and hospitality industries, respectively. 42
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Selected Financial Data - Unaudited
As of and for the three months ended As of and for the nine months ended
(Dollars in thousands, except per share June 30, September 30, September 30,
data) September 30, 2021 2021 September 30, 2020 2021 2020 Earnings Summary Interest income $ 22,322$ 21,737 $ 20,245$ 65,610 $ 60,458 Interest expense 1,807 2,121 3,648 6,322 12,808 Net interest income 20,515 19,616 16,597 59,288 47,650 Provision expense (recovery) for loan losses (1,189) 540 4,270 (384) 10,334 Noninterest income 6,041 4,326 9,125 17,645 21,604 Noninterest expense 15,989 14,588 15,126 45,716 44,771 Income before income taxes 11,756 8,814 6,326 31,601 14,149 Income tax provision 2,291 1,835 1,117 6,198 2,109 Net income 9,465 6,979 5,209 25,403 12,040 Preferred stock dividends 468 469 - 1,406 - Net income available to common shareholders 8,997 6,510 5,209 23,997
12,040
Net income allocated to participating securities 138 92 40 331 140 Net income attributable to common shareholders $ 8,859$ 6,418 $ 5,169$ 23,666 $
11,900
Per Share Data Basic earnings per common share $ 1.19$ 0.85 $ 0.68$ 3.15 $
1.56
Diluted earnings per common share 1.16 0.84 0.67 3.10
1.55
Diluted earnings per common share, excluding acquisition and due diligence fees (1) 1.16 0.84 0.67 3.10
1.72
Book value per common share 27.56 26.48 24.06 27.56
27.08
Tangible book value per common share (1) 21.89 20.84 18.74 21.89
18.74
Preferred shares outstanding (in thousands) 10 10 10 10 10 Common shares outstanding (in thousands) 7,640 7,629 7,734 7,640
7,734
Average basic common shares (in thousands) 7,519 7,520 7,675 7,526
7,640
Average diluted common shares (in thousands) 7,638 7,633 7,712 7,631
7,701
Selected Period End Balances Total assets$ 2,543,883 $ 2,506,523 $ 2,446,447 $ 2,543,883 $
2,446,447
Securities available-for-sale 389,528 376,453 253,527 389,528 253,527 Total loans 1,719,717 1,775,243 1,843,888 1,719,717 1,843,888 Total deposits 2,066,992 2,031,808 1,943,435 2,066,992 1,943,435 Total liabilities 2,309,949 2,281,114 2,236,979 2,309,949 2,236,979 Total shareholders' equity 233,934 225,409 209,468 233,934
209,468
Total common shareholders' equity 210,562 202,037 186,098 210,562
186.098
Tangible common shareholders' equity (1) 167,262 159,022 144,963 167,262
144,963
Performance and Capital Ratios Return on average assets 1.50 % 1.09 % 0.83 % 1.34 % 0.71 % Return on average equity 16.32 12.52 10.48 15.06 8.68 % Net interest margin (fully taxable equivalent) (2) 3.47 3.30 2.80 3.36 3.04 % Efficiency ratio (noninterest expense/net interest income plus noninterest income) 60.21 60.93 58.81 59.42 64.65 % Dividend payout ratio 5.08 7.02 7.41 5.40 8.99 % Total shareholders' equity to total assets 9.20 8.99 8.56 9.20 8.56 % Tangible common equity to tangible assets (1) 6.69 6.46 6.03 6.69 6.03 % Common equity tier 1 to risk-weighted assets 9.82 9.66 8.83 9.82 8.83 % Tier 1 capital to risk-weighted assets 11.19 11.09 10.31 11.19 10.31 % Total capital to risk-weighted assets 14.19 14.15 14.39 14.19 14.39 % Tier 1 capital to average assets (leverage ratio) 7.68 7.24 7.17 7.68 7.17 % Asset Quality Ratios: Net (recoveries) charge-offs to average loans 0.05 % (0.01) % 0.02 % 0.01 % 0.14 % Nonperforming assets as a percentage of total assets 0.48 0.55 0.79 0.48 0.79 % Nonaccrual loans as a percent of total loans 0.71 0.77 1.04 0.71 1.04 % Allowance for loan losses as a percentage of total loans 1.26 1.30 1.15 1.26 1.15 % Allowance for loan losses as a percentage of nonaccrual loans 179.11 168.64 110.32 179.11 110.32 % Allowance for loan losses as a percentage of nonaccrual loans, excluding allowance allocated to loans accounted for under ASC 310-30 173.58 163.76 105.46 173.58
105.46 %
(1) See section entitled "GAAP Reconciliation and Management Explanation of
Non-GAAP Financial Measures" below for a reconciliation to most comparable GAAP
equivalent.
(2) Presented on a tax equivalent basis using a 21% tax rate.
GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures
Some of the financial measures included in this report are not measures of
financial condition or performance recognized by GAAP. These non-GAAP financial
measures include tangible common shareholders' equity, tangible book value per
common share, the ratio of tangible common equity to tangible assets, net income
and diluted earnings per common share excluding acquisition and due diligence
fees as well as allowance for loan loss as a percentage of total loans excluding
PPP loans. Our management uses these non-GAAP financial measures in its analysis
of our performance, and we believe that providing this information to financial
analysts and investors allows them to evaluate capital adequacy, as well as
better understand and evaluate the Company's core financial results for the
periods in question.
The following presents these non-GAAP financial measures along with their most
directly comparable financial measures calculated in accordance with GAAP:
Tangible Common Shareholders' Equity, Tangible Common Equity to Tangible Assets Ratio and Tangible Book Value Per Share
As of
(Dollars in thousands, except per share data) September 30, 2021
(Unaudited) (Unaudited) (Unaudited)
Total shareholders' equity $ 233,934 $ 225,409 $ 209,468
Less:
Preferred stock 23,372 23,372 23,370
Total common shareholders' equity 210,562 202,037 186,098
Less:
Goodwill 35,554 35,554 35,554 Mortgage servicing rights, net 5,051 4,599 2,193 Other intangible assets, net 2,695 2,862 3,388 Tangible common shareholders' equity $ 167,262
Common shares outstanding (in thousands) 7,640 7,629 7,734 Tangible book value per common share $ 21.89$ 20.84 $ 18.74 Total assets$ 2,543,883 $ 2,506,523 $ 2,446,447 Less: Goodwill 35,554 35,554 35,554 Mortgage servicing rights, net 5,051 4,599 2,193 Other intangible assets, net 2,695 2,862 3,388 Tangible assets$ 2,500,583 $ 2,463,508 $ 2,405,312 Tangible common equity to tangible assets 6.69 % 6.46 % 6.03 % Adjusted Income and Diluted Earnings Per Share For the three months ended For the nine months ended (Dollars in thousands, except per June 30, September 30, September 30, September 30, share data) September 30, 2021 2021 2020 2021 2020 (Unaudited) (Unaudited) (Unaudited) (Unaudited) (Unaudited) Net income, as reported$ 9,465 $
6,979
- - 17 - 1,664
Income tax benefit (1) - - (4) - (333)
Net income, excluding acquisition and
due diligence fees $ 9,465 $
6,979
Diluted earnings per share, as reported$ 1.16 $ 0.84 $ 0.67 $ 3.10$ 1.55 Effect of acquisition and due diligence fees, net of income tax benefit - - - - 0.17 Diluted earnings per common share, excluding acquisition and due diligence fees$ 1.16 $
0.84
(1) Assumes income tax rate of 21% on deductible acquisition expenses.
Allowance for Loan Loss as a Percentage of Total Loans, Excluding PPP Loans
As of
(Dollars in thousands, except per share June 30,
data) September 30, 2021 2021 December 31, 2020 September 30, 2020
(Unaudited) (Unaudited) (Unaudited)
Total loans $ 1,719,717 $ 1,775,243 $ 1,723,537 $ 1,843,888
Less:
PPP loans 147,645 259,303 290,135 392,521
Total loans, excluding PPP loans $ 1,572,072 $
1,515,940
Allowance for loan loss $ 21,731 $
23,144 $ 22,297 $ 21,254 Allowance for loan loss as a percentage of total loans
1.26 % 1.30 % 1.29 % 1.15 %
Allowance for loan loss as a percentage of
total loans excluding PPP loans 1.38 % 1.53 % 1.56 % 1.46 %
Results of Operations
Net Income
We had net income of $9.5 million , or $1.16 per diluted common share, for the
three months ended September 30, 2021 , compared to $5.2 million , or $0.67 per
diluted common share, for the three months ended September 30, 2020 . The
increase of $4.3 million in net income reflected an increase of $3.9 million in
net interest income, primarily due to higher interest income on loans due, in
part, to the recognition of fees on PPP loans as they are forgiven, and lower
interest expense on deposits, borrowed funds, and subordinated notes. The
increase in net income also reflected a decrease of $5.5 million in provision
for loan loss, primarily due to a decrease in general reserves resulting from a
reduction in qualitative factors within the allowance for loan loss model as a
result of improved credit quality. These were partially offset by decreases of
$3.1 million in noninterest income, primarily due to lower mortgage banking
activities and net gain on sales of securities, and increases of $1.2 million in
income tax provision expense due to higher income before taxes and $863 thousand
in noninterest expense due to higher salary and employee benefits expense.
