Bank7 Corp. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this report. Unless the context indicates otherwise, references in this management’s discussion and analysis to “we”, “our”, and “us,” refer to Bank7 Corp. and its consolidated subsidiaries. All references to “the Bank” refer to Bank7, our wholly owned subsidiary. General We are Bank7 Corp., a bank holding company headquartered in Oklahoma City, Oklahoma. Through our wholly-owned subsidiary, Bank7, we operate nine full-service branches in Oklahoma, the Dallas/Fort Worth, Texas metropolitan area and Kansas. We are focused on serving business owners and entrepreneurs by delivering fast, consistent and well-designed loan and deposit products to meet their financing needs. We intend to grow organically by selectively opening additional branches in our target markets and we will also pursue strategic acquisitions. As a bank holding company, we generate most of our revenue from interest income on loans and from short-term investments. The primary source of funding for our loans and short-term investments are deposits held by our subsidiary, Bank7. We measure our performance by our return on average assets, return on average equity, earnings per share, capital ratios, and our efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax equivalent basis and noninterest income. As of December 31, 2020, we had total assets of $1.0 billion, total loans of $836.6 million, total deposits of $905.5 million and total shareholders’ equity of $107.3 million. In September 2018, in conjunction with our initial public offering, the Company terminated its status as an S Corporation and elected to be treated as a C Corporation. As this termination occurred at the end of the third quarter, we have presented information as pre-tax and pro forma numbers in the non-GAAP reconciliation below. 30 Table of Contents The U.S. economy experienced widespread volatility throughout 2020 as a result of the COVID-19 pandemic and government responses to the pandemic. Economic condition declined rapidly and significantly following the initial widespread U.S. outbreak in March and April of 2020. Federal stimulus was quickly passed in the form of the CARES Act and the economy rebounded significantly in the second half of 2020. In an emergency measure aimed at dampening the economic impact of COVID-19, the Federal Reserve lowered the target for the federal funds rate to a range of between zero to 0.25% effective on March 16, 2020 where it remained through the end of 2020. This action by the Federal Reserve followed a prior reduction of the targeted federal funds rates to a range of 1.0% to 1.25% effective March 4, 2020. This decline in interest rates led to new all-time low yields across the U.S. Treasury maturity curve. In September 2020, the Federal Reserve (FED) indicated that it expects to maintain the targeted federal funds rate at current levels and expects that to last through 2023. Although rates are at or near historical lows, it is possible the FED could force rates even lower, which could further negatively impact the net interest margins for the banking industry. Net interest income is a key driver for our earnings, and is defined as the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits. Our bank has an asset sensitive Balance Sheet, therefore, our earnings are susceptible to lower rates because the interest income received on loans and other investments falls more quickly and to a larger degree than the interest rates paid on deposits. Although we have implemented various strategies to mitigate the effects of lower interest rates, we have experienced a decrease in net interest income, and could possibly experience further degradation to our net interest margin. Factors Affecting Comparability of Financial Results S Corporation Status Since our formation in 2004, until our initial public offering, we have elected to be taxed for U.S. federal income tax purposes as an S Corporation. As a result, our net income has not been subject to, and we have not paid, U.S. federal or state income taxes, and we have not been required to make any provision or recognize any liability for U.S. federal income tax in our financial statements. The consummation of our initial public offering resulted in the termination of our status as an S Corporation and in our taxation as a C Corporation for U.S. federal and state income tax purposes. Upon the termination of our status as an S Corporation, we commenced paying U.S. federal income tax on our pre-tax net income for each year (including the short year beginning on the date our status as an S Corporation terminated), and our financial statements reflect a provision for U.S. federal income tax. As a result of this change, the net income and earnings per share data presented prior to our conversion to a C Corporation in 2018, which do not include any provision for U.S. federal income tax, will not be comparable with our current net income and earnings per share, which is calculated by including a provision for U.S. federal and state income tax. Furthermore, we have recognized deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of our existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of the change in tax rates resulting from becoming a C Corporation were recognized in income in the quarter the change took place. This difference between the financial statement carrying amounts of assets and liabilities and their respective tax bases was recorded as a net deferred tax asset of $2 million (net of $13,000 uncertain tax liability) on our consolidated balance sheet as of December 31, 2020. 31 Table of Contents Pro Forma Income Tax Expense and Net Income As a result of our status as an S Corporation, we had no U.S. federal income tax expense for the full year ended December 31, 2018, but rather only for the short year after conversion to C corporation status (as discussed earlier). The pro forma impact of being taxed as a C Corporation is illustrated in the following table: As of or for the year ended December 31, 2020 2019 2018 (Dollars in thousands) Before Taxes Net income (1) $ 25,884 $ 15,069 $ 25,797 Pro forma C Corporation Combined effective income tax rate (2) 25.57 % 45.42 % 22.19 % Income tax provision $ 6,618 $ 6,844 $ 5,720 Net income 19,266 8,225 20,077 Total shareholders’ equity 107,319 100,126 88,466 Earnings per share (basic) 2.05 0.81 2.48 Earnings per share (diluted) 2.05 0.81 2.44 Return on average: Assets 2.03 1.03 2.75 Shareholders’ equity 18.82 8.42 25.69 (1) A portion of our net income in each of these periods was derived from nontaxable investment income and other nondeductible expenses. (2) Based on a statutory federal income tax rate of 21%, 21% and 21%, for the years ended December 31, 2020, 2019 and 2018, respectively, plus the applicable statutory state income tax rate for each of the respective periods. State income tax was $1.6 million and $1.2 million, with an effective state tax rate of 4.9% and 4.4% for the years ended December 31, 2020 and 2019, respectively. State income tax expense would have been approximately $1.3 million for the year ended December 31, 2018 with an effective state tax rate of 4.9% 2020 Highlights For the year ended December 31, 2020, we reported pre-tax net income of $25.9 million compared to pre-tax net income of $15.0 million for the year ended December 31, 2019. The increase was primarily related to compensation expense from the one-time, non-cash executive stock transaction in 2019. For the year ended December 31, 2020, average loans totaled $823.2 million, an increase of $187.0 million or 29.4%, from December 31, 2019. For the year ended December 31, 2020, loan yields, excluding loan fee income, were 5.76%, a decrease of 112 basis points from the same period in 2019 due to decreasing interest rates. Loan yield excluding loan fee income is a non-GAAP measure. See “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures” elsewhere in this report. Pre-tax return on average assets and return on average equity was 2.73% and 25.29%, respectively for the year ended December 31, 2020, as compared to 1.88% and 15.44%, respectively, for the same period in 2019. Our efficiency ratio for the year ended December 31, 2020 was 36.03% as compared to 65.39% for the year ended December 31, 2019. The decrease was due to compensation expense from the the one-time, non-cash executive stock transaction in 2019. As of December 31, 2020, total loans were $836.6 million, an increase of $129.3 million, or 18.3%, from December 31, 2019. Total deposits were $905.5 million as of December 31, 2020, an increase of $148.0 million, or 19.5%, from December 31, 2019. Tangible book value per share was $11.69 as of December 31, 2020, an increase of $1.91, or 19.6%, from December 31, 2019. Tangible book value per share is a non-GAAP financial measure. See “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures” elsewhere in this report. 