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, 2021
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.)
4450 Excelsior Boulevard, Suite 100St. Louis Park, Minnesota(Address of principal executive offices)
55416(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 ☒
Securities registered pursuant to Section 12(b) of the Act:
Title of each class:
Trading Symbol
Name of each exchange on which registered:
Common Stock, $0.01 Par Value
BWB
The Nasdaq Stock Market LLC
Depositary Shares, each representing a 1/100th interest in a share of 5.875% Non-Cumulative Perpetual Preferred Stock, Series A, par value $0.01 per share
BWBBP
The number of shares of the Common Stock outstanding as of November 1, 2021 was 28,066,822.
PART I FINANCIAL INFORMATION
3
Item 1. Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets
Consolidated Statements of Income
4
Consolidated Statements of Comprehensive Income
5
Consolidated Statements of Shareholders’ Equity
6
Consolidated Statements of Cash Flows
7
Notes to Consolidated Financial Statements
8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
32
Item 3. Quantitative and Qualitative Disclosures About Market Risk
66
Item 4. Controls and Procedures
68
PART II OTHER INFORMATION
69
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
70
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
71
SIGNATURES
72
2
PART 1 – FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Bridgewater Bancshares, Inc. and Subsidiaries
(dollars in thousands, except share data)
September 30,
December 31,
2021
2020
(Unaudited)
ASSETS
Cash and Cash Equivalents
$
189,502
160,675
Bank-Owned Certificates of Deposit
1,877
2,860
Securities Available for Sale, at Fair Value
413,149
390,629
Loans, Net of Allowance for Loan Losses of $38,901 at September 30, 2021 (unaudited) and $34,841 at December 31, 2020
2,662,912
2,282,436
Federal Home Loan Bank (FHLB) Stock, at Cost
5,442
5,027
Premises and Equipment, Net
49,803
50,987
Accrued Interest
8,550
9,172
Goodwill
2,626
Other Intangible Assets, Net
527
670
Other Assets
54,737
22,263
Total Assets
3,389,125
2,927,345
LIABILITIES AND EQUITY
LIABILITIES
Deposits:
Noninterest Bearing
846,490
671,903
Interest Bearing
2,007,667
1,829,733
Total Deposits
2,854,157
2,501,636
Notes Payable
—
11,000
FHLB Advances
47,500
57,500
Subordinated Debentures, Net of Issuance Costs
92,153
73,739
Accrued Interest Payable
1,656
1,615
Other Liabilities
25,856
16,450
Total Liabilities
3,021,322
2,661,940
SHAREHOLDERS' EQUITY
Preferred Stock- $0.01 par value; Authorized 10,000,000
Preferred Stock - Issued and Outstanding 2,760,000 Series A shares ($25 liquidation preference) at September 30, 2021 (unaudited) and -0- at December 31, 2020
66,515
Common Stock- $0.01 par value; Authorized 75,000,000
Common Stock - Issued and Outstanding 28,066,822 at September 30, 2021 (unaudited) and 28,143,493 at December 31, 2020
281
Additional Paid-In Capital
103,471
103,714
Retained Earnings
188,004
154,831
Accumulated Other Comprehensive Income
9,532
6,579
Total Shareholders' Equity
367,803
265,405
Total Liabilities and Equity
See accompanying notes to consolidated financial statements.
(dollars in thousands, except per share data)
Three Months Ended
Nine Months Ended
INTEREST INCOME
Loans, Including Fees
31,049
26,224
87,705
77,250
Investment Securities
2,333
2,100
7,065
6,387
Other
135
169
334
490
Total Interest Income
33,517
28,493
95,104
84,127
INTEREST EXPENSE
Deposits
3,417
4,840
10,601
15,734
108
61
213
748
669
2,839
Subordinated Debentures
1,214
1,118
3,411
1,990
Federal Funds Purchased
107
Total Interest Expense
4,844
6,814
14,748
21,004
NET INTEREST INCOME
28,673
21,679
80,356
63,123
Provision for Loan Losses
1,300
3,750
4,000
8,850
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES
27,373
17,929
76,356
54,273
NONINTEREST INCOME
Customer Service Fees
268
200
733
575
Net Gain on Sales of Available for Sale Securities
48
109
750
1,473
Other Income
1,094
848
2,538
2,805
Total Noninterest Income
1,410
1,157
4,021
4,853
NONINTEREST EXPENSE
Salaries and Employee Benefits
8,309
6,550
22,923
19,352
Occupancy and Equipment
942
894
2,977
2,279
Other Expense
3,985
2,228
9,736
8,498
Total Noninterest Expense
13,236
9,672
35,636
30,129
INCOME BEFORE INCOME TAXES
15,547
9,414
44,741
28,997
Provision for Income Taxes
4,038
2,240
11,568
6,782
NET INCOME
11,509
7,174
33,173
22,215
EARNINGS PER SHARE
Basic
0.41
0.25
1.18
0.77
Diluted
0.40
1.14
0.76
(dollars in thousands)
Net Income
Other Comprehensive Income (Loss):
Unrealized Gains (Losses) on Available for Sale Securities
(237)
2,276
114
5,397
Unrealized Gains (Losses) on Cash Flow Hedges
242
3,295
(3,593)
Reclassification Adjustment for (Gains) Losses Realized in Income
358
204
329
(1,160)
Income Tax Impact
(73)
(522)
(785)
(135)
Total Other Comprehensive Income, Net of Tax
290
1,965
2,953
509
Comprehensive Income
11,799
9,139
36,126
22,724
Three and Nine Months Ended September 30, 2021 and 2020
Accumulated
Additional
Preferred
Common Stock
Paid-In
Retained
Comprehensive
Stock
Shares
Amount
Capital
Earnings
Income
Total
BALANCE June 30, 2020
28,837,560
288
110,906
142,678
3,318
257,190
Stock-based Compensation
7,399
384
Stock Options Exercised
2,000
15
Stock Repurchases
(137,984)
(1)
(1,295)
(1,296)
Issuance of Restricted Stock Awards
5,000
Forfeiture of Restricted Stock Awards
(3,200)
BALANCE September 30, 2020
28,710,775
287
110,010
149,852
5,283
265,432
BALANCE June 30, 2021
28,162,777
282
104,811
176,495
9,242
290,830
4,552
608
Preferred Stock Offering, Net of Issuance Costs
26,000
89
(126,507)
(2,037)
(2,038)
BALANCE September 30, 2021
28,066,822
BALANCE December 31, 2019
28,973,572
112,093
127,637
4,774
244,794
22,610
1,206
17,500
54
(315,848)
(3)
(3,343)
(3,346)
16,141
BALANCE December 31, 2020
28,143,493
14,408
1,765
52,400
1
243
(143,125)
(2,245)
(2,246)
Restricted Shares Withheld for Taxes
(354)
(5)
CASH FLOWS FROM OPERATING ACTIVITIES
Adjustments to Reconcile Net Income to Net Cash
Provided by (Used for) Operating Activities:
Net Amortization on Securities Available for Sale
2,567
1,891
Net Gain on Sales of Securities Available for Sale
(750)
(1,473)
Depreciation of Premises and Equipment
1,755
660
Loss on Sale of Premises and Equipment
Amortization of Other Intangible Assets
143
Amortization of Subordinated Debt Issuance Costs
299
138
Changes in Operating Assets and Liabilities:
Accrued Interest Receivable and Other Assets
(6,957)
(3,993)
Accrued Interest Payable and Other Liabilities
7,876
(11,716)
Net Cash Provided by Operating Activities
43,871
17,923
CASH FLOWS FROM INVESTING ACTIVITIES
(Increase) Decrease in Bank-Owned Certificates of Deposit
983
(208)
Proceeds from Sales of Securities Available for Sale
11,877
38,832
Proceeds from Maturities, Paydowns, Payups and Calls of Securities Available for Sale
33,250
23,629
Purchases of Securities Available for Sale
(64,669)
(140,974)
Net Increase in Loans
(384,476)
(342,464)
Net (Increase) Decrease in FHLB Stock
(415)
Purchases of Premises and Equipment
(571)
(22,040)
Proceeds from Sales of Foreclosed Assets
134
Purchase of Bank-Owned Life Insurance
(25,166)
Net Cash Used in Investing Activities
(429,187)
(443,084)
CASH FLOWS FROM FINANCING ACTIVITIES
Net Increase in Deposits
352,521
449,734
Principal Payments on Notes Payable
(11,000)
(1,500)
Proceeds from FHLB Advances
96,000
Principal Payments on FHLB Advances
(10,000)
(105,000)
Issuance of Preferred Stock, net of Issuance Costs
Issuance of Subordinated Debt, net of Issuance Costs
29,365
48,794
Redemption of Subordinated Debt
(11,250)
Shares Repurchased for Tax Withholdings Upon Vesting of Restricted Stock-Based Awards
Net Cash Provided by Financing Activities
414,143
484,736
NET CHANGE IN CASH AND CASH EQUIVALENTS
28,827
59,575
Cash and Cash Equivalents Beginning
31,935
Cash and Cash Equivalents Ending
91,510
SUPPLEMENTAL CASH FLOW DISCLOSURE
Cash Paid for Interest
20,766
Cash Paid for Income Taxes
15,176
7,917
Loans Transferred to Foreclosed Assets
Premises and Equipment Transferred to Other Assets
121
Net Investment Securities Purchased but Not Settled
5,432
2,059
Note 1: Description of the Business and Summary of Significant Accounting Policies
Organization
Bridgewater Bancshares, Inc. (the “Company”) is a financial holding company whose operations consist of the ownership of its wholly-owned subsidiaries, Bridgewater Bank (the “Bank”) and Bridgewater Risk Management, Inc. The Bank commenced operations in 2005 and provides retail and commercial loan and deposit services, principally to customers within the Minneapolis-St. Paul-Bloomington, MN-WI Metropolitan Statistical Area. In 2008, the Bank formed BWB Holdings, LLC, a wholly owned subsidiary of the Bank, for the purpose of holding repossessed property. In 2018, the Bank formed Bridgewater Investment Management, Inc., a wholly owned subsidiary of the Bank, for the purpose of holding certain municipal securities and to engage in municipal lending activities.
Bridgewater Risk Management, a subsidiary of the Company, was incorporated in 2016 as a wholly owned insurance company. It insures the Company and its subsidiaries against certain risks unique to the operations of the Company and for which insurance may not be currently available or economically feasible in today’s insurance marketplace. Bridgewater Risk Management pools resources with several other insurance company subsidiaries of financial institutions to spread a limited amount of risk among themselves.
Basis of Presentation
The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of the consolidated balance sheets, consolidated statements of income, consolidated statements of comprehensive income, consolidated statements of shareholders’ equity and consolidated statements of cash flows in conformity with U.S. generally accepted accounting principles (“GAAP”). However, all normal recurring adjustments which are, in the opinion of management, necessary for the fair presentation of the interim financial statements have been included. The results of operations for the three and nine-month periods ended September 30, 2021 are not necessarily indicative of the results which may be expected for the entire year. For further information, refer to the consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 11, 2021.
Principles of Consolidation
These consolidated financial statements include the amounts of the Company, the Bank, with locations in Bloomington, Greenwood, Minneapolis (2), St. Louis Park, Orono, and St. Paul, Minnesota, BWB Holdings, LLC, Bridgewater Investment Management, Inc., and Bridgewater Risk Management, Inc. All significant intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates in Preparation of Financial Statements
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Information available which could affect judgements includes, but is not limited to, changes in interest rates, changes in the performance of the economy, including COVID-19 pandemic related changes, and changes in the financial condition of borrowers.
Material estimates that are particularly susceptible to significant change in the near term include the determination of the allowance for loan losses, calculation of deferred tax assets, fair value of financial instruments, and investment securities impairment.
Emerging Growth Company
The Company qualifies as an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and may take advantage of certain exemptions from various reporting requirements that are applicable to public companies that are not emerging growth companies, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. In addition, even if the Company complies with the greater obligations of public companies that are not emerging growth companies, the Company may avail itself of the reduced requirements applicable to emerging growth companies from time to time in the future, so long as the Company is an emerging growth company. The Company will continue to be an emerging growth company until the earliest to occur of: (1) the end of the fiscal year following the fifth anniversary of the date of the first sale of common equity securities under the Company’s Registration Statement on Form S-1, which was declared effective by the SEC on March 13, 2018; (2) the last day of the fiscal year in which the Company has $1.07 billion or more in annual revenues; (3) the date on which the Company is deemed to be a “large accelerated filer” under the Securities Exchange Act of 1934, as amended (the “Exchange Act”); or (4) the date on which the Company has, during the previous three-year period, issued publicly or privately, more than $1.0 billion in non-convertible debt securities.
Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933 for complying with new or revised accounting standards. As an emerging growth company, the Company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. The Company elected to take advantage of the benefits of this extended transition period.
Impact of Recently Adopted Accounting Guidance
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This ASU aims to simplify the accounting for income taxes by removing certain exceptions to the general principles and also simplification of areas such as franchise taxes, step-up in tax basis goodwill, separate entity financial statements and interim recognition of enactment of tax laws or rate changes. The Company adopted this standard during the first quarter of 2021 and the adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
In January 2020, the FASB issued ASU 2020-01, Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815): Clarifying the Interactions between Topic 321, Topic 323 and Topic 815. This ASU clarifies that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting for the purposes of applying the fair value measurement alternative. The Company adopted this standard during the first quarter of 2021 and the adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
Subsequent Events
Subsequent events have been evaluated through November 4, 2021, which is the date the consolidated financial statements were available to be issued.
9
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 computed by dividing net income by the weighted average number of common shares adjusted for the dilutive effect of stock compensation. For the three and nine months ended September 30, 2021, stock options, restricted stock awards and restricted stock units of approximately 55,000 and 55,000, respectively, were excluded from the calculation because their effect would have been anti-dilutive. For the three and nine months ended September 30, 2020, stock options and restricted stock awards of approximately 557,000 and 557,000, respectively, were excluded from the calculation because their effect would have been anti-dilutive.
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, 2021 and 2020:
Net Income Available to Common Shareholders
Weighted Average Common Stock Outstanding:
Weighted Average Common Stock Outstanding (Basic)
28,047,280
28,683,855
28,035,246
28,717,142
Dilutive Effect of Stock Compensation
1,063,267
490,746
1,042,604
583,621
Weighted Average Common Stock Outstanding (Dilutive)
29,110,547
29,174,601
29,077,850
29,300,763
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, 2021 and December 31, 2020:
September 30, 2021
Gross
Amortized
Unrealized
Cost
Gains
Losses
Fair Value
Securities Available for Sale:
U.S. Treasury Securities
1,007
1,008
Municipal Bonds
129,730
7,662
(507)
136,885
Mortgage-Backed Securities
126,271
1,452
(1,711)
126,012
Corporate Securities
74,455
2,938
(147)
77,246
SBA Securities
33,220
97
(209)
33,108
Asset-Backed Securities
37,550
1,390
(50)
38,890
Total Securities Available for Sale
402,233
13,540
(2,624)
December 31, 2020
105,975
9,373
(336)
115,012
123,395
2,029
(1,164)
124,260
71,116
1,240
(201)
72,155
40,455
(380)
40,107
38,135
976
(16)
39,095
379,076
13,650
(2,097)
10
The following tables present the fair value and gross unrealized losses of securities with unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2021 and December 31, 2020:
Less Than 12 Months
12 Months or Greater
26,462
(435)
3,764
(72)
30,226
36,734
(719)
24,669
(992)
61,403
9,656
(123)
1,476
(24)
11,132
2,783
(2)
17,689
(207)
20,472
1,566
77,201
(1,329)
47,598
124,799
12,023
(329)
223
(7)
12,246
45,120
(1,163)
1,699
46,819
23,643
(131)
2,430
(70)
26,073
3,288
28,193
(377)
31,481
2,471
86,545
(1,642)
32,545
(455)
119,090
At September 30, 2021, 154 debt securities had unrealized losses with aggregate depreciation of approximately 2.1% from the Company’s amortized cost basis. At December 31, 2020, 150 debt securities had unrealized losses with aggregate depreciation of approximately 1.7% from the Company’s amortized cost basis. These unrealized losses related principally to changes in interest rates and were not due to changes in the financial condition of the issuer, the quality of any underlying assets, or applicable credit enhancements. In analyzing whether unrealized losses on debt securities are other than temporary, management considers whether the securities are issued by a government body or agency, whether a rating agency has downgraded the securities, industry analysts’ reports, the financial condition and performance of the issuer, and the quality of any underlying assets or credit enhancements. Since management has the ability and intent to hold these debt securities for the foreseeable future, no declines were deemed to be other than temporary as of September 30, 2021.
