LEVEL ONE BANCORP INC Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-K)
The following discussion explains our financial condition as of
December 31, 2021and 2020 and results of operations for the years ended December 31, 2021, 2020 and 2019. The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes presented in Item 8 of this report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Certain risks, uncertainties and other factors, including but not limited to those set forth under "Forward-Looking Statements," "Risk Factors" and elsewhere in this Form 10-K, may cause actual results to differ materially from those projected in the forward-looking statements. We assume no obligation to update any of these forward-looking statements. 32
Table of Contents Selected Financial Data As of and for the year ended December 31, (Dollars in thousands, except per share data) 2021 2020 2019 Earnings Summary Interest income
$ 86,650 $ 82,639 $ 70,448Interest expense 8,051 15,883 19,393 Net interest income 78,599 66,756 51,055 Provision for (recovery of) loan losses (725) 11,872 1,383 Noninterest income 22,372 29,714 14,211 Noninterest expense 61,839 60,232 44,369 Income before income taxes 39,857 24,366 19,514 Income tax provision 7,379 3,953 3,403 Net income 32,478 20,413 16,111 Preferred stock dividends 1,875 479 - Net income available to common shareholders 30,603 19,934 16,111 Net income allocated to participating securities (1) 441 244 159 Net income attributable to common shareholders (1)
Data per share Basic earnings per ordinary share
Diluted earnings per common share
3.95 2.57 2.05
Diluted earnings per common share, excluding acquisition and due diligence costs (2)
3.95 2.74 2.12 Book value per common share 28.02 25.14 22.13 Tangible book value per common share (2) 22.37 19.63 20.86 Preferred shares outstanding (in thousands) 10 10 - Common shares outstanding (in thousands) 7,734 7,634 7,715 Average basic common shares (in thousands) 7,536 7,627 7,632 Average diluted common shares (in thousands) 7,650 7,686 7,747 Selected Period End Balances Total assets
Titles available for sale
397,551 302,732 180,905 Total loans 1,652,771 1,723,537 1,227,609 Total deposits 2,040,082 1,963,312 1,135,428 Total liabilities 2,275,778 2,227,655 1,414,196 Total shareholders' equity 240,091 215,327 170,703 Total common shareholders' equity 216,719 191,955 170,703 Tangible common shareholders' equity (2) 173,033 149,844 160,940 Performance and Capital Ratios Return on average assets 1.28 % 0.88 % 1.08 % Return on average equity 14.24 10.61 9.90 Net interest margin (fully taxable equivalent) (3) 3.33 3.10 3.60
Efficiency ratio (non-interest expense/net interest income plus non-interest income)
61.24 62.44 67.98 Dividend payout ratio 5.74 7.37 7.20 Total shareholders' equity to total assets 9.54 8.81 10.77 Tangible common equity to tangible assets (2) 7.00 6.24 10.22 Common equity tier 1 to risk-weighted assets 10.37 9.30 11.72 Tier 1 capital to risk-weighted assets 11.75 10.80 11.72 Total capital to risk-weighted assets 14.76 14.91 15.99 Tier 1 capital to average assets (leverage ratio) 7.93 6.93 10.41 Asset Quality Ratios: Net (recoveries) charge-offs to average loans 0.01 % 0.13 % 0.02 % Nonperforming assets as a percentage of total assets 0.46 0.77 1.23 Nonaccrual loans as a percent of total loans 0.68 1.09 1.51 Allowance for loan losses as a percentage of total loans 1.30 1.29 1.03
Allowance for loan losses as a percentage of outstanding loans
189.79 118.50 68.40
Allowance for loan losses as a percentage of outstanding loans, excluding allowance allocated to loans accounted for under ASC 310-30
184.58 114.95 64.29 (1) Amounts presented are used in the two-class earnings per common share calculation. This method was adopted by the Company in the second quarter of 2019. (2) See section entitled "GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures" below for a reconciliation to most comparable GAAP equivalent. (3) Presented on a tax equivalent basis using a 21% tax rate for the 2019, 2020, and 2021 periods.
GAAP Reconciliation and Management’s 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 table presents these non-GAAP financial measures and their most directly comparable financial measures calculated in accordance with GAAP:
Common tangible equity, ratio of tangible equity to tangible assets and tangible book value per share
As of and for the
(Dollars in thousands, except per share data) 2021 2020 2019 Total shareholders' equity
Less: preferred shares
23,372 23,372 - Total common shareholders' equity 216,719 191,955 170,703
Goodwill 35,554 35,554 9,387 Mortgage servicing rights, net 5,604 3,361 76 Other intangible assets, net 2,528 3,196 300 Tangible common shareholders' equity
Common shares outstanding (in thousands) 7,734 7,634 7,715 Tangible book value per common share
$ 22.37 $ 19.63 $ 20.86Total assets $ 2,515,869 $ 2,442,982 $ 1,584,899Less: Goodwill 35,554 35,554 9,387 Mortgage servicing rights, net 5,604 3,361 76 Other intangible assets, net 2,528 3,196 300 Tangible assets
Tangible common equity to tangible assets 7.00 % 6.24 % 10.22 %
Adjusted earnings and diluted earnings per share
As of and for
ended December 31, (Dollars in thousands, except per share data) 2021 2020 2019 Net income, as reported
$ 32,478 $ 20,413 $ 16,111Acquisition and due diligence fees - 1,654 539 Income tax benefit (1) - (331) (51)
Net income, excluding acquisition and due diligence costs
Diluted earnings per share, as reported $
Impact of acquisition and due diligence costs, net of tax benefit
- 0.17 0.07 Diluted earnings per common share, excluding acquisition and due diligence fees $
(1) Assuming an income tax rate of 21% on deductible acquisition costs for the 2019 and 2020 periods.
