10-Q 1 levelone-q1201910q.htm 2019 FIRST QUARTER 10-Q Document

 
Section 1: 10-Q (10-Q)
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
    
 þ    Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2019
 o    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: 001-38458
LEVEL ONE BANCORP, INC.
(Exact name of registrant as specified in its charter)
Michigan
(State or other jurisdiction of
incorporation or organization)
 
71-1015624
(I.R.S. Employer
Identification No.)
32991 Hamilton Court
Farmington Hills, MI
(Address of principal executive offices)
 
48334
(Zip code)
(248) 737-0300
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Common Stock, no par value
Trading symbol(s)
LEVL

Name of each exchange on which registered
Nasdaq Global Select Market
Securities registered pursuant to Section 12(g) of the Act: None

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 þ No o

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 (Section 232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit such files). Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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     o                             Accelerated filer         o

Non-accelerated filer    þ                            Smaller reporting company þ

Emerging growth company    þ

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. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes o No þ

As of May 3, 2019, the number of shares outstanding of the registrant’s Common Stock, no par value, was 7,751,231 shares.



Level One Bancorp, Inc.
Table of Contents
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LEVEL ONE BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
 
 
March 31, 2019
 
December 31, 2018
(Dollars in thousands)
 
(Unaudited)
 
 
Assets
 
 

 
 

Cash and cash equivalents
 
$
35,982

 
$
33,296

Securities available-for-sale
 
226,874

 
204,258

Federal Home Loan Bank stock
 
8,325

 
8,325

Mortgage loans held for sale, at fair value
 
14,043

 
5,595

Loans:
 
 

 
 

Originated loans
 
1,051,169

 
1,041,898

Acquired loans
 
79,928

 
84,667

Total loans
 
1,131,097

 
1,126,565

Less: Allowance for loan losses
 
(11,960
)
 
(11,566
)
Net loans
 
1,119,137

 
1,114,999

Premises and equipment
 
13,172

 
13,242

Goodwill
 
9,387

 
9,387

Other intangible assets, net
 
395

 
447

Bank-owned life insurance
 
11,945

 
11,866

Income tax benefit
 
1,589

 
2,467

Other assets
 
15,703

 
12,333

Total assets
 
$
1,456,552

 
$
1,416,215

Liabilities
 
 

 
 

Deposits:
 
 

 
 

Noninterest-bearing demand deposits
 
$
293,217

 
$
309,384

Interest-bearing demand deposits
 
53,538

 
52,804

Money market and savings deposits
 
319,028

 
287,575

Time deposits
 
485,680

 
484,872

Total deposits
 
1,151,463

 
1,134,635

Borrowings
 
117,907

 
99,574

Subordinated notes
 
14,905

 
14,891

Other liabilities
 
16,158

 
15,355

Total liabilities
 
1,300,433

 
1,264,455

Shareholders' equity
 
 

 
 

Common stock, no par value per share:
 
 

 
 

Authorized—20,000,000 shares
 
 

 
 

Issued and outstanding—7,749,331 shares at March 31, 2019 and 7,750,216 shares at December 31, 2018
 
89,753

 
90,621

Retained earnings
 
66,049

 
62,891

Accumulated other comprehensive income (loss), net of tax
 
317

 
(1,752
)
Total shareholders' equity
 
156,119

 
151,760

Total liabilities and shareholders' equity
 
$
1,456,552

 
$
1,416,215

   
See accompanying notes to the consolidated financial statements.


3

LEVEL ONE BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME — (UNAUDITED)
 
 
For the three months ended March 31,
(In thousands, except per share data)
 
2019
 
2018
Interest income
 
 

 
 

Originated loans, including fees
 
$
13,894

 
$
11,178

Acquired loans, including fees
 
1,757

 
2,426

Securities:
 
 

 
 

Taxable
 
936

 
574

Tax-exempt
 
545

 
351

Federal funds sold and other
 
310

 
245

Total interest income
 
17,442

 
14,774

Interest Expense
 
 

 
 

Deposits
 
4,121

 
2,178

Borrowed funds
 
353

 
219

Subordinated notes
 
250

 
250

Total interest expense
 
4,724

 
2,647

Net interest income
 
12,718

 
12,127

Provision expense for loan losses
 
422

 
554

Net interest income after provision for loan losses
 
12,296

 
11,573

Noninterest income
 
 

 
 

Service charges on deposits
 
625

 
642

Net loss on sales of securities
 
(7
)
 
—

Mortgage banking activities
 
1,120

 
236

Other charges and fees
 
548

 
494

Total noninterest income
 
2,286

 
1,372

Noninterest expense
 
 

 
 

Salary and employee benefits
 
6,913

 
5,956

Occupancy and equipment expense
 
1,204

 
1,046

Professional service fees
 
362

 
266

Marketing expense
 
176

 
142

Printing and supplies expense
 
68

 
104

Data processing expense
 
595

 
436

Other expense
 
1,050

 
1,185

Total noninterest expense
 
10,368

 
9,135

Income before income taxes
 
4,214

 
3,810

Income tax provision
 
747

 
642

Net income
 
$
3,467

 
$
3,168

Per common share data:
 
 

 
 

Basic earnings per common share
 
$
0.45

 
$
0.48

Diluted earnings per common share
 
$
0.44

 
$
0.47

Cash dividends declared per common share
 
$
0.04

 
$
0.03

Weighted average common shares outstanding—basic
 
7,752

 
6,539

Weighted average common shares outstanding—diluted
 
7,869

 
6,699

See accompanying notes to the consolidated financial statements.

4

LEVEL ONE BANCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
 
 
For the three months ended March 31,
(Dollars in thousands)
 
2019
 
2018
Net income
 
$
3,467

 
$
3,168

Other comprehensive income:
 
 
 
 

Unrealized holding gains (losses) on securities available-for-sale arising during the period
 
2,612

 
(2,505
)
Reclassification adjustment for losses included in income
 
7

 
—

Tax effect(1)
 
(550
)
 
525

Net unrealized gains (losses) on securities available-for-sale, net of tax
 
2,069

 
(1,980
)
Total comprehensive income, net of tax
 
$
5,536

 
$
1,188

__________________________________________________________________________ 
(1) Includes $(1) thousand of tax benefit related to reclassification for the three months ended March 31, 2019. There was no tax expense (benefit) related to reclassification for the three months ended March 31, 2018.

See accompanying notes to the consolidated financial statements.

5

LEVEL ONE BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY — (UNAUDITED)
(Dollar in thousands)
 
Common Stock
 
Retained Earnings
 
Accumulated Other Comprehensive (Loss) Income
 
Total Shareholders' Equity
Balance at December 31, 2017
 
$
59,511

 
$
49,232

 
$
(783
)
 
$
107,960

Net Income
 
—

 
3,168

 
—

 
3,168

Other comprehensive loss
 
—

 
—

 
(1,980
)
 
(1,980
)
Reclass of tax reform adjustments due to early adoption of ASU 2018-02
 
—

 
$
168

 
$
(168
)
 
—

Exercise of stock options (118,944 shares)
 
1,192

 
—

 
—

 
1,192

Stock-based compensation expense
 
183

 
—

 
—

 
183

Balance at March 31, 2018
 
$
60,886

 
$
52,568

 
$
(2,931
)
 
$
110,523

 
 
 
 
 
 
 
 
 
Balance at December 31, 2018
 
$
90,621

 
$
62,891

 
$
(1,752
)
 
$
151,760

Net income
 
—

 
3,467

 
—

 
3,467

Other comprehensive income
 
—

 
—

 
2,069

 
2,069

Share buyback (46,626 shares)
 
(1,104
)
 
—

 
—

 
(1,104
)
Common stock dividends declared ($0.04 per share)
 
—

 
(309
)
 
—

 
(309
)
Exercise of stock options (12,300 shares)
 
125

 
—

 
—

 
125

Stock-based compensation expense, net of tax impact
 
111

 
—

 
—

 
111

Balance at March 31, 2019
 
$
89,753

 
$
66,049

 
$
317

 
$
156,119

See accompanying notes to the consolidated financial statements.


6

LEVEL ONE BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS — (UNAUDITED)
 
 
For the three months ended March 31,
(Dollars in thousands)
 
2019
 
2018
Cash flows from operating activities
 
 

 
 

Net income
 
$
3,467

 
$
3,168

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation of fixed assets
 
327

 
332

Amortization of core deposit intangibles
 
52

 
55

Stock-based compensation expense
 
154

 
183

Provision expense for loan losses
 
422

 
554

Net securities premium amortization
 
397

 
306

Net loss on sales of securities
 
7

 
—

Originations of loans held for sale
 
(36,793
)
 
(11,114
)
Proceeds from sales of loans originated for sale
 
29,137

 
14,027

Net gain on sales of loans
 
(1,200
)
 
(236
)
Accretion on acquired purchase credit impaired loans
 
(584
)
 
(918
)
Increase in cash surrender value of life insurance
 
(79
)
 
(80
)
Amortization of debt issuance costs
 
14

 
9

Net (increase) decrease in accrued interest receivable and other assets
 
(2,457
)
 
641

Net increase (decrease) in accrued interest payable and other liabilities
 
629

 
(446
)
Net cash (used in) provided by operating activities
 
(6,507
)
 
6,481

Cash flows from investing activities
 
 

 
 

Net increase in loans
 
(4,022
)
 
(16,274
)
Principal payments on securities available-for-sale
 
5,752

 
1,949

Purchases of securities available-for-sale
 
(32,153
)
 
(14,140
)
Additions to premises and equipment
 
(290
)
 
(199
)
Proceeds from:
 
 
 
 
Sale of securities available-for-sale
 
6,000

 
—

Net cash used in investing activities
 
(24,713
)
 
(28,664
)
Cash flows from financing activities
 
 

 
 

Net increase (decrease) in deposits
 
16,828

 
(7,738
)
Change in short-term borrowings
 
(1,649
)
 
4,968

Issuances of long term FHLB advances
 
20,000

 
—

Repayment of long-term FHLB advances
 
—

 
(18
)
Change in secured borrowing
 
(18
)
 
—

Share buyback - redeemed stock
 
(1,104
)
 
—

Proceeds from exercised stock options
 
125

 
1,192

Payments related to tax-withholding for share based compensation awards
 
(43
)
 
—

Common stock dividends paid
 
(233
)
 
—

Net cash (used in) provided by financing activities
 
33,906

 
(1,596
)
Net change in cash and cash equivalents
 
2,686

 
(23,779
)
Beginning cash and cash equivalents
 
33,296

 
63,661

Ending cash and cash equivalents
 
$
35,982

 
$
39,882

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 

 
 

Interest paid
 
$
4,397

 
$
2,291

Income taxes paid
 
360

 
—

Transfer from loans held for sale to loans held for investment
 
239

 
—

Transfer from loans to other real estate owned
 
373

 
—

Transfer from premises and equipment to other assets
 
—

 
20

See accompanying notes to the consolidated financial statements.

7

LEVEL ONE BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (UNAUDITED)
MARCH 31, 2019
NOTE 1—BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Nature of Operations:
Level One Bancorp, Inc. (the "Company" “we,” “our,” or “us”) is a financial holding company headquartered in Farmington Hills, Michigan. Its wholly owned bank subsidiary, Level One Bank (the "Bank"), has 14 offices, including 9 banking centers (our full service branches) in Oakland County, one banking center in each of Detroit and Grand Rapids, Michigan’s two largest cities, one banking center in Sterling Heights, and two mortgage loan production offices in Ann Arbor.
The Bank is a Michigan banking corporation with depository accounts insured by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation (the "FDIC"). The Bank provides a wide range of business and consumer financial services in the greater Farmington Hills, Novi, Northville, Birmingham, Ferndale, Sterling Heights, Bloomfield Township, Ann Arbor, Detroit and Grand Rapids areas. Its primary deposit products are checking, interest-bearing demand, money market and savings, and term certificate accounts, and its primary lending products are commercial real estate, commercial and industrial, residential real estate, and consumer loans. Substantially all loans are secured by specific items of collateral including business assets, consumer assets, and commercial and residential real estate. Commercial loans are expected to be repaid from cash flow from operations of businesses. Other financial instruments, which potentially represent concentrations of credit risk, include federal funds sold.
On July 9, 2017, the Company formed a new subsidiary, Hamilton Court Insurance Company ("Hamilton Court"), which is a wholly owned insurance subsidiary of the Company that provides property and casualty insurance coverage to the Company and the Bank, and reinsurance to ten other third party insurance captives for which insurance may not be currently available or economically feasible in the insurance marketplace. Hamilton Court was designed to insure the risks of the Company and the Bank by providing additional insurance coverage for deductibles, excess limits and uninsured exposures. Hamilton Court is domiciled in Nevada.
Initial Public Offering:
On April 24, 2018, the Company sold 1,150,765 shares of common stock in its initial public offering, including 180,000 shares of common stock pursuant to the exercise in full by the underwriters of their option to purchase additional shares. The aggregate offering price for the shares sold by the Company was $32.2 million, and after deducting $2.1 million of underwriting discounts and $1.1 million of offering expenses paid to third parties, the Company received total net proceeds of $29.0 million from the initial public offering. In addition, certain selling shareholders participated in the offering and sold an aggregate of 229,235 shares of our common stock at an aggregate offering price of $6.4 million. The Company did not receive any proceeds from the sales of shares by the selling shareholders.
Basis of Presentation and Principles of Consolidation:
The accompanying unaudited consolidated financial statements and notes thereto of the Company have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) and conform to practices within the banking industry and include all of the information and disclosures required by generally accepted accounting principles in the United States of America (“GAAP”) for interim financial reporting. The accompanying unaudited consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) that are necessary for a fair presentation of financial results for the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the results for the full year or any other period. These interim unaudited financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto as of and for the year ended December 31, 2018, included in our Annual Form 10-K, filed with the SEC on March 22, 2019.
The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, the Bank and Hamilton Court, after elimination of significant intercompany transactions and accounts.
Use of Estimates:
To prepare financial statements in conformity with GAAP, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided; therefore future results could differ.

8

Change in Accounting Policy:
For fiscal years beginning after December 31, 2018, the Company has elected to evaluate goodwill for impairment as of October 1st as opposed to September 30th in the preceding years. The change will have no impact on the current year or prior years financial statements.
Emerging Growth Company Status:
The Company is an "emerging growth company," as defined in the Jumpstart Our Business Startups Act of 2012 (the JOBS Act). Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period when complying with new or revised accounting standards. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have elected to take advantage of this extended transition period, which means these financial statements, as well as financial statements we file in the future for as long as we remain an emerging growth company, will be subject to all new or revised accounting standards generally applicable to private companies
Impact of Recently Issued Accounting Standards:
Revenue Recognition
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09 "Revenue from Contracts with Customers (Topic 606)," which provides a framework for revenue recognition that replaces the existing industry and transaction specific requirements under the existing standards. ASU 2014-09 requires an entity to apply a five-step model to determine when to recognize revenue and at what amount. The model specifies that revenue should be recognized when (or as) an entity transfers control of goods or services to a customer at the amount in which the entity expects to be entitled. Depending on whether certain criteria are met, revenue should be recognized either over time, in a manner that depicts the entity's performance, or at a point in time, when control of the goods or services are transferred to the customer.
The amendments of ASU 2014-09 may be applied either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying ASU 2014-09 recognized at the date of initial application. The guidance will be effective for the Company for the fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. The Company plans to adopt these amendments within the time frames stated above.
The Company is continuing to evaluate the impact ASU 2014-09 will have on our consolidated financial statements. Based on this evaluation to date, management has determined that the majority of the revenues earned by the Company are not within the scope of ASU 2014-09, and that a few of the revenue streams that have been identified as being in scope would include service charges and interchange fees. Management will continue to evaluate the impact the adoption of ASU 2014-09 will have on our consolidated financial statements, focusing on noninterest income sources within the scope of ASU 2014-09 as well as new disclosures required by these amendments; however, the adoption of ASU 2014-09 is not expected to have a material impact on the Company's consolidated financial statements but is expected to result in additional disclosures.
Financial Instruments
In January 2016, the FASB issued ASU No. 2016-01, "Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities," to improve the accounting for financial instruments. This ASU requires equity investments with readily determinable fair values to be measured at fair value with changes recognized in net income regardless of classification. For equity investments without a readily determinable fair value, the value of the investment would be measured at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer instead of fair value, unless a qualitative assessment indicates impairment. Additionally, this ASU requires the separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements, as well as the required use of exit pricing when measuring the fair value of financial instruments for disclosure purposes. The guidance will be effective for the Company for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019, and is to be applied prospectively with a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. Management is currently developing processes and procedures to comply with the disclosures requirements of this ASU, which will impact the disclosures the Company makes related to fair value of its financial instruments. This standard is not expected to have a material impact to the Company's consolidated financial statements. The Company is planning to adopt this new guidance within the time frames stated above.


9

Leases
In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)," to improve transparency and comparability across entities regarding leasing arrangements. This ASU requires the recognition of a separate lease liability representing the required discounted lease payments over the lease term and a separate lease asset representing the right to use the underlying asset during the same lease term. Additionally, this ASU provides clarification regarding the identification of certain components of contracts that would represent a lease as well as requires additional disclosures to the notes of the financial statements.
The guidance will be effective for the Company for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020, and is to be applied under an optional transition method. The Company is currently evaluating the impact of adopting this new guidance on the consolidated financial statements. Additionally, the Company does not expect to significantly change operating lease agreements prior to adoption. The Company is planning to adopt this new guidance within the time frames stated above.
Allowance for Credit Losses
In June 2016, the FASB issued ASU No. 2016-13, "Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments," to replace the current incurred loss methodology for recognizing credit losses, which delays recognition until it is probable a loss has been incurred, with a methodology that reflects an estimate of all expected credit losses and considers additional reasonable and supportable forecasted information when determining credit loss estimates. This impacts the calculation of the allowance for credit losses for all financial assets measured under the amortized cost basis, including PCI loans at the time of and subsequent to acquisition. Additionally, credit losses related to available-for-sale debt securities would be recorded through the allowance for credit losses and not as a direct adjustment to the amortized cost of the securities. Based on the ASU No. 2018-19, "Codification Improvements to Topic 326, Financial Instruments—Credit Losses," the guidance will be effective for the Company for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years, and is to be applied under a modified retrospective approach. The Company is currently evaluating the impact of adopting this new guidance on the consolidated financial statements as well as the impact on current systems and processes. At this time, the Company is reviewing potential methodologies for estimating expected credit losses using reasonable and supportable forecast information and has identified certain data and system requirements. Once adopted, we expect our allowance for loan losses to increase through a one-time adjustment to retained earnings; however, until our evaluation is complete, the estimated increase in allowance will be unknown. The Company is planning to adopt this new guidance within the time frames stated above.
Income Taxes - Tax Cuts and Jobs Act
In February 2018, the FASB issued ASU No. 2018-02, "Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (Topic 220)," which allows an entity to elect a reclassification from accumulated other comprehensive income (AOCI) to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act ("TCJA"). The amount of that reclassification should include the effect of changes of tax rate on the deferred tax amount, any related valuation allowance and other income tax effects on the items in AOCI. In addition, the ASU requires that an entity state if an election to reclassify the tax effects to retained earnings is made, along with a description of other income tax effects that are reclassified from AOCI. This guidance is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years, with early adoption permitted. The Company early adopted the ASU and reclassified $168 thousand from retained earnings to AOCI during the first quarter of 2018.
In May 2018, the FASB issued an update to ASU No. 2018-05, "Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118," regarding the accounting implications of the recently issued TCJA. The update clarifies that in a company's financial statements that include the reporting period in which the TCJA was enacted, a company must first reflect the income tax effects of the TCJA in which the accounting under GAAP is complete. These amounts would not be provisional amounts. The Company would also report provisional amounts for those specific income tax effects for which the accounting under GAAP will be incomplete but for which a reasonable estimate can be determined. This accounting update is effective immediately. The Company believes its accounting for the income tax effects of the TCJA is complete. Technical corrections or other forthcoming guidance could change how we interpret provisions of the TCJA, which may impact our effective tax rate and could affect our deferred tax assets, tax positions and/or our tax liabilities.

