Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
OR
☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ________
Commission File Number 001-38412
BRIDGEWATER BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
Minnesota(State or other jurisdiction ofincorporation or organization)
26‑0113412(I.R.S. EmployerIdentification No.)
3800 American Boulevard West, Suite 100Bloomington, Minnesota(Address of principal executive offices)
55431(Zip Code)
(952) 893‑6868
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S‑T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non‑accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b‑2 of the Exchange Act.
Large accelerated filer
☐
Accelerated filer
Non‑accelerated filer
☒
Smaller reporting company
Emerging growth company ☒
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Exchange Act). Yes ☐ No ☒
The number of shares of the Common Stock outstanding as of November 6, 2018 was 30,064,374.
The number of shares of the Non-voting Common Stock outstanding as of November 6, 2018 was 0.
PART I FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Comprehensive Income
Consolidated Statements of Shareholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II OTHER INFORMATION
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
SIGNATURES
2
PART 1 – FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Bridgewater Bancshares, Inc. and Subsidiaries
(dollars in thousands, except share data)
September 30,
December 31,
2018
2017
(Unaudited)
ASSETS
Cash and Cash Equivalents
$
21,537
23,725
Bank-owned Certificates of Deposits
3,305
3,072
Securities Available for Sale, at Fair Value
240,786
229,491
Loans, Net of Allowance for Loan Losses of $18,949 at September 30, 2018 (unaudited) and $16,502 at December 31, 2017
1,576,707
1,326,507
Federal Home Loan Bank (FHLB) Stock, at Cost
7,814
5,147
Premises and Equipment, Net
11,387
10,115
Foreclosed Assets
—
581
Accrued Interest
6,400
5,342
Goodwill
2,626
Other Intangible Assets, Net
1,100
1,243
Other Assets
14,131
8,763
Total Assets
1,885,793
1,616,612
LIABILITIES AND EQUITY
LIABILITIES
Deposits:
Noninterest Bearing
342,292
292,539
Interest Bearing
1,136,796
1,046,811
Total Deposits
1,479,088
1,339,350
Federal Funds Purchased
53,000
23,000
Notes Payable
15,500
17,000
FHLB Advances
94,000
68,000
Subordinated Debentures, Net of Issuance Costs
24,604
24,527
Accrued Interest Payable
1,230
1,408
Other Liabilities
7,519
6,165
Total Liabilities
1,674,941
1,479,450
SHAREHOLDERS' EQUITY
Preferred Stock- $0.01 par value
Authorized 10,000,000; None Issued and Outstanding at September 30, 2018 (unaudited) and December 31, 2017
Common Stock- $0.01 par value
Common Stock - Authorized 75,000,000; Issued and Outstanding 27,235,832 at September 30, 2018 (unaudited) and 20,834,001 at December 31, 2017
272
208
Non-voting Common Stock- Authorized 10,000,000; Issued and Outstanding 2,823,542 at September 30, 2018 (unaudited) and 3,845,860 at December 31, 2017
28
38
Additional Paid-In Capital
125,715
66,324
Retained Earnings
88,473
69,508
Accumulated Other Comprehensive Income (Loss)
(3,636)
1,084
Total Shareholders' Equity
210,852
137,162
Total Liabilities and Equity
See accompanying notes to consolidated financial statements.
3
(dollars in thousands, except per share data)
Three Months Ended
Nine Months Ended
INTEREST INCOME
Loans, Including Fees
20,207
15,707
56,055
43,060
Investment Securities
1,790
1,538
4,830
4,444
Other
139
353
266
Total Interest Income
22,136
17,384
61,238
47,770
INTEREST EXPENSE
Deposits
4,322
2,591
10,853
6,897
144
162
442
497
488
212
1,159
585
Subordinated Debentures
401
348
1,167
147
10
321
119
Total Interest Expense
5,502
3,323
13,942
8,446
NET INTEREST INCOME
16,634
14,061
47,296
39,324
Provision for Loan Losses
1,275
1,200
2,775
2,975
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES
15,359
12,861
44,521
36,349
NONINTEREST INCOME
Customer Service Fees
184
174
539
483
Net Gain (Loss) on Sales of Available for Sale Securities
(49)
15
(108)
(51)
Net Gain (Loss) on Sales of Foreclosed Assets
(88)
202
(225)
352
Other Income
767
596
1,480
1,169
Total Noninterest Income
814
987
1,686
1,953
NONINTEREST EXPENSE
Salaries and Employee Benefits
4,910
3,685
13,534
9,945
Occupancy and Equipment
570
1,767
1,629
Other Expense
2,020
1,854
5,221
5,060
Total Noninterest Expense
7,526
6,109
20,522
INCOME BEFORE INCOME TAXES
8,647
7,739
25,685
21,668
Provision for Income Taxes
2,184
3,064
6,526
8,113
NET INCOME
6,463
4,675
19,159
13,555
EARNINGS PER SHARE
Basic
0.22
0.19
0.67
0.55
Diluted
0.21
0.66
Dividends Paid Per Share
4
(dollars in thousands)
Net Income
Other Comprehensive Income (Loss):
Unrealized Gains (Losses) on Available for Sale Securities
(2,253)
475
(6,551)
6,820
Unrealized Gains on Cash Flow Hedge
5
6
155
17
Reclassification Adjustment for (Gains) Losses Realized in Income
49
(15)
108
51
Income Tax Impact
463
(163)
1,374
(2,411)
Total Other Comprehensive Income (Loss), Net of Tax
(1,736)
303
(4,914)
4,477
Comprehensive Income
4,727
4,978
14,245
18,032
Nine Months Ended September 30, 2018 and 2017
Accumulated
Additional
Shares
Common Stock
Paid‑In
Retained
Comprehensive
Voting
Nonvoting
Capital
Earnings
Income (Loss)
Total
BALANCE December 31, 2016
20,744,001
3,845,860
207
65,777
52,619
(3,275)
115,366
Stock-based Compensation
156
Stock Options Exercised
40,000
1
120
121
BALANCE September 30, 2017
20,784,001
66,053
66,174
1,202
133,675
BALANCE December 31, 2017
20,834,001
588
Comprehensive Income (Loss)
Issuance of Common Stock, Net of Issuance Costs
5,379,513
54
58,803
58,857
Conversion of Non-voting Stock to Voting Stock
1,022,318
(1,022,318)
(10)
Reclassification of the Income Tax Effects of the Tax Cuts and Jobs Act to Retained Earnings
(194)
194
BALANCE September 30, 2018
27,235,832
2,823,542
CASH FLOWS FROM OPERATING ACTIVITIES
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Net Amortization on Securities Available for Sale
2,309
2,081
Net Loss on Sales of Securities Available for Sale
Depreciation and Amortization of Premises and Equipment
560
522
Amortization of Other Intangible Assets
143
Amortization of Subordinated Debt Issuance Costs
77
Net (Gain) Loss on Sale of Foreclosed Assets
225
(352)
Changes in Operating Assets and Liabilities:
Accrued Interest Receivable and Other Assets
(4,897)
(1,969)
Accrued Interest Payable and Other Liabilities
1,176
1,832
Net Cash Provided by Operating Activities
CASH FLOWS FROM INVESTING ACTIVITIES
(Increase) Decrease in Bank-owned Certificates of Deposit
(233)
1,627
Proceeds from Sales of Securities Available for Sale
21,590
15,249
Proceeds from Maturities, Paydowns, Payups and Calls of Securities Available for Sale
17,298
17,971
Purchases of Securities Available for Sale
(59,043)
(54,710)
Net Increase in Loans
(252,975)
(271,139)
Net (Increase) Decrease in FHLB Stock
(2,667)
323
Purchases of Premises and Equipment
(1,832)
(1,102)
Proceeds from Sales of Foreclosed Assets
356
4,352
Net Cash Used in Investing Activities
(277,506)
(287,429)
CASH FLOWS FROM FINANCING ACTIVITIES
Increase in Deposits
139,738
271,240
Net Increase (Decrease) in Federal Funds Purchased
30,000
(28,000)
Principal Payments on Notes Payable
(1,500)
Proceeds from FHLB Advances
35,000
19,000
Principal Payments on FHLB Advances
(9,000)
Proceeds from Issuance of Subordinated Debentures
24,484
Issuance of Common Stock
Net Cash Provided by Financing Activities
253,095
276,345
NET CHANGE IN CASH AND CASH EQUIVALENTS
(2,188)
7,927
Cash and Cash Equivalents Beginning
16,499
Cash and Cash Equivalents Ending
24,426
SUPPLEMENTAL CASH FLOW DISCLOSURE
Cash Paid for Interest
14,043
8,066
Cash Paid for Income Taxes
5,590
9,360
Loans Transferred to Foreclosed Assets
689
7
Note 1: Description of the Business and Summary of Significant Accounting Policies
Organization
Bridgewater Bancshares, Inc. (the “Company”) is a financial holding company whose operations consist of the ownership of its wholly-owned subsidiaries, Bridgewater Bank (the “Bank”) and Bridgewater Risk Management, Inc. The Bank commenced operations in 2005 and provides retail and commercial loan and deposit services, principally to customers within the Minneapolis-St. Paul-Bloomington, MN-WI Metropolitan Statistical Area. In 2008, the Bank formed BWB Holdings, LLC, a wholly owned subsidiary of the Bank, for the purpose of holding repossessed property. In 2018, the Bank formed Bridgewater Investment Management, Inc., a wholly owned subsidiary of the Bank, for the purpose of holding certain municipal securities and to engage in municipal lending activities.
Bridgewater Risk Management was incorporated in December 2016 as a wholly-owned insurance company subsidiary of the Company. It insures the Company and its subsidiaries against certain risks unique to the operations of the Company and for which insurance may not be currently available or economically feasible in today’s insurance marketplace. Bridgewater Risk Management pools resources with several other insurance company subsidiaries of financial institutions to spread a limited amount of risk among themselves.
Initial Public Offering
On March 16, 2018, the Company completed an initial public offering (“IPO”) and received net proceeds, after deducting underwriting discounts and offering expenses, of $58.9 million for the shares of common stock sold by the Company in the offering.
Basis of Presentation
The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10‑Q and, therefore, do not include all disclosures necessary for a complete presentation of the consolidated balance sheets, consolidated statements of income, consolidated statements of comprehensive income, consolidated statements of shareholders’ equity and consolidated statements of cash flows in conformity with U.S. generally accepted accounting principles (“GAAP”). However, all normal recurring adjustments which are, in the opinion of management, necessary for the fair presentation of the interim financial statements have been included. The results of operations for the nine-month period ended September 30, 2018 are not necessarily indicative of the results which may be expected for the entire year. For further information, refer to the consolidated financial statements and footnotes included in the Company’s prospectus filed with the Securities and Exchange Commission (“SEC”) on March 14, 2018, pursuant to Rule 424(b)(4) under the Securities Act of 1933.
Principles of Consolidation
These consolidated financial statements include the amounts of the Company, the Bank and Bridgewater Risk Management. All significant intercompany balances and transactions have been eliminated in consolidation.
Emerging Growth Company
The Company qualifies as an “emerging growth company” under the Jumpstart Our Business Startups Act (the “JOBS Act”). Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933 for complying with new or revised accounting standards. As an emerging growth company, the Company can delay the adoption of certain
8
accounting standards until those standards would otherwise apply to private companies. The Company elected to take advantage of the benefits of this extended transition period.
Impact of Recently Adopted Accounting Standards
In May 2017, the Financial Accounting Standards Board (“FASB”) issued ASU 2017‑09, Compensation – Stock Compensation (Topic 718) (“ASU 2017-09”). ASU 2017-09 provides clarity about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The Company did not modify any share-based payment awards, thus, the impact of adopting the new standard, effective January 1, 2018, had no impact on the Company’s consolidated financial statements.
In February 2018, the FASB issued ASU 2018‑02, Income Statement-Reporting Comprehensive Income (Topic 220) (“ASU 2018-02”): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The amendments of this ASU allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from Public Law 115-97, commonly known as the Tax Cuts and Jobs Act. The Company elected to adopt ASU 2018-02 and, as a result, reclassified $194,000 from accumulated other comprehensive income to retained earnings as of January 1, 2018. The reclassification impacted the consolidated balance sheet and the consolidated statement of shareholders’ equity as of and for the nine months ended September 30, 2018.
Impact of Recently Issued Accounting Standards
The following ASUs have been issued by FASB and may impact the Company’s consolidated financial statements in future reporting periods.
In May 2014, the FASB issued ASU 2014‑09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014‑09”). ASU 2014‑09 implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of ASU 2014‑09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2015‑14, Revenue from Contracts with Customers (Topic 606) (“ASU 2015‑14”) was issued in August 2015 which defers adoption to annual reporting periods beginning after December 15, 2018 and interim reporting periods beginning after December 15, 2019. The timing of the Company’s revenue recognition is not expected to materially change. The Company’s largest portions of revenue, interest and fees on loans and gain on sales of loans, are specifically excluded from the scope of the guidance, and the Company currently recognizes the majority of the remaining revenue sources in a manner that management believes is consistent with the new guidance. Because of this, management believes that revenue recognized under the new guidance will generally approximate revenue recognized under current GAAP. These observations are subject to change as the evaluation is completed.