32 Table of Contents Results of Operations Years Ended December 31, 2020, December 31, 2019, and December 31, 2018 Net Interest Income and Net Interest Margin The following table presents, for the periods indicated, information about: (i) weighted average balances, the total dollar amount of interest income from interest-earning assets, and the resultant average yields; (ii) average balances, the total dollar amount of interest expense on interest-bearing liabilities, and the resultant average rates; (iii) net interest income; and (iv) the net interest margin. For the Years Ended December 31, 2020 2019 2018 Average Balance Interest Income/ Expense Average Yield/ Rate Average Balance Interest Income/ Expense Average Yield/ Rate Average Balance Interest Income/ Expense Average Yield/ Rate (Dollars in thousands) Interest-earning assets: Short-term investments (1) $ 116,295 $ 828 0.71 % $ 151,434 $ 3,459 2.28 % $ 136,880 $ 2,521 1.84 % Investment securities (2) $ 1,123 36 3.21 % $ 1,065 50 4.69 % $ 1,052 — 0.00 % Loans held for sale $ 244 — 0.00 % $ 236 — 0.00 % $ 182 — 0.00 % Total loans (3) $ 823,228 $ 52,450 6.37 % $ 636,274 $ 48,200 7.58 % $ 583,821 $ 44,279 7.58 % Total interest-earning assets $ 940,890 $ 53,314 5.67 % $ 789,009 $ 51,709 6.55 % $ 721,935 $ 46,800 6.48 % Noninterest-earning assets $ 8,067 $ 9,519 $ 8,629 Total assets $ 948,957 $ 798,528 $ 730,564 Funding sources: Interest-bearing liabilities: Deposits: Transaction accounts $ 377,519 $ 2,729 0.72 % $ 295,576 $ 5,057 1.71 % $ 240,881 $ 3,584 1.49 % Time deposits $ 207,442 $ 3,424 1.65 % $ 208,375 $ 4,459 2.14 % $ 220,023 $ 3,410 1.55 % Total interest-bearing deposits $ 584,961 $ 6,153 1.05 % $ 503,951 $ 9,516 1.89 % $ 460,904 $ 6,994 1.52 % Other borrowings $ — $ — 0.00 % $ — $ — 0.00 % $ 3,652 $ 175 4.79 % Total interest-bearing liabilities $ 584,961 $ 6,153 1.05 % $ 503,951 $ 9,516 1.89 % $ 464,556 $ 7,169 1.54 % Noninterest-bearing liabilities: Noninterest-bearing deposits $ 256,431 $ 192,562 $ 183,750 Other noninterest-bearing liabilities $ 5,206 $ 4,585 $ 4,110 Total noninterest-bearing liabilities $ 261,637 $ 197,147 $ 187,860 Shareholders’ equity $ 102,359 $ 97,430 $ 78,148 Total liabilities and shareholders’ equity $ 948,957 $ 798,528 $ 730,564 Net interest income $ 47,161 $ 42,193 $ 39,631 Net interest spread (4) 4.61 % 4.67 % 4.94 % Net interest margin 5.01 % 5.35 % 5.49 % (1) Includes income and weighted average balances for fed funds sold, interest-earning deposits in banks and other miscellaneous interest-earning assets. (2) Includes income and weighted average balances for FHLB and FRB stock. (3) Average loan balances include monthly average nonaccrual loans of $11.3 million, $2.1 million and $991,000 for the years ended December 31, 2020, 2019 and 2018, respectively. (4) Net interest spread is the average yield on interest-earning assets minus the average rate on interest-bearing liabilities. 33 Table of Contents We continued to experience strong asset growth for the year ended December 31, 2020 compared to the year ended December 31, 2019: - Total interest income on loans increased $4.3 million, or 8.8%, to $52.5 million which was attributable to a $187.0 million increase in the average balance of loans to $823.2 million during the year ended 2020 as compared with the average balance of $636.3 million for the year ended 2019; - Loan fees totaled $5.0 million, an increase of $592,000 or 13.3%; - Yields on our interest-earning assets totaled 5.67%, a decrease of 88 basis points which was attributable to lower loan rates and a decrease in yield on short term investments of 157 basis points, both were primarily impacted by the aforementioned changes in market interest rates related to the pandemic; and - Net interest margin for the year ended 2020 and 2019 was 5.01% and 5.35%, respectively. For the year ended December 31, 2019 compared to the year ended December 31, 2018: - Total interest income on loans increased $3.9 million, or 8.9%, to $48.2 million which was attributable to a $52.5 million increase in the average balance of loans to $636.3 million during the year ended 2019 as compared with the average balance of $583.8 million for the year ended 2018; - Loan fees totaled $4.4 million, a decrease of $678,000 or 13.2% which was attributable to nonrecurring loan fee income earned during the year ended 2018 as compared to 2019; - Yields on our interest-earning assets totaled 6.55%, an increase of 7 basis points; and - Net interest margin for the year ended 2019 and 2018 was 5.35% and 5.49%, respectively. The FED influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. Our loan portfolio is significantly affected by changes in the prime interest rate. For the two year period between January 1, 2018 and December 31, 2020, the prime rate fluctuated between a high of 5.5%, and a low of 3.25%. Although the FED has signaled continued low rates through 2023, changing interest rates will always be present and managing through those changes requires constant oversight. Interest income on short-term investments decreased $2.6 million, or 76.1%, to $828,000 for year ended December 31, 2020 compared to 2019, due to a decrease in the average balances of $35.1 million, or 23.2% and a yield decrease of 157 basis points which was related to the aforementioned changes in market interest rates related to the pandemic. Interest income on short-term investments increased $938,000, or 37.2%, to $3.5 million for year ended December 31, 2019 compared to 2018, due to an increase in the average balances of $14.5 million, or 10.63% and a yield increase of 44 basis points. Interest expense on interest-bearing deposits totaled $6.2 million for the year ended December 31, 2020, compared to $9.5 million for 2019, a decrease of $3.4 million, or 35.3%. The decrease was related to the cost of interest-bearing deposits decreasing to 1.05% for the year ended December 31, 2020 from 1.89% for the year ended December 31, 2019, which was related to the aforementioned changes in market interest rates related to the pandemic. Interest expense on interest-bearing deposits totaled $9.5 million for the year ended December 31, 2019, compared to $7.0 million for 2018, an increase of $2.5 million, or 36.1%. The increase was related to average daily interest bearing deposit balances increasing by $43.0 million or 9.3% while the cost of interest-bearing deposits grew to 1.89% for the year ended December 31, 2019 from 1.52% for the year ended December 31, 2018. Net interest margin, including loan fee income, for the years ended December 31, 2020, 2019 and 2018 was 5.01%, 5.35% and 5.49%, respectively. Excluding our loan fee income, net interest margin for the years ended December 31, 2020, 2019 and 2018 was 4.48%, 4.78% and 4.78%, respectively. Net interest margin excluding loan fee income is a non-GAAP measure. See “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures” elsewhere in this report. The following table sets forth the effects of changing rates and volumes on our net interest income during the period shown. Information is provided with respect to (i) effects on interest income attributable to changes in volume (change in volume multiplied by prior rate) and (ii) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume). 