EDGAR 10-K Filing

Company CIK: 1341317
Filing Year: 2021
Filename: 1341317_10-K_2021_0001558370-21-002761.json

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ITEM 1. BUSINESS
Item 1. Business

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ITEM 1A. RISK FACTORS
Item 1A. Risk Factors

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ITEM 1B. UNRESOLVED STAFF COMMENTS
Item 1B. Unresolved Staff Comments

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ITEM 2. PROPERTIES
ITEM 2. PROPERTIES
Our corporate headquarters is located at 4450 Excelsior Boulevard, Suite 100, St. Louis Park, Minnesota 55416. Including our corporate headquarters, we operate seven full-service branch offices located in the Twin Cities MSA. We currently own three of our branch offices located in Orono, St. Louis Park and Minneapolis (Hennepin Avenue), and lease the remaining four locations. Additional information regarding our locations is set forth below.
Address
Owned/Leased
Headquarters and St. Louis Park Branch:
4450 Excelsior Boulevard, Suite 100, St. Louis Park, Minnesota 55416
Owned
Other Branch Locations:
21500 Highway 7, Greenwood, Minnesota 55331
Leased
Northstar Center West, 625 Marquette Avenue, Suite #W0100, Minneapolis, Minnesota 55402
Leased
2445 Shadywood Road, Orono, Minnesota 55331
Owned
3100 Hennepin Avenue, Minneapolis, Minnesota 55408(1)
Owned
370 Wabasha Street N., St. Paul, Minnesota 55102
Leased
7831 East Bush Lake Road, Suite 300, Bloomington, Minnesota 55439
Leased
(1) Does not include the leased drive-up property located adjacent to the branch.

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ITEM 3. LEGAL PROCEEDINGS
ITEM 3. 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.

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ITEM 4. MINE SAFETY DISCLOSURE
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II

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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock trades on the Nasdaq Stock Market (“Nasdaq”) under the symbol “BWB.” As of March 2, 2021, the Company had 121 holders of record of the Company’s common stock and an estimated 3,283 additional beneficial holders of the Company’s common stock whose stock was held in street name by brokerages or fiduciaries.
Issuer Purchases of Equity Securities
On January 22, 2019, the Company’s board of directors approved a stock repurchase program (the “Program”) which authorized the Company to repurchase up to $15.0 million of its common stock, subject to certain limitations and conditions. The Program was effective immediately and was subsequently expanded. On July 23, 2019 and October 27, 2020, the Company's board of directors approved $10.0 million and $15.0 million increases, respectively, to the Program for a total authorization of $40.0 million. Additionally, on October 27, 2020, the Program duration was extended to run through October 27, 2022. The Program does not obligate the Company to repurchase any shares of its common stock,
and other than repurchases that have been completed to date, there is no assurance that the Company will do so. Under the Program, the Company may repurchase shares of common stock from time to time in open market or privately negotiated transactions. The extent to which the Company repurchases its shares, and the timing of such repurchases, will depend upon a variety of factors, including general market and economic conditions, regulatory requirements, availability of funds, and other relevant considerations, as determined by the Company. The Company may, in its discretion, begin, suspend or terminate repurchases at any time prior to the Program’s expiration, without any prior notice.
The following table presents stock purchases made during the fourth quarter of 2020:
Period
Total Number of Shares Purchased (1)
Average Price Paid Per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Maximum Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
October 1 - 31, 2020
433,664
$
10.76
433,664
$
17,030,445
November 1 - 30, 2020
110,370
11.98
110,370
15,707,899
December 1 - 31, 2020
84,088
12.36
80,899
14,707,185
Total
628,122
$
11.19
624,933
$
14,707,185
(1) The total number of shares repurchased during the periods indicated includes shares repurchased as part of the Company’s stock repurchase program and shares withheld for income tax purposes in connection with vesting of restricted stock awards. The shares were purchased or otherwise valued at the closing price of the Company’s common stock on the date of purchase and/or withholding.
Performance Graph
The following graph compares the percentage change in the cumulative shareholder return of the Company’s common stock during the period from the date of our initial public offering and listing on Nasdaq through December 31, 2020, with the cumulative return of the Nasdaq Composite Index and the total return of the Nasdaq Bank Index. This comparison assumes $100.00 was invested on March 14, 2018 and assumes the reinvestment of all cash dividends prior to any tax effect and retention of all stock dividends. There is no assurance that the Company's common stock performance will continue in the future with the same or similar results as shown in the graph.
Dividend Policy
The Company has not historically declared or paid dividends on its common stock and does not intend to declare or pay dividends on its common stock in the foreseeable future. Instead, the Company anticipates that future earnings will be retained to support its operations and to finance the growth and development of its business. Any future determination relating to the Company’s dividend policy will be made by the board of directors and will depend on a number of factors, including historic and projected financial condition, liquidity and results of operations, capital levels and needs, tax considerations, any acquisitions or potential acquisitions that may be pursued, statutory and regulatory prohibitions and other limitations, the terms of any credit agreements or other borrowing arrangements that restrict the ability to pay cash dividends, general economic conditions and other factors deemed relevant by the board of directors. The Company is not obligated to pay dividends on its common stock and is subject to restrictions on paying dividends on its common stock.
Dividend Restrictions
As a Minnesota corporation, the Company is subject to certain restrictions on dividends under the Minnesota Business Corporation Act, as amended. Generally, a Minnesota corporation is prohibited from paying a dividend if, after giving effect to the dividend the corporation would not be able to pay its debts as the debts become due in the usual course of business, or the corporation's total assets would be less than the sum of its total liabilities, plus the amount that would be needed, if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution.
In addition, the Company is subject to certain restrictions on the payment of cash dividends as a result of banking laws, regulations and policies. See "Supervision and Regulation-Supervision and Regulation of the Company-Dividend Payments." Because the Company is a financial holding company and does not engage directly in business activities of a material nature, the ability to pay dividends to shareholders depends, in large part, upon receipt of
dividends from the Bank, which is also subject to numerous limitations on the payment of dividends under federal and state banking laws, regulations and policies. See "Supervision and Regulation-Supervision and Regulation of the Bank-Dividend Payments."
Under the terms of a loan agreement with a third party correspondent lender which the Company entered into in March of 2021, the Company cannot declare or pay any cash dividend or make any other distribution in respect to capital stock, except in accordance with past practices and so long as no default has occurred and is continuing. In addition, under the terms of the subordinated notes issued in July of 2017 and June of 2020, and the related subordinated note purchase agreements, the Company is not permitted to declare or pay any dividends on capital stock if an event of default occurs under the terms of the subordinated notes, excluding any dividends or distributions in shares of, or options, warrants or rights to subscribe for or purchase shares of, any class of our common stock and any declaration of a non-cash dividend in connection with the implementation of a shareholders' rights plan.

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ITEM 6. SELECTED FINANCIAL DATA
ITEM 6. SELECTED FINANCIAL DATA
The following consolidated selected financial data is derived from the Company’s audited consolidated financial statements as of and for the five years ended December 31, 2020. This information should be read in connection with our audited consolidated financial statements, related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this report.
As of and for the year ended December 31,
Per Common Share Data (1)
Basic Earnings Per Share
$
0.95
$
1.07
$
0.93
$
0.69
$
0.59
Diluted Earnings Per Share
0.93
1.05
0.91
0.68
0.58
Book Value Per Share
9.43
8.45
7.34
5.56
4.69
Tangible Book Value Per Share (2)
9.31
8.33
7.22
5.40
4.53
Basic Weighted Average Shares Outstanding
28,582,064
29,358,644
29,001,393
24,604,464
22,294,837
Diluted Weighted Average Shares Outstanding
29,170,220
29,996,776
29,436,214
25,017,690
22,631,741
Shares Outstanding at Period End
28,143,493
28,973,572
30,097,274
24,679,861
24,589,861
Selected Performance Ratios
Return on Average Assets (ROA)
1.04
%
1.49
%
1.51
%
1.16
%
(6)
1.20
%
Pre-Provision Net Revenue Return on Average Assets (PPNR ROA) (3)
2.09
2.07
2.20
2.30
2.23
Return on Average Common Equity (ROE)
10.51
13.50
13.87
13.18
(6)
12.88
Return on Average Tangible Common Equity (2)
10.65
13.72
14.15
13.60
13.23
Average Equity to Average Assets (2)
9.88
11.00
10.92
8.83
9.34
Yield on Interest Earning Assets
4.51
5.01
4.88
4.76
4.78
Yield on Total Loans, Gross
4.90
5.31
5.23
5.10
5.20
Cost of Interest Bearing Liabilities
1.53
2.03
1.65
1.19
1.09
Cost of Total Deposits
0.93
1.42
1.12
0.80
0.76
Net Interest Margin (4)
3.46
3.59
3.72
3.92
4.00
Efficiency Ratio (2)
49.0
47.4
46.5
44.4
45.8
Adjusted Efficiency Ratio (3)
40.5
43.3
41.7
41.1
N/A
Noninterest Expense to Average Assets
1.73
1.75
1.78
1.76
1.84
Adjusted Noninterest Expense to Average Assets (3)
1.44
1.59
1.59
1.62
N/A
Loan to Deposit Ratio
93.0
104.9
106.7
100.6
97.8
Core Deposits to Total Deposits
78.1
80.7
74.2
76.7
77.2
Tangible Common Equity to Tangible Assets (2)
8.96
10.65
11.03
8.26
8.86
Selected Asset Quality Data
Loans 30-89 Days Past Due
$
$
$
$
$
Loans 30-89 Days Past Due to Total Loans
-
%
0.02
%
0.02
%
0.05
%
0.07
%
Nonperforming Loans
$
$
$
$
1,139
$
2,323
Nonperforming Loans to Total Loans
0.03
%
0.02
%
0.03
%
0.08
%
0.23
%
Foreclosed Assets
$
-
$
-
$
-
$
$
4,183
Nonaccrual Loans to Total Loans
0.03
%
0.02
%
0.03
%
0.08
%
0.23
%
Nonaccrual Loans and Loans Past Due 90 Days and Still Accruing to Total Loans
0.03
0.02
0.03
0.08
0.23
Nonperforming Assets (5)
$
$
$
$
1,720
$
6,506
Nonperforming Assets to Total Assets (5)
0.03
%
0.02
%
0.03
%
0.11
%
0.52
%
Allowance for Loan Losses to Total Loans
1.50
1.18
1.20
1.22
1.23
Allowance for Loan Losses to Total Loans, Excluding PPP Loans
1.59
N/A
N/A
N/A
N/A
Allowance for Loans Losses to Nonperforming Loans
4,495.61
4,886.33
3,447.68
1,448.81
530.91
Net Loan Charge-Offs to Average Loans
0.02
0.01
0.00
0.00
0.11
Capital Ratios (Bank Only)
Tier 1 Leverage Ratio
10.89
%
11.01
%
10.82
%
9.83
%
9.24
%
Tier 1 Risk-based Capital Ratio
12.12
11.72
11.63
11.15
11.38
Total Risk-based Capital Ratio
13.37
12.16
12.76
12.37
12.63
Capital Ratios (Consolidated)
Tier 1 Leverage Ratio
9.28
%
10.69
%
11.23
%
8.38
%
9.44
%
Tier 1 Risk-based Capital Ratio
10.35
11.39
12.07
9.49
11.49
Total Risk-based Capital Ratio
14.58
12.98
14.55
12.46
12.74
Growth Ratios
Percentage Change in Total Assets
29.0
%
15.0
%
22.1
%
28.3
%
35.7
%
Percentage Change in Total Loans, Gross
21.7
14.8
23.6
34.6
25.2
Percentage Change in Total Deposits
37.2
16.8
16.5
30.9
34.3
Percentage Change in Shareholders' Equity
8.4
10.8
61.1
18.9
43.9
Percentage Change in Net Income
(13.4)
16.7
59.4
27.8
18.0
Percentage Change in Diluted Earnings Per Share
(10.9)
14.5
35.5
15.6
(8.2)
Percentage Change in Tangible Book Value Per Share (2)
11.8
15.3
33.7
19.3
11.9
(1) Includes shares of common stock and non-voting common stock. On October 25, 2018, the Company exchanged shares of common stock for all of the outstanding shares of non-voting common stock. Following the exchange, no shares of non-voting common stock were outstanding.
(2) Represents a non-GAAP financial measure. See "GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures" for further details.
(3) Ratio excludes the amortization of tax credit investments, FHLB prepayment fees and represents a non-GAAP financial measure. See "GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures" for further details
(4) Amounts calculated on a tax-equivalent basis using the statutory federal tax rate of 21% beginning in 2018 and 35% for 2017 and 2016.
(5) Nonperforming assets are defined as nonaccrual loans plus loans 90 days past due plus foreclosed assets.
(6) ROA and ROE, excluding a one-time additional expense of $2.0 million related to the revaluation of the deferred tax asset, would have been 1.30% and 14.75%, respectively for the year ended December 31, 2017.
As of and for the year ended December 31,
(dollars in thousands)
Selected Balance Sheet Data
Total Assets
$
2,927,345
$
2,268,830
$
1,973,741
$
1,616,612
$
1,260,394
Total Loans, Gross
2,326,428
1,912,038
1,664,931
1,347,113
1,000,739
Allowance for Loan Losses
34,841
22,526
20,031
16,502
12,333
Securities Available for Sale
390,629
289,877
253,378
229,491
217,083
Goodwill and Other Intangibles
3,296
3,487
3,678
3,869
4,060
Deposits
2,501,636
1,823,310
1,560,934
1,339,350
1,023,508
Federal Funds Purchased
-
-
18,000
23,000
44,000
FHLB Advances and Notes Payable
68,500
149,500
139,000
85,000
72,000
Subordinated Debentures, Net of Issuance Costs
73,739
24,733
24,630
24,527
-
Tangible Common Equity (1)
262,109
241,307
217,320
133,293
111,306
Total Shareholders' Equity
265,405
244,794
220,998
137,162
115,366
Average Total Assets
2,617,579
2,114,211
1,777,592
1,451,732
1,098,654
Average Common Equity
258,736
232,539
194,083
128,123
102,588
(1) Represents a non-GAAP financial measure. See “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures” for further details.
For the year ended December 31,
(dollars in thousands)
Selected Income Statement Data
Interest Income
$
114,826
$
103,778
$
85,226
66,346
$
50,632
Interest Expense
26,862
29,646
20,488
12,173
8,514
Net Interest Income
87,964
74,132
64,738
54,173
42,118
Provision for Loan Losses
12,750
2,700
3,575
4,175
3,250
Net Interest Income after Provision for Loan Losses
75,214
71,432
61,163
49,998
38,868
Noninterest Income
5,839
3,826
2,543
2,536
2,567
Noninterest Expense
45,387
36,932
31,562
25,496
20,168
Income Before Income Taxes
35,666
38,326
32,144
27,038
21,267
Provision for Income Taxes
8,472
6,923
5,224
10,149
8,052
Net Income
$
27,194
$
31,403
$
26,920
$
16,889
$
13,215