Allowance for loan loss as a percentage of total loans, excluding PPP loans
As of and for the year ended December 31, (Dollars in thousands, except per share data) 2021 2020 2019 Total loans
$ 1,652,771 $ 1,723,537 $ 1,227,609Less: PPP loans 76,505 290,135 - Total loans, excluding PPP loans $ 1,576,266$
Allowance for loan loss
$ 21,425 $ 22,297 $ 12,674Allowance for loan loss as a percentage of total loans 1.30 % 1.29 % 1.03 % Allowance for loan loss as a percentage of total loans excluding PPP loans 1.36 % 1.56 % 1.03 % Critical Accounting Policies Our consolidated financial statements are prepared based on the application of accounting policies generally accepted in the United States. Our significant 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 in our consolidated financial statements included in Item 8. Financial Statements and Supplementary Data in this Form 10-K. Some of these 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. At December 31, 2021, the most critical of these significant accounting policies in understanding the estimates and assumptions involved in preparing our consolidated financial statements were the policies related to the allowance for loan losses, fair value measurement, and goodwill, which are discussed more fully below.
Allowance for loan losses
The allowance for loan losses is calculated with the objective of maintaining a reserve sufficient to absorb estimated probable losses. Management's determination of the appropriateness of the allowance is based on periodic evaluations of the loan portfolio, lending-related commitments, and other relevant factors. This evaluation is inherently subjective as it requires numerous estimates, including the loss content for internal risk ratings, collateral values, and the amounts and timing of expected future cash flows. In addition, management may include qualitative adjustments intended to capture the impact of other uncertainties in the lending environment such as underwriting standards, current economic and political conditions, and other factors affecting the credit quality. Changes to one or more of the estimates used would result in a different estimated allowance for loan loss.
Fair value measurement
Investment securities available-for-sale, derivatives, loans held for sale, and certain other loans are recorded at fair value on a recurring basis. Additionally, from time to time, other assets and liabilities may be recorded at fair value on a nonrecurring basis, such as impaired loans, other real estate, and certain other assets and liabilities. Fair value is an estimate of the exchange 33 -------------------------------------------------------------------------------- price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (i.e., not a forced transaction, such as a liquidation or distressed sale) between market participants at the measurement date and is based on the assumptions market participants would use when pricing an asset or liability. Fair value measurement and disclosure guidance establishes a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. At
December 31, 2021, assets and liabilities measured using observable inputs that are classified as Level 1 or Level 2 represented 97.45% and 100.00% of total assets and liabilities recorded at fair value, respectively. Valuations generated from model-based techniques that use at least one significant assumption not observable in the market are considered Level 3 and reflect estimates of assumptions market participants would use in pricing the asset or liability.
Valuation and recoverability of
Goodwillrepresents $35.6 millionof our $2.52 billionin total assets as of December 31, 2021. We review goodwill for impairment annually as of October 1stand also test for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of our Company below its carrying amount. The accounting estimates related to our goodwill require us to make considerable assumptions about fair values. Our assumptions regarding fair values require significant judgment about economic and industry factors and the growth and earnings prospects of the Company. Changes in these judgements, either individually or collectively, may have a significant effect on the estimated fair values. 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 Companyexited 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. Since 2007, we have grown substantially through organic growth and a series of five acquisitions, all of which have been fully integrated into our operations. We have made significant investments over the last several years in hiring additional staff and upgrading technology and system security. In 2016, we opened our first branch in the Grand Rapids, Michiganmarket. In the third quarter of 2017, we opened our second location in Bloomfield Townshiplocated in Oakland County. In the third quarter of 2018, we doubled the size of our mortgage division with the addition of new mortgage officers and support staff. On January 2, 2020, the Company completed its acquisition of Ann Arbor Bancorp, Inc.("AAB") and its wholly owned subsidiary, Ann Arbor State Bank. The transaction was completed pursuant to a merger of the Company's wholly owned merger subsidiary ("Merger Sub") with and into AAB, pursuant to the Agreement and Plan of Merger, dated as of August 12, 2019, among the Company, Merger Sub and AAB. The Company paid aggregate consideration of approximately $67.9 millionin cash. Our results of operations for the years ended December 31, 2021and 2020 include the results of operations of AAB on and after January 2, 2020, including $1.7 millionof acquisition fees. Results for periods before January 2, 2020reflect only those of Level One and do not include the results of operations of AAB. See "Note 2 - Business Combinations" for more information. In addition, all identifiable assets, including the intangible assets that consisted of $26.2 millionin goodwill and $3.7 millionin core deposit intangibles, and liabilities of AAB as of the merger date have been recorded at their estimated fair value and added to those of Level One. Recent Developments Fourth Quarter Common Stock Dividend. On December 15, 2021, Level One's Board of Directors declared a fourth quarter 2021 cash dividend of $0.06per common share. The dividend was paid on January 14, 2022, to shareholders of record at the close of business on December 31, 2021. 34 -------------------------------------------------------------------------------- First Quarter Preferred Stock Dividend. On January 19, 2022, Level One's Board of Directors declared a quarterly cash dividend of $46.88per share on its 7.50% Non-Cumulative Perpetual Preferred Stock, Series B. Holders of depositary shares will receive $0.4688per depositary share. The dividend is payable on February 15, 2022, to shareholders of record at the close of business on January 31, 2022. Impact of COVID-19 Pandemic. The COVID-19 pandemic in the United Stateshas 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, 2021through June 30, 2021, Level One funded 1,532 new PPP loan applications for $234.3 million, of which 1,187 were for loans $150,000or below. As of December 31, 2021, $76.5 millionof PPP loans were still outstanding. The Bank is actively working with the borrowers of PPP loans to obtain loan forgiveness from the SBA.