We had net income of $25.4 million , or $3.10 per diluted common share, for the
nine months ended September 30, 2021 , compared to $12.0 million , or $1.55 per
diluted common share, for the nine months ended September 30, 2020 . The increase
of $13.4 million in net income primarily reflected an increase of $11.6 million
in net interest income, primarily due to higher interest income on loans due, in
part, to the recognition of fees on PPP loans as they are forgiven. In addition,
there was higher interest income on securities due to increased volumes of
investment securities and lower interest expense on deposits, borrowed funds,
and subordinated notes. The increase in net income also reflected a decrease of
$10.7 million in provision for loan loss, primarily due to a decrease in general
reserves resulting from an increase in the economic qualitative factors in the
nine months ended September 30, 2020 and a reduction in qualitative factors in
the third quarter of 2021. These were partially offset by increases of $4.1
million of income tax provision primarily due to higher income before taxes and
$945 thousand of
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noninterest expense primarily due to increases of $1.7 million of salary and
employee benefits expense and $608 thousand of data processing expense partially
offset by a decrease of $1.7 million in acquisition and due diligence fees due
to the merger with Ann Arbor State Bank in the first quarter of 2020. In
addition, there was a $4.0 million decrease in noninterest income primarily due
to lower mortgage banking activities and net gain on sales of securities
partially offset by an increase in service charges on deposits.
Net Interest Income
Our primary source of revenue is net interest income, which is the difference
between interest income from interest-earning assets (primarily loans and
securities) and interest expense of funding sources (primarily interest-bearing
deposits and borrowings).
Net interest income of $20.5 million for the three months ended September 30,
2021 was $3.9 million higher than the net interest income of $16.6 million for
the three months ended September 30, 2020 . The three months ended September 30,
2021 included a $2.1 million increase in interest income as well as a
$1.8 million decrease in interest expense, compared to the same period in 2020.
The increase in interest income was primarily driven by increases of
$1.7 million in interest and fees on loans and $419 thousand in interest on
investment securities. The increase in interest and fees on loans for the three
months ended September 30, 2021 compared to the same period in 2020 was mainly
driven by the Bank earning $3.6 million of net SBA fees on PPP loans compared to
$1.5 million in the three months ended September 30, 2020 , with the remaining
$5.3 million of SBA fees expected to be earned over the life of the loans. The
majority of the PPP loans are expected to mature two or five years from the date
of funding, depending on the round of PPP funding, unless modified by the lender
and borrower. We anticipate a large portion of the PPP loan balance will be
forgiven before the maturity of the loans. In addition to the net SBA fees, the
Bank also recognized $521 thousand of interest income on PPP loans in the third
quarter of 2021. The increase in interest income on investment securities was
mainly due to an increase of $136.2 million in average balances due to increased
customer liquidity and new customer growth.
The decrease in interest expense was primarily driven by a decrease of $1.4
million in interest expense on deposits and a decrease of $483 thousand in
interest expense on borrowed funds and subordinated notes. The decrease in
deposit interest expense was primarily due to lower interest rates paid as a
result of revised internal deposit rates and maturity of higher cost time
deposits. The decrease in interest expense on borrowed funds and subordinated
notes was primarily due to the redemption of $15.0 million of subordinated notes
during the second quarter of 2021 and a decrease in Federal Reserve Bank
borrowings
Net interest income of $59.3 million for the nine months ended September 30,
2021 was $11.6 million higher than the net interest income of $47.7 million for
the nine months ended September 30, 2020 . The nine months ended September 30,
2021 included a $5.2 million increase in interest income as well as a
$6.5 million decrease in interest expense, compared to the same period in 2020.
The increase in interest income was primarily driven by increases of
$4.5 million in interest and fees on loans and $951 thousand in interest on
investment securities. These increases were partially offset by a $299 thousand
decrease in interest on federal funds and other investments. The increase in
interest and fees on loans for the nine months ended September 30, 2021 compared
to the same period in 2020 was mainly driven by the Bank earning $10.3 million
of net SBA fees on PPP loans compared to $2.9 million in the nine months ended
September 30, 2020 . In addition to the net SBA fees, the Bank also recognized
$2.4 million of interest income on PPP loans in the nine months ended September
30, 2021 . This was partially offset by a 56 basis point decrease in yield on
loans excluding PPP loans for the nine months ended September 30, 2021 compared
to the same period in 2020. The increase in interest income on investment
securities was mainly due to an increase of $125.3 million in average balances
due to increased customer liquidity and new customer growth.
The decrease in interest expense was primarily driven by a decrease of $5.6
million in interest expense on deposits and a decrease of $890 thousand in
interest expense on borrowed funds and subordinated notes. The decrease in
deposit interest expense was primarily due to lower interest rates paid as a
result of revised internal deposit rates and maturity of higher cost time
deposits. The decrease in interest expense on borrowed funds and subordinated
notes was primarily due to the redemption of $15.0 million of subordinated notes
during the second quarter of 2021 and a decrease in Federal Reserve Bank
borrowings.
Our net interest margin (on a fully tax equivalent basis ("FTE")) for the three
months ended September 30, 2021 was 3.47%, compared to 2.80% for the same period
in 2020. The increase of 67 basis points in the net interest margin year over
year was primarily a result of a decrease in cost of funds, which declined 40
basis points to 0.48% in the third quarter of 2021, compared to 0.88% in the
third quarter of 2020 primarily due to lower interest rates paid as a result of
revised internal deposit rates and maturity of higher cost time deposits. The
decrease in cost of funds was accompanied by higher yield on loans mostly
reflecting the increase in PPP fees earned during the period.
Our net interest margin benefits from discount accretion on our purchased credit
impaired loan portfolios, a component of our accretable yield. The accretable
yield represents the excess of the net present value of expected future cash
flows over the acquisition date fair value and includes both the expected coupon
of the loan and the discount accretion. The accretable yield is
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recognized as interest income over the expected remaining life of the purchased
credit impaired loan. The difference between the actual yield earned on total
loans and the yield generated based on the contractual coupon (not including any
interest income for loans in nonaccrual status) represents excess accretable
yield. The contractual coupon of the loan considers the contractual coupon rates
of the loan and does not include any interest income for loans in nonaccrual
status. For both the three months ended September 30, 2021 and 2020, the yield
on total loans was impacted by 7 basis points due to the accretable yield on
purchased credit impaired loans. Our net interest margin for the three months
ended September 30, 2021 and 2020, benefited by 6 basis points and 8 basis
points, respectively, as a result of the excess accretable yield. For the nine
months ended September 30, 2021 and 2020, the yield on total loans was impacted
by 6 and 7 basis points due to the accretable yield on purchased credit impaired
loans. Our net interest margin for the nine months ended September 30, 2021 and
2020, benefited by 4 basis points and 9 basis points, respectively, as a result
of the excess accretable yield. As of September 30, 2021 and December 31, 2020 ,
our remaining accretable yield was $5.9 million and $7.1 million , respectively,
and our nonaccretable difference was $2.1 million and $2.7 million ,
respectively.
Our net interest margin (FTE) for the nine months ended September 30, 2021 was
3.36%, compared to 3.04% for the same period in 2020. The increase of 32 basis
points in the net interest margin year over year was primarily a result of a
decrease in cost of funds, which declined 60 basis points to 0.55% in the first
nine months of 2021, compared to 1.15% in the first nine months of 2020
primarily due to lower interest rates paid as a result of revised internal
deposit rates and maturity of higher cost time deposits. The decrease in cost of
funds was accompanied by a lower yields across most interest-earning assets,
mostly reflecting the impact of lower market interest rates.
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The following table sets forth information related to our average balance sheet,
average yields on assets, and average rates on liabilities for the periods
indicated. We derived these yields by dividing income or expense by the average
daily balance of the corresponding assets or liabilities. In this table,
adjustments were made to the yields on tax-exempt assets in order to present
tax-exempt income and fully taxable income on a comparable basis.
