Bankwell Financial Group, Inc. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations This section presents management’s perspective on our financial condition and results of operations. The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes contained elsewhere in this annual report. To the extent that this discussion describes prior performance, the descriptions relate only to the periods listed, which may not be indicative of future financial outcomes. In addition to historical information, this discussion contains forward looking statements that involve risks, uncertainties and assumptions that could cause results to differ materially from management’s expectations. Factors that could cause such differences are discussed in the sections titled “Cautionary Note Regarding Forward-Looking Statements” and “Risk Factors”. We assume no obligation to update any of these forward-looking statements. General Bankwell Financial Group, Inc. (the "Parent Corporation") is a bank holding company headquartered in New Canaan, Connecticut. The Parent Corporation offers a broad range of financial services through its banking subsidiary, Bankwell Bank (the "Bank" and, collectively with the Parent Corporation and the Parent Corporation's subsidiaries, "we", "our", "us", or the "Company"). The Bank is a Connecticut state chartered commercial bank, founded in 2002, whose deposits are insured under the Deposit Insurance Fund administered by the Federal Deposit Insurance Corporation (“FDIC”). The Bank provides a full range of banking services to commercial and consumer customers, primarily concentrated in the New York metropolitan area and throughout Connecticut, with the majority of the Company's loans in Fairfield and New Haven Counties, Connecticut, with branch locations in New Canaan, Stamford, Fairfield, Wilton, Westport, Darien, Norwalk, and Hamden, Connecticut. The following discussion and analysis presents our results of operations and financial condition on a consolidated basis. However, because we conduct all of our material business operations through the Bank, the discussion and analysis relates to activities primarily conducted at the Bank. We generate most of our revenue from interest on loans and investments and fee-based revenues. Our primary source of funding for our loans is deposits. Our largest expenses are interest on these deposits and salaries and related employee benefits. We measure our performance primarily through our net interest margin, efficiency ratio, ratio of allowance for loan losses to total loans, return on average assets and return on average equity, among other metrics, while maintaining appropriate regulatory leverage and risk-based capital ratios. Executive Overview We are focused on being the “Hometown” bank and the banking provider of choice in our attractive market area, and to serve as a locally based alternative to our larger competitors. We aim to do this through: • Responsive, customer-centric products and services and a community focus; • Organic growth and strategic acquisitions when market opportunities present themselves; • Utilization of efficient and scalable infrastructure; and • Disciplined focus on risk management. Impact of COVID-19 The COVID-19 pandemic has resulted in, and is likely to continue to result in, significant economic disruption affecting our business and the clients we serve. A significant degree of uncertainty still exists concerning the duration and magnitude of the COVID-19 pandemic. Given the ongoing and dynamic nature of the circumstances, it is difficult to predict the full impact of the COVID-19 pandemic on our business. The extent of such impact will depend on future developments, which are highly uncertain, including when the coronavirus can be controlled and abated. For the year ended December 31, 2020, we increased the provision for loan losses and added liquidity to the balance sheet due to the impact of COVID-19, both of which adversely impacted our earnings and performance metrics. The primary measures we use to evaluate and manage our financial results are set forth in the table below. Although we believe these measures are meaningful in evaluating our results and financial condition, they may not be directly comparable to similar measures used by other financial services companies and may not provide an appropriate basis to compare our results or financial condition to the results or financial condition of our competitors. The following table sets forth the key financial measures we use to evaluate the success of our business and our financial position and operating performance. 35 Key Financial Measures Key Financial Measures (a) At or For the Years Ended December 31, 2020 2019 2018 (Dollars in thousands, except per share data) Selected balance sheet measures: Total assets $ 2,253,747 $ 1,882,182 $ 1,873,665 Gross portfolio loans 1,625,627 1,604,484 1,604,726 Deposits 1,827,316 1,491,903 1,502,244 FHLB borrowings 175,000 150,000 160,000 Subordinated debt 25,258 25,207 25,155 Total equity 176,602 182,397 174,196 Selected statement of income measures: Total revenue (c) 57,719 59,005 60,226 Net interest income before provision for loan losses 54,835 53,761 56,326 Income before income tax expense 7,301 22,942 21,153 Net income 5,904 18,216 17,433 Basic earnings per share $ 0.75 $ 2.32 $ 2.23 Diluted earnings per share $ 0.75 $ 2.31 $ 2.21 Key Financial Measures (a) At or For the Years Ended December 31, 2020 2019 2018 Other financial measures and ratios: Return on average assets 0.28 % 0.97 % 0.94 % Return on average common shareholders’ equity (c) 3.35 % 10.20 % 10.19 % Net interest margin 2.77 % 3.03 % 3.18 % Efficiency ratio (c) 73.9 % 60.2 % 59.2 % Tangible book value per share (end of period) (c)(d) $ 22.43 $ 23.15 $ 22.06 Net charge-offs to average loans (b) 0.01 % 0.15 % 0.44 % Nonperforming assets to total assets (e) 1.48 % 0.56 % 0.75 % Allowance for loan losses to nonperforming loans 62.87 % 127.59 % 109.80 % Allowance for loan losses to total loans (b) 1.29 % 0.84 % 0.96 % (a) We derived the selected balance sheet measures as of December 31, 2020 and 2019 and the selected statement of income measures for the years ended December 31, 2020, 2019 and 2018 from our audited consolidated financial statements included elsewhere in this annual report. Average balances have been computed using daily averages. Our historical results may not be indicative of our results for any future period. (b) Calculated using the principal amounts outstanding on loans. (c) This measure is not a measure recognized under GAAP and is therefore considered to be a non-GAAP financial measure. See “Non-GAAP Financial Measures” for a description of this measure and a reconciliation of this measure to its most directly comparable GAAP measure. (d) Excludes unvested restricted stock awards. (e) Nonperforming assets consist of nonperforming loans and other real estate owned. 36 Critical Accounting Policies and Estimates The discussion and analysis of our results of operations and financial condition are based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires us to make significant estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results could differ from our current estimates, as a result of changing conditions and future events. We believe that accounting estimates related to the measurement of the allowance for loan losses, the valuation of derivative instruments, investment securities and deferred income taxes, and the evaluation of investment securities for other than temporary impairment are particularly critical and susceptible to significant near-term change. Allowance for Loan Losses Determining an appropriate level of allowance for loan losses involves a high degree of judgment. We use a methodology to systematically measure the amount of estimated loan loss exposure inherent in the loan portfolio for purposes of establishing a sufficient allowance for loan losses. The methodology includes elements for specific reserves on impaired loans and loss allocations for non-impaired loans. Loss allocations are identified for individual loans deemed to be impaired in accordance with GAAP. Impaired loans are loans for which it is probable that the Bank will not be able to collect all amounts due according to the contractual terms of the loan agreements, including nonaccrual loans and all loans restructured in a troubled debt restructuring. Impaired loans do not include large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment. Impairment is measured on a discounted cash flow method based upon the loan’s contractual effective interest rate, or at the loan’s observable market price, or if the loan is collateral dependent, at the fair value of the collateral less costs to sell. For collateral dependent loans, management may adjust appraised values to reflect estimated market value declines or apply other discounts to appraised values for unobservable factors resulting from its knowledge of circumstances associated with the property. Loss allocations for non-impaired loans are determined by portfolio segment and are based on the Bank’s and peer banks’ historical loss experiences over an economic cycle adjusted for qualitative factors. Qualitative factors include, but are not limited to, lending policies and procedures, nature and volume of the portfolio, concentrations of credit, lending management and staff, volume and severity of problem loans, quality of review and rating systems, value of underlying collateral, current economic conditions, and competitive and regulatory issues. We analyze historical loss experience over periods deemed to be relevant to the inherent risk of loss in loan portfolios as of the balance sheet date. Loss allocations for non-impaired loans are based on an internal rating system and the application of loss allocation factors. The loan rating system is described under the caption “Credit quality indicators” in Note 5 of the Notes to Consolidated Financial Statements. The loan rating system and the related loss allocation factors take into consideration parameters including the borrower’s financial condition, the borrower’s performance with respect to loan terms, and the adequacy of collateral. The loss allocation factors also take into account general and regional economic