Level One also recognizes that some of the most affected industries are the restaurant and hospitality industries. From
Results of Operations
Net IncomeWe had net income of $32.5 million, or $3.95per diluted common share, for the year ended December 31, 2021, compared to $20.4 million, or $2.57per diluted common share, for the year ended December 31, 2020. The increase of $12.1 millionin net income primarily reflected an increase of $11.8 millionin 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 $12.6 millionin provision for loan loss, primarily due to a decrease in general reserves resulting from an increase in the economic qualitative factors in the year ended December 31, 2020and a reduction in qualitative factors in the third quarter of 2021. These were partially offset by a $7.3 milliondecrease 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. In addition, there were increases of $3.4 millionof income tax provision primarily due to higher income before taxes and $1.6 millionof noninterest expense primarily due to higher salary and employee benefits, other expense, data processing expense, and professional services fees partially offset by lower acquisition and due diligence fees.
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
$78.6 millionfor the year ended December 31, 2021was $11.8 millionhigher than the net interest income of $66.8 millionfor the year ended December 31, 2020. The year ended December 31, 2021included a $4.0 millionincrease in interest income as well as a $7.8 milliondecrease in interest expense, compared to December 31, 2020. The increase in interest income was primarily driven by increases of $2.9 millionin interest and fees on loans and $1.4 millionin interest on investment securities. The increase in interest and fees on loans for the year ended December 31, 2021compared to the same period in 2020 was mainly driven by the Bank earning $12.9 millionof net SBA fees on PPP loans compared to $6.5 millionfor the year ended December 31, 2020. The increase in interest income on investment securities was mainly due to an increase of $123.7 millionin average balances due to excess liquidity from PPP loan forgiveness and increased customer liquidity. 35 -------------------------------------------------------------------------------- The decrease in interest expense was primarily driven by a decrease of $6.7 millionin interest expense on deposits and a decrease of $1.2 millionin 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 millionof subordinated notes during the second quarter of 2021 and a decrease in FHLB borrowings. Our net interest margin (FTE) for the year ended December 31, 2021was 3.33%, compared to 3.10% for the same period in 2020. The increase of 23 basis points in the net interest margin year over year was primarily a result of a decrease in cost of funds, which declined 52 basis points to 0.53% in 2021, compared to 1.05% in 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. Our net interest margin benefits from discount accretion on our purchased credit impaired loan portfolios, a component of our accretable yield. The accretable yield represents the excess of the net present value of expected future cash flows over the acquisition date fair value and includes both the expected coupon of the loan and the discount accretion. The accretable yield is recognized as interest income over the expected remaining life of the purchased credit impaired loan. The difference between the actual yield earned on total loans and the yield generated based on the contractual coupon (not including any interest income for loans in nonaccrual status) represents excess accretable yield. The contractual coupon of the loan considers the contractual coupon rates of the loan and does not include any interest income for loans in nonaccrual status. For the years ended December 31, 2021and 2020, the yield on total loans was impacted by 6 basis points and 7 basis points due to the accretable yield on purchased credit impaired loans. Our net interest margin for the years ended December 31, 2021and 2020, benefited by 4 basis points and 8 basis points, respectively, as a result of the excess accretable yield. As of December 31, 2021and December 31, 2020, our remaining accretable yield was $5.7 millionand $7.1 million, respectively, and our nonaccretable difference was $1.4 millionand $2.7 million, respectively. 36 -------------------------------------------------------------------------------- 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.
Net Interest Income Analysis – Fully Taxable Equivalent
For the years ended December 31, (Dollars in thousands) 2021 2020 2019 Average Balance Sheets: Gross loans(1)
Investment securities: (2) Taxable
254,913 138,837 129,274 Tax-exempt 103,609 96,020 84,392 Interest-earning cash balances 218,931 194,545 38,268 Other investments 14,398 12,903 8,523 Total interest-earning assets
$ 2,383,522 $ 2,172,775 $ 1,429,943Non-earning assets: 145,990 135,229 68,015 Total assets $ 2,529,512 $ 2,308,004 $ 1,497,958Interest-bearing demand deposits
Money market and savings deposits
613,883 496,827 314,918 Time deposits 519,447 573,823 527,605 Borrowings 183,503 279,949 79,864 Subordinated notes 36,376 44,490 16,061 Total interest-bearing liabilities 1,515,614 1,510,338 995,928 Noninterest-bearing demand deposits 754,376 574,537 321,487 Other liabilities 31,466 30,787 17,750 Shareholders' equity 228,056 192,342 162,793 Total liabilities and shareholders' equity
$ 2,529,512 $ 2,308,004 $ 1,497,958Yields: (3) Earning Assets Gross loans 4.43 % 4.42 % 5.42 % Investment securities: Taxable 1.58 % 1.93 % 2.71 % Tax-exempt 3.02 % 3.19 % 3.27 % Interest earning cash balances 0.13 % 0.24 % 2.23 % Other investments 3.13 % 4.07 % 5.26 % Total interest earning assets 3.66 % 3.83 % 4.96 % Interest-bearing liabilities Interest-bearing demand deposits 0.14 % 0.28 % 0.49 % Money market and savings deposits 0.19 % 0.56 % 1.43 % Time deposits 0.56 % 1.38 % 2.30 % Borrowings 1.02 % 0.84 % 1.73 % Subordinated notes 5.12 % 5.70 % 6.69 % Total interest-bearing liabilities 0.53 % 1.05 % 1.95 % Interest spread 3.13 % 2.78 % 3.01 % Net interest margin(4) 3.30 % 3.07 % 3.57 % Tax equivalent effect 0.03 % 0.03 % 0.03 % Net interest margin on a fully tax equivalent basis 3.33 % 3.10 % 3.60 % (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 $617 thousand, $574 thousandand $453 thousandon tax-exempt securities for the years ended December 31, 2021, 2020 and 2019, respectively, using the federal corporate tax rate of 21%. (4) Net interest margin represents net interest income divided by average total interest-earning assets. 37 --------------------------------------------------------------------------------