Analysis of Net Interest Income-Fully Taxable Equivalent
For the three months ended September For the nine months ended September
30, 2021 30, 2021
(Dollars in thousands) 2021 2020 2021 2020
Average Balance Sheets:
Gross loans(1) $ 1,763,214 $ 1,871,164 $ 1,823,888 $ 1,696,073
Investment securities: (2)
Taxable 265,885 139,237 243,377 124,169
Tax-exempt 104,063 94,526 103,158 97,104
Interest-earning cash balances 221,261 259,349 192,309 188,179
Other investments 14,398 12,419 14,398 12,401
Total interest-earning assets $ 2,368,821 $ 2,376,695 $ 2,377,130 $ 2,117,926
Non-earning assets: 151,077 140,480 145,971 133,968
Total assets $ 2,519,898 $ 2,517,175 $ 2,523,101 $ 2,251,894
Interest-bearing demand deposits $ 156,977 $ 116,285 $ 144,449 $ 112,579
Money market and savings deposits 624,190 513,420 623,123 458,438
Time deposits 489,261 575,179 541,018 564,396
Borrowings 181,911 394,020 183,983 311,024
Subordinated notes 29,657 44,468 38,633 44,463
Total interest-bearing liabilities 1,481,996 1,643,372 1,531,206 1,490,900
Noninterest-bearing demand deposits 774,926 640,095 735,162 546,066
Other liabilities 31,012 34,846 31,822 30,047
Shareholders' equity 231,964 198,862 224,911 184,881
Total liabilities and shareholders' equity $ 2,519,898 $ 2,517,175 $ 2,523,101 $ 2,251,894
Yields: (3)
Earning Assets
Gross loans 4.60 % 3.98 % 4.42 % 4.40 %
Investment securities:
Taxable 1.57 % 1.86 % 1.59 % 2.08 %
Tax-exempt 2.99 % 3.19 % 3.04 % 3.20 %
Interest earning cash balances 0.15 % 0.12 % 0.12 % 0.28 %
Other investments 2.95 % 5.57 % 3.18 % 4.49 %
Total interest earning assets 3.76 % 3.41 % 3.72 % 3.84 %
Interest-bearing liabilities
Interest-bearing demand deposits 0.14 % 0.22 % 0.15 % 0.31 %
Money market and savings deposits 0.17 % 0.43 % 0.20 % 0.65 %
Time deposits 0.53 % 1.18 % 0.58 % 1.55 %
Borrowings 1.02 % 0.70 % 1.02 % 0.80 %
Subordinated notes 5.00 % 5.65 % 5.09 % 5.72 %
Total interest-bearing liabilities 0.48 % 0.88 % 0.55 % 1.15 %
Interest spread 3.28 % 2.53 % 3.17 % 2.69 %
Net interest margin(4) 3.44 % 2.78 % 3.33 % 3.01 %
Tax equivalent effect 0.03 % 0.02 % 0.03 % 0.03 %
Net interest margin on a fully tax equivalent basis 3.47 % 2.80 % 3.36 % 3.04 %
(1) Includes nonaccrual loans.
(2) For presentation in this table, average balances and the corresponding
average rates for investment securities are based upon historical cost, adjusted
for amortization of premiums and accretion of discounts.
(3) Average rates and yields are presented on an annual basis and include a
taxable equivalent adjustment to interest income of $155 thousand and
$144 thousand on tax-exempt securities for the three months ended September 30,
2021 and 2020, respectively, and $462 thousand and $431 thousand for the nine
months ended September 30 , 2021and 2020, respectively, using the federal
corporate tax rate of 21%.
(4) Net interest margin represents net interest income divided by average total
interest-earning assets.
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Rate/Volume Analysis
The table below presents the effect of volume and rate changes on interest
income and expense for the periods indicated. Changes in volume are changes in
the average balance multiplied by the previous period's average rate. Changes in
rate are changes in the average rate multiplied by the average balance from the
previous period. The net changes attributable to the combined impact of both
rate and volume have been allocated proportionately to the changes due to volume
and the changes due to rate. The average rate for tax-exempt securities is
reported on a fully taxable equivalent basis.
For the three
months ended
Increase
(Decrease) Due to:
Net Increase
(Dollars in thousands) Rate Volume (Decrease)
Interest-earning assets
Gross loans $ 2,842 $ (1,125) $ 1,717
Investment securities:
Taxable (111) 513 402
Tax-exempt (56) 73 17
Interest-earning cash balances 20 (12) 8
Other investments (92) 25 (67)
Total interest income 2,603 (526) 2,077
Interest-bearing liabilities
Interest-bearing demand deposits (30) 19 (11)
Money market and savings deposits (396) 101 (295)
Time deposits (827) (225) (1,052)
Borrowings 240 (465) (225)
Subordinated debt (66) (192) (258)
Total interest expense (1,079) (762) (1,841)
Change in net interest income $ 3,682 $ 236 $ 3,918
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For the nine
months ended
Increase
(Decrease) Due to:
Net Increase
(Dollars in thousands) Rate Volume (Decrease)
Interest-earning assets
Gross loans $ 276 $ 4,224 $ 4,500
Investment securities:
Taxable (539) 1,504 965
Tax-exempt (155) 141 (14)
Interest-earning cash balances (233) 9 (224)
Other investments (135) 60 (75)
Total interest income (786) 5,938 5,152
Interest-bearing liabilities
Interest-bearing demand deposits (164) 61 (103)
Money market and savings deposits (1,894) 612 (1,282)
Time deposits (3,951) (260) (4,211)
Borrowings 429 (886) (457)
Subordinated debt (198) (235) (433)
Total interest expense (5,778) (708) (6,486)
Change in net interest income $ 4,992 Provision for Loan Losses We established an allowance for loan losses through a provision for loan losses charged as an expense in our consolidated statements of income. Management reviews the loan portfolio, consisting of originated loans and acquired loans, on a quarterly basis to evaluate the outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses. Loans acquired in connection with acquisitions that have evidence of credit deterioration since origination and for which it is probable at the date of acquisition that we will not collect all contractually required principal and interest payments are accounted for under ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, or ASC 310-30. These credit-impaired loans have been recorded at their estimated fair value on the respective acquisition date, based on subjective determinations regarding risk ratings, expected future cash flows and fair value of the underlying collateral, without a carryover of the related allowance for loan losses. At the acquisition date, the Company recognizes the expected shortfall of expected future cash flows, as compared to the contractual amount due, as a nonaccretable discount. Any excess of the net present value of expected future cash flows over the acquisition date fair value is recognized as the accretable discount, or accretable yield. We evaluate these loans semi-annually to assess expected cash flows. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges or a reclassification of the difference from nonaccretable to accretable with a positive impact on interest income. As ofSeptember 30, 2021 , andDecember 31, 2020 , our remaining accretable yield was$5.9 million and$7.1 million , respectively, and our nonaccretable difference was$2.1 million and$2.7 million as of both dates. The provision for loan losses was a provision benefit of$1.2 million for the three months endedSeptember 30, 2021 , compared to a provision expense of$4.3 million for the three months endedSeptember 30, 2020 . The decrease of$5.5 million in the provision for loan losses was primarily due to a decrease in general reserves of$5.1 million due to a reduction in qualitative factors within the allowance for loan loss model as a result improved credit quality as well as a decrease of$531 thousand in specific reserves. The provision for loan losses was a provision benefit of$384 thousand for the nine months endedSeptember 30, 2021 , compared to a provision expense of$10.3 million for the nine months endedSeptember 30, 2020 . The decrease of$10.7 million in the provision for loan losses was primarily due to a decrease in general reserves of$8.6 million due to a reduction in qualitative factors mentioned above during the third quarter of 2021 while qualitative factors were increased during the nine months endedSeptember 30, 2020 due to economic uncertainty regarding the impact of the COVID-19 pandemic on credit 48 -------------------------------------------------------------------------------- Table of Contents quality. In addition, there was a decrease of$1.6 million in net chargeoffs resulting from a$1.3 million chargeoff on a nonaccrual loan during the second quarter of 2020 and a decrease of$402 thousand in specific reserves. Noninterest Income The following table presents noninterest income for the three and nine months endedSeptember 30, 2021 and 2020. For the three months
For the nine months ended September
ended September 30, 30,
(Dollars in thousands) 2021 2020 2021 2020
Noninterest income
Service charges on deposits $ 859
- 434 20 1,862
Mortgage banking activities 4,216 7,108 12,738 15,380
Other charges and fees 966 967 2,451 2,564
Total noninterest income $ 6,041 $ 9,125 $ 17,645 $ 21,604
Noninterest income decreased $3.1 million to $6.0 million for the three months
ended September 30, 2021 , compared to $9.1 million for the same period in 2020.
The decrease in noninterest income year over year was primarily due to decreases
of $2.9 million in mortgage banking activities and $434 thousand in net gains on
sales of investment securities. This was partially offset by an increase of $243
thousand in service charges on deposits. The decrease in mortgage banking
activities compared to the third quarter of 2020 was primarily due to $84.2
million fewer residential loan originations held for sale and $54.5 million
fewer residential loans sold. The higher volumes in the third quarter of 2020
were primarily as a result of the decrease in interest rates during the first
half of 2020 while interest rates have remained relatively stable in 2021. The
decrease in net gains on sales of investment securities was due to no securities
sold in the third quarter of 2021. The increase in service charges on deposits
was primarily due to higher transaction volumes and deposit balances.
Noninterest income decreased $4.0 million to $17.6 million for the nine months
ended September 30, 2021 , compared to $21.6 million for the same period in 2020.
