LEVEL ONE BANCORP, INC. The following discussion explains our financial condition as ofDecember 31, 2021 and 2020 and results of operations for the years endedDecember 31, 2021 , 2020 and 2019. The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes presented in Item 8 of this report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Certain risks, uncertainties and other factors, including but not limited to those set forth under "Forward-Looking Statements," "Risk Factors" and elsewhere in this Form 10-K, may cause actual results to differ materially from those projected in the forward-looking statements. We assume no obligation to update any of these forward-looking statements. 32
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Table of Contents
Selected Financial Data
As of and for the year
ended December 31,
(Dollars in thousands, except per share data) 2021 2020 2019
Earnings Summary
Interest income $ 86,650 $ 82,639 $ 70,448
Interest expense 8,051 15,883 19,393
Net interest income 78,599 66,756 51,055
Provision for (recovery of) loan losses (725) 11,872 1,383
Noninterest income 22,372 29,714 14,211
Noninterest expense 61,839 60,232 44,369
Income before income taxes 39,857 24,366 19,514
Income tax provision 7,379 3,953 3,403
Net income 32,478 20,413 16,111
Preferred stock dividends 1,875 479 -
Net income available to common shareholders 30,603 19,934 16,111
Net income allocated to participating securities (1) 441 244 159
Net income attributable to common shareholders (1)
3.95 2.57 2.05
Diluted earnings per common share, excluding acquisition and due diligence fees (2)
3.95 2.74 2.12
Book value per common share 28.02 25.14 22.13
Tangible book value per common share (2) 22.37 19.63 20.86
Preferred shares outstanding (in thousands) 10 10 -
Common shares outstanding (in thousands) 7,734 7,634 7,715
Average basic common shares (in thousands) 7,536 7,627 7,632
Average diluted common shares (in thousands) 7,650 7,686 7,747
Selected Period End Balances
Total assets
397,551 302,732 180,905
Total loans 1,652,771 1,723,537 1,227,609
Total deposits 2,040,082 1,963,312 1,135,428
Total liabilities 2,275,778 2,227,655 1,414,196
Total shareholders' equity 240,091 215,327 170,703
Total common shareholders' equity 216,719 191,955 170,703
Tangible common shareholders' equity (2) 173,033 149,844 160,940
Performance and Capital Ratios
Return on average assets 1.28 % 0.88 % 1.08 %
Return on average equity 14.24 10.61 9.90
Net interest margin (fully taxable equivalent) (3) 3.33 3.10 3.60
Efficiency ratio (noninterest expense/net interest income plus noninterest income)
61.24 62.44 67.98
Dividend payout ratio 5.74 7.37 7.20
Total shareholders' equity to total assets 9.54 8.81 10.77
Tangible common equity to tangible assets (2) 7.00 6.24 10.22
Common equity tier 1 to risk-weighted assets 10.37 9.30 11.72
Tier 1 capital to risk-weighted assets 11.75 10.80 11.72
Total capital to risk-weighted assets 14.76 14.91 15.99
Tier 1 capital to average assets (leverage ratio) 7.93 6.93 10.41
Asset Quality Ratios:
Net (recoveries) charge-offs to average loans 0.01 % 0.13 % 0.02 %
Nonperforming assets as a percentage of total assets 0.46 0.77 1.23
Nonaccrual loans as a percent of total loans 0.68 1.09 1.51
Allowance for loan losses as a percentage of total loans 1.30 1.29 1.03
Allowance for loan losses as a percentage of nonaccrual loans
189.79 118.50 68.40
Allowance for loan losses as a percentage of nonaccrual loans, excluding allowance allocated to loans accounted for under ASC 310-30
184.58 114.95 64.29
(1) Amounts presented are used in the two-class earnings per common share
calculation. This method was adopted by the Company in the second quarter of
2019.
(2) See section entitled "GAAP Reconciliation and Management Explanation of
Non-GAAP Financial Measures" below for a reconciliation to most comparable GAAP
equivalent.
(3) Presented on a tax equivalent basis using a 21% tax rate for the 2019, 2020,
and 2021 periods.
GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures
Some of the financial measures included in this report are not measures of financial condition or performance recognized by GAAP. These non-GAAP financial measures include tangible common shareholders' equity, tangible book value per common share, the ratio of tangible common equity to tangible assets, net income and diluted earnings per common share excluding acquisition and due diligence fees as well as allowance for loan loss as a percentage of total loans excluding PPP loans. Our management uses these non-GAAP financial measures in its analysis of our performance, and we believe that providing this information to financial analysts and investors allows them to evaluate capital adequacy, as well as better understand and evaluate the Company's core financial results for the periods in question.
The following presents these non-GAAP financial measures along with their most directly comparable financial measures calculated in accordance with GAAP:
Tangible Common Shareholders' Equity, Tangible Common Equity to Tangible Assets Ratio and Tangible Book Value Per Share
As of and for the year ended
December 31,
(Dollars in thousands, except per share data) 2021 2020 2019 Total shareholders' equity
23,372 23,372 -
Total common shareholders' equity 216,719 191,955 170,703
Less:
Goodwill 35,554 35,554 9,387 Mortgage servicing rights, net 5,604 3,361 76 Other intangible assets, net 2,528 3,196 300 Tangible common shareholders' equity
Common shares outstanding (in thousands) 7,734 7,634 7,715 Tangible book value per common share$ 22.37 $ 19.63 $ 20.86 Total assets$ 2,515,869 $ 2,442,982 $ 1,584,899 Less: Goodwill 35,554 35,554 9,387 Mortgage servicing rights, net 5,604 3,361 76 Other intangible assets, net 2,528 3,196 300 Tangible assets
Tangible common equity to tangible assets 7.00 % 6.24 % 10.22 %
Adjusted Income and Diluted Earnings Per Share
As of and for the year
ended December 31,
(Dollars in thousands, except per share data) 2021 2020 2019
Net income, as reported $ 32,478 $ 20,413 $ 16,111
Acquisition and due diligence fees - 1,654 539
Income tax benefit (1) - (331) (51)
Net income, excluding acquisition and due diligence fees
$
32,478
Diluted earnings per share, as reported $
3.95
- 0.17 0.07
Diluted earnings per common share, excluding
acquisition and due diligence fees $
3.95
Allowance for Loan Loss as a Percentage of Total Loans, Excluding PPP Loans
As of and for the year ended December 31,
(Dollars in thousands, except per share data) 2021 2020 2019
Total loans $ 1,652,771 $ 1,723,537 $ 1,227,609
Less:
PPP loans 76,505 290,135 -
Total loans, excluding PPP loans $ 1,576,266 $
1,433,402
Allowance for loan loss$ 21,425 $ 22,297 $ 12,674 Allowance for loan loss as a percentage of total loans 1.30 % 1.29 % 1.03 % Allowance for loan loss as a percentage of total loans excluding PPP loans 1.36 % 1.56 % 1.03 % Critical Accounting Policies Our consolidated financial statements are prepared based on the application of accounting policies generally accepted inthe United States . Our significant accounting policies are set forth in Note 1 - Basis of Presentation and Summary of Significant Accounting Policies of the Notes to the Consolidated Financial Statements in our consolidated financial statements included in Item 8. Financial Statements and Supplementary Data in this Form 10-K. Some of these policies require reliance on estimates and assumptions, which are based upon historical experience and on various other assumptions that management believes are reasonable under current circumstances, but may prove to be inaccurate or can be subject to variations. Changes in underlying factors, assumptions, or estimates could have a material impact on our future financial condition and results of operations. AtDecember 31, 2021 , the most critical of these significant accounting policies in understanding the estimates and assumptions involved in preparing our consolidated financial statements were the policies related to the allowance for loan losses, fair value measurement, and goodwill, which are discussed more fully below.
Allowance for Loan Losses
The allowance for loan losses is calculated with the objective of maintaining a reserve sufficient to absorb estimated probable losses. Management's determination of the appropriateness of the allowance is based on periodic evaluations of the loan portfolio, lending-related commitments, and other relevant factors. This evaluation is inherently subjective as it requires numerous estimates, including the loss content for internal risk ratings, collateral values, and the amounts and timing of expected future cash flows. In addition, management may include qualitative adjustments intended to capture the impact of other uncertainties in the lending environment such as underwriting standards, current economic and political conditions, and other factors affecting the credit quality. Changes to one or more of the estimates used would result in a different estimated allowance for loan loss.
Fair Value Measurement
Investment securities available-for-sale, derivatives, loans held for sale, and
certain other loans are recorded at fair value on a recurring basis.
