Bankwell Financial Group, Inc. 10-Q

Item 2. 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 unaudited interim consolidated financial statements and related notes contained elsewhere in this report on Form 10-Q. 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 Company’s Form 10-K filed for the year ended December 31, 2020 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. is a bank holding company headquartered in New Canaan, Connecticut. Through our wholly owned subsidiary, Bankwell Bank, or the Bank, we serve small and medium-sized businesses and retail customers primarily within an area encompassing approximately a 100 mile radius around our branch network. We have a history of building long-term customer relationships and attracting new customers through what we believe is our strong customer service and our ability to deliver a diverse product offering. 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 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 banking provider of choice in our highly 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 significant economic disruption affecting our business and the clients we serve. As vaccination efforts continue, restrictions on businesses have been lifted and a return to more normal economic activity has begun. However, a significant degree of uncertainty still exists concerning the ultimate duration and magnitude of the COVID-19 pandemic and subsequent outbreaks, including whether restrictions that have been lifted will need to be imposed again or tightened in the future. Given the ongoing and dynamic nature of the circumstances, it is still difficult to predict the full impact of the COVID-19 pandemic on our business. The extent of such impact will depend on future developments, including but not limited to the continued roll-out of vaccinations, which play an important role as to when the coronavirus can be controlled and abated. 43 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. Earnings and Performance Overview For the three months ended June 30, 2021, we had net interest income of $16.6 million, an increase of $2.9 million or 21.6% when compared to the same period in 2020. For the six months ended June 30, 2021, we had net interest income of $31.2 million, an increase of $4.3 million, or 16.0% when compared to the same period in 2020. The increase in net interest income for the three and six months ended June 30, 2021 was primarily due to lower interest expense on deposits when compared to the same periods in 2020. Noninterest income increased $0.9 million to $1.4 million for the three months ended June 30, 2021 compared to the same period in 2020. Noninterest income increased $1.7 million to $3.4 million for the six months ended June 30, 2021 compared to the same period in 2020. The increase in noninterest income was primarily a result of the resumption of SBA loan sales, resulting in $0.8 million of gains and fees from sales of loans for the three months ended June 30, 2021 and $1.3 million of gains and fees from sales of loans for the six months ended June 30, 2021. Noninterest income for the six months ended June 30, 2021 also benefited from a one-time federal payroll tax credit for COVID-19 of $0.9 million. In the fourth quarter of 2020, the Company recognized a $3.9 million one-time charge recorded in noninterest expense for office consolidation, vendor contract termination and employee severance costs. As of June 30, 2021, the Company has paid a total of $0.5 million in employee severance costs and a total of $1.1 million in vendor contract termination costs. Reference the 2020 Form 10-K for further discussion on these charges. Net income available to common shareholders was $6.2 million, or $0.79 per diluted share, and $1.2 million, or $0.16 per diluted share, for the three months ended June 30, 2021 and 2020, respectively. Net income available to common shareholders was $11.9 million, or $1.50 per diluted share, and $2.6 million, or $0.33 per diluted share, for the six months ended June 30, 2021 and 2020, respectively. The increase in net income was primarily impacted by the aforementioned increases in net interest income and noninterest income and a decrease in the provision for loan losses resulting from the absence of elevated reserves recognized in 2020 due to the impact of the COVID-19 pandemic and improving economic trends in 2021. Returns on average stockholders' equity and average assets for the three months ended June 30, 2021 were 13.06% and 1.11%, respectively, compared to 2.82% and 0.23%, respectively, for the three months ended June 30, 2020. Returns on average stockholders' equity and average assets for the six months ended June 30, 2021 were 12.87% and 1.07%, respectively, compared to 2.92% and 0.26%, respectively, for the six months ended June 30, 2020. 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 fully taxable equivalent ("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. FTE net interest income for the three months ended June 30, 2021 and 2020 was $16.6 million and $13.7 million, respectively. FTE net interest income for the six months ended June 30, 2021 and 2020 was $31.3 million and $27.0 million, respectively. 