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Table of Contents
Section 1: 10-Q (10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)
 ☑    Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2020
 ☐    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 71-1015624
(State or other jurisdiction of
incorporation or organization)		(I.R.S. Employer
Identification No.)
32991 Hamilton Court48334
Farmington Hills,(Zip code)
Michigan
(Address of principal executive offices)
(248) 737-0300
(Registrant's telephone number, including area code)
Title of Each ClassTrading symbol(s)Name of each exchange on which registered
Common Stock, no par valueLEVLNasdaq Global Select Market
Depositary Shares, each representing a 1/100th interest in a share of 7.50% Non-Cumulative Perpetual Preferred Stock, Series BLEVLPNasdaq Global Select Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (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 ☑ No ☐

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         ☐
Accelerated filer     
☑
Non-accelerated filer        ☐
Smaller reporting company
☑
Emerging growth company        ☑
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

As of November 2, 2020, the number of shares outstanding of the registrant’s common stock, no par value, was 7,734,322 shares.

Table of Contents
Level One Bancorp, Inc.
Table of Contents
Page

Table of Contents
PART I. FINANCIAL INFORMATION

Item 1 - Consolidated Financial Statements
LEVEL ONE BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
September 30, 2020December 31, 2019
(Dollars in thousands)(Unaudited)
Assets  
Cash and cash equivalents$176,486 $103,930 
Securities available-for-sale253,527 180,905 
Other investments14,398 11,475 
Mortgage loans held for sale, at fair value60,635 13,889 
Loans:
Originated loans1,603,893 1,158,138 
Acquired loans239,995 69,471 
Total loans1,843,888 1,227,609 
Less: Allowance for loan losses(21,254)(12,674)
Net loans1,822,634 1,214,935 
Premises and equipment, net15,646 13,838 
Goodwill35,554 9,387 
Other intangible assets, net5,581 383 
Other real estate owned— 921 
Bank-owned life insurance18,083 12,167 
Income tax benefit3,791 1,217 
Interest receivable and other assets40,112 21,852 
Total assets$2,446,447 $1,584,899 
Liabilities  
Deposits:  
Noninterest-bearing demand deposits$632,427 $325,885 
Interest-bearing demand deposits115,395 62,586 
Money market and savings deposits595,471 313,885 
Time deposits600,142 433,072 
Total deposits1,943,435 1,135,428 
Borrowings216,809 212,225 
Subordinated notes44,555 44,440 
Other liabilities32,180 22,103 
Total liabilities2,236,979 1,414,196 
Shareholders' equity 
Preferred stock, no par value per share; authorized—50,000 shares; issued and outstanding—10,000 shares, with a liquidation preference of $2,500 per share, at September 30, 2020 and 0 shares at December 31, 2019
23,370 — 
Common stock, no par value per share; authorized—20,000,000 shares; issued and outstanding—7,734,322 shares at September 30, 2020 and 7,715,491 shares at December 31, 2019
89,409 89,345 
Retained earnings88,646 77,766 
Accumulated other comprehensive income, net of tax8,043 3,592 
Total shareholders' equity209,468 170,703 
Total liabilities and shareholders' equity$2,446,447 $1,584,899 
   See accompanying notes to the consolidated financial statements.
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LEVEL ONE BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME - (UNAUDITED)
  For the three months ended September 30,For the nine months ended September 30,
(In thousands, except per share data)2020201920202019
Interest income  
Originated loans, including fees$15,274 $14,633 $44,630 $42,652 
Acquired loans, including fees3,456 1,501 11,187 4,895 
Securities:
Taxable652 857 1,930 2,773 
Tax-exempt613 588 1,894 1,728 
Federal funds sold and other investments 250 404 817 1,034 
Total interest income20,245 17,983 60,458 53,082 
Interest Expense 
Deposits2,323 4,478 9,039 13,216 
Borrowed funds693 261 1,866 960 
Subordinated notes632 256 1,903 759 
Total interest expense3,648 4,995 12,808 14,935 
Net interest income16,597 12,988 47,650 38,147 
Provision expense (benefit) for loan losses4,270 (16)10,334 835 
Net interest income after provision for loan losses12,327 13,004 37,316 37,312 
Noninterest income 
Service charges on deposits616 627 1,798 1,914 
Net gain on sales of securities434 151 1,862 151 
Mortgage banking activities7,108 2,352 15,380 5,788 
Other charges and fees967 728 2,564 1,768 
Total noninterest income9,125 3,858 21,604 9,621 
Noninterest expense 
Salary and employee benefits9,862 7,536 28,090 21,642 
Occupancy and equipment expense1,678 1,203 4,773 3,575 
Professional service fees808 465 2,141 1,212 
Acquisition and due diligence fees17 319 1,664 319 
Marketing expense257 379 709 843 
Printing and supplies expense89 78 398 250 
Data processing expense844 661 2,601 1,862 
Core deposit premium amortization192 29 576 117 
Other expense1,379 869 3,819 3,254 
Total noninterest expense15,126 11,539 44,771 33,074 
Income before income taxes6,326 5,323 14,149 13,859 
Income tax provision1,117 914 2,109 2,428 
Net income$5,209 $4,409 $12,040 $11,431 
Per common share data:   
Basic earnings per common share$0.68 $0.57 $1.56 $1.48 
Diluted earnings per common share$0.67 $0.56 $1.55 $1.46 
Cash dividends declared per common share$0.05 $0.04 $0.15 $0.12 
Weighted average common shares outstanding—basic7,675 7,721 7,640 7,738 
Weighted average common shares outstanding—diluted7,712 7,752 7,701 7,776 
See accompanying notes to the consolidated financial statements.
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LEVEL ONE BANCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME - (UNAUDITED)
 For the three months ended September 30,For the nine months ended September 30,
(Dollars in thousands)2020201920202019
Net income$5,209 $4,409 $12,040 $11,431 
Other comprehensive income: 
Unrealized gains on securities available-for-sale1,425 1,414 7,497 8,861 
Reclassification adjustment for gains included in income(434)151 (1,862)151 
Tax effect(1)
(208)(327)(1,184)(1,892)
Net unrealized gains on securities available-for-sale, net of tax783 1,238 4,451 7,120 
Total comprehensive income, net of tax$5,992 $5,647 $16,491 $18,551 
__________________________________________________________________________
(1) Includes $(91) thousand and $32 thousand of tax expense (benefit) related to reclassification adjustment for gains (losses) included in income for the three months ended September 30, 2020 and 2019, respectively. There was $(391) thousand and $32 thousand tax expense (benefit) related to reclassification for the nine months ended September 30, 2020 and 2019, respectively.

See accompanying notes to the consolidated financial statements.
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LEVEL ONE BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY - (UNAUDITED)
For the three months ended September 30, 2020
(Dollar in thousands)Preferred StockCommon StockRetained EarningsAccumulated Other Comprehensive Income Total Shareholders' Equity
Balance at June 30, 2020$— $89,175 $83,824 $7,260 $180,259 
Net income— — 5,209 — 5,209 
Other comprehensive income — — — 783 783 
Preferred stock offering, net of issuance costs23,370 — — — 23,370 
Common stock dividends declared ($0.05 per share)
— — (387)— (387)
Stock-based compensation expense, net of tax impact — 234 — — 234 
Balance at September 30, 2020$23,370 $89,409 $88,646 $8,043 $209,468 
For the nine months ended September 30, 2020
(Dollar in thousands)Preferred StockCommon StockRetained EarningsAccumulated Other Comprehensive Income Total Shareholders' Equity
Balance at December 31, 2019$— $89,345 $77,766 $3,592 $170,703 
Net income— — 12,040 — 12,040 
Other comprehensive income— — — 4,451 4,451 
Redeemed stock (25,256 shares)
— (620)— — (620)
Preferred stock offering, net of issuance costs23,370 — — — 23,370 
Common stock dividends declared ($0.15 per share)
— — (1,160)— (1,160)
Exercise of stock options (10,000 shares)
— 95 — — 95 
Stock-based compensation expense, net of tax impact— 589 — — 589 
Balance at September 30, 2020$23,370 $89,409 $88,646 $8,043 $209,468 





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For the three months ended September 30, 2019
(Dollar in thousands)Common StockRetained EarningsAccumulated Other Comprehensive Income Total Shareholders' Equity
Balance at June 30, 2019$89,442 $69,295 $4,130 $162,867 
Net income— 4,409 — 4,409 
Other comprehensive income— — 1,238 1,238 
Redeemed stock (20,530 shares)
(488)— — (488)
Common stock dividends declared ($0.04 per share)
— (310)— (310)
Exercise of stock options (6,250 shares)
63 — — 63 
Stock-based compensation expense189 — — 189 
Balance at September 30, 2019$89,206 $73,394 $5,368 $167,968 
For the nine months ended September 30, 2019
(Dollar in thousands)Common StockRetained EarningsAccumulated Other Comprehensive Income (Loss)Total Shareholders' Equity
Balance at December 31, 2018$90,621 $62,891 $(1,752)$151,760 
Net income— 11,431 — 11,431 
Other comprehensive income— — 7,120 7,120 
Redeemed Stock (88,457 shares)
(2,108)— — (2,108)
Common stock dividends declared ($0.12 per share)
— (928)— (928)
Exercise of stock options (21,550 shares)
219 — — 219 
Stock-based compensation expense474 — — 474 
Balance at September 30, 2019$89,206 $73,394 $5,368 $167,968 
See accompanying notes to the consolidated financial statements.
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LEVEL ONE BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - (UNAUDITED)
For the nine months ended September 30,
(Dollars in thousands)20202019
Cash flows from operating activities  
Net income$12,040 $11,431 
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation of fixed assets1,259 986 
Amortization of core deposit intangibles576 117 
Stock-based compensation expense653 517 
Provision expense for loan losses10,334 835 
Net securities premium amortization1,526 1,277 
Net gain on sales of securities(1,862)(151)
Originations of loans held for sale(409,312)(196,616)
Proceeds from sales of loans377,238 179,350 
Net gain on sales of loans(15,373)(5,788)
Accretion on acquired purchase credit impaired loans(1,350)(1,772)
Gain on sale of other real estate owned and repossessed assets(263)— 
Increase in cash surrender value of life insurance(353)(214)
Amortization of debt issuance costs115 43 
Deferred income tax benefit(3,758)— 
Net increase in accrued interest receivable and other assets(13,433)(14,127)
Net increase in accrued interest payable and other liabilities2,490 4,065 
Net cash used by operating activities(39,473)(20,047)
Cash flows from investing activities  
Net increase in loans(393,154)(39,007)
Principal payments on securities available-for-sale21,295 11,730 
Purchases of securities available-for-sale(83,170)(51,373)
Purchases of other investments(2,000)— 
Additions to premises and equipment(665)(1,269)
Proceeds from:
Sale of securities available-for-sale42,640 46,545 
Sale of other real estate owned and repossessed assets2,356 — 
Net cash used in acquisition(29,464)— 
Net cash used in investing activities(442,162)(33,374)
Cash flows from financing activities  
Net increase in deposits543,187 59,907 
Change in short-term borrowings(65,664)(87,584)
Issuances of FRB borrowings related to Paycheck Protection Program 34,098 — 
Issuances of long-term FHLB advances20,923 100,000 
Net proceeds from issuance of preferred stock23,370 — 
Change in secured borrowing(52)(53)
Share buyback - redeemed stock(620)(2,108)
Common stock dividends paid(1,082)(852)
Proceeds from exercised stock options95 219 
Payments related to tax-withholding for share based compensation awards(64)(43)
Net cash provided by financing activities554,191 69,486 
Net change in cash and cash equivalents72,556 16,065 
Beginning cash and cash equivalents103,930 33,296 
Ending cash and cash equivalents$176,486 $49,361 
Supplemental disclosure of cash flow information:  
Interest paid$12,117 $14,109 
Taxes paid6,909 2,071 
Transfer from loans held for sale to loans held for investment2,284 1,895 
Transfer from loans to other real estate owned1,172 373 
Increase in assets and liabilities in acquisitions:  
Assets acquired—Ann Arbor State Bank$325,303 $— 
Liabilities assumed—Ann Arbor State Bank283,526 — 
See accompanying notes to the consolidated financial statements.
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LEVEL ONE BANCORP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2020
NOTE 1—BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Nature of Operations:
Level One Bancorp, Inc. (the “Company,” “Level One,” “we,” “our,” or “us”) is a financial holding company headquartered in Farmington Hills, Michigan. In addition to the Company headquarters, as of September 30, 2020, its wholly owned bank subsidiary, Level One Bank (the "Bank"), had 17 offices, including 11 banking centers (our full service branches) in Metro Detroit, one banking center in Grand Rapids, one banking center in Jackson, three banking centers in Ann Arbor and one mortgage loan production office 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 southeastern Michigan and west Michigan. 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.
The Company's subsidiary, Hamilton Court Insurance Company ("Hamilton Court"), 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 incorporated in Nevada. During the third quarter of 2020, it was determined that Hamilton Court Insurance Company will exit the pool resources relationship to which it was previously a member and will dissolve, which is expected to occur in the fourth quarter of 2020 or the first quarter of 2021.
Preferred Stock Public Offering:
On August 10, 2020, the Company sold 1,000,000 depositary shares, each representing 1/100th interest in a share of 7.50% Non-Cumulative Perpetual Preferred Stock, Series B, with a liquidation preference of $2,500 per share of Preferred Stock (equivalent to $25 per depositary share). The aggregate offering price for the shares sold by the Company was $25.0 million, and after deducting $1.6 million of underwriting discounts and offering expenses paid to third parties, the Company received total net proceeds of $23.4 million.
Merger with Ann Arbor Bancorp, Inc.:
On January 2, 2020, the Company completed its previously announced acquisition of Ann Arbor Bancorp, Inc. (“AAB”) and its wholly owned subsidiary, Ann Arbor State Bank. The transaction was completed pursuant to a merger of the Company’s wholly owned merger subsidiary (“Merger Sub”) with and into AAB, pursuant to the Agreement and Plan of Merger, dated as of August 12, 2019, among the Company, Merger Sub and AAB. The Company paid aggregate consideration of approximately $67.9 million in cash. See "Note 2 - Business Combinations" for more information.
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, 2019, included in our Annual Form 10-K, filed with the SEC on March 13, 2020.
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.
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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. These estimates and assumptions are subject to many risks and uncertainties, including changes in interest rates and other general economic, business and political conditions, the effects of the Coronavirus Disease 2019 (“COVID-19”) pandemic, its potential effects on the economic environment, our customers and our operations, as well as any changes to federal, state and local government laws, regulations and orders in connection with the pandemic. The Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was signed into law on March 27, 2020, which provides a variety of provisions, including, among other things, a small business lending program to originate paycheck protection loans, temporary relief for the community bank leverage ratio, and temporary relief for financial institutions related to troubled debt restructurings. Actual results may differ from those estimates.
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 an 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 Adopted 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 Company adopted ASU 2014-09 and related issuances on January 1, 2019, with no cumulative effect adjustment to opening retained earnings required upon implementation of this standard. The adoption of this guidance does not result in changes to how revenue is recognized or the timing of recognition from our method prior to adoption. Revenue is recognized when obligations, under the terms of a contract with our customer, are satisfied, which generally occurs when services are performed. Revenue is measured as the amount of consideration we expect to receive in exchange for providing services.
The Company performed an analysis of the impact of adoption of this ASU, reviewing revenue recorded from service charges on deposit accounts, gains (losses) on other real estate owned and other assets, debit card interchange fees, and merchant processing fees. 
Service fees on deposit accounts - The fees are generated from a depositor’s option to purchase services offered under the contract and are only considered a contract when the depositor exercises their option to purchase these services. Therefore we deem the term of our contracts with depositors to be day-to-day and do not extend beyond the services already provided.
Debit card interchange fees - We collect interchange fee income when debit cards that we have issued to our customers are used in merchant transactions. Our performance obligation is satisfied and revenue is recognized at the point we initiate the payment of funds from a customer’s account to a merchant account.
Merchant processing fees - We receive referral fees for referring our customers to a merchant servicer. Fees are immaterial and recognized as received.
Gain (loss) on sale of other real estate owned - The Company records income or expense only upon consummation of the sale of the real estate.
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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 became effective for the Company for fiscal years beginning after December  15, 2018, and interim periods within fiscal years beginning after December 15, 2019, and was to be applied prospectively with a cumulative effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The Company adopted ASU 2016-01 and related issues on January 1, 2019 and determined that the implementation of this standard did not have a material impact to our consolidated financial statements.
Impact of Recently Issued Accounting Standards:
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 is effective for the Company for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022, and is to be applied under an optional transition method. The Company is planning to adopt this new guidance within the time frame noted above. The Company is currently evaluating the impact of adopting this new guidance on the consolidated financial statements but does not expect that the adoption will have a material impact. Additionally, the Company does not expect to significantly change operating lease agreements prior to adoption.
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.
The guidance is effective for the Company for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company is currently evaluating the impact of adopting this new guidance on the consolidated financial statements, 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 frame noted above.
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NOTE 2—BUSINESS COMBINATIONS
On January 2, 2020, the Company completed its previously announced acquisition of Ann Arbor Bancorp, Inc. and its wholly owned subsidiary, Ann Arbor State Bank. The Company paid an aggregate consideration of approximately $67.9 million in cash.
AAB's results of operations were included in the Company’s results beginning January 2, 2020. Acquisition-related costs of $1.7 million are included in the Company’s income statement for the nine months ended September 30, 2020.
Goodwill of $26.2 million arising from the acquisition consisted largely of synergies and the cost savings resulting from the combining of the operations of the companies. The goodwill arising from the acquisition of AAB is not deductible for tax purposes.
The following table summarizes the amounts of assets acquired and liabilities assumed recognized at the acquisition date.
(Dollars in thousands)
Consideration paid:
Cash$67,944 
Fair value of assets acquired:
Cash and cash equivalents38,480 
Investment securities47,416 
Federal Home Loan Bank stock923 
Loans held for sale1,703 
Loans held for investment222,356 
Premises and equipment2,404 
Core deposit intangibles3,663 
Other assets8,358 
Total assets acquired325,303 
Fair value of liabilities assumed:
Deposits264,820 
Federal Home Loan Bank advances15,279 
Other liabilities3,427 
Total liabilities assumed283,526 
Total identifiable net assets41,777 
Goodwill recognized in the acquisition$26,167 
Loans acquired in the acquisition were initially recorded at fair value with no separate allowance for loan losses. The Company reviewed the loans at acquisition to determine which should be considered purchased credit impaired loans (i.e. loans accounted for under ASC 310-30) defining impaired loans as those that were either not accruing interest or exhibited credit risk factors consistent with nonaccrual loans at the acquisition date. Fair values for purchased loans are based on a discounted cash flow methodology that considers various factors including the type of loan and related collateral, classification status, fixed or variable interest rate, term of the loan and whether or not the loan was amortizing, and a discount rate reflecting the Company's assessment of risk inherent in the cash flow estimates. The Company accounts for purchased credit impaired loans in accordance with the provisions of ASC 310-30. The cash flows expected to be collected on purchased loans are estimated based upon the expected remaining life of the underlying loans, which includes the effects of estimated prepayments. Purchased loans are considered credit impaired if there is evidence of credit deterioration at the date of purchase and if it is probable that not all contractually required payments will be collected. Interest income, through accretion of the difference between the carrying value of the loans and the expected cash flows is recognized on the acquired loans accounted for under ASC 310-30.
Purchased loans outside the scope of ASC 310-30 are accounted for under ASC 310-20. Premiums and discounts created when the loans were recorded at their fair values at acquisition are amortized over the remaining terms of the loans as an adjustment to the related loan's yield.
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(Dollars in thousands)
Accounted for under ASC 310-30: 
Contractual cash flows$1,018 
Contractual cash flows not expected to be collected (nonaccretable difference)82 
Expected cash flows936 
Interest component of expected cash flows (accretable yield)35 
Fair value at acquisition901 
Accounted for under ASC 310-20:
Unpaid principal and interest balance221,061 
Fair value premium394 
Fair value at acquisition221,455 
Total fair value at acquisition$222,356 