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 year
Increase (Decrease) Due to: Net Increase (Dollars in thousands) Rate Volume (Decrease) Interest-earning assets Gross loans
$ 163 $ 2,711 $ 2,874Investment securities: Taxable (547) 1,906 1,359 Tax-exempt (210) 234 24 Interest-earning cash balances (225) 53 (172) Other investments (130) 56 (74) Total interest income (949) 4,960 4,011 Interest-bearing liabilities Interest-bearing demand deposits (190) 102 (88) Money market and savings deposits (2,128) 542 (1,586) Time deposits (4,317) (689) (5,006) Borrowings 439 (917) (478) Subordinated debt (242) (432) (674) Total interest expense (6,438) (1,394) (7,832) Change in net interest income $ 5,489
For the year
Increase (Decrease) Due to: Net Increase (Dollars in thousands) Rate Volume (Decrease) Interest-earning assets Gross loans
$ (13,194) $ 26,353 $ 13,159Investment securities: Taxable (1,076) 244 (832) Tax-exempt (191) 372 181 Interest-earning cash balances (1,327) 933 (394) Other investments (117) 194 77 Total interest income (15,905) 28,096 12,191 Interest-bearing liabilities Interest-bearing demand deposits (157) 198 41 Money market and savings deposits (3,589) 1,830 (1,759) Time deposits (5,217) 987 (4,230) Borrowings (1,009) 1,984 975 Subordinated debt (180) 1,643 1,463 Total interest expense (10,152) 6,642 (3,510) Change in net interest income $ (5,753)
Allowance 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
December 31, 2021, and December 31, 2020, our remaining accretable yield was $5.7 millionand $7.1 million, and our nonaccretable difference was $1.4 millionand $2.7 million, respectively. The provision for loan losses was a provision benefit of $725 thousandfor the year ended December 31, 2021, compared to a provision expense of $11.9 millionfor the year ended December 31, 2020. The decrease of $12.6 millionin the provision for loan losses was primarily due to a decrease in general reserves of $10.6 milliondue to a reduction in qualitative factors within the allowance for loan loss model as a result of improved credit quality while qualitative factors were increased during the year ended December 31, 2020due to economic uncertainty regarding the impact of the COVID-19 pandemic on credit quality. In addition, there was a decrease of $2.1 millionin net chargeoffs resulting from a $1.3 millionchargeoff on a nonaccrual loan during the second quarter of 2020.
The following table presents noninterest income for the years ended
December 31, 2021, 2020 and 2019. For the year ended December 31, (Dollars in thousands) 2021 2020 2019 Noninterest income Service charges on deposits $ 3,311 $ 2,446 $ 2,547Net gain on sales of securities 21 1,862 1,174 Mortgage banking activities 15,843 22,190 7,880 Other charges and fees 3,197 3,216 2,610 Total noninterest income $ 22,372 $ 29,714 $ 14,211Noninterest income decreased $7.3 millionto $22.4 millionfor the year ended December 31, 2021, compared to $29.7 millionfor the same period in 2020. The decrease in noninterest income was primarily due to decreases of $6.3 millionin mortgage banking activities and $1.8 millionin net gain on sales of securities. These decreases were partially offset by an increase of $865 thousandin service charges on deposits. The decrease in mortgage banking activities was primarily due to $115.7 millionlower residential loan originations held for sale and $56.0 millionlower residential loans sold. The higher volumes in the year ended December 31, 2020were primarily due to a 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 securities was primarily due to fewer securities sold during 2021 compared to 2020. The increase in service charges on deposits was due to higher transaction volumes and deposit balances. 39
The following table presents noninterest expense for the years ended
December 31, 2021, 2020 and 2019. For the year ended December 31, (Dollars in thousands) 2021 2020 2019 Noninterest expense Salary and employee benefits $ 39,353 $ 38,304 $ 28,775Occupancy and equipment expense 6,631 6,549 4,939 Professional service fees 3,542 2,935 1,808 Acquisition and due diligence fees - 1,654 539 FDIC premium 1,027 1,119 310 Marketing expense 1,288 956 1,107 Loan processing expense 983 935 661 Data processing expense 4,125 3,460 2,374 Core deposit premium amortization 668 768 146 Other expense 4,222 3,552 3,710 Total noninterest expense $ 61,839 $ 60,232 $ 44,369Noninterest expense increased $1.6 millionto $61.8 millionfor the year ended December 31, 2021, compared to $60.2 millionfor the same period in 2020. The increase in noninterest expense was primarily due to increases in salary and employee benefits of $1.0 million, other expense of $670 thousand, data processing expense of $665 thousand, professional service fees of $607 thousand, and marketing expense of $332 thousand. These increases were partially offset by a decrease of $1.7 millionin acquisition and due diligence fees. The increase in salary and employee benefits was primarily due to annual compensation increases and an increase of 8 full-time equivalent employees. The increase in other expenses was primarily due to an increase in fraud losses. The increase in data processing expense was primarily due to a new loan processing system used for PPP loans. The increase in professional fees was primarily due to fees related to the pending merger. The increase in marketing expense was primarily due to an increase in advertising efforts. The decrease in acquisition and due diligence fees was due to the acquisition of Ann Arbor State Bankin the first quarter of 2020.