statistics, trends, and portfolio characteristics such as the age of the portfolio and the Bank’s experience with a particular loan product. We periodically reassess and adjust the loss allocation factors used in the assignment of loss factors that we believe are not adequately presented in historical loss experience including trends in real estate values, changes in unemployment levels and increases in delinquency levels to appropriately reflect our analysis of migratory loss experience. Because the methodology is partly based upon peer bank data and trends, current economic data as well as management’s judgment, factors may arise that result in different estimations. Adversely different conditions or assumptions could lead to increases in the allowance. In addition, various regulatory agencies periodically review the allowance for loans losses. Such agencies may require additions to the allowance based on their judgments about information available to them at the time of their examination. As of December 31, 2020, management believes that the allowance is adequate and consistent with asset quality and delinquency indicators. Derivative Instrument Valuation The Company enters into interest rate swap agreements as part of the Company’s interest rate risk management strategy. Management applies the hedge accounting provisions of Accounting Standards Codification (“ASC”) Topic 815, and formally documents at inception all relationships between hedging instruments and hedged items, as well as its risk management objectives and strategies for undertaking the various hedges. Additionally, the Company assesses whether the derivative used in its hedging transaction is expected to be and has been highly effective in offsetting changes in the fair value or cash flows of the hedged item. The Company discontinues hedge accounting when it is determined that a derivative is not expected to be or has ceased to be highly effective as a hedge, and then reflects changes in fair value of the derivative in earnings after termination of the hedge relationship. 37 The Company has characterized all of its interest rate swaps that qualify under ASC Topic 815 hedge accounting as cash flow hedges. Cash flow hedges are used to minimize the variability in cash flows of assets or liabilities, or forecasted transactions caused by fluctuations in the contractually specified interest rates, and are recorded at fair value in other assets within the consolidated balance sheet. Changes in the fair value of these cash flow hedges are initially recorded in accumulated other comprehensive income and subsequently reclassified into earnings when the forecasted transaction affects earnings. The Company also has derivatives not designated as hedges. Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain loan customers. The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting derivatives that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate derivatives associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting derivatives are recognized directly in earnings. Investment Securities Valuation Fair values of the Company’s investment securities are based on quoted market prices or dealer quotes, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. The Company’s private placement municipal housing authority bonds, classified as held to maturity, have no available quoted market price. The fair value for these securities is estimated using a discounted cash flow model. Due to the judgments and uncertainties involved in the estimation process, the estimates could result in materially different results under different assumptions and conditions. Evaluation of Investment Securities for Other Than Temporary Impairment The Company evaluates investment securities within the Company’s available for sale and held to maturity portfolios for other-than-temporary impairment (“OTTI”), at least quarterly. If the fair value of a debt security is below the amortized cost basis of the security, OTTI is required to be recognized if any of the following are met: (1) the Company intends to sell the security; (2) it is “more likely than not” that the Company will be required to sell the security before recovery of its amortized cost basis; or (3) for debt securities, the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. For all impaired debt securities that are intended for sale, or more likely than not will be required to sell, the full amount of the loss is recognized as OTTI through earnings. Credit related OTTI for all other impaired debt securities is recognized through earnings. Non-credit related OTTI for such debt securities is recognized in other comprehensive income, net of applicable taxes. Should actual factors and conditions differ materially from those expected by management, the actual realization of gains or losses on investment securities could differ materially from the amounts recorded in the financial statements. Deferred Income Taxes In accordance with ASC Topic 740, “ Income Taxes ,” certain aspects of accounting for income taxes require significant management judgment, including assessing the realizability of Deferred Tax Assets (DTAs). Such judgments are subjective and involve estimates and assumptions about matters that are inherently uncertain. Should actual factors and conditions differ materially from those used by management, the actual realization of DTAs could differ materially from the amounts recorded in the Consolidated Financial Statements and the accompanying Notes thereto. DTAs generally represent items for which a benefit has been recognized for financial accounting purposes that cannot be realized for tax purposes until a future period. The realization of DTAs depends upon future sources of taxable income. Valuation allowances are established for those DTAs determined not likely to be realized based on management’s judgment. Earnings and Performance Overview 2020 Earnings Overview Our net income for the year ended December 31, 2020 was $5.9 million, a decrease of $12.3 million, or 67.6%, compared to the year ended December 31, 2019. Diluted earnings per share was $0.75 for the year ended December 31, 2020, compared to diluted earnings per share of $2.31 for the year ended December 31, 2019. Our returns on average shareholders' equity and average assets for the year ended December 31, 2020, were 3.35% and 0.28%, respectively, compared to 10.20% and 0.97%, respectively for the year ended December 31, 2019. The decrease in net income for 2020 compared to 2019 was impacted by a $3.9 million one-time charge for office consolidation, vendor contract termination and employee severance costs recognized in the fourth quarter of 2020. In addition, the decrease in net income was also due to an increase in the provision for loan losses due to the COVID-19 pandemic. The 38 provision for loan losses totaled $7.6 million for the year ended December 31, 2020, consisting of COVID-19 related reserves of $9.0 million, partially offset due to changes in portfolio mix and growth. Net interest income for the year ended December 31, 2020 was $54.8 million, an increase of $1.1 million compared to the year ended December 31, 2019. Our net interest margin decreased 26 basis points to 2.77% for the year ended December 31, 2020 compared to the year ended December 31, 2019 reflecting excess liquidity resulting from successful commercial core deposit gathering efforts as well as a temporary increase in other deposits to expand on-balance sheet liquidity during the COVID-19 pandemic. 2019 Earnings Overview Reference the 2019 Form 10-K for discussion regarding financial performance and results for the year ended December 31, 2019 compared to the year ended December 31, 2018. Results of Operations Net Interest Income Net interest income is the difference between interest earned on loans and securities and interest paid on deposits and other borrowings, and is the primary source of our operating income. Net interest income is affected by the level of interest rates, changes in interest rates and changes in the amount and composition of interest-earning assets and interest-bearing liabilities. Included in interest income are certain loan fees, such as deferred origination fees and late charges. We convert tax-exempt income to a FTE basis using the statutory federal income tax rate adjusted for applicable state income taxes net of the related federal tax benefit. The average balances are principally daily averages. Interest income on loans includes the effect of deferred loan fees and costs accounted for as yield adjustments. Premium amortization and discount accretion are included in the respective interest income and interest expense amounts. Year ended December 31, 2020 compared to year ended December 31, 2019 FTE net interest income for the years ended December 31, 2020 and 2019 was $55.0 million and $54.0 million, respectively. Net interest income increased due to lower rates on interest bearing deposits. FTE basis interest income for the year ended December 31, 2020 decreased $5.5 million, or 7%, to $77.7 million compared to FTE basis interest income for the year ended December 31, 2019 due primarily to lower loan yields as loans were re-priced in the current low interest rate environment. Average interest earning assets were $2.0 billion for the year ended December 31, 2020, increasing by $206.4 million, or 11.6%, from the year ended December 31, 2019 due to an increase in cash and cash equivalents in part to maintain a higher level of liquidity during the COVID-19 pandemic. The average balance of total loans increased $43.7 million, or 2.8%. The total average balance of securities for the year ended December 31, 2020 decreased by $13.4 million, or 12%, from the year ended December 31, 2019. The total yield in earnings assets decreased to 3.85% at December 31, 2020, compared to 4.61% at December 31, 2019. The decrease in yield was primarily driven by a significant increase in cash and cash equivalents and lower yields on cash and cash equivalents and loans. Interest expense for the year ended December 31, 2020 decreased by $6.5 million, or 22%, compared to interest expense for 2019 due to a decrease in rates on interest bearing deposits. The weighted average cost of borrowed money decreased by 22 basis points to 2.31%. Average interest bearing liabilities for the year ended December 31, 2020 increased by $177.3 million, or 12%, from the year ended December 31, 2019, primarily due to higher average balances in money market and time deposits. 