LEVEL ONE BANCORP INC – 10-Q – Management report and analysis of the financial position and operating results


The following discussion explains our financial condition and results of
operations as of and for the three and nine months ended September 30, 2021. The
following discussion and analysis should be read in conjunction with the
consolidated financial statements and related notes presented elsewhere in this
report and our Annual Report on Form 10-K for the year ended December 31, 2020,
filed with the SEC on March 12, 2021. Annualized results for these interim
periods may not be indicative of results for the full year or future periods.
In addition to the historical information contained herein, this Form 10-Q
includes "forward-looking statements" within the meaning of such term in the
Private Securities Litigation Reform Act of 1995. These statements are subject
to many risks and uncertainties, including, but not limited to, the effects of
the COVID-19 pandemic, including its effects on the economic environment, our
customers and our operations, as well as any changes to federal, state or local
government laws, regulations or orders in connection with the pandemic; risks
related to the pending Merger with First Merchants, including the inability to
complete the Merger due to the failure of the Company's shareholders to approve
the merger agreement, the failure to satisfy other conditions to completion of
the Merger, including receipt of required regulatory and other approvals, the
failure of the proposed Merger to close for any other reason, diversion of
management's attention from ongoing business operations and opportunities due to
the Merger, and the effect of the announcement of the Merger on the Company's
customer and employee relationships and operating results; the ability of the
Company to implement its strategy and expand its lending
operations; changes in interest rates and other general economic, business and
political conditions, including changes in the
financial markets; changes in business plans as circumstances warrant; changes
in benchmark interest rates used to price loans and deposits, including the
expected elimination of LIBOR and the development of a substitute; changes in
tax laws, regulations and guidance; and other risks detailed from time to time
in filings made by the Company with the SEC. Readers should note that the
forward-looking statements included herein are not a guarantee of future events,
and that actual events may differ materially from those made in or suggested by
the forward-looking statements. Forward-looking statements generally can be
identified by the use of forward-looking terminology such as "will," "propose,"
"may," "plan," "seek," "expect," "intend," "estimate," "anticipate," "believe,"
"continue," or similar terminology. Any forward-looking statements presented
herein are made only as of the date of this document, and we do not undertake
any obligation to update or revise any forward-looking statements to reflect
changes in assumptions, the occurrence of unanticipated events, or otherwise.
                          Critical Accounting Policies
Our consolidated financial statements are prepared based on the application of
accounting policies generally accepted in the United States. Our critical
accounting policies require reliance on estimates and assumptions, which are
based upon historical experience and on various other assumptions that
management believes are reasonable under current circumstances, but may prove to
be inaccurate or can be subject to variations. Changes in underlying factors,
assumptions, or estimates could have a material impact on our future financial
condition and results of operations.
Our critical accounting policies are set forth in "Note 1 - Basis of
Presentation and Summary of Significant Accounting Policies" of the Notes to the
Consolidated Financial Statements and "Item 7 Management's Discussion and
Analysis of Financial Condition and Results of Operations" included in our
Annual Report on Form 10-K for the year ended December 31, 2020, which was filed
with the SEC on March 12, 2021. There have been no material changes in critical
accounting policies or the assumptions and judgments utilized in applying these
policies since December 31, 2020.
                                    Overview
Level One Bancorp, Inc. is a financial holding company headquartered in
Farmington Hills, Michigan, with its primary branch operations in southeastern
and west Michigan. Through our wholly owned subsidiary, Level One Bank, we offer
a broad range of loan products to the residential and commercial markets, as
well as retail and business banking services. Hamilton Court Insurance Company,
a wholly owned subsidiary of the Company, provided property and casualty
insurance to the Company and the Bank and reinsurance to ten other third-party
insurance captives for which insurance may not have been available or
economically feasible in the insurance marketplace. Hamilton Court Insurance
Company exited the pool resources relationship to which it was previously a
member and was dissolved in January 2021.
Our principal business activities have been lending to and accepting deposits
from individuals, businesses, municipalities and other entities. We derive
income principally from interest charged on loans and leases and, to a lesser
extent, from interest and dividends earned on investment securities. We have
also derived income from noninterest sources, such as fees received in
connection with various lending and deposit services and originations and sales
of residential mortgage loans. Our principal expenses include interest expense
on deposits and borrowings, operating expenses, such as salaries and employee
benefits, occupancy and equipment expenses, data processing costs, professional
fees and other noninterest expenses, provisions for loan losses and income tax
expense.
                              Recent Developments
                                       41
--------------------------------------------------------------------------------

Third Quarter Common Stock Dividend. On September 15, 2021, Level One's Board of
Directors declared a third quarter 2021 cash dividend of $0.06 per common share.
The dividend was paid on October 15, 2021, to shareholders of record at the
close of business on September 30, 2021.
Third Quarter Preferred Stock Dividend. On October 20, 2021, Level One's Board
of Directors declared a quarterly cash dividend of $46.88 per share on its 7.50%
Non-Cumulative Perpetual Preferred Stock, Series B. Holders of depositary shares
will receive $0.4688 per depositary share. The dividend is payable on November
15, 2021, to shareholders of record at the close of business on October 31,
2021.
Impact of COVID-19 Pandemic. The COVID-19 pandemic in the United States has had,
and is expected to continue to have, a complex and significant impact on the
economy, the banking industry and the Company.
Effects on Our Business. We currently expect that the COVID-19 pandemic,
federal, state and local government responses to the pandemic, supply
disruptions, labor availability challenges, and the effects of existing and
future variants of the disease, such as the Delta variant, may continue to have
a significant impact on our business. A substantial portion of the Bank's
borrowers in the restaurant and hospitality industries have endured substantial
economic distress, and while those challenges have been largely mitigated by the
PPP and other governmental assistance, there is still some uncertainty about the
ability of these clients to return to cash flow levels necessary to cover their
debt service. These developments, together with economic conditions generally,
are also expected to impact our commercial real estate portfolio, particularly
with respect to real estate with exposure to these industries and the value of
certain collateral securing our loans.
Level One's Response to the COVID-19 Pandemic. Level One has taken comprehensive
steps to help our customers, team members and communities during the COVID-19
pandemic. For our customers, we have provided loan payment deferrals and offered
fee waivers, among other actions.
Level One was also a participating lender in both the first and second rounds of
the PPP. In 2020, the Bank originated 2,208 PPP loans in the aggregate principal
amount of $417.0 million. From January 18, 2021 through June 30, 2021, Level One
funded 1,532 new PPP loan applications for $234.3 million, of which 1,187 were
for loans $150,000 or below. As of September 30, 2021, $147.6 million of PPP
loans were still outstanding. The Bank is actively working with the borrowers of
PPP loans to obtain loan forgiveness from the SBA.
We are continuing to enable the vast majority of our main office team members to
work remotely most days. We have also taken significant actions to help ensure
the safety of our team members whose roles require them to come into the office,
which include the development, implementation and communication of protocols
necessary for those who return. As of March 1, 2021, we opened branches for walk
in services. We continue to evaluate this fluid situation and take additional
actions as necessary.
Level One also recognizes that some of the most impacted industries are the
restaurant and hospitality industries. As of September 30, 2021, Level One had
less than 4.1% and 0.3% of loan concentrations in the restaurant and hospitality
industries, respectively.
                                       42

————————————————– ——————————-

  Table of Contents
                      Selected Financial Data - Unaudited
                                                         As of and for the three months ended                        As of and for the nine months ended
(Dollars in thousands, except per share                                June 30,                                      September 30,          September 

30,

data)                                     September 30, 2021             2021             September 30, 2020              2021                  2020
Earnings Summary
Interest income                          $          22,322          $    21,737          $          20,245          $     65,610           $     60,458
Interest expense                                     1,807                2,121                      3,648                 6,322                 12,808
Net interest income                                 20,515               19,616                     16,597                59,288                 47,650
Provision expense (recovery) for loan
losses                                              (1,189)                 540                      4,270                  (384)                10,334
Noninterest income                                   6,041                4,326                      9,125                17,645                 21,604
Noninterest expense                                 15,989               14,588                     15,126                45,716                 44,771
Income before income taxes                          11,756                8,814                      6,326                31,601                 14,149
Income tax provision                                 2,291                1,835                      1,117                 6,198                  2,109
Net income                                           9,465                6,979                      5,209                25,403                 12,040
Preferred stock dividends                              468                  469                          -                 1,406                      -
Net income available to common
shareholders                                         8,997                6,510                      5,209                23,997                 

12,040

Net income allocated to participating
securities                                             138                   92                         40                   331                    140
Net income attributable to common
shareholders                             $           8,859          $     6,418          $           5,169          $     23,666           $     

11,900

Per Share Data
Basic earnings per common share          $            1.19          $      0.85          $            0.68          $       3.15           $       

1.56

Diluted earnings per common share                     1.16                 0.84                       0.67                  3.10                   

1.55

Diluted earnings per common share,
excluding acquisition and due diligence
fees (1)                                              1.16                 0.84                       0.67                  3.10                   

1.72

Book value per common share                          27.56                26.48                      24.06                 27.56                  

27.08

Tangible book value per common share (1)             21.89                20.84                      18.74                 21.89                  

18.74

Preferred shares outstanding (in
thousands)                                              10                   10                         10                    10                     10
Common shares outstanding (in thousands)             7,640                7,629                      7,734                 7,640                  

7 734

Average basic common shares (in
thousands)                                           7,519                7,520                      7,675                 7,526                  

7640

Average diluted common shares (in
thousands)                                           7,638                7,633                      7,712                 7,631                  

7,701

Selected Period End Balances
Total assets                             $       2,543,883          $ 2,506,523          $       2,446,447          $  2,543,883           $  

2 446 447

Securities available-for-sale                      389,528              376,453                    253,527               389,528                253,527
Total loans                                      1,719,717            1,775,243                  1,843,888             1,719,717              1,843,888
Total deposits                                   2,066,992            2,031,808                  1,943,435             2,066,992              1,943,435
Total liabilities                                2,309,949            2,281,114                  2,236,979             2,309,949              2,236,979
Total shareholders' equity                         233,934              225,409                    209,468               233,934                

209,468

Total common shareholders' equity                  210,562              202,037                    186,098               210,562                

186,098

Tangible common shareholders' equity (1)           167,262              159,022                    144,963               167,262                

144,963

Performance and Capital Ratios
Return on average assets                              1.50  %              1.09  %                    0.83  %               1.34   %                0.71 %
Return on average equity                             16.32                12.52                      10.48                 15.06                    8.68 %
Net interest margin (fully taxable
equivalent) (2)                                       3.47                 3.30                       2.80                  3.36                    3.04 %
Efficiency ratio (noninterest
expense/net interest income plus
noninterest income)                                  60.21                60.93                      58.81                 59.42                   64.65 %
Dividend payout ratio                                 5.08                 7.02                       7.41                  5.40                    8.99 %
Total shareholders' equity to total
assets                                                9.20                 8.99                       8.56                  9.20                    8.56 %
Tangible common equity to tangible
assets (1)                                            6.69                 6.46                       6.03                  6.69                    6.03 %
Common equity tier 1 to risk-weighted
assets                                                9.82                 9.66                       8.83                  9.82                    8.83 %
Tier 1 capital to risk-weighted assets               11.19                11.09                      10.31                 11.19                   10.31 %
Total capital to risk-weighted assets                14.19                14.15                      14.39                 14.19                   14.39 %
Tier 1 capital to average assets
(leverage ratio)                                      7.68                 7.24                       7.17                  7.68                    7.17 %
Asset Quality Ratios:
Net (recoveries) charge-offs to average
loans                                                 0.05  %             (0.01) %                    0.02  %               0.01   %                0.14 %
Nonperforming assets as a percentage of
total assets                                          0.48                 0.55                       0.79                  0.48                    0.79 %
Nonaccrual loans as a percent of total
loans                                                 0.71                 0.77                       1.04                  0.71                    1.04 %
Allowance for loan losses as a
percentage of total loans                             1.26                 1.30                       1.15                  1.26                    1.15 %
Allowance for loan losses as a
percentage of nonaccrual loans                      179.11               168.64                     110.32                179.11                  110.32 %
Allowance for loan losses as a
percentage of nonaccrual loans,
excluding allowance allocated to loans
accounted for under ASC 310-30                      173.58               163.76                     105.46                173.58                  

105.46%


(1) See section entitled "GAAP Reconciliation and Management Explanation of
Non-GAAP Financial Measures" below for a reconciliation to most comparable GAAP
equivalent.
(2) Presented on a tax equivalent basis using a 21% tax rate.

 GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures
Some of the financial measures included in this report are not measures of
financial condition or performance recognized by GAAP. These non-GAAP financial
measures include tangible common shareholders' equity, tangible book value per
common share, the ratio of tangible common equity to tangible assets, net income
and diluted earnings per common share excluding acquisition and due diligence
fees as well as allowance for loan loss as a percentage of total loans excluding
PPP loans. Our management uses these non-GAAP financial measures in its analysis
of our performance, and we believe that providing this information to financial
analysts and investors allows them to evaluate capital adequacy, as well as
better understand and evaluate the Company's core financial results for the
periods in question.
The following presents these non-GAAP financial measures along with their most
directly comparable financial measures calculated in accordance with GAAP:
Tangible Common Shareholders' Equity, Tangible Common Equity to Tangible Assets Ratio and Tangible Book Value Per Share
                                                                                    As of
(Dollars in thousands, except per share data)        September 30, 2021     

June 30, 2021 September 30, 2020

                                                        (Unaudited)              (Unaudited)             (Unaudited)
Total shareholders' equity                          $         233,934          $    225,409          $         209,468
Less:
Preferred stock                                                23,372                23,372                     23,370
Total common shareholders' equity                             210,562               202,037                    186,098

Less:

Goodwill                                                       35,554                35,554                     35,554
Mortgage servicing rights, net                                  5,051                 4,599                      2,193
Other intangible assets, net                                    2,695                 2,862                      3,388
Tangible common shareholders' equity                $         167,262       

$ 159,022 $ 144,963

Common shares outstanding (in thousands)                        7,640                 7,629                      7,734
Tangible book value per common share                $           21.89          $      20.84          $           18.74

Total assets                                        $       2,543,883          $  2,506,523          $       2,446,447
Less:
Goodwill                                                       35,554                35,554                     35,554
Mortgage servicing rights, net                                  5,051                 4,599                      2,193
Other intangible assets, net                                    2,695                 2,862                      3,388
Tangible assets                                     $       2,500,583          $  2,463,508          $       2,405,312

Tangible common equity to tangible assets                        6.69  %               6.46  %                    6.03  %




Adjusted Income and Diluted Earnings
Per Share
                                                         For the three months ended                                 For the nine months ended
(Dollars in thousands, except per                                    June 30,           September 30,          September 30,          September 30,
share data)                            September 30, 2021              2021                  2020                  2021                   2020
                                          (Unaudited)              (Unaudited)           (Unaudited)            (Unaudited)            (Unaudited)
Net income, as reported               $       9,465              $       

6,979 $ 5,209 $ 25,403 $ 12,040
Acquisition and due diligence costs

                -                          -                   17                       -                 1,664
Income tax benefit (1)                            -                          -                   (4)                      -                  (333)
Net income, excluding acquisition and
due diligence fees                    $       9,465              $       

6,979 $ 5,222 $ 25,403 $ 13,371

Diluted earnings per share, as
reported                              $        1.16              $        0.84          $      0.67          $         3.10          $       1.55
Effect of acquisition and due
diligence fees, net of income tax
benefit                                           -                          -                    -                       -                  0.17
Diluted earnings per common share,
excluding acquisition and due
diligence fees                        $        1.16              $        

0.84 $ 0.67 $ 3.10 $ 1.72

(1) Assumes income tax rate of 21% on deductible
acquisition expenses.


Allowance for loan losses as a percentage of total loans, excluding PPP loans

                                                                                          As of
(Dollars in thousands, except per share                                    June 30,
data)                                         September 30, 2021             2021             December 31, 2020          September 30, 2020
                                                 (Unaudited)             (Unaudited)                                        (Unaudited)
Total loans                                  $       1,719,717          $ 1,775,243          $       1,723,537          $       1,843,888
Less:
PPP loans                                              147,645              259,303                    290,135                    392,521
Total loans, excluding PPP loans             $       1,572,072          $ 

1,515,940 $ 1,433,402 $ 1,451,367

Allowance for loan loss                      $          21,731          $   

$ 23,144 $ 22,297 $ 21,254
Allowance for loan losses as a percentage of
total loans

                                               1.26  %              1.30  %                    1.29  %                    1.15  %
Allowance for loan loss as a percentage of
total loans excluding PPP loans                           1.38  %              1.53  %                    1.56  %                    1.46  %


                             Results of Operations
Net Income
We had net income of $9.5 million, or $1.16 per diluted common share, for the
three months ended September 30, 2021, compared to $5.2 million, or $0.67 per
diluted common share, for the three months ended September 30, 2020. The
increase of $4.3 million in net income reflected an increase of $3.9 million in
net interest income, primarily due to higher interest income on loans due, in
part, to the recognition of fees on PPP loans as they are forgiven, and lower
interest expense on deposits, borrowed funds, and subordinated notes. The
increase in net income also reflected a decrease of $5.5 million in provision
for loan loss, primarily due to a decrease in general reserves resulting from a
reduction in qualitative factors within the allowance for loan loss model as a
result of improved credit quality. These were partially offset by decreases of
$3.1 million in noninterest income, primarily due to lower mortgage banking
activities and net gain on sales of securities, and increases of $1.2 million in
income tax provision expense due to higher income before taxes and $863 thousand
in noninterest expense due to higher salary and employee benefits expense.
We had net income of $25.4 million, or $3.10 per diluted common share, for the
nine months ended September 30, 2021, compared to $12.0 million, or $1.55 per
diluted common share, for the nine months ended September 30, 2020. The increase
of $13.4 million in net income primarily reflected an increase of $11.6 million
in net interest income, primarily due to higher interest income on loans due, in
part, to the recognition of fees on PPP loans as they are forgiven. In addition,
there was higher interest income on securities due to increased volumes of
investment securities and lower interest expense on deposits, borrowed funds,
and subordinated notes. The increase in net income also reflected a decrease of
$10.7 million in provision for loan loss, primarily due to a decrease in general
reserves resulting from an increase in the economic qualitative factors in the
nine months ended September 30, 2020 and a reduction in qualitative factors in
the third quarter of 2021. These were partially offset by increases of $4.1
million of income tax provision primarily due to higher income before taxes and
$945 thousand of
                                       43
--------------------------------------------------------------------------------
  Table of Contents
noninterest expense primarily due to increases of $1.7 million of salary and
employee benefits expense and $608 thousand of data processing expense partially
offset by a decrease of $1.7 million in acquisition and due diligence fees due
to the merger with Ann Arbor State Bank in the first quarter of 2020. In
addition, there was a $4.0 million decrease in noninterest income primarily due
to lower mortgage banking activities and net gain on sales of securities
partially offset by an increase in service charges on deposits.
Net Interest Income
Our primary source of revenue is net interest income, which is the difference
between interest income from interest-earning assets (primarily loans and
securities) and interest expense of funding sources (primarily interest-bearing
deposits and borrowings).
Net interest income of $20.5 million for the three months ended September 30,
2021 was $3.9 million higher than the net interest income of $16.6 million for
the three months ended September 30, 2020. The three months ended September 30,
2021 included a $2.1 million increase in interest income as well as a
$1.8 million decrease in interest expense, compared to the same period in 2020.
The increase in interest income was primarily driven by increases of
$1.7 million in interest and fees on loans and $419 thousand in interest on
investment securities. The increase in interest and fees on loans for the three
months ended September 30, 2021 compared to the same period in 2020 was mainly
driven by the Bank earning $3.6 million of net SBA fees on PPP loans compared to
$1.5 million in the three months ended September 30, 2020, with the remaining
$5.3 million of SBA fees expected to be earned over the life of the loans. The
majority of the PPP loans are expected to mature two or five years from the date
of funding, depending on the round of PPP funding, unless modified by the lender
and borrower. We anticipate a large portion of the PPP loan balance will be
forgiven before the maturity of the loans. In addition to the net SBA fees, the
Bank also recognized $521 thousand of interest income on PPP loans in the third
quarter of 2021. The increase in interest income on investment securities was
mainly due to an increase of $136.2 million in average balances due to increased
customer liquidity and new customer growth.
The decrease in interest expense was primarily driven by a decrease of $1.4
million in interest expense on deposits and a decrease of $483 thousand in
interest expense on borrowed funds and subordinated notes. The decrease in
deposit interest expense was primarily due to lower interest rates paid as a
result of revised internal deposit rates and maturity of higher cost time
deposits. The decrease in interest expense on borrowed funds and subordinated
notes was primarily due to the redemption of $15.0 million of subordinated notes
during the second quarter of 2021 and a decrease in Federal Reserve Bank
borrowings
Net interest income of $59.3 million for the nine months ended September 30,
2021 was $11.6 million higher than the net interest income of $47.7 million for
the nine months ended September 30, 2020. The nine months ended September 30,
2021 included a $5.2 million increase in interest income as well as a
$6.5 million decrease in interest expense, compared to the same period in 2020.
The increase in interest income was primarily driven by increases of
$4.5 million in interest and fees on loans and $951 thousand in interest on
investment securities. These increases were partially offset by a $299 thousand
decrease in interest on federal funds and other investments. The increase in
interest and fees on loans for the nine months ended September 30, 2021 compared
to the same period in 2020 was mainly driven by the Bank earning $10.3 million
of net SBA fees on PPP loans compared to $2.9 million in the nine months ended
September 30, 2020. In addition to the net SBA fees, the Bank also recognized
$2.4 million of interest income on PPP loans in the nine months ended September
30, 2021. This was partially offset by a 56 basis point decrease in yield on
loans excluding PPP loans for the nine months ended September 30, 2021 compared
to the same period in 2020. The increase in interest income on investment
securities was mainly due to an increase of $125.3 million in average balances
due to increased customer liquidity and new customer growth.
The decrease in interest expense was primarily driven by a decrease of $5.6
million in interest expense on deposits and a decrease of $890 thousand in
interest expense on borrowed funds and subordinated notes. The decrease in
deposit interest expense was primarily due to lower interest rates paid as a
result of revised internal deposit rates and maturity of higher cost time
deposits. The decrease in interest expense on borrowed funds and subordinated
notes was primarily due to the redemption of $15.0 million of subordinated notes
during the second quarter of 2021 and a decrease in Federal Reserve Bank
borrowings.
Our net interest margin (on a fully tax equivalent basis ("FTE")) for the three
months ended September 30, 2021 was 3.47%, compared to 2.80% for the same period
in 2020. The increase of 67 basis points in the net interest margin year over
year was primarily a result of a decrease in cost of funds, which declined 40
basis points to 0.48% in the third quarter of 2021, compared to 0.88% in the
third quarter of 2020 primarily due to lower interest rates paid as a result of
revised internal deposit rates and maturity of higher cost time deposits. The
decrease in cost of funds was accompanied by higher yield on loans mostly
reflecting the increase in PPP fees earned during the period.
Our net interest margin benefits from discount accretion on our purchased credit
impaired loan portfolios, a component of our accretable yield. The accretable
yield represents the excess of the net present value of expected future cash
flows over the acquisition date fair value and includes both the expected coupon
of the loan and the discount accretion. The accretable yield is
                                       44
--------------------------------------------------------------------------------
  Table of Contents
recognized as interest income over the expected remaining life of the purchased
credit impaired loan. The difference between the actual yield earned on total
loans and the yield generated based on the contractual coupon (not including any
interest income for loans in nonaccrual status) represents excess accretable
yield. The contractual coupon of the loan considers the contractual coupon rates
of the loan and does not include any interest income for loans in nonaccrual
status. For both the three months ended September 30, 2021 and 2020, the yield
on total loans was impacted by 7 basis points due to the accretable yield on
purchased credit impaired loans. Our net interest margin for the three months
ended September 30, 2021 and 2020, benefited by 6 basis points and 8 basis
points, respectively, as a result of the excess accretable yield. For the nine
months ended September 30, 2021 and 2020, the yield on total loans was impacted
by 6 and 7 basis points due to the accretable yield on purchased credit impaired
loans. Our net interest margin for the nine months ended September 30, 2021 and
2020, benefited by 4 basis points and 9 basis points, respectively, as a result
of the excess accretable yield. As of September 30, 2021 and December 31, 2020,
our remaining accretable yield was $5.9 million and $7.1 million, respectively,
and our nonaccretable difference was $2.1 million and $2.7 million,
respectively.
Our net interest margin (FTE) for the nine months ended September 30, 2021 was
3.36%, compared to 3.04% for the same period in 2020. The increase of 32 basis
points in the net interest margin year over year was primarily a result of a
decrease in cost of funds, which declined 60 basis points to 0.55% in the first
nine months of 2021, compared to 1.15% in the first nine months of 2020
primarily due to lower interest rates paid as a result of revised internal
deposit rates and maturity of higher cost time deposits. The decrease in cost of
funds was accompanied by a lower yields across most interest-earning assets,
mostly reflecting the impact of lower market interest rates.
                                       45
--------------------------------------------------------------------------------
  Table of Contents
The following table sets forth information related to our average balance sheet,
average yields on assets, and average rates on liabilities for the periods
indicated. We derived these yields by dividing income or expense by the average
daily balance of the corresponding assets or liabilities. In this table,
adjustments were made to the yields on tax-exempt assets in order to present
tax-exempt income and fully taxable income on a comparable basis.
Analysis of Net Interest Income-Fully Taxable Equivalent
                                                            For the three months ended September         For the nine months ended September
                                                                          30, 2021                                    30, 2021
(Dollars in thousands)                                            2021                  2020                  2021                  2020
Average Balance Sheets:
Gross loans(1)                                              $  1,763,214           $ 1,871,164          $  1,823,888           $ 1,696,073
Investment securities: (2)
Taxable                                                          265,885               139,237               243,377               124,169
Tax-exempt                                                       104,063                94,526               103,158                97,104
Interest-earning cash balances                                   221,261               259,349               192,309               188,179
Other investments                                                 14,398                12,419                14,398                12,401
Total interest-earning assets                               $  2,368,821           $ 2,376,695          $  2,377,130           $ 2,117,926
Non-earning assets:                                              151,077               140,480               145,971               133,968
Total assets                                                $  2,519,898           $ 2,517,175          $  2,523,101           $ 2,251,894