Additionally, from time to time, other assets and liabilities may be recorded at
fair value on a nonrecurring basis, such as impaired loans, other real estate,
and certain other assets and liabilities. Fair value is an estimate of the
exchange
33
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price that would be received to sell an asset or paid to transfer a liability in
an orderly transaction (i.e., not a forced transaction, such as a liquidation or
distressed sale) between market participants at the measurement date and is
based on the assumptions market participants would use when pricing an asset or
liability. Fair value measurement and disclosure guidance establishes a
three-level hierarchy for disclosure of assets and liabilities recorded at fair
value.
At December 31, 2021 , assets and liabilities measured using observable inputs
that are classified as Level 1 or Level 2 represented 97.45% and 100.00% of
total assets and liabilities recorded at fair value, respectively. Valuations
generated from model-based techniques that use at least one significant
assumption not observable in the market are considered Level 3 and reflect
estimates of assumptions market participants would use in pricing the asset or
liability.
Valuation and Recoverability of
Goodwill represents$35.6 million of our$2.52 billion in total assets as ofDecember 31, 2021 . We review goodwill for impairment annually as ofOctober 1st and also test for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of our Company below its carrying amount. The accounting estimates related to our goodwill require us to make considerable assumptions about fair values. Our assumptions regarding fair values require significant judgment about economic and industry factors and the growth and earnings prospects of the Company. Changes in these judgements, either individually or collectively, may have a significant effect on the estimated fair values. OverviewLevel One Bancorp, Inc. is a financial holding company headquartered inFarmington Hills, Michigan , with its primary branch operations in southeastern and westMichigan . Through our wholly owned subsidiary,Level One Bank , we offer a broad range of loan products to the residential and commercial markets, as well as retail and business banking services.Hamilton Court Insurance Company , a wholly owned subsidiary of the Company, provided property and casualty insurance to the Company and the Bank and reinsurance to ten other third-party insurance captives for which insurance may not have been available or economically feasible in the insurance marketplace.Hamilton Court Insurance Company exited the pool resources relationship to which it was previously a member and was dissolved inJanuary 2021 . Our principal business activities have been lending to and accepting deposits from individuals, businesses, municipalities and other entities. We derive income principally from interest charged on loans and leases and, to a lesser extent, from interest and dividends earned on investment securities. We have also derived income from noninterest sources, such as fees received in connection with various lending and deposit services and originations and sales of residential mortgage loans. Our principal expenses include interest expense on deposits and borrowings, operating expenses, such as salaries and employee benefits, occupancy and equipment expenses, data processing costs, professional fees and other noninterest expenses, provisions for loan losses and income tax expense. Since 2007, we have grown substantially through organic growth and a series of five acquisitions, all of which have been fully integrated into our operations. We have made significant investments over the last several years in hiring additional staff and upgrading technology and system security. In 2016, we opened our first branch in theGrand Rapids, Michigan market. In the third quarter of 2017, we opened our second location inBloomfield Township located inOakland County . In the third quarter of 2018, we doubled the size of our mortgage division with the addition of new mortgage officers and support staff. OnJanuary 2, 2020 , the Company completed its acquisition ofAnn Arbor Bancorp, Inc. ("AAB") and its wholly owned subsidiary,Ann Arbor State Bank . The transaction was completed pursuant to a merger of the Company's wholly owned merger subsidiary ("Merger Sub") with and into AAB, pursuant to the Agreement and Plan of Merger, dated as ofAugust 12, 2019 , among the Company, Merger Sub and AAB. The Company paid aggregate consideration of approximately$67.9 million in cash. Our results of operations for the years endedDecember 31, 2021 and 2020 include the results of operations of AAB on and afterJanuary 2, 2020 , including$1.7 million of acquisition fees. Results for periods beforeJanuary 2, 2020 reflect only those of Level One and do not include the results of operations of AAB. See "Note 2 - Business Combinations" for more information. In addition, all identifiable assets, including the intangible assets that consisted of$26.2 million in goodwill and$3.7 million in core deposit intangibles, and liabilities of AAB as of the merger date have been recorded at their estimated fair value and added to those of Level One. Recent Developments Fourth Quarter Common Stock Dividend. OnDecember 15, 2021 , Level One's Board of Directors declared a fourth quarter 2021 cash dividend of$0.06 per common share. The dividend was paid onJanuary 14, 2022 , to shareholders of record at the close of business onDecember 31, 2021 . 34 -------------------------------------------------------------------------------- First Quarter Preferred Stock Dividend. OnJanuary 19, 2022 , Level One's Board of Directors declared a quarterly cash dividend of$46.88 per share on its 7.50% Non-Cumulative Perpetual Preferred Stock, Series B. Holders of depositary shares will receive$0.4688 per depositary share. The dividend is payable onFebruary 15, 2022 , to shareholders of record at the close of business onJanuary 31, 2022 . Impact of COVID-19 Pandemic. The COVID-19 pandemic inthe United States has had, and is expected to continue to have, a complex and significant impact on the economy, the banking industry and the Company. Effects on Our Business. We currently expect that the COVID-19 pandemic, federal, state and local government responses to the pandemic, supply disruptions, labor availability challenges, and the effects of existing and future variants of the disease, such as the Delta variant, may continue to have a significant impact on our business. A substantial portion of the Bank's borrowers in the restaurant and hospitality industries have endured substantial economic distress, and while those challenges have been largely mitigated by the PPP and other governmental assistance, there is still some uncertainty about the ability of these clients to return to cash flow levels necessary to cover their debt service. These developments, together with economic conditions generally, are also expected to impact our commercial real estate portfolio, particularly with respect to real estate with exposure to these industries and the value of certain collateral securing our loans. Level One's Response to the COVID-19 Pandemic. Level One has taken comprehensive steps to help our customers, team members and communities during the COVID-19 pandemic. For our customers, we have provided loan payment deferrals and offered fee waivers, among other actions. Level One was also a participating lender in both the first and second rounds of the PPP. In 2020, the Bank originated 2,208 PPP loans in the aggregate principal amount of$417.0 million . FromJanuary 18, 2021 throughJune 30, 2021 , Level One funded 1,532 new PPP loan applications for$234.3 million , of which 1,187 were for loans$150,000 or below. As ofDecember 31, 2021 ,$76.5 million of PPP loans were still outstanding. The Bank is actively working with the borrowers of PPP loans to obtain loan forgiveness from the SBA.
Level One also recognizes that some of the most impacted industries are the
restaurant and hospitality industries. As of
Results of Operations
Net Income
We had net income of $32.5 million , or $3.95 per diluted common share, for the
year ended December 31, 2021 , compared to $20.4 million , or $2.57 per diluted
common share, for the year ended December 31, 2020 . The increase of $12.1
million in net income primarily reflected an increase of $11.8 million in net
interest income, primarily due to higher interest income on loans due, in part,
to the recognition of fees on PPP loans as they are forgiven. In addition, there
was higher interest income on securities due to increased volumes of investment
securities and lower interest expense on deposits, borrowed funds, and
subordinated notes. The increase in net income also reflected a decrease of
$12.6 million in provision for loan loss, primarily due to a decrease in general
reserves resulting from an increase in the economic qualitative factors in the
year ended December 31, 2020 and a reduction in qualitative factors in the third
quarter of 2021. These were partially offset by a $7.3 million decrease in
noninterest income primarily due to lower mortgage banking activities and net
gain on sales of securities partially offset by an increase in service charges
on deposits. In addition, there were increases of $3.4 million of income tax
provision primarily due to higher income before taxes and $1.6 million of
noninterest expense primarily due to higher salary and employee benefits, other
expense, data processing expense, and professional services fees partially
offset by lower acquisition and due diligence fees.