44 FTE interest income for the three months ended June 30, 2021 increased by $0.8 million, or 4.0%, to $20.1 million, compared to FTE interest income for the three months ended June 30, 2020. This increase was due to commercial real estate and commercial business loan growth. FTE interest income for the six months ended June 30, 2021 decreased by $0.6 million, or 1.4%, to $39.0 million, compared to FTE interest income for the six months ended June 30, 2020. This decrease was due to lower loan yields as loans re-priced at lower interest rates throughout 2020 and lower yields on cash, partially offset by loan growth. Interest expense for the three months ended June 30, 2021 decreased by $2.2 million, or 38.2%, compared to interest expense for the three months ended June 30, 2020. Interest expense for the six months ended June 30, 2021 decreased by $4.9 million, or 38.9%, compared to interest expense for the six months ended June 30, 2020. This decrease is due to lower interest rates on deposits. The net interest margin increased by 31 basis points to 3.12% for the three months ended June 30, 2021, compared to the three months ended June 30, 2020 and the net interest margin increased by 4 basis points to 2.93% for the six months ended June 30, 2021, compared to the six months ended June 30, 2020. The increase in net interest margin was primarily due to lower interest expense on deposits and a greater percentage of noninterest bearing deposits, partially offset by excess liquidity. 45 Distribution of Assets, Liabilities and Stockholders’ Equity; Interest Rates and Interest Differential The following tables present the average balances and yields earned on interest earning assets and average balances and weighted average rates paid on our funding liabilities for the three and six months ended June 30, 2021 and 2020. Three Months Ended June 30, 2021 2020 (Dollars in thousands) Average Balance Interest Yield / Rate (5) Average Balance Interest Yield / Rate (5) Assets: Cash and Fed funds sold $ 336,073 $ 90 0.11 % $ 234,979 $ 86 0.15 % Securities (1) 103,297 761 2.95 95,421 738 3.09 Loans: Commercial real estate 1,163,134 13,678 4.65 1,088,390 12,808 4.66 Residential real estate 105,975 958 3.62 134,295 1,251 3.73 Construction (2) 110,780 1,036 3.70 100,282 1,101 4.34 Commercial business 296,613 3,506 4.68 288,605 3,297 4.52 Consumer 8,851 88 3.98 111 2 8.71 Total loans 1,685,353 19,266 4.52 1,611,683 18,459 4.53 Federal Home Loan Bank stock 4,219 25 2.34 7,472 92 4.93 Total earning assets 2,128,942 $ 20,142 3.74 % 1,949,555 $ 19,375 3.93 % Other assets 117,334 129,247 Total assets $ 2,246,276 $ 2,078,802 Liabilities and shareholders' equity: Interest bearing liabilities: NOW $ 118,806 $ 54 0.18 % $ 74,050 $ 31 0.17 % Money market 782,079 941 0.48 464,230 862 0.75 Savings 168,870 92 0.22 162,283 295 0.73 Time 538,915 1,657 1.23 765,103 3,622 1.90 Total interest bearing deposits 1,608,670 2,744 0.68 1,465,666 4,810 1.32 Borrowed money 101,586 769 3.00 188,557 876 1.84 Total interest bearing liabilities 1,710,256 $ 3,513 0.82 % 1,654,223 $ 5,686 1.38 % Noninterest bearing deposits 298,467 198,253 Other liabilities 46,329 53,037 Total Liabilities 2,055,052 1,905,513 Shareholders' equity 191,224 173,289 Total liabilities and shareholders' equity $ 2,246,276 $ 2,078,802 Net interest income (3) $ 16,629 $ 13,689 Interest rate spread 2.92 % 2.55 % Net interest margin (4) 3.12 % 2.81 % (1) Average balances and yields for securities are based on amortized cost. (2) Includes commercial and residential real estate construction. (3) The adjustment for securities and loans taxable equivalency amounted to $50 thousand and $52 thousand for the three months ended June 30, 2021 and 2020, respectively. (4) Annualized net interest income as a percentage of earning assets. (5) Yields are calculated using the contractual day count convention for each respective product type. 46 Six Months Ended June 30, 2021 2020 (Dollars in thousands) Average Balance Interest Yield / Rate (5) Average Balance Interest Yield / Rate (5) Assets: Cash and Fed funds sold $ 368,779 $ 198 0.11 % $ 154,321 $ 372 0.48 % Securities (1) 102,252 1,549 3.03 96,932 1,513 3.12 Loans: Commercial real estate 1,146,258 26,354 4.57 1,098,550 25,839 4.65 Residential real estate 109,003 1,996 3.66 139,059 2,607 3.75 Construction (2) 102,459 1,916 3.72 100,338 2,316 4.57 Commercial business 295,682 6,763 4.55 273,767 6,676 4.82 Consumer 6,956 137 3.96 133 6 8.51 Total loans 1,660,358 37,166 4.45 1,611,847 37,444 4.60 Federal Home Loan Bank stock 5,356 56 2.11 7,401 195 5.30 Total earning assets 2,136,745 $ 38,969 3.64 % 1,870,501 $ 39,524 4.18 % Other assets 115,718 122,060 Total assets $ 2,252,463 $ 1,992,561 Liabilities and shareholders' equity: Interest bearing liabilities: NOW $ 109,990 $ 97 0.18 % $ 70,990 $ 59 0.17 % Money market 759,435 1,891 0.50 451,388 2,354 1.05 Savings 164,630 217 0.27 173,875 967 1.12 Time 574,876 3,653 1.28 702,853 7,139 2.04 Total interest bearing