39 Distribution of Assets, Liabilities and Stockholders’ Equity; Interest Rates and Interest Differential The following table below presents the average balances and yields earned on interest-earning assets and average balances and weighted average rates paid on our funding liabilities for the years ended December 31, 2020, 2019 and 2018. Years Ended December 31, 2020 2019 2018 Average Balance Interest Yield/ Rate (5) Average Balance Interest Yield/ Rate (5) Average Balance Interest Yield/ Rate (5) (Dollars in thousands) Assets: Cash and fed funds sold $ 261,689 $ 585 0.22 % $ 85,678 $ 1,859 2.17 % $ 77,923 $ 1,428 1.84 % Securities (1) 98,938 3,103 3.14 112,336 3,526 3.14 118,311 3,686 3.12 Loans: Commercial real estate 1,095,367 51,218 4.60 1,067,290 50,818 4.70 1,014,255 47,967 4.66 Residential real estate 129,585 4,645 3.58 165,384 6,367 3.85 189,121 7,016 3.71 Construction (2) 97,230 4,262 4.31 85,591 4,538 5.23 90,773 4,667 5.07 Commercial business 295,662 13,530 4.50 255,779 15,599 6.01 282,425 15,037 5.25 Consumer 121 10 8.00 258 17 6.70 481 28 5.88 Total loans 1,617,965 73,665 4.48 1,574,302 77,339 4.85 1,577,055 74,715 4.67 Federal Home Loan Bank stock 7,625 346 4.53 7,502 473 6.31 9,177 517 5.63 Total earning assets 1,986,217 $ 77,699 3.85 % 1,779,818 $ 83,197 4.61 % 1,782,466 $ 80,346 4.45 % Other assets 125,261 92,663 68,002 Total assets $ 2,111,478 $ 1,872,481 $ 1,850,468 Liabilities and shareholders’ equity: Interest bearing liabilities: NOW $ 80,805 $ 141 0.17 % $ 62,254 $ 128 0.21 % $ 60,410 $ 157 0.26 % Money market 516,527 4,071 0.79 439,867 7,139 1.62 482,886 6,431 1.33 Savings 169,763 1,368 0.81 177,854 2,968 1.67 124,214 1,649 1.33 Time 712,461 12,600 1.77 637,515 14,463 2.27 619,448 10,714 1.73 Total interest bearing deposits 1,479,556 18,180 1.23 1,317,490 24,698 1.87 1,286,958 18,951 1.47 Borrowed money 190,463 4,472 2.31 175,267 4,489 2.53 213,546 4,787 2.21 Total interest bearing liabilities 1,670,019 $ 22,652 1.36 % 1,492,757 $ 29,187 1.96 % 1,500,504 $ 23,738 1.58 % Noninterest bearing deposits 215,073 172,192 166,566 Other liabilities 49,897 29,022 12,374 Total liabilities 1,934,989 1,693,971 1,679,444 Shareholders’ equity 176,489 178,510 171,024 Total liabilities and shareholders’ equity $ 2,111,478 $ 1,872,481 $ 1,850,468 Net interest income (3) $ 55,047 $ 54,010 $ 56,608 Interest rate spread 2.49 % 2.65 % 2.87 % Net interest margin (4) 2.77 % 3.03 % 3.18 % (1) Average balances and yields for securities are based on amortized cost. (2) Includes commercial and residential real estate construction loans. (3) The adjustment for securities and loans taxable equivalency was $212 thousand, $249 thousand and $282 thousand, respectively, for the years ended December 31, 2020, 2019 and 2018. Tax exempt income was converted to a fully taxable equivalent basis at a 20 percent tax rate for 2020, 2019 and 2018. (4) Net interest income as a percentage of total earning assets. (5) Yields are calculated using the contractual day count convention for each respective product type. 40 Effect of changes in interest rates and volume of average earning assets and average interest-bearing liabilities The following table shows the extent to which changes in interest rates and changes in the volume of average earning assets and average interest-bearing liabilities have affected net interest income. For each category of earning assets and interest-bearing liabilities, information is provided relating to: changes in volume (changes in average balances multiplied by the prior year’s average interest rates); changes in rates (changes in average interest rates multiplied by the prior year’s average balances); and the total change. Changes attributable to both volume and rate have been allocated proportionately based on the relationship of the absolute dollar amount of change in each. Year Ended December 31, 2020 vs 2019 Increase (Decrease) Year Ended December 31, 2019 vs 2018 Increase (Decrease) Volume Rate Total Volume Rate Total (In thousands) Interest and dividend income: Cash and fed funds sold $ 1,435 $ (2,709) $ (1,274) $ 152 $ 279 $ 431 Securities (420) (3) (423) (187) 27 (160) Loans: Commercial real estate 1,321 (921) 400 2,523 328 2,851 Residential real estate (1,306) (416) (1,722) (906) 257 (649) Construction 570 (846) (276) (272) 143 (129) Commercial business 2,201 (4,270) (2,069) (1,498) 2,060 562 Consumer (10) 3 (7) (15) 4 (11) Total loans 2,776 (6,450) (3,674) (168) 2,792 2,624 Federal Home Loan Bank stock 8 (135) (127) (101) 57 (44) Total change in interest and dividend income $ 3,799 $ (9,297) $ (5,498) $ (304) $ 3,155 $ 2,851 Interest expense: Deposits: NOW $ 34 $ (21) $ 13 $ 5 $ (34) $ (29) Money market 1,082 (4,150) (3,068) (609) 1,317 708 Savings (130) (1,470) (1,600) 827 492 1,319 Time 1,570 (3,433) (1,863) 321 3,428 3,749 Total deposits 2,556 (9,074) (6,518) 544 5,203 5,747 Borrowed money 373 (390) (17) (925) 627 (298) Total change in interest expense 2,929 (9,464) (6,535) (381) 5,830 5,449 Change in net interest income $ 870 $ 167 $ 1,037 $ 77 $ (2,675) $ (2,598) Provision for Loan Losses The provision for loan losses is based on management’s periodic assessment of the adequacy of our allowance for loan losses which, in turn, is based on such interrelated factors as the composition of our loan portfolio and its inherent risk characteristics, the level of nonperforming loans and net charge-offs, both current and historic, local economic and credit conditions, the direction of real estate values, and regulatory guidelines. The provision for loan losses is charged against earnings in order to maintain our allowance for loan losses and reflects management’s best estimate of probable losses inherent in our loan portfolio at the balance sheet date. The provision for loan losses for the year ended December 31, 2020 was $7.6 million compared to a $0.4 million provision for loan losses for the year ended December 31, 2019. The increase in the provision for loan losses was primarily due to incremental loan loss reserves for increased credit risk relating to economic disruption and uncertainty caused by the COVID-19 pandemic. 41 Noninterest Income Noninterest income is a component of our revenue and is comprised primarily of fees generated from loan and deposit relationships with our customers, fees generated from sales and referrals of loans, income earned on bank owned life insurance and gains on sales of investment securities. The following table compares noninterest income for the years ended December 31, 2020, 2019 and 2018. Years Ended December 31, 2020/2019 Change 2019/2018 Change 2020 2019 2018 $ % $ % (Dollars in thousands) Bank owned life insurance $ 967 $ 1,008 $ 1,057 $ (41) (4) % $ (49) (5) % Service charges and fees 788 1,023 1,090 (235) (23) (67) (6) Gains and fees from sales of loans 43 1,791 984 (1,748) (98) 807 82 Gain (loss) on sale of other real estate owned, net 19 (102) — 121 (119) (102) N/A Net gain on sale of available for sale securities — 76 222 (76) (100) (146) (66) Other 1,067 1,448 547 (381) (26) 901 165 Total noninterest income $ 2,884 $ 5,244 $ 3,900 $ (2,360) (45) % $ 1,344 34 % Year ended December 31, 2020 compared to year ended December 31, 2019 Noninterest income decreased by $2.4 million to $2.9 million for the year ended December 31, 2020, compared to the year ended December 31, 2019. The decrease in noninterest income was primarily a result of the absence of gains and fees from SBA loan sales for the year ended December 31, 2020, when compared to the same period in 2019. In addition, for the year ended December 31, 2020, the decrease in noninterest income was also driven by certain waived service charges and fees on depository accounts as a courtesy to customers during the COVID-19 pandemic. The decrease in other noninterest income for the year ended December 31, 2020 was primarily a result of a decline in loan related interest rate swap fees in 2020, when compared to the same period in 2019. Noninterest Expense The following table compares noninterest expense for the years ended December 31, 2020, 2019 and 2018. Years Ended December 31, 2020/2019 Change 2019/2018 Change 2020 2019 2018 $ % $ % (Dollars in thousands) Salaries and employee benefits $ 21,355 $ 19,434 $ 18,973 $ 1,921 10 % $ 461 2 % Occupancy and equipment 10,926 7,594 6,790 3,332 44 804 12 Data processing 3,216 2,067 2,033 1,149 56 34 2 Professional services 2,110 1,857 2,103 253 14 (246) (12) Director fees 1,214 863 1,044 351 41 (181) (17) FDIC insurance 791 74 779 717 969 (705) (91) Marketing 630 971 1,587 (341) (35) (616) (39) Other 2,571 2,766 2,324 (195) (7) 442 19 Total noninterest expense $ 42,813 $ 35,626 $ 35,633 $ 7,187 20 % $ (7) — % Year ended December 31, 2020 compared to year ended December 31, 2019 Noninterest expense increased by $7.2 million, or 20%, to $42.8 million for the year ended December 31, 2020 compared to the year ended December 31, 2019. The increase in noninterest expense was primarily driven by $3.9 million in one-time charges recognized during the fourth quarter of 2020. These one-time charges impacted salaries and employee benefits, occupancy and equipment expense and data processing expense. 