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The following discussion and analysis of the Company’s results of operations and financial condition should be read in conjunction with the “Selected Financial Data” and the Company’s consolidated financial statements and related notes included elsewhere in this report. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Certain risks, uncertainties and
other factors, including but not limited to those set forth under “Forward-Looking Statements,” “Risk Factors” and elsewhere in this report, may cause actual results to differ materially from those projected in the forward looking statements. The Company assumes no obligation to update any of these forward-looking statements. Readers of the Company’s Annual Report on Form 10-K should consider these risks and uncertainties in evaluating forward-looking statements and should not place undue reliance on forward-looking statements.
Overview
The Company is a financial holding company headquartered in St. Louis Park, Minnesota, which is currently celebrating fifteen years of successful operations. 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.
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. Throughout 2020, Minnesota’s Governor issued a number of restrictions impacting business and gatherings within the state. The Company’s branch operations continue to operate in compliance with fluid statewide mandates, maintaining the safety of employees and clients as the utmost priority, all while attempting to ensure clients’ diverse banking needs are met.
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, as extended by the Coronavirus Response and Relief Supplemental Appropriations Act of 2021 (a part of the Consolidated Appropriations Act, 2021), 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 businesses, as well as state and local governments impacted by COVID-19. The Federal Reserve announced the Main Street 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, through the PPP Liquidity Facility. 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.
● On December 27, 2020, President Trump signed the Consolidated Appropriations Act, 2021, a $900.0 billion COVID-19 relief package that includes an additional $284.0 billion in PPP funding.
● In addition to the policy responses described above, the federal bank regulatory agencies, along with their state counterparts, have issued a stream of guidance in response to the COVID-19 pandemic and have taken a number of unprecedented steps to help banks navigate the pandemic and mitigate its impact. These include, without limitation: requiring banks to focus on business continuity and pandemic planning; adding pandemic scenarios to stress testing; encouraging bank use of capital buffers and reserves in lending programs; permitting certain regulatory reporting extensions; reducing margin requirements on swaps; permitting certain otherwise prohibited investments in investment funds; issuing guidance to encourage banks to work with customers affected by the pandemic and encourage loan workouts; and providing credit under the Community Reinvestment Act, 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 December 31, 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 year ended December 31, 2020, the economic turmoil and market volatility
resulting from the COVID-19 pandemic caused a substantial decline in the Company’s stock price and market capitalization. The Company believed such a decline was a triggering event requiring an interim goodwill impairment analysis during the year. 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 December 31, 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. 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, interest-only modifications, or extended amortization. As of December 31, 2020, the Company had active loan modifications for 26 loans totaling $66.6 million. Of that total, loan modifications to interest-only payments totaled $61.1 million, loans with payment deferrals totaled $613,000, and loans with extended amortization periods totaled $4.8 million. In accordance with recent regulatory guidance and the CARES Act, as extended by the Coronavirus Response and Relief Supplemental Appropriations Act of 2021 (a part of the Consolidated Appropriations Act, 2021), loans modified in response to the COVID-19 pandemic are not considered TDRs.
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 December 31, 2020, principal balances originated under the program totaled $181.6 million, $138.5 million of which was outstanding as of December 31, 2020. The Company has generated fees from the SBA, net of costs, of $5.7 million, $2.9 million of which was recognized in the year ended December 31, 2020. The Company has begun originating additional PPP loans under the most recent COVID-19 relief package signed into law on December 27, 2020. As of March 5, 2021, the Company had originated 416 new PPP loans totaling $56.1 million.
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 information about the Company’s COVID-19 pandemic assistance programs, including relevant disclosures and up-to-date information, is maintained at bwbmn.com.
The Company’s ongoing 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 this report. Certain 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. 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.
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 an 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, 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 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.
Results of Operations
Net Income
2020 Compared to 2019
Net income was $27.2 million for the year ended December 31, 2020, a 13.4% decrease compared to net income of $31.4 million for the year ended December 31, 2019. Net income per diluted common share for the year ended December 31, 2020 was $0.93, a 10.9% decrease, compared to $1.05 per diluted common share for the year ended December 31, 2019. Net income for the year ended December 31, 2020 was significantly impacted by increased provisions for loan losses, primarily attributable to economic uncertainties and evolving risks driven by the impacts of the COVID-19 pandemic, and non-recurring charges of $7.0 million related to prepayment fees associated with the early retirement of $94.0 million of FHLB term advances which had a weighted average rate of 2.83%. ROA was 1.04% and 1.49% for the years ended December 31, 2020 and 2019, respectively. ROE was 10.51% and 13.50% for the years ended December 31, 2020 and 2019, respectively.
2019 Compared to 2018
Net income was $31.4 million for the year ended December 31, 2019, a 16.7% increase over net income of $26.9 million for the year ended December 31, 2018. Net income per diluted common share for the year ended December 31, 2019 was $1.05, a 14.5% increase, compared to $0.91 per diluted common share for the year ended December 31, 2018. ROA was 1.49% and 1.51% for the years ended December 31, 2019 and 2018, respectively. ROE was 13.50% and 13.87% for the years ended December 31, 2019 and 2018, respectively.
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 decreased the targeted federal funds rate by a total of 150 basis points in March 2020, reaching a current range of 0.00 - 0.25%. This decrease may impact the comparability of net interest income between 2019 and 2020.
Average Balances and Yields
The following table presents, for the years ended December 31, 2020, 2019 and 2018, 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.
December 31, 2020
December 31, 2019
December 31, 2018
Average
Interest
Yield/
Average
Interest
Yield/
Average
Interest
Yield/
Balance
& Fees
Rate
Balance
& Fees
Rate
Balance
& Fees
Rate
(dollars in thousands)
Interest Earning Assets:
Cash Investments
$
80,113
$
0.21
%
$
46,366
$
1.63
%
$
22,962
$
1.09
%
Investment Securities:
Taxable Investment Securities
234,873
5,712
2.43
149,967
4,354
2.90
129,486
2,878
2.22
Tax-Exempt Investment Securities (1)
87,587
3,807
4.35
101,012
4,327
4.28
116,557
4,830
4.14
Total Investment Securities
322,460
9,519
2.95
250,979
8,681
3.46
246,043
7,708
3.13
Paycheck Protection Program Loans (2)
122,240
4,143
3.39
-
-
-
-
-
-
Loans (1)(2)
2,032,180
101,469
4.99
1,785,937
94,852
5.31
1,491,166
78,033
5.23
Total Loans
2,154,420
105,612
4.90
1,785,937
94,852
5.31
1,491,166
78,033
5.23
Federal Home Loan Bank Stock
8,866
5.01
7,916
5.03
6,321
3.94
Total Interest Earning Assets
2,565,859
115,745
4.51
%
2,091,198
104,686
5.01
%
1,766,492
86,240
4.88
%
Noninterest Earning Assets
51,720
23,013
11,100
Total Assets
$
2,617,579
$
2,114,211
$
1,777,592
Interest Bearing Liabilities:
Deposits:
Interest Bearing Transaction Deposits
295,036
1,626
0.55
%
223,376
1,634
0.73
%
177,335
0.36
%
Savings and Money Market Deposits
523,520
5,341
1.02
447,040
7,747
1.73
381,318
4,681
1.23
Time Deposits
374,195
7,806
2.09
349,148
8,379
2.40
300,021
5,731
1.91
Brokered Deposits
348,126
5,040
1.45
261,023
6,236
2.39
232,022
4,924
2.12
Total Interest Bearing Deposits
1,540,877
19,813
1.29
1,280,587
23,996
1.87
1,090,696
15,971
1.46
Federal Funds Purchased
7,239
1.53
7,433
2.50
29,671
2.15
Notes Payable
11,749
3.73
13,750
3.64
15,750
3.77
FHLB Advances
148,524
3,390
2.28
133,968
3,407
2.54
82,562
1,718
2.08
Subordinated Debentures
50,954
3,109
6.10
24,686
1,556
6.30
24,582
1,568
6.38
Total Interest Bearing Liabilities
1,759,343
26,862
1.53
%
1,460,424
29,646
2.03
%
1,243,261
20,488
1.65
%
Noninterest Bearing Liabilities:
Noninterest Bearing Transaction Deposits
579,595
414,377
330,898
Other Noninterest Bearing Liabilities
19,905
6,871
9,350
Total Noninterest Bearing Liabilities
599,500
421,248
340,248
Shareholders' Equity
258,736
232,539
194,083
Total Liabilities and Shareholders' Equity
$
2,617,579
$
2,114,211
$
1,777,592
Net Interest Income / Interest Rate Spread
88,883
2.98
%
75,040
2.98
%
65,752
3.23
%
Net Interest Margin (3)
3.46
%
3.59
%
3.72
%
Taxable Equivalent Adjustment:
Tax-Exempt Investment Securities
(919)
(908)
(1,014)
Net Interest Income
$
87,964
$
74,132
$
64,738
(1) Interest income and average rates for investments 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 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 table presents the changes in the volume and rate of interest bearing assets and liabilities for the year ended December 31, 2020, compared to the year ended December 31, 2019, and for the year ended December 31, 2019, compared to the year ended December 31, 2018.
Year Ended December 31, 2020
Year Ended December 31, 2019
Compared with
Compared with
Year Ended December 31, 2019
Year Ended December 31, 2018
Change Due To:
Interest
Change Due To:
Interest
(dollars in thousands)
Volume
Rate
Variance
Volume
Rate
Variance
Interest Earning Assets:
Cash Investments
$
$
(657)
$
(585)
$
$
$
Investment Securities:
Taxable Investment Securities
2,065
(707)
1,358
1,021
1,476
Tax Exempt Investment Securities
(583)
(520)
(645)
(503)
Total Securities
1,482
(644)
(190)
1,163
Loans:
Paycheck Protection Program Loans
4,143
-
4,143
-
-
-
Loans
12,293
(5,676)
6,617
15,425
1,394
16,819
Total Loans
16,436
(5,676)
10,760
15,425
1,394
16,819
Federal Home Loan Bank Stock
(1)
Total Interest Earning Assets
$
18,037
$
(6,978)
$
11,059
$
15,553
$
2,893
$
18,446
Interest Bearing Liabilities:
Interest Bearing Transaction Deposits
$
$
(403)
$
(8)
$
$
$
Savings and Money Market Deposits
(3,186)
(2,406)
2,259
3,066
Time Deposits
(1,096)
(573)
1,710
2,648
Brokered Deposits
1,261
(2,457)
(1,196)
1,312
Total Interest Bearing Deposits
2,959
(7,142)
(4,183)
2,525
5,500
8,025
Federal Funds Purchased
(3)
(72)
(75)
(478)
(451)
Notes Payable
(73)
(62)
(75)
(18)
(93)
FHLB Advances
(349)
(17)
1,069
1,689
Subordinated Debentures
1,603
(50)
1,553
(19)
(12)
Total Interest Bearing Liabilities
4,818
(7,602)
(2,784)
3,048
6,110
9,158
Net Interest Income
$
13,219
$
$
13,843
$
12,505
$
(3,217)
$
9,288
Interest Income, Interest Expense, and Net Interest Margin
2020 Compared to 2019
Net interest income was $88.0 million for the year ended December 31, 2020, an increase of $13.8 million, or 18.7%, compared to $74.1 million for the year ended December 31, 2019. The increase in net interest income was
largely attributable to growth in average interest earning assets, lower rates paid on deposits, and the recognition of PPP loan origination fees, offset partially by declining yields on loans and higher average balances of subordinated debentures.
Net interest margin (on a fully tax-equivalent basis) for the year ended December 31, 2020 was 3.46%, compared to 3.59% for the year ended December 31, 2019, a decrease of 13 basis points. Despite a significant reduction in interest bearing deposit costs throughout the year, the historically low interest rate environment coupled with a more liquid balance sheet mix pressured earning asset yields lower and ultimately compressed net interest margin. Furthermore, the Company’s subordinated debenture issuance and the PPP loan origination volumes occurring during the year had a negative impact on net interest margin.
Average interest earning assets for the year ended December 31, 2020 increased $474.7 million, or 22.7%, to $2.57 billion from $2.09 billion for the year ended December 31, 2019. This increase in average interest earning assets was due to continued organic growth in the loan portfolio as a result of increased loan production, including the funding of PPP loans. Average interest bearing liabilities increased $298.9 million, or 20.5%, to $1.76 billion for the year ended December 31, 2020, from $1.46 billion for the year ended December 31, 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, partially offset by a decrease in notes payable and overall higher levels of on-balance sheet liquidity.
Average interest earning assets produced a tax-equivalent yield of 4.51% for year ended December 31, 2020, compared to 5.01% for the year ended December 31, 2019. The average rate paid on interest bearing liabilities was 1.53% for the year ended December 31, 2020, compared to 2.03% for the year ended December 31, 2019.
Interest Income. Total interest income on a tax-equivalent basis was $115.7 million for the year ended December 31, 2020, compared to $104.7 million for the year ended December 31, 2019. The $11.1 million, or 10.6%, increase in total interest income on a tax-equivalent basis was primarily due to continued organic growth in the loan portfolio, as well as PPP loan interest and fee income.
Interest income on cash investments decreased $585,000, or 77.5%, for the year ended December 31, 2020, compared to the year ended December 31, 2019, despite a $33.8 million, or 72.8%, increase in average cash balances, due to the falling interest rate environment. The increase in average cash balances was due to extraordinary deposit inflows. Interest income on the investment securities portfolio on a fully-tax equivalent basis increased $838,000, or 9.7%, for the year ended December 31, 2020, compared to the year ended December 31, 2019, primarily due to a $71.5 million, or 28.5%, increase in average balances between the two periods, which was partially offset by a 51 basis point decrease in the aggregate portfolio yield, driven by the historically low interest rate environment.
Interest income on loans on a fully-tax equivalent basis for the year ended December 31, 2020 was $105.6 million, compared to $94.9 million for the year ended December 31, 2019. The $10.8 million, or 11.3%, increase was due to a $368.5 million, or 20.6%, increase in the average balance of loans outstanding, which was offset partially by a 41 basis point decrease in the average yield on loans, 9 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 and the funding of PPP loans. The decrease in yield on the loan portfolio was primarily due to the falling interest rate environment and the impact of PPP loans originated at a lower rate than the aggregate loan portfolio yield. The aggregate loan yield, excluding PPP loans, decreased to 4.99% for the year ended December 31, 2020, which was 32 basis points lower than 5.31% for the year ended December 31, 2019. While loan fees have maintained a stable contribution to the aggregate loan yield, the historically low 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 years ended December 31, 2020, 2019 and 2018:
For the year ended December 31,
Interest
4.73
%
5.06
%
4.85
%
Fees
0.26
0.25
0.38
Yield on Loans, Excluding PPP Loans
4.99
%
5.31
%
5.23
%
Interest Expense. Interest expense on interest bearing liabilities decreased $2.8 million, or 9.4%, to $26.9 million for the year ended December 31, 2020, compared to $29.6 million for the year ended December 31, 2019. The cost of interest bearing liabilities declined 50 basis points to 1.53% for the year ended December 31, 2020, compared to 2.03% for the year ended December 31, 2019. The decline was primarily due to lower rates paid on deposits, offset partially by growth of interest bearing deposits and additional subordinated debentures.
Interest expense on deposits decreased to $19.8 million for the year ended December 31, 2020, compared to $24.0 million for the year ended December 31, 2019. The $4.2 million, or 17.4%, decrease in interest expense on deposits was primarily due to deposit rate cuts consistent with a lower rate environment and the repricing of time deposits. The cost of total deposits declined 49 basis points from 1.42% for the year ended December 31, 2019, to 0.93% for the year ended December 31, 2020.
Interest expense on borrowings increased $1.4 million to $7.0 million for the year ended December 31, 2020, compared to $5.7 million for the year ended December 31, 2019. This increase was due to the issuance of additional subordinated debentures in 2020.
Given strong deposit inflows and ample time deposit maturities over the next 12 months, the Company anticipates continued deposit repricing opportunities in the future. Moreover, the significant FHLB de-leveraging strategy executed in the fourth quarter of 2020 will begin to manifest lower interest bearing liability costs in subsequent quarters.
2019 Compared to 2018
Net interest income was $74.1 million for the year ended December 31, 2019, an increase of $9.4 million, or 14.5%, compared to $64.7 million for the year ended December 31, 2018. The increase in net interest income was largely attributable to growth in average interest earning assets, particularly strong organic growth in the loan portfolio.
Net interest margin (on a fully tax-equivalent basis) for the year ended December 31, 2019 was 3.59%, compared to 3.72% for the year ended December 31, 2018, a decrease of 13 basis points. While net interest margin has benefitted from the repricing of variable rate loans and the origination of new loans at higher rates, this was outpaced by increased balances and rates on deposits and borrowings.
Average interest earning assets for the year ended December 31, 2019 increased $324.7 million, or 18.4%, to $2.09 billion from $1.77 billion for the year ended December 31, 2018. This increase in average interest earning assets was due to continued organic growth in the loan portfolio as a result of increased loan production. Average interest bearing liabilities increased $217.2 million, or 17.5%, to $1.46 billion for the year ended December 31, 2019, from $1.24 billion for the year ended December 31, 2018. The increase in average interest bearing liabilities was due to an increase in interest bearing deposits and FHLB advances, partially offset by a decrease in federal funds purchased and notes payable.
Average interest earning assets produced a tax-equivalent yield of 5.01% for year ended December 31, 2019, compared to 4.88% for the year ended December 31, 2018. The average rate paid on interest bearing liabilities was 2.03% for the year ended December 31, 2019, compared to 1.65% for the year ended December 31, 2018.
Interest Income. Total interest income on a tax-equivalent basis was $104.7 million for the year ended December 31, 2019, compared to $86.2 million for the year ended December 31, 2018. The $18.4 million, or 21.4%, increase in total interest income on a tax-equivalent basis was primarily due to strong organic growth in the loan portfolio and an increase in the average yield on loans.
Interest income on cash investments increased $505,000, or 202.0%, for the year ended December 31, 2019, compared to the year ended December 31, 2018, due to increased liquidity, which resulted from strong deposit growth. Interest income on the investment securities portfolio on a fully-tax equivalent basis increased $974,000, or 12.6%, for the year ended December 31, 2019, compared to the year ended December 31, 2018, primarily due to a 33 basis point increase in the aggregate portfolio yield.
Interest income on loans for the year ended December 31, 2019 was $94.9 million, compared to $78.0 million for the year ended December 31, 2018. The $16.8 million, or 21.6%, increase was due to a $294.8 million, or 19.8%, increase in the average balance of loans outstanding and an 8 basis point increase in the average yield on loans. The increase in the average balance of loans outstanding was due to organic loan growth. The increase in yield on the loan portfolio resulted primarily from strong loan growth at yields accretive to the existing portfolio yield and has enabled the Company to offset the decreases in loan fee income. While deferred fees are regularly amortized into income, fluctuations in the level of loan fees recognized can vary based on prepayments and other factors.
Interest Expense. Interest expense on interest bearing liabilities increased $9.2 million, or 44.7%, to $29.6 million for the year ended December 31, 2019, compared to $20.5 million for the year ended December 31, 2018, due to increases in market interest rates and growth in average balances of both deposits and borrowings, partially offset by a decrease in average balances of federal funds purchased.
Interest expense on deposits increased to $24.0 million for the year ended December 31, 2019, compared to $16.0 million for the year ended December 31, 2018. The $8.0 million, or 50.2%, increase in interest expense on deposits was primarily due to the average balance of interest bearing deposits increasing $189.9, or 17.4%, combined with a 41 basis point increase in the average rate paid. The increase in the average balance of interest bearing deposits resulted primarily from increases in interest bearing transaction deposits, savings and money market deposits, time deposits and brokered deposits. The increase in the average rate paid was primarily due to the impact of higher market interest rates demanded on deposits in the local and wholesale markets.