10

NOTE 2—SECURITIES
The following table summarizes the amortized cost and fair value of the available-for-sale securities portfolio at March 31, 2019 and December 31, 2018 and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss).
(Dollars in thousands)
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
March 31, 2019
 
 

 
 

 
 

 
 

 U.S. government sponsored entities & agencies
 
$
1,417

 
$
29

 
$
—

 
$
1,446

State and political subdivision
 
87,890

 
1,700

 
(173
)
 
89,417

Mortgage-backed securities: residential
 
9,912

 
30

 
(288
)
 
9,654

Mortgage-backed securities: commercial
 
16,481

 
128

 
(114
)
 
16,495

Collateralized mortgage obligations: residential              
 
17,933

 
32

 
(256
)
 
17,709

Collateralized mortgage obligations: commercial              
 
35,598

 
192

 
(301
)
 
35,489

U.S. Treasury
 
18,184

 
—

 
(526
)
 
17,658

SBA
 
20,684

 
26

 
(135
)
 
20,575

Asset backed securities
 
5,811

 
2

 
(6
)
 
5,807

Corporate bonds
 
12,564

 
96

 
(36
)
 
12,624

Total available-for-sale
 
$
226,474

 
$
2,235

 
$
(1,835
)
 
$
226,874

December 31, 2018
 
 

 
 

 
 

 
 

  U.S. government sponsored entities & agencies
 
$
2,404

 
$
4

 
$
(11
)
 
$
2,397

State and political subdivision
 
75,093

 
657

 
(604
)
 
75,146

Mortgage-backed securities: residential
 
10,114

 
4

 
(379
)
 
9,739

Mortgage-backed securities: commercial
 
12,594

 
17

 
(229
)
 
12,382

Collateralized mortgage obligations: residential              
 
18,916

 
51

 
(296
)
 
18,671

Collateralized mortgage obligations: commercial              
 
32,390

 
98

 
(500
)
 
31,988

U.S. Treasury
 
21,232

 
—

 
(751
)
 
20,481

SBA
 
15,856

 
—

 
(168
)
 
15,688

Asset backed securities
 
3,872

 
—

 
(30
)
 
3,842

Corporate bonds
 
14,006

 
18

 
(100
)
 
13,924

Total available-for-sale
 
$
206,477

 
$
849

 
$
(3,068
)
 
$
204,258

The proceeds from sales of securities and the associated gains and losses for the three months ended March 31, 2019 are summarized below. There were no sales of securities during the three months ended March 31, 2018.
(Dollars in thousands)
Three Months Ended
March 31, 2019
Proceeds
$
6,000

Gross gains
64

Gross losses
(71
)



    



11

The amortized cost and fair value of securities are shown in the table below by contractual maturity. Actual timing may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Additionally, residential mortgage-backed securities and collateralized mortgage obligations receive monthly principal payments, which are not reflected below.
 
 
March 31, 2019
(Dollars in thousands)
 
Amortized
Cost
 
Fair
Value
Within one year
 
$
681

 
$
677

One to five years
 
49,144

 
48,627

Five to ten years
 
46,389

 
46,822

Beyond ten years
 
130,260

 
130,748

Total
 
$
226,474

 
$
226,874

Securities pledged at March 31, 2019 and December 31, 2018 had a carrying amount of $26.0 million and $22.7 million, respectively, and were pledged to secure Federal Home Loan Bank ("FHLB") advances, a Federal Reserve Bank line of credit, repurchase agreements and deposits.
As of March 31, 2019, the Bank held 56 tax-exempt state and local municipal securities totaling $41.9 million backed by the Michigan School Bond Loan Fund. Other than the aforementioned investments, at March 31, 2019 and December 31, 2018, there were no holdings of securities of any one issuer, other than the U.S. government and its agencies, in an amount greater than 10% of shareholders' equity.

12

The following table summarizes securities with unrealized losses at March 31, 2019 and December 31, 2018 aggregated by security type and length of time in a continuous unrealized loss position:
 
 
Less than 12 Months
 
12 Months or Longer
 
Total
(Dollars in thousands)
 
Fair
value
 
Unrealized
Losses
 
Fair
value
 
Unrealized
Losses
 
Fair
value
 
Unrealized
Losses
March 31, 2019
 
 

 
 

 
 

 
 

 
 

 
 

Available-for-sale
 
 

 
 

 
 

 
 

 
 

 
 

State and political subdivision
 
$
705

 
$
(9
)
 
$
14,271

 
$
(164
)
 
$
14,976

 
$
(173
)
Mortgage-backed securities: residential
 
—

 
—

 
6,595

 
(288
)
 
6,595

 
(288
)
Mortgage-backed securities: commercial
 
—

 
—

 
7,528

 
(114
)
 
7,528

 
(114
)
Collateralized mortgage obligations: residential
 
5,280

 
(32
)
 
9,275

 
(224
)
 
14,555

 
(256
)
Collateralized mortgage obligations: commercial
 
—

 
—

 
17,630

 
(301
)
 
17,630

 
(301
)
U.S. Treasury
 
—

 
—

 
17,658

 
(526
)
 
17,658

 
(526
)
SBA
 
5,066

 
(16
)
 
11,736

 
(119
)
 
16,802

 
(135
)
Asset backed securities
 
1,927

 
(6
)
 
—

 
—

 
1,927

 
(6
)
Corporate bonds
 
493

 
(8
)
 
2,992

 
(28
)
 
3,485

 
(36
)
Total available-for-sale
 
$
13,471

 
$
(71
)
 
$
87,685

 
$
(1,764
)
 
$
101,156

 
$
(1,835
)
December 31, 2018
 
 

 
 

 
 

 
 

 
 

 
 

Available-for-sale
 
 

 
 

 
 

 
 

 
 

 
 

U.S. government sponsored entities & agencies
 
$
978

 
$
(11
)
 
$
—

 
$
—

 
$
978

 
$
(11
)
State and political subdivision
 
5,121

 
(25
)
 
27,667

 
(579
)
 
32,788

 
(604
)
Mortgage-backed securities: residential
 
2,595

 
(4
)
 
6,393

 
(375
)
 
8,988

 
(379
)
Mortgage-backed securities: commercial
 
1,967

 
(8
)
 
8,944

 
(221
)
 
10,911

 
(229
)
Collateralized mortgage obligations: residential
 
3,814

 
(27
)
 
8,958

 
(269
)
 
12,772

 
(296
)
Collateralized mortgage obligations: commercial
 
—

 
—

 
17,939

 
(500
)
 
17,939

 
(500
)
U.S. Treasury
 
—

 
—

 
20,481

 
(751
)
 
20,481

 
(751
)
SBA
 
12,420

 
(91
)
 
3,268

 
(77
)
 
15,688

 
(168
)
Asset backed securities
 
3,842

 
(30
)
 
—

 
—

 
3,842

 
(30
)
Corporate bonds
 
7,526

 
(28
)
 
2,950

 
(72
)
 
10,476

 
(100
)
Total available-for-sale
 
$
38,263

 
$
(224
)
 
$
96,600

 
$
(2,844
)
 
$
134,863

 
$
(3,068
)
As of March 31, 2019, the Company's investment portfolio consisted of 281 securities, 121 of which were in an unrealized loss position. The unrealized losses for these securities resulted primarily from changes in interest rates. The Company expects full recovery of the carrying amount of these securities and does not intend to sell the securities in an unrealized loss position nor does it believe it will be required to sell securities in an unrealized loss position before the value is recovered. The Company does not consider these securities to be other-than-temporarily impaired at March 31, 2019.

13

NOTE 3—LOANS
The following table presents the recorded investment in loans at March 31, 2019 and December 31, 2018. The recorded investment in loans excludes accrued interest receivable.
(Dollars in thousands)
 
Originated
 
Acquired
 
Total
March 31, 2019
 
 

 
 

 
 

Commercial real estate
 
$
489,856

 
$
58,211

 
$
548,067

Commercial and industrial
 
392,891

 
8,697

 
401,588

Residential real estate
 
167,413

 
12,973

 
180,386

Consumer
 
1,009

 
47

 
1,056

Total
 
$
1,051,169

 
$
79,928

 
$
1,131,097

December 31, 2018
 
 

 
 

 
 

Commercial real estate
 
$
500,809

 
$
61,284

 
$
562,093

Commercial and industrial
 
375,130

 
8,325

 
383,455

Residential real estate
 
165,015

 
15,003

 
180,018

Consumer
 
944

 
55

 
999

Total
 
$
1,041,898

 
$
84,667

 
$
1,126,565

At March 31, 2019 and December 31, 2018, the Company had residential loans held for sale, which were originated with the intent to sell, totaling $14.0 million and $5.6 million, respectively. During the three months ended March 31, 2019 and 2018, the Company sold residential real estate loans with proceeds totaling $29.1 million and $14.0 million, respectively.
Information as to nonperforming assets was as follows:
(Dollars in thousands)
 
March 31, 2019
 
December 31, 2018
Nonaccrual loans:
 
 

 
 

Commercial real estate
 
$
2,694

 
$
5,927

Commercial and industrial
 
10,495

 
9,605

Residential real estate
 
3,456

 
2,915

Total nonperforming loans
 
16,645

 
18,447

Other real estate owned
 
373

 
—

Total nonperforming assets
 
$
17,018

 
$
18,447

Loans 90 days or more past due and still accruing
 
$
453

 
$
243

At March 31, 2019 and December 31, 2018, all of the loans 90 days or more past due and still accruing were PCI loans.

14

Loan delinquency as of the dates presented below was as follows:
(Dollars in thousands)
 
Current
 
30 - 59 Days
Past Due
 
60 - 89 Days
Past Due
 
90+ Days
Past Due
 
Total
March 31, 2019
 
 

 
 

 
 

 
 

 
 

Commercial real estate
 
$
545,055

 
$
939

 
$
—

 
$
2,073

 
$
548,067

Commercial and industrial
 
400,002

 
72

 
240

 
1,274

 
401,588

Residential real estate
 
176,571

 
2,808

 
—

 
1,007

 
180,386

Consumer
 
1,056

 
—

 
—

 
—

 
1,056

Total
 
$
1,122,684

 
$
3,819

 
$
240

 
$
4,354

 
$
1,131,097

December 31, 2018
 
 

 
 

 
 

 
 

 
 

Commercial real estate
 
$
559,523

 
$
497

 
$
—

 
$
2,073

 
$
562,093

Commercial and industrial
 
381,424

 
664

 
82

 
1,285

 
383,455

Residential real estate
 
174,831

 
2,499

 
1,314

 
1,374

 
180,018

Consumer
 
998

 
—

 
1

 
—

 
999

Total
 
$
1,116,776

 
$
3,660

 
$
1,397

 
$
4,732

 
$
1,126,565

Impaired Loans:
Information as to impaired loans, excluding purchased credit impaired loans, was as follows:
(Dollars in thousands)
 
March 31, 2019
 
December 31, 2018
Nonaccrual loans
 
$
16,645

 
$
18,447

Performing troubled debt restructurings:
 
 

 
 
Commercial and industrial
 
562

 
568

Residential real estate
 
363

 
363

Total performing troubled debt restructurings
 
925

 
931

Total impaired loans, excluding purchase credit impaired loans
 
$
17,570

 
$
19,378

Troubled Debt Restructurings:
The Company assesses loan modifications to determine whether a modification constitutes a troubled debt restructuring ("TDR"). This applies to all loan modifications except for modifications to loans accounted for in pools under ASC 310-30, which are not subject to TDR accounting/classification. For loans excluded from ASC 310-30 accounting, a modification is considered a TDR when a borrower is experiencing financial difficulties and the Company grants a concession to the borrower. For loans accounted for individually under ASC 310-30, a modification is considered a TDR when a borrower is experiencing financial difficulties and the effective yield after the modification is less than the effective yield at the time the loan was acquired or less than the effective yield of any re-estimation of cash flows subsequent to acquisition in association with consideration of qualitative factors included within ASC 310-40. All TDRs are considered impaired loans. The nature and extent of impairment of TDRs, including those which have experienced a subsequent default, are considered in the determination of an appropriate level of allowance for loan losses.
As of March 31, 2019 and December 31, 2018, the Company had a recorded investment in troubled debt restructurings of $5.7 million and $5.9 million, respectively. The Company has allocated a specific reserve of $400 thousand for those loans at March 31, 2019 and a specific reserve of $258 thousand for those loans at December 31, 2018. The Company has not committed to lend additional amounts to borrowers whose loans have been modified. As of March 31, 2019, there were $4.8 million of nonperforming TDRs and $925 thousand of performing TDRs included in impaired loans. As of December 31, 2018, there were $5.0 million of nonperforming TDRs and $931 million of performing TDRs included in impaired loans.
All TDRs are considered impaired loans in the calendar year of their restructuring. A loan that has been modified can return to performing status if it satisfies a six-month performance requirement; however, it will continue to be reported as a TDR and considered impaired.

15

The following table presents the recorded investment of loans modified as TDRs during the three months ended March 31, 2019 and 2018, by type of concession granted. In cases where more than one type of concession was granted, the loans were categorized based on the most significant concession.
 
 
Concession type
 
 
 
 
 
Financial effects of
modification
(Dollars in thousands)
 
Principal
deferral
 
Interest
rate
 
Forbearance
agreement
 
Total
number of
loans
 
Total
recorded
investment
 
Net
charge-offs
 
Provision
for loan
losses
For the three months ended March 31, 2019
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Commercial and industrial
 
$
—

 
$
—

 
$
335

 
1

 
$
335

 
$
—

 
$
158

Total
 
$
—

 
$
—

 
$
335

 
1

 
$
335

 
$
—

 
$
158

For the three months ended March 31, 2018
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Commercial real estate
 
$
2,119

 
$
—

 
$
—

 
3

 
$
2,119

 
$
—

 
$
—

Commercial and industrial
 
930

 
—

 
—

 
1

 
930

 
—

 
—

Total
 
$
3,049

 
$
—

 
$
—

 
4

 
$
3,049

 
$
—

 
$
—

On an ongoing basis, the Company monitors the performance of TDRs to their modified terms. The following tables present the number of loans modified as TDRs during the twelve months ending March 31, 2019 and 2018 for which there was a subsequent payment default, including the recorded investment as of each period end. A payment on a TDR is considered to be in default once it is greater than 30 days past due.
 
 
For the three months ended March 31, 2019
(Dollars in thousands)
 
Total number of
loans
 
Total recorded
investment
 
Provision for loan losses following a
subsequent default
Residential real estate
 
1

 
$
115

 
$
5

Total
 
1

 
$
115

 
$
5

 
 
For the three months ended March 31, 2018
(Dollars in thousands)
 
Total number of
loans
 
Total recorded
investment
 
Provision for loan losses following a
subsequent default
Commercial real estate
 
2

 
$
1,499

 
$
—

Total
 
2

 
$
1,499

 
$
—

Credit Quality Indicators:
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes commercial and industrial and commercial real estate loans and is performed on an annual basis. The Company uses the following definitions for risk ratings:
Pass.    Loans classified as pass are higher quality loans that do not fit any of the other categories described below. This category includes loans risk rated with the following ratings: cash/stock secured, excellent credit risk, superior credit risk, good credit risk, satisfactory credit risk, and marginal credit risk.
Special Mention.    Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company's credit position at some future date.
Substandard.    Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

16

Doubtful.    Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Based on the most recent analysis performed, the risk category of loans by class of loans was as follows:
(Dollars in thousands)
 
Pass
 
Special
Mention
 
Substandard
 
Doubtful
 
Total
March 31, 2019
 
 

 
 

 
 

 
 

 
 

Commercial real estate
 
$
537,666

 
$
7,625

 
$
2,733

 
$
43

 
$
548,067

Commercial and industrial
 
386,625

 
1,987

 
12,936

 
40

 
401,588

Total
 
$
924,291

 
$
9,612

 
$
15,669

 
$
83

 
$
949,655

December 31, 2018
 
 

 
 

 
 

 
 

 
 

Commercial real estate
 
$
545,843

 
$
10,240

 
$
5,966

 
$
44

 
$
562,093

Commercial and industrial
 
368,189

 
2,841

 
12,425

 
—

 
383,455

Total
 
$
914,032

 
$
13,081

 
$
18,391

 
$
44

 
$
945,548

For residential real estate loans and consumer loans, the Company evaluates credit quality based on the aging status of the loan and by payment activity. Residential real estate loans and consumer loans are considered nonperforming if they are 90 days or more past due. Consumer loan types are continuously monitored for changes in delinquency trends and other asset quality indicators.
The following presents residential real estate and consumer loans by credit quality:
(Dollars in thousands)
 
Performing
 
Nonperforming
 
Total
March 31, 2019
 
 

 
 

 
 

Residential real estate
 
$
176,930

 
$
3,456

 
$
180,386

Consumer
 
1,056

 
—

 
1,056

Total
 
$
177,986

 
$
3,456

 
$
181,442

December 31, 2018
 
 

 
 

 
 

Residential real estate
 
$
177,103

 
$
2,915

 
$
180,018

Consumer
 
999

 
—

 
999

Total
 
$
178,102

 
$
2,915

 
$
181,017

Purchased Credit Impaired Loans:
As part of the Company's previous four acquisitions, the Company acquired purchase credit impaired ("PCI") loans for which there was evidence of credit quality deterioration since origination, and we determined that it was probable that the Company would be unable to collect all contractually required principal and interest payments. The total balance of all PCI loans from these acquisitions was as follows:
(Dollars in thousand)
 
Unpaid Principal Balance
 
Recorded Investment
March 31, 2019
 
 

 
 

Commercial real estate
 
$
7,081

 
$
4,235

Commercial and industrial
 
321

 
175

Residential real estate
 
4,746

 
3,321

Total PCI loans
 
$
12,148

 
$
7,731

December 31, 2018
 
 
 
 
Commercial real estate
 
$
7,406

 
$
4,344

Commercial and industrial
 
177

 
122

Residential real estate
 
4,974

 
3,409

Total PCI loans
 
$
12,557

 
$
7,875


17

The following table reflects the activity in the accretable yield of PCI loans from past acquisitions, which includes total expected cash flows, including interest, in excess of the recorded investment.
 