The pro forma table below presents information as if the acquisition had occurred on January 1, 2019. The pro forma information includes adjustments to give the effects to any changes in interest income due to the accretion (amortization) of the discount (premium) associated with the fair value adjustments to acquired loans, any changes in interest expense due to estimated premium amortization/discount accretion associated with the fair value adjustments to acquired time deposits and borrowings and other debt, amortization of core deposit intangibles that would have resulted had the deposits been acquired as of January 1, 2019, and the related income tax effects. The pro forma financial information is not necessarily indicative of the results of operations that would have occurred had the transaction been effected on the assumed date. Due diligence, professional fees, and other expenses related to the merger were incurred by the Company and AAB during the three and nine months ended September 30, 2020, but the pro forma condensed combined statement of income is not adjusted to exclude these costs.
Three months ended September 30,Nine months ended September 30,
(Dollars in thousands, except per share data)2020201920202019
Net interest income$16,593 $16,036 $47,709 $46,217 
Noninterest income9,125 4,486 21,604 11,228 
Noninterest expense15,143 13,742 44,822 38,879 
Net income5,211 4,865 12,062 13,188 
Net income per diluted share0.670.621.551.68
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NOTE 3—SECURITIES
The following table summarizes the amortized cost and fair value of the available-for-sale securities portfolio at September 30, 2020 and December 31, 2019 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
September 30, 2020    
 U.S. government sponsored entities & agencies$27,092 $126 $(19)$27,199 
State and political subdivision109,498 8,140 (88)117,550 
Mortgage-backed securities: residential19,237 255 — 19,492 
Mortgage-backed securities: commercial8,025 630 — 8,655 
Collateralized mortgage obligations: residential              14,177 169 (13)14,333 
Collateralized mortgage obligations: commercial              31,659 1,344 — 33,003 
U.S. Treasury1,000 3 — 1,003 
SBA18,869 63 (124)18,808 
Asset backed securities10,298 — (344)9,954 
Corporate bonds3,491 39 — 3,530 
Total available-for-sale$243,346 $10,769 $(588)$253,527 
December 31, 2019    
State and political subdivision$89,304 $4,463 $(20)$93,747 
Mortgage-backed securities: residential10,609 82 (126)10,565 
Mortgage-backed securities: commercial8,567 224 (12)8,779 
Collateralized mortgage obligations: residential              8,541 39 (51)8,529 
Collateralized mortgage obligations: commercial              22,891 300 (10)23,181 
U.S. Treasury1,976 23 — 1,999 
SBA22,051 87 (154)21,984 
Asset backed securities10,390 — (306)10,084 
Corporate bonds2,030 20 (13)2,037 
Total available-for-sale$176,359 $5,238 $(692)$180,905 
The proceeds from sales of securities and the associated gains and losses for the periods below are as follows:
For the three months ended September 30,For the nine months ended September 30,
(Dollars in thousands)2020201920202019
Proceeds$5,051 $11,080 $42,640 $46,545 
Gross gains434 202 1,871 543 
Gross losses— (51)(9)(392)
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.
 September 30, 2020
(Dollars in thousands)Amortized
Cost		Fair
Value
Within one year$11,141 $11,228 
One to five years27,530 28,494 
Five to ten years70,259 73,165 
Beyond ten years134,416 140,640 
Total$243,346 $253,527 
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Securities pledged at September 30, 2020 and December 31, 2019 had a carrying amount of $97.2 million and $27.3 million, respectively, and were pledged to secure Federal Home Loan Bank ("FHLB") advances, a Federal Reserve Bank line of credit, repurchase agreements, deposits and mortgage derivatives.
As of September 30, 2020, the Bank held 66 tax-exempt state and local municipal securities totaling $48.9 million backed by the Michigan School Bond Loan Fund. Other than the aforementioned investments, at September 30, 2020 and December 31, 2019, 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 following table summarizes securities with unrealized losses at September 30, 2020 and December 31, 2019 aggregated by security type and length of time in a continuous unrealized loss position:
 Less than 12 Months12 Months or LongerTotal
(Dollars in thousands)Fair
value		Unrealized
Losses		Fair
value		Unrealized
Losses		Fair
value		Unrealized
Losses
September 30, 2020      
Available-for-sale      
U.S. government sponsored entities & agencies$14,981 $(19)$— $— $14,981 $(19)
State and political subdivision1,858 (88)— — 1,858 (88)
Collateralized mortgage obligations: residential— — 1,136 (13)1,136 (13)
SBA— — 13,190 (124)13,190 (124)
Asset backed securities— — 9,954 (344)9,954 (344)
Total available-for-sale$16,839 $(107)$24,280 $(481)$41,119 $(588)
December 31, 2019      
Available-for-sale      
State and political subdivision$5,109 $(20)$305 $— $5,414 $(20)
Mortgage-backed securities: residential4,022 (39)3,982 (87)8,004 (126)
Mortgage-backed securities: commercial1,769 (11)430 (1)2,199 (12)
Collateralized mortgage obligations: residential770 (1)4,631 (50)5,401 (51)
Collateralized mortgage obligations: commercial— — 1,716 (10)1,716 (10)
SBA3,961 (13)12,405 (141)16,366 (154)
Asset backed securities8,220 (232)1,864 (74)10,084 (306)
Corporate bonds489 (13)— — 489 (13)
Total available-for-sale$24,340 $(329)$25,333 $(363)$49,673 $(692)
As of September 30, 2020, the Company's investment portfolio consisted of 306 securities, 29 of which were in an unrealized loss position. The unrealized losses for these securities resulted primarily from changes in interest rates since purchased. 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 September 30, 2020.







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NOTE 4—LOANS
The following table presents the recorded investment in loans at September 30, 2020 and December 31, 2019. The recorded investment in loans excludes accrued interest receivable.
(Dollars in thousands)OriginatedAcquiredTotal
September 30, 2020   
Commercial real estate$593,156 $137,033 $730,189 
Commercial and industrial748,913 59,010 807,923 
Residential real estate261,153 42,935 304,088 
Consumer671 1,017 1,688 
Total$1,603,893 $239,995 $1,843,888 
December 31, 2019   
Commercial real estate$551,565 $53,081 $604,646 
Commercial and industrial403,922 6,306 410,228 
Residential real estate201,787 10,052 211,839 
Consumer864 32 896 
Total$1,158,138 $69,471 $1,227,609 
At September 30, 2020 and December 31, 2019, the Company had residential loans held for sale, which were originated with the intent to sell, totaling $60.6 million and $13.9 million, respectively. During the three months ended September 30, 2020 and 2019, the Company sold residential real estate loans with proceeds totaling $157.2 million and $86.4 million, respectively, and $377.2 million and $179.4 million, during the nine months ended September 30, 2020 and 2019, respectively.
Nonperforming Assets

Nonperforming assets consist of loans for which the accrual of interest has been discontinued and other real estate owned obtained through foreclosure and other repossessed assets. Loans outside of those accounted for under ASC 310-30 are classified as nonaccrual when, in the opinion of management, it is probable that the Company will be unable to collect all the contractual interest and principal payments as scheduled in the loan agreement. The accrual of interest is discontinued when a loan is placed in nonaccrual status and any payments received reduce the carrying value of the loan. A loan may be placed back on accrual status if all contractual payments have been received and collection of future principal and interest payments is no longer doubtful. Acquired loans that are not performing in accordance with contractual terms are not reported as nonperforming because these loans are recorded at their net realizable value based on the principal and interest the Company expects to collect on these loans. There were $6 thousand and $1.2 million in commitments to lend additional funds to borrowers whose loans were classified as nonaccrual as of September 30, 2020 and December 31, 2019, respectively.
Information as to nonperforming assets was as follows:
(Dollars in thousands)September 30, 2020December 31, 2019
Nonaccrual loans:  
Commercial real estate$7,022 $4,832 
Commercial and industrial8,078 11,112 
Residential real estate4,151 2,569 
Consumer15 16 
Total nonaccrual loans19,266 18,529 
Other real estate owned— 921 
Total nonperforming assets$19,266 $19,450 
Loans 90 days or more past due and still accruing$552 $157 
At September 30, 2020 and December 31, 2019, the loans that were 90 days or more past due and still accruing comprised of either PCI loans or loans that were well-secured and in the process of collection.
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Loan delinquency as of the dates presented below was as follows:
(Dollars in thousands)Current30 - 59 Days
Past Due		60 - 89 Days
Past Due		90+ Days
Past Due		Total
September 30, 2020     
Commercial real estate$726,018 $3,934 $237 $— $730,189 
Commercial and industrial802,363 3,598 1,962 — 807,923 
Residential real estate294,478 4,067 2,133 3,410 304,088 
Consumer1,684 2 2 — 1,688 
Total$1,824,543 $11,601 $4,334 $3,410 $1,843,888 
December 31, 2019     
Commercial real estate$597,892 $3,630 $1,286 $1,838 $604,646 
Commercial and industrial407,692 377 1,275 884 410,228 
Residential real estate206,002 3,286 1,429 1,122 211,839 
Consumer892 4 — — 896 
Total$1,212,478 $7,297 $3,990 $3,844 $1,227,609 
Impaired Loans:
Information as to impaired loans, excluding purchased credit impaired loans, was as follows:
(Dollars in thousands)September 30, 2020December 31, 2019
Nonaccrual loans$19,266 $18,529 
Performing troubled debt restructurings: 
Commercial and industrial550 547 
Residential real estate599 359 
Total performing troubled debt restructurings1,149 906 
Total impaired loans, excluding purchase credit impaired loans$20,415 $19,435 
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.
The CARES Act was signed into law on March 27, 2020, which provides a variety of provisions, including, among other things, a small business lending program to originate paycheck protection loans, temporary relief for the community bank leverage ratio, and temporary relief for financial institutions related to troubled debt restructurings. As a result of the COVID-19 pandemic, the Company is currently working with borrowers to provide short-term payment modifications. Any short-term modifications made on a good-faith basis in response to the COVID-19 pandemic to borrowers who were current prior to any relief are not considered TDRs based on interagency guidance. This includes short-term modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program was implemented. The Company’s modification programs are designed to provide temporary relief for current borrowers affected by the COVID-19 pandemic. The Company has presumed that borrowers that are current on payments are not experiencing financial difficulties at the time of the modification for purposes of determining TDR status, and thus no further TDR analysis is required for each loan modification in the program.

As of September 30, 2020 and December 31, 2019, the Company had a recorded investment in troubled debt restructurings of $3.6 million and $3.9 million, respectively. The Company allocated a specific reserve of $235 thousand for
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those loans at September 30, 2020 and a specific reserve of $384 thousand for those loans at December 31, 2019. The Company has not committed to lend additional amounts to borrowers whose loans have been modified. As of September 30, 2020, there were $2.4 million of nonperforming TDRs and $1.2 million of performing TDRs included in impaired loans. As of December 31, 2019, there were $3.0 million of nonperforming TDRs and $906 thousand of performing TDRs included in impaired loans.
All TDRs are considered impaired loans in the calendar year of their restructuring. A loan that has been modified can return to performing status if it satisfies a six-month performance requirement; however, it will continue to be reported as a TDR and considered impaired.
The following table presents the recorded investment of loans modified as TDRs during the three and nine months ended September 30, 2020 and nine months ended September 30, 2019, by type of concession granted. There were no loans modified as TDRs during the three months ended September 30, 2019. In cases where more than one type of concession was granted, the loans were categorized based on the most significant concession.
 Concession typeFinancial effects of
modification
(Dollars in thousands)Principal
deferral		Interest
rate		Forbearance
agreement		Total
number of
loans		Total
recorded
investment		Net
charge-offs		Provision
for loan
losses
Three months ended September 30, 2020       
Commercial and industrial$— $— $148 1 $148 $— $— 
Total$— $— $148 1 $148 $— $— 
Nine months ended September 30, 2020       
Commercial and industrial$— $— $148 1 $148 $— $— 
Residential real estate— 75 — 1 75 — — 
Total$— $75 $148 2 $223 $— $— 
Nine months ended September 30, 2019
Commercial and industrial$— $— $351 2 $351 $— $174 
Total$— $— $351 2 $351 $— $174 
On an ongoing basis, the Company monitors the performance of TDRs to their modified terms. There were no loans modified as TDRs during the twelve months ending September 30, 2020 and 2019, for which there was a subsequent default. A payment on a TDR is considered to be in default once it is greater than 30 days past due.
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.

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Based on the most recent analysis performed, the risk category of loans by class of loans was as follows:
(Dollars in thousands)PassSpecial
Mention		SubstandardDoubtfulTotal
September 30, 2020     
Commercial real estate$703,241 $19,686 $6,723 $539 $730,189 
Commercial and industrial773,242 17,874 12,260 4,547 807,923 
Total$1,476,483 $37,560 $18,983 $5,086 $1,538,112 
December 31, 2019     
Commercial real estate$591,419 $8,325 $4,042 $860 $604,646 
Commercial and industrial383,756 8,967 16,527 978 410,228 
Total$975,175 $17,292 $20,569 $1,838 $1,014,874 
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)PerformingNonperformingTotal
September 30, 2020   
Residential real estate$299,937 $4,151 $304,088 
Consumer1,673 15 1,688 
Total$301,610 $4,166 $305,776 
December 31, 2019   
Residential real estate$209,270 $2,569 $211,839 
Consumer880 16 896 
Total$210,150 $2,585 $212,735 
Purchased Credit Impaired Loans:
As part of the Company's previous five 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 BalanceRecorded Investment
September 30, 2020  
Commercial real estate$6,304 $2,841 
Commercial and industrial683 281 
Residential real estate4,048 2,945 
Total PCI loans$11,035 $6,067 
December 31, 2019
Commercial real estate$6,597 $2,884 
Commercial and industrial556 135 
Residential real estate4,215 2,954 
Total PCI loans$11,368 $5,973 



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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 September 30,For the nine months ended September 30,
(Dollars in thousands)2020201920202019
Accretable yield at beginning of period$8,374 $10,194 $9,141 $10,947 
Additions due to acquisitions— — 35 — 
Accretion of income(482)(597)(1,350)(1,772)
Adjustments to accretable yield— — 66 422 
Accretable yield at end of period$7,892 $9,597 $7,892 $9,597 
"Additions due to acquisitions" represents the accretable yield added as a result of the AAB acquisition. "Accretion of income" represents the income earned on these loans for the year.
NOTE 5—ALLOWANCE FOR LOAN LOSSES
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 nonaccrual 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 September 30, 2020, the Company had six PCI loan pools and 13 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 significantly change. 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.

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Loans individually evaluated for impairment are presented below.
(Dollars in thousands)Recorded investment with
no related
allowance		Recorded investment
with related
allowance		Total
recorded
investment		Contractual
principal
balance		Related
allowance
September 30, 2020     
Individually evaluated impaired loans:     
Commercial real estate$7,022 $— $7,022 $7,355 $— 
Commercial and industrial4,465 4,717 9,182 10,031 798 
Residential real estate2,942 266 3,208 3,459 26 
Total$14,429 $4,983 $19,412 $20,845 $824 
December 31, 2019     
Individually evaluated impaired loans:     
Commercial real estate$4,832 $— $4,832 $5,156 $— 
Commercial and industrial10,739 913 11,652 12,521 363 
Residential real estate1,197 189 1,386 1,570 22 
Total$16,768 $1,102 $17,870 $19,247 $385 
(Dollars in thousands)Average
Recorded
Investment		Interest
Income
Recognized		Cash Basis
Interest
Recognized
For the three months ended September 30, 2020   
Individually evaluated impaired loans:   
Commercial real estate$7,139 $— $— 
Commercial and industrial8,960 12 — 
Residential real estate3,265 7 — 
Total$19,364 $19 $— 
For the nine months ended September 30, 2020
Individually evaluated impaired loans:  
Commercial real estate$7,433 $— $— 
Commercial and industrial13,086 34 84 
Residential real estate3,266 26 — 
Total$23,785 $60 $84 
For the three months ended September 30, 2019   
Individually evaluated impaired loans:   
Commercial real estate$3,111 $2 $35 
Commercial and industrial6,752 14 349 
Residential real estate1,428 7 — 
Total$11,291 $23 $384 
For the nine months ended September 30, 2019
Individually evaluated impaired loans:
Commercial real estate$4,034 $2 $209 
Commercial and industrial9,080 33 573 
Residential real estate2,059 21 10 
Total$15,173 $56 $792 



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Activity in the allowance for loan losses is presented below:
(Dollars in thousands)Commercial
Real Estate		Commercial
and Industrial		Residential
Real Estate		ConsumerTotal
For the three months ended September 30, 2020     
Allowance for loan losses:     
Beginning balance$7,987 $6,496 $2,565 $15 $17,063 
Provision (benefit) for loan losses1,820 1,679 781 (10)4,270 
Gross chargeoffs— (10)(110)(4)(124)
Recoveries12 15 10 8 45 
Net (chargeoffs) recoveries12 5 (100)4 (79)
Ending allowance for loan losses$9,819 $8,180 $3,246 $9 $21,254 
For the nine months ended September 30, 2020
Allowance for loan losses:
Beginning balance$5,773 $5,515 $1,384 $2 $12,674 
Provision for loan losses4,034 4,347 1,921 32 10,334 
Gross chargeoffs— (1,729)(110)(47)(1,886)
Recoveries12 47 51 22 132 
Net (chargeoffs) recoveries12 (1,682)(59)(25)(1,754)
Ending allowance for loan losses$9,819 $8,180 $3,246 $9 $21,254 
For the three months ended September 30, 2019
Allowance for loan losses:     
Beginning balance$5,219 $5,990 $1,142 $2 $12,353 
Provision (benefit) for loan losses184 (280)72 8 (16)
Gross chargeoffs— (49)— (34)(83)
Recoveries5 10 12 26 53 
Net (chargeoffs) recoveries5 (39)12 (8)(30)
Ending allowance for loan losses$5,408 $5,671 $1,226 $2 $12,307 
For the nine months ended September 30, 2019
Allowance for loan losses:
Beginning balance$5,227 $5,174 $1,164 $1 $11,566 
Provision for loan losses249 560 7 19 835 
Gross chargeoffs(74)(164)— (48)(286)
Recoveries6 101 55 30 192 
Net (chargeoffs) recoveries (68)(63)55 (18)(94)
Ending allowance for loan losses$5,408 $5,671 $1,226 $2 $12,307 