34 Table of Contents For the Year Ended December 31, 2020 vs. 2019 For the Year Ended December 31, 2019 vs. 2018 Change due to: Change due to: Volume (1) Rate (1) Interest Variance Volume (1) Rate (1) Interest Variance (Dollars in thousands) Increase (decrease) in interest income: Short-term investments $ (803 ) $ (1,828 ) $ (2,631 ) $ 268 $ 670 $ 938 Investment securities $ 3 $ (17 ) $ (14 ) $ --- $ 50 $ 50 Total loans $ 14.163 $ (9,913 ) $ 4,250 $ 3,978 $ (57 ) $ 3,921 Total increase in interest income $ 13,363 $ (11,758 ) $ 1,605 $ 4,246 $ 663 $ 4,909 Increase (decrease) in interest expense: Deposits: Transaction accounts $ 1,402 $ (3,730 ) $ (2,328 ) $ 814 $ 659 $ 1,473 Time deposits $ (20 ) $ (1,015 ) $ (1,035 ) $ (181 ) $ 1,230 $ 1,049 Total interest-bearing deposits $ 1,382 $ (4,745 ) $ (3,363 ) $ 633 $ 1,889 $ 2,522 Other borrowings --- --- --- --- (175 ) (175 ) Total interest-bearing liabilities $ 1,382 $ (4,745 ) $ (3,363 ) $ 633 $ 1,714 $ 2,347 Increase in net interest income $ 11,981 $ (7,013 ) $ 4,968 $ 3,613 $ (1,051 ) $ 2,562 (1) Variances attributable to both volume and rate are allocated on a consistent basis between rate and volume based on the absolute value of the variances in each category. Provision for Loan Losses For the year ended December 31, 2020 compared to the year ended December 31, 2019: - The provision for loan losses increased from zero to $5.4 million related to loan growth, uncertainty in the economy caused by the COVID-19 pandemic and $3.6 million in net charge offs; and - The allowance as a percentage of loans increased by 4 basis points to 1.15%. For the year ended December 31, 2019 compared to the year ended December 31, 2018: - The provision for loan losses decreased by $200,000, or 100%, to $0; and - The allowance as a percentage of loans decreased by 20 basis points to 1.11%. Noninterest Income Noninterest income for the year ended December 31, 2020 was $1.7 million compared to $1.3 million for the year ended December 31, 2019, an increase of $357,000, or 27.3%. Noninterest income for the year ended December 31, 2019 was $1.3 million compared to $1.3 million for the year ended December 31, 2018, a decrease of $23,000, or 1.7%. The following table sets forth the major components of our noninterest income for the years ended December 31, 2020, 2019 and 2018: For the Years Ended December 31, For the Years Ended December 31, 2020 2019 $ Increase (Decrease) % Increase (Decrease) 2019 2018 $ Increase (Decrease) % Increase (Decrease) (Dollars in thousands) (Dollars in thousands) Noninterest income: Secondary Market Income $ 175 $ 164 $ 11 6.71 % $ 164 $ 212 $ 45 12.97 % Service Charges on Deposit Accounts $ 442 $ 392 $ 50 12.76 % $ 392 $ 347 $ (48 ) (22.64 %) Other Income and Fees $ 1,048 $ 752 $ 296 39.36 % $ 752 $ 772 $ (20 ) (2.59 %) Total noninterest income $ 1,665 $ 1,308 $ 357 27.29 % $ 1,308 $ 1,331 $ (23 ) (1.73 %) 35 Table of Contents Noninterest Expense Noninterest expense for the year ended December 31, 2020 was $17.6 million compared to $28.4 million for the year ended December 31, 2019, a decrease of $10.8 million or 38.1%. Noninterest expense for the year ended December 31, 2019 was $28.4 compared to $15.0 million for the year ended December 31, 2018, an increase of $13.5 million, or 90.0%. The following table sets forth the major components of our noninterest expense for the years ended December 31, 2020, 2019 and 2018: For the Years Ended December 31, For the Years Ended December 31, 2020 2019 $ Increase (Decrease) % Increase (Decrease) 2019 2018 $ Increase (Decrease) % Increase (Decrease) (Dollars in thousands) (Dollars in thousands) Noninterest expense: Salaries and employee benefits $ 10,130 $ 21,265 $ (11,135 ) (52.36 %) $ 21,265 $ 8,113 $ 13,152 162.11 % Furniture and equipment 868 829 39 4.70 % 829 684 145 21.20 % Occupancy 1,957 1,677 280 16.70 % 1,677 1,105 572 51.76 % Data and item processing 1,091 1,078 13 1.21 % 1,078 966 112 11.59 % Accounting, legal and professional fees 536 757 (221 ) (29.19 %) 757 305 452 148.20 % Regulatory assessments 506 126 380 301.59 % 126 542 (416 ) (76.75 %) Advertising and public relations 400 588 (188 ) (31.97 %) 588 553 35 6.33 % Travel, lodging and entertainment 241 368 (127 ) (34.51 %) 368 699 (331 ) (47.35 %) Other expense 1,863 1,744 119 6.82 % 1,744 1,998 (254 ) (12.71 %) Total noninterest expense $ 17,592 $ 28,432 $ (10,840 ) (38.13 %) $ 28,432 $ 14,965 $ 13,467 89.99 % For the year ended December 31, 2020 compared to the year ended December 31, 2019: - Salaries and employee benefits expense was $10.1 million compared to $21.3 million, a decrease of $11.1 million, or 52.4%. The decrease was attributable to our one-time non-cash executive stock transaction in 2019. - Occupancy expense was $2.0 million compared to $1.7 million, an increase of $280,000, or 16.7%. The increase in 2020 was primarily due to 2020 being the first full year of depreciation for the renovation of our main branch and headquarters and increased rent at our full-service Tulsa location. For the year ended December 31, 2019 compared to the year ended December 31, 2018: - Salaries and employee benefits expense was $21.3 million compared to $8.1 million, an increase of $13.2 million, or 162.1%. The increase in 2019 was attributable to our one-time non-cash executive stock transaction. - Occupancy expense was $1.7 million compared to $1.1 million, an increase of $572,000, or 51.8%. The increase in 2019 was primarily due to the renovation of our headquarters and the expansion into two new markets. - Accounting, legal and professional fees were $757,000 compared to $305,000, an increase of $452,000, or 148.2%. The increase was primarily due to 2019 being our first full year as a public company. Financial Condition The following discussion of our financial condition compares December 31, 2020, 2019, and 2018. Total Assets Total assets increased $150.3 million, or 17.4%, to $1.0 billion as of December 31, 2020, as compared to $866.4 million as of December 31, 2019 and $770.5 million as of December 31, 2018. The increasing trend in total assets is primarily attributable to strong organic loan and retail deposit growth within the Oklahoma City market and expansion into the Dallas/Fort Worth metropolitan area, as well as the addition of loans related to the Paycheck Protection Program (PPP) in 2020. 36 Table of Contents Loan Portfolio Our loans represent the largest portion of our earning assets. The quality and diversification of the loan portfolio is an important consideration when reviewing our financial condition. As of December 31, 2020, 2019 and 2018, our gross loans were $839.1 million, $708.7 million and $601.9 million, respectively. The following table presents the balance and associated percentage of each major category in our loan portfolio as of December 31, 2020, December 31, 2019 and December 31, 2018: As of December 31, As of December 31, As of December 31, 2020 2019 2018 Amount % of Total Amount % of Total Amount % of Total (Dollars in thousands) Construction & development $ 107,855 12.8 % $ 70,628 10.0 % $ 87,267 14.5 % 1-4 family real estate 29,079 3.5 34,160 4.8 33,278 5.5 Commercial real estate - other 290,489 34.6 273,278 38.5 156,396 26.0 Total real estate 427,423 50.9 378,066 53.3 276,941 46.0 Commercial & industrial 351,248 41.9 260,762 36.8 248,394 41.3 Agricultural 50,519 6.0 57,945 8.2 62,844 10.4 Consumer 9,898 1.2 11,895 1.7 13,723 2.3 Gross loans 839,088 100.0 % 708,668 100.0 % 601,902 100.0 % Less deferred loan fees, net (2,475 ) (1,364 ) (1,992 ) Total loans 836,613 707,304 599,910 Allowance for loan and lease losses (9,639 ) (7,846 ) (7,832 ) Net loans $ 826,974 $ 699,458 $ 592,078 During the second quarter of 2020, we began originating loans to qualified small businesses under the PPP administered by the SBA under the provisions of the CARES Act. Included in our commercial & industrial balance at December 31, 2020, are $44.9 million of PPP loans. We have established internal concentration limits in the loan portfolio for CRE loans, hospitality loans, energy loans, and construction loans, among others. All loan types are within our established limits. We use underwriting guidelines to assess each borrower’s historical cash flow to determine debt service, and we further stress test the debt service under higher interest rate scenarios. Financial and performance covenants are used in commercial lending to allow us to react to a borrower’s deteriorating financial condition, should that occur. 