 
For the three months ended March 31,
(Dollars in thousands)
 
2019
 
2018
Accretable yield at beginning of period
 
$
10,947

 
$
14,452

Accretion of income
 
(584
)
 
(918
)
Adjustments to accretable yield
 
—

 
—

Accretable yield at end of period
 
$
10,363

 
$
13,534

"Accretion of income" represents the income earned on these loans for the year. "Adjustments to accretable yield" represents the net amount of accretable yield added or removed as a result of the semi-annual re-estimation of expected cash flows.
NOTE 4—ALLOWANCE
An allowance for loan losses is maintained to absorb probable incurred losses from the loan portfolio. The allowance for loan losses is based on management's continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of nonperforming loans.
The Company established an allowance for loan losses associated with PCI loans (accounted for under ASC 310-30) based on credit deterioration subsequent to the acquisition date. As of March 31, 2019, the Company had six PCI loan pools and 12 non-pooled PCI loans. The Company re-estimates cash flows expected to be collected for PCI loans on a semi-annual basis, with any decline in expected cash flows recorded as provision for loan losses on a discounted basis during the period. For any increases in cash flows expected to be collected, the Company adjusts the amount of accretable yield to be recognized on a prospective basis over the loan's remaining life.
For loans not accounted for under ASC 310-30, the Company individually evaluates certain impaired loans on a quarterly basis and establishes specific allowances for such loans, if required. A loan is considered impaired when it is probable that interest or principal payments will not be made in accordance with the contractual terms of the loan agreement. Consistent with this definition, all loans for which the accrual of interest has been discontinued (nonaccrual loans) and all TDRs are considered impaired. The Company individually evaluates nonaccrual loans with book balances of $250 thousand or more, all loans whose terms have been modified in a TDR, and certain other loans. The threshold for individual evaluation is revised on an infrequent basis, generally when economic circumstances change significantly. Specific allowances for impaired loans are estimated using one of several methods, including the estimated fair value of underlying collateral, observable market value of similar debt or discounted expected future cash flows. All other impaired loans are individually evaluated by identifying its risk characteristics and applying the standard reserve factor for the corresponding loan pool.
Loans which do not meet the criteria to be individually evaluated are evaluated in pools of loans with similar risk characteristics. Business loans are assigned to pools based on the Company's internal risk rating system. Internal risk ratings are assigned to each business loan at the time of approval and are subjected to subsequent periodic reviews by the Company's senior management, generally at least annually or more frequently upon the occurrence of a circumstance that affects the credit risk of the loan. For business loans not individually evaluated, losses inherent to the pool are estimated by applying standard reserve factors to outstanding principal balances.
The allowance for loans not individually evaluated is determined by applying estimated loss rates to various pools of loans within the portfolios with similar risk characteristics. Estimated loss rates for all pools are updated quarterly, incorporating quantitative and qualitative factors such as recent charge-off experience, current economic conditions and trends, changes in collateral values of properties securing loans (using index-based estimates), and trends with respect to past due and nonaccrual amounts.
Loans acquired in business combinations are initially recorded at fair value, which includes an estimate of credit losses expected to be realized over the remaining lives of the loans, and therefore no corresponding allowance for loan losses is recorded for these loans at acquisition. Methods utilized to estimate any subsequently required allowance for loan losses for acquired loans not deemed credit-impaired at acquisition are similar to originated loans; however, the estimate of loss is based on the unpaid principal balance less any remaining purchase discount.


18

Loans individually evaluated for impairment are presented below.
(Dollars in thousands)
 
Recorded investment with
no related
allowance
 
Recorded investment
with related
allowance (1)
 
Total
recorded
investment
 
Contractual
principal
balance
 
Related
allowance (1)
March 31, 2019
 
 

 
 

 
 

 
 

 
 

Individually evaluated impaired loans:
 
 

 
 

 
 

 
 

 
 

Commercial real estate
 
$
2,694

 
$
—

 
$
2,694

 
$
2,765

 
$
—

Commercial and industrial
 
6,518

 
4,221

 
10,739

 
11,110

 
735

Residential real estate
 
2,259

 
190

 
2,449

 
2,584

 
16

Total
 
$
11,471

 
$
4,411

 
$
15,882

 
$
16,459

 
$
751

December 31, 2018
 
 

 
 

 
 

 
 

 
 

Individually evaluated impaired loans:
 
 

 
 

 
 

 
 

 
 

Commercial real estate
 
$
5,898

 
$
3,991

 
$
9,889

 
$
13,076

 
$
815

Commercial and industrial
 
5,892

 
4,059

 
9,951

 
10,411

 
526

Residential real estate
 
1,666

 
3,255

 
4,921

 
6,604

 
101

Total
 
$
13,456

 
$
11,305

 
$
24,761

 
$
30,091

 
$
1,442

(1) December 31, 2018 individually evaluated impaired loans included $7.2 million of PCI loans with a related allowance of $920 thousand. March 31, 2019 individually evaluated impaired loans do not include PCI loans with a related allowance.  
(Dollars in thousands)
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
Cash Basis
Interest
Recognized
For the three months ended March 31, 2019
 
 

 
 

 
 

Individually evaluated impaired loans (1):
 
 

 
 

 
 

Commercial real estate
 
$
5,467

 
$
—

 
$
173

Commercial and industrial
 
10,868

 
9

 
224

Residential real estate
 
2,746

 
7

 
—

Total
 
$
19,081

 
$
16

 
$
397

For the three months ended March 31, 2018
 
 

 
 

 
 

Individually evaluated impaired loans (1):
 
 

 
 

 
 

Commercial real estate
 
$
9,014

 
$
412

 
$
12

Commercial and industrial
 
10,144

 
28

 
7

Residential real estate
 
5,230

 
87

 
—

Total
 
$
24,388

 
$
527

 
$
19

(1) March 31, 2018 individually evaluated impaired loans included PCI, whereas March 31, 2019 individually evaluated impaired loans are excluding PCI loans.









19


Activity in the allowance for loan losses and the allocation of the allowance for loans was as follows:
(Dollars in thousands)
 
Commercial
Real Estate
 
Commercial
and Industrial
 
Residential
Real Estate
 
Consumer
 
Total
For the three months ended March 31, 2019
 
 

 
 

 
 

 
 

 
 

Allowance for loan losses:
 
 

 
 

 
 

 
 

 
 

Beginning balance
 
$
5,227

 
$
5,174

 
$
1,164

 
$
1

 
$
11,566

Provision (benefit) for loan losses
 
(46
)
 
477

 
(15
)
 
6

 
422

Gross chargeoffs
 
—

 
(95
)
 
—

 
(6
)
 
(101
)
Recoveries
 
—

 
50

 
21

 
2

 
73

Net (chargeoffs) recoveries
 
—

 
(45
)
 
21

 
(4
)
 
(28
)
Ending allowance for loan losses
 
$
5,181

 
$
5,606

 
$
1,170

 
$
3

 
$
11,960

For the three months ended March 31, 2018
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
Beginning balance
 
$
4,852

 
$
5,903

 
$
950

 
$
8

 
$
11,713

Provision for loan losses
 
233

 
268

 
49

 
4

 
554

Gross chargeoffs
 
(11
)
 
(750
)
 
(50
)
 
(7
)
 
(818
)
Recoveries
 
2

 
37

 
18

 
—

 
57

Net chargeoffs
 
(9
)
 
(713
)
 
(32
)
 
(7
)
 
(761
)
Ending allowance for loan losses
 
$
5,076

 
$
5,458

 
$
967

 
$
5

 
$
11,506


(Dollars in thousands)
 
Commercial
Real Estate
 
Commercial
and Industrial
 
Residential
Real Estate
 
Consumer
 
Total
March 31, 2019
 
 

 
 

 
 

 
 

 
 

Allowance for loan losses:
 
 

 
 

 
 

 
 

 
 

Individually evaluated for impairment
 
$
—

 
$
735

 
$
16

 
$
—

 
$
751

Collectively evaluated for impairment
 
4,366

 
4,838

 
1,082

 
3

 
10,289

Acquired with deteriorated credit quality
 
815

 
33

 
72

 
—

 
920

Ending allowance for loan losses
 
$
5,181

 
$
5,606

 
$
1,170

 
$
3

 
$
11,960

Balance of loans:
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
 
$
2,694

 
$
10,739

 
$
2,449

 
$
—

 
$
15,882

Collectively evaluated for impairment
 
541,138

 
390,674

 
174,616

 
1,056

 
1,107,484

Acquired with deteriorated credit quality
 
4,235

 
175

 
3,321

 
—

 
7,731

Total loans
 
$
548,067

 
$
401,588

 
$
180,386

 
$
1,056

 
$
1,131,097

December 31, 2018
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
 
$
—

 
$
504

 
$
18

 
$
—

 
$
522

Collectively evaluated for impairment
 
4,412

 
4,648

 
1,063

 
1

 
10,124

Acquired with deteriorated credit quality
 
815

 
22

 
83

 
—

 
920

Ending allowance for loan losses
 
$
5,227

 
$
5,174

 
$
1,164

 
$
1

 
$
11,566

Balance of loans:
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
 
$
5,898

 
$
9,829

 
$
1,854

 
$
—

 
$
17,581

Collectively evaluated for impairment
 
551,851

 
373,504

 
174,755

 
999

 
1,101,109

Acquired with deteriorated credit quality
 
4,344

 
122

 
3,409

 
—

 
7,875

Total loans
 
$
562,093

 
$
383,455

 
$
180,018

 
$
999

 
$
1,126,565



20

NOTE 5—PREMISES AND EQUIPMENT
Premises and equipment were as follows at March 31, 2019 and December 31, 2018:
(Dollars in thousands)
 
March 31, 2019
 
December 31, 2018
Land
 
$
2,290

 
$
2,197

Buildings
 
9,746

 
9,746

Leasehold improvements
 
1,763

 
1,708

Furniture, fixtures and equipment
 
5,948

 
6,024

Total premises and equipment
 
$
19,747

 
$
19,675

Less: Accumulated depreciation
 
6,575

 
6,433

Net premises and equipment
 
$
13,172

 
$
13,242

Depreciation expense was $327 thousand and $332 thousand for the three months ended March 31, 2019 and 2018, respectively.
Most of the Company's branch facilities are rented under non-cancelable operating lease agreements. Total rent expense was $297 thousand and $252 thousand for the three months ended March 31, 2019 and 2018, respectively.
NOTE 6—GOODWILL AND INTANGIBLE ASSETS
Goodwill:    The Company acquired two banks, Lotus Bank in March 2015 and Bank of Michigan in March 2016, which resulted in the recognition of $4.6 million and $4.8 million of goodwill, respectively. Goodwill was $9.4 million at both March 31, 2019 and December 31, 2018.
Goodwill is not amortized but is evaluated at least annually for impairment. The Company's most recent annual goodwill impairment review performed as of September 30, 2018 did not indicate that an impairment of goodwill existed. The Company also determined that no triggering events have occurred that indicated impairment from the most recent valuation date through March 31, 2019 and that the Company's goodwill was not impaired at March 31, 2019.
For fiscal years beginning after December 31, 2018, the Company has elected to evaluate goodwill for impairment as of October 1st rather than September 30th as was done in the preceding years. The change will have no impact on the current year's or prior year's financial statements.
Acquired Intangible Assets:    The Company has recorded core deposit intangibles ("CDIs") associated with each of its acquisitions. CDIs are amortized on an accelerated basis over their estimated useful lives.
The table below presents the Company's net carrying amount of CDIs:
(Dollars in thousands)
 
March 31, 2019
 
December 31, 2018
Gross carrying amount
 
$
2,045

 
$
2,045

Accumulated amortization
 
(1,650
)
 
(1,598
)
Net Intangible
 
$
395

 
$
447

Amortization expense for the CDIs was $52 thousand and $55 thousand for the three months ended March 31, 2019 and 2018, respectively.

21

NOTE 7 —BORROWINGS AND SUBORDINATED DEBT
The following table presents the components of our short-term borrowings and long-term debt.
 
 
March 31, 2019
 
December 31, 2018
(Dollars in thousands)
 
Amount
 
Weighted
Average
Rate(1)
 
Amount
 
Weighted
Average
Rate(1)
Short-term borrowings:
 
 

 
 

 
 

 
 

Securities sold under agreements to repurchase
 
$
585

 
0.30
%
 
$
609

 
0.30
%
FHLB line of credit
 
895

 
2.84

 
2,520

 
2.87

Federal funds purchased
 
—

 
—

 
5,000

 
2.50

FHLB Advances
 
95,000

 
2.64

 
90,000

 
2.54

Total short-term borrowings
 
96,480

 
2.62

 
98,129

 
2.53

Long-term debt:
 
 
 
 
 
 
 
 
Secured borrowing due in 2022
 
1,427

 
1.00

 
1,445

 
1.00

FHLB advances due in 2022 to 2024(2)
 
20,000

 
2.08

 
—

 
—

Subordinated notes due in 2025(3)
 
14,905

 
6.38

 
14,891

 
6.38

Total long-term debt
 
36,332

 
3.80

 
16,336

 
5.90

Total short-term and long-term borrowings
 
$
132,812

 
2.95
%
 
$
114,465

 
3.01
%
_______________________________________________________________________________
(1) Weighted average rate presented is the contractual rate which excludes premiums and discounts related to purchase accounting.
(2) At March 31, 2019, the long-term FHLB advances consisted of 1.80% - 2.35% fixed rate notes.
(3) The March 31, 2019 balance includes subordinated notes of $15.0 million and debt issuance costs of $95 thousand. The December 31, 2018 balance includes subordinated notes of $15.0 million and debt issuance costs of $109 thousand.
The Bank is a member of the FHLB of Indianapolis, which provides short- and long-term funding collateralized by mortgage-related assets to its members. FHLB short-term borrowings bear interest at variable rates based on LIBOR. The advances were secured by a blanket lien on $396.3 million of real estate-related loans as of March 31, 2019. Based on this collateral and the Company's holdings of FHLB stock, the Company was eligible to borrow up to an additional $111.1 million from the FHLB at March 31, 2019. In addition, the Bank can borrow up to $130.0 million through the unsecured lines of credit it has established with other correspondent banks, as well as $5.0 million through a secured line with the Federal Reserve Bank. The Bank had no outstanding federal funds purchased as of March 31, 2019 and $5.0 million outstanding as of December 31, 2018.
At March 31, 2019, the Company had $585 thousand of securities sold under agreements to repurchase with customers, which mature overnight. These borrowings were secured by residential collateralized mortgage obligation securities with a fair value of $898 thousand at March 31, 2019.
The Company had a secured borrowing of $1.4 million as of March 31, 2019 relating to certain loan participations sold by the Company that did not qualify for sales treatment. The secured borrowing bears a fixed rate of 1.00% and matures on September 15, 2022.
As of March 31, 2019, the Company had outstanding $15.0 million of subordinated notes. The notes bear a fixed interest rate of 6.375% per annum, payable semiannually through December 15, 2020. The notes will bear a floating interest rate of three-month LIBOR plus 477 basis points payable quarterly after December 15, 2020 through maturity. The notes mature no later than December 15, 2025, and the Company has the option to redeem or prepay any or all of the subordinated notes without premium or penalty any time after December 15, 2020 or upon an occurrence of a Tier 2 capital event or tax event. The notes are subordinated to all other borrowings. At March 31, 2019, there was $95 thousand of debt issuance costs remaining, which are netted against the balance of the subordinated notes and recognized as expense over the expected term of the notes.

22

NOTE 8—INCOME TAXES
The Company records its federal income tax expense using its estimate of the effective income tax rate expected for the full year and applies that rate on a year-to-date basis. The fluctuations in the Company's effective federal income tax rate reflect changes related to interest income exempt from federal taxation and other nondeductible expenses relative to income tax credits.
A reconciliation of expected income tax expense using the federal corporate tax rate of 21% as of March 31, 2019 and 2018, respectively, and actual income tax expense is as follows:
 
 
For the three months ended March 31,
(Dollars in thousands)
 
2019
 
2018
Income tax expense based on federal corporate tax rate
 
$
885

 
$
800

Changes resulting from:
 
 

 
 

Tax-exempt income
 
(121
)
 
(88
)
Other, net
 
(17
)
 
(70
)
Income tax expense
 
$
747

 
$
642


NOTE 9—STOCK BASED COMPENSATION
2018 Equity Incentive Plan
On March 15, 2018, the Company’s Board of Directors approved the 2018 Equity Incentive Compensation Plan ("2018 Plan"). The 2018 Plan became effective upon shareholder approval at the annual shareholders meeting held on April 17, 2018. Under the 2018 Plan, the Company can grant incentive and non-qualified stock options, stock awards, stock appreciation rights, and other incentive awards to directors and employees of, and certain service providers to, the Company and its subsidiaries. Once the 2018 Plan became effective, no further awards could be granted from the 2007 Stock Option Plan ("Stock Option Plan") or the 2014 Equity Incentive Plan ("2014 Plan"). However, any outstanding equity award granted under the Stock Option Plan or the 2014 Plan will remain subject to the terms of such plans until the time it is no longer outstanding. For further discussion on the Stock Option Plan and 2014 Plan, refer to the disclosures included within the Annual Form 10-K, filed with the SEC on March 22, 2019.
The Company has reserved 250,000 shares of common stock for issuance under the 2018 Plan. During the three months ended March 31, 2019, the Company granted no stock options and issued 35,633 restricted stock awards under the 2018 Plan, resulting in 207,617 shares available to be granted as of March 31, 2019. During the three months ended March 31, 2018, the Company granted 30,000 stock options under the Stock Option Plan and 30,271 restricted stock awards under the 2014 Plan.
Stock Options
As of March 31, 2019, all of the Company's outstanding options were granted under the Stock Option Plan. The term of these options is ten years, and they vest one-third each year, over a three year period. The Company will use authorized, but unissued shares to satisfy share option exercises. The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model.
Expected volatilities are based on historical volatilities of the Company's common stock. The Company assumes all awards will vest. The expected term of options granted represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. The fair value of the stock options granted in the three months ended March 31, 2018 was determined using the following weighted-average assumptions as of grant date:
 
 
March 31, 2018
Risk Free Interest Rate
 
2.83%
Expected Term (years)
 
7.0
Expected Volatility
 
0.04%
Weighted average fair value of options granted
 
$4.46

23

The summary of our stock option activity for the three months ended March 31, 2019 is as follows:
 
 
Shares
 
Weighted Average
Exercise Price
 
Weighted Average Remaining Contractual
Term
Options outstanding at January 1, 2019
 
376,768

 
$
16.26

 
5.8
Exercised
 
(12,300
)
 
10.11

 
 
Options outstanding at March 31, 2019
 
364,468

 
16.47

 
5.7
Options exercisable at March 31, 2019
 
344,464

 
15.98

 
5.5
The aggregate intrinsic value was $2.5 million for both options outstanding and exercisable as of March 31, 2019. As of March 31, 2019, there was $84 thousand of total unrecognized compensation cost related to stock options granted under the Stock Option Plan. The cost is expected to be recognized over a weighted-average period of 1.4 years.
Share-based compensation expense charged against income was $20 thousand and $42 thousand for the three months ended March 31, 2019 and 2018, respectively.
Restricted Stock Awards
A summary of changes in the Company's nonvested shares for the three months ended March 31, 2019 is as follows:
Nonvested Shares
 
Shares
 
Weighted Average
Grant-Date Fair Value
Nonvested at January 1, 2019
 
53,770

 
$
24.14

Granted
 
35,633

 
23.76

Vested
 
(6,700
)
 
20.75

Forfeited
 
(400
)
 
24.80

Nonvested at March 31, 2019
 
82,303

 
$
24.25

As of March 31, 2019, there was $1.4 million of total unrecognized compensation cost related to nonvested shares granted under the 2014 Plan and 2018 Plan. The cost is expected to be recognized over a weighted average period of 2.3 years. The total fair value of shares vested during the three months ended March 31, 2019 was $139 thousand.
Total expense for restricted stock awards totaled $134 thousand and $141 thousand for the three months ended March 31, 2019 and 2018, respectively. For the three months ended March 31, 2019, there was $43 thousand of restricted stock redeemed to cover the payroll taxes due at the time of vesting.
NOTE 10—OFF-BALANCE SHEET ACTIVITIES
In the normal course of business, the Company offers a variety of financial instruments with off-balance sheet risk to meet the financing needs of its customers. These financial instruments include outstanding commitments to extend credit, credit lines, commercial letters of credit and standby letters of credit. These are agreements to provide credit, as long as conditions established in the contract are met, and usually have expiration dates. Commitments may expire without being used. Off-balance sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies used for loans are used to make such commitments, including obtaining collateral at exercise of the commitment.
A summary of the contractual amounts of the Company's exposure to off-balance sheet risk is as follows:
 
 
March 31, 2019
 
December 31, 2018
(Dollars in thousands)
 
Fixed
 
Variable
 
Fixed
 
Variable
Commitments to make loans
 
$
6,820

 
$
13,222

 
$
8,608

 
$
10,900

Unused lines of credit
 
24,142

 
234,329

 
18,672

 
229,490

Unused standby letters of credit
 
4,042

 
—

 
3,861

 
232

Commitments to make loans are generally made for periods of 90 days or less. The fixed rate loan commitments of $6.8 million as of March 31, 2019, have interest rates ranging from 4.9% to 6.5% and maturities ranging from 2 to 10 years.