Income taxes and tax-related items
During the year ended
December 31, 2021, we recognized income tax expense of $7.4 millionon $39.9 millionof pre-tax income resulting in an effective tax rate of 18.5%, compared to the same period in 2020, in which we recognized an income tax expense of $4.0 millionon $24.4 millionof pre-tax income, resulting in an effective tax rate of 16.2%. The increase in income tax provision for the year ended December 31, 2021compared to the same period in 2020 was primarily as a result of higher income before taxes. Additionally, a $290 thousandtax benefit related to the Ann Arbor State Banknet operating loss (NOL) in the first quarter of 2020 resulting from the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") provision that allows for NOLs generated in 2018 to 2020 to be carried back five years as well as disqualified dispositions of Ann Arbor State Bank'sstock options generated a $175 thousandtax benefit in the first quarter of 2020.
See “Note 11 – Income Taxes” in the Notes to the Consolidated Financial Statements for a reconciliation between forecast and actual income tax expense for the years ended.
The following table presents the fair value of the Company’s investment securities portfolio, all of which were classified as available for sale at
As of December 31, (Dollars in thousands) 2021 2020 2019 Securities available-for-sale: U.S. government sponsored entities and agencies
$ 21,774 $ 26,358$ - State and political subdivision 148,276 132,723 93,747 Mortgage-backed securities: residential 22,211 26,081 10,565 Mortgage-backed securities: commercial 23,271 11,918 8,779 Collateralized mortgage obligations: residential 13,461 13,446 8,529 Collateralized mortgage obligations: commercial 51,183 58,512 23,181 U.S. Treasury 64,387 - 1,999 SBA 13,927 17,593 21,984 Asset backed securities 9,706 10,072 10,084 Corporate bonds 29,355 6,029 2,037 Total securities available-for-sale $ 397,551$
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
December 31, 2021, total investment securities were $397.6 million, or 15.8% of total assets, compared to $302.7 million, or 12.4% of total assets, at December 31, 2020. The $94.8 millionincrease in securities available-for-sale from December 31, 2020to December 31, 2021, was due to the purchase of securities using the excess cash balances generated by the payoffs and forgiveness of PPP loans. Securities with a carrying value of $88.6 millionand $98.7 millionwere pledged at December 31, 2021and December 31, 2020, respectively, to secure borrowings, deposits and mortgage derivatives. As of December 31, 2021, the Company held 68 tax-exempt state and local municipal securities totaling $52.3 millionbacked by the Michigan School Bond Loan Fund. Other than the aforementioned investments and the U.S.government and its agencies, at December 31, 2021and 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 December 31, 2021and 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. 41 --------------------------------------------------------------------------------
December 31, 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 $ 2,5221.61 % $ - - % $ 15,0001.22 % $ 5,0001.48 % State and political subdivision 1,341 2.41 12,869 2.42 53,553 2.68 73,988 2.88 Mortgage-backed securities: residential - - 73 1.90 27 1.92 22,216 1.09 Mortgage-backed securities: commercial - - 5,090 2.44 16,534 1.27 1,787 3.63 Collateralized mortgage obligations: residential - - 326 2.91 163 1.20 13,068 1.21 Collateralized mortgage obligations: commercial 2,248 5.62 4,424 2.77 38,782 1.20 6,428 1.96 U.S. Treasury- - 35,705 0.87 29,393 1.34 - - SBA - - - - 7,424 1.45 6,427 1.31 Asset backed securities - - - - - - 9,762 0.76 Corporate bonds - - - - 29,673 3.61 - - Total securities available-for-sale $ 6,1113.26 % $ 58,4871.51 % $ 190,5492.03 % $ 138,6762.13 % 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 $ 4,0271.61 % $ 2,5481.61 % $ 15,0001.22 % $ 5,0001.48 % 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 $ 10,7172.18 % $ 24,5732.58 % $ 105,0411.82 % $ 152,0442.28 % Loans Our loan portfolio represents a broad range of borrowers comprised of commercial real estate, commercial and industrial, residential real estate, and consumer financing loans. Commercial real estate loans consist of term loans secured by a mortgage lien on the real property, such as office and industrial buildings, retail shopping centers and apartment buildings, as well as commercial real estate construction loans that are offered to builders and developers. Commercial real estate loans are then segregated into two classes: non-owner occupied and owner occupied commercial real estate loans. Non-owner occupied loans, which include loans secured by non-owner occupied and nonresidential properties, generally have a greater risk profile than owner-occupied loans, which include loans secured by multifamily structures and owner-occupied commercial structures. Commercial and industrial loans include financing for commercial purposes in various lines of 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. 42 -------------------------------------------------------------------------------- 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 December 31, (Dollars in thousands) 2021 2020 2019 2018 2017 Commercial real estate: Non-owner occupied $ 467,364 $ 445,810 $ 388,515 $ 367,671 $ 343,420Owner occupied 283,400 275,022 216,131 194,422 168,342 Total commercial real estate 750,764 720,832 604,646 562,093 511,762 Commercial and industrial 460,530 685,504 410,228 383,455 377,686 Residential real estate 440,640 315,476 211,839 180,018 144,439 Consumer 837 1,725 896 999 1,036 Total loans $ 1,652,771 $ 1,723,537 $ 1,227,609 $ 1,126,565 $ 1,034,923Total loans were $1.65 billionat December 31, 2021, a decrease of $70.8 millionfrom December 31, 2020. The decline in our loan portfolio compared to December 31, 2020was primarily due to a $225.0 milliondecrease in our commercial and industrial loan portfolio, $213.6 millionof which was due to the net change in PPP loans. This was partially offset by an increase of $125.2 millionin our residential 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 December 31, 2021, approximately 45.4% of our loans were commercial real estate, 27.9% were commercial and industrial, and 26.7% 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 8 - Mortgage Servicing Rights, Net for further details on our mortgage servicing rights.