deposits 1,608,931 5,858 0.73 1,399,106 10,519 1.51 Borrowed money 126,886 1,777 2.79 180,575 1,977 2.17 Total interest bearing liabilities 1,735,817 $ 7,635 0.89 % 1,579,681 $ 12,496 1.59 % Noninterest bearing deposits 284,226 188,722 Other liabilities 45,756 46,954 Total Liabilities 2,065,799 1,815,357 Shareholders' equity 186,664 177,204 Total liabilities and shareholders' equity $ 2,252,463 $ 1,992,561 Net interest income (3) $ 31,334 $ 27,028 Interest rate spread 2.75 % 2.59 % Net interest margin (4) 2.93 % 2.89 % (1) Average balances and yields for securities are based on amortized cost. (2) Includes commercial and residential real estate construction. (3) The adjustment for securities and loans taxable equivalency amounted to $100 thousand and $105 thousand for the six months ended June 30, 2021 and 2020, respectively. (4) Annualized net interest income as a percentage of earning assets. (5) Yields are calculated using the contractual day count convention for each respective product type. 47 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. Three Months Ended June 30, 2021 vs 2020 Increase (Decrease) Six Months Ended June 30, 2021 vs 2020 Increase (Decrease) (In thousands) Volume Rate Total Volume Rate Total Interest and dividend income: Cash and Fed funds sold $ 30 $ (26) $ 4 $ 259 $ (433) $ (174) Securities 59 (36) 23 82 (46) 36 Loans: Commercial real estate 879 (9) 870 1,109 (594) 515 Residential real estate (257) (36) (293) (551) (60) (611) Construction 108 (173) (65) 48 (448) (400) Commercial business 93 116 209 517 (430) 87 Consumer 87 (1) 86 136 (5) 131 Total loans 910 (103) 807 1,259 (1,537) (278) Federal Home Loan Bank stock (30) (37) (67) (44) (95) (139) Total change in interest and dividend income 969 (202) 767 1,556 (2,111) (555) Interest expense: Deposits: NOW 20 3 23 35 3 38 Money market 452 (373) 79 1,133 (1,596) (463) Savings 12 (215) (203) (49) (701) (750) Time (899) (1,066) (1,965) (1,141) (2,345) (3,486) Total deposits (415) (1,651) (2,066) (22) (4,639) (4,661) Borrowed money (510) 403 (107) (672) 472 (200) Total change in interest expense (925) (1,248) (2,173) (694) (4,167) (4,861) Change in net interest income $ 1,894 $ 1,046 $ 2,940 $ 2,250 $ 2,056 $ 4,306 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 interrelated factors such 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 as of the balance sheet date. The credit for loan losses for the three months ended June 30, 2021 was $20.0 thousand compared to a provision for loan losses of $3.0 million for the three months ended June 30, 2020. The credit for loan losses for the six months ended June 30, 2021 was $0.3 million compared to a provision for loan losses of $6.2 million for the six months ended June 30, 2020. The decrease in the provision for loan losses for the three and six months ended June 30, 2021 was primarily due to the absence of elevated reserves recognized in 2020 due to the impact of the COVID-19 pandemic and improving economic trends in 2021. 48 Noninterest Income Noninterest income is a component of our revenue and is comprised primarily of fees generated from 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 tables compare noninterest income for the three and six months ended June 30, 2021 and 2020: Three Months Ended June 30, Change (Dollars in thousands) 2021 2020 $ % Gains and fees from sales of loans $ 814 $ — $ 814 N/A Bank-owned life insurance 251 241 10 4.1 % Service charges and fees 217 171 46 26.9 Other 158 165 (7) (4.2) Total noninterest income $ 1,440 $ 577 $ 863 149.6 % Six Months Ended June 30, Change (Dollars in thousands) 2021 2020 $ % Gains and fees from sales of loans $ 1,327 $ — $ 1,327 N/A Bank-owned life insurance 482 484 (2) (0.4) % Service charges and fees 416 388 28 7.2 Other 1,170 777 393 50.6 Total noninterest income $ 3,395 $ 1,649 $ 1,746 105.9 % Noninterest income increased by $0.9 million to $1.4 million for the three months ended June 30, 2021 compared to the three months ended June 30, 2020. Noninterest income increased by $1.7 million to $3.4 million for the six months ended June 30, 2021 compared to the six months ended June 30, 2020. The increase in noninterest income was driven by resumed SBA loan sales, totaling $0.8 million and $1.3 million for the three and six months ended June 30, 2021, respectively. In addition, the increase in noninterest income for the six months ended June 30, 2021 was impacted by a one-time federal payroll tax credit for COVID-19 of $0.9 million. Noninterest Expense The following tables compare noninterest expense for the three and six months ended June 30, 2021 and 2020: Three Months Ended June 30, Change (Dollars in thousands) 2021 2020 $ % Salaries and employee benefits $ 3,960 $ 5,227 $ (1,267) (24.2) % Occupancy and equipment 3,250 2,235 1,015 45.4 Data processing 833 493 340 69.0 Professional services 547 434 113 26.0 Director fees 327 287 40 13.9 FDIC insurance 300 283 17 6.0 Marketing 140 199 (59) (29.6) Other 695 564 131 23.2 Total noninterest expense $ 10,052 $ 9,722 $ 330 3.4 % 49 Six Months Ended June 30, Change (Dollars in thousands) 2021 