24

NOTE 11—REGULATORY CAPITAL MATTERS
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. Management believed as of March 31, 2019, the Company and Bank met all capital adequacy requirements to which they were subject.
During the first quarter of 2015, regulations implementing the Basel III regulatory capital framework and the Dodd-Frank Wall Street Reform and Consumer Protection Act became effective, certain provisions of which were subject to a multi-year phase-in period. As of January 1, 2019, the rules require the Company to maintain a capital conservation buffer of common equity capital that exceeds by more than 2.5% the minimum risk-weighted assets ratios, which is the fully phased-in amount of the capital conservation buffer. The capital conservation buffer was 2.5% at March 31, 2019 and 1.875% at December 31, 2018.
Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required.
At March 31, 2019 and December 31, 2018, the most recent regulatory notifications categorized the Bank as "well capitalized" under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank's category.






















25

Actual and required capital amounts and ratios are presented below:
 
 
Actual
 
For Capital
Adequacy
Purposes
 
For Capital Adequacy
Purposes + Capital
Conservation Buffer(1)
 
Well Capitalized Under Prompt Corrective
Action Provisions
(Dollars in thousands)
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
March 31, 2019
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Common equity tier 1 to risk-weighted assets:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Consolidated
 
$
146,326

 
11.78
%
 
$
55,882

 
4.50
%
 
$
86,928

 
7.00
%
 


 


Bank
 
151,295

 
12.19
%
 
55,864

 
4.50
%
 
86,900

 
7.00
%
 
$
80,693

 
6.50
%
Tier 1 capital to risk-weighted assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
146,326

 
11.78
%
 
$
74,510

 
6.00
%
 
$
105,556

 
8.50
%
 


 


Bank
 
151,295

 
12.19
%
 
74,486

 
6.00
%
 
105,521

 
8.50
%
 
$
99,314

 
8.00
%
Total capital to risk-weighted assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
173,216

 
13.95
%
 
$
99,347

 
8.00
%
 
$
130,392

 
10.50
%
 


 


Bank
 
163,280

 
13.15
%
 
99,314

 
8.00
%
 
130,350

 
10.50
%
 
$
124,143

 
10.00
%
Tier 1 capital to average assets (leverage ratio):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
146,326

 
10.19
%
 
$
57,428

 
4.00
%
 
$
57,428

 
4.00
%
 


 


Bank
 
151,295

 
10.56
%
 
57,325

 
4.00
%
 
57,325

 
4.00
%
 
$
71,656

 
5.00
%
December 31, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common equity tier 1 to risk-weighted assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
144,008

 
11.82
%
 
$
54,803

 
4.50
%
 
$
77,699

 
6.38
%
 


 


Bank
 
147,495

 
12.12
%
 
54,780

 
4.50
%
 
77,666

 
6.38
%
 
$
79,126

 
6.50
%
Tier 1 capital to risk-weighted assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
144,008

 
11.82
%
 
$
73,071

 
6.00
%
 
$
95,967

 
7.88
%
 


 


Bank
 
147,495

 
12.12
%
 
73,040

 
6.00
%
 
95,926

 
7.88
%
 
$
97,386

 
8.00
%
Total capital to risk-weighted assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
170,503

 
14.00
%
 
$
97,428

 
8.00
%
 
$
120,324

 
9.88
%
 


 


Bank
 
159,100

 
13.07
%
 
97,386

 
8.00
%
 
120,272

 
9.88
%
 
$
121,733

 
10.00
%
Tier 1 capital to average assets (leverage ratio):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated
 
$
144,008

 
10.21
%
 
$
56,411

 
4.00
%
 
$
56,411

 
4.00
%
 


 


Bank
 
147,495

 
10.48
%
 
56,309

 
4.00
%
 
56,309

 
4.00
%
 
$
70,386

 
5.00
%
_______________________________________________________________________________
(1) Reflects the capital conservation buffer of 2.5% and 1.875% applicable during 2019 and 2018, respectively.
Dividend Restrictions - The Company’s primary source of cash is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. As of March 31, 2019, the Bank had the capacity to pay the Company a dividend of up to $32.9 million without the need to obtain prior regulatory approval.

26

NOTE 12—FAIR VALUE
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:
Level 1—Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2—Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.
Level 3—Significant unobservable inputs that reflect a company's own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:
Investment Securities:    Securities available for sale are recorded at fair value on a recurring basis as follows: the fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). No securities are valued using a Level 3 approach.
Loans Held for Sale, at Fair Value:    The fair value of loans held for sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan (Level 2).
Loans Measured at Fair Value:    During the normal course of business, loans originated with the initial intention to sell but not ultimately sold, are transferred from held for sale to our portfolio of loans held for investment at fair value as the Company adopted the fair value option at origination. The fair value of these loans is determined by obtaining fair value pricing from a third-party software, and then layering an additional adjustment, ranging from 5 to 75 basis points, as determined by management, depending on the reason for the transfer. Due to the adjustments made, the Company classifies the loans transferred from loans held for sale as recurring Level 3.
Impaired Loans:   Impaired loans are measured and recorded at fair value on a non-recurring basis. All of our nonaccrual loans and trouble debt restructured loans are considered impaired and are reviewed individually for the amount of impairment, if any. The fair value of impaired loans is estimated using one of several methods, including the fair value of the collateral or the present value of the expected future cash flows discounted at the loan's effective interest rate. For loans that are collateral dependent, the fair value of each loan’s collateral is generally based on estimated market prices from an independently prepared appraisal. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Non-real estate collateral may be valued using an appraisal, net book value per the borrower's financial statements, or aging reports, adjusted or discounted based on management's historical knowledge, changes in market conditions from the time of the valuation, and management's expertise and knowledge of the client and client's business. Such adjustments are considered unobservable and the fair value measurement is categorized as a Level 3 measurement.
Other Real Estate Owned:    The fair value of other real estate owned is based on recent real estate appraisals which are generally updated annually. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales, cost, and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Other real estate owned properties are evaluated on a quarterly basis for additional impairment and adjusted accordingly.
Appraisals for both collateral-dependent impaired loans and real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by either the Company or the Company's appraisal services vendor. Once received, management reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. Management monitors the actual selling price of collateral that has been sold to the most recent appraised value to determine what additional adjustment should be made to the appraisal value to arrive at fair value.

27

Derivatives: Customer-initiated derivatives are traded in over-the counter markets where quoted market prices are not readily available. Fair value of customer-initiated derivatives is measured on a recurring basis using valuation models that use market observable inputs (Level 2).
Mortgage banking related derivatives including commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of these mortgage loans are recorded at fair value on a recurring basis. The fair value of these commitments is based on the fair value of related mortgage loans determined using observable market data (Level 2). Interest rate lock commitments are adjusted for expectations of exercise and funding. This adjustment is not considered to be material input.































28

Assets and liabilities measured at fair value on a recurring basis are summarized below:
(Dollars in thousands)
 
Total
 
Quoted Prices
in Active Markets
for Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
March 31, 2019
 
 

 
 

 
 

 
 

Securities available for sale:
 
 

 
 

 
 

 
 

U.S. government sponsored entities and agencies
 
$
1,446

 
$
—

 
$
1,446

 
$
—

State and political subdivision
 
89,417

 
—

 
89,417

 
—

Mortgage-backed securities: residential
 
9,654

 
—

 
9,654

 
—

Mortgage-backed securities: commercial
 
16,495

 
—

 
16,495

 
—

Collateralized mortgage obligations: residential
 
17,709

 
—

 
17,709

 
—

Collateralized mortgage obligations: commercial
 
35,489

 
—

 
35,489

 
—

U.S. Treasury
 
17,658

 
—

 
17,658

 
—

SBA
 
20,575

 
—

 
20,575

 
—

Asset backed securities
 
5,807

 
—

 
5,807

 
—

Corporate bonds
 
12,624

 
—

 
12,624

 
—

Total securities available for sale
 
226,874

 
—

 
226,874

 
—

Loans held for sale
 
14,043

 
—

 
14,043

 
—

Loans measured at fair value:
 
 
 
 
 
 
 
 
Residential real estate
 
4,650

 
—

 
—

 
4,650

Derivative assets:
 
 
 
 
 
 
 
 
Customer-initiated derivatives
 
2,191

 
—

 
2,191

 
—

Forward contracts related to mortgage loans to be delivered for sale
 
77

 
—

 
77

 
—

Interest rate lock commitments
 
321

 
—

 
321

 
—

Total assets at fair value
 
$
248,156

 
$
—

 
$
243,506

 
$
4,650

Derivative liabilities:
 
 
 
 
 
 
 
 
Customer-initiated derivatives
 
2,191

 
—

 
2,191

 
—

Forward contracts related to mortgage loans to be delivered for sale
 
139

 
—

 
139

 
—

Interest rate lock commitments
 
1

 
—

 
1

 
—

Total liabilities at fair value
 
$
2,331

 
$
—

 
$
2,331

 
$
—


29

(Dollars in thousands)
 
Total
 
Quoted Prices
in Active Markets
for Identical Assets
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
December 31, 2018
 
 
 
 
 
 
 
 
Securities available for sale:
 
 
 
 
 
 
 
 
U.S. government sponsored entities and agencies
 
$
2,397

 
$
—

 
$
2,397

 
$
—

State and political subdivision
 
75,146

 
—

 
75,146

 
—

Mortgage-backed securities: residential
 
9,739

 
—

 
9,739

 
—

Mortgage-backed securities: commercial
 
12,382

 
—

 
12,382

 
—

Collateralized mortgage obligations: residential
 
18,671

 
—

 
18,671

 
—

Collateralized mortgage obligations: commercial
 
31,988

 
—

 
31,988

 
—

U.S. Treasury
 
20,481

 
—

 
20,481

 
—

SBA
 
15,688

 
—

 
15,688

 
—

Asset backed securities
 
3,842

 
—

 
3,842

 
—

Corporate bonds
 
13,924

 
—

 
13,924

 
—

Total securities available for sale
 
$
204,258

 
$
—

 
$
204,258

 
$
—

Loans held for sale
 
5,595

 
—

 
5,595

 
—

Loans measured at fair value:
 
 
 
 
 
 
 
 
Residential real estate
 
4,571

 
—

 
—

 
4,571

Derivative assets:
 
 
 
 
 
 
 
 
Customer-initiated derivatives
 
1,126

 
—

 
1,126

 
—

Forward contracts related to mortgage loans to be delivered for sale
 
22

 
—

 
22

 
—

Interest rate lock commitments
 
198

 
—

 
198

 
—

Total assets at fair value
 
$
215,770

 
$
—

 
$
211,199

 
$
4,571

Derivative liabilities:
 
 
 
 
 
 
 
 
Customer-initiated derivatives
 
1,126

 
—

 
1,126

 
—

Forward contracts related to mortgage loans to be delivered for sale
 
43

 
—

 
43

 
—

Total liabilities at fair value
 
$
1,169

 
$
—

 
$
1,169

 
$
—

There were no transfers between levels within the fair value hierarchy, within a specific category, during the three months ended March 31, 2019.













30

The following table summarizes the changes in Level 3 assets measured at fair value on a recurring basis.
(Dollars in thousands)
 
Loans held for investment
For the three months ended March 31, 2019
 
 
Beginning balance
 
$
4,571

Transfers from loans held for sale
 
239

Gains (losses):
 
 

Recorded in "Mortgage banking activities"
 
88

Repayments
 
(248
)
Ending balance
 
$
4,650

For the three months ended March 31, 2018
 
 
Beginning balance
 
$
4,291

Transfers from loans held for sale
 
—

Gains (losses):
 
 
Recorded in "Mortgage banking activities"
 
(96
)
Repayments
 
(36
)
Ending balance
 
$
4,159

The Company has elected the fair value option for loans held for sale. These loans are intended for sale and the Company believes that the fair value is the best indicator of the resolution of these loans. Interest income is recorded based on the contractual terms of the loan and in accordance with the Company's policy on loans held for investment. There were no loans held for sale that were on nonaccrual status or 90 days past due as of March 31, 2019 or December 31, 2018.
As of March 31, 2019 and December 31, 2018, the aggregate fair value, contractual balance (including accrued interest), and gain or loss for loans held for sale carried at fair value was as follows:
(Dollars in thousands)
 
March 31, 2019
 
December 31, 2018
Aggregate fair value
 
$
14,043

 
$
5,595

Contractual balance
 
13,877

 
5,512

Unrealized gain
 
166

 
83

The total amount of gains (losses) from changes in fair value of loans held for sale included in "Mortgage banking activities" for three months ended March 31, 2019 and 2018 were as follows:
 
 
For the three months ended March 31,
(Dollars in thousands)
 
2019
 
2018
Change in fair value
 
$
83

 
$
(46
)

31

Assets measured at fair value on a non-recurring basis are summarized below:
(Dollars in thousands)
 
Total
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
March 31, 2019
 
 
 
 
 
 
 
 
Impaired loans:
 
 
 
 
 
 
 
 
Commercial and industrial
 
$
3,391

 
$
—

 
$
—

 
$
3,391

Other real estate owned
 
373

 
—

 
—

 
373

Total
 
$
3,764

 
$
—

 
$
—

 
$
3,764

December 31, 2018
 
 
 
 
 
 
 
 
Impaired loans:
 
 
 
 
 
 
 
 
Commercial and industrial
 
$
3,337

 
$
—

 
$
—

 
$
3,337

Total
 
$
3,337

 
$
—

 
$
—

 
$
3,337

The Company recorded $509 thousand and $278 thousand of specific allowance allocations and no chargeoffs related to impaired loans at fair value in the three months ended March 31, 2019 and year ended December 31, 2018, respectively.
Other real estate owned measured at fair value had a net carrying amount of $373 thousand at March 31, 2019. There were no write downs in other real estate owned during the three months ended March 31, 2019. There were no other real estate owned assets at fair value at December 31, 2018.
The table below presents quantitative information about the significant unobservable inputs for assets measured at fair value on a nonrecurring basis at March 31, 2019 and December 31, 2018:
(Dollars in thousands)
 
Fair value at
March 31, 2019
 
Valuation
Technique(s)
 
Significant
Unobservable Input(s)
 
Discount %
Impaired loans
 
$
3,391

 
Discounted appraisals
 
Collateral discounts
 
17-50%
Other real estate owned
 
373

 
Sales comparison approach per appraisal
 
Discount for type of collateral and age of appraisal
 
0%

(Dollars in thousands)
 
Fair value at
December 31, 2018
 
Valuation
Technique(s)
 
Significant
Unobservable Input(s)
 
Discount % Range
Impaired loans
 
$
3,337

 
Discounted appraisals
 
Collateral discounts
 
17-50%
    












32

The carrying amounts and estimated fair values of financial instruments, excluding those previously presented unless otherwise noted, at March 31, 2019 and December 31, 2018 were as follows:
 
 
 
 
Estimated Fair Value
(Dollars in thousands)
 
Carrying Value
 
Quoted Prices in
Active Markets for
Identical Assets (Level 1)
 
Significant
Other Observable
Inputs (Level 2)
 
Significant
Unobservable
Inputs (Level 3)
Total
March 31, 2019
 
 

 
 

 
 

 
 

 
Financial assets:
 
 

 
 

 
 

 
 

 
Cash and cash equivalents
 
$
35,982

 
$
24,188

 
$
11,794

 
$
—

$
35,982

Federal Home Loan Bank stock
 
8,325

 
NA

 
NA

 
NA

NA

Net loans
 
1,119,137

 
—

 
—

 
1,120,249

1,120,249

Accrued interest receivable
 
5,114

 
—

 
1,921

 
3,193

5,114

Financial liabilities:
 
 
 
 
 
 
 
 


Deposits
 
1,151,463

 
—

 
1,154,745

 
—

1,154,745

Borrowings
 
117,907

 
—

 
118,597

 
—

118,597

Subordinated notes
 
14,905

 
—

 
15,225

 
—

15,225

Accrued interest payable
 
2,001

 
—

 
2,001

 
—

2,001

December 31, 2018
 
 
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
33,296

 
$
27,072

 
$
6,224

 
$
—

$
33,296

Federal Home Loan Bank stock
 
8,325

 
 NA

 
 NA

 
 NA

 NA

Net loans
 
1,114,999

 
—

 
—

 
1,113,648

1,113,648

Accrued interest receivable
 
4,207

 
—

 
1,210

 
2,997

4,207

Financial liabilities:
 
 
 
 
 
 
 
 


Deposits
 
1,134,635

 
—

 
1,137,575

 
—

1,137,575

Borrowings
 
99,574

 
—

 
100,602

 
—

100,602

Subordinated notes
 
14,891

 
—

 
15,450

 
—

15,450

Accrued interest payable
 
1,674

 
—

 
1,674

 
—

1,674

The methods and assumptions, not previously presented, used to estimate fair value are described as follows:
(a)Cash and Cash Equivalents
The carrying amounts of cash on hand and non-interest due from bank accounts approximate fair values and are classified as Level 1. The carrying amounts of fed funds sold and interest bearing due from bank accounts approximate fair values and are classified as Level 2.
(b)FHLB Stock
It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.
(c)Loans
Fair value of loans, excluding loans held for sale, are estimated as follows: Fair values for all loans are estimated using present value of future estimated cash flows, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality, resulting in a Level 3 classification. Impaired loans are values at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.
(d)Deposits
The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 2 classification. Fair values for fixed and variable rate certificates of deposit are estimated using a present value of future estimated cash flows calculation that applies interest rates currently being offered on certificates of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

