Level One Bancorp 10Q 2021 Q3 Quarterly report

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, 2021

☐ 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 Court									48334
Farmington Hills,									(Zip code)
Michigan
(Address of principal executive offices)

(248) 737-0300

(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:


Title of Each Class	Trading symbol(s)	Name of each exchange on which registered
Common Stock, no par value	LEVL	Nasdaq Global Select Market
Depositary Shares, each representing a 1/100th interest in a share of 7.50% Non-Cumulative Perpetual Preferred Stock, Series B	LEVLP	Nasdaq 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 for such shorter period that the registrant was required to submit such files). Yes ☑ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 October 29, 2021, the number of shares outstanding of the registrant’s common stock, no par value, was 7,641,044 shares.

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Level One Bancorp, Inc.

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		Page
Part I:	FINANCIAL INFORMATION	3
Item 1.	Financial Statements	3
	Consolidated Balance Sheets at September 30, 2021 (Unaudited) and December 31, 2020	3
	Consolidated Statements of Income (Unaudited) for the three and nine months ended September 30, 2021 and 2020	4
	Consolidated Statements of Comprehensive Income (Unaudited) for the three and nine months ended September 30, 2021 and 2020	5
	Consolidated Statements of Changes in Shareholders' Equity (Unaudited) for the three and nine months ended September 30, 2021 and 2020	6
	Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2021 and 2020	8
	Notes to the Consolidated Financial Statements (Unaudited)	10
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	41
Item 3.	Quantitative and Qualitative Disclosure about Market Risk	65
Item 4.	Controls and Procedures	66

Part II:	OTHER INFORMATION	66
Item 1.	Legal Proceedings	66
Item 1A.	Risk Factors	67
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	69
Item 3.	Defaults Upon Senior Securities	69
Item 4.	Mine Safety Disclosures	69
Item 5.	Other Information	69
Item 6.	Exhibits	70

Signatures		71

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PART I. FINANCIAL INFORMATION

Item 1 - Financial Statements

LEVEL ONE BANCORP, INC.

CONSOLIDATED BALANCE SHEETS


	September 30, 2021		December 31, 2020
(Dollars in thousands, except per share data)	(Unaudited)
Assets
Cash and cash equivalents	$	293,824	$	264,071
Securities available-for-sale	389,528		302,732
Other investments	14,398		14,398
Mortgage loans held for sale, at fair value	15,351		43,482
Loans:
Originated loans	1,537,145		1,498,458
Acquired loans	182,572		225,079
Total loans	1,719,717		1,723,537
Less: Allowance for loan losses	(21,731)		(22,297)
Net loans	1,697,986		1,701,240
Premises and equipment, net	15,170		15,834
Goodwill	35,554		35,554
Mortgage servicing rights, net	5,051		3,361
Core deposit intangibles, net	2,695		3,196

Bank-owned life insurance	29,774		18,200
Income tax benefit	4,041		3,686
Interest receivable and other assets	40,511		37,228
Total assets	$	2,543,883	$	2,442,982
Liabilities
Deposits:
Noninterest-bearing demand deposits	$	791,879	$	618,677
Interest-bearing demand deposits	179,814		127,920
Money market and savings deposits	631,551		619,900
Time deposits	463,748		596,815
Total deposits	2,066,992		1,963,312
Borrowings	182,058		185,684
Subordinated notes	29,668		44,592
Other liabilities	31,231		34,067
Total liabilities	2,309,949		2,227,655
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, 2021 and December 31, 2020	23,372		23,372
Common stock, no par value per share; authorized—20,000,000 shares; issued and outstanding—7,639,544 shares at September 30, 2021 and 7,633,780 shares at December 31, 2020	86,926		87,615
Retained earnings	118,781		96,158
Accumulated other comprehensive income, net of tax	4,855		8,182
Total shareholders' equity	233,934		215,327
Total liabilities and shareholders' equity	$	2,543,883	$	2,442,982

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)	2021		2020		2021		2020
Interest income
Originated loans, including fees	$	17,796	$	15,274	$	51,785	$	44,630
Acquired loans, including fees	2,651		3,456		8,532		11,187
Securities:
Taxable	1,054		652		2,895		1,930
Tax-exempt	630		613		1,880		1,894
Federal funds sold and other investments	191		250		518		817
Total interest income	22,322		20,245		65,610		60,458
Interest Expense
Deposits	965		2,323		3,443		9,039
Borrowed funds	468		693		1,409		1,866
Subordinated notes	374		632		1,470		1,903
Total interest expense	1,807		3,648		6,322		12,808
Net interest income	20,515		16,597		59,288		47,650
Provision expense (recovery) for loan losses	(1,189)		4,270		(384)		10,334
Net interest income after provision for loan losses	21,704		12,327		59,672		37,316
Noninterest income
Service charges on deposits	859		616		2,436		1,798
Net gain on sales of securities	—		434		20		1,862
Mortgage banking activities	4,216		7,108		12,738		15,380
Other charges and fees	966		967		2,451		2,564
Total noninterest income	6,041		9,125		17,645		21,604
Noninterest expense
Salary and employee benefits	10,551		9,862		29,825		28,090
Occupancy and equipment expense	1,680		1,678		4,971		4,773
Professional service fees	847		808		2,264		2,141
Acquisition and due diligence fees	—		17		—		1,664
FDIC premium expense	244		287		778		722
Marketing expense	428		257		842		709
Loan processing expense	231		262		755		690
Data processing expense	928		844		3,209		2,601
Core deposit premium amortization	167		192		501		576
Other expense	913		919		2,571		2,805
Total noninterest expense	15,989		15,126		45,716		44,771
Income before income taxes	11,756		6,326		31,601		14,149
Income tax provision	2,291		1,117		6,198		2,109
Net income	$	9,465	$	5,209	$	25,403	$	12,040
Preferred stock dividends	468		—		1,406		—
Net income attributable to common shareholders	$	8,997	$	5,209	$	23,997	$	12,040
Per common share data:
Basic earnings per common share	$	1.19	$	0.68	$	3.15	$	1.56
Diluted earnings per common share	$	1.16	$	0.67	$	3.10	$	1.55
Cash dividends declared per common share	$	0.06	$	0.05	$	0.18	$	0.15
Weighted average common shares outstanding—basic	7,519		7,675		7,526		7,640
Weighted average common shares outstanding—diluted	7,638		7,712		7,631		7,701

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)	2021		2020		2021		2020
Net income	$	9,465	$	5,209	$	25,403	$	12,040
Other comprehensive income:
Unrealized gains (losses) on securities available-for-sale	(273)		1,425		(4,192)		7,497
Reclassification adjustment for gains included in income	—		(434)		(20)		(1,862)
Tax effect(1)	57		(208)		885		(1,184)
Net unrealized gains (losses) on securities available-for-sale, net of tax	(216)		783		(3,327)		4,451
Total comprehensive income, net of tax	$	9,249	$	5,992	$	22,076	$	16,491

(1) Includes no tax expense (benefit) related to the reclassification adjustment for gains (losses) included in income for the three months ended September 30, 2021. There was $91 thousand of tax expense related to the reclassification adjustment for gains included in income for the three months ended September 30, 2020. There was $4 thousand and $391 thousand of tax expense related to the reclassification adjustment for gains included in income for the nine months ended September 30, 2021 and 2020, 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, 2021
(Dollar in thousands)	Preferred Stock		Common Stock		Retained Earnings		Accumulated Other Comprehensive Income		Total Shareholders' Equity






Balance at June 30, 2021	$	23,372	$	86,723	$	110,243	$	5,071	$	225,409
Net income	—		—		9,465		—		9,465
Other comprehensive income	—		—		—		(216)		(216)


Dividends on 7.50% Series B Preferred Stock	—		—		(468)		—		(468)
Common stock dividends declared ($0.06 per share)	—		—		(459)		—		(459)

Stock-based compensation expense, net of tax impact	—		203		—		—		203
Balance at September 30, 2021	$	23,372	$	86,926	$	118,781	$	4,855	$	233,934









	For the nine months ended September 30, 2021
(In thousands, except per share data)	Preferred Stock		Common Stock		Retained Earnings		Accumulated Other Comprehensive Income		Total Shareholders' Equity
Balance at December 31, 2020	$	23,372	$	87,615	$	96,158	$	8,182	$	215,327
Net income	—		—		25,403		—		25,403
Other comprehensive income	—		—		—		(3,327)		(3,327)
Redeemed stock (59,645 shares)	—		(1,364)		—		—		(1,364)




Dividends on 7.50% Series B Preferred Stock	—		—		(1,406)		—		(1,406)
Common stock dividends declared ($0.18 per share)	—		—		(1,374)		—		(1,374)
Exercise of stock options (23,800 shares)	—		243		—		—		243
Stock-based compensation expense, net of tax impact	—		432		—		—		432
Balance at September 30, 2021	$	23,372	$	86,926	$	118,781	$	4,855	$	233,934

See accompanying notes to the consolidated financial statements.

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	For the three months ended September 30, 2020
(Dollar in thousands)	Preferred Stock		Common Stock		Retained Earnings		Accumulated 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 costs	23,370		—		—		—		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
(In thousands, except per share data)	Preferred Stock		Common Stock		Retained Earnings		Accumulated 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 costs	23,370		—		—		—		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

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)	2021		2020
Cash flows from operating activities
Net income	$	25,403	$	12,040
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation of fixed assets	1,204		1,259
Amortization of core deposit intangibles	501		576

Stock-based compensation expense	569		653
Provision expense (benefit) for loan losses	(384)		10,334
Net securities premium amortization	2,180		1,526
Net gain on sales of securities	(20)		(1,862)
Originations of loans held for sale	(336,993)		(409,312)
Proceeds from sales of loans	371,371		377,238
Net gain on sales of loans	(12,988)		(15,373)
Accretion on acquired purchase credit impaired loans	(1,160)		(1,350)
Gain on sale of other real estate owned and repossessed assets	—		(263)

Increase in cash surrender value of life insurance	(474)		(353)
Amortization of debt issuance costs	76		115

Provision (benefit) for deferred income taxes	932		(3,758)
Net change in accrued interest receivable and other assets	(2,341)		(13,433)
Net change in accrued interest payable and other liabilities	(3,465)		2,490
Net cash provided by (used in) operating activities	44,411		(39,473)
Cash flows from investing activities
Net change in loans	9,057		(393,154)
Principal payments on securities available-for-sale	22,552		16,146
Purchases of securities available-for-sale	(116,827)		(83,170)
Purchases of Bank Owned Life Insurance	(11,100)		—

Purchases of other investments	—		(2,000)
Additions to premises and equipment	(541)		(665)
Proceeds from:

Sale and call of securities available-for-sale	1,107		47,789
Sale of other real estate owned and repossessed assets	—		2,356
Net cash used in acquisition	—		(29,464)
Net cash used in investing activities	(95,752)		(442,162)
Cash flows from financing activities
Net change in deposits	103,680		543,187
Change in short-term borrowings	(523)		(65,664)
Issuances of FRB borrowings related to Paycheck Protection Program	—		34,098
Issuances of long-term borrowings	—		20,923
Repayment of long-term borrowings	(3,071)		—

Net proceeds from issuance of preferred stock	—		23,370
Pay down of subordinated debt	(15,000)		—
Change in secured borrowing	(32)		(52)

Share buyback - redeemed stock	(1,364)		(620)
Preferred stock dividends paid	(1,406)		—
Common stock dividends paid	(1,296)		(1,082)
Proceeds from exercised stock options	243		95
Payments related to tax-withholding for share based compensation awards	(137)		(64)
Net cash provided by financing activities	81,094		554,191
Net change in cash and cash equivalents	29,753		72,556
Beginning cash and cash equivalents	264,071		103,930
Ending cash and cash equivalents	$	293,824	$	176,486

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Supplemental disclosure of cash flow information:
Interest paid	$	6,324	$	12,117
Taxes paid	6,242		6,909
Transfer from loans held for sale to loans held for investment and repurchases	4,656		2,284
Transfer from loans to other real estate owned	—		1,172

Non-cash transactions:
Increase in assets and liabilities in acquisitions:
Assets acquired—Ann Arbor State Bank	$	—	$	325,303
Liabilities assumed—Ann Arbor State Bank	—		283,526

See accompanying notes to the consolidated financial statements.

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LEVEL ONE BANCORP, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

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, 2021, its wholly owned bank subsidiary, Level One Bank (the "Bank"), had 17 offices, including 11 banking centers (our full service branches) in Metro Detroit, 1 banking center in Grand Rapids, 1 banking center in Jackson, 3 banking centers in Ann Arbor and 1 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.

Hamilton Court Insurance Company ("Hamilton Court") was a wholly owned insurance subsidiary of the Company that provided 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 have been 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 was incorporated in Nevada. Hamilton Court Insurance Company exited the pool resources relationship to which it was previously a member and was dissolved in 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 acquisition of Ann Arbor Bancorp, Inc. (“AAB”) and its wholly owned subsidiary, Ann Arbor State Bank. The Company paid aggregate consideration of approximately $67.9 million in cash.

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, 2020, included in our Annual Report on Form 10-K, filed with the SEC on March 12, 2021.

The accompanying consolidated financial statements include the accounts of the Company and its consolidated subsidiaries after elimination of significant intercompany transactions and accounts.

Use of Estimates:

To prepare financial statements in conformity with GAAP, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided; therefore, future results could differ. These estimates and assumptions are subject to many risks and

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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 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”), as supplemented by the Consolidated Appropriations Act, 2021, provided for among other things, a small business lending program to originate paycheck protection loans 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) through December 31, 2023. 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 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 its 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 its 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.

Reference Rate Reform

In March 2020, the FASB issued ASU No. 2020-04, "Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting" to provide guidance to ease the potential burden in accounting for, or recognizing the effects of, reference rate reform on financial reporting. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contracts, hedging relationships and other transactions affected by reference rate reform if certain criteria are met and only applies to contracts, hedging relationships and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. In addition, the ASU

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provides optional expedients for applying the requirements of certain topics or industry subtopics in the Codification for contracts that are modified because of reference rate reform and contemporaneous modifications of other contract terms related to the replacement of the reference rate. The ASU allows companies to apply the standard as of the beginning of the interim period that includes March 12, 2020 through December 31, 2022. The Company is currently assessing the impact of this guidance to its financial statements; however, the impact is not expected to be material.

NOTE 2—SECURITIES

The following table summarizes the amortized cost and fair value of the available-for-sale securities portfolio at September 30, 2021 and December 31, 2020 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, 2021
U.S. government sponsored entities & agencies	$	24,531	$	41	$	(536)	$	24,036
State and political subdivision	139,755		7,358		(418)		146,695
Mortgage-backed securities: residential	20,026		167		(107)		20,086
Mortgage-backed securities: commercial	23,531		387		(378)		23,540
Collateralized mortgage obligations: residential	9,796		87		(12)		9,871
Collateralized mortgage obligations: commercial	52,918		674		(854)		52,738
U.S. Treasury	65,118		67		(287)		64,898
SBA	15,011		154		(57)		15,108
Asset backed securities	9,896		11		(49)		9,858
Corporate bonds	22,801		27		(130)		22,698
Total available-for-sale	$	383,383	$	8,973	$	(2,828)	$	389,528
December 31, 2020
U.S. government sponsored entities & agencies	$	26,575	$	103	$	(320)	$	26,358
State and political subdivision	124,053		8,751		(81)		132,723
Mortgage-backed securities: residential	25,729		352		—		26,081
Mortgage-backed securities: commercial	11,434		484		—		11,918
Collateralized mortgage obligations: residential	13,320		138		(12)		13,446
Collateralized mortgage obligations: commercial	57,398		1,206		(92)		58,512

SBA	17,639		61		(107)		17,593
Asset backed securities	10,229		—		(157)		10,072
Corporate bonds	5,998		34		(3)		6,029
Total available-for-sale	$	292,375	$	11,129	$	(772)	$	302,732

The proceeds from sales and calls of securities and the associated gains and losses for the periods below were as follows:


(Dollars in thousands)	For the three months ended September 30,				For the nine months ended September 30,
	2021		2020		2021		2020
Proceeds	$	—	$	5,351	$	1,107	$	47,789
Gross gains	—		434		20		1,871
Gross losses	—		—		—		(9)

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The amortized cost and fair value of securities are shown in the table below by contractual maturity. Expected maturities may differ from contractual maturities as issuers may have the right to call or prepay obligations with or without call or prepayment penalties.


	September 30, 2021
(Dollars in thousands)	Amortized Cost		Fair Value
Within one year	$	7,839	$	7,916
One to five years	59,824		60,459
Five to ten years	181,283		182,244
Beyond ten years	134,437		138,909
Total	$	383,383	$	389,528

Securities pledged at September 30, 2021 and December 31, 2020 had a carrying amount of $90.6 million and $98.7 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, 2021, the Bank held 68 tax-exempt state and local municipal securities totaling $52.8 million backed by the Michigan School Bond Loan Fund. Other than the aforementioned investments and the U.S. government and its agencies, at September 30, 2021 and December 31, 2020, there were no holdings of securities of any one issuer in an amount greater than 10% of shareholders' equity.

