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Bridgewater Bancshares Inc - Quarter Report: 2020 September (Form 10-Q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2020

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ________

Commission File Number 001-38412

BRIDGEWATER BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

Minnesota
(State or other jurisdiction of
incorporation or organization)

26-0113412
(I.R.S. Employer
Identification No.)

4450 Excelsior Boulevard, Suite 100
St. Louis Park, Minnesota
(Address of principal executive offices)

55416
(Zip Code)

(952893-6868

(Registrant’s telephone number, including area code)

3800 American Boulevard West, Suite 100, Bloomington, Minnesota 55431

(Former name, former address and former fiscal year, if change since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  No 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes  No 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

Accelerated filer

Non-accelerated filer

  

Smaller reporting company

Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  No 

Securities registered pursuant to Section 12(b) of the Act:

Title of each class: 

      

Trading Symbol 

    

Name of each exchange on which registered: 

Common Stock, $0.01 Par Value 

 

BWB

 

The Nasdaq Stock Market LLC 

The number of shares of the Common Stock outstanding as of November 2, 2020 was 28,281,741.

Table of Contents

Table of Contents

PART I FINANCIAL INFORMATION

3

Item 1. Consolidated Financial Statements (unaudited)

3

Consolidated Balance Sheets

3

Consolidated Statements of Income

4

Consolidated Statements of Comprehensive Income

5

Consolidated Statements of Shareholders’ Equity

6

Consolidated Statements of Cash Flows

7

Notes to Consolidated Financial Statements

8

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

34

Item 3. Quantitative and Qualitative Disclosures About Market Risk

69

Item 4. Controls and Procedures

71

PART II OTHER INFORMATION

71

Item 1. Legal Proceedings

71

Item 1A. Risk Factors

71

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

74

Item 3. Defaults Upon Senior Securities

75

Item 4. Mine Safety Disclosures

75

Item 5. Other Information

75

Item 6. Exhibits

76

SIGNATURES

77

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Table of Contents

PART 1 – FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Bridgewater Bancshares, Inc. and Subsidiaries

Consolidated Balance Sheets

(dollars in thousands, except share data)

September 30, 

December 31, 

    

2020

    

2019

(Unaudited)

ASSETS

Cash and Cash Equivalents

$

91,510

$

31,935

Bank-Owned Certificates of Deposit

 

2,862

 

2,654

Securities Available for Sale, at Fair Value

 

373,955

 

289,877

Loans, Net of Allowance for Loan Losses of $31,381 at September 30, 2020 (unaudited) and $22,526 at December 31, 2019

2,217,480

 

1,884,000

Federal Home Loan Bank (FHLB) Stock, at Cost

 

7,817

 

7,824

Premises and Equipment, Net

 

48,885

 

27,628

Accrued Interest

 

9,647

 

6,775

Goodwill

 

2,626

 

2,626

Other Intangible Assets, Net

 

718

 

861

Other Assets

 

19,064

 

14,650

Total Assets

$

2,774,564

$

2,268,830

LIABILITIES AND EQUITY

 

  

 

  

LIABILITIES

 

  

 

  

Deposits:

 

  

 

  

Noninterest Bearing

$

685,773

$

447,509

Interest Bearing

 

1,587,271

 

1,375,801

Total Deposits

 

2,273,044

 

1,823,310

Notes Payable

 

11,500

 

13,000

FHLB Advances

 

127,500

 

136,500

Subordinated Debentures, Net of Issuance Costs

 

73,665

 

24,733

Accrued Interest Payable

 

2,082

 

1,982

Other Liabilities

 

21,341

 

24,511

Total Liabilities

 

2,509,132

 

2,024,036

SHAREHOLDERS' EQUITY

 

  

 

  

Preferred Stock- $0.01 par value

Authorized 10,000,000; None Issued and Outstanding at September 30, 2020 (unaudited) and December 31, 2019

 

Common Stock- $0.01 par value

 

 

  

Common Stock - Authorized 75,000,000; Issued and Outstanding 28,710,775 at September 30, 2020 (unaudited) and 28,973,572 at December 31, 2019

287

 

290

Additional Paid-In Capital

 

110,010

 

112,093

Retained Earnings

 

149,852

 

127,637

Accumulated Other Comprehensive Income

 

5,283

 

4,774

Total Shareholders' Equity

 

265,432

 

244,794

Total Liabilities and Equity

$

2,774,564

$

2,268,830

See accompanying notes to consolidated financial statements.

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Bridgewater Bancshares, Inc. and Subsidiaries

Consolidated Statements of Income

(dollars in thousands, except per share data)

(Unaudited)

Three Months Ended

Nine Months Ended

September 30, 

September 30, 

September 30, 

September 30, 

    

2020

    

2019

    

2020

    

2019

(Unaudited)

(Unaudited)

(Unaudited)

(Unaudited)

INTEREST INCOME

 

  

 

  

 

  

 

  

Loans, Including Fees

$

26,224

$

24,220

$

77,250

$

69,720

Investment Securities

 

2,100

 

1,910

 

6,387

 

5,739

Other

 

169

 

442

 

490

 

900

Total Interest Income

 

28,493

 

26,572

 

84,127

 

76,359

INTEREST EXPENSE

 

 

  

 

 

  

Deposits

 

4,840

 

6,209

 

15,734

17,932

Notes Payable

 

108

 

127

 

334

378

FHLB Advances

 

748

 

908

 

2,839

2,510

Subordinated Debentures

 

1,118

 

393

 

1,990

1,163

Federal Funds Purchased

 

 

 

107

172

Total Interest Expense

 

6,814

 

7,637

 

21,004

 

22,155

NET INTEREST INCOME

 

21,679

 

18,935

 

63,123

 

54,204

Provision for Loan Losses

 

3,750

 

900

 

8,850

2,100

NET INTEREST INCOME AFTER

 

  

 

  

 

  

 

  

PROVISION FOR LOAN LOSSES

 

17,929

 

18,035

 

54,273

 

52,104

NONINTEREST INCOME

 

  

 

  

 

  

 

  

Customer Service Fees

 

200

184

 

575

564

Net Gain on Sales of Available for Sale Securities

 

109

58

 

1,473

516

Net Gain on Sales of Foreclosed Assets

 

69

 

69

Other Income

 

848

635

 

2,805

1,565

Total Noninterest Income

 

1,157

 

946

 

4,853

 

2,714

NONINTEREST EXPENSE

 

  

 

  

 

  

 

Salaries and Employee Benefits

 

6,550

5,915

 

19,352

15,841

Occupancy and Equipment

 

894

761

 

2,279

2,202

Other Expense

 

2,228

2,408

 

8,498

8,400

Total Noninterest Expense

 

9,672

 

9,084

 

30,129

 

26,443

INCOME BEFORE INCOME TAXES

 

9,414

 

9,897

 

28,997

28,375

Provision for Income Taxes

 

2,240

2,092

 

6,782

5,543

NET INCOME

$

7,174

$

7,805

$

22,215

$

22,832

EARNINGS PER SHARE

 

  

 

  

 

 

Basic

$

0.25

$

0.27

$

0.77

$

0.77

Diluted

0.25

0.27

0.76

0.76

Dividends Paid Per Share

See accompanying notes to consolidated financial statements.

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Bridgewater Bancshares, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(dollars in thousands)

(Unaudited)

Three Months Ended

Nine Months Ended

September 30, 

September 30, 

    

2020

    

2019

    

2020

    

2019

Net Income

$

7,174

$

7,805

$

22,215

$

22,832

Other Comprehensive Income (Loss):

 

 

Unrealized Gains on Available for Sale Securities

2,276

2,014

5,397

10,218

Unrealized Gains (Losses) on Cash Flow Hedges

7

(306)

(3,593)

(1,324)

Reclassification Adjustment for (Gains) Losses Realized in Income

204

(78)

(1,160)

(536)

Income Tax Impact

(522)

(343)

(135)

(1,755)

Total Other Comprehensive Income (Loss), Net of Tax

1,965

1,287

509

6,603

Comprehensive Income

$

9,139

$

9,092

$

22,724

$

29,435

See accompanying notes to consolidated financial statements.

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Bridgewater Bancshares, Inc. and Subsidiaries

Consolidated Statements of Shareholders’ Equity

Three and Nine Months Ended September 30, 2020 and 2019

(dollars in thousands, except share data)

(Unaudited)

Accumulated

Additional

Other

Shares

Common Stock

Paid-In

Retained

Comprehensive

Three Months Ended

Voting

    

Voting

    

Capital

    

Earnings

    

Income (Loss)

    

Total

BALANCE June 30, 2019

 

28,986,729

$

290

$

113,838

$

111,261

$

3,748

$

229,137

Stock-based Compensation

 

 

 

175

 

 

 

175

Comprehensive Income

 

 

 

 

7,805

 

1,287

 

9,092

Stock Repurchases

(205,567)

(2)

(2,343)

(2,345)

BALANCE September 30, 2019

 

28,781,162

$

288

$

111,670

$

119,066

$

5,035

$

236,059

BALANCE June 30, 2020

 

28,837,560

$

288

$

110,906

$

142,678

$

3,318

$

257,190

Stock-based Compensation

 

7,399

384

 

384

Comprehensive Income

 

7,174

1,965

 

9,139

Stock Options Exercised

2,000

15

15

Stock Repurchases

(137,984)

(1)

(1,295)

(1,296)

Issuance of Restricted Stock Awards

5,000

Forfeiture of Restricted Stock Awards

(3,200)

BALANCE September 30, 2020

 

28,710,775

$

287

$

110,010

$

149,852

$

5,283

$

265,432

Accumulated

Additional

Other

Shares

Common Stock

Paid-In

Retained

Comprehensive

Nine Months Ended

    

Voting

    

Voting

    

Capital

    

Earnings

    

Income (Loss)

    

Total

BALANCE December 31, 2018

 

30,097,274

$

301

$

126,031

$

96,234

$

(1,568)

$

220,998

Stock-based Compensation

 

 

 

524

 

 

 

524

Comprehensive Income

 

 

 

 

22,832

 

6,603

 

29,435

Stock Options Exercised

15,400

61

61

Stock Repurchases

(1,331,512)

 

(13)

 

(14,946)

 

 

(14,959)

BALANCE September 30, 2019

 

28,781,162

$

288

$

111,670

$

119,066

$

5,035

$

236,059

BALANCE December 31, 2019

28,973,572

$

290

$

112,093

$

127,637

$

4,774

$

244,794

Stock-based Compensation

 

22,610

1,206

 

 

1,206

Comprehensive Income (Loss)

 

22,215

 

509

 

22,724

Stock Options Exercised

17,500

54

54

Stock Repurchases

(315,848)

(3)

(3,343)

(3,346)

Issuance of Restricted Stock Awards

16,141

Forfeiture of Restricted Stock Awards

(3,200)

BALANCE September 30, 2020

 

28,710,775

$

287

$

110,010

$

149,852

$

5,283

$

265,432

See accompanying notes to consolidated financial statements.

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Bridgewater Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(dollars in thousands)

(Unaudited)

Nine Months Ended

September 30, 

2020

2019

CASH FLOWS FROM OPERATING ACTIVITIES

Net Income

$

22,215

$

22,832

Adjustments to Reconcile Net Income to Net Cash

 

 

Provided by (Used for) Operating Activities:

 

 

Net Amortization on Securities Available for Sale

 

1,891

 

1,865

Net Gain on Sales of Securities Available for Sale

 

(1,473)

 

(516)

Provision for Loan Losses

 

8,850

 

2,100

Depreciation and Amortization of Premises and Equipment

 

660

 

662

Loss on Sale of Premises and Equipment

2

Amortization of Other Intangible Assets

 

143

 

143

Amortization of Subordinated Debt Issuance Costs

138

77

Net Gain on Sale of Foreclosed Assets

(69)

Stock-based Compensation

 

1,206

 

524

Changes in Operating Assets and Liabilities:

 

 

Accrued Interest Receivable and Other Assets

 

(3,993)

 

129

Accrued Interest Payable and Other Liabilities

 

(11,716)

 

4,158

Net Cash Provided by Operating Activities

 

17,923

 

31,905

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

(Increase) Decrease in Bank-owned Certificates of Deposit

 

(208)

651

Proceeds from Sales of Securities Available for Sale

 

38,832

42,864

Proceeds from Maturities, Paydowns, Payups and Calls of Securities Available for Sale

 

23,629

28,693

Purchases of Securities Available for Sale

 

(140,974)

(73,628)

Net Increase in Loans

 

(342,464)

(181,054)

Net (Increase) Decrease in FHLB Stock

 

7

(410)

Purchases of Premises and Equipment

 

(22,040)

(13,352)

Proceeds from Sales of Foreclosed Assets

 

134

1,102

Net Cash Used in Investing Activities

(443,084)

 

(195,134)

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

Net Increase in Deposits

 

449,734

241,302

Net Decrease in Federal Funds Purchased

 

(18,000)

Principal Payments on Notes Payable

 

(1,500)

(1,500)

Proceeds from FHLB Advances

 

96,000

37,500

Principal Payments on FHLB Advances

(105,000)

(20,000)

Issuance of Subordinated Debt, net of Issuance Costs

48,794

Stock Options Exercised

54

61

Stock Repurchases

(3,346)

(14,959)

Net Cash Provided by Financing Activities

 

484,736

 

224,404

NET CHANGE IN CASH AND CASH EQUIVALENTS

 

59,575

 

61,175

Cash and Cash Equivalents Beginning

 

31,935

 

28,444

Cash and Cash Equivalents Ending

$

91,510

$

89,619

SUPPLEMENTAL CASH FLOW DISCLOSURE

 

 

Cash Paid for Interest

$

20,766

$

22,121

Cash Paid for Income Taxes

 

7,917

 

3,800

Loans Transferred to Foreclosed Assets

 

134

 

1,033

Premises and Equipment Transferred to Other Assets

121

Net Investment Securities Purchased but Not Settled

2,059

See accompanying notes to consolidated financial statements.

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Bridgewater Bancshares, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(dollars in thousands, except share data)

(Unaudited)

Note 1: Description of the Business and Summary of Significant Accounting Policies

Organization

Bridgewater Bancshares, Inc. (the “Company”) is a financial holding company whose operations consist of the ownership of its wholly-owned subsidiaries, Bridgewater Bank (the “Bank”) and Bridgewater Risk Management, Inc. The Bank commenced operations in 2005 and provides retail and commercial loan and deposit services, principally to customers within the Minneapolis-St. Paul-Bloomington, MN-WI Metropolitan Statistical Area. In 2008, the Bank formed BWB Holdings, LLC, a wholly owned subsidiary of the Bank, for the purpose of holding repossessed property. In 2018, the Bank formed Bridgewater Investment Management, Inc., a wholly owned subsidiary of the Bank, for the purpose of holding certain municipal securities and to engage in municipal lending activities.

Bridgewater Risk Management, a subsidiary of the Company, was incorporated in 2016 as a wholly owned insurance company. It insures the Company and its subsidiaries against certain risks unique to the operations of the Company and for which insurance may not be currently available or economically feasible in today’s insurance marketplace. Bridgewater Risk Management pools resources with several other insurance company subsidiaries of financial institutions to spread a limited amount of risk among themselves.

Basis of Presentation

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of the consolidated balance sheets, consolidated statements of income, consolidated statements of comprehensive income, consolidated statements of shareholders’ equity and consolidated statements of cash flows in conformity with U.S. generally accepted accounting principles (“GAAP”). However, all normal recurring adjustments which are, in the opinion of management, necessary for the fair presentation of the interim financial statements have been included. The results of operations for the three and nine month periods ended September 30, 2020 are not necessarily indicative of the results which may be expected for the entire year. For further information, refer to the consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 12, 2020.

Principles of Consolidation

These consolidated financial statements include the amounts of the Company, the Bank, with locations in Bloomington, Greenwood, Minneapolis (2), St. Louis Park, Orono, and St. Paul, Minnesota, BWB Holdings, LLC, Bridgewater Investment Management, Inc., and Bridgewater Risk Management, Inc. All significant intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates in Preparation of Financial Statements

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Information available which could affect judgements includes, but is not limited to, changes in interest rates, changes in the performance of the economy, including COVID-19 pandemic related changes, and changes in the financial condition of borrowers.

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Material estimates that are particularly susceptible to significant change in the near term include the determination of the allowance for loan losses, calculation of deferred tax assets, fair value of financial instruments, and investment securities impairment.

Emerging Growth Company

The Company qualifies as an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and may take advantage of certain exemptions from various reporting requirements that are applicable to public companies that are not emerging growth companies, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. In addition, even if the Company complies with the greater obligations of public companies that are not emerging growth companies, the Company may avail itself of the reduced requirements applicable to emerging growth companies from time to time in the future, so long as the Company is an emerging growth company. The Company will continue to be an emerging growth company until the earliest to occur of: (1) the end of the fiscal year following the fifth anniversary of the date of the first sale of common equity securities under the Company’s Registration Statement on Form S-1, which was declared effective by the SEC on March 13, 2018; (2) the last day of the fiscal year in which the Company has $1.07 billion or more in annual revenues; (3) the date on which the Company is deemed to be a “large accelerated filer” under the Securities Exchange Act of 1934, as amended (the “Exchange Act”); or (4) the date on which the Company has, during the previous three-year period, issued publicly or privately, more than $1.0 billion in non-convertible debt securities.

Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933 for complying with new or revised accounting standards. As an emerging growth company, the Company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. The Company elected to take advantage of the benefits of this extended transition period.

Paycheck Protection Program Loan Segment

The Company maintains a separate general valuation allowance for each portfolio segment. The Paycheck Protection Program, or PPP, loan segment was added by the Company in the second quarter of 2020. PPP loans are loans to businesses, sole proprietorships, independent contractors and self-employed individuals who meet certain criteria and eligibility requirements through a loan program established by the Coronavirus Aid, Relief and Economic Security Act, or, CARES Act, and administered through the Small Business Administration (SBA). PPP loans generally have a two year term and earn interest at 1%. The Company believes that the primary source of repayment will be forgiveness granted by the SBA in accordance with the terms of the program. Credit risk in these loans is limited due to a full guarantee by the U.S. Government. The Company does not assign risk ratings to loans in this segment and will continue to monitor segment performance as circumstances evolve.  

Impact of Recently Adopted Accounting Guidance

In January 2017, the Financial Accounting Standards Board, or FASB, issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The amendments in this accounting standards update, or ASU, were issued to address concerns over the cost and complexity of the two-step goodwill impairment test and resulted in the removal of the second step of the test. The amendments require an entity to apply a one-step quantitative test and record the amount of goodwill impairment as the excess of a reporting unit’s carrying amount over its fair value, not to exceed the total amount of goodwill allocated to the reporting unit. The new guidance does not amend the optional qualitative assessment of goodwill impairment. The Company adopted the accounting standard during the first quarter of 2020. The adoption of the standard did not have a material impact on the Company’s consolidated financial statements. The Company’s policy is to test goodwill for impairment annually or on an interim basis if an event triggering impairment may have occurred. The economic turmoil and market volatility resulting from the COVID-19 pandemic resulted in a substantial decrease in the Company’s stock price and market capitalization. The

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Company believed such decrease was a triggering event requiring an interim goodwill impairment analysis as of March 31, 2020. Under the new simplified guidance, the Company’s estimated fair value to a market participant as of March 31, 2020, exceeded its carrying amount resulting in no impairment charge for the period.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement. The amendments of this ASU modify the disclosure requirements for fair value measurements by removing, modifying, or adding certain disclosures. The Company adopted this standard during the first quarter of 2020 and the adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

In August 2018, the FASB issued ASU 2018-15, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40). The amendments in this ASU align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). Implementation costs incurred in the application development stage are capitalized depending on the nature of the costs, while costs incurred during the preliminary project and post implementation stages are expensed as the activities are performed. The amendment also requires entities to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement and in the same income statement line item as the fees associated with the hosting element. The Company adopted the accounting standard during the first quarter of 2020. The adoption of the standard did not have a material impact on the Company’s consolidated financial statements.

In April 2020, various regulatory agencies, including the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, issued an interagency statement titled Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus, that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of the COVID-19 pandemic. The interagency statement was effective immediately and impacted accounting for loan modifications. Under Accounting Standards Codification 310-40, Receivables – Troubled Debt Restructurings by Creditors (ASC 310-40), a restructuring of debt constitutes a troubled debt restructuring, or TDR, if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The regulatory agencies confirmed with the staff of the FASB that 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, are not to be considered TDRs. These include short-term modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant.

Additionally, Section 4013 of the CARES Act that passed on March 27, 2020 further provides banks with the option to elect either or both of the following, from March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 pandemic declared by the President of the United States under the National Emergencies Act (50 U.S.C. 1601 et seq.) terminates:

(i)to suspend the requirements under GAAP for loan modifications related to the COVID–19 pandemic that would otherwise be categorized as a TDR; and/or
(ii)to suspend any determination of a loan modified as a result of the effects of the COVID–19 pandemic as being a TDR, including impairment for accounting purposes.

If a bank elects a suspension noted above, the suspension (i) will be effective for the term of the loan modification, but solely with respect to any modification, including a forbearance arrangement, an interest rate modification, a repayment plan, and any other similar arrangement that defers or delays the payment of principal or interest, that occurs during the applicable period for a loan that was not more than 30 days past due as of December 31, 2019; and (ii) will not apply to any adverse impact on the credit of a borrower that is not related to the COVID–19 pandemic. The Company has applied this guidance to qualifying loan modifications.

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Table of Contents

Impact of Recently Issued Accounting Standards

The following ASUs have been issued by the FASB and may impact the Company’s consolidated financial statements in future reporting periods.

In January 2020, the FASB issued ASU 2020-01, Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815): Clarifying the Interactions between Topic 321, Topic 323 and Topic 815. This ASU clarifies that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting for the purposes of applying the fair value measurement alternative. The ASU will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020, with early adoption permitted. The Company does not expect adoption to have a material impact on the consolidated financial statements.

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contracts, hedging relationships and other transactions that reference the London Interbank Offered Rate, or LIBOR, or another reference rate expected to be discontinued, if certain criteria are met. LIBOR is used as an index rate for the Company’s interest-rate swaps, subordinated debt, various investment securities, and approximately 8.6% of the Company’s loans as of September 30, 2020.

If reference rates are discontinued, the existing contracts will be modified to replace the discontinued rate with a replacement rate. For accounting purposes, such contract modifications would have to be evaluated to determine whether the modified contract is a new contract or a continuation of an existing contract. If they are considered new contracts, the previous contract would be extinguished. Under one of the optional expedients of ASU 2020-04, modifications of contracts within the scope of Topic 310, Receivables, and 470, Debt, will be accounted for by prospectively adjusting the effective interest rates and no such evaluation is required. When elected, the optional expedient for contract modifications must be applied consistently for all eligible contracts or eligible transactions. The expedients and exceptions in this update are available to all entities starting March 12, 2020 through December 31, 2022. The Company is in the process of evaluating the impact of this pronouncement on those financial assets and liabilities where LIBOR is used as an index rate.

In February 2016, the FASB issued ASU 2016-02, Leases  (Topic 842). The new topic supersedes Topic 840, Leases, and increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and requires disclosures of key information about leasing arrangements. In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842, which provides narrow amendments to clarify how to apply certain aspects of the new lease standard, and ASU 2018-11, Leases: Targeted Improvements, which was issued to provide relief to companies from restating comparative periods. Pursuant to this ASU, in the period of adoption the Company will not restate comparative periods presented in its condensed financial statements. The effective date of this guidance for public companies is for reporting periods beginning after December 15, 2018. In June 2020, the FASB issued ASU 2020-05, which delays the adoption for ASU 2016-02 for non-public entities to fiscal years beginning after December 15, 2021, and interim periods beginning after December 15, 2022. As an emerging growth company as defined in the JOBS Act, the Company has elected to delay adoption of this ASU until January 1, 2022. The Company continues to assess and implement changes to its accounting processes for leases to help ensure that it meets the reporting and disclosure requirements of this ASU. The Company’s assets and liabilities will increase based on the present value of the remaining lease payments for leases in place at the adoption date; however, this is not expected to be material to the Company’s consolidated financial statements.

Subsequent Events

Subsequent events have been evaluated through November 5, 2020, which is the date the consolidated financial statements were available to be issued.

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Note 2: Earnings Per Share

Basic earnings per common share are computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted earnings per common share are calculated by dividing net income by the weighted average number of shares adjusted for the dilutive effect of stock compensation. For the three and nine months ended September 30, 2020, stock options and restricted stock awards of approximately 557,000 and 557,000, respectively, were excluded from the calculation because their effect would have been anti-dilutive. For the three and nine months ended September 30, 2019, stock options of approximately 100,000 and 135,000, respectively were excluded from the calculation because their effect would have been anti-dilutive.