The decrease in noninterest income was primarily due to decreases of
$2.6 million in mortgage banking activities and $1.8 million in net gains on
sales of securities. These decreases were partially offset by an increase of
$638 thousand in service charges on deposits. The decrease in mortgage banking
activities was primarily due to $74.0 million lower residential loan
originations held for sale and $4.8 million lower residential loans sold. The
higher volumes in the nine months ended September 30, 2020 were primarily due to
lower interest rates during the first half of 2020 while interest rates have
remained relatively stable in 2021. The decrease in net gains on sales of
securities was primarily due to fewer securities sold during the first nine
months of 2021 compared to the same period in 2020. The increase in service
charges on deposits was due to higher transaction volumes and deposit balances.
Noninterest Expense
The following table presents noninterest expense for the three and nine months
ended September 30, 2021 and 2020.
For the three months ended For the nine months ended September
September 30, 30,
(Dollars in thousands) 2021 2020 2021 2020
Noninterest expense
Salary and employee benefits $ 10,551 $ 9,862 $ 29,825 $ 28,090
Occupancy and equipment expense 1,680 1,678 4,971 4,773
Professional service fees 847 808 2,264 2,141
Acquisition and due diligence fees - 17 - 1,664
FDIC premium 244 287 778 722
Marketing expense 428 257 842 709
Loan processing expense 231 262 755 690
Data processing expense 928 844 3,209 2,601
Core deposit premium amortization 167 192 501 576
Other expense 913 919 2,571 2,805
Total noninterest expense $ 15,989 $
15,126
Noninterest expense increased
49
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increases of $689 thousand in salary and employee benefits and $171 thousand in
marketing expenses. The increase in salary and employee benefits between the
periods was primarily due to an increase of 20 full-time equivalent employees as
well as incentive compensation. The increase in marketing expense between the
periods was due to an increase in advertising efforts.
Noninterest expense increased $945 thousand to $45.7 million for the nine months
ended September 30, 2021 , compared to $44.8 million for the same period in 2020.
The increase in noninterest expense was primarily due to increases in salary and
employee benefits of $1.7 million , data processing expense of $608 thousand and
occupancy and equipment expense of $198 thousand . These increases were partially
offset by decreases of $1.7 million in acquisition and due diligence fees and
$234 thousand of other expense. The increase in salary and employee benefits was
primarily due to increases of $719 thousand in incentive compensation, $606
thousand in salaries expense, and $291 thousand in contract labor. The increase
in data processing expense was primarily due to the new loan processing system
used for PPP loans. The increase in occupancy and equipment expense was
primarily due to software maintenance and licensing. The decrease in acquisition
and due diligence fees was primarily due to the acquisition of Ann Arbor State
Bank in the first quarter of 2020. The decrease in other expense was primarily
due to a decrease in the provision for unfunded commitments.
Income Taxes and Tax-Related Items
During the three months ended September 30, 2021 , we recognized income tax
expense of $2.3 million on $11.8 million of pre-tax income resulting in an
effective tax rate of 19.5%, compared to the same period in 2020, in which we
recognized an income tax expense of $1.1 million on $6.3 million of pre-tax
income, resulting in an effective tax rate of 17.7%.
During the nine months ended September 30, 2021 , we recognized income tax
expense of $6.2 million on $31.6 million of pre-tax income resulting in an
effective tax rate of 19.6%, compared to the same period in 2020, in which we
recognized an income tax expense of $2.1 million on $14.1 million of pre-tax
income, resulting in an effective tax rate of 14.9%.
The increase in income tax provision for the nine months ended September 30,
2021 compared to the same period in 2020 was primarily as a result of a $290
thousand tax benefit related to the Ann Arbor State Bank net operating loss
(NOL) in the first quarter of 2020 resulting from the CARES Act provision that
allows for NOLs generated in 2018 to 2020 to be carried back five years.
Additionally, disqualified dispositions of Ann Arbor State Bank's stock options
generated a $175 thousand tax benefit in the first quarter of 2020.
See "Note 9 - Income Taxes" of Notes to Consolidated Financial Statements for a
reconciliation between expected and actual income tax expense for the three and
nine months ended September 30, 2021 and 2020.
Financial Condition
Investment Securities
The following table presents the fair value of the Company's investment
securities portfolio, all of which were classified as available-for-sale as of
September 30, 2021 and December 31, 2020 .
September 30, December 31,
(Dollars in thousands) 2021 2020
Securities available-for-sale:
U.S. government sponsored entities and agencies $ 24,036 $ 26,358
State and political subdivision 146,695 132,723
Mortgage-backed securities: residential 20,086 26,081
Mortgage-backed securities: commercial 23,540 11,918
Collateralized mortgage obligations: residential 9,871 13,446
Collateralized mortgage obligations: commercial 52,738 58,512
U.S. Treasury 64,898 -
SBA 15,108 17,593
Asset backed securities 9,858 10,072
Corporate bonds 22,698 6,029
Total securities available-for-sale The composition of our investment securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity for both normal operations and potential acquisitions, while providing an additional source of revenue. The investment portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet, while providing a vehicle for the investment of available funds, furnishing liquidity, and supplying securities to pledge as collateral. AtSeptember 30, 2021 , total investment securities were$389.5 million , or 15.3% of total assets, compared to$302.7 million , 50 -------------------------------------------------------------------------------- Table of Contents or 12.4% of total assets, atDecember 31, 2020 . The$86.8 million increase in securities available-for-sale fromDecember 31, 2020 toSeptember 30, 2021 , was due to the purchase of securities using the excess cash balances generated by the payoffs of PPP loans and increase in deposits. Securities with a carrying value of$90.6 million and$98.7 million were pledged atSeptember 30, 2021 andDecember 31, 2020 , respectively, to secure borrowings, deposits and mortgage derivatives. As ofSeptember 30, 2021 , the Company held 68 tax-exempt state and local municipal securities totaling$52.8 million backed by theMichigan School Bond Loan Fund . Other than the aforementioned investments and theU.S. government and its agencies, atSeptember 30, 2021 andDecember 31, 2020 , there were no holdings of securities of any one issuer in an amount greater than 10% of shareholders' equity. The securities available-for-sale presented in the following tables are reported at amortized cost and by contractual maturity as ofSeptember 30, 2021 andDecember 31, 2020 . Expected maturities may differ from contractual maturities as issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Additionally, residential mortgage-backed securities and collateralized mortgage obligations receive monthly principal payments, which are not reflected below. The yields below are calculated on a tax equivalent basis. September 30, 2021 One year or less One to five years Five to ten years After ten years Amortized Average Amortized Average Amortized Average Amortized Average (Dollars in thousands) Cost Yield Cost Yield Cost Yield Cost Yield Securities available-for-sale:U.S. government sponsored agency obligations$ 4,010 1.61 %$ 521 1.62 %$ 15,000 1.22 %$ 5,000 1.48 % State and political subdivision 1,254 2.44 13,514 2.46 50,986 2.71 74,001 2.89 Mortgage-backed securities: residential - - 87 1.71 27 1.92 19,912 0.75 Mortgage-backed securities: commercial - - 5,120 2.46 16,620 1.28 1,791 3.63 Collateralized mortgage obligations: residential - - 331 2.91 186 1.21 9,279 1.09 Collateralized mortgage obligations: commercial 2,575 3.70 4,509 2.57 39,203 1.28 6,631 2.25U.S. Treasury - - 35,742 0.87 29,376 1.34 - - SBA - - - - 8,084 1.46 6,927 1.37 Asset backed securities - - - - - - 9,896 0.76 Corporate bonds - - - - 21,801 3.82 1,000 3.25 Total securities available-for-sale$ 7,839 2.43 %$ 59,824 1.52 %$ 181,283 2.00 %$ 134,437 2.14 % December 31, 2020 One year or less One to five years Five to ten years After ten years Amortized Average Amortized Average Amortized Average Amortized Average (Dollars in thousands) Cost Yield Cost Yield Cost Yield Cost Yield Securities available-for-sale:U.S. government sponsored agency obligations$ 4,027 1.61 %$ 2,548 1.61 %$ 15,000 1.22 %$ 5,000 1.48 % State and political subdivision 1,768 1.96 10,095 2.46 31,142 2.80 81,048 2.99 Mortgage-backed securities: residential - - 78 0.94 87 0.19 25,564 1.44 Mortgage-backed securities: commercial 847 1.36 3,795 2.46 4,985 1.69 1,807 3.64 Collateralized mortgage obligations: residential - - 46 4.02 559 2.11 12,715 1.25 Collateralized mortgage obligations: commercial 577 2.54 8,011 3.10 40,889 1.26 7,921 2.46 SBA - - - - 9,879 1.40 7,760 1.21 Asset backed securities - - - - - - 10,229 0.84 Corporate bonds 3,498 3.08 - - 2,500 4.38 - - Total securities available-for-sale$ 10,717 2.18 %$ 24,573 2.58 %$ 105,041 1.82 %$ 152,044 2.28 % Loans 51
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Our loan portfolio represents a broad range of borrowers comprised of commercial
real estate, commercial and industrial, residential real estate, and consumer
financing loans.