The following table summarizes securities with unrealized losses at September 30, 2021 and December 31, 2020 aggregated by security type and length of time in a continuous unrealized loss position:


	Less than 12 Months				12 Months or Longer				Total
(Dollars in thousands)	Fair value		Unrealized Losses		Fair value		Unrealized Losses		Fair value		Unrealized Losses
September 30, 2021
Available-for-sale
U.S. government sponsored entities & agencies	$	—	$	—	$	19,464	$	(536)	$	19,464	$	(536)
State and political subdivision	33,804		(418)		—		—		33,804		(418)
Mortgage-backed securities: residential	14,096		(107)		—		—		14,096		(107)
Mortgage-backed securities: commercial	16,241		(378)		—		—		16,241		(378)
Collateralized mortgage obligations: residential	906		(2)		950		(10)		1,856		(12)
Collateralized mortgage obligations: commercial	20,219		(484)		10,679		(370)		30,898		(854)
U.S. Treasury	55,186		(287)		—		—		55,186		(287)
SBA	—		—		6,282		(57)		6,282		(57)
Asset backed securities	4,770		(12)		2,493		(37)		7,263		(49)
Corporate bonds	12,920		(130)		—		—		12,920		(130)
Total available-for-sale	$	158,142	$	(1,818)	$	39,868	$	(1,010)	$	198,010	$	(2,828)
December 31, 2020
Available-for-sale
U.S. government sponsored entities & agencies	$	19,680	$	(320)	$	—	$	—	$	19,680	$	(320)
State and political subdivision	4,880		(81)		—		—		4,880		(81)


Collateralized mortgage obligations: residential	—		—		1,109		(12)		1,109		(12)
Collateralized mortgage obligations: commercial	26,477		(92)		—		—		26,477		(92)

SBA	—		—		12,209		(107)		12,209		(107)
Asset backed securities	—		—		10,072		(157)		10,072		(157)
Corporate bonds	2,497		(3)		—		—		2,497		(3)
Total available-for-sale	$	53,534	$	(496)	$	23,390	$	(276)	$	76,924	$	(772)

As of September 30, 2021, the Company's investment portfolio consisted of 330 securities, 67 of which were in an unrealized loss position. The unrealized losses for these securities resulted primarily from changes in interest rates since

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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 did not consider these securities to be other-than-temporarily impaired at September 30, 2021.

NOTE 3—LOANS

The following table presents the recorded investment in loans at September 30, 2021 and December 31, 2020. The recorded investment in loans excludes accrued interest receivable.


(Dollars in thousands)	Originated		Acquired		Total
September 30, 2021
Commercial real estate	$	660,255	$	114,606	$	774,861
Commercial and industrial	494,689		45,857		540,546
Residential real estate	381,515		22,002		403,517
Consumer	686		107		793
Total	$	1,537,145	$	182,572	$	1,719,717
December 31, 2020
Commercial real estate	$	587,631	$	133,201	$	720,832
Commercial and industrial	629,434		56,070		685,504
Residential real estate	280,645		34,831		315,476
Consumer	748		977		1,725
Total	$	1,498,458	$	225,079	$	1,723,537

At September 30, 2021 and December 31, 2020, the Company had residential loans held for sale, which were originated with the intent to sell, totaling $15.4 million and $43.5 million, respectively. During the three months ended September 30, 2021 and 2020, the Company sold residential real estate loans with proceeds totaling $101.3 million and $157.2 million, respectively, and $371.4 million and $377.2 million during the nine months ended September 30, 2021 and 2020, respectively. At September 30, 2021 and December 31, 2020, $147.6 million and $290.1 million, respectively, of PPP loans were included in the commercial and industrial loan balance.

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 $216 thousand and $12 thousand in commitments to lend additional funds to borrowers whose loans were classified as nonaccrual as of September 30, 2021 and December 31, 2020, respectively.

Information as to nonperforming assets was as follows:


(Dollars in thousands)	September 30, 2021		December 31, 2020
Nonaccrual loans:
Commercial real estate	$	3,768	$	7,320
Commercial and industrial	4,746		7,490
Residential real estate	3,610		3,991
Consumer	9		15
Total nonaccrual loans	12,133		18,816

Total nonperforming assets	$	12,133	$	18,816
Loans 90 days or more past due and still accruing	$	162	$	269

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At September 30, 2021 and December 31, 2020, the loans that were 90 days or more past due and still accruing were PCI loans.

Loan delinquency as of the dates presented below was as follows:


(Dollars in thousands)	Current		30 - 59 Days Past Due		60 - 89 Days Past Due		90+ Days Past Due		Total
September 30, 2021
Commercial real estate	$	773,426	$	1,435	$	—	$	—	$	774,861
Commercial and industrial	540,441		105		—		—		540,546
Residential real estate	401,281		851		226		1,159		403,517
Consumer	783		9		1		—		793
Total	$	1,715,931	$	2,400	$	227	$	1,159	$	1,719,717
December 31, 2020
Commercial real estate	$	714,196	$	4,863	$	1,773	$	—	$	720,832
Commercial and industrial	681,106		893		3,505		—		685,504
Residential real estate	305,800		5,420		1,110		3,146		315,476
Consumer	1,723		—		—		2		1,725
Total	$	1,702,825	$	11,176	$	6,388	$	3,148	$	1,723,537

Impaired Loans:

Information as to impaired loans, excluding PCI loans, was as follows:


(Dollars in thousands)	September 30, 2021		December 31, 2020
Nonaccrual loans	$	12,133	$	18,816
Performing troubled debt restructurings:

Commercial and industrial	336		546
Residential real estate	426		432
Total performing troubled debt restructurings	762		978
Total impaired loans, excluding purchase credit impaired loans	$	12,895	$	19,794

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. On December 27, 2020, the Consolidated Appropriations Act, 2021 was signed into law and extends the relief related to troubled debt restructurings to the earlier of January 1, 2022 or 60 days after the national emergency termination date. 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. As of September 30, 2021, we had $1.1 million of loans that remained on a COVID-related deferral, and no loans that had payments deferred greater than six months. 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

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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, 2021 and December 31, 2020, the Company had a recorded investment in troubled debt restructurings of $4.3 million and $4.8 million, respectively. The Company allocated a specific reserve of $351 thousand for those loans at September 30, 2021 and a specific reserve of $317 thousand for those loans at December 31, 2020. The Company had not committed to lend additional amounts to borrowers whose loans have been modified. As of September 30, 2021, there were $3.5 million of nonperforming TDRs and $762 thousand of performing TDRs included in impaired loans. As of December 31, 2020, there were $3.8 million of nonperforming TDRs and $978 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 by type of concession granted. There were no loans modified as TDRs during the three months ended September 30, 2021. There were 3 loans modified as TDRs during the nine months ended September 30, 2021 which were subsequently paid off during the three months ended September 30, 2021. In cases where more than one type of concession was granted, the loans were categorized based on the most significant concession.


	Concession type									Financial effects of modification
(Dollars in thousands)	Principal deferral		Interest rate		Forbearance agreement		Total number of loans	Total recorded investment		Net charge-offs		Provision for loan losses












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	$	—	$	—

On an ongoing basis, the Company monitors the performance of TDRs to their modified terms. The following table presents the number of loans modified as TDRs during the twelve months ended September 30, 2021 for which there was a subsequent payment default during the nine months ended September 30, 2021 and the recorded investment as of September 30, 2021. There were no loans modified as TDRs within the previous twelve months that subsequently defaulted during the three months ended September 30, 2021 and the three or nine months ended September 30, 2020. A payment on a TDR is considered to be in default once it is greater than 30 days past due.


	For the nine months ended September 30, 2021
(Dollars in thousands)	Total number of loans	Total recorded investment		Provision for loan losses following a subsequent default
Commercial real estate	2	$	1,556	$	—



Total	2	$	1,556	$	—

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.

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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.

Based on the most recent analysis performed, the risk category of loans by class of loans was as follows:


(Dollars in thousands)	Pass		Special Mention		Substandard		Doubtful		Total
September 30, 2021
Commercial real estate	$	748,486	$	15,683	$	10,204	$	488	$	774,861
Commercial and industrial	476,728		48,959		13,790		1,069		540,546
Total	$	1,225,214	$	64,642	$	23,994	$	1,557	$	1,315,407
December 31, 2020
Commercial real estate	$	685,690	$	21,570	$	13,045	$	527	$	720,832
Commercial and industrial	637,285		25,727		21,876		616		685,504
Total	$	1,322,975	$	47,297	$	34,921	$	1,143	$	1,406,336

For residential real estate loans and consumer loans, the Company evaluates credit quality based on the aging status of the loan and by payment activity. Residential real estate loans and consumer loans are considered nonperforming if they are 90 days or more past due. Consumer loan types are continuously monitored for changes in delinquency trends and other asset quality indicators.

The following presents residential real estate and consumer loans by credit quality:


(Dollars in thousands)	Performing		Nonperforming		Total
September 30, 2021
Residential real estate	$	399,907	$	3,610	$	403,517
Consumer	784		9		793
Total	$	400,691	$	3,619	$	404,310
December 31, 2020
Residential real estate	$	311,485	$	3,991	$	315,476
Consumer	1,710		15		1,725
Total	$	313,195	$	4,006	$	317,201

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Purchased Credit Impaired Loans:

As part of the Company's previous 5 acquisitions, the Company acquired purchase credit impaired ("PCI") loans for which there was evidence of credit quality deterioration since origination, and we determined that it was probable that the Company would be unable to collect all contractually required principal and interest payments. The total balance of all PCI loans from these acquisitions was as follows:


(Dollars in thousand)	Unpaid Principal Balance		Recorded Investment
September 30, 2021
Commercial real estate	$	3,656	$	1,663
Commercial and industrial	4,545		—
Residential real estate	255		2,698

Total PCI loans	$	8,456	$	4,361
December 31, 2020
Commercial real estate	$	5,109	$	1,773
Commercial and industrial	643		274
Residential real estate	4,017		2,949
Total PCI loans	$	9,769	$	4,996

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)	2021		2020		2021		2020
Accretable yield at beginning of period	$	6,242	$	8,374	$	7,097	$	9,141
Additions due to acquisitions	—		—		—		35
Accretion of income	(368)		(482)		(1,160)		(1,350)
Adjustments to accretable yield	—		—		(63)		66

Accretable yield at end of period	$	5,874	$	7,892	$	5,874	$	7,892

"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 4—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, 2021, the Company had 5 PCI loan pools and 9 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.

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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.

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, 2021
Individually evaluated impaired loans:
Commercial real estate	$	3,768	$	—	$	3,768	$	4,112	$	—
Commercial and industrial	4,055		842		4,897		5,512		343
Residential real estate	1,801		135		1,936		2,283		27
Total	$	9,624	$	977	$	10,601	$	11,907	$	370
December 31, 2020
Individually evaluated impaired loans:
Commercial real estate	$	7,320	$	—	$	7,320	$	7,720	$	—
Commercial and industrial	7,964		630		8,594		9,208		307
Residential real estate	2,153		192		2,345		2,447		25
Total	$	17,437	$	822	$	18,259	$	19,375	$	332

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(Dollars in thousands)	Average Recorded Investment		Interest Income Recognized		Cash Basis Interest Recognized
For the three months ended September 30, 2021
Individually evaluated impaired loans:
Commercial real estate	$	4,259	$	—	$	30
Commercial and industrial	5,356		8		118
Residential real estate	2,125		7		—

Total	$	11,740	$	15	$	148
For the nine months ended September 30, 2021
Individually evaluated impaired loans:
Commercial real estate	$	5,298	$	—	$	332
Commercial and industrial	6,449		23		233
Residential real estate	2,143		18		10

Total	$	13,890	$	41	$	575
For the three months ended September 30, 2020
Individually evaluated impaired loans:
Commercial real estate	$	7,139	$	—	$	—
Commercial and industrial	8,960		12		—
Residential real estate	3,265		7		—

Total	$	19,364	$	19	$	—
For the nine months ended September 30, 2020
Individually evaluated impaired loans:
Commercial real estate	$	7,433	$	—	$	—
Commercial and industrial	13,086		34		84
Residential real estate	3,266		26		—

Total	$	23,785	$	60	$	84

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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		Consumer		Total
For the three months ended September 30, 2021
Allowance for loan losses:
Beginning balance	$	10,931	$	8,390	$	3,819	$	4	$	23,144
Provision expense (benefit) for loan losses	(1,141)		(278)		232		(2)		(1,189)
Gross chargeoffs	—		(6)		(242)		(7)		(255)
Recoveries	—		8		14		9		31
Net (chargeoffs) recoveries	—		2		(228)		2		(224)
Ending allowance for loan losses	$	9,790	$	8,114	$	3,823	$	4	$	21,731
For the nine months ended September 30, 2021
Allowance for loan losses:
Beginning balance	$	9,975	$	8,786	$	3,527	$	9	$	22,297
Provision expense (benefit) for loan losses	(185)		(692)		492		1		(384)
Gross chargeoffs	—		(24)		(242)		(21)		(287)
Recoveries	—		44		46		15		105
Net (chargeoffs) recoveries	—		20		(196)		(6)		(182)
Ending allowance for loan losses	$	9,790	$	8,114	$	3,823	$	4	$	21,731
For the three months ended September 30, 2020
Allowance for loan losses:
Beginning balance	$	7,987	$	6,496	$	2,565	$	15	$	17,063
Provision expense (benefit) for loan losses	1,820		1,679		781		(10)		4,270
Gross chargeoffs	—		(10)		(110)		(4)		(124)
Recoveries	12		15		10		8		45
Net (chargeoffs) recoveries	12		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 expense for loan losses	4,034		4,347		1,921		32		10,334
Gross chargeoffs	—		(1,729)		(110)		(47)		(1,886)
Recoveries	12		47		51		22		132
Net (chargeoffs) recoveries	12		(1,682)		(59)		(25)		(1,754)
Ending Allowance for loan losses	$	9,819	$	8,180	$	3,246	$	9	$	21,254

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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		Consumer		Total
September 30, 2021
Allowance for loan losses:
Individually evaluated for impairment	$	—	$	343	$	27	$	—	$	370
Collectively evaluated for impairment	9,353		7,771		3,563		4		20,691
Acquired with deteriorated credit quality	437		—		233		—		670
Ending allowance for loan losses	$	9,790	$	8,114	$	3,823	$	4	$	21,731
Balance of loans:
Individually evaluated for impairment	$	3,768	$	4,897	$	1,936	$	—	$	10,601
Collectively evaluated for impairment	769,430		535,649		398,883		793		1,704,755
Acquired with deteriorated credit quality	1,663		—		2,698		—		4,361
Total loans	$	774,861	$	540,546	$	403,517	$	793	$	1,719,717
December 31, 2020
Allowance for loan losses:
Individually evaluated for impairment	$	—	$	307	$	25	$	—	$	332
Collectively evaluated for impairment	9,550		8,465		3,273		9		21,297
Acquired with deteriorated credit quality	425		14		229		—		668
Ending allowance for loan losses	$	9,975	$	8,786	$	3,527	$	9	$	22,297
Balance of loans:
Individually evaluated for impairment	$	7,320	$	8,594	$	2,345	$	—	$	18,259
Collectively evaluated for impairment	711,739		676,636		310,182		1,725		1,700,282
Acquired with deteriorated credit quality	1,773		274		2,949		—		4,996
Total loans	$	720,832	$	685,504	$	315,476	$	1,725	$	1,723,537

NOTE 5—PREMISES AND EQUIPMENT

Premises and equipment were as follows at September 30, 2021 and December 31, 2020:


(Dollars in thousands)	September 30, 2021		December 31, 2020
Land	$	3,572	$	3,514
Buildings	10,710		10,656
Leasehold improvements	3,007		3,017
Furniture, fixtures and equipment	8,147		7,786
Total premises and equipment	$	25,436	$	24,973
Less: Accumulated depreciation	10,266		9,139
Net premises and equipment	$	15,170	$	15,834

Depreciation expense was $406 thousand and $426 thousand for the three months ended September 30, 2021 and 2020, respectively, and $1.2 million and $1.3 million for the nine months ended September 30, 2021 and 2020, respectively.

Most of the Company's branch facilities are rented under non-cancelable operating lease agreements. Total rent expense was $456 thousand and $450 thousand for the three months ended September 30, 2021 and 2020, respectively, and $1.4 million for the nine months ended September 30, 2021 and 2020.

NOTE 6—GOODWILL AND INTANGIBLE ASSETS

Goodwill: The Company has acquired 3 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, 2021 and December 31, 2020.

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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.

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 the 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 engaged a third-party valuation firm to perform a quantitative analysis of goodwill as of August 31, 2020 ("the valuation date"). In deriving the fair value of the reporting unit (the Bank), the third-party firm assessed general economic conditions and outlook; industry and market considerations and outlook; the impact of recent events on financial performance; the market price of our common stock and other relevant events. In addition, the valuation relied on financial projections through 2023 and growth rates prepared by management. Based on the valuation prepared, it was determined that the Company's estimated fair value of the reporting unit at August 31, 2020 was greater than its book value, and impairment of goodwill was not required.

The Company completed its annual goodwill impairment review as of October 1, 2020, noting 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 Small Business Administration ("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 October 1, 2020. Management also determined that no triggering events have occurred that indicated impairment from the most recent valuation date through September 30, 2021, the stock was trading above book value as of September 30, 2021, and it is more likely than not that there was no goodwill impairment as of September 30, 2021.

