LEVEL ONE BANCORP, INC. The following discussion explains our financial condition as of and for the three and nine months endedSeptember 30, 2020 . 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, 2019 , filed with theSEC onMarch 13, 2020 . 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; 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; risks related to mergers and acquisitions; changes in benchmark interest rates used to price loans and deposits, including the expected elimination of LIBOR; 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. The most critical of these significant accounting policies are set forth in "Note 1 - Basis of Presentation and Summary of Significant Accounting Policies" of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year endedDecember 31, 2019 , which was filed with theSEC onMarch 13, 2020 . There have been no significant changes in critical accounting policies or the assumptions and judgments utilized in applying these policies sinceDecember 31, 2019 . 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, provides property and casualty insurance to the Company and the Bank and reinsurance to ten other third-party insurance captives for which insurance may not be currently available or economically feasible in the insurance marketplace. During the third quarter of 2020, it was determined thatHamilton Court Insurance Company will exit the pool resources relationship to which it was previously a member and will dissolve, which is expected to occur in the fourth quarter of 2020 or the first quarter of 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. Since 2007, we have grown substantially through organic growth and a series of five acquisitions, all of which have been fully integrated into our operations. We have made significant investments over the last several years in hiring additional staff and upgrading technology and system security. In 2016, we opened our first branch in theGrand Rapids, Michigan market. In the third quarter of 2017, we opened our second location inBloomfield Township located inOakland County . In the third quarter of 2018, we doubled the size of our mortgage division with the addition of new mortgage officers and support staff. 44 -------------------------------------------------------------------------------- OnJanuary 2, 2020 , the Company completed its previously announced acquisition ofAnn Arbor Bancorp, Inc. ("AAB") and its wholly owned subsidiary,Ann Arbor State Bank . The transaction was completed pursuant to a merger of the Company's wholly owned merger subsidiary ("Merger Sub") with and into AAB, pursuant to the Agreement and Plan of Merger, dated as ofAugust 12, 2019 , among the Company, Merger Sub and AAB. The Company paid aggregate consideration of approximately$67.9 million in cash. Our results of operations for the three and nine months endedSeptember 30, 2020 include the results of operations of AAB on and afterJanuary 2, 2020 , including$17 thousand and$1.7 million of acquisition fees, respectively. Results for periods beforeJanuary 2, 2020 reflect only those of Level One and do not include the results of operations of AAB. See "Note 2 - Business Combinations" for more information. In addition, all identifiable assets, including the intangible assets that consisted of$26.2 million in goodwill and$3.7 million in core deposit intangibles, and liabilities of AAB as of the merger date have been recorded at their estimated fair value and added to those of Level One. As ofSeptember 30, 2020 , the Company had total consolidated assets of$2.45 billion , total consolidated deposits of$1.94 billion and total consolidated shareholders' equity of$209.5 million . Recent Developments Third Quarter Dividend. OnSeptember 16, 2020 , the Company declared a third quarter 2020 cash dividend of$0.05 per common share, payable onOctober 15, 2020 . Preferred Stock Public Offering and First Cash Dividend. OnAugust 10, 2020 , the Company sold 1,000,000 depositary shares, each representing a 1/100th interest in a share of 7.50% Non-Cumulative Perpetual Preferred Stock, Series B, with a liquidation preference of$2,500 per share of Preferred Stock (equivalent to$25 per depositary share). The aggregate offering price for the shares sold by the Company was$25.0 million , and after deducting$1.6 million of underwriting discounts and offering expenses paid to third parties, the Company received total net proceeds of$23.4 million . OnOctober 21, 2020 , Level One's Board of Directors declared a quarterly cash dividend of$47.92 per share on its 7.50% Non-Cumulative Preferred Stock, Series B. Holders of depositary shares will receive$0.4792 per depositary share. The dividend is payable onNovember 15, 2020 , to shareholders of record at the close of business onOctober 31, 2020 . 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 adverse impact on the economy, the banking industry and the Company in future fiscal periods, all subject to a high degree of uncertainty. Effects on Our Market Areas. Our commercial and consumer banking products and services are offered primarily inMichigan , where individuals, companies and other organizations have limited their economic activity in response to the pandemic. It is uncertain whether and to what extent additional restrictions on economic activities and social gatherings will be imposed in future periods. These limitations on economic activity have had an adverse impact on theMichigan economy and our clients. The Bank and its branches have remained open during these orders because banks have been deemed essential businesses. Up untilJune 22, 2020 , the Bank had been serving its customers through its drive-thrus, by appointment only for in-person services, and online and mobile banking tools. While our branches became fully available for in-person services to serve our clients onJune 22, 2020 , we will continue to be diligent in our efforts to follow all CDC guidelines to ensure the health and safety of our clients and team members. As a result of the COVID-19 pandemic, the state's unemployment rate remained slightly elevated at 8.5% inSeptember 2020 compared to 4.1% inMarch 2020 before the full impact of COVID-19, according to theMichigan Department of Technology, Management & Budget . 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 Federal Reserve decreased the range for the federal funds target rate by 0.5% onMarch 3, 2020 , and by another 1.0% onMarch 16, 2020 , reaching a range of 0.0 - 0.25%. •OnMarch 27, 2020 ,President Trump signed the Coronavirus Aid, Relief and Economic Security Act ("CARES Act"), which established a$2.0 trillion economic stimulus package, including cash payments to individuals, supplemental unemployment insurance benefits and a$349 billion loan program administered through theU.S. Small Business Administration ("SBA"), referred to as the paycheck protection program ("PPP"). The Bank participated as a lender in the PPP. After the initial$349 billion in funds for the PPP was exhausted, an additional$310 billion in funding for PPP loans was authorized. In addition, the CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited 45 -------------------------------------------------------------------------------- period of time to account for the effects of COVID-19. Refer to Note 4 - Loans for further discussion of the CARES Act and its impact on TDRs. •OnApril 7, 2020 , federal banking regulators issued a revised Interagency Statement on Loan Modifications and Reporting for Financial Institutions, which, among other things, encouraged financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment 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. •OnApril 9, 2020 , theFederal Reserve announced additional measures aimed at supporting small and midsized business, as well as state and local governments impacted by COVID-19. TheFederal Reserve announced the Main Street Business Lending Program, which establishes three new loan facilities intended to facilitate lending to small and midsized businesses: (1) the Main Street New Loan Facility ("MSNLF"), (2) the Main Street Priority Loan Facility ("MSPLF"), and (3) the Main Street Expanded Loan Facility ("MSELF"). MSNLF and MSPLF loans are unsecured term loans originated on or afterApril 24, 2020 , while MSELF loans are provided as upsized tranches of existing loans originated beforeApril 24, 2020 . The combined size of the program is authorized up to$600 billion . The Company is currently participating in all three loan facilities established by the Main Street Business Lending Program. •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 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 ("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. TheFederal Reserve also issued guidance encouraging banking institutions to utilize 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. TheFDIC has also acted to mitigate the deposit insurance assessment effects of participating in the PPP and theFederal Reserve's PPP Liquidity Facility and Money Market Mutual Fund Liquidity Facility. •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. Effects on Our Business. We currently expect that the COVID-19 pandemic and the specific developments referred to above will have a significant impact on our business. In particular, we anticipate that a significant portion of the Bank's borrowers in the restaurant and hospitality industries will continue to endure significant economic distress, which has caused, and will continue to cause, them to draw on their existing lines of credit and adversely affect their ability and willingness to repay existing indebtedness, and is expected to adversely impact the value of collateral. 