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Allocation of the allowance for loan losses is presented below:
(Dollars in thousands)Commercial
Real Estate		Commercial
and Industrial		Residential
Real Estate		ConsumerTotal
September 30, 2020     
Allowance for loan losses:     
Individually evaluated for impairment$— $798 $26 $— $824 
Collectively evaluated for impairment9,109 7,352 3,023 9 19,493 
Acquired with deteriorated credit quality710 30 197 — 937 
Ending allowance for loan losses$9,819 $8,180 $3,246 $9 $21,254 
Balance of loans:
Individually evaluated for impairment$7,022 $9,182 $3,208 $— $19,412 
Collectively evaluated for impairment720,326 798,460 297,935 1,688 1,818,409 
Acquired with deteriorated credit quality2,841 281 2,945 — 6,067 
Total loans$730,189 $807,923 $304,088 $1,688 $1,843,888 
December 31, 2019
Allowance for loan losses:
Individually evaluated for impairment$— $363 $22 $— $385 
Collectively evaluated for impairment5,062 5,124 1,339 2 11,527 
Acquired with deteriorated credit quality711 28 23 — 762 
Ending allowance for loan losses$5,773 $5,515 $1,384 $2 $12,674 
Balance of loans:
Individually evaluated for impairment$4,832 $11,652 $1,386 $— $17,870 
Collectively evaluated for impairment596,930 398,441 207,499 896 1,203,766 
Acquired with deteriorated credit quality2,884 135 2,954 — 5,973 
Total loans$604,646 $410,228 $211,839 $896 $1,227,609 


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NOTE 6—PREMISES AND EQUIPMENT
Premises and equipment were as follows at September 30, 2020 and December 31, 2019:
(Dollars in thousands)September 30, 2020December 31, 2019
Land$3,514 $2,254 
Buildings10,656 9,825 
Leasehold improvements2,993 2,714 
Furniture, fixtures and equipment7,231 6,539 
Total premises and equipment$24,394 $21,332 
Less: Accumulated depreciation8,748 7,494 
Net premises and equipment$15,646 $13,838 
Depreciation expense was $426 thousand and $326 thousand for the three months ended September 30, 2020 and 2019, and $1.3 million and $986 thousand for the nine months ended September 30, 2020 and 2019, respectively.
Most of the Company's branch facilities are rented under non-cancelable operating lease agreements. Total rent expense was $450 thousand and $307 thousand for the three months ended September 30, 2020 and 2019, and $1.4 million and $840 thousand for the nine months ended September 30, 2020 and 2019, respectively.
NOTE 7—GOODWILL AND INTANGIBLE ASSETS
Goodwill:    The Company has acquired three banks, Lotus Bank in March 2015, Bank of Michigan in March 2016, and Ann Arbor State Bank in January 2020, which resulted in the recognition of goodwill of $4.6 million, $4.8 million, and $26.2 million, respectively. Total goodwill was $35.6 million at September 30, 2020 and $9.4 million at December 31, 2019.
Goodwill is not amortized but is evaluated annually for impairment and on an interim basis if events or changes in circumstances indicate that goodwill might be impaired. The goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount, and an impairment charge would be recognized for any amount by which the carrying amount exceeds the reporting unit's fair value. The Company's most recent annual goodwill impairment review as of October 1, 2019 did not indicate that an impairment existed.
As a result of the unprecedented decline in economic conditions triggered by the COVID-19 pandemic, the market valuations, including our stock price, saw a significant decline in March 2020, which then continued into second quarter of 2020. These events indicated that goodwill may be impaired and resulted in management performing a qualitative goodwill impairment assessment in the second quarter of 2020. As a result of the analysis, we concluded that it was more-likely-than-not that the fair value of the reporting unit could be greater than its carrying amount.
Since the price of our stock did not fully recover during the third quarter of 2020, the Company concluded to engage a reputable, third-party valuation firm to perform a quantitative analysis of goodwill as of August 31, 2020 ("the valuation date"). In deriving at the fair value of the reporting unit (the Bank), the third-party firm assessed general economic conditions and outlook; industry and market considerations and outlook; the impact of recent events to financial performance; the market price of our common stock and other relevant events. In addition, the valuation relied on financial projections through 2023 and growth rates prepared by management. Based on the valuation prepared, it was determined that the Company's estimated fair value of the reporting unit at August 31, 2020 was greater than its book value and impairment of goodwill was not required.

Furthermore, management noted that despite the market capitalization declining from December 2019 to September 2020 as a result of the COVID-19 pandemic, the Bank’s financial performance has remained positive. This is evidenced by the strong financial indicators for the Bank, solid credit quality ratios, as well as the strong capital position of the Bank. In addition, third quarter 2020 revenue reflected significant and continuing growth in our residential mortgage banking business, as well as net SBA fees related to Paycheck Protection Program ("PPP") loans funded during second and third quarters of 2020. Management concurred with the conclusion derived from the quantitative goodwill analysis as of August 31, 2020 and determined that there were no material changes between the valuation date and September 30, 2020. As such, management concluded that it is more likely than not that there was no goodwill impairment as of September 30, 2020.

Intangible Assets:    The Company recorded core deposit intangibles ("CDIs") associated with each of its acquisitions. CDIs are amortized on an accelerated basis over their estimated useful lives.

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The table below presents the Company's net carrying amount of CDIs:
(Dollars in thousands)September 30, 2020December 31, 2019
Gross carrying amount$5,708 $2,045 
Accumulated amortization(2,320)(1,744)
Net Intangible$3,388 $301 
Amortization expense for the CDIs was $191 thousand and $29 thousand for the three months ended September 30, 2020 and 2019, and $576 thousand and $117 thousand for the nine months ended September 30, 2020 and 2019, respectively.
Mortgage Servicing Rights ("MSRs"): The Company has recorded MSRs for loans that are sold with servicing retained. MSRs are carried at the lower of the initial capitalized amount, net of accumulated amortization or estimated fair value. MSRs are amortized in proportion to and over the period of estimated net servicing income. The Company serviced residential mortgage loans for others with unpaid principal balances of approximately $211.0 million and $9.0 million as of September 30, 2020 and December 31, 2019, respectively.
Changes in our mortgage servicing rights were as follows for the three and nine months ended September 30, 2020 . The Company had $1 thousand in mortgage servicing rights as of September 30, 2019:
For the three months ended September 30,For the nine months ended September 30,
(Dollars in thousands)20202020
Mortgage servicing rights:
Balance, beginning of period$1,213 $76 
Originated servicing1,073 2,250 
Amortization(93)(133)
Balance, end of period2,193 2,193 
Fair value:
At beginning of period$1,256 $87 
At end of period2,567 2,567 
















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NOTE 8 —BORROWINGS AND SUBORDINATED DEBT
The following table presents the components of our short-term borrowings and long-term debt.
 September 30, 2020December 31, 2019
(Dollars in thousands)Amount
Weighted
Average
Rate(1)
Amount
Weighted
Average
Rate(1)
Short-term borrowings:    
FHLB Advances$— — %$60,000 1.61 %
Securities sold under agreements to repurchase187 0.30 851 0.30 
Federal funds purchased— — 5,000 1.90 
Total short-term borrowings187 0.30 65,851 1.62 
Long-term debt:
Secured borrowing due in 20221,322 1.00 1,374 1.00 
FHLB advances due in 2022 to 2029(2)
181,202 1.09 145,000 1.06 
FRB borrowings (3)
34,098 0.35 — — 
Subordinated notes due in 2025 and 2029(4)
44,555 5.29 44,440 5.29 
Total long-term debt261,177 1.71 190,814 2.04 
Total short-term and long-term borrowings$261,364 1.71 %$256,665 1.93 %
_______________________________________________________________________________
(1) Weighted average rate presented is the contractual rate which excludes premiums and discounts related to purchase accounting.
(2) At September 30, 2020, the long-term FHLB advances consisted of 0.42% - 2.93% fixed rate notes and can be called through 2024 without penalty by the issuer. The September 30, 2020 balance includes FHLB advances of $181.0 million and purchase accounting premiums of $202 thousand.
(3) The September 30, 2020 balance of FRB borrowings consisted of 0.35% fixed rate notes utilized to fund the PPP loans. The FRB borrowings have a maturity date equal to the maturity date of the respective PPP loans pledged to secure the borrowings, which is two years after the origination date of the PPP loans.
(4) The September 30, 2020 balance includes subordinated notes of $45.0 million and debt issuance costs of $445 thousand. The December 31, 2019 balance includes subordinated notes of $45.0 million and debt issuance costs of $560 thousand.

At September 30, 2020, the Company had $34.1 million of debt outstanding with the Federal Reserve Bank. These borrowings reflected the Company's efforts to help facilitate the funding of the PPP loans that were approved by the SBA during the quarter ended September 30, 2020. The FRB borrowings bear a 0.35% fixed interest rate and mature two years after the origination date of the respective PPP loans that have been pledged to secure them.
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 $181.0 million of long-term FHLB advances as of September 30, 2020 were secured by a blanket lien on $510.6 million of real estate-related loans. Based on this collateral and the Company's holdings of FHLB stock, the Company was eligible to borrow up to an additional $211.1 million from the FHLB at September 30, 2020. In addition, the Bank can borrow up to $122.5 million through the unsecured lines of credit it has established with other correspondent banks, as well as $5.3 million through a secured line with the Federal Reserve Bank. The Bank had no outstanding federal funds purchased as of September 30, 2020 and $5.0 million outstanding federal funds purchased as of December 31, 2019.
At September 30, 2020, the Company had $187 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 $1.9 million at September 30, 2020.
The Company had a secured borrowing of $1.3 million as of September 30, 2020 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.
At September 30, 2020, the Company had $45.0 million outstanding subordinated notes and $445 thousand of debt issuance costs. The debt issuance costs are netted against the balance of the subordinated notes and recognized as expense over the expected term of the notes.
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The $15.0 million of subordinated notes issued on December 21, 2015 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 $30.0 million of subordinated notes issued on December 18, 2019 bear a fixed interest rate of 4.75% per annum, payable semiannually through December 18, 2024. The notes will bear a floating interest rate of three-month secured overnight financing rate (SOFR) plus 311 basis points payable quarterly after December 18, 2024 through maturity. The notes mature no later than December 18, 2029, and the Company has the option to redeem any or all of the subordinated notes without premium or penalty any time after December 18, 2024 or upon the occurrence of a Tier 2 capital event or tax event.
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NOTE 9—INCOME TAXES
The Company and its subsidiaries are subject to U.S. federal income tax. In the ordinary course of business, we are routinely subject to audit by Internal Revenue Service. Currently, the Company is subject to examination by taxing authorities for the 2016 tax return year and forward.
A reconciliation of expected income tax expense using the federal statutory rate of 21% as of September 30, 2020 and 2019 and actual income tax expense is as follows:
 For the three months ended September 30,For the nine months ended September 30,
(Dollars in thousands)2020201920202019
Income tax expense based on federal corporate tax rate$1,328 $1,118 $2,970 $2,911 
Changes resulting from:
Tax-exempt income(154)(142)(469)(398)
Net operating loss carryback due to CARES Act— — (290)— 
Disqualified dispositions from stock options— — (175)— 
Other, net(57)(62)73 (85)
Income tax expense$1,117 $914 $2,109 $2,428 
In March 2020, the United States government approved the CARES Act, allowing companies to carryback net operating losses generated in 2018 through 2020 for five years to periods in which the tax rate was higher. Ann Arbor State Bank had a net operating loss ("NOL") of approximately $2.2 million generated on its 2020 short tax return which resulted in an increase in value of the NOL (which is part of the deferred tax assets) and therefore a $290 thousand tax benefit to be recognized during the first quarter of 2020. Additionally, disqualified dispositions of Ann Arbor State Bank’s stock options generated a $175 thousand tax benefit.

NOTE 10—STOCK BASED COMPENSATION
On March 15, 2018, the Company’s Board of Directors approved the 2018 Equity Incentive 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 awards granted under the Stock Option Plan or the 2014 Plan will remain subject to the terms of such plans until the time such awards are no longer outstanding.
The Company has reserved 250,000 shares of common stock for issuance under the 2018 Plan. During the nine months ended September 30, 2020 and 2019, the Company issued 38,170 and 35,633 restricted stock awards, respectively, under the 2018 Plan. There were 165,597 shares available for issuance as of September 30, 2020.
Stock Options
As of September 30, 2020, 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 years 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. There were no stock options granted during the nine months ended September 30, 2020 or September 30, 2019.




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The summary of our stock option activity for the nine months ended September 30, 2020 is as follows:
SharesWeighted Average
Exercise Price		Weighted Average Remaining Contractual
Term
Options outstanding, beginning of period355,218 $16.63 5.0
Exercised(10,000)9.57 
Options outstanding, end of period 345,218 16.83 4.4
Options exercisable 335,216 $16.59 4.3
The aggregate intrinsic value was $516 thousand for both options outstanding and exercisable as of September 30, 2020. As of September 30, 2020, there was $17 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 0.38 years.
Share-based compensation expense charged against income was $11 thousand and $12 thousand for the three months ended September 30, 2020 and 2019, respectively, and $33 thousand and $43 thousand for the nine months ended September 30, 2020 and 2019, respectively.
Restricted Stock Awards
A summary of changes in the Company's nonvested shares for the nine months ended September 30, 2020 is as follows:
Nonvested SharesSharesWeighted Average
Grant-Date Fair Value
Nonvested at January 1, 202080,370 $24.28 
Granted38,170 24.90 
Vested(19,850)23.10 
Forfeited(1,400)24.46 
Nonvested at September 30, 202097,290 $24.76 
As of September 30, 2020, there was $1.2 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 1.88 years. The total fair value of shares vested during the nine months ended September 30, 2020 was $459 thousand.
Total expense for restricted stock awards totaled $223 thousand and $177 thousand for the three months ended September 30, 2020 and 2019, respectively, and $620 thousand and $474 thousand for the nine months ended September 30, 2020 and 2019, respectively. For the nine months ended September 30, 2020 and 2019, there was $64 thousand and $43 thousand, respectively, of restricted stock redeemed to cover the payroll taxes due at the time of vesting.
NOTE 11 —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. Commitments to extend credit are agreements to provide credit to a customer, as long as conditions established in the contract are met, and usually have expiration dates. Commitments may expire without being used and the total commitment amounts do not necessarily represent future cash flow requirements.
Standby letters of credit and commercial letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party, while commercial letters of credit are issued specifically to facilitate commerce and typically result in the commitment being drawn on when the underlying transaction is consummated between the customer and the third party. These financial standby letters of credit irrevocably obligate the Company to pay a third-party beneficiary when a customer fails to repay an outstanding loan or debt instrument.
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 September 30, 2020, the allowance for off-balance sheet risk was $498 thousand, compared to $318 thousand at December 31, 2019, and was included in "Other liabilities" on our consolidated balance sheets.
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A summary of the contractual amounts of the Company's exposure to off-balance sheet risk is as follows:
 September 30, 2020December 31, 2019
(Dollars in thousands)FixedVariableFixedVariable
Commitments to make loans$5,302 $5,295 $16,276 $20,128 
Unused lines of credit30,496 361,749 28,723 288,086 
Unused standby letters of credit and commercial letters of credit3,705 2,028 4,895 — 
Commitments to make loans are generally made for periods of 90 days or less. The fixed rate loan commitments of $5.3 million as of September 30, 2020, had interest rates ranging from 3.0% to 5.5% and maturities ranging from 3 months to 15 years.
NOTE 12—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 that as of September 30, 2020, the Company and Bank met all capital adequacy requirements to which they were subject.
The Basel III rules require the Company to maintain a capital conservation buffer of common equity capital of greater than 2.5% above the minimum risk-weighted assets ratios, which is the fully phased-in amount of the capital conservation buffer.
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 September 30, 2020 and December 31, 2019, the Bank's capital ratios were in excess of the requirement to be "well capitalized" under the regulatory framework for prompt corrective action. There are no conditions or events that management believes have changed the Bank's category.
















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Actual and required capital amounts and ratios are presented below:
 ActualFor Capital
Adequacy
Purposes		For Capital Adequacy
Purposes + Capital
Conservation Buffer(1)		Well Capitalized Under Prompt Corrective
Action Provisions
(Dollars in thousands)AmountRatioAmountRatioAmountRatioAmountRatio
September 30, 2020        
Common equity tier 1 to risk-weighted assets:        
Consolidated$139,067 8.83 %$70,875 4.50 %$110,250 7.00 %
Bank176,593 11.23 %70,760 4.50 %110,070 7.00 %$102,208 6.50 %
Tier 1 capital to risk-weighted assets:
Consolidated$162,437 10.31 %$94,500 6.00 %$133,875 8.50 %
Bank176,593 11.23 %94,346 6.00 %133,657 8.50 %$125,795 8.00 %
Total capital to risk-weighted assets:
Consolidated$226,679 14.39 %$126,000 8.00 %$165,375 10.50 %
Bank196,274 12.48 %125,795 8.00 %165,106 10.50 %$157,244 10.00 %
Tier 1 capital to average assets (leverage ratio):
Consolidated$162,437 7.17 %$90,664 4.00 %$90,664 4.00 %
Bank176,593 7.83 %90,220 4.00 %90,220 4.00 %$112,776 5.00 %
December 31, 2019
Common equity tier 1 to risk-weighted assets:
Consolidated$157,659 11.72 %$60,533 4.50 %$94,163 7.00 %
Bank165,199 12.27 %60,568 4.50 %94,217 7.00 %$87,487 6.50 %
Tier 1 capital to risk-weighted assets:
Consolidated$157,659 11.72 %$80,711 6.00 %$114,341 8.50 %
Bank165,199 12.27 %80,757 6.00 %114,406 8.50 %$107,676 8.00 %
Total capital to risk-weighted assets:
Consolidated$215,091 15.99 %$107,615 8.00 %$141,244 10.50 %
Bank178,191 13.24 %107,676 8.00 %141,325 10.50 %$134,595 10.00 %
Tier 1 capital to average assets (leverage ratio):
Consolidated$157,659 10.41 %$60,580 4.00 %$60,580 4.00 %
Bank165,199 10.96 %60,276 4.00 %60,276 4.00 %$75,345 5.00 %
_______________________________________________________________________________
(1) Reflects the capital conservation buffer of 2.5%.
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 September 30, 2020, the Bank had the capacity to pay the Company a dividend of up to $42.9 million without the need to obtain prior regulatory approval.
NOTE 13—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.
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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). For securities where pricing on similar securities is not available, a third party is engaged to calculate the fair value using the Municipal Market Data curve (Level 3).
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 from loans held for sale. Due to the adjustments made, the Company classifies the loans transferred from loans held for sale as recurring Level 3.
Mortgage Servicing Rights ("MSRs"): In accordance with GAAP, the Company must record impairment charges on mortgage servicing rights on a non-recurring basis when the carrying value exceeds the estimated fair value. The fair value of our MSRs is obtained from a third-party valuation company that uses a discounted cash flow valuation model which calculates the present value of estimated future net servicing cash flows, taking into consideration expected mortgage loan prepayment rates, discount rates, costs to service, contractual servicing fee income, ancillary income, late fees, replacement reserves and other economic factors that are determined based on current market conditions. The reliance on Level 3 inputs to derive at the fair value of MSRs results in a Level 3 classification.
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:   Other real estate owned assets are recorded at the lower of cost or fair value upon the transfer of a loan to other real estate owned and, subsequently, continue to be measured and carried at the lower of cost or fair value. 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
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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.
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.
Assets and liabilities measured at fair value on a recurring basis are summarized below:
(Dollars in thousands)TotalQuoted Prices
in Active Markets
for Identical Assets
(Level 1)		Significant Other
Observable
Inputs
(Level 2)		Significant
Unobservable
Inputs
(Level 3)
September 30, 2020    
Securities available for sale:    
U.S. government sponsored entities and agencies$27,199 $— $27,199 $— 
State and political subdivision117,550 — 115,838 1,712 
Mortgage-backed securities: residential19,492 — 19,492 — 
Mortgage-backed securities: commercial8,655 — 8,655 — 
Collateralized mortgage obligations: residential14,333 — 14,333 — 
Collateralized mortgage obligations: commercial33,003 — 33,003 — 
U.S. Treasury1,003 — 1,003 — 
SBA18,808 — 18,808 — 
Asset backed securities9,954 — 9,954 — 
Corporate bonds3,530 — 3,530 — 
Total securities available for sale253,527 — 251,815 1,712 
Loans held for sale60,635 — 60,635 — 
Loans measured at fair value:
Residential real estate5,080 — — 5,080 
Derivative assets:
Customer-initiated derivatives14,422 — 14,422 — 
Forward contracts related to mortgage loans to be delivered for sale117 — 117 — 
Interest rate lock commitments2,068 — 2,068 — 
Total assets at fair value$335,849 $— $329,057 $6,792 
Derivative liabilities:
Customer-initiated derivatives14,422 — 14,422 — 
Forward contracts related to mortgage loans to be delivered for sale441 — 441 — 
Interest rate lock commitments4 — 4 — 
Total liabilities at fair value$14,867 $— $14,867 $— 
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(Dollars in thousands)TotalQuoted Prices
in Active Markets
for Identical Assets
(Level 1)		Significant Other
Observable
Inputs
(Level 2)		Significant
Unobservable
Inputs
(Level 3)
December 31, 2019
Securities available for sale:
State and political subdivision$93,747 $— $93,747 $— 
Mortgage-backed securities: residential10,565 — 10,565 — 
Mortgage-backed securities: commercial8,779 — 8,779 — 
Collateralized mortgage obligations: residential8,529 — 8,529 — 
Collateralized mortgage obligations: commercial23,181 — 23,181 — 
U.S. Treasury1,999 — 1,999 — 
SBA21,984 — 21,984 — 
Asset backed securities10,084 — 10,084 — 
Corporate bonds2,037 — 2,037 — 
Total securities available for sale$180,905 $— $180,905 $— 
Loans held for sale13,889 — 13,889 — 
Loans measured at fair value:
Residential real estate4,063 — — 4,063 
Derivative assets:
Customer-initiated derivatives4,684 — 4,684 — 
Forward contracts related to mortgage loans to be delivered for sale34 — 34 — 
Interest rate lock commitments256 — 256 — 
Total assets at fair value$203,831 $— $199,768 $4,063 
Derivative liabilities:
Customer-initiated derivatives4,684 — 4,684 — 
Forward contracts related to mortgage loans to be delivered for sale33 — 33 — 
Total liabilities at fair value$4,717 $— $4,717 $— 
There were no transfers between levels within the fair value hierarchy, within a specific category, during the nine months ended September 30, 2020 or during the year ended December 31, 2019. The level 3 investment securities disclosed as of September 30, 2020 were acquired from Ann Arbor State Bank during the first quarter of 2020.