Interest-bearing demand deposits                            $    156,977           $   116,285          $    144,449           $   112,579
Money market and savings deposits                                624,190               513,420               623,123               458,438
Time deposits                                                    489,261               575,179               541,018               564,396
Borrowings                                                       181,911               394,020               183,983               311,024
Subordinated notes                                                29,657                44,468                38,633                44,463
Total interest-bearing liabilities                             1,481,996             1,643,372             1,531,206             1,490,900
Noninterest-bearing demand deposits                              774,926               640,095               735,162               546,066
Other liabilities                                                 31,012                34,846                31,822                30,047
Shareholders' equity                                             231,964               198,862               224,911               184,881
Total liabilities and shareholders' equity                  $  2,519,898           $ 2,517,175          $  2,523,101           $ 2,251,894

Yields: (3)
Earning Assets
Gross loans                                                         4.60   %              3.98  %               4.42   %              4.40  %
Investment securities:
Taxable                                                             1.57   %              1.86  %               1.59   %              2.08  %
Tax-exempt                                                          2.99   %              3.19  %               3.04   %              3.20  %
Interest earning cash balances                                      0.15   %              0.12  %               0.12   %              0.28  %
Other investments                                                   2.95   %              5.57  %               3.18   %              4.49  %
Total interest earning assets                                       3.76   %              3.41  %               3.72   %              3.84  %

Interest-bearing liabilities
Interest-bearing demand deposits                                    0.14   %              0.22  %               0.15   %              0.31  %
Money market and savings deposits                                   0.17   %              0.43  %               0.20   %              0.65  %
Time deposits                                                       0.53   %              1.18  %               0.58   %              1.55  %
Borrowings                                                          1.02   %              0.70  %               1.02   %              0.80  %
Subordinated notes                                                  5.00   %              5.65  %               5.09   %              5.72  %
Total interest-bearing liabilities                                  0.48   %              0.88  %               0.55   %              1.15  %

Interest spread                                                     3.28   %              2.53  %               3.17   %              2.69  %
Net interest margin(4)                                              3.44   %              2.78  %               3.33   %              3.01  %
Tax equivalent effect                                               0.03   %              0.02  %               0.03   %              0.03  %
Net interest margin on a fully tax equivalent basis                 3.47   %              2.80  %               3.36   %              3.04  %


(1) Includes nonaccrual loans.
(2) For presentation in this table, average balances and the corresponding
average rates for investment securities are based upon historical cost, adjusted
for amortization of premiums and accretion of discounts.
(3) Average rates and yields are presented on an annual basis and include a
taxable equivalent adjustment to interest income of $155 thousand and
$144 thousand on tax-exempt securities for the three months ended September 30,
2021 and 2020, respectively, and $462 thousand and $431 thousand for the nine
months ended September 30, 2021and 2020, respectively, using the federal
corporate tax rate of 21%.
(4) Net interest margin represents net interest income divided by average total
interest-earning assets.
                                       46
--------------------------------------------------------------------------------
  Table of Contents
Rate/Volume Analysis
The table below presents the effect of volume and rate changes on interest
income and expense for the periods indicated. Changes in volume are changes in
the average balance multiplied by the previous period's average rate. Changes in
rate are changes in the average rate multiplied by the average balance from the
previous period. The net changes attributable to the combined impact of both
rate and volume have been allocated proportionately to the changes due to volume
and the changes due to rate. The average rate for tax-exempt securities is
reported on a fully taxable equivalent basis.
                                                          For the three 

months ended September 30, 2021 vs 2020

                                                                    Increase
                                                               (Decrease) Due to:
                                                                                                    Net Increase
(Dollars in thousands)                                      Rate                Volume               (Decrease)
Interest-earning assets
Gross loans                                            $      2,842          $   (1,125)         $         1,717
Investment securities:
Taxable                                                        (111)                513                      402
Tax-exempt                                                      (56)                 73                       17
Interest-earning cash balances                                   20                 (12)                       8
Other investments                                               (92)                 25                      (67)
Total interest income                                         2,603                (526)                   2,077
Interest-bearing liabilities
Interest-bearing demand deposits                                (30)                 19                      (11)
Money market and savings deposits                              (396)                101                     (295)
Time deposits                                                  (827)               (225)                  (1,052)
Borrowings                                                      240                (465)                    (225)
Subordinated debt                                               (66)               (192)                    (258)
Total interest expense                                       (1,079)               (762)                  (1,841)
Change in net interest income                          $      3,682          $      236          $         3,918






                                       47

————————————————– ——————————-

Contents

                                                          For the nine 

months ended September 30, 2021 vs 2020

                                                                    Increase
                                                               (Decrease) Due to:
                                                                                                   Net Increase
(Dollars in thousands)                                      Rate                Volume              (Decrease)
Interest-earning assets
Gross loans                                            $        276          $    4,224          $        4,500
Investment securities:
Taxable                                                        (539)              1,504                     965
Tax-exempt                                                     (155)                141                     (14)
Interest-earning cash balances                                 (233)                  9                    (224)
Other investments                                              (135)                 60                     (75)
Total interest income                                          (786)              5,938                   5,152
Interest-bearing liabilities
Interest-bearing demand deposits                               (164)                 61                    (103)
Money market and savings deposits                            (1,894)                612                  (1,282)
Time deposits                                                (3,951)               (260)                 (4,211)
Borrowings                                                      429                (886)                   (457)
Subordinated debt                                              (198)               (235)                   (433)
Total interest expense                                       (5,778)               (708)                 (6,486)
Change in net interest income                          $      4,992         