2020 $ % Salaries and employee benefits $ 8,729 $ 10,607 $ (1,878) (17.7) % Occupancy and equipment 5,656 4,144 1,512 36.5 Data processing 1,345 1,029 316 30.7 Professional services 1,134 1,145 (11) (1.0) FDIC insurance 703 353 350 99.2 Director fees 644 582 62 10.7 Marketing 131 361 (230) (63.7) Other 1,348 1,160 188 16.2 Total noninterest expense $ 19,690 $ 19,381 $ 309 1.6 % Noninterest expense increased by $0.3 million to $10.1 million for the three months ended June 30, 2021 compared to the three months ended June 30, 2020. The increase in noninterest expense was primarily driven by an increase in occupancy and equipment expense and data processing expense, partially offset by a decrease in salaries and employee benefits expense. Noninterest expense increased by $0.3 million to $19.7 million for the six months ended June 30, 2021 compared to the six months ended June 30, 2020. The increase in noninterest expense was primarily driven by an increase in occupancy and equipment expense, FDIC insurance expense, and data processing expense, partially offset by a decrease in salaries and employee benefits expense. For the three months ended June 30, 2021 noninterest expense included $0.8 million of non-recurring items relating to office consolidation expenses ($0.4 million), COVID-19 cleaning protocols ($0.3 million) and the implementation of new online banking software ($0.1 million). See below for more information on what specific areas of non-interest expense were impacted by these non-recurring items. Occupancy and equipment expense totaled $3.3 million for the three months ended June 30, 2021, an increase of $1.0 million when compared to the same period in 2020. Occupancy and equipment expense totaled $5.7 million for the six months ended June 30, 2021, an increase of $1.5 million when compared to the same period in 2020. The increase in occupancy and equipment expense was primarily due to additional one-time charges of $0.4 million associated with office consolidation activity (previously disclosed in the fourth quarter of 2020) and an increase in lease expense resulting from the commencement of the lease on the Company's new headquarters building. In addition, the increase in occupancy and equipment expense for the six months ended June 30, 2021 was due to additional cleaning costs associated with precautions taken to prevent the spread of COVID-19. The additional cleaning protocols have been curtailed as of June 30, 2021. Data processing expense totaled $0.8 million for the three months ended June 30, 2021, an increase of $0.3 million when compared to the same period in 2020. Data processing expense totaled $1.3 million for the six months ended June 30, 2021, an increase of $0.3 million when compared to the same period in 2020. The increase in data processing expense was primarily due to $0.4 million in costs associated with the conversion to a new online banking system implemented in the second quarter of 2021. FDIC insurance expense totaled $0.7 million for the six months ended June 30, 2021, an increase of $0.4 million when compared to the same period in 2020. The increase in FDIC insurance expense was due to the absence of available FDIC insurance credits recognized in the first quarter of 2020 and elevated expense due to liquidity driven balance sheet growth in 2021. 50 Salaries and employee benefits expense totaled $4.0 million for the three months ended June 30, 2021, a decrease of $1.3 million when compared to the same period in 2020. Salaries and employee benefits expense totaled $8.7 million for the six months ended June 30, 2021, a decrease of $1.9 million when compared to the same period in 2020. The decrease in salaries and employee benefits expense was primarily driven by a decrease in full time equivalent employees as a direct result of the Voluntary Early Retirement Incentive Plan offered to eligible employees and other employee actions taken during the fourth quarter of 2020. Full time equivalent employees totaled 125 at June 30, 2021 compared to 152 for the same period in 2020. Average full time equivalent employees totaled 124 for the six months ended June 30, 2021 compared to 154 for the same period in 2020. Salaries and employee benefits expense was also favorably impacted as higher loan originations enabled the bank to defer a greater amount of expenses. Finally, salaries and employee benefits expense also benefited by a one-time deferral of $0.3 million in costs associated with a new online banking system implemented in the second quarter of 2021, partially offsetting the increase in data processing expenses relating to the same project described above. Income Taxes Income tax expense for the three months ended June 30, 2021 and 2020 totaled $1.8 million and $0.3 million, respectively. The effective tax rates for the three months ended June 30, 2021 and 2020 were 22.0% and 18.7%, respectively. Income tax expense for the six months ended June 30, 2021 and 2020 totaled $3.3 million and $0.4 million, respectively. The effective tax rates for the six months ended June 30, 2021 and 2020 were 21.9% and 