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. See "Part II-Item 1A. Risk Factors" for additional information regarding the effects and risks of the COVID-19 pandemic to our business, financial condition and results of operations. 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 current COVID-19 pandemic health crisis. For our customers, we have provided loan payment deferrals and offered fee waivers, among other actions. ThroughSeptember 30, 2020 , we have helped our consumer and small business customers by deferring loan payments and waiving fees on$416.3 million of non-PPP loans ($388.9 million of commercial balances and$27.4 million of consumer balances). As ofSeptember 30, 2020 , we had$16.3 million of loans that had an outstanding payment deferral. We are continuing to enable the vast majority of our main office team members to work remotely each day. 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 a comprehensive return to office plan. In addition, while our 46 -------------------------------------------------------------------------------- branches have fully opened to serve our clients, we continue to be diligent in our efforts to follow all CDC guidelines to ensure the health and safety of our clients and team members. We will continue to evaluate this fluid situation and take additional actions as necessary. To support our communities, we have made charitable donations, including one to a local health system, in order to help support the frontline workers impacted by the COVID-19 pandemic. Level One also recognizes that some of the most impacted industries are the food service and hospitality industries. As ofSeptember 30, 2020 , Level One had less than 4.4% and 0.5% of loan concentrations in the food service and hospitality industries, respectively. 47
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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,
data) September 30, 2020 2020 September 30, 2019 September 30, 2020 September 30, 2019 Earnings Summary Interest income $ 20,245$ 20,396 $ 17,983 $ 60,458 $ 53,082 Interest expense 3,648 4,163 4,995 12,808 14,935 Net interest income 16,597 16,233 12,988 47,650 38,147 Provision expense (benefit) for loan losses 4,270 5,575 (16) 10,334 835 Noninterest income 9,125 7,789 3,858 21,604 9,621 Noninterest expense 15,126 15,083 11,539 44,771 33,074 Income before income taxes 6,326 3,364 5,323 14,149 13,859 Income tax provision 1,117 643 914 2,109 2,428 Net income 5,209 2,721 4,409 12,040 11,431 Net income allocated to participating securities 40 19 45 140
110
Net income attributable to common shareholders $ 5,169$ 2,702 $ 4,364 $ 11,900 $
11,321
Per Share Data Basic earnings per common share $ 0.68$ 0.35 $ 0.57 $ 1.56 $
1.48
Diluted earnings per common share 0.67 0.35 0.56 1.55
1.46
Diluted earnings per common share, excluding acquisition and due diligence fees (1) 0.67 0.37 0.60 1.72
1.50
Book value per common share 24.06 23.31 21.77 27.08
21.77
Tangible book value per common share (1) 18.74 18.09 20.51 18.74
20.51
Preferred shares outstanding (in thousands) 10 - - 10 - Common shares outstanding (in thousands) 7,734 7,734 7,714 7,734
7,714
Average basic common shares (in thousands) 7,675 7,676 7,721 7,640
7,738
Average diluted common shares (in thousands) 7,712 7,721 7,752 7,701
7,776
Selected Period End Balances Total assets$ 2,446,447 $ 2,541,696 $ 1,509,463 $ 2,446,447 $
1,509,463
Securities available-for-sale 253,527 217,172 205,242 253,527 205,242 Total loans 1,843,888 1,815,353 1,168,923 1,843,888 1,168,923 Total deposits 1,943,435 1,821,351 1,194,542 1,943,435 1,194,542 Total liabilities 2,236,979 2,361,437 1,341,495 2,236,979 1,341,495 Total shareholders' equity 209,468 180,259 167,968 209,468
167,968
Total common shareholders' equity 186,098 180,259 167,968 186,098
167,968
Tangible common shareholders' equity (1) 144,963 139,913 158,250 144,963
158,250
Performance and Capital Ratios Return on average assets 0.83 % 0.46 % 1.16 % 0.71 % 1.02 % Return on average equity 10.48 6.02 10.58 8.68 9.51 Net interest margin (fully taxable equivalent) (2) 2.80 2.98 3.59 3.04
3.61
Efficiency ratio (noninterest expense/net interest income plus noninterest income) 58.81 62.79 68.50 64.65 69.24 Dividend payout ratio 7.41 14.22 7.03 8.99 7.45 Total shareholders' equity to total assets 8.56 7.09 11.13 8.56
11.13
Tangible common equity to tangible assets (1) 6.03 5.59 10.55 6.03
10.55
Common equity tier 1 to risk-weighted assets 8.83 8.76 11.73 8.83
11.73
Tier 1 capital to risk-weighted assets 10.31 8.76 11.73 10.31
11.73
Total capital to risk-weighted assets 14.39 12.81 13.84 14.39
13.84
Tier 1 capital to average assets (leverage ratio) 7.17 6.21 10.12 7.17
10.12
Asset Quality Ratios: Net charge-offs to average loans 0.02 % 0.34 % 0.01 % 0.14 % 0.03 % Nonperforming assets as a percentage of total assets 0.79 0.33 0.78 0.79
0.78
Nonaccrual loans as a percent of total loans 1.04 0.46 0.98 1.04
0.98
Allowance for loan losses as a percentage of total loans 1.15 0.94 1.05 1.15
1.05
Allowance for loan losses as a percentage of nonaccrual loans 110.32 206.37 107.46 110.32
107.46
Allowance for loan losses as a percentage of nonaccrual loans, excluding allowance allocated to loans accounted for under ASC 310-30 105.46 195.04 100.52 105.46
100.52
(1) See section entitled "GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures" below. (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 and 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
September 30, June 30, September 30,
(Dollars in thousands, except per share data) 2020 2020 2019
(Unaudited) (Unaudited) (Unaudited)
Total shareholders' equity $ 209,468 $ 180,259 $ 167,968
Less:
Preferred stock 23,370 - -
Total common shareholders' equity 186,098 180,259 167,968
Less:
Goodwill 35,554 35,554 9,387 Other intangible assets, net 5,581 4,792 331 Tangible common shareholders' equity$ 144,963 $ 139,913 $ 158,250 Common shares outstanding (in thousands) 7,734 7,734 7,714 Tangible book value per common share$ 18.74 $ 18.09 $ 20.51 Total assets$ 2,446,447 $ 2,541,696 $ 1,509,463 Less: Goodwill 35,554 35,554 9,387 Other intangible assets, net 5,581 4,792 331 Tangible assets$ 2,405,312 $ 2,501,350 $ 1,499,745 Tangible common equity to tangible assets 6.03 % 5.59 % 10.55 %
Adjusted Income and Diluted Earnings Per Share
For the three months ended For the nine months ended
(Dollars in thousands, except per September 30, June 30, September 30, September 30, September 30,
share data) 2020 2020 2019 2020 2019
(Unaudited) (Unaudited) (Unaudited) (Unaudited) (Unaudited)
Net income, as reported $ 5,209 $ 2,721 4,409 $ 12,040 11,431
Acquisition and due diligence fees 17 176 319 1,664 319
Income tax benefit (1) (4) (34) (25) (333) (25)
Net income, excluding acquisition
and due diligence fees $ 5,222 $ 2,863 4,703 $ 13,371 11,725
Diluted earnings per share, as
reported $ 0.67 $ 0.35 $ 0.56 $ 1.55 $ 1.46
Effect of acquisition and due
diligence fees, net of income tax
benefit 0.00 0.02 0.04 0.17 0.04
Diluted earnings per common share,
excluding acquisition and due
diligence fees $ 0.67 $ 0.37 $ 0.60 $ 1.72 $ 1.50(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
September 30, June 30,
(Dollars in thousands, except per share data) 2020 2020 September 30, 2019
(Unaudited) (Unaudited) (Unaudited)
Total loans $ 1,843,888 $ 1,815,353 $ 1,168,923
Less:
PPP loans 392,521 388,264 -
Total loans, excluding PPP loans $ 1,451,367 Allowance for loan loss 21,254 17,063 12,307
Allowance for loan loss as a percentage of total loans 1.15 %
0.94 % 1.05 %
Allowance for loan loss as a percentage of total loans
excluding PPP loans 1.46 % 1.20 % 1.05 %
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Results of Operations
Net Income
We had net income of $5.2 million , or $0.67 per diluted common share, for the
three months ended September 30, 2020 , compared to $4.4 million , or $0.56 per
diluted common share, for the three months ended September 30, 2019 . The
increase of $800 thousand in net income reflected increases of $5.3 million in
noninterest income, primarily as a result of higher mortgage banking income, and
$3.6 million in net interest income due to higher interest income on loans and
lower interest expense on deposits year over year. This was partially offset by
increases of $4.3 million in provision for loan losses as a result of the
economic factors relating to COVID-19 and $3.6 million in noninterest expense
mainly as a result of higher salary and employee benefits.