Interest expense on borrowings increased $1.1 million to $5.7 million for the year ended December 31, 2019, compared to $4.5 million for the year ended December 31, 2018. This increase was primarily due to increased rates and average balances of FHLB advances, offset in part by a reduction in interest expense on federal funds purchased and notes payable as a result of a decrease in the average balances of these types of borrowings.
Provision for Loan Losses
2020 Compared to 2019
The allowance for loan losses increased $12.3 million as of December 31, 2020, compared to December 31, 2019, reflecting a provision for loan losses of $12.8 million and net charge-offs of $435,000 during 2020. The provision for loan losses was $12.8 million for the year ended December 31, 2020, an increase of $10.1 million, compared to the provision for loan losses of $2.7 million for the year ended December 31, 2019. The increase in the provision for loan losses relates primarily to growth of the loan portfolio, economic uncertainties and evolving risks driven by the impact of the COVID-19 pandemic.
The allowance for loan losses to total loans was 1.50% at December 31, 2020, compared to 1.18% at December 31, 2019. The allowance for loan losses to total loans, excluding $138.5 million of PPP loans, was 1.59% at December 31, 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.
2019 Compared to 2018
The allowance for loan losses increased $2.5 million as of December 31, 2019, compared to December 31, 2018, reflecting a provision for loan losses of $2.7 million and net charge-offs of $205,000 during 2019. The provision for loan losses was $2.7 million for the year ended December 31, 2019, a decrease of $875,000, compared to the provision for loan losses of $3.6 million for the year ended December 31, 2018, due primarily to continued strength in credit quality and consistent performance of the loan portfolio.
The allowance for loan losses at December 31, 2019 represented 1.18% of gross loans outstanding, compared to 1.20% at December 31, 2018.
The following table presents a summary of the activity in the allowance for loan losses for the years ended December 31, 2020, 2019, and 2018:
Year Ended
December 31,
December 31,
December 31,
(dollars in thousands)
Balance at Beginning of Period
$
22,526
$
20,031
$
16,502
Provision for Loan Losses
12,750
2,700
3,575
Charge-offs
(517)
(388)
(421)
Recoveries
Balance at End of Period
$
34,841
$
22,526
$
20,031
Noninterest Income
2020 Compared to 2019
Noninterest income was $5.8 million for the year ended December 31, 2020, compared to $3.8 million for the year ended December 31, 2019, an increase of $2.0 million, or 52.6%. The increase was primarily due to increases in gains on sales of securities, letter of credit fees, and swap fees.
2019 Compared to 2018
Noninterest income was $3.8 million for the year ended December 31, 2019, compared to $2.5 million for the year ended December 31, 2018, an increase of $1.3 million, or 50.5%. The increase was primarily due to an increase in gains on sales of securities and foreclosed assets and an increase in swap fees, partially offset by decreased letter of credit fees.
The following table presents the major components of noninterest income for the year ended December 31, 2020, compared to the year ended December 31, 2019, and for the year ended December 31, 2019, compared to the year ended December 31, 2018:
Year Ended
Year Ended
December 31,
Increase/
December 31,
Increase/
(dollars in thousands)
(Decrease)
(Decrease)
Noninterest Income:
Customer Service Fees
$
$
$
$
$
$
Net Gain (Loss) on Sales of Securities
1,503
(125)
Net Gain (Loss) on Sales of Foreclosed Assets
-
(69)
(225)
Letter of Credit Fees
1,503
1,184
1,184
1,296
(112)
Debit Card Interchange Fees
Swap Fees
-
Other Income
Totals
$
5,839
$
3,826
$
2,013
$
3,826
$
2,543
$
1,283
Noninterest Expense
2020 Compared to 2019
Noninterest expense totaled $45.4 million for the year ended December 31, 2020, a $8.5 million, or 22.9% increase from $36.9 million for the year ended December 31, 2019. The increase was primarily driven by a $3.5 million increase in salaries and employee benefits as the result of merit increases and increased staff to meet the needs of the Company’s growth, and a $7.0 million non-recurring prepayment fee associated with the extinguishment of $94.0 million of FHLB term advances. The increases were partially offset by a decrease of $2.5 million in amortization of tax credit investments and a decrease of $719,000 in marketing and advertising expenses.
Full-time equivalent employees increased from 160 as of December 31, 2019, to 183 as of December 31, 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.
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, as well as other non-routine items, within noninterest expense.
The efficiency ratio was 49.0% for the year ended December 31, 2020, compared to 47.4% for the year ended December 31, 2019. The amortization of tax credit investments elevated the level of operating expenses in both years, and 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, a non-GAAP financial measure, which excludes the impact of certain non-routine income and expenses from noninterest expense, decreased to 40.5% for the year ended December 31, 2020, compared to 43.3% for the year ended December 31, 2019. The efficiencies of the Company's "branch-light" model have been evident throughout the COVID-19 pandemic, and going forward, have positioned the Company well to continue making investments in technology as the industry adapts to evolving client behavior.
2019 Compared to 2018
Noninterest expense totaled $36.9 million for the year ended December 31, 2019, a $5.4 million, or 17.0% increase from $31.6 million for the year ended December 31, 2018. The increase was primarily driven by a $3.5 million
increase in salaries and employee benefits, a $734,000 increase in occupancy and equipment, and a $565,000 increase in professional and consulting fees. The increases were partially offset by a decrease of $180,000 in FDIC Insurance Assessment due to a credit from the FDIC for a portion of premiums previously paid to the DIF that became refundable when the DIF exceeded 1.38% of insured deposits, which occurred during the year ended December 31, 2019. The Company has no remaining credits as of December 31, 2019.
Full-time equivalent employees increased from 140 as of December 31, 2018, to 160 as of December 31, 2019.
The efficiency ratio was 47.4% for the year ended December 31, 2019, a marginal increase over 46.5% for the year ended December 31, 2018. The amortization of tax credit investments elevated the level of operating expenses in both years, and 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, a non-GAAP financial measure, which excludes the impact of the amortization of tax credit investments, increased slightly to 43.3% for the year ended December 31, 2019, compared to 41.7% for the year ended December 31, 2018.
The following table presents the major components of noninterest expense for the year ended December 31, 2020, compared to the year ended December 31, 2019, and the year ended December 31, 2019, compared to the year ended December 31, 2018:
Year Ended
Year Ended
December 31,
Increase/
December 31,
Increase/
(dollars in thousands)
(Decrease)
(Decrease)
Noninterest Expense:
Salaries and Employee Benefits
$
25,568
$
22,076
$
3,492
$
22,076
$
18,620
$
3,456
Occupancy and Equipment
3,258
3,085
3,085
2,351
FDIC Insurance Assessment
(180)
Data Processing
1,027
Professional and Consulting Fees
1,966
1,690
1,690
1,125
Information Technology and Telecommunications
1,374
Marketing and Advertising
1,507
(719)
1,507
1,342
Intangible Asset Amortization
-
-
Amortization of Tax Credit Investments
3,225
(2,487)
3,225
3,293
(68)
FHLB Advance Prepayment Fees
7,043
-
7,043
-
-
-
Other Expense
2,646
2,780
(134)
2,780
2,323
Totals
$
45,387
$
36,932
$
8,455
$
36,932
$
31,562
$
5,370
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. At the same time, management seeks to contain costs whenever prudent, which is evident in the stable nature of the adjusted efficiency ratio.
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. 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.
2020 Compared to 2019
Income tax expense was $8.5 million for the year ended December 31, 2020, compared to $6.9 million for the year ended December 31, 2019. The effective combined federal and state income tax rate for the year ended December
31, 2020 was 23.8%, compared to 18.1% for the year ended December 31, 2019. The higher effective combined rate was primarily due to fewer tax credits being recognized during 2020.
The recognition of tax credit investments significantly impacts the Company’s effective tax rate. Excluding the impact of tax credit investments, the effective combined federal and state income tax rate for the year ended December 31, 2020 was 25.8%.
2019 Compared to 2018
Income tax expense was $6.9 million for the year ended December 31, 2019, compared to $5.2 million for the year ended December 31, 2018. The effective combined federal and state income tax rate for the year ended December 31, 2019 was 18.1%, compared to 16.3% for the year ended December 31, 2018. The higher effective combined rate was primarily due to fewer tax credits being recognized during 2019.
The recognition of tax credit investments significantly impacts the Company’s effective tax rate. Excluding the impact of tax credit investments, the effective combined federal and state income tax rate was 24.8% and 25.5% for the years ended December 31, 2019 and 2018, respectively.
Financial Condition
Overview
Total assets at December 31, 2020 were $2.93 billion, an increase of $658.5 million, or 29.0%, from December 31, 2019. The increase in total assets was primarily due to organic loan growth, PPP loan growth, purchases of investment securities, and excess cash balances linked to extraordinary deposit inflows. Total gross loans were $2.33 billion, an increase of $414.4 million, or 21.7%, from December 31, 2019. Securities available for sale were $390.6 million at December 31, 2020, an increase of $100.8 million, or 34.8%, from December 31, 2019.
Total liabilities at December 31, 2020 were $2.66 billion, an increase of $637.9 million, or 31.5%, from December 31, 2019. Total deposits were $2.50 billion, an increase of $678.3 million, or 37.2%, from December 31, 2019. Total borrowings were $142.2 million, a decrease of $32.0 million, or 18.4%, from December 31, 2019.
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 banks 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 $390.6 million at December 31, 2020, compared to $289.9 million at December 31, 2019, an increase of $100.8 million, or 34.8%. At December 31, 2020, municipal securities represented 29.4% of the investment securities portfolio, government agency mortgage-backed securities represented 31.6% of the portfolio, SBA securities represented 10.3% of the portfolio, corporate securities represented 18.5% of the portfolio,
asset-backed securities represented 10.0% 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 December 31, 2020, 2019 and 2018.
December 31, 2020
December 31, 2019
December 31, 2018
Amortized
Fair
Amortized
Fair
Amortized
Fair
Cost
Value
Cost
Value
Cost
Value
U.S. Treasury Securities
$
-
$
-
$
4,990
$
4,998
$
17,862
$
17,897
SBA Securities
40,455
40,107
50,126
49,559
49,876
49,054
Mortgage-Backed Securities Issued or Guaranteed by U.S. Agencies (MBS):
Residential Pass-Through:
Guaranteed by GNMA
1,195
1,215
6,357
6,137
Issued by FNMA and FHLMC
16,067
16,117
3,571
3,543
Other Residential Mortgage-Backed Securities
94,440
94,409
46,464
46,695
25,252
24,539
Commercial Mortgage-Backed Securities
11,254
12,032
12,019
12,213
15,443
14,736
All Other Commercial MBS
1,063
1,062
1,450
1,450
Total MBS
123,395
124,260
64,312
64,728
48,816
47,176
Municipal Securities
105,975
115,012
99,441
105,743
117,991
118,133
Corporate Securities
71,116
72,155
49,674
50,176
21,170
21,118
Asset-Backed Securities
38,135
39,095
14,673
14,673
-
-
Total
$
379,076
$
390,629
$
283,216
$
289,877
$
255,715
$
253,378
The following tables present the fair value of securities as of December 31, 2020 and 2019 by their stated maturities, as well as the fully tax-equivalent yields for each maturity range.
Maturity as of December 31, 2020
Due in One Year
More Than One
More Than Five
or Less
Year to Five Years
Years to Ten Years
Due After Ten Years
Weighted
Weighted
Weighted
Weighted
Fair
Average
Fair
Average
Fair
Average
Fair
Average
Value
Yield
Value
Yield
Value
Yield
Value
Yield
SBA Securities
$
-
-
%
$
1,971
1.82
%
$
18,158
1.39
%
$
19,978
1.83
%
Mortgage-Backed Securities Issued or Guaranteed by U.S. Agencies (MBS):
Residential Pass-Through:
Guaranteed by GNMA
-
-
-
-
-
-
2.13
Issued by FNMA and FHLMC
-
-
3.58
3.78
16,058
2.20
Other Residential Mortgage-Backed Securities
-
-
1.80
3.02
94,243
0.86
Commercial Mortgage-Backed Securities
-
-
3,735
1.76
8,297
2.28
-
-
All Other Commercial MBS
-
-
-
-
-
-
3.52
Total MBS
-
-
3,825
1.78
8,432
2.29
112,003
1.08
Municipal Securities
1,377
4.13
10,221
4.13
28,333
4.24
75,081
3.68
Corporate Securities
1,534
4.43
13,685
4.46
55,472
5.29
1,464
5.00
Asset-Backed Securities
-
-
-
-
-
-
39,095
1.51
Total
$
2,911
4.29
%
$
29,702
3.83
%
$
110,395
4.15
%
$
247,621
2.02
%
Maturity as of December 31, 2019
Due in One Year
More Than One
More Than Five
or Less
Year to Five Years
Years to Ten Years
Due After Ten Years
Weighted
Weighted
Weighted
Weighted
Fair
Average
Fair
Average
Fair
Average
Fair
Average
Value
Yield
Value
Yield
Value
Yield
Value
Yield
U.S. Treasury Securities
$
4,998
2.56
%
$
-
-
%
$
-
-
%
$
-
-
%
SBA Securities
-
-
1,770
3.16
22,550
2.58
25,239
2.83
Mortgage-Backed Securities Issued or Guaranteed by U.S. Agencies (MBS):
Residential Pass-Through:
Guaranteed by GNMA
-
-
-
-
-
-
1,215
2.87
Issued by FNMA and FHLMC
-
-
3.19
3.23
3,407
2.78
Other Residential Mortgage-Backed Securities
-
-
1.88
3.11
46,461
2.58
Commercial Mortgage-Backed Securities
-
-
-
-
10,622
2.68
1,591
2.41
All Other Commercial MBS
-
-
-
-
-
-
1,062
3.52
Total MBS
-
-
2.45
10,842
2.69
53,736
2.61
Municipal Securities
3.99
8,704
4.22
26,911
4.20
69,211
4.05
Corporate Securities
1,254
2.37
11,372
4.46
36,550
4.88
1,000
5.25
Asset-Backed Securities
-
-
-
-
-
-
14,673
2.90
Total
$
7,169
2.71
%
$
21,996
4.25
%
$
96,853
3.91
%
$
163,859
3.30
%
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 $1.45 billion, for the year ended December 31, 2020, compared to $954.7 million for the year ended December 31, 2019. Net loan exposures include principal advances and unfunded commitments on newly originated loans, net of loan participations sold and PPP loan originations. Total gross loans increased $414.4 million, or 21.7%, to $2.33 billion at December 31, 2020, compared to $1.91 billion at December 31, 2019. The increase included $138.5 million of PPP loans. The multifamily and commercial real estate, or CRE, nonowner occupied categories contributed most significantly to the $275.9 million of net loan growth, excluding PPP loans. As of December 31, 2020, multifamily loans increased $111.5 million, or 21.6%, and nonowner occupied CRE loans increased $116.8 million, or 19.7%, when compared to December 31, 2019. The Company’s loan growth for the year ended December 31, 2020, excluding PPP loans, was 14.4%.
The following table presents the dollar and percentage composition of the loan portfolio by category, at the dates indicated:
December 31, 2020
December 31, 2019
December 31, 2018
December 31, 2017
December 31, 2016
(dollars in thousands)
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Commercial
$
304,220
13.1
%
$
276,035
14.5
%
$
260,833
15.7
%
$
217,753
16.2
%
$
132,592
13.2
%
Paycheck Protection Program
138,454
6.0
-
-
-
-
-
-
-
-
Construction and Land Development
170,217
7.3
196,776
10.3
210,041
12.6
130,586
9.7
106,070
10.6
Real Estate Mortgage:
1 - 4 Family Mortgage
294,479
12.7
260,611
13.6
226,773
13.6
195,707
14.5
178,815
17.9
Multifamily
626,465
26.9
515,014
26.9
407,934
24.5
317,872
23.6
205,250
20.5
CRE Owner Occupied
75,604
3.2
66,584
3.5
64,458
3.9
65,909
4.9
62,347
6.2
CRE Nonowner Occupied
709,300
30.5
592,545
31.0
490,632
29.5
415,034
30.8
311,835
31.2
Total Real Estate Mortgage Loans
1,705,848
73.3
1,434,754
75.0
1,189,797
71.5
994,522
73.8
758,247
75.8
Consumer and Other
7,689
0.3
4,473
0.2
4,260
0.2
4,252
0.3
3,830
0.4
Total Loans, Gross
2,326,428
100.0
%
1,912,038
100.0
%
1,664,931
100.0
%
1,347,113
100.0
%
1,000,739
100.0
%
Allowance for Loan Losses
(34,841)
(22,526)
(20,031)
(16,502)
(12,333)
Net Deferred Loan Fees
(9,151)
(5,512)
(4,515)
(4,104)
(3,266)
Total Loans, Net
$
2,282,436
$
1,884,000
$
1,640,385
$
1,326,507
$
985,140
The Company’s primary focus has been on real estate mortgage lending, which constituted 73.3% of the portfolio as of December 31, 2020. The composition of the portfolio has remained relatively 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 December 31, 2020, investor CRE loans totaled $1.51 billion, consisting of $709.3 million of loans secured by nonowner occupied CRE, $626.5 million of loans secured by multifamily residential properties and $170.2 million of construction and land development loans. Investor CRE loans represented 68.8% of the total gross loan portfolio, excluding PPP loans, and 455.8% of the Bank’s total risk-based capital at December 31, 2020, compared to 516.6% at December 31, 2019.
The following table presents time to contractual maturity and sensitivity to interest rate changes for the loan portfolio at December 31, 2020:
As of December 31, 2020
Due in One Year
More Than One
(dollars in thousands)
or Less
Year to Five Years
After Five Years
Commercial
$
135,237
$
119,798
$
49,185
Paycheck Protection Program
-
138,454
-
Construction and Land Development
100,060
44,637
25,520
Real Estate Mortgage:
1 - 4 Family Mortgage
66,928
184,038
43,513
Multifamily
70,262
235,447
320,756
CRE Owner Occupied
14,930
16,701
43,973
CRE Nonowner Occupied
151,439
268,640
289,221
Total Real Estate Mortgage Loans
303,559
704,826
697,463
Consumer and Other
2,889
4,040
Total Loans, Gross
$
541,745
$
1,011,755
$
772,928
Interest Rate Sensitivity:
Fixed Interest Rates
$
219,464
$
777,201
$
336,008
Floating or Adjustable Rates
322,281
234,554
436,920
Total Loans, Gross
$
541,745
$
1,011,755
$
772,928
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 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 December 31, 2020. The Company had no assets classified as doubtful or loss.
Risk Category
(dollars in thousands)
Watch
Substandard
Total
Commercial
$
14,516
$
$
14,755
Construction and Land Development
-
Real Estate Mortgage:
1 - 4 Family Mortgage
1,498
2,201
CRE Owner Occupied
-
CRE Nonowner Occupied
29,576
12,388
41,964
Total Real Estate Mortgage Loans
30,279
14,756
45,035
Consumer and Other
-
Totals
$
44,795
$
15,164
$
59,959
The Company has increased oversight and analysis of all segments of 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. Loans that have potential weaknesses that warrant a watchlist risk rating at December 31, 2020, were $44.8 million, compared to $5.3 million at December 31, 2019. As the COVID-19 pandemic continues to evolve, the length and extent of the economic uncertainty may result in further watchlist or adverse classifications in the loan portfolio. Loans that warranted a substandard risk rating at December 31, 2020 were $15.2 million, compared to $2.7 at December 31, 2019. Subsequent to December 31, 2020, the Company had $8.4 million of substandard loans payoff in the CRE nonowner occupied segment of the portfolio.
In response to the COVID-19 pandemic, the Company has been 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.
The following table presents a rollforward of loan modification activity, by modification type, for the year ended December 31, 2020:
(dollars in thousands)
Interest-Only
Payment Deferral
Extended Amortization
Total
Principal Balance - Beginning of Period
$
-
$
-
$
-
$
-
Initial Modification Granted
187,354
117,719
-
305,073
Modification Expired
(157,542)
(120,604)
-
(278,146)
Multiple Modifications Granted
40,271
3,506
4,834
48,611
Net Principal Advances (Payments)
(8,978)
(8)
-
(8,986)
Principal Balance - End of Period
$
61,105
$
$
4,834
$
66,552
The following table presents a summary of active loan modifications, by loan segment and modification type, at December 31, 2020:
Interest-Only
Payment Deferral
Extended Amortization
Total
(dollars in thousands)
Amount
# of Loans
Amount
# of Loans
Amount
# of Loans
Amount
# of Loans
Commercial
$
5,212
$
-
-
$
4,834
$
10,046
Real Estate Mortgage:
1 - 4 Family Mortgage
-
-
-
-
Multifamily
23,636
-
-
-
-
23,636
CRE Owner Occupied
-
-
-
-
CRE Nonowner Occupied
32,209
-
-
-
-
32,209
Totals
$
61,105
$
$
4,834
$
66,552
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.
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 $775,000 at December 31, 2020 and $461,000 at December 31, 2019, an increase of $314,000. There were no loans 90 days past due and still accruing as of December 31, 2020 and 2019. There were no foreclosed assets as of December 31, 2020 and 2019.
The following table presents a summary of nonperforming assets, by category, at the dates indicated:
December 31,
(dollars in thousands)
Nonaccrual Loans:
Commercial
$
$
$
$
$
Construction and Land Development
Real Estate Mortgage:
1 - 4 Family Mortgage
-
CRE Owner Occupied
-
-
-
-
CRE Nonowner Occupied
-
-
-
-
Total Real Estate Mortgage Loans
1,606
Consumer and Other
-
-
Total Nonaccrual Loans
$
$
$
$
1,139
$
2,323
Total Nonperforming Loans
$
$
$
$
1,139
$
2,323
Plus: Foreclosed Assets
-
-
-
4,183
Total Nonperforming Assets (1)
$
$
$
$
1,720
$
6,506
Total Restructured Accruing Loans
2,178
3,286
Total Nonperforming Assets and Restructured Accruing Loans
$
1,040
$
$
$
3,898
$
9,792
Nonaccrual Loans to Total Loans
0.03
%
0.02
%
0.03
%
0.08
%
0.23
%
Nonperforming Loans to Total Loans
0.03
0.02
0.03
0.08
0.23
Nonperforming Assets to Total Loans Plus Foreclosed Assets (1)
0.03
0.02
0.03
0.13
0.65
Nonperforming Assets and Restructured Accruing Loans to Total Loans Plus Foreclosed Assets
0.04
0.04
0.05
0.29
0.97
(1) Nonperforming assets are defined as nonaccrual loans and loans greater than 90 days past due still accruing plus foreclosed assets. There were no loans greater than 90 days past due still accruing for any period shown.
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 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. There are not any loans, outside of those included in the tables above, that cause management to have serious doubts as to the ability of borrowers to comply with present repayment terms. Due to the low levels of nonaccrual loans, gross income that would have been recorded on nonaccrual loans is $27,000.