The following table presents a summary of amortized cost and estimated fair value of debt securities by the lesser of expected call date or contractual maturity as of September 30, 2021. Call date is used when a call of the debt security is expected, determined by the Company when the security has a market value above its amortized cost. Contractual maturities will differ from expected maturities for mortgage-backed, SBA securities and asset-backed securities because borrowers may have the right to call or prepay obligations without penalties.
Amortized Cost
Due in One Year or Less
8,325
8,425
Due After One Year Through Five Years
79,077
83,142
Due After Five Years Through 10 Years
71,434
75,398
Due After 10 Years
46,356
48,174
Subtotal
205,192
215,139
Totals
As of September 30, 2021 and December 31, 2020, the securities portfolio was unencumbered.
11
The following table presents a summary of the proceeds from sales of securities available for sale, as well as gross gains and losses, for the three and nine months ended September 30, 2021 and September 30, 2020:
Proceeds From Sales of Securities
4,119
4,794
Gross Gains on Sales
498
123
1,200
1,561
Gross Losses on Sales
(450)
(14)
(88)
Note 4: Loans
The following table presents the components of the loan portfolio at September 30, 2021 and December 31, 2020:
Commercial
350,081
304,220
Paycheck Protection Program
54,190
138,454
Construction and Land Development
257,167
170,217
Real Estate Mortgage:
1-4 Family Mortgage
290,535
294,479
Multifamily
865,172
626,465
CRE Owner Occupied
101,834
75,604
CRE Non-owner Occupied
786,271
709,300
Total Real Estate Mortgage Loans
2,043,812
1,705,848
Consumer and Other
6,762
7,689
Total Loans, Gross
2,712,012
2,326,428
Allowance for Loan Losses
(38,901)
(34,841)
Net Deferred Loan Fees
(10,199)
(9,151)
Total Loans, Net
The following table presents the activity in the allowance for loan losses, by segment, for the three months ended September 30, 2021 and 2020:
Paycheck
Construction
CRE
Protection
and Land
1--4 Family
Owner
Non-owner
Consumer
Three Months Ended September 30, 2021
Program
Development
Mortgage
Occupied
and Other
Unallocated
Allowance for Loan Losses:
Beginning Balance
6,525
50
3,427
3,502
11,150
1,244
11,018
220
455
37,591
171
(23)
47
33
816
179
(37)
111
Loans Charged-off
(6)
(20)
Recoveries of Loans
12
18
30
Total Ending Allowance Balance
6,702
27
3,474
3,553
11,966
1,423
11,021
566
38,901
Three Months Ended September 30, 2020
5,192
90
2,173
3,322
6,697
964
8,323
174
698
27,633
115
63
1,622
140
1,177
245
5,303
91
2,236
3,709
8,319
1,104
9,500
176
943
31,381
The following table presents the activity in the allowance for loan losses, by segment, for the nine months ended September 30, 2021 and 2020:
Nine Months Ended September 30, 2021
5,703
2,491
3,972
9,517
1,162
10,991
203
732
34,841
971
(43)
(437)
2,449
229
(166)
(26)
34
23
Nine Months Ended September 30, 2020
3,058
2,202
5,824
792
6,972
85
754
22,526
819
2,495
312
2,528
103
189
(39)
(15)
(54)
51
59
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, 2021 and December 31, 2020:
Allowance for Loan Losses at September 30, 2021
Individually Evaluated for Impairment
266
Collectively Evaluated for Impairment
6,436
38,635
Allowance for Loan Losses at December 31, 2020
37
13
5,666
190
34,791
Loans at September 30, 2021
1,203
1,346
841
4,218
7,742
348,878
257,033
289,189
100,993
782,053
2,704,270
Loans at December 31, 2020
239
156
1,498
870
12,388
15,164
303,981
170,061
292,981
74,734
696,912
7,676
2,311,264
The following table presents information regarding total carrying amounts and total unpaid principal balances of impaired loans by loan segment as of September 30, 2021 and December 31, 2020:
Recorded
Principal
Related
Investment
Balance
Allowance
Loans With No Related Allowance for Loan Losses:
122
741
763
HELOC and 1-4 Family Junior Mortgage
884
1st REM - Rentals
462
614
879
CRE Non Owner Occupied
6,589
7,234
15,034
15,641
Loans With An Allowance for Loan Losses:
1,153
117
120
130
133
Grand Totals
8,387
15,774
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, 2021 and 2020:
Three Months Ended September 30,
Nine Months Ended September 30,
Average
Interest
Recognized
272
277
137
162
144
168
865
804
31
465
470
753
21
867
1,594
868
1,602
65
4,232
12,115
172
4,262
161
12,145
514
6,635
76
15,756
216
6,678
225
15,749
640
1,154
14
1,155
40
124
278
7,789
16,034
217
7,833
265
16,030
643
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, 2021 and December 31, 2020, based on the most recent analysis performed by management:
Pass
Watch
Substandard
323,787
25,091
28,787
883
29,670
1st REM - 1-4 Family
46,197
692
46,889
LOCs and 2nd REM - Rentals
20,174
20,192
193,321
463
193,784
99,396
1,597
742,074
39,979
2,636,893
67,377
289,465
14,516
29,396
30,280
41,239
703
41,942
20,678
200,965
201,579
667,336
29,576
2,266,469
44,795
The following tables present the aging of the recorded investment in past due loans by loan segment as of September 30, 2021 and December 31, 2020:
Accruing Interest
30-89 Days
90 Days or
Current
Past Due
More Past Due
Nonaccrual
46,871
101,234
600
2,711,260
734
304,211
20,668
74,991
613
2,325,640
775
At September 30, 2021, there were four loans classified as troubled debt restructurings with total aggregate outstanding balances of $1,440. In comparison, at December 31, 2020, there were three loans classified as troubled debt restructurings with total aggregate outstanding balances of $421. There was one new loan classified as a troubled debt restructuring during the nine month period ended September 30, 2021, and no loans classified as troubled debt restructurings during the previous twelve months subsequently defaulted during the nine months ended September 30, 2021.
In response to the COVID-19 pandemic, the Company developed programs for clients who experienced business and personal disruptions due to the COVID-19 pandemic pursuant to which the Company provided interest-only modifications, loan payment deferrals, or extended amortization modifications. In accordance with interagency regulatory guidance and the CARES Act, qualifying loans modified in response to the COVID-19 pandemic are not considered troubled debt restructurings.
16
The following table presents a summary of active loan modifications made in response to the COVID-19 pandemic, by loan segment and modification type, as of September 30, 2021:
Interest-Only
Extended Amortization
# of Loans
320
4,764
5,084
638
CRE Nonowner Occupied
29,639
30,597
35,361
Note 5: Deposits
The following table presents the composition of deposits at September 30, 2021 and December 31, 2020:
Transaction Deposits
1,335,275
1,038,193
Savings and Money Market Deposits
791,861
657,617
Time Deposits
309,824
353,543
Brokered Deposits
417,197
452,283
Note 6: Notes Payable
On February 25, 2021, the Company’s $11,000 note payable matured and was paid off in full.
On March 1, 2021, the Company entered into a Loan and Security Agreement and related revolving note with an unaffiliated financial institution that was secured by 100% of the issued and outstanding stock of the Bank. The revolving line of credit is for a maximum principal amount of $25,000 and matures on February 28, 2023. Interest accrues on unpaid principal balances at a variable interest rate equal to the greater of the Wall Street Journal Prime Rate in effect or a floor rate of 3.85%. The Company is required to pay quarterly payments of interest on the unpaid principal balance. Principal payments may be made any time prior to the maturity date, on which date all unpaid principal and accrued interest are due and payable. The note contains customary representations, warranties, and covenants, including certain financial covenants and capital ratio requirements. As of September 30, 2021, the Company believes it was in compliance with all covenants. As of September 30, 2021, there were no outstanding balances under the revolving line of credit.
Note 7: Derivative Instruments and Hedging Activities
The Company uses derivative financial instruments, which consist of interest rate swaps and interest rate caps, to assist in its interest rate risk management. The notional amount does not represent amounts exchanged by the parties. The amount exchanged is determined by reference to the notional amount and the other terms of the individual agreements. Derivative financial instruments are reported at fair value in other assets or other liabilities. The accounting for changes in the fair value of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship. For derivatives not designated as hedges, the gain or loss is recognized in current earnings.
Non-hedge Derivatives
The Company enters into interest rate swaps to facilitate client transactions and meet their financing needs. Upon entering into these instruments to meet client needs, the Company enters into offsetting positions with large U.S. financial institutions in order to minimize the risk to the Company. These swaps are derivatives, but are not designated as hedging instruments.
17
Interest rate swap contracts involve the risk of dealing with counterparties and their ability to meet contractual terms. When the fair value of a derivative instrument contract is positive, this generally indicates that the counterparty or client owes the Company, and results in credit risk to the Company. When the fair value of a derivative instrument contract is negative, the Company owes the client or counterparty and therefore, the Company has no credit risk.
The following table presents a summary of the Company’s interest rate swaps to facilitate customer transactions as of September 30, 2021 and December 31, 2020:
Notional
Estimated
Interest Rate Swap Agreements:
Assets
49,252
654
49,696
2,701
Liabilities
(654)
(2,701)
98,504
99,392
Cash Flow Hedging Derivatives
For derivative instruments that are designated and qualify as a cash flow hedge, the aggregate fair value of the derivative instrument is recorded in other assets or other liabilities with any gain or loss related to changes in fair value recorded in accumulated other comprehensive income, net of tax. The gain or loss is reclassified into earnings in the same period during which the hedged asset or liability affects earnings and is presented in the same income statement line item as the earnings effect of the hedged asset or liability. The Company utilizes cash flow hedges to manage interest rate exposure for the brokered certificate of deposit, wholesale borrowing, and notes payable portfolios. During the next 12 months, the Company estimates that $1,455 will be reclassified to interest expense.
The following table presents a summary of the Company’s interest rate swaps designated as cash flow hedges as of September 30, 2021 and December 31, 2020:
Notional Amount
125,000
111,000
Weighted Average Pay Rate
1.27
%
1.26
Weighted Average Receive Rate
0.14
0.22
Weighted Average Maturity (Years)
4.02
3.95
Net Unrealized Loss
(683)
(3,410)
During 2020 and 2021, the Company purchased interest rate caps, designated as cash flow hedges, of certain deposit liabilities, with notional amounts totaling $95,000. The interest rate caps require receipt of variable amounts from the counterparties when interest rates rise above the strike price in the contracts. An initial premium of $2,689 was paid up front for the caps executed in 2020 and an initial premium of $2,465 was paid up front for caps executed in 2021. Amortization on the interest rate caps was $212 and was recorded as a component of interest expense on brokered deposits for the nine months ended September 30, 2021. At September 30, 2021, the weighted average strike price for outstanding interest rate caps was 0.89% and the weighted average maturity was 8.73 years.
The following table presents a summary of the Company’s interest rate contracts as of September 30, 2021 and December 31, 2020:
60,000
969
56
65,000
(1,652)
106,000
(3,466)
Interest Rate Cap Agreements:
95,000
6,693
50,000
2,834
The Company is party to collateral support agreements with certain derivative counterparties. These agreements require that the Company maintain collateral based on the fair values of derivative transactions. In the event of default by the Company, the counterparty would be entitled to the collateral. As of September 30, 2021 and December 31, 2020, the Company pledged cash collateral for the Company’s derivative contracts of $2,099 and $8,526, respectively. In addition, as of September 30, 2021 and December 31, 2020, the Company's interest rate cap counterparties have pledged cash collateral to the Company of $7,390 and $2,700, respectively.
The following table presents the effect of derivative instruments in cash flow hedging relationships on the consolidated statements of income for the three and nine months ended September 30, 2021 and 2020:
Derivatives in
Location of Loss
Loss
Cash Flow Hedging
Reclassified from
Relationships
AOCI into Income
AOCI into Earnings
Interest rate swaps
Interest expense
(290)
(241)
(827)
(313)
Interest rate caps
(116)
(252)
No amounts were reclassified from accumulated other comprehensive income into net income related to hedge ineffectiveness for these derivatives during the three and nine months ended September 30, 2021 and 2020, and no amounts are expected to be reclassified from accumulated other comprehensive income into net income related to hedge ineffectiveness over the next twelve months.
Note 8: Subordinated Debentures
On July 8, 2021, the Company entered into a Subordinated Note Purchase Agreement with certain institutional accredited investors and qualified institutional buyers pursuant to which the Company sold and issued $30,000 in aggregate principal amount of 3.25% Fixed-to-Floating Rate Subordinated Notes due 2031 (the “2031 Notes”). The 2031 Notes were issued by the Company to purchasers at a price equal to 100% of their face amount. Issuance costs were $665 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 optional redemption date of July 15, 2026. Total amortization expense for the three and nine months ended September 30, 2021 was $30, with $635 remaining to be amortized as of September 30, 2021.
The 2031 Notes mature on July 15, 2031, with a fixed rate of 3.25% payable semi-annually for five years to, but excluding July 15, 2026. Thereafter, the interest rate converts to a variable rate, reset quarterly, equal to the three-month term Secured Overnight Financing Rate, or SOFR, plus 252 basis points quarterly in arrears until either the early redemption date or the maturity date. The Notes are redeemable by the Company, in whole or in part, on or after July 15,
19
2026, 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 amount of the 2031 Notes being redeemed, including any accrued and unpaid interest thereon.
On June 19, 2020, the Company entered into a Subordinated Note Purchase Agreement with certain institutional accredited investors and qualified institutional buyers pursuant to which the Company sold and issued $50,000 in aggregate principal amount of 5.25% Fixed-to-Floating Rate Subordinated Notes due 2030 (the “2030 Notes”). The 2030 Notes were issued by the Company to purchasers at a price equal to 100% of their face amount. Issuance costs were $1,127 and have been netted against subordinated debt on the consolidated balance sheets. These costs are being amortized over five years, which represents the period from issuance to the first redemption date of July 1, 2025. Total amortization expense for the three and nine months ended September 30, 2021 was $61 and $183, respectively, with $914 remaining to be amortized as of September 30, 2021. On October 13, 2020, the Company completed an offer to exchange up to $50,000 total principal amount of the 2030 Notes for substantially identical subordinated notes registered under the Securities Act of 1933, in satisfaction of the Company’s obligations under a registration rights agreement entered into with the initial purchasers of the 2030 Notes. $47,000 of the $50,000 of the 2030 Notes were exchanged in the exchange offer.
The 2030 Notes mature on July 1, 2030, with a fixed rate of 5.25% payable semi-annually for five years until July 1, 2025. Thereafter, the interest rate converts to a variable interest rate, reset quarterly, equal to the three-month term SOFR, plus 513 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 1, 2025, and at any time upon the occurrence of certain events. Any redemption by the Company would be at a redemption price equal to 100% of the outstanding amount of the 2030 Notes being redeemed, including any accrued and unpaid interest thereon.