In January 2016, the FASB issued ASU 2016‑01, Financial Instruments—Overall (Subtopic 825‑10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016‑01”). This guidance changes how entities account for equity investments that do not result in consolidation and are not accounted for under the equity method of accounting. Entities will be required to measure these investments at fair value at the end of each reporting period and recognize changes in fair value in net income. A practicability exception will be available for equity investments that do not have readily determinable fair values; however, the exception requires the Company to adjust the carrying amount for impairment and observable price changes in orderly transactions for the identical or a similar investment of the same issuer. This guidance also changes certain disclosure requirements and other aspects of current GAAP. This guidance is effective for fiscal years beginning after December 15, 2018 and for interim reporting periods beginning after December 15, 2019. Early adoption is permitted for only one of the six amendments. The Company is evaluating the impact this new standard will have on its consolidated financial statements.
9
In February 2016, the FASB issued ASU 2016‑02, Leases (Topic 842) (“ASU 2016‑02”). The new guidance establishes the principles to report transparent and economically neutral information about the assets and liabilities that arise from leases. Entities will be required to recognize the lease assets and lease liabilities that arise from leases in the statement of financial position and to disclose qualitative and quantitative information about lease transactions, such as information about variable lease payments and options to renew and terminate leases. Also, in July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements which provides an optional transition method to adopt the new requirements of ASU 2016-02 as of the adoption date with no adjustment to the presentation or disclosure of comparative prior periods included in the financial statement in the period of adoption. The guidance is effective for fiscal years beginning after December 15, 2019 and interim reporting periods beginning after December 15, 2020. The Company’s assets and liabilities will increase based on the present value of the remaining lease payments for leases in place at the adoption date; however, this is not expected to be significant to the Company’s results of operations. The Company is evaluating the impact these new standards will have on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016‑05, Derivatives and Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships (“ASU 2016‑05”). The new guidance clarifies that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument under Topic 815 does not, in and of itself, require de-designation of that hedging relationship provided that all other hedge accounting criteria continue to be met. This guidance is effective for fiscal years beginning after December 15, 2017 and interim reporting periods beginning after December 15, 2018. The adoption of this guidance will not have a significant impact on the Company’s consolidated financial statements.
In March 2016, the FASB issued ASU 2016‑09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016‑09”). The new guidance simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Entities will be required to recognize the income tax effects of awards in the income statement when the awards vest or are settled. This guidance is effective for fiscal years beginning after December 15, 2017 and interim reporting periods beginning after December 31, 2018. The adoption of this ASU will not have a significant impact on the Company’s consolidated financial statements.
In June 2016, the FASB issued ASU 2016‑13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in this ASU affect all entities that measure credit losses on financial instruments including loans, debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, reinsurance receivables, and any other financial asset that has a contractual right to receive cash that is not specifically excluded. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this ASU replace the incurred loss impairment methodology required in current GAAP with a methodology that reflects expected credit losses that requires consideration of a broader range of reasonable and supportable information to estimate credit losses. The amendments in this ASU will affect entities to varying degrees depending on the credit quality of the assets held by the entity, the duration of the assets held, and how the entity applies the current incurred loss methodology. The amendments in this ASU are effective for fiscal years beginning after December 15, 2020 and interim reporting periods beginning after December 15, 2021.
All entities may adopt the amendments in the ASU early as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Amendments should be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. The Company is evaluating the impact this new standard will have on its consolidated financial statements.
In January 2017, the FASB issued ASU 2017‑04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The amendments in this ASU were issued to address concerns over the cost and complexity of the two-step goodwill impairment test and resulted in the removal of the second step of the test. The amendments require an entity to apply a one-step quantitative test and record the amount of goodwill impairment as the excess of a reporting unit’s carrying amount over its fair value, not to exceed the total amount of goodwill allocated to
the reporting unit. The new guidance does not amend the optional qualitative assessment of goodwill impairment. This ASU is intended to reduce the cost and complexity of the two-step goodwill impairment test and is effective for annual and interim goodwill impairment tests in fiscal years beginning after December 15, 2021, with early adoption permitted for testing performed after January 1, 2017. Upon adoption, the amendments should be applied on a prospective basis and the entity is required to disclose the nature of and reason for the change in accounting principle upon transition. The adoption of this guidance is not expected to have a significant impact on the Company’s consolidated financial statements.
In March 2017, the FASB issued ASU 2017‑08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310‑20): Premium Amortization on Purchased Callable Debt Securities. The amendments in this ASU shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount as discounts continue to be accreted to maturity. This ASU is intended to more closely align the amortization period of premiums and discounts to expectations incorporated in market pricing on the underlying securities. In most cases, market participants price securities to the call date that produces the worst yield when the coupon is above current market rates and prices securities to maturity when the coupon is below market rates. As a result, the amendments more closely align interest income recorded on bonds held at a premium or a discount with the economics of the underlying instrument. This ASU is intended to reduce diversity in practice and is effective for fiscal years beginning after December 15, 2019, with early adoption permitted. Upon adoption, the amendments should be applied using a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Additionally, in the period of adoption, an entity should provide disclosures about a change in accounting principles. The adoption of this guidance is not expected to have a significant impact on the Company’s consolidated financial statements.
In August 2017, the FASB issued ASU 2017‑12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The amendments of this ASU better align an entity’s accounting and financial reporting for hedging activities with the economic objectives of those activities. The ASU is effective for fiscal years beginning after December 15, 2019 and interim reporting periods beginning after December 15, 2020, with early adoption permitted. The Company is evaluating the impact this new standard with have on its consolidated financial statements.
In August 2018, the FASB issued ASU 2018‑13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement. The amendments of this ASU modify the disclosure requirements for fair value measurements by removing, modifying, or adding certain disclosures. The ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019, with early adoption permitted. The adoption of this guidance is not expected to have a significant impact on the Company’s consolidated financial statements.
In August 2018, the FASB issued ASU 2018-15, Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40). The amendments in this ASU align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by these amendments. The ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The adoption of this guidance is not expected to have a significant impact on the Company’s consolidated financial statements.
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Note 2: Earnings Per Share
Basic earnings per common share are computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted earnings per common share are calculated by dividing net income by the weighted average number of shares adjusted for the dilutive effect of stock options. The dilutive effect was computed using the treasury stock method, which assumes the stock options were exercised and the hypothetical proceeds from the exercise were used by the Company to purchase common stock at the average market price during the period.
The following table presents the numerators and denominators for basic and diluted earnings per share computations for the three and nine months ended September 30, 2018 and 2017:
Net Income Available to Common Shareholders
Weighted Average Common Stock Outstanding:
Weighted Average Common Stock Outstanding (Basic)
30,059,374
24,600,731
28,640,601
24,593,524
Stock Options
430,274
219,208
Weighted Average Common Stock Outstanding (Dilutive)
30,489,648
24,819,939
29,070,876
24,812,732
Basic Earnings per Common Share
Diluted Earnings per Common Share
Note 3: Securities
The following tables present the amortized cost and estimated fair value of securities with gross unrealized gains and losses at September 30, 2018 and December 31, 2017:
September 30, 2018
Gross
Amortized
Unrealized
Cost
Gains
Losses
Fair Value
Securities Available for Sale:
U.S. Treasury Securities
14,848
(32)
14,816
Municipal Bonds
117,495
518
(2,071)
115,942
Mortgage-Backed Securities
48,918
(2,376)
46,544
Corporate Securities
14,975
26
(195)
14,806
SBA Securities
49,650
(982)
48,678
Total Securities Available for Sale
245,886
556
(5,656)
December 31, 2017
115,784
3,005
(469)
118,320
61,945
(1,275)
60,681
5,052
80
(25)
5,107
45,368
242
(227)
45,383
228,149
3,338
(1,996)
12
The following table shows the fair value and gross unrealized losses of securities with unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:
Less Than 12 Months
12 Months or Greater
61,107
(1,054)
22,927
(1,017)
84,034
10,104
(437)
36,194
(1,939)
46,298
9,514
(113)
1,965
(82)
11,479
37,734
(687)
8,847
(295)
46,581
133,275
(2,323)
69,933
(3,333)
203,208
15,043
(89)
21,111
(380)
36,154
16,046
(105)
41,800
(1,170)
57,846
2,028
15,634
(189)
3,775
(38)
19,409
46,723
(383)
68,714
(1,613)
115,437
At September 30, 2018, 252 debt securities had unrealized losses with aggregate depreciation of approximately 2% from the Company’s amortized cost basis. At December 31, 2017, 133 debt securities had unrealized losses with aggregate depreciation of approximately 1% from the Company’s amortized cost basis. These unrealized losses relate principally to changes in interest rates and are not due to changes in the financial condition of the issuer, the quality of any underlying assets, or applicable credit enhancements. In analyzing whether unrealized losses on debt securities are other than temporary, management considers whether the securities are issued by a government body or agency, whether a rating agency has downgraded the securities, industry analysts’ reports, the financial condition and performance of the issuer, and the quality of any underlying assets or credit enhancements. Since management has the ability and intent to hold debt securities for the foreseeable future, no declines were deemed to be other than temporary as of September 30, 2018.
The following is a summary of amortized cost and estimated fair value of debt securities by the lesser of expected call date or contractual maturity as of September 30, 2018. Call date is used when a call of the debt security is expected, determined by the Company when the security has a market value above its amortized cost. Contractual maturities will differ from expected maturities for mortgage-backed and SBA securities because borrowers may have the right to call or prepay obligations without penalties.
Amortized Cost
Due in One Year or Less
1,170
1,171
Due After One Year Through Five Years
27,127
27,117
Due After Five Years Through 10 Years
49,221
48,887
Due After 10 Years
69,800
68,389
Subtotal
147,318
145,564
Totals
As of September 30, 2018, the securities portfolio was completely unencumbered. To increase on-balance sheet liquidity, all securities previously pledged to secure public deposits had the designation removed and an alternative means of permissible collateralization was utilized, primarily Federal Home Loan Bank letters of credit. As of
13
December 31, 2017, the amortized cost and fair value of securities pledged to secure public deposits and for other purposes required or permitted by law were $79,400 and $81,639, respectively.
The following is a summary of the proceeds from sales of securities available for sale, as well as gross gains and losses, for the three and nine months ended September 30, 2018 and 2017:
Proceeds From Sales of Securities
10,640
8,625
Gross Gains on Sales
237
90
289
229
Gross Losses on Sales
(286)
(75)
(397)
(280)
Note 4: Loans
The following table presents the components of loans at September 30, 2018 and December 31, 2017:
Commercial
235,502
217,753
Construction and Land Development
187,919
130,586
Real Estate Mortgage:
1-4 Family Mortgage
224,124
195,707
Multifamily
389,511
317,872
CRE Owner Occupied
65,905
65,909
CRE Non-owner Occupied
492,499
415,034
Total Real Estate Mortgage Loans
1,172,039
994,522
Consumer and Other
4,504
4,252
Total Loans, Gross
1,599,964
1,347,113
Allowance for Loan Losses
(18,949)
(16,502)
Net Deferred Loan Fees
(4,308)
(4,104)
Total Loans, Net
The following table presents the activity in the allowance for loan losses, by segment, for the three months ended September 30, 2018 and 2017:
Construction
CRE
and Land
1-‑4 Family
Owner
Non‑owner
Consumer
Three Months Ended September 30, 2018
Development
Mortgage
Occupied
and Other
Unallocated
Allowance for Loan Losses:
Beginning Balance
2,248
2,567
3,552
823
5,611
57
843
17,666
362
244
(47)
757
127
(176)
Loans Charged-off
(1)
(11)
Recoveries of Loans
16
19
Total Ending Allowance Balance
2,611
2,208
2,536
4,309
5,738
667
18,949
Three Months Ended September 30, 2017
1,542
1,604
2,102
2,057
1,131
4,349
73
1,195
14,053
384
(91)
(79)
284
(28)
460
(37)
1,926
1,513
2,035
2,341
1,103
4,772
68
1,461
15,219
14
The following table presents the activity in the allowance for loan losses, by segment, for the nine months ended September 30, 2018 and 2017:
Nine Months Ended September 30, 2018
2,435
1,892
2,317
3,170
956
5,087
60
16,502
153
674
190
1,139
(133)
651
82
(358)
(26)
(384)
23
29
56
Nine Months Ended September 30, 2017
1,315
1,379
2,410
1,568
1,160
78
12,333
610
132
(408)
773
(57)
1,560
361
(111)
(18)
(130)
33
41
The following tables present the balance in the allowance for loan losses and the recorded investment in loans, by segment, based on impairment method as of September 30, 2018 and December 31, 2017:
Allowance for Loan Losses at September 30, 2018
Individually Evaluated for Impairment
42
22
Collectively Evaluated for Impairment
2,597
2,494
801
18,871
Allowance for Loan Losses at December 31, 2017
24
109
2,421
2,260
3,156
932
16,393
1-4 Family
Loans at September 30, 2018
206
1,876
65
650
63
2,874
235,488
187,713
222,248
389,446
65,255
4,441
1,597,090
Loans at December 31, 2017
583
1,693
66
2,165
75
4,596
217,739
130,003
194,014
317,806
63,744
4,177
1,342,517
The following table presents information regarding total carrying amounts and total unpaid principal balances of impaired loans by loan segment as of September 30, 2018 and December 31, 2017:
Recorded
Principal
Related
Investment
Balance
Allowance
Loans With No Related Allowance for Loan Losses:
821
833
HELOC and 1-4 Family Junior Mortgage
157
508
515
1st REM - 1-4 Family
371
125
1st REM - Rentals
966
726
493
2,006
2,023
92
2,321
2,955
4,023
4,314
Loans With An Allowance for Loan Losses:
319
336
LOCs and 2nd REM - Rentals
64
47
270
159
553
573
Grand Totals
3,525
4,887
The following table presents information regarding the average balances and interest income recognized on impaired loans by loan segment for the three and nine months ended September 30, 2018 and 2017:
Three Months Ended September 30,
Nine Months Ended September 30,
Average
Interest
Recognized
200
1,403
214
738
217
740
635
639
372
452
376
681
971
929
981
36
976
35
501
1,844
512
21
1,437
43
67
2,344
25
4,798
40
2,377
74
5,876
145
322
328
275
278
158
160
161
83
558
656
564
663
20
2,902
5,454
2,941
81
6,539
165
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. The process of analyzing loans for changes in risk rating is ongoing through routine monitoring of the portfolio and annual internal credit reviews for credits meeting certain thresholds.