14.3%, respectively. The increase in the effective tax rates was primarily attributable to the absence of a discrete benefit recognized in the first quarter of 2020, and to a lesser extent, other permanent differences. The impact of these items on the effective tax rate varies with changes in pre-tax income. Financial Condition Summary At June 30, 2021 total assets were $2.3 billion, a $16.1 million, or a 0.7% increase compared to December 31, 2020. The change in assets remained relatively flat as the increase in loans were offset by a decrease in excess liquidity. Gross loans totaled $1.7 billion at June 30, 2021, an increase of $112.9 million compared to December 31, 2020. Excluding PPP loans, gross loans increased by $139.8 million at June 30, 2021 when compared to December 31, 2020. Deposits totaled $1.9 billion at June 30, 2021, compared to $1.8 billion at December 31, 2020. Total shareholders’ equity at June 30, 2021 and December 31, 2020 was $190.8 million and $176.6 million, respectively. The increase in shareholders' equity was primarily driven by (i) net income of $11.9 million for the six months ended June 30, 2021 and (ii) a $5.4 million favorable impact to accumulated other comprehensive income driven by fair value marks related to hedge positions involving interest rate swaps. 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. The increase in shareholders’ equity was partially offset by dividends paid of $2.2 million and common stock repurchases of $1.8 million. Loan Portfolio We originate commercial real estate loans, including construction loans, commercial business loans and other consumer loans. Our loan portfolio is the largest category of our earning assets. Total loans before deferred loan fees and the allowance for loan losses were $1.74 billion at June 30, 2021 and $1.63 billion at December 31, 2020. Total gross loans increased $112.9 million as of June 30, 2021 compared to the year ended December 31, 2020. 51 The following table compares the composition of our loan portfolio for the dates indicated: (In thousands) At June 30, 2021 At December 31, 2020 Change Real estate loans: Residential $ 100,260 $ 113,557 $ (13,297) Commercial 1,266,731 1,148,383 118,348 Construction 82,805 87,007 (4,202) 1,449,796 1,348,947 100,849 Commercial business 279,814 276,601 3,213 Consumer 8,883 79 8,804 Total loans $ 1,738,493 $ 1,625,627 $ 112,866 Asset Quality We actively manage asset quality through our underwriting practices and collection operations. Our Board of Directors monitors credit risk management. The Directors Loan Committee ("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, as well as loan review and problem loan management and resolution. The committee reports the results of its respective oversight functions to our Board of Directors. In addition, our Board of Directors receives information concerning asset quality measurements and trends on a monthly 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 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. As of 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. 52 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: (In thousands) At June 30, 2021 At December 31, 2020 Nonaccrual loans: Real estate loans: Residential $ 1,160 $ 1,492 Commercial 15,392 21,093 Commercial business 1,780 1,834 Construction 8,997 8,997 Total nonaccrual loans 27,329 33,416 Other real estate owned — — Total nonperforming assets $ 27,329 $ 33,416 Nonperforming assets to total assets 1.20 % 1.48 % Nonaccrual loans to total gross loans 1.57 % 2.06 % Total past due loans to total gross loans 1.65 % 0.93 % Nonperforming assets totaled $27.3 million and represented 1.20% of total assets at June 30, 2021, compared to $33.4 million and 1.48% of total assets at December 31, 2020. Nonaccrual loans totaled $27.3 million at June 30, 2021 and $33.4 million at December 31, 2020. The decrease in nonaccrual loans was partially a result of charge-offs primarily consisting of previously reserved commercial real estate exposure. The Bank continues work-out activity on its nonaccrual loan population. There was no other real estate owned at June 30, 2021 or December 31, 2020. Allowance for Loan Losses We evaluate the adequacy of the allowance for loan losses 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. 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. 