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.

The table below presents the Company's net carrying amount of CDIs:


(Dollars in thousands)	September 30, 2021		December 31, 2020
Gross carrying amount	$	5,708	$	5,708
Accumulated amortization	(3,013)		(2,512)
Net Intangible	$	2,695	$	3,196

Amortization expense for the CDIs was $167 thousand and $191 thousand for the three months ended September 30, 2021 and 2020, respectively, and $501 thousand and $576 thousand for the nine months ended September 30, 2021 and 2020, respectively.

NOTE 7—MORTGAGE SERVICING RIGHTS, NET

The Company has recorded a mortgage servicing rights asset for residential real estate mortgage loans that are sold to the secondary market for which servicing has been retained. Residential real estate mortgage loans serviced for others are not included in the consolidated balance sheets. Mortgage servicing rights are carried at the lower of the initial capitalized amount, net of accumulated amortization or estimated fair value. Mortgage servicing rights are amortized in proportion to and over the period of estimated net servicing income. The unpaid principal balances of these loans at September 30, 2021 and December 31, 2020 were as follows:


(Dollars in thousands)	September 30, 2021		December 31, 2020
Residential real estate mortgage loan portfolios serviced for:
FNMA	$	535,348	$	320,467

Custodial escrow balances maintained with these serviced loans were $3.3 million and $1.9 million at September 30, 2021 and December 31, 2020, respectively.

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Activity for mortgage servicing rights was as follows for the three and nine months ended September 30, 2021 and 2020:


	For the three months ended September 30,				For the nine months ended September 30,
(Dollars in thousands)	2021		2020		2021		2020
Mortgage servicing rights:
Balance, beginning of period	$	4,599	$	1,213	$	3,361	$	76
Originated servicing	787		1,073		3,199		2,250
Amortization	(335)		(93)		(1,509)		(133)
Balance, end of period	$	5,051	$	2,193	$	5,051	$	2,193

Servicing fee income, net of amortization of servicing rights and changes in the valuation allowance was $(32) thousand and $(93) thousand for the three months ended September 30, 2021 and 2020, respectively, and $(289) thousand and $(129) thousand for the nine months ended September 30, 2021 and 2020, respectively.

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. The fair value remained higher than book value at September 30, 2020. There was no valuation allowance related to mortgage servicing rights during the three or nine months ended September 30, 2021.

The fair value of mortgage servicing rights was $7.2 million and $4.0 million at September 30, 2021 and December 31, 2020, respectively. The fair value of mortgage servicing rights is highly sensitive to changes in underlying assumptions. The fair value at September 30, 2021 was determined using a discount rate of 8.00% and prepayment speeds ranging from 6.12% to 8.25%, depending on the stratification of the specific rights. The fair value at December 31, 2020 was determined using a discount rate of 7.75% and prepayment speeds ranging from 8.44% to 10.41%, depending on the stratification of the specific right.

NOTE 8—BORROWINGS AND SUBORDINATED DEBT

The following table presents the components of our short-term borrowings and long-term debt.


	September 30, 2021				December 31, 2020
(Dollars in thousands)	Amount		Weighted Average Rate(1)		Amount		Weighted Average Rate(1)
Short-term borrowings:

Securities sold under agreements to repurchase	$	2,681	0.25	%	$	3,204	0.30	%


Total short-term borrowings	2,681		0.25		3,204		0.30
Long-term debt:
Secured borrowing due in 2022	1,272		1.00		1,304		1.00
FHLB advances due in 2022 to 2029(2)	178,105		1.06		181,176		1.09

Subordinated notes due in 2025 and 2029(3)	29,668		4.75		44,592		5.29
Total long-term debt	209,045		1.58		227,072		1.91
Total short-term and long-term borrowings	$	211,726	1.56	%	$	230,276	1.89	%

(1) Weighted average rate presented is the contractual rate which excludes premiums and discounts related to purchase accounting.

(2) At September 30, 2021, 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, 2021 balance includes FHLB advances of $178.0 million and purchase accounting premiums of $105 thousand. The December 31, 2020 balance includes FHLB advances of $181.0 million and purchase accounting premiums of $176 thousand.

(3) The September 30, 2021 balance includes subordinated notes of $30.0 million and debt issuance costs of $332 thousand. The December 31, 2020 balance includes subordinated notes of $45.0 million and debt issuance costs of $408 thousand.

The following table presents long-term borrowings by contractual maturity date:

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(Dollars in thousands)	As of September 30, 2021
2021	$	3,008
2022	11,272
2023	3,047
2024	30,000
2025	2,050
Thereafter	159,668
Total long-term borrowings	$	209,045

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 $178.0 million of long-term FHLB advances as of September 30, 2021 were secured by a blanket lien on $582.8 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 $219.4 million from the FHLB at September 30, 2021. In addition, the Bank can borrow up to $157.5 million through the unsecured lines of credit it has established with other correspondent banks, as well as $5.1 million through a secured line with the Federal Reserve Bank. The Bank had no outstanding federal funds purchased as of September 30, 2021 and December 31, 2020.

At September 30, 2021, the Company had $2.7 million 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 $3.8 million at September 30, 2021.

The Company had a secured borrowing of $1.3 million as of September 30, 2021 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, 2021, the Company had $30.0 million outstanding subordinated notes and $332 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.

The $15.0 million of subordinated notes issued on December 21, 2015 had a fixed interest rate of 6.375% per annum, payable semiannually through December 15, 2020. As of December 15, 2020, the notes had a floating interest rate of three-month LIBOR plus 477 basis points payable quarterly through maturity. The notes were scheduled to mature on December 15, 2025, and the Company had the option to redeem or prepay any or all of the subordinated notes without premium or penalty any time after December 15, 2020 or upon an occurrence of a Tier 2 capital event or tax event. These subordinated notes were redeemed in June 2021.

The $30.0 million of subordinated notes issued on December 18, 2019 bear a fixed interest rate of 4.75% per annum, payable semiannually through December 18, 2024. The notes will bear a floating interest rate of three-month secured overnight financing rate (SOFR) plus 311 basis points payable quarterly after December 18, 2024 through maturity. The notes mature on December 18, 2029, and the Company has the option to redeem any or all of the subordinated notes without premium or penalty any time after December 18, 2024 or upon the occurrence of a Tier 2 capital event or tax event.

The Company has a short term line of credit of $30.0 million with Comerica Bank with a fixed interest rate of 4.05% per annum and a commitment fee of 0.20% on the average daily balance of the unused portion of the line of credit. As of September 30, 2021, the Company had no balance on the Comerica Bank line of credit. The Company participated in the PPP and also had the ability to borrow from the Federal Reserve's special purpose Paycheck Protection Program Liquidity Facility ("PPPLF") for additional funding. At September 30, 2021, the Company had no borrowings from the PPPLF.

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 2017 tax return year and forward.

A reconciliation of expected income tax expense using the federal statutory rate of 21% for the three and nine months ended September 30, 2021 and 2020 and actual income tax expense is as follows:

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	For the three months ended September 30,				For the nine months ended September 30,
(Dollars in thousands)	2021		2020		2021		2020
Income tax expense based on federal corporate tax rate	$	2,469	$	1,328	$	6,637	$	2,970
Changes resulting from:
Tax-exempt income	(166)		(154)		(471)		(469)


Net operating loss carryback due to CARES Act	—		—		—		(290)
Disqualified dispositions from stock options	—		—		(4)		(175)
Other, net	(12)		(57)		36		73
Income tax expense	$	2,291	$	1,117	$	6,198	$	2,109

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 in the first quarter of 2020.

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 reserved 250,000 shares of common stock for issuance under the 2018 Plan. During the nine months ended September 30, 2021 and 2020, the Company issued 55,320 and 38,170 restricted stock awards, respectively, under the 2018 Plan. There were 120,327 shares available for issuance as of September 30, 2021.

Stock Options

As of September 30, 2021, all of the Company's outstanding options were granted under the Stock Option Plan. The term of these options is ten years, and they vest one-third each year, over a three year period. The Company will use authorized but unissued shares to satisfy share option exercises. The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model.

Expected volatilities are based on historical volatilities of the Company's common stock. The Company assumes all awards will vest. The expected term of options granted represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. There were no stock options granted during the nine months ended September 30, 2021 or September 30, 2020.

The summary of our stock option activity for the nine months ended September 30, 2021 is as follows:



	Shares	Weighted Average Exercise Price		Weighted Average Remaining Contractual Term
Options outstanding, beginning of period	345,218	$	16.83	4.1

Exercised	(23,800)	10.19
Forfeited	(1,500)	10.00
Options outstanding, end of period	319,918	17.36		3.6
Options exercisable	319,918	$	17.36	3.6

The aggregate intrinsic value was $3.9 million for both options outstanding and exercisable as of September 30, 2021. As of September 30, 2021, there was no unrecognized compensation cost related to stock options granted under the Stock Option Plan.

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Share-based compensation expense charged against income was $11 thousand for the three months ended September 30, 2020, and $6 thousand and $33 thousand for the nine months ended September 30, 2021 and 2020, respectively. There was no share-based compensation expense charged against income for the three months ending September 30, 2021.

Restricted Stock Awards

A summary of changes in the Company's nonvested shares for the nine months ended September 30, 2021 is as follows:


Nonvested Shares	Shares	Weighted Average Grant-Date Fair Value
Nonvested at January 1, 2021	93,270	$	24.75
Granted	55,320	22.68
Vested	(22,220)	25.54
Forfeited	(8,000)	25.22
Nonvested at September 30, 2021	118,370	$	23.60

As of September 30, 2021, there was $1.5 million of total unrecognized compensation cost related to nonvested shares granted under the 2018 Plan. The cost is expected to be recognized over a weighted average period of 2.0 years. The total fair value of shares vested during the nine months ended September 30, 2021 was $568 thousand.

Total expense for restricted stock awards totaled $203 thousand and $223 thousand for the three months ended September 30, 2021 and 2020, respectively, and $563 thousand and $620 thousand for the nine months ended September 30, 2021 and 2020, respectively. For the nine months ended September 30, 2021 and 2020, there was $137 thousand and $64 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, 2021, the allowance for off-balance sheet risk was $318 thousand, compared to $490 thousand at December 31, 2020, and was included in "Other liabilities" on our consolidated balance sheets.

A summary of the contractual amounts of the Company's exposure to off-balance sheet risk is as follows:


	September 30, 2021				December 31, 2020
(Dollars in thousands)	Fixed		Variable		Fixed		Variable
Commitments to make loans	$	9,087	$	6,600	$	18,269	$	17,058
Unused lines of credit	33,383		397,716		28,898		385,307
Unused standby letters of credit and commercial letters of credit	3,353		—		2,340		1,992

Commitments to make loans are generally made for periods of 90 days or less. The fixed rate loan commitments of $9.1 million as of September 30, 2021, had interest rates ranging from 3.5% to 5.00% and maturities ranging from 1 year to 20 years.

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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, 2021, the Company and Bank met all capital adequacy requirements to which they were subject.

The Basel III rules require the Company and the Bank to maintain a capital conservation buffer of common equity Tier 1 capital of 2.5% above the minimum risk-weighted assets ratios.

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, 2021 and December 31, 2020, the Company's and the Bank's capital ratios were in excess of the requirement to be "well capitalized" under regulatory guidelines. There are no conditions or events that management believes have changed the Company or the Bank's category.

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Actual and required capital amounts and ratios are presented below:


	Actual				For Capital Adequacy Purposes				For Capital Adequacy Purposes + Capital Conservation Buffer(1)				Well Capitalized Under Prompt Corrective Action Provisions
(Dollars in thousands)	Amount		Ratio		Amount		Ratio		Amount		Ratio		Amount		Ratio
September 30, 2021
Common equity tier 1 to risk-weighted assets:
Consolidated	$	167,229	9.82	%	$	76,616	4.50	%	$	119,181	7.00	%
Bank	213,794		12.55	%	76,644		4.50	%	119,224		7.00	%	$	110,708	6.50	%
Tier 1 capital to risk-weighted assets:
Consolidated	$	190,602	11.19	%	$	102,155	6.00	%	$	144,719	8.50	%
Bank	213,794		12.55	%	102,192		6.00	%	144,772		8.50	%	$	136,256	8.00	%
Total capital to risk-weighted assets:
Consolidated	$	241,562	14.19	%	$	136,206	8.00	%	$	178,771	10.50	%
Bank	235,093		13.80	%	136,256		8.00	%	178,836		10.50	%	$	170,320	10.00	%
Tier 1 capital to average assets (leverage ratio):
Consolidated	$	190,602	7.68	%	$	99,227	4.00	%	$	99,227	4.00	%
Bank	213,794		8.64	%	98,954		4.00	%	98,954		4.00	%	$	123,692	5.00	%
December 31, 2020
Common equity tier 1 to risk-weighted assets:
Consolidated	$	144,938	9.30	%	$	70,141	4.50	%	$	109,108	7.00	%
Bank	185,655		11.94	%	69,950		4.50	%	108,812		7.00	%	$	101,040	6.50	%
Tier 1 capital to risk-weighted assets:
Consolidated	$	168,310	10.80	%	$	93,521	6.00	%	$	132,488	8.50	%
Bank	185,655		11.94	%	93,267		6.00	%	132,129		8.50	%	$	124,356	8.00	%
Total capital to risk-weighted assets:
Consolidated	$	232,386	14.91	%	$	124,695	8.00	%	$	163,662	10.50	%
Bank	205,127		13.20	%	124,356		8.00	%	163,218		10.50	%	$	155,446	10.00	%
Tier 1 capital to average assets (leverage ratio):
Consolidated	$	168,310	6.93	%	$	97,200	4.00	%	$	97,200	4.00	%
Bank	185,655		7.67	%	96,809		4.00	%	96,809		4.00	%	$	121,011	5.00	%

(1) Reflects the capital conservation buffer of 2.5% for risk-weighted asset ratios.

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, 2021, the Bank had the capacity to pay the Company a dividend of up to $56.3 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. Loans are also evaluated for further credit deterioration and additional credit adjustments are applied to the loan as necessary. 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 a material input.

Assets and liabilities measured at fair value on a recurring basis are summarized below:


(Dollars in thousands)	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
September 30, 2021
Securities available for sale:
U.S. government sponsored entities and agencies	$	24,036	$	—	$	24,036	$	—
State and political subdivision	146,695		—		145,562		1,133
Mortgage-backed securities: residential	20,086		—		20,086		—
Mortgage-backed securities: commercial	23,540		—		23,540		—
Collateralized mortgage obligations: residential	9,871		—		9,871		—
Collateralized mortgage obligations: commercial	52,738		—		52,738		—
U.S. Treasury	64,898		—		64,898		—
SBA	15,108		—		15,108		—
Asset backed securities	9,858		—		9,858		—
Corporate bonds	22,698		—		22,698		—
Total securities available for sale	389,528		—		388,395		1,133
Loans held for sale	15,351		—		15,351		—
Loans measured at fair value:
Residential real estate	9,764		—		—		9,764
Derivative assets:
Customer-initiated derivatives	6,906		—		6,906		—
Forward contracts related to mortgage loans to be delivered for sale	227		—		227		—
Interest rate lock commitments	670		—		670		—
Total assets at fair value	$	422,446	$	—	$	411,549	$	10,897
Derivative liabilities:
Customer-initiated derivatives	6,906		—		6,906		—
Forward contracts related to mortgage loans to be delivered for sale	21		—		21		—
Interest rate lock commitments	8		—		8		—
Total liabilities at fair value	$	6,935	$	—	$	6,935	$	—

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(Dollars in thousands)	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
December 31, 2020
Securities available for sale:
U.S. government sponsored entities and agencies	$	26,358	$	—	$	26,358	$	—
State and political subdivision	132,723		—		131,259		1,464
Mortgage-backed securities: residential	26,081		—		26,081		—
Mortgage-backed securities: commercial	11,918		—		11,918		—
Collateralized mortgage obligations: residential	13,446		—		13,446		—
Collateralized mortgage obligations: commercial	58,512		—		58,512		—

SBA	17,593		—		17,593		—
Asset backed securities	10,072		—		10,072		—
Corporate bonds	6,029		—		6,029		—
Total securities available for sale	$	302,732	$	—	$	301,268	$	1,464
Loans held for sale	43,482		—		43,482		—
Loans measured at fair value:
Residential real estate	8,037		—		—		8,037
Derivative assets:
Customer-initiated derivatives	12,515		—		12,515		—
Forward contracts related to mortgage loans to be delivered for sale	46		—		46		—
Interest rate lock commitments	2,194		—		2,194		—
Total assets at fair value	$	369,006	$	—	$	359,505	$	9,501
Derivative liabilities:
Customer-initiated derivatives	12,515		—		12,515		—
Forward contracts related to mortgage loans to be delivered for sale	423		—		423		—
Total liabilities at fair value	$	12,938	$	—	$	12,938	$	—

There were no transfers between levels within the fair value hierarchy, within a specific category, during the nine months ended September 30, 2021 or year ended December 31, 2020. The Level 3 investment securities disclosed as of September 30, 2021 and December 31, 2020 were acquired from Ann Arbor State Bank during the first quarter of 2020.