The following tables present the risk category of loans by loan segment as of September 30, 2018 and December 31, 2017, based on the most recent analysis performed by management:
Pass
Watch
Substandard
234,869
615
18
185,197
2,516
30,498
587
31,085
37,800
618
38,789
11,208
11,747
139,499
2,038
142,503
58,162
5,216
2,527
489,276
3,223
1,580,396
14,813
4,755
28,238
347
28,585
33,219
33,344
13,409
13,634
118,891
1,253
120,144
63,290
2,619
409,533
5,501
1,336,305
5,307
The following tables present the aging of the recorded investment in past due loans by loan segment as of September 30, 2018 and December 31, 2017:
Accruing Interest
30-89 Days
90 Days or
Current
Past Due
More Past Due
Nonaccrual
235,477
30,766
38,672
117
1,599,234
718
217,734
13,474
119,876
268
65,686
223
4,174
1,345,310
664
At September 30, 2018, there were four loans classified as troubled debt restructurings with a current outstanding balance of $569,000. In comparison, at December 31, 2017, there were nine loans classified as troubled debt restructurings with an outstanding balance of $3.0 million. There were no new loans classified as troubled debt restructurings during the nine month period ended September 30, 2018 and no loans classified as troubled debt restructurings during the previous twelve months that subsequently defaulted during the nine months ended September 30, 2018.
Note 5: Deposits
The following table presents the composition of deposits at September 30, 2018 and December 31, 2017:
Transaction Deposits
517,747
469,831
Savings and Money Market Deposits
416,140
369,942
Time Deposits
290,887
292,096
Brokered Deposits
254,314
207,481
Note 6: Subordinated Debentures
On July 12, 2017, the Company entered into a Subordinated Note Purchase Agreement with certain institutional accredited investors (the “Purchasers”) whereby the Company sold and issued $25.0 million in aggregate principal amount of fixed-to-floating subordinated notes due 2027 (the “Notes”). The Notes were issued by the Company to the Purchasers at a price equal to 100% of their face amount. Issuance costs were $516,000 and have been netted against Subordinated Debt on the consolidated balance sheets. These costs are being amortized over five years, which represents the period from issuance to the first redemption date of July 15, 2022. Total amortization expense for the three and nine months ended September 30, 2018 was $26,000 and $77,000, respectively, with $396,000 remaining to be amortized as of September 30, 2018. Total amortization expense for the three and nine months ended September 30, 2017 was $17,000, with $499,000 remaining to be amortized as of September 30, 2017.
The Notes mature on July 15, 2027, with a fixed interest rate of 5.875% payable semiannually in arrears for five years until July 15, 2022. Thereafter, the Company will be obligated to pay interest at a rate equal to 3‑month LIBOR plus 388 basis points quarterly in arrears until either the early redemption date or the maturity date. The Notes are not convertible into or exchangeable for any other securities or assets of the Company or any of its subsidiaries. The Notes are redeemable by the Company, in whole or in part, on or after July 15, 2022, and at any time upon the occurrence of certain events. Any redemption by the Company would be at a redemption price equal to 100% of the outstanding principal amount of the Notes being redeemed, including any accrued and unpaid interest thereon.
Note 7: Commitments, Contingencies and Credit Risk
Financial Instruments with Off-Balance Sheet Credit Risk
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.
The Company’s exposure to credit loss is represented by the contractual, or notional, amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance sheet instruments. Since some of the commitments are expected to expire without being drawn upon and some of the commitments may not be drawn upon to the total extent of the commitment, the notional amount of these commitments does not necessarily represent future cash requirements.
The following commitments were outstanding at September 30, 2018 and December 31, 2017:
Unfunded Commitments Under Lines of Credit
444,841
309,513
Letters of Credit
78,960
64,546
523,801
374,059
Legal Contingencies
Neither the Company nor any of its subsidiaries is a party, and no property of these entities is subject, to any material pending legal proceedings, other than ordinary routine litigation incidental to the Bank’s business. The Company does not know of any proceeding contemplated by a governmental authority against the Company or any of its subsidiaries.
Note 8: Stock Options
In 2017, the Company approved the Bridgewater Bancshares, Inc. 2017 Combined Incentive and Non-Statutory Stock Option Plan (the “2017 Plan”). Under the 2017 Plan, the Company may grant options to its directors, officers, and employees for up to 1,500,000 shares of common stock. Both incentive stock options and nonqualified stock options may be granted under the Plan. The exercise price of each option equals the estimated market value of the Company’s stock on the date of grant and an option’s maximum term is ten years and a vesting period of five years. As of September 30, 2018, there were 595,000 unissued shares of the Company’s common stock authorized for option grants under the 2017 Plan.
The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the assumptions noted in the table below. Expected volatilities are based on an industry index as described below. The expected term of options granted is based on historical data and represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. Historically, the Company has not paid a dividend on its common share and does not expect to do so in the near future.
The Company used the S&P 600 CM Bank Index as its historical volatility index. The S&P 600 CM Bank Index is an index of publicly traded small capitalization, regional, commercial banks located throughout the United States. There were 36 banks in the index ranging in market capitalization from $395 million up to $3.5 billion.
Dividend Yield
%
Expected Life
Years
Expected Volatility
20.23
Risk-Free Interest Rate
2.81
The following table presents a summary of the status of the Company’s stock option plans for the nine months ended September 30, 2018:
Weighted
Exercise Price
Outstanding at Beginning of Year
1,721,000
5.68
Granted
75,000
12.64
Exercised
Forfeitures
(6,000)
7.47
Outstanding at Period End
1,790,000
5.96
Options Exercisable at Period End
551,000
2.85
For the three months ended September 30, 2018 and 2017, the Company recognized compensation expense for stock options of $199 and $52, respectively. For the nine months ended September 30, 2018 and 2017, the Company recognized compensation expense for stock options of $588 and $156, respectively.
The following table presents information pertaining to options outstanding at September 30, 2018:
Options Outstanding
Options Exercisable
Number
Remaining
Outstanding
Contractual Life
1.65
15,000
3.1
2.13
90,000
4.5
3.00
520,000
5.3
416,000
3.58
50,000
6.3
1,040,000
9.0
7.78
5,000
9.3
13.22
25,000
9.6
12.86
45,000
9.9
7.3
As of September 30, 2018, there was $2,667 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the 2017 Plan that is expected to be recognized over a period of five years.
The following is an analysis of nonvested options to purchase shares of the Company’s stock issued and outstanding for the nine months ended September 30, 2018:
Number of
Average Grant
Date Fair Value
Nonvested Options at December 31, 2017
1,302,000
2.55
3.83
Vested
(132,000)
1.49
Forfeited
2.80
Nonvested Options at September 30, 2018
1,239,000
2.74
Note 9: Regulatory Capital
Effective January 1, 2015, the capital requirements of the Company and the Bank were changed to implement the regulatory requirements of the Basel III capital reforms. The Basel III requirements, among other things, (i) apply a strengthened set of capital requirements to the Company and Bank, including requirements related to common equity as a component of core capital, (ii) implement a “capital conservation buffer” against risk and higher minimum tier capital requirement, and (iii) revise the rules for calculating risk-weighted assets for purposes of such requirements. The rules made corresponding revisions to the prompt corrective action framework and include the new capital ratios and buffer requirements which will be phased in incrementally, with full implementation scheduled for January 1, 2019. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve qualitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios (set forth in the table and defined in the regulation) of Total Capital to Risk Weighted Assets, Tier 1 Capital to Risk Weighted Assets, Common Equity Tier 1 Capital to Risk Weighted Assets, and Tier 1 Capital to Average Assets.
The following tables present the Company and the Bank’s capital amounts and ratios as of September 30, 2018 and December 31, 2017:
To be Well Capitalized
For Capital Adequacy
Under Prompt Corrective
Actual
Purposes
Action Regulations
Amount
Ratio
Company (Consolidated):
Total Risk-Based Capital
254,675
14.84
137,496
8.00
N/A
Tier 1 Risk-Based Capital
210,762
12.28
103,122
6.00
Common Equity Tier 1 Capital
77,341
4.50
Leverage Ratio
11.61
72,613
4.00
Bank:
221,463
12.95
136,856
171,070
10.00
202,154
11.82
102,642
76,982
111,196
6.50
11.16
72,448
90,560
5.00
173,848
12.46
111,638
132,459
9.49
83,729
62,797
8.38
63,264
171,805
12.37
111,134
138,918
154,943
11.15
83,351
62,513
90,297
9.83
63,060
78,825
The Bank must maintain a capital conservation buffer as defined by Basel III regulatory capital guidelines, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. For 2018 and 2017, the capital conservation buffer is 1.875% and 1.25%, respectively. The buffer will increase incrementally each year until 2019 when the entire 2.5% capital conservation buffer will be fully phrased-in.
Note 10: Fair Value Measurement
The Company categorizes its assets and liabilities measured at fair value into a three-level hierarchy based on the priority of the inputs to the valuation technique used to determine fair value. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used in the determination of the fair value measurement fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement. Assets and liabilities valued at fair value are categorized based on the inputs to the valuation techniques as follows:
Level 1 – Inputs that utilized quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.
Level 2 – Inputs that include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instruments. Fair values for these instruments are estimated using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows.
Level 3 – Inputs that are unobservable for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity.
Subsequent to initial recognition, the Company may re-measure the carrying value of assets and liabilities measured on a nonrecurring basis to fair value. Adjustments to fair value usually result when certain assets are impaired. Such assets are written down from their carrying amounts to their fair value.
Professional standards allow entities the irrevocable option to elect to measure certain financial instruments and other items at fair value for the initial and subsequent measurement on an instrument-by-instrument basis. The Company adopted the policy to value certain financial instruments at fair value. The Company has not elected to measure any existing financial instruments at fair value; however, it may elect to measure newly acquired financial instruments at fair value in the future.
Recurring Basis
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The following table presents the balances of the assets and liabilities measured at fair value on a recurring basis as of September 30, 2018 and December 31, 2017:
Level 1
Level 2
Level 3
1,300
13,506
Interest Rate Swap
499
16,116
225,169
241,285
344
229,835
When available, the Company uses quoted market prices to determine the fair value of investment securities; such items are classified in Level 1 of the fair value hierarchy.
For the Company’s investments, when quoted prices are not available for identical securities in an active market, the Company determines fair value utilizing vendors who apply matrix pricing for similar bonds where no price is observable or may compile prices from various sources. These models are primarily industry-standard models that consider various assumptions, including time value, yield curve, volatility factors, prepayment speeds, default rates, loss severity, current market, and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Substantially, all of these assumptions are observable in the marketplace and can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace. Fair values from these models are verified, where possible, against quoted market prices for recent trading activity of assets with similar characteristics to the security being valued. Such methods are generally classified as Level 2. However, when prices from independent sources vary, or cannot be obtained or corroborated, a security is generally classified as Level 3.
Interest rate swaps are traded in over-the-counter markets where quoted market prices are not readily available. For those interest rate swaps, fair value is determined using internally developed models of a third party that uses primarily market observable inputs, such as yield curves and option volatilities, and accordingly are valued using Level 2 inputs.