On July 12, 2017, the Company entered into a Subordinated Note Purchase Agreement with certain institutional accredited investors whereby the Company sold and issued $25,000 in aggregate principal amount of 5.875% Fixed-to-Floating Rate Subordinated Notes due 2027 (the “2027 Notes”). The 2027 Notes were issued by the Company to the purchasers at a price equal to 100% of their face amount. Issuance costs were $516 and have been netted against subordinated debt on the consolidated balance sheets. These costs are being amortized over five years, which represents the period from issuance to the first redemption date of July 15, 2022. The total amortization expense for the three and nine months ended September 30, 2021 was $65 and $116, respectively, with $47 remaining to be amortized as of September 30, 2021. In July of 2021, the Company redeemed $11,250 of the 2027 Notes. The early redemption of the subordinated debentures was recorded as a loss on the extinguishment of subordinated debt, included in noninterest expense, in the amount of $582, consisting of $532 in prepayment penalties and $50 in unamortized issuance costs.
The 2027 Notes mature on July 15, 2027, with a fixed interest rate of 5.875% payable semi-annually in arrears for five years until July 15, 2022. Thereafter, the Company will be obligated to pay interest at a rate equal to 3-month LIBOR plus 388 basis points quarterly in arrears until either the early redemption date or the maturity date. The 2027 Notes are not convertible into or exchangeable for any other securities or assets of the Company or any of its subsidiaries. The 2027 Notes are redeemable by the Company, in whole or in part, on or after July 15, 2022, and at any time upon the occurrence of certain events. Any redemption by the Company would be at a redemption price equal to 100% of the outstanding principal amount of the 2027 Notes being redeemed, including any accrued and unpaid interest thereon.
Note 9: Tax Credit Investments
The Company invests in qualified affordable housing projects and federal historic projects for the purpose of community reinvestment and obtaining tax credits. The Company’s tax credit investments are limited to existing lending relationships with well-known developers and projects within the Company’s market area.
20
The following table presents a summary of the Company’s investments in qualified affordable housing projects and other tax credit investments at September 30, 2021 and December 31, 2020:
Accounting Method
Unfunded Commitment (1)
Unfunded Commitment
Low Income Housing Tax Credit (LIHTC)
Proportional Amortization
2,941
1,867
Federal Historic Tax Credit (FHTC)
Equity
1,883
407
2,198
1,858
4,824
4,065
The following table presents a summary of the amortization expense and tax benefit recognized for the Company’s qualified affordable housing projects and other tax credit investments for the three and nine months ended September 30, 2021 and 2020:
Amortization Expense (1)
LIHTC
210
211
FHTC
152
146
410
592
222
620
803
Tax Benefit Recognized (2)
(83)
(248)
(156)
(220)
(469)
(837)
(239)
(303)
(717)
(1,085)
Note 10: Commitments, Contingencies and Credit Risk
Financial Instruments with Off-Balance Sheet Credit Risk
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.
The Company’s exposure to credit loss is represented by the contractual, or notional, amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance sheet instruments. Since some of the commitments are expected to expire without being drawn upon and some of the commitments may not be drawn upon to the total extent of the commitment, the notional amount of these commitments does not necessarily represent future cash requirements.
The following commitments were outstanding at September 30, 2021 and December 31, 2020:
Unfunded Commitments Under Lines of Credit
802,190
644,338
Letters of Credit
113,023
90,206
915,213
734,544
The Company had outstanding letters of credit with the FHLB in total amounts of $38,109 and $60,091 at September 30, 2021 and December 31, 2020, respectively, on behalf of customers and to secure public deposits.
Legal Contingencies
Neither the Company nor any of its subsidiaries is a party, and no property of these entities is subject, to any material pending legal proceedings, other than ordinary routine litigation incidental to the Bank’s business. The Company does not know of any proceeding contemplated by a governmental authority against the Company or any of its subsidiaries.
Note 11: Stock Options and Restricted Stock Awards
The Company established the Bridgewater Bancshares, Inc. 2012 Combined Incentive and Non-Statutory Stock Option Plan (the “2012 Plan”) under which the Company may grant options to its directors, officers, and employees for up to 750,000 shares of common stock. Both incentive stock options and nonqualified stock options may be granted under the 2012 Plan. The exercise price of each option equals the fair market value of the Company’s stock on the date of grant and the maximum term of each outstanding option is ten years. All outstanding options have been granted with vesting periods of five years. As of September 30, 2021 and December 31, 2020, there were 30,000 shares of the Company’s common stock reserved for future option grants under the 2012 Plan.
In 2017, the Company adopted the Bridgewater Bancshares, Inc. 2017 Combined Incentive and Non-Statutory Stock Option Plan (the “2017 Plan”). Under the 2017 Plan, the Company may grant options to its directors, officers, employees and consultants for up to 1,500,000 shares of common stock. Both incentive stock options and nonqualified stock options may be granted under the 2017 Plan. The exercise price of each option equals the fair market value of the Company’s stock on the date of grant and the maximum term of each outstanding option is ten years. All outstanding options have been granted with vesting periods of four or five years. As of September 30, 2021 and December 31, 2020, there were 294,700 and 313,600 of remaining shares of the Company’s common stock reserved for future option grants under the 2017 Plan.
In 2019, the Company adopted the Bridgewater Bancshares, Inc. 2019 Equity Incentive Plan (the “2019 EIP”). The types of awards which may be granted under the 2019 EIP include incentive and nonqualified stock options, stock appreciation rights, stock awards, restricted stock units, restricted stock and cash incentive awards. The Company may grant these awards to its directors, officers, employees and certain other service providers for up to 1,000,000 shares of common stock. The exercise price of each option equals the fair market value of the Company’s stock on the date of grant and the maximum term of each award is ten years. All outstanding awards have been granted with a vesting period of four years. As of September 30, 2021 and December 31, 2020, there were 526,955 and 561,883 of remaining shares of the Company’s common stock reserved for future grants under the 2019 EIP.
Stock Options
The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the assumptions noted in the table below. Expected volatilities are based on an industry index as described below. The expected term of options granted is based on historical data and represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the
22
time of grant. Historically, the Company has not paid a dividend on its common stock and does not expect to do so in the near future.
The Company used the S&P 600 CM Bank Index as its historical volatility index. The S&P 600 CM Bank Index is an index of publicly traded small capitalization, regional, commercial banks located throughout the United States. There were 51 banks in the index ranging in market capitalization from $500 million up to $4.0 billion.
The weighted average assumptions used in the model of valuing stock option grants for the nine months ended September 30, 2021, are as follows:
Dividend Yield
Expected Life
Years
Expected Volatility
29.93
Risk-Free Interest Rate
The following table presents a summary of the status of the Company’s stock option grants for the nine months ended September 30, 2021:
Weighted
Exercise Price
Outstanding at Beginning of Year
1,914,250
7.29
Granted
20,500
16.88
Exercised
(52,400)
4.64
Forfeitures
(1,600)
7.47
Outstanding at Period End
1,880,750
Options Exercisable at Period End
1,193,950
6.21
For the three months ended September 30, 2021 and 2020, the Company recognized compensation expense for stock options of $234 and $205, respectively. For the nine months ended September 30, 2021 and 2020, the Company recognized compensation expense for stock options of $686 and $653, respectively.
The following table presents information pertaining to options outstanding at September 30, 2021:
Options Outstanding
Options Exercisable
Weighted Average
Number of
Remaining Contractual
Range of Exercise Prices
Options
Life in Years
2.13 - 3.99
486,500
2.99
2.3
7.00 - 7.99
962,200
6.0
571,400
8.00 - 8.99
20,000
8.76
8.5
1,250
10.00 - 10.99
10,000
10.08
8.7
2,500
11.00 - 11.99
85,000
11.27
7.6
34,000
12.00 - 12.99
271,550
12.90
7.9
83,300
13.00 - 13.99
25,000
13.22
6.6
15,000
16.00 - 16.99
16.23
9.6
17.00 - 17.99
10,500
17.49
9.7
5.5
As of September 30, 2021, there was $1,453 of total unrecognized compensation cost related to nonvested stock options granted under the 2012 Plan, 2017 Plan and 2019 EIP that is expected to be recognized over a weighted-average period of 1.9 years.
The following table presents an analysis of nonvested options to purchase shares of the Company’s stock issued and outstanding for the nine months ended September 30, 2021:
Average Grant
Date Fair Value
Nonvested Options at December 31, 2020
708,900
3.24
5.66
Vested
(41,000)
3.83
Forfeited
Nonvested Options at September 30, 2021
686,800
3.27
Restricted Stock Awards
In 2019 and 2020, the Company granted restricted stock awards out of the 2019 EIP. These awards vest in equal annual installments on the first four anniversaries of the date of the grant. Nonvested restricted stock awards are classified as outstanding shares with forfeitable voting and dividend rights.
The following table presents an analysis of nonvested restricted stock awards outstanding for the nine months ended September 30, 2021:
Nonvested Awards at December 31, 2020
110,962
12.63
(2,784)
10.32
Nonvested Awards at September 30, 2021
108,178
12.69
Compensation expense associated with the restricted stock awards is recognized on a straight-line basis over the period that the restrictions associated with the awards lapse based on the total cost of the award at the grant date. For the three months ended September 30, 2021 and 2020, the Company recognized compensation expense for restricted stock awards of $115 and $109, respectively. For the nine months ended September 30, 2021 and 2020, the Company recognized compensation expense for restricted stock awards of $340 and $330, respectively.
As of September 30, 2021, there was $1,009 of total unrecognized compensation cost related to nonvested restricted stock awards granted under the 2019 EIP that is expected to be recognized over a weighted-average period of 2.2 years.
In addition, during the nine months ended September 30, 2021, the Company issued 14,408 shares of unrestricted common stock to directors as a part of their compensation for their annual services on the Company’s board of directors. The aggregate value of the shares issued to directors of $239 was included in stock based compensation expense in the accompanying consolidated statements of shareholders’ equity.
Restricted Stock Units
In 2020, the Company granted restricted stock units out of the 2019 EIP. Restricted stock units granted out of the 2019 EIP represent the right to receive one share of Company stock upon vesting and vest in equal annual
24
installments on the first four anniversaries of the date of the grant. Nonvested restricted stock units have no voting or dividend rights and are not considered outstanding until vesting.
The following table presents an analysis of nonvested restricted stock units outstanding for the nine months ended September 30, 2021:
Units
Nonvested Units at December 31, 2020
205,666
12.27
21,600
15.70
(1,080)
Nonvested Units at September 30, 2021
226,186
12.60
Compensation expense associated with the restricted stock units is recognized on a straight-line basis over the period that the restrictions associated with the units lapse based on the total cost of the unit at the grant date. For the three months ended September 30, 2021 and 2020, the Company recognized compensation expense for restricted stock units of $179 and $109, respectively. For the nine months ended September 30, 2021 and 2020, the Company recognized compensation expense for restricted stock units of $499 and $330, respectively.
As of September 30, 2021, there was $2,307 of total unrecognized compensation cost related to nonvested restricted stock units granted under the 2019 EIP that is expected to be recognized over a weighted-average period of 3.2 years. As of September 30, 2021, no restricted stock units had vested.
Note 12: Preferred Stock
On August 17, 2021, the Company announced the closing of its underwritten public offering of 2,400,000 depositary shares, each representing a 1/100th interest in a share of the Company’s 5.875% Non-Cumulative Perpetual Preferred Stock, Series A, $0.01 par value per share (“Series A Preferred Stock”). On August 20, 2021, the underwriters of the offering exercised in full their option to purchase 360,000 additional depositary shares to cover over-allotments. As a result, the gross proceeds from the offering totaled $69,000. Dividends on the Series A Preferred Stock will be non-cumulative and, if declared, accrue and are payable quarterly, in arrears, at a rate of 5.875% per annum. The Series A Preferred Stock qualifies as Tier 1 capital for the purposes of the regulatory capital calculations. The net proceeds from the issuance and sale of the Series A Preferred Stock, after deducting $2,485 of issuance costs, including the underwriting discount and professional service fees, were $66,515.
Note 13: Regulatory Capital
The Company and the Bank are subject to various regulatory requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank must also meet certain specific capital guidelines under the regulatory framework for prompt corrective action. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios of common equity Tier 1 capital, Tier 1 capital and total capital to risk-weighted
25
assets and of Tier 1 capital to average consolidated assets (referred to as the “leverage ratio”), as defined under the applicable regulatory capital rules.
The following tables present the capital amounts and ratios for the Company and the Bank as of September 30, 2021 and December 31, 2020:
Minimum Required
For Capital Adequacy
To be Well Capitalized
Purposes Plus Capital
Under Prompt Corrective
Actual
Purposes
Conservation Buffer
Action Regulations
Ratio
Company (Consolidated):
Total Risk-Based Capital
485,377
15.93
243,787
8.00
319,970
10.50
N/A
Tier 1 Risk-Based Capital
355,118
11.65
182,840
6.00
259,023
8.50
Common Equity Tier 1 Capital
288,603
9.47
137,130
4.50
213,313
7.00
Tier 1 Leverage Ratio
10.70
132,757
4.00
Bank:
399,889
13.13
243,656
319,798
304,569
10.00
361,803
11.88
182,742
258,884
137,056
213,199
197,970
6.50
10.96
132,066
165,083
5.00
360,198
14.58
197,604
259,355
255,530
10.35
148,203
209,954
111,152
172,904
9.28
110,168
330,380
13.37
197,629
259,388
247,036
299,447
12.12
148,222
209,981
111,166
172,925
160,574
10.89
109,972
137,465
The Company and the Bank must maintain a capital conservation buffer, as defined by Basel III regulatory capital guidelines, in order to avoid limitations on capital distributions, including dividend payments, stock repurchases and certain discretionary bonus payments to executive officers.
Note 14: Fair Value Measurement
The Company categorizes its assets and liabilities measured at fair value into a three-level hierarchy based on the priority of the inputs to the valuation technique used to determine fair value. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used in the determination of the fair value measurement fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value
26
measurement. Assets and liabilities valued at fair value are categorized based on the inputs to the valuation techniques as follows:
Level 1 – Inputs that utilized quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.
Level 2 – Inputs that include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instruments. Fair values for these instruments are estimated using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows.
Level 3 – Inputs that are unobservable for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity.
Subsequent to initial recognition, the Company may re-measure the carrying value of assets and liabilities measured on a nonrecurring basis to fair value. Adjustments to fair value usually result when certain assets are impaired. Such assets are written down from their carrying amounts to their fair value.
Professional standards allow entities the irrevocable option to elect to measure certain financial instruments and other items at fair value for the initial and subsequent measurement on an instrument-by-instrument basis. The Company adopted the policy to value certain financial instruments at fair value. The Company has not elected to measure any existing financial instruments at fair value; however, it may elect to measure newly acquired financial instruments at fair value in the future.
Recurring Basis
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The following tables present the balances of the assets and liabilities measured at fair value on a recurring basis as of September 30, 2021 and December 31, 2020:
Level 1
Level 2
Level 3
Fair Value of Financial Assets:
Interest Rate Caps
Interest Rate Swaps
1,623
Total Fair Value of Financial Assets
420,457
421,465
Fair Value of Financial Liabilities:
2,306
Total Fair Value of Financial Liabilities
2,757
396,220
6,167
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.
The fair value of the caps is calculated by determining the total expected asset or liability exposure of the derivatives. Total expected exposure incorporates both the current and potential future exposure of the derivative, derived from using observable inputs, such as yield curves and volatilities, and accordingly are valued using Level 2 inputs.
Interest rate swaps 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.
28
The following tables present net impairment losses related to nonrecurring fair value measurements of certain assets at September 30, 2021 and December 31, 2020:
Impaired Loans
887
284
80
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.