37 Table of Contents The following tables show the contractual maturities of our gross loans as of the periods below: As of December 31, 2020 Due in One Year or Less Due after One Year Through Five Years Due after Five Years Fixed Rate Adjustable Rate Fixed Rate Adjustable Rate Fixed Rate Adjustable Rate Total (Dollars in thousands) Construction & development $ 14 $ 47,649 $ 885 $ 58,387 $ — $ 920 $ 107,855 1-4 family real estate 273 13,394 4,712 9,959 39 702 29,079 Commercial real estate - other 2,377 55,307 45,880 180,721 294 5,910 290,489 Total real estate 2,664 116,350 51,477 249,067 333 7,532 427,423 Commercial & industrial 16,914 194,520 39,593 93,707 11 6,503 351,248 Agricultural 5,141 27,215 2,534 14,420 60 1,149 50,519 Consumer 1,544 150 6,570 65 1,144 425 9,898 Gross loans $ 26,263 $ 338,235 $ 100,174 $ 357,259 $ 1,548 $ 15,609 $ 839,088 As of December 31, 2019 Due in One Year or Less Due after One Year Through Five Years Due after Five Years Fixed Rate Adjustable Rate Fixed Rate Adjustable Rate Fixed Rate Adjustable Rate Total (Dollars in thousands) Construction & development $ — $ 31,860 $ 833 $ 37,483 $ — $ 452 $ 70,628 1-4 family real estate 282 9,598 3,843 19,676 43 718 34,160 Commercial real estate - other 1,849 23,533 23,194 219,390 335 4,977 273,278 Total real estate 2,131 64,991 27,870 276,549 378 6,147 378,066 Commercial & industrial 11,677 176,329 9,973 54,233 12 8,538 260,762 Agricultural 3,947 34,875 2,786 13,055 1,319 1,963 57,945 Consumer 2,042 — 4,824 159 4,047 823 11,895 Gross loans $ 19,797 $ 276,195 $ 45,453 $ 343,996 $ 5,756 $ 17,471 $ 708,668 38 Table of Contents As of December 31, 2018 Due in One Year or Less Due after One Year Through Five Years Due after Five Years Fixed Rate Adjustable Rate Fixed Rate Adjustable Rate Fixed Rate Adjustable Rate Total (Dollars in thousands) Construction & development $ 741 $ 29,412 $ 617 $ 56,497 $ --- $ --- $ 87,267 1-4 family real estate 682 19,866 1,643 $ 10,934 --- 153 33,278 Commercial real estate - other 457 14,280 283 $ 134,090 2,197 5,089 156,396 Total real estate 1,880 63,558 2,543 201,521 2,197 5,242 276,941 Commercial & industrial 13,725 153,891 7,878 66,631 14 6,255 248,394 Agricultural 4,474 32,496 4,084 17,669 1,374 2,747 62,844 Consumer 2,688 --- 5,443 50 4,453 1,089 13,723 Gross loans $ 22,767 $ 249,945 $ 19,948 $ 285,871 $ 8,038 $ 15,333 $ 601,902 Allowance for Loan and Lease Losses The allowance is based on management’s estimate of probable losses inherent in the loan portfolio. In the opinion of management, the allowance is adequate to absorb estimated losses in the portfolio as of each balance sheet date. While management uses available information to analyze losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance. In analyzing the adequacy of the allowance, a comprehensive loan grading system to determine risk potential in loans is utilized together with the results of internal credit reviews. To determine the adequacy of the allowance, the loan portfolio is broken into segments based on loan type. Historical loss experience factors by segment, adjusted for changes in trends and conditions, are used to determine an indicated allowance for each portfolio segment. These factors are evaluated and updated based on the composition of the specific loan segment. Other considerations include volumes and trends of delinquencies, nonaccrual loans, levels of bankruptcies, criticized and classified loan trends, expected losses on real estate secured loans, new credit products and policies, economic conditions, concentrations of credit risk and the experience and abilities of our lending personnel. In addition to the segment evaluations, impaired loans with a balance of $250,000 or more are individually evaluated based on facts and circumstances of the loan to determine if a specific allowance amount may be necessary. Specific allowances may also be established for loans whose outstanding balances are below the $250,000 threshold when it is determined that the risk associated with the loan differs significantly from the risk factor amounts established for its loan segment. The allowance was $9.6 million at December 31, 2020, $7.8 million at December 31, 2019 and $7.8 million at December 31, 2018. The increasing trend was related to, and in conjunction with, loan growth and uncertainty in the economy caused by the COVID-19 pandemic. 39 Table of Contents The following table provides an analysis of the activity in our allowance for the periods indicated: For the Year Ended December 31, 2020 2019 2018 (Dollars in thousands) Balance at beginning of the period $ 7,846 $ 7,832 $ 7,654 Provision for loan losses 5,350 — 200 Charge-offs: Construction & development — — — 1-4 family real estate — (2 ) (25 ) Commercial real estate - other — — — Commercial & industrial (3,289 ) (4 ) (73 ) Agricultural (300 ) (11 ) — Consumer (1 ) (1 ) — Total charge-offs (3,590 ) (18 ) (98 ) Recoveries: Construction & development — — — 1-4 family real estate 2 5 3 Commercial real estate - other — — — Commercial & industrial 18 24 71 Agricultural 10 3 1 Consumer 3 — 1 Total recoveries 33 32 76 Net charge-offs (3,557 ) 14 (22 ) Balance at end of the period $ 9,639 $ 7,846 $ 7,832 While the entire allowance is available to absorb losses from any and all loans, the following table represents management’s allocation of the allowance by loan category, and the percentage of allowance in each category, for the periods indicated: As of December 31, 2020 2019 2018 Amount Percent Amount Percent Amount Percent (Dollars in thousands) Construction & development $ 1,239 12.85 % $ 782 9.97 % $ 1,136 14.50 % 1-4 family real estate 334 3.47 % 378 4.82 % 433 5.53 % Commercial real estate - other 3,337 34.62 % 3,025 38.55 % 2,035 25.98 % Commercial & industrial 4,035 41.86 % 2,887 36.80 % 3,231 41.26 % Agricultural 580 6.02 % 642 8.18 % 818 10.44 % Consumer 114 1.18 % 132 1.68 % 179 2.29 % Total $ 9,639 100.0 % $ 7,846 100.0 % $ 7,832 100.0 % Nonperforming Assets Loans are considered delinquent when principal or interest payments are past due 30 days or more. Delinquent loans may remain on accrual status between 30 days and 90 days past due. Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. Typically, the accrual of interest on loans is discontinued when principal or interest payments are past due 90 days or when, in the opinion of management, there is a reasonable doubt as to collectability of the obligation. When loans are placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Income on a nonaccrual loan is subsequently recognized only to the extent that cash is received and the loan’s principal balance is deemed collectible. Loans are restored to accrual status when loans become well-secured and management believes full collectability of principal and interest is probable. 