The following table presents the numerators and denominators for basic and diluted earnings per share computations for the three and nine months ended September 30, 2020 and 2019:

Three Months Ended

Nine Months Ended

September 30, 

September 30, 

    

2020

    

2019

    

2020

    

2019

Net Income Available to Common Shareholders

$

7,174

$

7,805

$

22,215

$

22,832

Weighted Average Common Stock Outstanding:

Weighted Average Common Stock Outstanding (Basic)

28,683,855

28,820,144

28,717,142

29,535,589

Dilutive Effect of Stock Compensation

490,746

677,817

583,621

645,967

Weighted Average Common Stock Outstanding (Dilutive)

29,174,601

29,497,961

29,300,763

30,181,556

Basic Earnings per Common Share

$

0.25

$

0.27

$

0.77

$

0.77

Diluted Earnings per Common Share

0.25

0.27

0.76

0.76

Note 3: Securities

The following tables present the amortized cost and estimated fair value of securities with gross unrealized gains and losses at September 30, 2020 and December 31, 2019:

September 30, 2020

Gross

Gross

Amortized

Unrealized

Unrealized

    

Cost

    

Gains

    

Losses

    

Fair Value

Securities Available for Sale:

Municipal Bonds

$

97,294

$

8,354

$

(394)

$

105,254

Mortgage-Backed Securities

 

116,252

 

2,517

 

(410)

 

118,359

Corporate Securities

 

68,043

 

1,006

 

(543)

 

68,506

SBA Securities

 

42,934

 

26

 

(453)

 

42,507

Asset-Backed Securities

38,846

683

(200)

39,329

Total Securities Available for Sale

$

363,369

$

12,586

$

(2,000)

$

373,955

December 31, 2019

Gross

Gross

Amortized

Unrealized

Unrealized

    

Cost

    

Gains

    

Losses

    

Fair Value

Securities Available for Sale:

U.S. Treasury Securities

$

4,990

$

8

$

$

4,998

Municipal Bonds

99,441

6,338

(36)

105,743

Mortgage-Backed Securities

 

64,312

 

697

 

(281)

 

64,728

Corporate Securities

 

49,674

 

633

 

(131)

 

50,176

SBA Securities

 

50,126

 

35

 

(602)

 

49,559

Asset-Backed Securities

14,673

14,673

Total Securities Available for Sale

$

283,216

$

7,711

$

(1,050)

$

289,877

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The following tables present the fair value and gross unrealized losses of securities with unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2020 and December 31, 2019:

Less Than 12 Months

12 Months or Greater

Total

Unrealized

Unrealized

Unrealized

    

Fair Value

    

Losses

    

Fair Value

    

Losses

    

Fair Value

    

Losses

September 30, 2020

Municipal Bonds

$

13,593

$

(387)

$

223

$

(7)

$

13,816

$

(394)

Mortgage-Backed Securities

 

28,897

(410)

2,481

 

31,378

 

(410)

Corporate Securities

 

22,714

(472)

1,429

(71)

 

24,143

 

(543)

SBA Securities

 

6,585

(16)

30,740

(437)

 

37,325

 

(453)

Asset-Backed Securities

15,073

(200)

15,073

(200)

Total Securities Available for Sale

$

86,862

$

(1,485)

$

34,873

$

(515)

$

121,735

$

(2,000)

Less Than 12 Months

12 Months or Greater

Total

Unrealized

Unrealized

Unrealized

    

Fair Value

    

Losses

    

Fair Value

    

Losses

    

Fair Value

    

Losses

December 31, 2019

Municipal Bonds

$

2,760

$

(23)

$

1,390

$

(13)

$

4,150

$

(36)

Mortgage-Backed Securities

 

32,276

(242)

3,098

(39)

 

35,374

 

(281)

Corporate Securities

 

8,350

(131)

 

8,350

 

(131)

SBA Securities

 

11,907

(64)

31,036

(538)

 

42,943

 

(602)

Total Securities Available for Sale

$

55,293

$

(460)

$

35,524

$

(590)

$

90,817

$

(1,050)

At September 30, 2020, 155 debt securities had unrealized losses with aggregate depreciation of approximately 1.6% from the Company’s amortized cost basis. At December 31, 2019, 110 debt securities had unrealized losses with aggregate depreciation of approximately 1.1% from the Company’s amortized cost basis. These unrealized losses related principally to changes in interest rates and were not due to changes in the financial condition of the issuer, the quality of any underlying assets, or applicable credit enhancements. In analyzing whether unrealized losses on debt securities are other than temporary, management considers whether the securities are issued by a government body or agency, whether a rating agency has downgraded the securities, industry analysts’ reports, the financial condition and performance of the issuer, and the quality of any underlying assets or credit enhancements. Since management has the ability and intent to hold these debt securities for the foreseeable future, no declines were deemed to be other than temporary as of September 30, 2020.

The following presents a summary of amortized cost and estimated fair value of debt securities by the lesser of expected call date or contractual maturity as of September 30, 2020. Call date is used when a call of the debt security is expected, determined by the Company when the security has a market value above its amortized cost. Contractual maturities will differ from expected maturities for mortgage-backed, SBA securities and asset-backed securities because borrowers may have the right to call or prepay obligations without penalties.

September 30, 2020

    

Amortized Cost

    

Fair Value

Due in One Year or Less

$

6,772

$

6,796

Due After One Year Through Five Years

 

49,190

 

50,410

Due After Five Years Through 10 Years

 

90,941

 

95,762

Due After 10 Years

 

18,434

 

20,792

Subtotal

 

165,337

 

173,760

Mortgage-Backed Securities

 

116,252

 

118,359

SBA Securities

 

42,934

 

42,507

Asset-Backed Securities

38,846

39,329

Totals

$

363,369

$

373,955

As of September 30, 2020 and December 31, 2019, the securities portfolio was unencumbered.

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Table of Contents

The following table presents a summary of the proceeds from sales of securities available for sale, as well as gross gains and losses, for the three and nine months ended September 30, 2020 and 2019:

Three Months Ended

Nine Months Ended

September 30, 

September 30, 

    

2020

    

2019

    

2020

    

2019

Proceeds From Sales of Securities

$

4,794

$

2,555

$

38,832

$

42,864

Gross Gains on Sales

 

123

 

58

 

1,561

 

774

Gross Losses on Sales

 

(14)

 

 

(88)

 

(258)

Note 4: Loans

The following table presents the components of the loan portfolio at September 30, 2020 and December 31, 2019:

September 30, 

December 31, 

    

2020

    

2019

Commercial

$

287,254

$

276,035

Paycheck Protection Program

181,596

Construction and Land Development

 

175,882

 

196,776

Real Estate Mortgage:

 

 

1-4 Family Mortgage

 

286,089

 

260,611

Multifamily

 

585,814

 

515,014

CRE Owner Occupied

75,963

66,584

CRE Non-owner Occupied

660,058

592,545

Total Real Estate Mortgage Loans

1,607,924

1,434,754

Consumer and Other

6,572

4,473

Total Loans, Gross

 

2,259,228

 

1,912,038

Allowance for Loan Losses

 

(31,381)

 

(22,526)

Net Deferred Loan Fees

 

(10,367)

 

(5,512)

Total Loans, Net

$

2,217,480

$

1,884,000

The following table presents the activity in the allowance for loan losses, by segment, for the three months ended September 30, 2020 and 2019:

Paycheck

Construction

CRE

CRE

Protection

and Land

1--4 Family

Owner

Non-owner

Consumer

Three Months Ended September 30, 2020

    

Commercial

    

Program

    

Development

    

Mortgage

    

Multifamily

    

Occupied

    

Occupied

    

and Other

    

Unallocated

    

Total

Allowance for Loan Losses:

Beginning Balance

$

5,192

$

90

$

2,173

$

3,322

$

6,697

$

964

$

8,323

$

174

$

698

$

27,633

Provision for Loan Losses

 

115

1

63

384

1,622

140

1,177

3

245

 

3,750

Loans Charged-off

 

(5)

(1)

 

(6)

Recoveries of Loans

 

1

3

 

4

Total Ending Allowance Balance

$

5,303

$

91

$

2,236

$

3,709

$

8,319

$

1,104

$

9,500

$

176

$

943

$

31,381

Three Months Ended September 30, 2019

Allowance for Loan Losses:

Beginning Balance

$

3,181

$

$

2,246

$

2,827

$

4,994

$

844

$

6,485

$

66

$

719

$

21,362

Provision for Loan Losses

 

196

196

(15)

183

5

50

18

267

 

900

Loans Charged-off

 

(141)

(3)

 

(144)

Recoveries of Loans

 

2

3

1

 

6

Total Ending Allowance Balance

$

3,238

$

$

2,442

$

2,815

$

5,177

$

849

$

6,535

$

82

$

986

$

22,124

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Table of Contents

The following table presents the activity in the allowance for loan losses, by segment, for the nine months ended September 30, 2020 and 2019:

Paycheck

Construction

CRE

CRE

Protection

and Land

1--4 Family

Owner

Non-owner

Consumer

Nine Months Ended September 30, 2020

    

Commercial

    

Program

    

Development

    

Mortgage

    

Multifamily

    

Occupied

    

Occupied

    

and Other

    

Unallocated

    

Total

Allowance for Loan Losses:

Beginning Balance

$

3,058

$

$

2,202

$

2,839

$

5,824

$

792

$

6,972

$

85

$

754

$

22,526

Provision for Loan Losses

 

2,279

91

34

819

2,495

312

2,528

103

189

 

8,850

Loans Charged-off

 

(39)

(15)

 

(54)

Recoveries of Loans

 

5

51

3

 

59

Total Ending Allowance Balance

$

5,303

$

91

$

2,236

$

3,709

$

8,319

$

1,104

$

9,500

$

176

$

943

$

31,381

Nine Months Ended September 30, 2019

Allowance for Loan Losses:

Beginning Balance

$

2,898

$

$

2,451

$

2,597

$

4,644

$

808

$

5,872

$

65

$

696

$

20,031

Provision for Loan Losses

 

495

(10)

53

533

41

663

35

290

 

2,100

Loans Charged-off

 

(160)

(23)

 

(183)

Recoveries of Loans

 

5

1

165

5

 

176

Total Ending Allowance Balance

$

3,238

$

$

2,442

$

2,815

$

5,177

$

849

$

6,535

$

82

$

986

$

22,124

The following tables present the balance in the allowance for loan losses and the recorded investment in loans, by segment, based on impairment method as of September 30, 2020 and December 31, 2019:

Paycheck

Construction

CRE

CRE

Protection

and Land

1--4 Family

Owner

Non-owner

Consumer

Allowance for Loan Losses at September 30, 2020

    

Commercial

Program

    

Development

    

Mortgage

    

Multifamily

    

Occupied

    

Occupied

    

and Other

    

Unallocated

    

Total

Individually Evaluated for Impairment

$

40

$

$

$

144

$

$

$

$

13

$

$

197

Collectively Evaluated for Impairment

5,263

91

2,236

3,565

8,319

1,104

9,500

163

943

 

31,184

Totals

$

5,303

$

91

$

2,236

$

3,709

$

8,319

$

1,104

$

9,500

$

176

$

943

$

31,381

Allowance for Loan Losses at December 31, 2019

Individually Evaluated for Impairment

$

31

$

$

$

$

$

$

$

14

$

$

45

Collectively Evaluated for Impairment

 

3,027

2,202

2,839

5,824

792

6,972

71

754

 

22,481

Totals

$

3,058

$

$

2,202

$

2,839

$

5,824

$

792

$

6,972

$

85

$

754

$

22,526

Paycheck

Construction

CRE

CRE

Protection

and Land

1--4 Family

Owner

Non-owner

Consumer

Loans at September 30, 2020

    

Commercial

    

Program

    

Development

    

Mortgage

    

Multifamily

    

Occupied

    

Occupied

    

and Other

    

Total

Individually Evaluated for Impairment

$

432

$

$

156

$

1,773

$

$

1,589

$

12,111

$

13

$

16,074

Collectively Evaluated for Impairment

 

286,822

181,596

175,726

284,316

585,814

74,374

647,947

6,559

 

2,243,154

Totals

$

287,254

$

181,596

$

175,882

$

286,089

$

585,814

$

75,963

$

660,058

$

6,572

$

2,259,228

Loans at December 31, 2019

Individually Evaluated for Impairment

$

273

$

$

176

$

1,059

$

$

236

$

$

14

$

1,758

Collectively Evaluated for Impairment

 

275,762

196,600

259,552

515,014

66,348

592,545

4,459

 

1,910,280

Totals

$

276,035

$

$

196,776

$

260,611

$

515,014

$

66,584

$

592,545

$

4,473

$

1,912,038

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Table of Contents

The following table presents information regarding total carrying amounts and total unpaid principal balances of impaired loans by loan segment as of September 30, 2020 and December 31, 2019:

September 30, 2020

December 31, 2019

Recorded

Principal

Related

Recorded

Principal

Related

    

Investment

    

Balance

    

Allowance

    

Investment

    

Balance

    

Allowance

Loans With No Related Allowance for Loan Losses:

 

Commercial

$

312

$

312

$

$

167

$

167

$

Construction and Land Development

156

765

176

785

Real Estate Mortgage:

 

 

 

 

  

 

  

 

  

HELOC and 1-4 Family Junior Mortgage

 

884

 

884

 

 

302

 

489

 

1st REM - Rentals

 

745

745

 

 

757

 

757

 

CRE Owner Occupied

 

1,589

 

1,589

 

 

236

 

236

 

CRE Non Owner Occupied

12,111

12,111

Totals

 

15,797

 

16,406

 

 

1,638

 

2,434

 

Loans With An Allowance for Loan Losses:

 

  

 

  

 

  

 

  

Commercial

 

120

123

40

 

106

 

109

 

31

Real Estate Mortgage:

 

  

 

  

 

 

  

 

  

 

HELOC and 1-4 Family Junior Mortgage

144

331

144

Consumer and Other

13

13

13

14

14

14

Totals

 

277

 

467

 

197

 

120

 

123

 

45

Grand Totals

$

16,074

$

16,873

$

197

$

1,758

$

2,557

$

45

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Table of Contents

The following table presents information regarding the average balances and interest income recognized on impaired loans by loan segment for the three and nine months ended September 30, 2020 and 2019:

Three Months Ended September 30,

Nine Months Ended September 30,

2020

    

2019

2020

    

2019

Average

Interest

Average

Interest

Average

Interest

Average

Interest

Investment

    

Recognized

    

Investment

    

Recognized

    

Investment

    

Recognized

    

Investment

    

Recognized

Loans With No Related Allowance for Loan Losses:

Commercial

$

272

$

4

$

$

$

277

$

9

$

$

Construction and Land Development

162

2,410

35

168

2,734

122

Real Estate Mortgage:

 

 

HELOC and 1-4 Family Junior Mortgage

865

11

155

2

804

31

156

6

1st REM - 1-4 Family

617

6

617

18

1st REM - Rentals

 

748

8

760

11

 

753

21

766

29

CRE Owner Occupied

 

1,594

21

338

5

 

1,602

65

406

17

CRE Non Owner Occupied

12,115

172

12,145

514

Totals

 

15,756

 

216

 

4,280

 

59

 

15,749

 

640

 

4,679

 

192

Loans With An Allowance for Loan Losses:

 

  

 

 

  

 

  

 

  

 

 

  

 

  

Commercial

 

121

1

133

6

 

124

2

138

7

Construction and Land Development

50

1

50

1

Real Estate Mortgage:

 

 

HELOC and 1-4 Family Junior Mortgage

144

305

144

306

1st REM - Rentals

 

128

3

 

129

3

Consumer and Other

13

14

2

13

1

54

2

 

278

 

1

 

630

 

12

 

281

 

3

 

677

 

13

Grand Totals

$

16,034

$

217

$

4,910

$

71

$

16,030

$

643

$

5,356

$

205

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 process of analyzing loans for changes in risk rating is ongoing through routine monitoring of the portfolio and annual internal credit reviews for credits meeting certain thresholds.

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The following tables present the risk category of loans by loan segment as of September 30, 2020 and December 31, 2019, based on the most recent analysis performed by management:

September 30, 2020

    

Pass

    

Watch

    

Substandard

    

Total

Commercial

$

266,555

$

20,267

$

432

$

287,254

Paycheck Protection Program

181,596

181,596

Construction and Land Development

 

175,597

129

156

 

175,882

Real Estate Mortgage:

 

 

HELOC and 1-4 Family Junior Mortgage

 

28,924

884

 

29,808

1st REM - 1-4 Family

 

37,134

706

173

 

38,013

LOCs and 2nd REM - Rentals

 

19,493

144

 

19,637

1st REM - Rentals

 

197,301

758

572

 

198,631

Multifamily

 

585,814

 

585,814

CRE Owner Occupied

 

74,374

1,589

 

75,963

CRE Non-owner Occupied

618,890

29,057

12,111

660,058

Consumer and Other

 

6,559

13

 

6,572

Totals

$

2,192,237

$

50,917

$

16,074

$

2,259,228

December 31, 2019

    

Pass

    

Watch

    

Substandard

    

Total

Commercial

$

275,741

$

21

$

273

$

276,035

Construction and Land Development

 

196,462

138

176

 

196,776

Real Estate Mortgage:

 

 

HELOC and 1-4 Family Junior Mortgage

 

28,483

138

 

28,621

1st REM - 1-4 Family

 

36,370

124

177

 

36,671

LOCs and 2nd REM - Rentals

 

17,890

479

302

 

18,671

1st REM - Rentals

 

174,781

1,287

580

 

176,648

Multifamily

 

515,014

 

515,014

CRE Owner Occupied

 

65,411

1,173

 

66,584

CRE Non-owner Occupied

589,457

3,088

592,545

Consumer and Other

 

4,459

14

 

4,473

Totals

$

1,904,068

$

5,275

$

2,695

$

1,912,038

The following tables present the aging of the recorded investment in past due loans by loan segment as of September 30, 2020 and December 31, 2019:

Accruing Interest

30-89 Days

90 Days or

September 30, 2020

    

Current

    

Past Due

    

More Past Due

    

Nonaccrual

    

Total

Commercial

$

287,228

$

19

$

$

7

$

287,254

Paycheck Protection Program

181,596

181,596

Construction and Land Development

 

175,287

439

156

 

175,882

Real Estate Mortgage:

 

 

HELOC and 1-4 Family Junior Mortgage

 

29,808

 

29,808

1st REM - 1-4 Family

 

38,013

 

38,013

LOCs and 2nd REM - Rentals

 

19,493

144

 

19,637

1st REM - Rentals

 

198,505

126

 

198,631

Multifamily

 

585,814

 

585,814

CRE Owner Occupied

 

75,963

 

75,963

CRE Non-owner Occupied

 

660,058

 

660,058

Consumer and Other

 

6,572

 

6,572

Totals

$

2,258,337

$

458

$

$

433

$

2,259,228

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Accruing Interest

30-89 Days

90 Days or

December 31, 2019

    

Current

    

Past Due

    

More Past Due

    

Nonaccrual

    

Total

Commercial

$

276,028

$

$

$

7

$

276,035

Construction and Land Development

 

196,600

176

 

196,776

Real Estate Mortgage:

 

 

HELOC and 1-4 Family Junior Mortgage

 

28,621

 

28,621

1st REM - 1-4 Family

 

36,671

 

36,671

LOCs and 2nd REM - Rentals

 

18,527

144

 

18,671

1st REM - Rentals

 

176,114

400

134

 

176,648

Multifamily

 

515,014

 

515,014

CRE Owner Occupied

 

66,584

 

66,584

CRE Non-owner Occupied

 

592,545

 

592,545

Consumer and Other

 

4,470

3

 

4,473

Totals

$

1,911,174

$

403

$

$

461

$

1,912,038

At September 30, 2020, there were four loans classified as troubled debt restructurings with a current outstanding balance of $820. At December 31, 2019, there were three loans classified as troubled debt restructurings with an outstanding balance of $452. There was one new loan classified as a troubled debt restructuring during the nine month period ended September 30, 2020 and no loans classified as troubled debt restructurings during the previous twelve months subsequently defaulted during the nine months ended September 30, 2020.

In response to the COVID-19 pandemic, the Company has developed programs for clients who are experiencing business and personal disruptions due to the COVID-19 pandemic pursuant to which the Company may provide loan payment deferrals or interest-only modifications. In accordance with interagency regulatory guidance and the CARES Act, qualifying loans modified in response to the COVID-19 pandemic will not be considered troubled debt restructurings.

The following table presents a summary of closed loan modifications made in response to the COVID-19 pandemic, by loan segment and modification type, as of September 30, 2020:

Interest-Only

Payment Deferral

Total

(dollars in thousands)

   

Amount

 

# of Loans

   

Amount

 

# of Loans

   

Amount

 

# of Loans

Commercial

$

11,705

21

$

414

2

$

12,119

23

Construction and Land Development

Real Estate Mortgage:

1 - 4 Family Mortgage

5,589

10

5,589

10

Multifamily

42,273

6

42,273

6

CRE Owner Occupied

1,646

4

1,502

3

3,148

7

CRE Nonowner Occupied

99,672

35

28,580

6

128,252

41

Consumer and Other

Totals

$

160,885

76

$

30,496

11

$

191,381

87

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Note 5: Premises and Equipment

Premises and equipment are summarized as follows as of September 30, 2020 and December 31, 2019:

Range of

September 30, 

December 31, 

Useful Lives

    

2020

    

2019

Land

N/A

$

5,174

$

5,174

Building

15 - 39 Years

 

39,139

 

3,487

Leasehold Improvements

3  10 Years

 

2,538

 

3,344

Furniture and Equipment

3  5 Years

 

5,398

 

3,902

Construction in Progress

N/A

 

 

16,693

Subtotal

 

52,249

 

32,600

Accumulated Depreciation

 

(3,364)

 

(4,972)

Totals

$

48,885

$

27,628

Depreciation and amortization expense charged to noninterest expense for the three months ended September 30, 2020 and 2019 totaled $280 and $244, respectively. Depreciation and amortization expense charged to noninterest expense for the nine months ended September 30, 2020 and 2019 totaled $660 and $662, respectively. Construction in progress represents amounts paid for the construction of the Company’s new corporate headquarters building. The new corporate headquarters building was placed into service in the third quarter of 2020.

Note 6: Deposits

The following table presents the composition of deposits at September 30, 2020 and December 31, 2019:

September 30, 

December 31, 

    

2020

    

2019

Transaction Deposits

$

1,008,026

$

712,136

Savings and Money Market Deposits

 

498,397

 

516,785

Time Deposits

 

363,897

 

360,027

Brokered Deposits

 

402,724

 

234,362

Totals

$

2,273,044

$

1,823,310




Note 7: Derivative Instruments and Hedging Activities

The Company uses derivative financial instruments, which consist of interest rate swaps, to assist in its interest rate risk management. The notional amount does not represent amounts exchanged by the parties. The amount exchanged is determined by reference to the notional amount and the other terms of the individual agreements. Derivative financial instruments are reported at fair value in other assets or other liabilities. The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship. For derivatives not designated as hedges, the gain or loss is recognized in current earnings.

Non-hedge Derivatives

The Company enters into interest rate swaps to facilitate client transactions and meet their financing needs. Upon entering into these instruments to meet client needs, the Company enters into offsetting positions with large U.S. financial institutions in order to minimize the risk to the Company. These swaps are derivatives, but are not designated as hedging instruments.

Interest rate swap contracts involve the risk of dealing with counterparties and their ability to meet contractual terms. When the fair value of a derivative instrument contract is positive, this generally indicates that the counter party or client owes the Company, and results in credit risk to the Company. When the fair value of a derivative instrument contract is negative, the Company owes the client or counterparty and therefore, the Company has no credit risk.

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The following table presents a summary of the Company’s interest rate swaps to facilitate customer transactions as of September 30, 2020 and December 31, 2019:

September 30, 2020

December 31, 2019

Notional

Estimated

Notional

Estimated

Amount

Fair Value

Amount

Fair Value

Interest Rate Swap Agreements:

Assets

$

49,842

$

3,581

$

7,140

$

150

Liabilities

 

49,842

 

(3,581)

 

7,140

 

(150)

Total

$

99,684

$

$

14,280

$

Cash Flow Hedging Derivatives

For derivative instruments that are designated and qualify as a cash flow hedge, the aggregate fair value of the derivative instrument is recorded in other assets or other liabilities with any gain or loss related to changes in fair value recorded in accumulated other comprehensive income, net of tax. The gain or loss is reclassified into earnings in the same period during which the hedged asset or liability affects earnings and is presented in the same income statement line item as the earnings effect of the hedged asset or liability. The Company utilizes cash flow hedges to manage interest rate exposure for the brokered certificate of deposit, wholesale borrowing, and notes payable portfolios. During the next 12 months, the Company estimates that $846 will be reclassified to interest expense.