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The following table summarizes the changes in Level 3 assets measured at fair value on a recurring basis.
For the three months ended September 30,For the nine months ended September 30,
(Dollars in thousands)2020201920202019
Loans held for investment
Beginning balance$4,056 $5,624 $4,063 $4,571 
Transfers from loans held for sale1,468 466 2,284 1,895 
Gains (losses):
Recorded in "Mortgage banking activities"65 (9)62 151 
Repayments(509)(1,191)(1,329)(1,727)
Ending balance$5,080 $4,890 $5,080 $4,890 
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 September 30, 2020 or December 31, 2019.
As of September 30, 2020 and December 31, 2019, 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)September 30, 2020December 31, 2019
Aggregate fair value$60,635 $13,889 
Contractual balance59,055 13,510 
Unrealized gain1,580 379 
The total amount of gains as a result of changes in fair value of loans held for sale included in "Mortgage banking activities" for three and nine months ended September 30, 2020 and 2019 were as follows:
 For the three months ended September 30,For the nine months ended September 30,
(Dollars in thousands)2020201920202019
Change in fair value$556 $(98)$1,201 $352 















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Assets measured at fair value on a non-recurring basis are summarized below:
(Dollars in thousands)TotalSignificant Unobservable Inputs
(Level 3)
September 30, 2020
Impaired loans:
Residential real estate$1,305 $1,305 
Commercial and industrial761 761 
Mortgage servicing rights2,567 2,567 
Total$4,633 $4,633 
December 31, 2019
Impaired loans:
Commercial real estate$265 $265 
Commercial and industrial261 261 
Mortgage servicing rights87 87 
Other real estate owned921 921 
Total$1,534 $1,534 
The Company recorded specific reserves of $91 thousand and $161 thousand to reduce the value of these loans at September 30, 2020 and December 31, 2019, respectively, based on the estimated fair value of the underlying collateral. The Company also recorded chargeoffs of $364 thousand during the nine months ended September 30, 2020 related to the impaired loans at fair value. There were chargeoffs of $298 thousand related to impaired loans at fair value during the year ended December 31, 2019.
The Company recorded a valuation allowance of $17 thousand related to mortgage servicing rights during the first quarter of 2020, which was then reversed during the second quarter of 2020 as a result of the fair value at June 30, 2020 being higher than book value, and the fair value remained higher as of September 30, 2020. There was no valuation allowance related to mortgage servicing rights during the year ended December 31, 2019. There were no write downs recorded in other real estate owned during the three and nine months ended September 30, 2020 or the year ended December 31, 2019.
The table below presents quantitative information about the significant unobservable inputs for assets measured at fair value on a nonrecurring basis at September 30, 2020 and December 31, 2019:
(Dollars in thousands)Fair value at
September 30, 2020		Valuation
Technique(s)		Significant
Unobservable Input(s)		Discount % Range/Amount
Impaired loans$2,066 Discounted appraisals; estimated net realizable value of collateralCollateral discounts
10.00-80.00%
Mortgage servicing rights2,567 Discounted cash flowPrepayment speed9.40 %
Discount rate7.75 %
(Dollars in thousands)Fair value at
December 31, 2019		Valuation
Technique(s)		Significant
Unobservable Input(s)		Discount % Range/Amount
Impaired loans$526 Discounted appraisals; estimated net realizable value of collateralCollateral discounts
10.00-50.00%
Mortgage servicing rights87 Discounted cash flowPrepayment speed13.42 %
Discount rate8.50 %
Other real estate owned921 Appraisal of propertyDiscounted appraisal value
18.00-36.00%



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The carrying amounts and estimated fair values of financial instruments, excluding those previously presented unless otherwise noted, at September 30, 2020 and December 31, 2019 are noted in the table below.
Estimated Fair Value
(Dollars in thousands)Carrying ValueQuoted Prices in
Active Markets for
Identical Assets (Level 1)		Significant
Other Observable
Inputs (Level 2)		Significant
Unobservable
Inputs (Level 3)		Total
September 30, 2020    
Financial assets:    
Cash and cash equivalents$176,486 $31,080 $145,406 $— $176,486 
Other investments14,398 N/AN/AN/AN/A
Net loans1,822,634 — — 1,863,805 1,863,805 
Accrued interest receivable8,541 — 1,966 6,575 8,541 
Financial liabilities:
Deposits1,943,435 — 2,008,494 — 2,008,494 
Borrowings216,809 — 224,511 — 224,511 
Subordinated notes44,555 — 44,795 — 44,795 
Accrued interest payable2,265 — 2,265 — 2,265 
December 31, 2019
Financial assets:
Cash and cash equivalents$103,930 $19,990 $83,940 $— $103,930 
Other investments11,475 N/AN/AN/A N/A
Net loans1,214,935 — — 1,203,639 1,203,639 
Accrued interest receivable4,403 — 1,236 3,167 4,403 
Financial liabilities:
Deposits1,135,428 — 1,138,202 — 1,138,202 
Borrowings212,225 — 212,125 — 212,125 
Subordinated notes44,440 — 47,100 — 47,100 
Accrued interest payable1,574 — 1,574 — 1,574 
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)Other Investments
It is not practical to determine the fair value of FHLB stock and Arctaris investment bond 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 valued at the lower of cost or fair value as described previously.
(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
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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.
(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 14—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.
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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:
September 30, 2020December 31, 2019
(Dollars in thousands)Notional AmountFair ValueNotional AmountFair Value
Included in other assets:
Customer-initiated and mortgage banking derivatives:
Customer-initiated derivatives$135,462 $14,422 $103,941 $4,684 
Forward contracts related to mortgage loans to be delivered for sale38,840 117 6,018 34 
Interest rate lock commitments110,179 2,068 25,519 256 
Total derivatives included in other assets$284,481 $16,607 $135,478 $4,974 
Included in other liabilities:
Customer-initiated and mortgage banking derivatives:
Customer-initiated derivatives$135,462 $14,422 $103,941 $4,684 
Forward contracts related to mortgage loans to be delivered for sale99,697 441 20,633 33 
Interest rate lock commitments4,053 4 928 — 
Total derivatives included in other liabilities$239,212 $14,867 $125,502 $4,717 

In the normal course of business, the Company may decide to settle a forward contract rather than fulfill the contract. Cash received or paid in this settlement manner is included in "Mortgage banking activities" in the consolidated statements of income and is considered a cost of executing a forward contract. The following table presents the gains (losses) related to derivative instruments reflecting the changes in fair value:
For the three months ended September 30,For the nine months ended September 30,
(Dollars in thousands)Location of Gain (Loss)2020201920202019
Forward contracts related to mortgage loans to be delivered for saleMortgage banking activities$(1,207)$(26)$(3,996)$(417)
Interest rate lock commitmentsMortgage banking activities391 (48)1,808 156 
Total loss recognized in income$(816)$(74)$(2,188)$(261)














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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 a 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 recognizedGross amounts offset in the statements of financial conditionNet amounts presented in the statements of financial conditionFinancial instrumentsCollateral (received)/postedNet amount
September 30, 2020
Offsetting derivative assets:
Customer initiated derivatives$14,422 $— $14,422 $— $— $14,422 
Offsetting derivative liabilities:
Customer initiated derivatives14,422 — 14,422 — 15,383 (961)
December 31, 2019
Offsetting derivative assets:
Customer initiated derivatives$4,684 $— $4,684 $— $— $4,684 
Offsetting derivative liabilities:
Customer initiated derivatives4,684 — 4,684 — 4,375 309 
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NOTE 15—PARENT COMPANY FINANCIAL STATEMENTS
Balance Sheets—Parent Company
(Dollars in thousands)September 30, 2020December 31, 2019
Assets  
Cash and cash equivalents$29,105 $35,210 
Investment in banking subsidiary223,624 178,240 
Investment in captive insurance subsidiary2,306 1,668 
Income tax benefit158 520 
Other assets41 99 
Total assets$255,234 $215,737 
Liabilities
Subordinated notes$44,555 $44,440 
Accrued expenses and other liabilities1,211 594 
Total liabilities45,766 45,034 
Shareholders' equity209,468 170,703 
Total liabilities and shareholders' equity$255,234 $215,737 

Statements of Income and Comprehensive Income—Parent Company
For the three months ended September 30,For the nine months ended September 30,
(Dollars in thousands)2020201920202019
Income  
Dividend income from bank subsidiary$5,000 $— $41,500 $— 
Total income$5,000 $— $41,500 $— 
Expenses
Interest on borrowed funds11 — 33 — 
Interest on subordinated notes632 256 1,903 759 
Other expenses302 516 1,017 902 
Total expenses$945 $772 $2,953 $1,661 
Income (loss) before income taxes and equity in (overdistributed) undistributed net earnings of subsidiaries4,055 (772)38,547 (1,661)
Income tax benefit228 181 383 272 
Equity in (overdistributed) undistributed earnings of subsidiaries926 5,000 (26,890)12,820 
Net income$5,209 $4,409 $12,040 $11,431 
Other comprehensive income783 1,238 4,451 7,120 
Total comprehensive income, net of tax$5,992 $5,647 $16,491 $18,551 







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Statements of Cash Flows—Parent Company
 For the nine months ended September 30,
(Dollars in thousands)20202019
Cash flows from operating activities  
Net income$12,040 $11,431 
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in over (under) distributed earnings of subsidiaries26,890 (12,820)
Stock based compensation expense72 54 
(Increase) Decrease in other assets, net420 (115)
Increase in other liabilities, net654 411 
Net cash provided by (used in) operating activities40,076 (1,039)
Cash flows from investing activities
Cash used in acquisitions(67,944)— 
Net cash used in investing activities(67,944)— 
Cash flows from financing activities
Preferred stock offering, net of issuance costs23,370 — 
Share buyback - redeemed stock(620)(2,108)
Common stock dividends paid(1,082)(852)
Proceeds from exercised stock options95 219 
Net cash provided by (used in) financing activities21,763 (2,741)
Net decrease in cash and cash equivalents(6,105)(3,780)
Beginning cash and cash equivalents35,210 9,690 
Ending cash and cash equivalents$29,105 $5,910 
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NOTE 16—EARNINGS PER COMMON SHARE
The two-class method is used in the calculation of basic and diluted earnings per common share. Under the two-class method, earnings available to common shareholders for the period are allocated between common shareholders and participating securities according to dividends declared (or accumulated) and participating rights in undistributed earnings.
Average shares of common stock for diluted net income per common share include shares to be issued upon the exercise of stock options granted under the Company's share-based compensation plans and restricted stock awards.
The calculation of basic and diluted earnings per share using the two-class method for the periods noted below was as follows:
For the three months ended September 30,For the nine months ended September 30,
(In thousands, except per share data) 2020201920202019
Net income$5,209 $4,409 $12,040 $11,431 
Net income allocated to participating securities40 45 140 110 
Net income allocated to common shareholders (1)
$5,169 $4,364 $11,900 $11,321 
Weighted average common shares - issued7,734 7,721 7,730 7,738 
Average unvested restricted share awards(59)(80)(90)(76)
Weighted average common shares outstanding - basic7,675 7,641 7,640 7,662 
Effect of dilutive securities:
Weighted average common stock equivalents37 111 61 114 
Weighted average common shares outstanding - diluted7,712 7,752 7,701 $7,776 
EPS available to common shareholders
Basic earnings per common share$0.68 $0.57 $1.56 $1.48 
Diluted earnings per common share$0.67 $0.56 $1.55 $1.46 
(1) Net income allocated to common shareholders for basic and diluted earnings per share may differ under the two-class method as a result of adding common share equivalents for options to dilutive shares outstanding, which alters the ratio used to allocate net income to common shareholders and participating securities for the purposes of calculating diluted earnings per share.
Stock options for 214,668 and 30,000 shares of common stock were not considered in computing diluted earnings per common share for the three months ended September 30, 2020 and 2019, respectively, and 117,334 and 30,000 of common stock were not considered in computing diluted earnings per common share for the nine months ended September 30, 2020 and 2019, respectively, because they were antidilutive.
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Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion explains our financial condition as of and for the three and nine months ended September 30, 2020. 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, 2019, filed with the SEC on March 13, 2020. 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" within the meaning of such term in the Private Securities Litigation Reform Act of 1995. These statements are subject to many risks and uncertainties, including, but not limited to, the effects of the COVID-19 pandemic, including its effects on the economic environment, our customers and our operations, as well as any changes to federal, state or local government laws, regulations or orders in connection with the pandemic; the ability of the Company to implement its strategy and expand its lending operations; 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; risks related to mergers and acquisitions; changes in benchmark interest rates used to price loans and deposits, including the expected elimination of LIBOR; 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," "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 – Basis of Presentation and 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, 2019, which was filed with the SEC on March 13, 2020. There have been no significant changes in critical accounting policies or the assumptions and judgments utilized in applying these policies since December 31, 2019.
Overview
Level One Bancorp, Inc. is a financial holding company headquartered in Farmington Hills, Michigan, with its primary branch operations in southeastern and west 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. During the third quarter of 2020, it was determined that Hamilton Court Insurance Company will exit the pool resources relationship to which it was previously a member and will dissolve, which is expected to occur in the fourth quarter of 2020 or the first quarter of 2021.
Our principal business activities have been lending to and accepting deposits from individuals, businesses, municipalities and other entities. We derive income principally from interest charged on loans and leases and, to a lesser extent, from interest and dividends earned on investment securities. We have also derived income from noninterest sources, such as fees received in connection with various lending and deposit services and originations and sales of residential mortgage loans. Our principal expenses include interest expense on deposits and borrowings, operating expenses, such as salaries and employee benefits, occupancy and equipment expenses, data processing costs, professional fees and other noninterest expenses, provisions for loan losses and income tax expense.
Since 2007, we have grown substantially through organic growth and a series of five acquisitions, all of which have been fully integrated into our operations. We have made significant investments over the last several years in hiring additional staff and upgrading technology and system security. In 2016, we opened our first branch in 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.
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On January 2, 2020, the Company completed its previously announced acquisition of Ann Arbor Bancorp, Inc. (“AAB”) and its wholly owned subsidiary, Ann Arbor State Bank. The transaction was completed pursuant to a merger of the Company’s wholly owned merger subsidiary (“Merger Sub”) with and into AAB, pursuant to the Agreement and Plan of Merger, dated as of August 12, 2019, among the Company, Merger Sub and AAB. The Company paid aggregate consideration of approximately $67.9 million in cash.
    Our results of operations for the three and nine months ended September 30, 2020 include the results of operations of AAB on and after January 2, 2020, including $17 thousand and $1.7 million of acquisition fees, respectively. Results for periods before January 2, 2020 reflect only those of Level One and do not include the results of operations of AAB. See "Note 2 - Business Combinations" for more information. In addition, all identifiable assets, including the intangible assets that consisted of $26.2 million in goodwill and $3.7 million in core deposit intangibles, and liabilities of AAB as of the merger date have been recorded at their estimated fair value and added to those of Level One. As of September 30, 2020, the Company had total consolidated assets of $2.45 billion, total consolidated deposits of $1.94 billion and total consolidated shareholders' equity of $209.5 million.

Recent Developments
Third Quarter Dividend. On September 16, 2020, the Company declared a third quarter 2020 cash dividend of $0.05 per common share, payable on October 15, 2020.
Preferred Stock Public Offering and First Cash Dividend. On August 10, 2020, the Company sold 1,000,000 depositary shares, each representing a 1/100th interest in a share of 7.50% Non-Cumulative Perpetual Preferred Stock, Series B, with a liquidation preference of $2,500 per share of Preferred Stock (equivalent to $25 per depositary share). The aggregate offering price for the shares sold by the Company was $25.0 million, and after deducting $1.6 million of underwriting discounts and offering expenses paid to third parties, the Company received total net proceeds of $23.4 million.
On October 21, 2020, Level One’s Board of Directors declared a quarterly cash dividend of $47.92 per share on its 7.50% Non-Cumulative Preferred Stock, Series B. Holders of depositary shares will receive $0.4792 per depositary share. The dividend is payable on November 15, 2020, to shareholders of record at the close of business on October 31, 2020.
Impact of COVID-19 Pandemic. The COVID-19 pandemic in the United States has had, and is expected to continue to have, a complex and significant adverse impact on the economy, the banking industry and the Company in future fiscal periods, all subject to a high degree of uncertainty.
Effects on Our Market Areas. Our commercial and consumer banking products and services are offered primarily in Michigan, where individuals, companies and other organizations have limited their economic activity in response to the pandemic. It is uncertain whether and to what extent additional restrictions on economic activities and social gatherings will be imposed in future periods. These limitations on economic activity have had an adverse impact on the Michigan economy and our clients. The Bank and its branches have remained open during these orders because banks have been deemed essential businesses. Up until June 22, 2020, the Bank had been serving its customers through its drive-thrus, by appointment only for in-person services, and online and mobile banking tools. While our branches became fully available for in-person services to serve our clients on June 22, 2020, we will continue to be diligent in our efforts to follow all CDC guidelines to ensure the health and safety of our clients and team members.
As a result of the COVID-19 pandemic, the state’s unemployment rate remained slightly elevated at 8.5% in September 2020 compared to 4.1% in March 2020 before the full impact of COVID-19, according to the Michigan Department of Technology, Management & Budget.