33

(e) Borrowings
The fair values of the Company's short-term and long-term borrowings are estimated using present value of future estimated cash flows using current interest rates offered to the Company for similar types of borrowing arrangements, resulting in a Level 2 classification.
(f)Subordinated notes
The fair value of the Company's subordinated notes is calculated based on present value of future estimated cash flows using current interest rates offered to the Company for similar types of borrowing arrangements, resulting in a Level 2 classification.
(g) Accrued Interest Receivable/Payable
The carrying amounts of accrued interest approximate fair value resulting in a Level 3 classification for receivable and a Level 2 classification for payable, consistent with their associated assets/liabilities.
NOTE 13—DERIVATIVES
The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. These interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions with approved, reputable, independent counterparties with substantially matching terms. The agreements are considered standalone derivatives, and changes in the fair value of derivatives are reported in earnings as non-interest income.
Credit risk arises from the possible inability of counterparties to meet the terms of their contracts. The Company's exposure is limited to the replacement value of the contracts rather than the notional, principal or contract amounts. There are provisions in the agreements with the counterparties that allow for certain unsecured credit exposure up to an agreed threshold. Exposures in excess of the agreed thresholds are collateralized. In addition, the Company minimizes credit risk through credit approvals, limits, and monitoring procedures.
Commitments to fund certain mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of mortgage loans to third party investors are considered derivatives. It is the Company's practice to enter into forward commitments for the future delivery of residential mortgage loans when interest rate lock commitments are entered into in order to economically hedge the effect of changes in interest rates resulting from its commitments to fund the loans. These mortgage banking derivatives are not designated in hedge relationships. Fair values were estimated based on changes in mortgage interest rates from the date of the commitments. Changes in the fair values of these mortgage-banking derivatives are included in mortgage banking activities.
The following table presents the notional amount and fair value of the Company's derivative instruments held or issued in connection with customer initiated and mortgage banking activities:
 
March 31, 2019
 
December 31, 2018
(Dollars in thousands)
Notional Amount
 
Fair Value
 
Notional Amount
 
Fair Value
Included in other assets
 
 
 
 
 
 
 
Customer-initiated and mortgage banking derivatives:
 
 
 
 
 
 
 
Customer-initiated derivatives
$
48,646

 
$
2,191

 
$
35,733

 
$
1,126

Forward contracts related to mortgage loans to be delivered for sale
14,589

 
77

 
5,241

 
22

Interest rate lock commitments
28,497

 
321

 
18,375

 
198

Total derivatives included in other assets
$
91,732

 
$
2,589

 
$
59,349

 
$
1,346

Included in other liabilities:
 
 
 
 
 
 
 
Customer-initiated and mortgage banking derivatives:
 
 
 
 
 
 
 
Customer-initiated derivatives
$
48,646

 
$
2,191

 
$
35,733

 
$
1,126

Forward contracts related to mortgage loans to be delivered for sale
20,651

 
139

 
11,195

 
43

Interest rate lock commitments
1,654

 
1

 
—

 
—

Total derivatives included in other liabilities
$
70,951

 
$
2,331

 
$
46,928

 
$
1,169


34

The following table presents the gains (losses) related to derivative instruments reflecting the changes in fair value:
 
 
 
Three months ended March 31,
(Dollars in thousands)
Location of Gain (Loss)
 
2019
 
2018
Forward contracts related to mortgage loans to be delivered for sale
Mortgage Banking Activities
 
$
(174
)
 
$
(1
)
Interest rate lock commitments
Mortgage Banking Activities
 
122

 
10

Total gain (loss) recognized in income
 
 
$
(52
)
 
$
9

Balance Sheet Offsetting:
Certain financial instruments, including customer-initiated derivatives and interest rate swaps, may be eligible for offset in the consolidated balance sheets and/or subject to master netting arrangements or similar agreements. The Company is party to master netting arrangements with its financial institution counterparties; however, the Company does not offset assets and liabilities under these arrangements for financial statement presentation purposes based on an accounting policy election. The table below presents information about the Company's financial instruments that are eligible for offset.
 
 
 
 
 
 
 
Gross amounts not offset in the statements of financial position
 
 
(Dollars in thousands)
Gross amounts recognized
 
Gross amounts offset in the statements of financial condition
 
Net amounts presented in the statements of financial condition
 
Financial instruments
 
Collateral (received)/posted
 
Net amount
March 31, 2019
 
 
 
 
 
 
 
 
 
 
 
Offsetting derivative assets:
 
 
 
 
 
 
 
 
 
 
 
Customer initiated derivatives
$
2,191

 
—

 
$
2,191

 
—

 
—

 
$
2,191

Offsetting derivative liabilities:
 
 
 
 
 
 
 
 
 
 
 
Customer initiated derivatives
$
2,191

 
—

 
$
2,191

 
—

 
$
2,257

 
$
(66
)
December 31, 2018
 
 
 
 
 
 
 
 
 
 
 
Offsetting derivative assets:
 
 
 
 
 
 
 
 
 
 
 
Customer initiated derivatives
$
1,126

 
—

 
$
1,126

 
—

 
—

 
$
1,126

Offsetting derivative liabilities:
 
 
 
 
 
 
 
 
 
 
 
Customer initiated derivatives
$
1,126

 
—

 
$
1,126

 
—

 
$
1,020

 
$
106



35

NOTE 14—PARENT COMPANY FINANCIAL STATEMENTS
Balance Sheets—Parent Company
(Dollars in thousands)
 
March 31, 2019
 
December 31, 2018
Assets
 
 

 
 

Cash and cash equivalents
 
$
8,297

 
$
9,690

Investment in banking subsidiary
 
161,088

 
155,248

Investment in captive insurance subsidiary
 
1,816

 
1,622

Income tax benefit
 
142

 
393

Other assets
 
69

 
21

Total assets
 
$
171,412

 
$
166,974

Liabilities
 
 
 
 
Subordinated notes
 
$
14,905

 
$
14,891

Accrued expenses and other liabilities
 
388

 
323

Total liabilities
 
15,293

 
15,214

Shareholders' equity
 
156,119

 
151,760

Total liabilities and shareholders' equity
 
$
171,412

 
$
166,974

Statements of Income and Comprehensive Income—Parent Company
 
 
For the three months ended March 31,
(Dollars in thousands)
 
2019
 
2018
Expenses
 
 
 
 
Interest on subordinated notes
 
$
250

 
$
250

Other expenses
 
200

 
64

Total expenses
 
450

 
314

Loss before income taxes and equity in undistributed net earnings of subsidiaries
 
(450
)
 
(314
)
Income tax benefit
 
52

 
97

Equity in undistributed earnings of subsidiaries
 
3,865

 
3,385

Net income
 
$
3,467

 
$
3,168

Other comprehensive income (loss)
 
2,069

 
(1,980
)
Total comprehensive income, net of tax
 
$
5,536

 
$
1,188














36

Statements of Cash Flows—Parent Company
 
 
For the three months ended March 31,
(Dollars in thousands)
 
2019
 
2018
Cash flows from operating activities
 
 

 
 

Net income
 
$
3,467

 
$
3,168

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Equity in undistributed earnings of subsidiaries
 
(3,865
)
 
(3,385
)
Stock based compensation expense
 
11

 
82

(Increase) decrease in other assets, net
 
203

 
(407
)
Increase (decrease) in other liabilities, net
 
(230
)
 
112

Net cash used in operating activities
 
(414
)
 
(430
)
Cash flows from financing activities
 
 
 
 
Share buyback
 
(1,104
)
 
—

Proceeds from exercised stock options
 
125

 
1,192

Net cash provided by (used in) financing activities
 
(979
)
 
1,192

Net increase (decrease) in cash and cash equivalents
 
(1,393
)
 
762

Beginning cash and cash equivalents
 
9,690

 
1,158

Ending cash and cash equivalents
 
$
8,297

 
$
1,920


37

NOTE 15—EARNINGS PER SHARE
The calculation of basic and diluted earnings per share for each period noted below was as follows:
 
 
For the three months ended March 31,
(Dollars in thousands, except per share data)
 
2019
 
2018
Basic:
 
 

 
 

Net Income attributable to common shareholders
 
$
3,467

 
$
3,168

Weighted average common shares outstanding
 
7,751,750

 
6,539,305

Basic earnings per share
 
$
0.45

 
$
0.48

Diluted:
 
 
 
 
Net Income attributable to common shareholders
 
$
3,467

 
$
3,168

Weighted average common shares outstanding
 
7,751,750

 
6,539,305

Add: Dilutive effects of assumed exercises of stock options
 
117,431

 
159,627

Weighted average common and dilutive potential common shares outstanding
 
7,869,181

 
6,698,932

Diluted earnings per common share
 
$
0.44

 
$
0.47

Stock options for 30 thousand shares and 15 thousand shares of common stock were not considered in computing diluted earnings per common share for the three months ended March 31, 2019 and 2018, respectively, because they were antidilutive.


38

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion explains our financial condition and results of operations as of and for the three months ended March 31, 2019. The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes presented elsewhere in this report and our Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC on March 22, 2019. Annualized results for these interim periods may not be indicative of results for the full year or future periods.
In addition to the historical information contained herein, this Form 10-Q includes "forward-looking statements." These statements are subject to many risks and uncertainties, including changes in interest rates and other general economic, business and political conditions, including changes in the financial markets; changes in business plans as circumstances warrant; and other risks detailed from time to time in filings made by the Company with the SEC. Readers should note that the forward-looking statements included herein are not a guarantee of future events, and that actual events may differ materially from those made in or suggested by the forward-looking statements. Forward-looking statements generally can be identified by the use of forward-looking terminology such as "will," "propose," "may," "plan," "seek," "expect," "intend," "estimate," "anticipate," "believe" or "continue," or similar terminology. Any forward-looking statements presented herein are made only as of the date of this document, and we do not undertake any obligation to update or revise any forward-looking statements to reflect changes in assumptions, the occurrence of unanticipated events, or otherwise.
Critical Accounting Policies
Our consolidated financial statements are prepared based on the application of accounting policies generally accepted in the United States. Our critical accounting policies require reliance on estimates and assumptions, which are based upon historical experience and on various other assumptions that management believes are reasonable under current circumstances, but may prove to be inaccurate or can be subject to variations. Changes in underlying factors, assumptions, or estimates could have a material impact on our future financial condition and results of operations.
The most critical of these significant accounting policies are set forth in "Note 1 – Summary of Significant Accounting Policies" of the Notes to Consolidated Financial Statements, included in our Annual Report on Form 10-K for the year ended December 31, 2018, which was filed with the SEC on March 22, 2019. There have been no significant changes in critical accounting policies or the assumptions and judgments utilized in applying these policies since December 31, 2018.
Overview
Level One Bancorp, Inc. is a bank holding company headquartered in Farmington Hills, Michigan, with its primary branch operations in southeastern Michigan and Grand Rapids, Michigan. Through our wholly owned subsidiary, Level One Bank, we offer a broad range of loan products to the residential and commercial markets, as well as retail and business banking services. Hamilton Court Insurance Company, a wholly owned subsidiary of the Company, provides property and casualty insurance to the Company and the Bank and reinsurance to ten other third-party insurance captives for which insurance may not be currently available or economically feasible in the insurance marketplace.
Since 2007, we have grown substantially through organic growth and a series of four acquisitions, all of which have been fully integrated into our operations. We have made significant investments over the last several years in hiring additional staff and upgrading technology and system security. In 2016, we opened our first branch in the Grand Rapids, Michigan market. In the third quarter of 2017, we opened our second location in Bloomfield Township located in Oakland County. In the third quarter of 2018, we doubled the size of our mortgage division with the addition of new mortgage officers and support staff. As of March 31, 2019, the Company had total consolidated assets of $1.46 billion, total consolidated deposits of $1.15 billion and total consolidated shareholders' equity of $156.1 million.
Our principal business activity has been lending to and accepting deposits from individuals, businesses, municipalities and other entities. We have derived income principally from interest charged on loans and leases and, to a lesser extent, from interest and dividends earned on investment securities. We have also derived income from noninterest sources, such as: fees received in connection with various lending and deposit services; and originations and sales of residential mortgage loans. Our principal expenses include interest expense on deposits and borrowings, operating expenses, such as salaries and employee benefits, occupancy and equipment expenses, data processing costs, professional fees and other noninterest expenses, provisions for loan losses and income tax expense.
Recent Developments
First Quarter Dividend. On March 21, 2019, the Company declared a first quarter 2019 cash dividend of $0.04 per share, payable on April 15, 2019. The first quarter cash dividend of $0.04 per share represents an increase of $0.01 per share, compared to $0.03 per share declared in prior quarter.

39

Selected Financial Data - Unaudited
 
As of and for the three months ended
 
March 31,
 
December 31,
 
March 31,
(Dollars in thousands, except per share data)
2019
 
2018
 
2018
Earnings Summary
 
 
 
 
 
Interest income
$
17,442

 
$
17,041

 
$
14,774

Interest expense
4,724

 
4,228

 
2,647

Net interest income
12,718

 
12,813

 
12,127

Provision expense (benefit) for loan losses
422

 
(51
)
 
554

Noninterest income
2,286

 
2,307

 
1,372

Noninterest expense
10,368

 
10,384

 
9,135

Income before income taxes
4,214

 
4,787

 
3,810

Income tax provision
747

 
836

 
642

Net income
3,467

 
3,951

 
3,168

Per Share Data
 
 
 
 
 
Basic earnings per common share
$
0.45

 
$
0.51

 
$
0.48

Diluted earnings per common share
0.44

 
0.50

 
0.47

Book value per common share
20.15

 
19.58

 
16.78

Tangible book value per share (1)
18.88

 
18.31

 
15.27

Shares outstanding (in thousands)
7,749

 
7,750

 
6,585

Average basic common shares (in thousands)
7,752

 
7,750

 
6,539

Average diluted common shares (in thousands)
7,869

 
7,893

 
6,699

Selected Period End Balances
 
 
 
 
 
Total assets
$
1,456,552

 
$
1,416,215

 
$
1,300,629

Securities available-for-sale
226,874

 
204,258

 
160,349

Total loans
1,131,097

 
1,126,565

 
1,051,354

Total deposits
1,151,463

 
1,134,635

 
1,112,644

Total liabilities
1,300,433

 
1,264,455

 
1,190,106

Total shareholders' equity
156,119

 
151,760

 
110,523

Tangible shareholders' equity (1)
146,337

 
141,926

 
100,524

Performance and Capital Ratios
 
 
 
 
 
Return on average assets
0.96
%
 
1.11
%
 
1.00
%
Return on average equity
8.99

 
10.69

 
11.64

Net interest margin (fully taxable equivalent) (2)
3.76

 
3.73

 
4.03

Efficiency ratio (noninterest expense/net interest income plus noninterest income)
69.10

 
68.68

 
67.67

Dividend payout ratio (3)
6.72

 
5.87

 
—

Total shareholders' equity to total assets
10.72

 
10.72

 
8.50

Tangible equity to tangible assets (1)
10.11

 
10.09

 
7.79

Common equity tier 1 to risk-weighted assets
11.78

 
11.82

 
9.47

Tier 1 capital to risk-weighted assets
11.78

 
11.82

 
9.47

Total capital to risk-weighted assets
13.95

 
14.00

 
11.87

Tier 1 capital to average assets (leverage ratio)
10.19

 
10.21

 
8.15

Asset Quality Ratios:
 
 
 
 
 
Net charge-offs to average loans
0.01
%
 
0.10
%
 
0.29
%
Nonperforming assets as a percentage of total assets
1.17

 
1.30

 
1.00

Nonperforming loans as a percent of total loans
1.47

 
1.64

 
1.23

Allowance for loan losses as a percentage of period-end loans
1.06

 
1.03

 
1.09

Allowance for loan losses as a percentage of nonperforming loans
71.85

 
62.70

 
88.67

Allowance for loan losses as a percentage of nonperforming loans, excluding allowance allocated to loans accounted for under ASC 310-30
66.33

 
57.71

 
80.36

(1) See section entitled "GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures" below.
(2) Presented on a tax equivalent basis using a 21% tax rate.
(3) The dividend payout ratio of 0 for the three months ended March 31, 2018 was due to the timing difference between the declaration date and payout date of the dividend. The Company declared a $0.03 dividend for the three months ended March 31, 2018 but it was not paid out until April 15, 2018.



40

GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures
Some of the financial measures included in this report are not measures of financial condition or performance recognized by GAAP. These non-GAAP financial measures include tangible shareholders' equity, tangible book value per share and the ratio of tangible shareholders' equity to tangible assets. Our management uses these non-GAAP financial measures in its analysis of our performance, and we believe financial analysts and others frequently use these measures, and other similar measures, to evaluate capital adequacy. We calculate: (i) tangible shareholders' equity as total shareholders' equity less core deposit intangibles and goodwill; (ii) tangible book value per share as tangible shareholders' equity divided by shares of common stock outstanding; and (iii) tangible assets as total assets, less core deposit intangibles and goodwill.
The following presents these non-GAAP financial measures along with their most directly comparable financial measures calculated in accordance with GAAP:
 
As of and for the three months ended,
(Dollars in thousands, except per share data)
March 31, 2019
 
December 31, 2018
 
March 31, 2018
 
(Unaudited)
 
 
 
(Unaudited)
Total shareholders' equity
$
156,119

 
$
151,760

 
$
110,523

Less:
 
 
 
 
 
Goodwill
9,387

 
9,387

 
9,387

Core deposit intangibles
395

 
447

 
612

Tangible shareholders' equity
$
146,337

 
$
141,926

 
$
100,524

 
 
 
 
 
 
Shares outstanding (in thousands)
7,749

 
7,750

 
6,585

Tangible book value per share
$
18.88

 
$
18.31

 
$
15.27

 
 
 
 
 
 
Total assets
$
1,456,552

 
$
1,416,215

 
$
1,300,629

Less:
 
 
 
 
 
Goodwill
9,387

 
9,387

 
9,387

Core deposit intangibles
395

 
447

 
612

Tangible assets
$
1,446,770

 
$
1,406,381

 
$
1,290,630

 
 
 
 
 
 
Tangible equity to tangible assets
10.11
%
 
10.09
%
 
7.79
%





41

Results of Operations
Net Income
We had net income of $3.5 million, or $0.44 per diluted common share, for the three months ended March 31, 2019, compared to $3.2 million, or $0.47 per diluted common share, for the three months ended March 31, 2018. The increase of $299 thousand in net income in the first quarter of 2019 primarily reflects an increase of $914 thousand in noninterest income, an increase of $591 thousand in net interest income and a decrease in provision expense for loan losses of $132 thousand. This was partially offset by an increase of $1.2 million in noninterest expenses and an increase in income tax provision of $105 thousand.
Net Interest Income
Net interest income is the difference between interest income and yield-related fees earned on assets and interest expense paid on liabilities.
We had net interest income of $12.7 million and $12.1 million for the three months ended March 31, 2019 and 2018, respectively. The three months ended March 31, 2019 included a $2.7 million increase in interest income as well as a $2.1 million increase in interest expense, compared to the same period in 2018. The increase in interest income was primarily driven by an increase of $2.0 million in interest and fees on loans and an increase of $556 thousand in interest income from investment securities, whereas the increase in interest expense was primarily driven by an increase of $1.9 million in deposit interest expense and an increase of $134 thousand in interest expense on borrowed funds. The change in interest and fees on loans and interest income from investment securities for the three months ended March 31, 2019 compared to the same period 2018 was primarily driven by the growth in total loans and investment securities portfolios and by higher interest rates. The increase in deposit interest expense during three months ended March 31, 2019 was primarily due to higher average rates paid on deposits as a result of the increase in the target federal fund rate, as well as an increase in total deposits compared to the same period in 2018.
Our net interest margin (on a fully tax equivalent basis ("FTE")) for the three months ended March 31, 2019 was 3.76%, compared to 4.03% for the same period in 2018. The decrease of 27 basis points was primarily a result of higher cost of funds compared to the same period in 2018. Our net interest margin benefits from discount accretion on our purchased credit impaired loan portfolios, a component of our accretable yield. The accretable yield represents the excess of the net present value of expected future cash flows over the acquisition date fair value and includes both the expected coupon of the loan and the discount accretion. The accretable yield is recognized as interest income over the expected remaining life of the purchased credit impaired loan. The difference between the actual yield earned on total loans and the yield generated based on the contractual coupon (not including any interest income for loans in nonaccrual status) represents excess accretable yield. The contractual coupon of the loan considers the contractual coupon rates of the loan and does not include any interest income for loans in nonaccrual status. For the three months ended March 31, 2019 and 2018, the average yield on total loans was 5.64% and 5.32%, respectively. The yield on total loans was impacted by 17 basis points and 30 basis points, respectively, due to the accretable yield on purchased credit impaired loans. Our net interest margin for the three months ended March 31, 2019 and 2018, benefited by 14 basis points and 25 basis points, respectively, as a result of the excess accretable yield. As of March 31, 2019 and December 31, 2018, our remaining accretable yield was $10.4 million and $10.9 million, respectively, and our nonaccretable difference was $5.6 million for both dates.
The following table sets forth information related to our average balance sheet, average yields on assets, and average rates of liabilities for the periods indicated. We derived these yields by dividing income or expense by the average daily balance of the corresponding assets or liabilities. In this table, adjustments are made to the yields on tax-exempt assets in order to present tax-exempt income and fully taxable income on a comparable basis.