The following tables present a summary of the Company’s interest rate swaps designated as cash flow hedges as of September 30, 2020 and December 31, 2019:

    

September 30, 2020

    

December 31, 2019

Notional Amount

$

111,500

$

48,000

Weighted Average Pay Rate

1.30

%

1.89

%

Weighted Average Receive Rate

0.30

%

2.25

%

Weighted Average Maturity (Years)

4.18

3.53

Net Unrealized Loss

$

(3,899)

$

(618)

September 30, 2020

December 31, 2019

Notional

Estimated

Notional

Estimated

Amount

Fair Value

Amount

Fair Value

Interest Rate Swap Agreements:

Assets

$

5,000

$

10

$

18,000

$

134

Liabilities

106,500

(3,909)

30,000

(752)

The following table presents the effect of derivative instruments in cash flow hedging relationships on the consolidated statements of income for the nine months ended September 30, 2020 and 2019:

Nine Months Ended September 30, 

(dollars in thousands)

2020

2019

Derivatives in

Location of Gain or

Gain (Loss)

Cash Flow Hedging

(Loss) Reclassified

Reclassified from

Relationships

from AOCI into Income

AOCI into Earnings

Interest Rate Swaps

Interest Expense

$

(313)

$

20

No amounts were reclassified from accumulated other comprehensive income into net income related to hedge ineffectiveness for these derivatives during the three and nine months ended September 30, 2020 and 2019, and no

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amounts are expected to be reclassified from accumulated other comprehensive income into net income related to hedge ineffectiveness over the next twelve months.

Note 8: Subordinated Debentures

On June 19, 2020, the Company entered into a Subordinated Note Purchase Agreement with certain institutional accredited investors and qualified institutional buyers pursuant to which the Company sold and issued $50,000 in aggregate principal amount of 5.25% Fixed-to-Floating Rate Subordinated Notes due 2030 (the “2030 Notes”). The 2030 Notes were issued by the Company to the purchasers at a price equal to 100% of their face amount. Issuance costs were $1,127 and have been netted against subordinated debt on the consolidated balance sheets. These costs are being amortized over five years, which represents the period from issuance to the first redemption date of July 1, 2025. Total amortization expense for the three months and nine months ended September 30, 2020 was $60. On October 13, 2020, the Company completed an offer to exchange up to $50,000 total principal amount of the 2030 Notes for substantially identical subordinated notes registered under the Securities Act of 1933, in satisfaction of the Company’s obligations under a registration rights agreement entered into with the initial purchasers of the 2030 Notes. $47,000 of the $50,000 of the 2030 Notes were exchanged in the exchange offer.

The 2030 Notes mature on July 1, 2030, with a fixed rate of 5.25% payable semi-annually for five years until July 1, 2025. Thereafter, the interest rate converts to a variable interest rate, reset quarterly, equal to the three-month term Secured Overnight Financing Rate, or SOFR, plus 513 basis points, and payments become payable quarterly in arrears until either the early redemption date or the maturity date. The Notes are not convertible into or exchangeable for any other securities or assets of the Company or any of its subsidiaries. The Notes are redeemable by the Company, in whole or in part, on or after July 1, 2025, and at any time upon the occurrence of certain events. Any redemption by the Company would be at a redemption price equal to 100% of the outstanding principal amount of the 2030 Notes being redeemed, including any accrued and unpaid interest thereon.

On July 12, 2017, the Company entered into a Subordinated Note Purchase Agreement with certain institutional accredited investors whereby the Company sold and issued $25,000 in aggregate principal amount of 5.875% Fixed-to-Floating Rate Subordinated Notes due 2027 (the “2027 Notes”). The 2027 Notes were issued by the Company to the purchasers at a price equal to 100% of their face amount. Issuance costs were $516 and have been netted against subordinated debt on the consolidated balance sheets. These costs are being amortized over five years, which represents the period from issuance to the first redemption date of July 15, 2022. Total amortization expense for the three months and nine months ended September 30, 2020, was $26 and $78, respectively, with $189 remaining to be amortized as of September 30, 2020.

The 2027 Notes mature on July 15, 2027, with a fixed interest rate of 5.875% payable semi-annually in arrears for five years until July 15, 2022. Thereafter, the Company will be obligated to pay interest at a rate equal to 3-month LIBOR plus 388 basis points quarterly in arrears until either the early redemption date or the maturity date. The 2027 Notes are not convertible into or exchangeable for any other securities or assets of the Company or any of its subsidiaries. The 2027 Notes are redeemable by the Company, in whole or in part, on or after July 15, 2022, and at any time upon the occurrence of certain events. Any redemption by the Company would be at a redemption price equal to 100% of the outstanding principal amount of the 2027 Notes being redeemed, including any accrued and unpaid interest thereon.

Note 9: Tax Credit Investments

The Company invests in qualified affordable housing projects and federal historic projects for the purpose of community reinvestment and obtaining tax credits. The Company’s tax credit investments are limited to existing lending relationships with well-known developers and projects within the Company’s market area.

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The following table presents the Company’s investments in qualified affordable housing projects and other tax credit investments at September 30, 2020 and December 31, 2019:

September 30, 2020

December 31, 2019

Investment

Accounting Method

Investment

Unfunded Commitment (1)

Investment

Unfunded Commitment

Low Income Housing Tax Credit (LIHTC)

Proportional Amortization

$

1,937

$

$

2,148

$

Federal Historic Tax Credit (FHTC)

Equity

2,344

2,394

2,262

3,395

Total

$

4,281

$

2,394

$

4,410

$

3,395

(1)All commitments are expected to be paid by the Company by September 30, 2021.

The following table presents the amortization expense and tax benefit recognized for the Company’s qualified affordable housing projects and other tax credit investments for the three and nine months ended September 30, 2020 and 2019:

Three Months Ended

Nine Months Ended

September 30, 

September 30, 

2020

    

2019

    

2020

    

2019

Amortization Expense (1)

LIHTC

$

70

$

72

$

211

$

216

FHTC

146

530

592

2,097

Total

$

216

$

602

$

803

$

2,313

Tax Benefit Recognized (2)

LIHTC

$

(83)

$

(83)

$

(248)

$

(248)

FHTC

(220)

(641)

(837)

(2,539)

Total

$

(303)

$

(724)

$

(1,085)

$

(2,787)

(1)The amortization expense for the LIHTC investments are included in income tax expense. The amortization for the FHTC tax credits are included in noninterest expense.
(2)All of the tax benefits recognized are included in income tax expense. The tax benefit recognized for the FHTC investments primarily reflects the tax credits generated from the investments, and excludes the net tax expense/benefit of the investments’ income/loss.

Note 10: Commitments, Contingencies and Credit Risk

Financial Instruments with Off-Balance Sheet Credit Risk

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.

The Company’s exposure to credit loss is represented by the contractual, or notional, amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance sheet instruments. Since some of the commitments are expected to expire without being drawn upon and some of the commitments may not be drawn upon to the total extent of the commitment, the notional amount of these commitments does not necessarily represent future cash requirements.

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Table of Contents

The following commitments were outstanding at September 30, 2020 and December 31, 2019:

September 30, 

December 31, 

    

2020

    

2019

Unfunded Commitments Under Lines of Credit

$

605,994

$

500,962

Letters of Credit

 

85,901

 

79,225

Totals

$

691,895

$

580,187

The Company had outstanding letters of credit with the FHLB in total amounts of $74,207 and $108,502 at September 30, 2020 and December 31, 2019, respectively, on behalf of customers and to secure public deposits.

On August 24, 2020, the Company opened its newly constructed office complex in St. Louis Park, Minnesota. The remaining contractual obligations relating to the construction costs of the building are minimal.

Legal Contingencies

Neither the Company nor any of its subsidiaries is a party, and no property of these entities is subject, to any material pending legal proceedings, other than ordinary routine litigation incidental to the Bank’s business. The Company does not know of any proceeding contemplated by a governmental authority against the Company or any of its subsidiaries.

Note 11: Stock Options and Restricted Stock Awards

The Company established the Bridgewater Bancshares, Inc. 2012 Combined Incentive and Non-Statutory Stock Option Plan (the “2012 Plan”) under which the Company may grant options to its directors, officers, employees, and consultants for up to 750,000 shares of common stock. Both incentive stock options and nonqualified stock options may be granted under the 2012 Plan. The exercise price of each option equals the fair market value of the Company’s stock on the date of grant and the maximum term of each outstanding option is ten years. All outstanding options have been granted with vesting periods of five years. As of September 30, 2020 and December 31, 2019, there were 30,000 and -0- shares, respectively, of the Company’s common stock reserved for future option grants under the 2012 Plan.

In 2017, the Company adopted the Bridgewater Bancshares, Inc. 2017 Combined Incentive and Non-Statutory Stock Option Plan (the “2017 Plan”). Under the 2017 Plan, the Company may grant options to its directors, officers, employees and consultants for up to 1,500,000 shares of common stock. Both incentive stock options and nonqualified stock options may be granted under the 2017 Plan. The exercise price of each option equals the fair market value of the Company’s stock on the date of grant and the maximum term of each outstanding option is ten years. All outstanding options have been granted with vesting periods of four or five years. As of September 30, 2020 and December 31, 2019, there were 313,600 and 310,600 of remaining shares of the Company’s common stock reserved for future option grants under the 2017 Plan.

In 2019, the Company adopted the Bridgewater Bancshares, Inc. 2019 Equity Incentive Plan (the “2019 EIP”). The types of awards which may be granted under the 2019 EIP include incentive and nonqualified stock options, stock appreciation rights, stock awards, restricted stock units, restricted stock and cash incentive awards. The Company may grant these awards to its directors, officers, employees and certain other service providers for up to 1,000,000 shares of common stock. The exercise price of each option equals the fair market value of the Company’s stock on the date of grant and the maximum term of each award is ten years. All outstanding awards have been granted with a vesting period of four years. As of September 30, 2020 and December 31, 2019, there were 771,489 and 867,040 of remaining shares of the Company’s common stock reserved for future grants under the 2019 EIP.

Stock Options

The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the assumptions noted in the table below. Expected volatilities are based on an industry index as described below. The expected term of options granted is based on historical data and represents the period of

24

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time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. Historically, the Company has not paid a dividend on its common stock and does not expect to do so in the near future.

The Company used the S&P 600 CM Bank Index as its historical volatility index. The S&P 600 CM Bank Index is an index of publicly traded small capitalization, regional, commercial banks located throughout the United States. There were 54 banks in the index ranging in market capitalization from $500 million up to $4.5 billion.

The weighted average assumptions used in the model for valuing stock option grants for the nine months ended September 30, 2020, are as follows:

September 30, 

    

2020

    

Dividend Yield

 

%  

Expected Life

 

7

Years

Expected Volatility

 

44.14

%  

Risk-Free Interest Rate

 

0.68

%  

The following table presents a summary of the status of the Company’s stock option grants for the nine months ended September 30, 2020:

September 30, 2020

    

    

    

Weighted

Average

Shares

Exercise Price

Outstanding at Beginning of Year

 

1,961,650

$

7.08

Granted

 

60,000

 

10.61

Exercised

 

(17,500)

 

3.11

Forfeitures

 

(33,000)

 

7.47

Outstanding at Period End

 

1,971,150

$

7.22

Options Exercisable at Period End

 

1,010,550

$

5.21

For the three months ended September 30, 2020 and 2019, the Company recognized compensation expense for stock options of $205 and $175, respectively. For the nine months ended September 30, 2020 and 2019, the Company recognized compensation expense for stock options of $653 and $524, respectively.

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The following table presents information pertaining to options outstanding at September 30, 2020:

Options Outstanding

Options Exercisable

Number

Remaining

    

Number

Exercise Price

    

Outstanding

    

Contractual Life

Exercise Price

    

Outstanding

$

2.13

 

66,750

 

2.5

Years  

$

2.13

 

66,750

3.00

 

447,500

 

3.3

Years  

 

3.00

 

447,500

3.58

 

45,000

 

4.3

Years  

 

3.58

 

45,000

7.47

 

988,900

 

7.0

Years  

 

7.47

 

400,300

13.22

25,000

7.6

Years  

13.22

10,000

12.86

45,000

7.9

Years  

12.86

18,000

12.94

30,000

8.0

Years  

12.94

6,000

11.59

25,000

8.1

Years  

11.59

5,000

11.15

10,000

8.4

Years  

11.15

2,000

11.13

50,000

8.9

Years  

11.13

10,000

12.92

178,000

9.2

Years  

12.92

12.67

25,000

9.4

Years  

12.67

8.76

25,000

9.5

Years  

8.76

10.08

10,000

9.7

Years  

10.08

Totals

 

1,971,150

 

6.3

Years  

$

7.22

1,010,550

As of September 30, 2020, there was $2,256 of total unrecognized compensation cost related to nonvested stock options granted under the 2012 Plan, 2017 Plan and 2019 EIP that is expected to be recognized over a weighted-average period of 4.8 years.

The following presents an analysis of nonvested stock options issued and outstanding for the nine months ended September 30, 2020:

    

    

    

Weighted

Number of

Average Grant

Shares

Date Fair Value

Nonvested Options at December 31, 2019

 

969,600

$

3.08

Granted

 

60,000

4.39

Vested

 

(36,000)

3.02

Forfeited

(33,000)

2.80

Nonvested Options at September 30, 2020

 

960,600

$

3.17

Restricted Stock Awards

In 2019, the Company granted restricted stock awards out of the 2019 EIP. These awards vest in equal annual installments on the first four anniversaries of the date of the grant. Nonvested restricted stock awards are classified as outstanding shares with voting and forfeitable dividend rights.

The following table presents an analysis of nonvested restricted stock awards outstanding for the nine months ended September 30, 2020:

    

    

    

Weighted

Number of

Average Grant

Shares

Date Fair Value

Nonvested Awards at December 31, 2019

 

132,960

$

12.92

Granted

 

16,141

10.11

Vested

 

Forfeited

(3,200)

12.92

Nonvested Awards at September 30, 2020

 

145,901

$

12.61

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Compensation expense associated with the restricted stock awards is recognized on a straight-line basis over the period that the restrictions associated with the awards lapse based on the total cost of the award at the grant date. For the three and nine months ended September 30, 2020, the Company recognized compensation expense for restricted stock awards of $109 and $330, respectively. No compensation expense was recognized for restricted stock awards for the three and nine months ended September 30, 2019.

As of September 30, 2020, there was $1,479 of total unrecognized compensation cost related to nonvested restricted stock awards granted under the 2019 EIP that is expected to be recognized over a period of four years.

In addition, during the nine months ended September 30, 2020, the Company issued 22,610 shares of common stock to directors as a part of their compensation for their annual services on the Company’s board of directors. The aggregate value of the shares issued to directors of $222 was included in stock based compensation expense in the accompanying consolidated statements of shareholders’ equity.

Note 12: Regulatory Capital

Effective January 1, 2015, the capital requirements of the Company and the Bank were changed to implement the regulatory requirements of the Basel III capital reforms. The Basel III requirements, among other things, (i) apply a strengthened set of capital requirements to the Company and Bank, including requirements related to common equity as a component of core capital, (ii) implement a “capital conservation buffer” against risk and higher minimum tier 1 capital requirement, and (iii) revise the rules for calculating risk-weighted assets for purposes of such requirements. The rules made corresponding revisions to the prompt corrective action framework and include the new capital ratios and buffer requirements which were phased in incrementally, with full implementation on January 1, 2019. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve qualitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios (set forth in the tables below and defined in the regulations) of Total Capital to Risk Weighted Assets, Tier 1 Capital to Risk Weighted Assets, Common Equity Tier 1 Capital to Risk Weighted Assets, and Tier 1 Capital to Average Assets.

The following tables present the Company and the Bank’s capital amounts and ratios as of September 30, 2020 and December 31, 2019:

Minimum Required

For Capital Adequacy

To be Well Capitalized

For Capital Adequacy

Purposes Plus Capital

Under Prompt Corrective

Actual

Purposes

Conservation Buffer

Action Regulations

September 30, 2020

    

Amount

    

Ratio

    

Amount

    

Ratio

    

Amount

    

Ratio

Amount

    

Ratio

(dollars in thousands)

Company (Consolidated):

Total Risk-Based Capital

$

359,597

15.45

%  

$

186,206

8.00

%  

$

244,396

10.50

%  

N/A

N/A

Tier 1 Risk-Based Capital

256,805

11.03

139,655

6.00

197,844

8.50

N/A

N/A

Common Equity Tier 1 Capital

256,805

11.03

104,741

4.50

162,931

7.00

N/A

N/A

Tier 1 Leverage Ratio

256,805

9.83

104,543

4.00

104,543

4.00

N/A

N/A

Bank:

Total Risk-Based Capital

$

322,276

13.85

%  

$

186,104

8.00

%  

$

244,262

10.50

%  

$

232,630

10.00

%

Tier 1 Risk-Based Capital

293,164

12.60

139,578

6.00

197,736

8.50

186,104

8.00

Common Equity Tier 1 Capital

293,164

12.60

104,684

4.50

162,841

7.00

151,210

6.50

Tier 1 Leverage Ratio

293,164

11.24

104,350

4.00

104,350

4.00

130,437

5.00

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Minimum Required

For Capital Adequacy

To be Well Capitalized

For Capital Adequacy

Purposes Plus Capital

Under Prompt Corrective

Actual

Purposes

Conservation Buffer

Action Regulations

December 31, 2019

    

Amount

    

Ratio

    

Amount

    

Ratio

    

Amount

    

Ratio

Amount

    

Ratio

(dollars in thousands)

Company (Consolidated):

Total Risk-Based Capital

$

269,613

12.98

%  

$

166,163

8.00

%  

$

218,089

10.50

%  

N/A

N/A

Tier 1 Risk-Based Capital

236,533

11.39

124,623

6.00

176,549

8.50

N/A

N/A

Common Equity Tier 1 Capital

236,533

11.39

93,467

4.50

145,393

7.00

N/A

N/A

Tier 1 Leverage Ratio

236,533

10.69

88,498

4.00

88,498

4.00

N/A

N/A

Bank:

Total Risk-Based Capital

$

252,501

12.16

%  

$

166,137

8.00

%  

$

218,055

10.50

%  

$

207,671

10.00

%

Tier 1 Risk-Based Capital

243,461

11.72

124,603

6.00

176,521

8.50

166,137

8.00

Common Equity Tier 1 Capital

243,461

11.72

93,452

4.50

145,370

7.00

134,986

6.50

Tier 1 Leverage Ratio

243,461

11.01

88,455

4.00

88,455

4.00

110,569

5.00

The Company and the Bank must maintain a capital conservation buffer, as defined by Basel III regulatory capital guidelines, in order to avoid limitations on capital distributions, including dividend payments, stock repurchases and certain discretionary bonus payments to executive officers.

Note 13: Stock Repurchase Program

On January 22, 2019, the Company adopted a stock repurchase program. Under the initial terms of the repurchase program, the Company could repurchase up to $15.0 million of its common stock during the 24-month period beginning on January 22, 2019. The stock repurchase program permits the Company’s management to acquire shares of the Company’s common stock from time to time in the open market in accordance with Rule 10b-18 of the Exchange Act or in privately negotiated transactions at prices management considers to be attractive and in the best interests of the Company and its shareholders. The stock repurchase program does not obligate the Company to repurchase shares of its common stock.

Any repurchases are subject to compliance with applicable laws and regulations. Repurchases are conducted in consideration of general market and economic conditions, regulatory requirements, availability of funds, and other relevant considerations, as determined by the Company. The stock repurchase program may be modified, suspended or discontinued at any time at the discretion of the Company’s Board of Directors.

On July 23, 2019, the Company’s Board of Directors approved a $10.0 million increase to the Company’s stock repurchase program, increasing the authorization to repurchase common stock under the program from a total of $15.0 million to up to a total of $25.0 million. The stock repurchase program continues through January 22, 2021.

In response to the pandemic and the related economic and market uncertainty, the Company stopped repurchasing shares under the program on March 16, 2020. Strong earnings and capital growth coupled with better asset quality visibility as loan modifications expired, supported management’s decision to resume repurchases under the Company’s stock repurchase program late in the third quarter of 2020. The Company remains committed to maintaining strong capital levels with enhancing shareholder value as it strategically executes its stock repurchase program in this fluid economic environment. During the three months ended September 30, 2020, the Company repurchased 137,984 shares of its common stock, representing less than 1% of the Company’s outstanding shares. Shares were repurchased during this period at a weighted average price of $9.39 for a total of $1.3 million. During the nine months ended September 30, 2020, the Company repurchased 315,848 shares of its common stock, representing approximately 1% of the Company’s outstanding shares. Shares were repurchased at a weighted average price of $10.59 for a total of $3.3 million. All shares repurchased under the stock repurchase program were converted to authorized but unissued shares. At September 30, 2020, the remaining amount that could be used to repurchase shares under the stock repurchase program was $6.7 million.

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Note 14: Fair Value Measurement

The Company categorizes its assets and liabilities measured at fair value into a three-level hierarchy based on the priority of the inputs to the valuation technique used to determine fair value. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used in the determination of the fair value measurement fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement. Assets and liabilities valued at fair value are categorized based on the inputs to the valuation techniques as follows:

Level 1 – Inputs that utilized quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.

Level 2 – Inputs that include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instruments. Fair values for these instruments are estimated using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows.

Level 3 – Inputs that are unobservable for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity.

Subsequent to initial recognition, the Company may re-measure the carrying value of assets and liabilities measured on a nonrecurring basis to fair value. Adjustments to fair value usually result when certain assets are impaired. Such assets are written down from their carrying amounts to their fair value.

Professional standards allow entities the irrevocable option to elect to measure certain financial instruments and other items at fair value for the initial and subsequent measurement on an instrument-by-instrument basis. The Company adopted the policy to value certain financial instruments at fair value. The Company has not elected to measure any existing financial instruments at fair value; however, it may elect to measure newly acquired financial instruments at fair value in the future.

Recurring Basis

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The following tables present the balances of the assets and liabilities measured at fair value on a recurring basis as of September 30, 2020 and December 31, 2019:

September 30, 2020

    

Level 1

    

Level 2

    

Level 3

    

Total

Fair Value of Financial Assets:

Securities Available for Sale:

Municipal Bonds

$

$

105,254

$

$

105,254

Mortgage-Backed Securities

118,359

118,359

Corporate Securities

68,506

68,506

SBA Securities

42,507

42,507

Asset-Backed Securities

39,329

39,329

Interest Rate Swaps

3,591

3,591

Total Fair Value of Financial Assets

$

$

377,546

$

$

377,546

Fair Value of Financial Liabilities:

Interest Rate Swaps

$

$

7,490

$

$

7,490

Total Fair Value of Financial Liabilities

$

$

7,490

$

$

7,490

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December 31, 2019

    

Level 1

    

Level 2

    

Level 3

    

Total

Fair Value of Financial Assets:

Securities Available for Sale:

U.S. Treasury Securities

$

4,998

$

$

$

4,998

Municipal Bonds

105,743

105,743

Mortgage-Backed Securities

64,728

64,728

Corporate Securities

50,176

50,176

SBA Securities

49,559

49,559

Asset-Backed Securities

14,673

14,673

Interest Rate Swaps

284

284

Total Fair Value of Financial Assets

$

4,998

$

285,163

$

$

290,161

Fair Value of Financial Liabilities:

Interest Rate Swaps

$

$

902

$

$

902

Total Fair Value of Financial Liabilities

$

$

902

$

$

902

Investment Securities

When available, the Company uses quoted market prices to determine the fair value of investment securities; such items are classified in Level 1 of the fair value hierarchy.

For the Company’s investments, when quoted prices are not available for identical securities in an active market, the Company determines fair value utilizing vendors who apply matrix pricing for similar bonds where no price is observable or may compile prices from various sources. These models are primarily industry-standard models that consider various assumptions, including time value, yield curve, volatility factors, prepayment speeds, default rates, loss severity, current market, and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Substantially, all of these assumptions are observable in the marketplace and can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace. Fair values from these models are verified, where possible, against quoted market prices for recent trading activity of assets with similar characteristics to the security being valued. Such methods are generally classified as Level 2. However, when prices from independent sources vary, or cannot be obtained or corroborated, a security is generally classified as Level 3.

Interest Rate Swaps

Interest rate swaps are traded in over-the-counter markets where quoted market prices are not readily available. For those interest rate swaps, fair value is determined using internally developed models of a third party that uses primarily market observable inputs, such as yield curves and option volatilities, and accordingly are valued using Level 2 inputs.

Nonrecurring Basis

Certain assets are measured at fair value on a nonrecurring basis. These assets are not measured at fair value on an ongoing basis; however, they are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment or a change in the amount of previously recognized impairment.

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The following tables present net impairment losses related to nonrecurring fair value measurements of certain assets at September 30, 2020 and December 31, 2019:

September 30, 2020

    

Level 1

    

Level 2

    

Level 3

    

Loss

Impaired Loans

$

$

80

$

$

197

Totals

$

$

80

$

$

197

December 31, 2019

    

Level 1

    

Level 2

    

Level 3

    

Loss

Impaired Loans

$

$

75

$

$

206

Totals

$

$

75

$

$

206

Impaired Loans

In accordance with the provisions of the loan impairment guidance, impairment is measured on loans when it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, or discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceeds the recorded investments in such loans. Impaired loans for which an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. Collateral values are estimated using Level 2 inputs based on customized discounting criteria.

Impairment amounts on impaired loans represent specific valuation allowance and write-downs during the period presented on impaired loans that were individually evaluated for impairment based on the estimated fair value of the collateral less estimated selling costs, excluding impaired loans fully charged-off.