Net Interest Income
Our primary source of revenue is net interest income, which is the difference between interest income from interest-earning assets (primarily loans and securities) and interest expense of funding sources (primarily interest-bearing deposits and borrowings). Net interest income of$78.6 million for the year endedDecember 31, 2021 was$11.8 million higher than the net interest income of$66.8 million for the year endedDecember 31, 2020 . The year endedDecember 31, 2021 included a$4.0 million increase in interest income as well as a$7.8 million decrease in interest expense, compared toDecember 31, 2020 . The increase in interest income was primarily driven by increases of$2.9 million in interest and fees on loans and$1.4 million in interest on investment securities. The increase in interest and fees on loans for the year endedDecember 31, 2021 compared to the same period in 2020 was mainly driven by the Bank earning$12.9 million of net SBA fees on PPP loans compared to$6.5 million for the year endedDecember 31, 2020 . The increase in interest income on investment securities was mainly due to an increase of$123.7 million in average balances due to excess liquidity from PPP loan forgiveness and increased customer liquidity. 35 -------------------------------------------------------------------------------- The decrease in interest expense was primarily driven by a decrease of$6.7 million in interest expense on deposits and a decrease of$1.2 million in interest expense on borrowed funds and subordinated notes. The decrease in deposit interest expense was primarily due to lower interest rates paid as a result of revised internal deposit rates and maturity of higher cost time deposits. The decrease in interest expense on borrowed funds and subordinated notes was primarily due to the redemption of$15.0 million of subordinated notes during the second quarter of 2021 and a decrease in FHLB borrowings. Our net interest margin (FTE) for the year endedDecember 31, 2021 was 3.33%, compared to 3.10% for the same period in 2020. The increase of 23 basis points in the net interest margin year over year was primarily a result of a decrease in cost of funds, which declined 52 basis points to 0.53% in 2021, compared to 1.05% in 2020 primarily due to lower interest rates paid as a result of revised internal deposit rates and maturity of higher cost time deposits. The decrease in cost of funds was accompanied by a lower yields across most interest-earning assets, mostly reflecting the impact of lower market interest rates. Our net interest margin benefits from discount accretion on our purchased credit impaired loan portfolios, a component of our accretable yield. The accretable yield represents the excess of the net present value of expected future cash flows over the acquisition date fair value and includes both the expected coupon of the loan and the discount accretion. The accretable yield is recognized as interest income over the expected remaining life of the purchased credit impaired loan. The difference between the actual yield earned on total loans and the yield generated based on the contractual coupon (not including any interest income for loans in nonaccrual status) represents excess accretable yield. The contractual coupon of the loan considers the contractual coupon rates of the loan and does not include any interest income for loans in nonaccrual status. For the years endedDecember 31, 2021 and 2020, the yield on total loans was impacted by 6 basis points and 7 basis points due to the accretable yield on purchased credit impaired loans. Our net interest margin for the years endedDecember 31, 2021 and 2020, benefited by 4 basis points and 8 basis points, respectively, as a result of the excess accretable yield. As ofDecember 31, 2021 andDecember 31, 2020 , our remaining accretable yield was$5.7 million and$7.1 million , respectively, and our nonaccretable difference was$1.4 million and$2.7 million , respectively. 36 -------------------------------------------------------------------------------- The following table sets forth information related to our average balance sheet, average yields on assets, and average rates on liabilities for the periods indicated. We derived these yields by dividing income or expense by the average daily balance of the corresponding assets or liabilities. In this table, adjustments were made to the yields on tax-exempt assets in order to present tax-exempt income and fully taxable income on a comparable basis.
Analysis of Net Interest Income-Fully Taxable Equivalent
For the years ended December 31,
(Dollars in thousands) 2021 2020 2019
Average Balance Sheets:
Gross loans(1)
254,913 138,837 129,274
Tax-exempt 103,609 96,020 84,392
Interest-earning cash balances 218,931 194,545 38,268
Other investments 14,398 12,903 8,523
Total interest-earning assets $ 2,383,522 $ 2,172,775 $ 1,429,943
Non-earning assets: 145,990 135,229 68,015
Total assets $ 2,529,512 $ 2,308,004 $ 1,497,958
Interest-bearing demand deposits
613,883 496,827 314,918
Time deposits 519,447 573,823 527,605
Borrowings 183,503 279,949 79,864
Subordinated notes 36,376 44,490 16,061
Total interest-bearing liabilities 1,515,614 1,510,338 995,928
Noninterest-bearing demand deposits 754,376 574,537 321,487
Other liabilities 31,466 30,787 17,750
Shareholders' equity 228,056 192,342 162,793
Total liabilities and shareholders' equity $ 2,529,512 $ 2,308,004 $ 1,497,958
Yields: (3)
Earning Assets
Gross loans 4.43 % 4.42 % 5.42 %
Investment securities:
Taxable 1.58 % 1.93 % 2.71 %
Tax-exempt 3.02 % 3.19 % 3.27 %
Interest earning cash balances 0.13 % 0.24 % 2.23 %
Other investments 3.13 % 4.07 % 5.26 %
Total interest earning assets 3.66 % 3.83 % 4.96 %
Interest-bearing liabilities
Interest-bearing demand deposits 0.14 % 0.28 % 0.49 %
Money market and savings deposits 0.19 % 0.56 % 1.43 %
Time deposits 0.56 % 1.38 % 2.30 %
Borrowings 1.02 % 0.84 % 1.73 %
Subordinated notes 5.12 % 5.70 % 6.69 %
Total interest-bearing liabilities 0.53 % 1.05 % 1.95 %
Interest spread 3.13 % 2.78 % 3.01 %
Net interest margin(4) 3.30 % 3.07 % 3.57 %
Tax equivalent effect 0.03 % 0.03 % 0.03 %
Net interest margin on a fully tax equivalent basis 3.33 % 3.10 % 3.60 %
(1) Includes nonaccrual loans.
(2) For presentation in this table, average balances and the corresponding
average rates for investment securities are based upon historical cost, adjusted
for amortization of premiums and accretion of discounts.
(3) Average rates and yields are presented on an annual basis and include a
taxable equivalent adjustment to interest income of $617 thousand , $574 thousand
and $453 thousand on tax-exempt securities for the years ended December 31,
2021 , 2020 and 2019, respectively, using the federal corporate tax rate of 21%.
(4) Net interest margin represents net interest income divided by average total
interest-earning assets.
37
--------------------------------------------------------------------------------Rate/Volume Analysis
The table below presents the effect of volume and rate changes on interest
income and expense for the periods indicated. Changes in volume are changes in
the average balance multiplied by the previous period's average rate. Changes in
rate are changes in the average rate multiplied by the average balance from the
previous period. The net changes attributable to the combined impact of both
rate and volume have been allocated proportionately to the changes due to volume
and the changes due to rate. The average rate for tax-exempt securities is
reported on a fully taxable equivalent basis.
For the year
ended
Increase
(Decrease) Due to:
Net Increase
(Dollars in thousands) Rate Volume (Decrease)
Interest-earning assets
Gross loans $ 163 $ 2,711 $ 2,874
Investment securities:
Taxable (547) 1,906 1,359
Tax-exempt (210) 234 24
Interest-earning cash balances (225) 53 (172)
Other investments (130) 56 (74)
Total interest income (949) 4,960 4,011
Interest-bearing liabilities
Interest-bearing demand deposits (190) 102 (88)
Money market and savings deposits (2,128) 542 (1,586)
Time deposits (4,317) (689) (5,006)
Borrowings 439 (917) (478)
Subordinated debt (242) (432) (674)
Total interest expense (6,438) (1,394) (7,832)
Change in net interest income $ 5,489
For the year
ended
Increase
(Decrease) Due to:
Net Increase
(Dollars in thousands) Rate Volume (Decrease)
Interest-earning assets
Gross loans $ (13,194) $ 26,353 $ 13,159
Investment securities:
Taxable (1,076) 244 (832)
Tax-exempt (191) 372 181
Interest-earning cash balances (1,327) 933 (394)
Other investments (117) 194 77
Total interest income (15,905) 28,096 12,191
Interest-bearing liabilities
Interest-bearing demand deposits (157) 198 41
Money market and savings deposits (3,589) 1,830 (1,759)
Time deposits (5,217) 987 (4,230)
Borrowings (1,009) 1,984 975
Subordinated debt (180) 1,643 1,463
Total interest expense (10,152) 6,642 (3,510)
Change in net interest income $ (5,753)
38
--------------------------------------------------------------------------------Provision for Loan Losses
We established an allowance for loan losses through a provision for loan losses charged as an expense in our consolidated statements of income. Management reviews the loan portfolio, consisting of originated loans and acquired loans, on a quarterly basis to evaluate the outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses. Loans acquired in connection with acquisitions that have evidence of credit deterioration since origination and for which it is probable at the date of acquisition that we will not collect all contractually required principal and interest payments are accounted for under ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, or ASC 310-30. These credit-impaired loans have been recorded at their estimated fair value on the respective acquisition date, based on subjective determinations regarding risk ratings, expected future cash flows and fair value of the underlying collateral, without a carryover of the related allowance for loan losses. At the acquisition date, the Company recognizes the expected shortfall of expected future cash flows, as compared to the contractual amount due, as a nonaccretable discount. Any excess of the net present value of expected future cash flows over the acquisition date fair value is recognized as the accretable discount, or accretable yield. We evaluate these loans semi-annually to assess expected cash flows. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges or a reclassification of the difference from nonaccretable to accretable with a positive impact on interest income. As ofDecember 31, 2021 , andDecember 31, 2020 , our remaining accretable yield was$5.7 million and$7.1 million , and our nonaccretable difference was$1.4 million and$2.7 million , respectively. The provision for loan losses was a provision benefit of$725 thousand for the year endedDecember 31, 2021 , compared to a provision expense of$11.9 million for the year endedDecember 31, 2020 . The decrease of$12.6 million in the provision for loan losses was primarily due to a decrease in general reserves of$10.6 million due to a reduction in qualitative factors within the allowance for loan loss model as a result of improved credit quality while qualitative factors were increased during the year endedDecember 31, 2020 due to economic uncertainty regarding the impact of the COVID-19 pandemic on credit quality. In addition, there was a decrease of$2.1 million in net chargeoffs resulting from a$1.3 million chargeoff on a nonaccrual loan during the second quarter of 2020.