42

Analysis of Net Interest Income—Fully Taxable Equivalent
 
 
For the three months ended March 31,
 
 
2019
 
2018
(Dollars in thousands)
 
Average Balance
 
Interest Revenue/Expense (1)
 
Average Yield/Rate (2)
 
Average Balance
 
Interest Revenue/Expense (1)
 
Average Yield/Rate (2)
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
Gross loans(3)
 
$
1,125,213

 
$
15,651

 
5.64
%
 
$
1,037,045

 
$
13,604

 
5.32
%
Investment securities(4):
 
 
 
 
 
 
 
 
 
 
 
 
Taxable
 
141,282

 
936

 
2.69

 
102,135

 
574

 
2.28

Tax-exempt
 
80,760

 
545

 
3.17

 
54,996

 
351

 
3.16

Interest-earning cash balances
 
28,076

 
176

 
2.54

 
27,090

 
106

 
1.59

Federal Home Loan Bank stock
 
8,325

 
134

 
6.53

 
8,303

 
139

 
6.78

Total interest-earning assets
 
$
1,383,656

 
$
17,442

 
5.14
%
 
$
1,229,569

 
$
14,774

 
4.90
%
Non-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
 
24,794

 
 
 
 
 
18,531

 
 
 
 
Premises and equipment
 
13,289

 
 
 
 
 
13,362

 
 
 
 
Goodwill
 
9,387

 
 
 
 
 
9,387

 
 
 
 
Other intangible assets, net
 
425

 
 
 
 
 
644

 
 
 
   
Bank-owned life insurance
 
11,893

 
 
 
 
 
11,570

 
 
 
 
Allowance for loan losses
 
(11,563
)
 
 
 
 
 
(11,822
)
 
 
 
 
Other non-earning assets
 
11,841

 
 
 
 
 
12,195

 
 
 
 
Total assets
 
$
1,443,722

 
 
 
 
 
$
1,283,436

 
 
 
   
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Deposits:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing demand deposits
 
$
53,299

 
$
48

 
0.37
%
 
$
63,501

 
$
51

 
0.33
%
Money market and savings deposits
 
306,496

 
1,094

 
1.45

 
273,699

 
548

 
0.81

Time deposits
 
544,130

 
2,979

 
2.22

 
456,555

 
1,579

 
1.40

Borrowings
 
55,814

 
353

 
2.57

 
56,819

 
219

 
1.56

Subordinated notes
 
14,896

 
250

 
6.81

 
14,844

 
250

 
6.83

Total interest-bearing liabilities
 
$
974,635

 
$
4,724

 
1.97
%
 
$
865,418

 
$
2,647

 
1.24
%
Noninterest-bearing liabilities and shareholders' equity:
 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-bearing demand deposits
 
300,680

 
 
 
 
 
298,681

 
 
 
 
Other liabilities
 
14,136

 
 
 
 
 
8,931

 
 
 
 
Shareholders' equity
 
154,271

 
 
 
 
 
110,406

 
 
 
 
Total liabilities and shareholders' equity
 
$
1,443,722

 
 
 
 
 
$
1,283,436

 
 
 
 
Net interest income
 
 
 
$
12,718

 
 
 
 
 
$
12,127

 
 
Interest spread
 
 
 
 
 
3.17
%
 
 
 
 
 
3.66
%
Net interest margin(5)
 
 
 
 
 
3.73

 
 
 
 
 
4.00

Tax equivalent effect
 
 
 
 
 
0.03

 
 
 
 
 
0.03

Net interest margin on a fully tax equivalent basis
 
 
 
 
 
3.76
%
 
 
 
 
 
4.03
%
______________________________________________________________________
(1) Interest income is shown on actual basis and does not include taxable equivalent adjustments.
(2) Average rates and yields are presented on an annual basis and include a taxable equivalent adjustment to interest income of $87 thousand and $78 thousand on tax-exempt securities for the three months ended March 31, 2019 and 2018, respectively, using the federal corporate tax rate of 21%.
(3) Includes nonaccrual loans
(4) For presentation in this table, average balances and the corresponding average rates for investment securities are based upon historical cost, adjusted for amortization of premiums and accretion of discounts.
(5) Net interest margin represents net interest income divided by average total interest-earning assets.





43


Rate/Volume Analysis
The table below presents the effect of volume and rate changes on interest income and expense for the periods indicated. Changes in volume are changes in the average balance multiplied by the previous year's average rate. Changes in rate are changes in the average rate multiplied by the average balance from the previous year. The net changes attributable to the combined impact of both rate and volume have been allocated proportionately to the changes due to volume and the changes due to rate. The average rate for tax-exempt securities is reported on a fully taxable equivalent basis.
 
 
For the three months ended March 31, 2019 vs. 2018
 
 
Increase
(Decrease) Due to:
 
 
(Dollars in thousands)
 
Rate
 
Volume
 
Net Increase (Decrease)
Interest-earning assets
 
 
 
 
 
 
Gross loans
 
$
850

 
$
1,197

 
$
2,047

Investment securities:
 
 
 
 
 
 
Taxable
 
115

 
247

 
362

Tax-exempt
 
(7
)
 
201

 
194

Interest-earning cash balances
 
66

 
4

 
70

FHLB Stock
 
(5
)
 
—

 
(5
)
Total interest income
 
1,019

 
1,649

 
2,668

Interest-bearing liabilities
 
 

 
 

 
 

Interest-bearing demand deposits
 
6

 
(9
)
 
(3
)
Money market and savings deposits
 
474

 
72

 
546

Time deposits
 
1,054

 
346

 
1,400

Borrowings
 
138

 
(4
)
 
134

Subordinated debt
 
(1
)
 
1

 
—

Total interest expense
 
1,671

 
406

 
2,077

Change in net interest income
 
$
(652
)
 
$
1,243

 
$
591

Provision for Loan Losses
We established an allowance for loan losses through a provision for loan losses charged as an expense in our consolidated statements of income. Management reviews the loan portfolio, consisting of originated loans and purchased loans, on a quarterly basis to evaluate the outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses.
Loans acquired in connection with acquisitions that have evidence of credit deterioration since origination and for which it is probable at the date of acquisition that we will not collect all contractually required principal and interest payments are accounted for under ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, or ASC 310-30. These credit-impaired loans have been recorded at their estimated fair value on the respective acquisition date, based on subjective determinations regarding risk ratings, expected future cash flows and fair value of the underlying collateral, without a carryover of the related allowance for loan losses. At the acquisition date, the Company recognizes the expected shortfall of expected future cash flows, as compared to the contractual amount due, as a nonaccretable discount. Any excess of the net present value of expected future cash flows over the acquisition date fair value is recognized as the accretable discount, or accretable yield. We evaluate these loans semi-annually to assess expected cash flows. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges or a reclassification of the difference from nonaccretable to accretable with a positive impact on interest income. As of March 31, 2019, and December 31, 2018, our remaining accretable yield was $10.4 million and $10.9 million, respectively, and our nonaccretable difference was $5.6 million for both dates.
The provision for loan losses was $422 thousand for the three months ended March 31, 2019, compared to $554 thousand for the same period in 2018. The decrease in the provision for loan losses was primarily due to a decrease in specific reserves on impaired loans and a decrease in net chargeoffs. Our total nonaccrual loans decreased to $16.6 million at March 31, 2019 compared to $18.4 million at December 31, 2018. The decrease in nonaccrual loans is primarily due to a large loan relationship

44

of $3.7 million that paid off during the first quarter of 2019, as well as a nonaccrual loan in the amount of $373 thousand moving to other real estate owned, partially offset by $3.0 million of new loans that moved to nonaccrual.
Noninterest Income
The following table presents noninterest income for the three months ended March 31, 2019 and 2018.
 
 
For the three months ended March 31,
(Dollars in thousands)
 
2019
 
2018
Noninterest income
 
 

 
 

Service charges on deposits
 
$
625

 
$
642

Net loss on sales of securities
 
(7
)
 
—

Mortgage banking activities
 
1,120

 
236

Other charges and fees
 
548

 
494

Total noninterest income
 
$
2,286

 
$
1,372

Noninterest income increased $914 thousand to $2.3 million for the three months ended March 31, 2019, compared to $1.4 million for the same period in 2018. The increase in noninterest income was primarily due to an increase in mortgage banking activities of $884 thousand. The increase in mortgage banking activities was primarily due to the Company's investment in the expansion of the mortgage banking division in the third quarter of 2018, which contributed to higher volume of loans sales.
Noninterest Expense
The following table presents noninterest expense for the three months ended March 31, 2019 and 2018.
 
 
For the three months ended March 31,
(Dollars in thousands)
 
2019
 
2018
Noninterest expense
 
 

 
 

Salary and employee benefits
 
$
6,913

 
$
5,956

Occupancy and equipment expense
 
1,204

 
1,046

Professional service fees
 
362

 
266

Marketing expense
 
176

 
142

Printing and supplies expense
 
68

 
104

Data processing expense
 
595

 
436

Other expense
 
1,050

 
1,185

Total noninterest expense
 
$
10,368

 
$
9,135

Noninterest expenses increased $1.3 million to $10.4 million for the three months ended March 31, 2019, as compared to $9.1 million for the same period in 2018. The increase in noninterest expense was primarily due to an increase in salary and employee benefits of $957 thousand, an increase in data processing expense of $159 thousand, and an increase in occupancy and equipment expense of $158 thousand. The increase in salary and employee benefits between the periods resulted from an increase of 29 full-time employees, which includes the expansion of the mortgage banking division. The increase in data processing expense was primarily due to higher software costs to sustain the growth of the Company. The increase in occupancy and equipment expense was primarily due to higher building expense due to expansion into new locations.
Income Taxes and Tax-Related Items
During the three months ended March 31, 2019, we recognized income tax expense of $747 thousand on $4.2 million of pre-tax income resulting in an effective tax rate of 17.7%, compared to the same period in 2018, in which we recognized an income tax expense of $642 thousand on $3.8 million of pre-tax income, resulting in an effective tax rate of 16.9%. Refer to Note 8 - Income Taxes in the notes to the consolidated statements for a reconciliation between expected and actual income tax expense for the three months ended March 31, 2019 and 2018.

45

Financial Condition
Total assets were $1.46 billion at March 31, 2019 and $1.42 billion at December 31, 2018. Total assets increased by $40.3 million between these two dates primarily due to increases of $22.6 million in securities available-for-sale, $8.4 million in mortgage loans held for sale, $4.5 million in gross loans, and $2.7 million in cash and cash equivalents. The increase in securities available-for-sale reflects management's decision to invest in liquid assets while retaining accessibility to the funds for potential liquidity needs. The increase in loans was primarily driven by the growth in our commercial and industrial portfolio. The increase in mortgage loans held for sale was primarily due to higher loan originations as a result of the addition of new mortgage lenders. The increase in cash and cash equivalents was primarily due to an increase of $4.3 million in cash balances held with the Federal Reserve Bank. The Company maintains a cash balance at the Federal Reserve and manages this liquidity balance on a daily basis as required, and may have significant cash balance fluctuations in the ordinary course of business based on inflows and outflows from changing loan totals, investment activity, and deposit flows.
Investment Securities
The following table presents the fair value of the Company's investment securities portfolio, all of which were classified as available-for-sale as of March 31, 2019 and December 31, 2018.
(Dollars in thousands)
 
March 31, 2019
 
December 31, 2018
Securities available-for-sale:
 
 

 
 

U.S. government sponsored entities and agencies
 
$
1,446

 
$
2,397

State and political subdivision
 
89,417

 
75,146

Mortgage-backed securities: residential
 
9,654

 
9,739

Mortgage-backed securities: commercial
 
16,495

 
12,382

Collateralized mortgage obligations: residential
 
17,709

 
18,671

Collateralized mortgage obligations: commercial
 
35,489

 
31,988

U.S. Treasury
 
17,658

 
20,481

SBA
 
20,575

 
15,688

Asset backed securities
 
5,807

 
3,842

Corporate bonds
 
12,624

 
13,924

Total securities available-for-sale              
 
$
226,874

 
$
204,258

The composition of our investment securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity for both normal operations and potential acquisitions while providing an additional source of revenue. The investment portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet, while providing a vehicle for the investment of available funds, furnishing liquidity, and supplying securities to pledge as collateral. At March 31, 2019, total investment securities were $226.9 million, or 15.6% of total assets, compared to $204.3 million, or 14.4% of total assets, at December 31, 2018. The $22.6 million increase in securities available for sale from December 31, 2018 to March 31, 2019, primarily reflected increases in obligations of state and political subdivisions, collateralized mortgage obligations: commercial, mortgage backed securities: commercial, SBA securities and asset backed securities. Securities with a carrying value of $26.0 million and $22.7 million were pledged at March 31, 2019 and December 31, 2018, respectively, to secure borrowings and deposits.
As of March 31, 2019, the Company held 56 tax-exempt state and local municipal securities totaling $41.9 million backed by the Michigan School Bond Loan Fund. Other than the aforementioned investments, at March 31, 2019 and December 31, 2018, there were no holdings of securities of any one issuer, other than the U.S. government and its agencies, in an amount greater than 10% of shareholders' equity.
The securities available for sale presented in the following tables are reported at amortized cost and by contractual maturity as of March 31, 2019 and December 31, 2018. Actual timing may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Additionally, residential mortgage-backed securities and collateralized mortgage obligations receive monthly principal payments, which are not reflected below. The yields below are calculated on a tax equivalent basis.

46

 
 
March 31, 2019
 
 
One year or less
 
One to five years
 
Five to ten years
 
After ten years
(Dollars in thousands)
 
Amortized
Cost
 
Average
Yield
 
Amortized
Cost
 
Average
Yield
 
Amortized
Cost
 
Average
Yield
 
Amortized
Cost
 
Average
Yield
Securities available-for-sale:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

U.S. government sponsored agency obligations
 
$
—

 
—
%
 
$
—

 
—
%
 
$
1,417

 
3.21
%
 
$
—

 
—
%
State and political subdivision
 
180

 
2.04

 
6,245

 
2.17

 
16,283

 
2.91

 
65,182

 
3.45

Mortgage-backed securities: residential
 
—

 
—

 
216

 
0.94

 
173

 
2.31

 
9,523

 
3.10

Mortgage-backed securities: commercial
 
—

 
—

 
4,603

 
2.32

 
8,609

 
3.05

 
3,269

 
3.61

Collateralized mortgage obligations: residential
 
—

 
—

 
—

 
—

 
812

 
2.10

 
17,121

 
3.18

Collateralized mortgage obligations: commercial
 
—

 
—

 
9,324

 
2.91

 
13,860

 
3.08

 
12,414

 
2.47

U.S. Treasury
 
—

 
—

 
18,184

 
1.58

 
—

 
—

 
—

 
—

SBA
 
—

 
—

 
—

 
—

 
3,744

 
3.56

 
16,940

 
2.86

Asset backed securities
 
—

 
—

 
—

 
—

 
—

 
—

 
5,811

 
3.35

Corporate bonds
 
501

 
1.80

 
10,572

 
3.48

 
1,491

 
3.67

 
—

 
—

Total securities available-for-sale
 
$
681

 
1.86
%
 
$
49,144

 
2.38
%
 
$
46,389

 
3.06
%
 
$
130,260

 
3.22
%

 
 
December 31, 2018
 
 
One year or less
 
One to five years
 
Five to ten years
 
After ten years
(Dollars in thousands)
 
Amortized
Cost
 
Average
Yield
 
Amortized
Cost
 
Average
Yield
 
Amortized
Cost
 
Average
Yield
 
Amortized
Cost
 
Average
Yield
Securities available-for-sale:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

U.S. government sponsored agency obligations
 
$
—

 
—
%
 
$
—

 
—
%
 
$
2,404

 
3.09
%
 
$
—

 
—
%
State and political subdivision
 
181

 
2.02

 
6,273

 
2.16

 
16,329

 
2.91

 
52,310

 
3.41

Mortgage-backed securities: residential
 
—

 
—

 
235

 
1.21

 
183

 
2.33

 
9,696

 
2.84

Mortgage-backed securities: commercial
 
—

 
—

 
6,124

 
2.30

 
5,016

 
2.91

 
1,454

 
3.46

Collateralized mortgage obligations: residential
 
—

 
—

 
—

 
—

 
837

 
2.09

 
18,079

 
3.22

Collateralized mortgage obligations: commercial
 
—

 
—

 
9,772

 
2.90

 
10,047

 
3.27

 
12,571

 
2.49

U.S. Treasury
 
—

 
—

 
21,232

 
1.53

 
—

 
—

 
—

 
—

SBA
 
—

 
—

 
—

 
—

 
1,664

 
3.17

 
14,192

 
3.21

Asset backed securities
 
—

 
—

 
—

 
—

 
—

 
—

 
3,872

 
3.04

Corporate bonds
 
1,501

 
2.04

 
10,034

 
3.43

 
2,471

 
3.75

 
—

 
—

Total securities available-for-sale
 
$
1,682

 
2.04
%
 
$
53,670

 
2.29
%
 
$
38,951

 
3.06
%
 
$
112,174

 
3.19
%
Loans
Our loan portfolio represents a broad range of borrowers comprised of commercial real estate, commercial and industrial, residential real estate, and consumer financing loans.
Commercial real estate loans consist of term loans secured by a mortgage lien on the real property, such as office and industrial buildings, retail shopping centers and apartment buildings, as well as commercial real estate construction loans that are offered to builders and developers. Commercial real estate loans are then segregated into two classes: non-owner occupied and owner occupied commercial real estate loans. Non-owner occupied loans, which include loans secured by non-owner occupied and nonresidential properties, generally have a greater risk profile than owner-occupied loans, which include loans secured by multifamily structures and owner-occupied commercial structures.
Commercial and industrial loans include financing for commercial purposes in various lines of businesses, including manufacturing, service industry and professional service areas. Commercial and industrial loans are generally secured with the assets of the company and/or the personal guarantee of the business owners.