40 Table of Contents A loan is considered impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans include loans on nonaccrual status and loans modified in a troubled debt restructuring, or TDR. Income from a loan on nonaccrual status is recognized to the extent cash is received and when the loan’s principal balance is deemed collectible. Depending on a particular loan’s circumstances, we measure impairment of a loan based upon either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the fair value of the collateral less estimated costs to sell if the loan is collateral dependent. A loan is considered collateral dependent when repayment of the loan is based solely on the liquidation of the collateral. Fair value, where possible, is determined by independent appraisals, typically on an annual basis. Between appraisal periods, the fair value may be adjusted based on specific events, such as if deterioration of quality of the collateral comes to our attention as part of our problem loan monitoring process, or if discussions with the borrower lead us to believe the last appraised value no longer reflects the actual market for the collateral. The impairment amount on a collateral dependent loan is charged off to the allowance if deemed not collectible and the impairment amount on a loan that is not collateral dependent is set up as a specific reserve. In cases where a borrower experiences financial difficulties and we make certain concessionary modifications to contractual terms, the loan is classified as a TDR. Included in certain loan categories of impaired loans are TDRs on which we have granted certain material concessions to the borrower as a result of the borrower experiencing financial difficulties. The concessions granted by us may include, but are not limited to: (1) a modification in which the maturity date, timing of payments or frequency of payments is modified, (2) an interest rate lower than the current market rate for new loans with similar risk, or (3) a combination of the first two concessions. If a borrower on a restructured accruing loan has demonstrated performance under the previous terms, is not experiencing financial difficulty and shows the capacity to continue to perform under the restructured terms, the loan will remain on accrual status. Otherwise, the loan will be placed on nonaccrual status until the borrower demonstrates a sustained period of performance, which generally requires six consecutive months of payments. Loans identified as TDRs are evaluated for impairment using the present value of the expected cash flows or the estimated fair value of the collateral, if the loan is collateral dependent. The fair value is determined, when possible, by an appraisal of the property less estimated costs related to liquidation of the collateral. The appraisal amount may also be adjusted for current market conditions. Adjustments to reflect the present value of the expected cash flows or the estimated fair value of collateral dependent loans are a component in determining an appropriate allowance, and as such, may result in increases or decreases to the provision for loan losses in current and future earnings. Real estate we acquire as a result of foreclosure or by deed-in-lieu of foreclosure is classified as other real estate owned, or OREO, until sold, and is initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. Nonperforming loans include nonaccrual loans, loans past due 90 days or more and still accruing interest and loans modified under TDRs that are not performing in accordance with their modified terms. Nonperforming assets consist of nonperforming loans plus OREO. Loans accounted for on a nonaccrual basis were $14.6 million as of December 31, 2020, $1.8 million as of December 31, 2019 and $2.6 million as of December 31, 2018. OREO was $0 as of December 31, 2020, $0 as of December 31, 2019 and $110,000 as of December 31, 2018. 41 Table of Contents The following table presents information regarding nonperforming assets as of the dates indicated. As of December 31, 2020 2019 2018 (Dollars in thousands) Nonaccrual loans $ 14,575 $ 1,809 $ 2,615 Troubled debt restructurings - 912 - Accruing loans 90 or more days past due 1,960 612 - Total nonperforming loans 16,535 3,333 2,615 Other real estate owned — — 110 Total nonperforming assets $ 16,535 $ 3,333 $ 2,725 Ratio of nonperforming loans to total loans 1.98 % 0.47 % 0.44 % Ratio of nonperforming assets to total assets 1.63 % 0.38 % 0.35 % The following tables present an aging analysis of loans as of the dates indicated. As of December 31, 2020 Loans 30-59 days past due Loans 60-89 days past due Loans 90+ days past due Total Loans 90+ days and accruing Total past due Loans Current Loans Gross Loans (Dollars in thousands) Construction & development $ 714 $ — $ — $ — $ 714 $ 107,141 $ 107,855 1-4 family real estate — — — — — 29,079 29,079 Commercial real estate - other 1,444 — 1,960 1,960 3,404 287,085 290,489 Commercial & industrial — — — — — 351,248 351,248 Agricultural — — — — — 50,519 50,519 Consumer 193 — — — 193 9,705 9,898 Total $ 2,351 $ 0 $ 1,960 $ 1,960 $ 4,311 $ 834,777 $ 839,088 As of December 31, 2019 Loans 30-59 days past due Loans 60-89 days past due Loans 90+ days past due Total Loans 90+ days and accruing Total past due Loans Current Loans Gross Loans (Dollars in thousands) Construction & development $ — $ — $ — $ — $ — $ 70,628 $ 70,628 1-4 family real estate — — — — — 34,160 34,160 Commercial real estate - other — — — — — 273,278 273,278 Commercial & industrial — — 14 14 14 260,748 260,762 Agricultural — — 598 598 598 57,347 57,945 Consumer 90 — — — 90 11,805 11,895 Total $ 90 $ 0 $ 612 $ 612 $ 702 $ 707,966 $ 708,668 42 Table of Contents As of December 31, 2018 Loans 30-59 days past due Loans 60-89 days past due Loans 90+ days past due Total Loans 90+ days and accruing Total past due Loans Current Loans Gross Loans (Dollars in thousands) Construction & development $ - $ - $ - $ - $ - $ 87,267 $ 87,267 1-4 family real estate 8 - - - 8 33,270 33,278 Commercial real estate - other - - - - - 156,396 156,396 Commercial & industrial - 5 - - 5 248,389 248,394 Agricultural - - - - - 62,844 62,844 Consumer 41 - - - 41 13,682 13,723 Total $ 49 $ 5 $ 0 $ 0 $ 54 $ 601,848 $ 601,902 In addition to the past due and nonaccrual criteria, the Company also evaluates loans according to its internal risk grading system. Loans are segregated between pass, watch, special mention, and substandard categories. The definitions of those categories are as follows: In addition to the past due and nonaccrual criteria, the Company also evaluates loans according to its internal risk grading system. Loans are segregated between pass, watch, special mention, and substandard categories. The definitions of those categories are as follows: Pass : These loans generally conform to Bank policies, are characterized by policy-conforming advance rates on collateral, and have well-defined repayment sources. In addition, these credits are extended to borrowers and guarantors with a strong balance sheet and either substantial liquidity or a reliable income history. Watch : These loans are still considered “Pass” credits; however, various factors such as industry stress, material changes in cash flow or financial conditions, or deficiencies in loan documentation, or other risk issues determined by the lending officer, Commercial Loan Committee or CQC warrant a heightened sense and frequency of monitoring. Special mention : These loans have observable weaknesses or evidence imprudent handling or structural issues. The weaknesses require close attention, and the remediation of those weaknesses is necessary. No risk of probable loss exists. Credits in this category are expected to quickly migrate to “Watch” or “Substandard” as this is viewed as a transitory loan grade. Substandard : These loans are not adequately protected by the sound worth and debt service capacity of the borrower, but may be well-secured. The loans have defined weaknesses relative to cash flow, collateral, financial condition or other factors that might jeopardize repayment of all of the principal and interest on a timely basis. There is the possibility that a future loss will occur if weaknesses are not remediated. Substandard loans totaled $23.1 million as of December 31, 2020, an increase of $12.0 million compared to December 31, 2019. The increase primarily related to two commercial and industrial relationships comprised of one note each totaling $14.4 million with no specific reserves and two commercial real estate relationships comprised of one note each totaling $5.0 million with no specific reserves. Substandard loans totaled $11.1 million as of December 31, 2019, an increase of $2.0 million compared to December 31, 2018. The increase primarily related to one agricultural relationship comprised of four notes totaling $1.8 million with no specific reserve, one agricultural relationship comprised of three notes totaling $555,000 with no specific reserve, one mixed relationship comprised of eight notes totaling $4.2 million with no specific reserve, and one mixed relationship comprised of four notes totaling $2.8 million with no specific reserve. 