Noninterest Income
The following table presents noninterest income for the years endedDecember 31, 2021 , 2020 and 2019. For the year ended December 31, (Dollars in thousands) 2021 2020 2019 Noninterest income Service charges on deposits$ 3,311 $ 2,446 $ 2,547 Net gain on sales of securities 21 1,862 1,174 Mortgage banking activities 15,843 22,190 7,880 Other charges and fees 3,197 3,216 2,610 Total noninterest income$ 22,372 $ 29,714 $ 14,211 Noninterest income decreased$7.3 million to$22.4 million for the year endedDecember 31, 2021 , compared to$29.7 million for the same period in 2020. The decrease in noninterest income was primarily due to decreases of$6.3 million in mortgage banking activities and$1.8 million in net gain on sales of securities. These decreases were partially offset by an increase of$865 thousand in service charges on deposits. The decrease in mortgage banking activities was primarily due to$115.7 million lower residential loan originations held for sale and$56.0 million lower residential loans sold. The higher volumes in the year endedDecember 31, 2020 were primarily due to a decrease in interest rates during the first half of 2020 while interest rates have remained relatively stable in 2021. The decrease in net gains on sales of securities was primarily due to fewer securities sold during 2021 compared to 2020. The increase in service charges on deposits was due to higher transaction volumes and deposit balances. 39
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Noninterest Expense
The following table presents noninterest expense for the years endedDecember 31, 2021 , 2020 and 2019. For the year ended December 31, (Dollars in thousands) 2021 2020 2019 Noninterest expense Salary and employee benefits$ 39,353 $ 38,304 $ 28,775 Occupancy and equipment expense 6,631 6,549 4,939 Professional service fees 3,542 2,935 1,808 Acquisition and due diligence fees - 1,654 539 FDIC premium 1,027 1,119 310 Marketing expense 1,288 956 1,107 Loan processing expense 983 935 661 Data processing expense 4,125 3,460 2,374 Core deposit premium amortization 668 768 146 Other expense 4,222 3,552 3,710 Total noninterest expense$ 61,839 $ 60,232 $ 44,369 Noninterest expense increased$1.6 million to$61.8 million for the year endedDecember 31, 2021 , compared to$60.2 million for the same period in 2020. The increase in noninterest expense was primarily due to increases in salary and employee benefits of$1.0 million , other expense of$670 thousand , data processing expense of$665 thousand , professional service fees of$607 thousand , and marketing expense of$332 thousand . These increases were partially offset by a decrease of$1.7 million in acquisition and due diligence fees. The increase in salary and employee benefits was primarily due to annual compensation increases and an increase of 8 full-time equivalent employees. The increase in other expenses was primarily due to an increase in fraud losses. The increase in data processing expense was primarily due to a new loan processing system used for PPP loans. The increase in professional fees was primarily due to fees related to the pending merger. The increase in marketing expense was primarily due to an increase in advertising efforts. The decrease in acquisition and due diligence fees was due to the acquisition ofAnn Arbor State Bank in the first quarter of 2020.
Income Taxes and Tax-Related Items
During the year endedDecember 31, 2021 , we recognized income tax expense of$7.4 million on$39.9 million of pre-tax income resulting in an effective tax rate of 18.5%, compared to the same period in 2020, in which we recognized an income tax expense of$4.0 million on$24.4 million of pre-tax income, resulting in an effective tax rate of 16.2%. The increase in income tax provision for the year endedDecember 31, 2021 compared to the same period in 2020 was primarily as a result of higher income before taxes. Additionally, a$290 thousand tax benefit related to theAnn Arbor State Bank net operating loss (NOL) in the first quarter of 2020 resulting from the Coronavirus Aid, Relief and Economic Security Act ("CARES Act") provision that allows for NOLs generated in 2018 to 2020 to be carried back five years as well as disqualified dispositions ofAnn Arbor State Bank's stock options generated a$175 thousand tax benefit in the first quarter of 2020.
See "Note 11 - Income Taxes" of Notes to Consolidated Financial Statements for a
reconciliation between expected and actual income tax expense for the years
ended
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Financial Condition
Investment Securities The following table presents the fair value of the Company's investment
securities portfolio, all of which were classified as available-for-sale as of
As of December 31,
(Dollars in thousands) 2021 2020 2019
Securities available-for-sale:
U.S. government sponsored entities and agencies $ 21,774 $ 26,358 $ -
State and political subdivision 148,276 132,723 93,747
Mortgage-backed securities: residential 22,211 26,081 10,565
Mortgage-backed securities: commercial 23,271 11,918 8,779
Collateralized mortgage obligations: residential 13,461 13,446 8,529
Collateralized mortgage obligations: commercial 51,183 58,512 23,181
U.S. Treasury 64,387 - 1,999
SBA 13,927 17,593 21,984
Asset backed securities 9,706 10,072 10,084
Corporate bonds 29,355 6,029 2,037
Total securities available-for-sale $ 397,551 $
302,732
The composition of our investment securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity for both normal operations and potential acquisitions, while providing an additional source of revenue. The investment portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet, while providing a vehicle for the investment of available funds, furnishing liquidity, and supplying securities to pledge as collateral. AtDecember 31, 2021 , total investment securities were$397.6 million , or 15.8% of total assets, compared to$302.7 million , or 12.4% of total assets, atDecember 31, 2020 . The$94.8 million increase in securities available-for-sale fromDecember 31, 2020 toDecember 31, 2021 , was due to the purchase of securities using the excess cash balances generated by the payoffs and forgiveness of PPP loans. Securities with a carrying value of$88.6 million and$98.7 million were pledged atDecember 31, 2021 andDecember 31, 2020 , respectively, to secure borrowings, deposits and mortgage derivatives. As ofDecember 31, 2021 , the Company held 68 tax-exempt state and local municipal securities totaling$52.3 million backed by theMichigan School Bond Loan Fund . Other than the aforementioned investments and theU.S. government and its agencies, atDecember 31, 2021 andDecember 31, 2020 , there were no holdings of securities of any one issuer in an amount greater than 10% of shareholders' equity. The securities available-for-sale presented in the following tables are reported at amortized cost and by contractual maturity as ofDecember 31, 2021 andDecember 31, 2020 . Expected maturities may differ from contractual maturities as issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Additionally, residential mortgage-backed securities and collateralized mortgage obligations receive monthly principal payments, which are not reflected below. The yields below are calculated on a tax equivalent basis. 41 --------------------------------------------------------------------------------
December 31, 2021
One year or less One to five years Five to ten years After ten years
Amortized Average Amortized Average Amortized Average Amortized Average
(Dollars in thousands) Cost Yield Cost Yield Cost Yield Cost Yield
Securities available-for-sale:
U.S. government sponsored agency
obligations $ 2,522 1.61 % $ - - % $ 15,000 1.22 % $ 5,000 1.48 %
State and political subdivision 1,341 2.41 12,869 2.42 53,553 2.68 73,988 2.88
Mortgage-backed securities:
residential - - 73 1.90 27 1.92 22,216 1.09
Mortgage-backed securities:
commercial - - 5,090 2.44 16,534 1.27 1,787 3.63
Collateralized mortgage
obligations: residential - - 326 2.91 163 1.20 13,068 1.21
Collateralized mortgage
obligations: commercial 2,248 5.62 4,424 2.77 38,782 1.20 6,428 1.96
U.S. Treasury - - 35,705 0.87 29,393 1.34 - -
SBA - - - - 7,424 1.45 6,427 1.31
Asset backed securities - - - - - - 9,762 0.76
Corporate bonds - - - - 29,673 3.61 - -
Total securities available-for-sale $ 6,111 3.26 % $ 58,487 1.51 % $ 190,549 2.03 % $ 138,676 2.13 %
December 31, 2020
One year or less One to five years Five to ten years After ten years
Amortized Average Amortized Average Amortized Average Amortized Average
(Dollars in thousands) Cost Yield Cost Yield Cost Yield Cost Yield
Securities available-for-sale:
U.S. government sponsored agency
obligations $ 4,027 1.61 % $ 2,548 1.61 % $ 15,000 1.22 % $ 5,000 1.48 %
State and political subdivision 1,768 1.96 10,095 2.46 31,142 2.80 81,048 2.99
Mortgage-backed securities:
residential - - 78 0.94 87 0.19 25,564 1.44
Mortgage-backed securities:
commercial 847 1.36 3,795 2.46 4,985 1.69 1,807 3.64
Collateralized mortgage
obligations: residential - - 46 4.02 559 2.11 12,715 1.25
Collateralized mortgage
obligations: commercial 577 2.54 8,011 3.10 40,889 1.26 7,921 2.46
SBA - - - - 9,879 1.40 7,760 1.21
Asset backed securities - - - - - - 10,229 0.84
Corporate bonds 3,498 3.08 - - 2,500 4.38 - -
Total securities available-for-sale $ 10,717 2.18 % $ 24,573 2.58 % $ 105,041 1.82 % $ 152,044 2.28 %
Loans
Our loan portfolio represents a broad range of borrowers comprised of commercial
real estate, commercial and industrial, residential real estate, and consumer
financing loans.