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 December 31, 2020, the allowance for loan losses was $34.8 million, an increase of $12.3 million from $22.5 million at December 31, 2019. Net charge-offs totaled $435,000 during the year ended December 31, 2020 and $205,000 during the year ended December 31, 2019. The allowance for loan losses as a percentage of total loans was 1.50% at December 31, 2020 and 1.18% at December 31, 2019. The allowance for loan losses to total loans, excluding $138.5 million of PPP loans, was 1.59% at December 31, 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 following table presents a summary of the activity in the allowance for loan loss reserve for the periods indicated:
As of and for the year ended December 31,
(dollars in thousands)
Balance, Beginning of Period
$
22,526
$
20,031
$
16,502
$
12,333
$
10,052
Charge-offs:
Commercial
Construction and Land Development
-
-
-
Real Estate Mortgage:
1 - 4 Family Mortgage
-
CRE Owner Occupied
-
-
-
-
CRE Nonowner Occupied
-
-
-
Total Real Estate Mortgage Loans
Consumer and Other
Total Charge-offs
1,114
Recoveries:
Commercial
Construction and Land Development
-
Real Estate Mortgage:
1 - 4 Family Mortgage
CRE Owner Occupied
-
-
-
-
Total Real Estate Mortgage Loans
Consumer and Other
Total Recoveries
Net Charge-offs
Provision for Loan Losses
12,750
2,700
3,575
4,175
3,250
Balance at End of Period
$
34,841
$
22,526
$
20,031
$
16,502
$
12,333
Gross Loans, End of Period
2,326,428
1,912,038
1,664,931
1,347,113
1,000,739
Average Loans
2,154,420
1,785,937
1,491,166
1,177,491
896,915
Net Charge-offs to Average Loans
0.02
%
0.01
%
0.00
%
0.00
%
0.11
%
Allowance to Total Gross Loans
1.50
%
1.18
%
1.20
%
1.22
%
1.23
%
Allowance to Total Gross Loans, Excluding PPP Loans
1.59
%
N/A
N/A
N/A
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:
December 31,
December 31,
December 31,
December 31,
December 31,
(dollars in thousands)
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Commercial
$
5,703
16.4
%
$
3,058
13.6
%
$
2,898
14.5
%
$
2,435
14.7
%
$
1,315
10.7
%
Paycheck Protection Program
0.2
-
-
-
-
-
-
-
-
Construction and Land Development
2,491
7.1
2,202
9.8
2,451
12.2
1,892
11.5
1,379
11.2
Real Estate Mortgage:
1 - 4 Family Mortgage
3,972
11.4
2,839
12.6
2,597
13.0
2,317
14.0
2,410
19.5
Multifamily
9,517
27.3
5,824
25.9
4,644
23.2
3,170
19.2
1,568
12.7
CRE Owner Occupied
1,162
3.3
3.5
4.0
5.8
1,160
9.4
CRE Nonowner Occupied
10,991
31.6
6,972
30.9
5,872
29.3
5,087
30.8
3,323
27.0
Total Real Estate Mortgage Loans
25,642
73.6
16,427
72.9
13,921
69.5
11,530
69.8
8,461
68.6
Consumer and Other
0.6
0.4
0.3
0.4
0.6
Unallocated
2.1
3.3
3.5
3.6
1,100
8.9
Total Allowance for Loan Losses
$
34,841
100.0
%
$
22,526
100.0
%
$
20,031
100.0
%
$
16,502
100.0
%
$
12,333
100.0
%
Goodwill and Other Intangible Assets
Goodwill was $2.6 million at December 31, 2020 and 2019. Goodwill represents the excess of the consideration paid over the fair value of the net assets acquired, which originated from the acquisition of First National Bank of the Lakes in May of 2016. Goodwill is not amortized but is subject to, at a minimum, an annual test for impairment. Other intangible assets consist of core deposit relationships and favorable lease term intangibles. Total other intangible assets at December 31, 2020 and 2019 were $670,000 and $861,000, respectively. Other intangible assets are amortized over their estimated useful life.
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 presents the dollar and percentage composition of the deposit portfolio, by category, at the dates indicated:
December 31,
December 31,
December 31,
December 31,
December 31,
(dollars in thousands)
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Noninterest Bearing Transaction Deposits
$
671,903
26.9
%
$
447,509
24.5
%
$
369,203
23.6
%
$
292,539
21.9
%
$
238,062
23.3
%
Interest Bearing Transaction Deposits
366,290
14.6
264,627
14.5
179,567
11.5
177,292
13.2
132,800
13.0
Savings and Money Market Deposits
657,617
26.3
516,785
28.3
402,639
25.8
369,942
27.6
239,084
23.4
Time Deposits
353,543
14.1
360,027
19.8
318,356
20.4
292,096
21.8
273,229
26.6
Brokered Deposits
452,283
18.1
234,362
12.9
291,169
18.7
207,481
15.5
140,333
13.7
Total Deposits
$
2,501,636
100.0
%
$
1,823,310
100.0
%
$
1,560,934
100.0
%
$
1,339,350
100.0
%
$
1,023,508
100.0
%
Total deposits at December 31, 2020 were $2.50 billion, an increase of $678.3 million, or 37.2%, compared to total deposits of $1.82 billion at December 31, 2019. Noninterest bearing deposits were $671.9 million at December 31, 2020, an increase of $224.4 million, or 50.1%, compared to $447.5 million at December 31, 2019. Noninterest bearing deposits comprised 26.9% of total deposits at December 31, 2020, compared to 24.5% at December 31, 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 believes that deposit levels could fluctuate in future periods as a result of the uncertain economic conditions relating to the COVID-19 pandemic.
The Company relies on increasing the deposit base to fund loan 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 December 31, 2020, total brokered deposits were $452.3 million or 18.1% of total deposits, compared to total brokered deposits of $234.4 million, or 12.9% of total deposits 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. 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 years ended December 31, 2020, 2019, and 2018:
As of and for the
As of and for the
As of and for the
Year Ended
Year Ended
Year Ended
December 31, 2020
December 31, 2019
December 31, 2018
Average
Average
Average
Average
Average
Average
(dollars in thousands)
Balance
Rate
Balance
Rate
Balance
Rate
Noninterest Bearing Transaction Deposits
$
579,595
-
%
$
414,377
-
%
$
330,898
-
%
Interest Bearing Transaction Deposits
295,036
0.55
223,376
0.73
177,335
0.36
Savings and Money Market Deposits
523,520
1.02
447,040
1.73
381,318
1.23
Time Deposits < $250,000
244,779
2.13
232,310
2.30
196,235
1.93
Time Deposits > $250,000
129,416
2.01
116,838
2.61
103,786
1.87
Brokered Deposits
348,126
1.45
261,023
2.39
232,022
2.12
Total Deposits
$
2,120,472
0.93
%
$
1,694,964
1.42
%
$
1,421,594
1.12
%
The following table presents time deposits, including brokered time deposits, of $100,000 or more, by time remaining until maturity.
December 31,
(dollars in thousands)
Three Months or Less
$
158,407
Over Three Months through Six Months
61,650
Over Six Months through 12 Months
74,260
Over 12 Months
283,466
Totals
$
577,783
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 presents a summary of overnight borrowings, which consist of federal funds purchased 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 year ended December 31,
(dollars in thousands)
Outstanding at Period-End
$
-
$
-
$
18,000
Average Amount Outstanding
7,239
7,433
29,671
Maximum Amount Outstanding at any Month-End
37,000
87,000
90,000
Weighted Average Interest Rate:
During Period
1.53
%
2.50
%
2.15
%
End of Period
0.29
%
1.73
%
2.63
%
Other Borrowings
At December 31, 2020, other borrowings outstanding consisted of FHLB advances of $57.5 million and a note payable of $11.0 million. During the year ended December 31, 2020, the Company prepaid $94.0 million of fixed rate FHLB term advances with an average cost of 2.83% and incurred a loss on extinguishment of debt of $7.0 million. The $11.0 million note payable matured in February 2021 and was paid off in full at maturity.
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 December 31, 2020, the Company had not pledged any PPP loans to borrow funds under this facility. The facility is available through June 30, 2021. 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 $361.2 million and $209.8 million at December 31, 2020 and December 31, 2019, respectively.
Additionally, the Company has borrowing capacity from other sources. As of December 31, 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 $76.8 million and $113.2 million at December 31, 2020 and December 31, 2019, respectively. As of December 31, 2020 and December 31, 2019, the Company had no outstanding advances from the discount window.
As of December 31, 2020, the Company has a swap agreement with an unaffiliated third party in order to hedge interest rate risk associated with the note 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 one-month LIBOR. The swap agreement matured in February 2021.
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 December 31, 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 debentures, net of issuance costs, were $24.8 million at December 31, 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 under applicable regulatory guidelines.
Contractual Obligations
The following table presents supplemental information regarding total contractual obligations at December 31, 2020:
Within
One to
Three to
After
(dollars in thousands)
One Year
Three Years
Five Years
Five Years
Total
Deposits Without a Stated Maturity
$
1,855,475
$
-
$
-
$
-
$
1,855,475
Time Deposits
338,261
114,473
193,427
-
646,161
Note Payable
11,000
-
-
-
11,000
FHLB Advances
15,000
-
38,500
4,000
57,500
Subordinated Debentures
-
-
-
75,000
75,000
Commitment to Fund Tax Credit Investments
1,858
-
-
-
1,858
Operating Lease Obligations
1,015
3,421
Totals
$
2,222,096
$
115,465
$
232,942
$
79,912
$
2,650,415
Operating lease obligations are in place for facilities and land on which banking branches are located. See Note 6 of the Company’s Consolidated Financial Statements included as part of this report for additional information.
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 December 31, 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 $27.2 million of net income retained and a $1.8 million increase in accumulated other comprehensive income, partially offset by $10.3 million of stock repurchases made under the Company’s stock repurchase program. The increase in accumulated other comprehensive income primarily resulted from interest rate fluctuations between periods.
Stock Repurchase Program. On January 22, 2019, the Company adopted a stock repurchase program. Under the stock 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 and October 27, 2020, the Company's board of directors approved $10.0 million and $15.0 million increases, respectively, to the program for a total authorization of $40.0 million. Additionally, on October 27, 2020, the program duration was extended to run through October 27, 2022.
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 year ended December 31, 2020, the Company repurchased 940,781 shares of its common stock, representing approximately 3% of the Company's outstanding shares. Shares were repurchased at a weighted average price of $10.98 for a total of $10.3 million. All shares repurchased under the stock repurchase program were converted to authorized but unissued shares. At December 31, 2020, the remaining amount that could be used to repurchase shares under the stock repurchase program was $14.7 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 classifications 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 December 31, 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
December 31, 2020
Amount
Ratio
Amount
Ratio
Amount
Ratio
Amount
Ratio
(dollars in thousands)
Company (Consolidated):
Total Risk-based Capital
$
360,198
14.58
%
$
197,604
8.00
%
$
259,355
10.50
%
N/A
N/A
Tier 1 Risk-based Capital
255,530
10.35
148,203
6.00
209,954
8.50
N/A
N/A
Common Equity Tier 1 Capital
255,530
10.35
111,152
4.50
172,904
7.00
N/A
N/A
Tier 1 Leverage Ratio
255,530
9.28
110,168
4.00
110,168
4.00
N/A
N/A
Bank:
Total Risk-based Capital
$
330,380
13.37
%
$
197,629
8.00
%
$
259,388
10.50
%
$
247,036
10.00
%
Tier 1 Risk-based Capital
299,447
12.12
148,222
6.00
209,981
8.50
197,629
8.00
Common Equity Tier 1 Capital
299,447
12.12
111,166
4.50
172,925
7.00
160,574
6.50
Tier 1 Leverage Ratio
299,447
10.89
109,972
4.00
109,972
4.00
137,465
5.00
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 December 31, 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. 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.
The following table presents credit arrangements and financial instruments whose contract amounts represent credit risk as of December 31, 2020 and December 31, 2019:
December 31, 2020
December 31, 2019
Fixed
Variable
Fixed
Variable
(dollars in thousands)
Unfunded Commitments Under Lines of Credit
$
243,988
$
400,350
$
181,622
$
319,340
Letters of Credit
10,954
79,252
17,503
61,722
Totals
$
254,942
$
479,602
$
199,125
$
381,062
Commitments to extend credit beyond current funding are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Such commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our management’s credit evaluation. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. Commercial letters of credit are issued specifically to facilitate trade or commerce and are paid directly when the underlying transaction is consummated. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
The Company had outstanding letters of credit with the FHLB in the amount of $60,091 and $108,502 at December 31, 2020 and 2019, respectively, on behalf of customers and to secure public deposits.
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 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 December 31, 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 December 31, 2020, the Company had no borrowings outstanding through this facility and $138.5 million of PPP loans available to pledge. The facility is available through June 30, 2021.
The following tables present a summary of primary and secondary liquidity levels as of the dates indicated:
Primary Liquidity-On-Balance Sheet
December 31, 2020
December 31, 2019
(Dollars in thousands)
Cash and Cash Equivalents
$
145,348
$
31,935
Securities Available for Sale
390,629
289,877
Total Primary Liquidity
$
535,977
$
321,812
Ratio of Primary Liquidity to Total Deposits
21.4
%
17.6
%
Secondary Liquidity-Off-Balance Sheet
Borrowing Capacity
December 31, 2020
December 31, 2019
(Dollars in thousands)
Net Secured Borrowing Capacity with the FHLB
$
361,236
$
209,840
Net Secured Borrowing Capacity with the Federal Reserve Bank
76,830
113,164
Unsecured Borrowing Capacity with Correspondent Lenders
143,000
105,000
Total Secondary Liquidity
$
581,066
$
428,004
Ratio of Primary and Secondary Liquidity to Total Deposits
45.3
%
41.1
%
During the year ended December 31, 2020, primary liquidity increased $214.2 million due to a $113.4 million increase in cash and cash equivalents and a $100.8 million increase in securities available for sale, when compared to December 31, 2019. Secondary liquidity increased $153.1 million as of December 31, 2020 when compared to December 31, 2019, due to a $151.4 million increase in the borrowing capacity on the secured borrowing line with the FHLB and a $38.0 million increase in unsecured borrowing capacity with correspondent lenders, offset partially by a $36.3 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 December 31, 2020, core deposits totaled approximately $1.95 billion and represented 78.1% 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 December 31, 2020, brokered deposits totaled $452.3 million, consisting of $292.6 million of brokered time deposits and $159.7 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 December 31, 2020, the Company was in compliance with all established liquidity guidelines in the policy.
GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures
Some of the financial data included in this report are not measures of financial performance recognized by GAAP. Management uses these non-GAAP financial measures in the analysis of performance:
● “Efficiency ratio” is defined as noninterest expense less the amortization of intangibles divided by our operating revenue, which is equal to net interest income plus noninterest income excluding gains and losses on sales of assets. In our judgment, the adjustments made to operating revenue allow investors and analysts to better assess our operating expenses in relation to our core operating revenue by removing the volatility that is associated with certain one-time items and other discrete items that are unrelated to our core business.
● “Adjusted Efficiency ratio” is defined as the efficiency ratio adjusted to exclude the amortization of tax credit investments and FHLB advance prepayments fees from noninterest expense.
● "Pre-Provision Net Revenue" is defined as net interest income plus total non-interest income (excluding all gains and losses) minus total non-interest expense, excluding the amortization of tax credit investments and FHLB advance prepayment fees.
● “Tangible common equity” is defined as shareholders’ equity reduced by goodwill and other intangible assets. We believe that this measure is important to many investors in the marketplace who are interested in changes from period to period in shareholders’ equity exclusive of changes in intangible assets. Goodwill and other intangibles that were recorded in a purchase business combination have the effect of increasing both equity and assets while not increasing our tangible equity or tangible assets.
● “Tangible common equity to tangible assets” is defined as the ratio of tangible common equity, as defined above, divided by total assets reduced by goodwill and other intangible assets. We believe that this measure is important to many investors in the market place who are interested in relative changes from period to period in shareholders’ equity to total assets, each exclusive of changes in intangible assets. Goodwill and other intangibles that were recorded in a purchase business combination have the effect of increasing both equity and assets while not increasing our tangible equity or tangible assets.
● “Tangible book value per share” is defined as tangible shareholders’ equity divided by total common voting and non-voting shares outstanding. We believe that this measure is important to many investors in the marketplace who are interested in changes from period to period in book value per share exclusive of changes in intangible assets. Goodwill and other intangibles that were recorded in a purchase business combination have the effect of increasing book value while not increasing our tangible book value.
The Company believes these non-GAAP financial measures provide useful information to management and investors that is supplementary to our financial condition, results of operations and cash flows computed in accordance with GAAP; however, we acknowledge that our non-GAAP financial measures have a number of limitations. As such, you should not view these disclosures as a substitute for results determined in accordance with GAAP, and they are not necessarily comparable to non-GAAP financial measures that other companies use. The following reconciliation table provides a more detailed analysis of these non-GAAP financial measures:
As of and for the year ended December 31,
(dollars in thousands)
Efficiency Ratio
Noninterest Expense
$
45,387
$
36,932
$
31,562
$
25,496
$
20,168
Less: Amortization of Intangible Assets
(191)
(191)
(191)
(191)
(104)
Adjusted Noninterest Expense
$
45,196
$
36,741
$
31,371
$
25,305
$
20,064
Net Interest Income
$
87,964
$
74,132
$
64,738
$
54,173
$
42,118
Noninterest Income
5,839
3,826
2,543
2,536
2,567
Less: (Gain) Loss on Sales of Securities
(1,503)
(516)
(830)
Adjusted Operating Revenue
$
92,300
$
77,442
$
67,406
$
56,959
$
43,855
Efficiency Ratio
49.0
%
47.4
%
46.5
%
44.4
%
45.8
%
Adjusted Efficiency Ratio
Noninterest Expense
$
45,387
$
36,932
$
31,562
$
25,496
$
20,168
Less: Amortization of Tax Credit Investments
(738)
(3,225)
(3,293)
(1,916)
-
Less: FHLB Advance Prepayment Fees
(7,043)
-
-
-
-
Less: Amortization of Intangible Assets
(191)
(191)
(191)
(191)
(104)
Adjusted Noninterest Expense
$
37,415
$
33,516
$
28,078
$
23,389
$
20,064
Net Interest Income
$
87,964
$
74,132
$
64,738
$
54,173
$
42,118
Noninterest Income
5,839
3,826
2,543
2,536
2,567
Less: (Gain) Loss on Sales of Securities
(1,503)
(516)
(830)
Adjusted Operating Revenue
$
92,300
$
77,442
$
67,406
$
56,959
$
43,855
Adjusted Efficiency Ratio
40.5
%
43.3
%
41.7
%
41.1
%
45.8
%
As of and for the year ended December 31,
(dollars in thousands)
Pre-Provision Net Revenue
Noninterest Income
$
5,839
$
3,826
$
2,543
$
2,536
$
2,567
Less: (Gain) Loss on sales of Securities
(1,503)
(516)
(830)
Total Operating Noninterest Income
4,336
3,310
2,668
2,786
1,737
Plus: Net Interest income
87,964
74,132
64,738
54,173
42,118
Net Operating Revenue
$
92,300
$
77,442
$
67,406
$
56,959
$
43,855
Noninterest Expense
$
45,387
$
36,932
$
31,562
$
25,496
$
20,168
Less: Amortization of Tax Credit Investments
(738)
(3,225)
(3,293)
(1,916)
-
Less: FHLB Advance Prepayment Fees
(7,043)
-
-
-
-
Total Operating Noninterest Expense
$
37,606
$
33,707
$
28,269
$
23,580
$
20,168
Pre-Provision Net Revenue
$
54,694
$
43,735
$
39,137
$
33,379
$
23,687
Plus:
Non-Operating Revenue Adjustments
1,503
(125)
(250)
Less:
Provision for Loan Losses
12,750
2,700
3,575
4,175
3,250
Non-Operating Expense Adjustments
7,781
3,225
3,293
1,916
-
Provision for Income Taxes
8,472
6,923
5,224
10,149
8,052
Net Income
$
27,194
$
31,403
$
26,920
$
16,889
$
13,215
Average Assets
$
2,617,579
$
2,114,211
$
1,777,592
$
1,451,732
$
1,098,654
Pre-Provision Net Revenue Return on Average Assets
2.09
%
2.07
%
2.20
%
2.30
%
2.16
%
As of and for the year ended December 31,
(dollars in thousands, except share data)
Tangible Common Equity and Tangible Common Equity/Tangible Assets
Common Equity
$
265,405
$
244,794
$
220,998
$
137,162
$
115,366
Less: Intangible Assets
(3,296)
(3,487)
(3,678)
(3,869)
(4,060)
Tangible Common Equity
262,109
241,307
217,320
133,293
111,306
Total Assets
2,927,345
2,268,830
1,973,741
1,616,612
1,260,394
Less: Intangible Assets
(3,296)
(3,487)
(3,678)
(3,869)
(4,060)
Tangible Assets
$
2,924,049
$
2,265,343
$
1,970,063
$
1,612,743
$
1,256,334
Tangible Common Equity/Tangible Assets
8.96
%
10.65
%
11.03
%
8.26
%
8.86
%
Tangible Book Value Per Share
Book Value Per Common Share
$
9.43
$
8.45
$
7.34
$
5.56
$
4.69
Less: Effects of Intangible Assets
(0.12)
(0.12)
(0.12)
(0.16)
(0.17)
Tangible Book Value Per Common Share
$
9.31
$
8.33
$
7.22
$
5.40
$
4.52
Average Tangible Common Equity
Average Common Equity
$
258,736
$
232,539
$
194,083
$
128,123
$
102,588
Less: Effects of Average Intangible Assets
(3,395)
(3,582)
(3,772)
(3,956)
(2,701)
Average Tangible Common Equity
$
255,341
$
228,957
$
190,311
$
124,167
$
99,887