Fair Value

Disclosure of fair value information about financial instruments, for which it is practicable to estimate that value, is required whether or not recognized in the consolidated balance sheets. In cases where quoted market prices are not available, fair values are based on estimates using present value of cash flow or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimate of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases could not be realized in immediate settlement of the instruments. Certain financial instruments with a fair value that is not practicable to estimate and all non-financial instruments are excluded from the disclosure requirements. Accordingly, the aggregate fair value amounts presented do not necessarily represent the underlying value of the Company.

Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters that could affect the estimates. Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business. Deposits with no stated maturities are defined as having a fair value equivalent to the amount payable on demand. This prohibits adjusting fair value derived from retaining those deposits for an expected future period of time. This component, commonly referred to as a deposit base intangible, is neither considered in the above amounts nor is it recorded as an intangible asset on the balance sheet. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

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The following tables present the carrying amount and estimated fair values of financial instruments at September 30, 2020 and December 31, 2019:

September 30, 2020

Fair Value Hierarchy

Carrying

Estimated

    

Amount

    

Level 1

    

Level 2

    

Level 3

    

Fair Value

Financial Assets:

Cash and Due From Banks

$

91,510

$

91,510

$

$

$

91,510

Bank-Owned Certificates of Deposit

2,862

2,920

2,920

Securities Available for Sale

373,955

373,955

373,955

FHLB Stock, at Cost

7,817

7,817

7,817

Loans, Net

2,217,480

2,256,282

2,256,282

Accrued Interest Receivable

9,647

9,647

9,647

Interest Rate Swaps

3,591

3,591

3,591

Financial Liabilities:

Deposits

$

2,273,044

$

$

2,281,737

$

$

2,281,737

Notes Payable

11,500

11,502

11,502

FHLB Advances

127,500

134,533

134,533

Subordinated Debentures

73,665

74,964

74,964

Accrued Interest Payable

2,082

2,082

2,082

Interest Rate Swaps

7,490

7,490

7,490

December 31, 2019

Fair Value Hierarchy

Carrying

Estimated

    

Amount

    

Level 1

    

Level 2

    

Level 3

    

Fair Value

Financial Assets:

Cash and Due From Banks

$

31,935

$

31,935

$

$

$

31,935

Bank-Owned Certificates of Deposit

2,654

2,677

2,677

Securities Available for Sale

289,877

4,998

284,879

289,877

FHLB Stock, at Cost

7,824

7,824

7,824

Loans, Net

1,884,000

1,891,987

1,891,987

Accrued Interest Receivable

6,775

6,775

6,775

Interest Rate Swaps

284

284

284

Financial Liabilities:

Deposits

$

1,823,310

$

$

1,821,915

$

$

1,821,915

Notes Payable

13,000

13,022

13,022

FHLB Advances

136,500

141,152

141,152

Subordinated Debentures

24,733

25,309

25,309

Accrued Interest Payable

1,982

1,982

1,982

Interest Rate Swaps

902

902

902

The following methods and assumptions were used by the Company to estimate fair value of consolidated financial statements not previously discussed.

Cash and due from banks – The carrying amount of cash and cash equivalents approximates their fair value.

Bank-owned certificates of deposit – Fair values of bank-owned certificates of deposit are estimated using the discounted cash flow analysis based on current rates for similar types of deposits.

FHLB stock – The carrying amount of FHLB stock approximates its fair value.

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Loans, Net – Fair values for loans are estimated based on discounted cash flows, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality.

Accrued interest receivable – The carrying amount of accrued interest receivable approximates its fair value since it is short term in nature and does not present anticipated credit concerns.

Deposits – The fair values disclosed for demand deposits without stated maturities (interest and noninterest transaction, savings, and money market accounts) are equal to the amount payable on demand at the reporting date (their carrying amounts). Fair values for the fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Federal funds purchased – The carrying amount of federal funds purchased approximates the fair value.

Notes payable and subordinated debentures – The fair values of the Company’s notes payable and subordinated debt are estimated using a discounted cash flow analysis, based on the Company’s current incremental borrowing rate for similar types of borrowing arrangements.

FHLB advances – The fair values of the Company’s FHLB advances are estimated using discounted cash flow analysis based on the Company’s current incremental borrowing rates for similar types of borrowing agreements.

Accrued interest payable – The carrying amount of accrued interest payable approximates its fair value since it is short term in nature.

Off-balance sheet instruments – Fair values of the Company’s off-balance sheet instruments (lending commitments and unused lines of credit) are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the counterparties’ credit standing and discounted cash flow analysis. The fair value of these off-balance-sheet items approximates the recorded amounts of the related fees and was not material at September 30, 2020 and December 31, 2019.

Limitations – The fair value of a financial instrument is the current amount that would be exchanged between market participants, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Consequently, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

Note 15: Subsequent Events

On October 27, 2020, the Company’s Board of Directors approved a $15 million increase to the Company’s previously announced stock repurchase program, increasing the amount of common stock to be repurchased from $25 million to up to $40 million for the duration of the program. Additionally, the Board extended the stock repurchase program to run through October 27, 2022.

 

Any repurchases are subject to compliance with applicable laws and regulations. Repurchases will be conducted in consideration of general market and economic conditions, regulatory requirements, availability of funds, and other relevant considerations, as determined by the Company. The stock repurchase program may be modified, suspended or discontinued at any time at the discretion of the Company’s Board of Directors.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

The following discussion explains the Company’s financial condition and results of operations as of and for the three and nine months ended September 30, 2020. Annualized results for these interim periods may not be indicative of results for the full year or future periods. The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes presented elsewhere in this report and the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, filed with the Securities and Exchange Commission, or the SEC, on March 12, 2020.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, statements concerning plans, estimates, calculations, forecasts and projections with respect to the anticipated future performance of the Company. These statements are often, but not always, identified by words such as “may”, “might”, “should”, “could”, “predict”, “potential”, “believe”, “expect”, “continue”, “will”, “anticipate”, “seek”, “estimate”, “intend”, “plan”, “projection”, “would”, “annualized”, “target” and “outlook”, or the negative version of those words or other comparable words of a future or forward-looking nature. Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Our actual results and financial condition may differ materially from those indicated in the forward-looking statements. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:

the negative effects of the COVID-19 pandemic, including its effects on the economic environment, our clients and our operations, as well as any changes to federal, state or local government laws, regulations or orders in connection with the pandemic;
loan concentrations in our portfolio;
the overall health of the local and national real estate market;
the ability to successfully manage credit risk;
business and economic conditions generally and in the financial services industry, nationally and within our market area;
the ability to maintain an adequate level of allowance for loan losses;
new or revised accounting standards, including as a result of the future implementation of the Current Expected Credit Loss standard;
the concentration of large loans to certain borrowers;
the ability to successfully manage liquidity risk;
the dependence on non-core funding sources and our cost of funds;
the concentration of large deposits from certain clients;
the ability to raise additional capital to implement our business plan;
the ability to implement the Company’s growth strategy and manage costs effectively;
developments and uncertainty related to the future use and availability of some reference rates, such as the London Interbank Offered Rate, as well as other alternative reference rates;
the composition of our senior leadership team and our ability to attract and retain key personnel;

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the occurrence of fraudulent activity, breaches or failures of our information security controls or cybersecurity-related incidents;
interruptions involving our information technology and telecommunications systems or third-party servicers;
competition in the financial services industry;
severe weather, natural disasters, wide spread disease or pandemics (including the COVID-19 pandemic), acts of war or terrorism or other adverse external events;
the effectiveness of our risk management framework;
the commencement and outcome of litigation and other legal proceedings and regulatory actions against us;
the impact of recent and future legislative and regulatory changes;
interest rate risk;
fluctuations in the values of the securities held in our securities portfolio;
changes in federal tax law or policy;
the imposition of tariffs or other governmental policies impacting the value of products produced by our commercial borrowers;
potential impairment to the goodwill we recorded in connection with our past acquisition; and
any other risks described in the “Risk Factors” section of this report and in the Company’s Annual Report on Form 10-K as of December 31, 2019, filed with the SEC on March 12, 2020, as well as those set forth in this report and other reports filed by the Company with the SEC.

The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this report. In addition, past results of operations are not necessarily indicative of future results. Any forward-looking statement made by us in this report is based only on information currently available to us and speaks only as of the date on which it is made. We undertake no obligation to publicly update any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future developments or otherwise.

Overview

The Company is a financial holding company headquartered in St. Louis Park, Minnesota. The principal sources of funds for loans and investments are transaction, savings, time, and other deposits, and short-term and long-term borrowings. The Company’s principal sources of income are interest and fees collected on loans, interest and dividends earned on investment securities and service charges. The Company’s principal expenses are interest paid on deposit accounts and borrowings, employee compensation and other overhead expenses. The Company’s simple, efficient business model of providing responsive support and unconventional experiences to clients continues to be the underlying principle that drives the Company’s profitable growth.

During the third quarter of 2020, the Company opened its newly constructed office complex in St. Louis Park, Minnesota. The Company relocated its headquarters from Bloomington, Minnesota and relocated its current branch location in St. Louis Park to the new office complex.

Information Regarding COVID-19 Impact

Financial Position and Results of Operations. The outbreak of the novel coronavirus, or COVID-19, which was declared a pandemic by the World Health Organization on March 11, 2020, has continued to create uncertainty and extraordinary change for the Company, its clients, its communities and the country as a whole. In response to this pandemic, the Company rapidly deployed its business continuity plan and continues to take steps to protect the health and safety of its employees and clients. Given the fluidity of the situation, management cannot estimate the duration and full impact of the COVID-19 pandemic on the economy, financial markets and the Company’s financial condition and results of operations. At this point, management does not expect that the Company’s financial results in future quarters

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will track with the Company’s historical performance.

Effects on the Company’s Market Area. The Company’s primary banking market area is the Minneapolis-St. Paul-Bloomington, MN-WI Metropolitan Statistical Area. In Minnesota, the Governor issued an order on March 25, 2020 that, subject to limited exceptions, required individuals to stay at home and non-essential businesses to cease all activities, other than minimum basic operations. This order was lifted as of May 18, 2020, and the state has continued its phased-in approach to reopening, where businesses must operate under certain restrictions based on the nature and industry of the business. Recent increases in COVID-19 infections locally and across the nation have created uncertainty surrounding future restrictions, companies’ operations, and the impacts on the economy.

Policy and Regulatory Developments. Federal, state and local governments and regulatory authorities have enacted and issued a range of policy responses to the COVID-19 pandemic, including the following:

The Federal Reserve decreased the range for the Federal Funds Target Rate by 0.50% on March 3, 2020, and by another 1.00% on March 16, 2020, reaching a current range of 0.00 – 0.25%.
On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief and Economic Security Act, or 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 the U.S. Small Business Administration, or SBA, referred to as the Paycheck Protection Program, or PPP. On April 24, 2020, an additional $310 billion in funding for PPP loans was authorized, with such funds available for PPP loans beginning on April 27, 2020. In addition, the CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to troubled debt restructurings, or TDRs, for a limited period of time to account for the effects of COVID-19. The Company is applying this guidance to qualifying loan modifications.  
On April 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.  
On April 9, 2020, the Federal Reserve announced additional measures aimed at supporting small and midsized business, as well as state and local governments impacted by COVID-19. The Federal Reserve announced the Main Street Business Lending Program, which established two new loan facilities intended to facilitate lending to small and midsized businesses: (1) the Main Street New Loan Facility, or MSNLF, and (2) the Main Street Expanded Loan Facility, or MSELF. MSNLF loans are unsecured term loans originated on or after April 8, 2020, while MSELF loans are provided as upsized tranches of existing loans originated before April 8, 2020. The combined size of the program is $600 billion. The Federal Reserve also stated that it would provide additional funding to banks offering PPP loans to struggling small businesses. Lenders participating in the PPP will be able to exclude loans pledged to the facility from their leverage ratio.
On August 3, 2020, the FFIEC issued a joint statement on Additional Loan Accommodations Related to COVID-19, which, among other things, encouraged financial institutions to consider prudent additional loan accommodation options when borrowers are unable to meet their obligations due to continuing financial challenges. Accommodation options should be based on prudent risk management and consumer protection principles.
In addition to the policy responses described above, the federal bank regulatory agencies, along with their state counterparts, have issued a stream of guidance in response to the COVID-19 pandemic and have taken a number of unprecedented steps to help banks navigate the pandemic and mitigate its impact. These include, without limitation: requiring banks to focus on business continuity and pandemic

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planning; adding pandemic scenarios to stress testing; encouraging bank use of capital buffers and reserves in lending programs; permitting certain regulatory reporting extensions; reducing margin requirements on swaps; permitting certain otherwise prohibited investments in investment funds; issuing guidance to encourage banks to work with customers affected by the pandemic and encourage loan workouts; and providing credit under the Community Reinvestment Act, or CRA, for certain pandemic-related loans, investments and public service. Moreover, because of the need for social distancing measures, the agencies revamped the manner in which they conducted periodic examinations of their regulated institutions, including making greater use of off-site reviews. The Federal 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. The FDIC has also acted to mitigate the deposit insurance assessment effects of participating in the PPP and the Federal Reserve’s PPP Liquidity Facility and Money Market Mutual Fund Liquidity Facility.

Capital and Liquidity. At September 30, 2020, the Company and Bank’s capital ratios were in excess of all regulatory requirements. The Company maintains access to multiple sources of liquidity.

In addition, the Company issued $50.0 million of 5.25% Fixed-to-Floating Rate Subordinated Notes due June 2030 in a private placement on June 19, 2020. These notes are callable starting in 2025 and qualify for tier 2 capital treatment at the holding company level. The Company injected $25.0 million of capital into the Bank in connection with the subordinated note issuance, which qualifies for tier 1 capital treatment at the bank level.

Asset Valuation. During the nine months ended September 30, 2020, the economic turmoil and market volatility resulting from the COVID-19 pandemic resulted in a substantial decrease in the Company’s stock price and market capitalization. The Company believed such decrease was a triggering event requiring an interim goodwill impairment analysis as of March 31, 2020. The Company performed an interim analysis and determined that goodwill was not more likely than not impaired, resulting in no impairment charge for the period. In the event that all or a portion of goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital or regulatory capital. At September 30, 2020, the Company had goodwill of $2.6 million.

Active Management of Credit Risk. The Company has modified its internal policies to increase oversight and analysis of all credits, especially in vulnerable industries such as hospitality and restaurants to proactively monitor evolving credit risk. With the change in economic conditions and uncertain duration of the COVID-19 pandemic, the Company’s portfolio is expected to be negatively impacted and management anticipates delinquencies and charge-offs could rise in future periods. The Company has not yet experienced charge-offs related to the COVID-19 pandemic, but the continued uncertainty regarding the severity and duration of the pandemic and related economic effects has and will continue to affect the Company’s estimate of its allowance for loan losses and resulting provision for loan losses. The Company will continue to monitor credits closely while working with clients to provide relief when appropriate.

COVID-19 Related Loan Deferrals and PPP Lending. The Company has developed programs for assisting existing clients through this uncertain time by providing, when appropriate, loan modifications that may include loan payment deferrals or interest-only modifications. As of September 30, 2020, the Company had active loan modifications for 87 loans totaling $191.4 million. Of that total, loan modifications to interest-only payments totaled $160.9 million and loans with payment deferrals totaled $30.5 million. In accordance with recent regulatory guidance and the CARES Act, loans modified in response to the COVID-19 pandemic are not considered TDRs. New modification activity has been limited in the third quarter of 2020.

In a further effort to assist both existing and new clients, the Company participated in government loan programs through the SBA, primarily the PPP. As of September 30, 2020, principal balances originated under the program totaled $181.6 million. The Company has generated fees from the SBA, net of costs, of $5.7 million, $1.2 million of which was recognized in the nine months ended September 30, 2020. In the third quarter of 2020, the Company began to shift its efforts to principal forgiveness processing; however, the SBA did not grant forgiveness to any borrowers during the third quarter of 2020.

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Processes, Controls, and Business Continuity. The Company’s operations are being conducted in material compliance with current federal, state and local government guidelines regarding social distancing, sanitation, and personal hygiene. During the third quarter of 2020, the Company began allowing employees to return to the office in accordance with new health and safety procedures, including increasing physical space between employees, using face coverings, alternating schedules for employees in the workspace and requiring employees with COVID-19 symptoms or exposure to quarantine away from the office. Additional details about the Company’s COVID-19 pandemic assistance programs, including relevant disclosures and up-to-date information, are maintained at bwbmn.com.

The Company’s investments in technology, digital platforms and electronic banking have allowed clients and employees to transact with minimal interruption during this time of uncertainty. Additional team members have been assigned to assist clients over the telephone and work with clients on new enrollments in online banking and other treasury management services. Internally, these investments in technology have enabled increased communication capabilities for departments by use of video conferencing, chat, and other collaborative features.

The Company believes it is positioned to continue these business continuity measures for the foreseeable future; however, no assurances can be provided as circumstances may change depending on the duration of the pandemic.

Critical Accounting Policies and Estimates

The consolidated financial statements of the Company are prepared based on the application of certain accounting policies, the most significant of which are described in Note 1 of the notes to the consolidated financial statements included as a part of the Company’s Annual Report on Form 10-K. Certain of these policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or subject to variation and may significantly affect the reported results and financial position for the current period or in future periods. The use of estimates, assumptions, and judgments are necessary when financial assets and liabilities are required to be recorded or adjusted to reflect fair value. Assets carried at fair value inherently result in more financial statement volatility. Fair values and information used to record valuation adjustments for certain assets and liabilities are based on either quoted market prices or are provided by other independent third-party sources, when available. When such information is not available, management estimates valuation adjustments. Changes in underlying factors, assumptions or estimates in any of these areas could have a material impact on the future financial condition and results of operations of the Company. Management has discussed each critical accounting policy and the methodology for the identification and determination of critical accounting policies with the Company's Audit Committee.

The JOBS Act permits the Company an extended transition period for complying with new or revised accounting standards affecting public companies. The Company has elected to take advantage of this extended transition period, which means that the financial statements included in this report, as well as any financial statements filed in the future, will not be subject to all new or revised accounting standards generally applicable to public companies for the transition period for so long as the Company remains an emerging growth company or until the Company affirmatively and irrevocably opts out of the extended transition period under the JOBS Act.

The following is a discussion of the critical accounting policies and significant estimates that require the Company to make complex and subjective judgements.

Allowance for Loan Losses

The allowance for loan losses, sometimes referred to as the “allowance,” is established through a provision for loan losses which is charged to expense. Loan losses are charged against the allowance when management determines all or a portion of the loan balance to be uncollectible. Subsequent recoveries, if any, are credited to the allowance for cash received on previously charged-off amounts. If the allowance is considered inadequate to absorb future loan losses on existing loans for any reason, including but not limited to, increases in the size of the loan portfolio, increases in charge-offs or changes in the risk characteristics of the loan portfolio, then the provision for loan losses is increased.

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A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the original contractual terms of the loan agreement. The collection of all amounts due according to original contractual terms means that both the contractual interest and principal payments of a loan will be collected as scheduled in the loan agreement. An impaired loan is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or, as a practical expedient, at the loan’s observable market price, or the fair value of the underlying collateral, reduced by costs to sell on a discounted basis, is used if a loan is collateral dependent.

Investment Securities Impairment

Periodically, the Company may need to assess whether there have been any events or economic circumstances to indicate that a security on which there is an unrealized loss is impaired on an other than temporary basis. In any such instance, the Company would consider many factors, including the length of time and the extent to which the fair value has been less than the amortized cost basis, the market liquidity for the security, the financial condition and the near-term prospects of the issuer, expected cash flows, and the intent and ability to hold the investment for a period of time sufficient to recover the temporary loss. Securities on which there is an unrealized loss that is deemed to be other than temporary are written down to fair value, with the write-down recorded as a realized loss in securities gains (losses).

The fair values of investment securities are generally determined by various pricing models. The Company evaluates the methodologies used to develop the resulting fair values. The Company performs a semi-annual analysis on the pricing of investment securities to ensure that the prices represent reasonable estimates of fair value. The procedures include initial and ongoing reviews of pricing methodologies and trends. The Company seeks to ensure prices represent reasonable estimates of fair value through the use of broker quotes, current sales transactions from the portfolio and pricing techniques, which are based on the net present value of future expected cash flows discounted at a rate of return market participants would require. As a result of this analysis, if the Company determines there is a more appropriate fair value, the price is adjusted accordingly.

Fair Value of Financial Instruments

The fair value of a financial instrument is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts business. A framework has been established for measuring the fair value of financial instruments that considers the attributes specific to particular assets or liabilities and includes a three-level hierarchy for determining fair value based on the transparency of inputs to each valuation as of the measurement date. The Company estimates the fair value of financial instruments using a variety of valuation methods. When financial instruments are actively traded and have quoted market prices, quoted market prices are used for fair value and are classified as Level 1. When financial instruments, such as investment securities and derivatives, are not actively traded, the Company determines fair value based on various sources and may apply matrix pricing with observable prices for similar instruments where a price for the identical instrument is not observable. The fair values of these financial instruments, which are classified as Level 2, are determined by pricing models that consider observable market data such as interest rate volatilities, London Interbank Offered Rate, or LIBOR, yield curve, credit spreads, prices from external market data providers and/or nonbinding broker-dealer quotations. When observable inputs do not exist, the Company estimates fair value based on available market data, and these values are classified as Level 3. Imprecision in estimating fair values can impact the carrying value of assets and liabilities and the amount of revenue or loss recorded.

Deferred Tax Asset

The Company uses the asset and liability method of accounting for income taxes as prescribed by GAAP. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. If currently available information indicates it is “more likely than not” that the deferred tax asset will not be realized, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Accounting for deferred income taxes is a critical accounting estimate because the Company exercises

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significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. Management’s determination of the realization of deferred tax assets is based upon management’s judgment of various future events and uncertainties, including the timing and amount of future income, reversing temporary differences which may offset, and the implementation of various tax plans to maximize realization of the deferred tax asset. These judgments and estimates are inherently subjective and reviewed on a continual basis as regulatory and business factors change. Any reduction in estimated future taxable income may require the Company to record a valuation allowance against the deferred tax assets. A valuation allowance would result in additional income tax expense in such period, which would negatively affect earnings.

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Operating Results Overview

The following table summarizes certain key financial results for the periods indicated:

As of and for the Three Months Ended

September 30, 

June 30, 

March 31,

December 31, 

September 30, 

2020

2020

2020

2019

2019

Per Common Share Data

Basic Earnings Per Share

$

0.25

$

0.26

$

0.26

$

0.30

$

0.27

Diluted Earnings Per Share

0.25

0.26

0.25

0.29

0.27

Book Value Per Share

9.25

8.92

8.61

8.45

8.20

Tangible Book Value Per Share (1)

9.13

8.80

8.49

8.33

8.08

Basic Weighted Average Shares Outstanding

28,683,855

28,676,441

28,791,494

28,833,576

28,820,144

Diluted Weighted Average Shares Outstanding

29,174,601

29,165,157

29,502,245

29,561,103

29,497,961

Shares Outstanding at Period End

28,710,775

28,837,560

28,807,375

28,973,572

28,781,162

Selected Performance Ratios

Return on Average Assets (Annualized)

1.05

%  

1.17

%  

1.29

%  

1.53

%

1.43

%

Pre-Provision Net Revenue Return on Average Assets (Annualized)(1)

1.94

2.00

2.11

2.09

2.08

Return on Average Common Equity (Annualized)

10.84

11.98

11.94

14.16

13.31

Return on Average Tangible Common Equity (Annualized) (1)

10.98

12.14

12.10

14.37

13.52

Yield on Interest Earning Assets

4.30

4.45

4.90

5.01

4.98

Yield on Total Loans, Gross

4.73

4.85

5.17

5.33

5.32

Cost of Interest Bearing Liabilities

1.50

1.58

1.84

1.96

2.04

Cost of Total Deposits

0.87

0.99

1.27

1.34

1.42

Net Interest Margin (2)

3.28

3.38

3.59

3.65

3.56

Efficiency Ratio (1)

42.3

48.6

44.4

49.6

45.6

Adjusted Efficiency Ratio (1)

41.7

40.4

44.1

44.3

42.9

Noninterest Expense to Average Assets (Annualized)

1.42

1.64

1.69

1.87

1.66

Adjusted Noninterest Expense to Average Assets (Annualized) (1)

1.40

1.37

1.68

1.67

1.56

Loan to Deposit Ratio

99.4

97.8

105.4

104.9

102.4

Core Deposits to Total Deposits

77.1

75.7

78.6

80.7

79.9

Tangible Common Equity to Tangible Assets (1)

9.46

9.23

10.13

10.65

10.43

(1)Represents a non-GAAP financial measure. See "Non-GAAP Financial Measures" for further details.
(2)Amounts calculated on a tax-equivalent basis using the statutory federal tax rate of 21%.