We had net income of $12.0 million , or $1.55 per diluted common share, for the
nine months ended September 30, 2020 , compared to $11.4 million , or $1.46 per
diluted common share, for the nine months ended September 30, 2019 . The increase
of $609 thousand in net income primarily reflected increases of $12.0 million in
noninterest income and $9.5 million in net interest income and a decrease of
$319 thousand in income tax provision. The factors contributing to the increases
in noninterest income and net interest income year over year are noted above.
This was partially offset by increases of $11.7 million in noninterest expense,
primarily due to higher salary and employee benefits as well as increase
acquisition and due diligence fees, and $9.5 million in provision for loan
losses due to the same factors discussed above.
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 $16.6 million in the third quarter of 2020 was $3.6
million higher than net interest income of $13.0 million in the third quarter of
2019. The three months ended September 30, 2020 included a $2.3 million increase
in interest income as well as a $1.3 million decrease in interest expense,
compared to the same period in 2019. The increase in interest income was
primarily driven by increases of $2.6 million in interest and fees on loans
partially offset by a decrease of $180 thousand in interest on investment
securities. The increase in interest and fees on loans for the three months
ended September 30, 2020 compared to the same period in 2019 was mainly driven
by an increase of $688.4 million in the average balance of loans primarily as a
result of the origination of $392.5 million of PPP loans and the acquisition of
Ann Arbor State Bank . In the third quarter of 2020, the Bank earned $1.5 million
of the total projected $12.1 million net SBA fees on PPP loans, with the
remaining expected to be earned over the life of the loans, the majority of
which are expected to mature two years from the date of funding unless modified
by the lender and borrower. In addition to the net SBA fees, the Bank also
recognized $1.0 million of interest income on the PPP loans. The decrease in
interest on investment securities was mainly due to lower average interest
rates. The decrease in interest expense was primarily driven by a decrease of
$2.2 million in interest expense on deposits partially offset by increases of
$432 thousand of interest expense on borrowed funds and $376 thousand of
interest expense on subordinated notes. The decrease in deposit interest expense
during the three months ended September 30, 2020 compared to 2019 was primarily
due to lower interest rates paid as a result of revised internal deposit rates,
mainly driven by the decreases in the target federal funds interest rate of 150
basis points during first quarter of 2020 and 25 basis points in each of August,
September and October of 2019. The increase in interest expense on subordinated
notes was primarily due to the issuance of $30.0 million of subordinated debt in
the fourth quarter of 2019. The increase in interest expense on borrowings was
mainly driven by an increase of $323.3 million in the average balance of
borrowings primarily as a result of funding PPP loans through FRB borrowings.
Net interest income of $47.7 million for the nine months ended September 30,
2020 was $9.4 million higher than the net interest income of $38.1 million for
the nine months ended September 30, 2019 . The nine months ended September 30,
2020 included a $7.4 million increase in interest income as well as a $2.0
million decrease in interest expense, compared to the same period in 2019. The
increase in interest income was primarily driven by increases of $8.3 million in
interest and fees on loans partially offset by a decrease of $677 thousand in
interest on investment securities. The increase in interest and fees on loans
for the nine months ended September 30, 2020 compared to the same period in 2019
was mainly driven by an increase of $538.2 million in the average balance of
loans primarily as result of the acquisition of Ann Arbor State Bank , as well as
the origination of PPP loans. In the nine months ending September 30, 2020 , the
Bank earned $2.9 million of the total projected $12.1 million net SBA fees on
PPP loans, with the remaining expected to be earned over the life of the loans,
the majority of which are expected to mature two years from the date of funding
unless modified by the lender and borrower. In addition to the net SBA fees, the
Bank also recognized $1.8 million of interest income on the PPP loans. The
decrease in interest income on investment securities was mainly due to lower
average interest rates. The decrease in interest expense was primarily driven by
a decrease of $4.2 million in interest expense on deposits partially offset by
increases of $1.1 million in interest expense on subordinated notes and $906
thousand in interest expense on borrowed funds. The increase in interest expense
on borrowings was mainly
49
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driven by an increase of $249.0 million in the average balance of borrowings
primarily as a result of higher FHLB borrowings as well as funding PPP loans
through FRB borrowings. The increase in interest expense on subordinated notes
was due to the same factors mentioned above.
Our net interest margin (on a fully tax equivalent basis ("FTE")) for the three
months ended September 30, 2020 was 2.80%, compared to 3.59% for the same period
in 2019. The decrease of 79 basis points in the net interest margin year over
year was primarily a result of lower average loan yield as well as lower yields
on interest earning cash balances. Average loan yield decreased to 3.98% for the
third quarter of 2020, compared to 5.41% for the third quarter of 2019,
primarily due to the target federal funds interest rate dropping 150 basis
points in March 2020 in response to the COVID-19 pandemic and decreasing 25
basis points in each of August, September and October of 2019. Another
contributing factor to the decrease in loan yields was the impact of the PPP
loans originated during the second and third quarters of 2020, which had an
average yield of 2.59%, net of deferred fees/costs, compared to the non-PPP
loans which had an average yield of 4.35%. The decrease in loan yields was
accompanied by a corresponding decrease in the cost of funds, which declined 110
basis points to 0.88% in the third quarter 2020 from 1.98% in the third quarter
of 2019. Finally, during the third quarter of 2020, our average interest-earning
cash balances of $259.3 million , of which the vast majority comprised of excess
funding from the PPP process, earned 0.12%, which negatively affected the net
interest margin. As a result of the reductions in the target federal funds
interest rate, as well as the impact of the COVID-19 pandemic, we expect that
our net interest income and net interest margin will decrease in future periods.
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 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 the three months ended September 30, 2020 and 2019, the yield on total loans
was impacted by 7 basis points and 15 basis points, respectively, due to the
accretable yield on purchased credit impaired loans. Our net interest margin for
the three months ended September 30, 2020 and 2019, benefited by 8 basis points
and 13 basis points, respectively, as a result of the excess accretable yield.
As of September 30, 2020 and December 31, 2019 , our remaining accretable yield
was $7.9 million and $9.1 million , respectively, and our nonaccretable
difference was $2.7 million and $3.9 million , respectively.
Our net interest margin (FTE) for the nine months ended September 30, 2020 was
3.04%, compared to 3.61% for the same period in 2019. The decrease of 57 basis
points reflected the lower average loan yield as well as lower average interest
earning cash yield that is described above. For the nine months ended September
30, 2020 and 2019, the average yield on total loans was 4.40% and 5.49%,
respectively. PPP loans had an average yield of 2.87%, net of deferred
fees/costs, compared to the non-PPP loans which had an average yield of 4.62%.
The yield on total loans was impacted by 7 basis points and 15 basis points,
respectively due to the accretable yield on purchased credit impaired loans. Our
net interest margin for the nine months ended September 30, 2020 and 2019,
benefited by 9 basis points and 12 basis points, respectively, as a result of
the excess accretable yield.