Commercial real estate loans consist of term loans secured by a mortgage lien on
the real property, such as office and industrial buildings, retail shopping
centers and apartment buildings, as well as commercial real estate construction
loans that are offered to builders and developers. Commercial real estate loans
are then segregated into two classes: non-owner occupied and owner occupied
commercial real estate loans. Non-owner occupied loans, which include loans
secured by non-owner occupied and nonresidential properties, generally have a
greater risk profile than owner-occupied loans, which include loans secured by
multifamily structures and owner-occupied commercial structures.
Commercial and industrial loans include financing for commercial purposes in
various lines of business, including manufacturing, service industry and
professional service areas. Commercial and industrial loans are generally
secured with the assets of the company and/or the personal guarantee of the
business owners. The PPP loans funded during the second and third quarters of
2020 and first and second quarters of 2021, which are guaranteed by the SBA, are
reported within the commercial and industrial loan category.
Residential real estate loans represent loans to consumers for the purchase or
refinance of a residence. These loans are generally financed over a 15- to
30-year term and, in most cases, are extended to borrowers to finance their
primary residence with both fixed-rate and adjustable-rate terms. Real estate
construction loans are also offered to consumers who wish to build their own
homes and are often structured to be converted to permanent loans at the end of
the construction phase, which is typically twelve months. Residential real
estate loans also include home equity loans and lines of credit that are secured
by a first- or second-lien on the borrower's residence. Home equity lines of
credit consist mainly of revolving lines of credit secured by residential real
estate.
Consumer loans include loans made to individuals not secured by real estate,
including loans secured by automobiles or watercraft, and personal unsecured
loans.
The following table details our loan portfolio by loan type at the dates
presented:
As of September
30, As of December 31,
(Dollars in thousands) 2021 2020 2019 2018 2017
Commercial real estate:
Non-owner occupied $ 479,633 $ 445,810 $ 388,515 $ 367,671 $ 343,420
Owner occupied 295,228 275,022 216,131 194,422 168,342
Total commercial real estate 774,861 720,832 604,646 562,093 511,762
Commercial and industrial 540,546 685,504 410,228 383,455 377,686
Residential real estate 403,517 315,476 211,839 180,018 144,439
Consumer 793 1,725 896 999 1,036
Total loans $ 1,719,717 $ 1,723,537 $ 1,227,609 $ 1,126,565 $ 1,034,923
Total loans were $1.72 billion at September 30, 2021 , a decrease of $3.8 million
from December 31, 2020 . The decline in our loan portfolio compared to December
31, 2021 was primarily due to a $145.0 million decrease in our commercial and
industrial loan portfolio, $142.5 million of which was due to the net change in
PPP loans. This was partially offset by increases of $88.0 million in our
residential real estate portfolio and $54.0 million in our commercial real
estate portfolio. In general, we target a loan portfolio mix of approximately
one-half commercial real estate, approximately one-third commercial and
industrial loans and one-sixth a mix of residential real estate and consumer
loans. As of September 30, 2021 , approximately 45.1% of our loans were
commercial real estate, 31.4% were commercial and industrial, and 23.5% were
residential real estate and consumer loans.
We originate both fixed and adjustable rate residential real estate loans
conforming to the underwriting guidelines of Fannie Mae and Freddie Mac, as well
as home equity loans and lines of credit that are secured by first or junior
liens. Most of our fixed rate residential loans, along with some of our
adjustable rate mortgages, are sold to Fannie Mae and other financial
institutions with which we have established a correspondent lending
relationship. The Company established a direct relationship with Fannie Mae and
began locking and selling loans to Fannie Mae with servicing retained during the
third quarter of 2019. Refer to Note 7 - Mortgage Servicing Rights, Net for
further details on our mortgage servicing rights.
Loan Maturity/Rate Sensitivity
52--------------------------------------------------------------------------------
Table of Contents The following table shows the contractual maturities of our loans as ofSeptember 30, 2021 . After one but One year or within five After five
(Dollars in thousands) less years years TotalSeptember 30, 2021 Commercial real estate$ 105,954 $ 427,610 $ 241,297 $ 774,861 Commercial and industrial 148,351 320,319 71,876 540,546 Residential real estate 14,176 6,911 382,430 403,517 Consumer 121 630 42 793 Total loans$ 268,602 $ 755,470 $ 695,645 $ 1,719,717 Sensitivity of loans to changes in interest rates: Fixed interest rates$ 650,027 $ 273,194 Floating interest rates 105,443 422,451 Total$ 755,470 $ 695,645 Summary of Impaired Assets and Past Due Loans Nonperforming assets consist of nonaccrual loans and other real estate owned. We do not consider performing TDRs to be nonperforming assets, but they are included as part of impaired assets. The level of nonaccrual loans is an important element in assessing asset quality. Loans are classified as nonaccrual when, in the opinion of management, collection of principal or interest is not expected according to the terms of the agreement. Generally, loans are placed on nonaccrual status due to the continued failure by the borrower to adhere to contractual payment terms coupled with other pertinent factors, such as insufficient collateral value. A loan is categorized as a troubled debt restructuring if a concession is granted, such as to provide for the reduction of either interest or principal, due to deterioration in the financial condition of the borrower. Typical concessions include reduction of the interest rate on the loan to a rate considered lower than the current market rate, forgiveness of a portion of the loan balance, extension of the maturity date, and/or modifications from principal and interest payments to interest-only payments for a certain period. Loans are not classified as TDRs when the modification is short-term or results in only an insignificant delay or shortfall in the payments to be received. In accordance with bank regulatory guidance, troubled debt restructurings do not include short-term modifications made on a good-faith basis in response to the COVID-19 pandemic to borrowers who were current prior to any relief. This includes short-term modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. As ofSeptember 30, 2021 , there were$1.1 million of loans that remained on a COVID-related deferral compared to$19.8 million as ofDecember 31, 2020 . As ofSeptember 30, 2021 , there were no loans that had payments deferred greater than six months compared to$11.4 million as ofDecember 31, 2020 . Credit Quality Indicators: The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes commercial and industrial and commercial real estate loans and is performed on an annual basis. The Company uses the following definitions for risk ratings: Pass. Loans classified as pass are higher quality loans that do not fit any of the other categories described below. This category includes loans risk rated with the following ratings: cash/stock secured, excellent credit risk, superior credit risk, good credit risk, satisfactory credit risk, and marginal credit risk. Special Mention. Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company's credit position at some future date. Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. 53 -------------------------------------------------------------------------------- Table of Contents Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. For residential real estate loans and consumer loans, the Company evaluates credit quality based on the aging status of the loan and by payment activity. Residential real estate loans and consumer loans are considered nonperforming if they are 90 days or more past due. Consumer loan types are continuously monitored for changes in delinquency trends and other asset quality indicators. Purchased credit impaired loans accounted for under ASC 310-30 are classified as performing, even though they may be contractually past due, as any nonpayment of contractual principal or interest is considered in the semi-annual re-estimation of expected cash flows and is included in the resulting recognition of current period loan loss provision or future period yield adjustments. Total classified and criticized loans as ofSeptember 30, 2021 compared toDecember 31, 2020 were as follows: (Dollars in thousands) September 30, 2021 December 31, 2020 Classified loans: Substandard $ 23,994 $ 34,921 Doubtful 1,557 1,143 Total classified loans $ 25,551 $ 36,064 Special mention 64,642 47,297 Total classified and criticized loans $ 90,193 $
83,361
A summary of nonperforming assets (defined as nonaccrual loans and other real
estate owned), performing troubled debt restructurings and loans 90 days or more
past due and still accruing, as of the dates indicated, are presented below.