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 7A. 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 and caps, which are designed to lessen elements of the Company’s interest rate exposure. Cash flow hedge relationships mitigate exposure to the variability of future cash flows or other forecasted transactions. The Company utilizes cash flow hedges to manage interest rate exposure for the brokered certificate of deposit, wholesale borrowing, and notes payable portfolios. At December 31, 2020 and December 31, 2019, these cash flow hedges had a total notional amount of $161.0 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 December 31, 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.
December 31, 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
$
91,046
10.03
%
$
80,558
13.47
%
+300
88,698
7.19
78,064
9.95
+200
86,241
4.22
75,591
6.47
+100
84,195
1.75
73,113
2.98
82,747
-
70,996
-
−100
81,780
(1.17)
68,685
(3.26)
The table above indicates that as of December 31, 2020, in the event of an immediate and sustained 400 basis point increase in interest rates, the Company would experience a 10.03% increase in net interest income. In the event of an immediate 100 basis point decrease in interest rates, the Company would experience a 1.17% 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 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 and caps, a portion of its subordinated debt, various investment securities and approximately 9.0% of the Company’s loans as of December 31, 2020. It is expected that the number of institutions that have been reporting information used to set LIBOR will stop doing so starting after 2021 through June 30, 2023 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 2023.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Bridgewater Bancshares, Inc.
St. Louis Park, Minnesota
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Bridgewater Bancshares, Inc. and Subsidiaries (the Company) as of December 31, 2020 and 2019, and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2020 and the related notes (collectively referred to as the financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and their cash flows for each of the three years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting in accordance with the standards of the PCAOB. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting in accordance with the standards of the PCAOB. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
CliftonLarsonAllen LLP
Minneapolis, Minnesota
March 10, 2021
We have served as the Company’s auditor since 2005.
Bridgewater Bancshares, Inc. and Subsidiaries
Consolidated Balance Sheets
(dollars in thousands, except share data)
December 31,
December 31,
ASSETS
Cash and Cash Equivalents
$
160,675
$
31,935
Bank-Owned Certificates of Deposit
2,860
2,654
Securities Available for Sale, at Fair Value
390,629
289,877
Loans, Net of Allowance for Loan Losses of $34,841 at December 31, 2020 and $22,526 at December 31, 2019
2,282,436
1,884,000
Federal Home Loan Bank (FHLB) Stock, at Cost
5,027
7,824
Premises and Equipment, Net
50,987
27,628
Accrued Interest
9,172
6,775
Goodwill
2,626
2,626
Other Intangible Assets, Net
Other Assets
22,263
14,650
Total Assets
$
2,927,345
$
2,268,830
LIABILITIES AND EQUITY
LIABILITIES
Deposits:
Noninterest Bearing
$
671,903
$
447,509
Interest Bearing
1,829,733
1,375,801
Total Deposits
2,501,636
1,823,310
Notes Payable
11,000
13,000
FHLB Advances
57,500
136,500
Subordinated Debentures, Net of Issuance Costs
73,739
24,733
Accrued Interest Payable
1,615
1,982
Other Liabilities
16,450
24,511
Total Liabilities
2,661,940
2,024,036
SHAREHOLDERS' EQUITY
Preferred Stock- $0.01 par value
Authorized 10,000,000; None Issued and Outstanding at December 31, 2020 and December 31, 2019
-
-
Common Stock- $0.01 par value
Common Stock - Authorized 75,000,000; Issued and Outstanding 28,143,493 at December 31, 2020 and 28,973,572 at December 31, 2019
Additional Paid-In Capital
103,714
112,093
Retained Earnings
154,831
127,637
Accumulated Other Comprehensive Income
6,579
4,774
Total Shareholders' Equity
265,405
244,794
Total Liabilities and Shareholders' Equity
$
2,927,345
$
2,268,830
See accompanying notes to consolidated financial statements.
Bridgewater Bancshares, Inc. and Subsidiaries
Consolidated Statements of Income
(dollars in thousands, except per share data)
Year Ended
December 31,
December 31,
December 31,
INTEREST INCOME
Loans, Including Fees
$
105,492
$
94,852
$
78,033
Investment Securities
8,720
7,773
6,694
Other
1,153
Total Interest Income
114,826
103,778
85,226
INTEREST EXPENSE
Deposits
19,813
23,996
15,972
Notes Payable
FHLB Advances
3,390
3,407
1,718
Subordinated Debentures
3,109
1,556
1,568
Federal Funds Purchased
Total Interest Expense
26,862
29,646
20,488
NET INTEREST INCOME
87,964
74,132
64,738
Provision for Loan Losses
12,750
2,700
3,575
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES
75,214
71,432
61,163
NONINTEREST INCOME
Customer Service Fees
Net Gain (Loss) on Sales of Available for Sale Securities
1,503
(125)
Net Gain (Loss) on Sales of Foreclosed Assets
-
(225)
Other Income
3,510
2,481
2,148
Total Noninterest Income
5,839
3,826
2,543
NONINTEREST EXPENSE
Salaries and Employee Benefits
25,568
22,076
18,620
Occupancy and Equipment
3,258
3,085
2,351
Other Expense
16,561
11,771
10,591
Total Noninterest Expense
45,387
36,932
31,562
INCOME BEFORE INCOME TAXES
35,666
38,326
32,144
Provision for Income Taxes
8,472
6,923
5,224
NET INCOME
$
27,194
$
31,403
$
26,920
EARNINGS PER SHARE
Basic
$
0.95
$
1.07
$
0.93
Diluted
0.93
1.05
0.91
Dividends Paid Per Share
-
-
-
See accompanying notes to consolidated financial statements.
Bridgewater Bancshares, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income
(dollars in thousands)
December 31,
December 31,
December 31,
Net Income
$
27,194
$
31,403
$
26,920
Other Comprehensive Income (Loss):
Unrealized Gains (Losses) on Available for Sale Securities
6,394
9,514
(3,804)
Unrealized Gains (Losses) on Cash Flow Hedges
(3,185)
(962)
Reclassification Adjustment for (Gains) Losses Realized in Income
(924)
(525)
Income Tax Impact
(480)
(1,685)
Total Other Comprehensive Income (Loss), Net of Tax
1,805
6,342
(2,846)
Comprehensive Income
$
28,999
$
37,745
$
24,074
See accompanying notes to consolidated financial statements.
Bridgewater Bancshares, Inc. and Subsidiaries
Consolidated Statements of Shareholders’ Equity
(amounts in thousands, except share data)
Accumulated
Additional
Other
Shares
Common Stock
Paid-In
Retained
Comprehensive
Voting
Non-voting
Voting
Non-voting
Capital
Earnings
Income (Loss)
Total
BALANCE, December 31, 2017
20,834,001
3,845,860
$
$
$
66,324
$
69,508
$
1,084
$
137,162
Stock-based Compensation
-
-
-
-
-
-
Comprehensive Income (Loss)
-
-
-
-
-
26,920
(2,846)
24,074
Issuance of Common Stock, Net of Issuance Costs
5,379,513
-
-
58,803
-
-
58,857
Conversion of Non-voting Stock to Voting Stock
3,845,860
(3,845,860)
(38)
-
-
-
-
Stock Options Exercised
37,900
-
-
-
-
Reclassification of the Income Tax Effects of the Tax Cuts and Jobs Act to Retained Earnings
-
-
-
-
-
(194)
-
BALANCE, December 31, 2018
30,097,274
-
-
126,031
96,234
(1,568)
220,998
Stock-based Compensation
-
-
-
-
-
-
Comprehensive Income
-
-
-
-
-
31,403
6,342
37,745
Stock Options Exercised
74,850
-
-
-
-
Stock Repurchases
(1,331,512)
-
(13)
-
(14,946)
-
-
(14,959)
Issuance of Restricted Stock Awards
132,960
-
-
(1)
-
-
-
BALANCE, December 31, 2019
28,973,572
-
-
112,093
127,637
4,774
244,794
Stock-based Compensation
29,050
-
-
-
1,668
-
-
1,668
Comprehensive Income
-
-
-
-
-
27,194
1,805
28,999
Stock Options Exercised
74,400
-
-
-
-
Stock Repurchases
(940,781)
-
(10)
-
(10,324)
-
-
(10,334)
Issuance of Restricted Stock Awards
18,641
-
-
-
-
-
-
-
Forfeiture of Restricted Stock Awards
(8,200)
-
-
-
-
-
-
-
Restricted Shares Withheld for Taxes
(3,189)
-
-
-
(39)
-
-
(39)
BALANCE, December 31, 2020
28,143,493
-
$
$
-
$
103,714
$
154,831
$
6,579
$
265,405
See accompanying notes to consolidated financial statements.
Bridgewater Bancshares, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(dollars in thousands)
December 31,
December 31,
December 31,
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income
$
27,194
$
31,403
$
26,920
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Net Amortization on Securities Available for Sale
2,691
2,523
3,028
Net (Gain) Loss on Sales of Securities Available for Sale
(1,503)
(516)
Provision for Loan Losses
12,750
2,700
3,575
Depreciation and Amortization of Premises and Equipment
1,206
1,008
Loss on Sale of Premises and Equipment
-
Amortization of Other Intangible Assets
Amortization of Subordinated Debt Issuance Costs
Net (Gain) Loss on Sale of Foreclosed Assets
-
(69)
Stock-based Compensation
1,668
Deferred Income Taxes
(2,590)
(747)
(1,298)
Changes in Operating Assets and Liabilities:
Accrued Interest Receivable and Other Assets
(5,121)
(7,627)
Accrued Interest Payable and Other Liabilities
(13,692)
1,641
2,606
Net Cash Provided by Operating Activities
23,019
39,527
29,408
CASH FLOWS FROM INVESTING ACTIVITIES
(Increase) Decrease in Bank-owned Certificates of Deposit
(206)
(233)
Proceeds from Sales of Securities Available for Sale
40,862
42,864
24,684
Proceeds from Maturities, Paydowns, Payups and Calls of Securities Available for Sale
32,577
41,118
22,965
Purchases of Securities Available for Sale
(170,488)
(98,817)
(78,368)
Proceeds from Sale of Premises and Equipment
-
-
Net Increase in Loans
(411,320)
(247,573)
(317,453)
Net (Increase) Decrease in FHLB Stock
2,797
(210)
(2,467)
Purchases of Premises and Equipment
(24,688)
(15,572)
(3,720)
Proceeds from Sales of Foreclosed Assets
1,327
Net Cash Used in Investing Activities
(530,332)
(276,211)
(354,236)
CASH FLOWS FROM FINANCING ACTIVITIES
Net Increase in Deposits
678,326
262,376
221,584
Net Decrease in Federal Funds Purchased
-
(18,000)
(5,000)
Principal Payments on Notes Payable
(2,000)
(2,000)
(2,000)
Proceeds from FHLB Advances
100,000
42,500
70,000
Principal Payments on FHLB Advances
(179,000)
(30,000)
(14,000)
Issuance of Subordinated Debt, Net of Issuance Costs
48,783
-
-
Stock Options Exercised
Issuance of Common Stock
-
-
58,857
Stock Repurchases
(10,334)
(14,959)
-
Shares Repurchased for Tax Withholdings Upon Vesting of Restricted Stock-Based Awards
(39)
-
-
Net Cash Provided by Financing Activities
636,053
240,175
329,547
NET CHANGE IN CASH AND CASH EQUIVALENTS
128,740
3,491
4,719
Cash and Cash Equivalents Beginning
31,935
28,444
23,725
Cash and Cash Equivalents Ending
$
160,675
$
31,935
$
28,444
SUPPLEMENTAL CASH FLOW DISCLOSURE
Cash Paid for Interest
$
27,004
$
29,367
$
19,987
Cash Paid for Income Taxes
10,723
7,625
7,865
Loans Transferred to Foreclosed Assets
1,258
-
Premises and Equipment Transferred to Other Assets
-
-
Net Investment Securities Purchased but Not Settled
-
14,673
-
See accompanying notes to consolidated financial statements.
Bridgewater Bancshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(dollars in thousands, except share data)
Note 1: Description of the Business and Summary of Significant Accounting Policies
Organization
Bridgewater Bancshares, Inc. (the “Company”) is a financial holding company headquartered in St. Louis Park, Minnesota, 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, Inc. was incorporated in December 2016 as a wholly-owned insurance company subsidiary of the 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.
Principles of Consolidation
The 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.
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, or 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. Management cannot predict if investors will find the Company’s common stock less attractive because it will rely on these exemptions. If some investors find the Company’s common stock less attractive as a result, there may be a less active trading market for its common stock and the Company’s stock price may be more volatile.
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.
Cash and Cash Equivalents
For purpose of the consolidated statements of cash flows, cash and cash equivalents include cash, both interest bearing and noninterest bearing balances due from banks and federal funds sold, all of which mature within 90 days. Cash flows from loans and deposits are reported net.
Bank-Owned Certificates of Deposit
Bank-owned certificates of deposit mature within five years and are carried at cost.
Securities Available for Sale
Debt securities are classified as available for sale and are carried at fair value with unrealized gains and losses reported in other comprehensive income (loss). Realized gains and losses on securities available for sale are included in noninterest income and, when applicable, are reported as a reclassification adjustment, net of tax, in other comprehensive income (loss). Gains and losses on sales of securities are determined using the specific identification method on the trade date. The amortization of premiums and accretion of discounts are recognized in interest income using methods approximating the interest method over the period to maturity.
Declines in the fair value of individual available for sale securities below their cost that are other than temporary result in write-downs of the individual securities to the fair value. The Company monitors the investment securities portfolio for impairment on an individual security basis and has a process in place to identify securities that could potentially have a credit impairment that is other than temporary. This process involves analyzing 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 near-term prospects of the issuer, expected cash flows, and the Company’s intent and ability to hold the investment for a period of time sufficient to recover the temporary loss. The ability to hold is determined by whether it is more likely than not that the Company will be required to sell the security before its anticipated recovery. A decline in value due to a credit event that is considered other than temporary is recorded as a loss in noninterest income.
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid balances adjusted for charge-offs, the allowance for loan losses, any deferred fees or costs on originated loans, and premiums or discounts on purchased loans.
Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, as well as premiums and discounts, are deferred and recognized as an adjustment of the related loan yield using the interest method. Amortization of deferred loan fees is discontinued when a loan is placed on nonaccrual status.
The accrual of interest on all loans is discounted if the loan is 90 days past due unless the credit is well-secured and in process of collection. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued, but not collected for loans that are placed on nonaccrual or charged-off is reversed against interest income and amortization of related deferred loan fees or costs is suspended. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. The cash-basis is used when a determination has been made that the principal and interest of the loan is collectible. If collectability of the principal and interest is in doubt, payments are applied to loan principal. The determination of ultimate collectability is supported by a current, well documented credit evaluation of the borrower’s financial condition and prospects for repayment, including consideration of the borrower’s sustained historical repayment performance and other relevant factors. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current, the borrower has demonstrated a period of sustained performance, and future payments are reasonably assured. A sustained period of repayment performance generally would be a minimum of six months.
Allowance for Loan Losses
The allowance for loan losses (the “allowance”) is an estimate of loan losses inherent in the Company’s loan portfolio. The allowance is established through a provision for loan losses which is charged to expense. Additions to the allowance are expected to maintain the adequacy of the total allowance after loan losses and loan growth. Loan losses are charged-off against the allowance when the Company determines all or a portion of the loan balance to be uncollectible. Cash received on previously charged-off amounts is recorded as a recovery to the allowance.
The allowance consists of three primary components, general reserves, specific reserves related to impaired loans, and unallocated reserves. The general component covers nonimpaired loans and is based on historical losses adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent five years. This actual loss experience is adjusted for economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; trends in volume and terms of loans; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions, including uncertainty related to effects of the COVID-19 pandemic; industry conditions; COVID-19 pandemic related modifications; and effects of change in credit concentrations. These factors are inherently subjective and are driven by the repayment risk associated with each portfolio segment.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Loans determined to be impaired are individually evaluated for impairment. 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. The fair value of collateral, reduced by costs to sell on a discounted basis, is used if a loan is collateral dependent. A loan is collateral dependent if the repayment is expected to be provided solely by the underlying collateral.
Allowance allocations other than general and specific reserves are included in the unallocated portion. While allocations are made for loans and leases based upon historical loss analysis, the unallocated portion is designed to cover the uncertainty of how current economic conditions and other uncertainties may impact the existing loan portfolio. Factors to consider include global, national and state economic conditions such as changes in unemployment rates and productivity, geopolitical tensions, monetary and fiscal policy uncertainty, political gridlock, and real estate market trends. The unallocated reserve addresses inherent probable losses not included elsewhere in the allowance for loan losses.
Under certain circumstances, the Company will provide borrowers relief through loan restructurings. A restructuring of debt constitutes a troubled debt restructuring (TDR) if the Company, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. Restructured loans typically present an elevated level of credit risk as the borrowers are not able to perform according to the original contractual terms. Loans that are reported as TDRs are considered impaired and measured for impairment as described above in the calendar year of the restructuring. In subsequent years, a restructured loan may cease being classified as impaired if the loan was modified at a market rate and is performing according to the modified terms. TDR concessions can include reduction of interest rates, extension of maturity dates, forgiveness of principal or interest due, or acceptance of other assets in full or partial satisfaction of the debt. Restructured loans can involve loans remaining on nonaccrual, moving to nonaccrual, or continuing on accrual status, depending on the individual facts and circumstances of the borrower. Nonaccrual restructured loans are included with other nonaccrual loans.
The Coronavirus Aid, Relief and Economic Security Act, or, CARES Act, signed into law on March 27, 2020, included provisions that provide temporary relief from TDR accounting for certain types of modifications. Under these provisions, modifications deemed to be COVID-19-related would not be considered a TDR if the loan was not more than 30 days past due as of December 31, 2019 and the deferral was executed between March 1, 2020 and the earlier of 60 days after the date of termination of the COVID-19 national emergency or December 31, 2020. The termination of these provisions was extended, to the earlier of 60 days after the COVID-19 national emergency date or January 1, 2022, by the Consolidated Appropriations Act, 2021. The banking regulators issued similar guidance, which also clarified that a COVID-19-related modification should not be considered a TDR if the borrower was current on payments at the time the underlying loan modification program was implemented and if the modification was considered to be short-term. Modifications are first evaluated for eligibility under the CARES Act, then the interagency guidance if they do not qualify for the CARES Act relief. Modifications that are not eligible for either program continue to follow the Company’s established TDR policy. Additionally, loans with deferrals granted due to COVID-19 are not generally reported as past due or nonaccrual.
The Company assigns risk ratings to all loans and periodically performs detailed internal reviews of all such loans over a certain threshold to identify credit risks and to assess the overall collectability of the portfolio. These risk ratings are also subject to examination by the Company’s regulators. During the internal reviews, management monitors and analyzes the financial condition of borrowers and guarantors, trends in the industries in which the borrowers operate, and the fair values of collateral securing the loans. These credit quality indicators are used to assign a risk rating to each individual loan. The risk ratings can be grouped into five major categories defined as follows:
Pass: A pass loan is a credit with no known or existing potential weaknesses deserving of management’s close attention.
Watch: Loans classified as watch have a potential weakness that deserves management’s close attention. If left uncorrected, this potential weakness may result in deterioration of the repayment prospects for the loan or of the Company’s credit position at some future date. Watch loans are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.
Substandard: Loans classified as substandard are not adequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the repayment of the debt. Well defined weaknesses include a borrower’s lack of marketability, inadequate cash flow or collateral support, failure to complete construction on time, or the failure to fulfill economic expectations. They are characterized by the distinct possibility that the Company will sustain loss if the deficiencies are not corrected.
Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or repayment in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Loss: Loans classified as loss are considered uncollectible and charged-off immediately.
The Company maintains a separate general valuation allowance for each portfolio segment. These portfolio segments include commercial, Paycheck Protection Program, construction and land development, 1-4 family mortgage, multifamily, CRE owner occupied, CRE nonowner occupied, and consumer and other with risk characteristics described as follows:
Commercial: Commercial loans generally are loans to sole proprietorships, partnerships, corporations, and other business enterprises to finance accounts receivable or inventory, capital assets, or for other business related purposes. Commercial lending is not without risk as this asset class has generally exhibited higher loss rates compared to other loan types. The primary repayment sources for commercial and industrial loans are the existing cash flows of operating businesses which can be adversely affected by company, industry and economic business cycles. Economic trends influenced by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. The liquidation of collateral, typically accounts receivable, inventory, equipment, or other business assets, is the primary source of principal repayment if the borrower defaults. The value of these assets can be uncertain in a liquidation scenario.
Paycheck Protection Program: The Paycheck Protection Program, or PPP, loan segment was added by the Company starting 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 CARES Act and administered through the Small Business Administration, or SBA. PPP loans generally have two or five year terms 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.
Construction and Land Development: Construction and land development loans generally possess a higher inherent risk of loss and have experienced the highest loss rates of any loan category based on statistics published by the FDIC. Risks associated with these loans often include the borrower’s ability to complete the project within specified costs and timelines and the reliance on the sale of the completed project as the primary repayment source for the loan. Trends in the commercial and residential construction industries can significantly impact the credit quality of these loans due to supply and demand imbalances. In addition, fluctuations in real estate values can significantly impact the credit quality of these loans, as property values may determine the economic viability of construction projects and adversely impact the value of the collateral securing the loan.
1-4 Family Mortgage: The degree of risk in residential mortgage lending involving owner occupied properties depends primarily on the borrower’s ability to repay in an orderly fashion and the loan amount in relation to collateral value. Economic trends determined by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. Weak economic trends indicate that the borrower’s capacity to repay their obligations may be deteriorating. Residential mortgage lending also includes the credits to finance nonowner occupied properties used as rentals. These loans can involve additional risks as the borrower’s ability to repay is based on the net operating income from the property which can be impacted by occupancy levels, rental rates, and operating expenses. Declines in net operating income can negatively impact the value of the property which increases the credit risk in the event of default. While 1-4 family mortgage loans have historically possessed a lower inherent risk of loss than other real estate portfolio segments, this loan class was significantly impacted during the last recession due in part to weak credit underwriting and speculative lending practices which led to higher default rates and deterioration in residential real estate values.
Multifamily: Multifamily lending has historically had the lowest default rate of any loan class. Nonetheless, economic factors such as unemployment, wage growth and home affordability can impact vacancy rates and property cash flow. In addition, an overbuilt supply of multifamily units can increase competition amongst properties and could have an adverse effect on leasing rates and overall occupancy, which could result in higher default rates and possible loan losses.
CRE Owner Occupied: Owner occupied commercial real estate loans are generally reliant on a single tenant as the repayment source for the loan. The underlying business can be affected by changes in industry and economic
business cycles, unemployment and other key economic indicators, which could impact the cash flows of the business and their ability to make rental payments. Certain types of businesses also may require specialized facilities that can increase costs and may not be economically feasible to an alternative user, which could adversely impact the market value of the collateral.
CRE Nonowner Occupied: Nonowner occupied commercial real estate loans can possess a higher inherent risk of loss as the primary repayment source for these loans is based on the net operating income from the underlying property. Changes in economic and market conditions can affect different segments of commercial real estate by impacting overall leasing rates, absorption timelines, vacancy rates, and operating expenses. Banks which are concentrated in commercial real estate lending are subject to additional regulatory scrutiny and must employ enhanced risk management practices.
Consumer and Other: The consumer and other loan portfolio is usually comprised of a large number of small loans scheduled to be amortized over a specific period. Most loans are made directly for consumer purchases. Economic trends determined by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. Weak economic trends indicate the borrowers’ capacity to repay their obligations may be deteriorating.
Although management believes the allowance to be adequate, ultimate losses may vary from its estimates. At least quarterly, the Board of Directors reviews the adequacy of the allowance, including consideration of the relevant risks in the portfolio, current economic conditions, and other factors. If the Board of Directors and management determine that changes are warranted based on those reviews, the allowance is adjusted. In addition, the Company’s regulators assess the adequacy of the allowance from time to time. The regulatory agencies may require adjustments to the allowance based on their judgement about information available at the time of their review and examinations.
Off-Balance Sheet Instruments
In the ordinary course of business, the Company has entered into off-balance sheet instruments including commitments to extend credit and unfunded commitments under lines of credit, standby letters of credit, and commercial letters of credit. Such financial instruments are recorded in the consolidated financial statements when they become payable. The Company maintains a separate allowance for off-balance sheet commitments. Management estimates anticipated losses using historical data and utilization assumptions. The allowance for off-balance sheet commitments is included in other liabilities.
Federal Home Loan Bank Stock
The Bank is a member of FHLB Des Moines. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. Restricted stock is carried at cost and periodically evaluated for impairment. Because this stock is viewed as a long-term investment, impairment is based on ultimate recovery at par value. Both cash and stock dividends are reported as income.
Premises and Equipment
Land is stated at cost. Premises and equipment are stated at cost less accumulated depreciation on the straight-line method over the estimated useful lives of the assets. Leasehold improvements are depreciated over the shorter of the estimated useful life or lease term for leasehold improvements. Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized. Gains and losses on dispositions are included in current operations.
Foreclosed Assets
Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less estimated selling cost at the date of foreclosure, establishing a new cost basis. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance. Subsequent to foreclosure, valuations are periodically performed by management and the assets held for sale are carried at the lower of the new cost basis or fair value less cost
to sell. This evaluation is inherently subjective and requires estimates that are susceptible to significant revisions as more information becomes available.
Impairment losses on assets to be held and used are measured at the amount by which the carrying amount of a property exceeds its fair value. Costs relating to holding and improving assets are expensed. Revenues and expenses from operations are included in other noninterest income and expense on the income statement.
Goodwill and Intangible Assets
Intangible assets attributed to the value of core deposits and favorable lease terms are stated at cost less accumulated amortization and reported in other intangible assets in the consolidated balance sheets. Intangible assets are amortized on a straight-line basis over the estimated lives of the assets.
The excess of purchase price over fair value of net assets acquired is recorded as goodwill and is not amortized.
The Company evaluates whether goodwill and other intangible assets may be impaired at least annually and whenever events or changes in circumstances indicate it is more likely than not the fair value of the reporting unit or asset is less than its carrying amount.
Transfers of Financial Assets and Participating Interests
Transfers of an entire financial asset or a participating interest in an entire financial asset are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before maturity.