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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 30,
2020 2019
Interest Average Yield/Rate Interest Average Yield/Rate
(Dollars in thousands) Average Balance Revenue/Expense (1) (2) Average Balance Revenue/Expense (1) (2)
Interest-earning assets:
Gross loans(3) $ 1,871,164 $ 18,730 3.98 % $ 1,182,764 $ 16,134 5.41 %
Investment securities(4):
Taxable 139,237 652 1.86 121,473 857 2.80
Tax-exempt 94,526 613 3.19 85,332 588 3.28
Interest-earning cash balances 259,349 76 0.12 51,142 289 2.24
Other investments 12,419 174 5.57 8,325 115 5.48
Total interest-earning assets $ 2,376,695 $ 20,245 3.41 % $ 1,449,036 $ 17,983 4.96 %
Non-earning assets:
Cash and due from banks 27,571 23,103
Premises and equipment 15,791 13,228
Goodwill 35,554 9,387
Other intangible assets, net 4,980 347
Bank-owned life insurance 18,006 12,023
Allowance for loan losses (17,321) (12,241)
Other non-earning assets 55,899 27,145
Total assets $ 2,517,175 $ 1,522,028
Interest-bearing liabilities:
Deposits:
Interest-bearing demand deposits $ 116,285 $ 65 0.22 % $ 51,963 $ 63 0.48 %
Money market and savings deposits 513,420 556 0.43 320,363 1,170 1.45
Time deposits 575,179 1,702 1.18 543,765 3,245 2.37
Borrowings 394,020 693 0.70 70,766 261 1.46
Subordinated notes 44,468 632 5.65 14,925 256 6.81
Total interest-bearing liabilities $ 1,643,372 $ 3,648 0.88 % $ 1,001,782 $ 4,995 1.98 %
Noninterest-bearing liabilities and shareholders'
equity:
Noninterest-bearing demand deposits $ 640,095 $ 333,690
Other liabilities 34,846 19,804
Shareholders' equity 198,862 166,752
Total liabilities and shareholders' equity $ 2,517,175 $ 1,522,028
Net interest income $ 16,597 $ 12,988
Interest spread 2.53 % 2.98 %
Net interest margin(5) 2.78 % 3.56 %
Tax equivalent effect 0.02 % 0.03 %
Net interest margin on a fully tax equivalent
basis 2.80 % 3.59 %
______________________________________________________________________
(1) Interest income is shown on actual basis and does not include taxable equivalent adjustments. (2) Average rates and yields are presented on an annual basis and include a taxable equivalent adjustment to interest income of$144 thousand and$118 thousand on tax-exempt securities for the three months endedSeptember 30, 2020 and 2019, respectively, using the federal corporate tax rate of 21%. (3) Includes nonaccrual loans. (4) 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. (5) Net interest margin represents net interest income divided by average total interest-earning assets. 51
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For the nine months ended September 30,
2020 2019
Interest Interest
(Dollars in thousands) Average Balance Revenue/Expense(1) Average Yield/Rate(2) Average Balance Revenue/Expense(1) Average Yield/Rate(2)
Interest-earning assets:
Gross loans(3) $ 1,696,073 $ 55,817 4.40 % $ 1,157,837 $ 47,547 5.49 %
Investment securities(4):
Taxable 124,169 1,930 2.08 135,460 2,773 2.74
Tax-exempt 97,104 1,894 3.20 84,476 1,728 3.28
Interest-earning cash balances 188,179 400 0.28 37,359 670 2.40
Other investments 12,401 417 4.49 8,325 364 5.85
Total interest-earning assets $ 2,117,926 $ 60,458 3.84 % $ 1,423,457 $ 53,082 5.02 %
Non-earning assets:
Cash and due from banks 26,264 24,075
Premises and equipment 16,195 13,252
Goodwill 35,894 9,387
Other intangible assets, net 4,420 383
Bank-owned life insurance 17,868 11,955
Allowance for loan losses (14,387) (11,950)
Other non-earning assets 47,714 18,642
Total assets $ 2,251,894 $ 1,489,201
Interest-bearing liabilities:
Deposits:
Interest-bearing demand deposits $ 112,579 $ 262 0.31 % $ 53,894 $ 180 0.45 %
Money market and savings deposits 458,438 2,217 0.65 307,461 3,389 1.47
Time deposits 564,396 6,560 1.55 556,922 9,647 2.32
Borrowings 311,024 1,866 0.80 62,006 960 2.07
Subordinated notes 44,463 1,903 5.72 14,910 759 6.81
Total interest-bearing liabilities $ 1,490,900 $ 12,808 1.15 % $ 995,193 $ 14,935 2.01 %
Noninterest-bearing liabilities and
shareholders' equity:
Noninterest-bearing demand deposits $ 546,066 $ 316,754
Other liabilities 30,047 17,048
Shareholders' equity 184,881 160,206
Total liabilities and shareholders' equity
$
1,489,201
Net interest income $ 47,650 $ 38,147 Interest spread 2.69 % 3.01 % Net interest margin(5) 3.01 % 3.58 % Tax equivalent effect 0.03 % 0.03 % Net interest margin on a fully tax equivalent basis 3.04 % 3.61 % (1) Interest income is shown on actual basis and does not include taxable equivalent adjustments. (2) Average rates and yields are presented on an annual basis and include a taxable equivalent adjustment to interest income of$431 thousand and$347 thousand on tax-exempt securities for the nine months endedSeptember 30, 2020 and 2019, respectively, using the federal corporate tax rate of 21%. (3) Includes nonaccrual loans. (4) 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. (5) Net interest margin represents net interest income divided by average total interest-earning assets. 52
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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 $ (5,085) $ 7,681 $ 2,596
Investment securities:
Taxable (317) 112 (205)
Tax-exempt (49) 74 25
Interest-earning cash balances (486) 273 (213)
Other investments 59 - 59
Total interest income (5,878) 8,140 2,262
Interest-bearing liabilities
Interest-bearing demand deposits (47) 49 2
Money market and savings deposits (1,091) 477 (614)
Time deposits (1,721) 178 (1,543)
Borrowings (202) 634 432
Subordinated debt (52) 428 376
Total interest expense (3,113) 1,766 (1,347)
Change in net interest income $ (2,765) $ 6,374 $ 3,609
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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 $ (10,773) $ 19,043 $ 8,270
Investment securities:
Taxable (625) (218) (843)
Tax-exempt (137) 303 166
Interest-earning cash balances (1,016) 746 (270)
Other investments (98) 151 53
Total interest income (12,649) 20,025 7,376
Interest-bearing liabilities
Interest-bearing demand deposits (68) 150 82
Money market and savings deposits (2,398) 1,226 (1,172)
Time deposits (3,215) 128 (3,087)
Borrowings (895) 1,801 906
Subordinated debt (138) 1,282 1,144
Total interest expense (6,714) 4,587 (2,127)
Change in net interest income $ (5,935) $ 15,438 $ 9,503
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 purchased 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 of September 30, 2020 , and December 31,
2019 , our remaining accretable yield was $7.9 million and $9.1 million , and our
nonaccretable difference was $2.7 million and $3.9 million , respectively.
The provision for loan losses was a provision expense of $4.3 million for the
three months ended September 30, 2020 compared to a $16 thousand provision
benefit for the same period in 2019. The $4.3 million increase in the provision
for loan losses was primarily a result of a $3.3 million increase in general
reserves due to the uncertainty surrounding the impact of the COVID-19 pandemic
on the loan portfolio as well as a $794 thousand increase in specific reserves.
The provision for loan losses was a provision expense of $10.3 million for the
nine months ended September 30, 2020 , compared to $835 thousand for the nine
months ended September 30, 2019 . The increase of $9.5 million in the provision
for loan losses was primarily as a result of a $6.7 million increase in general
reserves due to an adjustment of qualitative factors attributable to the
COVID-19 pandemic during the second and third quarters of 2020. In addition,
there was a $1.6 million increase in provision resulting primarily from a $1.3
million chargeoff during the second quarter of 2020 on a nonaccrual loan that
was subsequently sold. Lastly, there was also a $782 thousand increase in
specific reserves on loans individually evaluated
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for impairment. The Company will continue to monitor the impacts of the COVID-19
pandemic and will re-evaluate the appropriateness of the provision for loan
losses in future quarters as needed.
Noninterest Income
The following table presents noninterest income for the three and nine months
ended September 30, 2020 and 2019.
For the three months ended For the nine months ended September
September 30, 30,
(Dollars in thousands) 2020 2019 2020 2019
Noninterest income
Service charges on deposits $ 616 $ 627 $ 1,798 $ 1,914
Net gain on sales of securities 434 151 1,862 151
Mortgage banking activities 7,108 2,352 15,380 5,788
Other charges and fees 967 728 2,564 1,768
Total noninterest income $ 9,125 $ 3,858 $ 21,604 $ 9,621
Noninterest income increased $5.2 million to $9.1 million for the three months
ended September 30, 2020 compared to $3.9 million for the same period in 2019.