Loan Maturity/Rate Sensitivity
The following table shows the contractual maturities of our loans as of
December 31, 2021. After one but After five but One year or within five within fifteen After fifteen (Dollars in thousands) less years years years
December 31, 2021Commercial real estate $ 90,512$
Commercial and industrial
135,940 243,580 78,135 2,875
Residential real estate 25,846 8,366 39,740 366,688 440,640 Consumer 62 586 40 149 837 Total loans
$ 252,360 $ 675,213 $ 346,347 $ 378,851 $ 1,652,771Sensitivity of loans to changes in interest rates: Fixed interest rates $
Floating interest rates
99,180 168,524 229,881 Total
$ 675,213 $ 346,347 $ 378,85143
Summary of Impaired Assets and Defaulted 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
December 31, 2021, there were no loans that remained on a COVID-related deferral compared to $20.1 millionas 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.
Doubtful. Loans classified as impaired have all of the inherent weaknesses of those classified as poor, with the additional characteristic that the weaknesses make recovery or full liquidation, based on currently existing facts, conditions and values, highly questionable and unlikely.
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 loans classified and criticized in
(Dollars in thousands) December 31, 2021 December 31, 2020 Classified loans: Substandard $ 24,866 $ 34,921 Doubtful 1,477 1,143 Total classified loans $ 26,343 $ 36,064 Special mention 74,254 47,297
Total loans classified and discriminated $100,597
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 December 31, (Dollars in thousands) 2021 2020 2019 Nonaccrual loans Commercial real estate
$ 4,246 $ 7,320 $ 4,832Commercial and industrial 4,208 7,490 11,112 Residential real estate 2,819 3,991 2,569 Consumer 16 15 16 Total nonaccrual loans(1) 11,289 18,816 18,529 Other real estate owned 201 - 921 Total nonperforming assets 11,490 18,816 19,450 Performing troubled debt restructurings Commercial and industrial 334 546 547 Residential real estate 365 432 359 Total performing troubled debt restructurings 699 978 906
Total impaired assets, excluding ASC 310-30 loans
Loans 90 days or more past due and still outstanding
(1) Unexpected loans include non-performing distressed debt restructurings of
During the years ended
December 31, 2021and 2020, the Company recorded $641 thousandand $234 thousand, respectively, of interest income on nonaccrual loans and performing TDRs excluding PCI loans.
In addition to non-performing and impaired assets, the Company had purchased impaired loans accounted for under ASC 310-30 which amounted to
Nonperforming assets decreased
$7.3 millionas of December 31, 2021compared to December 31, 2020. The decrease in nonperforming assets was attributable to a decrease in nonaccrual loans primarily due to pay offs of four commercial loan relationships totaling $5.4 million, paydowns on four commercial loan relationships totaling $3.9 million, and one $759 thousandresidential loan relationship moving back to accruing. This was partially offset by two commercial loan relationships moving to nonaccrual status totaling $2.6 million.
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.
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 45 -------------------------------------------------------------------------------- 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. 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 type of loan, the evolution of the provision for loan losses for the periods presented.
For the year ended December 31, (Dollars in thousands) 2021 2020 2019 Balance at beginning of period
$ 22,297 $ 12,674 $ 11,566Loan charge-offs: Commercial real estate - - (92) Commercial and industrial (31) (2,118) (438) Residential real estate (242) (285) - Consumer (33) (58) (106) Total loan charge-offs (306) (2,461) (636) Recoveries of loans previously charged-off: Commercial real estate - 12 6 Commercial and industrial 53 87 246 Residential real estate 86 85 77 Consumer 20 28 32 Total loan recoveries 159 212 361 Net charge-offs (147) (2,249) (275) Provision for (recovery of) loan losses (725) 11,872 1,383 Balance at end of period $ 21,425 $ 22,297 $ 12,674
Allowance for loan losses as a percentage of loans at end of period
1.30 % 1.29 % 1.03 % Net charge-offs to average loans 0.01 0.13 0.02 Our allowance for loan losses was
$21.4 million, or 1.30% of loans, at December 31, 2021compared to $22.3 million, or 1.29% of loans, at December 31, 2020. As of December 31, 2021and December 31, 2020, the allowance for loan losses as a percentage of loans excluding PPP loans (a non-GAAP measure), was 1.36% and 1.56%, respectively. The $872 thousanddecrease in the allowance for loan losses during the year ended December 31, 2021was 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 partially offset by loan growth.. 47
The following table shows, by type of loan, the breakdown of the allowance for loan losses at the dates presented.