42 Salaries and employee benefits totaled $21.4 million for the year ended December 31, 2020, an increase of $1.9 million when compared to the same period in 2019. The increase in salaries and employee benefits was primarily driven by a $0.8 million expense for the Voluntary Early Retirement Incentive Plan offered to eligible employees and additional severance charges recognized during the fourth quarter of 2020. The increase in salaries and employee benefits was also driven by normal annual salary increases and key hires in support of growth initiatives, partially offset by a reduction in overall headcount. Occupancy and equipment expense totaled $10.9 million for the year ended December 31, 2020, an increase of $3.3 million when compared to the same period in 2019. The increase in occupancy and equipment expense was primarily due to a $2.0 million one-time expense related to office and branch consolidation recognized during the fourth quarter of 2020. The $2.0 million one-time expense included a charge of $1.7 million recognized upon the transfer of a bank owned property to held for sale. The asset transferred to held for sale was written down to its fair market value, less cost to sell. In addition, the $2.0 million one-time expense included a $0.3 million impairment charge on a leased asset. In addition, the increase in occupancy and equipment expense was due to additional cleaning costs associated with precautions taken to prevent the spread of COVID-19. Data processing expense totaled $3.2 million for the year ended December 31, 2020, an increase of $1.1 million when compared to the same period in 2019. The increase in data processing expense was primarily driven by a $1.1 million one-time charge related to early termination fees payable to a legacy technology vendor. Income Taxes Income tax expense for the years ended December 31, 2020, 2019 and 2018 totaled $1.4 million, $4.7 million and $3.7 million, respectively. The effective tax rates for the years ended December 31, 2020, 2019 and 2018, were 19.1%, 20.6% and 17.6%, respectively. Our net deferred tax asset at December 31, 2020 was $11.3 million, compared to $5.8 million at December 31, 2019. The increase in the deferred tax asset at December 31, 2020 when compared to the same period in 2019 was primarily a result of an increase in the allowance for loan losses and unrealized losses on derivatives. On October 8, 2015, the Bank established a wholly-owned subsidiary, Bankwell Loan Servicing Group, Inc. (a Passive Investment Company “PIC”). The PIC was organized in accordance with Connecticut statutes to hold and manage certain loans that are collateralized by real estate. Income earned by the PIC is exempt from Connecticut income tax and any dividends paid by the PIC to the Bank are not taxable income for Connecticut income tax purposes. See Note 13 to our Consolidated Financial Statements for further information regarding income taxes. Financial Condition Summary Assets totaled $2.3 billion at December 31, 2020, compared to assets of $1.9 billion at December 31, 2019. The increase in assets is primarily due to an increase in cash and cash equivalents in part to maintain a higher level of liquidity during the COVID-19 pandemic. Gross loans totaled $1.6 billion at December 31, 2020, an increase of $21.1 million compared to December 31, 2019. Excluding Paycheck Protection Program ("PPP") loans, gross loans decreased by $13.7 million at December 31, 2020 when compared to December 31, 2019. Deposits totaled $1.8 billion at December 31, 2020, compared to deposits of $1.5 billion at December 31, 2019. The increase in deposits was a result of successful commercial core deposit gathering efforts and a temporary increase in deposits to expand on-balance sheet liquidity during the COVID-19 pandemic. Shareholders’ equity totaled $176.6 million as of December 31, 2020, a decrease of $5.8 million compared to December 31, 2019, primarily a result of an $8.1 million unfavorable impact to accumulated other comprehensive loss driven by fair value marks related to hedge positions involving interest rate swaps, as well as dividends paid of $4.4 million and common stock repurchases of $1.0 million. The decrease was partially offset by net income for the year ended December 31, 2020 of $5.9 million. The marks on the interest rate swaps are driven by lower long term market interest rates in 2020 when compared to 2019. The Company's interest rate swaps are used to hedge interest rate risk. The Company's current interest rate swap positions will cause a decrease to other comprehensive income in a falling interest rate environment and an increase in a rising interest rate environment. 43 Loan Portfolio We originate commercial real estate loans, construction loans, commercial business loans and other consumer loans. Lending activities are conducted principally in the New York metropolitan area and throughout Connecticut, with the majority in Fairfield and New Haven Counties of Connecticut. Our loan portfolio is the largest category of our earnings assets. The following table compares the composition of our loan portfolio for the dates indicated: 2020 2019 Change Total % Total % Total (Dollars in thousands) Real estate loans: Residential $ 113,557 6.99 % $ 147,109 9.17 % $ (33,552) Commercial 1,148,383 70.64 1,128,614 70.34 19,769 Construction 87,007 5.35 98,583 6.14 (11,576) 1,348,947 82.98 1,374,306 85.65 (25,359) Commercial business 276,601 17.02 230,028 14.34 46,573 Consumer 79 — 150 0.01 (71) Total loans $ 1,625,627 100.00 % $ 1,604,484 100.00 % $ 21,143 Primary loan categories Residential real estate . Residential real estate loans decreased by $33.6 million, or 22.8%, at December 31, 2020 compared to December 31, 2019 and amounted to $113.6 million, representing 7% of total loans at December 31, 2020. In the fourth quarter of 2017, management made the strategic decision to no longer originate residential mortgage loans. Commercial real estate. Commercial real estate loans were $1.1 billion and represented 71% of our total loan portfolio at December 31, 2020, a net increase of $19.8 million, or 1.75%, from December 31, 2019. Commercial real estate loan growth during this period largely reflects strong production from experienced relationship managers in the marketplace and their ability to source quality opportunities, and enhanced lending to existing customers. Commercial real estate loans are secured by a variety of property types, including office buildings, retail facilities, commercial mixed use and multi-family dwellings. Construction. Construction loans were $87.0 million at December 31 2020, down $11.6 million from December 31, 2019. Construction loans totaled $98.6 million at December 31, 2019. Commercial construction loans consist of commercial development projects, such as apartment buildings and condominiums, as well as office buildings, retail and other income producing properties and land loans. Commercial business. Commercial business loans were $276.6 million and represented 17% of our total loan portfolio at December 31, 2020, a net increase of $46.6 million, or 20.2%, from December 31, 2019. The December 31, 2020 balance includes $34.8 million of PPP loans made under the Coronavirus Aid, Relief and Economic Security Act ("CARES Act"). Commercial business loans primarily provide working capital, equipment financing, financing for leasehold improvements and financing for expansion and are generally secured by assignments of corporate assets, real estate and personal guarantees of the business owners. We evaluate the appropriateness of our underwriting standards in response to changes in national and regional economic conditions, including such matters as market interest rates, energy prices, trends in real estate values, and employment levels. Based on our assessment of these matters, underwriting standards and credit monitoring activities are enhanced from time to time in response to changes in these conditions. 44 The following table presents an analysis of the maturity of our commercial real estate, commercial construction and commercial business loan portfolios as of December 31, 2020. December 31, 2020 Commercial Real Estate Commercial Construction Commercial Business Total (In thousands) Amounts due: One year or less $ 82,657 $ 26,364 $ 16,847 $ 125,868 After one year: One to five years 655,541 38,118 144,136 837,795 Over five years 410,185 22,525 115,618 548,328 Total due after one year 1,065,726 60,643 259,754 1,386,123 Total $ 1,148,383 $ 87,007 $ 276,601 $ 1,511,991 The following table presents an analysis of the interest rate sensitivity of our commercial real estate, commercial construction and commercial business loan portfolios due after one year as of December 31, 2020. December 31, 2020 Adjustable Interest Rate Fixed Interest Rate Total (In thousands) Commercial real estate $ 314,197 $ 751,529 $ 1,065,726 Commercial construction 26,371 34,272 60,643 Commercial business 133,162 126,592 259,754 Total loans due after one year $ 473,730 $ 912,393 $ 1,386,123 Asset Quality We actively manage asset quality through our underwriting practices and collection operations. Our Board of Directors monitors credit risk management through two committees, the Directors' Loan Committee ("DLC") and the Audit Committee. The DLC has primary oversight responsibility for the credit granting function including approval authority for credit granting policies, review of management’s credit granting activities and approval of large exposure credit requests. The Audit Committee oversees management’s procedures to monitor the credit quality of our loan portfolio and the loan review program. These committees report the results of their respective oversight functions to our Board of Directors. In addition, our Board of Directors receives information concerning asset quality measurements and trends on a periodic basis. While we continue to adhere to prudent underwriting standards, our loan portfolio is not immune to potential negative consequences as a result of general economic weakness, such as a prolonged downturn in the housing market on a regional or national scale. Decreases in real estate values could adversely affect the value of property used as collateral for loans. In addition, adverse changes in the economy could have a negative effect on the ability of borrowers to make scheduled loan payments, which would likely have an adverse impact on earnings. The Company has established credit policies applicable to each type of lending activity in which it engages. The Company evaluates the creditworthiness of each customer and extends credit of up to 80% of the market value of the collateral, depending on the borrower's creditworthiness and the type of collateral. The borrower’s ability to service the debt is monitored on an ongoing basis. Real estate is the primary form of collateral. Other important forms of collateral are business assets, time deposits and marketable securities. While collateral provides assurance as a secondary source of repayment, the Company ordinarily requires the primary source of repayment for commercial loans, to be based on the borrower’s ability to generate continuing cash flows. In the fourth quarter of 2017 management made the strategic decision to no longer originate residential mortgage loans. At the beginning of the third quarter of 2019, the Company no longer offered home equity loans or lines of credit. The Company’s policy for residential lending generally required that the amount of the loan may not exceed 80% of the original appraised value of the property. In certain situations, the amount may have exceeded 80% LTV either with private mortgage insurance being required for that portion of the residential loan in excess of 80% of the appraised value of the property or where secondary financing is provided by a housing authority program second mortgage, a community’s low/moderate income housing program, or a religious or civic organization. Credit risk management involves a partnership between our relationship managers and our credit approval, portfolio management, credit administration and collections personnel. Disciplined underwriting, portfolio monitoring and early problem recognition are important aspects of maintaining our high credit quality standards and low levels of nonperforming assets since our inception in 2002. 