The transfer of a participating interest in an entire financial asset must also meet the definition of a participating interest. A participating interest in a financial asset has all of the following characteristics: (1) from the date of transfer, it must represent a proportionate (pro rata) ownership interest in the financial asset, (2) from the date of transfer, all cash flows received, except any cash flows allocated as any compensation for servicing or other services performed, must be divided proportionately among participating interest holders in the amount equal to their share ownership, (3) the rights of each participating interest holder must have the same priority, and (4) no party has the right to pledge or exchange the entire financial asset unless all participating interest holders agree to do so.
Advertising
Advertising costs are expensed as incurred.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. 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. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
These calculations are based on many factors including estimates of the timing of reversals of temporary differences, the interpretation of federal and state income tax laws, and a determination of the differences between the tax and the financial reporting basis of assets and liabilities. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income tax liabilities.
Under GAAP, a valuation allowance is required to be recognized if it is “more likely than not” that the deferred tax asset will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and
dependent upon judgment concerning management’s evaluation of both positive and negative evidence, the forecasts of future income, applicable tax planning strategies, and assessments of the current and future economic and business conditions.
In preparation of the income tax returns, tax positions are taken based on interpretation of federal and state income tax laws. Management periodically reviews and evaluates the status of uncertain tax positions and makes estimates of amounts ultimately due or owed. The Company can recognize in financial statements the impact of a tax position taken, or expected to be taken, if it is more likely than not that the position will be sustained on audit based on the technical merit of the position. The Company recognizes both interest and penalties as a component of other noninterest expense.
The amount of the uncertain tax positions was not deemed to be material. It is not expected that the unrecognized tax benefit will be material within the next 12 months. The Company did not recognize any interest or penalties for the years ended December 31, 2020, 2019 and 2018.
The Company is no longer subject to federal or state tax examination by tax authorities for years ending before December 31, 2017.
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. These investments are included in other assets on the balance sheet, with any unfunded commitments included within other liabilities. The qualified affordable housing projects are accounted for under the proportional amortization method. Under the proportional amortization method, the initial cost of the investment is recognized over the period that the Company expects to receive the tax credits, with the expense included within income tax expense on the consolidated statements of income. The historic tax credits are accounted for under the equity method, with the expense included within noninterest expense on the consolidated statements of income. Management analyzes these investments for potential impairment when events or changes in circumstances indicate that it is more likely than not that the carrying amount of the investment will not be realized. An impairment loss is measured as the amount by which the carrying amount of an investment exceeds its fair value.
Comprehensive Income (Loss)
Recognized revenue, expenses, gains, and losses are included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on securities available for sale and changes in the fair value of derivative instruments designated as a cash flow hedge, are reported as a separate component of the equity section of the consolidated balance sheets, such items, along with net income, are components of comprehensive income (loss).
Derivative Financial Instruments
The Company uses derivative financial instruments, which consist of interest rate swaps and interest rate caps, to assist in its interest rate risk management. All derivatives are measured and reported at fair value on the Company’s consolidated balance sheet as other assets or other liabilities. The accounting for changes in fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship. If the derivative instrument is not designated as a hedge, changes in the fair value of the derivative instrument are recognized in earnings, specifically in noninterest income.
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. and international financial institutions in order to minimize the risk to the Company. These swaps are derivatives, but are not designated as hedging instruments.
Cash flow hedges represent a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability. The Company prepares written hedge documentation for all derivatives
which are designed as hedges. The written hedge documentation includes identification of, among other items, the risk management objective, hedging instrument, hedged item and methodologies for assessing and measuring hedge effectiveness and ineffectiveness, along with support for management's assertion that the hedge will be highly effective. Assessments of hedge effectiveness and measurements of hedge ineffectiveness are performed at least quarterly. For a cash flow hedge that is effective, the gain or loss on the derivative is reported as a component in other comprehensive income and is reclassified into earnings in the same periods during which the hedged transaction affects earnings. The changes in the fair value of derivatives that are not highly effective in hedging the changes in expected cash flows of the hedged item are recognized immediately in current earnings. To determine fair value, the Company uses third party pricing models that incorporate assumptions about market conditions and risks that are current at the reporting date. The Company does not use derivative instruments for trading or speculative purposes.
Net cash settlements on derivatives that qualify for hedge accounting are recorded in interest income or interest expense, based on the item being hedged. Net cash settlements on derivatives that do not qualify for hedge accounting are reported in noninterest income.
Hedge accounting discontinues on transactions that are no longer deemed effective, or for which the derivative has been terminated or de-designated. When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as noninterest income. When a cash flow hedge is discontinued but the hedged cash flows or forecasted transaction is still expected to occur, changes in value that were accumulated in other comprehensive income are amortized or accreted into earnings over the same periods which the hedged transactions will affect earnings.
Stock-based Compensation
The Company’s stock-based compensation plans provide for awards of stock options and restricted stock to directors, officers and employees. The cost of employee services received in exchange for awards of equity instruments is based on the grant-date fair value of those awards. Compensation cost is recognized over the requisite service period as a component of compensation expense. Compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. Forfeitures are recognized as they occur. The Company uses the Black-Scholes model to estimate the fair value of stock options, while the market price of the Company’s common stock at the date of grant is used for restricted stock awards and restricted stock units.
Compensating Balances
The Bank is required to maintain average balances with the Federal Reserve Bank. The Bank has implemented a deposit reclassification program which allows the Bank to reclassify a portion of transaction accounts to nontransaction accounts for reserve purposes. The deposit reclassification program was provided by a third-party vendor, and has been approved by the Federal Reserve Bank. At December 31, 2020, and 2019, the Bank was subject to maintaining an average balance of $-0- and $776.
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 share are calculated by dividing net income by the weighted average number of shares adjusted for the dilutive effect of stock compensation using the treasury stock method.
Segment Reporting
All of the Company’s operations are considered by management to be one operating segment.
Reclassifications
Certain reclassifications have been made to the 2019 consolidated financial statements to conform to the 2020 classifications.
Impact of Recently Adopted Accounting Guidance
In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The amendments in this 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 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.
In March 2017, the FASB issued ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The amendments in this ASU shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount as discounts continue to be accreted to maturity. This ASU is intended to more closely align the amortization period of premiums and discounts to expectations incorporated in market pricing on the underlying securities. In most cases, market participants price securities to the call date that produces the worst yield when the coupon is above current market rates and prices securities to maturity when the coupon is below market rates. As a result, the amendments more closely align interest income recorded on bonds held at a premium or a discount with the economics of the underlying instrument. The Company adopted the accounting standard during 2020. The adoption of the standard did not have a material impact on the Company's consolidated financial statements.
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The amendments of this ASU better align an entity’s accounting and financial reporting for hedging activities with the economic objectives of those activities. The Company adopted the accounting standard during 2020. The adoption of the standard did not have a material impact on the Company's consolidated financial statements.
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 the accounting standard during 2020. The adoption of the 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 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. This guidance was extended by the 2021 Consolidated Appropriations Act. This new legislation extends the relief to financial institutions to suspend TDR assessment and reporting requirements under GAAP for loan modifications to the earlier of 60 days after the national emergency termination date or January 1, 2022.
Impact of Recently Issued Accounting Standards
The following ASUs have been issued by FASB and may impact the Company’s consolidated financial statements in future reporting periods.
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.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (modified by ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments Credit Losses, ASU 2019-05, Financial Instruments Credit Losses - Targeted Transition Relief, and ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments - Credit Losses). The amendments in this ASU affect all entities that measure credit losses on financial instruments including loans, debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, reinsurance receivables, and any other
financial asset that has a contractual right to receive cash that is not specifically excluded. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this ASU replace the incurred loss impairment methodology required in current GAAP with a methodology that reflects expected credit losses that requires consideration of a broader range of reasonable and supportable information to estimate credit losses. The amendments in this ASU will affect entities to varying degrees depending on the credit quality of the assets held by the entity, the duration of the assets held, and how the entity applies the current incurred loss methodology. In November 2019, the FASB issued ASU 2019-10, Financial Instruments - Credit Losses (Topic 326), Derivatives and Hedging (815), and Leases (Topic 842) - Effective Dates. This ASU amended the effective date of ASU 2016-13 for smaller reporting companies and non-SEC reporting entities. The amendment delays the effective date to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. As an emerging growth company, the Company can take advantage of this delay.
All entities may adopt the amendments in the ASU as early as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Amendments should be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. The Company has contracted with a third party to develop a model to comply with CECL requirements. The Company has established a steering committee with representation from various departments across the enterprise. The Company is currently evaluating the impact the new standard will have on the its consolidated financial statements.
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This ASU aims to simplify the accounting for income taxes by removing certain exceptions to the general principles and also simplification of areas such as franchise taxes, step-up in tax basis goodwill, separate entity financial statements and interim recognition of enactment of tax laws or rate changes. 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 is currently evaluating the potential impact this guidance will have on the consolidated financial statements.
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, a portion of its subordinated debt, various investment securities, and approximately 9.0% of the Company’s loans as of December 31, 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.
Subsequent Events
Subsequent events have been evaluated through March 11, 2021, which is the date the consolidated financial statements were available to be issued.
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 years ended December 31, 2020, 2019 and 2018, 732,433, 303,000, and 130,000, respectively, of stock options, restricted stock awards and restricted stock units were excluded from the calculation because they were deemed to be antidilutive.
The following table presents the numerators and denominators for basic and diluted earnings per share computations for the years ended December 31, 2020, 2019 and 2018:
Year Ended December 31,
Net Income Available to Common Shareholders
$
27,194
$
31,403
$
26,920
Weighted Average Common Stock Outstanding:
Weighted Average Common Stock Outstanding (Basic)
28,582,064
29,358,644
29,001,393
Dilutive Effect of Stock Compensation
588,156
638,132
434,821
Weighted Average Common Stock Outstanding (Dilutive)
29,170,220
29,996,776
29,436,214
Basic Earnings per Common Share
$
0.95
$
1.07
$
0.93
Diluted Earnings per Common Share
0.93
1.05
0.91
Note 3: Bank-Owned Certificates of Deposit
Certificates of deposit in other financial institutions by maturity are as follows:
Certificates of Deposit at Cost Maturing in:
One Year or Less
$
$
1,229
After One Year Through Five Years
1,880
1,425
$
2,860
$
2,654
Note 4: Securities
The following tables present the amortized cost and estimated fair value of securities with gross unrealized gains and losses at December 31, 2020 and 2019:
December 31, 2020
Gross
Gross
Amortized
Unrealized
Unrealized
Cost
Gains
Losses
Fair Value
Securities Available for Sale:
Municipal Bonds
105,975
9,373
(336)
115,012
Mortgage-Backed Securities
123,395
2,029
(1,164)
124,260
Corporate Securities
71,116
1,240
(201)
72,155
SBA Securities
40,455
(380)
40,107
Asset-Backed Securities
38,135
(16)
39,095
Total Securities Available for Sale
$
379,076
$
13,650
$
(2,097)
$
390,629
December 31, 2019
Gross
Gross
Amortized
Unrealized
Unrealized
Cost
Gains
Losses
Fair Value
Securities Available for Sale:
U.S. Treasury Securities
$
4,990
$
$
-
$
4,998
Municipal Bonds
99,441
6,338
(36)
105,743
Mortgage-Backed Securities
64,312
(281)
64,728
Corporate Securities
49,674
(131)
50,176
SBA Securities
50,126
(602)
49,559
Asset-Backed Securities
14,673
-
-
14,673
Total Securities Available for Sale
$
283,216
$
7,711
$
(1,050)
$
289,877
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 December 31, 2020 and 2019:
Less Than 12 Months
12 Months or Greater
Total
Unrealized
Unrealized
Unrealized
Fair Value
Losses
Fair Value
Losses
Fair Value
Losses
December 31, 2020
Municipal Bonds
$
12,023
$
(329)
$
$
(7)
$
12,246
$
(336)
Mortgage-Backed Securities
45,120
(1,163)
1,699
(1)
46,819
(1,164)
Corporate Securities
23,643
(131)
2,430
(70)
26,073
(201)
SBA Securities
3,288
(3)
28,193
(377)
31,481
(380)
Asset-Backed Securities
2,471
(16)
-
-
2,471
(16)
Total Securities Available for Sale
$
86,545
$
(1,642)
$
32,545
$
(455)
$
119,090
$
(2,097)
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 December 31, 2020, 150 debt securities had unrealized losses with aggregate depreciation of approximately 1.7% 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 December 31, 2020.
The following table 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 December 31, 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.
December 31, 2020
Amortized Cost
Fair Value
Due in One Year or Less
$
6,949
$
6,985
Due After One Year Through Five Years
58,476
60,244
Due After Five Years Through 10 Years
92,936
98,500
Due After 10 Years
18,730
21,438
Subtotal
177,091
187,167
Mortgage-Backed Securities
123,395
124,260
SBA Securities
40,455
40,107
Asset-Backed Securities
38,135
39,095
Totals
$
379,076
$
390,629
As of December 31, 2020 and 2019, the securities portfolio was unencumbered.
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 years ended December 31, 2020 and 2019:
Proceeds From Sales of Securities
$
40,862
$
42,864
$
24,684
Gross Gains on Sales
1,592
Gross Losses on Sales
(89)
(258)
(415)
Note 5: Loans
The following table presents the components of the loan portfolio at December 31, 2020 and 2019:
December 31,
December 31,
Commercial
$
304,220
$
276,035
Paycheck Protection Program
138,454
-
Construction and Land Development
170,217
196,776
Real Estate Mortgage:
1-4 Family Mortgage
294,479
260,611
Multifamily
626,465
515,014
CRE Owner Occupied
75,604
66,584
CRE Nonowner Occupied
709,300
592,545
Total Real Estate Mortgage Loans
1,705,848
1,434,754
Consumer and Other
7,689
4,473
Total Loans, Gross
2,326,428
1,912,038
Allowance for Loan Losses
(34,841)
(22,526)
Net Deferred Loan Fees
(9,151)
(5,512)
Total Loans, Net
$
2,282,436
$
1,884,000
The following table presents the activity in the allowance for loan losses, by segment, for the years ended December 31, 2020, 2019 and 2018:
Paycheck
Construction
CRE
CRE
Protection
and Land
1-4 Family
Owner
Nonowner
Consumer
Commercial
Program
Development
Mortgage
Multifamily
Occupied
Occupied
and Other
Unallocated
Total
Balance at January 1, 2018
$
2,435
$
-
$
1,892
$
2,317
$
3,170
$
$
5,087
$
$
16,502
Provision for Loan Losses
-
1,474
(148)
3,575
Loans Charged-off
(10)
-
(358)
(21)
-
-
-
(32)
-
(421)
Recoveries of Loans
-
-
-
-
-
Balance at December 31, 2018
$
2,898
$
-
$
2,451
$
2,597
$
4,644
$
$
5,872
$
$
20,031
Provision for Loan Losses
-
(250)
1,180
(16)
1,100
2,700
Loans Charged-off
(160)
-
-
(195)
-
-
-
(33)
-
(388)
Recoveries of Loans
-
-
-
-
-
Balance at December 31, 2019
$
3,058
$
-
$
2,202
$
2,839
$
5,824
$
$
6,972
$
$
$
22,526
Provision for Loan Losses
2,984
1,223
3,693
4,019
(22)
12,750
Loans Charged-off
(346)
-
-
(144)
-
-
-
(27)
-
(517)
Recoveries of Loans
-
-
-
-
-
Balance at December 31, 2020
$
5,703
$
$
2,491
$
3,972
$
9,517
$
1,162
$
10,991
$
$
$
34,841
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 December 31, 2020 and 2019:
Paycheck
Construction
CRE
CRE
Protection
and Land
1--4 Family
Owner
Nonowner
Consumer
Allowance for Loan Losses at December 31, 2020
Commercial
Program
Development
Mortgage
Multifamily
Occupied
Occupied
and Other
Unallocated
Total
Individually Evaluated for Impairment
$
$
-
$
-
$
-
$
-
$
-
$
-
$
$
-
$
Collectively Evaluated for Impairment
5,666
2,491
3,972
9,517
1,162
10,991
34,791
Totals
$
5,703
$
$
2,491
$
3,972
$
9,517
$
1,162
$
10,991
$
$
$
34,841
Allowance for Loan Losses at December 31, 2019
Individually Evaluated for Impairment
$
$
-
$
-
$
-
$
-
$
-
$
-
$
$
-
$
Collectively Evaluated for Impairment
3,027
-
2,202
2,839
5,824
6,972
22,481
Totals
$
3,058
$
-
$
2,202
$
2,839
$
5,824
$
$
6,972
$
$
$
22,526
Paycheck
Construction
CRE
CRE
Protection
and Land
1--4 Family
Owner
Nonowner
Consumer
Loans at December 31, 2020
Commercial
Program
Development
Mortgage
Multifamily
Occupied
Occupied
and Other
Total
Individually Evaluated for Impairment
$
$
-
$
$
1,498
$
-
$
$
12,388
$
$
15,164
Collectively Evaluated for Impairment
303,981
138,454
170,061
292,981
626,465
74,734
696,912
7,676
2,311,264
Totals
$
304,220
$
138,454
$
170,217
$
294,479
$
626,465
$
75,604
$
709,300
$
7,689
$
2,326,428
Loans at December 31, 2019
Individually Evaluated for Impairment
$
$
-
$
$
1,059
$
-
$
$
-
$
$
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
The following table presents information regarding total carrying amounts and total unpaid principal balances of impaired loans by loan segment as of December 31, 2020 and 2019:
December 31, 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
$
$
$
-
$
$
$
-
Construction and Land Development
-
-
Real Estate Mortgage:
HELOC and 1-4 Family Junior Mortgage
-
-
1st REM - Rentals
-
-
CRE Owner Occupied
-
-
CRE Nonowner Occupied
12,388
12,388
-
-
-
-
Totals
15,034
15,641
-
1,638
2,434
-
Loans With An Allowance for Loan Losses:
Commercial
Consumer and Other
Totals
Grand Totals
$
15,164
$
15,774
$
$
1,758
$
2,557
$
The following table presents information regarding the average balances and interest income recognized on impaired loans by loan segment for the years ended December 31, 2020, 2019 and 2018:
Year Ended December 31,
Year Ended December 31,
Year Ended December 31,
Average
Interest
Average
Interest
Average
Interest
Investment
Recognized
Investment
Recognized
Investment
Recognized
Loans With No Related Allowance for Loan Losses:
Commercial
$
$
$
$
$
-
$
-
Construction and Land Development
-
-
-
Real Estate Mortgage:
HELOC and 1-4 Family Junior Mortgage
1st REM - 1-4 Family
-
-
-
-
1st REM - Rentals
CRE Owner Occupied
CRE Nonowner Occupied
12,334
-
-
-
-
Consumer and Other
-
-
-
-
-
Totals
14,983
1,732
1,890
Loans With An Allowance for Loan Losses:
Commercial
-
Real Estate Mortgage:
HELOC and 1-4 Family Junior Mortgage
-
-
-
-
-
Multifamily
-
-
-
-
CRE Owner Occupied
-
-
-
-
Consumer and Other
-
-
Totals
Grand Totals
$
15,118
$
$
1,885
$
$
2,445
$
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 ratings is ongoing through routine monitoring of the portfolio and annual internal credit reviews for credits meeting certain thresholds.
The following tables present the risk category of loans by loan segment as of December 31, 2020 and 2019, based on the most recent analysis performed by management:
December 31, 2020
Pass
Watch
Substandard
Total
Commercial
$
289,465
$
14,516
$
$
304,220
Paycheck Protection Program
138,454
-
-
138,454
Construction and Land Development
170,061
-
170,217
Real Estate Mortgage:
HELOC and 1-4 Family Junior Mortgage
29,396
-
30,280
1st REM - 1-4 Family
41,239
-
41,942
LOCs and 2nd REM - Rentals
20,678
-
-
20,678
1st REM - Rentals
200,965
-
201,579
Multifamily
626,465
-
-
626,465
CRE Owner Occupied
74,734
-
75,604
CRE Nonowner Occupied
667,336
29,576
12,388
709,300
Consumer and Other
7,676
-
7,689
Totals
$
2,266,469
$
44,795
$
15,164
$
2,326,428
December 31, 2019
Pass
Watch
Substandard
Total
Commercial
$
275,741
$
$
$
276,035
Construction and Land Development
196,462
196,776
Real Estate Mortgage:
HELOC and 1-4 Family Junior Mortgage
28,483
-
28,621
1st REM - 1-4 Family
36,370
36,671
LOCs and 2nd REM - Rentals
17,890
18,671
1st REM - Rentals
174,781
1,287
176,648
Multifamily
515,014
-
-
515,014
CRE Owner Occupied
65,411
-
1,173
66,584
CRE Nonowner Occupied
589,457
3,088
-
592,545
Consumer and Other
4,459
-
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 December 31, 2020 and 2019:
Accruing Interest
30-89 Days
90 Days or
December 31, 2020
Current
Past Due
More Past Due
Nonaccrual
Total
Commercial
$
304,211
$
$
-
$
$
304,220
Paycheck Protection Program
138,454
-
-
-
138,454
Construction and Land Development
170,061
-
-
170,217
Real Estate Mortgage:
HELOC and 1-4 Family Junior Mortgage
30,280
-
-
-
30,280
1st REM - 1-4 Family
41,942
-
-
-
41,942
LOCs and 2nd REM - Rentals
20,668
-
-
20,678
1st REM - Rentals
201,579
-
-
-
201,579
Multifamily
626,465
-
-
-
626,465
CRE Owner Occupied
74,991
-
-
75,604
CRE Nonowner Occupied
709,300
-
-
-
709,300
Consumer and Other
7,689
-
-
-
7,689
Totals
$
2,325,640
$
$
-
$
$
2,326,428
Accruing Interest
30-89 Days
90 Days or
December 31, 2019
Current
Past Due
More Past Due
Nonaccrual
Total
Commercial
$
276,028
$
-
$
-
$
$
276,035
Construction and Land Development
196,600
-
-
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
-
-
18,671
1st REM - Rentals
176,114
-
176,648
Multifamily
515,014
-
-
-
515,014
CRE Owner Occupied
66,584
-
-
-
66,584
CRE Nonowner Occupied
592,545
-
-
-
592,545
Consumer and Other
4,470
-
-
4,473
Totals
$
1,911,174
$
$
-
$
$
1,912,038
At December 31, 2020, there were three loans classified as troubled debt restructurings with a current outstanding balance of $421. In comparison, at December 31, 2019, there were three loans classified as troubled debt
restructurings with an outstanding balance of $452. There were no new loans classified as troubled debt restructurings during the year ended December 31, 2020 and no loans classified as troubled debt restructurings during the previous twelve months that subsequently defaulted during the year ended December 31, 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 active loan modifications made in response to the COVID-19 pandemic, by loan segment and modification type, as of December 31, 2020:
Interest-Only
Payment Deferral
Extended Amortization
Total
(dollars in thousands)
Amount
# of Loans
Amount
# of Loans
Amount
# of Loans
Amount
# of Loans
Commercial
$
5,212
$
-
-
$
4,834
$
10,046
Real Estate Mortgage:
1 - 4 Family Mortgage
-
-
-
-
Multifamily
23,636
-
-
-
-
23,636
CRE Owner Occupied
-
-
-
-
CRE Nonowner Occupied
32,209
-
-
-
-
32,209
Totals
$
61,105
$
$
4,834
$
66,552
Note 6: Premises and Equipment
Premises and equipment are summarized as follows for the years ended December 31, 2020 and 2019:
Range of
December 31,
Useful Lives
Land
N/A
$
5,174
$
5,174
Building
15 - 39 Years
41,025
3,487
Leasehold Improvements
3 - 10 Years
2,538
3,344
Furniture and Equipment
2 - 5 Years
6,160
3,902
Construction in Progress
N/A
-
16,693
Subtotal
54,897
32,600
Accumulated Depreciation
(3,910)
(4,972)
Totals
$
50,987
$
27,628
Depreciation and amortization expense charged to noninterest expense for the years ended December 31, 2020, 2019 and 2018, totaled $1,206, $1,008 and $761, 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.
Pursuant to the terms of non-cancelable lease agreements in effect at December 31, 2020, pertaining to banking premises in Bloomington, Downtown Minneapolis, St. Paul and Uptown Minneapolis (Drive-Up), total future minimum rent commitments under the leases are as follows:
$
Thereafter
Total
$
2,444
Rent expense, including common area maintenance pertaining to banking premises for the years ended December 31, 2020, 2019 and 2018, totaled $1,178, $1,264 and $870, respectively.
The Bloomington, Downtown Minneapolis and St. Paul leases each contain two consecutive options to extend the lease for a period of five years each. The Uptown Minneapolis (Drive-Up) contains one option to extend the lease for a period of five years. The monthly minimum rent payable will be at a market rate as reasonably determined by the lessor.
The Greenwood location is leased pursuant to the terms of a non-cancelable lease agreement with Bridgewater Properties Greenwood, LLC, a related party through common ownership, in effect at December 31, 2020. The lease contains one option to extend the lease for a period of five years. Future minimum rent commitments under the operating lease are listed below.
$
Thereafter
Total
$
The Company receives rents from the lease of office and retail space in its corporate headquarters building. Rental income is included in noninterest expense as an offset to rental expense. Future minimum rental income under these leases are listed below.
$
Thereafter
1,218
Total
$
3,692
Note 7: Intangible Assets
The following table presents a summary of intangible assets at December 31, 2020 and 2019:
December 31,
Core Deposit Intangible
$
1,093
$
1,093
Favorable Lease
Subtotal
1,538
1,538
Accumulated Amortization
(868)
(677)
Totals
$
$
Amortization expense of intangible assets was $191 for the years ended December 31, 2020, 2019 and 2018.
The following table presents the estimated future amortization of the core deposit intangible and favorable lease asset for the next five years and thereafter. The projections of amortization expense are based on existing asset balances as of December 31, 2020.
Core Deposit
Favorable
Intangible
Lease
$
$
-
-
Thereafter
-
Totals
$
$
Note 8: Deposits
The following table presents the composition of deposits at December 31, 2020 and 2019:
December 31,
Transaction Deposits
$
1,038,193
$
712,136
Savings and Money Market Deposits
657,617
516,785
Time Deposits
353,543
360,027
Brokered Deposits
452,283
234,362
Totals
$
2,501,636
$
1,823,310
Brokered deposits contain brokered money market accounts of $159,665 and $2,443 as of December 31, 2020 and 2019, respectively.
The following table presents the scheduled maturities of brokered and customer time deposits at December 31, 2020:
Less than 1 Year
$
338,261
1 to 2 Years
51,455
2 to 3 Years
63,018
3 to 4 Years
84,964
4 to 5 Years
108,463
Totals
$
646,161
The aggregate amount of time deposits greater than $250 was approximately $96,102 and $118,318 at December 31, 2020 and 2019, respectively.
Note 9: Notes Payable
During 2016, the Company entered into a note payable with an unaffiliated financial institution that was secured by 100% of the stock of the Bank. The proceeds of the note were partially used to payoff existing notes payable. The note required interest payments monthly and principal payments of $500 quarterly. Interest was accrued at a variable rate equal to 1-month LIBOR plus 2.40% and matured in February 2021. The interest rate at December 31, 2020 and 2019, was 2.55% and 4.09%, respectively. The note contained several financial and reporting covenants. As of December 31, 2020 and 2019, the Company believes it was in compliance with all covenants. The unpaid principal balance of the note at December 31, 2020 and 2019, was $11,000 and $13,000, respectively.
Note 10: Derivative Instruments and Hedging Activities
The Company uses derivative financial instruments, which consist of interest rate swaps and interest rate caps, 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.
The following table presents a summary of the Company’s interest rate swaps to facilitate customer transactions as of December 31, 2020 and 2019:
December 31, 2020
December 31, 2019
Notional
Estimated
Notional
Estimated
Amount
Fair Value
Amount
Fair Value
Interest rate swap agreements:
Assets
$
49,696
$
2,701
$
7,140
$
Liabilities
49,696
(2,701)
7,140
(150)
Total
$
99,392
$
-
$
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 $868 will be reclassified to interest expense.
The following table presents a summary of the Company’s interest rate swaps designated as cash flow hedges as of December 31, 2020 and 2019:
Notional Amount
$
111,000
$
48,000
Weighted Average Pay Rate
1.26
%
1.89
%
Weighted Average Receive Rate
0.22
%
2.25
%
Weighted Average Maturity (Years)
3.95
3.53
Net Unrealized Gain (Loss)
$
(3,410)
$
(618)
During 2020, the Company purchased interest rate caps, designated as cash flow hedges, of certain deposit liabilities, with notional amounts totaling $50,000. The interest rate caps require receipt of variable amounts from the counterparties when interest rates rise above the strike price in the contracts. An initial premium of $2,689 was paid up front for the caps executed in 2020. Amortization on the interest rate caps totaled $41 and was recorded as a component of interest expense on brokered deposits for the year ended December 31, 2020. The weighted average strike rate for outstanding interest rate caps was 0.75% at December 31, 2020.