$ 6,646 $ 11,638


Provision for Loan Losses
We established an allowance for loan losses through a provision for loan losses
charged as an expense in our consolidated statements of income. Management
reviews the loan portfolio, consisting of originated loans and acquired loans,
on a quarterly basis to evaluate the outstanding loans and to measure both the
performance of the portfolio and the adequacy of the allowance for loan losses.
Loans acquired in connection with acquisitions that have evidence of credit
deterioration since origination and for which it is probable at the date of
acquisition that we will not collect all contractually required principal and
interest payments are accounted for under ASC Topic 310-30, Loans and Debt
Securities Acquired with Deteriorated Credit Quality, or ASC 310-30. These
credit-impaired loans have been recorded at their estimated fair value on the
respective acquisition date, based on subjective determinations regarding risk
ratings, expected future cash flows and fair value of the underlying collateral,
without a carryover of the related allowance for loan losses. At the acquisition
date, the Company recognizes the expected shortfall of expected future cash
flows, as compared to the contractual amount due, as a nonaccretable discount.
Any excess of the net present value of expected future cash flows over the
acquisition date fair value is recognized as the accretable discount, or
accretable yield. We evaluate these loans semi-annually to assess expected cash
flows. Subsequent decreases to the expected cash flows will generally result in
a provision for loan losses. Subsequent increases in cash flows result in a
reversal of the provision for loan losses to the extent of prior charges or a
reclassification of the difference from nonaccretable to accretable with a
positive impact on interest income. As of September 30, 2021, and December 31,
2020, our remaining accretable yield was $5.9 million and $7.1 million,
respectively, and our nonaccretable difference was $2.1 million and $2.7 million
as of both dates.
The provision for loan losses was a provision benefit of $1.2 million for the
three months ended September 30, 2021, compared to a provision expense of
$4.3 million for the three months ended September 30, 2020. The decrease of
$5.5 million in the provision for loan losses was primarily due to a decrease in
general reserves of $5.1 million due to a reduction in qualitative factors
within the allowance for loan loss model as a result improved credit quality as
well as a decrease of $531 thousand in specific reserves.
The provision for loan losses was a provision benefit of $384 thousand for the
nine months ended September 30, 2021, compared to a provision expense of
$10.3 million for the nine months ended September 30, 2020. The decrease of
$10.7 million in the provision for loan losses was primarily due to a decrease
in general reserves of $8.6 million due to a reduction in qualitative factors
mentioned above during the third quarter of 2021 while qualitative factors were
increased during the nine months ended September 30, 2020 due to economic
uncertainty regarding the impact of the COVID-19 pandemic on credit
                                       48
--------------------------------------------------------------------------------
  Table of Contents
quality. In addition, there was a decrease of $1.6 million in net chargeoffs
resulting from a $1.3 million chargeoff on a nonaccrual loan during the second
quarter of 2020 and a decrease of $402 thousand in specific reserves.
Noninterest Income
The following table presents noninterest income for the three and nine months
ended September 30, 2021 and 2020.
                                                   For the three months     

For the nine months ending in September

                                                   ended September 30,                          30,
(Dollars in thousands)                                          2021                 2020                 2021                2020
Noninterest income
Service charges on deposits                                 $      859     

$ 616 $ 2,436 $ 1,798
Net gain on sales of securities

                                      -                   434                  20               1,862
Mortgage banking activities                                      4,216                 7,108              12,738              15,380

Other charges and fees                                             966                   967               2,451               2,564
Total noninterest income                                    $    6,041          $      9,125          $   17,645          $   21,604


Noninterest income decreased $3.1 million to $6.0 million for the three months
ended September 30, 2021, compared to $9.1 million for the same period in 2020.
The decrease in noninterest income year over year was primarily due to decreases
of $2.9 million in mortgage banking activities and $434 thousand in net gains on
sales of investment securities. This was partially offset by an increase of $243
thousand in service charges on deposits. The decrease in mortgage banking
activities compared to the third quarter of 2020 was primarily due to $84.2
million fewer residential loan originations held for sale and $54.5 million
fewer residential loans sold. The higher volumes in the third quarter of 2020
were primarily as a result of the decrease in interest rates during the first
half of 2020 while interest rates have remained relatively stable in 2021. The
decrease in net gains on sales of investment securities was due to no securities
sold in the third quarter of 2021. The increase in service charges on deposits
was primarily due to higher transaction volumes and deposit balances.
Noninterest income decreased $4.0 million to $17.6 million for the nine months
ended September 30, 2021, compared to $21.6 million for the same period in 2020.
The decrease in noninterest income was primarily due to decreases of
$2.6 million in mortgage banking activities and $1.8 million in net gains on
sales of securities. These decreases were partially offset by an increase of
$638 thousand in service charges on deposits. The decrease in mortgage banking
activities was primarily due to $74.0 million lower residential loan
originations held for sale and $4.8 million lower residential loans sold. The
higher volumes in the nine months ended September 30, 2020 were primarily due to
lower interest rates during the first half of 2020 while interest rates have
remained relatively stable in 2021. The decrease in net gains on sales of
securities was primarily due to fewer securities sold during the first nine
months of 2021 compared to the same period in 2020. The increase in service
charges on deposits was due to higher transaction volumes and deposit balances.
Noninterest Expense
The following table presents noninterest expense for the three and nine months
ended September 30, 2021 and 2020.
                                                   For the three months ended            For the nine months ended September
                                                          September 30,                                  30,
(Dollars in thousands)                              2021                 2020                 2021                 2020
Noninterest expense
Salary and employee benefits                   $     10,551          $    9,862          $     29,825          $   28,090
Occupancy and equipment expense                       1,680               1,678                 4,971               4,773
Professional service fees                               847                 808                 2,264               2,141
Acquisition and due diligence fees                        -                  17                     -               1,664
FDIC premium                                            244                 287                   778                 722
Marketing expense                                       428                 257                   842                 709
Loan processing expense                                 231                 262                   755                 690
Data processing expense                                 928                 844                 3,209               2,601
Core deposit premium amortization                       167                 192                   501                 576
Other expense                                           913                 919                 2,571               2,805
Total noninterest expense                      $     15,989          $   

15,126 $ 45,716 $ 44,771

Increase in non-interest charges $ 863,000 To $ 16.0 million for the three
months ended September 30, 2021, compared to $ 15.1 million for the same period
in 2020. The increase in non-interest expenses from one year to the next was mainly
attributable to

                                       49
--------------------------------------------------------------------------------
  Table of Contents
increases of $689 thousand in salary and employee benefits and $171 thousand in
marketing expenses. The increase in salary and employee benefits between the
periods was primarily due to an increase of 20 full-time equivalent employees as
well as incentive compensation. The increase in marketing expense between the
periods was due to an increase in advertising efforts.
Noninterest expense increased $945 thousand to $45.7 million for the nine months
ended September 30, 2021, compared to $44.8 million for the same period in 2020.
The increase in noninterest expense was primarily due to increases in salary and
employee benefits of $1.7 million, data processing expense of $608 thousand and
occupancy and equipment expense of $198 thousand. These increases were partially
offset by decreases of $1.7 million in acquisition and due diligence fees and
$234 thousand of other expense. The increase in salary and employee benefits was
primarily due to increases of $719 thousand in incentive compensation, $606
thousand in salaries expense, and $291 thousand in contract labor. The increase
in data processing expense was primarily due to the new loan processing system
used for PPP loans. The increase in occupancy and equipment expense was
primarily due to software maintenance and licensing. The decrease in acquisition
and due diligence fees was primarily due to the acquisition of Ann Arbor State
Bank in the first quarter of 2020. The decrease in other expense was primarily
due to a decrease in the provision for unfunded commitments.
Income Taxes and Tax-Related Items
During the three months ended September 30, 2021, we recognized income tax
expense of $2.3 million on $11.8 million of pre-tax income resulting in an
effective tax rate of 19.5%, compared to the same period in 2020, in which we
recognized an income tax expense of $1.1 million on $6.3 million of pre-tax
income, resulting in an effective tax rate of 17.7%.
During the nine months ended September 30, 2021, we recognized income tax
expense of $6.2 million on $31.6 million of pre-tax income resulting in an
effective tax rate of 19.6%, compared to the same period in 2020, in which we
recognized an income tax expense of $2.1 million on $14.1 million of pre-tax
income, resulting in an effective tax rate of 14.9%.
The increase in income tax provision for the nine months ended September 30,
2021 compared to the same period in 2020 was primarily as a result of a $290
thousand tax benefit related to the Ann Arbor State Bank net operating loss
(NOL) in the first quarter of 2020 resulting from the CARES Act provision that
allows for NOLs generated in 2018 to 2020 to be carried back five years.
Additionally, disqualified dispositions of Ann Arbor State Bank's stock options
generated a $175 thousand tax benefit in the first quarter of 2020.
See "Note 9 - Income Taxes" of Notes to Consolidated Financial Statements for a
reconciliation between expected and actual income tax expense for the three and
nine months ended September 30, 2021 and 2020.
                              Financial Condition
Investment Securities
The following table presents the fair value of the Company's investment
securities portfolio, all of which were classified as available-for-sale as of
September 30, 2021 and December 31, 2020.
                                                                           September 30,         December 31,
(Dollars in thousands)                                                          2021                 2020
Securities available-for-sale:
U.S. government sponsored entities and agencies                            $    24,036          $    26,358
State and political subdivision                                                146,695              132,723
Mortgage-backed securities: residential                                         20,086               26,081
Mortgage-backed securities: commercial                                          23,540               11,918
Collateralized mortgage obligations: residential                                 9,871               13,446
Collateralized mortgage obligations: commercial                                 52,738               58,512
U.S. Treasury                                                                   64,898                    -
SBA                                                                             15,108               17,593
Asset backed securities                                                          9,858               10,072
Corporate bonds                                                                 22,698                6,029
Total securities available-for-sale                                        

$ 389,528 $ 302,732


The composition of our investment securities portfolio reflects our investment
strategy of maintaining an appropriate level of liquidity for both normal
operations and potential acquisitions, while providing an additional source of
revenue. The investment portfolio also provides a balance to interest rate risk
and credit risk in other categories of the balance sheet, while providing a
vehicle for the investment of available funds, furnishing liquidity, and
supplying securities to pledge as collateral. At September 30, 2021, total
investment securities were $389.5 million, or 15.3% of total assets, compared to
$302.7 million,
                                       50
--------------------------------------------------------------------------------
  Table of Contents
or 12.4% of total assets, at December 31, 2020. The $86.8 million increase in
securities available-for-sale from December 31, 2020 to September 30, 2021, was
due to the purchase of securities using the excess cash balances generated by
the payoffs of PPP loans and increase in deposits. Securities with a carrying
value of $90.6 million and $98.7 million were pledged at September 30, 2021 and
December 31, 2020, respectively, to secure borrowings, deposits and mortgage
derivatives.
As of September 30, 2021, the Company held 68 tax-exempt state and local
municipal securities totaling $52.8 million backed by the Michigan School Bond
Loan Fund. Other than the aforementioned investments and the U.S. government and
its agencies, at September 30, 2021 and December 31, 2020, there were no
holdings of securities of any one issuer in an amount greater than 10% of
shareholders' equity.
The securities available-for-sale presented in the following tables are reported
at amortized cost and by contractual maturity as of September 30, 2021 and
December 31, 2020. Expected maturities may differ from contractual maturities as
issuers may have the right to call or prepay obligations with or without call or
prepayment penalties. Additionally, residential mortgage-backed securities and
collateralized mortgage obligations receive monthly principal payments, which
are not reflected below. The yields below are calculated on a tax equivalent
basis.
                                                                                                                   September 30, 2021
                                                     One year or less                          One to five years                       Five to ten years                           After ten years
                                              Amortized              Average            Amortized            Average             Amortized            Average               Amortized              Average
(Dollars in thousands)                          Cost                  Yield                Cost               Yield                Cost                Yield                  Cost                  Yield
Securities available-for-sale:
U.S. government sponsored agency
obligations                               $        4,010                 1.61  %       $     521                 1.62  %       $   15,000                 1.22  %       $        5,000                 1.48  %
State and political subdivision                    1,254                 2.44             13,514                 2.46              50,986                 2.71                  74,001                 2.89
Mortgage-backed securities:
residential                                            -                    -                 87                 1.71                  27                 1.92                  19,912                 0.75
Mortgage-backed securities:
commercial                                             -                    -              5,120                 2.46              16,620                 1.28                   1,791                 3.63
Collateralized mortgage
obligations: residential                               -                    -                331                 2.91                 186                 1.21                   9,279                 1.09
Collateralized mortgage
obligations: commercial                            2,575                 3.70              4,509                 2.57              39,203                 1.28                   6,631                 2.25
U.S. Treasury                                          -                    -             35,742                 0.87              29,376                 1.34                       -                    -
SBA                                                    -                    -                  -                    -               8,084                 1.46                   6,927                 1.37
Asset backed securities                                -                    -                  -                    -                   -                    -                   9,896                 0.76
Corporate bonds                                        -                    -                  -                    -              21,801                 3.82                   1,000                 3.25
Total securities available-for-sale       $        7,839                 2.43  %       $  59,824                 1.52  %       $  181,283                 2.00  %       $      134,437                 2.14  %