45 Acquired Loans . Loans acquired in acquisitions are initially recorded at fair value with no carryover of the related allowance for credit losses. Acquired loans that have evidence of deterioration in credit quality since origination and for which it is probable, at acquisition, that all contractually required payments will not be collected are initially recorded at fair value without recording an allowance for loan losses. Determining the fair value of the loans is determined using market participant assumptions in estimating the amount and timing of principal and interest cash flows initially expected to be collected on the loans and discounting those cash flows at an appropriate market rate of interest. Under the accounting model for acquired loans, the excess of cash flows expected to be collected over the carrying amount of the loans, referred to as the “accretable yield”, is accreted into interest income over the life of the loans. Accordingly, acquired loans are not subject to classification as nonaccrual in the same manner as originated loans. Rather, acquired loans are considered to be accruing loans because their interest income relates to the accretable yield recognized and not to contractual interest payments. The excess of the loans' contractually required payments over the cash flows expected to be collected is the nonaccretable difference. As such, charge-offs on acquired loans are first applied to the nonaccretable difference and then to any allowance for loan losses recognized subsequent to the acquisition. A decrease in expected cash flows in subsequent periods may indicate that the loan pool is impaired, which would require the establishment of an allowance for loan losses by a charge to the provision for loan losses. Nonperforming Assets . Nonperforming assets include nonaccrual loans and property acquired through foreclosures or repossession. The following table presents nonperforming assets and additional asset quality data for the dates indicated: At December 31, 2020 2019 2018 2017 2016 (Dollars in thousands) Nonaccrual loans: Real estate loans: Residential $ 1,492 $ 1,560 $ 3,812 $ 1,590 $ 1,612 Commercial 21,093 5,222 5,950 3,371 446 Commercial business 1,834 3,806 4,320 520 538 Construction 8,997 — — — — Consumer — — — — 341 Total nonaccrual loans 33,416 10,588 14,082 5,481 2,937 Property acquired through foreclosure or repossession, net — — — — 272 Total nonperforming assets $ 33,416 $ 10,588 $ 14,082 $ 5,481 $ 3,209 Nonperforming assets to total assets 1.48 % 0.56 % 0.75 % 0.31 % 0.20 % Nonperforming loans to total loans 2.06 % 0.66 % 0.88 % 0.36 % 0.22 % Total past due loans to total loans 0.93 % 0.77 % 0.78 % 1.67 % 0.47 % Total nonaccrual loans were $33.4 million as of December 31, 2020, of which $2.6 million are guaranteed by the Small Business Administration ("SBA"). The Company individually analyzed all existing COVID-19 deferrals and COVID-19 impacted loans for collectability as of December 31, 2020, resulting in a $25.6 million increase to the nonperforming loan population which are adequately reserved. Nonperforming assets as a percentage of total assets was 1.48% at December 31, 2020, up from 0.56% at December 31, 2019. The allowance for loan losses at December 31, 2020 was $21.0 million, representing 1.29% of total loans. The $7.5 million increase in the allowance for loan losses at December 31, 2020 when compared to December 31, 2019 was primarily due to incremental loan loss reserves for increased credit risk relating to economic disruption and uncertainty caused by the COVID-19 pandemic. Nonaccrual Loans . Loans greater than 90 days past due are generally put on nonaccrual status (excluding certain acquired credit impaired loans). Loans are also placed on nonaccrual status when, in the opinion of management, full collection of principal and interest is doubtful. Interest previously accrued, but uncollected, is reversed against current period income. Subsequent payments are recognized on a cash basis or principal recapture basis depending on a number of factors including probability of collection and if impairment is identified. A nonaccrual loan is restored to accrual status when it is no longer delinquent and collectability of interest and principal is no longer in doubt. At December 31, 2020 and 2019, there were no commitments to lend additional funds to any borrower on nonaccrual status. Past Due Loans . When a loan is 15 days past due, the Company sends the borrower a late notice. The Company attempts to contact the borrower by phone if the delinquency is not corrected promptly after the notice has been sent. When the loan is 30 days past due, the Company mails the borrower a letter reminding the borrower of the delinquency, and attempts to contact 46 the borrower personally to determine the reason for the delinquency and ensure the borrower understands the terms of the loan. If necessary, after the 90th day of delinquency, the Company may take other appropriate legal action. A summary report of all loans 30 days or more past due is provided to the Board of Directors of the Company periodically. Loans greater than 90 days past due are generally put on nonaccrual status. A nonaccrual loan is restored to accrual status when it is no longer delinquent and collectability of interest and principal is no longer in doubt. A loan is considered to be no longer delinquent when timely payments are made for a period of at least six months (one year for loans providing for quarterly or semi-annual payments) by the borrower in accordance with the contractual terms. Loans that are granted payment deferrals under the CARES Act are not required to be reported as past due or placed on non-accrual status if the criteria under section 4013 of the CARES Act are met. The following table presents past due loans as of December 31, 2020 and 2019: 30–59 Days Past Due 60–89 Days Past Due 90 Days or Greater Past Due Total Past Due (In thousands) As of December 31, 2020 Residential real estate $ 245 $ — $ 177 $ 422 Commercial real estate 1,305 193 2,541 4,039 Construction 8,997 — — 8,997 Commercial business 45 55 1,526 1,626 Total loans $ 10,592 $ 248 $ 4,244 $ 15,084 As of December 31, 2019 Residential real estate $ — $ 943 $ 281 $ 1,224 Commercial real estate 355 — 5,935 6,290 Construction 1,357 — — 1,357 Commercial business — — 3,455 3,455 Total loans $ 1,712 $ 943 $ 9,671 $ 12,326 Troubled Debt Restructurings (TDR) . Loans are considered restructured in a troubled debt restructuring when the borrower is experiencing financial difficulties and the Bank has granted concessions to a borrower due to the borrower’s financial condition that we otherwise would not have considered. These concessions may include modifications of the terms of the debt such as reduction of the stated interest rate other than normal market rate adjustments, extension of maturity dates, or reduction of principal balance or accrued interest. The decision to restructure a loan, rather than aggressively enforcing the collection of the loan, may benefit us by increasing the ultimate probability of collection. Section 4013 of the CARES Act provides relief from certain requirements under GAAP and permits a financial institution to elect to suspend troubled debt restructuring accounting, in certain circumstances, beginning March 1, 2020 and ending on the earlier of January 1, 2022, or sixty days after the national emergency concerning COVID-19 terminates. All short term loan modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any request for relief are not considered TDRs. As of December 31, 2020, the Company had active COVID-19 related deferrals totaling $29.4 million (excluding SBA loans, which are paid for 6 months by the SBA on behalf of borrowers). The Company granted initial three month payment deferral periods and, in some instances, extended the initial payment deferral period. This excludes SBA loans, which are mandated to receive an automatic six month deferral. These deferrals are not considered troubled debt restructurings based on Section 4013 of the CARES Act and interagency guidance issued in March of 2020. Restructured loans are classified as accruing or nonaccruing based on management’s assessment of the collectability of the loan. Loans which are already on nonaccrual status at the time of the restructuring generally remain on nonaccrual status for approximately six months before management considers such loans for return to accruing status. Accruing restructured loans are placed into nonaccrual status if and when the borrower fails to comply with the restructured terms and management deems it unlikely that the borrower will return to a status of compliance in the near term. At December 31, 2020 and December 31, 2019 there were three nonaccrual loans identified as TDRs totaling $1.4 million and three nonaccrual loans identified as TDRs totaling $1.6 million, respectively. 