43 Table of Contents Outstanding loan balances categorized by internal risk grades as of the periods indicated are summarized as follows: As of December 31, 2020 Pass Watch Special mention Substandard Total (Dollars in thousands) Construction & development $ 107,855 $ — $ — $ — $ 107,855 1-4 family real estate 28,711 368 — — 29,079 Commercial real estate - other 248,194 24,155 10,086 8,054 290,489 Commercial & industrial 328,656 7,691 300 14,601 351,248 Agricultural 50,051 — — 468 50,519 Consumer 9,898 — — — 9,898 Total $ 773,365 $ 32,214 $ 10,386 $ 23,123 $ 839,088 As of December 31, 2019 Pass Watch Special mention Substandard Total (Dollars in thousands) Construction & development $ 70,628 $ — $ — $ — $ 70,628 1-4 family real estate 33,622 538 — — 34,160 Commercial real estate - other 267,437 — — 5,841 273,278 Commercial & industrial 241,176 5,312 11,524 2,750 260,762 Agricultural 53,290 — 2,128 2,527 57,945 Consumer 11,895 — — — 11,895 Total $ 678,048 $ 5,850 $ 13,652 $ 11,118 $ 708,668 As of December 31, 2018 Pass Watch Special mention Substandard Total (Dollars in thousands) Construction & development $ 84,485 $ 2,782 $ — $ — $ 87,267 1-4 family real estate 29,942 3,221 — 115 33,278 Commercial real estate - other 154,353 1,559 — 484 156,396 Commercial & industrial 204,671 36,342 — 7,381 248,394 Agricultural 57,782 758 3,207 1,097 62,844 Consumer 13,723 — — — 13,723 Total $ 544,956 $ 44,662 $ 3,207 $ 9,077 $ 601,902 Troubled Debt Restructurings TDRs are defined as those loans in which a bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due from the borrower in accordance with original contractual terms of the loan. Loans with insignificant delays or insignificant short-falls in the amount of payments expected to be collected are not considered to be impaired. Loans defined as individually impaired, based on applicable accounting guidance, include larger balance nonperforming loans and TDRs. 44 Table of Contents The CARES Act includes a provision that permits a financial institution to elect to suspend temporarily troubled debt restructuring accounting under ASC Subtopic 310-40 in certain circumstances (“section 4013”). To be eligible under section 4013, a loan modification must be (1) related to COVID-19; (2) executed on a loan that was not more than 30 days past due as of December 31, 2019; and (3) executed between March 1, 2020, and the earlier of (A) 60 days after the date of termination of the National Emergency or (B) January 1, 2022. In response to this section of the CARES Act, the federal banking agencies issued a revised interagency statement on April 7, 2020 that, in consultation with the Financial Accounting Standards Board, confirmed that for loans not subject to section 4013, short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not troubled debt restructurings under ASC Subtopic 310-40. This includes short-term (e.g., up to six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. As of December 31, 2020, eight loans totaling $33.0 million were modified, related to COVID-19, which were not considered troubled debt restructurings. The following table presents loans restructured as TDRs as of December 31, 2020, December 31, 2019 and December 31, 2018. As of December 31, 2020 Number of Contracts Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment Specific Reserves Allocated (Dollars in thousands) Commercial and industrial 1 $ 10,886 $ 10,886 $ - Agricultural 1 469 469 - Commercial real estate - other 1 1,622 1,622 - Total 3 $ 12,977 $ 12,977 $ - As of December 31, 2019 Number of Contracts Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment Specific Reserves Allocated (Dollars in thousands) Commercial real estate - other 1 $ 1,809 $ 1,809 $ 26 Agricultural 2 912 912 - Total 3 $ 2,721 $ 2,721 $ 26 As of December 31, 2018 Number of Contracts Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment Specific Reserves Allocated (Dollars in thousands) Commercial & industrial 1 $ 501 $ 501 $ - Total 1 $ 501 $ 501 $ - There were no payment defaults with respect to loans modified as TDRs as of December 31, 2020, 2019, and 2018. Impairment analyses are prepared on TDRs in conjunction with the normal allowance process. TDRs restructured during the years ended December 31, 2020, 2019 and 2018 required $0, $26,000 and $0 in specific reserves, respectively. 45 Table of Contents The following table presents total TDRs, both in accrual and nonaccrual status as of the periods indicated: As of December 31, 2020 As of December 31, 2019 As of December 31, 2018 Number of Contracts Amount Number of Contracts Amount Number of Contracts Amount (Dollars in thousands) Accrual - $ - 2 $ 912 - $ - Nonaccrual 3 12,977 1 1,809 1 501 Total 3 $ 12,977 3 $ 2,721 1 $ 501 Deposits We gather deposits primarily through our seven branch locations and online though our website. We offer a variety of deposit products including demand deposit accounts and interest-bearing products, such as savings accounts and certificates of deposit. We put continued effort into gathering noninterest-bearing demand deposit accounts through loan production cross-selling, customer referrals, marketing efforts and various involvement with community networks. Some of our interest-bearing deposits were obtained through brokered transactions. We participate in the CDARS program, where customer funds are placed into multiple certificates of deposit, each in an amount under the standard FDIC insurance maximum of $250,000, and placed at a network of banks across the United States. Total deposits as of December 31, 2020, 2019 and 2018 were $905.5 million, $757.5 million and $675.9 million, respectively. The increase was primarily due to organic deposit growth. The following table sets forth deposit balances by certain categories as of the dates indicated and the percentage of each deposit category to total deposits. As of December 31, 2020 2019 2018 Amount Percentage of Total Amount Percentage of Total Amount Percentage of Total (Dollars in thousands) Noninterest-bearing demand $ 246,569 27.2 % $ 219,221 29.0 % $ 201,159 29.8 % Interest-bearing: NOW deposits 232,676 25.6 112,420 14.8 91,896 13.6 Money market 160,108 17.7 150,554 19.9 118,150 17.5 Savings deposits 54,008 6.0 72,750 9.6 69,548 10.3 Time deposits (more than $100,000) 187,964 20.8 176,998 23.3 167,304 24.8 Time deposits ($100,000 or less) 24,189 2.7 25,540 3.4 27,846 4.1 Total interest-bearing 658,945 72.8 538,262 71.0 474,744 70.2 Total deposits $ 905,514 100.0 % $ 757,483 100.0 % 675,903 100.0 % The following table summarizes our average deposit balances and weighted average rates for the years ended December 31, 2020, 2019 and 2018: 46 Table of Contents As of the Year Ended December 31, 2020 2019 2018 Average Balance Weighted Average Rate Average Balance Weighted Average Rate Average Balance Weighted Average Rate (Dollars in thousands) Noninterest-bearing demand $ 256,431 0.00 % $ 192,562 0.00 % $ 183,750 0.00 % Interest-bearing: NOW 163,989 0.78 95,694 1.83 71,384 1.56 Money market 154,724 0.72 132,265 1.83 90,230 1.65 Savings 58,806 0.56 67,617 1.30 79,267 1.23 Time 207,442 1.65 208,375 2.14 220,023 1.55 Total interest-bearing 584,961 1.05 503,951 1.89 460,904 1.52 Total deposits $ 841,392 0.73 % $ 696,513 1.37 % $ 644,654 1.08 % The following tables set forth the maturity of time deposits as of the dates indicated below: As of December 31, 2020 Maturity Within: (Dollars in thousands) Three Months Three to Six Months Six to 12 Months After 12 Months Total (Dollars in thousands) Time deposits ($100,000 or less) $ 6,537 $ 4,923 $ 8,234 $ 7,295 $ 26,989 Time deposits (more than $100,000) 34,312 28,817 81,945 40,090 185,164 Total time deposits $ 40,849 $ 33,740 $ 90,179 $ 47,385 $ 212,153 As of December 31, 2019 Maturity Within: (Dollars in thousands) Three Months Three to Six Months Six to 12 Months After 12 Months Total (Dollars in thousands) Time deposits ($100,000 or less) $ 6,998 $ 5,024 $ 8,387 $ 8,231 $ 28,640 Time deposits (more than $100,000) 52,048 34,126 49,700 38,024 173,898 Total time deposits $ 59,046 $ 39,150 $ 58,087 $ 46,255 $ 202,538 As of December 31, 2018 Maturity Within: Three Months Three to Six Months Six to 12 Months After 12 Months Total (Dollars in thousands) Time deposits ($100,000 or less) $ 6,229 $ 4,791 $ 10,342 $ 6,484 $ 27,846 Time deposits (more than $100,000) 33,308 41,193 71,827 20,976 167,304 Total time deposits $ 39,537 $ 45,984 $ 82,169 $ 27,460 $ 195,150 Liquidity Liquidity refers to the measure of our ability to meet the cash flow requirements of depositors and borrowers, while at the same time meeting our operating, capital and strategic cash flow needs, all at a reasonable cost. We continuously monitor our liquidity position to ensure that assets and liabilities are managed in a manner that will meet all short-term and long-term cash requirements. We manage our liquidity position to meet the daily cash flow needs of customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of our shareholders. 