Commercial real estate loans consist of term loans secured by a mortgage lien on
the real property, such as office and industrial buildings, retail shopping
centers and apartment buildings, as well as commercial real estate construction
loans that are offered to builders and developers. Commercial real estate loans
are then segregated into two classes: non-owner occupied and owner occupied
commercial real estate loans. Non-owner occupied loans, which include loans
secured by non-owner occupied and nonresidential properties, generally have a
greater risk profile than owner-occupied loans, which include loans secured by
multifamily structures and owner-occupied commercial structures.
Commercial and industrial loans include financing for commercial purposes in
various lines of business, including manufacturing, service industry and
professional service areas. Commercial and industrial loans are generally
secured with the assets of the company and/or the personal guarantee of the
business owners. The PPP loans funded during the second and third quarters of
2020 and first and second quarters of 2021, which are guaranteed by the SBA, are
reported within the commercial and industrial loan category.
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Residential real estate loans represent loans to consumers for the purchase or
refinance of a residence. These loans are generally financed over a 15- to
30-year term and, in most cases, are extended to borrowers to finance their
primary residence with both fixed-rate and adjustable-rate terms. Real estate
construction loans are also offered to consumers who wish to build their own
homes and are often structured to be converted to permanent loans at the end of
the construction phase, which is typically twelve months. Residential real
estate loans also include home equity loans and lines of credit that are secured
by a first- or second-lien on the borrower's residence. Home equity lines of
credit consist mainly of revolving lines of credit secured by residential real
estate.
Consumer loans include loans made to individuals not secured by real estate,
including loans secured by automobiles or watercraft, and personal unsecured
loans.
The following table details our loan portfolio by loan type at the dates
presented:
As of December 31,
(Dollars in thousands) 2021 2020 2019 2018 2017
Commercial real estate:
Non-owner occupied $ 467,364 $ 445,810 $ 388,515 $ 367,671 $ 343,420
Owner occupied 283,400 275,022 216,131 194,422 168,342
Total commercial real estate 750,764 720,832 604,646 562,093 511,762
Commercial and industrial 460,530 685,504 410,228 383,455 377,686
Residential real estate 440,640 315,476 211,839 180,018 144,439
Consumer 837 1,725 896 999 1,036
Total loans $ 1,652,771 $ 1,723,537 $ 1,227,609 $ 1,126,565 $ 1,034,923
Total loans were $1.65 billion at December 31, 2021 , a decrease of $70.8 million
from December 31, 2020 . The decline in our loan portfolio compared to December
31, 2020 was primarily due to a $225.0 million decrease in our commercial and
industrial loan portfolio, $213.6 million of which was due to the net change in
PPP loans. This was partially offset by an increase of $125.2 million in our
residential real estate portfolio. In general, we target a loan portfolio mix of
approximately one-half commercial real estate, approximately one-third
commercial and industrial loans and one-sixth a mix of residential real estate
and consumer loans. As of December 31, 2021 , approximately 45.4% of our loans
were commercial real estate, 27.9% were commercial and industrial, and 26.7%
were residential real estate and consumer loans.
We originate both fixed and adjustable rate residential real estate loans
conforming to the underwriting guidelines of Fannie Mae and Freddie Mac, as well
as home equity loans and lines of credit that are secured by first or junior
liens. Most of our fixed rate residential loans, along with some of our
adjustable rate mortgages, are sold to Fannie Mae and other financial
institutions with which we have established a correspondent lending
relationship. The Company established a direct relationship with Fannie Mae and
began locking and selling loans to Fannie Mae with servicing retained during the
third quarter of 2019. Refer to Note 8 - Mortgage Servicing Rights, Net for
further details on our mortgage servicing rights.
Loan Maturity/Rate Sensitivity
The following table shows the contractual maturities of our loans as ofDecember 31, 2021 . After one but After five but One year or within five within fifteen After fifteen (Dollars in thousands) less years years years
Total
December 31, 2021 Commercial real estate$ 90,512 $
422,681
135,940 243,580 78,135 2,875 460,530
Residential real estate 25,846 8,366 39,740 366,688 440,640 Consumer 62 586 40 149 837 Total loans$ 252,360 $ 675,213 $ 346,347 $ 378,851 $ 1,652,771 Sensitivity of loans to changes in interest rates: Fixed interest rates $
576,033
99,180 168,524 229,881 Total$ 675,213 $ 346,347 $ 378,851 43
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Summary of Impaired Assets and Past Due Loans
Nonperforming assets consist of nonaccrual loans and other real estate owned. We do not consider performing TDRs to be nonperforming assets, but they are included as part of impaired assets. The level of nonaccrual loans is an important element in assessing asset quality. Loans are classified as nonaccrual when, in the opinion of management, collection of principal or interest is not expected according to the terms of the agreement. Generally, loans are placed on nonaccrual status due to the continued failure by the borrower to adhere to contractual payment terms coupled with other pertinent factors, such as insufficient collateral value. A loan is categorized as a troubled debt restructuring if a concession is granted, such as to provide for the reduction of either interest or principal, due to deterioration in the financial condition of the borrower. Typical concessions include reduction of the interest rate on the loan to a rate considered lower than the current market rate, forgiveness of a portion of the loan balance, extension of the maturity date, and/or modifications from principal and interest payments to interest-only payments for a certain period. Loans are not classified as TDRs when the modification is short-term or results in only an insignificant delay or shortfall in the payments to be received. In accordance with bank regulatory guidance, troubled debt restructurings do not include short-term modifications made on a good-faith basis in response to the COVID-19 pandemic to borrowers who were current prior to any relief. This includes short-term modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. As ofDecember 31, 2021 , there were no loans that remained on a COVID-related deferral compared to$20.1 million as ofDecember 31, 2020 .
Credit Quality Indicators:
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes commercial and industrial and commercial real estate loans and is performed on an annual basis. The Company uses the following definitions for risk ratings: Pass. Loans classified as pass are higher quality loans that do not fit any of the other categories described below. This category includes loans risk rated with the following ratings: cash/stock secured, excellent credit risk, superior credit risk, good credit risk, satisfactory credit risk, and marginal credit risk. Special Mention. Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company's credit position at some future date. Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
For residential real estate loans and consumer loans, the Company evaluates credit quality based on the aging status of the loan and by payment activity. Residential real estate loans and consumer loans are considered nonperforming if they are 90 days or more past due. Consumer loan types are continuously monitored for changes in delinquency trends and other asset quality indicators. Purchased credit impaired loans accounted for under ASC 310-30 are classified as performing, even though they may be contractually past due, as any nonpayment of contractual principal or interest is considered in the semi-annual re-estimation of expected cash flows and is included in the resulting recognition of current period loan loss provision or future period yield adjustments.
Total classified and criticized loans as of
44
--------------------------------------------------------------------------------(Dollars in thousands) December 31, 2021 December 31, 2020 Classified loans: Substandard $ 24,866 $ 34,921 Doubtful 1,477 1,143 Total classified loans $ 26,343 $ 36,064 Special mention 74,254 47,297
Total classified and criticized loans $ 100,597 $
83,361
A summary of nonperforming assets (defined as nonaccrual loans and other real
estate owned), performing troubled debt restructurings and loans 90 days or more
past due and still accruing, as of the dates indicated, are presented below.
As of December 31,
(Dollars in thousands) 2021 2020 2019
Nonaccrual loans
Commercial real estate $ 4,246 $ 7,320 $ 4,832
Commercial and industrial 4,208 7,490 11,112
Residential real estate 2,819 3,991 2,569
Consumer 16 15 16
Total nonaccrual loans(1) 11,289 18,816 18,529
Other real estate owned 201 - 921
Total nonperforming assets 11,490 18,816 19,450
Performing troubled debt restructurings
Commercial and industrial 334 546 547
Residential real estate 365 432 359
Total performing troubled debt restructurings 699 978 906
Total impaired assets, excluding ASC 310-30 loans
269
(1)Nonaccrual loans include nonperforming troubled debt restructurings of
During the years endedDecember 31, 2021 and 2020, the Company recorded$641 thousand and$234 thousand , respectively, of interest income on nonaccrual loans and performing TDRs excluding PCI loans.