47 The following table presents information on troubled debt restructured loans: At December 31, 2020 2019 2018 2017 2016 (In thousands) Accruing troubled debt restructured loans: Residential real estate $ 2,399 $ 2,460 $ 2,722 $ 2,957 $ 69 Commercial real estate 4,929 4,952 37 51 402 Commercial business 328 524 923 1,346 893 Accruing troubled debt restructured loans 7,656 7,936 3,682 4,354 1,364 Nonaccrual troubled debt restructured loans: Residential real estate $ 872 $ 943 $ 3,008 $ — $ — Commercial real estate — — 334 334 — Commercial business 571 680 217 219 66 Nonaccrual troubled debt restructured loans 1,443 1,623 3,559 553 66 Total troubled debt restructured loans $ 9,099 $ 9,559 $ 7,241 $ 4,907 $ 1,430 As of December 31, 2020 and 2019, loans classified as troubled debt restructurings totaled $9.1 million and $9.6 million, respectively. Potential Problem Loans . We classify certain loans as “special mention”, “substandard”, or “doubtful”, based on criteria consistent with guidelines provided by our banking regulators. Potential problem loans represent loans that are currently performing, but for which known information about possible credit problems of the related borrowers causes management to have doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in disclosure of such loans as nonperforming at some time in the future. We cannot predict the extent to which economic conditions or other factors may impact borrowers and the potential problem loans. Accordingly, there can be no assurance that other loans will not become 90 days or more past due, be placed on nonaccrual, become restructured, or require increased allowance coverage and provision for loan losses. Potential problem loans are assessed for loss exposure using the methods described in Note 5 to our Consolidated Financial Statements under the caption “Credit Quality Indicators”. We expect the levels of nonperforming assets and potential problem loans to fluctuate in response to changing economic and market conditions, and the relative sizes of the respective loan portfolios, along with our degree of success in resolving problem assets. We take a proactive approach with respect to the identification and resolution of problem loans. Allowance for Loan Losses We evaluate the adequacy of the allowance at least quarterly, and in determining our allowance for loan losses, we estimate losses on specific loans, or groups of loans, where the probable loss can be identified and reasonably determined. The balance of our allowance for loan losses is based on internally assigned risk classifications of loans, the Bank’s and peer banks’ historical loss experience, changes in the nature of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, current economic factors and the estimated impact of current economic conditions on certain historical loan loss rates. See additional discussion regarding our allowance for loan losses under the caption “Critical Accounting Policies and Estimates.” Our general practice is to identify problem credits early and recognize full or partial charge-offs as promptly as practicable when it is determined that it is probable that the loan will not be repaid according to its original contractual terms, including principal and interest. Full or partial charge-offs on collateral dependent impaired loans are recognized when the collateral is deemed to be insufficient to support the carrying value of the loan. We do not recognize a recovery when an updated appraisal indicates a subsequent increase in value of the collateral. Our charge-off policies, which comply with standards established by our banking regulators, are consistently applied from period to period. Charge-offs are recorded on a monthly basis, as incurred. Partially charged-off loans continue to be evaluated on a monthly basis and additional charge-offs or loan loss provisions may be recorded on the remaining loan balance based on the same criteria. 48 The following table presents the activity in our allowance for loan losses and related ratios for the dates indicated: At December 31, 2020 2019 2018 2017 2016 (Dollars in thousands) Balance at beginning of period $ 13,509 $ 15,462 $ 18,904 $ 17,982 $ 14,169 Charge-offs: Residential real estate — (875) (420) — — Commercial real estate — (594) (5,614) — — Construction — — — — (7) Commercial business (83) (897) (815) (521) (69) Consumer (40) (75) (77) (51) (35) Total charge-offs (123) (2,441) (6,926) (572) (111) Recoveries: Residential real estate — — — 146 — Commercial real estate 15 — 18 — — Consumer 3 32 7 3 10 Commercial Business — 19 19 4 — Total recoveries 18 51 44 153 10 Net charge-offs (105) (2,390) (6,882) (419) (101) Provision charged to earnings 7,605 437 3,440 1,341 3,914 Balance at end of period $ 21,009 $ 13,509 $ 15,462 $ 18,904 $ 17,982 Net charge-offs (recoveries) to average loans 0.01 % 0.15 % 0.44 % 0.03 % 0.01 % Allowance for loan losses to total loans 1.29 % 0.84 % 0.96 % 1.23 % 1.32 % At December 31, 2020, our allowance for loan losses was $21.0 million and represented 1.29% of total loans, compared to $13.5 million and 0.84% of total loans at December 31, 2019. The increase in the ratio of allowance for loan losses to total loans is driven by incremental loan loss reserves for increased credit risk relating to economic disruption and uncertainty caused by the COVID-19 pandemic. The Company individually analyzed all existing COVID-19 deferrals and COVID-19 impacted loans for collectability as of December 31, 2020. For the years ended December 31, 2020, 2019 and 2018, the provision for loan losses charged to earnings totaled $7.6 million, $0.4 million and $3.4 million, respectively. Net charge-offs for the year ended December 31, 2020 were $0.1 million and represented 0.01% of average loans. For the year ended December 31, 2019, net charge-offs were $2.4 million and represented 0.15% of average loans. The carrying amount of total impaired loans at December 31, 2020 was $47.7 million. This compares to a carrying amount of $22.6 million for total impaired loans at December 31, 2019. The amount of allowance for loan losses related to impaired loans was $5.0 million and $0.5 million, respectively, at December 31, 2020 and 2019. 49 The following table presents the allocation of the allowance for loan losses and the percentage of the related loan segments to total loans: At December 31, 2020 2019 2018 2017 2016 Amount Percent of Loan Portfolio Amount Percent of Loan Portfolio Amount Percent of Loan Portfolio Amount Percent of Loan Portfolio Amount Percent of Loan Portfolio (Dollars in thousands) Residential real estate $ 610 6.99 % $ 730 9.17 % $ 857 11.10 % $ 1,721 12.54 % $ 1,802 14.33 % Commercial real estate 16,425 70.64 10,551 70.34 11,562 68.18 12,777 63.98 9,415 61.89 Construction 221 5.35 324 6.14 140 4.56 907 6.59 2,105 7.86 Commercial business 3,753 17.02 1,903 14.34 2,902 16.14 3,498 16.85 4,283 15.81 Consumer — — 1 0.01 1 0.02 1 0.04 377 0.11 Total allowance for loan losses $ 21,009 100.00 % $ 13,509 100.00 % $ 15,462 100.00 % $ 18,904 100.00 % $ 17,982 100.00 % The allocation of the allowance for loan losses at December 31, 2020 reflects our assessment of credit risk and probable loss within each portfolio. We believe that the level of the allowance for loan losses at December 31, 2020 is appropriate to cover probable losses. Investment Securities We manage our investment securities portfolio to provide a readily available source of liquidity for balance sheet management, to generate interest income and to implement interest rate risk management strategies. Investments are designated as either marketable equity, available for sale, held to maturity or trading securities at the time of purchase. We do not currently maintain a portfolio of trading securities. Investment securities available for sale may be sold in response to changes in market conditions, prepayment risk, rate fluctuations, liquidity, or capital requirements. Investment securities available for sale are reported at fair value, with any unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity, net of tax, until realized. Investment securities held to maturity are reported at amortized cost. Marketable equity securities are reported at fair value, with any changes in fair value recognized in earnings. The amortized cost and fair value of investment securities as of the dates indicated are presented in the following table: At December 31, 2020 2019 2018 Amortized Cost Fair Value Amortized Cost Fair Value Amortized Cost Fair Value (In thousands) Marketable equity securities $ 2,083 $ 2,207 $ 2,047 $ 2,118 $ 2,003 $ 2,009 Securities available for sale: U.S. Government and agency obligations 73,574 76,878 81,263 82,439 83,815 82,136 State agency and municipal obligations — — — — 4,023 4,007 Corporate bonds 11,500 11,727 — — 7,061 7,011 Total securities available for sale $ 85,074 $ 88,605 $ 81,263 $ 82,439 $ 94,899 $ 93,154 Securities held to maturity: State agency and municipal obligations $ 16,018 $ 19,962 $ 16,231 $ 18,222 $ 20,328 $ 20,890 Corporate bonds — — — — 1,000 1,000 Government mortgage-backed securities 60 70 77 85 93 98 Total securities held to maturity $ 16,078 $ 20,032 $ 16,308 $ 18,307 $ 21,421 $ 21,988 50 At December 31, 2020, the carrying value of our investment securities portfolio totaled $106.9 million and represented 5% of total assets, compared to $100.9 million and 5% of total assets at December 31, 2019. The increase of $6.0 million primarily reflects purchases of corporate bonds and increases in unrealized gains. We purchase investment grade securities with a focus on liquidity, earnings and duration exposure. The net unrealized gain position on our investment portfolio at December 31, 2020 was $7.5 million and did not include any gross unrealized losses. The net unrealized gain position on our investment portfolio at December 31, 2019 was $3.2 million and included gross unrealized losses of $2.0 thousand. All of our investment securities are rated investment grade or deemed to be of investment grade quality. The following tables summarize the amortized cost and weighted average yield of securities in our investment securities portfolio as of December 31, 2020 and 2019, based on remaining period to contractual maturity. Information for mortgage-backed securities is based on the final contractual maturity dates without considering repayments and prepayments. Due Within 1 Year Due 1–5 Years Due 5–10 Years Due After 10 Years or No Contractual Maturity At December 31, 