29
The following tables present the carrying amount and estimated fair values of financial instruments at September 30, 2021 and December 31, 2020:
Fair Value Hierarchy
Carrying
Financial Assets:
Cash and Due From Banks
1,896
Securities Available for Sale
412,141
FHLB Stock, at Cost
Loans, Net
2,643,925
Accrued Interest Receivable
Financial Liabilities:
2,819,393
47,941
98,092
2,908
2,309,421
2,509,148
11,001
58,830
74,769
The following methods and assumptions were used by the Company to estimate fair value of consolidated financial statements not previously discussed.
Cash and due from banks – The carrying amount of cash and cash equivalents approximates their fair value.
Bank-owned certificates of deposit – Fair values of bank-owned certificates of deposit are estimated using the discounted cash flow analysis based on current rates for similar types of deposits.
FHLB stock – The carrying amount of FHLB stock approximates its fair value.
Loans, Net – Fair values for loans are estimated based on discounted cash flows, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality.
Accrued interest receivable – The carrying amount of accrued interest receivable approximates its fair value since it is short term in nature and does not present anticipated credit concerns.
Deposits – The fair values disclosed for demand deposits without stated maturities (interest and noninterest transaction, savings, and money market accounts) are equal to the amount payable on demand at the reporting date (their carrying amounts). Fair values for the fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Federal funds purchased – The carrying amount of federal funds purchased approximates the fair value.
Notes payable and subordinated debentures – The fair values of the Company’s notes payable and subordinated debt are estimated using a discounted cash flow analysis, based on the Company’s current incremental borrowing rate for similar types of borrowing arrangements.
FHLB advances – The fair values of the Company’s FHLB advances are estimated using discounted cash flow analysis based on the Company’s current incremental borrowing rates for similar types of borrowing agreements.
Accrued interest payable – The carrying amount of accrued interest payable approximates its fair value since it is short term in nature.
Off-balance sheet instruments – Fair values of the Company’s off-balance sheet instruments (lending commitments and unused lines of credit) are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the counterparties’ credit standing and discounted cash flow analysis. The fair value of these off-balance-sheet items approximates the recorded amounts of the related fees and was not material at September 30, 2021 and December 31, 2020.
Limitations – The fair value of a financial instrument is the current amount that would be exchanged between market participants, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Consequently, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.
Note 15: Subsequent Events
On October 26, 2021, the Company’s Board of Directors declared a quarterly cash dividend of $42.43 per share ($0.4243 per depositary share) on the Series A Preferred Stock, payable on December 1, 2021, to shareholders of record on the Series A Preferred Stock at the close of business on November 15, 2021.
On November 5, 2021, the Company expects to complete an offer to exchange up to $30,000 total principal amount of the 2031 Notes for substantially identical subordinated notes registered under the Securities Act of 1933, in satisfaction of the Company’s obligations under a registration rights agreement entered into with the initial purchasers of the 2031 Notes.
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, 2021. Annualized results for these interim periods may not be indicative of results for the full year or future periods. The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes presented elsewhere in this report and the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, filed with the Securities and Exchange Commission, or the SEC, on March 11, 2021.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, statements concerning plans, estimates, calculations, forecasts and projections with respect to the anticipated future performance of the Company. These statements are often, but not always, identified by words such as “may”, “might”, “should”, “could”, “predict”, “potential”, “believe”, “expect”, “continue”, “will”, “anticipate”, “seek”, “estimate”, “intend”, “plan”, “projection”, “would”, “annualized”, “target” and “outlook”, or the negative version of those words or other comparable words of a future or forward-looking nature. Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Our actual results and financial condition may differ materially from those indicated in the forward-looking statements. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:
The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this report. In addition, past results of operations are not necessarily indicative of future results. Any forward-looking statement made by us in this report is based only on information currently available to us and speaks only as of the date on which it is made. We undertake no obligation to publicly update any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future developments or otherwise.
Overview
The Company is a financial holding company headquartered in St. Louis Park, Minnesota. The principal sources of funds for loans and investments are transaction, savings, time, and other deposits, and short-term and long-term borrowings. The Company’s principal sources of income are interest and fees collected on loans, interest and dividends earned on investment securities and service charges. The Company’s principal expenses are interest paid on deposit accounts and borrowings, employee compensation and other overhead expenses. The Company’s simple, efficient business model of providing responsive support and unconventional experiences to clients continues to be the underlying principle that drives the Company’s profitable growth.
Information Regarding COVID-19 Impact
Financial Position and Results of Operations. The novel coronavirus, or COVID-19, pandemic has continued to create uncertainty and extraordinary change for the Company, its clients, its communities and the country as a whole. Vaccines have been rolled out nationwide, however the situation remains fluid and management cannot estimate the duration and full impact of the COVID-19 pandemic on the economy, financial markets and the Company’s financial condition and results of operations.
Effects on the Company’s Market Area. The Company’s primary banking market area is the Minneapolis-St. Paul-Bloomington, MN-WI Metropolitan Statistical Area. Minnesota continues to return to pre-pandemic levels of activity as vaccines are readily available.
Active Management of Credit Risk. The Company has modified its internal policies to increase oversight and analysis of all credits, especially in vulnerable industries such as hospitality and restaurants, to proactively monitor evolving credit risk. The Company has not yet experienced charge-offs related to the COVID-19 pandemic, but the continued uncertainty regarding the severity and duration of the pandemic and related economic effects has and will
continue to affect the Company’s estimate of its allowance for loan losses and resulting provision for loan losses. The Company will continue to monitor credits closely while working with clients to provide relief when appropriate.
COVID-19 Related Loan Modifications and PPP Lending. The Company developed programs for clients who experienced business and personal disruptions due to the COVID-19 pandemic by providing interest-only modifications, loan payment deferrals, and extended amortization modifications. In accordance with regulatory guidance and the CARES Act, qualifying loans modified in response to the COVID-19 pandemic are not considered TDRs. The Company had 13 modified loans totaling $35.4 million outstanding as of September 30, 2021, representing 1.3% of the total loan portfolio, excluding PPP loans.
In a further effort to assist both existing and new clients, the Company participated in both the first and second rounds of the SBA’s PPP, which stemmed from the CARES Act that was signed into law on March 27, 2020, and reopened as authorized by the Economic Aid to Hard-Hit Small Businesses, Non-Profits, and Venues Act, or Economic Aid Act, which was signed into law on December 27, 2020. As of September 30, 2021, $6.7 million of round one PPP loans and $47.5 million of round two PPP loans remained outstanding for total outstanding PPP principal balances of $54.2 million. The Company recognized $1.6 million and $4.5 million of net origination fees associated with the program during the three and nine months ended September 30, 2021, respectively.
Processes, Controls, and Business Continuity. As of September 30, 2021, all seven Bank branches were open and fully operational and employees have returned to the office. Despite the recent easing of many federal, state and local government guidelines regarding COVID-19, the Company continues to take precautions to keep employees and clients safe, including providing masks and hand sanitizer, increasing cleaning efforts and requiring employees with COVID-19 symptoms to quarantine away from the office. In addition, the Company will continue to leverage its investments in technology, digital platforms, and electronic banking to allow clients and employees to communicate and transact with minimal interruption. Additional information about the Company’s COVID-19 pandemic assistance programs, including relevant disclosures and up-to-date information, is maintained at bridgewaterbankmn.com.
Critical Accounting Policies and Estimates
The consolidated financial statements of the Company are prepared based on the application of certain accounting policies, the most significant of which are described in Note 1 of the notes to the consolidated financial statements included as a part of the Company’s Annual Report on Form 10-K. Certain policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or subject to variation and may significantly affect the reported results and financial position for the current period or in future periods. The use of estimates, assumptions, and judgments are necessary when financial assets and liabilities are required to be recorded or adjusted to reflect fair value. Assets carried at fair value inherently result in more financial statement volatility. Fair values and information used to record valuation adjustments for certain assets and liabilities are based on either quoted market prices or are provided by other independent third-party sources, when available. When such information is not available, management estimates valuation adjustments. Changes in underlying factors, assumptions or estimates in any of these areas could have a material impact on the future financial condition and results of operations of the Company. Management has discussed each critical accounting policy and the methodology for the identification and determination of critical accounting policies with the Company's Audit Committee.
The JOBS Act permits the Company an extended transition period for complying with new or revised accounting standards affecting public companies. The Company has elected to take advantage of this extended transition period, which means that the financial statements included in this report, as well as any financial statements filed in the future, will not be subject to all new or revised accounting standards generally applicable to public companies for the transition period for so long as the Company remains an emerging growth company or until the Company affirmatively and irrevocably opts out of the extended transition period under the JOBS Act.
The following is a discussion of the critical accounting policies and significant estimates that require the Company to make complex and subjective judgements.
The allowance for loan losses, sometimes referred to as the “allowance,” is established through a provision for loan losses which is charged to expense. Loan losses are charged against the allowance when management determines all or a portion of the loan balance to be uncollectible. Subsequent recoveries, if any, are credited to the allowance for cash received on previously charged-off amounts. If the allowance is considered inadequate to absorb future loan losses on existing loans for any reason, including but not limited to, increases in the size of the loan portfolio, increases in charge-offs or changes in the risk characteristics of the loan portfolio, then the provision for loan losses is increased.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the original contractual terms of the loan agreement. The collection of all amounts due according to original contractual terms means that both the contractual interest and principal payments of a loan will be collected as scheduled in the loan agreement. An impaired loan is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or, as a practical expedient, at the loan’s observable market price, or the fair value of the underlying collateral, reduced by costs to sell on a discounted basis, is used if a loan is collateral dependent.
Investment Securities Impairment
Periodically, the Company may need to assess whether there have been any events or economic circumstances to indicate that a security on which there is an unrealized loss is impaired on an other than temporary basis. In any such instance, the Company would consider many factors, including the length of time and the extent to which the fair value has been less than the amortized cost basis, the market liquidity for the security, the financial condition and the near-term prospects of the issuer, expected cash flows, and the intent and ability to hold the investment for a period of time sufficient to recover the temporary loss. Securities on which there is an unrealized loss that is deemed to be other than temporary are written down to fair value, with the write-down recorded as a realized loss in securities gains (losses).
The fair values of investment securities are generally determined by various pricing models. The Company evaluates the methodologies used to develop the resulting fair values. The Company performs a semi-annual analysis on the pricing of investment securities to ensure that the prices represent reasonable estimates of fair value. The procedures include initial and ongoing reviews of pricing methodologies and trends. The Company seeks to ensure prices represent reasonable estimates of fair value through the use of broker quotes, current sales transactions from the portfolio and pricing techniques, which are based on the net present value of future expected cash flows discounted at a rate of return market participants would require. As a result of this analysis, if the Company determines there is a more appropriate fair value, the price is adjusted accordingly.
Fair Value of Financial Instruments
The fair value of a financial instrument is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts business. A framework has been established for measuring the fair value of financial instruments that considers the attributes specific to particular assets or liabilities and includes a three-level hierarchy for determining fair value based on the transparency of inputs to each valuation as of the measurement date. The Company estimates the fair value of financial instruments using a variety of valuation methods. When financial instruments are actively traded and have quoted market prices, quoted market prices are used for fair value and are classified as Level 1. When financial instruments, such as investment securities and derivatives, are not actively traded, the Company determines fair value based on various sources and may apply matrix pricing with observable prices for similar instruments where a price for the identical instrument is not observable. The fair values of these financial instruments, which are classified as Level 2, are determined by pricing models that consider observable market data such as interest rate volatilities, yield curve, credit spreads, prices from external market data providers and/or nonbinding broker-dealer quotations. When observable inputs do not exist, the Company estimates fair value based on available market data, and these values are classified as Level 3. Imprecision in estimating fair values can impact the carrying value of assets and liabilities and the amount of revenue or loss recorded.
35
Deferred Tax Asset
The Company uses the asset and liability method of accounting for income taxes as prescribed by GAAP. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. If currently available information indicates it is “more likely than not” that the deferred tax asset will not be realized, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Accounting for deferred income taxes is a critical accounting estimate because the Company exercises significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. Management’s determination of the realization of deferred tax assets is based upon management’s judgment of various future events and uncertainties, including the timing and amount of future income, reversing temporary differences which may offset, and the implementation of various tax plans to maximize realization of the deferred tax asset. These judgments and estimates are inherently subjective and reviewed on a continual basis as regulatory and business factors change. Any reduction in estimated future taxable income may require the Company to record a valuation allowance against the deferred tax assets. A valuation allowance would result in additional income tax expense in such period, which would negatively affect earnings.
36
Operating Results Overview
The following table summarizes certain key financial results for the periods indicated:
As of and for the Three Months Ended
June 30,
March 31,
Per Common Share Data
Basic Earnings Per Share
0.39
0.38
0.18
Diluted Earnings Per Share
0.37
0.17
Adjusted Diluted Earnings Per Common Share (1)
0.32
Book Value Per Share
10.73
10.33
9.92
9.43
9.25
Tangible Book Value Per Share (1)
10.62
10.22
9.80
9.31
9.13
Basic Weighted Average Shares Outstanding
28,040,762
28,017,366
28,179,768
Diluted Weighted Average Shares Outstanding
29,128,181
28,945,212
28,823,384
Shares Outstanding at Period End
28,132,929
Selected Performance Ratios
Return on Average Assets (Annualized)
1.37
1.43
1.47
0.70
1.05
Pre-Provision Net Revenue Return on Average Assets (Annualized) (1)
2.09
2.07
2.15
2.30
1.94
Return on Average Shareholders' Equity (Annualized)
13.81
15.40
15.87
7.45
10.84
Return on Average Tangible Common Equity (Annualized) (1)
15.47
15.58
16.06
7.55
10.98
Average Shareholders' Equity to Average Assets
9.44
9.71
Yield on Interest Earning Assets
4.14
4.17
4.31
4.46
4.30
Yield on Total Loans, Gross
4.65
4.56
4.74
4.89
4.73
Cost of Interest Bearing Liabilities
0.88
0.96
1.04
1.24
1.50
Cost of Total Deposits
0.48
0.54
0.59
0.69
0.87
Net Interest Margin (2)
3.54
3.52
3.60
3.61
3.28
Core Net Interest Margin (1)(2)
3.22
3.31
3.34
3.29
3.14
Efficiency Ratio (1)
43.9
42.0
41.2
59.0
42.3
Adjusted Efficiency Ratio (1)
41.5
40.7
36.6
41.7
Noninterest Expense to Average Assets (Annualized)
1.58
1.51
2.16
1.42
Adjusted Noninterest Expense to Average Assets (Annualized) (1)
1.49
1.48
1.34
1.40
Loan to Deposit Ratio
95.0
95.3
91.9
93.0
99.4
Core Deposits to Total Deposits (3)
83.3
81.2
83.5
78.1
77.1
Tangible Common Equity to Tangible Assets (1)
8.81
9.10
8.99
8.96
9.46
Selected Financial Data
The following tables summarize certain selected financial data as of and for the periods indicated:
Selected Balance Sheet Data
3,162,612
3,072,359
2,774,564
2,594,186
2,426,123
2,259,228
35,987
Goodwill and Other Intangibles
3,153
3,200
3,248
3,296
3,344
2,720,906
2,638,654
2,273,044
Tangible Common Equity (1)
298,135
287,630
275,923
262,109
262,088
279,171
Average Total Assets - Quarter-to-Date
3,332,301
3,076,712
2,940,262
2,816,032
2,711,755
Average Shareholders' Equity - Quarter-to-Date
330,604
286,311
272,729
265,716
263,195
For the Three Months Ended
Selected Income Statement Data
Interest Income
31,147
30,440
30,699
Interest Expense
4,859
5,045
5,858
Net Interest Income
26,288
25,395
24,841
1,600
1,100
3,900
Net Interest Income after Provision for Loan Losses
24,688
24,295
20,941
Noninterest Income
1,603
986
Noninterest Expense
11,477
10,923
15,258
Income Before Income Taxes
14,814
14,380
6,669
3,821
1,690
10,993
10,671
4,979
38
Discussion and Analysis of Results of Operations
Net income was $11.5 million for the third quarter of 2021, a 60.4% increase compared to net income of $7.2 million for the third quarter of 2020. Net income per diluted common share for the third quarter of 2021 was $0.40, a 60.8% increase compared to $0.25 per diluted common share for the third quarter of 2020. Net income was $33.2 million for the nine months ended September 30, 2021, a 49.3% increase compared to net income of $22.2 million for the nine months ended September 30, 2020. Net income per diluted common share for the nine months ended September 30, 2021 was $1.14, a 50.5% increase compared to $0.76 per diluted common share for the nine months ended September 30, 2020.