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Selected Financial Data

The following tables summarize certain selected financial data as of and for the periods indicated:

September 30, 

June 30,

March 31,

December 31, 

September 30, 

(dollars in thousands)

    

2020

    

2020

    

2020

2019

    

2019

Selected Balance Sheet Data

Total Assets

$

2,774,564

$

2,754,463

$

2,418,730

$

2,268,830

$

2,232,339

Total Loans, Gross

2,259,228

2,193,778

2,002,817

1,912,038

1,846,218

Allowance for Loan Losses

31,381

27,633

24,585

22,526

22,124

Goodwill and Other Intangibles

3,344

3,391

3,439

3,487

3,535

Deposits

2,273,044

2,242,051

1,900,127

1,823,310

1,802,236

Tangible Common Equity (1)

262,088

253,799

244,704

241,307

232,524

Total Shareholders' Equity

265,432

257,190

248,143

244,794

236,059

Average Total Assets - Quarter-to-Date

2,711,755

2,622,272

2,317,040

2,221,370

2,168,909

Average Common Equity - Quarter-to-Date

263,195

255,109

250,800

240,188

232,590

(1)Represents a non-GAAP financial measure. See “Non-GAAP Financial Measures” for further details.

For the Three Months Ended

September 30, 

June 30,

March 31,

December 31, 

September 30, 

(dollars in thousands)

2020

    

2020

2020

2019

    

2019

Selected Income Statement Data

Interest Income

$

28,493

$

28,166

$

27,468

$

27,419

$

26,572

Interest Expense

6,814

6,824

7,366

7,491

7,637

Net Interest Income

21,679

21,342

20,102

19,928

18,935

Provision for Loan Losses

3,750

3,000

2,100

600

900

Net Interest Income after Provision for Loan Losses

17,929

18,342

18,002

19,328

18,035

Noninterest Income

1,157

1,977

1,719

1,112

946

Noninterest Expense

9,672

10,711

9,746

10,489

9,084

Income Before Income Taxes

9,414

9,608

9,975

9,951

9,897

Provision for Income Taxes

2,240

2,010

2,532

1,380

2,092

Net Income

$

7,174

$

7,598

$

7,443

$

8,571

$

7,805

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Discussion and Analysis of Results of Operations

Net Income

Net income was $7.2 million for the third quarter of 2020, an 8.1% decrease compared to net income of $7.8 million for the third quarter of 2019. Net income per diluted common share for the third quarter of 2020 was $0.25, a 7.1% decrease compared to $0.27 per diluted common share for the third quarter of 2019. Net income was $22.2 million for the nine months ended September 30, 2020, a 2.7% decrease compared to net income of $22.8 million for the third quarter of 2019. Net income per diluted common share for the nine months ended September 30, 2020 and 2019 was $0.76. 

Net Interest Income

The Company’s primary source of revenue is net interest income, which is impacted by the level of interest earning assets and related funding sources, as well as changes in the level of interest rates. The difference between the average yield on earning assets and the average rate paid for interest bearing liabilities is the net interest spread. Noninterest bearing sources of funds, such as demand deposits and shareholders’ equity, also support earning assets. The impact of the noninterest bearing sources of funds is captured in the net interest margin, which is calculated as net interest income divided by average earning assets. Both the net interest margin and net interest spread are presented on a tax-equivalent basis, which means that tax-free interest income has been adjusted to pretax-equivalent income, assuming a 21% federal tax rate. Management’s ability to respond to changes in interest rates by using effective asset-liability management techniques is critical to maintaining the stability of the net interest margin and the momentum of the Company’s primary source of earnings. In response to the COVID-19 pandemic, the Federal Open Market Committee, or FOMC, decreased the targeted federal funds rate by a total of 150 basis points in March 2020. This decrease may impact the comparability of net interest income between 2019 and 2020.

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Table of Contents

Average Balances and Yields

The following tables present, for the three and nine months ended September 30, 2020 and 2019, the average balances of each principal category of assets, liabilities and shareholders’ equity, and an analysis of net interest income. The average balances are principally daily averages and, for loans, include both performing and nonperforming balances. Interest income on loans includes the effects of net deferred loan origination fees and costs accounted for as yield adjustments. These tables are presented on a tax-equivalent basis, if applicable.

For the Three Months Ended

 

September 30, 2020

September 30, 2019

 

Average

Interest

Yield/

Average

Interest

Yield/

 

    

Balance

    

& Fees

    

Rate

    

Balance

    

& Fees

    

Rate

 

(dollars in thousands)

Interest Earning Assets:

Cash Investments

$

101,787

$

42

0.16

%

$

73,970

$

346

1.86

%

Investment Securities:

Taxable Investment Securities

 

256,808

 

1,389

2.15

 

151,319

 

1,095

2.87

Tax-Exempt Investment Securities (1)

 

82,579

 

900

4.33

 

95,575

 

1,031

4.28

Total Investment Securities

 

339,387

 

2,289

2.68

 

246,894

 

2,126

3.42

Paycheck Protection Program Loans (2)

 

181,397

1,173

2.57

 

 

Loans (1)(2)

2,025,410

25,081

4.93

1,805,920

24,220

5.32

Total Loans

 

2,206,807

 

26,254

4.73

 

1,805,920

 

24,220

5.32

Federal Home Loan Bank Stock

 

7,901

127

6.38

 

8,111

 

96

4.72

Total Interest Earning Assets

 

2,655,882

 

28,712

4.30

%

 

2,134,895

 

26,788

4.98

%

Noninterest Earning Assets

55,873

34,014

Total Assets

$

2,711,755

$

2,168,909

Interest Bearing Liabilities:

Deposits:

Interest Bearing Transaction Deposits

 

306,162

400

0.52

%

 

250,667

 

511

0.81

%

Savings and Money Market Deposits

 

501,246

1,106

0.88

 

453,340

 

2,080

1.82

Time Deposits

 

369,975

1,899

2.04

 

359,329

 

2,229

2.46

Brokered Deposits

 

419,744

1,435

1.36

 

242,600

 

1,389

2.27

Total Interest Bearing Deposits

1,597,127

4,840

1.21

1,305,936

 

6,209

1.89

Federal Funds Purchased

 

152

0.33

 

 

Notes Payable

 

11,500

108

3.74

 

13,500

 

127

3.73

FHLB Advances

 

129,457

748

2.30

 

143,690

 

908

2.51

Subordinated Debentures

 

73,649

1,118

6.04

 

24,699

 

393

6.31

Total Interest Bearing Liabilities

 

1,811,885

 

6,814

1.50

%

 

1,487,825

 

7,637

2.04

%

Noninterest Bearing Liabilities:

Noninterest Bearing Transaction Deposits

 

615,214

 

434,021

Other Noninterest Bearing Liabilities

21,461

14,473

Total Noninterest Bearing Liabilities

 

636,675

 

448,494

Shareholders' Equity

263,195

 

232,590

Total Liabilities and Shareholders' Equity

$

2,711,755

$

2,168,909

Net Interest Income / Interest Rate Spread

 

21,898

2.80

%

 

19,151

2.94

%

Net Interest Margin (3)

3.28

%

3.56

%

Taxable Equivalent Adjustment:

Tax-Exempt Investment Securities

 

(219)

 

(216)

Net Interest Income

$

21,679

$

18,935

(1)Interest income and average rates for tax-exempt investment securities and loans are presented on a tax-equivalent basis, assuming a federal income tax rate of 21%.
(2)Average loan balances include nonaccrual loans. Interest income on loans includes amortization of deferred loan fees, net of deferred loan costs.

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(3)Net interest margin includes the tax equivalent adjustment and represents the annualized results of: (i) the difference between interest income on interest earning assets and the interest expense on interest bearing liabilities, divided by (ii) average interest earning assets for the period.

For the Nine Months Ended

 

September 30, 2020

September 30, 2019

 

Average

Interest

Yield/

Average

Interest

Yield/

    

Balance

    

& Fees

    

Rate

    

Balance

    

& Fees

    

Rate

 

(dollars in thousands)

Interest Earning Assets:

Cash Investments

$

80,186

$

138

0.23

%

$

46,158

$

604

1.75

%

Investment Securities:

Taxable Investment Securities

 

216,332

 

4,080

2.52

 

143,583

 

3,126

2.91

Tax-Exempt Investment Securities (1)

 

89,674

 

2,920

4.35

 

103,032

 

3,307

4.29

Total Investment Securities

 

306,006

 

7,000

3.06

 

246,615

 

6,433

3.49

Paycheck Protection Program Loans (2)

 

107,541

 

2,046

2.54

 

 

Loans (1)(2)

1,997,553

75,301

5.04

1,756,855

69,720

5.31

Total Loans

 

2,105,094

 

77,347

4.91

 

1,756,855

 

69,720

5.31

Federal Home Loan Bank Stock

 

9,541

 

352

4.93

 

7,906

 

296

5.00

Total Interest Earning Assets

 

2,500,827

 

84,837

4.53

%

 

2,057,534

 

77,053

5.01

%

Noninterest Earning Assets

50,118

26,303

Total Assets

$

2,550,945

$

2,083,837

Interest Bearing Liabilities:

Deposits:

Interest Bearing Transaction Deposits

 

275,303

 

1,207

0.58

%

 

211,784

 

1,130

0.71

%

Savings and Money Market Deposits

 

518,648

 

4,338

1.12

 

433,430

 

5,784

1.78

Time Deposits

 

378,133

 

6,199

2.19

 

347,731

 

6,230

2.40

Brokered Deposits

 

319,615

 

3,990

1.67

 

266,976

 

4,788

2.40

Total Interest Bearing Deposits

 

1,491,699

 

15,734

1.41

 

1,259,921

 

17,932

1.90

Federal Funds Purchased

 

8,302

 

107

1.73

 

8,923

 

172

2.58

Notes Payable

 

12,000

 

334

3.72

 

14,000

 

378

3.61

FHLB Advances

 

165,088

 

2,839

2.30

 

133,097

 

2,510

2.52

Subordinated Debentures

 

43,318

 

1,990

6.14

 

24,673

 

1,163

6.30

Total Interest Bearing Liabilities

 

1,720,407

 

21,004

1.63

%

 

1,440,614

 

22,155

2.06

%

Noninterest Bearing Liabilities:

Noninterest Bearing Transaction Deposits

 

554,513

 

401,973

Other Noninterest Bearing Liabilities

19,632

11,289

Total Noninterest Bearing Liabilities

 

574,145

 

413,262

Shareholders' Equity

256,393

 

229,961

Total Liabilities and Shareholders' Equity

$

2,550,945

$

2,083,837

Net Interest Income / Interest Rate Spread

 

63,833

2.90

%

 

54,898

2.95

%

Net Interest Margin (3)

3.41

%

3.57

%

Taxable Equivalent Adjustment:

Tax-Exempt Investment Securities

 

(710)

 

(694)

Net Interest Income

$

63,123

$

54,204

(1)Interest income and average rates for tax-exempt investment securities and loans are presented on a tax-equivalent basis, assuming a federal income tax rate of 21%.
(2)Average loan balances include nonaccrual loans. Interest income on loans includes amortization of deferred loan fees, net of deferred loan costs.
(3)Net interest margin includes the tax equivalent adjustment and represents the annualized results of: (i) the difference between interest income on interest earning assets and the interest expense on interest bearing liabilities, divided by (ii) average interest earning assets for the period.

Interest Rates and Operating Interest Differential

Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest earning assets and interest bearing liabilities, as well as changes in average interest rates. The

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following table presents the effect that these factors had on the interest earned on interest earning assets and the interest incurred on interest bearing liabilities. The effect of changes in volume is determined by multiplying the change in volume by the previous period’s average rate. Similarly, the effect of rate changes is calculated by multiplying the change in average rate by the previous period’s volume. The changes not attributable specifically to either volume or rate have been allocated to the changes due to volume. The following tables present the changes in the volume and rate of interest bearing assets and liabilities for the three months ended September 30, 2020, compared to the three months ended September 30, 2019, and for the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019.

Three Months Ended September 30, 2020

Compared with

Three Months Ended September 30, 2019

Change Due To:

Interest

(dollars in thousands)

    

Volume

    

Rate

    

Variance

Interest Earning Assets:

Cash Investments

$

12

$

(316)

$

(304)

Investment Securities:

Taxable Investment Securities

568

(274)

294

Tax-Exempt Investment Securities

(142)

11

(131)

Total Securities

426

(263)

163

Loans:

Paycheck Protection Program Loans

1,173

1,173

Loans

2,656

(1,795)

861

Total Loans

3,829

(1,795)

2,034

Federal Home Loan Bank Stock

(3)

34

31

Total Interest Earning Assets

$

4,264

$

(2,340)

$

1,924

Interest Bearing Liabilities:

Interest Bearing Transaction Deposits

$

73

$

(184)

$

(111)

Savings and Money Market Deposits

103

(1,077)

(974)

Time Deposits

49

(379)

(330)

Brokered Deposits

603

(557)

46

Total Deposits

828

(2,197)

(1,369)

Notes Payable

(19)

(19)

FHLB Advances

(84)

(76)

(160)

Subordinated Debentures

742

(17)

725

Total Interest Bearing Liabilities

1,467

(2,290)

(823)

Net Interest Income

$

2,797

$

(50)

$

2,747

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Nine Months Ended September 30, 2020

Compared with

Nine Months Ended September 30, 2019

Change Due To:

Interest

(dollars in thousands)

    

Volume

    

Rate

    

Variance

Interest Earning Assets:

Cash Investments

$

59

$

(525)

$

(466)

Investment Securities:

Taxable Investment Securities

1,374

(420)

954

Tax Exempt Investment Securities

(432)

45

(387)

Total Securities

942

(375)

567

Loans:

Paycheck Protection Program Loans

2,046

2,046

Loans

9,134

(3,553)

5,581

Total Loans

11,180

(3,553)

7,627

Federal Home Loan Bank Stock

60

(4)

56

Total Interest Earning Assets

$

12,241

$

(4,457)

$

7,784

Interest Bearing Liabilities:

Interest Bearing Transaction Deposits

$

281

$

(204)

$

77

Savings and Money Market Deposits

716

(2,162)

(1,446)

Time Deposits

504

(535)

(31)

Brokered Deposits

660

(1,458)

(798)

Total Deposits

2,161

(4,359)

(2,198)

Federal Funds Purchased

(8)

(57)

(65)

Notes Payable

(55)

11

(44)

FHLB Advances

552

(223)

329

Subordinated Debentures

858

(31)

827

Total Interest Bearing Liabilities

3,508

(4,659)

(1,151)

Net Interest Income

$

8,733

$

202

$

8,935

Comparison of Interest Income, Interest Expense, and Net Interest Margin

Third Quarter of 2020 Compared to Third Quarter of 2019

Net interest income was $21.7 million for the third quarter of 2020, an increase of $2.7 million, or 14.5%, compared to $18.9 million for the third quarter of 2019. The increase in net interest income was primarily due to growth in average interest earning assets and lower rates paid on deposits, offset partially by lower rates on interest earning assets. The increase in average interest earning assets was primarily due to continued organic growth in the loan portfolio and most recently, the funding of PPP loans. The Company anticipates that its net interest income will be adversely affected in future periods as a result of the COVID-19 pandemic and the effects of lower interest rates.

Net interest margin (on a fully tax-equivalent basis) for the third quarter of 2020 was 3.28%, a 28 basis point decrease from 3.56% in the third quarter of 2019.

While the Company is encouraged by the continued reduction in the cost of interest bearing liabilities during the third quarter of 2020, the year-over-year decline in net interest margin was primarily attributed to a meaningful increase in on-balance sheet liquidity in conjunction with the historically low and flat yield curve weighing on subsequent earning asset yields. Furthermore, the Company’s participation in the PPP generated strong loan origination volume during the second quarter of 2020; however, the interest rate of 1.00% earned on these loans is significantly lower than the aggregate loan yield, thus impacting the net interest margin during the third quarter of 2020.

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The core net interest margin, excluding PPP loans and corresponding deposit balances, was 3.33% for the third quarter of 2020. As a result of the low interest rate environment, as well as the impact of the COVID-19 pandemic, the Company expects that its net interest margin will continue to be under pressure in future periods.

Average interest earning assets for the third quarter of 2020 increased $521.0 million, or 24.4%, to $2.66 billion, from $2.13 billion for the third quarter of 2019. This increase in average interest earning assets was primarily due to continued organic growth in the loan portfolio and the funding of PPP loans. Average interest bearing liabilities increased $324.1 million, or 21.8%, to $1.81 billion for the third quarter of 2020, from $1.49 billion for the third quarter of 2019. The increase in average interest bearing liabilities was primarily due to an increase in interest bearing deposits and the issuance of subordinated debentures in the second quarter of 2020, offset partially by a decrease in FHLB advances and notes payable.

Average interest earning assets produced a tax-equivalent yield of 4.30% for the third quarter of 2020, compared to 4.98% for the third quarter of 2019. The decrease in the yield on interest earning assets was due to the falling interest rate environment which created lower loan and security yields, the impact of PPP loans at a meaningfully lower rate than the aggregate loan portfolio yield, and an increase in cash balances held by the Company due to the uncertain impacts of the COVID-19 pandemic. The average rate paid on interest bearing liabilities was 1.50% for the third quarter of 2020, compared to 2.04% for the third quarter of 2019, which benefitted from the falling interest rate environment.

Interest Income. Total interest income on a tax-equivalent basis was $28.7 million for the third quarter of 2020, compared to $26.8 million for the third quarter of 2019. The $1.9 million, or 7.2%, increase in total interest income on a tax-equivalent basis was primarily due to continued organic growth in the loan portfolio and PPP loan income.

Interest income on loans, on a tax-equivalent basis, for the third quarter of 2020 was $26.3 million, compared to $24.2 million for the third quarter of 2019. The $2.0 million, or 8.4%, increase was due to a 22.2% increase in the average balance of loans outstanding due to continued organic loan growth, which included $181.4 million of PPP loans.

Loan interest income and loan fees remain the primary contributing factors to the changes in yield on interest earning assets. The aggregate loan yield, excluding PPP loans, decreased to 4.93% in the third quarter of 2020, which was 39 basis points lower than 5.32% in the third quarter of 2019. While loan fees have maintained a stable contribution to aggregate loan yield, the historically low and flat yield curve has resulted in a declining core yield on loans in comparison to prior periods.

The following table presents a summary of interest and fees recognized on loans, excluding PPP loans, for the periods indicated as follows:

Three Months Ended

September 30, 2020

June 30, 2020

March 31, 2020

December 31, 2019

September 30, 2019

 

Interest

4.69

%  

4.76

%  

4.90

%  

5.00

%  

5.07

%

Fees

0.24

0.25

0.27

0.33

0.25

Yield on Loans, Excluding PPP Loans

4.93

%  

5.01

%  

5.17

%  

5.33

%  

5.32

%

Interest Expense. Interest expense on interest bearing liabilities decreased $823,000, or 10.8%, to $6.8 million for the third quarter of 2020, compared to $7.6 million for the third quarter of 2019. The cost of interest bearing liabilities declined 54 basis points from 2.04% in the third quarter of 2019 to 1.50% in the third quarter of 2020, primarily due to deposit rate cuts consistent with a lower rate environment and the repricing of time deposits. Given the strong deposit growth and ample time deposit maturities over the next 12 months, the Company anticipates meaningful deposit repricing opportunities in future quarters.

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Interest expense on deposits was $4.8 million for the third quarter of 2020, compared to $6.2 million for the third quarter of 2019. The $1.4 million, or 22.1%, decrease in interest expense on deposits was primarily due to a 68 basis point decrease in the average rate paid on interest bearing deposits. The average balance of interest bearing deposits increased $291.2 million, or 22.3%, to $1.60 billion in the third quarter of 2020, compared to $1.31 billion for the third quarter of 2019. The increase in the average balance of interest bearing deposits resulted from growth among all interest bearing deposit types over the year. The average rate paid on interest bearing deposits decreased from 1.89% in the third quarter of 2019 to 1.21% in the third quarter of 2020. The decrease in the average rate paid was primarily due to the decline of market interest rates.

Interest expense on borrowings increased $546,000 to $2.0 million for the third quarter of 2020, compared to $1.4 million for the third quarter of 2019. This increase was primarily due to a higher average balance of subordinated debentures, partially offset by a decrease in FHLB advances. The higher subordinated debentures balance was due to the issuance of $50.0 million of subordinated debentures during the second quarter of 2020.

Nine Months Ended September 30, 2020 Compared to Nine Months Ended September 30, 2019

Net interest income was $63.1 million for the nine months ended September 30, 2020, an increase of $8.9 million, or 16.5%, compared to $54.2 million for the nine months ended September 30, 2019. The increase in net interest income was primarily attributable to growth in average interest earning assets due to organic growth in the loan portfolio and lower rates paid on deposits due to the falling interest rate environment. The Company anticipates that its net interest income will be adversely affected in future periods as a result of the COVID-19 pandemic and the effects of lower interest rates.

Net interest margin (on a fully tax-equivalent basis) for the nine months ended September 30, 2020 was 3.41%, compared to 3.57% for the nine months ended September 30, 2019, a decrease of 16 basis points. Despite a significant reduction in interest bearing liability costs over the year, the historically low interest rate environment, coupled with a more liquid balance sheet mix, pressured earning asset yields lower and ultimately compressed the net interest margin year-over-year.

Average interest earning assets for the nine months ended September 30, 2020 increased $443.3 million, or 21.5%, to $2.50 billion from $2.06 billion for the nine months ended September 30, 2019. This increase in average interest earning assets was primarily due to continued organic growth in the loan portfolio and the funding of PPP loans. Average interest bearing liabilities increased $280.0 million, or 19.4%, to $1.72 billion for the nine months ended September 30, 2020, from $1.44 billion for the nine months ended September 30, 2019. The increase in average interest bearing liabilities was primarily due to increases in interest bearing deposits, FHLB advances and subordinated debentures, offset partially by decreases in federal funds purchased and notes payable.

Average interest earning assets produced a tax-equivalent yield of 4.53% for the nine months ended September 30, 2020, compared to 5.01% for the nine months ended September 30, 2019. The average rate paid on interest bearing liabilities was 1.63% for the nine months ended September 30, 2020, compared to 2.06% for the nine months ended September 30, 2019.

Interest Income. Total interest income on a tax-equivalent basis was $84.8 million for the nine months ended September 30, 2020, compared to $77.1 million for the nine months ended September 30, 2019. The $7.8 million, or 10.1%, increase in total interest income on a tax-equivalent basis was primarily due to organic growth in the loan portfolio.

Interest income on the investment securities portfolio on a fully-tax equivalent basis increased $567,000, or 8.8%, during the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019, due to a $59.4 million, or 24.1%, increase in average balances between the periods, which was partially offset by a 43 basis point decrease in the aggregate portfolio yield.

Interest income on loans for the nine months ended September 30, 2020 was $77.3 million, compared to $69.7 million for the nine months ended September 30, 2019. The $7.6 million, or 10.9%, increase was primarily due to

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a 19.8% increase in the average balance of loans outstanding, which was offset partially by a 40 basis point decrease in the average yield on loans, 13 basis points of which was attributed to the origination of PPP loans. The increase in the average balance of loans outstanding was due to organic loan growth. The decrease in yield on the loan portfolio was primarily driven by lower market interest rates and an interest rate of 1.00% earned on PPP loans.

Interest Expense. Interest expense on interest bearing liabilities decreased $1.2 million, or 5.2%, to $21.0 million for the nine months ended September 30, 2020, compared to $22.2 million for the nine months ended September 30, 2019, due to lower interest rates paid on both deposits and borrowings.

Interest expense on deposits decreased to $15.7 million for the nine months ended September 30, 2020, compared to $17.9 million for the nine months ended September 30, 2019. The $2.2 million, or 12.3%, decrease in interest expense on deposits was primarily due to a 49 basis point decrease in the average rate paid, even as the average balance of deposits increased 18.4%. The decrease in the average rate paid was primarily due to the impact of lower market interest rates. The increase in the average balance of interest bearing deposits resulted primarily from increases in interest bearing transaction deposits and savings and money market deposits.

Interest expense on borrowings increased $1.0 million to $5.3 million for the nine months ended September 30, 2020, compared to $4.2 million for the nine months ended September 30, 2019. This increase was primarily due to a higher average balances of FHLB advances and subordinated debentures.

Provision for Loan Losses

The provision for loan losses was $3.8 million for the third quarter of 2020, an increase of $2.9 million, compared to the provision for loan losses of $900,000 for the third quarter of 2019. The provision for loan losses was $8.9 million for the nine months ended September 30, 2020, an increase of $6.8 million compared to the provision for loan losses of $2.1 million for the nine months ended September 30, 2019. The increase in the provision for loan losses compared to both prior periods relates primarily to growth of the loan portfolio, economic uncertainties and evolving risks driven by the impact of the COVID-19 pandemic. The Company expects the provision for loan losses to remain at an increased level compared to recent historical periods based on its belief that the credit quality of its loan portfolio will decline, and the likelihood of loan defaults will increase the longer the COVID-19 pandemic persists.

The allowance for loan losses to total loans was 1.39% at September 30, 2020, compared to 1.20% at September 30, 2019. The allowance for loan losses to total loans, excluding $181.6 million of PPP loans, was 1.51% at September 30, 2020.