In addition to nonperforming and impaired assets, the Company had purchased
credit impaired loans accounted for under ASC 310-30 which amounted to
Nonperforming assets decreased$7.3 million as ofDecember 31, 2021 compared toDecember 31, 2020 . The decrease in nonperforming assets was attributable to a decrease in nonaccrual loans primarily due to pay offs of four commercial loan relationships totaling$5.4 million , paydowns on four commercial loan relationships totaling$3.9 million , and one$759 thousand residential loan relationship moving back to accruing. This was partially offset by two commercial loan relationships moving to nonaccrual status totaling$2.6 million .
Allowance for Loan Losses
We maintain the allowance for loan losses at a level we believe is sufficient to absorb probable incurred losses in our loan portfolio given the conditions at the time. Management determines the adequacy of the allowance based on periodic evaluations of the loan portfolio and other factors. These evaluations are inherently subjective as they require management to make material estimates, all of which may be susceptible to significant change. The allowance is increased by provisions charged to expense and decreased by actual charge-offs, net of recoveries.
Acquired Loans
The allowance for loan losses on acquired loans is based on credit deterioration
subsequent to the acquisition date. In accordance with the accounting guidance
for business combinations, there was no allowance brought forward on any of the
acquired loans as any credit deterioration evident in the loans was included in
the determination of the fair value of the loans at
45
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the acquisition date. For purchased credit impaired loans, accounted for under
ASC 310-30, management establishes an allowance for credit deterioration
subsequent to the date of acquisition by re-estimating expected cash flows on a
semi-annual basis with any decline in expected cash flows recorded as provision
for loan losses. Impairment is measured as the excess of the recorded investment
in a loan over the present value of expected future cash flows discounted at the
pre-impairment accounting yield of the loan. For increases in cash flows
expected to be collected, we first reverse any previously recorded allowance for
loan losses, then adjust the amount of accretable yield recognized on a
prospective basis over the loan's remaining life. These cash flow evaluations
are inherently subjective as they require material estimates, all of which may
be susceptible to significant change. For non-purchased credit impaired loans
acquired in our acquisitions that are accounted for under ASC 310-20, the
historical loss estimates are based on the historical losses experienced since
acquisition. We record an allowance for loan losses only when the calculated
amount exceeds the discount remaining from acquisition that was established for
the similar period covered in the allowance for loan loss calculation. For all
other purchased loans, the allowance is calculated in accordance with the
methods used to calculate the allowance for loan losses for originated loans, as
described below.
Originated Loans
The allowance for loan losses represents management's assessment of probable
credit losses inherent in the loan portfolio. The allowance for loan losses
consists of specific components, based on individual evaluation of certain
loans, and general components for homogeneous pools of loans with similar risk
characteristics.
Impaired loans include loans placed on nonaccrual status and troubled debt
restructurings. Loans are considered impaired when based on current information
and events it is probable that we will be unable to collect all amounts due in
accordance with the original contractual terms of the loan agreements. When
determining if we will be unable to collect all principal and interest payments
due in accordance with the original contractual terms of the loan agreement, we
consider the borrower's overall financial condition, resources and payment
record, support from guarantors, and the realizable value of any collateral.
Loans that experience insignificant payment delays and payment shortfalls
generally are not classified as impaired. Management determines the significance
of payment delays and payment shortfalls on a case-by-case basis, taking into
consideration all of the circumstances surrounding the loan and the borrower,
including the length of the delay, the reasons for the delay, the borrower's
prior payment record, and the amount of the shortfall in relation to the
principal and interest owed.
All impaired loans are identified to be individually evaluated for impairment.
If a loan is impaired, a portion of the allowance is allocated so that the loan
is reported, net, at the discounted expected future cash flows or at the fair
value of collateral if repayment is collateral dependent.
The allowance for our nonimpaired loans, which includes commercial real estate,
commercial and industrial, residential real estate, and consumer loans that are
not individually evaluated for impairment, begins with a process of estimating
the probable incurred losses in the portfolio. These estimates are established
based on our historical loss data. Additional allowance estimates for commercial
and industrial and commercial real estate loans are based on internal credit
risk ratings. Internal credit risk ratings are assigned to each business loan at
the time of approval and are subjected to subsequent periodic reviews by senior
management, at least annually or more frequently upon the occurrence of a
circumstance that affects the credit risk of the loan. There is no allowance on
PPP loans (included in the commercial and industrial loan category) since they
are 100% guaranteed by the SBA.
The Company's current methodology on historical loss analysis incorporates and
fully relies on the Company's own historical loss data. The historical loss
estimates are established by loan type including commercial real estate,
commercial and industrial, residential real estate, and consumer. In addition,
consideration is given to the borrower's rating for commercial and industrial
and commercial real estate loans.
The following table presents, by loan type, the changes in the allowance for loan losses for the periods presented.
46
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For the year ended
December 31,
(Dollars in thousands) 2021 2020 2019
Balance at beginning of period $ 22,297 $ 12,674 $ 11,566
Loan charge-offs:
Commercial real estate - - (92)
Commercial and industrial (31) (2,118) (438)
Residential real estate (242) (285) -
Consumer (33) (58) (106)
Total loan charge-offs (306) (2,461) (636)
Recoveries of loans previously charged-off:
Commercial real estate - 12 6
Commercial and industrial 53 87 246
Residential real estate 86 85 77
Consumer 20 28 32
Total loan recoveries 159 212 361
Net charge-offs (147) (2,249) (275)
Provision for (recovery of) loan losses (725) 11,872 1,383
Balance at end of period $ 21,425 $ 22,297 $ 12,674 Allowance for loan losses as a percentage of period-end loans
1.30 % 1.29 % 1.03 %
Net charge-offs to average loans 0.01 0.13 0.02
Our allowance for loan losses was $21.4 million , or 1.30% of loans, at December
31, 2021 compared to $22.3 million , or 1.29% of loans, at December 31, 2020 . As
of December 31, 2021 and December 31, 2020 , the allowance for loan losses as a
percentage of loans excluding PPP loans (a non-GAAP measure), was 1.36% and
1.56%, respectively. The $872 thousand decrease in the allowance for loan losses
during the year ended December 31, 2021 was primarily due to a decrease in
general reserves related to the reduction in qualitative factors within the
allowance for loan loss model as a result of improved credit quality partially
offset by loan growth..
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The following table presents, by loan type, the allocation of the allowance for loan losses at the dates presented.
Percentage of loans in
Allocated each category
(Dollars in thousands) Allowance to total loans
December 31, 2021
Balance at end of period applicable to:
Commercial real estate $ 9,455 45.3 %
Commercial and industrial 7,799 27.9
Residential real estate 4,166 26.7
Consumer 5 0.1
Total loans $ 21,425 100.0 %
December 31, 2020
Balance at end of period applicable to:
Commercial real estate $ 9,975 41.8 %
Commercial and industrial 8,786 39.8
Residential real estate 3,527 18.3
Consumer 9 0.1
Total loans $ 22,297 100.0 %
December 31, 2019
Balance at end of period applicable to:
Commercial real estate $ 5,773 49.2 %
Commercial and industrial 5,515 33.4
Residential real estate 1,384 17.3
Consumer 2 0.1
Total loans $ 12,674 100.0 %
The following table presents, by loan type, the net loan charge-offs for the
dates presented.
Net charge-offs Percentage of average
(Dollars in thousands) (recoveries) loans
For the year ended
Commercial and industrial $ (22) - % Residential real estate 156 - Consumer 13 1.1 Total net charge-offs (recoveries) $ 147 - % For the year endedDecember 31, 2020 Commercial real estate $ (12) - % Commercial and industrial 2,031 0.3 Residential real estate 200 0.1 Consumer 30 1.0 Total net charge-offs (recoveries) $ 2,249 0.1 % Goodwill The Company has acquired three banks,Lotus Bank inMarch 2015 ,Bank of Michigan inMarch 2016 , andAnn Arbor State Bank inJanuary 2020 , which resulted in the recognition of goodwill. Total goodwill was$35.6 million atDecember 31, 2021 andDecember 31, 2020 . As a result of the unprecedented decline in economic conditions triggered by the COVID-19 pandemic, the market valuations, including our stock price, saw a significant decline inMarch 2020 , which then continued into the second quarter of 2020. These events indicated that goodwill may be impaired and resulted in us performing a qualitative goodwill impairment assessment in the second quarter of 2020. As a result of the analysis, we concluded that it was more-likely-than-not that the fair value of the reporting unit could be greater than its carrying amount. Since the price of our stock did not fully recover during the third quarter of 2020, the Company engaged a reputable, third-party valuation firm to perform a quantitative analysis of goodwill as ofAugust 31, 2020 ("the valuation date"). In 48 -------------------------------------------------------------------------------- deriving the fair value of the reporting unit (the Bank), the third-party firm assessed general economic conditions and outlook; industry and market considerations and outlook; the impact of recent events on financial performance; the market price of our common stock; and other relevant events. In addition, the valuation relied on financial projections through 2023 and growth rates prepared by management. Based on the valuation prepared, it was determined that the Company's estimated fair value of the reporting unit atAugust 31, 2020 was greater than its book value, and impairment of goodwill was not required. The Company completed its annual goodwill impairment review as ofOctober 1, 2021 , noting strong financial indicators for the Bank, solid credit quality ratios, as well as the strong capital position of the Bank. Management determined that no triggering events have occurred that indicated impairment from the most recent valuation date throughDecember 31, 2021 , the stock was trading above book value as ofDecember 31, 2021 , and it is more likely than not that there was no goodwill impairment as ofDecember 31, 2021 .