                                                                                                                 December 31, 2020
                                                  One year or less                        One to five years                       Five to ten years                           After ten years
                                           Amortized            Average            Amortized            Average             Amortized            Average               Amortized              Average
(Dollars in thousands)                        Cost               Yield                Cost               Yield                Cost                Yield                  Cost                  Yield
Securities available-for-sale:
U.S. government sponsored agency
obligations                               $   4,027                 1.61  %       $   2,548                 1.61  %       $   15,000                 1.22  %       $        5,000                 1.48  %
State and political subdivision               1,768                 1.96             10,095                 2.46              31,142                 2.80                  81,048                 2.99
Mortgage-backed securities:
residential                                       -                    -                 78                 0.94                  87                 0.19                  25,564                 1.44
Mortgage-backed securities:
commercial                                      847                 1.36              3,795                 2.46               4,985                 1.69                   1,807                 3.64
Collateralized mortgage
obligations: residential                          -                    -                 46                 4.02                 559                 2.11                  12,715                 1.25
Collateralized mortgage
obligations: commercial                         577                 2.54              8,011                 3.10              40,889                 1.26                   7,921                 2.46

SBA                                               -                    -                  -                    -               9,879                 1.40                   7,760                 1.21
Asset backed securities                           -                    -                  -                    -                   -                    -                  10,229                 0.84
Corporate bonds                               3,498                 3.08                  -                    -               2,500                 4.38                       -                    -
Total securities available-for-sale       $  10,717                 2.18  %       $  24,573                 2.58  %       $  105,041                 1.82  %       $      152,044                 2.28  %


Loans
                                       51
--------------------------------------------------------------------------------
  Table of Contents
Our loan portfolio represents a broad range of borrowers comprised of commercial
real estate, commercial and industrial, residential real estate, and consumer
financing loans.
Commercial real estate loans consist of term loans secured by a mortgage lien on
the real property, such as office and industrial buildings, retail shopping
centers and apartment buildings, as well as commercial real estate construction
loans that are offered to builders and developers. Commercial real estate loans
are then segregated into two classes: non-owner occupied and owner occupied
commercial real estate loans. Non-owner occupied loans, which include loans
secured by non-owner occupied and nonresidential properties, generally have a
greater risk profile than owner-occupied loans, which include loans secured by
multifamily structures and owner-occupied commercial structures.
Commercial and industrial loans include financing for commercial purposes in
various lines of business, including manufacturing, service industry and
professional service areas. Commercial and industrial loans are generally
secured with the assets of the company and/or the personal guarantee of the
business owners. The PPP loans funded during the second and third quarters of
2020 and first and second quarters of 2021, which are guaranteed by the SBA, are
reported within the commercial and industrial loan category.
Residential real estate loans represent loans to consumers for the purchase or
refinance of a residence. These loans are generally financed over a 15- to
30-year term and, in most cases, are extended to borrowers to finance their
primary residence with both fixed-rate and adjustable-rate terms. Real estate
construction loans are also offered to consumers who wish to build their own
homes and are often structured to be converted to permanent loans at the end of
the construction phase, which is typically twelve months. Residential real
estate loans also include home equity loans and lines of credit that are secured
by a first- or second-lien on the borrower's residence. Home equity lines of
credit consist mainly of revolving lines of credit secured by residential real
estate.
Consumer loans include loans made to individuals not secured by real estate,
including loans secured by automobiles or watercraft, and personal unsecured
loans.
The following table details our loan portfolio by loan type at the dates
presented:
                                           As of September
                                                 30,                                          As of December 31,
(Dollars in thousands)                          2021                  2020                 2019                 2018                 2017
Commercial real estate:
Non-owner occupied                         $    479,633          $   445,810          $   388,515          $   367,671          $   343,420
Owner occupied                                  295,228              275,022              216,131              194,422              168,342
Total commercial real estate                    774,861              720,832              604,646              562,093              511,762
Commercial and industrial                       540,546              685,504              410,228              383,455              377,686
Residential real estate                         403,517              315,476              211,839              180,018              144,439
Consumer                                            793                1,725                  896                  999                1,036
Total loans                                $  1,719,717          $ 1,723,537          $ 1,227,609          $ 1,126,565          $ 1,034,923


Total loans were $1.72 billion at September 30, 2021, a decrease of $3.8 million
from December 31, 2020. The decline in our loan portfolio compared to December
31, 2021 was primarily due to a $145.0 million decrease in our commercial and
industrial loan portfolio, $142.5 million of which was due to the net change in
PPP loans. This was partially offset by increases of $88.0 million in our
residential real estate portfolio and $54.0 million in our commercial real
estate portfolio. In general, we target a loan portfolio mix of approximately
one-half commercial real estate, approximately one-third commercial and
industrial loans and one-sixth a mix of residential real estate and consumer
loans. As of September 30, 2021, approximately 45.1% of our loans were
commercial real estate, 31.4% were commercial and industrial, and 23.5% were
residential real estate and consumer loans.
We originate both fixed and adjustable rate residential real estate loans
conforming to the underwriting guidelines of Fannie Mae and Freddie Mac, as well
as home equity loans and lines of credit that are secured by first or junior
liens. Most of our fixed rate residential loans, along with some of our
adjustable rate mortgages, are sold to Fannie Mae and other financial
institutions with which we have established a correspondent lending
relationship. The Company established a direct relationship with Fannie Mae and
began locking and selling loans to Fannie Mae with servicing retained during the
third quarter of 2019. Refer to Note 7 - Mortgage Servicing Rights, Net for
further details on our mortgage servicing rights.

Loan maturity / interest rate sensitivity

                                       52

————————————————– ——————————-

  Table of Contents
The following table shows the contractual maturities of our loans as of
September 30, 2021.
                                                                        After one but
                                                  One year or            within five           After five
(Dollars in thousands)                               less                   years                 years               Total
September 30, 2021
Commercial real estate                          $    105,954          $      427,610          $  241,297          $   774,861
Commercial and industrial                            148,351                 320,319              71,876              540,546
Residential real estate                               14,176                   6,911             382,430              403,517
Consumer                                                 121                     630                  42                  793
Total loans                                     $    268,602          $      755,470          $  695,645          $ 1,719,717
Sensitivity of loans to changes in
interest rates:
Fixed interest rates                                                  $      650,027          $  273,194
Floating interest rates                                                      105,443             422,451
Total                                                                 $      755,470          $  695,645


Summary of Impaired Assets and Past Due Loans
Nonperforming assets consist of nonaccrual loans and other real estate owned. We
do not consider performing TDRs to be nonperforming assets, but they are
included as part of impaired assets. The level of nonaccrual loans is an
important element in assessing asset quality. Loans are classified as nonaccrual
when, in the opinion of management, collection of principal or interest is not
expected according to the terms of the agreement. Generally, loans are placed on
nonaccrual status due to the continued failure by the borrower to adhere to
contractual payment terms coupled with other pertinent factors, such as
insufficient collateral value.
A loan is categorized as a troubled debt restructuring if a concession is
granted, such as to provide for the reduction of either interest or principal,
due to deterioration in the financial condition of the borrower. Typical
concessions include reduction of the interest rate on the loan to a rate
considered lower than the current market rate, forgiveness of a portion of the
loan balance, extension of the maturity date, and/or modifications from
principal and interest payments to interest-only payments for a certain period.
Loans are not classified as TDRs when the modification is short-term or results
in only an insignificant delay or shortfall in the payments to be received. In
accordance with bank regulatory guidance, troubled debt restructurings do not
include short-term modifications made on a good-faith basis in response to the
COVID-19 pandemic to borrowers who were current prior to any relief. This
includes short-term modifications such as payment deferrals, fee waivers,
extensions of repayment terms, or other delays in payment that are
insignificant. As of September 30, 2021, there were $1.1 million of loans that
remained on a COVID-related deferral compared to $19.8 million as of December
31, 2020. As of September 30, 2021, there were no loans that had payments
deferred greater than six months compared to $11.4 million as of December 31,
2020.
Credit Quality Indicators:
The Company categorizes loans into risk categories based on relevant information
about the ability of borrowers to service their debt such as: current financial
information, historical payment experience, credit documentation, public
information, and current economic trends, among other factors. The Company
analyzes loans individually by classifying the loans as to credit risk. This
analysis includes commercial and industrial and commercial real estate loans and
is performed on an annual basis. The Company uses the following definitions for
risk ratings:
Pass.  Loans classified as pass are higher quality loans that do not fit any of
the other categories described below. This category includes loans risk rated
with the following ratings: cash/stock secured, excellent credit risk, superior
credit risk, good credit risk, satisfactory credit risk, and marginal credit
risk.
Special Mention.  Loans classified as special mention have a potential weakness
that deserves management's close attention. If left uncorrected, these potential
weaknesses may result in deterioration of the repayment prospects for the loan
or of the Company's credit position at some future date.
Substandard.  Loans classified as substandard are inadequately protected by the
current net worth and paying capacity of the obligor or of the collateral
pledged, if any. Loans so classified have a well-defined weakness or weaknesses
that jeopardize the liquidation of the debt. They are characterized by the
distinct possibility that the Company will sustain some loss if the deficiencies
are not corrected.
                                       53
--------------------------------------------------------------------------------
  Table of Contents
Doubtful.  Loans classified as doubtful have all the weaknesses inherent in
those classified as substandard, with the added characteristic that the
weaknesses make collection or liquidation in full, on the basis of currently
existing facts, conditions, and values, highly questionable and improbable.
For residential real estate loans and consumer loans, the Company evaluates
credit quality based on the aging status of the loan and by payment activity.
Residential real estate loans and consumer loans are considered nonperforming if
they are 90 days or more past due. Consumer loan types are continuously
monitored for changes in delinquency trends and other asset quality indicators.
Purchased credit impaired loans accounted for under ASC 310-30 are classified as
performing, even though they may be contractually past due, as any nonpayment of
contractual principal or interest is considered in the semi-annual re-estimation
of expected cash flows and is included in the resulting recognition of current
period loan loss provision or future period yield adjustments.
Total classified and criticized loans as of September 30, 2021 compared to
December 31, 2020 were as follows:
(Dollars in thousands)                        September 30, 2021       December 31, 2020
Classified loans:
Substandard                                  $            23,994      $           34,921
Doubtful                                                   1,557                   1,143
Total classified loans                       $            25,551      $           36,064
Special mention                                           64,642                  47,297
Total classified and criticized loans        $            90,193      $     