Nonrecurring Basis
Certain assets are measured at fair value on a nonrecurring basis. These assets are not measured at fair value on an ongoing basis; however, they are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment or a change in the amount of previously recognized impairment.
The following tables present net impairment losses related to nonrecurring fair value measurements of certain assets for the periods ended September 30, 2018 and December 31, 2017:
Loss
Impaired Loans
422
464
In accordance with the provisions of the loan impairment guidance, impairment is measured on loans when it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, or discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceeds the recorded investments in such loans. Impaired loans for which an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. Collateral values are estimated using Level 2 inputs based on customized discounting criteria.
Impairment amounts on impaired loans represent specific valuation allowance and write-downs during the period presented on impaired loans that were individually evaluated for impairment based on the estimated fair value of the collateral less estimated selling costs, excluding impaired loans fully charged-off.
Disclosure of fair value information about financial instruments, for which it is practicable to estimate that value, is required whether or not recognized in the consolidated balance sheets. In cases where quoted market prices are not available, fair values are based on estimates using present value of cash flow or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimate of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases could not be realized in immediate settlement of the instruments. Certain financial instruments with a fair value that is not practicable to estimate and all non-financial instruments are excluded from the disclosure requirements. Accordingly, the aggregate fair value amounts presented do not necessarily represent the underlying value of the Company.
Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters that could affect the estimates. Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business. Deposits with no stated maturities are defined as having a fair value equivalent to the amount payable on demand. This prohibits adjusting fair value derived from retaining those deposits for an expected future
period of time. This component, commonly referred to as a deposit base intangible, is neither considered in the above amounts nor is it recorded as an intangible asset on the balance sheet. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.
The following tables present the carrying amount and estimated fair values of financial instruments at September 30, 2018 and December 31, 2017:
Fair Value Hierarchy
Carrying
Estimated
Financial Assets:
Cash and Due From Banks
Bank-Owned Certificates of Deposit
3,280
Securities Available for Sale
224,670
FHLB Stock, at Cost
Loans, Net
1,574,829
Accrued Interest Receivable
Financial Liabilities:
1,472,714
15,484
92,572
25,031
3,075
1,323,495
1,340,109
17,024
67,282
25,090
The following methods and assumptions were used by the Company to estimate fair value of consolidated financial statements not previously discussed.
Cash and cash equivalents – The carrying amount of cash and cash equivalents approximates their fair value.
Bank-owned certificates of deposit – Fair values of bank-owned certificates of deposit are estimated using the discounted cash flow analysis based on current rates for similar types of deposits.
FHLB stock – The carrying amount of FHLB stock approximates its fair value.
Loans, Net – Fair values for loans are estimated based on discounted cash flows, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality.
Accrued interest receivable – The carrying amount of accrued interest receivable approximates its fair value since it is short term in nature and does not present anticipated credit concerns.
Deposits – The fair values disclosed for demand deposits without stated maturities (interest and noninterest transaction, savings, and money market accounts) are equal to the amount payable on demand at the reporting date (their carrying amounts). Fair values for the fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Federal funds purchased – The carrying amount of federal funds purchased approximates the fair value.
Notes payable and subordinated debt – The fair value of the Company’s notes payable and subordinated debt are estimated using a discounted cash flow analysis, based on the Company’s current incremental borrowing rate for similar types of borrowing arrangements.
FHLB advances – The fair values of the Company’s FHLB advances are estimated using discounted cash flow analysis based on the Company’s current incremental borrowing rates for similar types of borrowing agreements.
Accrued interest payable – The carrying amount of accrued interest payable approximates its fair value since it is short term in nature.
Off-balance-sheet instruments – Fair values of the Company’s off-balance-sheet instruments (lending commitments and unused lines of credit) are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the counterparties’ credit standing and discounted cash flow analysis. The fair value of these off-balance-sheet items approximates the recorded amounts of the related fees and was not material at September 30, 2018 and December 31, 2017.
Limitations – The fair value of a financial instrument is the current amount that would be exchanged between market participants, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Consequently, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.
Note 11: Subsequent Events
On October 25, 2018, the Company entered into Exchange Agreements (the “Exchange Agreements”) with Castle Creek Capital Partners V, LP (“Castle Creek”), EJF Sidecar Fund, Series LLC – Series E and Endeavour Regional Bank Opportunities Fund II LP (collectively, the “Investors”), providing for the exchange of a total of 2,823,542 shares of the Company’s non-voting common stock, par value $0.01 per share (“Non-Voting Common Stock”), for 2,823,542 shares of the Company’s common stock, par value $0.01 per share (“Common Stock”). The Non-Voting Common Stock was originally issued to the Investors in private placement transactions that were completed in 2015 and 2016, and was issued to enable the equity ownership of the Investors to comply with applicable banking laws and regulations. The Exchange Agreements contain customary representations, warranties and covenants made by each of the Investors and the Company.
27
A member of the Company’s board of directors, David J. Volk, is a principal at Castle Creek Capital V LLC, which is the sole general partner of Castle Creek.
General
The following discussion explains the Company’s financial condition and results of operations as of and for the three and nine months ended September 30, 2018. Annualized results for these interim periods may not be indicative of results for the full year or future periods. The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes presented elsewhere in this report and the Company’s prospectus filed with the Securities and Exchange Commission (the “SEC”) on March 14, 2018, pursuant to Rule 424(b)(4) under the Securities Act of 1933.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, statements concerning plans, estimates, calculations, forecasts and projections with respect to the anticipated future performance of the Company. These statements are often, but not always, identified by words such as “may”, “might”, “should”, “could”, “predict”, “potential”, “believe”, “expect”, “continue”, “will”, “anticipate”, “seek”, “estimate”, “intend”, “plan”, “projection”, “would”, “annualized”, “target” and “outlook”, or the negative version of those words or other comparable words of a future or forward-looking nature. Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Our actual results and financial condition may differ materially from those indicated in the forward-looking statements. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:
·
loan concentrations in our portfolio;
the overall health of the local and national real estate market;
our ability to successfully manage credit risk;
business and economic conditions generally and in the financial services industry, nationally and within our market area;
our ability to maintain an adequate level of allowance for loan losses;
our high concentration of large loans to certain borrowers;
our ability to successfully manage liquidity risk;
our dependence on non-core funding sources and our cost of funds;
our ability to raise additional capital to implement our business plan;
our ability to implement our growth strategy and manage costs effectively;
the composition of our senior leadership team and our ability to attract and retain key personnel;
the occurrence of fraudulent activity, breaches or failures of our information security controls or cybersecurity-related incidents;
interruptions involving our information technology and telecommunications systems or third-party servicers;
competition in the financial services industry;
the effectiveness of our risk management framework;
the commencement and outcome of litigation and other legal proceedings and regulatory actions against us;
the impact of recent and future legislative and regulatory changes;
interest rate risk;
fluctuations in the values of the securities held in our securities portfolio;
the imposition of tariffs or other governmental policies impacting the value of products produced by our commercial borrowers; and
any other risks described in the “Risk Factors” section of this report and in the prospectus filed with the SEC on March 14, 2018, pursuant to Rule 424(b)(4) under the Securities Act of 1933, as well as those set forth in other reports filed by the Company with the SEC.
Any forward-looking statement made by us in this report is based only on information currently available to us and speaks only as of the date on which it is made. We undertake no obligation to publicly update any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future developments or otherwise.
Overview
Bridgewater Bancshares, Inc. (the “Company”) is a financial holding company headquartered in Bloomington, Minnesota with two wholly-owned subsidiaries, Bridgewater Bank (the “Bank”) and Bridgewater Risk Management, Inc., a captive insurance entity. The Bank has formed two wholly owned subsidiaries: BWB Holdings, LLC, for the purpose of holding repossessed property; and Bridgewater Investment Management, Inc., for the purpose of holding certain municipal securities and to engage in municipal lending activities. The Bank has seven full-service offices located in Bloomington, Greenwood, Minneapolis (2), St. Louis Park, Orono, and St. Paul, Minnesota. The principal sources of funds for loans and investments are transaction, savings, time, and other deposits, and short-term and long-term borrowings. The Company’s principal sources of income are interest and fees collected on loans, interest and dividends earned on investment securities and service charges. The Company’s principal expenses are interest paid on deposit accounts and borrowings, employee compensation and other overhead expenses. The Company’s simple, efficient business model of providing responsive support and unconventional experiences to clients continues to be the underlying principle that drives the Company’s profitable growth.
Critical Accounting Policies and Estimates
The consolidated financial statements of the Company are prepared based on the application of certain accounting policies, the most significant of which are described in Note 1 of the notes to the consolidated financial statements included in the Company’s prospectus that was filed with the SEC on March 14, 2018, pursuant to Rule 424(b)(4) under the Securities Act of 1933. Certain of these policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or subject to variation and may significantly affect the reported results and financial position for the current period or in future periods. The use of estimates, assumptions, and judgments are necessary when financial assets and liabilities are required to be recorded or adjusted to reflect fair value. Assets carried at fair value inherently result in more financial statement volatility. Fair values and information used to record valuation adjustments for certain assets and liabilities are based on either quoted market prices or are provided by other independent third-party sources, when available. When such information is not available, management estimates valuation adjustments. Changes in underlying factors, assumptions or estimates in any of these areas could have a material impact on the future financial condition and results of operations.
The allowance for loan losses, sometimes referred to as the “allowance,” is established through a provision for loan losses which is charged to expense. Loan losses are charged against the allowance when management determines all or a portion of the loan balance to be uncollectible. Subsequent recoveries, if any, are credited to the allowance for cash received on previously charged-off amounts. If the allowance is considered inadequate to absorb future loan losses on existing loans for any reason, including but not limited to, increases in the size of the loan portfolio, increases in charge-offs or changes in the risk characteristics of the loan portfolio, then the provision for loan losses is increased.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the original contractual terms of the loan agreement. The
30
collection of all amounts due according to original contractual terms means that both the contractual interest and principal payments of a loan will be collected as scheduled in the loan agreement. An impaired loan is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or, as a practical expedient, at the loan’s observable market price, or the fair value of the underlying collateral, reduced by costs to sell on a discounted basis, is used if a loan is collateral dependent.
Investment Securities Impairment
Periodically, the Company may need to assess whether there have been any events or economic circumstances to indicate that a security on which there is an unrealized loss is impaired on an other than temporary basis. In any such instance, the Company would consider many factors, including the length of time and the extent to which the fair value has been less than the amortized cost basis, the market liquidity for the security, the financial condition and the near-term prospects of the issuer, expected cash flows, and the intent and ability to hold the investment for a period of time sufficient to recover the temporary loss. Securities on which there is an unrealized loss that is deemed to be other than temporary are written down to fair value, with the write-down recorded as a realized loss in securities gains (losses).
The fair values of investment securities are generally determined by various pricing models. The Company evaluates the methodologies used to develop the resulting fair values. The Company performs a semi-annual analysis on the pricing of investment securities to ensure that the prices represent reasonable estimates of fair value. The procedures include initial and ongoing reviews of pricing methodologies and trends. The Company seeks to ensure prices represent reasonable estimates of fair value through the use of broker quotes, current sales transactions from the portfolio and pricing techniques, which are based on the net present value of future expected cash flows discounted at a rate of return market participants would require. As a result of this analysis, if the Company determines there is a more appropriate fair value, the price is adjusted accordingly.
Deferred Tax Asset
The Company uses the asset and liability method of accounting for income taxes as prescribed by GAAP. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If currently available information indicates it is “more likely than not” that the deferred tax asset will not be realized, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Accounting for deferred income taxes is a critical accounting estimate because the Company exercises significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. Management’s determination of the realization of deferred tax assets is based upon management’s judgment of various future events and uncertainties, including the timing and amount of future income, reversing temporary differences which may offset, and the implementation of various tax plans to maximize realization of the deferred tax asset. These judgments and estimates are inherently subjective and reviewed on a continual basis as regulatory and business factors change. Any reduction in estimated future taxable income may require us to record a valuation allowance against the deferred tax assets. A valuation allowance would result in additional income tax expense in such period, which would negatively affect earnings.
31
Operating Results Overview
The following table summarizes certain key financial results for the periods indicated:
As of and for the Three Months Ended
As of and for the Nine Months Ended
Per Common Share Data (1)
Basic Earnings Per Share
Diluted Earnings Per Share
Book Value Per Share
7.01
5.43
Tangible Book Value Per Share (2)
6.89
5.27
Basic Weighted Average Shares Outstanding
Diluted Weighted Average Shares Outstanding
Shares Outstanding at Period End
24,629,861
Selected Performance Ratios
Return on Average Assets (Annualized)
1.41
1.23
1.29
Return on Average Common Equity (Annualized)
14.07
13.70
14.44
Return on Average Tangible Common Equity (Annualized) (2)
12.51
14.50
13.99
14.91
Yield on Interest Earning Assets
4.92
4.77
4.85
4.74
Yield on Total Loans, Gross
5.25
5.13
5.22
5.08
Cost of Interest Bearing Liabilities
1.73
1.24
1.54
1.16
Cost of Total Deposits
1.19
0.81
1.05
0.78
Net Interest Margin (3)
3.71
3.89
3.76
3.93
Efficiency Ratio (2)
42.7
40.3
41.5
39.9
Noninterest Expense to Average Assets (Annualized)
1.64
1.61
1.60
1.58
Loan to Deposit Ratio
108.2
98.2
Core Deposits to Total Deposits
76.6
Tangible Common Equity to Tangible Assets (2)
11.01
8.36
Includes shares of our common stock and our non-voting common stock.