The increase in noninterest income was primarily due to increases in mortgage
banking activities of $4.8 million and net gains on sales of securities of $283
thousand . The increase in the mortgage banking activities was mainly
attributable to $98.2 million higher residential loan originations held for sale
and $66.9 million higher residential loans sold as a result of the lower
interest rate environment during the third quarter of 2020. The increase in net
gain on sales of securities was due to higher gains realized on securities sold
in the third quarter of 2020 than those sold in the third quarter of 2019.
Noninterest income increased $12.0 million to $21.6 million for the nine months
ended September 30, 2020 , compared to $9.6 million for the same period in 2019.
The increase in noninterest income was primarily due to increases in mortgage
banking activities of $9.6 million , net gain on sales of securities of $1.7
million , as well as increases of $263 thousand net gain on sales of other real
estate owned, $139 thousand in bank owned life insurance ("BOLI") interest
income, and $118 thousand in interest rate swap fees (all included in "other
charges and fees" in the table above). The increase in the mortgage banking
activities was mainly attributable to $214.4 million higher residential loan
originations held for sale and $189.8 million higher residential loans sold as a
result of the lower interest rate environment in 2020. The increase in the net
gain on sales of securities was attributable to the same factors mentioned
above. The increase in net gains on sales of other real estate owned was due to
the sale of four properties during the second and third quarters of 2020. The
increase in BOLI interest income was due to an increase in bank owned life
insurance attributable to the acquisition of Ann Arbor State Bank . The increase
in interest rate swap fees was due to increased volumes of customer-initiated
derivatives.
Noninterest Expense
The following table presents noninterest expense for the three and nine months
ended September 30, 2020 and 2019.
For the three months ended For the nine months ended September
September 30, 30,
(Dollars in thousands) 2020 2019 2020 2019
Noninterest expense
Salary and employee benefits $ 9,862 $ 7,536 $ 28,090 $ 21,642
Occupancy and equipment expense 1,678 1,203 4,773 3,575
Professional service fees 808 465 2,141 1,212
Acquisition and due diligence fees 17 319 1,664 319
Marketing expense 257 379 709 843
Printing and supplies expense 89 78 398 250
Data processing expense 844 661 2,601 1,862
Core deposit premium amortization 192 29 576 117
Other expense 1,379 869 3,819 3,254
Total noninterest expense $ 15,126 $
11,539
Noninterest expense increased$3.6 million to$15.1 million for the three months endedSeptember 30, 2020 , as compared to$11.5 million for the same period in 2019. The increase in noninterest expense was primarily due to increases in salary and employee benefits of$2.3 million , occupancy and equipment expense of$475 thousand ,FDIC premium expense of$417 55 -------------------------------------------------------------------------------- Table of Contents thousand (included in "other expense" in the table above), professional service fees of$343 thousand , data processing expense of$183 thousand , and core deposit premium amortization of$163 thousand . This was partially offset by a decrease in acquisition expense of$302 thousand . The increase in salary and employee benefits between the periods was primarily due to an increase of$1.6 million in mortgage commissions expense as well as an increase of 37 full-time equivalent employees, mainly attributable to the acquisition ofAnn Arbor State Bank as well as organic growth. The increase in occupancy and equipment expense was primarily attributable to increased building rent and other expenses related to the addition of the three new branches acquired withAnn Arbor State Bank , as well as organic growth in the organization. The increase inFDIC premium expense was primarily due to the increase in assets related to the acquisition ofAnn Arbor State Bank in addition to credits received during the third quarter of 2019. The increase in professional service fees was primarily related to increased residential mortgage volumes as well as increased legal fees. The increase in data processing expense was due to increased costs of loan systems. As a result of the acquisition, the Company recorded$3.7 million of core deposit premiums, leading to the increased amortization expense on core deposit intangibles compared to the same period in prior year. The decrease in acquisition and due diligence fees was primarily due to the majority of expenses related to the merger withAnn Arbor State Bank being incurred from the third quarter of 2019 to the first quarter of 2020. Noninterest expense increased$11.7 million to$44.8 million for the nine months endedSeptember 30, 2020 , as compared to$33.1 million for the same period in 2019. The increase in noninterest expense was primarily due to increases in salary and employee benefits of$6.4 million , acquisition and due diligence fees of$1.3 million , occupancy and equipment expense of$1.2 million , professional service fees of$929 thousand , data processing expense of$739 thousand ,FDIC premium expense of$525 thousand (included in "other expense" in the table above), and core deposit premium amortization of$459 thousand . The increase in salary and employee benefits between the periods was primarily due to an increase of$4.3 million in mortgage commissions expense as well as an increase of 30 full-time equivalent employees. The increase in acquisition and due diligence fees and core deposit premium amortization related to the merger withAnn Arbor State Bank , which closed onJanuary 2, 2020 . Acquisition and due diligence fees comprised of contract terminations, core system conversion, as well as severance and retention payments during the nine months endedSeptember 30, 2020 . The increase in occupancy and equipment expense,FDIC premium, professional service fees, and core deposit premiums were attributable to the same factors mentioned above. The increase in data processing expense was primarily attributable to the retention and maintenance ofAnn Arbor State Bank legacy systems during the first quarter of 2020 prior to system integration, in addition to the organic growth in the organization. Income Taxes and Tax-Related Items During the three months endedSeptember 30, 2020 , we recognized income tax expense of$1.1 million on$6.3 million of pre-tax income resulting in an effective tax rate of 17.7% compared to the same period in 2019, in which we recognized an income tax expense of$914 thousand on$5.3 million of pre-tax income, resulting in an effective tax rate of 17.2%. During the nine months endedSeptember 30, 2020 , we recognized income tax expense of$2.1 million on$14.1 million of pre-tax income resulting in an effective tax rate of 14.9%, compared to the same period in 2019, in which we recognized an income tax expense of$2.4 million on$13.9 million of pre-tax income, resulting in an effective tax rate of 17.5%. The decrease in income tax provision for the nine months endedSeptember 30, 2020 compared to the same period in 2019 was primarily as a result of a$290 thousand tax benefit related to theAnn Arbor State Bank net operating loss (NOL) resulting from the CARES Act provision that allows for NOLs generated in 2018 to 2020 to be carried back five years. Additionally, disqualified dispositions ofAnn Arbor State Bank's stock options generated a$175 thousand tax benefit. Refer to Note 9 - Income Taxes in the notes to the consolidated financial statements for a reconciliation between expected and actual income tax expense for the three and nine months endedSeptember 30, 2020 and 2019. 56
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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, 2020 and December 31, 2019 .