Deposits
Total deposits were$2.04 billion atDecember 31, 2021 and$1.96 billion atDecember 31, 2020 , representing 89.6% and 88.1% of total liabilities, respectively. The increase in deposits of$76.8 million was comprised of an increase of$291.0 million in demand deposits partially offset by decreases of$171.0 million in time deposits and$43.2 million in money market and savings deposits. The increase in deposits was primarily due to organic deposit growth during the year endedDecember 31, 2021 mainly as a result of increased customer liquidity and new customer growth. We had$1.16 billion and$1.13 billion atDecember 31, 2021 and 2020, respectively. Our average interest-bearing deposit costs were 0.33% and 0.93% for the years endedDecember 31, 2021 and 2020, respectively. The decrease in interest-bearing deposit costs between the two periods was primarily due to lower interest rates paid as a result of revised internal deposit rates, mainly driven by the continuation of the low level of the target federal funds rate. The target federal funds interest rate decreased 150 basis points duringMarch 2020 . Brokered deposits. Brokered deposits are marketed through national brokerage firms to their customers in$1,000 increments. For these brokered deposits, detailed records of owners are maintained byThe Depository Trust Company under the name ofCEDE & Co. This relationship provides a large source of deposits for the Company. Due to the competitive nature of the brokered deposit market, brokered deposits tend to bear higher rates of interest than non-brokered deposits. AtDecember 31, 2021 andDecember 31, 2020 , the Company had approximately$23.1 million and$29.3 million , respectively, of brokered deposits. The Company's ability to accept, roll-over or renew brokered deposits is contingent upon the Bank maintaining a capital level of "well-capitalized." Included in the brokered deposits total atDecember 31, 2021 andDecember 31, 2020 was$690 thousand and$1.2 million , respectively, in Certificate of Deposit Account Registry Service ("CDARS") one-way buys that were acquired fromAnn Arbor State Bank . Management understands the importance of core deposits as a stable source of funding and may periodically implement various deposit promotion strategies to encourage core deposit growth. For periods of rising interest rates, management has modeled the aggregate yields for non-maturity deposits and time deposits to increase at a slower pace than the increase in underlying market rates, which is intended to result in net interest margin expansion and an increase in net interest income. 49
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The following table sets forth the distribution of average deposits by account type for the periods indicated below.
Year Ended December 31, 2021
Average Average
(Dollars in thousands) Balance Percent Rate
Noninterest-bearing demand deposits $ 754,376 36.9 % - %
Interest-bearing demand deposits 162,405 7.9 0.14
Money market and savings deposits 613,883 29.9 0.19
Time deposits 519,447 25.3 0.56
Total deposits $ 2,050,111 100.0 % 0.21 %
Year Ended December 31, 2020
Average Average
(Dollars in thousands) Balance Percent Rate
Noninterest-bearing demand deposits $ 574,537 32.7 % - %
Interest-bearing demand deposits 115,249 6.5 0.28
Money market and savings deposits 496,827 28.2 0.56
Time deposits 573,823 32.6 1.38
Total deposits $ 1,760,436 100.0 % 0.62 %
Year Ended December 31, 2019
Average Average
(Dollars in thousands) Balance Percent Rate
Noninterest-bearing demand deposits $ 321,487 26.3 % - %
Interest-bearing demand deposits 57,480 4.7 0.49
Money market and savings deposits 314,918 25.8 1.43
Time deposits 527,605 43.2 2.30
Total deposits $ 1,221,490 100.0 % 1.39 %
The following table shows the contractual maturity of time deposits, including
CDARS and IRA deposits and other brokered funds, over $250 thousand that were
outstanding as of the date presented.
(Dollars in thousands) December 31, 2021
Maturing in:
3 months or less $ 124,718
3 months to 6 months 60,458
6 months to 1 year 64,470
1 year or greater 17,668
Total $ 267,314
Borrowings
Total debt outstanding at December 31, 2021 was $208.4 million , a decrease of
$21.9 million from $230.3 million at December 31, 2020 . The decrease in total
borrowings compared to December 31, 2020 was primarily due to the redemption of
$15.0 million of subordinated notes as well as a decrease of $6.0 million in
FHLB long term borrowings.
At December 31, 2021 , FHLB advances were secured by a blanket lien on $580.6
million of real estate-related loans, and repurchase agreements were secured by
securities with a fair value of $4.0 million . At December 31, 2020 , FHLB
advances were secured by a blanket lien on $512.3 million of real estate-related
loans, and repurchase agreements were secured by securities with a fair value of
$3.7 million .
As of December 31, 2021 , the Company had $30.0 million of subordinated notes
outstanding and debt issuance costs of $306 thousand related to these
subordinated notes. As of December 31, 2020 , the Company had $45.0 million of
subordinated notes outstanding and debt issuance costs of $408 thousand related
to these subordinated notes.
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The $15.0 million of subordinated notes issued on December 21, 2015 had a fixed
interest rate of 6.375% per annum, payable semiannually through December 15,
2020 . From December 15, 2020 , through maturity, the notes had a floating
interest rate of three-month LIBOR plus 477 basis points payable quarterly
through maturity. The notes were scheduled to mature on December 15, 2025 , and
the Company had the option to redeem or prepay any or all of the subordinated
notes without premium or penalty any time after December 15, 2020 or upon an
occurrence of a Tier 2 capital event or tax event. These subordinated notes were
redeemed in June 2021 .
The $30.0 million of subordinated notes issued on December 18, 2019 bear a fixed
interest rate of 4.75% per annum, payable semiannually through December 18,
2024 . The notes will bear a floating interest rate of three-month SOFR plus 311
basis points payable quarterly after December 18, 2024 through maturity. The
notes mature on December 18, 2029 , and the Company has the option to redeem any
or all of the subordinated notes without premium or penalty any time after
December 18, 2024 or upon the occurrence of a Tier 2 capital event or tax event.
The issuance of the $30.0 million subordinated notes reflected management's
efforts to fund the liquidity needs of the Company as well as pay the merger
consideration to purchase Ann Arbor State Bank .
Selected financial information pertaining to the components of our short-term borrowings for the periods and as of the dates indicated is as follows:
For the year ended December 31,
(Dollars in thousands) 2021 2020 2019
Securities sold under agreements to repurchase
Average daily balance
0.25 % 0.30 % 0.30 %
Amount outstanding at period end
0.25 % 0.30 % 0.30 %
Maximum month-end balance
$ -
- % 0.98 % 2.32 %
Amount outstanding at period end
$ - $ -
- % - % 1.61 %
Maximum month-end balance
$ -
0.44 % 1.47 % 2.85 %
Amount outstanding at period end $ - $ - $ - Weighted-average rate at period end
- % - % - %
Maximum month-end balance $ - $ - $ 895
Federal funds purchased
Average daily balance
$ -
- % 1.79 % 2.75 %
Amount outstanding at period end
$ - $ -
- % - % 1.90 %
Maximum month-end balance $ - $ - $ 15,000
Capital Resources
Shareholders' equity is influenced primarily by earnings, dividends, the
Company's sales and repurchases of its common stock and changes in accumulated
other comprehensive income caused primarily by fluctuations in unrealized gains
or losses, net of taxes, on available for sale securities.
Shareholders' equity increased $24.8 million to $240.1 million at December 31,
2021 compared to $215.3 million at December 31, 2020 . The increase in
shareholders' equity was primarily impacted by $32.5 million of net income
generated during the year ended December 31, 2021 and $1.9 million of options
exercised during the year, partially offset by decreases of
51
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$5.2 million of accumulated other comprehensive income due to decreases in net
unrealized gains on available-for-sale securities, $1.9 million of dividends
declared on our preferred stock, $1.8 million of dividends declared on our
common stock, and $1.4 million of stock repurchased through the share buyback
program during the year ended December 31, 2021 .