47

Residential real estate loans represent loans to consumers for the purchase or refinance of a residence. These loans are generally financed over a 15- to 30-year term and, in most cases, are extended to borrowers to finance their primary residence with both fixed-rate and adjustable-rate terms. Real estate construction loans are also offered to consumers who wish to build their own homes and are often structured to be converted to permanent loans at the end of the construction phase, which is typically twelve months. Residential real estate loans also include home equity loans and lines of credit that are secured by a first- or second-lien on the borrower's residence. Home equity lines of credit consist mainly of revolving lines of credit secured by residential real estate.
Consumer loans include loans made to individuals not secured by real estate, including loans secured by automobiles or watercraft, and personal unsecured loans.
The following table details our loan portfolio by loan type at the dates presented:
 
 
As of March 31,
 
As of December 31,
(Dollars in thousands)
 
2019
 
2018
 
2017
 
2016
 
2015
Commercial real estate:
 
 

 
 

 
 

 
 

 
 

Non-owner occupied
 
$
361,066

 
$
367,671

 
$
343,420

 
$
322,354

 
$
240,161

Owner occupied
 
187,001

 
194,422

 
168,342

 
169,348

 
146,487

Total commercial real estate
 
548,067

 
562,093

 
511,762

 
491,702

 
386,648

Commercial and industrial
 
401,588

 
383,455

 
377,686

 
342,069

 
254,808

Residential real estate
 
180,386

 
180,018

 
144,439

 
118,730

 
116,734

Consumer
 
1,056

 
999

 
1,036

 
892

 
1,528

Total loans
 
$
1,131,097

 
$
1,126,565

 
$
1,034,923

 
$
953,393

 
$
759,718

Total loans were $1.13 billion at March 31, 2019, an increase of $4.5 million from December 31, 2018. The total increase in loans of $4.5 million was primarily due to an increase in commercial and industrial loans of $18.1 million, partially offset by a decrease in commercial real estate loans of $14.0 million. In general, we target a loan portfolio mix of approximately one-half commercial real estate, approximately one-third commercial and industrial loans and one-sixth a mix of residential real estate and consumer loans. As of March 31, 2019, approximately 48.5% of our loans were commercial real estate, 35.5% were commercial and industrial, and 16.0% were residential real estate and consumer loans.
We originate both fixed and adjustable rate residential real estate loans conforming to the underwriting guidelines of the Federal National Mortgage Association (FNMA) or the Federal Home Loan Mortgage Corporation, as well as home equity loans and lines of credit that are secured by first or junior liens. Most of our fixed rate residential loans, along with some of our adjustable rate mortgages, are sold to other financial institutions with which we have established a correspondent lending relationship. The Company is in the process of establishing a direct relationship with FNMA and hopes to begin locking and selling loans to FNMA in mid 2019.













48

Loan Maturity/Rate Sensitivity
The following table shows the contractual maturities of our loans as of March 31, 2019.
(Dollars in thousands)
 
One year or
less
 
After one but
within five
years
 
After five
years
 
Total
March 31, 2019
 
 

 
 

 
 

 
 

Commercial real estate
 
$
72,798

 
$
338,539

 
$
136,730

 
$
548,067

Commercial and industrial
 
101,296

 
156,954

 
143,338

 
401,588

Residential real estate
 
1,729

 
4,061

 
174,596

 
180,386

Consumer
 
246

 
520

 
290

 
1,056

Total Loans
 
$
176,069

 
$
500,074

 
$
454,954

 
$
1,131,097

Sensitivity of loans to changes in interest rates:
 
 

 
 
 
 

 
 

Fixed interest rates
 
 

 
$
387,138

 
$
148,170

 
 

Floating interest rates
 
 

 
112,936

 
306,784

 
 

Total
 
 

 
$
500,074

 
$
454,954

 
 

Summary of Impaired Assets and Past Due Loans
Nonperforming assets consist of nonaccrual loans and other real estate owned. We do not consider performing troubled debt restructurings (TDRs) to be nonperforming assets, but they are included as part of impaired assets. The level of nonaccrual loans is an important element in assessing asset quality. Loans are classified as nonaccrual when, in the opinion of management, collection of principal or interest is not expected according to the terms of the agreement. Generally, loans are placed on nonaccrual status due to the continued failure by the borrower to adhere to contractual payment terms coupled with other pertinent factors, such as insufficient collateral value.
A loan is categorized as a troubled debt restructuring if a concession is granted, such as to provide for the reduction of either interest or principal, due to deterioration in the financial condition of the borrower. Typical concessions include reduction of the interest rate on the loan to a rate considered lower than the current market rate, forgiveness of a portion of the loan balance, extension of the maturity date, and/or modifications from principal and interest payments to interest-only payments for a certain period. Loans are not classified as TDRs when the modification is short-term or results in only an insignificant delay or shortfall in the payments to be received.
Credit Quality Indicators:
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes commercial and industrial and commercial real estate loans and is performed on an annual basis. The Company uses the following definitions for risk ratings:
Pass.    Loans classified as pass are higher quality loans that do not fit any of the other categories described below. This category includes loans risk rated with the following ratings: cash/stock secured, excellent credit risk, superior credit risk, good credit risk, satisfactory credit risk, and marginal credit risk.
Special Mention.    Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company's credit position at some future date.
Substandard.    Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
Doubtful.    Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

49

For residential real estate loans and consumer loans, the Company evaluates credit quality based on the aging status of the loan and by payment activity. Residential real estate loans and consumer loans are considered nonperforming if they are 90 days or more past due. Consumer loan types are continuously monitored for changes in delinquency trends and other asset quality indicators.
Purchased credit impaired loans accounted for under ASC 310-30 are classified as performing, even though they may be contractually past due, as any nonpayment of contractual principal or interest is considered in the semi-annual re-estimation of expected cash flows and is included in the resulting recognition of current period loan loss provision or future period yield adjustments.
Total classified and criticized loans as of March 31, 2019 compared to December 31, 2018 were as follows:
(Dollars in thousands)
 
March 31, 2019
 
December 31, 2018
Classified loans:
 
 

 
 

Substandard
 
$
15,669

 
$
18,391

Doubtful
 
83

 
44

Total classified loans
 
$
15,752

 
$
18,435

Special mention
 
9,612

 
13,081

Total classified and criticized loans
 
$
25,364

 
$
31,516

A summary of nonperforming assets (defined as nonaccrual loans and other real estate owned), performing troubled debt restructurings and loans 90 days or more past due and still accruing, as of the dates indicated, are presented below.
 
 
As of March 31,
 
As of December 31,
(Dollars in thousands)
 
2019
 
2018
 
2017
 
2016
 
2015
Nonaccrual loans
 
 

 
 

 
 

 
 

 
 

Commercial real estate
 
$
2,694

 
$
5,927

 
$
2,257

 
$
147

 
$
141

Commercial and industrial
 
10,495

 
9,605

 
9,024

 
13,389

 
309

Residential real estate
 
3,456

 
2,915

 
2,767

 
1,498

 
1,177

Total nonaccrual loans(1)
 
16,645

 
18,447

 
14,048

 
15,034

 
1,627

Other real estate owned
 
373

 
—

 
652

 
258

 
81

Total nonperforming assets
 
17,018

 
18,447

 
14,700

 
15,292

 
1,708

Performing troubled debt restructurings
 
 

 
 

 
 

 
 

 
 

Commercial real estate
 
—

 
—

 
—

 
290

 
—

Commercial and industrial
 
562

 
568

 
961

 
1,018

 
1,069

Residential real estate
 
363

 
363

 
261

 
207

 
279

Total performing troubled debt restructurings              
 
925

 
931

 
1,222

 
1,515

 
1,348

Total impaired assets, excluding ASC 310-30 loans
 
$
17,943

 
$
19,378

 
$
15,922

 
$
16,807

 
$
3,056

Loans 90 days or more past due and still accruing
 
$
453

 
$
243

 
$
440

 
$
377

 
$
883

______________________________________________________
(1)
Nonaccrual loans include nonperforming troubled debt restructurings of $4.8 million, $5.0 million, $6.4 million, $5.8 million, and $564 thousand, at the respective dates indicated above.
During the three months ended March 31, 2019 and 2018, the Company recorded $414 thousand and $39 thousand, respectively, of interest income on nonaccrual loans and performing TDRs excluding PCI loans.
In addition to nonperforming and impaired assets, the Company had purchased credit impaired loans accounted for under ASC 310-30 which amounted to $7.7 million, $7.9 million, $9.7 million, $11.6 million and $17.6 million at the respective dates indicated in the table above.



50

Allowance for Loan Losses
We maintain the allowance for loan losses at a level we believe is sufficient to absorb probable incurred losses in our loan portfolio given the conditions at the time. Management determines the adequacy of the allowance based on periodic evaluations of the loan portfolio and other factors. These evaluations are inherently subjective as they require management to make material estimates, all of which may be susceptible to significant change. The allowance is increased by provisions charged to expense and decreased by actual charge-offs, net of recoveries.
Purchased Loans
The allowance for loan losses on purchased loans is based on credit deterioration subsequent to the acquisition date. In accordance with the accounting guidance for business combinations, there was no allowance brought forward on any of the acquired loans as any credit deterioration evident in the loans was included in the determination of the fair value of the loans at the acquisition date. For purchased credit impaired loans, accounted for under ASC 310-30, management establishes an allowance for credit deterioration subsequent to the date of acquisition by re-estimating expected cash flows on a semi-annual basis with any decline in expected cash flows recorded as provision for loan losses. Impairment is measured as the excess of the recorded investment in a loan over the present value of expected future cash flows discounted at the pre-impairment accounting yield of the loan. For increases in cash flows expected to be collected, we first reverse any previously recorded allowance for loan losses, then adjust the amount of accretable yield recognized on a prospective basis over the loan's remaining life. These cash flow evaluations are inherently subjective as they require material estimates, all of which may be susceptible to significant change. For non-purchased credit impaired loans acquired in our acquisitions that are accounted for under ASC 310-20, the historical loss estimates are based on the historical losses experienced since acquisition. We record an allowance for loan losses only when the calculated amount exceeds the discount remaining from acquisition that was established for the similar period covered in the allowance for loan loss calculation. For all other purchased loans, the allowance is calculated in accordance with the methods used to calculate the allowance for loan losses for originated loans, as described below.
Originated Loans
The allowance for loan losses represents management's assessment of probable credit losses inherent in the loan portfolio. The allowance for loan losses consists of specific components, based on individual evaluation of certain loans, and general components for homogeneous pools of loans with similar risk characteristics.
Impaired loans include loans placed on nonaccrual status and troubled debt restructurings. Loans are considered impaired when based on current information and events it is probable that we will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreements. When determining if we will be unable to collect all principal and interest payments due in accordance with the original contractual terms of the loan agreement, we consider the borrower's overall financial condition, resources and payment record, support from guarantors, and the realizable value of any collateral. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
All impaired loans are identified to be individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the discounted expected future cash flows or at the fair value of collateral if repayment is collateral dependent.
The allowance for our nonimpaired loans, which includes commercial real estate, commercial and industrial, residential, and consumer loans that are not individually evaluated for impairment, begins with a process of estimating the probable incurred losses in the portfolio. These estimates are established based on our historical loss data. Additional allowance estimates for commercial and industrial and commercial real estate loans are based on internal credit risk ratings. Internal credit risk ratings are assigned to each business loan at the time of approval and are subjected to subsequent periodic reviews by senior management, at least annually or more frequently upon the occurrence of a circumstance that affects the credit risk of the loan.
As our operating history is limited and we have grown rapidly, the historical loss estimates for loans prior to 2017 were based primarily on the actual historical loss experienced by our peer banks combined with a small factor representing our own loss history. Starting in 2017, the Company modified its methodology on historical loss analysis to incorporate and fully rely on the Company's own historical loss data, which did not have a material impact. The historical loss estimates are established by loan type including commercial real estate, commercial and industrial, residential, and consumer. In addition, consideration is given to borrower’s rating for commercial and industrial and commercial real estate loans.

51

The following table presents, by loan type, the changes in the allowance for loan losses for the periods presented.
 
 
For the three months ended March 31,
(Dollars in thousands)
 
2019
 
2018
Balance at beginning of period
 
$
11,566

 
$
11,713

Loan charge-offs:
 
 
 
 
Commercial real estate
 
—

 
(11
)
Commercial and industrial
 
(95
)
 
(750
)
Residential real estate
 
—

 
(50
)
Consumer
 
(6
)
 
(7
)
Total loan charge-offs
 
(101
)
 
(818
)
Recoveries of loans previously charged-off:
 
 
 
 
Commercial real estate
 
—

 
2

Commercial and industrial
 
50

 
37

Residential real estate
 
21

 
18

Consumer
 
2

 
—

Total loan recoveries
 
73

 
57

Net charge-offs
 
(28
)
 
(761
)
Provision for loan losses
 
422

 
554

Balance at end of period
 
$
11,960

 
$
11,506

Allowance for loan losses as a percentage of period-end loans
 
1.06

 
1.03

Net charge-offs to average loans
 
0.01

 
0.29

Our allowance for loan losses was $12.0 million, or 1.06% of loans, at March 31, 2019 compared to $11.6 million, or 1.03% of loans at December 31, 2018. The $394 thousand increase in the allowance for loan losses during the three months ended March 31, 2019 was primarily due to a $229 thousand increase in specific reserves related to impaired loans as well as an increase in general reserves related to organic loan growth.

















52

The following table presents, by loan type, the allocation of the allowance for loan losses for the dates presented.
(Dollars in thousands)
 
Allocated
Allowance
 
Percentage of loans in each category
to total loans
March 31, 2019
 
 

 
 

Balance at end of period applicable to:
 
 
 
 

Commercial real estate
 
$
5,181

 
48.5
%
Commercial and industrial
 
5,606

 
35.5

Residential real estate
 
1,170

 
15.9

Consumer
 
3

 
0.1

Total loans
 
$
11,960

 
100.0
%
December 31, 2018
 
 
 
 
Balance at end of period applicable to:
 
 
 
 
Commercial real estate
 
$
5,227

 
49.9
%
Commercial and industrial
 
5,174

 
34.0

Residential real estate
 
1,164

 
16.0

Consumer
 
1

 
0.1

Total loans
 
$
11,566

 
100.0
%
December 31, 2017
 
 
 
 
Balance at end of period applicable to:
 
 
 
 
Commercial real estate
 
$
4,852

 
49.4
%
Commercial and industrial
 
5,903

 
36.5

Residential real estate
 
950

 
14.0

Consumer
 
8

 
0.1

Total loans
 
$
11,713

 
100.0
%
December 31, 2016
 
 
 
 
Balance at end of period applicable to:
 
 
 
 
Commercial real estate
 
$
4,124

 
51.5
%
Commercial and industrial
 
5,932

 
35.9

Residential real estate
 
1,030

 
12.5

Consumer
 
3

 
0.1

Total loans
 
$
11,089

 
100.0
%
December 31, 2015
 
 
 
 
Balance at end of period applicable to:
 
 
 
 
Commercial real estate
 
$
3,299

 
50.9
%
Commercial and industrial
 
3,256

 
33.5

Residential real estate
 
1,307

 
15.4

Consumer
 
28

 
0.2

Total loans
 
$
7,890

 
100.0
%
Deposits
Total deposits were $1.15 billion at March 31, 2019 and $1.13 billion at December 31, 2018, representing 88.5% and 89.7% of total liabilities at each date, respectively. The increase in deposits of $16.8 million was due to an increase of $31.5 million in money market and savings deposits, partially offset by a decrease of $15.4 million in demand deposits. Our average interest-bearing deposit costs were 1.85% and 1.11% for the three months ended March 31, 2019 and 2018, respectively. The increase in interest-bearing deposit costs between the two periods was impacted by the changing mix of deposit types, as well as by the increase in overnight market rates, as measured by the target federal funds rate. The target federal funds rate rose 1.00% during 2018 and did not rise during the three months ended March 31, 2019.
Brokered deposits.    Brokered deposits are marketed through national brokerage firms to their customers in $1,000 increments. For these brokered deposits, detailed records of owners are maintained by the Depository Trust Company under the name of CEDE & Co. This relationship provides a large source of deposits for the Company. Due to the competitive nature of the brokered deposit market, brokered deposits tend to bear higher rates of interest than non-brokered deposits. At March 31, 2019 and December 31, 2018, the Company had approximately $109.2 million and $110.3 million in brokered deposits,

53

respectively. The Company's ability to accept, roll-over or renew brokered deposits is contingent upon the Bank maintaining a capital level of "well-capitalized."
For periods prior to September 30, 2018, Certificate of Deposit Account Registry Service (CDARS) and reciprocal money market accounts were considered to be brokered deposits by regulatory authorities and were reported as such on quarterly Call Reports. With the passage of The Economic Growth, Regulatory Relief and Consumer Protection Act in May 2018, these items are no longer considered brokered deposits. Included in the brokered deposits total at December 31, 2018 were $1.8 million in CDARS customer deposit accounts.
Management understands the importance of core deposits as a stable source of funding and may periodically implement various deposit promotion strategies to encourage core deposit growth, including recent promotions for time deposits and money market deposits. For periods of rising interest rates, management has modeled the aggregate yields for non-maturity deposits and time deposits to increase at a slower pace than the increase in underlying market rates, which is intended to result in net interest margin expansion and an increase in net interest income.
The following table sets forth the distribution of average deposits by account type for the periods indicated below.
 
 
Three Months Ended March 31, 2019
(Dollars in thousands)
 
Average
Balance
 
Percent
 
Average
Rate
Noninterest-bearing demand deposits
 
$
300,964

 
25.0
%
 
—
%
Interest-bearing demand deposits
 
53,015

 
4.4

 
0.37

Money market and savings deposits
 
306,496

 
25.4

 
1.45

Time deposits
 
544,130

 
45.2

 
2.22

Total deposits
 
$
1,204,605

 
100.0
%
 
1.39
%
The following table shows the contractual maturity of time deposits, including CDARs and IRA deposits and other brokered funds, of $100 thousand and over that were outstanding as of the date presented.
(Dollars in thousands)
 
March 31, 2019
Maturing in:
 
 

3 months or less
 
$
3,507

3 months to 6 months
 
93,372

6 months to 1 year
 
130,753

1 year or greater
 
101,408

Total
 
$
329,040

Borrowings
Total debt outstanding at March 31, 2019 was $132.8 million, an increase of $18.3 million from $114.5 million at December 31, 2018. The increase in total borrowings was primarily due to an increase of $20.0 million in long-term FHLB advances and $5.0 million in short-term FHLB advances, partially offset by a $5.0 million payoff in our federal funds purchased and $1.6 million decrease in our FHLB line of credit. The increase in total borrowings was a result of the addition of FHLB advances used to fund liquidity needs of the Company.
At March 31, 2019, FHLB advances were secured by a blanket lien on $396.3 million of real estate-related loans, and repurchase agreements were secured by securities with a fair value of $898 thousand. At December 31, 2018, FHLB advances were secured by a blanket lien on $372.5 million of real estate-related loans, and repurchase agreements were secured by securities with a fair value of $1.0 million.
As of March 31, 2019 and December 31, 2018, the Company had $15.0 million of subordinated notes outstanding at each date, and debt issuance costs of $95 thousand and $109 thousand, respectively, related to these subordinated notes. The notes bear a fixed interest rate of 6.375% per annum, payable semi-annually through December 15, 2020. The notes will bear a floating interest rate of three-month LIBOR plus 477 basis points payable quarterly after December 15, 2020 through maturity. The notes mature December 15, 2025, and the Company has the option to redeem or prepay any or all of the subordinated notes without premium or penalty any time after December 15, 2020 or at any time in the event of certain changes that affect the deductibility of interest for tax purposes or the treatment of the notes as Tier 2 Capital.