The Company’s primary source of revenue is net interest income, which is impacted by the level of interest earning assets and related funding sources, as well as changes in the level of interest rates. The difference between the average yield on earning assets and the average rate paid for interest bearing liabilities is the net interest spread. Noninterest bearing sources of funds, such as demand deposits and shareholders’ equity, also support earning assets. The impact of the noninterest bearing sources of funds is captured in the net interest margin, which is calculated as net interest income divided by average earning assets. Both the net interest margin and net interest spread are presented on a tax-equivalent basis, which means that tax-free interest income has been adjusted to pretax-equivalent income, assuming a 21% federal tax rate. Management’s ability to respond to changes in interest rates by using effective asset-liability management techniques is critical to maintaining the stability of the net interest margin and the momentum of the Company’s primary source of earnings. In response to the COVID-19 pandemic, the Federal Open Market Committee, or FOMC, decreased the targeted federal funds rate by a total of 150 basis points in March 2020. This decrease may impact the comparability of year-to-date net interest income between 2021 and 2020.
39
Average Balances and Yields
The following tables present, for the three and nine months ended September 30, 2021 and 2020, the average balances of each principal category of assets, liabilities and shareholders’ equity, and an analysis of net interest income. The average balances are principally daily averages and, for loans, include both performing and nonperforming balances. Interest income on loans includes the effects of net deferred loan origination fees and costs accounted for as yield adjustments. These tables are presented on a tax-equivalent basis, if applicable.
September 30, 2020
Yield/
& Fees
Rate
Interest Earning Assets:
Cash Investments
187,405
67
101,787
42
0.16
Investment Securities:
Taxable Investment Securities
314,367
1,751
2.21
256,808
1,389
Tax-Exempt Investment Securities (1)
71,801
737
4.07
82,579
900
4.33
Total Investment Securities
386,168
2,488
2.56
339,387
2,289
2.68
Paycheck Protection Program Loans (2)
76,006
1,753
9.15
181,397
1,173
2.57
Loans (1)(2)
2,579,021
29,348
4.51
2,025,410
25,081
4.93
Total Loans
2,655,027
31,101
2,206,807
26,254
Federal Home Loan Bank Stock
5,701
7,901
127
6.38
Total Interest Earning Assets
3,234,301
33,724
2,655,882
28,712
Noninterest Earning Assets
98,000
55,873
Interest Bearing Liabilities:
Interest Bearing Transaction Deposits
479,580
562
0.47
306,162
400
0.52
801,354
904
0.45
501,246
1,106
318,222
928
1.16
369,975
1,899
2.04
440,167
1,023
0.92
419,744
1,435
1.36
Total Interest Bearing Deposits
2,039,323
0.66
1,597,127
1.21
0.33
11,500
3.74
54,130
1.56
129,457
91,337
5.27
73,649
6.04
Total Interest Bearing Liabilities
2,184,790
1,811,885
Noninterest Bearing Liabilities:
Noninterest Bearing Transaction Deposits
784,148
615,214
Other Noninterest Bearing Liabilities
32,759
21,461
Total Noninterest Bearing Liabilities
816,907
636,675
Shareholders' Equity
Total Liabilities and Shareholders' Equity
Net Interest Income / Interest Rate Spread
28,880
3.26
21,898
2.80
Net Interest Margin (3)
Taxable Equivalent Adjustment:
Tax-Exempt Investment Securities and Loans
(219)
For the Nine Months Ended
127,283
80,186
0.23
310,078
5,122
216,332
4,080
2.52
76,564
2,460
89,674
2,920
4.35
386,642
7,582
2.62
306,006
7,000
3.06
124,466
5,384
5.78
107,541
2,046
2.54
2,402,844
82,433
4.59
1,997,553
75,301
5.04
2,527,310
87,817
2,105,094
77,347
4.91
5,658
4.71
9,541
352
3,046,893
95,733
4.20
2,500,827
84,837
4.53
70,968
50,118
3,117,861
2,550,945
422,000
1,504
275,303
1,207
0.58
763,646
2,853
0.50
518,648
4,338
1.12
331,664
3,269
1.32
378,133
6,199
2.19
407,680
2,975
0.98
319,615
3,990
1.67
1,924,990
0.74
1,491,699
1.41
3,311
0.24
8,302
1.73
2,216
3.66
12,000
3.72
56,364
1.59
165,088
79,723
5.72
43,318
6.14
2,066,604
0.95
1,720,407
1.63
731,269
554,513
23,228
19,632
754,497
574,145
296,760
256,393
80,985
3.25
63,833
2.90
3.55
3.41
(629)
(710)
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 present 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
41
volume by the previous period’s average rate. Similarly, the effect of rate changes is calculated by multiplying the change in average rate by the previous period’s volume. The changes not attributable specifically to either volume or rate have been allocated to the changes due to volume. The following tables present the changes in the volume and rate of interest bearing assets and liabilities for the three months ended September 30, 2021, compared to the three months ended September 30, 2020, and for the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020.
Compared with
Change Due To:
Volume
Variance
325
362
Tax-Exempt Investment Securities
(110)
(53)
(163)
Total Securities
215
199
Loans:
Paycheck Protection Program Loans
(2,427)
3,007
580
Loans
6,368
(2,101)
4,267
3,941
906
4,847
(25)
(34)
(59)
4,161
851
5,012
202
(40)
341
(543)
(202)
(146)
(825)
(971)
52
(464)
(412)
449
(1,872)
(1,423)
(108)
(295)
(240)
(535)
198
(102)
96
244
(2,214)
(1,970)
3,917
3,065
6,982
49
(4)
1,545
(503)
1,042
(425)
(35)
(460)
1,120
(538)
582
730
2,608
3,338
13,835
(6,703)
7,132
14,565
(4,095)
10,470
(136)
(152)
15,598
(4,702)
10,896
520
(223)
297
911
(2,396)
(1,485)
(2,466)
(2,930)
639
(1,654)
(1,015)
1,606
(6,739)
(5,133)
(8)
(93)
(101)
(267)
(273)
(1,293)
(877)
(2,170)
1,528
(107)
1,421
(7,822)
(6,256)
14,032
3,120
17,152
Comparison of Interest Income, Interest Expense, and Net Interest Margin
Third Quarter of 2021 Compared to Third Quarter of 2020
Net interest income was $28.7 million for the third quarter of 2021, an increase of $7.0 million, or 32.3%, compared to $21.7 million for the third quarter of 2020. The increase in net interest income was primarily due to robust growth in average interest earning assets, lower rates paid on deposits, and the recognition of PPP loan origination fees, offset partially by declining yields on loans. The increase in average interest earning assets was primarily due to increased cash balances, continued purchases of investment securities, and strong organic growth in the loan portfolio, offset partially by the payoff of PPP loans.
Net interest margin (on a fully tax-equivalent basis) for the third quarter of 2021 was 3.54%, a 26 basis point increase from 3.28% in the third quarter of 2020. Core net interest margin (on a fully tax-equivalent basis), a non-GAAP financial measure which excludes the impact of loan fees and PPP balances, interest, and fees, for the third quarter of 2021 was 3.22%, an 8 basis point increase from 3.14% in the third quarter of 2020. The expansion of core net interest margin, a non-GAAP financial measure, was primarily due to the repricing of deposits and the early extinguishment of higher priced FHLB advances, offset partially by a decline in the core loan yield.
While the origination volume of PPP loans earning 1.00% has negatively impacted net interest margin, the recognition of fees associated with the originations has benefited net interest margin for each of the past four quarters. The SBA has been forgiving PPP loans, which accelerated the recognition of PPP fees starting in the fourth quarter of 2020 and continuing into the third quarter of 2021. The Company recognized $1.6 million of PPP origination fees during the third quarter of 2021, compared to $716,000 during the third quarter of 2020. The elevated fee recognition is illustrated in the 9.15% PPP loan yield for the third quarter of 2021, compared to 2.57% for the third quarter of 2020.
43
The following table summarizes PPP loan originations and net origination fees through September 30, 2021:
Originated
Outstanding
Program Lifetime
Number
Net Origination
of Loans
Fees Generated
Fees Earned
Round One PPP Loans
181,600
6,715
5,706
5,624
Round Two PPP Loans
651
78,386
301
47,475
3,544
1,769
1,851
259,986
373
9,250
7,393
Average interest earning assets for the third quarter of 2021 increased $578.4 million, or 21.8%, to $3.23 billion, from $2.66 billion for the third quarter of 2020. This increase in average interest earning assets was primarily due to increased cash balances, continued purchases of investment securities, and strong organic growth in the loan portfolio, offset partially by the payoff of PPP loans. Average interest bearing liabilities increased $372.9 million, or 20.6%, to $2.18 billion for the third quarter of 2021, from $1.81 billion for the third quarter of 2020. The increase in average interest bearing liabilities was primarily due to an increase in interest bearing deposits, as well as the issuance of additional subordinated debentures in July 2021, offset partially by a decrease in FHLB advances and the payoff of the Company’s notes payable.
Average interest earning assets produced a tax-equivalent yield of 4.14% for the third quarter of 2021, compared to 4.30% for the third quarter of 2020. The decline in the yield on interest earning assets was primarily due to excess cash balances and the historically low interest rate environment resulting in lower loan and security yields. The average rate paid on interest bearing liabilities was 0.88% for the third quarter of 2021, compared to 1.50% for the third quarter of 2020 primarily due to lower rates paid on deposits, the payoff of the Company’s notes payable and the early extinguishment of $94.0 million of FHLB advances, offset partially by strong growth of interest bearing deposits and additional subordinated debentures.
Interest Income. Total interest income, on a tax-equivalent basis, was $33.7 million for the third quarter of 2021, compared to $28.7 million for the third quarter of 2020. The $5.0 million, or 17.6%, increase in total interest income on a tax-equivalent basis was primarily due to continued organic growth in the loan portfolio and PPP loan income.
Interest income on loans, on a tax-equivalent basis, was $31.1 million for the third quarter of 2021, compared to $26.3 million for the third quarter of 2020. The $4.8 million, or 18.5%, increase was due to a 20.3% increase in the average balance of loans outstanding from continued organic loan growth.
Loan interest income and loan fees remain the primary contributing factors to the changes in yield on interest earning assets. The aggregate loan yield, excluding PPP loans, decreased to 4.51% in the third quarter of 2021, which was 42 basis points lower than 4.93% in the third quarter of 2020. While loan fees have maintained a relatively stable contribution to the aggregate loan yield, the historically low yield curve has resulted in a declining core yield on loans in comparison to prior periods.
44
The following table presents a summary of interest and fees recognized on loans, excluding PPP loans, for the periods indicated is as follows:
June 30, 2021
March 31, 2021
4.28
4.37
4.69
Fees
0.28
Yield on Loans, Excluding PPP Loans
4.54
4.72
4.87
Interest Expense. Interest expense on interest bearing liabilities decreased $2.0 million, or 28.9%, to $4.8 million for the third quarter of 2021, compared to $6.8 million for the third quarter of 2020. The cost of interest bearing liabilities declined 62 basis points from 1.50% in the third quarter of 2020 to 0.88% in the third quarter of 2021, primarily due to lower rates paid on deposits, the payoff of the Company’s notes payable and the early extinguishment of $94.0 million of longer term FHLB advances, offset partially by strong growth of interest bearing deposits and additional subordinated debentures.
Interest expense on deposits was $3.4 million for the third quarter of 2021, a decrease of $1.4 million, or 29.4%, from $4.8 million for the third quarter of 2020. The cost of total deposits declined 39 basis points from 0.87% in the third quarter of 2020, to 0.48% in the third quarter of 2021, primarily due to deposit rate cuts consistent with a lower rate environment and the continued downward repricing of time deposits.
Interest expense on borrowings decreased $547,000 to $1.4 million for the third quarter of 2021, compared to $2.0 million for the third quarter of 2020. This decrease was primarily due to the payoff of the Company’s notes payable, the early extinguishment of $94.0 million of FHLB advances, and the partial early redemption of $11.3 million of subordinated debentures, partially offset by higher average balances of subordinated debentures due to the issuance of $30.0 million of subordinated debentures in July 2021.
Nine Months Ended September 30, 2021 Compared to Nine Months Ended September 30, 2020
Net interest income was $80.4 million for the nine months ended September 30, 2021, an increase of $17.2 million, or 27.3%, compared to $63.1 million for the nine months ended September 30, 2020. The increase in net interest income was primarily due to growth in average interest earning assets, lower rates paid on deposits, and the recognition of PPP loan origination fees, offset partially by declining yields on loans.
Net interest margin (on a fully tax-equivalent basis) for the nine months ended September 30, 2021 was 3.55%, compared to 3.41% for the nine months ended September 30, 2020, an increase of 14 basis points. Core net interest margin (on a fully tax-equivalent basis), a non-GAAP financial measure which excludes the impact of loan fees and PPP balances, interest, and fees, for the nine months ended September 30, 2021 was 3.29%, a 5 basis point increase from 3.24% for the nine months ended September 30, 2020.
Average interest earning assets for the nine months ended September 30, 2021 increased $546.1 million, or 21.8%, to $3.05 billion from $2.50 billion for the nine months ended September 30, 2020. This increase in average interest earning assets was primarily due to increased cash balances, continued purchases of investment securities, strong organic growth in the loan portfolio, and the funding of round 2 PPP loans. Average interest bearing liabilities increased $346.2 million, or 20.1%, to $2.07 billion for the nine months ended September 30, 2021, from $1.72 billion for the nine months ended September 30, 2020. The increase in average interest bearing liabilities was primarily due to an increase in interest bearing deposits and the additional issuance of subordinated debentures in July 2021, offset partially by a decrease in federal funds purchased, FHLB advances, and the payoff of the Company’s notes payable.
45
Average interest earning assets produced a tax-equivalent yield of 4.20% for the nine months ended September 30, 2021, compared to 4.53% for the nine months ended September 30, 2020. The average rate paid on interest bearing liabilities was 0.95% for the nine months ended September 30, 2021, compared to 1.63% for the nine months ended September 30, 2020.
Interest Income. Total interest income on a tax-equivalent basis was $95.7 million for the nine months ended September 30, 2021, compared to $84.8 million for the nine months ended September 30, 2020. The $10.9 million, or 12.8%, increase in total interest income on a tax-equivalent basis was primarily due to continued organic growth in the loan portfolio and PPP loan income.
Interest income on the investment securities portfolio (on a fully-tax equivalent basis) increased $582,000, or 8.3%, during the nine months ended September 30, 2021, compared to the nine months ended September 30, 2020, due to a $80.6 million, or 26.4%, increase in average balances between the periods, which was offset partially by a 44 basis point decrease in the aggregate portfolio yield.
Interest income on loans (on a fully-tax equivalent basis) for the nine months ended September 30, 2021 was $87.8 million, compared to $77.3 million for the nine months ended September 30, 2020. The $10.5 million, or 13.5%, increase was primarily due to a 20.1% increase in the average balance of loans outstanding, which was offset partially by a 26 basis point decrease in the average yield on loans. The increase in the average balance of loans outstanding was due to strong organic loan growth. The decrease in yield on the loan portfolio was primarily driven by lower market interest rates and lower loan fee recognition, offset partially by increased recognition of PPP loan fees.