Policy and Regulatory Developments. Federal, state and local governments and regulatory authorities have enacted and issued a range of policy responses to the COVID-19 pandemic, including the following:

•The Federal Reserve decreased the range for the federal funds target rate by 0.5% on March 3, 2020, and by another 1.0% on March 16, 2020, reaching a range of 0.0 - 0.25%.
•On March 27, 2020, President Trump signed the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), which established a $2.0 trillion economic stimulus package, including cash payments to individuals, supplemental unemployment insurance benefits and a $349 billion loan program administered through the U.S. Small Business Administration (“SBA”), referred to as the paycheck protection program (“PPP”). The Bank participated as a lender in the PPP. After the initial $349 billion in funds for the PPP was exhausted, an additional $310 billion in funding for PPP loans was authorized. In addition, the CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited
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period of time to account for the effects of COVID-19. Refer to Note 4 - Loans for further discussion of the CARES Act and its impact on TDRs.
•On April 7, 2020, federal banking regulators issued a revised Interagency Statement on Loan Modifications and Reporting for Financial Institutions, which, among other things, encouraged financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19, and stated that institutions generally do not need to categorize COVID-19-related modifications as TDRs and that the agencies will not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as TDRs.
•On April 9, 2020, the Federal Reserve announced additional measures aimed at supporting small and midsized business, as well as state and local governments impacted by COVID-19. The Federal Reserve announced the Main Street Business Lending Program, which establishes three new loan facilities intended to facilitate lending to small and midsized businesses: (1) the Main Street New Loan Facility (“MSNLF”), (2) the Main Street Priority Loan Facility (“MSPLF”), and (3) the Main Street Expanded Loan Facility (“MSELF”). MSNLF and MSPLF loans are unsecured term loans originated on or after April 24, 2020, while MSELF loans are provided as upsized tranches of existing loans originated before April 24, 2020. The combined size of the program is authorized up to $600 billion. The Company is currently participating in all three loan facilities established by the Main Street Business Lending Program.
•In addition to the policy responses described above, the federal bank regulatory agencies, along with their state counterparts, have issued a stream of guidance in response to the COVID-19 pandemic and have taken a number of unprecedented steps to help banks navigate the pandemic and mitigate its impact. These include, without limitation: requiring banks to focus on business continuity and pandemic planning; adding pandemic scenarios to stress testing; encouraging bank use of capital buffers and reserves in lending programs; permitting certain regulatory reporting extensions; reducing margin requirements on swaps; permitting certain otherwise prohibited investments in investment funds; issuing guidance to encourage banks to work with customers affected by the pandemic and encourage loan workouts; and providing credit under the Community Reinvestment Act (“CRA”) for certain pandemic-related loans, investments and public service. Moreover, because of the need for social distancing measures, the agencies revamped the manner in which they conducted periodic examinations of their regulated institutions, including making greater use of off-site reviews. The Federal Reserve also issued guidance encouraging banking institutions to utilize its discount window for loans and intraday credit extended by its Reserve Banks to help households and businesses impacted by the pandemic and announced numerous funding facilities. The FDIC has also acted to mitigate the deposit insurance assessment effects of participating in the PPP and the Federal Reserve’s PPP Liquidity Facility and Money Market Mutual Fund Liquidity Facility.
•On August 3, 2020, the FFIEC issued a joint statement on Additional Loan Accommodations Related to COVID-19, which, among other things, encouraged financial institutions to consider prudent additional loan accommodation options when borrowers are unable to meet their obligations due to continuing financial challenges. Accommodation options should be based on prudent risk management and consumer protection principles.

Effects on Our Business. We currently expect that the COVID-19 pandemic and the specific developments referred to above will have a significant impact on our business. In particular, we anticipate that a significant portion of the Bank’s borrowers in the restaurant and hospitality industries will continue to endure significant economic distress, which has caused, and will continue to cause, them to draw on their existing lines of credit and adversely affect their ability and willingness to repay existing indebtedness, and is expected to adversely impact the value of collateral. These developments, together with economic conditions generally, are also expected to impact our commercial real estate portfolio, particularly with respect to real estate with exposure to these industries and the value of certain collateral securing our loans. See “Part II-Item 1A. Risk Factors” for additional information regarding the effects and risks of the COVID-19 pandemic to our business, financial condition and results of operations.
Level One's Response to the COVID-19 Pandemic. Level One has taken comprehensive steps to help our customers, team members and communities during the current COVID-19 pandemic health crisis. For our customers, we have provided loan payment deferrals and offered fee waivers, among other actions. Through September 30, 2020, we have helped our consumer and small business customers by deferring loan payments and waiving fees on $416.3 million of non-PPP loans ($388.9 million of commercial balances and $27.4 million of consumer balances). As of September 30, 2020, we had $16.3 million of loans that had an outstanding payment deferral.
We are continuing to enable the vast majority of our main office team members to work remotely each day. We have also taken significant actions to help ensure the safety of our team members whose roles require them to come into the office, which include the development, implementation and communication of a comprehensive return to office plan. In addition, while our
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branches have fully opened to serve our clients, we continue to be diligent in our efforts to follow all CDC guidelines to ensure the health and safety of our clients and team members. We will continue to evaluate this fluid situation and take additional actions as necessary.
To support our communities, we have made charitable donations, including one to a local health system, in order to help support the frontline workers impacted by the COVID-19 pandemic.
Level One also recognizes that some of the most impacted industries are the food service and hospitality industries. As of September 30, 2020, Level One had less than 4.4% and 0.5% of loan concentrations in the food service and hospitality industries, respectively.
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Selected Financial Data - Unaudited
As of and for the three months ended As of and for the nine months ended
(Dollars in thousands, except per share data)September 30, 2020June 30,
2020		September 30, 2019September 30, 2020September 30, 2019
Earnings Summary
Interest income$20,245 $20,396 $17,983 $60,458 $53,082 
Interest expense3,648 4,163 4,995 12,808 14,935 
Net interest income16,597 16,233 12,988 47,650 38,147 
Provision expense (benefit) for loan losses4,270 5,575 (16)10,334 835 
Noninterest income9,125 7,789 3,858 21,604 9,621 
Noninterest expense15,126 15,083 11,539 44,771 33,074 
Income before income taxes6,326 3,364 5,323 14,149 13,859 
Income tax provision1,117 643 914 2,109 2,428 
Net income5,209 2,721 4,409 12,040 11,431 
Net income allocated to participating securities40 19 45 140 110 
Net income attributable to common shareholders$5,169 $2,702 $4,364 $11,900 $11,321 
Per Share Data
Basic earnings per common share$0.68 $0.35 $0.57 $1.56 $1.48 
Diluted earnings per common share0.67 0.35 0.56 1.55 1.46 
Diluted earnings per common share, excluding acquisition and due diligence fees (1)
0.67 0.37 0.60 1.72 1.50 
Book value per common share24.06 23.31 21.77 27.08 21.77 
Tangible book value per common share (1)
18.74 18.09 20.51 18.74 20.51 
Preferred shares outstanding (in thousands)10 — — 10 — 
Common shares outstanding (in thousands)7,734 7,734 7,714 7,734 7,714 
Average basic common shares (in thousands)7,675 7,676 7,721 7,640 7,738 
Average diluted common shares (in thousands)7,712 7,721 7,752 7,701 7,776 
Selected Period End Balances
Total assets$2,446,447 $2,541,696 $1,509,463 $2,446,447 $1,509,463 
Securities available-for-sale253,527 217,172 205,242 253,527 205,242 
Total loans1,843,888 1,815,353 1,168,923 1,843,888 1,168,923 
Total deposits1,943,435 1,821,351 1,194,542 1,943,435 1,194,542 
Total liabilities2,236,979 2,361,437 1,341,495 2,236,979 1,341,495 
Total shareholders' equity209,468 180,259 167,968 209,468 167,968 
Total common shareholders' equity186,098 180,259 167,968 186,098 167,968 
Tangible common shareholders' equity (1)
144,963 139,913 158,250 144,963 158,250 
Performance and Capital Ratios
Return on average assets0.83 %0.46 %1.16 %0.71 %1.02 %
Return on average equity10.48 6.02 10.58 8.68 9.51 
Net interest margin (fully taxable equivalent) (2)
2.80 2.98 3.59 3.04 3.61 
Efficiency ratio (noninterest expense/net interest income plus noninterest income)58.81 62.79 68.50 64.65 69.24 
Dividend payout ratio7.41 14.22 7.03 8.99 7.45 
Total shareholders' equity to total assets8.56 7.09 11.13 8.56 11.13 
Tangible common equity to tangible assets (1)
6.03 5.59 10.55 6.03 10.55 
Common equity tier 1 to risk-weighted assets8.83 8.76 11.73 8.83 11.73 
Tier 1 capital to risk-weighted assets10.31 8.76 11.73 10.31 11.73 
Total capital to risk-weighted assets14.39 12.81 13.84 14.39 13.84 
Tier 1 capital to average assets (leverage ratio)7.17 6.21 10.12 7.17 10.12 
Asset Quality Ratios:
Net charge-offs to average loans0.02 %0.34 %0.01 %0.14 %0.03 %
Nonperforming assets as a percentage of total assets0.79 0.33 0.78 0.79 0.78 
Nonaccrual loans as a percent of total loans1.04 0.46 0.98 1.04 0.98 
Allowance for loan losses as a percentage of total loans1.15 0.94 1.05 1.15 1.05 
Allowance for loan losses as a percentage of nonaccrual loans110.32 206.37 107.46 110.32 107.46 
Allowance for loan losses as a percentage of nonaccrual loans, excluding allowance allocated to loans accounted for under ASC 310-30105.46 195.04 100.52 105.46 100.52 
(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.

GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures
Some of the financial measures included in this report are not measures of financial condition or performance recognized by GAAP. These non-GAAP financial measures include tangible common shareholders' equity, tangible book value per common share and the ratio of tangible common equity to tangible assets, net income and diluted earnings per common share excluding acquisition and due diligence fees as well as allowance for loan loss as a percentage of total loans excluding PPP loans. Our management uses these non-GAAP financial measures in its analysis of our performance, and we believe that providing this information to financial analysts and investors allows them to evaluate capital adequacy, as well as better understand and evaluate the Company’s core financial results for the periods in question.
The following presents these non-GAAP financial measures along with their most directly comparable financial measures calculated in accordance with GAAP:
Tangible Common Shareholders' Equity, Tangible Common Equity to Tangible Assets Ratio and Tangible Book Value Per Share
As of
(Dollars in thousands, except per share data)September 30,
2020		June 30,
2020		September 30,
2019
(Unaudited)(Unaudited)(Unaudited)
Total shareholders' equity$209,468 $180,259 $167,968 
Less:
Preferred stock23,370 — — 
Total common shareholders' equity186,098 180,259 167,968 
Less:
Goodwill35,554 35,554 9,387 
Other intangible assets, net5,581 4,792 331 
Tangible common shareholders' equity$144,963 $139,913 $158,250 
Common shares outstanding (in thousands)7,734 7,734 7,714 
Tangible book value per common share$18.74 $18.09 $20.51 
Total assets$2,446,447 $2,541,696 $1,509,463 
Less:
Goodwill35,554 35,554 9,387 
Other intangible assets, net5,581 4,792 331 
Tangible assets$2,405,312 $2,501,350 $1,499,745 
Tangible common equity to tangible assets6.03 %5.59 %10.55 %


Adjusted Income and Diluted Earnings Per Share
For the three months endedFor the nine months ended
(Dollars in thousands, except per share data)September 30,
2020		June 30,
2020		September 30,
2019		September 30,
2020		September 30,
2019
(Unaudited)(Unaudited)(Unaudited)(Unaudited)(Unaudited)
Net income, as reported$5,209 $2,721 4,409 $12,040 11,431 
Acquisition and due diligence fees17 176 319 1,664 319 
Income tax benefit (1)
(4)(34)(25)(333)(25)
Net income, excluding acquisition and due diligence fees$5,222 $2,863 4,703 $13,371 11,725 
Diluted earnings per share, as reported$0.67 $0.35 $0.56 $1.55 $1.46 
Effect of acquisition and due diligence fees, net of income tax benefit0.00 0.02 0.04 0.17 0.04 
Diluted earnings per common share, excluding acquisition and due diligence fees$0.67 $0.37 $0.60 $1.72 $1.50 
(1) Assumes income tax rate of 21% on deductible acquisition expenses.
Allowance for Loan Loss as a Percentage of Total Loans, Excluding PPP Loans
As of
(Dollars in thousands, except per share data)September 30,
2020		June 30,
2020		September 30, 2019
(Unaudited)(Unaudited)(Unaudited)
Total loans$1,843,888 $1,815,353 $1,168,923 
Less:
PPP loans392,521 388,264 — 
Total loans, excluding PPP loans$1,451,367 $1,427,089 $1,168,923 
Allowance for loan loss21,254 17,063 12,307 
Allowance for loan loss as a percentage of total loans1.15 %0.94 %1.05 %
Allowance for loan loss as a percentage of total loans excluding PPP loans1.46 %1.20 %1.05 %
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Results of Operations
Net Income
We had net income of $5.2 million, or $0.67 per diluted common share, for the three months ended September 30, 2020, compared to $4.4 million, or $0.56 per diluted common share, for the three months ended September 30, 2019. The increase of $800 thousand in net income reflected increases of $5.3 million in noninterest income, primarily as a result of higher mortgage banking income, and $3.6 million in net interest income due to higher interest income on loans and lower interest expense on deposits year over year. This was partially offset by increases of $4.3 million in provision for loan losses as a result of the economic factors relating to COVID-19 and $3.6 million in noninterest expense mainly as a result of higher salary and employee benefits.
We had net income of $12.0 million, or $1.55 per diluted common share, for the nine months ended September 30, 2020, compared to $11.4 million, or $1.46 per diluted common share, for the nine months ended September 30, 2019. The increase of $609 thousand in net income primarily reflected increases of $12.0 million in noninterest income and $9.5 million in net interest income and a decrease of $319 thousand in income tax provision. The factors contributing to the increases in noninterest income and net interest income year over year are noted above. This was partially offset by increases of $11.7 million in noninterest expense, primarily due to higher salary and employee benefits as well as increase acquisition and due diligence fees, and $9.5 million in provision for loan losses due to the same factors discussed above.
Net Interest Income
Our primary source of revenue is net interest income, which is the difference between interest income from interest-earning assets (primarily loans and securities) and interest expense of funding sources (primarily interest-bearing deposits and borrowings).
Net interest income of $16.6 million in the third quarter of 2020 was $3.6 million higher than net interest income of $13.0 million in the third quarter of 2019. The three months ended September 30, 2020 included a $2.3 million increase in interest income as well as a $1.3 million decrease in interest expense, compared to the same period in 2019. The increase in interest income was primarily driven by increases of $2.6 million in interest and fees on loans partially offset by a decrease of $180 thousand in interest on investment securities. The increase in interest and fees on loans for the three months ended September 30, 2020 compared to the same period in 2019 was mainly driven by an increase of $688.4 million in the average balance of loans primarily as a result of the origination of $392.5 million of PPP loans and the acquisition of Ann Arbor State Bank. In the third quarter of 2020, the Bank earned $1.5 million of the total projected $12.1 million net SBA fees on PPP loans, with the remaining expected to be earned over the life of the loans, the majority of which are expected to mature two years from the date of funding unless modified by the lender and borrower. In addition to the net SBA fees, the Bank also recognized $1.0 million of interest income on the PPP loans. The decrease in interest on investment securities was mainly due to lower average interest rates. The decrease in interest expense was primarily driven by a decrease of $2.2 million in interest expense on deposits partially offset by increases of $432 thousand of interest expense on borrowed funds and $376 thousand of interest expense on subordinated notes. The decrease in deposit interest expense during the three months ended September 30, 2020 compared to 2019 was primarily due to lower interest rates paid as a result of revised internal deposit rates, mainly driven by the decreases in the target federal funds interest rate of 150 basis points during first quarter of 2020 and 25 basis points in each of August, September and October of 2019. The increase in interest expense on subordinated notes was primarily due to the issuance of $30.0 million of subordinated debt in the fourth quarter of 2019. The increase in interest expense on borrowings was mainly driven by an increase of $323.3 million in the average balance of borrowings primarily as a result of funding PPP loans through FRB borrowings.
Net interest income of $47.7 million for the nine months ended September 30, 2020 was $9.4 million higher than the net interest income of $38.1 million for the nine months ended September 30, 2019. The nine months ended September 30, 2020 included a $7.4 million increase in interest income as well as a $2.0 million decrease in interest expense, compared to the same period in 2019. The increase in interest income was primarily driven by increases of $8.3 million in interest and fees on loans partially offset by a decrease of $677 thousand in interest on investment securities. The increase in interest and fees on loans for the nine months ended September 30, 2020 compared to the same period in 2019 was mainly driven by an increase of $538.2 million in the average balance of loans primarily as result of the acquisition of Ann Arbor State Bank, as well as the origination of PPP loans. In the nine months ending September 30, 2020, the Bank earned $2.9 million of the total projected $12.1 million net SBA fees on PPP loans, with the remaining expected to be earned over the life of the loans, the majority of which are expected to mature two years from the date of funding unless modified by the lender and borrower. In addition to the net SBA fees, the Bank also recognized $1.8 million of interest income on the PPP loans. The decrease in interest income on investment securities was mainly due to lower average interest rates. The decrease in interest expense was primarily driven by a decrease of $4.2 million in interest expense on deposits partially offset by increases of $1.1 million in interest expense on subordinated notes and $906 thousand in interest expense on borrowed funds. The increase in interest expense on borrowings was mainly
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driven by an increase of $249.0 million in the average balance of borrowings primarily as a result of higher FHLB borrowings as well as funding PPP loans through FRB borrowings. The increase in interest expense on subordinated notes was due to the same factors mentioned above.
Our net interest margin (on a fully tax equivalent basis ("FTE")) for the three months ended September 30, 2020 was 2.80%, compared to 3.59% for the same period in 2019. The decrease of 79 basis points in the net interest margin year over year was primarily a result of lower average loan yield as well as lower yields on interest earning cash balances. Average loan yield decreased to 3.98% for the third quarter of 2020, compared to 5.41% for the third quarter of 2019, primarily due to the target federal funds interest rate dropping 150 basis points in March 2020 in response to the COVID-19 pandemic and decreasing 25 basis points in each of August, September and October of 2019. Another contributing factor to the decrease in loan yields was the impact of the PPP loans originated during the second and third quarters of 2020, which had an average yield of 2.59%, net of deferred fees/costs, compared to the non-PPP loans which had an average yield of 4.35%. The decrease in loan yields was accompanied by a corresponding decrease in the cost of funds, which declined 110 basis points to 0.88% in the third quarter 2020 from 1.98% in the third quarter of 2019. Finally, during the third quarter of 2020, our average interest-earning cash balances of $259.3 million, of which the vast majority comprised of excess funding from the PPP process, earned 0.12%, which negatively affected the net interest margin. As a result of the reductions in the target federal funds interest rate, as well as the impact of the COVID-19 pandemic, we expect that our net interest income and net interest margin will decrease in future periods.
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 September 30, 2020 and 2019, the yield on total loans was impacted by 7 basis points and 15 basis points, respectively, due to the accretable yield on purchased credit impaired loans. Our net interest margin for the three months ended September 30, 2020 and 2019, benefited by 8 basis points and 13 basis points, respectively, as a result of the excess accretable yield. As of September 30, 2020 and December 31, 2019, our remaining accretable yield was $7.9 million and $9.1 million, respectively, and our nonaccretable difference was $2.7 million and $3.9 million, respectively.
Our net interest margin (FTE) for the nine months ended September 30, 2020 was 3.04%, compared to 3.61% for the same period in 2019. The decrease of 57 basis points reflected the lower average loan yield as well as lower average interest earning cash yield that is described above. For the nine months ended September 30, 2020 and 2019, the average yield on total loans was 4.40% and 5.49%, respectively. PPP loans had an average yield of 2.87%, net of deferred fees/costs, compared to the non-PPP loans which had an average yield of 4.62%. The yield on total loans was impacted by 7 basis points and 15 basis points, respectively due to the accretable yield on purchased credit impaired loans. Our net interest margin for the nine months ended September 30, 2020 and 2019, benefited by 9 basis points and 12 basis points, respectively, as a result of the excess accretable yield.
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The following table sets forth information related to our average balance sheet, average yields on assets, and average rates on liabilities for the periods indicated. We derived these yields by dividing income or expense by the average daily balance of the corresponding assets or liabilities. In this table, adjustments were made to the yields on tax-exempt assets in order to present tax-exempt income and fully taxable income on a comparable basis.
Analysis of Net Interest Income—Fully Taxable Equivalent
 For the three months ended September 30,
 20202019
(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)
$1,871,164 $18,730 3.98 %$1,182,764 $16,134 5.41 %
Investment securities(4):
Taxable139,237 652 1.86 121,473 857 2.80 
Tax-exempt94,526 613 3.19 85,332 588 3.28 
Interest-earning cash balances259,349 76 0.12 51,142 289 2.24 
Other investments12,419 174 5.57 8,325 115 5.48 
Total interest-earning assets$2,376,695 $20,245 3.41 %$1,449,036 $17,983 4.96 %
Non-earning assets:
Cash and due from banks27,571 23,103 
Premises and equipment15,791 13,228 
Goodwill35,554 9,387 
Other intangible assets, net4,980 347 
Bank-owned life insurance18,006 12,023 
Allowance for loan losses(17,321)(12,241)
Other non-earning assets55,899 27,145 
Total assets$2,517,175 $1,522,028 
Interest-bearing liabilities:
Deposits:
Interest-bearing demand deposits$116,285 $65 0.22 %$51,963 $63 0.48 %
Money market and savings deposits513,420 556 0.43 320,363 1,170 1.45 
Time deposits575,179 1,702 1.18 543,765 3,245 2.37 
Borrowings394,020 693 0.70 70,766 261 1.46 
Subordinated notes44,468 632 5.65 14,925 256 6.81 
Total interest-bearing liabilities$1,643,372 $3,648 0.88 %$1,001,782 $4,995 1.98 %
Noninterest-bearing liabilities and shareholders' equity:
Noninterest-bearing demand deposits$640,095 $333,690 
Other liabilities34,846 19,804 
Shareholders' equity198,862 166,752 
Total liabilities and shareholders' equity$2,517,175 $1,522,028 
Net interest income$16,597 $12,988 
Interest spread2.53 %2.98 %
Net interest margin(5)
2.78 %3.56 %
Tax equivalent effect0.02 %0.03 %
Net interest margin on a fully tax equivalent basis2.80 %3.59 %
______________________________________________________________________
(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 $144 thousand and $118 thousand on tax-exempt securities for the three months ended September 30, 2020 and 2019, 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.
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For the nine months ended September 30,
20202019
(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)
$1,696,073 $55,817 4.40 %$1,157,837 $47,547 5.49 %
Investment securities(4):
Taxable124,169 1,930 2.08 135,460 2,773 2.74 
Tax-exempt97,104 1,894 3.20 84,476 1,728 3.28 
Interest-earning cash balances188,179 400 0.28 37,359 670 2.40 
Other investments12,401 417 4.49 8,325 364 5.85 
Total interest-earning assets$2,117,926 $60,458 3.84 %$1,423,457 $53,082 5.02 %
Non-earning assets:
Cash and due from banks26,264 24,075 
Premises and equipment16,195 13,252 
Goodwill35,894 9,387 
Other intangible assets, net4,420 383 
Bank-owned life insurance17,868 11,955 
Allowance for loan losses(14,387)(11,950)
Other non-earning assets47,714 18,642 
Total assets$2,251,894 $1,489,201 
Interest-bearing liabilities:
Deposits:
Interest-bearing demand deposits$112,579 $262 0.31 %$53,894 $180 0.45 %
Money market and savings deposits458,438 2,217 0.65 307,461 3,389 1.47 
Time deposits564,396 6,560 1.55 556,922 9,647 2.32 
Borrowings311,024 1,866 0.80 62,006 960 2.07 
Subordinated notes44,463 1,903 5.72 14,910 759 6.81 
Total interest-bearing liabilities$1,490,900 $12,808 1.15 %$995,193 $14,935 2.01 %
Noninterest-bearing liabilities and shareholders' equity:
Noninterest-bearing demand deposits$546,066 $316,754 
Other liabilities30,047 17,048 
Shareholders' equity184,881 160,206 
Total liabilities and shareholders' equity$2,251,894 $1,489,201 
Net interest income$47,650 $38,147 
Interest spread2.69 %3.01 %
Net interest margin(5)
3.01 %3.58 %
Tax equivalent effect0.03 %0.03 %
Net interest margin on a fully tax equivalent basis3.04 %3.61 %
(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 $431 thousand and $347 thousand on tax-exempt securities for the nine months ended September 30, 2020 and 2019, 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.