September 30, December 31,
(Dollars in thousands) 2020 2019
Securities available-for-sale:
U.S. government sponsored entities and agencies $ 27,199 $ -
State and political subdivision 117,550 93,747
Mortgage-backed securities: residential 19,492 10,565
Mortgage-backed securities: commercial 8,655 8,779
Collateralized mortgage obligations: residential 14,333 8,529
Collateralized mortgage obligations: commercial 33,003 23,181
U.S. Treasury 1,003 1,999
SBA 18,808 21,984
Asset backed securities 9,954 10,084
Corporate bonds 3,530 2,037
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, 2020 , total investment securities were$253.5 million , or 10.4% of total assets, compared to$180.9 million , or 11.4% of total assets, atDecember 31, 2019 . The$72.6 million increase in securities available-for-sale fromDecember 31, 2019 toSeptember 30, 2020 , was primarily due to the acquisition ofAnn Arbor State Bank , which contributed$47.4 million of investment securities as ofJanuary 2, 2020 . In addition, we repositioned our investment portfolio through purchases of investment securities of$83.2 million and sales, calls, payoffs and maturities of investment securities of$52.4 million . Securities with a carrying value of$97.2 million and$27.3 million were pledged atSeptember 30, 2020 andDecember 31, 2019 , respectively, to secure borrowings, deposits and mortgage derivatives. As ofSeptember 30, 2020 , the Company held 66 tax-exempt state and local municipal securities totaling$48.9 million backed by theMichigan School Bond Loan Fund . Other than the aforementioned investments, atSeptember 30, 2020 andDecember 31, 2019 , there were no holdings of securities of any one issuer, other than theU.S. government and its agencies, 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, 2020 andDecember 31, 2019 . Actual timing may differ from contractual maturities if borrowers 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. 57
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September 30, 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 $ 2,520 1.61 % $ 4,572 1.62 % $ 15,000 1.22 % $ 5,000 1.48 %
State and political subdivision 2,267 2.08 9,942 2.39 29,081 2.87 68,208 3.18
Mortgage-backed securities:
residential - - 96 0.89 111 2.23 19,030 1.90
Mortgage-backed securities:
commercial 858 1.38 3,943 2.45 1,412 2.63 1,812 3.64
Collateralized mortgage
obligations: residential - - 51 3.98 589 2.01 13,537 1.23
Collateralized mortgage
obligations: commercial 1,005 1.51 8,926 3.08 13,678 1.66 8,050 2.44
U.S. Treasury 1,000 1.65 - - - - - -
SBA - - - - 10,388 1.36 8,481 1.22
Asset backed securities - - - - - - 10,298 0.89
Corporate bonds 3,491 3.09 - - - - - -
Total securities available-for-sale $ 11,141 2.15 % $ 27,530 2.49 % $ 70,259 2.04 % $ 134,416 2.40 %
December 31, 2019
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:
State and political subdivision$ 1,375 2.25 %$ 3,747 2.24 %$ 18,566 2.95 %$ 65,616 3.38 % Mortgage-backed securities: residential - - 153 0.93 143 2.07 10,313 2.84 Mortgage-backed securities: commercial 431 0.99 4,874 2.27 1,435 2.65 1,827 3.64 Collateralized mortgage obligations: residential - - - - 727 2.15 7,814 2.11 Collateralized mortgage obligations: commercial - - 9,031 2.87 4,371 2.83 9,489 2.39U.S. Treasury - - 1,976 2.06 - - - - SBA - - - - 8,706 2.59 13,345 2.49 Asset backed securities - - - - - - 10,390 2.59 Corporate bonds 1,006 2.44 1,024 4.43 - - - - Total securities available-for-sale$ 2,812 2.13 %$ 20,805 2.60 %$ 33,948 2.81 %$ 118,794 3.01 % Loans 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 businesses, 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, which are guaranteed by the SBA, are reported within the commercial and industrial loan category. 58 -------------------------------------------------------------------------------- Table of Contents 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) 2020 2019 2018 2017 2016 Commercial real estate: Non-owner occupied$ 460,708 $ 388,515 $ 367,671 $ 343,420 $ 322,354 Owner occupied 269,481 216,131 194,422 168,342 169,348 Total commercial real estate 730,189 604,646 562,093 511,762 491,702 Commercial and industrial 807,923 410,228 383,455 377,686 342,069 Residential real estate 304,088 211,839 180,018 144,439 118,730 Consumer 1,688 896 999 1,036 892 Total loans$ 1,843,888 $ 1,227,609 $ 1,126,565 $ 1,034,923 $ 953,393 Total loans were$1.84 billion atSeptember 30, 2020 , an increase of$616.3 million fromDecember 31, 2019 . The growth in our loan portfolio compared toDecember 31, 2019 was primarily due to$392.5 million of PPP loans that were originated during the second and third quarters of 2020. The acquisition ofAnn Arbor State Bank also contributed$224.1 million of loans as ofJanuary 2, 2020 . There was additional organic growth of$53.3 million during the first three quarters of 2020. The loan growth was partially offset by$53.6 million of runoff of acquired loans. In general, we target a loan portfolio mix of approximately one-half commercial real estate, approximately one-third commercial and industrial loans and one-sixth a mix of residential real estate and consumer loans. As ofSeptember 30, 2020 , approximately 39.6% of our loans were commercial real estate, 43.8% were commercial and industrial, and 16.6% were residential real estate and consumer loans. The loan mix was affected by PPP loans, which fall into the commercial and industrial loan type. We originate both fixed and adjustable rate residential real estate loans conforming to the underwriting guidelines of Fannie Mae and Freddie Mac, as well as home equity loans and lines of credit that are secured by first or junior liens. Most of our fixed rate residential loans, along with some of our adjustable rate mortgages, are sold to other financial institutions with which we have established a correspondent lending relationship. The Company established a direct relationship with Fannie Mae and began locking and selling loans to Fannie Mae with servicing retained during the third quarter of 2019. Refer to Note 7-Goodwill and Intangible Assets for further details on our mortgage servicing rights. 59
-------------------------------------------------------------------------------- Table of Contents Loan Maturity/Rate Sensitivity The following table shows the contractual maturities of our loans as ofSeptember 30, 2020 . After one but One year or within five After five
(Dollars in thousands) less years years TotalSeptember 30, 2020 Commercial real estate$ 93,069 $ 435,324 $ 201,796 $ 730,189 Commercial and industrial 149,938 579,914 78,071 807,923 Residential real estate 9,175 7,907 287,006 304,088 Consumer 59 1,499 130 1,688 Total loans$ 252,241 $ 1,024,644 $ 567,003 $ 1,843,888 Sensitivity of loans to changes in interest rates: Fixed interest rates$ 905,028 $ 185,832 Floating interest rates 119,616 381,171 Total$ 1,024,644 $ 567,003 Summary of Impaired Assets and Past Due Loans Nonperforming assets consist of nonaccrual loans and other real estate owned. We do not consider performing troubled debt restructurings (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. 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. 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. 60 -------------------------------------------------------------------------------- Table of Contents 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, 2020 compared toDecember 31, 2019 were as follows: (Dollars in thousands) September 30, 2020 December 31, 2019 Classified loans: Substandard $ 18,983 $ 20,569 Doubtful 5,086 1,838 Total classified loans $ 24,069 $ 22,407 Special mention 37,560 17,292 Total classified and criticized loans $ 61,629 $
39,699
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) 2020 2019 2018 2017 2016
Nonaccrual loans
Commercial real estate $ 7,022 $ 4,832 $ 5,927 $ 2,257 $ 147
Commercial and industrial 8,078 11,112 9,605 9,024 13,389
Residential real estate 4,151 2,569 2,915 2,767 1,498
Consumer 15 16 - - -
Total nonaccrual loans(1) 19,266 18,529 18,447 14,048 15,034
Other real estate owned - 921 - 652 258
Total nonperforming assets 19,266 19,450 18,447 14,700 15,292
Performing troubled debt restructurings
Commercial real estate - - - - 290
Commercial and industrial 550 547 568 961 1,018
Residential real estate 599 359 363 261 207
Total performing troubled debt
restructurings 1,149 906 931 1,222 1,515
Total impaired assets, excluding ASC 310-30 loans
______________________________________________________
(1)Nonaccrual loans include nonperforming troubled debt restructurings of$2.4 million ,$3.0 million ,$5.0 million ,$6.4 million , and$5.8 million at the respective dates indicated above. During the nine months endedSeptember 30, 2020 and 2019, the Company recorded$144 thousand and$848 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$6.1 million ,$6.0 million ,$7.9 million ,$9.7 million , and$11.6 million at the respective dates indicated in the table above. The increase in purchase credit impaired loans as ofSeptember 30, 2020 compared toDecember 31, 2019 was due to the acquisition ofAnn Arbor State Bank . 61 -------------------------------------------------------------------------------- Table of Contents Nonperforming assets decreased$184 thousand as ofSeptember 30, 2020 compared toDecember 31, 2019 . The decrease in nonperforming assets was attributable to a decrease of$921 thousand in other real estate owned, partially offset by an increase of$737 thousand in nonaccrual loans. The decrease in other real estate owned assets was due to the sale of four properties totaling$2.1 million during the second and third quarters of 2020, which included the sale of a property related to a$1.0 million commercial loan relationship transferred from nonaccrual loans to other real estate owned during the first nine months of 2020. The increase in nonaccrual loans was primarily due to five commercial loan relationships and two residential loan relationships totaling$11.4 million moving to nonaccrual status, partially offset by the sale of a$7.9 million commercial loan relationship on nonaccrual status as well as the transfer of the$1.0 million commercial loan relationship from nonaccrual loans to other real estate owned during the second quarter of 2020. 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. Purchased Loans The allowance for loan losses on purchased 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 62 -------------------------------------------------------------------------------- Table of Contents senior management, at least annually or more frequently upon the occurrence of a circumstance that affects the credit risk of the loan. 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 ended
September For the nine months ended September
30, 30,
(Dollars in thousands) 2020 2019 2020 2019
Balance at beginning of period $ 17,063 $ 12,353 $ 12,674 $ 11,566
Loan charge-offs:
Commercial real estate - - - (74)
Commercial and industrial (10) (49) (1,729) (164)
Consumer (4) (34) (47) (48)
Total loan charge-offs (124) (83) (1,886) (286)
Recoveries of loans previously
charged-off:
Commercial real estate 12 5 12 6
Commercial and industrial 15 10 47 101
Residential real estate 10 12 51 55
Consumer 8 26 22 30
Total loan recoveries 45 53 132 192
Net charge-offs (79) (30) (1,754) (94)
Provision expense for loan losses 4,270 (16) 10,334 835
Balance at end of period $ 21,254 $ 12,307 $ 21,254 $ 12,307
Allowance for loan losses as a percentage
of period-end loans 1.15 % 1.05 % 1.15 % 1.05 %
Net charge-offs to average loans 0.02 0.01 0.14 0.03
Our allowance for loan losses was $21.3 million , or 1.15% of loans, at September
30, 2020 compared to $12.7 million , or 1.03% of loans, at December 31, 2019 . As
of September 30, 2020 , the allowance for loan losses as a percentage of loans
excluding PPP loans, was 1.46%. The $8.6 million increase in the allowance for
loan losses since December 31, 2019 was primarily due to increases in general
reserves related to a 25 basis point increase of the economic qualitative
factors, reflecting the expected economic impact of the COVID-19 pandemic in the
second quarter of 2020 as well as a 20-25 basis point increase of the
qualitative factors in the third quarter of 2020 reflecting the uncertainty
surrounding the impact of the COVID-19 pandemic on the loan portfolio.