83,361


A summary of nonperforming assets (defined as nonaccrual loans and other real
estate owned), performing troubled debt restructurings and loans 90 days or more
past due and still accruing, as of the dates indicated, are presented below.
                                                               As of
                                                           September 30,                              As of December 31,
(Dollars in thousands)                                         2021               2020              2019              2018              2017
Nonaccrual loans
Commercial real estate                                     $    3,768          $  7,320          $  4,832          $  5,927          $  2,257
Commercial and industrial                                       4,746             7,490            11,112             9,605             9,024
Residential real estate                                         3,610             3,991             2,569             2,915             2,767
Consumer                                                            9                15                16                 -                 -
Total nonaccrual loans(1)                                      12,133            18,816            18,529            18,447            14,048
Other real estate owned                                             -                 -               921                 -               652
Total nonperforming assets                                     12,133            18,816            19,450            18,447            14,700

Carry out restructuring of troubled debts

Commercial and industrial                                         336               546               547               568               961
Residential real estate                                           426               432               359               363               261
Total performing troubled debt restructurings                     762               978               906               931             1,222

Total impaired assets, excluding loans ASC 310-30 $ 12,895

$ 19,794 $ 20,356 $ 19,378 $ 15,922
Loans 90 days or more past due and still outstanding $ 162

$ 269 $ 157 $ 243 $ 440


(1)Nonaccrual loans include nonperforming troubled debt restructurings of $3.5
million, $3.8 million, $3.0 million, $5.0 million and $6.4 million at the
respective dates indicated above.
During the nine months ended September 30, 2021 and 2020, the Company recorded
$616 thousand and $144 thousand, respectively, of interest income on nonaccrual
loans and performing TDRs excluding PCI loans.`
In addition to nonperforming and impaired assets, the Company had purchased
credit impaired loans accounted for under ASC 310-30 which amounted to $4.4
million, $5.0 million, $6.0 million, $7.9 million, and $9.7 million at the
respective dates indicated in the table above.
                                       54
--------------------------------------------------------------------------------
  Table of Contents
Nonperforming assets decreased $6.7 million as of September 30, 2021 compared to
December 31, 2020. The decrease in nonperforming assets was attributable to a
decrease in nonaccrual loans primarily due to pay offs of three commercial loan
relationships totaling $5.1 million and a $2.8 million paydown on one commercial
loan relationship. This was partially offset by three commercial loan
relationships moving to nonaccrual status totaling $2.3 million. There was $735
thousand of nonperforming loans that were in the process of foreclosure at
September 30, 2021.
Allowance for Loan Losses
We maintain the allowance for loan losses at a level we believe is sufficient to
absorb probable incurred losses in our loan portfolio given the conditions at
the time. Management determines the adequacy of the allowance based on periodic
evaluations of the loan portfolio and other factors. These evaluations are
inherently subjective as they require management to make material estimates, all
of which may be susceptible to significant change. The allowance is increased by
provisions charged to expense and decreased by actual charge-offs, net of
recoveries.
Acquired Loans
The allowance for loan losses on acquired loans is based on credit deterioration
subsequent to the acquisition date. In accordance with the accounting guidance
for business combinations, there was no allowance brought forward on any of the
acquired loans as any credit deterioration evident in the loans was included in
the determination of the fair value of the loans at the acquisition date. For
purchased credit impaired loans, accounted for under ASC 310-30, management
establishes an allowance for credit deterioration subsequent to the date of
acquisition by re-estimating expected cash flows on a semi-annual basis with any
decline in expected cash flows recorded as provision for loan losses. Impairment
is measured as the excess of the recorded investment in a loan over the present
value of expected future cash flows discounted at the pre-impairment accounting
yield of the loan. For increases in cash flows expected to be collected, we
first reverse any previously recorded allowance for loan losses, then adjust the
amount of accretable yield recognized on a prospective basis over the loan's
remaining life. These cash flow evaluations are inherently subjective as they
require material estimates, all of which may be susceptible to significant
change. For non-purchased credit impaired loans acquired in our acquisitions
that are accounted for under ASC 310-20, the historical loss estimates are based
on the historical losses experienced since acquisition. We record an allowance
for loan losses only when the calculated amount exceeds the discount remaining
from acquisition that was established for the similar period covered in the
allowance for loan loss calculation. For all other purchased loans, the
allowance is calculated in accordance with the methods used to calculate the
allowance for loan losses for originated loans, as described below.
Originated Loans
The allowance for loan losses represents management's assessment of probable
credit losses inherent in the loan portfolio. The allowance for loan losses
consists of specific components, based on individual evaluation of certain
loans, and general components for homogeneous pools of loans with similar risk
characteristics.
Impaired loans include loans placed on nonaccrual status and troubled debt
restructurings. Loans are considered impaired when based on current information
and events it is probable that we will be unable to collect all amounts due in
accordance with the original contractual terms of the loan agreements. When
determining if we will be unable to collect all principal and interest payments
due in accordance with the original contractual terms of the loan agreement, we
consider the borrower's overall financial condition, resources and payment
record, support from guarantors, and the realizable value of any collateral.
Loans that experience insignificant payment delays and payment shortfalls
generally are not classified as impaired. Management determines the significance
of payment delays and payment shortfalls on a case-by-case basis, taking into
consideration all of the circumstances surrounding the loan and the borrower,
including the length of the delay, the reasons for the delay, the borrower's
prior payment record, and the amount of the shortfall in relation to the
principal and interest owed.
All impaired loans are identified to be individually evaluated for impairment.
If a loan is impaired, a portion of the allowance is allocated so that the loan
is reported, net, at the discounted expected future cash flows or at the fair
value of collateral if repayment is collateral dependent.
The allowance for our nonimpaired loans, which includes commercial real estate,
commercial and industrial, residential real estate, and consumer loans that are
not individually evaluated for impairment, begins with a process of estimating
the probable incurred losses in the portfolio. These estimates are established
based on our historical loss data. Additional allowance estimates for commercial
and industrial and commercial real estate loans are based on internal credit
risk ratings. Internal credit risk ratings are assigned to each business loan at
the time of approval and are subjected to subsequent periodic reviews by senior
management, at least annually or more frequently upon the occurrence of a
circumstance that affects the credit risk of the loan. There is no allowance on
PPP loans (included in the commercial and industrial loan category) since they
are 100% guaranteed by the SBA.
                                       55
--------------------------------------------------------------------------------
  Table of Contents
The Company's current methodology on historical loss analysis incorporates and
fully relies on the Company's own historical loss data. The historical loss
estimates are established by loan type including commercial real estate,
commercial and industrial, residential real estate, and consumer. In addition,
consideration is given to the borrower's rating for commercial and industrial
and commercial real estate loans.
The following table presents, by loan type, the changes in the allowance for
loan losses for the periods presented.
                                                    For the three months    

For the nine months ending in September

                                                    ended September 30,                          30,
(Dollars in thousands)                                          2021                  2020                  2021                2020
Balance at beginning of period                              $   23,144          $     17,063            $   22,297          $   12,674
Loan charge-offs:

Commercial and industrial                                           (6)                  (10)                  (24)             (1,729)
Residential real estate                                           (242)                 (110)                 (242)               (110)
Consumer                                                            (7)                   (4)                  (21)                (47)
Total loan charge-offs                                            (255)                 (124)                 (287)             (1,886)
Recoveries of loans previously
charged-off:
Commercial real estate                                               -                    12                     -                  12
Commercial and industrial                                            8                    15                    44                  47
Residential real estate                                             14                    10                    46                  51
Consumer                                                             9                     8                    15                  22
Total loan recoveries                                               31                    45                   105                 132
Net charge-offs                                                   (224)                  (79)                 (182)             (1,754)
Provision expense (benefit) for loan
losses                                                          (1,189)                4,270                  (384)             10,334
Balance at end of period                                    $   21,731          $     21,254            $   21,731          $   21,254
Allowance for loan losses as a percentage
of period-end loans                                               1.26  %               1.15    %             1.26  %             1.15  %
Net charge-offs to average loans                                  0.05                  0.02                  0.01                0.14


Our allowance for loan losses was $21.7 million, or 1.26% of loans, at September
30, 2021 compared to $22.3 million, or 1.29% of loans, at December 31, 2020. As
of September 30, 2021 and December 31, 2020, the allowance for loan losses as a
percentage of loans excluding PPP loans (a non-GAAP measure), was 1.38% and
1.56%, respectively. The $566 thousand decrease in the allowance for loan losses
during the nine months ended September 30, 2021 was primarily due to a decrease
in general reserves related to the reduction in qualitative factors within the
allowance for loan loss model as a result of improved credit quality.