2020 Amortized Cost Yield Amortized Cost Yield Amortized Cost Yield Amortized Cost Yield (Dollars in thousands) Marketable equity securities $ — — % $ — — % $ — — % $ 2,083 2.20 % Securities available for sale: U.S. Government and agency obligations 9,976 2.02 — — 8,038 2.88 55,560 2.49 Corporate bonds — — 4,000 4.09 6,000 4.65 1,500 4.50 Total securities available for sale $ 9,976 2.02 % $ 4,000 4.09 % $ 14,038 3.63 % $ 57,060 2.54 % Securities held to maturity: State agency and municipal obligations $ — — % $ — — % $ — — % $ 16,018 5.01 % Government mortgage-backed securities — — — — — — 60 5.35 Total securities held to maturity $ — — % $ — — % $ — — % $ 16,078 5.01 % Due Within 1 Year Due 1–5 Years Due 5–10 Years Due After 10 Years or No Contractual Maturity At December 31, 2019 Amortized Cost Yield Amortized Cost Yield Amortized Cost Yield Amortized Cost Yield (Dollars in thousands) Marketable equity securities $ — — % $ — — % $ — — % $ 2,047 2.20 % Securities available for sale: U.S. Government and agency obligations 2,100 1.59 9,950 2.02 8,311 2.87 60,902 2.61 Total securities available for sale $ 2,100 1.59 % $ 9,950 2.02 % $ 8,311 2.87 % $ 60,902 2.61 % Securities held to maturity: State agency and municipal obligations $ — — % $ — — % $ — — % $ 16,231 5.05 % Government mortgage-backed securities — — — — — — 77 5.35 Total securities held to maturity $ — — % $ — — % $ — —% $ 16,308 5.05 % 51 Bank Owned Life Insurance ("BOLI") BOLI amounted to $42.7 million as of December 31, 2020. The purchase of life insurance policies results in an income-earning asset on our consolidated balance sheet that provides monthly tax-free income to us. We expect to benefit from the BOLI contracts as a result of the tax-free growth in cash surrender value and death benefits that are expected to be generated over time. BOLI is included in our Consolidated Balance Sheets at its cash surrender value. Increases in the cash surrender value are reported as a component of noninterest income in our Consolidated Statements of Income. Deposit Activities and Other Sources of Funds Our sources of funds include deposits, brokered certificates of deposit, FHLB borrowings, subordinated debt and proceeds from the sales, maturities and payments of loans and investment securities. Total deposits represented 81% of our total assets at December 31, 2020. While scheduled loan and securities repayments are a relatively stable sources of funds, loan and investment security prepayments and deposit inflows are influenced by prevailing interest rates and local economic conditions and are inherently uncertain. Deposits We offer a wide variety of deposit products and rates to consumer and business customers consistent with FDIC regulations. Our management team meets regularly to determine pricing and marketing initiatives. In addition to being an important source of funding for us, deposits also provide an ongoing stream of fee revenue. We participate in the Certificate of Deposit Account Registry Service ("CDARS") and Insured Cash Sweep Service ("ICS") programs. We use CDARS and ICS to place customer funds into certificate of deposit accounts and money market accounts, respectively, into other participating banks. These transactions occur in amounts that are less than FDIC insurance limits to ensure that deposit customers are eligible for FDIC insurance on the full amount of their deposits. Reciprocal amounts of deposits are received from other participating banks that do the same with their customer deposits, and, we also execute one-way buy transactions. CDARS and ICS deposits, except for reciprocal deposits, are considered to be brokered deposits for bank regulatory purposes. Time deposits may also be generated through the use of a listing service. We subscribe to a listing service, accessible to financial institutions, in which we may advertise our time deposit rates in exchange for a set subscription fee. Interested financial institutions then contact us directly to acquire a time certificate of deposit. There is no third party brokerage service involved in this transaction. The following table sets forth the composition of our deposits for the dates indicated: At December 31, 2020 2019 Amount Percent Weighted Average Rate Amount Percent Weighted Average Rate (Dollars in thousands) Noninterest-bearing demand $ 270,235 14.79 % — % $ 191,518 12.84 % — % NOW 101,737 5.57 0.17 70,020 4.69 0.21 Money market 669,364 36.63 0.79 419,495 28.12 1.62 Savings 158,750 8.69 0.81 183,729 12.31 1.67 Time 627,230 34.32 1.77 627,141 42.04 2.27 Total deposits $ 1,827,316 100.00 % 1.23 % $ 1,491,903 100.00 % 1.87 % Total deposits were $1.8 billion at December 31, 2020, an increase of $335.4 million, or 22%, from December 31, 2019, reflecting successful commercial core deposit gathering efforts, as well as a temporary increase in deposits to expand on-balance sheet liquidity during the COVID-19 pandemic. Brokered certificates of deposits ("Brokered CDs") totaled $238.9 million and $179.8 million at December 31, 2020 and December 31, 2019, respectively. Certificates of deposits from national listing services totaled $18.4 million at December 31, 2020 and $21.3 million at December 31, 2019. Brokered money market accounts totaled $13.5 million and $39.9 million at December 31, 2020 and 2019, respectively. Brokered deposits represent brokered certificates of deposit, brokered money 52 market accounts, one way buy CDARS, and one way buy Insured Cash Sweep ("ICS"). Brokered deposits are utilized as an additional source of funding. At December 31, 2020 and 2019, time deposits, including CDARS and brokered certificates of deposit, with a denomination of $100 thousand or more totaled $519.8 million and $502.8 million, respectively, maturing during the periods indicated in the table below: At December 31, 2020 2019 (In thousands) Maturing: Within 3 months $ 141,784 $ 114,636 After 3 but within 6 months 67,064 139,852 After 6 months but within 1 year 118,880 104,355 After 1 year 192,051 143,907 Total $ 519,779 $ 502,750 The Bank is a member of the FHLB, which is part of a twelve district Federal Home Loan Bank System. Members are required to own capital stock of the FHLB, and borrowings are collateralized by qualifying assets not otherwise pledged. The maximum amount of credit that the FHLB will extend varies from time to time, depending on its policies and the amount of qualifying collateral the member can pledge. The Bank had satisfied its collateral requirement at December 31, 2020. We utilize advances from the FHLB as part of our overall funding strategy, to meet short-term liquidity needs and to manage interest rate risk arising from the difference in asset and liability maturities. Total FHLB advances were $175.0 million at December 31, 2020 compared to $150.0 million at December 31, 2019. The increase of $25.0 million reflects normal fluctuations in our borrowings. Advances from the FHLB include short-term advances with original maturity dates of one year or less. The following table sets forth certain information concerning short-term FHLB advances as of and for the periods indicated in the following table: Year Ended December 31, 2020 2019 2018 (Dollars in thousands) Average amount outstanding during the period $ 165,232 $ 145,921 $ 163,419 Amount outstanding at end of period 175,000 150,000 135,000 Highest month end balance during the period 175,000 150,000 174,000 Weighted average interest rate at end of period (1) 1.84 % 1.93 % 2.55 % (1) The Company's FHLB borrowings are subject to longer term swap agreements and the weighted average rate reflects the all in swap rate under these long term swap agreements. On August 19, 2015, the Company completed a private placement of $25.5 million in aggregate principal amount of fixed rate subordinated notes (the “Notes”) to certain institutional investors. The Notes are non-callable for five years, have a stated maturity of August 15, 2025, and bear interest at a quarterly pay fixed rate of 5.75% per annum to the maturity date. The Notes became callable, in part or in whole, beginning August 2020. Derivative Instruments The Company uses interest rate swap instruments to fix the interest rate on short-term FHLB borrowings or Brokered CDs, all of which are designated as cash flow hedges. The hedge strategy converts the rate of interest on short-term rolling FHLB advances or Brokered CDs to long-term fixed interest rates, thereby protecting the Bank from interest rate variability in the contractually specified interest rates. Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain loan customers. The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting derivatives that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate derivatives associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting derivatives are recognized directly in earnings. 53 Information about derivative instruments at December 31, 2020 and 2019 was as follows: December 31, 2020: Original Notional Amount Original Maturity Maturity Date Received Paid Fair Value Asset (Liability) (Dollars in thousands) Derivatives designated as hedging instruments: Interest rate swap $ 25,000 5.0 years July 1, 2021 3-month LIBOR 1.22% $ (128) Interest rate swap 25,000 3.0 years December 23, 2022 3-month LIBOR 1.28% (541) Interest rate swap 25,000 7.0 years August 25, 2024 3-month LIBOR 2.04% (1,622) Interest rate swap 25,000 7.0 years August 25, 2024 3-month LIBOR 2.04% (1,618) Interest rate swap 25,000 5.0 years April 9, 2025 3-month LIBOR 0.55% (224) Interest rate swap 25,000 5.0 years April 23, 2025 3-month LIBOR 0.54% (212) Interest rate swap 25,000 15.0 years January 1, 2034 3-month LIBOR 3.01% (6,086) Interest rate swap 25,000 15.0 years January 1, 2035 3-month LIBOR 3.03% (6,445) Interest rate swap 25,000 15.0 years August 26, 2035 3-month LIBOR 3.05% (6,691) $ 225,000 $ (23,567) Derivatives not designated as hedging instruments: (1) Interest rate swap $ 18,500 10.0 years March 10, 2030 1-month LIBOR 3.15% $ (648) Interest rate swap 18,500 10.0 years March 10, 2030 1-month LIBOR 3.15% 648 Interest rate swap 20,000 20.0 years March 10, 2039 1-month LIBOR 5.00% (3,796) Interest rate swap 20,000 20.0 years March 10, 2039 1-month LIBOR 5.00% 3,796 $ 77,000 $ — Total Derivatives $ 302,000 $ (23,567) (1) Represents interest rate swaps with commercial banking customers, which are offset by derivatives with a third party. 