54

Selected financial information pertaining to the components of our short-term borrowings for the periods and as of the dates indicated is as follows:
 
 
Three months ended March 31,
(Dollars in thousands)
 
2019
 
2018
FHLB Line of Credit
 
 
 
 
Average daily balance
 
$
320

 
$
—

Weighted-average rate during period
 
2.65
%
 
—
%
Amount outstanding at period end
 
$
895

 
$
—

Weighted-average rate at period end
 
2.84
%
 
—
%
Maximum month-end balance
 
$
895

 
$
—

Securities sold under agreements to repurchase
 
 

 
 

Average daily balance
 
$
533

 
$
1,198

Weighted-average rate during period
 
0.30
%
 
0.28
%
Amount outstanding at period end
 
$
585

 
$
1,287

Weighted-average rate at period end
 
0.30
%
 
0.30
%
Maximum month-end balance
 
$
682

 
$
1,287

FHLB Advances
 
 
 
 
Average daily balance
 
$
48,028

 
$
44,112

Weighted-average rate during period
 
2.63
%
 
1.51
%
Amount outstanding at period end
 
$
95,000

 
$
40,000

Weighted-average rate at period end
 
2.64
%
 
1.58
%
Maximum month-end balance
 
$
95,000

 
$
40,000

Federal funds purchased
 
 
 
 
Average daily balance
 
$
3,278

 
$
—

Weighted-average rate during period
 
3.01
%
 
—
%
Amount outstanding at period end
 
$
—

 
$
—

Weighted-average rate at period end
 
—
%
 
—
%
Maximum month-end balance
 
$
—

 
$
—

















55

Capital Resources
Shareholders' equity is influenced primarily by earnings, dividends, sales and repurchases of common stock and changes in accumulated other comprehensive income caused primarily by fluctuations in unrealized gains or losses, net of taxes, on available for sale securities.
Shareholders' equity increased $4.3 million to $156.1 million at March 31, 2019 as compared to $151.8 million at December 31, 2018. The increase in shareholders' equity was primarily impacted by $3.5 million of net income generated during the three months ended March 31, 2019 as well as an increase of $2.0 million of other comprehensive income, partially offset by $1.1 million of stock repurchased through the share buyback program and $309 thousand of common stock dividends declared in the first quarter of 2019.
The following table summarizes the changes in our shareholders' equity for the periods indicated below:
 
 
Three months ended March 31,
(Dollars in thousands)
 
2019
 
2018
Balance at beginning of period
 
$
151,760

 
$
107,960

Net income
 
3,467

 
3,168

Other comprehensive income (loss)
 
2,069

 
(1,980
)
Share buyback (46,626 shares)
 
(1,104
)
 
—

Common stock dividends declared ($0.04 per share)
 
(309
)
 
—

Exercise of stock options (12,300 shares)
 
125

 
1,192

Stock-based compensation expense, net of tax impact
 
111

 
183

Balance at end of period
 
$
156,119

 
$
110,523

We strive to maintain an adequate capital base to support our activities in a safe and sound manner while at the same time attempting to maximize shareholder value. We assess capital adequacy against the risk inherent in our balance sheet, recognizing that unexpected loss is the common denominator of risk and that common equity has the greatest capacity to absorb unexpected loss.
We are subject to various regulatory capital requirements both at the Company and at the Bank level. Failure to meet minimum capital requirements could result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have an adverse material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting policies. We have consistently maintained regulatory capital ratios at or above the well-capitalized standards.
During the first quarter of 2015, regulations implementing the Basel III regulatory capital framework and the Dodd-Frank Wall Street Reform and Consumer Protection Act became effective, certain provisions of which were subject to a multi-year phase-in period. As of January 1, 2019, the rules require the Company to maintain a capital conservation buffer of common equity capital that exceeds by more than 2.5% the minimum risk-weighted assets ratios, which is the fully phased-in amount of the capital conservation buffer. The capital conservation buffer requirement was 2.5% as of March 31, 2019 and 1.875% as of December 31, 2018, which is reflected in the table below.
At March 31, 2019, the Company and the Bank met all the capital adequacy requirements to which they were subject.

56

The summary below compares the actual capital ratios with the minimum quantitative measures established by regulation to ensure capital adequacy:
 
 
Actual
Capital
Ratio
 
Capital
Adequacy
Regulatory
Requirement
 
Capital
Adequacy
Regulatory
Requirement +
Capital
Conservation
Buffer(1)
 
Well
Capitalized
Regulatory
Requirement
March 31, 2019
 
 
 
 

 
 

 
 

Common equity tier 1 to risk-weighted assets:
 
 
 
 

 
 

 
 

Consolidated
 
11.78
%
 
4.50
%
 
7.00
%
 


Bank
 
12.19
%
 
4.50
%
 
7.00
%
 
6.50
%
Tier 1 capital to risk-weighted assets:
 
 
 
 
 
 
 
 

Consolidated
 
11.78
%
 
6.00
%
 
8.50
%
 


Bank
 
12.19
%
 
6.00
%
 
8.50
%
 
8.00
%
Total capital to risk-weighted assets:
 
 
 
 
 
 
 
 

Consolidated
 
13.95
%
 
8.00
%
 
10.50
%
 


Bank
 
13.15
%
 
8.00
%
 
10.50
%
 
10.00
%
Tier 1 capital to average assets (leverage ratio):
 
 
 
 
 
 
 
 

Consolidated
 
10.19
%
 
4.00
%
 
4.00
%
 


Bank
 
10.56
%
 
4.00
%
 
4.00
%
 
5.00
%
December 31, 2018
 
 

 
 

 
 

 
 

Common equity tier 1 to risk-weighted assets:
 
 

 
 

 
 

 
 

Consolidated
 
11.82
%
 
4.50
%
 
6.38
%
 


Bank
 
12.12
%
 
4.50
%
 
6.38
%
 
6.50
%
Tier 1 capital to risk-weighted assets:
 
 
 
 
 
 
 
 

Consolidated
 
11.82
%
 
6.00
%
 
7.88
%
 


Bank
 
12.12
%
 
6.00
%
 
7.88
%
 
8.00
%
Total capital to risk-weighted assets:
 
 
 
 
 
 
 
 

Consolidated
 
14.00
%
 
8.00
%
 
9.88
%
 


Bank
 
13.07
%
 
8.00
%
 
9.88
%
 
10.00
%
Tier 1 capital to average assets (leverage ratio):
 
 
 
 
 
 
 
 

Consolidated
 
10.21
%
 
4.00
%
 
4.00
%
 


Bank
 
10.48
%
 
4.00
%
 
4.00
%
 
5.00
%
_______________________________________________________________________________
(1)
Reflects the capital conservation buffer of 2.5% and 1.875% applicable during 2019 and 2018, respectively.










57

Off-Balance Sheet Arrangements
In the normal course of business, the Company offers a variety of financial instruments with off-balance sheet risk to meet the financing needs of its customers. These financial instruments include outstanding commitments to extend credit, credit lines, commercial letters of credit and standby letters of credit. These are agreements to provide credit, as long as conditions established in the contract are met, and usually have expiration dates. Commitments may expire without being used. Off-balance sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies used for loans are used to make such commitments, including obtaining collateral at exercise of the commitment.
We maintain an allowance to cover probable losses inherent in our financial instruments with off-balance sheet risk. At March 31, 2019, the allowance for off-balance sheet risk was $25 thousand, and included in "Other liabilities" on our consolidated balance sheets.
A summary of the contractual amounts of our exposure to off-balance sheet risk is as follows.
 
 
March 31, 2019
 
December 31, 2018
(Dollars in thousands)
 
Fixed Rate
 
Variable Rate
 
Fixed Rate
 
Variable Rate
Commitments to make loans
 
$
6,820

 
$
13,222

 
$
8,608

 
$
10,900

Unused lines of credit
 
24,142

 
234,329

 
18,672

 
229,490

Unused standby letters of credit
 
4,042

 
—

 
3,861

 
232

Of the total unused lines of credit of $258.5 million at March 31, 2019, $64.9 million was comprised of undisbursed construction loan commitments. The Company expects to have sufficient access to liquidity to fund its off-balance sheet commitments.
Liquidity
Liquidity management is the process by which we manage the flow of funds necessary to meet our financial commitments on a timely basis and at a reasonable cost and to take advantage of earnings enhancement opportunities. These financial commitments include withdrawals by depositors, credit commitments to borrowers, expenses of our operations, and capital expenditures. Liquidity is monitored and closely managed by the Bank's Asset and Liability Committee (ALCO), a group of senior officers from the finance, enterprise risk management, treasury, and lending areas, as well as two Board members. It is ALCO's responsibility to ensure we have the necessary level of funds available for normal operations as well as maintain a contingency funding policy to ensure that potential liquidity stress events are planned for and quickly identified, and management has plans in place to respond. ALCO has created policies which establish limits and require measurements to monitor liquidity trends, including modeling and management reporting that identifies the amounts and costs of all available funding sources. In addition, we have implemented modeling software that projects cash flows from the balance sheet under a broad range of potential scenarios, including severe changes in the economic environment.
At March 31, 2019, we had liquid assets of $236.8 million, compared to $213.7 million at December 31, 2018. Liquid assets include cash and due from banks, federal funds sold, interest-bearing deposits with banks and unencumbered securities available-for-sale.
The Bank is a member of the FHLB, which provides short- and long-term funding to its members through advances collateralized by real estate-related assets and other select collateral, most typically in the form of debt securities. The actual borrowing capacity is contingent on the amount of collateral available to be pledged to the FHLB. As of March 31, 2019, we had $115.9 million of outstanding borrowings from the FHLB. The advances were secured by a blanket lien on $396.3 million of real estate-related loans as of March 31, 2019. Based on this collateral and the approved policy limits, the Company is eligible to borrow up to an additional $111.1 million. In addition, the Bank can borrow up to $130.0 million through the unsecured lines of credit it has established with nine other banks, as well as $5.0 million through a secured line with the Federal Reserve Bank.
In addition, because the Bank is "well capitalized," it can accept wholesale funding up to 40% of total assets based on current policy limits, which at March 31, 2019 was approximately $581.7 million. Management believed that we had adequate resources to fund all of our commitments as of March 31, 2019.



58

The following liquidity ratios compare certain assets and liabilities to total deposits or total assets.
 
 
March 31, 2019
 
December 31, 2018
Investment securities available-for-sale to total assets
 
15.58
%
 
14.42
%
Loans to total deposits
 
98.23

 
99.29

Interest-earning assets to total assets
 
95.66

 
95.31

Interest-bearing deposits to total deposits
 
74.54

 
72.73


59

Item 3 – Quantitative and Qualitative Disclosures About Market Risk
Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates. Interest-rate risk is the risk to earnings and equity value arising from changes in market interest rates and arises in the normal course of business to the extent that there is a divergence between the amount of our interest-earning assets and the amount of interest-bearing liabilities that are prepaid/withdrawn, re-price, or mature in specified periods. We seek to achieve consistent growth in net interest income and equity while managing volatility arising from shifts in market interest rates. ALCO oversees market risk management, monitoring risk measures, limits, and policy guidelines for managing the amount of interest-rate risk and its effect on net interest income and capital. Our Board of Directors approves policy limits with respect to interest rate risk.
Interest Rate Risk
Interest rate risk management is an active process that encompasses monitoring loan and deposit flows complemented by investment and funding activities. Effective interest rate risk management begins with understanding the dynamic characteristics of assets and liabilities and determining the appropriate interest rate risk position given business activities, management objectives, market expectations and ALCO policy limits and guidelines.
Interest rate risk can come in a variety of forms, including repricing risk, basis risk, yield curve risk and option risk. Repricing risk is the risk of adverse consequences from a change in interest rates that arises because of differences in the timing of when those interest rate changes impact our assets and liabilities. Basis risk is the risk of adverse consequence resulting from unequal change in the spread between two or more rates for different instruments with the same maturity. Yield curve risk is the risk of adverse consequence resulting from unequal changes in the spread between two or more rates for different maturities for the same or different instruments. Option risk in financial instruments arises from embedded options such as options provided to borrowers to make unscheduled loan prepayments, options provided to debt issuers to exercise call options prior to maturity, and depositor options to make withdrawals and early redemptions.
We regularly review our exposure to changes in interest rates. Among the factors we consider are changes in the mix of interest-earning assets and interest-bearing liabilities, interest rate spreads and repricing periods. ALCO reviews, on at least a quarterly basis, our interest rate risk position.
The interest rate risk position is measured and monitored at the Bank using net interest income simulation models and economic value of equity sensitivity analysis that capture both short-term and long-term interest-rate risk exposure.
Modeling the sensitivity of net interest income and the economic value of equity to changes in market interest rates is highly dependent on numerous assumptions incorporated into the modeling process. The models used for these measurements rely on estimates of the potential impact that changes in interest rates may have on the value and prepayment speeds on all components of our loan portfolio, investment portfolio, as well as embedded options and cash flows of other assets and liabilities. Balance sheet growth assumptions are also included in the simulation modeling process. The analysis provides a framework as to what our overall sensitivity position is as of our most recent reported position and the impact that potential changes in interest rates may have on net interest income and the economic value of our equity.
Net interest income simulation involves forecasting net interest income under a variety of interest rate scenarios including instantaneous shocks.
The estimated impact on our net interest income as of March 31, 2019 and December 31, 2018, assuming immediate parallel moves in interest rates is presented in the table below.
 
March 31, 2019
 
December 31, 2018
Change in rates
Following 12 months
 
Following 24 months
 
Following 12 months
 
Following 24 months
+400 basis points
4.3
 %
 
0.7
 %
 
1.8
 %
 
(1.0
)%
+300 basis points
3.7

 
1.2

 
1.8

 
(0.2
)
+200 basis points
2.9

 
1.4

 
1.5

 
0.4

+100 basis points
2.0

 
1.3

 
1.3

 
0.8

-100 basis points
(1.5
)
 
(1.1
)
 
(0.9
)
 
(0.8
)
Management strategies may impact future reporting periods, as our actual results may differ from simulated results due to the timing, magnitude, and frequency of interest rate changes, the difference between actual experience and the characteristics assumed, as well as changes in market conditions. Market-based prepayment speeds are factored into the analysis for loan and

60

securities portfolios. Rate sensitivity for transactional deposit accounts is modeled based on both historical experience and external industry studies.
We use economic value of equity sensitivity analysis to understand the impact of interest rate changes on long-term cash flows, income, and capital. Economic value of equity is based on discounting the cash flows for all balance sheet instruments under different interest rate scenarios. Deposit premiums are based on external industry studies and utilizing historical experience.
The table below presents the change in our economic value of equity as of March 31, 2019 and December 31, 2018, assuming immediate parallel shifts in interest rates.
Change in rates
March 31, 2019
 
December 31, 2018
+400 basis points
(36.7
)%
 
(38.1
)%
+300 basis points
(26.7
)
 
(28.5
)
+200 basis points
(16.9
)
 
(18.3
)
+100 basis points
(7.9
)
 
(8.4
)
-100 basis points
7.4

 
7.9




61

Item 4 – Controls and Procedures
Evaluation of disclosure controls and procedures. The Company’s management, including our President and Chief Executive Officer and our Chief Financial Officer, have evaluated the effectiveness of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Exchange Act, as of the end of the period covered by this report. Based on such evaluation, our President and Chief Executive Officer and our Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective as of that date to provide reasonable assurance 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 rules and forms of the SEC and that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its President and Chief Executive Officer and its Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting. There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1 – Legal Proceedings
In the normal course of business, we are named or threatened to be named as a defendant in various lawsuits, none of which we expect to have a material effect on the Company. However, given the nature, scope and complexity of the extensive legal and regulatory landscape applicable to our business (including laws and regulations governing consumer protection, fair lending, fair labor, privacy, information security, anti-money laundering and anti-terrorism), we, like all banking organizations, are subject to heightened legal and regulatory compliance and litigation risk. There are no material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which we or any of our subsidiaries is a party or to which our property is the subject.
Item 1A – Risk Factors

There have been no material changes from the risk factors previously disclosed in the “Risk Factors” section included in our Annual Report on Form 10-K for the year ended December 31, 2018.
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

Unregistered Sales of Equity Securities
None.
Use of Proceeds from Registered Securities
On April 24, 2018, the Company sold 1,150,765 shares of common stock in its initial public offering, including 180,000 shares of common stock pursuant to the exercise in full by the underwriters of their option to purchase additional shares. All of the shares were sold pursuant to our Registration Statement on Form S-1, as amended (File No. 333-223866), which was declared effective by the SEC on April 19, 2018. Our common stock is currently traded on Nasdaq under the symbol “LEVL”.
There has been no material change in the planned use of proceeds from our initial public offering as described in our prospectus filed with the SEC on April 20, 2018 pursuant to Rule 424(b)(4) under the Securities Act. On April 25, 2018, the Company contributed $20.0 million of the net proceeds of the initial public offering to the Bank.
Issuer Purchases of Equity Securities
Share Buyback Program. On January 23, 2019, the Company announced that its Board of Directors approved a repurchase program under which the Company is authorized to repurchase, from time to time as the Company deems appropriate, shares of the Company’s common stock with an aggregate purchase price of up to $5 million. The repurchase program began on January 23, 2019, and expires on December 31, 2020. The repurchase program does not obligate the Company to repurchase any dollar amount or number of shares, and the program may be extended, modified, suspended or discontinued at any time.

The following table sets forth information regarding the Company’s repurchase of shares of its outstanding common stock during the first quarter of 2019.

62

Period
Total Number of Shares Purchased
 
Average Price Paid Per Share
 
Total Number of Shares Repurchased as Part of Publicly Announced Plans or Programs
January 1-31, 2019
—

 
$
—

 
—

February 1-28, 2019
39,919

 
23.73

 
39,919

March 1-31, 2019
6,707

 
23.35

 
6,707

Total
46,626

 
$
23.67

 
46,626

Under applicable state law, Michigan corporations are not permitted to retain treasury stock. As such, the price paid for the repurchased shares is recorded to common stock. As of March 31, 2019, the total shares repurchased in the amount of $1.1 million were redeemed but remain authorized, unissued shares.

Item 3 – Defaults Upon Senior Securities

None.

Item 4 – Mine Safety Disclosures
Not Applicable.
Item 5 – Other Information
None.
Item 6 – Exhibits
 
 
 
Exhibit No.
 
Description
31.1
 
 
 
 
31.2
 
 
 
 
32.1
 
 
 
 
32.2
 
 
 
 
101
 
Financial information from the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2019, formatted in XBRL interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Income; (iii) Consolidated Statements of Comprehensive Income; (iv) Consolidated Statements of Changes in Shareholders’ Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to the Consolidated Financial Statements – filed herewith.

63

SIGNATURES
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.
 
Level One Bancorp, Inc.
 
 
 
 
Date: May 10, 2019
By:
/s/
Patrick J. Fehring
 
 
 
Patrick J. Fehring
 
 
 
President and Chief Executive Officer
 
 
 
(principal executive officer)
 
 
 
 
Date: May 10, 2019
By:
/s/
David C. Walker
 
 
 
David C. Walker
 
 
 
Executive Vice President and Chief Financial Officer
 
 
 
(principal financial officer)

    


64