The following table summarizes the changes in Level 3 loans 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)	2021		2020		2021		2020
Loans held for investment
Beginning balance	$	11,059	$	4,056	$	8,037	$	4,063
Transfers from loans held for sale	—		1,468		4,656		2,284
Gains (losses):
Recorded in "Mortgage banking activities"	(43)		65		(397)		62
Repayments	(1,252)		(509)		(2,532)		(1,329)
Ending balance	$	9,764	$	5,080	$	9,764	$	5,080

There were $100 thousand in loans held for investment measured at fair value that were on nonaccrual status or 90 days past due with a fair value of $100 thousand as of September 30, 2021. There were $105 thousand in loans held for investment measured at fair value that were on nonaccrual status or 90 days past due with a fair value of $109 thousand as of December 31, 2020.

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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.

As of September 30, 2021 and December 31, 2020, 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, 2021		December 31, 2020
Aggregate fair value	$	15,351	$	43,482
Contractual balance	14,835		41,808
Unrealized gain	516		1,674

The total amount of gains as a result of changes in fair value of loans held for sale included in "Mortgage banking activities" for the three months ended September 30, 2021 and 2020 were as follows:


	For the three months ended September 30,				For the nine months ended September 30,
(Dollars in thousands)	2021		2020		2021		2020
Change in fair value	$	194	$	556	$	(1,158)	$	1,201

Assets measured at fair value on a non-recurring basis are summarized below:


(Dollars in thousands)	Total		Significant Unobservable Inputs (Level 3)
September 30, 2021
Impaired loans:
Residential real estate	$	488	$	488

Commercial and industrial	302		302
Mortgage servicing rights	7,205		7,205






Total	$	7,995	$	7,995
December 31, 2020
Impaired loans:

Commercial and industrial	$	1,270	$	1,270
Mortgage servicing rights	3,981		3,981

Total	$	5,251	$	5,251

The Company recorded specific reserves of $130 thousand and $95 thousand to reduce the value of the impaired loans noted above at September 30, 2021 and December 31, 2020, respectively, based on the estimated fair value of the underlying collateral. The Company also recorded $242 thousand of chargeoffs during the nine months ended September 30, 2021 related to the impaired loans at fair value. There were chargeoffs of $315 thousand related to impaired loans at fair value during the year ended December 31, 2020.

There were no write downs recorded in other real estate owned during the nine months ended September 30, 2021 or the year ended December 31, 2020.

The table below presents quantitative information about the significant unobservable inputs for assets measured at fair value on a nonrecurring basis at September 30, 2021 and December 31, 2020:


(Dollars in thousands)	Fair Value at September 30, 2021		Valuation Technique(s)	Significant Unobservable Input(s)	Discount % Range/Amount
Impaired loans	$	790	Discounted appraisals; estimated net realizable value of collateral	Collateral discounts	5.00-100.00%
Mortgage servicing rights	7,205		Discounted cash flow	Prepayment speed	6.83	%
				Discount rate	8.00	%

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(Dollars in thousands)	Fair value at December 31, 2020		Valuation Technique(s)	Significant Unobservable Input(s)	Discount % Range/Amount
Impaired loans	$	1,270	Discounted appraisals; estimated net realizable value of collateral	Collateral discounts	10.00-90.00%
Mortgage servicing rights	3,981		Discounted cash flow	Prepayment speed	8.71	%
				Discount rate	7.75	%

The carrying amounts and estimated fair values of financial instruments, excluding those previously presented unless otherwise noted, at September 30, 2021 and December 31, 2020 are noted in the table below.


			Estimated Fair Value
(Dollars in thousands)	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
September 30, 2021
Financial assets:
Cash and cash equivalents	$	293,824	$	30,810	$	263,014	$	—	$	293,824
Other investments	14,398		N/A		N/A		N/A		N/A
Net loans	1,697,986		—		—		1,728,396		1,728,396
Accrued interest receivable	7,779		—		2,696		5,083		7,779
Financial liabilities:
Deposits	2,066,992		—		2,099,195		—		2,099,195
Borrowings	182,058		—		186,018		—		186,018
Subordinated notes	29,668		—		31,500		—		31,500
Accrued interest payable	1,079		—		1,079		—		1,079
December 31, 2020
Financial assets:
Cash and cash equivalents	$	264,071	$	25,245	$	238,826	$	—	$	264,071
Other investments	14,398		N/A		N/A		N/A		N/A
Net loans	1,701,240		—		—		1,740,093		1,740,093
Accrued interest receivable	7,511		—		1,460		6,051		7,511
Financial liabilities:
Deposits	1,963,312		—		2,022,399		—		2,022,399
Borrowings	185,684		—		192,546		—		192,546
Subordinated notes	44,592		—		45,902		—		45,902
Accrued interest payable	1,081		—		1,081		—		1,081

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 their 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

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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 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, 2021				December 31, 2020
(Dollars in thousands)	Notional Amount		Fair Value		Notional Amount		Fair Value
Included in other assets:
Customer-initiated and mortgage banking derivatives:
Customer-initiated derivatives	$	151,095	$	6,906	$	136,023	$	12,515
Forward contracts related to mortgage loans to be delivered for sale	38,721		227		10,191		46
Interest rate lock commitments	56,871		670		91,531		2,194
Total derivatives included in other assets	$	246,687	$	7,803	$	237,745	$	14,755
Included in other liabilities:
Customer-initiated and mortgage banking derivatives:
Customer-initiated derivatives	$	151,095	$	6,906	$	136,023	$	12,515
Forward contracts related to mortgage loans to be delivered for sale	15,645		21		92,899		423
Interest rate lock commitments	3,096		8		—		—
Total derivatives included in other liabilities	$	169,836	$	6,935	$	228,922	$	12,938

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)	2021		2020		2021		2020
Forward contracts related to mortgage loans to be delivered for sale	Mortgage banking activities	$	34	$	(1,207)	$	1,528	$	(3,996)
Interest rate lock commitments	Mortgage banking activities	87		391		(1,532)		1,808
Total loss recognized in income		$	121	$	(816)	$	(4)	$	(2,188)

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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 recognized		Gross amounts offset in the statements of financial condition		Net amounts presented in the statements of financial condition		Financial instruments		Collateral (received)/posted		Net amount
September 30, 2021
Offsetting derivative assets:
Customer initiated derivatives	$	6,906	$	—	$	6,906	$	—	$	—	$	6,906
Offsetting derivative liabilities:
Customer initiated derivatives	$	6,906	$	—	$	6,906	$	—	$	10,383	$	(3,477)
December 31, 2020
Offsetting derivative assets:
Customer initiated derivatives	$	12,515	$	—	$	12,515	$	—	$	—	$	12,515
Offsetting derivative liabilities:
Customer initiated derivatives	$	12,515	$	—	$	12,515	$	—	$	15,383	$	(2,868)

NOTE 15—PARENT COMPANY FINANCIAL STATEMENTS

Balance Sheets—Parent Company


(Dollars in thousands)	September 30, 2021		December 31, 2020
Assets
Cash and cash equivalents	$	8,220	$	25,779
Investment in banking subsidiary	257,126		232,671
Investment in captive insurance subsidiary	—		1,625
Income tax benefit	78		355
Other assets	23		63
Total assets	$	265,447	$	260,493
Liabilities
Subordinated notes	$	29,668	$	44,592
Accrued expenses and other liabilities	1,845		574
Total liabilities	31,513		45,166
Shareholders' equity	233,934		215,327
Total liabilities and shareholders' equity	$	265,447	$	260,493

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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)	2021		2020		2021		2020
Income
Dividend income from bank subsidiary	$	—	$	5,000	$	—	$	41,500
Dividend income from captive subsidiary	—		—		1,629		—
Total income	$	—	$	5,000	$	1,629	$	41,500
Expenses
Interest on borrowed funds	—		11		—		33
Interest on subordinated notes	373		632		1,469		1,903
Other expenses	363		302		895		1,017
Total expenses	$	736	$	945	$	2,364	$	2,953
Income (loss) before income taxes and equity in undistributed net earnings of subsidiaries	(736)		4,055		(735)		38,547
Income tax (benefit) expense	132		228		342		383
Equity in (overdistributed) undistributed earnings of subsidiaries	10,069		926		25,796		(26,890)
Net income	$	9,465	$	5,209	$	25,403	$	12,040
Other comprehensive income (loss)	(216)		783		(3,327)		4,451
Total comprehensive income, net of tax	$	9,249	$	5,992	$	22,076	$	16,491

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Statements of Cash Flows—Parent Company


	For the nine months ended September 30,
(Dollars in thousands)	2021		2020
Cash flows from operating activities
Net income	$	25,403	$	12,040
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in over (under) distributed earnings of subsidiaries	(25,796)		26,890
Stock based compensation expense	71		72
Net change in other assets, net	317		420
Net change in other liabilities, net	1,269		654
Net cash provided by operating activities	1,264		40,076
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 costs	—		23,370
Pay down of subordinated debt	(15,000)		—
Share buyback - redeemed stock	(1,364)		(620)
Common stock dividends paid	(1,296)		(1,082)
Preferred stock dividends paid	(1,406)		—
Proceeds from exercised stock options	243		95
Net cash (used in) provided by financing activities	(18,823)		21,763
Net decrease in cash and cash equivalents	(17,559)		(6,105)
Beginning cash and cash equivalents	25,779		35,210
Ending cash and cash equivalents	$	8,220	$	29,105

NOTE 16—EARNINGS PER COMMON SHARE

The Company has elected to use the two-class method in calculating earnings per share due to the unvested restricted stock awards qualifying as participating securities. 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.

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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)	2021		2020		2021		2020
Net income	$	9,465	$	5,209	$	25,403	$	12,040
Preferred stock dividends	468		—		1,406		—
Net income available to common shareholders	8,997		5,209		23,997		12,040
Net income allocated to participating securities	138		40		331		140
Net income allocated to common shareholders (1)	$	8,859	$	5,169	$	23,666	$	11,900
Weighted average common shares - issued	7,638		7,734		7,633		7,730
Average unvested restricted share awards	(119)		(59)		(107)		(90)
Weighted average common shares outstanding - basic	7,519		7,675		7,526		7,640
Effect of dilutive securities:
Weighted average common stock equivalents	119		37		105		61
Weighted average common shares outstanding - diluted	7,638		7,712		7,631		7,701
EPS available to common shareholders
Basic earnings per common share	$	1.19	$	0.68	$	3.15	$	1.56
Diluted earnings per common share	$	1.16	$	0.67	$	3.10	$	1.55

(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.

There were no common stock options excluded in computing diluted earnings per share for the three and nine months ending September 30, 2021 compared to 214,668 and 117,334 shares of common stock options that were excluded in computing diluted earnings per common share for the three and nine months ending September 30, 2020, because they were anti-dilutive.

NOTE 17—SUBSEQUENT EVENTS

On November 4, 2021, the Company entered into an Agreement and Plan of Merger with First Merchants Corporation (“First Merchants”), pursuant to which the Company will merge with and into First Merchants (the “Merger”), subject to the satisfaction of customary closing conditions. At the effective time of the Merger, each outstanding share of common stock of the Company will be converted into the right to receive 0.7167 shares of First Merchants common stock and $10.17 in cash, and each outstanding share of the Company’s 7.50% Non-Cumulative Perpetual Preferred Stock, Series B (the “Company Preferred Stock”) will be converted into the right to receive a share of a newly created series of preferred stock of First Merchants having voting powers, preferences and special rights that are substantially identical to the Company Preferred Stock.

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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 and results of operations as of and for the three and nine months ended September 30, 2021. 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, 2020, filed with the SEC on March 12, 2021. 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; risks related to the pending Merger with First Merchants, including the inability to complete the Merger due to the failure of the Company’s shareholders to approve the merger agreement, the failure to satisfy other conditions to completion of the Merger, including receipt of required regulatory and other approvals, the failure of the proposed Merger to close for any other reason, diversion of management’s attention from ongoing business operations and opportunities due to the Merger, and the effect of the announcement of the Merger on the Company’s customer and employee relationships and operating results; 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; changes in benchmark interest rates used to price loans and deposits, including the expected elimination of LIBOR and the development of a substitute; changes in tax laws, regulations and guidance; 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.

Our critical accounting policies are set forth in "Note 1 – Basis of Presentation and Summary of Significant Accounting Policies" of the Notes to the Consolidated Financial Statements and "Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the year ended December 31, 2020, which was filed with the SEC on March 12, 2021. There have been no material changes in critical accounting policies or the assumptions and judgments utilized in applying these policies since December 31, 2020.

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, provided property and casualty insurance to the Company and the Bank and reinsurance to ten other third-party insurance captives for which insurance may not have been available or economically feasible in the insurance marketplace. Hamilton Court Insurance Company exited the pool resources relationship to which it was previously a member and was dissolved in January 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.

Recent Developments

Third Quarter Common Stock Dividend. On September 15, 2021, Level One's Board of Directors declared a third quarter 2021 cash dividend of $0.06 per common share. The dividend was paid on October 15, 2021, to shareholders of record at the close of business on September 30, 2021.

Third Quarter Preferred Stock Dividend. On October 20, 2021, Level One’s Board of Directors declared a quarterly cash dividend of $46.88 per share on its 7.50% Non-Cumulative Perpetual Preferred Stock, Series B. Holders of depositary shares will receive $0.4688 per depositary share. The dividend is payable on November 15, 2021, to shareholders of record at the close of business on October 31, 2021.

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 impact on the economy, the banking industry and the Company.

Effects on Our Business. We currently expect that the COVID-19 pandemic, federal, state and local government responses to the pandemic, supply disruptions, labor availability challenges, and the effects of existing and future variants of the disease, such as the Delta variant, may continue to have a significant impact on our business. A substantial portion of the Bank’s borrowers in the restaurant and hospitality industries have endured substantial economic distress, and while those challenges have been largely mitigated by the PPP and other governmental assistance, there is still some uncertainty about the ability of these clients to return to cash flow levels necessary to cover their debt service. These developments, together with economic conditions generally, are also expected to impact our commercial real estate portfolio, particularly with respect to real estate with exposure to these industries and the value of certain collateral securing our loans.

Level One's Response to the COVID-19 Pandemic. Level One has taken comprehensive steps to help our customers, team members and communities during the COVID-19 pandemic. For our customers, we have provided loan payment deferrals and offered fee waivers, among other actions.

Level One was also a participating lender in both the first and second rounds of the PPP. In 2020, the Bank originated 2,208 PPP loans in the aggregate principal amount of $417.0 million. From January 18, 2021 through June 30, 2021, Level One funded 1,532 new PPP loan applications for $234.3 million, of which 1,187 were for loans $150,000 or below. As of September 30, 2021, $147.6 million of PPP loans were still outstanding. The Bank is actively working with the borrowers of PPP loans to obtain loan forgiveness from the SBA.

We are continuing to enable the vast majority of our main office team members to work remotely most days. 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 protocols necessary for those who return. As of March 1, 2021, we opened branches for walk in services. We continue to evaluate this fluid situation and take additional actions as necessary.