53 The following table presents the activity in our allowance for loan losses and related ratios for the dates indicated: Three Months Ended June 30, Six Months Ended June 30, (Dollars in thousands) 2021 2020 2021 2020 Balance at beginning of period $ 20,545 $ 16,686 $ 21,009 $ 13,509 Charge-offs: Commercial real estate (3,814) — (3,977) — Commercial business (51) — (51) (8) Consumer (4) (23) (18) (25) Total charge-offs (3,869) (23) (4,046) (33) Recoveries: Commercial business 16 — 16 1 Consumer — — 9 1 Total recoveries 16 — 25 2 Net charge-offs (3,853) (23) (4,021) (31) (Credit) provision charged to earnings (20) 2,999 (316) 6,184 Balance at end of period $ 16,672 $ 19,662 $ 16,672 $ 19,662 Net charge-offs to average loans 0.23 % — % 0.24 % — % Allowance for loan losses to total gross loans 0.96 % 1.22 % 0.96 % 1.22 % At June 30, 2021, our allowance for loan losses was $16.7 million and represented 0.96% of total gross loans, compared to $21.0 million, or 1.29% of total gross loans, at December 31, 2020. The following table presents the allocation of the allowance for loan losses and the percentage of these loans to total loans for the dates indicated: At June 30, 2021 At December 31, 2020 (Dollars in thousands) Amount Percent of Loan Portfolio Amount Percent of Loan Portfolio Residential real estate $ 318 5.77 % $ 610 6.99 % Commercial real estate 13,209 72.86 16,425 70.64 Construction 133 4.76 221 5.35 Commercial business 2,976 16.10 3,753 17.02 Consumer 36 0.51 — — Total allowance for loan losses $ 16,672 100.00 % $ 21,009 100.00 % The allocation of the allowance for loan losses at June 30, 2021 reflects our assessment of credit risk and probable loss within each portfolio. We believe that the level of the allowance for loan losses at June 30, 2021 is appropriate to cover probable losses. Reserve for Unfunded Commitments The reserve for unfunded commitments provides for probable losses inherent with funding the unused portion of legal commitments to lend. The unfunded reserve calculation is primarily based on our allowance for loan loss methodology for funded loans, adjusted for utilization expectations. The reserve for unfunded credit commitments is included within other liabilities in the accompanying Consolidated Balance Sheets. Changes in the reserve are reported as a component of other noninterest expense in the accompanying Consolidated Statements of Income. Investment Securities At June 30, 2021, the carrying value of our investment securities portfolio totaled $109.3 million and represented 4.8% of total assets, compared to $106.9 million, or 4.7% of total assets, at December 31, 2020. 54 The net unrealized gain position on our investment portfolio at June 30, 2021 was $5.7 million and included gross unrealized losses of $0.3 million. The net unrealized gain position on our investment portfolio at December 31, 2020 was $7.5 million and included no gross unrealized losses. Deposit Activities and Other Sources of Funds June 30, 2021 December 31, 2020 (Dollars in thousands) Amount Percent Amount Percent Noninterest bearing demand $ 328,473 16.94 % $ 270,235 14.79 % NOW 136,558 7.04 101,737 5.57 Money market 814,083 41.98 669,364 36.63 Savings 173,943 8.97 158,750 8.69 Time 486,245 25.07 627,230 34.32 Total deposits $ 1,939,302 100.00 % $ 1,827,316 100.00 % Total deposits were $1.9 billion at June 30, 2021, an increase of $112.0 million, from the balance at December 31, 2020. Brokered certificates of deposits totaled $200.1 million at June 30, 2021 and $238.9 million at December 31, 2020. Certificates of deposits from national listing services totaled $1.1 million at June 30, 2021 and $18.4 million at December 31, 2020. Brokered money market accounts totaled $104.0 million at June 30, 2021 and $13.5 million at December 31, 2020. Brokered deposits represent brokered certificates of deposit, brokered money market accounts and one way buy Certificate of Deposit Account Registry Service (CDARS), and one way buy Insured Cash Sweep (ICS). At June 30, 2021 and December 31, 2020, time deposits with a denomination of $100 thousand or more, including CDARS and brokered deposits, totaled $400.7 million and $519.8 million, respectively, maturing during the periods indicated in the table below: (Dollars in thousands) June 30, 2021 December 31, 2020 Maturing: Within 3 months $ 131,455 $ 141,784 After 3 but within 6 months 41,502 67,064 After 6 months but within 1 year 48,089 118,880 After 1 year 179,674 192,051 Total $ 400,720 $ 519,779 We utilize advances from the Federal Home Loan Bank of Boston, or FHLB, as part of our overall funding strategy and to meet short-term liquidity needs, and to a lesser degree, manage interest rate risk arising from the difference in asset and liability maturities. Total FHLB advances were $75.0 million and $175.0 million at June 30, 2021 and December 31, 2020, respectively. The decrease of $100.0 million, or 57.1%, primarily reflects the substitution of lower cost brokered deposits in lieu of FHLB advances totaling $75.0 million and a permanent reduction in wholesale funding totaling $25.0 million. The Bank has additional borrowing capacity at the FHLB up to a certain percentage of the value of qualified collateral. In accordance with agreements with the FHLB, the qualified collateral must be free and clear of liens, pledges and encumbrances. At June 30, 2021, the Bank had pledged $778.3 million of eligible loans as collateral to support borrowing capacity at the FHLB of Boston. As of June 30, 2021, the Bank had immediate availability to borrow an additional $411.5 million based on qualified collateral. 