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 June 30, 2022
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)
. 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
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company ☒
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The number of shares of the Common Stock outstanding as of August 1, 2022 was 27,579,984.
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
30
Item 3. Quantitative and Qualitative Disclosures About Market Risk
61
Item 4. Controls and Procedures
63
PART II OTHER INFORMATION
64
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
65
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
66
Item 6. Exhibits
SIGNATURES
67
2
PART 1 – FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Bridgewater Bancshares, Inc. and Subsidiaries
(dollars in thousands, except share data)
June 30,
December 31,
2022
2021
(Unaudited)
ASSETS
Cash and Cash Equivalents
$
73,517
143,473
Bank-Owned Certificates of Deposit
1,138
1,876
Securities Available for Sale, at Fair Value
482,583
439,362
Loans, Net of Allowance for Loan Losses of $44,711 at June 30, 2022 (unaudited) and $40,020 at December 31, 2021
3,171,638
2,769,917
Federal Home Loan Bank (FHLB) Stock, at Cost
9,921
5,242
Premises and Equipment, Net
49,294
49,395
Accrued Interest
10,010
9,186
Goodwill
2,626
Other Intangible Assets, Net
383
479
Other Assets
82,154
56,103
Total Assets
3,883,264
3,477,659
LIABILITIES AND EQUITY
LIABILITIES
Deposits:
Noninterest Bearing
961,998
875,084
Interest Bearing
2,239,955
2,071,153
Total Deposits
3,201,953
2,946,237
Federal Funds Purchased
86,000
—
FHLB Advances
56,500
42,500
Subordinated Debentures, Net of Issuance Costs
92,459
92,239
Accrued Interest Payable
1,393
1,409
Other Liabilities
70,076
16,002
Total Liabilities
3,508,381
3,098,387
SHAREHOLDERS' EQUITY
Preferred Stock- $0.01 par value; Authorized 10,000,000
Preferred Stock - Issued and Outstanding 27,600 Series A shares ($2,500 liquidation preference) at June 30, 2022 (unaudited) and December 31, 2021
66,514
Common Stock- $0.01 par value; Authorized 75,000,000
Common Stock - Issued and Outstanding 27,677,372 at June 30, 2022 (unaudited) and 28,206,566 at December 31, 2021
277
282
Additional Paid-In Capital
96,689
104,123
Retained Earnings
222,464
199,347
Accumulated Other Comprehensive Income (Loss)
(11,061)
9,006
Total Shareholders' Equity
374,883
379,272
Total Liabilities and Equity
See accompanying notes to consolidated financial statements.
(dollars in thousands, except per share data)
Three Months Ended
Six Months Ended
INTEREST INCOME
Loans, Including Fees
34,358
28,748
66,102
56,656
Investment Securities
3,325
2,312
6,195
4,732
Other
99
87
179
199
Total Interest Income
37,782
31,147
72,476
61,587
INTEREST EXPENSE
Deposits
3,456
3,513
6,614
7,184
Notes Payable
167
228
317
456
Subordinated Debentures
1,219
1,112
2,416
2,197
410
419
Total Interest Expense
5,252
4,859
9,766
9,904
NET INTEREST INCOME
32,530
26,288
62,710
51,683
Provision for Loan Losses
3,025
1,600
4,700
2,700
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES
29,505
24,688
58,010
48,983
NONINTEREST INCOME
Customer Service Fees
298
231
579
465
Net Gain on Sales of Available for Sale Securities
52
702
Other Income
1,300
670
2,576
1,444
Total Noninterest Income
1,650
1,603
3,207
2,611
NONINTEREST EXPENSE
Salaries and Employee Benefits
8,977
7,512
17,671
14,614
Occupancy and Equipment
1,042
980
2,127
2,035
Other Expense
3,733
2,985
7,462
5,751
Total Noninterest Expense
13,752
11,477
27,260
22,400
INCOME BEFORE INCOME TAXES
17,403
14,814
33,957
29,194
Provision for Income Taxes
4,521
3,821
8,813
7,530
NET INCOME
12,882
10,993
25,144
21,664
Preferred Stock Dividends
(1,014)
(2,027)
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS
11,868
23,117
EARNINGS PER SHARE
Basic
0.43
0.39
0.83
0.77
Diluted
0.41
0.38
0.80
0.75
(dollars in thousands)
Net Income
Other Comprehensive Income (Loss):
Unrealized Gains (Losses) on Available for Sale Securities
(15,402)
2,866
(38,414)
350
Unrealized Gains (Losses) on Cash Flow Hedges
4,363
(2,551)
13,392
3,054
Reclassification Adjustment for (Gains) Losses Realized in Income
207
(357)
630
(29)
Income Tax Impact
1,478
(17)
4,325
(712)
Total Other Comprehensive Income (Loss), Net of Tax
(9,354)
(59)
(20,067)
2,663
Comprehensive Income
3,528
10,934
5,077
24,327
Three and Six Months Ended June 30, 2022 and 2021
Accumulated
Additional
Preferred
Common Stock
Paid-In
Retained
Comprehensive
Stock
Shares
Amount
Capital
Earnings
Income (Loss)
Total
BALANCE March 31, 2021
28,132,929
281
104,087
165,502
9,301
279,171
Stock-based Compensation
4,848
583
Comprehensive Income (Loss)
Stock Options Exercised
25,000
1
141
142
BALANCE June 30, 2021
28,162,777
104,811
176,495
9,242
290,830
BALANCE March 31, 2022
28,150,389
103,756
210,596
(1,707)
379,441
5,000
850
14,750
44
Stock Repurchases
(492,417)
(5)
(7,954)
(7,959)
Issuance of Restricted Stock Awards
Forfeiture of Restricted Stock Awards
(600)
(2)
Vested Restricted Stock Units
600
Restricted Shares Withheld for Taxes
(350)
Preferred Stock Dividend
BALANCE June 30, 2022
27,677,372
BALANCE December 31, 2020
28,143,493
103,714
154,831
6,579
265,405
9,856
1,157
26,400
153
154
(16,618)
(208)
(354)
BALANCE December 31, 2021
28,206,566
9,656
1,681
24,750
(563,455)
(9,157)
(9,162)
(1,000)
(3)
2,100
(1,245)
(20)
CASH FLOWS FROM OPERATING ACTIVITIES
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Net Amortization on Securities Available for Sale
1,333
1,755
Net Gain on Sales of Securities Available for Sale
(52)
(702)
Depreciation of Premises and Equipment
1,260
1,146
Amortization of Other Intangible Assets
96
Amortization of Subordinated Debt Issuance Costs
220
174
Changes in Operating Assets and Liabilities:
Accrued Interest Receivable and Other Assets
(4,944)
(4,870)
Accrued Interest Payable and Other Liabilities
41,788
4,810
Net Cash Provided by Operating Activities
71,226
27,930
CASH FLOWS FROM INVESTING ACTIVITIES
Decrease in Bank-Owned Certificates of Deposit
738
492
Proceeds from Sales of Securities Available for Sale
25,066
7,757
Proceeds from Maturities, Paydowns, Payups and Calls of Securities Available for Sale
18,986
18,023
Purchases of Securities Available for Sale
(118,282)
(39,341)
Net Increase in Loans
(406,421)
(265,409)
Net Increase in FHLB Stock
(4,679)
(805)
Purchases of Premises and Equipment
(1,159)
(336)
Purchase of Bank-Owned Life Insurance
(25,000)
Net Cash Used in Investing Activities
(485,751)
(304,619)
CASH FLOWS FROM FINANCING ACTIVITIES
Net Increase in Deposits
255,716
219,270
Net Increase in Federal Funds Purchased
Principal Payments on Notes Payable
(11,000)
Proceeds from FHLB Advances
14,000
Preferred Stock Dividends Paid
Shares Repurchased for Tax Withholdings Upon Vesting of Restricted Stock-Based Awards
Net Cash Provided by Financing Activities
344,569
208,211
NET CHANGE IN CASH AND CASH EQUIVALENTS
(69,956)
(68,478)
Cash and Cash Equivalents Beginning
160,675
Cash and Cash Equivalents Ending
92,197
SUPPLEMENTAL CASH FLOW DISCLOSURE
Cash Paid for Interest
9,562
8,691
Cash Paid for Income Taxes
7,955
10,438
Net Investment Securities Purchased but Not Settled
8,738
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, Inc. was incorporated in December 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 six-month periods ended June 30, 2022 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 8, 2022.