Level One also recognizes that some of the most impacted industries are the restaurant and hospitality industries. As of September 30, 2021, Level One had less than 4.1% and 0.3% of loan concentrations in the restaurant 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, 2021			June 30, 2021			September 30, 2020			September 30, 2021			September 30, 2020
Earnings Summary
Interest income	$	22,322		$	21,737		$	20,245		$	65,610		$	60,458
Interest expense	1,807			2,121			3,648			6,322			12,808
Net interest income	20,515			19,616			16,597			59,288			47,650
Provision expense (recovery) for loan losses	(1,189)			540			4,270			(384)			10,334
Noninterest income	6,041			4,326			9,125			17,645			21,604
Noninterest expense	15,989			14,588			15,126			45,716			44,771
Income before income taxes	11,756			8,814			6,326			31,601			14,149
Income tax provision	2,291			1,835			1,117			6,198			2,109
Net income	9,465			6,979			5,209			25,403			12,040
Preferred stock dividends	468			469			—			1,406			—
Net income available to common shareholders	8,997			6,510			5,209			23,997			12,040
Net income allocated to participating securities	138			92			40			331			140
Net income attributable to common shareholders	$	8,859		$	6,418		$	5,169		$	23,666		$	11,900
Per Share Data
Basic earnings per common share	$	1.19		$	0.85		$	0.68		$	3.15		$	1.56
Diluted earnings per common share	1.16			0.84			0.67			3.10			1.55
Diluted earnings per common share, excluding acquisition and due diligence fees (1)	1.16			0.84			0.67			3.10			1.72
Book value per common share	27.56			26.48			24.06			27.56			27.08
Tangible book value per common share (1)	21.89			20.84			18.74			21.89			18.74
Preferred shares outstanding (in thousands)	10			10			10			10			10
Common shares outstanding (in thousands)	7,640			7,629			7,734			7,640			7,734
Average basic common shares (in thousands)	7,519			7,520			7,675			7,526			7,640
Average diluted common shares (in thousands)	7,638			7,633			7,712			7,631			7,701
Selected Period End Balances
Total assets	$	2,543,883		$	2,506,523		$	2,446,447		$	2,543,883		$	2,446,447
Securities available-for-sale	389,528			376,453			253,527			389,528			253,527
Total loans	1,719,717			1,775,243			1,843,888			1,719,717			1,843,888
Total deposits	2,066,992			2,031,808			1,943,435			2,066,992			1,943,435
Total liabilities	2,309,949			2,281,114			2,236,979			2,309,949			2,236,979
Total shareholders' equity	233,934			225,409			209,468			233,934			209,468
Total common shareholders' equity	210,562			202,037			186,098			210,562			186.098
Tangible common shareholders' equity (1)	167,262			159,022			144,963			167,262			144,963
Performance and Capital Ratios
Return on average assets	1.50		%	1.09		%	0.83		%	1.34		%	0.71 %
Return on average equity	16.32			12.52			10.48			15.06			8.68 %
Net interest margin (fully taxable equivalent) (2)	3.47			3.30			2.80			3.36			3.04 %
Efficiency ratio (noninterest expense/net interest income plus noninterest income)	60.21			60.93			58.81			59.42			64.65 %
Dividend payout ratio	5.08			7.02			7.41			5.40			8.99 %
Total shareholders' equity to total assets	9.20			8.99			8.56			9.20			8.56 %
Tangible common equity to tangible assets (1)	6.69			6.46			6.03			6.69			6.03 %
Common equity tier 1 to risk-weighted assets	9.82			9.66			8.83			9.82			8.83 %
Tier 1 capital to risk-weighted assets	11.19			11.09			10.31			11.19			10.31 %
Total capital to risk-weighted assets	14.19			14.15			14.39			14.19			14.39 %
Tier 1 capital to average assets (leverage ratio)	7.68			7.24			7.17			7.68			7.17 %
Asset Quality Ratios:
Net (recoveries) charge-offs to average loans	0.05		%	(0.01)		%	0.02		%	0.01		%	0.14 %
Nonperforming assets as a percentage of total assets	0.48			0.55			0.79			0.48			0.79 %
Nonaccrual loans as a percent of total loans	0.71			0.77			1.04			0.71			1.04 %
Allowance for loan losses as a percentage of total loans	1.26			1.30			1.15			1.26			1.15 %
Allowance for loan losses as a percentage of nonaccrual loans	179.11			168.64			110.32			179.11			110.32 %
Allowance for loan losses as a percentage of nonaccrual loans, excluding allowance allocated to loans accounted for under ASC 310-30	173.58			163.76			105.46			173.58			105.46 %

(1) See section entitled "GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures" below for a reconciliation to most comparable GAAP equivalent.

(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, 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, 2021			June 30, 2021			September 30, 2020
	(Unaudited)			(Unaudited)			(Unaudited)
Total shareholders' equity	$	233,934		$	225,409		$	209,468
Less:
Preferred stock	23,372			23,372			23,370
Total common shareholders' equity	210,562			202,037			186,098
Less:
Goodwill	35,554			35,554			35,554
Mortgage servicing rights, net	5,051			4,599			2,193
Other intangible assets, net	2,695			2,862			3,388
Tangible common shareholders' equity	$	167,262		$	159,022		$	144,963

Common shares outstanding (in thousands)	7,640			7,629			7,734
Tangible book value per common share	$	21.89		$	20.84		$	18.74

Total assets	$	2,543,883		$	2,506,523		$	2,446,447
Less:
Goodwill	35,554			35,554			35,554
Mortgage servicing rights, net	5,051			4,599			2,193
Other intangible assets, net	2,695			2,862			3,388
Tangible assets	$	2,500,583		$	2,463,508		$	2,405,312

Tangible common equity to tangible assets	6.69		%	6.46		%	6.03		%


Adjusted Income and Diluted Earnings Per Share
	For the three months ended						For the nine months ended
(Dollars in thousands, except per share data)	September 30, 2021		June 30, 2021		September 30, 2020		September 30, 2021		September 30, 2020
	(Unaudited)		(Unaudited)		(Unaudited)		(Unaudited)		(Unaudited)
Net income, as reported	$	9,465	$	6,979	$	5,209	$	25,403	$	12,040
Acquisition and due diligence fees	—		—		17		—		1,664
Income tax benefit (1)	—		—		(4)		—		(333)
Net income, excluding acquisition and due diligence fees	$	9,465	$	6,979	$	5,222	$	25,403	$	13,371

Diluted earnings per share, as reported	$	1.16	$	0.84	$	0.67	$	3.10	$	1.55
Effect of acquisition and due diligence fees, net of income tax benefit	—		—		—		—		0.17
Diluted earnings per common share, excluding acquisition and due diligence fees	$	1.16	$	0.84	$	0.67	$	3.10	$	1.72

(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, 2021			June 30, 2021			December 31, 2020			September 30, 2020
	(Unaudited)			(Unaudited)						(Unaudited)
Total loans	$	1,719,717		$	1,775,243		$	1,723,537		$	1,843,888
Less:
PPP loans	147,645			259,303			290,135			392,521
Total loans, excluding PPP loans	$	1,572,072		$	1,515,940		$	1,433,402		$	1,451,367

Allowance for loan loss	$	21,731		$	23,144		$	22,297		$	21,254
Allowance for loan loss as a percentage of total loans	1.26		%	1.30		%	1.29		%	1.15		%
Allowance for loan loss as a percentage of total loans excluding PPP loans	1.38		%	1.53		%	1.56		%	1.46		%

Results of Operations

Net Income

We had net income of $9.5 million, or $1.16 per diluted common share, for the three months ended September 30, 2021, compared to $5.2 million, or $0.67 per diluted common share, for the three months ended September 30, 2020. The increase of $4.3 million in net income reflected an increase of $3.9 million in net interest income, primarily due to higher interest income on loans due, in part, to the recognition of fees on PPP loans as they are forgiven, and lower interest expense on deposits, borrowed funds, and subordinated notes. The increase in net income also reflected a decrease of $5.5 million in provision for loan loss, primarily due to a decrease in general reserves resulting from a reduction in qualitative factors within the allowance for loan loss model as a result of improved credit quality. These were partially offset by decreases of $3.1 million in noninterest income, primarily due to lower mortgage banking activities and net gain on sales of securities, and increases of $1.2 million in income tax provision expense due to higher income before taxes and $863 thousand in noninterest expense due to higher salary and employee benefits expense.

We had net income of $25.4 million, or $3.10 per diluted common share, for the nine months ended September 30, 2021, compared to $12.0 million, or $1.55 per diluted common share, for the nine months ended September 30, 2020. The increase of $13.4 million in net income primarily reflected an increase of $11.6 million in net interest income, primarily due to higher interest income on loans due, in part, to the recognition of fees on PPP loans as they are forgiven. In addition, there was higher interest income on securities due to increased volumes of investment securities and lower interest expense on deposits, borrowed funds, and subordinated notes. The increase in net income also reflected a decrease of $10.7 million in provision for loan loss, primarily due to a decrease in general reserves resulting from an increase in the economic qualitative factors in the nine months ended September 30, 2020 and a reduction in qualitative factors in the third quarter of 2021. These were partially offset by increases of $4.1 million of income tax provision primarily due to higher income before taxes and $945 thousand of

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noninterest expense primarily due to increases of $1.7 million of salary and employee benefits expense and $608 thousand of data processing expense partially offset by a decrease of $1.7 million in acquisition and due diligence fees due to the merger with Ann Arbor State Bank in the first quarter of 2020. In addition, there was a $4.0 million decrease in noninterest income primarily due to lower mortgage banking activities and net gain on sales of securities partially offset by an increase in service charges on deposits.

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 $20.5 million for the three months ended September 30, 2021 was $3.9 million higher than the net interest income of $16.6 million for the three months ended September 30, 2020. The three months ended September 30, 2021 included a $2.1 million increase in interest income as well as a $1.8 million decrease in interest expense, compared to the same period in 2020. The increase in interest income was primarily driven by increases of $1.7 million in interest and fees on loans and $419 thousand in interest on investment securities. The increase in interest and fees on loans for the three months ended September 30, 2021 compared to the same period in 2020 was mainly driven by the Bank earning $3.6 million of net SBA fees on PPP loans compared to $1.5 million in the three months ended September 30, 2020, with the remaining $5.3 million of SBA fees expected to be earned over the life of the loans. The majority of the PPP loans are expected to mature two or five years from the date of funding, depending on the round of PPP funding, unless modified by the lender and borrower. We anticipate a large portion of the PPP loan balance will be forgiven before the maturity of the loans. In addition to the net SBA fees, the Bank also recognized $521 thousand of interest income on PPP loans in the third quarter of 2021. The increase in interest income on investment securities was mainly due to an increase of $136.2 million in average balances due to increased customer liquidity and new customer growth.

The decrease in interest expense was primarily driven by a decrease of $1.4 million in interest expense on deposits and a decrease of $483 thousand in interest expense on borrowed funds and subordinated notes. The decrease in deposit interest expense was primarily due to lower interest rates paid as a result of revised internal deposit rates and maturity of higher cost time deposits. The decrease in interest expense on borrowed funds and subordinated notes was primarily due to the redemption of $15.0 million of subordinated notes during the second quarter of 2021 and a decrease in Federal Reserve Bank borrowings

Net interest income of $59.3 million for the nine months ended September 30, 2021 was $11.6 million higher than the net interest income of $47.7 million for the nine months ended September 30, 2020. The nine months ended September 30, 2021 included a $5.2 million increase in interest income as well as a $6.5 million decrease in interest expense, compared to the same period in 2020. The increase in interest income was primarily driven by increases of $4.5 million in interest and fees on loans and $951 thousand in interest on investment securities. These increases were partially offset by a $299 thousand decrease in interest on federal funds and other investments. The increase in interest and fees on loans for the nine months ended September 30, 2021 compared to the same period in 2020 was mainly driven by the Bank earning $10.3 million of net SBA fees on PPP loans compared to $2.9 million in the nine months ended September 30, 2020. In addition to the net SBA fees, the Bank also recognized $2.4 million of interest income on PPP loans in the nine months ended September 30, 2021. This was partially offset by a 56 basis point decrease in yield on loans excluding PPP loans for the nine months ended September 30, 2021 compared to the same period in 2020. The increase in interest income on investment securities was mainly due to an increase of $125.3 million in average balances due to increased customer liquidity and new customer growth.

The decrease in interest expense was primarily driven by a decrease of $5.6 million in interest expense on deposits and a decrease of $890 thousand in interest expense on borrowed funds and subordinated notes. The decrease in deposit interest expense was primarily due to lower interest rates paid as a result of revised internal deposit rates and maturity of higher cost time deposits. The decrease in interest expense on borrowed funds and subordinated notes was primarily due to the redemption of $15.0 million of subordinated notes during the second quarter of 2021 and a decrease in Federal Reserve Bank borrowings.

Our net interest margin (on a fully tax equivalent basis ("FTE")) for the three months ended September 30, 2021 was 3.47%, compared to 2.80% for the same period in 2020. The increase of 67 basis points in the net interest margin year over year was primarily a result of a decrease in cost of funds, which declined 40 basis points to 0.48% in the third quarter of 2021, compared to 0.88% in the third quarter of 2020 primarily due to lower interest rates paid as a result of revised internal deposit rates and maturity of higher cost time deposits. The decrease in cost of funds was accompanied by higher yield on loans mostly reflecting the increase in PPP fees earned during the period.

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

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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 both the three months ended September 30, 2021 and 2020, the yield on total loans was impacted by 7 basis points due to the accretable yield on purchased credit impaired loans. Our net interest margin for the three months ended September 30, 2021 and 2020, benefited by 6 basis points and 8 basis points, respectively, as a result of the excess accretable yield. For the nine months ended September 30, 2021 and 2020, the yield on total loans was impacted by 6 and 7 basis points due to the accretable yield on purchased credit impaired loans. Our net interest margin for the nine months ended September 30, 2021 and 2020, benefited by 4 basis points and 9 basis points, respectively, as a result of the excess accretable yield. As of September 30, 2021 and December 31, 2020, our remaining accretable yield was $5.9 million and $7.1 million, respectively, and our nonaccretable difference was $2.1 million and $2.7 million, respectively.

Our net interest margin (FTE) for the nine months ended September 30, 2021 was 3.36%, compared to 3.04% for the same period in 2020. The increase of 32 basis points in the net interest margin year over year was primarily a result of a decrease in cost of funds, which declined 60 basis points to 0.55% in the first nine months of 2021, compared to 1.15% in the first nine months of 2020 primarily due to lower interest rates paid as a result of revised internal deposit rates and maturity of higher cost time deposits. The decrease in cost of funds was accompanied by a lower yields across most interest-earning assets, mostly reflecting the impact of lower market interest rates.

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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, 2021						For the nine months ended September 30, 2021
(Dollars in thousands)	2021			2020			2021			2020
Average Balance Sheets:
Gross loans(1)	$	1,763,214		$	1,871,164		$	1,823,888		$	1,696,073
Investment securities: (2)
Taxable	265,885			139,237			243,377			124,169
Tax-exempt	104,063			94,526			103,158			97,104
Interest-earning cash balances	221,261			259,349			192,309			188,179
Other investments	14,398			12,419			14,398			12,401
Total interest-earning assets	$	2,368,821		$	2,376,695		$	2,377,130		$	2,117,926
Non-earning assets:	151,077			140,480			145,971			133,968
Total assets	$	2,519,898		$	2,517,175		$	2,523,101		$	2,251,894

Interest-bearing demand deposits	$	156,977		$	116,285		$	144,449		$	112,579
Money market and savings deposits	624,190			513,420			623,123			458,438
Time deposits	489,261			575,179			541,018			564,396
Borrowings	181,911			394,020			183,983			311,024
Subordinated notes	29,657			44,468			38,633			44,463
Total interest-bearing liabilities	1,481,996			1,643,372			1,531,206			1,490,900
Noninterest-bearing demand deposits	774,926			640,095			735,162			546,066
Other liabilities	31,012			34,846			31,822			30,047
Shareholders' equity	231,964			198,862			224,911			184,881
Total liabilities and shareholders' equity	$	2,519,898		$	2,517,175		$	2,523,101		$	2,251,894

Yields: (3)
Earning Assets
Gross loans	4.60		%	3.98		%	4.42		%	4.40		%
Investment securities:
Taxable	1.57		%	1.86		%	1.59		%	2.08		%
Tax-exempt	2.99		%	3.19		%	3.04		%	3.20		%
Interest earning cash balances	0.15		%	0.12		%	0.12		%	0.28		%
Other investments	2.95		%	5.57		%	3.18		%	4.49		%
Total interest earning assets	3.76		%	3.41		%	3.72		%	3.84		%

Interest-bearing liabilities
Interest-bearing demand deposits	0.14		%	0.22		%	0.15		%	0.31		%
Money market and savings deposits	0.17		%	0.43		%	0.20		%	0.65		%
Time deposits	0.53		%	1.18		%	0.58		%	1.55		%
Borrowings	1.02		%	0.70		%	1.02		%	0.80		%
Subordinated notes	5.00		%	5.65		%	5.09		%	5.72		%
Total interest-bearing liabilities	0.48		%	0.88		%	0.55		%	1.15		%

Interest spread	3.28		%	2.53		%	3.17		%	2.69		%
Net interest margin(4)	3.44		%	2.78		%	3.33		%	3.01		%
Tax equivalent effect	0.03		%	0.02		%	0.03		%	0.03		%
Net interest margin on a fully tax equivalent basis	3.47		%	2.80		%	3.36		%	3.04		%

(1) Includes nonaccrual loans.

(2) For presentation in this table, average balances and the corresponding average rates for investment securities are based upon historical cost, adjusted for amortization of premiums and accretion of discounts.

(3) Average rates and yields are presented on an annual basis and include a taxable equivalent adjustment to interest income of $155 thousand and $144 thousand on tax-exempt securities for the three months ended September 30, 2021 and 2020, respectively, and $462 thousand and $431 thousand for the nine months ended September 30, 2021and 2020, respectively, using the federal corporate tax rate of 21%.

(4) 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, 2021 vs. 2020
	Increase (Decrease) Due to:
(Dollars in thousands)	Rate		Volume		Net Increase (Decrease)
Interest-earning assets
Gross loans	$	2,842	$	(1,125)	$	1,717
Investment securities:
Taxable	(111)		513		402
Tax-exempt	(56)		73		17
Interest-earning cash balances	20		(12)		8
Other investments	(92)		25		(67)
Total interest income	2,603		(526)		2,077
Interest-bearing liabilities
Interest-bearing demand deposits	(30)		19		(11)
Money market and savings deposits	(396)		101		(295)
Time deposits	(827)		(225)		(1,052)
Borrowings	240		(465)		(225)
Subordinated debt	(66)		(192)		(258)
Total interest expense	(1,079)		(762)		(1,841)
Change in net interest income	$	3,682	$	236	$	3,918

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	For the nine months ended September 30, 2021 vs. 2020
	Increase (Decrease) Due to:
(Dollars in thousands)	Rate		Volume		Net Increase (Decrease)
Interest-earning assets
Gross loans	$	276	$	4,224	$	4,500
Investment securities:
Taxable	(539)		1,504		965
Tax-exempt	(155)		141		(14)
Interest-earning cash balances	(233)		9		(224)
Other investments	(135)		60		(75)
Total interest income	(786)		5,938		5,152
Interest-bearing liabilities
Interest-bearing demand deposits	(164)		61		(103)
Money market and savings deposits	(1,894)		612		(1,282)
Time deposits	(3,951)		(260)		(4,211)
Borrowings	429		(886)		(457)
Subordinated debt	(198)		(235)		(433)
Total interest expense	(5,778)		(708)		(6,486)
Change in net interest income	$	4,992	$	6,646	$	11,638

Provision for Loan Losses

We established an allowance for loan losses through a provision for loan losses charged as an expense in our consolidated statements of income. Management reviews the loan portfolio, consisting of originated loans and acquired loans, on a quarterly basis to evaluate the outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses.