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Rate/Volume Analysis
The table below presents the effect of volume and rate changes on interest income and expense for the periods indicated. Changes in volume are changes in the average balance multiplied by the previous period's average rate. Changes in rate are changes in the average rate multiplied by the average balance from the previous period. The net changes attributable to the combined impact of both rate and volume have been allocated proportionately to the changes due to volume and the changes due to rate. The average rate for tax-exempt securities is reported on a fully taxable equivalent basis.
For the three months ended September 30, 2020 vs. 2019
Increase
(Decrease) Due to:
(Dollars in thousands)RateVolumeNet Increase (Decrease)
Interest-earning assets
Gross loans$(5,085)$7,681 $2,596 
Investment securities:
Taxable(317)112 (205)
Tax-exempt(49)74 25 
Interest-earning cash balances(486)273 (213)
Other investments59 — 59 
Total interest income(5,878)8,140 2,262 
Interest-bearing liabilities   
Interest-bearing demand deposits(47)49 2 
Money market and savings deposits(1,091)477 (614)
Time deposits(1,721)178 (1,543)
Borrowings(202)634 432 
Subordinated debt(52)428 376 
Total interest expense(3,113)1,766 (1,347)
Change in net interest income$(2,765)$6,374 $3,609 


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For the nine months ended September 30, 2020 vs. 2019
Increase
(Decrease) Due to:
(Dollars in thousands)RateVolumeNet Increase (Decrease)
Interest-earning assets
Gross loans$(10,773)$19,043 $8,270 
Investment securities:
Taxable(625)(218)(843)
Tax-exempt(137)303 166 
Interest-earning cash balances(1,016)746 (270)
Other investments(98)151 53 
Total interest income(12,649)20,025 7,376 
Interest-bearing liabilities
Interest-bearing demand deposits(68)150 82 
Money market and savings deposits(2,398)1,226 (1,172)
Time deposits(3,215)128 (3,087)
Borrowings(895)1,801 906 
Subordinated debt(138)1,282 1,144 
Total interest expense(6,714)4,587 (2,127)
Change in net interest income$(5,935)$15,438 $9,503 

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 September 30, 2020, and December 31, 2019, our remaining accretable yield was $7.9 million and $9.1 million, and our nonaccretable difference was $2.7 million and $3.9 million, respectively.
The provision for loan losses was a provision expense of $4.3 million for the three months ended September 30, 2020 compared to a $16 thousand provision benefit for the same period in 2019. The $4.3 million increase in the provision for loan losses was primarily a result of a $3.3 million increase in general reserves due to the uncertainty surrounding the impact of the COVID-19 pandemic on the loan portfolio as well as a $794 thousand increase in specific reserves.
The provision for loan losses was a provision expense of $10.3 million for the nine months ended September 30, 2020, compared to $835 thousand for the nine months ended September 30, 2019. The increase of $9.5 million in the provision for loan losses was primarily as a result of a $6.7 million increase in general reserves due to an adjustment of qualitative factors attributable to the COVID-19 pandemic during the second and third quarters of 2020. In addition, there was a $1.6 million increase in provision resulting primarily from a $1.3 million chargeoff during the second quarter of 2020 on a nonaccrual loan that was subsequently sold. Lastly, there was also a $782 thousand increase in specific reserves on loans individually evaluated
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for impairment. The Company will continue to monitor the impacts of the COVID-19 pandemic and will re-evaluate the appropriateness of the provision for loan losses in future quarters as needed.
Noninterest Income
The following table presents noninterest income for the three and nine months ended September 30, 2020 and 2019.
 For the three months ended September 30,For the nine months ended September 30,
(Dollars in thousands)2020201920202019
Noninterest income    
Service charges on deposits$616 $627 $1,798 $1,914 
Net gain on sales of securities434 151 1,862 151 
Mortgage banking activities7,108 2,352 15,380 5,788 
Other charges and fees967 728 2,564 1,768 
Total noninterest income$9,125 $3,858 $21,604 $9,621 
Noninterest income increased $5.2 million to $9.1 million for the three months ended September 30, 2020 compared to $3.9 million for the same period in 2019. The increase in noninterest income was primarily due to increases in mortgage banking activities of $4.8 million and net gains on sales of securities of $283 thousand. The increase in the mortgage banking activities was mainly attributable to $98.2 million higher residential loan originations held for sale and $66.9 million higher residential loans sold as a result of the lower interest rate environment during the third quarter of 2020. The increase in net gain on sales of securities was due to higher gains realized on securities sold in the third quarter of 2020 than those sold in the third quarter of 2019.
Noninterest income increased $12.0 million to $21.6 million for the nine months ended September 30, 2020, compared to $9.6 million for the same period in 2019. The increase in noninterest income was primarily due to increases in mortgage banking activities of $9.6 million, net gain on sales of securities of $1.7 million, as well as increases of $263 thousand net gain on sales of other real estate owned, $139 thousand in bank owned life insurance ("BOLI") interest income, and $118 thousand in interest rate swap fees (all included in "other charges and fees" in the table above). The increase in the mortgage banking activities was mainly attributable to $214.4 million higher residential loan originations held for sale and $189.8 million higher residential loans sold as a result of the lower interest rate environment in 2020. The increase in the net gain on sales of securities was attributable to the same factors mentioned above. The increase in net gains on sales of other real estate owned was due to the sale of four properties during the second and third quarters of 2020. The increase in BOLI interest income was due to an increase in bank owned life insurance attributable to the acquisition of Ann Arbor State Bank. The increase in interest rate swap fees was due to increased volumes of customer-initiated derivatives.
Noninterest Expense
The following table presents noninterest expense for the three and nine months ended September 30, 2020 and 2019.
 For the three months ended September 30,For the nine months ended September 30,
(Dollars in thousands)2020201920202019
Noninterest expense  
Salary and employee benefits$9,862 $7,536 $28,090 $21,642 
Occupancy and equipment expense1,678 1,203 4,773 3,575 
Professional service fees808 465 2,141 1,212 
Acquisition and due diligence fees17 319 1,664 319 
Marketing expense257 379 709 843 
Printing and supplies expense89 78 398 250 
Data processing expense844 661 2,601 1,862 
Core deposit premium amortization192 29 576 117 
Other expense1,379 869 3,819 3,254 
Total noninterest expense$15,126 $11,539 $44,771 $33,074 
Noninterest expense increased $3.6 million to $15.1 million for the three months ended September 30, 2020, as compared to $11.5 million for the same period in 2019. The increase in noninterest expense was primarily due to increases in salary and employee benefits of $2.3 million, occupancy and equipment expense of $475 thousand, FDIC premium expense of $417
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thousand (included in "other expense" in the table above), professional service fees of $343 thousand, data processing expense of $183 thousand, and core deposit premium amortization of $163 thousand. This was partially offset by a decrease in acquisition expense of $302 thousand. The increase in salary and employee benefits between the periods was primarily due to an increase of $1.6 million in mortgage commissions expense as well as an increase of 37 full-time equivalent employees, mainly attributable to the acquisition of Ann Arbor State Bank as well as organic growth. The increase in occupancy and equipment expense was primarily attributable to increased building rent and other expenses related to the addition of the three new branches acquired with Ann Arbor State Bank, as well as organic growth in the organization. The increase in FDIC premium expense was primarily due to the increase in assets related to the acquisition of Ann Arbor State Bank in addition to credits received during the third quarter of 2019. The increase in professional service fees was primarily related to increased residential mortgage volumes as well as increased legal fees. The increase in data processing expense was due to increased costs of loan systems. As a result of the acquisition, the Company recorded $3.7 million of core deposit premiums, leading to the increased amortization expense on core deposit intangibles compared to the same period in prior year. The decrease in acquisition and due diligence fees was primarily due to the majority of expenses related to the merger with Ann Arbor State Bank being incurred from the third quarter of 2019 to the first quarter of 2020.
Noninterest expense increased $11.7 million to $44.8 million for the nine months ended September 30, 2020, as compared to $33.1 million for the same period in 2019. The increase in noninterest expense was primarily due to increases in salary and employee benefits of $6.4 million, acquisition and due diligence fees of $1.3 million, occupancy and equipment expense of $1.2 million, professional service fees of $929 thousand, data processing expense of $739 thousand, FDIC premium expense of $525 thousand (included in "other expense" in the table above), and core deposit premium amortization of $459 thousand. The increase in salary and employee benefits between the periods was primarily due to an increase of $4.3 million in mortgage commissions expense as well as an increase of 30 full-time equivalent employees. The increase in acquisition and due diligence fees and core deposit premium amortization related to the merger with Ann Arbor State Bank, which closed on January 2, 2020. Acquisition and due diligence fees comprised of contract terminations, core system conversion, as well as severance and retention payments during the nine months ended September 30, 2020. The increase in occupancy and equipment expense, FDIC premium, professional service fees, and core deposit premiums were attributable to the same factors mentioned above. The increase in data processing expense was primarily attributable to the retention and maintenance of Ann Arbor State Bank legacy systems during the first quarter of 2020 prior to system integration, in addition to the organic growth in the organization.
Income Taxes and Tax-Related Items
During the three months ended September 30, 2020, we recognized income tax expense of $1.1 million on $6.3 million of pre-tax income resulting in an effective tax rate of 17.7% compared to the same period in 2019, in which we recognized an income tax expense of $914 thousand on $5.3 million of pre-tax income, resulting in an effective tax rate of 17.2%.
During the nine months ended September 30, 2020, we recognized income tax expense of $2.1 million on $14.1 million of pre-tax income resulting in an effective tax rate of 14.9%, compared to the same period in 2019, in which we recognized an income tax expense of $2.4 million on $13.9 million of pre-tax income, resulting in an effective tax rate of 17.5%. The decrease in income tax provision for the nine months ended September 30, 2020 compared to the same period in 2019 was primarily as a result of a $290 thousand tax benefit related to the Ann Arbor State Bank net operating loss (NOL) resulting from the CARES Act provision that allows for NOLs generated in 2018 to 2020 to be carried back five years. Additionally, disqualified dispositions of Ann Arbor State Bank’s stock options generated a $175 thousand tax benefit.
Refer to Note 9 - Income Taxes in the notes to the consolidated financial statements for a reconciliation between expected and actual income tax expense for the three and nine months ended September 30, 2020 and 2019.