As an emerging growth company, the Company is not subject to Accounting Standards Update No. 2016-13 “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses of Financial Instruments,” or CECL, until January 1, 2023.

The following table presents the activity in the allowance for loan losses for the three and nine month periods ended September 30, 2020 and 2019:

Three Months Ended

Nine Months Ended

September 30, 

September 30, 

September 30, 

September 30, 

(dollars in thousands)

2020

    

2019

2020

    

2019

Balance at Beginning of Period

$

27,633

$

21,362

$

22,526

$

20,031

Provision for Loan Losses

3,750

900

8,850

2,100

Charge-offs

(6)

(144)

(54)

(183)

Recoveries

4

6

59

176

Balance at End of Period

$

31,381

$

22,124

$

31,381

$

22,124

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Noninterest Income

Noninterest income was $1.2 million for the third quarter of 2020, an increase of $211,000 from $946,000 for the third quarter of 2019. The increase was primarily due to increased letter of credit fees. Noninterest income was $4.9 million for the nine months ended September 30, 2020, an increase of $2.1 million, compared to $2.7 million for the nine months ended September 30, 2019. The increase was primarily due to increased gains on sales of securities and swap fees.

The following table presents the major components of noninterest income for the three and nine months ended September 30, 2020, compared to the three and nine months ended September 30, 2019:

Three Months Ended

Nine Months Ended

September 30, 

Increase/

September 30, 

Increase/

(dollars in thousands)

2020

    

2019

    

(Decrease)

    

2020

    

2019

    

(Decrease)

Noninterest Income:

Customer Service Fees

$

200

$

184

$

16

$

575

$

564

$

11

Net Gain on Sales of Securities

109

58

51

1,473

516

957

Net Gain on Sales of Foreclosed Assets

69

(69)

69

(69)

Letter of Credit Fees

487

331

156

1,026

790

236

Debit Card Interchange Fees

119

116

3

310

313

(3)

Swap Fees

907

907

Other Income

242

188

54

562

462

100

Totals

$

1,157

$

946

$

211

$

4,853

$

2,714

$

2,139

Noninterest Expense

Third Quarter of 2020 Compared to Third Quarter of 2019

Noninterest expense was $9.7 million for the third quarter of 2020, an increase of $588,000 from $9.1 million for the third quarter of 2019. The increase was primarily driven by a $635,000 increase in salaries and employee benefits as the result of merit increases and increased staff to meet the needs of the Company’s growth. The increase was partially offset by a decrease of $385,000 in amortization of tax credit investments and a $245,000 decrease in marketing and advertising expenses due to the COVID-19 pandemic.

During the third quarter of 2020, the Company opened its newly constructed office complex in St. Louis Park, Minnesota. Management expects that occupancy and equipment expenses will increase in future periods related to the operation and depreciation of the building.

Nine Months Ended September 30, 2020 Compared to Nine Months Ended September 30, 2019

Noninterest expense was $30.1 million for the nine months ended September 30, 2020, an increase of $3.7 million, or 13.9%, from $26.4 million for the nine months ended September 30, 2019. The increase was primarily driven by a $3.5 million increase in salaries and employee benefits and a $1.4 million one-time FHLB advance prepayment fee. The increase was partially offset by decreased marketing and advertising and amortization of tax credit investments.

The Company expects future increases in noninterest expense as the Company continues investing in infrastructure to support balance sheet growth; particularly occupancy and equipment expenses related to the new corporate headquarters. Management remains focused on supporting growth primarily by adding to staff, investing in technology, and by enhancing risk controls. Full-time equivalent employees increased from 158 at the end of the third quarter of 2019 to 180 at the end of the third quarter of 2020. Despite the uncertainty surrounding the COVID-19 pandemic, the Company continues to attract strategic hires in lending, deposit gathering, technology and risk management roles.

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Efficiency Ratio. The efficiency ratio, a non-GAAP financial measure, reports total noninterest expense, less amortization of intangible assets, as a percentage of net interest income plus total noninterest income, less gains (losses) on sales of securities. Management believes this non-GAAP financial measure provides a meaningful comparison of operational performance and facilitates investors’ assessments of business performance and trends in comparison to peers in the banking industry. The Company’s efficiency ratio, and its comparability to some peers, is negatively impacted by the amortization of tax credit investments within noninterest expense.

The efficiency ratio was 42.3% for the third quarter of 2020, compared to 45.6% for the third quarter of 2019. While the recognition of the tax credits increases operating expenses, and concurrently the efficiency ratio, it directly reduces income tax expense and the effective tax rate. The adjusted efficiency ratio, which excludes the impact of the amortization of tax credit investments and certain non-routine income and expenses, decreased to 41.7% for the third quarter of 2020, compared to 42.9% for the third quarter of 2019. The adjusted efficiency ratio for the nine months ended September 30, 2020 and 2019 was 42.0% and 42.9%, respectively. Management seeks to contain costs whenever prudent, which is evident in the historical stability of the adjusted efficiency ratio.

The following table presents the major components of noninterest expense for the three and nine months ended September 30, 2020, compared to the three and nine months ended September 30, 2019:

Three Months Ended

Nine Months Ended

September 30, 

Increase/

September 30, 

Increase/

(dollars in thousands)

2020

    

2019

    

(Decrease)

    

2020

    

2019

    

(Decrease)

Noninterest Expense:

Salaries and Employee Benefits

$

6,550

$

5,915

$

635

$

19,352

$

15,841

$

3,511

Occupancy and Equipment

894

761

133

2,279

2,202

77

FDIC Insurance Assessment

160

160

518

570

(52)

Data Processing

267

182

85

734

486

248

Professional and Consulting Fees

492

414

78

1,400

1,253

147

Information Technology and Telecommunications

385

233

152

977

677

300

Marketing and Advertising

94

339

(245)

645

1,208

(563)

Intangible Asset Amortization

48

48

143

143

Amortization of Tax Credit Investments

145

530

(385)

592

2,097

(1,505)

FHLB Advance Prepayment Fees

1,430

1,430

Other Expense

637

662

(25)

2,059

1,966

93

Totals

$

9,672

$

9,084

$

588

$

30,129

$

26,443

$

3,686

Income Tax Expense

The provision for income taxes includes both federal and state taxes. Fluctuations in effective tax rates reflect the differences in the inclusion or deductibility of certain income and expenses for income tax purposes and the recognition of tax credits. The Company’s future effective income tax rate will fluctuate based on the mix of taxable and tax-free investments and loans, the recognition and availability of tax credit investments, and overall taxable income.

Income tax expense was $2.2 million for the third quarter of 2020, compared to $2.1 million for the third quarter of 2019. The effective combined federal and state income tax rate for the third quarter of 2020 was 23.8%, compared to 21.1% for the third quarter of 2019. Income tax expense was $6.8 million for the nine months ended September 30, 2020, compared to $5.5 million for the nine months ended September 30, 2019. The effective combined federal and state income tax rate for the nine months ended September 30, 2020 and 2019 was 23.4% and 19.5%, respectively. The higher effective combined rate compared to both prior periods was primarily due to fewer tax credits being recognized.

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Financial Condition

Assets

Total assets at September 30, 2020 were $2.77 billion, an increase of $505.7 million, or 22.3%, over total assets of $2.27 billion at December 31, 2019, and an increase of $542.2 million, or 24.3%, over total assets of $2.23 billion at September 30, 2019. The growth in both periods was primarily due to organic loan growth, PPP loan growth and purchases of investment securities.

Investment Securities Portfolio

The investment securities portfolio is used to make various term investments and is intended to provide the Company with adequate liquidity, a source of stable income, and at times, serve as collateral for certain types of deposits. Investment balances in the investment securities portfolio are subject to change over time based on funding needs and interest rate risk management objectives. The liquidity levels take into account anticipated future cash flows and are maintained at levels management believes are appropriate to ensure future flexibility in meeting anticipated funding needs.

The investment securities portfolio consists primarily of municipal securities, U.S. government agency mortgage backed securities, SBA securities, and corporate securities comprised of subordinated debentures of bank and financial holding companies. In addition, the Company also holds U.S. treasury securities, asset-backed securities and other debt securities, all with varying contractual maturities. These maturities do not necessarily represent the expected life of the securities as the securities may be called or paid down without penalty prior to their stated maturities. All investment securities are held as available for sale.

Securities available for sale were $374.0 million at September 30, 2020, compared to $289.9 million at December 31, 2019, an increase of $84.1 million or 29.0%. At September 30, 2020, municipal securities represented 28.2% of the investment securities portfolio, government agency mortgage-backed securities represented 31.4% of the portfolio, SBA securities represented 11.4% of the portfolio, corporate securities represented 18.3% of the portfolio, asset-backed securities represented 10.5% of the portfolio, and other mortgage-backed securities represented 0.2% of the portfolio.

The following table presents the amortized cost and fair value of securities available for sale, by type, at September 30, 2020 and December 31, 2019:

    

September 30, 2020

    

December 31, 2019

Amortized

Fair

Amortized

Fair

    

Cost

    

Value

    

Cost

    

Value

U.S. Treasury Securities

$

$

$

4,990

$

4,998

SBA Securities

42,934

42,507

50,126

49,559

Mortgage-Backed Securities Issued or Guaranteed by U.S. Agencies (MBS):

 

 

 

 

  

Residential Pass-Through:

 

 

 

 

  

Guaranteed by GNMA

 

958

 

1,015

 

1,195

 

1,215

Issued by FNMA and FHLMC

 

14,864

 

14,949

 

3,571

 

3,543

Other Residential Mortgage-Backed Securities

 

87,954

 

89,055

 

46,464

 

46,695

Commercial Mortgage-Backed Securities

 

11,658

 

12,519

 

12,019

 

12,213

All Other Commercial MBS

 

818

 

821

 

1,063

 

1,062

Total MBS

 

116,252

 

118,359

 

64,312

 

64,728

Municipal Securities

 

97,294

105,254

99,441

 

105,743

Corporate Securities

 

68,043

68,506

49,674

50,176

Asset-Backed Securities

38,846

39,329

14,673

14,673

Total

$

363,369

$

373,955

$

283,216

$

289,877

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Loan Portfolio

The Company focuses on lending to borrowers located or investing in the Minneapolis-St. Paul-Bloomington, MN-WI Metropolitan Statistical Area across a diverse range of industries and property types. The Company lends primarily to commercial customers, consisting of loans secured by nonfarm, nonresidential properties, multifamily residential properties, land, and non-real estate business assets. Responsive service, local decision making, and an efficient turnaround time from application to closing have been significant factors in growing the loan portfolio.

The Company manages concentrations of credit exposure through a risk management program which implements formalized processes and procedures specifically for managing and mitigating risk within the loan portfolio. The processes and procedures include board and management oversight, commercial real estate exposure limits, portfolio monitoring tools, management information systems, market reports, underwriting standards, internal and external loan review, and stress testing.

The Company originated net loan exposures of $405.6 million, for the third quarter of 2020, compared to $302.0 million for the third quarter of 2019. Net loan exposures include principal advances and unfunded commitments on newly originated loans, net of loan participations sold. Total gross loans increased $347.2 million, or 18.2%, to $2.26 billion at September 30, 2020, compared to $1.91 billion at December 31, 2019 and increased $413.0 million, or 22.4%, from $1.85 billion at September 30, 2019. The increase in both periods included PPP loans funded primarily in the second quarter of 2020. The 1-4 family mortgage, multifamily, and commercial real estate, or CRE, nonowner occupied categories contributed most significantly to the $165.6 million of loan growth, excluding PPP loans, in the nine months ended September 30, 2020. As of September 30, 2020, 1-4 family mortgage loans increased $25.5 million, or 9.8%, multifamily loans increased $70.8 million, or 13.7%, and nonowner occupied CRE loans increased $67.5 million, or 11.4%, when compared to December 31, 2019. Collectively, the Company’s annualized loan growth for the nine months ended September 30, 2020, excluding PPP loans, was 11.6%.

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The following table presents the dollar and percentage composition of the loan portfolio by category, at the dates indicated:

September 30, 2020

June 30, 2020

March 31, 2020

December 31, 2019

September 30, 2019

 

    

Amount

    

Percent

    

Amount

    

Percent

    

Amount

    

Percent

    

Amount

    

Percent

    

Amount

    

Percent

 

(dollars in thousands)

Commercial

$

287,254

12.7

%

$

302,536

13.8

%

$

299,425

15.0

%

$

276,035

14.5

%

$

291,723

15.8

%

Paycheck Protection Program

181,596

8.0

180,228

8.2

Construction and Land Development

175,882

7.8

191,768

8.7

183,350

9.2

196,776

10.3

216,054

11.7

Real Estate Mortgage:

1 - 4 Family Mortgage

286,089

12.7

289,456

13.2

272,590

13.6

260,611

13.6

254,782

13.8

Multifamily

585,814

25.9

522,491

23.8

536,380

26.8

515,014

26.9

456,257

24.7

CRE Owner Occupied

75,963

3.4

73,539

3.4

75,207

3.8

66,584

3.5

71,209

3.9

CRE Nonowner Occupied

660,058

29.2

627,651

28.6

631,541

31.4

592,545

31.0

551,992

29.9

Total Real Estate Mortgage Loans

 

1,607,924

71.2

 

1,513,137

69.0

 

1,515,718

75.6

 

1,434,754

75.0

 

1,334,240

72.3

Consumer and Other

6,572

0.3

6,109

0.3

4,324

0.2

4,473

0.2

4,201

0.2

Total Loans, Gross

 

2,259,228

100.0

%

 

2,193,778

100.0

%

 

2,002,817

100.0

%

 

1,912,038

100.0

%

 

1,846,218

100.0

%

Allowance for Loan Losses

(31,381)

(27,633)

(24,585)

(22,526)

(22,124)

Net Deferred Loan Fees

(10,367)

(10,287)

(5,336)

(5,512)

(5,788)

Total Loans, Net

$

2,217,480

$

2,155,858

$

1,972,896

$

1,884,000

$

1,818,306

The Company’s primary focus historically has been on real estate mortgage lending, which constituted 77.4% of the portfolio, excluding PPP loans, as of September 30, 2020. The composition of the portfolio has remained consistent with prior periods and the Company does not expect any significant changes in the foreseeable future in the composition of the loan portfolio or in the emphasis on real estate lending.

As of September 30, 2020, investor CRE loans totaled $1.42 billion, consisting of $660.1 million of loans secured by nonowner occupied CRE, $585.8 million of loans secured by multifamily residential properties and $175.9 million of construction and land development loans. Investor CRE loans represented 68.4% of the total gross loan portfolio, excluding PPP loans, and 441.2% of the Bank’s total risk-based capital at September 30, 2020, compared to 516.6% at December 31, 2019.

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The following table presents time to contractual maturity and sensitivity to interest rate changes for the loan portfolio at September 30, 2020 and December 31, 2019:

As of September 30, 2020

    

Due in One Year

    

More Than One

    

    

(dollars in thousands)

or Less

Year to Five Years

After Five Years

Commercial

$

134,014

$

116,056

$

37,184

Paycheck Protection Program

181,596

Construction and Land Development

 

91,295

 

62,656

 

21,931

Real Estate Mortgage:

 

 

 

1 - 4 Family Mortgage

 

62,528

 

184,165

 

39,396

Multifamily

 

61,365

 

239,031

 

285,418

CRE Owner Occupied

 

15,560

 

17,409

 

42,994

CRE Nonowner Occupied

 

130,685

 

282,935

 

246,438

Total Real Estate Mortgage Loans

 

270,138

 

723,540

 

614,246

Consumer and Other

 

2,992

2,821

759

Total Loans, Gross

$

498,439

$

1,086,669

$

674,120

Interest Rate Sensitivity:

 

  

 

  

 

  

Fixed Interest Rates

$

199,251

$

841,868

$

285,364

Floating or Adjustable Rates

 

299,188

 

244,801

 

388,756

Total Loans, Gross

$

498,439

$

1,086,669

$

674,120

As of December 31, 2019

    

Due in One Year

    

More Than One

    

    

(dollars in thousands)

or Less

Year to Five Years

After Five Years

Commercial

$

121,383

$

119,575

$

35,077

Construction and Land Development

 

132,221

 

53,194

 

11,361

Real Estate Mortgage:

 

 

 

1 - 4 Family Mortgage

 

53,707

 

170,116

 

36,788

Multifamily

 

117,406

 

168,770

 

228,838

CRE Owner Occupied

 

4,078

 

25,286

 

37,220

CRE Nonowner Occupied

 

114,533

 

234,599

 

243,413

Total Real Estate Mortgage Loans

 

289,724

 

598,771

 

546,259

Consumer and Other

 

1,589

 

2,420

464

Total Loans, Gross

$

544,917

$

773,960

$

593,161

Interest Rate Sensitivity:

 

  

 

  

 

  

Fixed Interest Rates

$

184,370

$

545,855

$

197,151

Floating or Adjustable Rates

 

360,547

 

228,105

 

396,010

Total Loans, Gross

$

544,917

$

773,960

$

593,161

Asset Quality

The Company emphasizes credit quality in the originating and monitoring of the loan portfolio, and success in underwriting is measured by the levels of classified and nonperforming assets and net charge-offs. Federal regulations and internal policies require the use of an asset classification system as a means of managing and reporting problem and potential problem assets. The Company has incorporated an internal asset classification system, substantially consistent with federal banking regulations, as a part of the credit monitoring system. Federal banking regulations set forth a classification scheme for problem and potential problem assets as “substandard,” “doubtful” or “loss” assets. An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the financial institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value

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that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated “watch.”

The following table presents information on loan classifications at September 30, 2020. The Company had no assets classified as doubtful or loss.

Risk Category

    

(dollars in thousands)

Watch

Substandard

Total

Commercial

$

20,267

$

432

$

20,699

Construction and Land Development

 

129

 

156

 

285

Real Estate Mortgage:

 

1 - 4 Family Mortgage

 

1,464

 

1,773

 

3,237

Multifamily

 

 

 

CRE Owner Occupied

 

 

1,589

 

1,589

CRE Nonowner Occupied

 

29,057

 

12,111

 

41,168

Total Real Estate Mortgage Loans

 

30,521

 

15,473

 

45,994

Consumer and Other

 

13

 

13

Totals

$

50,917

$

16,074

$

66,991

The Company has increased oversight and analysis of all segments within the loan portfolio in response to the COVID-19 pandemic, especially in vulnerable industries such as hospitality and restaurants, to proactively monitor evolving credit risk. Although the Company has not yet seen direct impacts to the asset quality metrics, such as delinquencies and charge-offs, through September 30, 2020, management believes the economic uncertainty that exists may begin to negatively impact these metrics in future quarters. Management actively evaluates loan classifications and as a result of the COVID-19 pandemic, watchlist and adversely classified assets as of September 30, 2020 increased when compared to December 31, 2019. At September 30, 2020, watchlist loans were $50.9 million, compared to $5.3 million at December 31, 2019. At September 30, 2020, substandard loans were $16.1 million, compared to $2.7 million at December 31, 2019. As the COVID-19 pandemic continues to evolve, the length and extent of the economic contraction may dictate further watchlist or adverse classifications in the loan portfolio.

In response to the COVID-19 pandemic, the Company is offering loan modifications, when appropriate, to borrowers who were current and otherwise not past due as of December 31, 2019. These include modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment. In accordance with interagency regulatory guidance and the CARES Act, qualifying loans modified in response to the COVID-19 pandemic are not considered TDRs. New modification activity has been limited in the third quarter of 2020.

The following table presents a rollforward of loan modification activity, by modification type, from June 30, 2020 to September 30, 2020:

(dollars in thousands)

Interest-Only

Payment Deferral

Total

Principal Balance - June 30, 2020

$

175,307

$

117,703

$

293,010

Modification Expired

(45,392)

(90,108)

(135,500)

Second Modification Granted

18,909

2,909

21,818

New Modifications

10,502

10,502

Net Principal Advances (Payments)

1,559

(8)

1,551

Principal Balance - September 30, 2020

$

160,885

$

30,496

$

191,381

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The following table presents a summary of active loan modifications, by loan segment and modification type, at September 30, 2020:

Interest-Only

Payment Deferral

Total

(dollars in thousands)

   

Amount

 

# of Loans

   

Amount

 

# of Loans

   

Amount

 

# of Loans

Commercial

$

11,705

21

$

414

2

$

12,119

23

Construction and Land Development

Real Estate Mortgage:

1 - 4 Family Mortgage

5,589

10

5,589

10

Multifamily

42,273

6

42,273

6

CRE Owner Occupied

1,646

4

1,502

3

3,148

7

CRE Nonowner Occupied

99,672

35

28,580

6

128,252

41

Consumer and Other

Totals

$

160,885

76

$

30,496

11

$

191,381

87

Modifications have been granted on a case-by-case basis based on specific needs and circumstances affecting each borrower. Interest-only modifications have been primarily granted for three to six month periods, but range up to twelve months. Payment deferral modifications have been granted for three to six month periods. The Company has 52 modified loans totaling $99.8 million set to expire in October 2020. As of October 22, 2020, based on lender and client surveys, the Company estimates that $73.6 million will return to regular payment status, bringing loan modification balances as a percent of total loans, excluding PPP loans, to 5.6%.

Nonperforming Assets

Nonperforming loans include loans accounted for on a nonaccrual basis and loans 90 days past due and still accruing. Nonperforming assets consist of nonperforming loans plus foreclosed assets (i.e., real or personal property acquired through foreclosure). Nonaccrual loans totaled $433,000 and $461,000 as of September 30, 2020 and December 31, 2019, respectively, a decrease of $28,000. There were no loans 90 days past due and still accruing as of September 30, 2020 or December 31, 2019. There were no foreclosed assets as of September 30, 2020 or December 31, 2019.

The following table presents a summary of nonperforming assets, by category, at the dates indicated:

September 30, 

December 31, 

(dollars in thousands)

    

2020

    

2019

Nonaccrual Loans:

  

 

  

 

Commercial

$

7

$

7

Construction and Land Development

 

156

 

176

Real Estate Mortgage:

 

 

1 - 4 Family Mortgage

 

270

 

278

Total Nonaccrual Loans

$

433

$

461

Total Nonperforming Loans

$

433

$

461

Total Nonperforming Assets (1)

$

433

$

461

Total Restructured Accruing Loans

 

664

 

276

Total Nonperforming Assets and Restructured Accruing Loans

$

1,097

$

737

Nonaccrual Loans to Total Loans

 

0.02

%  

 

0.02

%

Nonperforming Loans to Total Loans

 

0.02

 

0.02

Nonperforming Assets to Total Loans Plus Foreclosed Assets (1)

 

0.02

 

0.02

Nonperforming Assets and Restructured Accruing Loans to Total Loans Plus Foreclosed Assets

 

0.05

 

0.04

(1)Nonperforming assets are defined as nonaccrual loans and loans greater than 90 days past due still accruing plus foreclosed assets.

The balance of nonperforming assets can fluctuate due to changes in economic conditions. The Company has established a policy to discontinue accruing interest on a loan (that is, place the loan on nonaccrual status) after it has become 90 days delinquent as to payment of principal or interest, unless the loan is considered to be well-collateralized and is actively in the process of collection. In addition, a loan will be placed on nonaccrual status before it becomes 90 days delinquent unless management believes that the collection of interest is expected. Interest previously accrued but

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Table of Contents

uncollected on such loans is reversed and charged against current income when the receivable is determined to be uncollectible. If management believes that a loan will not be collected in full, an increase to the allowance for loan losses is recorded to reflect management’s estimate of any potential exposure or loss. Generally, payments received on nonaccrual loans are applied directly to principal. Gross income that would have been recorded on nonaccrual loans during the three and nine months ended September 30, 2020 was $4,000 and $36,000, respectively.

Allowance for Loan Losses

The allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. The Company maintains an allowance for loan losses at a level management considers adequate to provide for known and probable incurred losses in the portfolio. The level of the allowance is based on management’s evaluation of estimated losses in the portfolio, after consideration of risk characteristics of the loans and prevailing and anticipated economic conditions. Loan charge-offs (i.e., loans judged to be uncollectible) are charged against the reserve and any subsequent recovery is credited to the reserve. The Company analyzes risks within the loan portfolio on a continual basis. A risk system, consisting of multiple grading categories for each portfolio class, is utilized as an analytical tool to assess risk and appropriate reserves. In addition to the risk system, management further evaluates risk characteristics of the loan portfolio under current and anticipated economic conditions, including the economic distress caused by the COVID-19 pandemic, and considers such factors as the financial condition of the borrower, past and expected loss experience, and other factors which management feels deserve recognition in establishing an appropriate reserve. These estimates are reviewed at least quarterly, and as adjustments become necessary, they are recognized in the periods in which they become known. Although management strives to maintain an allowance it deems adequate, future economic changes, deterioration of borrowers’ creditworthiness, and the impact of examinations by regulatory agencies all could cause changes to the allowance for loan losses.