                                       56
--------------------------------------------------------------------------------
  Table of Contents
The following table presents, by loan type, the allocation of the allowance for
loan losses at the dates presented.
                                                                                       Percentage of loans in
                                                                   Allocated               each category
(Dollars in thousands)                                             Allowance               to total loans
September 30, 2021
Balance at end of period applicable to:
Commercial real estate                                          $      9,790                           45.1  %
Commercial and industrial                                              8,114                           31.4
Residential real estate                                                3,823                           23.5
Consumer                                                                   4                              -
Total loans                                                     $     21,731                          100.0  %
December 31, 2020
Balance at end of period applicable to:
Commercial real estate                                          $      9,975                           41.8  %
Commercial and industrial                                              8,786                           39.8
Residential real estate                                                3,527                           18.3
Consumer                                                                   9                            0.1
Total loans                                                     $     22,297                          100.0  %
December 31, 2019
Balance at end of period applicable to:
Commercial real estate                                          $      5,773                           49.2  %
Commercial and industrial                                              5,515                           33.4
Residential real estate                                                1,384                           17.3
Consumer                                                                   2                            0.1
Total loans                                                     $     12,674                          100.0  %
December 31, 2018
Balance at end of period applicable to:
Commercial real estate                                          $      5,227                           49.9  %
Commercial and industrial                                              5,174                           34.0
Residential real estate                                                1,164                           16.0
Consumer                                                                   1                            0.1
Total loans                                                     $     11,566                          100.0  %
December 31, 2017
Balance at end of period applicable to:
Commercial real estate                                          $      4,852                           49.4  %
Commercial and industrial                                              5,903                           36.5
Residential real estate                                                  950                           14.0
Consumer                                                                   8                            0.1
Total loans                                                     $     11,713                          100.0  %


Goodwill
The Company has acquired three banks, Lotus Bank in March 2015, Bank of Michigan
in March 2016, and Ann Arbor State Bank in January 2020, which resulted in the
recognition of goodwill. Total goodwill was $35.6 million at September 30, 2021
and December 31, 2020.
As a result of the unprecedented decline in economic conditions triggered by the
COVID-19 pandemic, the market valuations, including our stock price, saw a
significant decline in March 2020, which then continued into the second quarter
of 2020. These events indicated that goodwill may be impaired and resulted in us
performing a qualitative goodwill impairment assessment in the second quarter of
2020. As a result of the analysis, we concluded that it was more-likely-than-not
that the fair value of the reporting unit could be greater than its carrying
amount.
Since the price of our stock did not fully recover during the third quarter of
2020, the Company engaged a reputable, third-party valuation firm to perform a
quantitative analysis of goodwill as of August 31, 2020 ("the valuation date").
In deriving the fair value of the reporting unit (the Bank), the third-party
firm assessed general economic conditions and outlook; industry and market
considerations and outlook; the impact of recent events on financial
performance; the market price of our common stock; and other relevant events. In
addition, the valuation relied on financial projections through 2023 and growth
                                       57
--------------------------------------------------------------------------------
  Table of Contents
rates prepared by management. Based on the valuation prepared, it was determined
that the Company's estimated fair value of the reporting unit at August 31, 2020
was greater than its book value, and impairment of goodwill was not required.

The Company completed its annual goodwill impairment review as of October 1,
2020, noting strong financial indicators for the Bank, solid credit quality
ratios, as well as the strong capital position of the Bank. In addition, third
quarter 2020 revenue reflected significant and continuing growth in our
residential mortgage banking business, as well as net SBA fees related to PPP
loans funded during second and third quarters of 2020. Management concurred with
the conclusion derived from the quantitative goodwill analysis as of August 31,
2020 and determined that there were no material changes between the valuation
date and October 1, 2020. Management also determined that no triggering events
have occurred that indicated impairment from the most recent valuation date
through September 30, 2021, the stock was trading above book value as of
September 30, 2021, and it is more likely than not that there was no goodwill
impairment as of September 30, 2021.
Deposits
Total deposits were $2.07 billion at September 30, 2021 and $1.96 billion at
December 31, 2020, representing 89.5% and 88.1% of total liabilities,
respectively. The increase in deposits of $103.7 million was comprised of
increases of $225.1 million in demand deposits and $11.7 million in money market
and savings deposits, partially offset by a decrease of $133.1 million in time
deposits. The increase in deposits was primarily due to organic deposit growth
during the nine months ended September 30, 2021 mainly as a result of increased
customer liquidity and new customer growth.
Our average interest-bearing deposit costs were 0.35% and 1.06% for the nine
months ended September 30, 2021 and 2020, respectively. The decrease in
interest-bearing deposit costs between the two periods was primarily due to
lower interest rates paid as a result of revised internal deposit rates, mainly
driven by the continuation of the low level of the target federal funds rate.
The target federal funds interest rate decreased 150 basis points during March
2020.
Brokered deposits.  Brokered deposits are marketed through national brokerage
firms to their customers in $1,000 increments. For these brokered deposits,
detailed records of owners are maintained by The Depository Trust Company under
the name of CEDE & Co. This relationship provides a large source of deposits for
the Company. Due to the competitive nature of the brokered deposit market,
brokered deposits tend to bear higher rates of interest than non-brokered
deposits. At September 30, 2021 and December 31, 2020, the Company had
approximately $23.1 million and $29.3 million, respectively, of brokered
deposits. The Company's ability to accept, roll-over or renew brokered deposits
is contingent upon the Bank maintaining a capital level of "well-capitalized."
Included in the brokered deposits total at September 30, 2021 and December 31,
2020 was $679 thousand and $1.2 million, respectively, in Certificate of Deposit
Account Registry Service ("CDARS") one-way buys that were acquired from Ann
Arbor State Bank.
Management understands the importance of core deposits as a stable source of
funding and may periodically implement various deposit promotion strategies to
encourage core deposit growth. For periods of rising interest rates, management
has modeled the aggregate yields for non-maturity deposits and time deposits to
increase at a slower pace than the increase in underlying market rates, which is
intended to result in net interest margin expansion and an increase in net
interest income.












                                       58
--------------------------------------------------------------------------------
  Table of Contents
The following table sets forth the distribution of average deposits by account
type for the periods indicated below.
                                                                                       Three Months Ended September 30, 2021
                                                                              Average                                         Average
(Dollars in thousands)                                                        Balance                 Percent                  Rate
Noninterest-bearing demand deposits                                       $     774,926                    37.9  %                    -  %
Interest-bearing demand deposits                                                156,977                     7.7                    0.14
Money market and savings deposits                                               624,190                    30.5                    0.17
Time deposits                                                                   489,261                    23.9                    0.53
Total deposits                                                            $   2,045,354                   100.0  %                 0.19  %

                                                                                        Nine Months Ended September 30, 2021
                                                                              Average                                         Average
(Dollars in thousands)                                                        Balance                 Percent                  Rate
Noninterest-bearing demand deposits                                       $     735,162                    35.9  %                    -  %
Interest-bearing demand deposits                                                144,449                     7.1                    0.15
Money market and savings deposits                                               623,123                    30.5                    0.20
Time deposits                                                                   541,018                    26.5                    0.58
Total deposits                                                            $   2,043,752                   100.0  %                 0.23  %


The following table shows the contractual maturity of time deposits, including
CDARS and IRA deposits and other brokered funds, of $100 thousand and over that
were outstanding as of the date presented.
(Dollars in thousands)         September 30, 2021
Maturing in:
3 months or less              $          108,867
3 months to 6 months                     118,644
6 months to 1 year                       120,922
1 year or greater                         67,157
Total                         $          415,590


Borrowings
Total debt outstanding at September 30, 2021 was $211.7 million, a decrease of
$18.6 million from $230.3 million at December 31, 2020. The decrease in total
borrowings was primarily due to a $15.0 million redemption of subordinated debt
in June 2021.
At September 30, 2021, FHLB advances were secured by a blanket lien on $582.8
million of real estate-related loans, and repurchase agreements were secured by
securities with a fair value of $3.8 million. At December 31, 2020, FHLB
advances were secured by a blanket lien on $512.3 million of real estate-related
loans, and repurchase agreements were secured by securities with a fair value of
$3.7 million.
As of September 30, 2021, the Company had $30.0 million of subordinated notes
outstanding and debt issuance costs of $332 thousand related to these
subordinated notes. As of December 31, 2020, the Company had $45.0 million of
subordinated notes outstanding and debt issuance costs of $408 thousand related
to these subordinated notes.
The $15.0 million of subordinated notes issued on December 21, 2015 had a fixed
interest rate of 6.375% per annum, payable semiannually through December 15,
2020. From December 15, 2020, through maturity, the notes had a floating
interest rate of three-month LIBOR plus 477 basis points payable quarterly
through maturity. The notes were scheduled to mature on December 15, 2025, and
the Company had the option to redeem or prepay any or all of the subordinated
notes without premium or penalty any time after December 15, 2020 or upon an
occurrence of a Tier 2 capital event or tax event. These subordinated notes were
redeemed in June 2021.
The $30.0 million of subordinated notes issued on December 18, 2019 bear a fixed
interest rate of 4.75% per annum, payable semiannually through December 18,
2024. The notes will bear a floating interest rate of three-month SOFR plus 311
basis points payable quarterly after December 18, 2024 through maturity. The
notes mature on December 18, 2029, and the Company has the option to redeem any
or all of the subordinated notes without premium or penalty any time after
December 18, 2024 or upon the occurrence of a Tier 2 capital event or tax event.
The issuance of the $30.0 million subordinated notes
                                       59
--------------------------------------------------------------------------------
  Table of Contents
reflected management's efforts to fund the liquidity needs of the Company as
well as pay the merger consideration to purchase Ann Arbor State Bank.
Selected financial information pertaining to the components of our short-term
borrowings for the periods and as of the dates indicated is as follows:
                                                    For the three months 

finished in september

                                                                     30,                         For the nine months ended September 30,
(Dollars in thousands)                                    2021                  2020                     2021                    2020
Securities sold under agreements to
repurchase
Average daily balance                               $      2,517            $      163          $           3,011            $      330
Weighted-average rate during period                         0.25    %             0.30  %                    0.25    %             0.30  %
Amount outstanding at period end                    $      2,681            $      187          $           2,681            $      187
Weighted-average rate at period end                         0.25    %             0.30  %                    0.25    %             0.30  %
Maximum month-end balance                           $      2,681            $      187          $           3,993            $      936
FHLB Advances
Average daily balance                               $          -            $        -          $               -            $    5,456
Weighted-average rate during period                            -    %                -  %                       -    %             0.99  %

Maximum month-end balance                           $          -            $        -          $               -            $   25,000
FHLB Line of Credit
Average daily balance                               $          -            $       63          $               4            $       60
Weighted-average rate during period                            -    %                -  %                    0.44    %             1.29  %

Federal funds purchased
Average daily balance                               $          -            $        -          $               -            $      193
Weighted-average rate during period                            -    %                -  %                       -    %             2.73  %



Capital Resources
Shareholders' equity is influenced primarily by earnings, dividends, the
Company's sales and repurchases of its common stock and changes in accumulated
other comprehensive income caused primarily by fluctuations in unrealized gains
or losses, net of taxes, on available for sale securities.
Shareholders' equity increased $18.6 million to $233.9 million at September 30,
2021 as compared to $215.3 million at December 31, 2020. The increase in
shareholders' equity was primarily impacted by $25.4 million of net income
generated during the nine months ended September 30, 2021, partially offset by
decreases of $3.3 million of accumulated other comprehensive income due to
decreases in net unrealized gains on available-for-sale securities, $1.4 million
of dividends declared on our preferred stock, $1.4 million of dividends declared
on our common stock, and $1.4 million of stock repurchased through the share
buyback program during the nine months ended September 30, 2021.
                                       60
--------------------------------------------------------------------------------
  Table of Contents
The following table summarizes the changes in our shareholders' equity for the
periods indicated below:
                                                     For the three months ended            For the nine months ended September
                                                            September 30,                                  30,
(Dollars in thousands)                                2021                 2020                 2021                 2020
Balance at beginning of period                   $    225,409          $  180,259          $    215,327          $  170,703
Net income                                              9,465               5,209                25,403              12,040
Other comprehensive income (loss)                        (216)                783                (3,327)              4,451
Preferred stock offering, net of issuance
costs                                                       -              23,370                     -              23,370
Redeemed stock                                              -                   -                (1,364)               (620)
Common stock dividends declared                          (459)               (387)               (1,374)             (1,160)
Dividends on 7.50% Series B Preferred
Stock                                                    (468)                  -                (1,406)                  -
Exercise of stock options                                   -                   -                   243                  95
Stock-based compensation expense                          203                 234                   432                 589
Balance at end of period                         $    233,934          $  209,468          $    233,934          $  209,468