Interest Expense. Interest expense on interest bearing liabilities decreased $6.3 million, or 29.8%, to $14.7 million for the nine months ended September 30, 2021, compared to $21.0 million for the nine months ended September 30, 2020, due to lower interest rates paid on both deposits and borrowings.
Interest expense on deposits decreased to $10.6 million for the nine months ended September 30, 2021, compared to $15.7 million for the nine months ended September 30, 2020. The $5.1 million, or 32.6%, decrease in interest expense on deposits was primarily due to a 67 basis point decrease in the average rate paid, even as the average balance of deposits increased 29.0%. The decrease in the average rate paid was primarily due to the impact of lower market interest rates. The increase in the average balance of interest bearing deposits resulted primarily from increases in interest bearing transaction deposits, savings and money market deposits and brokered deposits, offset partially by a decline in time deposits.
Interest expense on borrowings decreased $1.1 million to $4.1 million for the nine months ended September 30, 2021, compared to $5.3 million for the nine months ended September 30, 2020. This decrease was primarily due to lower average balance of FHLB advances and federal funds purchased, as well as the payoff of the Company's notes payable, offset partially by the issuance of additional subordinated debentures in July 2021.
The provision for loan losses was $1.3 million for the third quarter of 2021, a decrease of $2.5 million, compared to the provision for loan losses of $3.8 million for the third quarter of 2020. The provision for loan losses was $4.0 million for the nine months ended September 30, 2021, a decrease of $4.9 million compared to the provision for loan losses of $8.9 million for the nine months ended September 30, 2020. The decrease in the provision for loan losses compared to both prior periods related to improving economic conditions.
The allowance for loan losses to total loans was 1.43% at September 30, 2021, compared to 1.39% at September 30, 2020. The allowance for loan losses to total loans, excluding PPP loans, was 1.46% at September 30, 2021, compared to 1.51% at September 30, 2020.
As an emerging growth company, the Company is not subject to Accounting Standards Update No. 2016-13 “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses of Financial Instruments,” or CECL, until January 1, 2023.
46
The following table presents the activity in the allowance for loan losses for the three and nine month periods ended September 30, 2021 and 2020:
Balance at Beginning of Period
Charge-offs
Recoveries
Balance at End of Period
Noninterest income was $1.4 million for the third quarter of 2021, an increase of $253,000 from $1.2 million for the third quarter of 2020. The increase was primarily due to increased letter of credit fees and bank-owned life insurance income. Noninterest income was $4.0 million for the nine months ended September 30, 2021, a decrease of $832,000, compared to $4.9 million for the nine months ended September 30, 2020. The decrease was primarily due to decreased gains on sales of securities and swap fees.
The following table presents the major components of noninterest income for the three and nine months ended September 30, 2021, compared to the three and nine months ended September 30, 2020:
Increase/
(Decrease)
Noninterest Income:
158
Net Gain on Sales of Securities
(61)
(723)
Letter of Credit Fees
577
487
1,135
1,026
Debit Card Interchange Fees
119
414
310
104
Swap Fees
907
(907)
374
132
989
427
253
(832)
Noninterest expense was $13.2 million for the third quarter of 2021, an increase of $3.6 million from $9.7 million for the third quarter of 2020. The increase was primarily driven by a $1.8 million increase in salaries and employee benefits as the result of merit increases and increased staff to meet the needs of the Company’s growth, as well as increases in professional and consulting fees, marketing and advertising fees, and $582,000 of prepayment fees associated with a partial early redemption of $11.3 million of subordinated debentures issued in July 2017.
Nine months ended September 30, 2021 Compared to Nine months ended September 30, 2020
Noninterest expense was $35.6 million for the nine months ended September 30, 2021, an increase of $5.5 million, or 18.3%, from $30.1 million for the nine months ended September 30, 2020. The increase was primarily driven by a $3.6 million increase in salaries and employee benefits, a $698,000 increase in occupancy and equipment expense and a $632,000 increase in information technology expense. While debt prepayment activity occurred during both periods, it was not to the same magnitude for the nine months ended September 30, 2021, which explains the $848,000 decrease when compared to the nine months ended September 30, 2020.
Full-time equivalent employees increased from 180 at the end of the third quarter of 2020 to 219 at the end of the third quarter of 2021. The Company continues to attract strategic hires in lending, deposit gathering, technology, risk management, and other supportive roles.
Efficiency Ratio. The efficiency ratio, a non-GAAP financial measure, reports total noninterest expense, less amortization of intangible assets, as a percentage of net interest income plus total noninterest income, less gains (losses) on sales of securities. Management believes this non-GAAP financial measure provides a meaningful comparison of operational performance and facilitates investors’ assessments of business performance and trends in comparison to peers in the banking industry. The Company’s efficiency ratio, and its comparability to some peers, is negatively impacted by the amortization of tax credit investments, as well as other non-routine items, within noninterest expense.
The efficiency ratio was 43.9% for the third quarter of 2021, compared to 42.3% for the third quarter of 2020. Excluding the impact of certain non-routine income and expenses from noninterest expense, the adjusted efficiency ratio, a non-GAAP financial measure, decreased to 41.5% for the third quarter of 2021, compared to 41.7% for the third quarter of 2020. The adjusted efficiency ratio for the nine months ended September 30, 2021 and 2020 was 41.3% and 42.0%, respectively. The efficiencies of the Company's "branch-light" model have positioned the Company well and going forward, provide more flexibility for the Company to make significant investments in technology as the industry adapts to evolving client behavior.
The following table presents the major components of noninterest expense for the three and nine months ended September 30, 2021, compared to the three and nine months ended September 30, 2020:
Noninterest Expense:
1,759
3,571
FDIC Insurance Assessment
355
160
195
960
518
442
Data Processing
267
58
916
182
Professional and Consulting Fees
708
492
1,804
1,400
404
Information Technology and Telecommunications
598
385
1,609
977
632
Marketing and Advertising
418
94
324
1,018
645
Intangible Asset Amortization
Amortization of Tax Credit Investments
145
(182)
Debt Prepayment Fees
1,430
(848)
799
637
2,294
235
3,564
5,507
Income Tax Expense
The provision for income taxes includes both federal and state taxes. Fluctuations in effective tax rates reflect the differences in the inclusion or deductibility of certain income and expenses for income tax purposes and the recognition of tax credits. The Company’s future effective income tax rate will fluctuate based on the mix of taxable and tax-free investments and loans, the recognition and availability of tax credit investments, and overall taxable income.
Income tax expense was $4.0 million for the third quarter of 2021, compared to $2.2 million for the third quarter of 2020. The effective combined federal and state income tax rate for the third quarter of 2021 was 26.0%, compared to 23.8% for the third quarter of 2020. Income tax expense was $11.6 million for the nine months ended September 30, 2021, compared to $6.8 million for the nine months ended September 30, 2020. The effective combined federal and state income tax rate for the nine months ended September 30, 2021 and 2020 was 25.9% and 23.4%, respectively. The higher effective combined rate compared to both prior periods was due to fewer tax credits being recognized.
Financial Condition
Total assets at September 30, 2021 were $3.39 billion, an increase of $461.8 million, or 15.8%, over total assets of $2.93 billion at December 31, 2020, and an increase of $614.6 million, or 22.1%, over total assets of $2.77 billion at September 30, 2020. The growth in both periods was primarily driven by increased cash balances, robust organic loan growth, as well as continued purchases of investment securities.
Total gross loans at September 30, 2021 were $2.71 billion, an increase of $385.6 million, or 16.6%, over total gross loans of $2.33 billion at December 31, 2020, and an increase of $452.8 million, or 20.0%, over total gross loans of $2.26 billion at September 30, 2020. The Company’s continued strong loan growth has been driven by the expansion of the talented lending teams, PPP-related client acquisition opportunities, the strong and growing brand of the Bank in the Twin Cities market and the M&A-related market disruption in the Twin Cities resulting in client and banker acquisition opportunities.
Investment Securities Portfolio
The investment securities portfolio is used to make various term investments and is intended to provide the Company with adequate liquidity, a source of stable income, and at times, serve as collateral for certain types of deposits. Investment balances in the investment securities portfolio are subject to change over time based on funding needs and interest rate risk management objectives. The liquidity levels take into account anticipated future cash flows and are maintained at levels management believes are appropriate to ensure future flexibility in meeting anticipated funding needs.
The investment securities portfolio consists primarily of municipal securities, U.S. government agency mortgage backed securities, SBA securities, asset-backed securities, and corporate securities comprised primarily of subordinated debentures of bank and financial holding companies. In addition, the Company also holds U.S. treasury 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 $413.1 million at September 30, 2021, compared to $390.6 million at December 31, 2020, an increase of $22.5 million or 5.8%. At September 30, 2021, municipal securities represented 33.1% of the investment securities portfolio, government agency mortgage-backed securities represented 29.2% of the portfolio, SBA securities represented 8.0% of the portfolio, corporate securities represented 18.7% of the portfolio, U.S. treasury securities represented 0.2% of the portfolio, asset-backed securities represented 9.5% of the portfolio, and other mortgage-backed securities represented 1.3% of the portfolio.
The following table presents the amortized cost and fair value of securities available for sale, by type, at September 30, 2021 and December 31, 2020:
Fair
Value
Mortgage-Backed Securities Issued or Guaranteed by U.S. Agencies (MBS):
Residential Pass-Through:
Guaranteed by GNMA
717
756
892
957
Issued by FNMA and FHLMC
21,782
21,665
16,067
16,117
Other Residential Mortgage-Backed Securities
87,567
86,847
94,440
94,409
Commercial Mortgage-Backed Securities
10,789
11,351
11,254
12,032
All Other Commercial MBS
5,416
5,393
742
745
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, multifamily residential properties, land, and non-real estate business assets. Responsive service, local decision making, and an efficient turnaround time from application to closing have been significant factors in growing the loan portfolio.
The Company manages concentrations of credit exposure through a risk management program which implements formalized processes and procedures specifically for managing and mitigating risk within the loan portfolio. The processes and procedures include board and management oversight, commercial real estate exposure limits, portfolio monitoring tools, management information systems, market reports, underwriting standards, internal and external loan review, and stress testing.
The Company originated net loan exposures of $334.0 million for the third quarter of 2021, compared to $405.6 million for the third quarter of 2020. Net loan exposures include principal advances and unfunded commitments on newly originated loans, net of loan participations sold and PPP loan originations. Total gross loans increased $385.6 million, or 16.6%, to $2.71 billion at September 30, 2021, compared to $2.33 billion at December 31, 2020 and increased $452.8 million, or 20.0%, from $2.26 billion at September 30, 2020. As of September 30, 2021, construction and land development loans increased $87.0 million, or 51.1%, multifamily loans increased $238.7 million, or 38.1%, and nonowner occupied CRE loans increased $77.0 million, or 10.9%, when compared to December 31, 2020. Collectively, the Company’s annualized loan growth for the nine months ended September 30, 2021, excluding PPP loans, was 28.7%.
The following table presents the dollar and percentage composition of the loan portfolio by category, at the dates indicated:
Percent
12.9
321,474
12.4
301,023
13.1
287,254
12.7
2.0
99,072
3.8
163,258
6.7
181,596
8.0
9.5
251,573
193,372
7.3
175,882
7.8
1 - 4 Family Mortgage
10.7
277,943
294,964
12.2
286,089
31.9
790,275
30.5
665,415
27.4
26.9
585,814
25.9
87,507
3.4
79,665
3.3
3.2
75,963
29.0
758,101
29.2
720,396
29.7
660,058
75.4
1,913,826
73.8
1,760,440
72.6
73.3
1,607,924
71.2
0.2
8,241
0.3
8,030
6,572
100.0
(37,591)
(35,987)
(31,381)
(11,450)
(11,273)
(10,367)
2,545,145
2,378,863
2,217,480
The Company’s primary focus historically has been on real estate mortgage lending, which constituted 76.9% of the portfolio, excluding PPP loans, as of September 30, 2021. The composition of the portfolio has remained consistent with prior periods and the Company does not expect any significant changes in the foreseeable future in the composition of the loan portfolio or in the emphasis on real estate lending.
As of September 30, 2021, investor CRE loans totaled $1.91 billion, consisting of $786.3 million of loans secured by nonowner occupied CRE, $865.2 million of loans secured by multifamily residential properties and $257.2 million of construction and land development loans. Investor CRE loans represented 71.8% of the total gross loan portfolio, excluding PPP loans, and 477.3% of the Bank’s total risk-based capital at September 30, 2021, compared to 455.8% at December 31, 2020.
The following tables present time to contractual maturity and sensitivity to interest rate changes for the loan portfolio at September 30, 2021 and December 31, 2020:
As of September 30, 2021
Due in One Year
More Than One
or Less
Year to Five Years
After Five Years
156,839
134,079
59,163
6,700
47,490
95,704
117,947
43,516
52,261
175,930
62,344
115,088
277,450
472,634
3,616
20,833
77,385
137,630
329,676
318,965
308,595
803,889
931,328
3,361
2,725
676
571,199
1,106,130
1,034,683
Interest Rate Sensitivity:
Fixed Interest Rates
255,663
823,376
536,749
Floating or Adjustable Rates
315,536
282,754
497,934
As of December 31, 2020
135,237
119,798
49,185
100,060
44,637
25,520
66,928
184,038
43,513
70,262
235,447
320,756
14,930
16,701
43,973
151,439
268,640
289,221
303,559
704,826
697,463
2,889
4,040
760
541,745
1,011,755
772,928
219,464
777,201
336,008
322,281
234,554
436,920
Asset Quality
The Company emphasizes credit quality in the originating and monitoring of the loan portfolio, and success in underwriting is measured by the levels of classified and nonperforming assets and net charge-offs. Federal regulations and internal policies require the use of an asset classification system as a means of managing and reporting problem and potential problem assets. The Company has incorporated an internal asset classification system, substantially consistent with federal banking regulations, as a part of the credit monitoring system. Federal banking regulations set forth a classification scheme for problem and potential problem assets as “substandard,” “doubtful” or “loss” assets. An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the financial institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly
questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated “watch.”
The following table presents information on loan classifications at September 30, 2021. The Company had no assets classified as doubtful or loss.
Risk Category
26,294
710
2,056
2,438
44,197
42,286
6,405
48,691
75,119
The Company has increased oversight and analysis of all segments of the loan portfolio in response to the COVID-19 pandemic, especially in vulnerable industries such as hospitality and restaurants, to proactively monitor evolving credit risk. Loans that have potential weaknesses that warrant a watchlist risk rating at September 30, 2021, totaled $67.4 million, compared to $44.8 million at December 31, 2020. As the COVID-19 pandemic continues to evolve, the length and extent of the economic uncertainty may result in further watchlist or adverse classifications in the loan portfolio. Loans that warranted a substandard risk rating at September 30, 2021 totaled $7.7 million, compared to $15.2 million at December 31, 2020.
The Company developed programs for clients who experienced business and personal disruptions due to the COVID-19 pandemic by providing interest-only modifications, loan payment deferrals, and extended amortization modifications. In accordance with interagency regulatory guidance and the CARES Act, qualifying loans modified in response to the COVID-19 pandemic are not considered TDRs. The Company had 13 modified loans totaling $35.4 million outstanding as of September 30, 2021, representing 1.3% of the loan portfolio, excluding PPP loans.
The following table presents a rollforward of loan modification activity, by modification type, from December 31, 2020 to September 30, 2021:
Payment Deferral
Principal Balance - December 31, 2020
61,105
4,834
66,552
Modification Expired
(61,056)
(618)
(4,764)
(66,438)
Additional Modification Granted
19,486
24,250
New Modifications
11,091
Net Principal Advances (Payments)
(29)
(94)
Principal Balance - September 30, 2021
53
The following table presents a summary of active loan modifications, by loan segment and modification type, at September 30, 2021:
Modifications have been granted on a case-by-case basis based on specific needs and circumstances affecting each borrower. Interest-only modifications have been primarily granted for three to six month periods, but range up to twelve months.