Loans acquired in connection with acquisitions that have evidence of credit deterioration since origination and for which it is probable at the date of acquisition that we will not collect all contractually required principal and interest payments are accounted for under ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, or ASC 310-30. These credit-impaired loans have been recorded at their estimated fair value on the respective acquisition date, based on subjective determinations regarding risk ratings, expected future cash flows and fair value of the underlying collateral, without a carryover of the related allowance for loan losses. At the acquisition date, the Company recognizes the expected shortfall of expected future cash flows, as compared to the contractual amount due, as a nonaccretable discount. Any excess of the net present value of expected future cash flows over the acquisition date fair value is recognized as the accretable discount, or accretable yield. We evaluate these loans semi-annually to assess expected cash flows. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges or a reclassification of the difference from nonaccretable to accretable with a positive impact on interest income. As of September 30, 2021, and December 31, 2020, our remaining accretable yield was $5.9 million and $7.1 million, respectively, and our nonaccretable difference was $2.1 million and $2.7 million as of both dates.

The provision for loan losses was a provision benefit of $1.2 million for the three months ended September 30, 2021, compared to a provision expense of $4.3 million for the three months ended September 30, 2020. The decrease of $5.5 million in the provision for loan losses was primarily due to a decrease in general reserves of $5.1 million due to a reduction in qualitative factors within the allowance for loan loss model as a result improved credit quality as well as a decrease of $531 thousand in specific reserves.

The provision for loan losses was a provision benefit of $384 thousand for the nine months ended September 30, 2021, compared to a provision expense of $10.3 million for the nine months ended September 30, 2020. The decrease of $10.7 million in the provision for loan losses was primarily due to a decrease in general reserves of $8.6 million due to a reduction in qualitative factors mentioned above during the third quarter of 2021 while qualitative factors were increased during the nine months ended September 30, 2020 due to economic uncertainty regarding the impact of the COVID-19 pandemic on credit

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quality. In addition, there was a decrease of $1.6 million in net chargeoffs resulting from a $1.3 million chargeoff on a nonaccrual loan during the second quarter of 2020 and a decrease of $402 thousand in specific reserves.

Noninterest Income

The following table presents noninterest income for the three and nine months ended September 30, 2021 and 2020.


	For the three months ended September 30,			For the nine months ended September 30,
(Dollars in thousands)		2021		2020		2021		2020
Noninterest income
Service charges on deposits		$	859	$	616	$	2,436	$	1,798
Net gain on sales of securities		—		434		20		1,862
Mortgage banking activities		4,216		7,108		12,738		15,380

Other charges and fees		966		967		2,451		2,564
Total noninterest income		$	6,041	$	9,125	$	17,645	$	21,604

Noninterest income decreased $3.1 million to $6.0 million for the three months ended September 30, 2021, compared to $9.1 million for the same period in 2020. The decrease in noninterest income year over year was primarily due to decreases of $2.9 million in mortgage banking activities and $434 thousand in net gains on sales of investment securities. This was partially offset by an increase of $243 thousand in service charges on deposits. The decrease in mortgage banking activities compared to the third quarter of 2020 was primarily due to $84.2 million fewer residential loan originations held for sale and $54.5 million fewer residential loans sold. The higher volumes in the third quarter of 2020 were primarily as a result of the decrease in interest rates during the first half of 2020 while interest rates have remained relatively stable in 2021. The decrease in net gains on sales of investment securities was due to no securities sold in the third quarter of 2021. The increase in service charges on deposits was primarily due to higher transaction volumes and deposit balances.

Noninterest income decreased $4.0 million to $17.6 million for the nine months ended September 30, 2021, compared to $21.6 million for the same period in 2020. The decrease in noninterest income was primarily due to decreases of $2.6 million in mortgage banking activities and $1.8 million in net gains on sales of securities. These decreases were partially offset by an increase of $638 thousand in service charges on deposits. The decrease in mortgage banking activities was primarily due to $74.0 million lower residential loan originations held for sale and $4.8 million lower residential loans sold. The higher volumes in the nine months ended September 30, 2020 were primarily due to lower interest rates during the first half of 2020 while interest rates have remained relatively stable in 2021. The decrease in net gains on sales of securities was primarily due to fewer securities sold during the first nine months of 2021 compared to the same period in 2020. The increase in service charges on deposits was due to higher transaction volumes and deposit balances.

Noninterest Expense

The following table presents noninterest expense for the three and nine months ended September 30, 2021 and 2020.


	For the three months ended September 30,				For the nine months ended September 30,
(Dollars in thousands)	2021		2020		2021		2020
Noninterest expense
Salary and employee benefits	$	10,551	$	9,862	$	29,825	$	28,090
Occupancy and equipment expense	1,680		1,678		4,971		4,773
Professional service fees	847		808		2,264		2,141
Acquisition and due diligence fees	—		17		—		1,664
FDIC premium	244		287		778		722
Marketing expense	428		257		842		709
Loan processing expense	231		262		755		690
Data processing expense	928		844		3,209		2,601
Core deposit premium amortization	167		192		501		576
Other expense	913		919		2,571		2,805
Total noninterest expense	$	15,989	$	15,126	$	45,716	$	44,771

Noninterest expense increased $863 thousand to $16.0 million for the three months ended September 30, 2021, compared to $15.1 million for the same period in 2020. The increase in noninterest expense year over year was mainly attributable to

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increases of $689 thousand in salary and employee benefits and $171 thousand in marketing expenses. The increase in salary and employee benefits between the periods was primarily due to an increase of 20 full-time equivalent employees as well as incentive compensation. The increase in marketing expense between the periods was due to an increase in advertising efforts.

Noninterest expense increased $945 thousand to $45.7 million for the nine months ended September 30, 2021, compared to $44.8 million for the same period in 2020. The increase in noninterest expense was primarily due to increases in salary and employee benefits of $1.7 million, data processing expense of $608 thousand and occupancy and equipment expense of $198 thousand. These increases were partially offset by decreases of $1.7 million in acquisition and due diligence fees and $234 thousand of other expense. The increase in salary and employee benefits was primarily due to increases of $719 thousand in incentive compensation, $606 thousand in salaries expense, and $291 thousand in contract labor. The increase in data processing expense was primarily due to the new loan processing system used for PPP loans. The increase in occupancy and equipment expense was primarily due to software maintenance and licensing. The decrease in acquisition and due diligence fees was primarily due to the acquisition of Ann Arbor State Bank in the first quarter of 2020. The decrease in other expense was primarily due to a decrease in the provision for unfunded commitments.

Income Taxes and Tax-Related Items

During the three months ended September 30, 2021, we recognized income tax expense of $2.3 million on $11.8 million of pre-tax income resulting in an effective tax rate of 19.5%, compared to the same period in 2020, in which we recognized an income tax expense of $1.1 million on $6.3 million of pre-tax income, resulting in an effective tax rate of 17.7%.

During the nine months ended September 30, 2021, we recognized income tax expense of $6.2 million on $31.6 million of pre-tax income resulting in an effective tax rate of 19.6%, compared to the same period in 2020, in which we recognized an income tax expense of $2.1 million on $14.1 million of pre-tax income, resulting in an effective tax rate of 14.9%.

The increase in income tax provision for the nine months ended September 30, 2021 compared to the same period in 2020 was primarily as a result of a $290 thousand tax benefit related to the Ann Arbor State Bank net operating loss (NOL) in the first quarter of 2020 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 in the first quarter of 2020.

See "Note 9 - Income Taxes" of Notes to Consolidated Financial Statements for a reconciliation between expected and actual income tax expense for the three and nine months ended September 30, 2021 and 2020.

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, 2021 and December 31, 2020.


(Dollars in thousands)	September 30, 2021		December 31, 2020
Securities available-for-sale:
U.S. government sponsored entities and agencies	$	24,036	$	26,358
State and political subdivision	146,695		132,723
Mortgage-backed securities: residential	20,086		26,081
Mortgage-backed securities: commercial	23,540		11,918
Collateralized mortgage obligations: residential	9,871		13,446
Collateralized mortgage obligations: commercial	52,738		58,512
U.S. Treasury	64,898		—
SBA	15,108		17,593
Asset backed securities	9,858		10,072
Corporate bonds	22,698		6,029
Total securities available-for-sale	$	389,528	$	302,732

The composition of our investment securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity for both normal operations and potential acquisitions, while providing an additional source of revenue. The investment portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet, while providing a vehicle for the investment of available funds, furnishing liquidity, and supplying securities to pledge as collateral. At September 30, 2021, total investment securities were $389.5 million, or 15.3% of total assets, compared to $302.7 million,

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or 12.4% of total assets, at December 31, 2020. The $86.8 million increase in securities available-for-sale from December 31, 2020 to September 30, 2021, was due to the purchase of securities using the excess cash balances generated by the payoffs of PPP loans and increase in deposits. Securities with a carrying value of $90.6 million and $98.7 million were pledged at September 30, 2021 and December 31, 2020, respectively, to secure borrowings, deposits and mortgage derivatives.

As of September 30, 2021, the Company held 68 tax-exempt state and local municipal securities totaling $52.8 million backed by the Michigan School Bond Loan Fund. Other than the aforementioned investments and the U.S. government and its agencies, at September 30, 2021 and December 31, 2020, there were no holdings of securities of any one issuer in an amount greater than 10% of shareholders' equity.

The securities available-for-sale presented in the following tables are reported at amortized cost and by contractual maturity as of September 30, 2021 and December 31, 2020. Expected maturities may differ from contractual maturities as issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Additionally, residential mortgage-backed securities and collateralized mortgage obligations receive monthly principal payments, which are not reflected below. The yields below are calculated on a tax equivalent basis.


	September 30, 2021
	One year or less				One to five years				Five to ten years				After ten years
(Dollars in thousands)	Amortized Cost		Average Yield		Amortized Cost		Average Yield		Amortized Cost		Average Yield		Amortized Cost		Average Yield
Securities available-for-sale:
U.S. government sponsored agency obligations	$	4,010	1.61	%	$	521	1.62	%	$	15,000	1.22	%	$	5,000	1.48	%
State and political subdivision	1,254		2.44		13,514		2.46		50,986		2.71		74,001		2.89
Mortgage-backed securities: residential	—		—		87		1.71		27		1.92		19,912		0.75
Mortgage-backed securities: commercial	—		—		5,120		2.46		16,620		1.28		1,791		3.63
Collateralized mortgage obligations: residential	—		—		331		2.91		186		1.21		9,279		1.09
Collateralized mortgage obligations: commercial	2,575		3.70		4,509		2.57		39,203		1.28		6,631		2.25
U.S. Treasury	—		—		35,742		0.87		29,376		1.34		—		—
SBA	—		—		—		—		8,084		1.46		6,927		1.37
Asset backed securities	—		—		—		—		—		—		9,896		0.76
Corporate bonds	—		—		—		—		21,801		3.82		1,000		3.25
Total securities available-for-sale	$	7,839	2.43	%	$	59,824	1.52	%	$	181,283	2.00	%	$	134,437	2.14	%


	December 31, 2020
	One year or less				One to five years				Five to ten years				After ten years
(Dollars in thousands)	Amortized Cost		Average Yield		Amortized Cost		Average Yield		Amortized Cost		Average Yield		Amortized Cost		Average Yield
Securities available-for-sale:
U.S. government sponsored agency obligations	$	4,027	1.61	%	$	2,548	1.61	%	$	15,000	1.22	%	$	5,000	1.48	%
State and political subdivision	1,768		1.96		10,095		2.46		31,142		2.80		81,048		2.99
Mortgage-backed securities: residential	—		—		78		0.94		87		0.19		25,564		1.44
Mortgage-backed securities: commercial	847		1.36		3,795		2.46		4,985		1.69		1,807		3.64
Collateralized mortgage obligations: residential	—		—		46		4.02		559		2.11		12,715		1.25
Collateralized mortgage obligations: commercial	577		2.54		8,011		3.10		40,889		1.26		7,921		2.46

SBA	—		—		—		—		9,879		1.40		7,760		1.21
Asset backed securities	—		—		—		—		—		—		10,229		0.84
Corporate bonds	3,498		3.08		—		—		2,500		4.38		—		—
Total securities available-for-sale	$	10,717	2.18	%	$	24,573	2.58	%	$	105,041	1.82	%	$	152,044	2.28	%

Loans

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Our loan portfolio represents a broad range of borrowers comprised of commercial real estate, commercial and industrial, residential real estate, and consumer financing loans.

Commercial real estate loans consist of term loans secured by a mortgage lien on the real property, such as office and industrial buildings, retail shopping centers and apartment buildings, as well as commercial real estate construction loans that are offered to builders and developers. Commercial real estate loans are then segregated into two classes: non-owner occupied and owner occupied commercial real estate loans. Non-owner occupied loans, which include loans secured by non-owner occupied and nonresidential properties, generally have a greater risk profile than owner-occupied loans, which include loans secured by multifamily structures and owner-occupied commercial structures.

Commercial and industrial loans include financing for commercial purposes in various lines of business, including manufacturing, service industry and professional service areas. Commercial and industrial loans are generally secured with the assets of the company and/or the personal guarantee of the business owners. The PPP loans funded during the second and third quarters of 2020 and first and second quarters of 2021, which are guaranteed by the SBA, are reported within the commercial and industrial loan category.

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)	2021		2020		2019		2018		2017
Commercial real estate:
Non-owner occupied	$	479,633	$	445,810	$	388,515	$	367,671	$	343,420
Owner occupied	295,228		275,022		216,131		194,422		168,342
Total commercial real estate	774,861		720,832		604,646		562,093		511,762
Commercial and industrial	540,546		685,504		410,228		383,455		377,686
Residential real estate	403,517		315,476		211,839		180,018		144,439
Consumer	793		1,725		896		999		1,036
Total loans	$	1,719,717	$	1,723,537	$	1,227,609	$	1,126,565	$	1,034,923

Total loans were $1.72 billion at September 30, 2021, a decrease of $3.8 million from December 31, 2020. The decline in our loan portfolio compared to December 31, 2021 was primarily due to a $145.0 million decrease in our commercial and industrial loan portfolio, $142.5 million of which was due to the net change in PPP loans. This was partially offset by increases of $88.0 million in our residential real estate portfolio and $54.0 million in our commercial real estate portfolio. In general, we target a loan portfolio mix of approximately one-half commercial real estate, approximately one-third commercial and industrial loans and one-sixth a mix of residential real estate and consumer loans. As of September 30, 2021, approximately 45.1% of our loans were commercial real estate, 31.4% were commercial and industrial, and 23.5% were residential real estate and consumer loans.

We originate both fixed and adjustable rate residential real estate loans conforming to the underwriting guidelines of Fannie Mae and Freddie Mac, as well as home equity loans and lines of credit that are secured by first or junior liens. Most of our fixed rate residential loans, along with some of our adjustable rate mortgages, are sold to Fannie Mae and other financial institutions with which we have established a correspondent lending relationship. The Company established a direct relationship with Fannie Mae and began locking and selling loans to Fannie Mae with servicing retained during the third quarter of 2019. Refer to Note 7 - Mortgage Servicing Rights, Net for further details on our mortgage servicing rights.

Loan Maturity/Rate Sensitivity

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The following table shows the contractual maturities of our loans as of September 30, 2021.


(Dollars in thousands)	One year or less		After one but within five years		After five years		Total
September 30, 2021
Commercial real estate	$	105,954	$	427,610	$	241,297	$	774,861
Commercial and industrial	148,351		320,319		71,876		540,546
Residential real estate	14,176		6,911		382,430		403,517
Consumer	121		630		42		793
Total loans	$	268,602	$	755,470	$	695,645	$	1,719,717
Sensitivity of loans to changes in interest rates:
Fixed interest rates			$	650,027	$	273,194
Floating interest rates			105,443		422,451
Total			$	755,470	$	695,645

Summary of Impaired Assets and Past Due Loans

Nonperforming assets consist of nonaccrual loans and other real estate owned. We do not consider performing TDRs to be nonperforming assets, but they are included as part of impaired assets. The level of nonaccrual loans is an important element in assessing asset quality. Loans are classified as nonaccrual when, in the opinion of management, collection of principal or interest is not expected according to the terms of the agreement. Generally, loans are placed on nonaccrual status due to the continued failure by the borrower to adhere to contractual payment terms coupled with other pertinent factors, such as insufficient collateral value.