The following table presents a summary of the Company’s interest rate contracts as of December 31, 2020 and 2019:
December 31, 2020
December 31, 2019
Notional
Estimated
Notional
Estimated
Amount
Fair Value
Amount
Fair Value
Interest rate swap agreements:
Assets
$
5,000
$
$
18,000
$
Liabilities
106,000
(3,466)
30,000
(752)
Interest rate cap agreements:
Assets
50,000
2,834
-
-
The Company is party to collateral support agreements with certain derivative counterparties. These agreements require that the Company maintain collateral based on the fair values of derivative transactions. In the event of default
by the Company, the counterparty would be entitled to the collateral. As of December 31, 2020 and 2019, the Company pledged cash collateral for the Company’s derivative contracts of $8,526 and $1,404, respectively. In addition, as of December 31, 2020, the Company's interest rate cap counterparties have pledged cash collateral to the Company of $2,700.
The following table presents the effect of derivative instruments in cash flow hedging relationships on the consolidated statements of income for the year ended December 31, 2020, 2019 and 2018:
Year Ended December 31,
(dollars in thousands)
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
$
(579)
$
$
-
Interest rate caps
Interest expense
-
-
-
No amounts were reclassified from accumulated other comprehensive income into net income related to hedge ineffectiveness for these derivatives during the years ended December 31, 2020, 2019 and 2018, and no amounts are expected to be reclassified from accumulated other comprehensive income into net income related to hedge ineffectiveness over the next twelve months.
Note 11: Federal Home Loan Bank Advances and Other Borrowings
Federal Home Loan Bank Advances. The Company has entered into an Advances, Pledge, and Security Agreement with the FHLB whereby specific mortgage loans of the Bank’s with principal balances of $739,912 and $690,609 at December 31, 2020 and 2019, respectively, were pledged to the FHLB as collateral. FHLB advances are also secured with FHLB stock owned by the Company. Total remaining available capacity under the agreement was $361,236 and $209,840 at December 31, 2020 and 2019, respectively.
The following table presents FHLB advances, by maturity, at December 31, 2020 and 2019:
Weighted
Weighted
Average
Total
Average
Total
Rate
Outstanding
Rate
Outstanding
N/A
$
-
1.76
%
$
10,000
1.99
%
15,000
1.99
15,000
N/A
-
2.50
29,000
N/A
-
2.93
45,000
1.66
22,500
2.20
27,500
1.22
16,000
3.29
10,000
0.78
4,000
N/A
-
Totals
$
57,500
$
136,500
Federal Reserve Discount Window. At December 31, 2020 and 2019, the Company had the ability to draw additional borrowings of $76,830 and $113,164, respectively, from the Federal Reserve Bank of Minneapolis. The ability to draw borrowings is based on loan collateral pledged with principal balances of $120,692 and $159,568 as of December 31, 2020 and 2019, subject to the approval from the Board of Governors of the Federal Reserve System. There were no federal reserve borrowings outstanding as of December 31, 2020 and 2019.
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 December 31, 2020, the Company had not pledged any PPP loans to borrow funds under this facility. The facility is available through June 30, 2021.
Federal Funds Purchased. Federal funds purchased mature one business day from the transaction date. There were no federal funds purchased outstanding as of December 31, 2020 and 2019.
Note 12: 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 year ended December 31, 2020 was $120. There was no amortization expense for the years ended December 31, 2019 and 2018. 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 year ended December 31, 2020 was $103, with $164 remaining to be amortized as of December 31, 2020. Total amortization expense for the year ended December 31, 2019 was $103, with $267 remaining to be amortized as of December 31, 2019. Total amortization expense for the year ended December 31, 2018 was $103, with $370 remaining to be amortized as of December 31, 2018
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 13: Related-Party Transactions
In the ordinary course of business, the Company has granted loans to executive officers, directors, principal shareholders, and their affiliates (related parties). The following table presents the activity associated with loans made between related parties for the years ended December 31, 2020 and 2019:
Beginning Balance
$
37,483
$
39,454
New Loans and Advances
8,076
13,298
Repayments
(11,429)
(15,269)
Totals
$
34,130
$
37,483
Deposits from related parties held by the Company at December 31, 2020 and 2019 were $7,870 and $11,223, respectively.
The Company has a related party lease which is disclosed in Note 6.
Note 14: Income Taxes
The following table presents the allocation of federal and state income taxes between current and deferred portions as of December 31, 2020, 2019 and 2018:
Current Tax Provision
$
11,062
$
7,670
$
6,522
Deferred Tax Benefit
(2,590)
(747)
(1,298)
Total Income Tax Provision
$
8,472
$
6,923
$
5,224
The reasons for the differences between the statutory federal income tax rate and the effective tax rates are summarized as follows as of December 31, 2020, 2019 and 2018:
Amount
Percent
Amount
Percent
Amount
Percent
Amount of Statutory Rate
$
7,489
21.0
%
$
8,048
21.0
%
$
6,750
21.0
%
State Income Taxes (Net of Federal Income Tax Benefit)
3,014
8.5
2,711
7.1
2,755
8.6
Interest on Investment Securities and Loans Exempt From Federal Income Tax
(702)
(2.0)
(734)
(1.9)
(719)
(2.2)
Tax Credits
(770)
(2.1)
(2,781)
(7.3)
(3,207)
(10.0)
Other Differences
(559)
(1.6)
(321)
(0.8)
(355)
(1.1)
Totals
$
8,472
23.8
%
$
6,923
18.1
%
$
5,224
16.3
%
The Company’s effective tax rate may fluctuate as it is impacted by the level and timing of the Company’s utilization of historic tax credits, low-income housing tax credits, the level of tax-exempt investments and loans, and the overall level of pre-tax income.
The following table presents the components of the net deferred tax asset included in other assets, as of December 31, 2020 and 2019:
Depreciation
$
(986)
$
(231)
Allowance for Loan Losses
9,848
6,342
Unrealized (Gain) Loss on Securities Available for Sale
(2,426)
(1,399)
Unrealized (Gain) Loss on Cash Flow Hedges
Prepaid Expenses
(522)
(50)
Deferred Compensation
Deferred Loan Fees
Other
(95)
(230)
Totals
$
8,013
$
5,903
Note 15: 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.
The following table presents a summary of the Company’s investments in qualified affordable housing projects and other tax credit investments at December 31, 2020 and 2019:
December 31, 2020
December 31, 2019
Investment
Accounting Method
Investment
Unfunded Commitment (1)
Investment
Unfunded Commitment
Low Income Housing Tax Credit (LIHTC)
Proportional Amortization
$
1,867
$
-
$
2,148
$
-
Federal Historic Tax Credit (FHTC)
Equity
2,198
1,858
2,262
3,395
Total
$
4,065
$
1,858
$
4,410
$
3,395
(1) All commitments are expected to be paid by the Company by December 31, 2021.
The following table presents a summary of the amortization expense and tax benefit recognized for the Company’s qualified affordable housing projects and other tax credit investments during 2020, 2019 and 2018.
Amortization
Tax Benefit
Expense (1)
Recognized (2)
Year Ended December 31, 2020
LIHTC
$
$
(330)
FHTC
(1,056)
Total
$
1,019
$
(1,386)
Year Ended December 31, 2019
LIHTC
$
$
(330)
FHTC
3,225
(3,687)
Total
$
3,514
$
(4,017)
Year Ended December 31, 2018
LIHTC
$
$
(346)
FHTC
3,293
(3,782)
Total
$
3,603
$
(4,128)
(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 16: 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.
The following commitments were outstanding at December 31, 2020 and 2019:
December 31,
December 31,
Unfunded Commitments Under Lines of Credit
$
644,338
$
500,962
Letters of Credit
90,206
79,225
Totals
$
734,544
$
580,187
Commitments to extend credit are agreements to lend to a customer at fixed or variable rates as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The amount of collateral obtained upon extension of credit is based on management’s credit evaluation of the customer. Collateral held varies but may include accounts receivable; inventory; property, plant, and equipment; real estate; and stocks and bonds. Unfunded commitments under commercial lines of credit, home equity lines of credit, and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit may or may not require collateral and may or may not contain a specific maturity date.
Standby letters of credit are conditional lending commitments issued by the Company to guarantee the performance of a customer to a third party. Generally, all standby letters of credit issued have expiration dates within two years. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company generally holds collateral supporting these commitments.
The Company had outstanding letters of credit with the FHLB in total amounts of $60,091 and $108,502 at December 31, 2020 and 2019, respectively, on behalf of customers and to secure public deposits.
Legal Contingencies
Various legal claims arise from time to time in the normal course of business. In the opinion of management, any liability resulting from such proceedings would not have a material impact on the consolidated financial statements.
Note 17: Stock Options and Restricted Stock
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, and employees 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 December 31, 2020 and 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, and 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 December 31, 2020 and 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 December 31, 2020, and 2019, there were 561,883 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 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 61 banks in the index ranging in market capitalization from $300 million up to $3.5 billion.
The weighted average assumptions used in the model for valuing stock option grants in 2020 is as follows:
December 31,
Dividend Yield
-
%
Expected Life
Years
Expected Volatility
44.14
%
Risk-Free Interest Rate
0.68
%
The following table presents a summary of the status of the Company’s outstanding stock options for the years ended December 31, 2020 and 2019:
December 31, 2020
December 31, 2019
Weighted
Weighted
Average
Average
Shares
Exercise Price
Shares
Exercise Price
Outstanding at Beginning of Year
1,961,650
$
7.08
1,807,100
$
6.24
Granted
60,000
10.61
238,000
12.47
Exercised
(74,400)
4.26
(74,850)
3.45
Forfeitures
(33,000)
7.47
(8,600)
10.65
Outstanding at End of Year
1,914,250
$
7.29
1,961,650
$
7.08
Options Exercisable at End of Year
1,205,350
$
5.96
992,050
$
5.01
For the years ended December 31, 2020, 2019 and 2018, the Company recognized compensation expense for stock options of $881, $721 and $799, respectively.
The following table presents information pertaining to options outstanding at December 31, 2020:
Options Outstanding
Options Exercisable
Weighted Average
Number of
Weighted Average
Remaining Contractual
Number of
Weighted Average
Range of Exercise Prices
Options
Exercise Price
Life in Years
Options
Exercise Price
$
2.13 - 3.99
522,750
$
2.94
3.0
522,750
$
2.94
7.00 - 7.99
968,500
7.47
6.8
576,100
7.47
8.00 - 8.99
25,000
8.76
9.3
-
-
10.00 - 10.99
10,000
10.08
9.4
-
-
11.00 - 11.99
85,000
11.27
8.4
22,000
11.34
12.00 - 12.99
278,000
12.89
8.6
74,500
12.91
13.00 - 13.99
25,000
13.22
7.4
10,000
13.22
Totals
1,914,250
$
7.29
6.1
1,205,350
$
5.96
As of December 31, 2020, there was $2,027 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 2.7 years.
The following table presents an analysis of nonvested options to purchase shares of the Company’s stock issued and outstanding for the year ended December 31, 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
(287,700)
2.98
Forfeited
(33,000)
2.80
Nonvested Options at December 31, 2020
708,900
$
3.24
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 year ended December 31, 2020 and 2019:
December 31, 2020
December 31, 2019
Weighted
Weighted
Number of
Average Grant
Average
Shares
Date Fair Value
Shares
Exercise Price
Nonvested at December 31, 2019
132,960
$
12.92
-
$
-
Granted
18,641
10.29
132,960
12.92
Vested
(32,439)
12.92
-
-
Forfeited
(8,200)
10.91
-
-
Nonvested at December 31, 2020
110,962
$
12.63
132,960
$
12.92
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 years ended December 31, 2020 and 2019, the Company recognized compensation expense for restricted stock awards of $441 and $31, respectively. No compensation expense was recognized for restricted stock awards for the year ended December 31, 2018.
As of December 31, 2020, there was $1,349 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 year ended December 31, 2020, the Company issued 29,050 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 $303 was included in stock based compensation expense in the accompanying consolidated statements of shareholders’ equity.
Restricted Stock Units
In 2020, the Company granted 205,666 restricted stock units with a grant date fair value of $12.27. Restricted stock units granted out of the 2019 EIP represent the right to receive one share of Company stock upon vesting and vest in equal annual installments on the first four anniversaries of the date of the grant. Nonvested restricted stock units have no voting or dividend rights and are not considered outstanding until vesting.
Compensation expense associated with the restricted stock units is recognized on a straight-line basis over the period that the restrictions associated with the units lapse based on the total cost of the unit at the grant date. For the year
ended December 31, 2020, the Company recognized compensation expense for restricted stock units of $43. No compensation expense was recognized for restricted stock units for the years ended December 31, 2019 and 2018.
As of December 31, 2020, there was $2,505 of total unrecognized compensation cost related to nonvested restricted stock units granted under the 2019 EIP that is expected to be recognized over a period of four years. No restricted stock units vested during 2020.
Note 18: Profit Sharing Plan
The Company has a combined profit sharing 401(k) plan which provides that an annual contribution, up to 100% of each participating employee’s total pay, may be contributed to the plan. Employees are eligible to participate after meeting certain eligibility requirements as defined in the plan and are allowed to make pre-tax contributions up to the maximum amount allowed by the Internal Revenue Service. The terms of the 401(k) plan require employer match contributions equal to 100% of the employee contributions up to 4% of pay. In addition, the terms of the plan allow for discretionary contributions as determined by the Company and approved by the Board of Directors.
The employer match contributions for the 401(k) plan were $743, $603, and $483 for the years ended December 31, 2020, 2019 and 2018, respectively. The total employer profit sharing contributions to the plan were $533, $473, and $328 for the years ended December 31, 2020, 2019 and 2018, respectively.
Note 19: Deferred Compensation Plan
In 2013, the Company implemented a deferred compensation plan for certain employees which allows the Company to make a discretionary contribution to the account of any employee designated as a participant in the plan based upon the participant’s performance for the calendar year. Company contributions to the plan vest on the fourth anniversary of the last day of the calendar year for which the contribution was made to the plan and accrue interest at a rate equal to the Bank’s return on average equity for the immediately preceding calendar year. Distribution of amounts contributed under the plan, including accrued interest, is made in a lump sum cash payment within 75 days following the date such amounts become vested. As of December 31, 2020 and 2019, the Company had a liability of $3,571 and $3,546, respectively, recorded on the consolidated balance sheets. There were no new contributions made to the plan during the years ended December 31, 2020 and 2019.
Note 20: Regulatory Capital
The Company and the Bank are subject to various regulatory requirements administered by federal banking agencies. 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, the Company and the 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 regulatory framework for prompt corrective action. 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 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.
The following tables present the capital amounts and ratios for the Company and the Bank as of December 31, 2020 and 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
December 31, 2020
Amount
Ratio
Amount
Ratio
Amount
Ratio
Amount
Ratio
(dollars in thousands)
Company (Consolidated):
Total Risk-based Capital
$
360,198
14.58
%
$
197,604
8.00
%
$
259,355
10.50
%
N/A
N/A
Tier 1 Risk-based Capital
255,530
10.35
148,203
6.00
209,954
8.50
N/A
N/A
Common Equity Tier 1 Capital
255,530
10.35
111,152
4.50
172,904
7.00
N/A
N/A
Tier 1 Leverage Ratio
255,530
9.28
110,168
4.00
110,168
4.00
N/A
N/A
Bank:
Total Risk-based Capital
$
330,380
13.37
%
$
197,629
8.00
%
$
259,388
10.50
%
$
247,036
10.00
%
Tier 1 Risk-based Capital
299,447
12.12
148,222
6.00
209,981
8.50
197,629
8.00
Common Equity Tier 1 Capital
299,447
12.12
111,166
4.50
172,925
7.00
160,574
6.50
Tier 1 Leverage Ratio
299,447
10.89
109,972
4.00
109,972
4.00
137,465
5.00
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.
Management believes that, as of December 31, 2020 and 2019, the capital ratios of the Company and the Bank were in excess of the quantitative capital ratio standards applicable on those dates. However, there can be no assurance that the Company and the Bank will continue to maintain such status in the future.
Note 21: 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 table presents the balances of the assets and liabilities measured at fair value on a recurring basis as of December 31, 2020 and 2019:
December 31, 2020
Level 1
Level 2
Level 3
Total
Fair Value of Financial Assets:
Securities Available for Sale:
Municipal Bonds
$
-
$
115,012
$
-
$
115,012
Mortgage-Backed Securities
-
124,260
-
124,260
Corporate Securities
-
72,155
-
72,155
SBA Securities
-
40,107
-
40,107
Asset-Backed Securities
-
39,095
-
39,095
Interest Rate Caps
-
2,834
-
2,834
Interest Rate Swaps
-
2,757
-
2,757
Total Fair Value of Financial Assets
$
-
$
396,220
$
-
$
396,220
Fair Value of Financial Liabilities:
Interest Rate Swaps
$
-
$
6,167
$
-
$
6,167
Total Fair Value of Financial Liabilities
$
-
$
6,167
$
-
$
6,167
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
-
-
Total Fair Value of Financial Assets
$
4,998
$
285,163
$
-
$
290,161
Fair Value of Financial Liabilities:
Interest Rate Swaps
$
-
$
$
-
$
Total Fair Value of Financial Liabilities
$
-
$
$
-
$
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 Caps
The fair value of the caps are calculated by determining the total expected asset or liability exposure of the derivatives. Total expected exposure incorporates both the current and potential future exposure of the derivative, derived from using observable inputs, such as yield curves and volatilities, and accordingly are valued using Level 2 inputs.
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.
The following tables present net impairment losses related to nonrecurring fair value measurements of certain assets for the periods ended December 31, 2020, 2019 and 2018:
December 31, 2020
Level 1
Level 2
Level 3
Loss
Impaired Loans
$
-
$
$
-
$
Totals
$
-
$
$
-
$
December 31, 2019
Level 1
Level 2
Level 3
Loss
Impaired Loans
$
-
$
$
-
$
Totals
$
-
$
$
-
$
December 31, 2018
Level 1
Level 2
Level 3
Loss
Impaired Loans
$
-
$
$
-
$
Totals
$
-
$
$
-
$
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 below
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.
The following tables present the carrying amounts and estimated fair values of financial instruments at December 31, 2020 and 2019:
December 31, 2020
Fair Value Hierarchy
Carrying
Estimated
Amount
Level 1
Level 2
Level 3
Fair Value
Financial Assets:
Cash and Due From Banks
$
160,675
$
160,675
$
-
$
-
$
160,675
Bank-Owned Certificates of Deposit
2,860
-
2,908
-
2,908
Securities Available for Sale
390,629
-
390,629
-
390,629
FHLB Stock, at Cost
5,027
-
5,027
-
5,027
Loans, Net
2,282,436
-
2,309,421
-
2,309,421
Accrued Interest Receivable
9,172
-
9,172
-
9,172
Interest Rate Caps
2,834
-
2,834
-
2,834
Interest Rate Swaps
2,757
-
2,757
-
2,757
Financial Liabilities:
Deposits
$
2,501,636
$
-
$
2,509,148
$
-
$
2,509,148
Notes Payable
11,000
-
11,001
-
11,001
FHLB Advances
57,500
-
58,830
-
58,830
Subordinated Debentures
73,739
-
74,769
-
74,769
Accrued Interest Payable
1,615
-
1,615
-
1,615
Interest Rate Swaps
6,167
-
6,167
-
6,167
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
-
-
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
-
-
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.
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.
Notes payable and subordinated debentures - The fair values of the Company’s notes payable and subordinated debentures 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 December 31, 2020 and 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 22: Revenue Recognition
The Company recognizes revenue from contracts with customers in accordance with ASC Topic 606, Revenue from Contracts with Customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration it expects to be entitled to receive in exchange for those goods or services recognized as performance obligations are satisfied.
Substantially all of the Company’s revenue is generated from financial instruments, including interest income related to loans and investment securities, letters of credit, and derivatives, which are not within the scope of Topic 606 as these activities are subject to other GAAP discussed elsewhere within the Company’s disclosures. The following is a summary of revenue-generating activities that are within the scope of Topic 606, which are presented in the Company’s income statements as components of noninterest income:
Service charges on deposit accounts. These represent general service fees for monthly account maintenance and activity and transaction-based fees such as wire transfer fees, check cashing fees, check printing fees, stop payment fees and ATM and card replacement fees. Revenue is recognized when the Company’s performance obligation is completed, which is generally monthly for account maintenance services or when a transaction has been completed. Payments for these performance obligations are generally received at the time the performance obligations are satisfied. The adoption of Topic 606 had no impact on the Company’s revenue recognition practice for these services.
Debit card interchange fees. When a debit card issued by the Company is used to purchase goods or services from a merchant, the Company earns an interchange fee. The performance obligation is completed and the fees are recognized as the service is provided (i.e., when the customer uses the debit card). The adoption of Topic 606 has no impact on the Company’s revenue recognition related to debit card interchange fees.
Gain on sales of other real estate. ASU 2014-09 also created Topic 610-20, under which a gain on sale should be recognized when a contract for sale exists and control of the asset has been transferred to the buyer. Topic 606 list several criteria which must exist to conclude that a contract for sale exists, including a determination that the institution will collect substantially all of the consideration to which it is entitled. This presents a key difference between the current and new guidance related to the recognition of the gain when the institution finances the sale of the property. Rather than basing recognition on the amount of the buyer's initial investment, which was the primary consideration under prior guidance, the analysis is now based on various factors including not only the loan to value, but also the credit quality of the borrower, the structure of the loan, and any other factors that may affect collectability. The new requirements could result in earlier revenue recognition; however, such sales are infrequent, and the impact of this change is not considered material to the Company’s consolidated financial statements.
Note 23: Accumulated Other Comprehensive Income (Loss)
The following table presents the components of other comprehensive income (loss) for the years ended December 31, 2020, 2019 and 2018.
Before Tax
Tax Effect
Net of Tax
Year Ended December 31, 2020
Net Unrealized Gain on Available for Sale Securities
$
6,394
$
(1,343)
$
5,051
Less: Reclassification Adjustment for Net Gains Included in Net Income
(1,503)
(1,187)
Total Unrealized Gain
4,891
(1,027)
3,864
Net Unrealized Loss on Cash Flow Hedge
(3,185)
(2,516)
Less: Reclassification Adjustment for Losses Included in Net Income
(122)
Total Unrealized Loss
(2,606)
(2,059)
Other Comprehensive Gain
$
2,285
$
(480)
$
1,805
Year Ended December 31, 2019
Net Unrealized Gain on Available for Sale Securities
$
9,514
$
(1,998)
$
7,516
Less: Reclassification Adjustment for Net Gains Included in Net Income
(516)
(407)
Total Unrealized Gain
8,998
(1,889)
7,109
Net Unrealized Loss on Cash Flow Hedge
(962)
(760)
Less: Reclassification Adjustment for Gains Included in Net Income
(9)
(7)
Total Unrealized Loss
(971)
(767)
Other Comprehensive Gain
$
8,027
$
(1,685)
$
6,342
Year Ended December 31, 2018
Net Unrealized Loss on Available for Sale Securities
$
(3,804)
$
$
(2,952)
Less: Reclassification Adjustment for Net Losses Included in Net Income
(26)
Total Unrealized Loss
(3,679)
(2,853)
Net Unrealized Gain on Cash Flow Hedge
(2)
Less: Reclassification Adjustment for Gains Included in Net Income
-
-
-
Total Unrealized Gain
(2)
Other Comprehensive Loss
$
(3,670)
$
$
(2,846)
The following table presents the changes in each component of accumulated other comprehensive income (loss), net of tax, for the years ended December 31, 2020, 2019 and 2018.
Accumulated
Available For
Other Comprehensive
Sale Securities
Cash Flow Hedge
Income (Loss)
Year Ended December 31, 2020
Balance at Beginning of Year
$
5,263
$
(489)
$
4,774
Other Comprehensive Income (Loss) Before Reclassifications
5,051
(2,516)
2,535
Amounts Reclassified from Accumulated Other Comprehensive Income
(1,187)
(730)
Net Other Comprehensive Income (Loss) During Period
3,864
(2,059)
1,805
Balance at End of Year
$
9,127
$
(2,548)
$
6,579
Year Ended December 31, 2019
Balance at Beginning of Year
$
(1,846)
$
$
(1,568)
Other Comprehensive Income (Loss) Before Reclassifications
7,516
(760)
6,756
Amounts Reclassified from Accumulated Other Comprehensive Income
(407)
(7)
(414)
Net Other Comprehensive Income (Loss) During Period
7,109
(767)
6,342
Balance at End of Year
$
5,263
$
(489)
$
4,774
Year Ended December 31, 2018
Balance at Beginning of Year
$
$
$
1,084
Reclassification of the Income Tax Effects of the Tax Cuts and Jobs Act
Other Comprehensive Income (Loss) Before Reclassifications
(2,952)
(2,945)
Amounts Reclassified from Accumulated Other Comprehensive Income
-
Net Other Comprehensive Income (Loss) During Period
(2,853)
(2,846)
Balance at End of Year
$
(1,846)
$
$
(1,568)
Note 24: Parent Company Financial Information
The following information presents the condensed balance sheets of the Company as of December 31, 2020 and 2019, and the condensed statements of income and cash flows of the Company for the years ended December 31, 2020, 2019 and 2018:
Condensed Balance Sheets
December 31,
December 31,
ASSETS
Cash and Cash Equivalents
$
37,880
$
27,315
Investment in Subsidiaries
311,329
253,456
Premises and Equipment, Net
Other Assets
1,437
2,181
Total Assets
$
351,420
$
283,747
LIABILITIES AND EQUITY
LIABILITIES
Notes Payable
$
11,000
$
13,000
Subordinated Debentures, Net of Issuance Costs
73,739
24,733
Accrued Interest Payable
Other Liabilities
Total Liabilities
86,015
38,953
SHAREHOLDERS’ EQUITY
Preferred Stock-$0.01 par value
Preferred Stock-Authorized 10,000,000
-
-
Common Stock-$0.01 par value
Voting Common Stock-Authorized 75,000,000
Additional Paid-In Capital
103,714
112,093
Retained Earnings
154,831
127,637
Accumulated Other Comprehensive Income
6,579
4,774
Total Shareholders’ Equity
265,405
244,794
Total Liabilities and Shareholders' Equity
$
351,420
$
283,747
Condensed Statements of Income
December 31,
December 31,
December 31,
INCOME
Dividend Income
$
1,300
$
1,040
$
1,100
Interest Income
Other Income
Total Income
1,498
1,225
1,239
EXPENSE
Interest Expense
3,547
2,056
2,162
Other Expenses
1,412
1,152
Total Interest Expense
4,959
3,052
3,314
LOSS BEFORE INCOME TAX BENEFIT AND EQUITY IN UNDISTRIBUTED EARNINGS
(3,461)
(1,827)
(2,075)
Income Tax Benefit
1,323
LOSS BEFORE EQUITY IN UNDISTRIBUTED EARNINGS
(2,138)
(1,051)
(1,151)
Equity in Undistributed Earnings
29,332
32,454
28,071
NET INCOME
$
27,194
$
31,403
$
26,920
Condensed Statements of Cash Flows
December 31,
December 31,
December 31,
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income
$
27,194
$
31,403
$
26,920
Adjustments to Reconcile Net Income to Net Cash Provided (Used) by Operating Activities:
Equity in Undistributed Earnings of Subsidiaries
(29,332)
(32,454)
(28,071)
Changes in Other Assets and Liabilities
(368)
Net Cash Used by Operating Activities
(1,904)
(740)
(1,519)
CASH FLOWS FROM INVESTING ACTIVITIES
Net (Increase) Decrease in Loans
(742)
-
Investment in Subsidiaries
(25,000)
-
(25,000)
Net Cash Used in Investing Activities
(24,258)
(742)
(25,000)
CASH FLOWS FROM FINANCING ACTIVITIES
Principal Payments on Notes Payable
(2,000)
(2,000)
(2,000)
Proceeds from Issuance of Subordinated Debt
48,783
-
-
Stock Options Exercised
Stock Repurchases
(10,373)
(14,959)
-
Issuance of Common Stock
-
-
58,857
Net Cash Provided (Used) by Financing Activities
36,727
(16,701)
56,963
NET CHANGE IN CASH AND CASH EQUIVALENTS
10,565
(18,183)
30,444
Cash and Cash Equivalents Beginning
27,315
45,498
15,054
Cash and Cash Equivalents Ending
$
37,880
$
27,315
$
45,498
Note 25: Quarterly Condensed Financial Information (Unaudited)
The following tables present the unaudited quarterly condensed financial information for the years ended December 31, 2020 and 2019:
2020 Quarter Ended
March 31
June 30
September 30
December 31
(dollars in thousands)
Interest Income
$
27,468
$
28,166
$
28,493
$
30,699
Interest Expense
7,366
6,824
6,814
5,858
Net Interest Income
20,102
21,342
21,679
24,841
Provision for Loan Losses
2,100
3,000
3,750
3,900
Net Interest Income after Provision for Loan Losses
18,002
18,342
17,929
20,941
Noninterest Income
1,719
1,977
1,157
Noninterest Expense
9,746
10,711
9,672
15,258
Income Before Income Taxes
9,975
9,608
9,414
6,669
Provision for Income Taxes
2,532
2,010
2,240
1,690
Net Income
$
7,443
$
7,598
$
7,174
$
4,979
Earnings per share
Basic
$
0.26
$
0.26
$
0.25
$
0.18
Diluted
$
0.25
$
0.26
$
0.25
$
0.17
2019 Quarter Ended
March 31
June 30
September 30
December 31
(dollars in thousands)
Interest Income
$
24,267
$
25,520
$
26,572
$
27,419
Interest Expense
7,136
7,382
7,637
7,491
Net Interest Income
17,131
18,138
18,935
19,928
Provision for Loan Losses
Net Interest Income after Provision for Loan Losses
16,531
17,538
18,035
19,328
Noninterest Income
1,134
1,112
Noninterest Expense
7,885
9,474
9,084
10,489
Income Before Income Taxes
9,280
9,198
9,897
9,951
Provision for Income Taxes
2,262
1,189
2,092
1,380
Net Income
$
7,018
$
8,009
$
7,805
$
8,571
Earnings per share
Basic
$
0.23
$
0.27
$
0.27
$
0.30
Diluted
$
0.23
$
0.26
$
0.27
$
0.29
Note 26: Subsequent Events
Payoff of Note Payable
On February 25, 2021, the Company paid off its $11.0 million bank stock loan.
New Revolving Line of Credit
On March 1, 2021, the Company entered into a Loan and Security Agreement and revolving note with ServisFirst Bank, pursuant to which ServisFirst Bank has made a $25.0 million revolving line of credit available to the Company which is secured by 100% of the stock of the Bank. The maturity of the line of credit is February 28, 2023. As of March 5, 2021, there was no outstanding balance under the line of credit, and the entire amount of the line of credit remained available to the Company.