47 Table of Contents Our liquidity position is supported by management of liquid assets and access to alternative sources of funds. Our liquid assets include cash, interest-bearing deposits in correspondent banks and fed funds sold. Other available sources of liquidity include wholesale deposits and borrowings from correspondent banks and FHLB advances. Our short-term and long-term liquidity requirements are primarily met through cash flow from operations, redeployment of prepaying and maturing balances in our loan portfolios, and increases in customer deposits. Other alternative sources of funds will supplement these primary sources to the extent necessary to meet additional liquidity requirements on either a short-term or long-term basis. As of December 31, 2020, we had no unsecured fed funds lines with correspondent depository institutions with no amounts advanced. In addition, based on the values of loans pledged as collateral, we had borrowing availability with the FHLB of $64.8 million as of December 31, 2020 and $71.7 million as of December 31, 2019. Capital Requirements The Bank is subject to various regulatory capital requirements administered by the federal and state banking regulators. Failure to meet regulatory capital requirements may result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for “prompt corrective action” (described below), the Bank 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. The capital amounts and classifications are subject to qualitative judgments by the federal banking regulators about components, risk weightings and other factors. Qualitative measures established by regulation to ensure capital adequacy required the Bank to maintain minimum amounts and ratios of Common Equity Tier 1, or CET1, capital, Tier 1 capital and total capital to risk-weighted assets and of Tier 1 capital to average consolidated assets, referred to as the “leverage ratio.” For further information, see “Supervision and Regulation – Regulatory Capital Requirements” and “Supervision and Regulation – Prompt Corrective Action Framework.” In the wake of the global financial crisis of 2008 and 2009, the role of capital has become fundamentally more important, as banking regulators have concluded that the amount and quality of capital held by banking organizations was insufficient to absorb losses during periods of severely distressed economic conditions. The Dodd-Frank Act and banking regulations promulgated by the U.S. federal banking regulators to implement Basel III have established strengthened capital standards for banks and bank holding companies and require more capital to be held in the form of common stock. These provisions, which generally became applicable to the Bank on January 1, 2015, impose meaningfully more stringent regulatory capital requirements than those applicable to the Bank prior to that date. In addition, the Basel III regulations implement a concept known as the “capital conservation buffer.” In general, banks, bank holding companies with more than $3.0 billion in assets and bank holding companies with publicly-traded equity are required to hold a buffer of CET1 capital equal to 2.5% of risk-weighted assets over each minimum capital ratio by January 1, 2019 in order to avoid being subject to limits on capital distributions (e.g., dividends, stock buybacks, etc.) and certain discretionary bonus payments to executive officers. For community banks, such as us, the capital conservation buffer requirement commenced on January 1, 2016, with a gradual phase-in. Full compliance with the capital conservation buffer was required by January 1, 2019. As of December 31, 2020, the FDIC categorized the Bank as “well-capitalized” under the prompt corrective action framework. There have been no conditions or events since December 31, 2020 that management believes would change this classification. 48 Table of Contents The table below also summarizes the capital requirements applicable to the Bank in order to be considered “well-capitalized” from a regulatory perspective, as well as the Bank’s capital ratios as of December 31, 2020, 2019 and 2018. The Bank exceeded all regulatory capital requirements under Basel III and the Bank was considered to be “well-capitalized” as of the dates reflected in the tables below. Actual With Capital Conservation Buffer Minimum To be Considered “Well-Capitalized” Amount Ratio Amount Ratio Amount Ratio (Dollars in thousands) As of December 31, 2020 : Total capital to risk-weighted assets Company $ 115,375 14.73 % $ 82,216 10.500 % N/A N/A Bank 115,335 14.75 82,114 10.500 78,204 10.00 Tier 1 capital to risk-weighted assets Company 105,736 13.50 66,556 8.500 N/A N/A Bank 105,696 13.51 66,473 8.500 62,563 8.00 CET 1 capital to risk-weighted assets Company 105,736 13.50 54,811 7.000 N/A N/A Bank 105,696 13.51 54,743 7.000 50,832 6.50 Tier 1 leverage ratio Company 105,736 10.78 N/A N/A N/A N/A Bank 105,696 10.78 N/A N/A 49,041 5.00 Actual With Capital Conservation Buffer Minimum To be Considered “Well-Capitalized” Amount Ratio Amount Ratio Amount Ratio (Dollars in thousands) As of December 31, 2019 : Total capital to risk-weighted assets Company $ 105,137 15.25 % $ 72,393 10.500 % N/A N/A Bank 106,148 15.42 72,287 10.500 68,845 10.00 Tier 1 capital to risk-weighted assets Company 97,291 14.11 58,604 8.500 N/A N/A Bank 98,302 14.28 58,518 8.500 55,076 8.00 CET 1 capital to risk-weighted assets Company 97,291 14.11 48,262 7.000 N/A N/A Bank 98,302 14.28 48,192 7.000 44,749 6.50 Tier 1 leverage ratio Company 97,291 11.53 N/A N/A N/A N/A Bank 98,302 11.65 N/A N/A 42,241 5.00 49 Table of Contents Actual With Capital Conservation Buffer Minimum To be Considered “Well-Capitalized” Amount Ratio Amount Ratio Amount Ratio (Dollars in thousands) As of December 31, 2018: Total capital to risk-weighted assets Company $ 92,693 15.86 % $ 57,709 9.875 % N/A N/A Bank 93,704 16.03 57,709 9.875 58,439 10.00 Tier 1 capital to risk-weighted assets Company 85,382 14.61 46,021 7.875 N/A N/A Bank 86,393 14.78 46,021 7.875 46,751 8.00 CET 1 capital to risk-weighted assets Company 85,382 14.61 37,255 6.375 N/A N/A Bank 86,393 14.78 37,255 6.375 37,985 6.50 Tier 1 leverage ratio Company 85,382 11.13 N/A N/A N/A N/A Bank 86,393 11.26 N/A N/A 38,355 5.00 Shareholders’ equity provides a source of permanent funding, allows for future growth and provides a cushion to withstand unforeseen adverse developments. Total shareholders’ equity increased to $107.3 million as of December 31, 2020, compared to $100.1 million as of December 31, 2019 and $88.5 million as of December 31, 2018. The increases were driven by retained capital from net income during the periods. Contractual Obligations The following tables contain supplemental information regarding our total contractual obligations as of December 31, 2020: Payments Due as of December 31, 2020 Within One Year One to Three Years Three to Five Years After Five Years Total (Dollars in thousands) Deposits without a stated maturity $ 693,361 $ - $ - $ - $ 693,361 Time deposits 164,753 46,563 822 - 212,138 Borrowings - - - - - Operating lease commitments 470 390 49 - 909 Total contractual obligations $ 858,599 $ 46,953 $ 871 $ - $ 906,423 We believe that we will be able to meet our contractual obligations as they come due through the maintenance of adequate cash levels. We expect to maintain adequate cash levels through profitability, loan repayment and maturity activity and continued deposit gathering activities. We have in place various borrowing mechanisms for both short-term and long-term liquidity needs. Off-Balance Sheet Arrangements We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The contractual or notional amounts of those instruments reflect the extent of involvement we have in particular classes of financial instruments. To control this credit risk, the Company uses the same underwriting standards as it uses for loans recorded on the balance sheet. 