(2)
Represents a non-GAAP financial measure. See "Non-GAAP Financial Measures" for further details.
(3)
Amounts calculated on a tax-equivalent basis using the statutory federal tax rate of 21% for 2018 and 35% for 2017.
32
Selected Financial Data
The following tables summarize certain selected financial data as of and for the periods indicated:
% Change
Selected Balance Sheet Data
1,556,665
21.1
1,271,962
25.8
24.5
Goodwill and Other Intangibles
3,726
3,916
(4.9)
1,294,748
14.2
Tangible Common Equity (1)
207,126
129,759
59.6
57.7
Average Total Assets - Quarter-to-Date
1,816,485
1,505,307
20.7
Average Common Equity - Quarter-to-Date
208,773
131,862
58.3
Represents a non-GAAP financial measure. See “Non-GAAP Financial Measures” for further details.
For the Three Months Ended
For the Nine Months Ended
Selected Income Statement Data
Interest Income
27.3
28.2
Interest Expense
65.6
65.1
Net Interest Income
18.3
20.3
(6.7)
Net Interest Income after Provision for Loan Losses
19.4
22.5
Noninterest Income
(17.5)
(13.7)
Noninterest Expense
23.2
23.4
Income Before Income Taxes
11.7
18.5
(28.7)
(19.6)
38.2
41.3
Discussion and Analysis of Results of Operations
Net income was $6.5 million for the third quarter of 2018, a 38.2% increase over net income of $4.7 million for the third quarter of 2017. Net income per diluted common share for the third quarter of 2018 was $0.21, a 12.5% increase, compared to $0.19 per diluted common share for the same period in 2017. Net income was $19.2 million for the nine months ended September 30, 2018, a 41.3% increase over net income of $13.6 million for the nine months ended September 30, 2017. Net income per diluted common share for the nine months ended September 30, 2018 was $0.66, a 20.6% increase, compared to $0.55 per diluted common share for the nine months ended September 30, 2017.
The Company’s primary source of revenue is net interest income, which is impacted by the level of interest earning assets and related funding sources, as well as changes in the levels of interest rates. The difference between the average yield on earning assets and the average rate paid for interest bearing liabilities is the net interest spread. Noninterest bearing sources of funds, such as demand deposits and shareholders’ equity, also support earning assets. The impact of the noninterest bearing sources of funds is captured in the net interest margin, which is calculated as net interest income divided by average earning assets. Both the net interest margin and net interest spread are presented on a tax-equivalent basis, which means that tax-free interest income has been adjusted to pretax-equivalent income, assuming a 21% federal tax rate beginning in 2018. A 35% federal tax rate has been applied to periods prior to 2018. Management’s ability to respond to changes in interest rates by effective asset-liability management techniques is critical to maintaining the stability of the net interest margin and the momentum of the Company’s primary source of earnings.
34
Average Balances and Yields
The following tables show, for the three and nine months ended September 30, 2018 and 2017, the average balances of each principal category of assets, liabilities and shareholders’ equity, and an analysis of net interest income. The average balances are principally daily averages and, for loans, include both performing and nonperforming balances. Interest income on loans includes the effects of net deferred loan origination costs accounted for as yield adjustments. These tables are presented on a tax-equivalent basis, if applicable.
September 30, 2017
Yield/
& Fees
Rate
Interest Earning Assets:
Cash Investments
23,822
72
1.20
40,480
110
1.08
Investment Securities:
Taxable Investment Securities
132,197
839
2.52
102,592
491
1.90
Tax-Exempt Investment Securities (1)
116,042
1,204
4.12
130,772
1,610
4.88
Total Investment Securities
248,239
2,043
3.27
233,364
2,101
3.57
Loans (2)
1,526,765
1,214,501
Federal Home Loan Bank Stock
6,619
4.02
3,772
3.05
Total Interest Earning Assets
1,805,445
22,389
1,492,117
17,947
Noninterest Earning Assets
11,040
13,190
Interest Bearing Liabilities:
Interest Bearing Transaction Deposits
171,923
0.38
178,074
97
398,092
1,373
1.37
302,885
619
295,320
1,490
2.00
288,782
1,117
1.53
241,355
1,294
193,587
758
1.55
27,391
3,420
3.69
17,500
3.67
89,652
2.16
53,217
24,595
6.47
21,562
6.40
Total Interest Bearing Liabilities
1,263,828
1,059,027
Noninterest Bearing Liabilities:
Noninterest Bearing Transaction Deposits
335,483
307,361
Other Noninterest Bearing Liabilities
8,401
7,057
Total Noninterest Bearing Liabilities
343,884
314,418
Shareholders' Equity
Total Liabilities and Shareholders' Equity
Net Interest Income / Interest Rate Spread
16,887
3.19
14,624
3.53
Taxable Equivalent Adjustment:
Tax-Exempt Investment Securities
(253)
(563)
Interest income and average rates for tax-exempt securities are presented on a tax-equivalent basis, assuming a federal income tax rate of 21% in 2018 and 35% in 2017.
Average loan balances include nonaccrual loans. Interest income on loans includes amortization of deferred loan fees, net of deferred loan costs.
Net interest margin includes the tax equivalent adjustment and represents the annualized results of: (i) the difference between interest income on interest earning assets and the interest expense on interest bearing liabilities, divided by (ii) average interest earning assets for the period.
23,540
188
1.07
26,537
180
0.91
125,668
1,960
2.09
99,280
1,342
1.81
117,284
3,634
4.14
132,556
4.81
242,952
5,594
3.08
231,836
6,114
1,436,152
1,132,217
5,837
3.78
4,111
86
1,708,481
62,002
1,394,701
49,440
11,410
11,931
1,719,891
1,406,632
178,518
438
0.33
156,532
273
0.23
366,198
3,006
1.10
266,964
1,503
0.75
299,566
4,099
1.83
285,721
3,212
1.50
220,733
3,310
174,633
1,909
1.46
22,743
1.89
15,535
1.02
16,000
18,000
78,212
1.98
52,454
24,570
6.35
7,267
1,206,540
977,106
317,437
300,313
8,965
3,674
326,402
303,987
186,949
125,539
48,060
3.31
40,994
(764)
(1,670)
Interest Rates and Operating Interest Differential
Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest earning assets and interest bearing liabilities, as well as changes in average interest rates. The following tables show the effect that these factors had on the interest earned on interest earning assets and the interest incurred on interest bearing liabilities. The effect of changes in volume is determined by multiplying the change in volume by the previous period’s average rate. Similarly, the effect of rate changes is calculated by multiplying the change in average rate by the previous period’s volume. Changes which are not due solely to volume or rate have been allocated to these categories based on the respective percentage changes in average volume and average rate as they compare to each other. The following tables present the changes in the volume and rate of interest bearing assets and liabilities for the three months ended September 30, 2018, compared to the three months ended September 30, 2017, and for the nine months ended September 30, 2018, compared to the nine months ended September 30, 2017.
Compared with
Change Due To:
Volume
Variance
(45)
142
Tax Exempt Investment Securities
(181)
(406)
Total Securities
(39)
(19)
(58)
Loans
4,038
462
4,500
3,976
466
4,442
71
195
559
754
373
187
349
536
70
137
131
276
53
649
1,530
2,179
3,327
(1,064)
2,263
37
(20)
357
261
(550)
(588)
(1,138)
(193)
(327)
(520)
11,559
1,436
12,995
79
11,382
1,180
12,562
944
731
887
504
897
1,401
55
(55)
287
574
829
819
2,373
3,123
5,496
9,009
(1,943)
7,066
Comparison of Interest Income, Interest Expense, and Net Interest Margin
Third Quarter of 2018 Compared to Third Quarter of 2017
Net interest income was $16.6 million for the third quarter of 2018, an increase of $2.6 million, or 18.3%, compared to $14.1 million for the third quarter of 2017. The increase in net interest income was largely attributable to growth in average interest earning assets, particularly strong organic growth in the loan portfolio.
Net interest margin (on a fully tax-equivalent basis) for the third quarter of 2018 was 3.71%, compared to 3.89% for the third quarter of 2017, a decrease of 18 basis points. While net interest margin has benefitted from the repricing of variable-rate loans and the origination of new loans at higher rates, this was offset by increased balances and rates on non-core deposits and borrowings. Furthermore, the lower statutory federal tax rate reduced the net interest income tax equivalent adjustment by six basis points.
Average interest earning assets for the third quarter of 2018 increased $313.3 million, or 21.0%, to $1.81 billion from $1.49 billion for the third quarter of 2017. This increase in average interest earning assets was due to continued organic growth in the loan portfolio as a result of increased loan production. Average interest bearing liabilities increased $204.8 million, or 19.3%, to $1.26 billion for the third quarter of 2018, from $1.06 billion for the third quarter of 2017. The increase in average interest bearing liabilities was due to an increase in interest bearing deposits, federal funds purchased and FHLB advances.
Average interest earning assets produced a tax-equivalent yield of 4.92% for the third quarter of 2018, compared to 4.77% for the third quarter of 2017. The average rate paid on interest bearing liabilities was 1.73% for the third quarter of 2018, compared to 1.24% for the third quarter of 2017.
Interest Income. Total interest income on a tax-equivalent basis was $22.4 million for the third quarter of 2018, compared to $17.9 million for the third quarter of 2017. The $4.4 million, or 24.8%, increase in total interest income on a tax-equivalent basis was primarily due to organic growth in the loan portfolio.
Interest income on loans for the third quarter of 2018 was $20.2 million, compared to $15.7 million for the third quarter of 2017. The $4.5 million, or 28.6%, increase was due to a 25.7% increase in the average balance of loans outstanding and a 12 basis point increase in the average yield on loans. The increase in the average balance of loans outstanding was due to organic loan growth. The increase in yield on the loan portfolio resulted primarily from repricing of variable-rate loans and new loan production at yields accretive to the existing portfolio yield. Interest income on the investment securities portfolio on a fully-tax equivalent basis decreased $58,000, or 2.8%, during the third quarter of 2018 compared to the third quarter of 2017 despite a $14.9 million increase in average balances between the periods.
Interest Expense. Interest expense on interest bearing liabilities increased $2.2 million, or 65.6%, to $5.5 million for the third quarter of 2018, compared to $3.3 million for the third quarter of 2017, due to increases in interest rates and average balances of both deposits and borrowings.
Interest expense on deposits increased to $4.3 million for the third quarter of 2018, compared to $2.6 million for the third quarter of 2017. The $1.7 million, or 66.8%, increase in interest expense on deposits was primarily due to the average balance of deposits increasing 14.9% combined with a 48 basis point increase in the average rate paid. The increase in the average balance of deposits resulted primarily from increases in savings and money market deposits, time deposits, and brokered deposits. The increase in the average rate paid was primarily due to the impact of higher market interest rates demanded on deposits in the local and wholesale markets.
Interest expense on borrowings increased $448,000 to $1.2 million for the third quarter of 2018, compared to $732,000 for the third quarter of 2017. This increase was primarily due to increased rates and average balances of federal funds purchased and FHLB advances, offset in part by a reduction in interest expense on notes payable as a result of a decreased principal balance.
Nine Months Ended September 30, 2018 Compared to Nine Months Ended September 30, 2017
Net interest income was $47.3 million for the nine months ended September 30, 2018, an increase of $8.0 million, or 20.3%, compared to $39.3 million for the nine months ended September 30, 2017. The increase in net interest income was largely attributable to growth in average interest earning assets, particularly strong organic growth in the loan portfolio.
Net interest margin (on a fully tax-equivalent basis) for the nine months ended September 30, 2018 was 3.76%, compared to 3.93% for the nine months ended September 30, 2017, a decrease of 17 basis points. While net interest margin has benefitted from the repricing of variable-rate loans and the origination of new loans at higher rates, this was offset by increased balances and rates on non-core deposits and borrowings. Furthermore, the lower statutory federal tax rate reduced the net interest income tax equivalent adjustment by six basis points.
Average interest earning assets for the nine months ended September 30, 2018 increased $313.8 million, or 22.5%, to $1.71 billion from $1.39 billion for the nine months ended September 30, 2017. This increase in average interest earning assets was due to continued organic growth in the loan portfolio as a result of increased loan production. Average interest bearing liabilities increased $229.4 million, or 23.5%, to $1.21 billion for the nine months ended September 30, 2018, from $977.1 million for the nine months ended September 30, 2017. The increase in average interest bearing liabilities was due to an increase in interest bearing deposits which was the result of improved deposit gathering efforts. Also contributing to the increase in average interest bearing liabilities was the utilization of federal funds purchased and FHLB advances as the rising rate environment continues to heighten competition for local, core deposits.