As of
September 30, As of December 31,
(Dollars in thousands) 2021 2020 2019 2018 2017
Nonaccrual loans
Commercial real estate $ 3,768 $ 7,320 $ 4,832 $ 5,927 $ 2,257
Commercial and industrial 4,746 7,490 11,112 9,605 9,024
Residential real estate 3,610 3,991 2,569 2,915 2,767
Consumer 9 15 16 - -
Total nonaccrual loans(1) 12,133 18,816 18,529 18,447 14,048
Other real estate owned - - 921 - 652
Total nonperforming assets 12,133 18,816 19,450 18,447 14,700Performing troubled debt restructurings
Commercial and industrial 336 546 547 568 961 Residential real estate 426 432 359 363 261 Total performing troubled debt restructurings 762 978 906 931 1,222
Total impaired assets, excluding ASC 310-30 loans
(1)Nonaccrual loans include nonperforming troubled debt restructurings of$3.5 million ,$3.8 million ,$3.0 million ,$5.0 million and$6.4 million at the respective dates indicated above. During the nine months endedSeptember 30, 2021 and 2020, the Company recorded$616 thousand and$144 thousand , respectively, of interest income on nonaccrual loans and performing TDRs excluding PCI loans.` In addition to nonperforming and impaired assets, the Company had purchased credit impaired loans accounted for under ASC 310-30 which amounted to$4.4 million ,$5.0 million ,$6.0 million ,$7.9 million , and$9.7 million at the respective dates indicated in the table above. 54 -------------------------------------------------------------------------------- Table of Contents Nonperforming assets decreased$6.7 million as ofSeptember 30, 2021 compared toDecember 31, 2020 . The decrease in nonperforming assets was attributable to a decrease in nonaccrual loans primarily due to pay offs of three commercial loan relationships totaling$5.1 million and a$2.8 million paydown on one commercial loan relationship. This was partially offset by three commercial loan relationships moving to nonaccrual status totaling$2.3 million . There was$735 thousand of nonperforming loans that were in the process of foreclosure atSeptember 30, 2021 . Allowance for Loan Losses We maintain the allowance for loan losses at a level we believe is sufficient to absorb probable incurred losses in our loan portfolio given the conditions at the time. Management determines the adequacy of the allowance based on periodic evaluations of the loan portfolio and other factors. These evaluations are inherently subjective as they require management to make material estimates, all of which may be susceptible to significant change. The allowance is increased by provisions charged to expense and decreased by actual charge-offs, net of recoveries. Acquired Loans The allowance for loan losses on acquired loans is based on credit deterioration subsequent to the acquisition date. In accordance with the accounting guidance for business combinations, there was no allowance brought forward on any of the acquired loans as any credit deterioration evident in the loans was included in the determination of the fair value of the loans at the acquisition date. For purchased credit impaired loans, accounted for under ASC 310-30, management establishes an allowance for credit deterioration subsequent to the date of acquisition by re-estimating expected cash flows on a semi-annual basis with any decline in expected cash flows recorded as provision for loan losses. Impairment is measured as the excess of the recorded investment in a loan over the present value of expected future cash flows discounted at the pre-impairment accounting yield of the loan. For increases in cash flows expected to be collected, we first reverse any previously recorded allowance for loan losses, then adjust the amount of accretable yield recognized on a prospective basis over the loan's remaining life. These cash flow evaluations are inherently subjective as they require material estimates, all of which may be susceptible to significant change. For non-purchased credit impaired loans acquired in our acquisitions that are accounted for under ASC 310-20, the historical loss estimates are based on the historical losses experienced since acquisition. We record an allowance for loan losses only when the calculated amount exceeds the discount remaining from acquisition that was established for the similar period covered in the allowance for loan loss calculation. For all other purchased loans, the allowance is calculated in accordance with the methods used to calculate the allowance for loan losses for originated loans, as described below. Originated Loans The allowance for loan losses represents management's assessment of probable credit losses inherent in the loan portfolio. The allowance for loan losses consists of specific components, based on individual evaluation of certain loans, and general components for homogeneous pools of loans with similar risk characteristics. Impaired loans include loans placed on nonaccrual status and troubled debt restructurings. Loans are considered impaired when based on current information and events it is probable that we will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreements. When determining if we will be unable to collect all principal and interest payments due in accordance with the original contractual terms of the loan agreement, we consider the borrower's overall financial condition, resources and payment record, support from guarantors, and the realizable value of any collateral. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. All impaired loans are identified to be individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the discounted expected future cash flows or at the fair value of collateral if repayment is collateral dependent. The allowance for our nonimpaired loans, which includes commercial real estate, commercial and industrial, residential real estate, and consumer loans that are not individually evaluated for impairment, begins with a process of estimating the probable incurred losses in the portfolio. These estimates are established based on our historical loss data. Additional allowance estimates for commercial and industrial and commercial real estate loans are based on internal credit risk ratings. Internal credit risk ratings are assigned to each business loan at the time of approval and are subjected to subsequent periodic reviews by senior management, at least annually or more frequently upon the occurrence of a circumstance that affects the credit risk of the loan. There is no allowance on PPP loans (included in the commercial and industrial loan category) since they are 100% guaranteed by the SBA. 55 -------------------------------------------------------------------------------- Table of Contents The Company's current methodology on historical loss analysis incorporates and fully relies on the Company's own historical loss data. The historical loss estimates are established by loan type including commercial real estate, commercial and industrial, residential real estate, and consumer. In addition, consideration is given to the borrower's rating for commercial and industrial and commercial real estate loans. The following table presents, by loan type, the changes in the allowance for loan losses for the periods presented. For the three months
For the nine months ended September
ended September 30, 30,
(Dollars in thousands) 2021 2020 2021 2020
Balance at beginning of period $ 23,144 $ 17,063 $ 22,297 $ 12,674
Loan charge-offs:
Commercial and industrial (6) (10) (24) (1,729)
Residential real estate (242) (110) (242) (110)
Consumer (7) (4) (21) (47)
Total loan charge-offs (255) (124) (287) (1,886)
Recoveries of loans previously
charged-off:
Commercial real estate - 12 - 12
Commercial and industrial 8 15 44 47
Residential real estate 14 10 46 51
Consumer 9 8 15 22
Total loan recoveries 31 45 105 132
Net charge-offs (224) (79) (182) (1,754)
Provision expense (benefit) for loan
losses (1,189) 4,270 (384) 10,334
Balance at end of period $ 21,731 $ 21,254 $ 21,731 $ 21,254
Allowance for loan losses as a percentage
of period-end loans 1.26 % 1.15 % 1.26 % 1.15 %
Net charge-offs to average loans 0.05 0.02 0.01 0.14
Our allowance for loan losses was $21.7 million , or 1.26% of loans, at September
30, 2021 compared to $22.3 million , or 1.29% of loans, at December 31, 2020 . As
of September 30, 2021 and December 31, 2020 , the allowance for loan losses as a
percentage of loans excluding PPP loans (a non-GAAP measure), was 1.38% and
1.56%, respectively. The $566 thousand decrease in the allowance for loan losses
during the nine months ended September 30, 2021 was primarily due to a decrease
in general reserves related to the reduction in qualitative factors within the
allowance for loan loss model as a result of improved credit quality.
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The following table presents, by loan type, the allocation of the allowance for
loan losses at the dates presented.
Percentage of loans in
Allocated each category
(Dollars in thousands) Allowance to total loans
September 30, 2021
Balance at end of period applicable to:
Commercial real estate $ 9,790 45.1 %
Commercial and industrial 8,114 31.4
Residential real estate 3,823 23.5
Consumer 4 -
Total loans $ 21,731 100.0 %
December 31, 2020
Balance at end of period applicable to:
Commercial real estate $ 9,975 41.8 %
Commercial and industrial 8,786 39.8
Residential real estate 3,527 18.3
Consumer 9 0.1
Total loans $ 22,297 100.0 %
December 31, 2019
Balance at end of period applicable to:
Commercial real estate $ 5,773 49.2 %
Commercial and industrial 5,515 33.4
Residential real estate 1,384 17.3
Consumer 2 0.1
Total loans $ 12,674 100.0 %
December 31, 2018
Balance at end of period applicable to:
Commercial real estate $ 5,227 49.9 %
Commercial and industrial 5,174 34.0
Residential real estate 1,164 16.0
Consumer 1 0.1
Total loans $ 11,566 100.0 %
December 31, 2017
Balance at end of period applicable to:
Commercial real estate $ 4,852 49.4 %
Commercial and industrial 5,903 36.5
Residential real estate 950 14.0
Consumer 8 0.1
Total loans $ 11,713 100.0 %
Goodwill
The Company has acquired three banks, Lotus Bank in March 2015 , Bank of Michigan
in March 2016 , and Ann Arbor State Bank in January 2020 , which resulted in the
recognition of goodwill. Total goodwill was $35.6 million at September 30, 2021
and December 31, 2020 .
As a result of the unprecedented decline in economic conditions triggered by the
COVID-19 pandemic, the market valuations, including our stock price, saw a
significant decline in March 2020 , which then continued into the second quarter
of 2020. These events indicated that goodwill may be impaired and resulted in us
performing a qualitative goodwill impairment assessment in the second quarter of
2020. As a result of the analysis, we concluded that it was more-likely-than-not
that the fair value of the reporting unit could be greater than its carrying
amount.
Since the price of our stock did not fully recover during the third quarter of
2020, the Company engaged a reputable, third-party valuation firm to perform a
quantitative analysis of goodwill as of August 31, 2020 ("the valuation date").
In deriving the fair value of the reporting unit (the Bank), the third-party
firm assessed general economic conditions and outlook; industry and market
considerations and outlook; the impact of recent events on financial
performance; the market price of our common stock; and other relevant events. In
addition, the valuation relied on financial projections through 2023 and growth
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rates prepared by management. Based on the valuation prepared, it was determined
that the Company's estimated fair value of the reporting unit at August 31, 2020
was greater than its book value, and impairment of goodwill was not required.