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 rising inflation and ongoing 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 Issued Accounting Guidance
In March 2022, the FASB issued ASU 2022-02, Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. This ASU updates guidance in Topic 326 to eliminate the accounting guidance for TDRs by creditors in Subtopic 310-40, Receivables – Troubled Debt Restructurings by Creditors, while enhancing disclosure requirements for certain loan refinancing and restructuring activities by creditors when a borrower is experiencing financial difficulty. Additionally, the amendments to ASC 326 require that an entity disclose current period gross write offs by year of origination within the vintage disclosures, which requires that an entity disclose the amortized cost basis of financing receivables by credit quality indicator and class of financing receivables by year of origination. ASU 2022-02 is effective for fiscal years beginning after December 15, 2022 for companies that have adopted CECL, including interim periods within those fiscal years, with early adoption permitted.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (modified by ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments Credit Losses, ASU 2019-05, Financial Instruments Credit Losses – Targeted Transition Relief, and ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments – Credit Losses). The amendments in this ASU affect all entities that measure credit losses on financial instruments including loans, debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, reinsurance receivables, and any other financial asset that has a contractual right to receive cash that is not specifically excluded. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this ASU replace the incurred loss impairment methodology required in current GAAP with a methodology that reflects expected credit losses that requires consideration of a broader range of reasonable and supportable information to estimate credit losses. The amendments in this ASU will affect entities to
9
varying degrees depending on the credit quality of the assets held by the entity, the duration of the assets held, and how the entity applies the current incurred loss methodology. In November 2019, the FASB issued ASU 2019-10, Financial Instruments — Credit Losses (Topic 326), Derivatives and Hedging (815), and Leases (Topic 842) – Effective Dates. This ASU amended the effective date of ASU 2016-13 for smaller reporting companies and non-SEC reporting entities. The amendment delays the effective date to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. As an emerging growth company, the Company is required to implement by January 1, 2023 and is currently evaluating the impact on its consolidated financial statements. Amendments should be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. The Company has contracted with a third party to develop a model to comply with CECL requirements. The Company has established a steering committee with representation from various departments across the enterprise. While the Company has not finalized the impact of implementing CECL, the Company expects to recognize a one-time cumulative effect adjustment to the allowance and beginning retained earnings upon adoption. The future impact of CECL on the Company’s allowance for credit losses and provision expense subsequent to initial adoption will depend on changes in the loan portfolio, economic conditions and refinements to key assumptions including forecasting and qualitative factors.
Subsequent Events
Subsequent events have been evaluated through August 4, 2022, which is the date the consolidated financial statements were available to be issued.
Note 2: Earnings Per Share
Basic earnings per common share are computed by dividing net income available to common shareholders 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 six months ended June 30, 2022, stock options, restricted stock awards and restricted stock units of approximately 332,200 and 300,500 shares, respectively, were excluded from the calculation because they were deemed to be anti-dilutive. For the three and six months ended June 30, 2021, stock options, restricted stock awards and restricted stock units of approximately 23,000 and 56,000 shares, 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 six months ended June 30, 2022 and 2021:
Net Income Available to Common Shareholders
Weighted Average Common Stock Outstanding:
Weighted Average Common Stock Outstanding (Basic)
27,839,260
28,040,762
27,980,749
28,029,129
Dilutive Effect of Stock Compensation
964,582
1,087,419
1,011,031
1,019,295
Weighted Average Common Stock Outstanding (Dilutive)
28,803,842
29,128,181
28,991,780
29,048,424
Basic Earnings per Common Share
Diluted Earnings per Common Share
10
Note 3: Securities
The following tables present the amortized cost and estimated fair value of securities with gross unrealized gains and losses at June 30, 2022 and December 31, 2021:
June 30, 2022
Gross
Amortized
Unrealized
Cost
Gains
Losses
Fair Value
Securities Available for Sale:
U.S. Treasury Securities
2,620
(14)
2,606
Municipal Bonds
184,401
618
(17,498)
167,521
Mortgage-Backed Securities
155,580
(10,616)
144,969
Corporate Securities
104,647
402
(1,952)
103,097
SBA Securities
24,690
113
(161)
24,642
Asset-Backed Securities
40,000
219
(471)
39,748
Total Securities Available for Sale
511,938
1,357
(30,712)
December 31, 2021
756
754
151,665
7,492
(788)
158,369
125,563
1,085
(2,111)
124,537
81,925
2,740
(185)
84,480
30,474
102
(206)
30,370
39,867
1,044
40,852
430,250
12,463
(3,351)
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 June 30, 2022 and December 31, 2021:
Less Than 12 Months
12 Months or Greater
118,200
(15,176)
10,705
(2,322)
128,905
95,492
(5,124)
39,148
(5,492)
134,640
60,879
(1,883)
1,930
(69)
62,809
3,549
(19)
10,942
(142)
14,491
21,264
(395)
1,304
(76)
22,568
301,990
(22,611)
64,029
(8,101)
366,019
11
44,332
(708)
3,757
(80)
48,089
36,921
(630)
35,949
(1,481)
72,870
9,398
(133)
1,948
11,346
3,896
(7)
16,297
(199)
20,193
6,742
102,043
(1,539)
57,951
(1,812)
159,994
At June 30, 2022, 448 debt securities had unrealized losses with aggregate depreciation of approximately 7.7% from the Company’s amortized cost basis. At December 31, 2021, 199 debt securities had unrealized losses with aggregate depreciation of approximately 2.1% 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 June 30, 2022.
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 June 30, 2022. Call date is used when a call of the debt security is expected, as 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
4,696
4,707
Due After One Year Through Five Years
72,588
72,446
Due After Five Years Through 10 Years
106,866
102,636
Due After 10 Years
107,518
93,435
Subtotal
291,668
273,224
Totals
As of June 30, 2022 and December 31, 2021, the securities portfolio was unencumbered.
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 six months ended June 30, 2022 and June 30, 2021:
Proceeds From Sales of Securities
6,107
Gross Gains on Sales
234
Gross Losses on Sales
(182)
12
Note 4: Loans
The following table presents the components of the loan portfolio at June 30, 2022 and December 31, 2021:
Commercial
403,569
360,169
Paycheck Protection Program
4,860
26,162
Construction and Land Development
359,191
281,474
Real Estate Mortgage:
1-4 Family Mortgage
334,815
305,317
Multifamily
1,087,865
910,243
CRE Owner Occupied
142,214
111,096
CRE Nonowner Occupied
886,432
818,569
Total Real Estate Mortgage Loans
2,451,326
2,145,225
Consumer and Other
6,939
6,442
Total Loans, Gross
3,225,885
2,819,472
Allowance for Loan Losses
(44,711)
(40,020)
Net Deferred Loan Fees
(9,536)
(9,535)
Total Loans, Net
The following table presents the activity in the allowance for loan losses, by segment, for the three months ended June 30, 2022 and 2021:
Paycheck
Construction
CRE
Protection
and Land
1--4 Family
Owner
Non-owner
Consumer
Program
Development
Mortgage
Occupied
and Other
Unallocated
Three Months Ended June 30, 2022
Allowance for Loan Losses:
Beginning Balance
5,638
4,319
3,885
14,083
1,595
11,663
177
326
41,692
648
(4)
453
319
894
325
572
(26)
(156)
Loans Charged-off
(13)
(1)
Recoveries of Loans
Total Ending Allowance Balance
6,275
4,772
4,206
14,977
1,920
12,235
170
44,711
Three Months Ended June 30, 2021
6,451
83
2,773
3,894
1,187
11,026
232
485
35,987
71
(33)
654
(394)
1,294
57
(8)
(11)
(30)
6,525
50
3,427
3,502
11,150
1,244
11,018
455
37,591
The following table presents the activity in the allowance for loan losses, by segment, for the six months ended June 30, 2022 and 2021:
Six Months Ended June 30, 2022
6,256
13
12,610
1,495
11,335
147
650
40,020
28
1,015
444
2,367
425
900
(480)
(16)
20
Six Months Ended June 30, 2021
5,703
70
2,491
3,972
9,517
1,162
10,991
203
732
34,841
800
936
(470)
1,633
27
21
(277)
(12)
22
32
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 June 30, 2022 and December 31, 2021:
Allowance for Loan Losses at June 30, 2022
Individually Evaluated for Impairment
223
235
Collectively Evaluated for Impairment
6,263
12,012
44,476
Allowance for Loan Losses at December 31, 2021
607
5,649
39,413
Loans at June 30, 2022
9,798
116
284
1,696
15,097
26,991
393,771
359,075
334,531
140,518
871,335
3,198,894
Loans at December 31, 2021
14,512
130
1,390
2,421
4,188
22,641
345,657
281,344
303,927
108,675
814,381
2,796,831
The following table presents information regarding total carrying amounts and total unpaid principal balances of impaired loans by loan segment as of June 30, 2022 and December 31, 2021:
Recorded
Principal
Related
Investment
Balance
Allowance
Loans With No Related Allowance for Loan Losses:
9,713
4,545
723
737
HELOC and 1-4 Family Junior Mortgage
933
1st REM - Rentals
457
1,761
2,466
2,962
14,771
15,443
12,674
13,326
Loans With An Allowance for Loan Losses:
85
9,967
12,135
12,220
Grand Totals
27,663
23,293
14
The following table presents information regarding the average balances and interest income recognized on impaired loans by loan segment for the three and six months ended June 30, 2022 and 2021:
Three Months Ended June 30,
Six Months Ended June 30,
Average
Interest
Recognized
11,156
53
12,074
331
56
120
144
123
883
884
286
471
288
473
1,765
16
867
1,768
33
869
2,970
38
3,624
2,987
75
3,635
91
212
6,042
72
17,240
446
6,064
133
86
1,161
26
12,136
244
12,221
1,174
12,222
245
28,518
335
7,216
29,462
691
7,238
159
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 June 30, 2022 and December 31, 2021, based on the most recent analysis performed by management:
Pass
Watch
Substandard
387,317
6,454
33,263
1st REM - 1-4 Family
51,356
682
52,038
LOCs and 2nd REM - Rentals
25,533
25,545
223,685
223,969
843,778
27,557
3,164,189
34,705
15
336,939
8,718
30,327
31,260
48,024
689
48,713
21,625
21,641
203,246
203,703
774,474
39,907
2,747,501
49,330
The following tables present the aging of the recorded investment in past due loans by loan segment as of June 30, 2022 and December 31, 2021:
Accruing Interest
30-89 Days
90 Days or
Current
Past Due
More Past Due
Nonaccrual
4,856
33,012
251
141,642
3,224,942
255
688
31,211
49
110,504
592
2,818,701
722
At June 30, 2022, there were two loans classified as troubled debt restructurings with total aggregate outstanding balances of $201,000. In comparison, at December 31, 2021, there were four loans classified as troubled debt restructurings with total aggregate outstanding balances of $1.4 million. There were no new loans classified as troubled debt restructurings during the six month period ended June 30, 2022 and no loans classified as troubled debt restructurings during the previous twelve months subsequently defaulted during the six months ended June 30, 2022.