Average interest earning assets produced a tax-equivalent yield of 4.85% for the nine months ended September 30, 2018, compared to 4.74% for the nine months ended September 30, 2017. The average rate paid on interest bearing
39
liabilities was 1.54% for the nine months ended September 30, 2018, compared to 1.16% for the nine months ended September 30, 2017.
Interest Income. Total interest income on a tax-equivalent basis was $62.0 million for the nine months ended September 30, 2018, compared to $49.4 million for the nine months ended September 30, 2017. The $12.6 million, or 25.4%, increase in total interest income on a tax-equivalent basis was primarily due to organic growth in the loan portfolio.
Interest income on loans for the nine months ended September 30, 2018 was $56.1 million, compared to $43.1 million for the nine months ended September 30, 2017. The $13.0 million, or 30.2%, increase was primarily due to a 26.8% increase in the average balance of loans outstanding and a 14 basis point increase in the average yield on loans. Interest income on the investment securities portfolio on a fully-tax equivalent basis decreased $520,000, or 8.5%, during the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017 despite a $11.1 million increase in average balances between the periods.
Interest Expense. Interest expense on interest bearing liabilities increased $5.5 million, or 65.1%, to $13.9 million for the nine months ended September 30, 2018, compared to $8.5 million for the nine months ended September 30, 2017, due to increases in interest rates and average balances of both deposits and borrowings.
Interest expense on deposits increased to $10.9 million for the nine months ended September 30, 2018, compared to $6.9 million for the nine months ended September 30, 2017. The $4.0 million, or 57.4%, increase in interest expense on deposits was primarily due to the average balance of deposits increasing 20.5% combined with a 32 basis point increase in the average rate paid.
Interest expense on borrowings increased $1.5 million to $3.1 million for the nine months ended September 30, 2018, compared to $1.5 million for the nine months ended September 30, 2017. This increase was due to increased rates and average balances of federal funds purchased, FHLB advances, and subordinated debentures, offset in part by a reduction in interest expense on notes payable as a result of a decreased principal balance.
The provision for loan losses was $1.3 million for the third quarter of 2018, an increase of $75,000, compared to the provision for loan losses of $1.2 million for the third quarter of 2017. The provision increased in the third quarter of 2018 primarily due to higher loan growth in comparison to the third quarter of 2017. The provision for loan losses was $2.8 million for the nine months ended September 30, 2018, a decrease of $200,000 compared to the provision for loan losses of $3.0 million for the nine months ended September 30, 2017 primarily due to improved credit quality in the overall loan portfolio. The allowance for loan losses to total gross loans ratio was 1.18% and 1.20% as of September 30, 2018 and 2017, respectively.
A reconciliation of the Company’s allowance for loan losses for the three and nine month periods ended September 30, 2018 and 2017 is as follows:
Balance at Beginning of Period
Charge-offs
Recoveries
Balance at End of Period
Noninterest income was $814,000 and $987,000 for the third quarter of 2018 and 2017, respectively, a decrease of $173,000. Noninterest income was $1.7 million and $2.0 million for the nine months ended September 30, 2018 and 2017, respectively, a decrease of $267,000. The decreases in both periods were primarily due to lower gains on sales of foreclosed assets which were partially offset by increased customer service fees related to deposit accounts due to an overall increase in the number of deposit clients, as well as increased letter of credit fees. The following table presents the major components of noninterest income for the three and nine months ended September 30, 2018, compared to the three and nine months ended September 30, 2017:
Increase/
(Decrease)
Noninterest Income:
Net Gain (Loss) on Sales of Securities
(64)
(290)
(577)
Letter of Credit Fees
447
387
634
Debit Card Interchange Fees
99
101
293
(6)
221
113
379
(173)
(267)
Noninterest expense was $7.5 million for the third quarter of 2018, an increase of $1.4 million, or 23.2%, from $6.1 million for the third quarter of 2017. The increase was primarily driven by a $1.2 million increase in salaries and employee benefits as a result of merit increases and increased staff to meet the needs of the Company’s growth. The increase was partially offset by a decrease in professional and consulting expenses due to higher expenses incurred in the third quarter of 2017 in contemplation of the initial public offering, in comparison to the third quarter of 2018.
Noninterest expense was $20.5 million for the nine months ended September 30, 2018, an increase of $3.9 million, or 23.4%, from $16.6 million for the nine months ended September 30, 2017. The decrease in data processing expenses for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017 was the result of one-time credits provided by the data processor in the first quarter of 2018.
The following table presents the major components of noninterest expense for the three and nine months ended September 30, 2018, compared to the three and nine months ended September 30, 2017:
Noninterest Expense:
1,225
3,589
138
FDIC Insurance Assessment
240
675
525
150
Data Processing
167
325
(139)
Professional and Consulting Fees
313
769
(456)
836
1,328
(492)
Information Technology and Telecommunications
271
178
93
500
Marketing and Advertising
141
911
736
175
Intangible Asset Amortization
48
134
1,657
1,364
1,417
3,888
The Company expects future increases in noninterest expense as the Company continues investing in infrastructure to support balance sheet growth. Management remains focused on supporting growth primarily by adding to staff, investing in technology, and by enhancing risk controls. Full-time equivalent employees increased from 115 at the end of the third quarter of 2017 to 139 at the end of the third quarter of 2018. The increase includes strategic hires, particularly in deposit gathering roles, as the Company continues to capitalize on M&A disruption in its market. Despite increased overhead, the Company experienced only a marginal increase in the efficiency ratio, a non-GAAP financial measure which measures operating expense as a percentage of net revenue. The efficiency ratio was 42.7% for the third quarter of 2018, compared to 40.3% for the third quarter of 2017. The efficiency ratio was 41.5% for the nine months ended September 30, 2018, compared to 39.9% for the nine months ended September 30, 2017.
Income Tax Expense
The provision for income taxes includes both federal and state taxes. Fluctuations in effective tax rates reflect the differences in the inclusion or deductibility of certain income and expenses for income tax purposes.
Income tax expense was $2.2 million for the third quarter of 2018, compared to $3.1 million for the third quarter of 2017. The effective combined federal and state income tax rate for the third quarter of 2018 was 25.3%, compared to 39.6% for the third quarter of 2017. Income tax expense was $6.5 million for the nine months ended September 30, 2018, compared to $8.1 million for the nine months ended September 30, 2018. The effective combined federal and state income tax rate for the nine months ended September 30, 2018 and 2017 was 25.4% and 37.4%, respectively. In both periods, the decrease in tax expense, despite the increase in pre-tax net income, was the result of the enactment of Public Law 115-97, commonly known as the Tax Cuts and Jobs Act, on December 22, 2017. This legislation reduced the federal corporate tax rate from 35% in periods prior to 2018 to 21% starting in 2018.
Financial Condition
Assets
Total assets at September 30, 2018 were $1.89 billion, an increase of $269.2 million, or 16.7%, over total assets of $1.62 billion at December 31, 2017, and an increase of $329.1 million, or 21.1%, over total assets of $1.56 billion at September 30, 2017.
Investment Securities Portfolio
The investment securities portfolio is used to make various term investments, maintain a source of liquidity and at times, serve as collateral for certain types of deposits. Investment balances in the investment securities portfolio are
subject to change over time based on funding needs and interest rate risk management objectives. The liquidity levels take into account anticipated future cash flows and all available sources of credits and are maintained at levels management believes are appropriate to assure future flexibility in meeting anticipated funding needs.
The investment securities portfolio consists primarily of municipal securities, U.S. government agency mortgage backed securities, and Small Business Administration, or SBA, securities, although the Company also holds U.S. treasury securities, corporate securities and other debt securities, all with varying contractual maturities. These maturities do not necessarily represent the expected life of the securities as the securities may be called or paid down without penalty prior to their stated maturities. All investment securities are held as available for sale.
Securities available for sale were $240.8 million at September 30, 2018, compared to $229.5 million at December 31, 2017, an increase of $11.3 million or 4.9%. At September 30, 2018, municipal securities represented 48.2% of the investment securities portfolio, government agency mortgage-backed securities represented 18.7% of the portfolio, SBA securities represented 20.2% of the portfolio, corporate securities represented 6.1% of the portfolio, U.S. treasury securities represented 6.2% of the portfolio, and other mortgage-backed securities represented 0.6% of the portfolio. The following table presents the amortized cost and fair value of securities available for sale, by type, at September 30, 2018 and December 31, 2017:
Fair
Value
Mortgage-Backed Securities Issued or Guaranteed by U.S. Agencies (MBS):
Residential Pass-Through:
Guaranteed by GNMA
6,547
6,250
7,080
6,940
Issued by FNMA and FHLMC
382
381
11,340
11,272
Other Residential Mortgage-Backed Securities
26,457
25,302
29,516
28,834
Commercial Mortgage-Backed Securities
13,982
13,061
12,121
11,748
All Other Commercial MBS
1,550
1,888
1,887
Total MBS
Municipal Securities
Loan Portfolio
The Company focuses on lending to borrowers located or investing in the Minneapolis-St. Paul-Bloomington, MN-WI Metropolitan Statistical Area across a diverse range of industries and property types. The Company lends primarily to commercial customers, consisting of loans secured by nonfarm, nonresidential properties, loans secured by multifamily residential properties, construction loans, land development loans, and commercial and industrial loans. The Company manages concentrations of credit exposure through a comprehensive program which implements formalized processes and procedures specifically for managing and mitigating risk within the loan portfolio. The processes and procedures include board and management oversight, commercial real estate exposure limits, portfolio monitoring tools, management information systems, market reports, underwriting standards, a credit risk review function and periodic stress testing to evaluate potential credit risk and the subsequent impact on capital and earnings.
Total gross loans increased $252.9 million, or 18.8%, to $1.60 billion at September 30, 2018, compared to $1.35 billion at December 31, 2017, and increased $328.0 million, or 25.8%, from $1.27 billion at September 30, 2017. The Company’s annualized loan growth for the nine months ended September 30, 2018 was 25.1%. The multifamily, construction and land development, and commercial real estate (“CRE”) nonowner occupied categories contributed most significantly to the $252.9 million growth in the nine months ended September 30, 2018. As of September 30, 2018,
multifamily loans increased $71.6 million, or 22.5%, construction and land development loans increased $57.3 million, or 43.9%, and, nonowner occupied CRE loans increased $77.5, or 18.7%, when compared to December 31, 2017.
The following table details the dollar composition and percentage composition of the loan portfolio by category, at the dates indicated:
June 30, 2018
Percent
204,072
192,840
164,492
119,427
1 - 4 Family Mortgage
213,265
187,573
340,888
286,191
65,891
59,208
CRE Nonowner Occupied
470,437
422,269
1,090,481
955,241
4,275
4,454
1,463,320
(17,666)
(15,219)
(4,058)
(4,128)
1,441,596
1,252,615
The Company’s primary focus has been on real estate mortgage lending, which constituted 73.2% of the portfolio as of September 30, 2018. The composition of the portfolio remained consistent with prior periods and although the Company expects continued growth, it does not expect any significant changes in the foreseeable future in the composition of the loan portfolio or in the emphasis on real estate lending.
As of September 30, 2018, CRE loans totaled $1.07 billion, consisting of $492.5 million of loans secured by nonowner occupied CRE, $389.5 million of loans secured by multifamily residential properties and $187.9 million of construction and land development loans. CRE loans represented 66.9% of the total gross loan portfolio and 483.1% of the Bank’s total capital at September 30, 2018, which is comprised of Tier 1 capital plus Tier 2 capital.
44
The following table details maturities and sensitivity to interest rate changes for the loan portfolio at September 30, 2018 and December 31, 2017:
As of September 30, 2018
Due in One Year
More Than One
or Less
Year to Five Years
After Five Years
111,461
85,798
38,243
147,563
22,143
18,213
47,848
146,478
29,798
21,837
148,840
218,834
5,959
31,359
28,587
84,753
248,586
159,160
160,397
575,263
436,379
1,698
2,162
644
421,119
685,366
493,479
Interest Rate Sensitivity:
Fixed Interest Rates
143,264
510,173
154,708
Floating or Adjustable Rates
277,855
175,193
338,771
As of December 31, 2017
119,225
73,093
25,435
97,183
29,074
4,329
47,587
125,890
22,230
11,869
91,778
214,225
7,252
29,363
29,294
71,330
206,873
136,831
138,038
453,904
402,580
764
3,426
62
355,210
559,497
432,406
144,115
430,496
111,939
211,095
129,001
320,467
Asset Quality
The Company emphasizes credit quality in the originating and monitoring of the loan portfolio, and success in underwriting is measured by the levels of classified and nonperforming assets and net charge-offs.