Nonperforming Assets
Nonperforming loans include loans accounted for on a nonaccrual basis and loans 90 days past due and still accruing. Nonperforming assets consist of nonperforming loans plus foreclosed assets (i.e., real or personal property acquired through foreclosure). Nonaccrual loans totaled $734,000 and $775,000 as of September 30, 2021 and December 31, 2020, respectively, a decrease of $41,000. There were no loans 90 days past due and still accruing as of September 30, 2021 or December 31, 2020 and there were no foreclosed assets as of September 30, 2021 or December 31, 2020.
The following table presents a summary of nonperforming assets, by category, at the dates indicated:
Nonaccrual Loans:
Total Nonaccrual Loans
Total Nonperforming Loans
Plus: Foreclosed Assets
Total Nonperforming Assets (1)
Total Restructured Accruing Loans
1,307
Total Nonperforming Assets and Restructured Accruing Loans
2,041
1,040
Nonaccrual Loans to Total Loans
0.03
Nonperforming Loans to Total Loans
Nonperforming Assets to Total Loans Plus Foreclosed Assets (1)
Nonperforming Assets and Restructured Accruing Loans to Total Loans Plus Foreclosed Assets
0.08
0.04
The balance of nonperforming assets can fluctuate due to changes in economic conditions. The Company has established a policy to discontinue accruing interest on a loan (that is, place the loan on nonaccrual status) after it has become 90 days delinquent as to payment of principal or interest, unless the loan is considered to be well-collateralized and is actively in the process of collection. In addition, a loan will be placed on nonaccrual status before it becomes 90 days delinquent unless management believes that the collection of interest is expected. Interest previously accrued but uncollected on such loans is reversed and charged against current income when the receivable is determined to be uncollectible. If management believes that a loan will not be collected in full, an increase to the allowance for loan losses is recorded to reflect management’s estimate of any potential exposure or loss. Generally, payments received on
nonaccrual loans are applied directly to principal. Gross income that would have been recorded on nonaccrual loans during the three and nine months ended September 30, 2021 was $16,000 and $47,000, respectively.
The allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. The Company maintains an allowance for loan losses at a level management considers adequate to provide for known and probable incurred losses in the portfolio. The level of the allowance is based on management’s evaluation of estimated losses in the portfolio, after consideration of risk characteristics of the loans and prevailing and anticipated economic conditions. Loan charge-offs (i.e., loans judged to be uncollectible) are charged against the reserve and any subsequent recovery is credited to the reserve. The Company analyzes risks within the loan portfolio on a continual basis. A risk system, consisting of multiple grading categories for each portfolio class, is utilized as an analytical tool to assess risk and appropriate reserves. In addition to the risk system, management further evaluates risk characteristics of the loan portfolio under current and anticipated economic conditions, including the economic distress caused by the COVID-19 pandemic, and considers such factors as the financial condition of the borrower, past and expected loss experience, and other factors which management feels deserve recognition in establishing an appropriate reserve. These estimates are reviewed at least quarterly, and as adjustments become necessary, they are recognized in the periods in which they become known. Although management strives to maintain an allowance it deems adequate, future economic changes, deterioration of borrowers’ creditworthiness, and the impact of examinations by regulatory agencies all could cause changes to the allowance for loan losses.
At September 30, 2021, the allowance for loan losses was $38.9 million, an increase of $4.1 million from $34.8 million at December 31, 2020. Net charge-offs (recoveries) totaled ($10,000) during the third quarter of 2021 and $2,000 during the third quarter of 2020. Net charge-offs (recoveries) totaled $(60,000) for the nine months ended September 30, 2021 and $(5,000) for the nine months ended September 30, 2020. The allowance for loan losses as a percentage of total loans was 1.43% as of September 30, 2021 and 1.50% as of December 31, 2020. Excluding PPP loans, the allowance for loan losses as a percentage of total loans was 1.46% as of September 30, 2021, compared to 1.59% at December 31, 2020.
55
The following table presents a summary of the activity in the allowance for loan loss reserve for the periods indicated:
Balance, Beginning of Period
Charge-offs:
Total Charge-offs
Recoveries:
Total Recoveries
Net Charge-offs (Recoveries)
(10)
(60)
Gross Loans, End of Period
Average Loans
Net Charge-offs (Recoveries) (Annualized) to Average Loans
Allowance to Total Gross Loans
1.39
Allowance to Total Gross Loans, Excluding PPP Loans
1.46
The following table presents a summary of the allocation of the allowance for loan losses by loan portfolio segment for the periods indicated:
17.2
16.4
0.1
8.9
7.1
9.1
11.4
30.8
27.3
3.7
28.3
31.6
27,963
71.9
25,642
73.6
0.4
0.6
1.5
2.1
Total Allowance for Loan Losses
The principal sources of funds for the Company are deposits, consisting of demand deposits, money market accounts, savings accounts, and certificates of deposit. The following table presents the dollar and percentage composition of the deposit portfolio, by category, at the dates indicated:
758,023
27.9
712,999
27.0
685,773
30.2
488,785
17.1
432,123
15.9
433,344
366,290
14.6
322,253
14.2
27.7
761,485
28.0
791,583
30.0
26.3
498,397
21.9
10.9
321,857
11.8
344,581
14.1
363,897
16.0
447,418
356,147
13.5
18.1
402,724
17.7
Total deposits at September 30, 2021 were $2.85 billion, an increase of $352.5 million, or 14.1%, compared to total deposits of $2.50 billion at December 31, 2020, and an increase of $581.1 million, or 25.6%, over total deposits of $2.27 billion at September 30, 2020. Noninterest bearing transaction deposits were $846.5 million at September 30, 2021, compared to $671.9 million at December 31, 2020, and $685.8 million at September 30, 2020. Noninterest bearing deposits comprised 29.7% of total deposits at September 30, 2021, compared to 26.9% at December 31, 2020, and 30.2% at September 30, 2020. The growth in core deposits has been a result of successful new client and banker acquisition initiatives, pandemic-related accumulation of liquidity by existing clients, and the strong, growing brand of the Bank in the Twin Cities market. Given the fluid environment, management believes deposits could experience fluctuations in future periods.
The Company relies on increasing the deposit base to fund loans and other asset growth. The Company is in a highly competitive market and competes for local deposits by offering attractive products with competitive rates. The Company expects to have a higher average cost of funds for local deposits compared to competitor banks due to the lack of an extensive branch network. The Company’s strategy is to offset the higher cost of funding with a lower level of operating expense. When appropriate, the Company utilizes alternative funding sources such as brokered deposits. The brokered deposit market provides flexibility in structure, optionality and efficiency not afforded in traditional retail deposit channels. At September 30, 2021, total brokered deposits were $417.2 million, a decrease of $35.1 million, or 7.8%, compared to total brokered deposits of $452.3 million at December 31, 2020, and an increase of $14.5 million, or 3.6%, compared to September 30, 2020.
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, 2021 and September 30, 2020:
As of and for the
Time Deposits < $250,000
256,160
242,048
2.08
Time Deposits > $250,000
62,062
1.22
127,927
1.98
2,823,471
2,212,341
57
Borrowed Funds
In addition to deposits, the Company utilizes overnight borrowings to meet the daily liquidity needs of clients and to 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
4,072
Maximum Amount Outstanding at any Month-End
24,000
Weighted Average Interest Rate:
During Period
End of Period
0.30
0.29
Other Borrowings
At September 30, 2021, other borrowings outstanding consisted of FHLB advances of $47.5 million. The Company’s $11.0 million note payable matured during the first quarter of 2021 and was paid off in full at maturity. On March 1, 2021, the Company entered into a Loan and Security Agreement and revolving note which has made a $25.0 million revolving line of credit available to the Company, secured by 100% of the issued and outstanding stock of the Bank. The maturity of the line of credit is February 28, 2023. As of September 30, 2021, there were no outstanding balances under the revolving line of credit.
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 $487.2 million and $361.2 million at September 30, 2021 and December 31, 2020, respectively.
Additionally, the Company has borrowing capacity from other sources. As of September 30, 2021, the Bank was eligible to use the Federal Reserve discount window for borrowings. Based on assets pledged as collateral as of the applicable date, the Bank’s borrowing availability was approximately $106.2 million and $76.8 million at September 30, 2021 and December 31, 2020, respectively. As of September 30, 2021 and December 31, 2020, the Company had no outstanding advances.
On July 8, 2021, the Company issued $30.0 million of subordinated debentures at an initial fixed interest rate of 3.25%, which is payable semi-annually. Beginning July 15, 2026, the interest rate converts to a variable interest rate, reset quarterly, equal to the three-month SOFR plus 2.52%, which is payable quarterly. The subordinated debentures mature on July 15, 2031. The subordinated debentures, net of issuance costs, were $29.4 million at September 30, 2021.
On June 19, 2020, the Company issued $50.0 million of subordinated debentures at an initial fixed interest rate of 5.25%, which is payable semi-annually. Beginning July 1, 2025, the interest rate converts to a variable interest rate equal to the three-month term SOFR, plus 5.13%, which is payable quarterly. The subordinated debentures mature on July 1, 2030. The subordinated debentures, net of issuance costs, were $49.1 million at September 30, 2021, compared to $48.9 million at December 31, 2020. On October 13, 2020, the Company completed an exchange of $47.0 million total principal amount of the subordinated debentures for substantially identical subordinated debentures registered under the Securities Act of 1933, in satisfaction of the Company’s obligations under a registration rights agreement entered into with the initial purchasers of the subordinated debentures.
On July 12, 2017, the Company issued $25.0 million of subordinated debentures at an initial fixed interest rate of 5.875%, which is payable semi-annually. Beginning July 15, 2022, the interest rate converts to a variable interest rate equal to the three-month LIBOR plus 3.88%, which is payable quarterly. The subordinated debentures mature on July 15, 2027. In July of 2021, the Company redeemed $11.3 million of the $25.0 million outstanding of its subordinated debentures due in 2027. The early redemption of the subordinated debentures was recorded as a loss on the extinguishment of subordinated debt, included in noninterest expense, in the amount of $582,000, consisting of $532,000 in prepayment penalties and $50,000 in unamortized issuance costs. The subordinated debentures, net of issuance costs, were $13.7 million at September 30, 2021, compared to $24.8 million at December 31, 2020.
All of the subordinated debentures qualify for Tier 2 regulatory capital treatment at the Company level under applicable regulatory guidelines.
Contractual Obligations
The following table presents supplemental information regarding total contractual obligations at September 30, 2021:
Within
One to
Three to
After
One Year
Three Years
Five Years
Deposits Without a Stated Maturity
2,293,579
175,122
152,547
189,953
42,956
560,578
22,500
16,000
93,750
Commitment to Fund Tax Credit Investments
Operating Lease Obligations
504
992
930
619
3,045
2,474,612
176,039
206,883
141,325
2,998,859
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.
On August 17, 2021, the Company announced the closing of its underwritten public offering of 2,400,000 depositary shares, each representing a 1/100th interest in a share of the Company’s 5.875% Non-Cumulative Perpetual Preferred Stock, Series A, $0.01 par value per share (“Series A Preferred Stock”). On August 20, 2021, the underwriters of the offering exercised in full their option to purchase 360,000 additional depositary shares to cover over-allotments. As a result, the gross proceeds from the offering totaled $69.0 million. The Company intends to use the net proceeds from the offering for general corporate purposes, including support for organic growth plans, support for bank level capital ratios and possible redemption or repurchase of outstanding indebtedness. On October 26, 2021, the Company’s Board of Directors declared a quarterly cash dividend of $42.43 per share ($0.4243 per depositary share) on the Series A Preferred Stock, payable on December 1, 2021, to shareholders of record on the Series A Preferred Stock at the close of business of November 15, 2021.
Shareholders’ equity at September 30, 2021 was $367.8 million, an increase of $102.4 million, or 38.6%, over shareholders’ equity of $265.4 million at December 31, 2020, primarily due to $33.2 million of net income retained, the issuance of preferred stock, and an increase in unrealized gains in the securities and derivatives portfolios, offset partially by stock repurchases made under the Company’s stock repurchase program.
Stock Repurchase Program. During the three months ended September 30, 2021, the Company repurchased 126,507 shares of its common stock, representing less than 1% of the Company’s outstanding shares. Shares were repurchased during this period at a weighted average price of $16.11 for a total of $2.0 million. During the nine months ended September 30, 2021, the Company repurchased 143,125 shares of its common stock, representing less than 1% of
the Company’s outstanding shares. Shares were repurchased at a weighted average price of $15.69 for a total of $2.2 million. All shares repurchased under the stock repurchase program were converted to authorized but unissued shares. At September 30, 2021, the remaining amount that could be used to repurchase shares under the stock repurchase program was $12.5 million.
Strong earnings and capital growth coupled with better asset quality visibility as loan modifications expired, supported management’s decision to resume repurchases under the Company’s stock repurchase program. The Company remains committed to maintaining strong capital levels while enhancing shareholder value as it strategically executes its stock repurchase program in this fluid economic environment.
Regulatory Capital. The Company and the Bank are subject to various regulatory capital requirements administered by federal banking regulators. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by federal banking regulators that, if undertaken, could have a direct material effect on the Company’s and Bank’s business.
Under applicable regulatory capital rules, the Company and Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank must also meet certain specific capital guidelines under the prompt corrective action framework. The capital amounts and classification are subject to qualitative judgments by the federal banking regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of common equity Tier 1 capital, Tier 1 capital and total capital to risk-weighted assets and of Tier 1 capital to average consolidated assets (referred to as the “leverage ratio”), as defined under the applicable regulatory capital rules.
Management believes the Company and the Bank met all capital adequacy requirements to which they were subject as of September 30, 2021. The regulatory capital ratios for the Company and the Bank to meet the minimum capital adequacy standards and for the Bank to be considered well capitalized under the prompt corrective action framework are set forth in the following tables. The Company’s and the Bank’s actual capital amounts and ratios are as of the dates indicated.
60
The Company and the Bank are subject to the rules of the Basel III regulatory capital framework and related Dodd-Frank Wall Street Reform and Consumer Protection Act. The rules require a capital conservation buffer of 2.5% that was added to the minimum requirements for capital adequacy purposes. A banking organization with a conservation buffer of less than the required amount is subject to limitations on capital distributions, including dividend payments, stock repurchases and certain discretionary bonus payments to executive officers. At September 30, 2021, the ratios for the Company and the Bank were sufficient to meet the 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 presents credit arrangements and financial instruments whose contract amounts represent credit risk as of September 30, 2021 and December 31, 2020:
Fixed
Variable
342,706
459,484
243,988
400,350
104,698
10,954
79,252
351,031
564,182
254,942
479,602
Liquidity
Liquidity is the Company’s capacity to meet cash and collateral obligations at a reasonable cost. Maintaining an adequate level of liquidity depends on the Company’s ability to efficiently meet both expected and unexpected cash flows and collateral needs without adversely affecting either daily operations or financial condition. The Bank’s Asset
Liability Management, or ALM, Committee, which is comprised of members of senior management, is responsible for managing commitments to meet the needs of customers while achieving the Company’s financial objectives. The ALM Committee meets regularly to review balance sheet composition, funding capacities, and current and forecasted loan demand.
The Company manages liquidity by maintaining adequate levels of cash and other assets from on- and off-balance sheet arrangements. Specifically, on-balance sheet liquidity consists of cash and due from banks and unpledged investment securities available for sale, which are referred to as primary liquidity. In regards to off-balance sheet capacity, the Company maintains available borrowing capacity under secured borrowing lines with the FHLB, the Federal Reserve Bank of Minneapolis, and a correspondent lender, as well as unsecured lines of credit for the purpose of overnight funds with various correspondent banks, which the Company refers to as secondary liquidity.