55 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 positions are monitored daily by management. The Asset Liability Committee ("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 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. The Company anticipates that it will have sufficient funds available to meet its current loan and other commitments. As of June 30, 2021, the Company had cash and cash equivalents of $301.9 million and available-for-sale securities of $91.0 million. At June 30, 2021, outstanding commitments to originate loans totaled $85.7 million and undisbursed funds from approved lines of credit, home equity lines of credit and secured commercial lines of credit totaled $212.9 million. Capital Resources Shareholders’ equity totaled $190.8 million as of June 30, 2021, an increase of $14.2 million compared to December 31, 2020, primarily a result of (i) net income of $11.9 million for the six months ended June 30, 2021 and (ii) a $5.4 million favorable impact to accumulated other comprehensive income driven by fair value marks related to hedge positions involving interest rate swaps. 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. The increase in Shareholders’ equity was partially offset by dividends paid of $2.2 million and common stock repurchases of $1.8 million. As of June 30, 2021, the tangible common equity ratio and tangible book value per share were 8.30% and $24.40, 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 June 30, 2021, 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 for prompt corrective action. At June 30, 2021, the Bank’s ratio of Common Equity Tier 1 capital to risk-weighted assets was 10.95%, total capital to risk-weighted assets was 11.84%, Tier 1 capital to risk-weighted assets was 10.95% and Tier 1 capital to average assets was 9.19%. In July 2013, the Federal Reserve published Basel III rules establishing a new comprehensive capital framework of U.S. banking organizations. Under the rules, effective January 1, 2015 for the Company and Bank, the minimum capital ratios became a) 4.5% Common Equity Tier 1 to risk-weighted assets, b) 6.0% Tier 1 capital to risk weighted assets and c) 8.0% total capital to risk-weighted assets. In addition, the new regulations imposed certain limitations on dividends, share buy-backs, discretionary payments on Tier 1 instruments and discretionary bonuses to executive officers if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity to risk weighted assets, in addition to the amounts necessary to meet the minimum risk-based capital requirements described above. 56 Asset/Liability Management and Interest Rate Risk We measure interest rate risk using simulation analysis to calculate earnings and equity at risk. These risk measures are quantified using simulation software from one of the leading firms in the field of asset/liability modeling. Key assumptions relate to the behavior of interest rates and spreads, prepayment speeds and the run-off of deposits. From such simulations, interest rate risk, or IRR, is quantified and appropriate strategies are formulated and implemented. We model IRR by using two primary risk measurement techniques: simulation of net interest income and simulation of economic value of equity. These two measurements are complementary and provide both short-term and long-term risk profiles for the Company. Because both baseline simulations assume that our balance sheet will remain static over the simulation horizon, the results do not reflect adjustments in strategy that ALCO could implement in response to rate shifts. The simulation analyses are updated quarterly. We use a net interest income at risk simulation to measure the sensitivity of net interest income to changes in market rates. This simulation captures underlying product behaviors, such as asset and liability repricing dates, balloon dates, interest rate indices and spreads, rate caps and floors, as well as other behavioral attributes. The simulation of net interest income also requires a number of key assumptions such as: (i) prepayment projections for loans and securities that are projected under each interest rate scenario using internal and external mortgage analytics; (ii) new business loan rates that are based on recent new business origination experience; and (iii) deposit pricing assumptions for non-maturity deposits reflecting the Bank’s limited history, management judgment and core deposit studies. Combined, these assumptions can be inherently uncertain, and as a result, actual results may differ from simulation forecasts due to the timing, magnitude and frequency of interest rate changes, future business conditions, as well as unanticipated changes in management strategies. We use two sets of standard scenarios to measure net interest income at risk. For the Parallel Ramp Scenarios, rate changes are ramped over a twelve-month horizon based upon a parallel yield curve shift and then maintained at those levels over the remainder of the simulation horizon. Parallel Shock Scenarios assume instantaneous parallel movements in the yield curve compared to a flat yield curve scenario. Simulation analysis involves projecting a future balance sheet structure and interest income and expense under the various rate scenarios. Internal policy regarding internal rate risk