The following table summarizes the changes in our shareholders' equity for the
periods indicated below:
For the year ended December 31,
(Dollars in thousands) 2021 2020 2019
Balance at beginning of period $ 215,327 $ 170,703 $ 151,760
Net income 32,478 20,413 16,111
Other comprehensive income (loss) (5,237) 4,590 5,344
Preferred stock offering, net of issuance costs - 23,372 -
Redeemed stock (1,364) (2,648) (2,165)
Dividends on 7.50% Series B Preferred Stock (1,875) (479) -
Common stock dividends declared (1,838) (1,542) (1,236)
Exercise of stock options 1,920 95 219
Stock-based compensation expense 680 823 670
Balance at end of period $ 240,091 $ 215,327 $ 170,703
We strive to maintain an adequate capital base to support our activities in a
safe and sound manner while at the same time attempting to maximize shareholder
value. We assess capital adequacy against the risk inherent in our balance
sheet, recognizing that unexpected loss is the common denominator of risk and
that common equity has the greatest capacity to absorb unexpected loss.
We are subject to various regulatory capital requirements both at the Company
level and at the Bank level. Failure to meet minimum capital requirements could
result in certain mandatory and possible additional discretionary actions by
regulators that, if undertaken, could have an adverse material effect on our
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, we must meet specific capital guidelines
that involve quantitative measures of our assets, liabilities, and certain
off-balance sheet items as calculated under regulatory accounting policies. We
have consistently maintained regulatory capital ratios at or above the
well-capitalized standards.
A capital conservation buffer, comprised of common equity tier 1 capital, is
established above the regulatory minimum capital requirements, and financial
institutions that maintain a capital conservation buffer of 2.5% are generally
not subject to the additional restrictions on dividends, share repurchases and
discretionary bonus payments to executive officers under the Basel III Rule.
At
The summary below compares the actual capital ratios with the minimum quantitative measures established by regulation to ensure capital adequacy:
52
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Capital Adequacy
Capital Regulatory Well
Actual Adequacy Requirement + Capitalized
Capital Regulatory Capital Conservation Regulatory
Ratio Requirement Buffer(1) Requirement
December 31, 2021
Common equity tier 1 to risk-weighted
assets:
Consolidated 10.37 % 4.50 % 7.00 %
Bank 13.12 % 4.50 % 7.00 % 6.50 %
Tier 1 capital to risk-weighted assets:
Consolidated 11.75 % 6.00 % 8.50 %
Bank 13.12 % 6.00 % 8.50 % 8.00 %
Total capital to risk-weighted assets:
Consolidated 14.76 % 8.00 % 10.50 %
Bank 14.37 % 8.00 % 10.50 % 10.00 %
Tier 1 capital to average assets
(leverage ratio):
Consolidated 7.93 % 4.00 % 4.00 %
Bank 8.86 % 4.00 % 4.00 % 5.00 %
December 31, 2020
Common equity tier 1 to risk-weighted
assets:
Consolidated 9.30 % 4.50 % 7.00 %
Bank 11.94 % 4.50 % 7.00 % 6.50 %
Tier 1 capital to risk-weighted assets:
Consolidated 10.80 % 6.00 % 8.50 %
Bank 11.94 % 6.00 % 8.50 % 8.00 %
Total capital to risk-weighted assets:
Consolidated 14.91 % 8.00 % 10.50 %
Bank 13.20 % 8.00 % 10.50 % 10.00 %
Tier 1 capital to average assets
(leverage ratio):
Consolidated 6.93 % 4.00 % 4.00 %
Bank 7.67 % 4.00 % 4.00 % 5.00 %
(1) Reflects the capital conservation buffer of 2.5% for risk-weighted asset ratios.
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--------------------------------------------------------------------------------Contractual Obligations
In the ordinary course of our operations, we enter into certain contractual obligations. Total contractual obligations atDecember 31, 2021 were$644.7 million , a decrease of$193.9 million from$838.6 million atDecember 31, 2020 . The decrease of$193.9 million was primarily due to decreases of$171.0 million in time deposits and$14.9 million in subordinated notes.
The following tables present our contractual obligations as of
Contractual
Maturities as of
Less Than One to Three to Over
(Dollars in thousands) One Year Three Years Five Years Five Years Total
Operating lease obligations $ 1,833 $ 3,185 $ 2,391 $ 3,110 $ 10,519
Short-term borrowings 2,342 - - - 2,342
Long-term borrowings 11,254 33,039 2,047 130,000 176,340
Subordinated notes - - - 29,694 29,694
Time deposits 359,707 64,036 2,058 - 425,801
Total $ 375,136 $ 100,260 $ 6,496 $ 162,804 $ 644,696
Contractual
Maturities as of
Less Than One to Three to Over
(Dollars in thousands) One Year Three Years Five Years Five Years Total
Operating lease obligations $ 1,731 $ 3,478 $ 2,509 $ 3,775 $ 11,493
Short-term borrowings 3,204 - - - 3,204
Long-term borrowings 6,176 14,304 32,000 130,000 182,480
Subordinated notes - - 15,000 29,592 44,592
Time deposits 437,211 153,759 5,845 - 596,815
Total $ 448,322 $ 171,541 $ 55,354 $ 163,367 $ 838,584 Off-Balance Sheet Arrangements
In the normal course of business, the Company offers a variety of financial instruments with off-balance sheet risk to meet the financing needs of its customers. These financial instruments include outstanding commitments to extend credit, credit lines, commercial letters of credit and standby letters of credit. These are agreements to provide credit, as long as conditions established in the contract are met, and usually have expiration dates. Commitments may expire without being used. Off-balance sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies used for loans are used to make such commitments, including obtaining collateral at exercise of the commitment. We maintain an allowance to cover probable losses inherent in our financial instruments with off-balance sheet risk. AtDecember 31, 2021 , the allowance for off-balance sheet risk was$369 thousand , compared to$490 thousand atDecember 31, 2020 , and was included in "Other liabilities" on our consolidated balance sheets. A summary of the contractual amounts of our exposure to off-balance sheet risk is as follows. December 31, 2021 December 31, 2020 (Dollars in thousands) Fixed Rate Variable Rate Fixed Rate Variable Rate Commitments to make loans$ 13,532
49,841 392,186 28,898 385,307
Unused standby letters of credit and commercial
letters of credit 2,145 - 2,340 1,992
Of the total unused lines of credit of $442.0 million at December 31, 2021 ,
$71.3 million was comprised of undisbursed construction loan commitments. The
Company expects to have sufficient access to liquidity to fund its off-balance
sheet commitments.
54
--------------------------------------------------------------------------------Liquidity
Liquidity management is the process by which we manage the flow of funds necessary to meet our financial commitments on a timely basis and at a reasonable cost and to take advantage of earnings enhancement opportunities. These financial commitments include withdrawals by depositors, credit commitments to borrowers, expenses of our operations, and capital expenditures. Liquidity is monitored and closely managed by the Bank'sAsset and Liability Committee (ALCO), a group of senior officers from the finance, enterprise risk management, treasury, and lending areas, as well as two board members. It is ALCO's responsibility to ensure we have the necessary level of funds available for normal operations as well as maintain a contingency funding policy to ensure that potential liquidity stress events are planned for and quickly identified, and management has plans in place to respond. ALCO has created policies which establish limits and require measurements to monitor liquidity trends, including modeling and management reporting that identifies the amounts and costs of all available funding sources. In addition, we have implemented modeling software that projects cash flows from the balance sheet under a broad range of potential scenarios, including severe changes in the economic environment. AtDecember 31, 2021 , we had liquid assets of$639.1 million , compared to$455.4 million atDecember 31, 2020 . Liquid assets include cash and due from banks, federal funds sold, interest-bearing deposits with banks and unencumbered securities available-for-sale. Cash and due from banks increased to$330.1 million , compared to$264.1 million atDecember 31, 2020 primarily as a result of forgiveness of PPP loans and new customer growth. The Bank is a member of the FHLB, which provides short- and long-term funding to its members through advances collateralized by real estate-related assets and other select collateral, most typically in the form of debt securities. The actual borrowing capacity is contingent on the amount of collateral available to be pledged to the FHLB. As ofDecember 31, 2021 , we had$175.1 million of outstanding borrowings from the FHLB, and these advances were secured by a blanket lien on$580.6 million of real estate-related loans. Based on this collateral and the approved policy limits, the Company is eligible to borrow up to an additional$228.7 million from the FHLB. Additionally, the Bank can borrow up to$157.5 million through the unsecured lines of credit it has established with eight other banks, as well as$5.0 million through a secured line with theFederal Reserve Bank . Further, because the Bank is "well capitalized," it can accept wholesale funding up to 40% of total assets, or approximately$1.01 billion , based on current policy limits atDecember 31, 2021 . Management believed that as ofDecember 31, 2021 , we had adequate resources to fund all of our commitments. The following liquidity ratios compare certain assets and liabilities to total deposits or total assets. December 31, 2021 December 31, 2020 Investment securities available-for-sale to total assets 15.80 % 12.39 % Loans to total deposits 81.01 87.79 Interest-earning assets to total assets 94.37 94.64 Interest-bearing deposits to total deposits 60.94 68.49 55
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