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.

---

ITEM 9A. CONTROLS AND PROCEDURES
ITEM 9A. 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 December 31, 2020, the end of the fiscal year covered by this Annual Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 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.
Management’s Report on Internal Control over Financial Reporting
This annual report does not include an attestation report of the Company’s independent registered public accounting firm. As an emerging growth company, management’s report on internal control over financial reporting was not subject to attestation by the Company’s independent registered public accounting firm in accordance with the JOBS Act.
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act). The Company’s internal control system is a process designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements.
Internal control over financial reporting of the Company includes those policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions of the Company; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the Company’s consolidated financial statements.
Because of inherent limitations in any system of internal control, no matter how well designed, misstatements due to error or fraud may occur and not be detected, including the possibility of the circumvention or overriding of controls. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, internal control effectiveness may vary over time.
Management assessed the Company’s internal control over financial reporting as of December 31, 2020. This assessment was based on criteria for effective internal control over financial reporting set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework in 2013. Based on this assessment, the Chief Executive Officer and Chief Financial Officer assert that the Company maintained effective internal control over financial reporting as of December 31, 2020 based on the specified criteria.
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 Annual Report on Form 10-K that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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ITEM 9B. OTHER INFORMATION
ITEM 9B. OTHER INFORMATION
None.
PART III

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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
The information called for by this item is set forth under the headings “Proposal 1 - Election of Directors,” “Security Ownership of Certain Beneficial Owners,” and “Corporate Governance and the Board of Directors” appearing in the Company’s definitive Proxy Statement for our Annual Meeting of Shareholders to be held on April 27, 2021, which will be filed with the SEC pursuant to Regulation 14A under the Exchange Act within 120 days of the Company’s fiscal year end, which is incorporated herein by reference.

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ITEM 11. EXECUTIVE COMPENSATION
ITEM 11. EXECUTIVE COMPENSATION.
The information called for by this item is set forth under the headings “Executive Compensation,” “Corporate Governance and the Board of Directors - Director Compensation,” and “Corporate Governance and the Board of Directors - Compensation Committee Interlocks and Insider Participation” appearing in the Company's definitive Proxy Statement for our Annual Meeting of Shareholders to be held on April 27, 2021, which will be filed with the SEC pursuant to Regulation 14A under the Exchange Act within 120 days of the Company’s fiscal year end, which is incorporated herein by reference.

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
Equity Compensation Plans
The following table presents the number of outstanding options, warrants and rights granted to participants by the Company under its equity compensation plans, as well as the number of securities remaining available for future issuance under these plans as of December 31, 2020. The table provides this information separately for equity compensation plans that have and have not been approved by security holders. Additional information regarding stock incentive plans is presented in Note 17 to the Consolidated Financial Statements for the year ending December 31, 2020.
(c)
Number of
securities
(a)
remaining
Number of
(b)
available for
securities to be
Weighted-
future issuance
issued upon
average
under equity
exercise of
exercise price
compensation
outstanding
of outstanding
plans (excluding
options,
options,
securities
warrants and
warrants and
reflected in
Plan Category
rights
rights
column (a))
Equity compensation plans approved by shareholders (1)
1,914,250
$
7.29
905,483
Equity compensation plans not approved by shareholders
-
-
-
Total
1,914,250
$
7.29
905,483
(1) Column (a) includes outstanding stock options granted under the Bridgewater Bancshares, Inc. 2019 Equity Incentive Plan, the Bridgewater Bancshares, Inc. 2017 Combined Incentive and Non-Statutory Stock Option Plan, the Bridgewater Bancshares, Inc. 2012 Combined Incentive and Non-Statutory Stock Option Plan and the Bridgewater Bancshares, Inc. 2005 Combined Incentive and Non-Statutory Stock Option Plan. Column (c) includes 30,000, 313,600 and 561,883 shares remaining available for future issuance under the Bridgewater Bancshares, Inc. 2012 Combined Incentive and Non-Statutory Stock Option Plan, the Bridgewater Bancshares, Inc. 2017 Combined Incentive and Non-Statutory Stock Option Plan and the Bridgewater Bancshares, Inc. 2019 Equity Incentive Plan, respectively.
The information required pursuant to Item 403 of Regulation S-K can be found under the caption “Security Ownership of Certain Beneficial Owners” in the Company’s definitive Proxy Statement on Form DEF 14A for our Annual Meeting of Shareholders to be held on April 27, 2021, which will be filed with the SEC within 120 days of the Company’s fiscal year end, and is incorporated herein by reference.

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
The information called for by this item is set forth under the headings “Certain Relationships and Related Party Transactions” and “Corporate Governance and the Board of Directors” appearing in the Company’s definitive Proxy Statement for our Annual Meeting of Shareholders to be held on April 27, 2021, which will be filed with the SEC pursuant to Regulation 14A under the Exchange Act within 120 days of the Company’s fiscal year end, which is incorporated herein by reference.

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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
The information called for by this item is set forth under the heading “Proposal 2 - Ratification of the Appointment of CliftonLarsonAllen LLP as our Independent Registered Public Accounting Firm” appearing in the Company’s definitive Proxy Statement for our Annual Meeting of Shareholders to be held on April 27, 2021, which will be filed with the SEC pursuant to Regulation 14A under the Exchange Act within 120 days of the Company’s fiscal year end, which is incorporated herein by reference.
PART IV

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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
1. Financial Statements: The consolidated financial statements that appear in Item 8 of this Form 10-K are incorporated herein by reference.
2. Financial Statement Schedules: All schedules are omitted because they are not applicable, not required, or because the required information is included in the consolidated financial statements or notes thereto.
3. Exhibits.
Exhibit
Number
Description
3.1
Second Amended and Restated Articles of Incorporation of Bridgewater Bancshares, Inc. (incorporated herein by reference to Exhibit 3.1 on Form 8-K filed on April 25, 2019)
3.2
Amended and Restated Bylaws of Bridgewater Bancshares, Inc. (incorporated herein by reference to Exhibit 3.2 on Form S-1/A filed on March 5, 2018)
4.1
Description of the Company’s Securities Registered Pursuant to Section 12 of the Securities Exchange Act of 1934 (incorporated herein by reference to Exhibit 4.1 on Form 10-K filed on March 12, 2020)
4.3
Indenture, dated June 19, 2020, by and between Bridgewater Bancshares, Inc. and U.S. Bank National Association, as trustee (incorporated herein by reference to Exhibit 4.1 on Form 8-K filed on June 19, 2020)
4.4
Forms of 5.25% Fixed-to-Floating Rate Subordinated Note due July 1, 2030 (included as Exhibit A-1 and Exhibit A-2 to the Indenture filed as Exhibit 4.3 hereto and incorporated herein by reference to Exhibit 4.1 on Form 8-K filed on June 19, 2020)
10.1
Employment Agreement by and among Bridgewater Bancshares, Inc., Bridgewater Bank and Jerry Baack, dated October 1, 2017 (incorporated herein by reference to Exhibit 10.1 on Form S-1 filed on February 16, 2018)†
10.2
Employment Agreement by and among Bridgewater Bancshares, Inc., Bridgewater Bank and Mary Jayne Crocker, dated October 1, 2017 (incorporated herein by reference to Exhibit 10.2 on Form S-1 filed on February 16, 2018)†
10.3
Employment Agreement by and among Bridgewater Bancshares, Inc., Bridgewater Bank and Jeffrey D. Shellberg, dated October 1, 2017 (incorporated herein by reference to Exhibit 10.3 on Form S-1 filed on February 16, 2018)†
10.4
Bridgewater Bank Deferred Cash Incentive Plan effective December 31, 2013 (incorporated herein by reference to Exhibit 10.4 filed on Form S-1 on February 16, 2018)†
10.5
Bridgewater Bancshares, Inc. 2017 Combined Incentive and Non-Statutory Stock Option Plan (incorporated herein by reference to Exhibit 10.5 on Form S-1 filed on February 16, 2018)†
10.6
Form of Stock Option Agreement under the Bridgewater Bancshares, Inc. 2017 Combined Incentive and Non-Statutory Stock Option Plan (incorporated herein by reference to Exhibit 10.6 to the Company’s Quarterly Report on Form 10-Q filed on August 8, 2019)†
10.7
Bridgewater Bancshares, Inc. 2012 Combined Incentive and Non-Statutory Stock Option Plan (incorporated herein by reference to Exhibit 10.7 on Form S-1 filed on February 16, 2018)†
10.8
Form of Stock Option Agreement under the Bridgewater Bancshares, Inc. 2012 Combined Incentive and Non-Statutory Stock Option Plan (incorporated herein by reference to Exhibit 10.8 on Form S-1 filed on February 16, 2018)†
10.9
Bridgewater Bancshares, Inc. 2005 Combined Incentive and Non-Statutory Stock Option Plan (incorporated herein by reference to Exhibit 10.9 filed on Form S-1 on February 16, 2018)†
10.10
Form of Incentive Stock Option Agreement under the Bridgewater Bancshares, Inc. 2005 Combined Incentive and Non-Statutory Stock Option Plan (incorporated herein by reference to Exhibit 10.10 on Form S-1 filed on February 16, 2018)†
10.11
Construction Contract, dated as of August 27, 2018, by and between Bridgewater Bank and Reuter Walton Commercial, LLC (incorporated herein by reference to Exhibit 10.1 filed with the Form 8-K on August 30, 2018)
10.12
Exchange Agreement, dated as of October 25, 2018 by and between Bridgewater Bancshares, Inc. and Castle Creek Capital Partners V, LP (incorporated herein by reference to Exhibit 10.1 filed with the Form 8-K on October 26, 2018)
10.13
Exchange Agreement, dated as of October 25, 2018 by and between Bridgewater Bancshares, Inc. and EJF Sidecar Fund, Series LLC - Series E (incorporated herein by reference to Exhibit 10.2 filed with the Form 8-K on October 26, 2018)
10.14
Exchange Agreement, dated as of October 25, 2018 by and between Bridgewater Bancshares, Inc. and Endeavour Regional Bank Opportunities Fund II LP (incorporated herein by reference to Exhibit 10.3 filed with the Form 8-K on October 26, 2018)
10.15
Bridgewater Bancshares, Inc. 2019 Equity Incentive Plan (incorporated herein by reference to Exhibit 4.3 to the Company’s Registration Statement on Form S-8 filed on April 26, 2019)†
10.16
Form of Restricted Stock Award Agreement under the Bridgewater Bancshares, Inc. 2019 Equity Incentive Plan (incorporated herein by reference to Exhibit 4.4 to the Company’s Registration Statement on Form S-8 filed on April 26, 2019)†
10.17
Form of Restricted Stock Unit Award Agreement under the Bridgewater Bancshares, Inc. 2019 Equity Incentive Plan (incorporated herein by reference to Exhibit 4.5 to the Company’s Registration Statement on Form S-8 filed on April 26, 2019)†
10.18
Form of Nonqualified Stock Option Award Agreement under the Bridgewater Bancshares, Inc. 2019 Equity Incentive Plan (incorporated herein by reference to Exhibit 4.6 to the Company’s Registration Statement on Form S-8 filed on April 26, 2019)†
10.19
Form of Incentive Stock Option Award Agreement under the Bridgewater Bancshares, Inc. 2019 Equity Incentive Plan (incorporated herein by reference to Exhibit 4.7 to the Company’s Registration Statement on Form S-8 filed on April 26, 2019)†
10.20
Form of Subordinated Note Purchase Agreement, dated June 19, 2020, by and among Bridgewater Bancshares, Inc. and the Purchasers (incorporated herein by reference to Exhibit 10.1 on Form 8-K filed on June 19, 2020)
10.21
Form of Registration Rights Agreement, dated June 19, 2020, by and among Bridgewater Bancshares, Inc. and the Purchasers (incorporated herein by reference to Exhibit 10.2 on Form 8-K filed on June 19, 2020)
21.1
Subsidiaries of Bridgewater Bancshares, Inc. (incorporated herein by reference to Exhibit 21.1 filed with the Form S-1 on February 16, 2018)
23.1
Consent of CliftonLarsonAllen LLP
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 Annual Report on Form 10-K for the year ended December 31, 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
Cover Page Interactive Data File (formatted as inline XBRL, with applicable taxonomy extension information contained in Exhibit 101)
________________
† Indicates a management contract or compensatory plan.