50 Table of Contents Loan commitments are agreements to lend to a customer, as long as there is no violation of any condition established in the contract. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of the customer to a third party. They are intended to be disbursed, subject to certain conditions, upon request of the borrower. The following table summarizes commitments as of the dates presented. As of December 31, 2020 2019 2018 (Dollars in thousands) Commitments to extend credit $ 206,520 $ 191,459 $ 135,015 Standby letters of credit 2,366 3,338 1,078 Total $ 208,886 $ 194,797 $ 136,093 Critical Accounting Policies and Estimates Our accounting and reporting policies conform to GAAP and conform to general practices within the industry in which we operate. To prepare financial statements in conformity with GAAP, management makes estimates, assumptions and judgments based on available information. These estimates, assumptions and judgments affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements and, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the financial statement. In particular, management has identified several accounting policies that, due to the estimates, assumptions and judgments inherent in those policies, are critical in understanding our financial statements. The JOBS Act permits us an extended transition period for complying with new or revised accounting standards affecting public companies. We have elected to take advantage of this extended transition period, which means that the financial statements included in this report, as well as any financial statements that we file in the future, will not be subject to all new or revised accounting standards generally applicable to public companies for the transition period for so long as we remain an emerging growth company or until we affirmatively and irrevocably opt out of the extended transition period under the JOBS Act. The following is a discussion of the critical accounting policies and significant estimates that we believe require us to make the most complex or subjective decisions or assessments. Additional information about these policies can be found in Note 1 of the Company’s consolidated financial statements as of December 31, 2020. Allowance for Loan and Lease Losses The allowance is based on management’s estimate of probable losses inherent in the loan portfolio. In the opinion of management, the allowance is adequate to absorb estimated losses in the portfolio as of each balance sheet date. While management uses available information to analyze losses on loans, future additions to the allowance may be necessary based on changes in economic conditions and changes in the composition of the loan portfolio. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance. In analyzing the adequacy of the allowance, a comprehensive loan grading system to determine risk potential in loans is utilized together with the results of internal credit reviews. To determine the adequacy of the allowance, the loan portfolio is broken into segments based on loan type. Historical loss experience factors by segment, adjusted for changes in trends and conditions, are used to determine an indicated allowance for each portfolio segment. These factors are evaluated and updated based on the composition of the specific loan segment. Other considerations include volumes and trends of delinquencies, nonaccrual loans, levels of bankruptcies, criticized and classified loan trends, expected losses on real estate secured loans, new credit products and policies, economic conditions, concentrations of credit risk and the experience and abilities of our lending personnel. In addition to the segment evaluations, impaired loans with a balance of $250,000 or more are individually evaluated based on facts and circumstances of the loan to determine if a specific allowance amount may be necessary. Specific allowances may also be established for loans whose outstanding balances are below the $250,000 threshold when it is determined that the risk associated with the loan differs significantly from the risk factor amounts established for its loan segment. 51 Table of Contents Goodwill and Intangibles Goodwill from an acquisition is the value attributable to unidentifiable intangible elements acquired. At a minimum, annual evaluation of the value of goodwill is required. Management evaluated the carrying value of the Company’s goodwill as of December 31, 2020, 2019 and 2018, and determined that no impairment existed. An entity may assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Factors assessed include all relevant events and circumstances including macroeconomic conditions, industry and market conditions, cost factors that have a negative effect on earnings and cash flows, overall financial performance, other relevant entity or reporting unit specific events and, if applicable, a sustained decrease in share price. If after assessing the totality of events or circumstances, such as those described above, an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the entity is to perform a two-step impairment test. The first step of the impairment test compares the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of a reporting unit exceeds its fair value, the second step of the impairment test is to be performed to measure the amount of impairment loss, if any, when it is more likely than not that goodwill impairment exists. Other intangible assets consist of core deposit intangible assets and are amortized on a straight-line basis based on the estimated useful life of 10 years. Such assets are periodically evaluated as to the recoverability of their carrying values. Income Taxes The Company files a consolidated income tax return. Deferred taxes are recognized under the balance sheet method based upon the future tax consequences of temporary differences between the carrying amounts and tax basis of assets and liabilities, using the tax rates expected to apply to taxable income in the periods when the related temporary differences are expected to be realized. The amount of accrued current and deferred income taxes is based on estimates of taxes due or receivable from taxing authorities either currently or in the future. Changes in these accruals are reported as tax expense, and involve estimates of the various components included in determining taxable income, tax credits, other taxes and temporary differences. Changes periodically occur in the estimates due to changes in tax rates, tax laws and regulations and implementation of new tax planning strategies. The process of determining the accruals for income taxes necessarily involves the exercise of considerable judgment and consideration of numerous subjective factors. Management performs an analysis of the Company’s tax positions annually and believes it is more likely than not that all of its tax positions will be utilized in future years. 52 Table of Contents Fair Value of Financial Instruments ASC Topic 820, Fair Value Measurement, defines fair value as the price that would be received to sell a financial asset or paid to transfer a financial liability in an orderly transaction between market participants at the measurement date. The degree of management judgment involved in determining the fair value of assets and liabilities is dependent upon the availability of quoted market prices or observable market parameters. For financial instruments that trade actively and have quoted market prices or observable market parameters, there is minimal subjectivity involved in measuring fair value. When observable market prices and parameters are not available, management judgment is necessary to estimate fair value. In addition, changes in market conditions may reduce the availability of quoted prices or the observable date.