Federal regulations and internal policies require the use of an asset classification system as a means of managing and reporting problem and potential problem assets. The Company has incorporated an internal asset classification system, substantially consistent with federal banking regulations, as a part of the credit monitoring system. Federal banking regulations set forth a classification scheme for problem and potential problem assets as “substandard,” “doubtful” or “loss” assets. An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered
45
“uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated “watch.”
The following table presents information on loan classifications at September 30, 2018. The Company had no assets classified as doubtful or loss.
Risk Category
633
2,722
3,243
5,119
7,743
11,682
4,468
16,150
19,568
Nonperforming Assets
Nonperforming loans include loans accounted for on a nonaccrual basis and loans 90 days past due and still accruing. Nonperforming assets consist of nonperforming loans plus foreclosed assets (i.e., real estate acquired through foreclosure). Nonaccrual loans totaled $718,000 as of September 30, 2018 and $1.1 million as of December 31, 2017, a decrease of $421,000. There were no loans 90 days past due and still accruing as of September 30, 2018 or December 31, 2017.
The following table summarizes nonperforming assets, by category, at the dates indicated:
Nonaccrual Loans:
436
472
Total Nonaccrual Loans
Total Nonperforming Loans
Plus: Foreclosed Assets
Total Nonperforming Assets (1)
1,720
Total Restructured Accruing Loans
183
2,178
Total Nonperforming Assets and Restructured Accruing Loans
901
3,898
Nonaccrual Loans to Total Loans
0.04
0.08
Nonperforming Loans to Total Loans
Nonperforming Assets to Total Loans Plus Foreclosed Assets (1)
0.13
Nonperforming Assets and Restructured Accruing Loans to Total Loans Plus Foreclosed Assets
0.06
0.29
Nonperforming assets are defined as nonaccrual loans and loans greater than 90 days past due still accruing plus foreclosed assets.
The balance of nonperforming assets can fluctuate due to changes in economic conditions. The Company has established a policy to discontinue accruing interest on a loan (that is, place the loan on nonaccrual status) after it has
46
become 90 days delinquent as to payment of principal or interest, unless the loan is considered to be well-collateralized and is actively in the process of collection. In addition, a loan will be placed on nonaccrual status before it becomes 90 days delinquent unless management believes that the collection of interest is expected. Interest previously accrued but uncollected on such loans is reversed and charged against current income when the receivable is determined to be uncollectible. If management believes that a loan will not be collected in full, an increase to the allowance for loan losses is recorded to reflect management’s estimate of any potential exposure or loss. Generally, payments received on nonaccrual loans are applied directly to principal. There are not any loans, outside of those included in the table above, that cause management to have serious doubts as to the ability of borrowers to comply with present repayment terms.
The allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. The Company maintains an allowance for loan losses at a level management considers adequate to provide for known and probable incurred losses in the portfolio. The level of the allowance is based on management’s evaluation of estimated losses in the portfolio, after consideration of risk characteristics of the loans and prevailing and anticipated economic conditions. Loan charge-offs (i.e., loans judged to be uncollectible) are charged against the reserve and any subsequent recovery is credited. The Company analyzes risks within the loan portfolio on a continuous basis. A risk system, consisting of multiple grading categories for each portfolio class, is utilized as an analytical tool to assess risk and appropriate reserves. In addition to the risk system, management further evaluates risk characteristics of the loan portfolio under current and anticipated economic conditions and considers such factors as the financial condition of the borrower, past and expected loss experience, and other factors which management feels deserve recognition in establishing an appropriate reserve. These estimates are reviewed at least quarterly, and, as adjustments become necessary, they are recognized in the periods in which they become known. Although management strives to maintain an allowance it deems adequate, future economic changes, deterioration of borrowers’ creditworthiness, and the impact of examinations by regulatory agencies all could cause changes to the allowance for loan losses.
At September 30, 2018, the allowance for loan losses was $18.9 million, an increase of $2.4 million from $16.5 million at December 31, 2017. Net charge-offs totaled ($8,000) (net recoveries) during the third quarter of 2018 and $34,000 during the third quarter of 2017. Net charge-offs totaled $328,000 during the nine months ended September 30, 2018 and $89,000 during the nine months ended September 30, 2017. The allowance for loan losses as a percentage of total loans was 1.18% and 1.22% at September 30, 2018 and December 31, 2017.
The following is a summary of the activity in the allowance for loan loss reserve for the periods indicated:
Balance, Beginning of Period
Charge-offs:
358
111
Total Charge-offs
130
Recoveries:
Total Recoveries
Net Charge-offs
(8)
89
Gross Loans, End of Period
1,559,964
Average Loans
Net Charge-offs (Recoveries) (Annualized) to Average Loans
0.03
0.01
Allowance to Total Gross Loans
1.18
The following table presents a summary of the allocation of the allowance for loan losses by loan portfolio segment for the periods indicated:
13.8
14.7
11.5
13.4
14.0
22.7
19.2
4.3
5.8
30.3
30.8
13,406
70.7
11,530
69.9
0.3
0.4
3.5
3.6
Total Allowance for Loan Losses
100.0
The following table details the dollar composition and percentage composition of the deposit portfolio, by category, at the dates indicated:
23.1
323,320
22.8
21.9
303,824
23.5
175,455
11.9
178,045
12.6
177,292
13.2
173,947
28.1
381,942
27.0
27.6
330,935
19.7
300,701
21.3
21.8
289,084
22.3
17.2
230,683
16.3
15.5
196,958
15.2
1,414,691
Total deposits at September 30, 2018 were $1.48 billion, an increase of $139.7 million, or 10.4%, compared to total deposits of $1.34 billion at December 31, 2017, and an increase of $184.3 million, or 14.2%, over total deposits of $1.29 billion at September 30, 2017. Noninterest bearing deposits were $342.3 million at September 30, 2018, compared to $292.5 million at December 31, 2017, and $303.8 million at September 30, 2017. Noninterest bearing deposits comprised 23.1% of total deposits at September 30, 2018, compared to 21.9% at December 31, 2017, and 23.5% at September 30, 2017.
The Company relies on increasing the deposit base to fund loans and other asset growth. When appropriate, the Company utilizes alternative funding sources such as brokered deposits. At September 30, 2018, total brokered deposits were $254.3 million or 17.2% of total deposits.
The following table presents the average balance and average rate paid on each of the following deposit categories for the three months ended September 30, 2018, December 31, 2017, and September 30, 2017:
As of and for the
296,018
176,067
0.26
337,028
0.88
Time Deposits < $250,000
200,100
1.99
184,728
1.68
185,463
Time Deposits > $250,000
95,220
2.03
105,788
103,319
1.33
216,044
1,442,173
1,315,673
0.86
1,270,689
Borrowed Funds
In addition to deposits, the Company utilizes overnight borrowings to meet the daily liquidity needs of clients and fund loan growth. The following table summarizes overnight borrowings, which consist of federal funds purchased from correspondent banks on an overnight basis at the prevailing overnight market rates and the weighted average interest rates paid for the periods presented:
Outstanding at Period-End
Average Amount Outstanding
14,391
Weighted Average Interest Rate:
During Period
End of Period
2.39
1.63
Other Borrowings
At September 30, 2018, other borrowings outstanding consisted of FHLB advances of $94.0 million, notes payable of $15.5 million, and subordinated debentures of $24.6 million. The Company’s borrowing capacity at the FHLB is determined based on collateral pledged, generally consisting of loans. The Company had additional borrowing capacity under this credit facility of $80.4 million and $180.9 million at September 30, 2018 and December 31, 2017, respectively, based on collateral amounts pledged.
Additionally, the Company has borrowing capacity from other sources. As of September 30, 2018, the Bank was eligible to use the Federal Reserve discount window for borrowings. Based on assets available for collateral as of the applicable date, the Bank’s borrowing availability was approximately $108.8 million and $37.5 million at September 30, 2018 and December 31, 2017, respectively. As of September 30, 2018 and December 31, 2017, the Company had no outstanding advances.
The Company has entered into a swap agreement with an unaffiliated third party in order to hedge interest rate risk associated with the notes payable. This agreement provides for the Company to make payments at a fixed rate in exchange for receiving payments at a variable rate determined by one-month LIBOR.
Contractual Obligations
The following table contains supplemental information regarding total contractual obligations at September 30, 2018:
Within
One to
Three to
After
One Year
Three Years
Five Years
Deposits Without a Stated Maturity
937,521
119,347
298,407
123,813
2,000
4,000
5,500
20,000
54,000
Operating Lease Obligations
1,018
1,575
652
1,079,886
323,982
182,465
32,013
On August 27, 2018, the Bank and Reuter Walton Commercial, LLC (the “Contractor”) entered into a Standard Form of Agreement Between Owner and Contractor and the corresponding General Conditions of the Contract for Construction (collectively, the “Construction Contract”). Under the Construction Contract, the Contractor will construct
50
the core and shell of a new headquarters building for the Bank in St. Louis Park, Minnesota, and the Bank will pay the Contractor a contract price consisting of the cost of work plus a fee equal to 3.75% of the cost of work, subject to a guaranteed maximum price of $23.0 million, with anticipated construction completed in 2020.
The Company believes that it will be able to meet all contractual obligations as they come due through the maintenance of adequate cash levels. The Company expects to maintain adequate cash levels through earnings, loan and securities repayments and maturity activity and continued deposit gathering activities. As described above, the Company has in place various borrowing mechanisms for both short-term and long-term liquidity needs.
Shareholders’ Equity
Shareholders’ equity at September 30, 2018 was $210.9 million, an increase of $73.7 million, or 53.7%, over shareholders’ equity of $137.2 million at December 31, 2017, primarily due to $58.9 million of net proceeds from the issuance of common stock in the Company’s initial public offering and $19.2 million of net income, offset by a $4.7 million decrease in accumulated other comprehensive income. The decrease in accumulated other comprehensive income primarily resulted from interest rate fluctuations between periods.
The Company and the Bank are subject to various regulatory capital requirements administered by federal banking regulators. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by federal banking regulators that, if undertaken, could have a direct material effect on the Company’s and Bank’s business.
Under applicable regulatory capital rules, the Company and Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank must also meet certain specific capital guidelines under the prompt corrective action framework. The capital amounts and classification are subject to qualitative judgments by the federal banking regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of common equity Tier 1 capital, Tier 1 capital and total capital to risk-weighted assets and of Tier 1 capital to average consolidated assets (referred to as the “leverage ratio”), as defined under the applicable regulatory capital rules.
Management believes the Company and the Bank met all capital adequacy requirements to which they were subject as of September 30, 2018. The regulatory capital ratios for the Company and the Bank to meet the minimum capital adequacy standards and for the Bank to be considered well capitalized under the prompt corrective action framework are set forth in the following tables. The Company’s and the Bank’s actual capital amounts and ratios as of the dates indicated.
The Company and the Bank are subject to the rules of the Basel III regulatory capital framework and related Dodd-Frank Wall Street Reform and Consumer Protection Act. The rules include the implementation of a capital conservation buffer that is added to the minimum requirements for capital adequacy purposes. The capital conservation buffer is subject to a three year phase-in period that began on January 1, 2016, and will be fully phased-in on January 1, 2019, at 2.5%. The required phase-in capital conservation buffer during 2018 is 1.875%. A banking organization with a conservation buffer of less than the required amount will be subject to limitations on capital distributions, including dividend payments, and certain discretionary bonus payments to executive officers. At September 30, 2018, the ratios for the Company and the Bank were sufficient to meet the fully phased-in conservation buffer.
Off-Balance Sheet Arrangements
In the normal course of business, the Company enters into various transactions to meet the financing needs of clients, which, in accordance with GAAP, are not included in the consolidated balance sheets. These transactions include commitments to extend credit, standby letters of credit, and commercial letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. Most of these commitments mature within two years and the standby letters of credit are expected to expire without being drawn upon. All off-balance sheet commitments are included in the determination of the amount of risk-based capital that the Company and the Bank are required to hold.
The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit, standby letters of credit, and commercial letters of credit is represented by the contractual or notional amount of those instruments. The Company decreases its exposure to losses under these commitments by subjecting them to credit approval and monitoring procedures. The Company assesses the credit risk associated with certain commitments to extend credit and establishes a liability for probable credit losses.
The following table sets forth credit arrangements and financial instruments whose contract amounts represent credit risk as of September 30, 2018 and December 31, 2017:
Fixed
Variable
144,244
300,597
112,555
34,711
44,249
12,334
52,212
178,955
344,846
124,889
249,170
Liquidity
Liquidity is the Company’s capacity to meet cash and collateral obligations at a reasonable cost. Maintaining an adequate level of liquidity depends on the Company’s ability to efficiently meet both expected and unexpected cash
52
flows and collateral needs without adversely affecting either daily operations or financial condition. The Company’s Asset Liability Management (“ALM”) Committee, which is comprised of members of senior management, is responsible for managing commitments to meet the needs of customers while achieving the Company’s financial objectives. The ALM Committee meets regularly to review balance sheet composition, funding capacities, and current and forecasted loan demand.