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, made before January 1, 2022, are not considered troubled debt restructurings.
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 June 30, 2022:
Interest-Only
Extended Amortization
# of Loans
315
4,694
5,009
24,776
25,091
29,785
Note 5: Deposits
The following table presents the composition of deposits at June 30, 2022 and December 31, 2021:
Transaction Deposits
1,484,149
1,419,873
Savings and Money Market Deposits
952,138
863,567
Time Deposits
272,424
293,474
Brokered Deposits
493,242
369,323
Brokered deposits contain brokered transaction and money market accounts of $221.4 million and $131.2 million as of June 30, 2022 and December 31, 2021, respectively.
The following table presents the scheduled maturities of brokered and customer time deposits at June 30, 2022:
Less than 1 Year
172,726
1 to 2 Years
94,935
2 to 3 Years
124,252
3 to 4 Years
105,491
4 to 5 Years
22,442
Greater than 5 Years
24,423
544,269
The aggregate amount of time deposits greater than $250,000 was approximately $53.4 million and $59.6 million at June 30, 2022 and December 31, 2021, respectively.
17
Note 6: 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.
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 June 30, 2022 and December 31, 2021:
Notional
Estimated
Interest rate swap agreements:
Assets
65,916
5,099
49,101
641
Liabilities
(5,099)
(641)
131,832
98,202
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 deposit and wholesale borrowing portfolios. During the next 12 months, the Company estimates that $1.1 million 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 June 30, 2022 and December 31, 2021:
Notional Amount
125,000
Weighted Average Pay Rate
1.23
%
1.27
Weighted Average Receive Rate
1.01
0.14
Weighted Average Maturity (Years)
3.27
3.76
Net Unrealized Gain (Loss)
7,487
791
18
The Company purchases interest rate caps, designated as cash flow hedges, of certain deposit liabilities. The interest rate caps require receipt of variable amounts from the counterparties when interest rates rise above the strike price in the contracts. For the six months ended June 30, 2022 and 2021, the company recognized amortization expense on the interest rate caps of $370,000 and $95,000, respectively, which was recorded as a component of interest expense on brokered deposits.
The following table presents a summary of the Company’s interest rate caps designated as cash flow hedges as of June 30, 2022 and December 31, 2021:
110,000
Unamortized Premium Paid
6,269
5,859
Weighted Average Strike Rate
0.96
0.90
8.08
8.72
The following table presents a summary of the Company’s interest rate contracts as of June 30, 2022 and December 31, 2021:
90,000
1,717
35,000
(926)
Interest rate cap agreements:
15,144
7,356
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 June 30, 2022 and December 31, 2021, the Company pledged cash collateral for the Company’s derivative contracts of $0 and $370,000, respectively. In addition, as of June 30, 2022 and December 31, 2021, the Company's counterparties pledged cash collateral to the Company of $30.0 million and $8.6 million, 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 six months ended June 30, 2022 and 2021:
Derivatives in
Location of Loss
Loss
Cash Flow Hedging
Reclassified
Reclassified from
Relationships
from AOCI into Income
AOCI into Earnings
Interest rate swaps
Interest expense
(65)
(275)
(312)
(537)
Interest rate caps
(194)
(70)
(370)
(136)
No amounts were reclassified from accumulated other comprehensive income into net income related to hedge ineffectiveness for these derivatives during the three and six months ended June 30, 2022 and 2021, 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.
19
Note 7: Subordinated Debentures
The following table presents a summary of the Company’s subordinated debentures as of June 30, 2022:
Total Debt
Date
First
Maturity
Outstanding
Name
Established
Redemption Date
Rate
Coupon Structure
2027 Notes
July 12, 2017
July 15, 2022
July 15, 2027
13,750
5.88
Fixed-to-Floating (1)
2030 Notes
June 19, 2020
July 1, 2025
July 1, 2030
50,000
5.25
Fixed-to-Floating (2)
2031 Notes
July 8, 2021
July 15, 2026
July 15, 2031
30,000
3.25
Fixed-to-Floating (3)
93,750
Debt Issuance Costs
(1,291)
(1,511)
Note 8: 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 June 30, 2022 and December 31, 2021:
Unfunded Commitments Under Lines of Credit
892,523
799,148
Letters of Credit
116,017
119,647
1,008,540
918,795
The Company had outstanding letters of credit with the FHLB in total amounts of $53.7 million and $36.5 million at June 30, 2022 and December 31, 2021, 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 9: Stock Options and Restricted Stock
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 were 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. The 2012 Plan expired in March 2022 and awards are no longer able to be granted 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 June 30, 2022 and December 31, 2021, there were 44,700 and 294,700 shares, respectively, 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 June 30, 2022 and December 31, 2021, there were 350,991 and 352,575 shares, respectively, 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 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 six months ended June 30, 2022, are as follows:
Dividend Yield
Expected Life
Years
Expected Volatility
24.71
Risk-Free Interest Rate
1.70
The following table presents a summary of the status of the Company’s stock option grants for the six months ended June 30, 2022:
Weighted
Exercise Price
Outstanding at Beginning of Year
1,768,745
7.67
Granted
290,000
17.50
Exercised
(24,750)
2.65
Forfeitures
(12,000)
14.77
Outstanding at Period End
2,021,995
9.10
Options Exercisable at Period End
1,332,720
7.00
For the three months ended June 30, 2022 and 2021, the Company recognized compensation expense for stock options of $312,000 and $229,000, respectively. For the six months ended June 30, 2022 and 2021, the Company recognized compensation expense for stock options of $600,000 and $452,000, respectively.
The following table presents information pertaining to options outstanding at June 30, 2022:
Options Outstanding
Options Exercisable
Weighted Average
Number of
Remaining Contractual
Range of Exercise Prices
Options
Life in Years
2.13 - 3.99
384,000
3.04
1.6
7.00 - 7.99
926,717
7.47
5.3
733,317
8.00 - 8.99
20,000
8.76
7.8
7,500
10.00 - 10.99
10,000
10.08
7.9
11.00 - 11.99
85,000
11.27
6.9
41,000
11.30
12.00 - 12.99
270,778
12.89
7.1
139,278
12.90
13.00 - 13.99
13.22
5.9
17.00 - 17.99
300,500
9.6
2,625
17.49
5.6
As of June 30, 2022, there was $2.1 million 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 2.8 years.
The following table presents an analysis of nonvested options to purchase shares of the Company’s stock issued and outstanding for the six months ended June 30, 2022:
Average Grant
Date Fair Value
Nonvested Options at December 31, 2021
435,900
3.43
5.28
Vested
(24,625)
4.39
Forfeited
5.12
Nonvested Options at June 30, 2022
689,275
4.15
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 six months ended June 30, 2022:
Nonvested Awards at December 31, 2021
75,113
12.59
(2,786)
10.32
12.92
Nonvested Awards at June 30, 2022
71,327
12.68
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 June 30, 2022 and 2021, the Company recognized compensation expense for restricted stock awards of $111,000 and $113,000, respectively. For the six months ended June 30, 2022 and 2021, the Company recognized compensation expense for restricted stock awards of $222,000 and $225,000, respectively.
As of June 30, 2022, there was $659,000 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 1.5 years.
In addition, during the six months June 30, 2022, the Company issued 9,656 shares of unrestricted common stock to non-employee directors, or their designee, 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 non-employee directors, or their designee, of $158,000 was included in stock based compensation expense in the accompanying consolidated statements of shareholders’ equity.
Restricted Stock Units
In 2020, the Company began granting 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 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 six months ended June 30, 2022:
Units
Nonvested Units at December 31, 2021
344,908
15.02
2,500
(2,100)
14.94
(9,572)
15.12
Nonvested Units at June 30, 2022
335,736
15.03
23
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 June 30, 2022 and 2021, the Company recognized compensation expense for restricted stock units of $345,000 and $162,000, respectively. For the six months ended June 30, 2022 and 2021, the Company recognized compensation expense for restricted stock units of $699,000 and $320,000, respectively.
As of June 30, 2022, there was $4.2 million 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 3.1 years.
Note 10: 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 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, on a consolidated basis, and the Bank as of June 30, 2022 and December 31, 2021:
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
520,465
13.98
297,826
8.00
390,897
10.50
N/A
Tier 1 Risk-based Capital
382,935
10.29
223,370
6.00
316,441
8.50
Common Equity Tier 1 Capital
316,421
167,527
4.50
260,598
Tier 1 Leverage Ratio
10.33
148,348
4.00
Bank:
474,151
12.74
297,672
390,695
372,090
10.00
429,080
11.53
223,254
316,277
167,441
260,463
241,859
6.50
11.43
150,118
187,647
5.00
24
499,554
15.55
256,966
337,268
367,161
192,725
273,027
300,647
9.36
144,543
224,845
10.82
135,723
415,848
12.94
257,005
337,319
321,256
375,688
11.69
192,754
273,068
144,565
224,879
208,816
11.09
135,508
169,386
The Company and the Bank must maintain a capital conservation buffer, as defined by regulatory guidelines, in order to avoid limitations on capital distributions, including dividend payments, stock repurchases and certain discretionary bonus payments to executive officers.