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Financial Condition
Investment Securities
The following table presents the fair value of the Company's investment securities portfolio, all of which were classified as available-for-sale as of September 30, 2020 and December 31, 2019.
(Dollars in thousands)September 30, 2020December 31, 2019
Securities available-for-sale:  
U.S. government sponsored entities and agencies$27,199 $— 
State and political subdivision117,550 93,747 
Mortgage-backed securities: residential19,492 10,565 
Mortgage-backed securities: commercial8,655 8,779 
Collateralized mortgage obligations: residential14,333 8,529 
Collateralized mortgage obligations: commercial33,003 23,181 
U.S. Treasury1,003 1,999 
SBA18,808 21,984 
Asset backed securities9,954 10,084 
Corporate bonds3,530 2,037 
Total securities available-for-sale              $253,527 $180,905 
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 September 30, 2020, total investment securities were $253.5 million, or 10.4% of total assets, compared to $180.9 million, or 11.4% of total assets, at December 31, 2019. The $72.6 million increase in securities available-for-sale from December 31, 2019 to September 30, 2020, was primarily due to the acquisition of Ann Arbor State Bank, which contributed $47.4 million of investment securities as of January 2, 2020. In addition, we repositioned our investment portfolio through purchases of investment securities of $83.2 million and sales, calls, payoffs and maturities of investment securities of $52.4 million. Securities with a carrying value of $97.2 million and $27.3 million were pledged at September 30, 2020 and December 31, 2019, respectively, to secure borrowings, deposits and mortgage derivatives.
As of September 30, 2020, the Company held 66 tax-exempt state and local municipal securities totaling $48.9 million backed by the Michigan School Bond Loan Fund. Other than the aforementioned investments, at September 30, 2020 and December 31, 2019, 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 September 30, 2020 and December 31, 2019. 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.
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 September 30, 2020
 One year or lessOne to five yearsFive to ten yearsAfter 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$2,520 1.61 %$4,572 1.62 %$15,000 1.22 %$5,000 1.48 %
State and political subdivision2,267 2.08 9,942 2.39 29,081 2.87 68,208 3.18 
Mortgage-backed securities: residential— — 96 0.89 111 2.23 19,030 1.90 
Mortgage-backed securities: commercial858 1.38 3,943 2.45 1,412 2.63 1,812 3.64 
Collateralized mortgage obligations: residential— — 51 3.98 589 2.01 13,537 1.23 
Collateralized mortgage obligations: commercial1,005 1.51 8,926 3.08 13,678 1.66 8,050 2.44 
U.S. Treasury1,000 1.65 — — — — — — 
SBA— — — — 10,388 1.36 8,481 1.22 
Asset backed securities— — — — — — 10,298 0.89 
Corporate bonds3,491 3.09 — — — — — — 
Total securities available-for-sale$11,141 2.15 %$27,530 2.49 %$70,259 2.04 %$134,416 2.40 %
 December 31, 2019
 One year or lessOne to five yearsFive to ten yearsAfter 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:        
State and political subdivision$1,375 2.25 %$3,747 2.24 %$18,566 2.95 %$65,616 3.38 %
Mortgage-backed securities: residential— — 153 0.93 143 2.07 10,313 2.84 
Mortgage-backed securities: commercial431 0.99 4,874 2.27 1,435 2.65 1,827 3.64 
Collateralized mortgage obligations: residential— — — — 727 2.15 7,814 2.11 
Collateralized mortgage obligations: commercial— — 9,031 2.87 4,371 2.83 9,489 2.39 
U.S. Treasury— — 1,976 2.06 — — — — 
SBA— — — — 8,706 2.59 13,345 2.49 
Asset backed securities— — — — — — 10,390 2.59 
Corporate bonds1,006 2.44 1,024 4.43 — — — — 
Total securities available-for-sale$2,812 2.13 %$20,805 2.60 %$33,948 2.81 %$118,794 3.01 %
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. The PPP loans funded during the second and third quarters of 2020, which are guaranteed by the SBA, are reported within the commercial and industrial loan category.
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Residential real estate loans represent loans to consumers for the purchase or refinance of a residence. These loans are generally financed over a 15- to 30-year term and, in most cases, are extended to borrowers to finance their primary residence with both fixed-rate and adjustable-rate terms. Real estate construction loans are also offered to consumers who wish to build their own homes and are often structured to be converted to permanent loans at the end of the construction phase, which is typically twelve months. Residential real estate loans also include home equity loans and lines of credit that are secured by a first- or second-lien on the borrower's residence. Home equity lines of credit consist mainly of revolving lines of credit secured by residential real estate.
Consumer loans include loans made to individuals not secured by real estate, including loans secured by automobiles or watercraft, and personal unsecured loans.
The following table details our loan portfolio by loan type at the dates presented:
 As of September 30,As of December 31,
(Dollars in thousands)20202019201820172016
Commercial real estate:     
Non-owner occupied$460,708 $388,515 $367,671 $343,420 $322,354 
Owner occupied269,481 216,131 194,422 168,342 169,348 
Total commercial real estate730,189 604,646 562,093 511,762 491,702 
Commercial and industrial807,923 410,228 383,455 377,686 342,069 
Residential real estate304,088 211,839 180,018 144,439 118,730 
Consumer1,688 896 999 1,036 892 
Total loans$1,843,888 $1,227,609 $1,126,565 $1,034,923 $953,393 
Total loans were $1.84 billion at September 30, 2020, an increase of $616.3 million from December 31, 2019. The growth in our loan portfolio compared to December 31, 2019 was primarily due to $392.5 million of PPP loans that were originated during the second and third quarters of 2020. The acquisition of Ann Arbor State Bank also contributed $224.1 million of loans as of January 2, 2020. There was additional organic growth of $53.3 million during the first three quarters of 2020. The loan growth was partially offset by $53.6 million of runoff of acquired loans. 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 September 30, 2020, approximately 39.6% of our loans were commercial real estate, 43.8% were commercial and industrial, and 16.6% were residential real estate and consumer loans. The loan mix was affected by PPP loans, which fall into the commercial and industrial loan type.
We originate both fixed and adjustable rate residential real estate loans conforming to the underwriting guidelines of Fannie Mae and Freddie Mac, as well as home equity loans and lines of credit that are secured by first or junior liens. Most of our fixed rate residential loans, along with some of our adjustable rate mortgages, are sold to other financial institutions with which we have established a correspondent lending relationship. The Company established a direct relationship with Fannie Mae and began locking and selling loans to Fannie Mae with servicing retained during the third quarter of 2019. Refer to Note 7- Goodwill and Intangible Assets for further details on our mortgage servicing rights.











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Loan Maturity/Rate Sensitivity
The following table shows the contractual maturities of our loans as of September 30, 2020.
(Dollars in thousands)One year or
less		After one but
within five
years		After five
years		Total
September 30, 2020    
Commercial real estate$93,069 $435,324 $201,796 $730,189 
Commercial and industrial149,938 579,914 78,071 807,923 
Residential real estate9,175 7,907 287,006 304,088 
Consumer59 1,499 130 1,688 
Total loans$252,241 $1,024,644 $567,003 $1,843,888 
Sensitivity of loans to changes in interest rates:   
Fixed interest rates $905,028 $185,832  
Floating interest rates 119,616 381,171  
Total $1,024,644 $567,003  
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. In accordance with bank regulatory guidance, troubled debt restructurings do not include short-term modifications made on a good-faith basis in response to the COVID-19 pandemic to borrowers who were current prior to any relief.
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.
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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 September 30, 2020 compared to December 31, 2019 were as follows:
(Dollars in thousands)September 30, 2020December 31, 2019
Classified loans:  
Substandard$18,983 $20,569 
Doubtful5,086 1,838 
Total classified loans$24,069 $22,407 
Special mention37,560 17,292 
Total classified and criticized loans$61,629 $39,699 
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 September 30,As of December 31,
(Dollars in thousands)20202019201820172016
Nonaccrual loans     
Commercial real estate$7,022 $4,832 $5,927 $2,257 $147 
Commercial and industrial8,078 11,112 9,605 9,024 13,389 
Residential real estate4,151 2,569 2,915 2,767 1,498 
Consumer15 16 — — — 
Total nonaccrual loans(1)
19,266 18,529 18,447 14,048 15,034 
Other real estate owned— 921 — 652 258 
Total nonperforming assets19,266 19,450 18,447 14,700 15,292 
Performing troubled debt restructurings     
Commercial real estate— — — — 290 
Commercial and industrial550 547 568 961 1,018 
Residential real estate599 359 363 261 207 
Total performing troubled debt restructurings              1,149 906 931 1,222 1,515 
Total impaired assets, excluding ASC 310-30 loans$20,415 $20,356 $19,378 $15,922 $16,807 
Loans 90 days or more past due and still accruing$552 $157 $243 $440 $377 
______________________________________________________
(1)Nonaccrual loans include nonperforming troubled debt restructurings of $2.4 million, $3.0 million, $5.0 million, $6.4 million, and $5.8 million at the respective dates indicated above.
During the nine months ended September 30, 2020 and 2019, the Company recorded $144 thousand and $848 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 $6.1 million, $6.0 million, $7.9 million, $9.7 million, and $11.6 million at the respective dates indicated in the table above. The increase in purchase credit impaired loans as of September 30, 2020 compared to December 31, 2019 was due to the acquisition of Ann Arbor State Bank.
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Nonperforming assets decreased $184 thousand as of September 30, 2020 compared to December 31, 2019. The decrease in nonperforming assets was attributable to a decrease of $921 thousand in other real estate owned, partially offset by an increase of $737 thousand in nonaccrual loans. The decrease in other real estate owned assets was due to the sale of four properties totaling $2.1 million during the second and third quarters of 2020, which included the sale of a property related to a $1.0 million commercial loan relationship transferred from nonaccrual loans to other real estate owned during the first nine months of 2020. The increase in nonaccrual loans was primarily due to five commercial loan relationships and two residential loan relationships totaling $11.4 million moving to nonaccrual status, partially offset by the sale of a $7.9 million commercial loan relationship on nonaccrual status as well as the transfer of the $1.0 million commercial loan relationship from nonaccrual loans to other real estate owned during the second quarter of 2020.
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 real estate, and consumer loans that are not individually evaluated for impairment, begins with a process of estimating the probable incurred losses in the portfolio. These estimates are established based on our historical loss data. Additional allowance estimates for commercial and industrial and commercial real estate loans are based on internal credit risk ratings. Internal credit risk ratings are assigned to each business loan at the time of approval and are subjected to subsequent periodic reviews by
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senior management, at least annually or more frequently upon the occurrence of a circumstance that affects the credit risk of the loan.
The Company's current methodology on historical loss analysis incorporates and fully relies on the Company's own historical loss data. The historical loss estimates are established by loan type including commercial real estate, commercial and industrial, residential real estate, and consumer. In addition, consideration is given to the borrower’s rating for commercial and industrial and commercial real estate loans.
The following table presents, by loan type, the changes in the allowance for loan losses for the periods presented.
 For the three months ended September 30,For the nine months ended September 30,
(Dollars in thousands)2020201920202019
Balance at beginning of period$17,063 $12,353 $12,674 $11,566 
Loan charge-offs:
Commercial real estate— — — (74)
Commercial and industrial(10)(49)(1,729)(164)
Consumer(4)(34)(47)(48)
Total loan charge-offs(124)(83)(1,886)(286)
Recoveries of loans previously charged-off:
Commercial real estate12 5 12 6 
Commercial and industrial15 10 47 101 
Residential real estate10 12 51 55 
Consumer8 26 22 30 
Total loan recoveries45 53 132 192 
Net charge-offs(79)(30)(1,754)(94)
Provision expense for loan losses4,270 (16)10,334 835 
Balance at end of period$21,254 $12,307 $21,254 $12,307 
Allowance for loan losses as a percentage of period-end loans1.15 %1.05 %1.15 %1.05 %
Net charge-offs to average loans0.02 0.01 0.14 0.03 
Our allowance for loan losses was $21.3 million, or 1.15% of loans, at September 30, 2020 compared to $12.7 million, or 1.03% of loans, at December 31, 2019. As of September 30, 2020, the allowance for loan losses as a percentage of loans excluding PPP loans, was 1.46%. The $8.6 million increase in the allowance for loan losses since December 31, 2019 was primarily due to increases in general reserves related to a 25 basis point increase of the economic qualitative factors, reflecting the expected economic impact of the COVID-19 pandemic in the second quarter of 2020 as well as a 20-25 basis point increase of the qualitative factors in the third quarter of 2020 reflecting the uncertainty surrounding the impact of the COVID-19 pandemic on the loan portfolio.










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The following table presents, by loan type, the allocation of the allowance for loan losses at the dates presented.
(Dollars in thousands)Allocated
Allowance		Percentage of loans in each category
to total loans
September 30, 2020  
Balance at end of period applicable to: 
Commercial real estate$9,819 39.6 %
Commercial and industrial8,180 43.8 
Residential real estate3,246 16.5 
Consumer9 0.1 
Total loans$21,254 100.0 %
December 31, 2019
Balance at end of period applicable to:
Commercial real estate$5,773 49.2 %
Commercial and industrial5,515 33.4 
Residential real estate1,384 17.3 
Consumer2 0.1 
Total loans$12,674 100.0 %
December 31, 2018
Balance at end of period applicable to:
Commercial real estate$5,227 49.9 %
Commercial and industrial5,174 34.0 
Residential real estate1,164 16.0 
Consumer1 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 industrial5,903 36.5 
Residential real estate950 14.0 
Consumer8 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 industrial5,932 35.9 
Residential real estate1,030 12.5 
Consumer3 0.1 
Total loans$11,089 100.0 %
Goodwill
The Company has acquired three banks, Lotus Bank in March 2015, Bank of Michigan in March 2016, and Ann Arbor State Bank in January 2020, which resulted in the recognition of goodwill. Total goodwill was $35.6 million at September 30, 2020 and $9.4 million at December 31, 2019.
As a result of the unprecedented decline in economic conditions triggered by the COVID-19 pandemic, the market valuations, including our stock price, saw a significant decline in March 2020, which then continued into second quarter of 2020. These events indicated that goodwill may be impaired and resulted in us performing a qualitative goodwill impairment assessment in the second quarter of 2020. As a result of the analysis, we concluded that it was more-likely-than-not that the fair value of the reporting unit could be greater than its carrying amount.
Since the price of our stock did not fully recover during the third quarter of 2020, the Company decided to engage a reputable, third-party valuation firm to perform a quantitative analysis of goodwill as of August 31, 2020 ("the valuation date").
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In deriving at the fair value of the reporting unit (the Bank), the third-party firm assessed general economic conditions and outlook; industry and market considerations and outlook; the impact of recent events to financial performance; the market price of our common stock; and other relevant events. In addition, the valuation relied on financial projections through 2023 and growth rates prepared by management. Based on the valuation prepared, it was determined that the Company's estimated fair value of the reporting unit at August 31, 2020 was greater than its book value and impairment of goodwill was not required.

Furthermore, management noted that despite the market capitalization declining from December 2019 to September 2020 as a result of the COVID-19 pandemic, the Bank’s financial performance has remained positive. This is evidenced by the strong financial indicators for the Bank, solid credit quality ratios, as well as the strong capital position of the Bank. In addition, third quarter 2020 revenue reflected significant and continuing growth in our residential mortgage banking business, as well as net SBA fees related to PPP loans funded during second and third quarters of 2020. Management concurred with the conclusion derived from the quantitative goodwill analysis as of August 31, 2020 and determined that there were no material changes between the valuation date and September 30, 2020. As such, management concluded that it more likely than not that there was no goodwill impairment as of September 30, 2020.
Deposits
Total deposits were $1.94 billion at September 30, 2020 and $1.14 billion at December 31, 2019, representing 86.9% and 80.3% of total liabilities, respectively. The increase in deposits of $808.0 million was comprised of increases of $359.4 million in demand deposits, $281.6 million in money market and savings deposits and $167.1 million in time deposits. The increase in deposits was primarily due to $543.2 million of organic deposit growth during the nine months ended September 30, 2020 mainly as a result of PPP loan funds deposited into customer accounts. In addition, the acquisition of Ann Arbor State Bank in first quarter of 2020 contributed $264.8 million in deposits.
Our average interest-bearing deposit costs were 1.06% and 1.92% for the nine months ended September 30, 2020 and 2019, respectively. The decrease in interest-bearing deposit costs between the two periods was impacted by the changing mix of deposit types, as well as by the decrease in overnight market rates, as measured by the target federal funds interest rate. The target federal funds interest rate decreased 25 basis points in each of August, September and October of 2019 and decreased 150 basis points during March 2020.
Brokered deposits.    Brokered deposits are marketed through national brokerage firms to their customers in $1,000 increments. For these brokered deposits, detailed records of owners are maintained 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 September 30, 2020 and December 31, 2019, the Company had approximately $54.4 million and $67.4 million of brokered deposits, 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."
Included in the brokered deposits total at December 31, 2019 was $514 thousand in Certificate of Deposit Account Registry Service ("CDARS") customer deposit accounts due to an early withdrawal from a CDARS customer deposit account in the first quarter of 2018 that was paid at maturity.
Management understands the importance of core deposits as a stable source of funding and may periodically implement various deposit promotion strategies to encourage core deposit growth. For periods of rising interest rates, management has modeled the aggregate yields for non-maturity deposits and time deposits to increase at a slower pace than the increase in underlying market rates, which is intended to result in net interest margin expansion and an increase in net interest income.
The following table sets forth the distribution of average deposits by account type for the periods indicated below.
Three Months Ended September 30, 2020
(Dollars in thousands)Average
Balance		PercentAverage
Rate
Noninterest-bearing demand deposits$640,095 34.6 %— %
Interest-bearing demand deposits116,285 6.3 0.22 
Money market and savings deposits513,420 27.8 0.43 
Time deposits575,179 31.3 1.18 
Total deposits$1,844,979 100.0 %0.50 %
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Nine Months Ended September 30, 2020
(Dollars in thousands)Average
Balance		PercentAverage
Rate
Noninterest-bearing demand deposits$546,066 32.5 %— %
Interest-bearing demand deposits112,579 6.7 0.31 
Money market and savings deposits458,438 27.3 0.65 
Time deposits564,396 33.5 1.55 
Total deposits$1,681,479 100.0 %0.72 %

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)September 30, 2020
Maturing in: 
3 months or less$5,232 
3 months to 6 months140,383 
6 months to 1 year130,872 
1 year or greater243,354 
Total$519,841 
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Borrowings
Total debt outstanding at September 30, 2020 was $261.4 million, an increase of $4.6 million from $256.7 million at December 31, 2019. The increase in total borrowings was primarily due to increases of $34.1 million in FRB borrowings to help facilitate the funding of PPP loans, and $36.2 million in long-term FHLB advances, partially offset by decreases of $60.0 million in short-term FHLB advances, $5.0 million in federal funds purchased and $664 thousand in securities sold under agreements to repurchase.
At September 30, 2020, the Company had $34.1 million of debt outstanding with the Federal Reserve Bank under the PPP Liquidity Facility. The FRB borrowings bear a 0.35% fixed interest rate and mature two years after the origination date of the respective PPP loans that have been pledged to secure them.
At September 30, 2020, FHLB advances were secured by a blanket lien on $510.6 million of real estate-related loans, and repurchase agreements were secured by securities with a fair value of $1.9 million. At December 31, 2019, FHLB advances were secured by a blanket lien on $408.9 million of real estate-related loans, and repurchase agreements were secured by securities with a fair value of $1.5 million.
As of September 30, 2020, the Company had $45.0 million of subordinated notes outstanding and debt issuance costs of $445 thousand related to these subordinated notes. As of December 31, 2019, the Company had $45.0 million of subordinated notes outstanding and debt issuance costs of $560 thousand related to these subordinated notes.
The $15.0 million of subordinated notes issued on December 21, 2015 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 $30.0 million of subordinated notes issued on December 18, 2019 bear a fixed interest rate of 4.75% per annum, payable semiannually through December 18, 2024. The notes will bear a floating interest rate of three-month secured overnight financing rate (SOFR) plus 311 basis points payable quarterly after December 18, 2024 through maturity. The notes mature no later than December 18, 2029, and the Company has the option to redeem any or all of the subordinated notes without premium or penalty any time after December 18, 2024 or upon the occurrence of a Tier 2 capital event or tax event. The issuance of the $30.0 million subordinated notes reflected management's efforts to fund the liquidity needs of the Company as well as pay the merger consideration to purchase Ann Arbor State Bank.
















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Selected financial information pertaining to the components of our short-term borrowings for the periods and as of the dates indicated is as follows:
 For the three months ended September 30,For the nine months ended September 30,
(Dollars in thousands)2020201920202019
Securities sold under agreements to repurchase  
Average daily balance$163 $563 $330 $537 
Weighted-average rate during period0.30 %0.30 %0.30 %0.30 %
Amount outstanding at period end$187 $545 $187 $545 
Weighted-average rate at period end0.30 %0.30 %0.30 %0.30 %
Maximum month-end balance$187 $866 $936 $866 
FHLB Advances
Average daily balance$— $6,630 $5,456 $27,903 
Weighted-average rate during period— %2.57 %0.99 %2.49 %
Amount outstanding at period end$— $— $— $— 
Weighted-average rate at period end— %— %— %— %
Maximum month-end balance$— $— $25,000 $95,000 
FHLB Line of Credit
Average daily balance$63 $— $60 $111 
Weighted-average rate during period— %— %1.29 %2.92 %
Amount outstanding at period end$— $— $— $— 
Weighted-average rate at period end— %— %— %— %
Maximum month-end balance$— $— $— $895 
Federal funds purchased
Average daily balance$— $109 $193 $2,044 
Weighted-average rate during period— %— %2.73 %2.74 %
Amount outstanding at period end$— $10,000 $— $10,000 
Weighted-average rate at period end— %1.90 %— %1.90 %
Maximum month-end balance$— $10,000 $— $15,000 

Capital Resources
Shareholders' equity is influenced primarily by earnings, dividends, the Company's sales and repurchases of its common stock and changes in accumulated other comprehensive income caused primarily by fluctuations in unrealized gains or losses, net of taxes, on available for sale securities.
Shareholders' equity increased $38.8 million to $209.5 million at September 30, 2020 as compared to $170.7 million at December 31, 2019. The increase in shareholders' equity was primarily impacted by $23.4 million from the issuance of preferred stock as well as $12.0 million of net income generated during the nine months ended September 30, 2020 and an increase of $4.5 million of other comprehensive income due to increases in net unrealized gains on available-for-sale securities, partially offset by $1.2 million of dividends declared on our common stock and $620 thousand of stock repurchased through the share buyback program during the nine months ended September 30, 2020.
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The following table summarizes the changes in our shareholders' equity for the periods indicated below:
 For the three months ended September 30,For the nine months ended September 30,
(Dollars in thousands)2020201920202019
Balance at beginning of period$180,259 $162,867 $170,703 $151,760 
Net income5,209 4,409 12,040 11,431 
Other comprehensive income 783 1,238 4,451 7,120 
Preferred stock offering, net of issuance costs23,370 — 23,370 — 
Redeemed stock— (488)(620)(2,108)
Common stock dividends declared(387)(310)(1,160)(928)
Exercise of stock options— 63 95 219 
Stock-based compensation expense234 189 589 474 
Balance at end of period$209,468 $167,968 $209,468 $167,968 
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.
A capital conservation buffer, comprised of common equity tier 1 capital, is established above the regulatory minimum capital requirements, and financial institutions that maintain a capital conservation buffer greater than 2.5% are generally not subject to the additional restrictions on dividends, share repurchases and discretionary bonus payments to executive officers under the Basel III Rule.
At September 30, 2020 and December 31, 2019, the Bank's capital ratios were in excess of the requirement to be "well capitalized" under the regulatory framework for prompt corrective action.