The Company manages liquidity by maintaining adequate levels of cash and other assets from on and off-balance sheet arrangements. Specifically, on-balance sheet liquidity consists of cash and due from banks and unpledged investment securities available for sale, which are referred to as primary liquidity. Furthermore, these unencumbered liquid assets are comprised of primarily U.S. government agency mortgage backed securities and other agency securities, which the regulatory bodies consider the most marketable and liquid, especially in a stress scenario. In regards to off-balance sheet capacity, the Company maintains available borrowing capacity under secured borrowing lines with the FHLB and the Federal Reserve Bank of Minneapolis, as well as unsecured lines of credit for the purpose of overnight funds with various correspondent banks, which the Company refers to as secondary liquidity. In addition, the Bank is a member of the American Financial Exchange (“AFX”), through which it may either borrow or lend funds on an overnight or short-term basis with a group of approved commercial banks. The availability of funds changes daily. As of September 30, 2018, the Company had no borrowings outstanding through the AFX.
The following tables provide a summary of primary and secondary liquidity levels as of the dates indicated:
Primary Liquidity—On-Balance Sheet
(Dollars in thousands)
Less: pledged securities
81,639
Total primary liquidity
262,323
171,577
Ratio of primary liquidity to total deposits
17.7
12.8
Secondary Liquidity—Off-Balance Sheet
Borrowing Capacity
Net secured borrowing capacity with the FHLB
80,382
180,942
Net secured borrowing capacity with the Federal Reserve Bank
108,805
37,530
Unsecured borrowing capacity with correspondent lenders
60,000
Total secondary liquidity
279,187
278,472
Ratio of primary and secondary liquidity to total deposits
36.6
33.6
During the nine months ended September 30, 2018, primary liquidity increased by $90.7 million due to a $11.3 million increase in securities available for sale and a $81.6 million decrease in pledged securities, offset by a $2.2 million decrease in cash and cash equivalents, when compared to December 31, 2017. Secondary liquidity increased by $715,000 as of September 30, 2018 when compared to December 31, 2017, primarily due to a $71.3 million increase in the borrowing capacity on the secured credit line with the Federal Reserve Bank and a $30.0 million increase in unsecured borrowing capacity with correspondent lenders, offset by a $100.6 million decrease in the borrowing capacity on the secured borrowing line with the FHLB.
In addition to primary liquidity, the Company generates liquidity from cash flows from the loan and securities portfolios and from the large base of core customer deposits, defined as noninterest bearing transaction, interest bearing transaction, savings, non-brokered money market accounts and non-brokered time deposits less than $250,000. At September 30, 2018, core deposits totaled approximately $1.13 billion and represented 76.6% of total deposits. These core deposits are normally less volatile, often with customer relationships tied to other products offered by the Company, which promote long-standing relationships and stable funding sources.
The Company uses brokered deposits, the availability of which is uncertain and subject to competitive market forces and regulation, for liquidity management purposes. At September 30, 2018, brokered deposits totaled $254.3
million, consisting of $250.7 million of brokered time deposits and $3.6 million of non-maturity brokered money market and transaction accounts. At December 31, 2017, brokered deposits totaled $207.5 million, consisting of $183.4 million of brokered time deposits and $24.1 million of non-maturity brokered money market accounts. The Company has increased the amount of brokered deposits in recent quarters because of the efficiency in obtaining such deposits, as well as the cost savings relative to comparable core deposit offerings.
The Company’s liquidity policy includes guidelines for On-Balance Sheet Liquidity (a measurement of primary liquidity to total deposits plus borrowings), Total On-Balance Sheet Liquidity with Borrowing Capacity (a measurement of primary and secondary liquidity to total deposits plus borrowings), Wholesale Funding Ratio (a measurement of total wholesale funding to total deposits plus borrowings), and other guidelines developed for measuring and maintaining liquidity. As of September 30, 2018, the Company was in compliance with all established liquidity guidelines.
Non-GAAP Financial Measures
In addition to the results presented in accordance with Generally Accepted Accounting Principles (“GAAP”), the Company routinely supplements its evaluation with an analysis of certain non-GAAP financial measures. The Company believes these non-GAAP financial measures, in addition to the related GAAP measures, provide meaningful information to investors to help them understand the Company’s operating performance and trends, and to facilitate comparisons with the performance of peers. These disclosures should not be viewed as a substitute for operating results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. Reconciliations of non-GAAP disclosures used in this report to the comparable GAAP measures are provided in the following tables.
Efficiency Ratio
Less: Amortization of Intangible Assets
(48)
(143)
Adjusted Noninterest Expense
7,478
6,061
20,379
16,491
Less: (Gain) Loss on Sales of Securities
Adjusted Operating Revenue
17,497
15,033
49,090
41,328
Tangible Common Equity and Tangible Common Equity/Tangible Assets
Common Equity
Less: Intangible Assets
(3,726)
(3,916)
Tangible Common Equity
Tangible Assets
1,882,067
1,552,749
Tangible Common Equity/Tangible Assets
Tangible Book Value Per Share
Book Value Per Common Share
Less: Effects of Intangible Assets
(0.12)
(0.16)
Tangible Book Value Per Common Share
Average Tangible Common Equity
Average Common Equity
Less: Effects of Average Intangible Assets
(3,748)
(3,932)
(3,797)
(3,980)
205,025
127,930
183,152
121,559
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
As a financial institution, the Company’s primary market risk is interest rate risk, which is defined as the risk of loss of net interest income or net interest margin because of changes in interest rates. The Company continually seeks to measure and manage the potential impact of interest rate risk. Interest rate risk occurs when interest earning assets and interest bearing liabilities mature or re-price at different times, on a different basis or in unequal amounts. Interest rate risk also arises when assets and liabilities each respond differently to changes in interest rates.
The Company’s management of interest rate risk is overseen by its ALM Committee, based on a risk management infrastructure approved by the board of directors that outlines reporting and measurement requirements. In particular, this infrastructure sets limits and management targets for various metrics, including net interest income simulation involving parallel shifts in interest rate curves, steepening and flattening yield curves, and various prepayment and deposit duration assumptions. The Company’s risk management infrastructure also requires a periodic review of all key assumptions used, such as identifying appropriate interest rate scenarios, setting loan prepayment rates based on historical analysis and noninterest bearing and interest bearing transaction deposit durations based on historical analysis.
The Company does not engage in speculative trading activities relating to interest rates, foreign exchange rates, commodity prices, equities or credit.
The Company manages the interest rate risk associated with interest earning assets by managing the interest rates and terms associated with investment securities portfolio by purchasing and selling investment securities from time to time. The Company manages the interest rate risk associated with interest bearing liabilities by managing the interest rates and terms associated with wholesale borrowings and deposits from customers which the Company relies on for funding. For instance, the Company occasionally uses special offers on deposits to alter the interest rates and terms associated with interest bearing liabilities.
Net Interest Income Simulation
The Company uses a net interest income simulation model to measure and evaluate potential changes in net interest income that would result over the next 12 months from immediate and sustained changes in interest rates as of the measurement date. This model has inherent limitations and the results are based on a given set of rate changes and assumptions as of a certain point in time. For purposes of the simulation, the Company assumes no growth in either interest-sensitive assets or liabilities over the next 12 months; therefore, the model’s results reflect an interest rate shock to a static balance sheet. The simulation model also incorporates various other assumptions, which the Company believes are reasonable but which may have a significant impact on results, such as: (1) the timing of changes in interest rates, (2) shifts or rotations in the yield curve, (3) re-pricing characteristics for market-rate-sensitive instruments, (4) differing sensitivities of financial instruments due to differing underlying rate indices, (5) varying loan prepayment speeds for different interest rate scenarios, (6) the effect of interest rate limitations in assets, such as floors and caps, and (7) overall growth and repayment rates and product mix of assets and liabilities. Because of the limitations inherent in any approach used to measure interest rate risk, simulation results are not intended as a forecast of the actual effect of a change in market interest rates on the results, but rather as a means to better plan and execute appropriate asset-liability management strategies and to manage interest rate risk.
Potential changes to our net interest income in hypothetical rising and declining rate scenarios calculated as of September 30, 2018 are presented in the table below. The projections assume immediate, parallel shifts downward of the yield curve of 100 basis points and immediate, parallel shifts upward of the yield curve of 100, 200, 300 and 400 basis points. In the current interest rate environment, a downward shift of the yield curve of 200, 300 and 400 basis points does not provide us with meaningful results and thus is not presented.
Change (basis points) in Interest Rates
Forecasted Net
Percentage Change
(12-Month Projection)
from Base
+400
74,224
14.15
+300
71,983
10.66
+200
69,713
7.17
+100
67,401
3.64
0
65,043
−100
62,623
(4.25)
The table above indicates that as of September 30, 2018, in the event of an immediate and sustained 300 basis point increase in interest rates, we would experience an 10.66% increase in net interest income. In the event of an immediate 100 basis point decrease in interest rates, we would experience a 4.25% decrease in net interest income.
The results of this simulation analysis are hypothetical, and a variety of factors might cause actual results to differ substantially from what is depicted. For example, if the timing and magnitude of interest rate changes differ from those projected, our net interest income might vary significantly. Non-parallel yield curve shifts such as a flattening or steepening of the yield curve or changes in interest rate spreads would also cause our net interest income to be different from that depicted. An increasing interest rate environment could reduce projected net interest income if deposits and other short-term liabilities re-price faster than expected or re-price faster than our assets. Actual results could differ from those projected if we grow assets and liabilities faster or slower than estimated, if we experience a net outflow of deposit liabilities or if our mix of assets and liabilities otherwise changes. Actual results could also differ from those projected if
we experience substantially different repayment speeds in our loan portfolio than those assumed in the simulation model. Finally, these simulation results do not contemplate all the actions that we may undertake in response to potential or actual changes in interest rates, such as changes to our loan, investment, deposit, or funding strategies.
Evaluation of Disclosure Controls and Procedures
The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of the Company’s “disclosure controls and procedures” (as that term is defined in Rule 13a‑15(e) under the Securities Exchange Act of 1934, or the Exchange Act) as of September 30, 2018, the end of the fiscal quarter covered by this Quarterly Report on Form 10‑Q. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2018, the Company’s disclosure controls and procedures were effective to ensure that the information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There has been no change in the Company’s internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10‑Q that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II – OTHER INFORMATION
Item 1.A. Risk Factors
There have been no material changes to the risk factors disclosed in the Company’s prospectus filed with the SEC on March 14, 2018, pursuant to Rule 424(b)(4) under the Securities Act of 1933.
Unregistered Sales of Equity Securities
None.
Use of Proceeds from Registered Securities
On March 16, 2018, the Company sold 5,379,513 shares of common stock in its initial public offering, including 1,005,000 shares of common stock sold pursuant to the exercise in full by the underwriters of their option to purchase additional shares to cover over-allotments. The aggregate offering price for the shares sold by the Company was $63.2 million, and after deducting $4.3 million of underwriting discounts and offering expenses paid to third parties, the Company received total net proceeds of $58.9 million. In addition, certain selling shareholders participated in the offering and sold an aggregate of 2,325,487 shares of common stock at an aggregate offering price of $27.3 million. All of the shares were sold pursuant to the Company’s Registration Statement on Form S-1, as amended (File No. 333-223019), which was declared effective by the SEC on March 13, 2018, and registered shares of the Company’s common stock with a maximum aggregate offering price of $96.3 million. Sandler O’Neill + Partners, L.P. and D.A. Davidson & Co. acted as joint book-running managers for the offering. The Company’s common stock is currently traded on the Nasdaq Capital Market under the symbol “BWB”.
There has been no material change in the planned use of proceeds from the initial public offering as described in the Company’s prospectus filed with the SEC on March 14, 2018 pursuant to Rule 424(b)(4) under the Securities Act of 1933. From the effective date of the registration statement through September 30, 2018, the Company contributed $25.0 million of the net proceeds of the initial public offering to the Bank.
Not applicable.
58
Exhibit Number
Description
10.1
Construction Contract, dated as of August 27, 2018, by and between Bridgewater Bank and Reuter Walton Commercial, LLC (incorporated herein by reference to Exhibit 10.1 filed with the Form 8-K on August 30, 2018)
31.1
Certification of the Chief Executive Officer required by Rule 13a-14(a) of the Securities Exchange Act of 1934, and Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of the Chief Financial Officer required by Rule 13a-14(a) of the Securities Exchange Act of 1934, and Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.1
Financial information from the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2018, formatted in XBRL interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Income; (iii) Consolidated Statements of Comprehensive Income; (iv) Consolidated Statements of Shareholders’ Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements
59
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Bridgewater Bancshares, Inc.
Date: November 8, 2018
By:
/s/ Jerry Baack
Name:
Jerry Baack
Title:
Chairman, Chief Executive Officer and President(Principal Executive Officer)
/s/ Joe Chybowski
Joe Chybowski
Senior Vice President and Chief Financial Officer(Principal Financial and Accounting Officer)