Note 11: Fair Value Measurement
The Company categorizes its assets and liabilities measured at fair value into a three-level hierarchy based on the priority of the inputs to the valuation technique used to determine fair value. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used in the determination of the fair value measurement fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement. Assets and liabilities valued at fair value are categorized based on the inputs to the valuation techniques as follows:
Level 1 – Inputs that utilized quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.
Level 2 – Inputs that include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instruments. Fair values for these instruments are estimated using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows.
Level 3 – Inputs that are unobservable for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity.
Subsequent to initial recognition, the Company may re-measure the carrying value of assets and liabilities measured on a nonrecurring basis to fair value. Adjustments to fair value usually result when certain assets are impaired. Such assets are written down from their carrying amounts to their fair value.
Professional standards allow entities the irrevocable option to elect to measure certain financial instruments and other items at fair value for the initial and subsequent measurement on an instrument-by-instrument basis. The Company adopted the policy to value certain financial instruments at fair value. The Company has not elected to measure any existing financial instruments at fair value; however, it may elect to measure newly acquired financial instruments at fair value in the future.
25
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 June 30, 2022 and December 31, 2021:
Level 1
Level 2
Level 3
Fair Value of Financial Assets:
Interest Rate Caps
Interest Rate Swaps
12,586
Total Fair Value of Financial Assets
507,707
510,313
Fair Value of Financial Liabilities:
Total Fair Value of Financial Liabilities
2,358
448,322
449,076
1,567
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.
The following tables present net impairment losses related to nonrecurring fair value measurements of certain assets at June 30, 2022 and December 31, 2021:
Impaired Loans
11,985
9,360
625
In accordance with the provisions of the loan impairment guidance, impairment is measured on loans when it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, or discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceeds the recorded investments in such loans. Impaired loans for which an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. Collateral values are estimated using Level 2 inputs based on customized discounting criteria.
Impairment amounts on impaired loans represent specific valuation allowance and write-downs during the period presented on impaired loans that were individually evaluated for impairment based on the estimated fair value of the collateral less estimated selling costs, excluding impaired loans fully charged-off.
Disclosure of fair value information about financial instruments, for which it is practicable to estimate that value, is required whether or not recognized in the consolidated balance sheets. In cases where quoted market prices are not available, fair values are based on estimates using present value of cash flow or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimate of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases could not be realized in immediate settlement of the instruments. Certain financial instruments with a fair value that is not practicable to estimate and all non-financial instruments are excluded from the disclosure requirements. Accordingly, the aggregate fair value amounts presented do not necessarily represent the underlying value of the Company.
Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters that could affect the estimates. Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business. Deposits with no stated maturities are defined as having a fair value equivalent to the amount payable on demand. This prohibits adjusting fair value derived from retaining those deposits for an expected future period of time. This component, commonly referred to as a deposit base intangible, is neither considered in the above amounts nor is it recorded as an intangible asset on the balance sheet. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.
The following tables present the carrying amount and estimated fair values of financial instruments at June 30, 2022 and December 31, 2021:
Fair Value Hierarchy
Carrying
Financial Assets:
Cash and Due From Banks
1,127
Securities Available for Sale
479,977
FHLB Stock, at Cost
Loans, Net
3,113,609
Accrued Interest Receivable
Financial Liabilities:
3,171,333
55,687
90,857
1,884
438,608
2,726,417
2,931,215
42,515
97,700
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.
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.
Subordinated debentures – The fair values of the Company’s 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.
Accrued interest payable – The carrying amount of accrued interest payable approximates its fair value since it is short term in nature.
29
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 June 30, 2022 and December 31, 2021.
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 12: Subsequent Events
On July 26, 2022, the Company’s Board of Directors declared a quarterly cash dividend of $36.72 per share ($0.3672 per depositary share) on its 5.875% Non-Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”), payable on September 1, 2022, to shareholders of record on the Series A Preferred Stock at the close of business on August 15, 2022.
General
The following discussion explains the Company’s financial condition and results of operations as of and for the three and six months ended June 30, 2022. Annualized results for this interim period 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, 2021, filed with the Securities and Exchange Commission, or the SEC, on March 8, 2022.
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
31
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
Management continues to monitor and consider the impact of the ongoing COVID-19 pandemic closely, given the unpredictable nature in which it is evolving. This includes monitoring the effects of the CARES Act and Coronavirus Relief Act and the prospects for additional fiscal stimulus programs, the acceptance of COVID-19 vaccines and new variants of the virus. 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.
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 most recent Annual Report on Form 10-K, filed with the SEC on March 8, 2022. 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. 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 an 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.
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.
34
Operating Results Overview
The following table summarizes certain key financial results for the periods indicated:
As of and for the Three Months Ended
March 31,
September 30,
Per Common Share Data
Basic Earnings Per Share
0.40
Diluted Earnings Per Share
Adjusted Diluted Earnings Per Common Share (1)
Book Value Per Share
11.14
11.12
10.73
Tangible Book Value Per Share (1)
11.03
11.01
10.98
10.62
10.22
Basic Weighted Average Shares Outstanding
28,123,809
28,004,334
28,047,280
Diluted Weighted Average Shares Outstanding
29,156,085
29,038,785
29,110,547
Shares Outstanding at Period End
28,066,822
Selected Performance Ratios
Return on Average Assets (Annualized)
1.38
1.42
1.46
1.37
1.43
Pre-Provision Net Revenue Return on Average Assets (Annualized) (1)
2.19
2.12
2.11
2.09
2.07
Return on Average Shareholders' Equity (Annualized)
13.55
12.98
13.27
13.81
15.40
Return on Average Tangible Common Equity (Annualized) (1)
15.26
14.56
14.78
15.47
15.58
Yield on Interest Earning Assets
4.16
4.13
4.06
4.14
4.17
Yield on Total Loans, Gross
4.45
4.49
4.65
4.56
Cost of Interest Bearing Liabilities
0.86
0.88
Cost of Total Deposits
0.46
0.45
0.48
0.54
Net Interest Margin (2)
3.58
3.60
3.51
3.54
3.52
Core Net Interest Margin (1)(2)
3.34
3.22
3.31
Efficiency Ratio (1)
40.2
42.4
40.8
43.9
42.0
Adjusted Efficiency Ratio (1)
40.0
40.3
41.5
Noninterest Expense to Average Assets (Annualized)
1.47
1.56
1.45
1.58
1.50
Adjusted Noninterest Expense to Average Assets (Annualized) (1)
1.55
1.49
1.48
Loan to Deposit Ratio
100.7
98.4
95.7
95.0
95.3
Core Deposits to Total Deposits (3)
82.9
84.3
85.4
83.3
81.2
Tangible Common Equity to Tangible Assets (1)
7.87
8.60
8.91
8.81
35
Selected Financial Data
The following tables summarize certain selected financial data as of and for the periods indicated:
Selected Balance Sheet Data
3,607,920
3,389,125
3,162,612
2,987,967
2,712,012
2,594,186
38,901
Goodwill and Other Intangibles
3,009
3,057
3,105
3,153
3,200
3,035,611
2,854,157
2,720,906
Tangible Common Equity (1)
305,360
309,870
309,653
298,135
287,630
367,803
Average Total Assets - Quarter-to-Date
3,743,575
3,513,798
3,403,270
3,332,301
3,076,712
Average Shareholders' Equity - Quarter-to-Date
381,448
383,024
374,035
330,604
286,311
For the Three Months Ended
Selected Income Statement Data
Interest Income
34,694
33,775
33,517
Interest Expense
4,514
4,622
4,844
Net Interest Income
30,180
29,153
28,673
1,675
1,150
Net Interest Income after Provision for Loan Losses
28,505
28,003
27,373
Noninterest Income
1,557
1,288
1,410
Noninterest Expense
13,508
12,459
13,236
Income Before Income Taxes
16,554
16,832
15,547
4,292
4,318
4,038
12,262
12,514
11,509
(1,013)
(1,171)
11,249
11,343
36
Discussion and Analysis of Results of Operations
Net income was $12.9 million for the second quarter of 2022, a 17.2% increase compared to net income of $11.0 million for the second quarter of 2021. Earnings per diluted common share for the second quarter of 2022 were $0.41, a 9.2% increase compared to $0.38 per diluted common share for the second quarter of 2021. Net income was $25.1 million for the six months ended June 30, 2022, a 16.1% increase compared to net income of $21.7 million for the six months ended June 30, 2021. Net income per diluted common share for the six months ended June 30, 2022 was $0.80, a 6.9% increase compared to $0.75 per diluted common share for the six months ended June 30, 2021.
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.
37
Average Balances and Yields
The following tables present, for the three and six months ended June 30, 2022 and 2021, 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.