At September 30, 2020, the allowance for loan losses was $31.4 million, an increase of $8.9 million from $22.5 million at December 31, 2019. Net charge-offs totaled $2,000 during the third quarter of 2020 and $138,000 during the third quarter of 2019. Net charge-offs (recoveries) totaled $(5,000) for the nine months ended September 30, 2020 and $7,000 for the nine months ended September 30, 2019. The allowance for loan losses as a percentage of total loans was 1.39% as of September 30, 2020 and 1.18% as of December 31, 2019. The allowance for loan losses to total loans, excluding $181.6 million of PPP loans, was 1.51% as of September 30, 2020. Based on current economic indicators, the Company increased the economic factors within the allowance for loan losses evaluation, primarily in response to the impacts of the COVID-19 pandemic. The Company expects that the allowance for loan losses as a percent of total loans will increase in future periods based on its belief that the credit quality of its loan portfolio will decline, and loan defaults will increase as a result of the COVID-19 pandemic.

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The following presents a summary of the activity in the allowance for loan loss reserve for the periods indicated:

Three Months Ended

Nine Months Ended

September 30, 

September 30, 

(dollars in thousands)

    

2020

    

2019

2020

    

2019

 

Balance, Beginning of Period

$

27,633

$

21,362

$

22,526

$

20,031

Charge-offs:

 

 

 

 

Commercial

 

5

 

141

 

39

 

160

Consumer and Other

 

1

 

3

 

15

23

Total Charge-offs

 

6

 

144

 

54

 

183

Recoveries:

 

  

 

  

 

  

 

  

Commercial

 

1

 

2

 

5

5

Construction and Land Development

 

 

 

1

Real Estate Mortgage:

 

 

 

1 - 4 Family Mortgage

 

3

 

3

 

51

165

Consumer and Other

 

 

1

 

3

5

Total Recoveries

 

4

 

6

 

59

 

176

Net Charge-offs (Recoveries)

 

2

 

138

 

(5)

 

7

Provision for Loan Losses

 

3,750

 

900

 

8,850

2,100

Balance at End of Period

$

31,381

$

22,124

$

31,381

$

22,124

Gross Loans, End of Period

 

2,259,228

 

1,846,218

 

2,259,228

 

1,846,218

Average Loans

2,206,807

 

1,805,920

2,105,094

 

1,756,855

Net Charge-offs (Recoveries) (Annualized) to Average Loans

 

%

 

0.03

%

 

%

 

%

Allowance to Total Gross Loans

 

1.39

%

 

1.20

%

 

1.39

%

 

1.20

%

Allowance to Total Gross Loans, Excluding PPP Loans

1.51

%

 

N/A

 

1.51

%

 

N/A

The following table presents a summary of the allocation of the allowance for loan losses by loan portfolio segment for the periods indicated:

September 30, 

December 31, 

2020

2019

(dollars in thousands)

    

Amount

    

Percent

    

Amount

    

Percent

Commercial

$

5,303

16.9

%  

$

3,058

13.6

%

Paycheck Protection Program

91

0.3

Construction and Land Development

 

2,236

7.1

 

2,202

9.8

Real Estate Mortgage:

 

 

1 - 4 Family Mortgage

 

3,709

11.8

 

2,839

12.6

Multifamily

 

8,319

26.5

 

5,824

25.9

CRE Owner Occupied

 

1,104

3.5

 

792

3.5

CRE Nonowner Occupied

 

9,500

30.3

 

6,972

30.9

Total Real Estate Mortgage Loans

 

22,632

 

72.1

 

16,427

 

72.9

Consumer and Other

 

176

0.6

 

85

0.4

Unallocated

 

943

3.0

 

754

3.3

Total Allowance for Loan Losses

$

31,381

 

100.0

%  

$

22,526

 

100.0

%

Deposits

The principal sources of funds for the Company are deposits, consisting of demand deposits, money market accounts, savings accounts, and certificates of deposit. The following table details the dollar and percentage composition of the deposit portfolio, by category, at the dates indicated:

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September 30, 2020

June 30, 2020

March 31, 2020

December 31, 2019

September 30, 2019

 

(dollars in thousands)

    

Amount

    

Percent

    

Amount

    

Percent

    

Amount

    

Percent

    

Amount

    

Percent

    

Amount

    

Percent

 

Noninterest Bearing Transaction Deposits

$

685,773

30.2

%

$

648,869

28.9

%

$

476,217

25.1

%

$

447,509

24.5

%

$

478,493

26.5

%

Interest Bearing Transaction Deposits

 

322,253

14.2

 

285,386

12.7

 

255,483

13.4

 

264,627

14.5

 

243,889

13.5

Savings and Money Market Deposits

 

498,397

21.9

 

516,543

23.0

 

514,113

27.1

 

516,785

28.3

 

470,518

26.1

Time Deposits

 

363,897

16.0

 

382,187

17.1

 

393,340

20.7

 

360,027

19.8

 

363,308

20.2

Brokered Deposits

 

402,724

17.7

 

409,066

18.3

 

260,974

13.7

 

234,362

12.9

 

246,028

13.7

Total Deposits

$

2,273,044

100.0

%

$

2,242,051

100.0

%

$

1,900,127

100.0

%

$

1,823,310

100.0

%

$

1,802,236

100.0

%

Total deposits at September 30, 2020 were $2.27 billion, an increase of $449.7 million, or 24.7%, compared to total deposits of $1.82 billion at December 31, 2019, and an increase of $470.8 million, or 26.1%, over total deposits of $1.80 billion at September 30, 2019. Noninterest bearing transaction deposits were $685.8 million at September 30, 2020, compared to $447.5 million at December 31, 2019, and $478.5 million at September 30, 2019. Noninterest bearing deposits comprised 30.2% of total deposits at September 30, 2020, compared to 24.5% at December 31, 2019, and 26.5% at September 30, 2019. The growth in noninterest bearing transaction deposits was a result of both successful new client acquisition initiatives and pandemic-related accumulation of liquidity in existing client accounts. The Company estimates approximately $30.0 million of the noninterest bearing transaction deposit growth in 2020 was due to remaining PPP loan funds. The Company expects that deposit levels will fluctuate in future periods as a result of the distressed and uncertain economic conditions relating to the COVID-19 pandemic.

The Company relies on increasing the deposit base to fund loans and other asset growth. The Company is in a highly competitive market and competes for local deposits by offering attractive products with competitive rates. The Company expects to have a higher average cost of funds for local deposits compared to competitor banks due to the lack of an extensive branch network. The Company’s strategy is to offset the higher cost of funding with a lower level of operating expense. When appropriate, the Company utilizes alternative funding sources such as brokered deposits. At September 30, 2020, total brokered deposits were $402.7 million, an increase of $168.4 million, or 71.8%, compared to total brokered deposits of $234.4 million at December 31, 2019. Brokered deposits increased as a result of a change in mix of wholesale funding sources due to favorable funding costs offered compared to other wholesale funding alternatives and to expand on-balance sheet liquidity in this uncertain environment. Furthermore, the brokered deposit market provides flexibility in structure, optionality and efficiency not afforded in traditional, retail deposit channels.

The following table presents the average balance and average rate paid on each of the following deposit categories for the three months ended September 30, 2020 and September 30, 2019:

As of and for the

As of and for the

Three Months Ended

Three Months Ended

September 30, 2020

September 30, 2019

Average

Average

Average

Average

(dollars in thousands)

    

Balance

    

Rate

    

Balance

    

Rate

Noninterest Bearing Transaction Deposits

$

615,214

%  

$

434,021

 

%

Interest Bearing Transaction Deposits

 

306,162

0.52

 

250,667

 

0.81

Savings and Money Market Deposits

 

501,246

0.88

 

453,340

 

1.82

Time Deposits < $250,000

 

242,048

2.08

 

238,556

 

2.35

Time Deposits > $250,000

 

127,927

1.98

 

120,773

 

2.69

Brokered Deposits

 

419,744

1.36

 

242,600

 

2.27

Total Deposits

$

2,212,341

 

0.87

%  

$

1,739,957

1.42

%

Borrowed Funds

Federal Funds Purchased

In addition to deposits, the Company utilizes overnight borrowings to meet the daily liquidity needs of clients and fund loan growth. The following table summarizes overnight borrowings, which consist of federal funds purchased

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from correspondent banks on an overnight basis at the prevailing overnight market rates and the weighted average interest rates paid for the periods presented:

As of and for the

As of and for the

As of and for the

Three Months Ended

Three Months Ended

Three Months Ended

(dollars in thousands)

    

September 30, 2020

    

December 31, 2019

September 30, 2019

Outstanding at Period-End

$

$

$

Average Amount Outstanding

 

152

 

3,011

 

Maximum Amount Outstanding at any Month-End

6,000

Weighted Average Interest Rate:

 

 

 

  

During Period

 

0.33

%  

 

1.82

%

 

%

End of Period

 

0.30

%  

 

2.63

%

 

%

Other Borrowings

At September 30, 2020, other borrowings outstanding consisted of FHLB advances of $127.5 million and notes payable of $11.5 million. During the second quarter of 2020, the Company paid off $25.0 million of fixed rate FHLB advances with an average cost of 2.89% and incurred a loss on extinguishment of debt of $1.4 million. The Company’s borrowing capacity at the FHLB is determined based on collateral pledged, generally consisting of loans. The Company had additional borrowing capacity under this credit facility of $250.8 million and $209.8 million at September 30, 2020 and December 31, 2019, respectively, based on collateral amounts pledged.

Additionally, the Company has borrowing capacity from other sources. As of September 30, 2020, the Bank was eligible to use the Federal Reserve discount window for borrowings. Based on assets pledged as collateral as of the applicable date, the Bank’s borrowing availability was approximately $73.1 million and $113.2 million at September 30, 2020 and December 31, 2019, respectively. As of September 30, 2020 and December 31, 2019, the Company had no outstanding advances.

As part of the CARES Act, the Federal Reserve Bank offered secured borrowings to banks who originated PPP loans through the Paycheck Protection Program Liquidity Facility, or PPPLF. As of September 30, 2020, the Company had not pledged any PPP loans to borrow funds under this facility. The facility is available through December 31, 2020, unless the Federal Reserve Board and the Department of the Treasury determine to extend the facility.

The Company has a swap agreement with an unaffiliated third party in order to hedge interest rate risk associated with the notes payable. This agreement provides for the Company to make payments at a fixed rate in exchange for receiving payments at a variable rate determined by the one-month LIBOR.

Subordinated Debentures

On June 19, 2020, the Company issued $50.0 million of subordinated debentures at an initial fixed interest rate of 5.25% which is payable semi-annually. Beginning July 1, 2025, the interest rate converts to a variable interest rate equal to the three-month term SOFR, plus 5.13%, which is payable quarterly. The subordinated debentures mature on July 1, 2030. The subordinated debentures, net of issuance costs, were $48.9 million at September 30, 2020.

On October 13, 2020, the Company completed an offer to exchange up to $50.0 million total principal amount of the subordinated debentures for substantially identical subordinated debentures registered under the Securities Act of 1933, in satisfaction of the Company’s obligations under a registration rights agreement entered into with the initial purchasers of the subordinated debentures. $47.0 million of the $50.0 million of the subordinated debentures were exchanged in the exchange offer.

On July 12, 2017, the Company issued $25.0 million of subordinated debentures at an initial fixed interest rate of 5.875% which is payable semi-annually. Beginning July 15, 2022, the interest rate converts to a variable interest rate equal to the three-month LIBOR plus 3.88%. The subordinated debentures mature on July 15, 2027. The subordinated

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debentures, net of issuance costs, were $24.8 million at September 30, 2020, compared to $24.7 million at December 31, 2019.

All of the subordinated debentures qualify for Tier 2 regulatory capital treatment at the Company level for the first five years, under applicable regulatory guidelines.

Contractual Obligations

The following table presents supplemental information regarding total contractual obligations at September 30, 2020:

    

Within

    

One to

    

Three to

    

After

    

(dollars in thousands)

One Year

Three Years

Five Years

Five Years

Total

Deposits Without a Stated Maturity

$

1,664,123

$

$

$

$

1,664,123

Time Deposits

 

365,231

125,851

117,839

608,921

Notes Payable

 

11,500

11,500

FHLB Advances

 

15,000

39,000

68,500

5,000

127,500

Subordinated Debentures

 

75,000

75,000

Commitment to Fund Tax Credit Investments

2,394

2,394

Operating Lease Obligations

 

488

652

653

886

2,679

Totals

$

2,058,736

$

165,503

$

186,992

$

80,886

$

2,492,117

During the third quarter, the Company opened its newly constructed office complex in St. Louis Park, Minnesota. The remaining contractual obligations relating to the construction costs of the building are minimal.

The Company believes that it will be able to meet all contractual obligations as they come due through the maintenance of adequate cash levels. The Company expects to maintain adequate cash levels through earnings, loan and securities repayments and maturity activity and continued deposit gathering activities. As described above, the Company has in place various borrowing mechanisms for both short-term and long-term liquidity needs.

Shareholders’ Equity

Shareholders’ equity at September 30, 2020 was $265.4 million, an increase of $20.6 million, or 8.4%, over shareholders’ equity of $244.8 million at December 31, 2019, primarily due to $22.2 million of net income and $509,000 increase in unrealized gains in the securities portfolio, partially offset by $3.3 million of stock repurchases in the first and third quarter of 2020 under the Company’s stock repurchase program.

Stock Repurchase Program. On January 22, 2019, the Company adopted a stock repurchase program. Under the repurchase program, the Company was initially authorized to repurchase up to $15.0 million of its common stock in open market transactions or through privately negotiated transactions at the Company’s discretion. On July 23, 2019, the Company’s Board of Directors approved a $10.0 million increase to the Company’s stock repurchase program, increasing the authorization to repurchase common stock under the program from a total of $15.0 million to a total of $25.0 million. Subsequent to September 30, 2020, on October 27, 2020, the Company’s Board of Directors approved a $15.0 million increase to the Company’s stock repurchase program, increasing the authorization to repurchase common stock under the program from a total of $25.0 million to $40.0 million and extending the program until October 27, 2022.

In response to the pandemic and the related economic and market uncertainty, the Company stopped repurchasing shares under the program on March 16, 2020. Strong earnings and capital growth coupled with better asset quality visibility as loan modifications expired, supported management’s decision to resume repurchases under the Company’s stock repurchase program late in the third quarter of 2020. The Company remains committed to maintaining strong capital levels while enhancing shareholder value as it strategically executes its stock repurchase program in this fluid economic environment. During the three months ended September 30, 2020, the Company repurchased 137,984 shares of its common stock, representing less than 1% of the Company’s outstanding shares. Shares were repurchased

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during this period at a weighted average price of $9.39 for a total of $1.3 million. During the nine months ended September 30, 2020, the Company repurchased 315,848 shares of its common stock, representing approximately 1% of the Company’s outstanding shares. Shares were repurchased at a weighted average price of $10.59 for a total of 3.3 million. All shares repurchased under the stock repurchase program were converted to authorized but unissued shares. At September 30, 2020, the remaining amount that could be used to repurchase shares under the stock repurchase program was $6.7 million.

Regulatory Capital. The Company and the Bank are subject to various regulatory capital requirements administered by federal banking regulators. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by federal banking regulators that, if undertaken, could have a direct material effect on the Company’s and Bank’s business.

Under applicable regulatory capital rules, the Company and Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank must also meet certain specific capital guidelines under the prompt corrective action framework. The capital amounts and classification are subject to qualitative judgments by the federal banking regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of common equity Tier 1 capital, Tier 1 capital and total capital to risk-weighted assets and of Tier 1 capital to average consolidated assets (referred to as the “leverage ratio”), as defined under the applicable regulatory capital rules.

Management believes the Company and the Bank met all capital adequacy requirements to which they were subject as of September 30, 2020. The regulatory capital ratios for the Company and the Bank to meet the minimum capital adequacy standards and for the Bank to be considered well capitalized under the prompt corrective action framework are set forth in the following tables. The Company’s and the Bank’s actual capital amounts and ratios are as of the dates indicated.

Minimum Required

For Capital Adequacy

To be Well Capitalized

For Capital Adequacy

Purposes Plus Capital

Under Prompt Corrective

Actual

Purposes

Conservation Buffer

Action Regulations

September 30, 2020

    

Amount

    

Ratio

    

Amount

    

Ratio

    

Amount

    

Ratio

Amount

    

Ratio

(dollars in thousands)

Company (Consolidated):

Total Risk-Based Capital

$

359,597

15.45

%  

$

186,206

8.00

%  

$

244,396

10.50

%  

N/A

N/A

Tier 1 Risk-Based Capital

256,805

11.03

139,655

6.00

197,844

8.50

N/A

N/A

Common Equity Tier 1 Capital

256,805

11.03

104,741

4.50

162,931

7.00

N/A

N/A

Tier 1 Leverage Ratio

256,805

9.83

104,543

4.00

104,543

4.00

N/A

N/A

Bank:

Total Risk-Based Capital

$

322,276

13.85

%  

$

186,104

8.00

%  

$

244,262

10.50

%  

$

232,630

10.00

%

Tier 1 Risk-Based Capital

293,164

12.60

139,578

6.00

197,736

8.50

186,104

8.00

Common Equity Tier 1 Capital

293,164

12.60

104,684

4.50

162,841

7.00

151,210

6.50

Tier 1 Leverage Ratio

293,164

11.24

104,350

4.00

104,350

4.00

130,437

5.00

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Minimum Required

For Capital Adequacy

To be Well Capitalized

For Capital Adequacy

Purposes Plus Capital

Under Prompt Corrective

Actual

Purposes

Conservation Buffer

Action Regulations

December 31, 2019

    

Amount

    

Ratio

    

Amount

    

Ratio

    

Amount

    

Ratio

Amount

    

Ratio

(dollars in thousands)

Company (Consolidated):

Total Risk-Based Capital

$

269,613

12.98

%  

$

166,163

8.00

%  

$

218,089

10.50

%  

N/A

N/A

Tier 1 Risk-Based Capital

236,533

11.39

124,623

6.00

176,549

8.50

N/A

N/A

Common Equity Tier 1 Capital

236,533

11.39

93,467

4.50

145,393

7.00

N/A

N/A

Tier 1 Leverage Ratio

236,533

10.69

88,498

4.00

88,498

4.00

N/A

N/A

Bank:

Total Risk-Based Capital

$

252,501

12.16

%  

$

166,137

8.00

%  

$

218,055

10.50

%  

$

207,671

10.00

%

Tier 1 Risk-Based Capital

243,461

11.72

124,603

6.00

176,521

8.50

166,137

8.00

Common Equity Tier 1 Capital

243,461

11.72

93,452

4.50

145,370

7.00

134,986

6.50

Tier 1 Leverage Ratio

243,461

11.01

88,455

4.00

88,455

4.00

110,569

5.00

The Company and the Bank are subject to the rules of the Basel III regulatory capital framework and related Dodd-Frank Wall Street Reform and Consumer Protection Act. The rules require a capital conservation buffer of 2.5% that was added to the minimum requirements for capital adequacy purposes. A banking organization with a conservation buffer of less than the required amount is subject to limitations on capital distributions, including dividend payments, stock repurchases and certain discretionary bonus payments to executive officers. At September 30, 2020, the ratios for the Company and the Bank were sufficient to meet the conservation buffer.

In 2019, the federal banking agencies issued a final rule to provide an optional simplified measure of capital adequacy for qualifying depository institutions and depository institution holding companies, titled the community bank leverage ratio, or CBLR framework. Generally, under the CBLR framework, qualifying depository institutions and depository institution holding companies that have less than $10 billion in total consolidated assets and that meet other qualifying criteria, including a leverage ratio (equal to tier 1 capital divided by average total consolidated assets) of greater than 9% (subsequently reduced to 8% as a COVID-19 relief measure), are eligible to opt into the CBLR framework. Qualifying organizations that elect to use the CBLR framework and that maintain a leverage ratio of greater than 9% will be considered to have met the well capitalized ratio requirements for purposes of the FDIC’s prompt corrective action framework. The final rule was effective on January 1, 2020. The Company has elected not to opt into the CBLR framework and will continue to compute regulatory capital ratios based on the Basel III Capital Rules discussed above.

Off-Balance Sheet Arrangements

In the normal course of business, the Company enters into various transactions to meet the financing needs of clients, which, in accordance with GAAP, are not included in the consolidated balance sheets. These transactions include commitments to extend credit, standby letters of credit, and commercial letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. Most of these commitments mature within two years and the standby letters of credit are expected to expire without being drawn upon. All off-balance sheet commitments are included in the determination of the amount of risk-based capital that the Company and the Bank are required to hold.

The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit, standby letters of credit, and commercial letters of credit is represented by the contractual or notional amount of those instruments. The Company decreases its exposure to losses under these commitments by subjecting them to credit approval and monitoring procedures. The Company assesses the credit risk associated with certain commitments to extend credit and establishes a liability for probable credit losses.

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The following table presents credit arrangements and financial instruments whose contract amounts represent credit risk as of September 30, 2020 and December 31, 2019:

September 30, 2020

December 31, 2019

    

Fixed

    

Variable

    

Fixed

    

Variable

(dollars in thousands)

Unfunded Commitments Under Lines of Credit

$

196,552

$

409,442

$

181,622

$

319,340

Letters of Credit

 

12,911

 

72,990

 

17,503

 

61,722

Totals

$

209,463

$

482,432

$

199,125

$

381,062

Liquidity

Liquidity is the Company’s capacity to meet cash and collateral obligations at a reasonable cost. Maintaining an adequate level of liquidity depends on the Company’s ability to efficiently meet both expected and unexpected cash flows and collateral needs without adversely affecting either daily operations or financial condition. The Bank’s Asset Liability Management, or ALM, Committee, which is comprised of members of senior management, is responsible for managing commitments to meet the needs of customers while achieving the Company’s financial objectives. The ALM Committee meets regularly to review balance sheet composition, funding capacities, and current and forecasted loan demand.

The Company manages liquidity by maintaining adequate levels of cash and other assets from on- and off-balance sheet arrangements. Specifically, on-balance sheet liquidity consists of cash and due from banks and unpledged investment securities available for sale, which are referred to as primary liquidity. In regards to off-balance sheet capacity, the Company maintains available borrowing capacity under secured borrowing lines with the FHLB and the Federal Reserve Bank of Minneapolis, as well as unsecured lines of credit for the purpose of overnight funds with various correspondent banks, which the Company refers to as secondary liquidity.

In addition, the Bank is a member of the American Financial Exchange, or AFX, through which it may either borrow or lend funds on an overnight or short-term basis with a group of approved commercial banks. The availability of funds changes daily. As of September 30, 2020, the Company had no borrowings outstanding through the AFX. The Bank has also established additional borrowing capacity through the Federal Reserve Bank’s PPPLF, where it can pledge PPP loans to borrow an equal amount of funds. As of September 30, 2020, the Company had no borrowings outstanding through this facility and $181.6 million of PPP loans available to pledge. The facility is available through December 31, 2020.

The following tables provide a summary of primary and secondary liquidity levels as of the dates indicated:

Primary Liquidity—On-Balance Sheet

    

September 30, 2020

    

December 31, 2019

 

(Dollars in thousands)

 

Cash and Cash Equivalents

$

91,510

$

31,935

Securities Available for Sale

 

373,955

 

289,877

Total Primary Liquidity

$

465,465

$

321,812

Ratio of Primary Liquidity to Total Deposits

 

20.5

%

 

17.6

%

Secondary Liquidity—Off-Balance Sheet

 

Borrowing Capacity

    

September 30, 2020

    

December 31, 2019

 

(Dollars in thousands)

 

Net Secured Borrowing Capacity with the FHLB

$

250,834

$

209,840

Net Secured Borrowing Capacity with the Federal Reserve Bank

 

73,074

 

113,164

Unsecured Borrowing Capacity with Correspondent Lenders

 

105,000

 

105,000

Total Secondary Liquidity

$

428,908

$

428,004

Ratio of Primary and Secondary Liquidity to Total Deposits

 

39.9

%

 

41.1

%

During the nine months ended September 30, 2020, primary liquidity increased by $143.7 million due to a $59.6 million increase in cash and cash equivalents and a $84.1 million increase in securities available for sale, when

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compared to December 31, 2019. Secondary liquidity increased by $904,000 as of September 30, 2020 when compared to December 31, 2019, due to a $41.0 million increase in the borrowing capacity on the secured borrowing line with the FHLB, partially offset by a $40.1 million decrease in the borrowing capacity on the secured credit line with the Federal Reserve Bank.

In addition to primary liquidity, the Company generates liquidity from cash flows from the loan and securities portfolios and from the large base of core customer deposits, defined as noninterest bearing transaction, interest bearing transaction, savings, non-brokered money market accounts and non-brokered time deposits less than $250,000. At September 30, 2020, core deposits totaled approximately $1.75 billion and represented 77.1% of total deposits. These core deposits are normally less volatile, often with customer relationships tied to other products offered by the Company, which promote long-standing relationships and stable funding sources.