A loan is categorized as a troubled debt restructuring if a concession is granted, such as to provide for the reduction of either interest or principal, due to deterioration in the financial condition of the borrower. Typical concessions include reduction of the interest rate on the loan to a rate considered lower than the current market rate, forgiveness of a portion of the loan balance, extension of the maturity date, and/or modifications from principal and interest payments to interest-only payments for a certain period. Loans are not classified as TDRs when the modification is short-term or results in only an insignificant delay or shortfall in the payments to be received. In accordance with bank regulatory guidance, troubled debt restructurings do not include short-term modifications made on a good-faith basis in response to the COVID-19 pandemic to borrowers who were current prior to any relief. This includes short-term modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. As of September 30, 2021, there were $1.1 million of loans that remained on a COVID-related deferral compared to $19.8 million as of December 31, 2020. As of September 30, 2021, there were no loans that had payments deferred greater than six months compared to $11.4 million as of December 31, 2020.

Credit Quality Indicators:

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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, 2021 compared to December 31, 2020 were as follows:


(Dollars in thousands)	September 30, 2021		December 31, 2020
Classified loans:
Substandard	$	23,994	$	34,921
Doubtful	1,557		1,143
Total classified loans	$	25,551	$	36,064
Special mention	64,642		47,297
Total classified and criticized loans	$	90,193	$	83,361

A summary of nonperforming assets (defined as nonaccrual loans and other real estate owned), performing troubled debt restructurings and loans 90 days or more past due and still accruing, as of the dates indicated, are presented below.


	As of September 30,		As of December 31,
(Dollars in thousands)	2021		2020		2019		2018		2017
Nonaccrual loans
Commercial real estate	$	3,768	$	7,320	$	4,832	$	5,927	$	2,257
Commercial and industrial	4,746		7,490		11,112		9,605		9,024
Residential real estate	3,610		3,991		2,569		2,915		2,767
Consumer	9		15		16		—		—
Total nonaccrual loans(1)	12,133		18,816		18,529		18,447		14,048
Other real estate owned	—		—		921		—		652
Total nonperforming assets	12,133		18,816		19,450		18,447		14,700
Performing troubled debt restructurings

Commercial and industrial	336		546		547		568		961
Residential real estate	426		432		359		363		261
Total performing troubled debt restructurings	762		978		906		931		1,222
Total impaired assets, excluding ASC 310-30 loans	$	12,895	$	19,794	$	20,356	$	19,378	$	15,922
Loans 90 days or more past due and still accruing	$	162	$	269	$	157	$	243	$	440

(1)Nonaccrual loans include nonperforming troubled debt restructurings of $3.5 million, $3.8 million, $3.0 million, $5.0 million and $6.4 million at the respective dates indicated above.

During the nine months ended September 30, 2021 and 2020, the Company recorded $616 thousand and $144 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 $4.4 million, $5.0 million, $6.0 million, $7.9 million, and $9.7 million at the respective dates indicated in the table above.

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Nonperforming assets decreased $6.7 million as of September 30, 2021 compared to December 31, 2020. The decrease in nonperforming assets was attributable to a decrease in nonaccrual loans primarily due to pay offs of three commercial loan relationships totaling $5.1 million and a $2.8 million paydown on one commercial loan relationship. This was partially offset by three commercial loan relationships moving to nonaccrual status totaling $2.3 million. There was $735 thousand of nonperforming loans that were in the process of foreclosure at September 30, 2021.

Allowance for Loan Losses

We maintain the allowance for loan losses at a level we believe is sufficient to absorb probable incurred losses in our loan portfolio given the conditions at the time. Management determines the adequacy of the allowance based on periodic evaluations of the loan portfolio and other factors. These evaluations are inherently subjective as they require management to make material estimates, all of which may be susceptible to significant change. The allowance is increased by provisions charged to expense and decreased by actual charge-offs, net of recoveries.

Acquired Loans

The allowance for loan losses on acquired loans is based on credit deterioration subsequent to the acquisition date. In accordance with the accounting guidance for business combinations, there was no allowance brought forward on any of the acquired loans as any credit deterioration evident in the loans was included in the determination of the fair value of the loans at the acquisition date. For purchased credit impaired loans, accounted for under ASC 310-30, management establishes an allowance for credit deterioration subsequent to the date of acquisition by re-estimating expected cash flows on a semi-annual basis with any decline in expected cash flows recorded as provision for loan losses. Impairment is measured as the excess of the recorded investment in a loan over the present value of expected future cash flows discounted at the pre-impairment accounting yield of the loan. For increases in cash flows expected to be collected, we first reverse any previously recorded allowance for loan losses, then adjust the amount of accretable yield recognized on a prospective basis over the loan's remaining life. These cash flow evaluations are inherently subjective as they require material estimates, all of which may be susceptible to significant change. For non-purchased credit impaired loans acquired in our acquisitions that are accounted for under ASC 310-20, the historical loss estimates are based on the historical losses experienced since acquisition. We record an allowance for loan losses only when the calculated amount exceeds the discount remaining from acquisition that was established for the similar period covered in the allowance for loan loss calculation. For all other purchased loans, the allowance is calculated in accordance with the methods used to calculate the allowance for loan losses for originated loans, as described below.

Originated Loans

The allowance for loan losses represents management's assessment of probable credit losses inherent in the loan portfolio. The allowance for loan losses consists of specific components, based on individual evaluation of certain loans, and general components for homogeneous pools of loans with similar risk characteristics.

Impaired loans include loans placed on nonaccrual status and troubled debt restructurings. Loans are considered impaired when based on current information and events it is probable that we will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreements. When determining if we will be unable to collect all principal and interest payments due in accordance with the original contractual terms of the loan agreement, we consider the borrower's overall financial condition, resources and payment record, support from guarantors, and the realizable value of any collateral. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

All impaired loans are identified to be individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the discounted expected future cash flows or at the fair value of collateral if repayment is collateral dependent.

The allowance for our nonimpaired loans, which includes commercial real estate, commercial and industrial, residential real estate, and consumer loans that are not individually evaluated for impairment, begins with a process of estimating the probable incurred losses in the portfolio. These estimates are established based on our historical loss data. Additional allowance estimates for commercial and industrial and commercial real estate loans are based on internal credit risk ratings. Internal credit risk ratings are assigned to each business loan at the time of approval and are subjected to subsequent periodic reviews by senior management, at least annually or more frequently upon the occurrence of a circumstance that affects the credit risk of the loan. There is no allowance on PPP loans (included in the commercial and industrial loan category) since they are 100% guaranteed by the SBA.

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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)		2021			2020			2021			2020
Balance at beginning of period		$	23,144		$	17,063		$	22,297		$	12,674
Loan charge-offs:

Commercial and industrial		(6)			(10)			(24)			(1,729)
Residential real estate		(242)			(110)			(242)			(110)
Consumer		(7)			(4)			(21)			(47)
Total loan charge-offs		(255)			(124)			(287)			(1,886)
Recoveries of loans previously charged-off:
Commercial real estate		—			12			—			12
Commercial and industrial		8			15			44			47
Residential real estate		14			10			46			51
Consumer		9			8			15			22
Total loan recoveries		31			45			105			132
Net charge-offs		(224)			(79)			(182)			(1,754)
Provision expense (benefit) for loan losses		(1,189)			4,270			(384)			10,334
Balance at end of period		$	21,731		$	21,254		$	21,731		$	21,254
Allowance for loan losses as a percentage of period-end loans		1.26		%	1.15		%	1.26		%	1.15		%
Net charge-offs to average loans		0.05			0.02			0.01			0.14

Our allowance for loan losses was $21.7 million, or 1.26% of loans, at September 30, 2021 compared to $22.3 million, or 1.29% of loans, at December 31, 2020. As of September 30, 2021 and December 31, 2020, the allowance for loan losses as a percentage of loans excluding PPP loans (a non-GAAP measure), was 1.38% and 1.56%, respectively. The $566 thousand decrease in the allowance for loan losses during the nine months ended September 30, 2021 was primarily due to a decrease in general reserves related to the reduction in qualitative factors within the allowance for loan loss model as a result of improved credit quality.

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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, 2021
Balance at end of period applicable to:
Commercial real estate	$	9,790	45.1	%
Commercial and industrial	8,114		31.4
Residential real estate	3,823		23.5
Consumer	4		—
Total loans	$	21,731	100.0	%
December 31, 2020
Balance at end of period applicable to:
Commercial real estate	$	9,975	41.8	%
Commercial and industrial	8,786		39.8
Residential real estate	3,527		18.3
Consumer	9		0.1
Total loans	$	22,297	100.0	%
December 31, 2019
Balance at end of period applicable to:
Commercial real estate	$	5,773	49.2	%
Commercial and industrial	5,515		33.4
Residential real estate	1,384		17.3
Consumer	2		0.1
Total loans	$	12,674	100.0	%
December 31, 2018
Balance at end of period applicable to:
Commercial real estate	$	5,227	49.9	%
Commercial and industrial	5,174		34.0
Residential real estate	1,164		16.0
Consumer	1		0.1
Total loans	$	11,566	100.0	%
December 31, 2017
Balance at end of period applicable to:
Commercial real estate	$	4,852	49.4	%
Commercial and industrial	5,903		36.5
Residential real estate	950		14.0
Consumer	8		0.1
Total loans	$	11,713	100.0	%

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, 2021 and December 31, 2020.

As a result of the unprecedented decline in economic conditions triggered by the COVID-19 pandemic, the market valuations, including our stock price, saw a significant decline in March 2020, which then continued into the second quarter of 2020. These events indicated that goodwill may be impaired and resulted in us performing a qualitative goodwill impairment assessment in the second quarter of 2020. As a result of the analysis, we concluded that it was more-likely-than-not that the fair value of the reporting unit could be greater than its carrying amount.

Since the price of our stock did not fully recover during the third quarter of 2020, the Company engaged a reputable, third-party valuation firm to perform a quantitative analysis of goodwill as of August 31, 2020 ("the valuation date"). In deriving the fair value of the reporting unit (the Bank), the third-party firm assessed general economic conditions and outlook; industry and market considerations and outlook; the impact of recent events on financial performance; the market price of our common stock; and other relevant events. In addition, the valuation relied on financial projections through 2023 and growth

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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.

The Company completed its annual goodwill impairment review as of October 1, 2020, noting 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 October 1, 2020. Management also determined that no triggering events have occurred that indicated impairment from the most recent valuation date through September 30, 2021, the stock was trading above book value as of September 30, 2021, and it is more likely than not that there was no goodwill impairment as of September 30, 2021.

Deposits

Total deposits were $2.07 billion at September 30, 2021 and $1.96 billion at December 31, 2020, representing 89.5% and 88.1% of total liabilities, respectively. The increase in deposits of $103.7 million was comprised of increases of $225.1 million in demand deposits and $11.7 million in money market and savings deposits, partially offset by a decrease of $133.1 million in time deposits. The increase in deposits was primarily due to organic deposit growth during the nine months ended September 30, 2021 mainly as a result of increased customer liquidity and new customer growth.

Our average interest-bearing deposit costs were 0.35% and 1.06% for the nine months ended September 30, 2021 and 2020, respectively. The decrease in interest-bearing deposit costs between the two periods was primarily due to lower interest rates paid as a result of revised internal deposit rates, mainly driven by the continuation of the low level of the target federal funds rate. The target federal funds interest rate decreased 150 basis points 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, 2021 and December 31, 2020, the Company had approximately $23.1 million and $29.3 million, respectively, of brokered deposits. The Company's ability to accept, roll-over or renew brokered deposits is contingent upon the Bank maintaining a capital level of "well-capitalized."

Included in the brokered deposits total at September 30, 2021 and December 31, 2020 was $679 thousand and $1.2 million, respectively, in Certificate of Deposit Account Registry Service ("CDARS") one-way buys that were acquired from Ann Arbor State Bank.

Management understands the importance of core deposits as a stable source of funding and may periodically implement various deposit promotion strategies to encourage core deposit growth. For periods of rising interest rates, management has modeled the aggregate yields for non-maturity deposits and time deposits to increase at a slower pace than the increase in underlying market rates, which is intended to result in net interest margin expansion and an increase in net interest income.

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The following table sets forth the distribution of average deposits by account type for the periods indicated below.


	Three Months Ended September 30, 2021
(Dollars in thousands)	Average Balance		Percent		Average Rate
Noninterest-bearing demand deposits	$	774,926	37.9	%	—	%
Interest-bearing demand deposits	156,977		7.7		0.14
Money market and savings deposits	624,190		30.5		0.17
Time deposits	489,261		23.9		0.53
Total deposits	$	2,045,354	100.0	%	0.19	%

	Nine Months Ended September 30, 2021
(Dollars in thousands)	Average Balance		Percent		Average Rate
Noninterest-bearing demand deposits	$	735,162	35.9	%	—	%
Interest-bearing demand deposits	144,449		7.1		0.15
Money market and savings deposits	623,123		30.5		0.20
Time deposits	541,018		26.5		0.58
Total deposits	$	2,043,752	100.0	%	0.23	%

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, 2021
Maturing in:
3 months or less	$	108,867
3 months to 6 months	118,644
6 months to 1 year	120,922
1 year or greater	67,157
Total	$	415,590

Borrowings

Total debt outstanding at September 30, 2021 was $211.7 million, a decrease of $18.6 million from $230.3 million at December 31, 2020. The decrease in total borrowings was primarily due to a $15.0 million redemption of subordinated debt in June 2021.

At September 30, 2021, FHLB advances were secured by a blanket lien on $582.8 million of real estate-related loans, and repurchase agreements were secured by securities with a fair value of $3.8 million. At December 31, 2020, FHLB advances were secured by a blanket lien on $512.3 million of real estate-related loans, and repurchase agreements were secured by securities with a fair value of $3.7 million.

As of September 30, 2021, the Company had $30.0 million of subordinated notes outstanding and debt issuance costs of $332 thousand related to these subordinated notes. As of December 31, 2020, the Company had $45.0 million of subordinated notes outstanding and debt issuance costs of $408 thousand related to these subordinated notes.

The $15.0 million of subordinated notes issued on December 21, 2015 had a fixed interest rate of 6.375% per annum, payable semiannually through December 15, 2020. From December 15, 2020, through maturity, the notes had a floating interest rate of three-month LIBOR plus 477 basis points payable quarterly through maturity. The notes were scheduled to mature on December 15, 2025, and the Company had the option to redeem or prepay any or all of the subordinated notes without premium or penalty any time after December 15, 2020 or upon an occurrence of a Tier 2 capital event or tax event. These subordinated notes were redeemed in June 2021.

The $30.0 million of subordinated notes issued on December 18, 2019 bear a fixed interest rate of 4.75% per annum, payable semiannually through December 18, 2024. The notes will bear a floating interest rate of three-month SOFR plus 311 basis points payable quarterly after December 18, 2024 through maturity. The notes mature on December 18, 2029, and the Company has the option to redeem any or all of the subordinated notes without premium or penalty any time after December 18, 2024 or upon the occurrence of a Tier 2 capital event or tax event. The issuance of the $30.0 million subordinated notes

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reflected management's efforts to fund the liquidity needs of the Company as well as pay the merger consideration to purchase Ann Arbor State Bank.

Selected financial information pertaining to the components of our short-term borrowings for the periods and as of the dates indicated is as follows:


	For the three months ended September 30,						For the nine months ended September 30,
(Dollars in thousands)	2021			2020			2021			2020
Securities sold under agreements to repurchase
Average daily balance	$	2,517		$	163		$	3,011		$	330
Weighted-average rate during period	0.25		%	0.30		%	0.25		%	0.30		%
Amount outstanding at period end	$	2,681		$	187		$	2,681		$	187
Weighted-average rate at period end	0.25		%	0.30		%	0.25		%	0.30		%
Maximum month-end balance	$	2,681		$	187		$	3,993		$	936
FHLB Advances
Average daily balance	$	—		$	—		$	—		$	5,456
Weighted-average rate during period	—		%	—		%	—		%	0.99		%


Maximum month-end balance	$	—		$	—		$	—		$	25,000
FHLB Line of Credit
Average daily balance	$	—		$	63		$	4		$	60
Weighted-average rate during period	—		%	—		%	0.44		%	1.29		%



Federal funds purchased
Average daily balance	$	—		$	—		$	—		$	193
Weighted-average rate during period	—		%	—		%	—		%	2.73		%

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 $18.6 million to $233.9 million at September 30, 2021 as compared to $215.3 million at December 31, 2020. The increase in shareholders' equity was primarily impacted by $25.4 million of net income generated during the nine months ended September 30, 2021, partially offset by decreases of $3.3 million of accumulated other comprehensive income due to decreases in net unrealized gains on available-for-sale securities, $1.4 million of dividends declared on our preferred stock, $1.4 million of dividends declared on our common stock, and $1.4 million of stock repurchased through the share buyback program during the nine months ended September 30, 2021.

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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)	2021		2020		2021		2020
Balance at beginning of period	$	225,409	$	180,259	$	215,327	$	170,703
Net income	9,465		5,209		25,403		12,040
Other comprehensive income (loss)	(216)		783		(3,327)		4,451
Preferred stock offering, net of issuance costs	—		23,370		—		23,370
Redeemed stock	—		—		(1,364)		(620)
Common stock dividends declared	(459)		(387)		(1,374)		(1,160)
Dividends on 7.50% Series B Preferred Stock	(468)		—		(1,406)		—
Exercise of stock options	—		—		243		95
Stock-based compensation expense	203		234		432		589
Balance at end of period	$	233,934	$	209,468	$	233,934	$	209,468

We strive to maintain an adequate capital base to support our activities in a safe and sound manner while at the same time attempting to maximize shareholder value. We assess capital adequacy against the risk inherent in our balance sheet, recognizing that unexpected loss is the common denominator of risk and that common equity has the greatest capacity to absorb unexpected loss.