June 30, 2021
Yield/
& Fees
Interest Earning Assets:
Cash Investments
61,046
40
0.26
88,067
0.15
Investment Securities:
Taxable Investment Securities
417,142
2,696
2.59
314,049
1,647
2.10
Tax-Exempt Investment Securities (1)
74,261
795
4.30
77,029
842
4.38
Total Investment Securities
491,403
3,491
2.85
391,078
2,489
2.55
Paycheck Protection Program Loans (2)
8,335
263
12.67
149,312
1,767
4.75
Loans (1)(2)
3,099,344
34,205
4.43
2,384,759
27,011
4.54
Total Loans
3,107,679
34,468
2,534,071
28,778
Federal Home Loan Bank Stock
11,620
59
2.04
6,221
54
Total Interest Earning Assets
3,671,748
38,058
3,019,437
31,354
Noninterest Earning Assets
71,827
57,275
Interest Bearing Liabilities:
Interest Bearing Transaction Deposits
552,502
694
0.50
421,132
520
925,354
1,185
0.51
764,632
940
0.49
280,645
665
0.95
332,346
1,075
1.30
403,931
912
0.91
379,768
978
1.03
Total Interest Bearing Deposits
2,162,432
0.64
1,897,878
0.74
137,379
1.20
9,932
0.24
47,511
1.41
57,500
1.59
92,396
5.29
73,862
6.04
Total Interest Bearing Liabilities
2,439,718
2,039,172
Noninterest Bearing Liabilities:
Noninterest Bearing Transaction Deposits
882,477
732,299
Other Noninterest Bearing Liabilities
39,932
18,930
Total Noninterest Bearing Liabilities
922,409
751,229
Shareholders' Equity
Total Liabilities and Shareholders' Equity
Net Interest Income / Interest Rate Spread
32,806
3.30
26,495
3.21
Net Interest Margin (3)
Taxable Equivalent Adjustment:
Tax-Exempt Investment Securities and Loans
(276)
(207)
For the Six Months Ended
70,718
0.19
96,724
395,203
4,951
2.53
307,898
3,371
2.21
72,933
1,574
4.35
78,985
1,723
4.40
468,136
2.81
386,883
5,094
2.66
13,210
826
12.61
149,098
3,631
4.91
2,991,195
65,480
4.41
2,313,295
53,085
4.63
3,004,405
66,306
2,462,393
56,716
4.64
8,667
2.63
5,636
132
4.74
3,551,926
73,010
2,951,636
62,009
4.24
77,395
57,228
3,629,321
3,008,864
559,352
1,291
0.47
392,732
942
901,102
2,103
744,480
1,949
0.53
284,757
1.00
338,497
2,341
1.39
405,282
1,810
391,167
1,952
2,150,493
0.62
1,866,876
0.78
74,340
1.14
4,993
3,343
3.66
45,019
1.60
92,341
73,819
2,362,193
2,006,531
852,648
704,391
32,248
18,384
884,896
722,775
382,232
279,558
63,244
3.32
52,105
3.24
3.59
3.56
(534)
(422)
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 table presents the effect that these factors had on the interest earned on interest earning assets and the interest incurred on interest bearing liabilities. The effect of changes in volume is determined by multiplying the change in volume by the previous period’s average rate. Similarly, the effect of rate changes is calculated by multiplying the
39
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 June 30, 2022, compared to the three months ended June 30, 2021, and for the six months ended June 30, 2022, compared to the June 30, 2021.
Compared with
Change Due To:
Volume
Variance
666
1,049
Tax-Exempt Investment Securities
(31)
(47)
Total Securities
635
367
1,002
Loans:
Paycheck Protection Program Loans
(4,453)
2,949
(1,504)
Loans
7,886
(692)
7,194
3,433
2,257
5,690
(23)
4,079
6,704
165
206
(124)
(286)
(410)
55
(121)
(66)
302
(359)
(57)
380
404
(35)
(61)
(138)
107
892
(499)
393
3,187
3,124
6,311
(25)
1,094
486
1,580
(131)
(18)
(149)
963
468
1,431
(8,496)
5,691
(2,805)
14,840
(2,445)
12,395
6,344
3,246
9,590
7,322
3,679
11,001
385
(36)
349
366
(212)
(267)
(664)
(931)
(205)
547
(1,117)
(570)
391
413
(89)
(50)
(139)
(266)
1,273
(1,411)
6,049
5,090
11,139
Comparison of Interest Income, Interest Expense, and Net Interest Margin
Second Quarter of 2022 Compared to Second Quarter of 2021
Net interest income was $32.5 million for the second quarter of 2022, an increase of $6.2 million, or 23.7%, compared to $26.3 million for the second quarter of 2021. The increase in net interest income was primarily due to growth in average interest earning assets and lower rates paid on deposits, offset partially by declining yields on loans and lower PPP fee recognition. The increase in average interest earning assets was primarily due to strong organic growth in the loan portfolio and continued purchases of investment securities, offset partially by the forgiveness of PPP loans and the reduction of cash balances.
Net interest margin (on a fully tax-equivalent basis) for the second quarter of 2022 was 3.58%, a six basis point increase from 3.52% in the second quarter of 2021. 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 second quarter of 2022 was 3.34%, a three basis point increase from 3.31% in the second quarter of 2021. The stability in core net interest margin was primarily due to rising earning asset yields in conjunction with increasing funding costs associated with the higher interest rate environment. With the rapid increase in interest rates in 2022, earning asset yields and funding costs have both reached a bottom. The Company remains focused on the impact of continued interest rate hikes and the evolving shape of the yield curve throughout 2022.
As the PPP loan portfolio continues to pay down, the recognition of fees associated with the originations has decreased, which impacts comparability between periods. The Company recognized $244,000 of PPP origination fees during the second quarter of 2022, compared to $1.4 million during the second quarter of 2021. Remaining PPP origination fees to be recognized as of June 30, 2022 were $135,000.
The following table summarizes PPP loan originations and net origination fees through June 30, 2022:
Originated
Program Lifetime
Number
Net Origination
of Loans
Fees Generated
Fees Earned
Round One PPP Loans
1,200
181,600
180
5,706
Round Two PPP Loans
651
78,386
4,680
3,544
3,409
1,851
259,986
9,250
9,115
Average interest earning assets for the second quarter of 2022 increased $652.3 million, or 21.6%, to $3.67 billion, from $3.02 billion for the second quarter of 2021. This increase in average interest earning assets was primarily due to strong organic growth in the loan portfolio and continued purchases of investment securities, offset partially by the forgiveness of PPP loans and the reduction of cash balances. Average interest bearing liabilities increased $400.5 million, or 19.6%, to $2.44 billion for the second quarter of 2022, from $2.04 billion for the second quarter of 2021. The increase in average interest bearing liabilities was primarily due to an increase in interest bearing deposits and federal funds purchased, as well as the issuance of additional subordinated debentures in July 2021, offset partially by a decrease in FHLB advances.
41
Average interest earning assets produced a tax-equivalent yield of 4.16% for the second quarter of 2022, compared to 4.17% for the second quarter of 2021. The decline in the yield on interest earning assets was primarily due to lower recognition of PPP origination fees, offset partially by rising yields in the investment securities portfolio. The average rate paid on interest bearing liabilities was 0.86% for the second quarter of 2022, compared to 0.96% for the second quarter of 2021 primarily due to lower rates paid on deposits, offset partially by the strong growth of interest bearing deposits, an increase in federal funds purchased, and the issuance of additional subordinated debentures.
Interest Income. Total interest income, on a tax-equivalent basis, was $38.1 million for the second quarter of 2022, compared to $31.4 million for the second quarter of 2021. The $6.6 million, or 21.4%, increase in total interest income on a tax-equivalent basis was primarily due to continued organic growth in the loan portfolio and continued purchases of investment securities, offset partially by a reduction in the recognition of PPP origination fees as the PPP loan portfolio continues to be forgiven.
Interest income on loans, on a tax-equivalent basis, was $34.5 million for the second quarter of 2022, compared to $28.8 million for the second quarter of 2021. The $5.7 million, or 19.8%, increase was primarily due to a 22.6% increase in the average balance of loans outstanding from continued organic loan growth, which was partially offset by a 11 basis point decline in the average yield on loans.
Loan interest income and loan fees remain the primary contributing factors to the changes in the yield on interest earning assets. The aggregate loan yield, excluding PPP loans, decreased to 4.43% in the second quarter of 2022, which was 11 basis points lower than 4.54% in the second quarter of 2021. The Company believes that the portfolio yield has bottomed as new loan originations and the existing portfolio continue to reprice in the higher rate environment.
The following table presents a summary of interest and fees recognized on loans, excluding PPP loans, for the periods indicated is as follows:
March 31, 2022
September 30, 2021
4.20
4.28
4.37
Fees
0.25
0.21
0.23
0.17
Yield on Loans, Excluding PPP Loans
4.51
Interest Expense. Interest expense on interest bearing liabilities increased $393,000, or 8.1%, to $5.3 million for the second quarter of 2022, compared to $4.9 million for the second quarter of 2021. The cost of interest bearing liabilities declined 10 basis points from 0.96% in the second quarter of 2021 to 0.86% in the second quarter of 2022, primarily due to lower rates paid on deposits, offset partially by strong growth of interest bearing deposits, an increase of federal funds purchased, and the issuance of additional subordinated debentures.
Interest expense on deposits was $3.5 million for the second quarter of 2022, a decrease of $57,000, or 1.6%, from $3.5 million for the second quarter of 2021. The cost of total deposits declined eight basis points from 0.54% in the second quarter of 2021, to 0.46% in the second quarter of 2022, primarily due to the downward repricing of time and brokered deposits over the course of the year.
Interest expense on borrowings increased $450,000 to $1.8 million for the second quarter of 2022, compared to $1.3 million for the second quarter of 2021. This increase was primarily due to higher average balances of federal funds purchased and subordinated debentures due to the issuance of additional subordinated debentures in July 2021, offset partially by a decrease in FHLB advances.
Six Months Ended June 30, 2022 Compared to Six Months Ended June 30, 2021
42
Net interest income was $62.7 million for the six months ended June 30, 2022, an increase of $11.0 million, or 21.3%, compared to $51.7 million for the six months ended June 30, 2021. The increase in net interest income was primarily due to growth in average interest earning assets and lower rates paid on deposits, offset partially by declining yields on loans and lower PPP fee recognition.