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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, 2020
Balance at end of period applicable to:
Commercial real estate $ 9,819 39.6 %
Commercial and industrial 8,180 43.8
Residential real estate 3,246 16.5
Consumer 9 0.1
Total loans $ 21,254 100.0 %
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 %
December 31, 2016
Balance at end of period applicable to:
Commercial real estate $ 4,124 51.5 %
Commercial and industrial 5,932 35.9
Residential real estate 1,030 12.5
Consumer 3 0.1
Total loans $ 11,089 100.0 %
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, 2020
and $9.4 million at December 31, 2019 .
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 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 decided to engage a reputable, third-party valuation firm to
perform a quantitative analysis of goodwill as of August 31, 2020 ("the
valuation date").
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In deriving at 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 to 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
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.
Furthermore, management noted that despite the market capitalization declining
from December 2019 to September 2020 as a result of the COVID-19 pandemic, the
Bank's financial performance has remained positive. This is evidenced by the
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
September 30, 2020 . As such, management concluded that it more likely than not
that there was no goodwill impairment as of September 30, 2020 .
Deposits
Total deposits were $1.94 billion at September 30, 2020 and $1.14 billion at
December 31, 2019 , representing 86.9% and 80.3% of total liabilities,
respectively. The increase in deposits of $808.0 million was comprised of
increases of $359.4 million in demand deposits, $281.6 million in money market
and savings deposits and $167.1 million in time deposits. The increase in
deposits was primarily due to $543.2 million of organic deposit growth during
the nine months ended September 30, 2020 mainly as a result of PPP loan funds
deposited into customer accounts. In addition, the acquisition of Ann Arbor
State Bank in first quarter of 2020 contributed $264.8 million in deposits.
Our average interest-bearing deposit costs were 1.06% and 1.92% for the nine
months ended September 30, 2020 and 2019, respectively. The decrease in
interest-bearing deposit costs between the two periods was impacted by the
changing mix of deposit types, as well as by the decrease in overnight market
rates, as measured by the target federal funds interest rate. The target federal
funds interest rate decreased 25 basis points in each of August, September and
October of 2019 and 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, 2020 and December 31, 2019 , the Company had
approximately $54.4 million and $67.4 million of brokered deposits,
respectively. 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 December 31, 2019 was $514 thousand
in Certificate of Deposit Account Registry Service ("CDARS") customer deposit
accounts due to an early withdrawal from a CDARS customer deposit account in the
first quarter of 2018 that was paid at maturity.
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.
The following table sets forth the distribution of average deposits by account
type for the periods indicated below.
Three Months Ended September 30, 2020
Average Average
(Dollars in thousands) Balance Percent Rate
Noninterest-bearing demand deposits $ 640,095 34.6 % - %
Interest-bearing demand deposits 116,285 6.3 0.22
Money market and savings deposits 513,420 27.8 0.43
Time deposits 575,179 31.3 1.18
Total deposits $ 1,844,979 100.0 % 0.50 %
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Nine Months Ended September 30, 2020
Average Average
(Dollars in thousands) Balance Percent Rate
Noninterest-bearing demand deposits $ 546,066 32.5 % - %
Interest-bearing demand deposits 112,579 6.7 0.31
Money market and savings deposits 458,438 27.3 0.65
Time deposits 564,396 33.5 1.55
Total deposits $ 1,681,479 100.0 % 0.72 %
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, 2020
Maturing in:
3 months or less $ 5,232
3 months to 6 months 140,383
6 months to 1 year 130,872
1 year or greater 243,354
Total $ 519,841
66-------------------------------------------------------------------------------- Table of Contents Borrowings Total debt outstanding atSeptember 30, 2020 was$261.4 million , an increase of$4.6 million from$256.7 million atDecember 31, 2019 . The increase in total borrowings was primarily due to increases of$34.1 million in FRB borrowings to help facilitate the funding of PPP loans, and$36.2 million in long-term FHLB advances, partially offset by decreases of$60.0 million in short-term FHLB advances,$5.0 million in federal funds purchased and$664 thousand in securities sold under agreements to repurchase. AtSeptember 30, 2020 , the Company had$34.1 million of debt outstanding with theFederal Reserve Bank under the PPP Liquidity Facility. The FRB borrowings bear a 0.35% fixed interest rate and mature two years after the origination date of the respective PPP loans that have been pledged to secure them. AtSeptember 30, 2020 , FHLB advances were secured by a blanket lien on$510.6 million of real estate-related loans, and repurchase agreements were secured by securities with a fair value of$1.9 million . AtDecember 31, 2019 , FHLB advances were secured by a blanket lien on$408.9 million of real estate-related loans, and repurchase agreements were secured by securities with a fair value of$1.5 million . As ofSeptember 30, 2020 , the Company had$45.0 million of subordinated notes outstanding and debt issuance costs of$445 thousand related to these subordinated notes. As ofDecember 31, 2019 , the Company had$45.0 million of subordinated notes outstanding and debt issuance costs of$560 thousand related to these subordinated notes. The$15.0 million of subordinated notes issued onDecember 21, 2015 bear a fixed interest rate of 6.375% per annum, payable semiannually throughDecember 15, 2020 . The notes will bear a floating interest rate of three-month LIBOR plus 477 basis points payable quarterly afterDecember 15, 2020 through maturity. The notes mature no later thanDecember 15, 2025 , and the Company has the option to redeem or prepay any or all of the subordinated notes without premium or penalty any time afterDecember 15, 2020 or upon an occurrence of a Tier 2 capital event or tax event. The$30.0 million of subordinated notes issued onDecember 18, 2019 bear a fixed interest rate of 4.75% per annum, payable semiannually throughDecember 18, 2024 . The notes will bear a floating interest rate of three-month secured overnight financing rate (SOFR) plus 311 basis points payable quarterly afterDecember 18, 2024 through maturity. The notes mature no later thanDecember 18, 2029 , and the Company has the option to redeem any or all of the subordinated notes without premium or penalty any time afterDecember 18, 2024 or upon the occurrence of a Tier 2 capital event or tax event. The issuance of the$30.0 million subordinated notes reflected management's efforts to fund the liquidity needs of the Company as well as pay the merger consideration to purchaseAnn Arbor State Bank . 67
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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 For the nine months ended September
30, 30,
(Dollars in thousands) 2020 2019 2020 2019
Securities sold under agreements to
repurchase
Average daily balance $ 163 $ 563 $ 330 $ 537