simulations currently specifies that for instantaneous parallel shifts of the yield curve, estimated net interest income at risk for the subsequent one-year period should not decline by more than: 6% for a 100 basis point shift; 12% for a 200 basis point shift; and 18% for a 300 basis point shift. Per Company policy, the Bank should not be outside these limits for twelve consecutive months unless the Bank's forecasted capital ratios are considered to be "well capitalized". As of June 30, 2021, the Bank has met all minimum regulatory capital requirements to be considered "well capitalized", reference footnote 7 to the consolidated financial statements for more detail. The following tables set forth the estimated percentage change in our net interest income at risk over one-year simulation periods beginning June 30, 2021 and December 31, 2020: Parallel Ramp Estimated Percent Change in Net Interest Income Rate Changes (basis points) June 30, 2021 December 31, 2020 -100 (1.00) % 0.20 % +200 (2.40) (1.40) Parallel Shock Estimated Percent Change in Net Interest Income Rate Changes (basis points) June 30, 2021 December 31, 2020 -100 (2.00) % (0.30) % +100 (1.40) (1.00) +200 (2.30) (1.70) +300 (2.60) (2.00) The net interest income at risk simulation results indicate that, as of June 30, 2021, we remain liability sensitive. The liability sensitivity is due to the fact that there are more liabilities than assets subject to repricing as market rates change. 57 We conduct an economic value of equity at risk simulation in tandem with net interest income simulations, to ascertain a longer term view of our interest rate risk position by capturing longer-term repricing risk and options risk embedded in the balance sheet. It measures the sensitivity of economic value of equity to changes in interest rates. The economic value of equity at risk simulation values only the current balance sheet and does not incorporate the growth assumptions used in one of the income simulations. As with the net interest income simulation, this simulation captures product characteristics such as loan resets, repricing terms, maturity dates, rate caps and floors. Key assumptions include loan prepayment speeds, deposit pricing elasticity and non-maturity deposit attrition rates. These assumptions can have significant impacts on valuation results as the assumptions remain in effect for the entire life of each asset and liability. All key assumptions are subject to a periodic review. Base case economic value of equity at risk is calculated by estimating the net present value of all future cash flows from existing assets and liabilities using current interest rates. The base case scenario assumes that future interest rates remain unchanged. The following table sets forth the estimated percentage change in our economic value of equity at risk, assuming various shifts in interest rates: Estimated Percent Change in Economic Value of Equity ("EVE") Rate Changes (basis points) June 30, 2021 December 31, 2020 -100 (29.40) % (47.30) % +100 5.00 9.30 +200 7.10 13.80 +300 9.80 18.40 While ALCO reviews and updates simulation assumptions and also periodically back-tests the simulation results to ensure that the assumptions are reasonable and current, income simulation may not always prove to be an accurate indicator of interest rate risk or future net interest margin. Over time, the repricing, maturity and prepayment characteristics of financial instruments and the composition of our balance sheet may change to a different degree than estimated. ALCO recognizes that deposit balances could shift into higher yielding alternatives as market rates change. ALCO has modeled increased costs of deposits in the rising rate simulation scenarios presented above. In the minus 100 scenario above, the change in EVE of (29.4)% is outside of policy parameters, however, the Bank continues to be well-capitalized. The result of this simulation was discussed with the ALCO committee and the Company has decided to not take any further action at this time as this scenario is deemed unlikely in the current interest rate environment. It should be noted that the static balance sheet assumption does not necessarily reflect our expectation for future balance sheet growth, which is a function of the business environment and customer behavior. Another significant simulation assumption is the sensitivity of core deposits to fluctuations in interest rates. Income simulation results assume that changes in both core savings deposit rates and balances are related to changes in short-term interest rates. Lastly, mortgage-backed securities and mortgage loans involve a level of risk that unforeseen changes in prepayment speeds may cause related cash flows to vary significantly in differing rate environments. Such changes could affect the level of reinvestment risk associated with cash flow from these instruments, as well as their market value. Changes in prepayment speeds could also increase or decrease the amortization of premium or accretion of discounts related to such instruments, thereby affecting interest income.