Net interest margin (on a fully tax-equivalent basis) for the six months ended June 30, 2022 was 3.59%, compared to 3.56% for the six months ended June 30, 2021, an increase of three 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 six months ended June 30, 2022 was 3.34%, a one basis point increase from 3.33% for the six months ended June 30, 2021.
Average interest earning assets for the six months ended June 30, 2022 increased $600.3 million, or 20.3%, to $3.55 billion from $2.95 billion for the six months ended June 30, 2021. This increase in average interest earning assets was primarily due to strong organic growth in the loan portfolio and continued purchases of investment securities, offset partially by the forgiveness of PPP loans and the reduction of cash balances. Average interest bearing liabilities increased $355.7 million, or 17.7%, to $2.36 billion for the six months ended June 30, 2022, from $2.01 billion for the six months ended June 30, 2021. The increase in average interest bearing liabilities was primarily due to an increase in interest bearing deposits and federal funds purchased, as well as the issuance of additional subordinated debentures in July 2021, offset partially by a decrease in FHLB advances.
Average interest earning assets produced a tax-equivalent yield of 4.15% for the six months ended June 30, 2022, compared to 4.24% for the six months ended June 30, 2021. The average rate paid on interest bearing liabilities was 0.83% for the six months ended June 30, 2022, compared to 1.00% for the six months ended June 30, 2021.
Interest Income. Total interest income on a tax-equivalent basis was $73.0 million for the six months ended June 30, 2022, compared to $62.0 million for the six months ended June 30, 2021. The $11.0 million, or 17.7%, increase in total interest income on a tax-equivalent basis was primarily due to strong organic growth in the loan portfolio and continued purchases of investment securities, offset partially by a reduction in the recognition of PPP origination fees as the PPP loan portfolio continues to be forgiven.
Interest income on the investment securities portfolio, on a fully-tax equivalent basis, increased $1.4 million, or 28.1%, during the six months ended June 30, 2022, compared to the six months ended June 30, 2021, primarily due to an $81.3 million, or 21.0%, increase in average balances between the periods.
Interest income on loans, on a fully-tax equivalent basis, for the six months ended June 30, 2022 was $66.3 million, compared to $56.7 million for the six months ended June 30, 2021. The $9.6 million, or 16.9%, increase was primarily due to a 22.0% increase in the average balance of loans outstanding, which was offset partially by a 19 basis point decline in the average yield on loans.
Interest Expense. Interest expense on interest bearing liabilities decreased $137,000, or 1.4%, to $9.8 million for the six months ended June 30, 2022, compared to $9.9 million for the six months ended June 30, 2021, primarily due to lower rates paid on deposits, offset partially by the growth of interest bearing deposits, an increase of federal funds purchased and the issuance of additional subordinated debentures.
Interest expense on deposits decreased to $6.6 million for the six months ended June 30, 2022, compared to $7.2 million for the six months ended June 30, 2021. The $570,000, or 7.9%, decrease in interest expense on deposits was primarily due to a 16 basis point decrease in the average rate paid, even as the average balance of interest bearing deposits increased 15.2%. The decrease in the average rate paid was primarily due to the downward repricing of time and brokered deposits over the course of the year. 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.
43
Interest expense on borrowings increased $433,000 to $3.2 million for the six months ended June 30, 2022, compared to $2.7 million for the six months ended June 30, 2021. This increase was primarily due to an increase in federal funds purchased and the issuance of additional subordinated debentures in July 2021, offset partially by a lower average balance of FHLB advances and the payoff of the Company's notes payable.
The provision for loan losses was $3.0 million for the second quarter of 2022, an increase of $1.4 million, compared to the provision for loan losses of $1.6 million for the second quarter of 2021. The provision for loan losses was $4.7 million for the six months ended June 30, 2022, an increase of $2.0 million compared to the provision for loan losses of $2.7 million for the six months ended June 30, 2021. The increase in the provision for loan losses was primarily attributable to the robust growth of the loan portfolio. The allowance for loan losses to total loans was 1.39% at June 30, 2022, compared to 1.45% at June 30, 2021.
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.
The following table presents a summary of the activity in the allowance for loan losses for the periods indicated:
Balance at Beginning of Period
Charge-offs
Recoveries
Balance at End of Period
Noninterest income was $1.7 million for the second quarter of 2022, an increase of $47,000 from $1.6 million for the second quarter of 2021. The increase was primarily due to increased letter of credit fees, bank-owned life insurance income, and other income, offset partially by lower gains on sales of securities. Noninterest income was $3.2 million for the six months ended June 30, 2022, an increase of $596,000, compared to $2.6 million for the six months ended June 30, 2021. The increase was primarily due to increased letter of credit fees, bank-owned life insurance income, and swap fees, offset partially by lower gains on sales of securities.
The following table presents the major components of noninterest income for the periods indicated:
Increase/
(Decrease)
Noninterest Income:
114
Net Gain on Sales of Securities
(650)
Letter of Credit Fees
564
333
806
558
248
Debit Card Interchange Fees
152
285
271
Swap Fees
557
Bank-Owned Life Insurance
149
297
435
137
631
615
47
596
Noninterest expense was $13.8 million for the second quarter of 2022, an increase of $2.3 million from $11.5 million for the second quarter of 2021. The increase was primarily driven by a $1.5 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 expenses, and other expenses.
Six months ended June 30, 2022 Compared to Six months ended June 30, 2021
Noninterest expense was $27.3 million for the six months ended June 30, 2022, an increase of $4.9 million, or 21.7%, from $22.4 million for the six months ended June 30, 2021. The increase was primarily driven by a $3.1 million increase in salaries and employee benefits, a $550,000 increase in marketing and advertising expense, a $369,000 increase in professional and consulting fees, and a $562,00 increase in other expenses.
The Company continues to add key talent across the organization. Full-time equivalent employees increased from 214 at the end of the second quarter of 2021 to 236 at the end of the second quarter of 2022.
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 40.2% for the second quarter of 2022, compared to 42.0% for the second quarter of 2021. Excluding the impact of certain non-routine income and expenses, the adjusted efficiency ratio, a non-GAAP financial measure, was 40.0% for the second quarter of 2022, compared to 41.5% for the second quarter of 2021. The adjusted efficiency ratio for the six months ended June 30, 2022 and 2021 was 41.0% and 41.1%, respectively. The efficiencies of the Company's "branch-light" model have positioned the Company well to continue making investments in technology and branding as the industry adapts to evolving client behavior.
The following table presents the major components of noninterest expense for the periods indicated:
Noninterest Expense:
1,465
62
92
FDIC Insurance Assessment
330
290
690
605
Data Processing
356
300
653
591
Professional and Consulting Fees
769
552
217
1,096
369
Information Technology and Telecommunications
594
549
45
1,172
1,011
161
Marketing and Advertising
524
314
210
550
Intangible Asset Amortization
95
Amortization of Tax Credit Investments
140
(77)
258
(78)
1,050
793
257
2,057
562
2,275
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 $4.5 million for the second quarter of 2022, compared to $3.8 million for the second quarter of 2021. The effective combined federal and state income tax rate for the second quarter of 2022 was 26.0%, compared to 25.8% for the second quarter of 2021. Income tax expense was $8.8 million for the six months ended June 30, 2022, compared to $7.5 million for the six months ended June 30, 2021. The effective combined federal and state income tax rate for the six months ended June 30, 2022 and 2021 was 26.0% and 25.8%, respectively.
Financial Condition
Total assets at June 30, 2022 were $3.88 billion, an increase of $405.6 million, or 11.7%, over total assets of $3.48 billion at December 31, 2021, and an increase of $720.7 million, or 22.8%, over total assets of $3.16 billion at June 30, 2021. The growth in both periods was primarily driven by strong organic loan growth and purchases of investment securities, offset partially by a decrease in cash and cash equivalents.
Total gross loans at June 30, 2022 were $3.23 billion, an increase of $406.4 million, or 14.4%, over total gross loans of $2.82 billion at December 31, 2021, and an increase of $631.7 million, or 24.4%, over total gross loans of $2.59 billion at June 30, 2021. The increase in the loan portfolio during the second quarter of 2022 was primarily due to growth in the commercial, construction and land development, multifamily, and CRE nonowner occupied segments, offset partially by the forgiveness of PPP loans. When excluding PPP loans, gross loans grew $245.4 million during the second quarter of 2022, or 33.1% on an annualized basis. The Company's continued strong loan growth has been driven by the expansion of its talented lending teams, the strong, 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 banks 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 $482.6 million at June 30, 2022, compared to $439.4 million at December 31, 2021, an increase of $43.2 million or 9.8%. At June 30, 2022, municipal securities represented 34.7% of the investment securities portfolio, government agency mortgage-backed securities represented 24.2% of the portfolio, SBA securities represented 5.1% of the portfolio, corporate securities represented 21.4% of the portfolio, U.S. treasury securities represented 0.5% of the portfolio, asset-backed securities represented 8.2% of the portfolio, and other mortgage-backed securities represented 5.9% of the portfolio.
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The following table presents the amortized cost and fair value of securities available for sale, by type, at June 30, 2022 and December 31, 2021:
Fair
Value
Mortgage-Backed Securities Issued or Guaranteed by U.S. Agencies (MBS):
Residential Pass-Through:
Guaranteed by GNMA
7,365
7,181
671
Issued by FNMA and FHLMC
25,276
23,121
20,649
20,363
Other Residential Mortgage-Backed Securities
81,756
75,017
83,394
82,271
Commercial Mortgage-Backed Securities
11,192
10,938
10,646
11,138
All Other Commercial MBS
29,991
28,712
10,203
10,063
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.