We are subject to various regulatory capital requirements both at the Company level and at the Bank level. Failure to meet minimum capital requirements could result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have an adverse material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting policies. We have consistently maintained regulatory capital ratios at or above the well-capitalized standards.

A capital conservation buffer, comprised of common equity tier 1 capital, is established above the regulatory minimum capital requirements, and financial institutions that maintain a capital conservation buffer of 2.5% are generally not subject to the additional restrictions on dividends, share repurchases and discretionary bonus payments to executive officers under the Basel III Rule.

At September 30, 2021 and December 31, 2020, the Company's and the Bank's capital ratios were in excess of the requirement to be "well capitalized" under the regulatory guidelines.

The summary below compares the actual capital ratios with the minimum quantitative measures established by regulation to ensure capital adequacy:

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	Actual Capital Ratio		Capital Adequacy Regulatory Requirement		Capital Adequacy Regulatory Requirement + Capital Conservation Buffer(1)		Well Capitalized Regulatory Requirement
September 30, 2021
Common equity tier 1 to risk-weighted assets:
Consolidated	9.82	%	4.50	%	7.00	%
Bank	12.55	%	4.50	%	7.00	%	6.50	%
Tier 1 capital to risk-weighted assets:
Consolidated	11.19	%	6.00	%	8.50	%
Bank	12.55	%	6.00	%	8.50	%	8.00	%
Total capital to risk-weighted assets:
Consolidated	14.19	%	8.00	%	10.50	%
Bank	13.80	%	8.00	%	10.50	%	10.00	%
Tier 1 capital to average assets (leverage ratio):
Consolidated	7.68	%	4.00	%	4.00	%
Bank	8.64	%	4.00	%	4.00	%	5.00	%
December 31, 2020
Common equity tier 1 to risk-weighted assets:
Consolidated	9.30	%	4.50	%	7.00	%
Bank	11.94	%	4.50	%	7.00	%	6.50	%
Tier 1 capital to risk-weighted assets:
Consolidated	10.80	%	6.00	%	8.50	%
Bank	11.94	%	6.00	%	8.50	%	8.00	%
Total capital to risk-weighted assets:
Consolidated	14.91	%	8.00	%	10.50	%
Bank	13.20	%	8.00	%	10.50	%	10.00	%
Tier 1 capital to average assets (leverage ratio):
Consolidated	6.93	%	4.00	%	4.00	%
Bank	7.67	%	4.00	%	4.00	%	5.00	%

(1) Reflects the capital conservation buffer of 2.5% for risk-weighted asset ratios.

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Contractual Obligations

In the ordinary course of our operations, we enter into certain contractual obligations. Total contractual obligations at September 30, 2021 were $686.4 million, a decrease of $152.2 million from $838.6 million at December 31, 2020. The decrease of $152.2 million was primarily due to decreases of $133.1 million in time deposits and $14.9 million in subordinated notes.

The following tables present our contractual obligations as of September 30, 2021 and December 31, 2020.


	Contractual Maturities as of September 30, 2021
(Dollars in thousands)	Less Than One Year		One to Three Years		Three to Five Years		Over Five Years		Total
Operating lease obligations	$	1,820	$	3,320	$	2,446	$	3,382	$	10,968
Short-term borrowings	2,681		—		—		—		2,681
Long-term borrowings	13,105		14,272		22,000		130,000		179,377
Subordinated notes	—		—		—		29,668		29,668
Time deposits	389,990		70,841		2,917		—		463,748
Total	$	407,596	$	88,433	$	27,363	$	163,050	$	686,442


	Contractual Maturities as of December 31, 2020
(Dollars in thousands)	Less Than One Year		One to Three Years		Three to Five Years		Over Five Years		Total
Operating lease obligations	$	1,731	$	3,478	$	2,509	$	3,775	$	11,493
Short-term borrowings	3,204		—		—		—		3,204
Long-term borrowings	6,176		14,304		32,000		130,000		182,480
Subordinated notes	—		—		15,000		29,592		44,592
Time deposits	437,211		153,759		5,845		—		596,815
Total	$	448,322	$	171,541	$	55,354	$	163,367	$	838,584

Off-Balance Sheet Arrangements

In the normal course of business, the Company offers a variety of financial instruments with off-balance sheet risk to meet the financing needs of its customers. These financial instruments include outstanding commitments to extend credit, credit lines, commercial letters of credit and standby letters of credit. These are agreements to provide credit, as long as conditions established in the contract are met, and usually have expiration dates. Commitments may expire without being used. Off-balance sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies used for loans are used to make such commitments, including obtaining collateral at exercise of the commitment.

We maintain an allowance to cover probable losses inherent in our financial instruments with off-balance sheet risk. At September 30, 2021, the allowance for off-balance sheet risk was $318 thousand, compared to $490 thousand at December 31, 2020, and was included in "Other liabilities" on our consolidated balance sheets.

A summary of the contractual amounts of our exposure to off-balance sheet risk is as follows.


	September 30, 2021				December 31, 2020
(Dollars in thousands)	Fixed Rate		Variable Rate		Fixed Rate		Variable Rate
Commitments to make loans	$	9,087	$	6,600	$	18,269	$	17,058
Unused lines of credit	33,383		397,716		28,898		385,307
Unused standby letters of credit and commercial letters of credit	3,353		—		2,340		1,992

Of the total unused lines of credit of $431.1 million at September 30, 2021, $58.7 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 economic environment due to COVID-19. Management maintained an elevated level of liquidity on the balance sheet in the third quarter of 2021, 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, 2021, we had liquid assets of $592.7 million, compared to $455.4 million at December 31, 2020. Liquid assets include cash and due from banks, federal funds sold, interest-bearing deposits with banks and unencumbered securities available-for-sale. Cash and due from banks increased to $293.8 million, compared to $264.1 million at December 31, 2020 primarily as a result of forgiveness of PPP loans and increased deposit balances.

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, 2021, we had $178.1 million of outstanding borrowings from the FHLB, and these advances were secured by a blanket lien on $582.8 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 $219.4 million from the FHLB. Additionally, the Bank can borrow up to $157.5 million through the unsecured lines of credit it has established with eight other banks, as well as $5.1 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 $1.02 billion, based on current policy limits at September 30, 2021. Management believed that as of September 30, 2021, we had adequate resources to fund all of our commitments.

The following liquidity ratios compare certain assets and liabilities to total deposits or total assets.


	September 30, 2021		December 31, 2020
Investment securities available-for-sale to total assets	15.31	%	12.39	%
Loans to total deposits	83.20		87.79
Interest-earning assets to total assets	94.17		94.64
Interest-bearing deposits to total deposits	61.69		68.49

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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 low 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.

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The estimated impact on our net interest income as of September 30, 2021 and December 31, 2020, assuming immediate parallel moves in interest rates is presented in the table below.


	September 30, 2021				December 31, 2020
Change in rates	Following 12 months		Following 24 months		Following 12 months		Following 24 months
+400 basis points	(4.6)	%	(10.8)	%	2.8	%	5.5	%
+300 basis points	0.9		(4.2)		5.5		7.6
+200 basis points	3.4		1.2		6.2		8.6
+100 basis points	4.8		5.3		5.7		8.2
-100 basis points	(4.4)		(7.3)		(3.3)		(5.2)

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, 2021 and December 31, 2020, 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 rates	September 30, 2021		December 31, 2020
+400 basis points	(10.0)	%	15.0	%
+300 basis points	(3.0)		19.0
+200 basis points	2.0		20.0
+100 basis points	4.0		15.0
-100 basis points	(13.0)		(26.0)

Item 4 – Controls and Procedures

Evaluation of disclosure controls and procedures. The Company’s management, including our 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 Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, our 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 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

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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

For information regarding the factors that could affect our business, results of operations, financial condition and liquidity, see the risk factors discussed under Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2020.

The risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2020, are updated by adding the following risk factors:

Failure to complete our proposed Merger with First Merchants could negatively impact our business, financial results and stock price.

If the Merger is not completed for any reason, our ongoing business may be adversely affected, and, without realizing any of the benefits of having completed the Merger, we will be subject to a number of risks, including the following:

•we may experience negative reactions from the financial markets, including negative impacts on our stock price;

•the market price of our common stock could decline to the extent that the current market prices reflect a market assumption that the Merger will be completed;

•we may experience negative reactions from our customers, vendors and team members;

•we will have incurred substantial expenses and will be required to pay certain costs relating to the Merger, whether or not the Merger is completed, such as legal, accounting, investment banking and advisory and printing fees;

•the merger agreement places certain restrictions on the conduct of our business prior to completion of the Merger, such restrictions, the waiver of which is subject to the consent of First Merchants, may adversely affect our ability to execute certain of our business strategies; and

•matters relating to the Merger may require substantial commitments of time and resources by our management (including integration planning), which could otherwise have been devoted to other opportunities that may have been beneficial to us, as an independent company.

In addition to the above risks, if the merger agreement is terminated and our board of directors seeks another merger or business combination, the market price of our common stock could decline, which could make it more difficult to find a party willing to offer equivalent or more attractive consideration than the consideration First Merchants has agreed to provide. If the merger agreement is terminated under certain circumstances, we may be required to pay a termination fee of $11.13 million to First Merchants, which may adversely affect the price of our common stock. Any of the above risks could materially affect our business, financial results and stock price.

We face risks and uncertainties related to our proposed Merger with First Merchants.

Uncertainty about the effect of the Merger on our team members and customers may have an adverse effect on us. These uncertainties may impair our ability to attract, retain and motivate key personnel until the Merger is consummated and for a period of time thereafter, and could cause customers and others that deal with us to seek to change their existing business relationships with us. Team member retention may be particularly challenging during the pendency of the Merger, as team members may experience uncertainty about their roles with the surviving corporation following the Merger.

In addition, the merger agreement contains provisions that restrict our ability to, among other things, solicit, knowingly encourage or facilitate inquiries or proposals or enter into any agreement with respect to, or initiate or participate in any negotiations or discussions with any person concerning any alternative business combination proposals, subject to certain exceptions generally related to our board of directors’ exercise of its fiduciary duties. These provisions, which include a $11.13 million termination fee payable under certain circumstances, might discourage a potential competing acquirer that might have an interest in engaging in a superior transaction from considering or proposing that acquisition, or might result in lower value received by our shareholders than would have otherwise been received.

The Company and First Merchants have operated and, until the completion of the Merger, will continue to operate, independently. The success of the Merger, including anticipated benefits and cost savings among other things, will depend, in part, on our and First Merchants’ ability to successfully combine and integrate our and First Merchants’ businesses in a manner that facilitates growth opportunities and realizes cost savings. It is possible that the integration process could result in the loss of key employees, the loss of customers, the disruption of either company’s or both companies’ ongoing business, inconsistencies

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in standards, controls, procedures and policies, unexpected integration issues, higher than expected integration costs and an overall post-completion integration process that takes longer than originally anticipated. If the combined companies experience difficulties with the integration process, the anticipated benefits of the Merger may not be realized fully or at all, or may take longer to realize than expected.

The merger agreement may be terminated in accordance with its terms and the Merger may not be completed.

The merger agreement is subject to a number of conditions which must be fulfilled in order to complete the Merger. Those conditions include: the approval of the Merger by our shareholders; the effectiveness of the registration statement on Form S-4 for the shares of First Merchants common stock and preferred stock (or depositary shares in respect thereof) to be issued in the Merger; the receipt of authorization for listing on Nasdaq of the shares of First Merchants common stock and preferred stock (or depositary shares in respect thereof) to be issued in the Merger; the receipt of all required regulatory approvals; the absence of any order, decree or injunction enjoining or prohibiting the Merger; the receipt of a fairness opinion by the Company’s financial advisor; subject to certain exceptions, the accuracy of representations and warranties under the merger agreement; our and First Merchants’ performance of our and their respective obligations under the merger agreement in all material respects; and each of our and First Merchants’ receipt of a tax opinion to the effect that the Merger will be treated as a “reorganization” within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as amended. These conditions to the closing of the Merger may not be fulfilled in a timely manner or at all, and, accordingly, the Merger may be delayed or may not be completed.

We and First Merchants may elect to terminate the merger agreement under certain circumstances. Among other situations, if the Merger is not completed by July 31, 2022 (or if the sole impediment to closing is the lack of regulatory approval, September 30, 2022), either we or First Merchants may choose not to proceed with the Merger, subject to certain exceptions. We and First Merchants can also mutually decide to terminate the merger agreement at any time. If the merger agreement is terminated, under certain limited circumstances, we may be required to pay a termination fee of $11.13 million to First Merchants, or First Merchants may be required to pay a termination fee of $10.0 million to us.

Our ability to complete the Merger is subject to the receipt of approval from various regulatory agencies, which may impose conditions that could adversely affect us or cause the Merger to be abandoned.

Before the transactions contemplated in the merger agreement can be completed, the Company and First Merchants must obtain various regulatory approvals. The terms and conditions of the approvals that are granted may impose conditions, limitations, obligations or costs, or place restrictions on the conduct of the combined company’s business or require changes to the terms of the transactions contemplated by the merger agreement. Although the Company and First Merchants do not currently expect that any such conditions or changes would be imposed, there can be no assurance that the regulators will not impose any such conditions, obligations or restrictions, and that such conditions, limitations, obligations or restrictions will not have the effect of delaying or preventing completion of any of the transactions contemplated by the merger agreement, imposing additional material costs on or materially limiting the revenues of the combined company following the Merger or otherwise reduce the anticipated benefits of the Merger if the Merger were consummated successfully within the expected timeframe, any of which might have an adverse effect on the combined company following the Merger.

Because the market price of First Merchants common stock may fluctuate, our shareholders cannot be certain of the precise value of the Merger consideration they may receive in the Merger.

At the time the Merger is completed, each issued and outstanding share of our common stock will be converted into the right to receive 0.7167 of a share of First Merchants common stock and $10.17 in cash.

There will be a time lapse between each of the date of the proxy statement/prospectus for the shareholder meeting to adopt the merger agreement, the date on which our shareholders vote to approve the merger agreement, and the date on which our shareholders entitled to receive shares of First Merchants common stock actually receive such shares. The market value of First Merchants common stock may fluctuate during these periods as a result of a variety of factors, including general market and economic conditions, changes in First Merchants’ businesses, operations and prospects, and regulatory considerations. Many of these factors are outside of our and First Merchants’ control. Consequently, at the time that our shareholders must decide whether to approve the merger agreement, they will not know the actual market value of the shares of First Merchants common stock that they will receive when the Merger is completed. The actual value of the shares of First Merchants common stock received by our shareholders will depend on the market value of shares of First Merchants common stock at the time the Merger is completed. This market value may be less or more than the value used to determine the exchange ratio stated in the merger agreement.

Shareholder litigation could prevent or delay the closing of the proposed Merger or otherwise negatively impact our business and operations.

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In connection with the Merger, lawsuits may be filed against us, First Merchants, or the directors and officers of either company in connection with the Merger. Litigation filed against us, our board of directors or First Merchants and its board of directors could prevent or delay the completion of the Merger or result in the payment of damages following completion of the Merger. The defense or settlement of any lawsuit or claim that remains unresolved at the effective time of the Merger may adversely affect the combined company’s business, financial condition, results of operations, cash flows and market price.

The risks described above and in our Annual Report on Form 10-K for the year ended December 31, 2020, are not the only risks that we encounter. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, results of operations, financial condition and/or liquidity.

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 December 16, 2020, the Company announced that its Board of Directors approved a new share repurchase program that began on January 1, 2021 and expires on December 31, 2022 to replace the prior repurchase program. This repurchase program authorizes the 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 $10.0 million. The repurchase program does not obligate the Company to repurchase any dollar amount or number of shares, and the program can be extended, modified, suspended or discontinued at any time.

There were no repurchases of the Company’s shares of its outstanding common stock during the three months ended September 30, 2021.

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


3.1						Articles of Incorporation, as amended, of Level One Bancorp, Inc. (incorporated by reference to Exhibit 3.1 to the Company’s current report on Form 8-K filed August 13, 2020).

3.2						Amended and Restated Bylaws of Level One Bancorp, Inc. (incorporated by reference to Exhibit 3.2 to the Company's registration statement on Form S-1 (File no. 333-223866) filed March 23, 2018).








































































31.1						Principal Executive Officer’s Certifications required by Rule 13(a)-14(a) – filed herewith.

31.2						Principal Financial Officer’s Certifications required by Rule 13(a)-14(a) – filed herewith.

32.1						Principal Executive Officer Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – filed herewith.

32.2						Principal Financial Officer Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – filed herewith.

101						Financial information from the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2021, 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 Shareholders’ Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to the Consolidated Financial Statements – filed herewith.

104						Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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 5, 2021	By:	/s/	Patrick J. Fehring
			Patrick J. Fehring
			Chief Executive Officer
			(principal executive officer)

Date: November 5, 2021	By:	/s/	David C. Walker
			David C. Walker
			Executive Vice President and Chief Financial Officer
			(principal financial officer)

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Level One Bancorp (FRMEP) 10-Q2021 Q3 Quarterly report

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