The Company completed its annual goodwill impairment review as of October 1,
2020 , noting strong financial indicators for the Bank, solid credit quality
ratios, as well as the strong capital position of the Bank. In addition, third
quarter 2020 revenue reflected significant and continuing growth in our
residential mortgage banking business, as well as net SBA fees related to PPP
loans funded during second and third quarters of 2020. Management concurred with
the conclusion derived from the quantitative goodwill analysis as of August 31,
2020 and determined that there were no material changes between the valuation
date and October 1, 2020 . Management also determined that no triggering events
have occurred that indicated impairment from the most recent valuation date
through September 30, 2021 , the stock was trading above book value as of
September 30, 2021 , and it is more likely than not that there was no goodwill
impairment as of September 30, 2021 .
Deposits
Total deposits were $2.07 billion at September 30, 2021 and $1.96 billion at
December 31, 2020 , representing 89.5% and 88.1% of total liabilities,
respectively. The increase in deposits of $103.7 million was comprised of
increases of $225.1 million in demand deposits and $11.7 million in money market
and savings deposits, partially offset by a decrease of $133.1 million in time
deposits. The increase in deposits was primarily due to organic deposit growth
during the nine months ended September 30, 2021 mainly as a result of increased
customer liquidity and new customer growth.
Our average interest-bearing deposit costs were 0.35% and 1.06% for the nine
months ended September 30, 2021 and 2020, respectively. The decrease in
interest-bearing deposit costs between the two periods was primarily due to
lower interest rates paid as a result of revised internal deposit rates, mainly
driven by the continuation of the low level of the target federal funds rate.
The target federal funds interest rate decreased 150 basis points during March
2020 .
Brokered deposits. Brokered deposits are marketed through national brokerage
firms to their customers in $1,000 increments. For these brokered deposits,
detailed records of owners are maintained by The Depository Trust Company under
the name of CEDE & Co. This relationship provides a large source of deposits for
the Company. Due to the competitive nature of the brokered deposit market,
brokered deposits tend to bear higher rates of interest than non-brokered
deposits. At September 30, 2021 and December 31, 2020 , the Company had
approximately $23.1 million and $29.3 million , respectively, of brokered
deposits. The Company's ability to accept, roll-over or renew brokered deposits
is contingent upon the Bank maintaining a capital level of "well-capitalized."
Included in the brokered deposits total at September 30, 2021 and December 31,
2020 was $679 thousand and $1.2 million , respectively, in Certificate of Deposit
Account Registry Service ("CDARS") one-way buys that were acquired from Ann
Arbor State Bank .
Management understands the importance of core deposits as a stable source of
funding and may periodically implement various deposit promotion strategies to
encourage core deposit growth. For periods of rising interest rates, management
has modeled the aggregate yields for non-maturity deposits and time deposits to
increase at a slower pace than the increase in underlying market rates, which is
intended to result in net interest margin expansion and an increase in net
interest income.
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The following table sets forth the distribution of average deposits by account
type for the periods indicated below.
Three Months Ended September 30, 2021
Average Average
(Dollars in thousands) Balance Percent Rate
Noninterest-bearing demand deposits $ 774,926 37.9 % - %
Interest-bearing demand deposits 156,977 7.7 0.14
Money market and savings deposits 624,190 30.5 0.17
Time deposits 489,261 23.9 0.53
Total deposits $ 2,045,354 100.0 % 0.19 %
Nine Months Ended September 30, 2021
Average Average
(Dollars in thousands) Balance Percent Rate
Noninterest-bearing demand deposits $ 735,162 35.9 % - %
Interest-bearing demand deposits 144,449 7.1 0.15
Money market and savings deposits 623,123 30.5 0.20
Time deposits 541,018 26.5 0.58
Total deposits $ 2,043,752 100.0 % 0.23 %
The following table shows the contractual maturity of time deposits, including
CDARS and IRA deposits and other brokered funds, of $100 thousand and over that
were outstanding as of the date presented.
(Dollars in thousands) September 30, 2021
Maturing in:
3 months or less $ 108,867
3 months to 6 months 118,644
6 months to 1 year 120,922
1 year or greater 67,157
Total $ 415,590
Borrowings
Total debt outstanding at September 30, 2021 was $211.7 million , a decrease of
$18.6 million from $230.3 million at December 31, 2020 . The decrease in total
borrowings was primarily due to a $15.0 million redemption of subordinated debt
in June 2021 .
At September 30, 2021 , FHLB advances were secured by a blanket lien on $582.8
million of real estate-related loans, and repurchase agreements were secured by
securities with a fair value of $3.8 million . At December 31, 2020 , FHLB
advances were secured by a blanket lien on $512.3 million of real estate-related
loans, and repurchase agreements were secured by securities with a fair value of
$3.7 million .
As of September 30, 2021 , the Company had $30.0 million of subordinated notes
outstanding and debt issuance costs of $332 thousand related to these
subordinated notes. As of December 31, 2020 , the Company had $45.0 million of
subordinated notes outstanding and debt issuance costs of $408 thousand related
to these subordinated notes.
The $15.0 million of subordinated notes issued on December 21, 2015 had a fixed
interest rate of 6.375% per annum, payable semiannually through December 15,
2020 . From December 15, 2020 , through maturity, the notes had a floating
interest rate of three-month LIBOR plus 477 basis points payable quarterly
through maturity. The notes were scheduled to mature on December 15, 2025 , and
the Company had the option to redeem or prepay any or all of the subordinated
notes without premium or penalty any time after December 15, 2020 or upon an
occurrence of a Tier 2 capital event or tax event. These subordinated notes were
redeemed in June 2021 .
The $30.0 million of subordinated notes issued on December 18, 2019 bear a fixed
interest rate of 4.75% per annum, payable semiannually through December 18,
2024 . The notes will bear a floating interest rate of three-month SOFR plus 311
basis points payable quarterly after December 18, 2024 through maturity. The
notes mature on December 18, 2029 , and the Company has the option to redeem any
or all of the subordinated notes without premium or penalty any time after
December 18, 2024 or upon the occurrence of a Tier 2 capital event or tax event.
The issuance of the $30.0 million subordinated notes
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reflected management's efforts to fund the liquidity needs of the Company as
well as pay the merger consideration to purchase Ann Arbor State Bank .
Selected financial information pertaining to the components of our short-term
borrowings for the periods and as of the dates indicated is as follows:
For the three months ended September
30, For the nine months ended September 30,
(Dollars in thousands) 2021 2020 2021 2020
Securities sold under agreements to
repurchase
Average daily balance $ 2,517 $ 163 $ 3,011 $ 330
Weighted-average rate during period 0.25 % 0.30 % 0.25 % 0.30 %
Amount outstanding at period end $ 2,681 $ 187 $ 2,681 $ 187
Weighted-average rate at period end 0.25 % 0.30 % 0.25 % 0.30 %
Maximum month-end balance $ 2,681 $ 187 $ 3,993 $ 936
FHLB Advances
Average daily balance $ - $ - $ - $ 5,456
Weighted-average rate during period - % - % - % 0.99 %
Maximum month-end balance $ - $ - $ - $ 25,000
FHLB Line of Credit
Average daily balance $ - $ 63 $ 4 $ 60
Weighted-average rate during period - % - % 0.44 % 1.29 %
Federal funds purchased
Average daily balance $ - $ - $ - $ 193
Weighted-average rate during period - % - % - % 2.73 %
Capital Resources
Shareholders' equity is influenced primarily by earnings, dividends, the
Company's sales and repurchases of its common stock and changes in accumulated
other comprehensive income caused primarily by fluctuations in unrealized gains
or losses, net of taxes, on available for sale securities.
Shareholders' equity increased $18.6 million to $233.9 million at September 30,
2021 as compared to $215.3 million at December 31, 2020 . The increase in
shareholders' equity was primarily impacted by $25.4 million of net income
generated during the nine months ended September 30, 2021 , partially offset by
decreases of $3.3 million of accumulated other comprehensive income due to
decreases in net unrealized gains on available-for-sale securities, $1.4 million
of dividends declared on our preferred stock, $1.4 million of dividends declared
on our common stock, and $1.4 million of stock repurchased through the share
buyback program during the nine months ended September 30, 2021 .
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The following table summarizes the changes in our shareholders' equity for the
periods indicated below:
For the three months ended For the nine months ended September
September 30, 30,
(Dollars in thousands) 2021 2020 2021 2020
Balance at beginning of period $ 225,409 $ 180,259 $ 215,327 $ 170,703
Net income 9,465 5,209 25,403 12,040
Other comprehensive income (loss) (216) 783 (3,327) 4,451
Preferred stock offering, net of issuance
costs - 23,370 - 23,370
Redeemed stock - - (1,364) (620)
Common stock dividends declared (459) (387) (1,374) (1,160)
Dividends on 7.50% Series B Preferred
Stock (468) - (1,406) -
Exercise of stock options - - 243 95
Stock-based compensation expense 203 234 432 589
Balance at end of period $ 233,934 $ 209,468 $ 233,934 $ 209,468
We strive to maintain an adequate capital base to support our activities in a
safe and sound manner while at the same time attempting to maximize shareholder
value. We assess capital adequacy against the risk inherent in our balance
sheet, recognizing that unexpected loss is the common denominator of risk and
that common equity has the greatest capacity to absorb unexpected loss.