Total gross loans increased $406.4 million to $3.23 billion at June 30, 2022, compared to $2.82 billion at December 31, 2021 and increased $631.7 million from $2.59 billion at June 30, 2021. As of June 30, 2022, construction and land development loans increased $77.7 million, multifamily loans increased $177.6 million, and nonowner occupied CRE loans increased $67.9 million, when compared to December 31, 2021. Collectively, the Company’s annualized loan growth for the six months ended June 30, 2022, excluding PPP loans, was 30.9%.
The following table presents the dollar and percentage composition of the loan portfolio by category, at the dates indicated:
March 31, 2021
Percent
12.5
363,290
12.2
12.8
350,081
12.9
321,474
12.4
0.2
12,309
0.4
0.9
54,190
2.0
99,072
3.8
11.1
321,131
10.7
10.0
257,167
9.5
251,573
9.7
1 - 4 Family Mortgage
10.4
312,201
10.5
10.8
290,535
277,943
33.7
1,012,623
33.9
32.3
865,172
31.9
790,275
30.5
4.4
117,969
3.9
4.0
101,834
87,507
3.4
27.5
840,463
28.1
29.0
786,271
758,101
29.2
76.0
2,283,256
76.4
76.1
2,043,812
75.4
1,913,826
73.8
7,981
0.3
6,762
8,241
100.0
(41,692)
(38,901)
(37,591)
(9,065)
(10,199)
(11,450)
2,937,210
2,662,912
2,545,145
The Company’s primary focus has been on real estate mortgage lending, which constituted 76.0% of the portfolio as of June 30, 2022. The composition of the portfolio has remained relatively 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 June 30, 2022, investor CRE loans totaled $2.33 billion, consisting of $886.4 million of loans secured by nonowner occupied CRE, $1.09 billion of loans secured by multifamily residential properties and $359.2 million of construction and land development loans. Investor CRE loans represented 72.4% of the total gross loan portfolio, excluding PPP loans, and 492.1% of the Bank’s total risk-based capital at June 30, 2022, compared to 483.4% at December 31, 2021.
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The following tables present time to contractual maturity and sensitivity to interest rate changes for the loan portfolio at June 30, 2022 and December 31, 2021:
As of June 30, 2022
Due in One Year
More Than One
More Than Five
After
or Less
Year to Five Years
Year to Fifteen Years
Fifteen Years
135,621
182,415
82,405
3,128
118,654
154,659
85,828
50,651
208,405
75,090
669
76,416
412,903
551,208
47,338
6,126
42,177
93,911
157,053
385,805
343,574
290,246
1,049,290
1,063,783
48,007
3,621
3,120
198
548,146
1,394,340
1,232,016
51,383
Interest Rate Sensitivity:
Fixed Interest Rates
275,040
1,068,944
752,365
4,470
Floating or Adjustable Rates
273,106
325,396
479,651
46,913
As of December 31, 2021
143,878
149,541
63,588
3,162
898
25,264
88,814
121,357
71,303
55,794
185,729
63,117
677
78,875
331,447
470,353
29,568
4,679
22,385
84,032
146,508
359,735
312,326
285,856
899,296
929,828
30,245
3,088
2,645
495
214
522,534
1,198,103
1,065,214
33,621
226,008
919,024
591,560
7,477
296,526
279,079
473,654
26,144
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 June 30, 2022. The Company had no assets classified as doubtful or loss.
Risk Category
16,252
42,654
28,251
17,077
45,328
61,696
The Company has increased oversight and analysis of all segments of the loan portfolio in response to the COVID-19 pandemic and now economic uncertainty. Loans that have potential weaknesses that warranted a watchlist risk rating at June 30, 2022, totaled $34.7 million, compared to $49.3 million at December 31, 2021. Loans that warranted a substandard risk rating at June 30, 2022 totaled $27.0 million, compared to $22.6 million at December 31, 2021. The increase in substandard loans was due to the migration of one relationship from watch to a substandard risk rating. Management continues to actively work with these borrowers and closely monitor substandard credits.
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. Modifications under this guidance, which could only be applied to modifications made by January 1, 2022, have been granted on a case-by-case basis based on specific needs and circumstances affecting each borrower. The Company had 7 modified loans totaling $29.8 million outstanding as of June 30, 2022 representing 0.9% of the loan portfolio, excluding PPP loans, which was down from $35.0 million at December 31, 2021.
The following table presents a rollforward of loan modification activity, by modification type, from December 31, 2021 to June 30, 2022:
Principal Balance - December 31, 2021
30,249
4,740
34,989
Modification Expired
(4,595)
Net Principal Advances (Payments)
(563)
(46)
(609)
Principal Balance - June 30, 2022
The following table presents a summary of active loan modifications, by loan segment and modification type, at June 30, 2022:
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 $688,000 at June 30, 2022 and $722,000 at December 31, 2021, a decrease of $34,000. There were no loans 90 days past due and still accruing as of June 30, 2022 or December 31, 2021 and there were no foreclosed assets as of June 30, 2022 or December 31, 2021.
The following table presents a summary of nonperforming assets, by category, at the dates indicated:
Total Nonaccrual Loans
Total Nonperforming Loans
Plus: Foreclosed Assets
Total Nonperforming Assets (1)
Total Restructured Accruing Loans
Total Nonperforming Assets and Restructured Accruing Loans
773
2,026
Nonaccrual Loans to Total Loans
0.02
0.03
Nonperforming Loans to Total Loans
Nonperforming Assets to Total Loans Plus Foreclosed Assets (1)
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 six months ended June 30, 2022 was $15,000 and $22,000, 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, rising inflation and the risk of recession, 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
51
borrowers’ creditworthiness, and the impact of examinations by regulatory agencies all could cause changes to the allowance for loan losses.
At June 30, 2022, the allowance for loan losses was $44.7 million, an increase of $4.7 million from $40.0 million at December 31, 2021. Net charge-offs (recoveries) totaled $6,000 during the second quarter of 2022 and ($4,000) during the second quarter of 2021. Net charge-offs (recoveries) totaled $9,000 for the six months ended June 30, 2022 and ($50,000) for the six months ended June 30, 2021. The allowance for loan losses as a percentage of total loans was 1.39% at June 30, 2022, compared to 1.42% at December 31, 2021.
The following table presents a summary of net charge-offs for the periods indicated:
Net Charge-offs (Recoveries)
(22)
(32)
Total Net Charge-offs (Recoveries)
Net Charge-offs to Average Loans
0.01
0.00
(0.01)
(0.08)
(0.16)
0.06
0.13
0.11
Total Net Charge-offs (Recoveries) (Annualized) to Average Loans
Gross Loans, End of Period
Average Loans
Allowance to Total Gross Loans
Allowance to Total Gross Loans, Excluding PPP Loans
The following table presents a summary of the allocation of the allowance for loan losses by loan portfolio segment for the periods indicated:
14.0
15.6
9.4
33.5
31.5
4.3
3.7
27.4
28.3
33,338
74.6
29,197
72.9
0.5
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:
30.0
835,482
29.7
846,490
758,023
27.9
522,151
17.1
598,402
19.7
544,789
18.5
488,785
432,123
15.9
890,926
29.3
791,861
27.7
761,485
28.0
8.5
286,674
309,824
10.9
321,857
11.8
15.4
424,127
417,197
14.6
447,418
16.4
Total deposits at June 30, 2022 were $3.20 billion, an increase of $255.7 million, or 8.7%, compared to total deposits of $2.95 billion at December 31, 2021, and an increase of $481.0 million, or 17.7%, over total deposits of $2.72 billion at June 30, 2021. Deposit growth in the second quarter of 2022 was primarily due to an increase in noninterest bearing transaction deposits, savings and money market deposits, and brokered deposits, offset partially by declines in interest bearing transaction deposits and time deposits. On a year-over-year basis, noninterest bearing transaction deposits increased $204.0 million, or 26.9%, compared to June 30, 2021. Similar to the loan portfolio, the growth in core deposits has been a result of successful new client and banker acquisition initiatives, expansion of commercial client relationships, and the strong, growing brand of the Bank in the Twin Cities market. Given the rapid rise in interest rates and the prospect for more, 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 June 30, 2022, total brokered deposits were $493.2 million, an increase of $123.9 million, or 33.6%, compared to total brokered deposits of $369.3 million at December 31, 2021.
The following table presents the average balance and average rate paid on each of the following deposit categories for the three months ended June 30, 2022 and June 30, 2021:
As of and for the
Time Deposits < $250,000
228,406
0.92
266,116
Time Deposits > $250,000
52,239
1.10
66,230
3,044,909
2,630,177
The Company’s total uninsured deposits, which are the amounts of deposit accounts that exceed the FDIC insurance limit, currently $250,000, were approximately $1.33 billion and $1.21 billion at June 30, 2022 and December 31, 2021, respectively. These amounts were estimated based on the same methodologies and assumptions used for regulatory reporting purposes.
Borrowed Funds
Other Borrowings
At June 30, 2022, other borrowings outstanding consisted of FHLB advances of $56.5 million. The Company’s borrowing capacity at the FHLB is determined based on collateral pledged, generally consisting of loans. The Company had additional borrowing capacity under this credit facility of $569.1 million and $550.8 million at June 30, 2022 and December 31, 2021, respectively.
The Company has an outstanding 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 June 30, 2022, there were no outstanding balances under the revolving line of credit.