The Company uses brokered deposits, the availability of which is uncertain and subject to competitive market forces and regulation, for liquidity management purposes. At September 30, 2020, brokered deposits totaled $402.7 million, consisting of $245.0 million of brokered time deposits and $157.7 million of non-maturity brokered money market and transaction accounts. At December 31, 2019, brokered deposits totaled $234.4 million, consisting of $231.9 million of brokered time deposits and $2.4 million of non-maturity brokered money market and transaction accounts.

The Company’s liquidity policy includes guidelines for On-Balance Sheet Liquidity (a measurement of primary liquidity to total deposits plus borrowings), Total On-Balance Sheet Liquidity with Borrowing Capacity (a measurement of primary and secondary liquidity to total deposits plus borrowings), Wholesale Funding Ratio (a measurement of total wholesale funding to total deposits plus borrowings), and other guidelines developed for measuring and maintaining liquidity. As of September 30, 2020, the Company was in compliance with all established liquidity guidelines in the policy.

Non-GAAP Financial Measures

In addition to the results presented in accordance with GAAP, the Company routinely supplements its evaluation with an analysis of certain non-GAAP financial measures. The Company believes these non-GAAP financial measures, in addition to the related GAAP measures, provide meaningful information to investors to help them understand the Company’s operating performance and trends, and to facilitate comparisons with the performance of peers. These disclosures should not be viewed as a substitute for operating results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. Reconciliations of non-GAAP disclosures used in this report to the comparable GAAP measures are provided in the following tables.

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For the Three Months Ended

For the Nine Months Ended

September 30, 

June 30,

March 31,

December 31, 

September 30, 

September 30, 

September 30, 

    

2020

    

2020

    

2020

2019

2019

    

2020

    

2019

    

(dollars in thousands)

Efficiency Ratio

Noninterest Expense

 

$

9,672

$

10,711

$

9,746

$

10,489

$

9,084

$

30,129

$

26,443

Less: Amortization of Intangible Assets

(48)

(47)

(48)

(48)

(48)

(143)

(143)

Adjusted Noninterest Expense

$

9,624

$

10,664

$

9,698

$

10,441

$

9,036

$

29,986

$

26,300

Net Interest Income

21,679

21,342

20,102

19,928

18,935

63,123

54,204

Noninterest Income

1,157

1,977

1,719

1,112

946

4,853

2,714

Less: Gain on Sales of Securities

(109)

(1,361)

(3)

(58)

(1,473)

(516)

Adjusted Operating Revenue

$

22,727

$

21,958

$

21,818

$

21,040

$

19,823

$

66,503

$

56,402

Efficiency Ratio

 

42.3

%  

 

48.6

%  

 

44.4

%  

 

49.6

%  

 

45.6

%  

 

45.1

%  

 

46.6

%  

Adjusted Efficiency Ratio

Noninterest Expense

$

9,672

$

10,711

$

9,746

$

10,489

$

9,084

$

30,129

$

26,443

Less: Amortization of Tax Credit Investments

(145)

(362)

(85)

(1,128)

(530)

(592)

(2,097)

Less: FHLB Advance Prepayment Fees

(1,430)

(1,430)

Less: Amortization of Intangible Assets

(48)

(47)

(48)

(48)

(48)

(143)

(143)

Adjusted Noninterest Expense

$

9,479

$

8,872

$

9,613

$

9,313

$

8,506

$

27,964

$

24,203

Net Interest Income

21,679

21,342

20,102

19,928

18,935

63,123

54,204

Noninterest Income

1,157

1,977

1,719

1,112

946

4,853

2,714

Less: Gain on Sales of Securities

(109)

(1,361)

(3)

(58)

(1,473)

(516)

Adjusted Operating Revenue

$

22,727

$

21,958

$

21,818

$

21,040

$

19,823

$

66,503

$

56,402

Adjusted Efficiency Ratio

 

41.7

%  

 

40.4

%  

 

44.1

%  

 

44.3

%  

 

42.9

%  

 

42.0

%  

 

42.9

%  

For the Three Months Ended

For the Nine Months Ended

September 30, 

June 30,

March 31,

December 31, 

September 30, 

September 30, 

September 30, 

2020

    

2020

    

2020

2019

2019

2020

    

2019

(dollars in thousands)

Pre-Provision Net Revenue

Noninterest Income

$

1,157

$

1,977

$

1,719

$

1,112

$

946

$

4,853

$

1,768

Less: Gain on sales of Securities

(109)

(1,361)

(3)

(58)

(1,473)

(458)

Total Operating Noninterest Income

1,048

616

1,716

1,112

888

3,380

1,310

Plus: Net Interest income

21,679

21,342

20,102

19,928

18,935

63,123

35,269

Net Operating Revenue

$

22,727

$

21,958

$

21,818

$

21,040

$

19,823

$

66,503

$

36,579

Noninterest Expense

$

9,672

$

10,711

$

9,746

$

10,489

$

9,084

$

30,129

$

17,359

Less: Amortization of Tax Credit Investments

(145)

(362)

(85)

(1,128)

(530)

(592)

(1,567)

Less: FHLB Advance Prepayment Fees

(1,430)

(1,430)

Total Operating Noninterest Expense

$

9,527

$

8,919

$

9,661

$

9,361

$

8,554

$

28,107

$

15,792

Pre-Provision Net Revenue

$

13,200

$

13,039

$

12,157

$

11,679

$

11,269

$

38,396

$

20,787

Plus:

Non-Operating Revenue Adjustments

109

1,361

3

58

1,473

458

Less:

Provision for Loan Losses

3,750

3,000

2,100

600

900

8,850

1,200

Non-Operating Expense Adjustments

145

1,792

85

1,128

530

2,022

1,567

Provision for Income Taxes

2,240

2,010

2,532

1,380

2,092

6,782

3,451

Net Income

$

7,174

$

7,598

$

7,443

$

8,571

$

7,805

$

22,215

$

15,027

Average Assets

$

2,711,755

$

2,622,272

$

2,317,040

$

2,221,370

$

2,168,909

$

2,550,945

$

2,040,602

Pre-Provision Net Revenue Return on Average Assets

1.94

%

2.00

%

2.11

%

2.09

%

2.08

%

2.01

%

2.06

%

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For the Three Months Ended

For the Nine Months Ended

September 30, 

June 30,

March 31,

December 31, 

September 30, 

September 30, 

September 30, 

2020

    

2020

    

2020

2019

2019

2020

    

2019

(dollars in thousands)

Tangible Common Equity and Tangible Common Equity/Tangible Assets

Common Equity

$

265,432

$

257,190

$

248,143

$

244,794

$

236,059

Less: Intangible Assets

(3,344)

(3,391)

(3,439)

(3,487)

(3,535)

Tangible Common Equity

 

262,088

 

253,799

 

244,704

 

241,307

 

232,524

Total Assets

2,774,564

2,754,463

2,418,730

2,268,830

2,232,339

Less: Intangible Assets

(3,344)

(3,391)

(3,439)

(3,487)

(3,535)

Tangible Assets

$

2,771,220

$

2,751,072

$

2,415,291

$

2,265,343

$

2,228,804

Tangible Common Equity/Tangible Assets

 

9.46

%  

 

9.23

%  

 

10.13

%  

 

10.65

%  

 

10.43

%  

Tangible Book Value Per Share

Book Value Per Common Share

$

9.25

$

8.92

$

8.61

$

8.45

$

8.20

Less: Effects of Intangible Assets

(0.12)

(0.12)

(0.12)

(0.12)

(0.12)

Tangible Book Value Per Common Share

$

9.13

$

8.80

$

8.49

$

8.33

$

8.08

Average Tangible Common Equity

Average Common Equity

$

263,195

$

255,109

$

250,800

$

240,188

$

232,590

$

256,393

$

229,961

Less: Average Intangible Assets

(3,371)

(3,419)

(3,466)

(3,510)

(3,558)

(3,418)

(3,605)

Average Tangible Common Equity

$

259,824

$

251,690

$

247,334

$

236,678

$

229,032

$

252,975

$

226,356

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

As a financial institution, the Company’s primary market risk is interest rate risk, which is defined as the risk of loss of net interest income or net interest margin because of changes in interest rates. The Company continually seeks to measure and manage the potential impact of interest rate risk. Interest rate risk occurs when interest earning assets and interest bearing liabilities mature or re-price at different times, on a different basis or in unequal amounts. Interest rate risk also arises when assets and liabilities each respond differently to changes in interest rates.

The Company’s management of interest rate risk is overseen by its ALM Committee, based on a risk management infrastructure approved by the board of directors that outlines reporting and measurement requirements. In particular, this infrastructure sets limits and management targets for various metrics, including net interest income simulation involving parallel shifts in interest rate curves, steepening and flattening yield curves, and various prepayment and deposit duration assumptions. The Company’s risk management infrastructure also requires a periodic review of all key assumptions used, such as identifying appropriate interest rate scenarios, setting loan prepayment rates based on historical analysis and noninterest bearing and interest bearing transaction deposit durations based on historical analysis. The Company does not engage in speculative trading activities relating to interest rates, foreign exchange rates, commodity prices, equities or credit.

The Company manages the interest rate risk associated with interest earning assets by managing the interest rates and terms associated with the investment securities portfolio by purchasing and selling investment securities from time to time. The Company manages the interest rate risk associated with interest bearing liabilities by managing the interest rates and terms associated with wholesale borrowings and deposits from customers which the Company relies on for funding. For example, the Company occasionally uses special offers on deposits to alter the interest rates and terms associated with interest bearing liabilities.

The Company has entered into certain hedging transactions including interest rate swaps, which are designed to lessen elements of the Company’s interest rate exposure. The Company utilizes cash flow hedges to manage interest rate

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exposure for the brokered certificate of deposit, wholesale borrowing, and notes payable portfolios. The hedging strategy converts variable interest rates to a fixed interest rate and is used in an effort to protect the Company from floating interest rate variability. At September 30, 2020 and December 31, 2019, these cash flow hedges had a total notional amount of $111.5 million and $48.0 million, respectively. In the event that interest rates do not change in the manner anticipated, such transactions may adversely affect the Company’s results of operations.

Net Interest Income Simulation

The Company uses a net interest income simulation model to measure and evaluate potential changes in net interest income that would result over the next 12 months from immediate and sustained changes in interest rates as of the measurement date. This model has inherent limitations and the results are based on a given set of rate changes and assumptions as of a certain point in time. For purposes of the simulation, the Company assumes no growth in either interest-sensitive assets or liabilities over the next 12 months; therefore, the model’s results reflect an interest rate shock to a static balance sheet. The simulation model also incorporates various other assumptions, which the Company believes are reasonable but which may have a significant impact on results, such as: (1) the timing of changes in interest rates, (2) shifts or rotations in the yield curve, (3) re-pricing characteristics for market-rate-sensitive instruments, (4) differing sensitivities of financial instruments due to differing underlying rate indices, (5) varying loan prepayment speeds for different interest rate scenarios, (6) the effect of interest rate limitations in assets, such as floors and caps, and (7) overall growth and repayment rates and product mix of assets and liabilities. Because of the limitations inherent in any approach used to measure interest rate risk, simulation results are not intended as a forecast of the actual effect of a change in market interest rates on the results, but rather as a means to better plan and execute appropriate asset-liability management strategies and to manage interest rate risk.

Potential changes to the Company’s net interest income in hypothetical rising and declining rate scenarios calculated as of September 30, 2020 are presented in the table below. The projections assume an immediate, parallel shift downward of the yield curve of 100 basis points and immediate, parallel shifts upward of the yield curve of 100, 200, 300 and 400 basis points. In the current interest rate environment, a downward shift of the yield curve of 200, 300 and 400 basis points does not provide us with meaningful results and thus is not presented.

September 30, 2020

December 31, 2019

Change (basis points) in Interest Rates

    

Forecasted Net 

Percentage Change

    

Forecasted Net 

Percentage Change

(12-Month Projection)

Interest Income

from Base

Interest Income

from Base

+400

$

85,300

10.45

%

$

80,558

13.47

%

+300

 

82,836

7.26

 

78,064

9.95

+200

 

80,276

3.95

 

75,591

6.47

+100

 

78,360

1.47

 

73,113

2.98

0

 

77,228

 

70,996

−100

76,567

(0.86)

68,685

(3.26)

The table above indicates that as of September 30, 2020, in the event of an immediate and sustained 400 basis point increase in interest rates, the Company would experience a 10.45% increase in net interest income. In the event of an immediate 100 basis point decrease in interest rates, the Company would experience a 0.86% decrease in net interest income.

The results of this simulation analysis are hypothetical, and a variety of factors might cause actual results to differ substantially from what is depicted. For example, if the timing and magnitude of interest rate changes differ from those projected, net interest income might vary significantly. Non-parallel yield curve shifts such as a flattening or steepening of the yield curve or changes in interest rate spreads would also cause net interest income to be different from that depicted. An increasing interest rate environment could reduce projected net interest income if deposits and other short-term liabilities re-price faster than expected or re-price faster than the Company’s assets. Actual results could differ from those projected if the Company grows assets and liabilities faster or slower than estimated, if the Company experienced a net outflow of deposit liabilities, or if the mix of assets and liabilities otherwise changes. Actual results could also differ from those projected if the Company experienced substantially different repayment speeds in the loan

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portfolio than those assumed in the simulation model. Finally, these simulation results do not contemplate all the actions that the Company may undertake in response to potential or actual changes in interest rates, such as changes to the Company’s loan, investment, deposit, or funding strategies.

LIBOR Transition

LIBOR is used as an index rate for the Company’s interest-rate swaps, subordinated debt, various investment securities and approximately 8.6% of the Company’s loans as of September 30, 2020. It is expected that the number of institutions that have been reporting information used to set LIBOR will stop doing so after 2021 when their reporting commitment ends. As a result, LIBOR may no longer be available as an index or may be seen as no longer representative of the market. Alternative reference rates are being identified, but existing contracts may not have been written to allow the use of these alternatives. The Company is evaluating the risks related to this transition and its evaluation and mitigation of risks related to the discontinuation of LIBOR may span several reporting periods through 2021.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of the Company’s “disclosure controls and procedures” (as that term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, or the Exchange Act) as of September 30, 2020, the end of the fiscal quarter covered by this Quarterly Report on Form 10-Q. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2020, the Company’s disclosure controls and procedures were effective to ensure that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There has been no change in the Company’s internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

Neither the Company nor any of its subsidiaries is a party, and no property of these entities is subject, to any material pending legal proceedings, other than ordinary routine litigation incidental to the Bank’s business. The Company does not know of any proceeding contemplated by a governmental authority against the Company or any of its subsidiaries.

Item 1.A. Risk Factors

In addition to the risk factors set forth under Part I, Item 1A “Risk Factors” in the Company’s Form 10-K for the fiscal year ended December 31, 2019, the following risk factors apply to the Company:

The outbreak of COVID-19 has led to an economic recession and other severe disruptions in the U.S. economy and has adversely impacted certain industries in which our clients operate and impaired their ability to fulfill their financial obligations to us. As a result, we are starting to see the impact from COVID-19 on our business, and we believe that it will be significant, adverse and potentially material.

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Currently, COVID-19 is spreading through the United States and the world. The spread of COVID-19 has caused severe disruptions in the U.S. economy at large, and for small businesses in particular, which has disrupted our operations. We are starting to see the impact from COVID-19 on our business, and we believe that it will be significant, adverse and potentially material. The responses on the part of the U.S. and global governments and populations have created a recessionary environment, reduced economic activity and caused significant volatility in the global stock markets. We expect that we will experience significant disruptions across our business due to these effects, leading to decreased earnings and significant loan defaults and slowdowns in our loan collections. We expect increased unemployment and recessionary concerns will adversely affect loan originations in future periods.

The outbreak of COVID-19 has resulted in a decline in our clients’ businesses, a decrease in consumer confidence, an increase in unemployment and a disruption in the services provided by our vendors. Continued disruptions to our clients’ businesses could result in increased risk of delinquencies, defaults, foreclosures and losses on our loans, negatively impact regional economic conditions, result in declines in local loan demand, liquidity of loan guarantors, the value of loan collateral (particularly in real estate), loan originations and deposit availability and negatively impact the implementation of our growth strategy. Although the U.S. government initially introduced a number of programs designed to soften the impact of COVID-19 on small businesses, the lack of additional programs may cause our borrowers to be unable to satisfy their financial obligations to us.

In addition, COVID-19 has impacted and likely will continue to impact the financial ability of businesses and consumers to borrow money, which would negatively impact loan volumes. Certain of our borrowers are in or have exposure to the hospitality and restaurant industries and are located in areas that are or were quarantined or under stay-at-home orders, and COVID-19 may also have an adverse effect on our commercial real estate portfolio, particularly with respect to real estate with exposure to affected industries, and consumer loan portfolio. As COVID-19 cases have begun to surge in recent months, any new or prolonged quarantine or stay-at-home orders would have a negative adverse impact on these borrowers and their revenue streams, which consequently impacts their ability to meet their financial obligations to us and could result in loan defaults.

The ultimate extent of the COVID-19 pandemic’s effect on our business will depend on many factors, primarily including the speed and extent of any recovery from the related economic recession. Among other things, this will depend on the duration of the COVID-19 pandemic, particularly in our markets, the development and distribution of vaccines, therapies and other public health initiatives to control the spread of the disease, the nature and size of federal economic stimulus and other governmental efforts, and the possibility of additional state lockdown or stay-at-home orders in our markets in response to the recent surge in the number of COVID-19 cases.

As a result of the COVID-19 pandemic we may experience adverse financial consequences due to a number of other factors, including, but not limited to:

a further and sustained decline in our stock price or the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause management to perform impairment testing on our goodwill and other intangible assets that could result in an impairment charge being recorded for that period, and adversely impact our results of operations and the ability of the Bank to pay dividends to us;
the negative effect on earnings resulting from the Bank modifying loans and agreeing to loan payment deferrals due to the COVID-19 crisis;
increased demand on our liquidity as we meet borrowers’ needs and cover expenses related to our business continuity plan;
the potential for reduced liquidity and its negative effect on our capital and leverage ratios;
the modification of our business practices, including with respect to branch operations, employee travel, employee work locations, participation in meetings, events and conferences, and related changes for our vendors and other business partners;
increases in federal and state taxes as a result of the effects of the pandemic and stimulus programs on governmental budgets;

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an increase in FDIC premiums if the agency experiences additional resolution costs relating to bank failures;
increased cyber and payment fraud risk due to increased online and remote activity; and
other operational failures due to changes in our normal business practices because of the pandemic and governmental actions to contain it.

Overall, we believe that the economic impact from COVID-19 will be severe and could have a material and adverse impact on our business and result in significant losses in our loan portfolio, all of which would adversely and materially impact our earnings and capital. Even after the COVID-19 pandemic has subsided, we may continue to experience materially adverse impacts to our business as a result of the global economic impact of the COVID-19 pandemic, including the availability of credit, adverse impacts on liquidity and any recession that has occurred or may occur in the future. There are no comparable recent events that provide guidance as to the effect the spread of COVID-19 as a global pandemic may have, and, as a result, the ultimate impact of the pandemic is highly uncertain and subject to change.

The U.S. government and banking regulators, including the Federal Reserve, have taken a number of unprecedented actions in response to the COVID-19 pandemic, which could ultimately have a material adverse effect on our business and results of operations.

On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief and Economic Security Act, or 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 the SBA, referred to as the PPP. In addition to implementing the programs contemplated by the CARES Act, the federal bank regulatory agencies have issued a steady 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 CRA for certain pandemic-related loans, investments and public service.

The COVID-19 pandemic has significantly affected the financial markets, and the Federal Reserve has taken a number of actions in response. In March 2020, the Federal Reserve dramatically reduced the target federal funds rate and announced a $700 billion quantitative easing program in response to the expected economic downturn caused by the COVID-19 pandemic. In addition, the Federal Reserve reduced the interest that it pays on excess reserves. We expect that these reductions in interest rates, especially if prolonged, could adversely affect our net interest income, our net interest margin and our profitability. The Federal Reserve also launched the Main Street Lending Program, which offers deferred interest on four-year loans to small and mid-sized businesses. The full impact of the COVID-19 pandemic on our business activities as a result of new government and regulatory laws, policies, programs and guidelines, as well as market reactions to such activities, remains uncertain but may ultimately have a material adverse effect on our business and results of operations.

COVID-19 has disrupted banking and other financial activities in the areas in which we operate and could potentially create widespread business continuity issues for us.

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The COVID-19 pandemic has negatively impacted the ability of our employees and clients to engage in banking and other financial transactions in the geographic area in which we operate and could create widespread business continuity issues for us. We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of an outbreak or escalation of the COVID-19 pandemic in our market area, including because of illness, quarantines, government actions or other restrictions in connection with the COVID-19 pandemic. Although we have business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective. Further, we rely upon our third-party vendors to conduct business and to process, record, and monitor transactions. If any of these vendors are unable to continue to provide us with these services, it could negatively impact our ability to serve our clients.

As a participating lender in the PPP, we are subject to additional risks of litigation from our clients or other parties regarding our processing of loans for the PPP and risks that the SBA may not fund some of or all PPP loan guarantees.

The CARES Act included a $349 billion loan program administered through the SBA referred to as the PPP. Under the PPP, small businesses and other entities and individuals could apply for loans from existing SBA lenders and other approved regulated lenders that enrolled in the program, subject to numerous limitations and eligibility criteria. The Bank participated as a lender in the PPP. The PPP opened on April 3, 2020; however, because of the short timeframe between the passing of the CARES Act and the opening of the PPP, there is some ambiguity in the laws, rules, and guidance regarding the operation of the PPP, which exposes us to risks relating to noncompliance with the PPP. On April 24, 2020, an additional $310 billion in funding for PPP loans was authorized, and such funds became available for PPP loans beginning on April 27, 2020.

Since the opening of the PPP, several other larger banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP and claims related to agent fees. If any such litigation is filed against us and is not resolved in a manner favorable to us, it may result in significant financial liability or adversely affect our reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigations costs, or reputational damage caused by the PPP related litigation could have a material adverse impact on our business, financial condition, and results of operations.

We also have credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by the Bank, such as an issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules, and guidance regarding the operation of the PPP. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there is a deficiency in the manner in which the PPP loan was originated, funded, or serviced by us, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from us.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Repurchases of Equity Securities

The following table presents stock purchases made during the third quarter of 2020:

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Period

Total Number of Shares Purchased

Average Price Paid Per Share

Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(1)

Maximum Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs(1)

July 1 - 31, 2020

-

$

-

-

$

7,991,429

August 1 - 31, 2020

-

-

-

7,991,429

September 1 - 30, 2020

137,984

9.39

137,984

6,695,271

Total

137,984

$

9.39

137,984

$

6,695,271

(1)On January 22, 2019, the Company's Board of Directors authorized the Company to repurchase up to $15.0 million of its outstanding common stock. The Company may repurchase these shares from time to time in the open market in accordance with Rule 10b-18 of the Exchange Act or in privately negotiated transactions at the Company's discretion. The amount, timing and nature of any share repurchases will be based on a variety of factors, including the trading price of the Company’s common stock, applicable securities laws restrictions, regulatory limitations and market and economic factors. This repurchase program is authorized for a 24-month period and does not require the Company to repurchase any specific number of shares. The repurchase program may be modified, suspended or discontinued at any time, at the Company’s discretion. On July 23, 2019, the Company’s Board of Directors approved a $10.0 million increase to the Company’s stock repurchase program, increasing the authorization to repurchase common stock under the program from a total of $15.0 million to up to a total of $25.0 million. On October 27, 2020, the Board of Directors of the Company approved a $15.0 million increase to the Company’s previously announced stock repurchase program, increasing the amount of common stock authorized to be repurchased under the program from a total of $25.0 million to up to $40.0 million for the duration of the program. Additionally, the Board of Directors of the Company extended the duration of the program to run through October 27, 2022.


Unregistered Sales of Equity Securities

None.

Use of Proceeds from Registered Securities

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

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Item 6. Exhibits

Exhibit Number

    

Description

31.1

Certification of the Chief Executive Officer required by Rule 13a-14(a) of the Securities Exchange Act of 1934, and Section 302 of the Sarbanes-Oxley Act of 2002

31.2

Certification of the Chief Financial Officer required by Rule 13a-14(a) of the Securities Exchange Act of 1934, and Section 302 of the Sarbanes-Oxley Act of 2002

32.1

Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2

Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101.1

Financial information from the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2020, formatted in inline XBRL interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Income; (iii) Consolidated Statements of Comprehensive Income; (iv) Consolidated Statements of Shareholders’ Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements

104

The cover page for Bridgewater Bancshares, Inc’s Form 10-Q Report for the quarterly period ended September 30, 2020 formatted in inline XBRL and contained in Exhibit 101.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Bridgewater Bancshares, Inc.

Date: November 5, 2020

By:

/s/ Jerry J. Baack

Name:

Jerry J. Baack

Title:

Chairman, Chief Executive Officer and President
(Principal Executive Officer)

Date: November 5, 2020

By:

/s/ Joe M. Chybowski

Name:

Joe M. Chybowski

Title:

Chief Financial Officer
(Principal Financial and Accounting Officer)

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