We are subject to various regulatory capital requirements both at the Company
level and at the Bank level. Failure to meet minimum capital requirements could
result in certain mandatory and possible additional discretionary actions by
regulators that, if undertaken, could have an adverse material effect on our
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, we must meet specific capital guidelines
that involve quantitative measures of our assets, liabilities, and certain
off-balance sheet items as calculated under regulatory accounting policies. We
have consistently maintained regulatory capital ratios at or above the
well-capitalized standards.
A capital conservation buffer, comprised of common equity tier 1 capital, is
established above the regulatory minimum capital requirements, and financial
institutions that maintain a capital conservation buffer of 2.5% are generally
not subject to the additional restrictions on dividends, share repurchases and
discretionary bonus payments to executive officers under the Basel III Rule.
At September 30, 2021 and December 31, 2020 , the Company's and the Bank's
capital ratios were in excess of the requirement to be "well capitalized" under
the regulatory guidelines.
The summary below compares the actual capital ratios with the minimum
quantitative measures established by regulation to ensure capital adequacy:
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Capital Adequacy
Capital Regulatory Well
Actual Adequacy Requirement + Capitalized
Capital Regulatory Capital Conservation Regulatory
Ratio Requirement Buffer(1) Requirement
September 30, 2021
Common equity tier 1 to risk-weighted
assets:
Consolidated 9.82 % 4.50 % 7.00 %
Bank 12.55 % 4.50 % 7.00 % 6.50 %
Tier 1 capital to risk-weighted assets:
Consolidated 11.19 % 6.00 % 8.50 %
Bank 12.55 % 6.00 % 8.50 % 8.00 %
Total capital to risk-weighted assets:
Consolidated 14.19 % 8.00 % 10.50 %
Bank 13.80 % 8.00 % 10.50 % 10.00 %
Tier 1 capital to average assets
(leverage ratio):
Consolidated 7.68 % 4.00 % 4.00 %
Bank 8.64 % 4.00 % 4.00 % 5.00 %
December 31, 2020
Common equity tier 1 to risk-weighted
assets:
Consolidated 9.30 % 4.50 % 7.00 %
Bank 11.94 % 4.50 % 7.00 % 6.50 %
Tier 1 capital to risk-weighted assets:
Consolidated 10.80 % 6.00 % 8.50 %
Bank 11.94 % 6.00 % 8.50 % 8.00 %
Total capital to risk-weighted assets:
Consolidated 14.91 % 8.00 % 10.50 %
Bank 13.20 % 8.00 % 10.50 % 10.00 %
Tier 1 capital to average assets
(leverage ratio):
Consolidated 6.93 % 4.00 % 4.00 %
Bank 7.67 % 4.00 % 4.00 % 5.00 %
(1) Reflects the capital conservation buffer of 2.5% for risk-weighted asset ratios.
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Contractual Obligations
In the ordinary course of our operations, we enter into certain contractual
obligations. Total contractual obligations at September 30, 2021 were
$686.4 million , a decrease of $152.2 million from $838.6 million at December 31,
2020 . The decrease of $152.2 million was primarily due to decreases of $133.1
million in time deposits and $14.9 million in subordinated notes.
The following tables present our contractual obligations as of September 30,
2021 and December 31, 2020 .
Contractual
Maturities as of
Less Than One to Three to Over
(Dollars in thousands) One Year Three Years Five Years Five Years Total
Operating lease obligations $ 1,820 $ 3,320 $ 2,446 $ 3,382 $ 10,968
Short-term borrowings 2,681 - - - 2,681
Long-term borrowings 13,105 14,272 22,000 130,000 179,377
Subordinated notes - - - 29,668 29,668
Time deposits 389,990 70,841 2,917 - 463,748
Total $ 407,596 $ 88,433 $ 27,363 $ 163,050 $ 686,442
Contractual
Maturities as of
Less Than One to Three to Over
(Dollars in thousands) One Year Three Years Five Years Five Years Total
Operating lease obligations $ 1,731 $ 3,478 $ 2,509 $ 3,775 $ 11,493
Short-term borrowings 3,204 - - - 3,204
Long-term borrowings 6,176 14,304 32,000 130,000 182,480
Subordinated notes - - 15,000 29,592 44,592
Time deposits 437,211 153,759 5,845 - 596,815
Total $ 448,322 $ 171,541 $ 55,354 $ 163,367 $ 838,584
Off-Balance Sheet Arrangements
In the normal course of business, the Company offers a variety of financial
instruments with off-balance sheet risk to meet the financing needs of its
customers. These financial instruments include outstanding commitments to extend
credit, credit lines, commercial letters of credit and standby letters of
credit. These are agreements to provide credit, as long as conditions
established in the contract are met, and usually have expiration dates.
Commitments may expire without being used. Off-balance sheet risk to credit loss
exists up to the face amount of these instruments, although material losses are
not anticipated. The same credit policies used for loans are used to make such
commitments, including obtaining collateral at exercise of the commitment.
We maintain an allowance to cover probable losses inherent in our financial
instruments with off-balance sheet risk. At September 30, 2021 , the allowance
for off-balance sheet risk was $318 thousand , compared to $490 thousand at
December 31, 2020 , and was included in "Other liabilities" on our consolidated
balance sheets.
A summary of the contractual amounts of our exposure to off-balance sheet risk
is as follows.
September 30, 2021 December 31, 2020
(Dollars in thousands) Fixed Rate Variable Rate Fixed Rate Variable Rate
Commitments to make loans $ 9,087
33,383 397,716 28,898 385,307
Unused standby letters of credit and commercial
letters of credit 3,353 - 2,340 1,992
Of the total unused lines of credit of $431.1 million at September 30, 2021 ,
$58.7 million was comprised of undisbursed construction loan commitments. The
Company expects to have sufficient access to liquidity to fund its off-balance
sheet commitments.
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Liquidity
Liquidity management is the process by which we manage the flow of funds
necessary to meet our financial commitments on a timely basis and at a
reasonable cost and to take advantage of earnings enhancement opportunities.
These financial commitments include withdrawals by depositors, credit
commitments to borrowers, expenses of our operations, and capital expenditures.
Liquidity is monitored and closely managed by the Bank's Asset and Liability
Committee (ALCO), a group of senior officers from the finance, enterprise risk
management, treasury, and lending areas, as well as two board members. It is
ALCO's responsibility to ensure we have the necessary level of funds available
for normal operations as well as maintain a contingency funding policy to ensure
that potential liquidity stress events are planned for and quickly identified,
and management has plans in place to respond. ALCO has created policies which
establish limits and require measurements to monitor liquidity trends, including
modeling and management reporting that identifies the amounts and costs of all
available funding sources. In addition, we have implemented modeling software
that projects cash flows from the balance sheet under a broad range of potential
scenarios, including severe changes in the economic environment.
During the second quarter of 2020, management took steps to increase liquidity
on the balance sheet and expand the capacity for additional funding in the
uncertain economic environment due to COVID-19. Management maintained an
elevated level of liquidity on the balance sheet in the third quarter of 2021,
and will continue to monitor and determine the appropriate levels of liquidity
as economic conditions develop. Furthermore, the Company continues to monitor
its capital ratios regularly and has benefited from income from participation in
the PPP, offset by potential stress from the weakening economy due to the
COVID-19 pandemic.
At September 30, 2021 , we had liquid assets of $592.7 million , compared to
$455.4 million at December 31, 2020 . Liquid assets include cash and due from
banks, federal funds sold, interest-bearing deposits with banks and unencumbered
securities available-for-sale. Cash and due from banks increased to $293.8
million , compared to $264.1 million at December 31, 2020 primarily as a result
of forgiveness of PPP loans and increased deposit balances.
The Bank is a member of the FHLB, which provides short- and long-term funding to
its members through advances collateralized by real estate-related assets and
other select collateral, most typically in the form of debt securities. The
actual borrowing capacity is contingent on the amount of collateral available to
be pledged to the FHLB. As of September 30, 2021 , we had $178.1 million of
outstanding borrowings from the FHLB, and these advances were secured by a
blanket lien on $582.8 million of real estate-related loans. Based on this
collateral and the approved policy limits, the Company is eligible to borrow up
to an additional $219.4 million from the FHLB. Additionally, the Bank can borrow
up to $157.5 million through the unsecured lines of credit it has established
with eight other banks, as well as $5.1 million through a secured line with the
Federal Reserve Bank .
Further, because the Bank is "well capitalized," it can accept wholesale funding
up to 40% of total assets, or approximately $1.02 billion , based on current
policy limits at September 30, 2021 . Management believed that as of September
30, 2021 , we had adequate resources to fund all of our commitments.
The following liquidity ratios compare certain assets and liabilities to total
deposits or total assets.
September 30, 2021 December 31, 2020
Investment securities available-for-sale to total assets 15.31 % 12.39 %
Loans to total deposits 83.20 87.79
Interest-earning assets to total assets 94.17 94.64
Interest-bearing deposits to total deposits 61.69 68.49
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