54 December 31, 2019: Original Notional Amount Original Maturity Maturity Date Received Paid Fair Value Asset (Liability) (Dollars in thousands) Derivatives designated as hedging instruments: Interest rate swap $ 25,000 5.0 years January 1, 2020 3-month LIBOR 1.83% $ — Interest rate swap 25,000 5.0 years August 26, 2020 3-month LIBOR 1.48% 51 Interest rate swap 25,000 5.0 years July 1, 2021 3-month LIBOR 1.22% 174 Interest rate swap 25,000 7.0 years August 25, 2024 3-month LIBOR 2.04% (396) Interest rate swap 25,000 7.0 years August 25, 2024 3-month LIBOR 2.04% (402) Interest rate swap 25,000 15.0 years January 1, 2034 3-month LIBOR 3.01% (3,328) Interest rate swap 25,000 3.0 years December 23, 2022 3-month LIBOR 1.28% 279 Forward-starting interest rate swap (1) 25,000 15.0 years January 1, 2035 3-month LIBOR 3.03% (3,557) Forward-starting interest rate swap (1) 25,000 15.0 years August 26, 2035 3-month LIBOR 3.05% (3,512) $ 225,000 $ (10,691) Derivatives not designated as hedging instruments: (2) Interest rate swap $ 20,000 20.0 years March 20, 2039 1-month USD LIBOR 5.00% $ (1,762) Interest rate swap 20,000 20.0 years March 20, 2039 1-month USD LIBOR 5.00% 1,762 $ 40,000 $ — Total Derivatives $ 265,000 $ (10,691) (1) The effective date of the forward-starting interest rate swaps listed above are January 2, 2020 and August 26, 2020, respectively. (2) Represents an interest rate swap with a commercial banking customer, which is offset by a derivative with a third party. Liquidity and Capital Resources Liquidity Management Liquidity is defined as the ability to generate sufficient cash flows to meet all present and future funding requirements at reasonable costs. Our primary source of liquidity is deposits. While our generally preferred funding strategy is to attract and retain low cost deposits, our ability to do so is affected by competitive interest rates and terms in the marketplace. Other sources of funding include discretionary use of purchased liabilities (e.g., FHLB term advances and other borrowings), cash flows from our investment securities portfolios, loan sales, loan repayments and earnings. Investment securities designated as available for sale may also be sold in response to short-term or long-term liquidity needs. The Bank’s liquidity position is monitored daily by management. The Asset Liability Committee, or ALCO, establishes guidelines to ensure maintenance of prudent levels of liquidity. ALCO reports to the Company’s Board of Directors. The Bank has a detailed liquidity funding policy and a contingency funding plan that provide for the prompt and comprehensive response to unexpected demands for liquidity. We employ a stress testing methodology to estimate needs for contingent funding that could result from unexpected outflows of funds in excess of “business as usual” cash flows. The Bank has established unsecured borrowing capacity with the Atlantic Community Bankers Bank (ACBB) (formerly Bankers’ Bank 55 Northeast), Zion’s Bank and Texas Capital Bank and also maintains additional collateralized borrowing capacity with the FHLB in excess of levels used in the ordinary course of business. Our sources of liquidity include cash, unpledged investment securities, borrowings from the FHLB, lines of credit from ACBB, Zion's Bank and Texas Capital Bank, the brokered deposit market and national CD listing services. Capital Resources Shareholders’ equity totaled $176.6 million as of December 31, 2020, a decrease of $5.8 million compared to December 31, 2019, primarily a result of an $8.1 million unfavorable impact to accumulated other comprehensive loss driven by fair value marks related to hedge positions involving interest rate swaps, as well as dividends paid of $4.4 million and common stock repurchases of $1.0 million. The decrease was partially offset by net income for the year ended December 31, 2020 of $5.9 million. The marks on the interest rate swaps are driven by lower long term market interest rates in 2020 when compared to 2019. The Company's interest rate swaps are used to hedge interest rate risk. The Company's current interest rate swap positions will cause a decrease to other comprehensive income in a falling interest rate environment and an increase in a rising interest rate environment. As of December 31, 2020, the tangible common equity ratio and tangible book value per share were 7.73% and $22.43, respectively. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. At December 31, 2020, the Bank met all capital adequacy requirements to which it was subject and exceeded the regulatory minimum capital levels to be considered well-capitalized under the regulatory framework. At December 31, 2020, the Bank’s ratio of total common equity tier 1 capital to risk-weighted assets was 11.06%, total capital to risk-weighted assets was 12.28%, Tier 1 capital to risk-weighted assets was 11.06% and Tier 1 capital to average assets was 8.44%. As of January 1, 2015, the Parent Corporation and the Bank became subject to new capital rules set forth by the Federal Reserve, the FDIC and the other federal and state bank regulatory agencies. The capital rules revise the banking agencies’ leverage and risk-based capital requirements and the method for calculating risk weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act (the Basel III Capital Rules). The Basel III Capital Rules establish a minimum Common Equity Tier 1 capital requirement of 4.5% of risk-weighted assets; set the minimum leverage ratio at 4.0% of total assets; increased the minimum Tier 1 capital to risk-weighted assets requirement from 4.0% to 6.0%; and retained the minimum total capital to risk weighted assets requirement at 8.0%. A “well capitalized” institution must generally maintain capital ratios 100 to 200 basis points higher than the minimum guidelines. The Basel III Capital Rules also change the risk weights assigned to certain assets. The Basel III Capital Rules assigned a higher risk weight (150%) to loans that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The Basel III Capital Rules also alter the risk weighting for other assets, including marketable equity securities that are risk weighted generally at 300%. The Basel III Capital Rules require certain components of accumulated other comprehensive income (loss) to be included for purposes of calculating regulatory capital requirements unless a one-time opt-out is exercised. The Bank did exercise its opt-out option and will excludes the unrealized gain (loss) on investment securities component of accumulated other comprehensive income (loss) from regulatory capital. The Basel III Capital Rules limit a banking organization’s capital distributions and certain discretionary bonus payments to executive officers if the banking organization does not hold a “capital conservation buffer” of 2.5% in addition to the minimum risk based capital requirement. The “capital conservation buffer” was phased in from January 1, 2016 to January 1, 2019, when the full capital conservation buffer became effective. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Contractual Obligations The following table summarizes our contractual obligations to make future payments as of December 31, 2020. Payments for borrowings do not include interest. Payments related to leases are based on actual payments specified in the underlying contracts. 56 Payments Due by Period Total Less Than 1 Year 1–3 Years 4–5 Years After 5 Years (in thousands) Contractual Obligations: FHLB advances $ 175,000 $ 175,000 $ — $ — $ — Subordinated debt 25,500 — — 25,500 — Operating lease agreements 22,929 1,826 2,389 1,488 17,226 Time deposits with stated maturity dates 627,230 418,117 178,920 30,193 — Total contractual obligations $ 850,659 $ 594,943 $ 181,309 $ 57,181 $ 17,226 Off-Balance Sheet Arrangements In the normal course of business, we are a party to financial instruments with off-balance sheet risk to meet the financing needs of our customers. These financial instruments include commitments to extend credit and involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the financial statements. The contractual amounts of these instruments reflect the extent of involvement we have in particular classes of financial instruments. We enter into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Substantially all of the Bank’s commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of loan funding. The Bank minimizes its exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures. Commitments to extend credit totaled $237.1 million and $189.7 million, respectively at December 31, 2020 and 2019. The following table summarizes our commitments to extend credit as of the dates indicated. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements. In addition, borrowers may be required to meet certain performance requirements to continue to draw on these commitments. We manage our liquidity in light of the aggregate amounts of commitments to extend credit and outstanding standby letters of credit in effect from time to time to ensure that we will have adequate sources of liquidity to fund such commitments and honor drafts under such letters of credit. 57 As of December 31, 2020 Amount of Commitment Expiration per Period Total Less Than 1 Year 1–3 Years 4–5 Years After 5 Years (in thousands) Other Commitments: Loan commitments $ 114,574 $ 70,958 $ 18,447 $ 17,030 $ 8,139 Undisbursed construction loans 117,457 9,862 40,635 14,599 52,361 Unused home equity lines of credit 5,029 250 210 — 4,569 Total other commitments $ 237,060 $ 81,070 $ 59,292 $ 31,629 $ 65,069 As of December 31, 2019 Amount of Commitment Expiration per Period Total Less Than 1 Year 1–3 Years 4–5 Years After 5 Years (in thousands) Other Commitments: Loan commitments $ 102,986 $ 56,483 $ 12,628 $ 15,166 $ 18,709 Undisbursed construction loans 80,472 1,715 26,281 15,340 37,136 Unused home equity lines of credit 6,284 368 200 10 5,706 Total other commitments $ 189,742 $ 58,566 $ 39,109 $ 30,516 $ 61,551 Recently Issued Accounting Pronouncements See Note 1 to our Consolidated Financial Statements for details of recently issued accounting pronouncements and their expected impact on our financial statements.