We strive to maintain an adequate capital base to support our activities in a
safe and sound manner while at the same time attempting to maximize shareholder
value. We assess capital adequacy against the risk inherent in our balance
sheet, recognizing that unexpected loss is the common denominator of risk and
that common equity has the greatest capacity to absorb unexpected loss.
We are subject to various regulatory capital requirements both at the Company
level and at the Bank level. Failure to meet minimum capital requirements could
result in certain mandatory and possible additional discretionary actions by
regulators that, if undertaken, could have an adverse material effect on our
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, we must meet specific capital guidelines
that involve quantitative measures of our assets, liabilities, and certain
off-balance sheet items as calculated under regulatory accounting policies. We
have consistently maintained regulatory capital ratios at or above the
well-capitalized standards.
A capital conservation buffer, comprised of common equity tier 1 capital, is
established above the regulatory minimum capital requirements, and financial
institutions that maintain a capital conservation buffer of 2.5% are generally
not subject to the additional restrictions on dividends, share repurchases and
discretionary bonus payments to executive officers under the Basel III Rule.
At September 30, 2021 and December 31, 2020, the Company's and the Bank's
capital ratios were in excess of the requirement to be "well capitalized" under
the regulatory guidelines.
The summary below compares the actual capital ratios with the minimum
quantitative measures established by regulation to ensure capital adequacy:
                                       61

————————————————– ——————————-

  Table of Contents
                                                                                                     Capital Adequacy
                                                                             Capital                    Regulatory                       Well
                                                   Actual                   Adequacy                   Requirement +                 Capitalized
                                                   Capital                 Regulatory              Capital Conservation               Regulatory
                                                    Ratio                  Requirement                   Buffer(1)                   Requirement
September 30, 2021
Common equity tier 1 to risk-weighted
assets:
Consolidated                                            9.82  %                     4.50  %                       7.00  %
Bank                                                   12.55  %                     4.50  %                       7.00  %                      6.50  %
Tier 1 capital to risk-weighted assets:
Consolidated                                           11.19  %                     6.00  %                       8.50  %
Bank                                                   12.55  %                     6.00  %                       8.50  %                      8.00  %
Total capital to risk-weighted assets:
Consolidated                                           14.19  %                     8.00  %                      10.50  %
Bank                                                   13.80  %                     8.00  %                      10.50  %                     10.00  %
Tier 1 capital to average assets
(leverage ratio):
Consolidated                                            7.68  %                     4.00  %                       4.00  %
Bank                                                    8.64  %                     4.00  %                       4.00  %                      5.00  %
December 31, 2020
Common equity tier 1 to risk-weighted
assets:
Consolidated                                            9.30  %                     4.50  %                       7.00  %
Bank                                                   11.94  %                     4.50  %                       7.00  %                      6.50  %
Tier 1 capital to risk-weighted assets:
Consolidated                                           10.80  %                     6.00  %                       8.50  %
Bank                                                   11.94  %                     6.00  %                       8.50  %                      8.00  %
Total capital to risk-weighted assets:
Consolidated                                           14.91  %                     8.00  %                      10.50  %
Bank                                                   13.20  %                     8.00  %                      10.50  %                     10.00  %
Tier 1 capital to average assets
(leverage ratio):
Consolidated                                            6.93  %                     4.00  %                       4.00  %
Bank                                                    7.67  %                     4.00  %                       4.00  %                      5.00  %

(1) Reflects the 2.5% capital conservation buffer for risk-weighted assets
reports.

                                       62
--------------------------------------------------------------------------------
  Table of Contents
Contractual Obligations
In the ordinary course of our operations, we enter into certain contractual
obligations. Total contractual obligations at September 30, 2021 were
$686.4 million, a decrease of $152.2 million from $838.6 million at December 31,
2020. The decrease of $152.2 million was primarily due to decreases of $133.1
million in time deposits and $14.9 million in subordinated notes.
The following tables present our contractual obligations as of September 30,
2021 and December 31, 2020.
                                                                Contractual 

Due from September 30, 2021

                                          Less Than               One to               Three to              Over
(Dollars in thousands)                    One Year              Three Years           Five Years          Five Years            Total
Operating lease obligations           $     1,820             $      3,320          $     2,446          $    3,382          $  10,968
Short-term borrowings                       2,681                        -                    -                   -              2,681
Long-term borrowings                       13,105                   14,272               22,000             130,000            179,377
Subordinated notes                              -                        -                    -              29,668             29,668
Time deposits                             389,990                   70,841                2,917                   -            463,748
Total                                 $   407,596             $     88,433          $    27,363          $  163,050          $ 686,442


                                                               Contractual

Due from December 31, 2020

                                        Less Than              One to               Three to              Over
(Dollars in thousands)                   One Year            Three Years           Five Years          Five Years            Total
Operating lease obligations           $     1,731          $      3,478          $     2,509          $    3,775          $  11,493
Short-term borrowings                       3,204                     -                    -                   -              3,204
Long-term borrowings                        6,176                14,304               32,000             130,000            182,480
Subordinated notes                              -                     -               15,000              29,592             44,592
Time deposits                             437,211               153,759                5,845                   -            596,815
Total                                 $   448,322          $    171,541          $    55,354          $  163,367          $ 838,584


Off-Balance Sheet Arrangements
In the normal course of business, the Company offers a variety of financial
instruments with off-balance sheet risk to meet the financing needs of its
customers. These financial instruments include outstanding commitments to extend
credit, credit lines, commercial letters of credit and standby letters of
credit. These are agreements to provide credit, as long as conditions
established in the contract are met, and usually have expiration dates.
Commitments may expire without being used. Off-balance sheet risk to credit loss
exists up to the face amount of these instruments, although material losses are
not anticipated. The same credit policies used for loans are used to make such
commitments, including obtaining collateral at exercise of the commitment.
We maintain an allowance to cover probable losses inherent in our financial
instruments with off-balance sheet risk. At September 30, 2021, the allowance
for off-balance sheet risk was $318 thousand, compared to $490 thousand at
December 31, 2020, and was included in "Other liabilities" on our consolidated
balance sheets.
A summary of the contractual amounts of our exposure to off-balance sheet risk
is as follows.
                                                                   September 30, 2021                            December 31, 2020
(Dollars in thousands)                                     Fixed Rate            Variable Rate          Fixed Rate           Variable Rate
Commitments to make loans                               $    9,087          

$ 6,600 $ 18,269 $ 17,058
Unused lines of credit

                                      33,383                    397,716              28,898                 385,307
Unused standby letters of credit and commercial
letters of credit                                            3,353                          -               2,340                   1,992


Of the total unused lines of credit of $431.1 million at September 30, 2021,
$58.7 million was comprised of undisbursed construction loan commitments. The
Company expects to have sufficient access to liquidity to fund its off-balance
sheet commitments.
                                       63
--------------------------------------------------------------------------------
  Table of Contents
Liquidity
Liquidity management is the process by which we manage the flow of funds
necessary to meet our financial commitments on a timely basis and at a
reasonable cost and to take advantage of earnings enhancement opportunities.
These financial commitments include withdrawals by depositors, credit
commitments to borrowers, expenses of our operations, and capital expenditures.
Liquidity is monitored and closely managed by the Bank's Asset and Liability
Committee (ALCO), a group of senior officers from the finance, enterprise risk
management, treasury, and lending areas, as well as two board members. It is
ALCO's responsibility to ensure we have the necessary level of funds available
for normal operations as well as maintain a contingency funding policy to ensure
that potential liquidity stress events are planned for and quickly identified,
and management has plans in place to respond. ALCO has created policies which
establish limits and require measurements to monitor liquidity trends, including
modeling and management reporting that identifies the amounts and costs of all
available funding sources. In addition, we have implemented modeling software
that projects cash flows from the balance sheet under a broad range of potential
scenarios, including severe changes in the economic environment.
During the second quarter of 2020, management took steps to increase liquidity
on the balance sheet and expand the capacity for additional funding in the
uncertain economic environment due to COVID-19. Management maintained an
elevated level of liquidity on the balance sheet in the third quarter of 2021,
and will continue to monitor and determine the appropriate levels of liquidity
as economic conditions develop. Furthermore, the Company continues to monitor
its capital ratios regularly and has benefited from income from participation in
the PPP, offset by potential stress from the weakening economy due to the
COVID-19 pandemic.
At September 30, 2021, we had liquid assets of $592.7 million, compared to
$455.4 million at December 31, 2020. Liquid assets include cash and due from
banks, federal funds sold, interest-bearing deposits with banks and unencumbered
securities available-for-sale. Cash and due from banks increased to $293.8
million, compared to $264.1 million at December 31, 2020 primarily as a result
of forgiveness of PPP loans and increased deposit balances.
The Bank is a member of the FHLB, which provides short- and long-term funding to
its members through advances collateralized by real estate-related assets and
other select collateral, most typically in the form of debt securities. The
actual borrowing capacity is contingent on the amount of collateral available to
be pledged to the FHLB. As of September 30, 2021, we had $178.1 million of
outstanding borrowings from the FHLB, and these advances were secured by a
blanket lien on $582.8 million of real estate-related loans. Based on this
collateral and the approved policy limits, the Company is eligible to borrow up
to an additional $219.4 million from the FHLB. Additionally, the Bank can borrow
up to $157.5 million through the unsecured lines of credit it has established
with eight other banks, as well as $5.1 million through a secured line with the
Federal Reserve Bank.
Further, because the Bank is "well capitalized," it can accept wholesale funding
up to 40% of total assets, or approximately $1.02 billion, based on current
policy limits at September 30, 2021. Management believed that as of September
30, 2021, we had adequate resources to fund all of our commitments.
The following liquidity ratios compare certain assets and liabilities to total
deposits or total assets.
                                                                               September 30, 2021         December 31, 2020
Investment securities available-for-sale to total assets                                  15.31  %                  12.39  %
Loans to total deposits                                                                   83.20                     87.79
Interest-earning assets to total assets                                                   94.17                     94.64
Interest-bearing deposits to total deposits                                               61.69                     68.49


                                       64

————————————————– ——————————-

Contents


Source link

Previous Funding Estate Disputes - Another Way to Fund Litigation Probate Cases
Next Italian prosecutor’s claims against Guardian reporter flagged by human rights watchdog | Press freedom

No Comment

Leave a reply

Your email address will not be published. Required fields are marked *