Weighted-average rate during period 0.30 % 0.30 % 0.30 % 0.30 %
Amount outstanding at period end $ 187 $ 545 $ 187 $ 545
Weighted-average rate at period end 0.30 % 0.30 % 0.30 % 0.30 %
Maximum month-end balance $ 187 $ 866 $ 936 $ 866
FHLB Advances
Average daily balance $ - $ 6,630 $ 5,456 $ 27,903
Weighted-average rate during period - % 2.57 % 0.99 % 2.49 %
Amount outstanding at period end $ - $ - $ - $ -
Weighted-average rate at period end - % - % - % - %
Maximum month-end balance $ - $ - $ 25,000 $ 95,000
FHLB Line of Credit
Average daily balance $ 63 $ - $ 60 $ 111
Weighted-average rate during period - % - % 1.29 % 2.92 %
Amount outstanding at period end $ - $ - $ - $ -
Weighted-average rate at period end - % - % - % - %
Maximum month-end balance $ - $ - $ - $ 895
Federal funds purchased
Average daily balance $ - $ 109 $ 193 $ 2,044
Weighted-average rate during period - % - % 2.73 % 2.74 %
Amount outstanding at period end $ - $ 10,000 $ - $ 10,000
Weighted-average rate at period end - % 1.90 % - % 1.90 %
Maximum month-end balance $ - $ 10,000 $ - $ 15,000
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 $38.8 million to $209.5 million at September 30,
2020 as compared to $170.7 million at December 31, 2019 . The increase in
shareholders' equity was primarily impacted by $23.4 million from the issuance
of preferred stock as well as $12.0 million of net income generated during the
nine months ended September 30, 2020 and an increase of $4.5 million of other
comprehensive income due to increases in net unrealized gains on
available-for-sale securities, partially offset by $1.2 million of dividends
declared on our common stock and $620 thousand of stock repurchased through the
share buyback program during the nine months ended September 30, 2020 .
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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) 2020 2019 2020 2019
Balance at beginning of period $ 180,259 $ 162,867 $ 170,703 $ 151,760
Net income 5,209 4,409 12,040 11,431
Other comprehensive income 783 1,238 4,451 7,120
Preferred stock offering, net of issuance
costs 23,370 - 23,370 -
Redeemed stock - (488) (620) (2,108)
Common stock dividends declared (387) (310) (1,160) (928)
Exercise of stock options - 63 95 219
Stock-based compensation expense 234 189 589 474
Balance at end of period $ 209,468 $ 167,968 $ 209,468 $ 167,968
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
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 greater than 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, 2020 and December 31, 2019 , the Bank's capital ratios were in
excess of the requirement to be "well capitalized" under the regulatory
framework for prompt corrective action.
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Table of Contents The summary below compares the actual capital ratios with the minimum quantitative measures established by regulation to ensure capital adequacy:
Capital Adequacy
Capital Regulatory Well
Actual Adequacy Requirement + Capitalized
Capital Regulatory Capital Conservation Regulatory
Ratio Requirement Buffer(1) Requirement
September 30, 2020
Common equity tier 1 to risk-weighted
assets:
Consolidated 8.83 % 4.50 % 7.00 %
Bank 11.23 % 4.50 % 7.00 % 6.50 %
Tier 1 capital to risk-weighted assets:
Consolidated 10.31 % 6.00 % 8.50 %
Bank 11.23 % 6.00 % 8.50 % 8.00 %
Total capital to risk-weighted assets:
Consolidated 14.39 % 8.00 % 10.50 %
Bank 12.48 % 8.00 % 10.50 % 10.00 %
Tier 1 capital to average assets
(leverage ratio):
Consolidated 7.17 % 4.00 % 4.00 %
Bank 7.83 % 4.00 % 4.00 % 5.00 %
December 31, 2019
Common equity tier 1 to risk-weighted
assets:
Consolidated 11.72 % 4.50 % 7.00 %
Bank 12.27 % 4.50 % 7.00 % 6.50 %
Tier 1 capital to risk-weighted assets:
Consolidated 11.72 % 6.00 % 8.50 %
Bank 12.27 % 6.00 % 8.50 % 8.00 %
Total capital to risk-weighted assets:
Consolidated 15.99 % 8.00 % 10.50 %
Bank 13.24 % 8.00 % 10.50 % 10.00 %
Tier 1 capital to average assets
(leverage ratio):
Consolidated 10.41 % 4.00 % 4.00 %
Bank 10.96 % 4.00 % 4.00 % 5.00 %
_______________________________________________________________________________
(1) Reflects the capital conservation buffer of 2.5%.
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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, 2020 were $873.4
million , an increase of $173.1 million , from $700.3 million at December 31,
2019 . The increase of $173.1 million was primarily due to increases of $167.1
million in time deposits, $36.2 million in long-term FHLB advances, $34.1
million in FRB borrowings under the Paycheck Protection Program Liquidity
Facility ("PPPLF"), and $1.4 million in operating lease obligations, partially
offset by a decrease of $65.7 million in short-term borrowings.
The following tables present our contractual obligations as of September 30,
2020 and December 31 , 2019.The $34.1 million of FRB borrowings under PPPLF
mature two years after the origination date of the respective PPP loans that
have been pledged to secure them.
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 $ 1,739 $ 3,507 $ 2,613 $ 4,074 $ 11,933
Short-term borrowings 187 - - - 187
Long-term borrowings 3,202 51,420 32,000 130,000 216,622
Subordinated notes - - - 44,555 44,555
Time deposits 444,662 150,575 4,905 - 600,142
Total $ 449,790 $ 205,502 $ 39,518 $ 178,629 $ 873,439
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 $ 1,341 $ 2,351 $ 2,149 $ 4,736 $ 10,577
Short-term borrowings 65,851 - - - 65,851
Long-term borrowings - 11,375 30,000 105,000 146,375
Subordinated notes - - - 44,440 44,440
Time deposits 392,839 39,855 378 - 433,072
Total $ 460,031 $ 53,581 $ 32,527 $ 154,176 $ 700,315
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, 2020 , the allowance
for off-balance sheet risk was $498 thousand , compared to $318 thousand at
December 31, 2019 , 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, 2020 December 31, 2019
(Dollars in thousands) Fixed Rate Variable Rate Fixed Rate Variable Rate
Commitments to make loans $ 5,302
30,496 361,749 28,723 288,086
Unused standby letters of credit and commercial
letters of credit 3,705 2,028 4,895 -
Of the total unused lines of credit of $392.2 million at September 30, 2020 ,
$49.2 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 environment. Management maintained an elevated level of liquidity on
the balance sheet in the third quarter of 2020, 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, 2020 , we had liquid assets of $316.8 million , compared to
$257.5 million at December 31, 2019 . 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 $176.5
million , compared to $103.9 million at December 31, 2019 primarily as a result
of excess deposits.
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, 2020 , we had $181.2 million of
outstanding borrowings from the FHLB, and these advances were secured by a
blanket lien on $510.6 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 $211.1 million from the FHLB. Additionally, the Bank can borrow
up to $122.5 million through the unsecured lines of credit it has established
with eight other banks, as well as $5.3 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 $977.5 million , based on current
policy limits at September 30, 2020 . Management believed that as of September
30, 2020 , 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, 2020 December 31, 2019
Investment securities available-for-sale to total assets 10.36 % 11.41 %
Loans to total deposits 94.88 108.12
Interest-earning assets to total assets 94.32 95.58
Interest-bearing deposits to total deposits 67.46 71.30
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