Additionally, the Company has borrowing capacity from other sources. As of June 30, 2022, 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 $169.8 million and $126.0 million at June 30, 2022 and December 31, 2021, respectively. As of June 30, 2022 and December 31, 2021, the Company had no outstanding advances from the discount window.
For additional information, see “Note 7 – Subordinated Debentures” of the Company’s Consolidated Financial Statements included as part of this report.
Contractual Obligations
The following table presents supplemental information regarding total contractual obligations at June 30, 2022:
Within
One to
Three to
One Year
Three Years
Five Years
Deposits Without a Stated Maturity
2,657,684
219,187
127,933
32,500
4,000
Commitment to Fund Tax Credit Investments
323
Operating Lease Obligations
518
1,006
735
433
2,692
2,851,251
252,693
132,668
118,606
3,355,218
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.
Total shareholders’ equity at June 30, 2022 was $374.9 million, a decrease of $4.4 million compared to total shareholders’ equity of $379.3 million at December 31, 2021, primarily due to an increase in unrealized losses in the securities portfolio and stock repurchases made under the Company’s stock repurchase program, offset partially by net income retained and unrealized gains in the derivatives portfolio.
Stock Repurchase Program. During the three months ended June 30, 2022, the Company repurchased 492,417 shares of its common stock, representing 1.8% of the Company’s outstanding shares. Shares were repurchased during this period at a weighted average price of $16.16 for a total of $8.0 million. During the six months ended June 30, 2022, the Company repurchased 563,455 shares of its common stock, representing 2.0% of the Company’s outstanding shares. Shares were repurchased during this period at a weighted average price of $16.26 for a total of $9.2 million. All shares repurchased under the stock repurchase program were converted to authorized but unissued shares. At June 30, 2022, the remaining amount that could be used to repurchase shares under the stock repurchase program was $3.2 million. The Company remains committed to maintaining strong capital levels while enhancing shareholder value as it strategically executes its stock repurchase program based on various factors including valuation, capital levels and other uses of capital.
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.
Management believes the Company and the Bank met all capital adequacy requirements to which they were subject as of June 30, 2022. 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.
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 June 30, 2022, 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 June 30, 2022 and December 31, 2021:
Fixed
Variable
438,914
453,609
335,842
463,306
13,108
102,909
10,521
109,126
452,022
556,518
346,363
572,432
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 June 30, 2022, the Company had no borrowings outstanding through the AFX.
The following tables present a summary of primary and secondary liquidity levels as of the dates indicated:
Primary Liquidity—On-Balance Sheet
(Dollars in thousands)
43,168
130,884
Total Primary Liquidity
525,751
570,246
Ratio of Primary Liquidity to Total Deposits
19.4
Secondary Liquidity—Off-Balance Sheet
Borrowing Capacity
Net Secured Borrowing Capacity with the FHLB
569,076
550,807
Net Secured Borrowing Capacity with the Federal Reserve Bank
169,766
126,043
Unsecured Borrowing Capacity with Correspondent Lenders
208,000
Secured Borrowing Capacity with Correspondent Lender
Total Secondary Liquidity
971,842
909,850
Ratio of Primary and Secondary Liquidity to Total Deposits
46.8
50.2
During the six months ended June 30, 2022, primary liquidity decreased by $44.5 million due to a $87.7 million decrease in cash and cash equivalents, offset partially by a $43.2 million increase in securities available for sale, when compared to December 31, 2021. Secondary liquidity increased by $62.0 million as of June 30, 2022, when compared to December 31, 2021, due to a $43.7 million increase in the borrowing capacity on the secured credit line with the Federal Reserve Bank and an $18.3 million increase in the borrowing capacity on the secured borrowing line with the FHLB.
In addition to primary liquidity, the Company generates liquidity from cash flows from the loan and securities portfolios and from the large base of core customer deposits, defined as noninterest bearing transaction, interest bearing transaction, savings, non-brokered money market accounts and non-brokered time deposits less than $250,000. At June 30, 2022, core deposits totaled approximately $2.66 billion and represented 82.9% 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 and interest rate risk management purposes. At June 30, 2022, brokered deposits totaled $493.2 million, consisting of $271.8 million of brokered time deposits and $221.4 million of non-maturity brokered money market and transaction accounts. At December 31, 2021, brokered deposits totaled $369.3 million, consisting of $238.1 million of brokered time deposits and $131.2 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 June 30, 2022, the Company was in compliance with all established liquidity guidelines in the policy.
58
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)
Total Operating Noninterest Income
1,598
1,362
901
3,155
1,909
Plus: Net Interest Income
Net Operating Revenue
34,128
31,737
30,441
30,035
27,189
65,865
53,592
Less: Amortization of Tax Credit Investments
(63)
(117)
(152)
(140)
(180)
(258)
Less: Debt Prepayment Fees
(582)
Total Operating Noninterest Expense
13,689
13,391
12,307
12,502
11,337
27,080
22,142
20,439
18,346
18,134
17,533
15,852
38,785
31,450
Plus:
Non-Operating Revenue Adjustments
Less:
Non-Operating Expense Adjustments
117
734
Average Assets
Pre-Provision Net Revenue Return on Average Assets
2.16
Core Net Interest Margin
Net Interest Income (Tax-equivalent Basis)
30,438
29,388
28,880
Less: Loan Fees
(2,030)
(1,743)
(1,462)
(1,487)
(1,023)
(3,773)
(2,225)
Less: PPP Interest and Fees
(263)
(1,057)
(1,753)
(1,767)
(826)
(3,631)
Core Net Interest Income
30,513
28,132
26,869
25,640
23,705
58,645
46,249
Average Interest Earning Assets
3,430,774
3,320,603
3,234,301
Less: Average PPP Loans
(8,335)
(18,140)
(39,900)
(76,006)
(149,312)
(13,210)
(149,098)
Core Average Interest Earning Assets
3,663,413
3,412,634
3,280,703
3,158,295
2,870,125
3,538,716
2,802,538
3.33
Efficiency Ratio
Less: Amortization of Intangible Assets
(95)
Adjusted Noninterest Expense
13,705
13,460
12,411
13,188
11,430
27,165
22,305
Less: Gain on Sales of Securities
Adjusted Operating Revenue
41.2
41.6
Adjusted Efficiency Ratio
13,642
13,343
12,259
12,454
11,290
26,985
22,047
41.0
41.1
Adjusted Noninterest Expense to Average Assets (Annualized)
60
Tangible Common Equity and Tangible Common Equity/Tangible Assets
Less: Preferred Stock
(66,514)
(66,515)
Total Common Shareholders' Equity
308,369
312,927
312,758
301,288
Less: Intangible Assets
(3,009)
(3,057)
(3,105)
(3,153)
(3,200)
Tangible Common Equity
Tangible Assets
3,880,255
3,604,863
3,474,554
3,385,972
3,159,412
Tangible Common Equity/Tangible Assets
Tangible Book Value Per Share
Book Value Per Common Share
Less: Effects of Intangible Assets
(0.11)
Tangible Book Value Per Common Share
Return on Average Tangible Common Equity
Average Shareholders' Equity
Less: Average Preferred Stock
(32,332)
Average Common Equity
314,934
316,510
307,520
298,272
315,718
Less: Effects of Average Intangible Assets
(3,037)
(3,084)
(3,132)
(3,180)
(3,228)
(3,060)
(3,251)
Average Tangible Common Equity
311,897
313,426
304,388
295,092
283,083
312,658
276,307
14.91
15.81
Adjusted Diluted Earnings Per Common Share
Add: Debt Prepayment Fees
582
Less: Tax Impact
(151)
Net Income, Excluding Impact of Debt Prepayment Fees
11,940
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 June 30, 2022 and December 31, 2021, these cash flow hedges had a total notional amount of $250.0 million and $235.0 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 June 30, 2022 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)
Forecasted
Percentage
in Interest Rates
Net Interest
Change
(12-Month Projection)
Income
from Base
+400
137,534
(1.61)
116,256
5.75
+300
138,282
(1.07)
114,328
+200
138,863
(0.66)
112,288
2.15
+100
(0.36)
110,539
0.55
0
139,783
109,930
−100
140,495
106,955
(2.71)
The table above indicates that as of June 30, 2022, in the event of an immediate and sustained 400 basis point increase in interest rates, the Company would experience a 1.61% decrease in net interest income. In the event of an immediate 100 basis point decrease in interest rates, the Company would experience a 0.51% increase 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.
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 June 30, 2022, 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 June 30, 2022, 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 8, 2022.
Issuer Repurchases of Equity Securities
The following table presents stock purchases made during the second quarter of 2022:
Period
Total Number of Shares Purchased (1)
Average Price Paid Per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2)
Maximum Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
April 1 - 30, 2022
179,996
16.56
8,222,832
May 1 - 31, 2022
174,100
15.91
5,453,402
June 1 - 30, 2022
138,671
15.97
138,321
3,243,732
492,767
16.16
492,417
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)
3.2
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)
3.3
Statement of Designation of 5.875% Non-Cumulative Perpetual Preferred Stock, Series A (incorporated herein by reference to Exhibit 3.1 on Form 8-K filed on August 17, 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 June 30, 2022, 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
104
The cover page for Bridgewater Bancshares, Inc’s Form 10-Q Report for the quarterly period ended June 30, 2022 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: August 4, 2022
By:
/s/ Jerry J. Baack
Name:
Jerry J. Baack
Title:
Chairman, Chief Executive Officer and President(Principal Executive Officer)
/s/ Joe M. Chybowski
Joe M. Chybowski
Chief Financial Officer(Principal Financial and Accounting Officer)