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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
September 30, 2020   
Common equity tier 1 to risk-weighted assets:   
Consolidated8.83 %4.50 %7.00 %
Bank11.23 %4.50 %7.00 %6.50 %
Tier 1 capital to risk-weighted assets: 
Consolidated10.31 %6.00 %8.50 %
Bank11.23 %6.00 %8.50 %8.00 %
Total capital to risk-weighted assets: 
Consolidated14.39 %8.00 %10.50 %
Bank12.48 %8.00 %10.50 %10.00 %
Tier 1 capital to average assets (leverage ratio): 
Consolidated7.17 %4.00 %4.00 %
Bank7.83 %4.00 %4.00 %5.00 %
December 31, 2019    
Common equity tier 1 to risk-weighted assets:    
Consolidated11.72 %4.50 %7.00 %
Bank12.27 %4.50 %7.00 %6.50 %
Tier 1 capital to risk-weighted assets: 
Consolidated11.72 %6.00 %8.50 %
Bank12.27 %6.00 %8.50 %8.00 %
Total capital to risk-weighted assets: 
Consolidated15.99 %8.00 %10.50 %
Bank13.24 %8.00 %10.50 %10.00 %
Tier 1 capital to average assets (leverage ratio): 
Consolidated10.41 %4.00 %4.00 %
Bank10.96 %4.00 %4.00 %5.00 %
_______________________________________________________________________________
(1) Reflects the capital conservation buffer of 2.5%.
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Contractual Obligations
In the ordinary course of our operations, we enter into certain contractual obligations. Total contractual obligations at September 30, 2020 were $873.4 million, an increase of $173.1 million, from $700.3 million at December 31, 2019. The increase of $173.1 million was primarily due to increases of $167.1 million in time deposits, $36.2 million in long-term FHLB advances, $34.1 million in FRB borrowings under the Paycheck Protection Program Liquidity Facility ("PPPLF"), and $1.4 million in operating lease obligations, partially offset by a decrease of $65.7 million in short-term borrowings.
The following tables present our contractual obligations as of September 30, 2020 and December 31, 2019.The $34.1 million of FRB borrowings under PPPLF mature two years after the origination date of the respective PPP loans that have been pledged to secure them.
 Contractual Maturities as of September 30, 2020
(Dollars in thousands)Less Than
One Year		One to
Three Years		Three to
Five Years		Over
Five Years		Total
Operating lease obligations$1,739 $3,507 $2,613 $4,074 $11,933 
Short-term borrowings187 — — — 187 
Long-term borrowings3,202 51,420 32,000 130,000 216,622 
Subordinated notes— — — 44,555 44,555 
Time deposits444,662 150,575 4,905 — 600,142 
Total$449,790 $205,502 $39,518 $178,629 $873,439 
 Contractual Maturities as of December 31, 2019
(Dollars in thousands)Less Than
One Year		One to
Three Years		Three to
Five Years		Over
Five Years		Total
Operating lease obligations$1,341 $2,351 $2,149 $4,736 $10,577 
Short-term borrowings65,851 — — — 65,851 
Long-term borrowings— 11,375 30,000 105,000 146,375 
Subordinated notes— — — 44,440 44,440 
Time deposits392,839 39,855 378 — 433,072 
Total$460,031 $53,581 $32,527 $154,176 $700,315 

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 September 30, 2020, the allowance for off-balance sheet risk was $498 thousand, compared to $318 thousand at December 31, 2019, and was included in "Other liabilities" on our consolidated balance sheets.
A summary of the contractual amounts of our exposure to off-balance sheet risk is as follows.
 September 30, 2020December 31, 2019
(Dollars in thousands)Fixed RateVariable RateFixed RateVariable Rate
Commitments to make loans$5,302 $5,295 $16,276 $20,128 
Unused lines of credit30,496 361,749 28,723 288,086 
Unused standby letters of credit and commercial letters of credit3,705 2,028 4,895 — 
Of the total unused lines of credit of $392.2 million at September 30, 2020, $49.2 million was comprised of undisbursed construction loan commitments. The Company expects to have sufficient access to liquidity to fund its off-balance sheet commitments.
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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.
During the second quarter of 2020, management took steps to increase liquidity on the balance sheet and expand the capacity for additional funding in the uncertain environment. Management maintained an elevated level of liquidity on the balance sheet in the third quarter of 2020, and will continue to monitor and determine the appropriate levels of liquidity as economic conditions develop. Furthermore, the Company continues to monitor its capital ratios regularly and has benefited from income from participation in the PPP, offset by potential stress from the weakening economy due to the COVID-19 pandemic.
At September 30, 2020, we had liquid assets of $316.8 million, compared to $257.5 million at December 31, 2019. Liquid assets include cash and due from banks, federal funds sold, interest-bearing deposits with banks and unencumbered securities available-for-sale. Cash and due from banks increased to $176.5 million, compared to $103.9 million at December 31, 2019 primarily as a result of excess deposits.
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 September 30, 2020, we had $181.2 million of outstanding borrowings from the FHLB, and these advances were secured by a blanket lien on $510.6 million of real estate-related loans. Based on this collateral and the approved policy limits, the Company is eligible to borrow up to an additional $211.1 million from the FHLB. Additionally, the Bank can borrow up to $122.5 million through the unsecured lines of credit it has established with eight other banks, as well as $5.3 million through a secured line with the Federal Reserve Bank.
Further, because the Bank is "well capitalized," it can accept wholesale funding up to 40% of total assets, or approximately $977.5 million, based on current policy limits at September 30, 2020. Management believed that as of September 30, 2020, we had adequate resources to fund all of our commitments.
The following liquidity ratios compare certain assets and liabilities to total deposits or total assets.
 September 30, 2020December 31, 2019
Investment securities available-for-sale to total assets10.36 %11.41 %
Loans to total deposits94.88 108.12 
Interest-earning assets to total assets94.32 95.58 
Interest-bearing deposits to total deposits67.46 71.30 
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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.
Modeling assumptions were enhanced in the first quarter of 2020 to include a more robust modeling of decay rates for non-maturity deposits.  The assumption changes more accurately reflect the interest rate position of the Bank to increase in value for rising interest rate scenarios.  In addition, the lower rate environment in the quarter extended the expected average life on certain borrowings.
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 September 30, 2020 and December 31, 2019, assuming immediate parallel moves in interest rates is presented in the table below.
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September 30, 2020December 31, 2019
Change in ratesFollowing 12 monthsFollowing 24 monthsFollowing 12 monthsFollowing 24 months
+400 basis points(2.6)%4.8 %5.8 %1.9 %
+300 basis points1.2 7.0 5.2 2.6 
+200 basis points3.2 8.3 4.2 2.7 
+100 basis points3.9 7.9 2.7 2.1 
-100 basis points(2.8)(4.2)(4.0)(3.9)
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 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.
The table below presents the change in our economic value of equity as of September 30, 2020 and December 31, 2019, assuming immediate parallel shifts in interest rates. Changes noted between the two periods reflect recent enhancements in our asset/liability modeling, including projected values for non-maturity deposits in changing interest rate environments and limitations on lowering certain deposit rates below zero.
Change in ratesSeptember 30, 2020December 31, 2019
+400 basis points24.0 %(39.4)%
+300 basis points27.0 (28.4)
+200 basis points26.0 (17.8)
+100 basis points19.0 (8.1)
-100 basis points(30.0)6.6 

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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
    In addition to the risk factors set forth under Part I, Item 1A “Risk Factors” in the Company’s Form 10-K for the fiscal year ended December 31, 2019, the following risk factors apply to the Company.

The COVID-19 pandemic has adversely impacted our business, and we expect that it will continue to negatively affect economic conditions, our borrowers and our business, financial condition, liquidity and results of operations, all in a complex manner with uncertain duration and magnitude.
The COVID-19 pandemic has caused substantial economic dislocation in the United States. As a result, the Company has taken comprehensive steps to help our customers, team members and communities during the current COVID-19 pandemic health crisis. For our customers, we have provided loan payment deferrals and offered fee waivers, among other actions. Through September 30, 2020, we have helped our consumer and small business customers by deferring loan payments and waiving fees on $416.3 million of non-PPP loans ($388.9 million of commercial balances and $27.4 million of consumer balances). As of September 30, 2020, we had $16.3 million of loans that had an outstanding payment deferral.
In addition, the spread of the coronavirus has caused us to modify our business practices, including employee travel, employee work locations, social distancing in our branches and cancellation of physical participation in meetings, events and conferences. We have many employees working remotely, and we may take further actions as may be required by government authorities or that we determine are in the best interests of our employees, customers and business partners.
Given the ongoing and dynamic nature of the pandemic, it is difficult to predict the full impact on our business. The extent of such impact will depend on future developments, which are highly uncertain, including when and whether the pandemic can be controlled or abated. Further, while jurisdictions in which we operate have gradually allowed the reopening of businesses and other organizations, and removed the sheltering restrictions, those actions can be reversed, and it is premature to assess whether such reopening will result in a meaningful increase in economic activity and the impact of such actions on further COVID-19 cases. As the result of the pandemic and the related adverse local and national economic consequences, we could be subject to the following risks, among others, any of which could have a material, adverse effect on our business, financial condition, liquidity and results of operations:
•demand for our products and services may decline, and we may determine that we are not able to prudently grow our loan portfolio, any of which would negatively affect our future growth and income;
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•if the economy, including our business and commercial real estate borrowers and customers, is unable to substantially and successfully reopen, or if high levels of unemployment continue for an extended period of time, loan delinquencies, problem assets, and foreclosures may increase, resulting in increased provisions for credit losses and charge-offs and reduced income;
•in the event of a prolonged or more permanent shift toward a wide-spread work-remote environment, collateral for loans, especially commercial real estate, may decline in value, which could cause loan losses to increase;
•our allowance for credit losses may increase if borrowers experience financial difficulties beyond forbearance periods, which will adversely affect our net income;
•the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us;
•a further and sustained decline in our stock price or the occurrence of other developments could, under certain circumstances, cause our management to perform impairment testing on our goodwill or other intangibles, which could require us to record an impairment charge that would adversely impact our results of operations, the ability of the Bank to pay dividends to us, and the Company's ability to pay dividends to its shareholders;
•as a result of the decline in the Federal Reserve’s target federal funds rate to near 0% (or possibly below 0% in the future), the yield on our assets may decline to a greater extent than the decline in our cost of interest-bearing liabilities, reducing our net interest margin and reducing net income;
•uncertainties created by the pandemic, combined with the disruptions to our own business, will negatively affect our ability to execute our acquisition strategy for the foreseeable future, limiting or delaying our future growth plans;
•any negative developments in our business, financial condition, capital ratios, liquidity or results of operations could result in the elimination of or a decrease in the rate of our historical quarterly cash dividend on our common stock, and could affect our board of directors’ determination of whether to declare dividends on our preferred stock;
•our cyber security risks are increased as the result of an increase in the number of our employees and the employees of our third-party vendors and partners working remotely;
•we rely on third party vendors and partners for certain services, and the unavailability of a critical service due to the COVID-19 pandemic, including as a result of any heightened cyber-related risks and/or incidents such third-parties might experience, could adversely affect us;
•local, state and federal taxes may increase as a result of deficits created by the numerous governmental support programs enacted and efforts taken to attempt to lessen the economic impact of the pandemic, which could reduce our net income; and
•FDIC premiums may increase if the agency experiences additional resolution costs.
Moreover, our future success and profitability depend substantially upon the management skills of our executive officers and directors, many of whom have held officer and director positions with us for many years. The unanticipated loss or unavailability of key employees due to the pandemic could harm our ability to operate our business or execute our business strategy. We may not be successful in finding and integrating suitable successors in the event of key employee loss or unavailability.
Any one or a combination of the factors identified above, or other factors, could materially and adversely affect our business, financial condition, results of operations and prospects.
We may be adversely affected by actions taken by the U.S. government to mitigate the impact of the COVID-19 pandemic on the U.S. economy.
The United States government has taken a number of actions to mitigate the impact of the COVID-19 pandemic on the U.S. economy. Among other steps, the Federal Reserve cut the federal funds rate in March 2020, and also lowered the interest rate on emergency lending at the discount window and lengthened the term of loans to 90 days. On March 27, 2020, the CARES Act was signed into law, which, among other things, provided for one-time payments to individuals, additional unemployment insurance, additional health-care funding, loans and grants to certain businesses, and temporary amendments to the Internal Revenue Code. In addition, the CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time to account for the effects of COVID-19 pandemic.
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The SBA was tapped to lead the effort to loan funds to small businesses, in conjunction with banks. The Federal Reserve and the U.S. Treasury have also responded with lending programs under the CARES Act. Further, the Federal Reserve has intervened with a number of credit facilities intended to keep the capital markets liquid.
There can be no assurance that these actions or any future interventions by the U.S. government will be successful in mitigating the impact of the COVID-19 pandemic, and it is unclear what the cumulative effect of these extraordinary actions will be on the economy as a whole and our business. In addition, many of these measures designed to support and benefit the economy, businesses and consumers during this time have expired or are set to expire in the near future, absent further affirmative action of and extension by the government. There can be no assurance that the expiration of these programs and measures will not have a material adverse effect on our customers, including our borrowers, our employees and the economies in our market areas, which, in turn, could negatively affect our business, financial condition, results of operations and growth strategy. Also, we may experience a significant increase in inflation as a result of local, state and federal deficits created as a result of the numerous governmental support efforts enacted to attempt to lessen the economic impact of the COVID-19 pandemic, which could negatively impact our business and our earnings.
We are subject to potential litigation, regulatory enforcement risk and reputation risk regarding the Bank’s participation in the Paycheck Protection Program and the risk that the SBA may not fund some or all PPP loan guaranties.
The CARES Act included a $349 billion loan program administered through the SBA referred to as the PPP. The $349 billion in funds for the PPP were exhausted on April 16, 2020. On April 27, 2020, the program was reopened with an additional $310 billion approved by Congress. Under the PPP, small businesses and other entities and individuals could apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to detailed qualifications and eligibility criteria. As of September 30, 2020, Level One had $392.5 million of PPP loans outstanding to more than 2,000 small and mid-sized businesses.
Because of the short timeframe between the passing of the CARES Act and implementation of the PPP, some of the rules and guidance relating to PPP were issued after lenders began processing PPP applications. Also, there was and continues to be uncertainty in the laws, rules and guidance relating to the PPP. Since the opening of the PPP, several banks have been subject to litigation regarding the procedures used in processing PPP applications or litigation from agents with respect to agent fees. In addition, some banks and borrowers have received negative media attention associated with PPP loans. Although we believe that we have administered the PPP in accordance with all applicable laws, regulations and guidance, we may be exposed to litigation risk and negative media attention our participation in the PPP. Any financial liability, litigation costs or reputational damage caused by PPP-related litigation or media attention could have a material adverse impact on our business, financial condition, and results of operations.
The PPP has also attracted interest from federal and state enforcement authorities, oversight agencies, regulators, and Congressional committees. State Attorneys General and other federal and state agencies may assert that they are not subject to the provisions of the CARES Act and the PPP regulations entitling the Bank to rely on borrower certifications, and take more aggressive action against the Bank for alleged violations of the provisions governing the Bank’s participation in the PPP. Federal and state regulators can impose or request that we consent to substantial sanctions, restrictions and requirements if they determine there are violations of laws, rules or regulations or weaknesses or failures with respect to general standards of safety and soundness, which could adversely affect our business, reputation, results of operation and financial condition.
The Bank also has credit risk on PPP loans if the SBA determines that there is a deficiency in the manner in which any loans were originated, funded or serviced by the Bank, including any issue with the eligibility of a borrower to receive a PPP loan. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded or serviced by the Bank, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty or, if the SBA has already paid under the guaranty, seek recovery of any loss related to the deficiency from the Bank.
If the goodwill that we recorded in connection with a business acquisition becomes impaired, it could require charges to earnings, which would have a negative impact on our financial condition and results of operations.

Goodwill represents the amount by which the cost of an acquisition exceeded the fair value of net assets we acquired in connection with the purchase. We review goodwill for impairment at least annually, or more frequently if events or changes in circumstances indicate that the carrying value of the asset might be impaired.

We determine impairment by comparing the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. Any such adjustments are reflected in our results of operations
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in the periods in which they become known. As of September 30, 2020, our goodwill totaled $35.6 million. The Company conducted an interim period goodwill impairment assessment, triggered by the COVID-19 pandemic, and concluded that goodwill was not impaired as of September 30, 2020. However, there can be no assurance that our future evaluations of goodwill will not result in findings of impairment and related write-downs, which may have a material adverse effect on our financial condition and results of operations.

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
Unregistered Sales of Equity Securities
None.
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. As of September 30, 2020, $2.2 million of shares remained available to be repurchased under the repurchase program.

The following table sets forth information regarding the Company’s repurchase of shares of its outstanding common stock during the three months ended September 30, 2020.
(Dollars in thousands, except per share amounts)Total Number of Shares PurchasedAverage Price Paid Per ShareTotal Number of Shares Purchased as Part of Publicly Announced Plans or ProgramsApproximate Dollar Value of Shares That May Yet be Purchased under the Plans or Programs
July 1-31, 2020— $— — $2,215 
August 1-31, 2020— — — 2,215 
September 1-30, 2020— — — 2,215 
Total — $— — 
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 September 30, 2020, the total shares repurchased in the amount of $2.8 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.
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Item 6 - Exhibits
Exhibit No.Description
1.1
3.1
4.1
4.2
31.1
31.2
32.1
32.2
101Financial information from the Company’s Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 2020, formatted in iXBRL 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.
104Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)
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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: November 6, 2020By:/s/ Patrick J. Fehring
Patrick J. Fehring
President and Chief Executive Officer
(principal executive officer)
Date: November 6, 2020By: /s/ David C. Walker
David C. Walker
Executive Vice President and Chief Financial Officer
(principal financial officer)

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