Percentage of loans in Allocated each category (Dollars in thousands) Allowance to total loans
December 31, 2021Balance at end of period applicable to: Commercial real estate $ 9,45545.3 % Commercial and industrial 7,799 27.9 Residential real estate 4,166 26.7 Consumer 5 0.1 Total loans $ 21,425100.0 % December 31, 2020 Balance at end of period applicable to: Commercial real estate $ 9,97541.8 % Commercial and industrial 8,786 39.8 Residential real estate 3,527 18.3 Consumer 9 0.1 Total loans $ 22,297100.0 % December 31, 2019 Balance at end of period applicable to: Commercial real estate $ 5,77349.2 % Commercial and industrial 5,515 33.4 Residential real estate 1,384 17.3 Consumer 2 0.1 Total loans $ 12,674100.0 % The following table presents, by loan type, the net loan charge-offs for the dates presented. Net charge-offs Percentage of average (Dollars in thousands) (recoveries) loans
For the year ended
Commercial and industrial $ (22) - % Residential real estate 156 - Consumer 13 1.1 Total net charge-offs (recoveries) $ 147 - % For the year ended
December 31, 2020Commercial real estate $ (12) - % Commercial and industrial 2,031 0.3 Residential real estate 200 0.1 Consumer 30 1.0 Total net charge-offs (recoveries) $ 2,249 0.1 % Goodwill The Company has acquired three banks, Lotus Bankin March 2015, Bank of Michiganin March 2016, and Ann Arbor State Bankin January 2020, which resulted in the recognition of goodwill. Total goodwill was $35.6 millionat December 31, 2021and 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 48 -------------------------------------------------------------------------------- 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 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, 2020was greater than its book value, and impairment of goodwill was not required. The Company completed its annual goodwill impairment review as of October 1, 2021, noting strong financial indicators for the Bank, solid credit quality ratios, as well as the strong capital position of the Bank. Management determined that no triggering events have occurred that indicated impairment from the most recent valuation date through December 31, 2021, the stock was trading above book value as of December 31, 2021, and it is more likely than not that there was no goodwill impairment as of December 31, 2021.
Total deposits were
$2.04 billionat December 31, 2021and $1.96 billionat December 31, 2020, representing 89.6% and 88.1% of total liabilities, respectively. The increase in deposits of $76.8 millionwas comprised of an increase of $291.0 millionin demand deposits partially offset by decreases of $171.0 millionin time deposits and $43.2 millionin money market and savings deposits. The increase in deposits was primarily due to organic deposit growth during the year ended December 31, 2021mainly as a result of increased customer liquidity and new customer growth. We had $1.16 billionand $1.13 billionat December 31, 2021and 2020, respectively. Our average interest-bearing deposit costs were 0.33% and 0.93% for the years ended December 31, 2021and 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 $1,000increments. For these brokered deposits, detailed records of owners are maintained by The Depository Trust Companyunder 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 December 31, 2021and December 31, 2020, the Company had approximately $23.1 millionand $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 December 31, 2021and December 31, 2020was $690 thousandand $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. 49
The following table shows the distribution of average deposits by account type for the periods indicated below.
Year Ended December 31, 2021 Average Average (Dollars in thousands) Balance Percent Rate Noninterest-bearing demand deposits
$ 754,37636.9 % - % Interest-bearing demand deposits 162,405 7.9 0.14 Money market and savings deposits 613,883 29.9 0.19 Time deposits 519,447 25.3 0.56 Total deposits $ 2,050,111100.0 % 0.21 % Year Ended December 31, 2020 Average Average (Dollars in thousands) Balance Percent Rate Noninterest-bearing demand deposits $ 574,53732.7 % - % Interest-bearing demand deposits 115,249 6.5 0.28 Money market and savings deposits 496,827 28.2 0.56 Time deposits 573,823 32.6 1.38 Total deposits $ 1,760,436100.0 % 0.62 % Year Ended December 31, 2019 Average Average (Dollars in thousands) Balance Percent Rate Noninterest-bearing demand deposits $ 321,48726.3 % - % Interest-bearing demand deposits 57,480 4.7 0.49 Money market and savings deposits 314,918 25.8 1.43 Time deposits 527,605 43.2 2.30 Total deposits $ 1,221,490100.0 % 1.39 % The following table shows the contractual maturity of time deposits, including CDARS and IRA deposits and other brokered funds, over $250 thousandthat were outstanding as of the date presented. (Dollars in thousands) December 31, 2021 Maturing in: 3 months or less $ 124,718 3 months to 6 months 60,458 6 months to 1 year 64,470 1 year or greater 17,668 Total $ 267,314 Borrowings Total debt outstanding at December 31, 2021was $208.4 million, a decrease of $21.9 millionfrom $230.3 millionat December 31, 2020. The decrease in total borrowings compared to December 31, 2020was primarily due to the redemption of $15.0 millionof subordinated notes as well as a decrease of $6.0 millionin FHLB long term borrowings. At December 31, 2021, FHLB advances were secured by a blanket lien on $580.6 millionof real estate-related loans, and repurchase agreements were secured by securities with a fair value of $4.0 million. At December 31, 2020, FHLB advances were secured by a blanket lien on $512.3 millionof real estate-related loans, and repurchase agreements were secured by securities with a fair value of $3.7 million. As of December 31, 2021, the Company had $30.0 millionof subordinated notes outstanding and debt issuance costs of $306 thousandrelated to these subordinated notes. As of December 31, 2020, the Company had $45.0 millionof subordinated notes outstanding and debt issuance costs of $408 thousandrelated to these subordinated notes. 50 -------------------------------------------------------------------------------- The $15.0 millionof subordinated notes issued on December 21, 2015had 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, 2020or upon an occurrence of a Tier 2 capital event or tax event. These subordinated notes were redeemed in June 2021. The $30.0 millionof subordinated notes issued on December 18, 2019bear 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, 2024through 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, 2024or upon the occurrence of a Tier 2 capital event or tax event. The issuance of the $30.0 millionsubordinated notes 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 relating to the components of our short-term borrowings for the periods and dates indicated is as follows:
For the year ended December 31, (Dollars in thousands) 2021 2020 2019 Securities sold under agreements to repurchase Average daily balance
Weighted average rate during the period
0.25 % 0.30 % 0.30 % Amount outstanding at period end
Weighted average rate at the end of the period
0.25 % 0.30 % 0.30 % Maximum month-end balance
FHLB advances Average daily balance
Weighted average rate during the period
- % 0.98 % 2.32 % Amount outstanding at period end
Weighted average rate at the end of the period
- % - % 1.61 % Maximum month-end balance
FHLB Line of Credit Average Daily Balance
Weighted average rate during the period
0.44 % 1.47 % 2.85 % Amount outstanding at period end
$ – $ – $ – Weighted average rate at the end of the period
- % - % - % Maximum month-end balance $ - $ -
$ 895Federal funds purchased Average daily balance
Weighted average rate during the period
- % 1.79 % 2.75 % Amount outstanding at period end
Weighted average rate at the end of the period
- % - % 1.90 % Maximum month-end balance $ - $ -
$ 15,000Capital 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 $24.8 millionto $240.1 millionat December 31, 2021compared to $215.3 millionat December 31, 2020. The increase in shareholders' equity was primarily impacted by $32.5 millionof net income generated during the year ended December 31, 2021and $1.9 millionof options exercised during the year, partially offset by decreases of 51 -------------------------------------------------------------------------------- $5.2 millionof accumulated other comprehensive income due to decreases in net unrealized gains on available-for-sale securities, $1.9 millionof dividends declared on our preferred stock, $1.8 millionof dividends declared on our common stock, and $1.4 millionof stock repurchased through the share buyback program during the year ended December 31, 2021. The following table summarizes the changes in our shareholders' equity for the periods indicated below: For the year ended December 31, (Dollars in thousands) 2021 2020 2019 Balance at beginning of period $ 215,327 $ 170,703 $ 151,760Net income 32,478 20,413 16,111 Other comprehensive income (loss) (5,237) 4,590 5,344 Preferred stock offering, net of issuance costs - 23,372 - Redeemed stock (1,364) (2,648) (2,165) Dividends on 7.50% Series B Preferred Stock (1,875) (479) - Common stock dividends declared (1,838) (1,542) (1,236) Exercise of stock options 1,920 95 219 Stock-based compensation expense 680 823 670 Balance at end of period $ 240,091 $ 215,327 $ 170,703We 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.
The summary below compares the actual capital ratios to the minimum quantitative measures established by regulation to ensure capital adequacy:
Capital Adequacy Capital Regulatory Well Actual Adequacy Requirement + Capitalized Capital Regulatory Capital Conservation Regulatory Ratio Requirement Buffer(1) Requirement
December 31, 2021Common equity tier 1 to risk-weighted assets: Consolidated 10.37 % 4.50 % 7.00 % Bank 13.12 % 4.50 % 7.00 % 6.50 % Tier 1 capital to risk-weighted assets: Consolidated 11.75 % 6.00 % 8.50 % Bank 13.12 % 6.00 % 8.50 % 8.00 % Total capital to risk-weighted assets: Consolidated 14.76 % 8.00 % 10.50 % Bank 14.37 % 8.00 % 10.50 % 10.00 % Tier 1 capital to average assets (leverage ratio): Consolidated 7.93 % 4.00 % 4.00 % Bank 8.86 % 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 2.5% capital conservation buffer for risk-weighted asset ratios.
In the ordinary course of our operations, we enter into certain contractual obligations. Total contractual obligations at
December 31, 2021were $644.7 million, a decrease of $193.9 millionfrom $838.6 millionat December 31, 2020. The decrease of $193.9 millionwas primarily due to decreases of $171.0 millionin time deposits and $14.9 millionin subordinated notes.
The following tables present our contractual obligations as of
Less Than One to Three to Over (Dollars in thousands) One Year Three Years Five Years Five Years Total Operating lease obligations
$ 1,833 $ 3,185 $ 2,391 $ 3,110 $ 10,519Short-term borrowings 2,342 - - - 2,342 Long-term borrowings 11,254 33,039 2,047 130,000 176,340 Subordinated notes - - - 29,694 29,694 Time deposits 359,707 64,036 2,058 - 425,801 Total $ 375,136 $ 100,260 $ 6,496 $ 162,804 $ 644,696Contractual
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 $ 11,493Short-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
December 31, 2021, the allowance for off-balance sheet risk was $369 thousand, compared to $490 thousandat 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. December 31, 2021 December 31, 2020 (Dollars in thousands) Fixed Rate Variable Rate Fixed Rate Variable Rate Commitments to make loans $ 13,532
Unused credit lines
49,841 392,186 28,898 385,307 Unused standby letters of credit and commercial letters of credit 2,145 - 2,340 1,992 Of the total unused lines of credit of
$442.0 millionat December 31, 2021, $71.3 millionwas comprised of undisbursed construction loan commitments. The Company expects to have sufficient access to liquidity to fund its off-balance sheet commitments. 54 --------------------------------------------------------------------------------
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. At December 31, 2021, we had liquid assets of $639.1 million, compared to $455.4 millionat 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 $330.1 million, compared to $264.1 millionat December 31, 2020primarily as a result of forgiveness of PPP loans and new customer growth. 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 December 31, 2021, we had $175.1 millionof outstanding borrowings from the FHLB, and these advances were secured by a blanket lien on $580.6 millionof real estate-related loans. Based on this collateral and the approved policy limits, the Company is eligible to borrow up to an additional $228.7 millionfrom the FHLB. Additionally, the Bank can borrow up to $157.5 millionthrough the unsecured lines of credit it has established with eight other banks, as well as $5.0 millionthrough 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 $1.01 billion, based on current policy limits at December 31, 2021. Management believed that as of December 31, 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. December 31, 2021 December 31, 2020 Investment securities available-for-sale to total assets 15.80 % 12.39 % Loans to total deposits 81.01 87.79 Interest-earning assets to total assets 94.37 94.64 Interest-bearing deposits to total deposits 60.94 68.49 55
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