In addition, the Bank is a member of the American Financial Exchange, or AFX, through which it may either borrow or lend funds on an overnight or short-term basis with a group of approved commercial banks. The availability of funds changes daily. As of September 30, 2021, 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)
178,532
145,348
Total Primary Liquidity
591,681
535,977
Ratio of Primary Liquidity to Total Deposits
20.7
21.4
Secondary Liquidity—Off-Balance Sheet
Borrowing Capacity
Net Secured Borrowing Capacity with the FHLB
487,195
361,236
Net Secured Borrowing Capacity with the Federal Reserve Bank
106,209
76,830
Unsecured Borrowing Capacity with Correspondent Lenders
208,000
143,000
Secured Borrowing Capacity with Correspondent Lender
Total Secondary Liquidity
826,404
581,066
Ratio of Primary and Secondary Liquidity to Total Deposits
49.7
44.7
During the nine months ended September 30, 2021, primary liquidity increased by $55.7 million due to a $33.2 million increase in cash and cash equivalents and a $22.5 million increase in securities available for sale, when compared to December 31, 2020. Secondary liquidity increased by $245.3 million as of September 30, 2021 when compared to December 31, 2020, due to a $126.0 million increase in the borrowing capacity on the secured borrowing line with the FHLB, a $29.4 million increase in the borrowing capacity on the secured credit line with the Federal Reserve Bank, a $65.0 million increase in unsecured borrowing capacity with correspondent lenders, and a $25.0 million increase from the addition of a secured revolving line of credit with a correspondent lender.
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, 2021, core deposits totaled approximately $2.38 billion and represented 83.3% 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, 2021, brokered deposits totaled $417.2 million, consisting of $250.8 million of brokered time deposits and $166.4 million of non-maturity brokered money market and transaction accounts. At December 31, 2020, brokered deposits totaled $452.3 million, consisting of
62
$292.6 million of brokered time deposits and $159.7 million of non-maturity brokered money market and transaction accounts.
The Company’s liquidity policy includes guidelines for On-Balance Sheet Liquidity (a measurement of primary liquidity to total deposits plus borrowings), Total On-Balance Sheet Liquidity with Borrowing Capacity (a measurement of primary and secondary liquidity to total deposits plus borrowings), Wholesale Funding Ratio (a measurement of total wholesale funding to total deposits plus borrowings), and other guidelines developed for measuring and maintaining liquidity. As of September 30, 2021, the Company was in compliance with all established liquidity guidelines in the policy.
Non-GAAP Financial Measures
In addition to the results presented in accordance with GAAP, the Company routinely supplements its evaluation with an analysis of certain non-GAAP financial measures. The Company believes these non-GAAP financial measures, in addition to the related GAAP measures, provide meaningful information to investors to help them understand the Company’s operating performance and trends, and to facilitate comparisons with the performance of peers. These disclosures should not be viewed as a substitute for operating results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. Reconciliations of non-GAAP disclosures used in this report to the comparable GAAP measures are provided in the following tables.
Pre-Provision Net Revenue
Less: Gain on sales of Securities
(48)
(702)
(30)
(109)
Total Operating Noninterest Income
1,362
901
956
1,048
3,271
3,380
Plus: Net Interest Income
Net Operating Revenue
30,035
27,189
26,403
25,797
22,727
83,627
66,503
Less: Amortization of Tax Credit Investments
(140)
(118)
(145)
(410)
(592)
Less: Debt Prepayment Fees
(582)
(5,613)
(1,430)
Total Operating Noninterest Expense
12,502
11,337
10,805
9,499
9,527
34,644
28,107
17,533
15,852
16,298
13,200
48,983
38,396
Plus:
Non-Operating Revenue Adjustments
702
Less:
Non-Operating Expense Adjustments
118
5,759
2,022
Average Assets
Pre-Provision Net Revenue Return on Average Assets
2.10
2.01
Core Net Interest Margin
Net Interest Income (Tax-equivalent Basis)
26,495
25,609
25,051
Less: Loan Fees
(1,487)
(1,023)
(1,202)
(1,514)
(1,198)
(3,712)
(3,769)
Less: PPP Interest and Fees
(1,753)
(1,767)
(1,864)
(1,173)
(5,384)
(2,046)
Core Net Interest Income
25,640
23,705
22,543
21,440
19,527
71,889
58,018
Average Interest Earning Assets
3,019,437
2,883,084
2,759,543
Less: Average PPP Loans
(76,006)
(149,312)
(148,881)
(165,099)
(181,397)
(124,466)
(107,541)
Core Average Interest Earning Assets
3,158,295
2,870,125
2,734,203
2,594,444
2,474,485
2,922,427
2,393,286
64
Efficiency Ratio
Less: Amortization of Intangible Assets
(47)
(143)
Adjusted Noninterest Expense
13,188
11,430
10,875
15,210
9,624
35,493
29,986
Less: Gain on Sales of Securities
Adjusted Operating Revenue
42.4
45.1
Adjusted Efficiency Ratio
12,454
11,290
10,757
9,451
9,479
34,501
27,964
41.3
Adjusted Noninterest Expense to Average Assets (Annualized)
Tangible Common Equity and Tangible Common Equity/Tangible Assets
Less: Preferred Stock
(66,515)
Total Common Shareholders' Equity
301,288
Less: Intangible Assets
(3,153)
(3,248)
(3,296)
(3,344)
Tangible Common Equity
Tangible Assets
3,385,972
3,159,412
3,069,111
2,924,049
2,771,220
Tangible Common Equity/Tangible Assets
Tangible Book Value Per Share
Book Value Per Common Share
Less: Effects of Intangible Assets
(0.11)
(0.12)
Tangible Book Value Per Common Share
Return on Average Tangible Common Equity
Average Shareholders' Equity
Less: Average Preferred Stock
(32,332)
(10,896)
Average Common Equity
298,272
285,864
Less: Effects of Average Intangible Assets
(3,180)
(3,228)
(3,276)
(3,323)
(3,371)
(3,227)
(3,418)
Average Tangible Common Equity
295,092
283,083
269,453
262,393
259,824
282,637
252,975
15.69
11.73
Adjusted Diluted Earnings Per Common Share
Add: Debt Prepayment Fees
5,613
Less: Tax Impact
(151)
(1,336)
(335)
Net Income, Excluding Impact of Debt Prepayment Fees
11,940
9,256
33,604
23,310
0.80
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
As a financial institution, the Company’s primary market risk is interest rate risk, which is defined as the risk of loss of net interest income or net interest margin because of changes in interest rates. The Company continually seeks to measure and manage the potential impact of interest rate risk. Interest rate risk occurs when interest earning assets and interest bearing liabilities mature or re-price at different times, on a different basis or in unequal amounts. Interest rate risk also arises when assets and liabilities each respond differently to changes in interest rates.
The Company’s management of interest rate risk is overseen by its ALM Committee, based on a risk management infrastructure approved by the board of directors that outlines reporting and measurement requirements. In particular, this infrastructure sets limits and management targets for various metrics, including net interest income simulation involving parallel shifts in interest rate curves, steepening and flattening yield curves, and various prepayment and deposit duration assumptions. The Company’s risk management infrastructure also requires a periodic review of all key assumptions used, such as identifying appropriate interest rate scenarios, setting loan prepayment rates based on historical analysis and noninterest bearing and interest bearing transaction deposit durations based on historical analysis. The Company does not engage in speculative trading activities relating to interest rates, foreign exchange rates, commodity prices, equities or credit.
The Company manages the interest rate risk associated with interest earning assets by managing the interest rates and terms associated with the investment securities portfolio by purchasing and selling investment securities from time to time. The Company manages the interest rate risk associated with interest bearing liabilities by managing the interest rates and terms associated with wholesale borrowings and deposits from customers which the Company relies on for funding. For example, the Company occasionally uses special offers on deposits to alter the interest rates and terms associated with interest bearing liabilities.
The Company has entered into certain hedging transactions including interest rate swaps and caps, which are designed to lessen elements of the Company’s interest rate exposure. Cash flow hedge relationships mitigate exposure to the variability of future cash flows or other forecasted transactions. The Company utilizes cash flow hedges to manage interest rate exposure for the brokered deposit and wholesale borrowing portfolios. At September 30, 2021 and December 31, 2020, these cash flow hedges had a total notional amount of $220.0 million and $161.0 million, respectively. In the event that interest rates do not change in the manner anticipated, such transactions may adversely affect the Company’s results of operations.
Net Interest Income Simulation
The Company uses a net interest income simulation model to measure and evaluate potential changes in net interest income that would result over the next 12 months from immediate and sustained changes in interest rates as of the measurement date. This model has inherent limitations and the results are based on a given set of rate changes and assumptions as of a certain point in time. For purposes of the simulation, the Company assumes no growth in either interest-sensitive assets or liabilities over the next 12 months; therefore, the model’s results reflect an interest rate shock to a static balance sheet. The simulation model also incorporates various other assumptions, which the Company believes are reasonable but which may have a significant impact on results, such as: (1) the timing of changes in interest rates, (2) shifts or rotations in the yield curve, (3) re-pricing characteristics for market-rate-sensitive instruments, (4) differing sensitivities of financial instruments due to differing underlying rate indices, (5) varying loan prepayment speeds for different interest rate scenarios, (6) the effect of interest rate limitations in assets, such as floors and caps, and (7) overall growth and repayment rates and product mix of assets and liabilities. Because of the limitations inherent in any approach used to measure interest rate risk, simulation results are not intended as a forecast of the actual effect of a change in market interest rates on the results, but rather as a means to better plan and execute appropriate asset-liability management strategies and to manage interest rate risk.
Potential changes to the Company’s net interest income in hypothetical rising and declining rate scenarios calculated as of September 30, 2021 are presented in the table below. The projections assume an immediate, parallel shift downward of the yield curve of 100 basis points and immediate, parallel shifts upward of the yield curve of 100, 200, 300 and 400 basis points. In the current interest rate environment, a downward shift of the yield curve of 200, 300 and 400 basis points does not provide us with meaningful results and thus is not presented.
Change (basis points) in Interest Rates
Forecasted Net
Percentage Change
(12-Month Projection)
from Base
+400
108,391
6.79
91,046
10.03
+300
106,298
88,698
7.19
+200
104,174
2.64
86,241
4.22
+100
102,241
0.73
84,195
1.75
0
101,496
82,747
−100
99,260
(2.20)
81,780
(1.17)
The table above indicates that as of September 30, 2021, in the event of an immediate and sustained 400 basis point increase in interest rates, the Company would experience a 6.79% increase in net interest income. In the event of an immediate 100 basis point decrease in interest rates, the Company would experience a 2.20% decrease in net interest income.
The results of this simulation analysis are hypothetical, and a variety of factors might cause actual results to differ substantially from what is depicted. For example, if the timing and magnitude of interest rate changes differ from those projected, net interest income might vary significantly. Non-parallel yield curve shifts such as a flattening or steepening of the yield curve or changes in interest rate spreads would also cause net interest income to be different from that depicted. An increasing interest rate environment could reduce projected net interest income if deposits and other short-term liabilities re-price faster than expected or re-price faster than the Company’s assets. Actual results could differ from those projected if the Company grows assets and liabilities faster or slower than estimated, if the Company experienced a net outflow of deposit liabilities, or if the mix of assets and liabilities otherwise changes. Actual results could also differ from those projected if the Company experienced substantially different repayment speeds in the loan portfolio than those assumed in the simulation model. Finally, these simulation results do not contemplate all the actions that the Company may undertake in response to potential or actual changes in interest rates, such as changes to the Company’s loan, investment, deposit, or funding strategies.LIBOR Transition
LIBOR is used as an index rate for the Company’s interest rate swaps and caps, a portion of its subordinated debt, various investment securities and approximately 7.6% of the Company’s loans as of September 30, 2021. It is expected that the number of institutions that have been reporting information used to set LIBOR will stop doing so starting after December 31, 2021 through June 30, 2023 when their reporting commitment ends. As a result, LIBOR may no longer be available as an index or may be seen as no longer representative of the market. Alternative reference rates are being identified, but existing contracts may not have been written to allow the use of these alternatives. The Company is evaluating the risks related to this transition and its evaluation and mitigation of risks related to the discontinuation of LIBOR may span several reporting periods through 2023.
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, 2021, 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, 2021, 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 Annual Report on Form 10-K filed with the SEC on March 11, 2021.
Issuer Repurchases of Equity Securities
The following table presents stock purchases made during the third quarter of 2021:
Period
Total Number of Shares Purchased
Average Price Paid Per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1)
Maximum Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1)
July 1 - 31, 2021
-
14,499,391
August 1 - 31, 2021
19,412
16.47
14,179,694
September 1 - 30, 2021
107,095
16.05
12,461,284
126,507
16.11
Unregistered Sales of Equity Securities
None.
Use of Proceeds from Registered Securities
Not applicable.
Exhibit Number
Description
3.1
Second Amended and Restated Articles of Incorporation of Bridgewater Bancshares, Inc. (incorporated herein by reference to Exhibit 3.1 on Form 8-K filed on April 25, 2019).
Amended and Restated Bylaws of Bridgewater Bancshares, Inc. (incorporated herein by reference to Exhibit 3.2 on Form S-1/A filed on March 5, 2018).
Statement of Designation of 5.875% of Non-Cumulative Perpetual Preferred Stock, Series A of Bridgewater Bancshares, Inc. (incorporated herein by reference to Exhibit 3.1 of Bridgewater Bancshares, Inc.’s Form 8-K filed with the SEC on August 17, 2021).
4.1
Indenture, dated July 8, 2021, by and between Bridgewater Bancshares, Inc. and U.S. Bank National Association, as trustee (incorporated herein by reference to Exhibit 4.1 filed with the Form 8-K on July 8, 2021).
4.2
Forms of 3.25% Fixed-to-Floating Rate Subordinated Note due July 15, 2031 (included as Exhibit A-1 and Exhibit A-2 to the Indenture filed as Exhibit 4.1 hereto and incorporated by reference to Exhibit 4.1 filed with the Form 8-K on July 8, 2021).
4.3
Deposit Agreement, dated as of August 17, 2021, among Bridgewater Bancshares, Inc., Computershare Inc. and Computershare Trust Company, N.A., jointly as depositary, and the holders from time to time of the depositary receipts issued thereunder (incorporated herein by reference to Exhibit 4.1 on Form 8-K filed on August 17, 2021).
4.4
Form of depositary receipt representing the Depositary Shares (included as Exhibit A to Exhibit 4.3 hereto).
10.1
Form of Subordinated Note Purchase Agreement, dated July 8, 2021, by and among Bridgewater Bancshares, Inc. and the Purchasers (incorporated herein by reference to Exhibit 10.1 filed with the Form 8-K on July 8, 2021).
10.2
Form of Registration Rights Agreement, dated July 8, 2021, by and among Bridgewater Bancshares, Inc. and the Purchasers (incorporated herein by reference to Exhibit 10.2 filed with the Form 8-K on July 8, 2021).
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, 2021, formatted in inline XBRL interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Income; (iii) Consolidated Statements of Comprehensive Income; (iv) Consolidated Statements of Shareholders’ Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements
The cover page for Bridgewater Bancshares, Inc’s Form 10-Q Report for the quarterly period ended September 30, 2021 formatted in inline XBRL and contained in Exhibit 101
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 4, 2021
By:
/s/ Jerry J. Baack
Name:
Jerry J. Baack
Title:
Chairman, Chief Executive Officer and President(Principal Executive Officer)
/s/ Joe M. Chybowki
Joe M. Chybowski
Chief Financial Officer(Principal Financial and Accounting Officer)