What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-11-06 compared with 2020-08-07 · 461 added, 365 removed, 807 unchanged (51% of the section changed)

Management’s Discussion and Analysis of Financial Condition and Results of Operations

We are a bank holding company that operates through our wholly owned subsidiary, Coastal Community Bank (the “Bank”).

We are a bank holding company that operates through our wholly owned subsidiaries, Coastal Community Bank (the “Bank”) and Arlington Olympic LLC.

We are headquartered in Everett, Washington, which by population is the largest city in, and the county seat of, Snohomish County.

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We currently operate 15 full-service banking locations, 12 of which are located in Snohomish County, where we are the largest community bank by deposit market share, and three of which are located in neighboring counties (one in King County and two in Island County).

We opened our 15 th branch in Arlington, Washington during the second quarter of 2020.

The Bank also provides banking as a service (“BaaS”) that allows our broker-dealer and digital financial service partners to offer their customers banking services.

As of June 30, 2020, we had total assets of $1.68 billion, total gross loans of $1.45 billion, total deposits of $1.31 billion and total shareholders’ equity of $131.0 million.

The Bank also provides banking as a service (“BaaS”) that allows our broker-dealer and digital financial service providers to offer their customers banking services and expects to introduce a digital bank offering in collaboration with Google in 2021.

As of September 30, 2020, we had total assets of $1.75 billion, total gross loans of $1.51 billion, total deposits of $1.36 billion and total shareholders’ equity of $135.2 million.

The following discussion and analysis presents our financial condition and results of operations on a consolidated basis.

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As a bank holding company that operates through one segment, community banking, we generate most of our revenue from interest on loans and investments.

Our primary source of funding for our loans is commercial and retail deposits.

Our primary source of funding for our loans is commercial and retail deposits from our customer relationships.

We place secondary reliance on wholesale funding, primarily borrowings from the Federal Home Loan Bank (“FHLB”).

We are utilizing the Paycheck Protection Program Liquidity Facility (“PPPLF”), which provides an additional source of low cost funding for the PPP loans, with a contractual 0.35% interest rate.

The borrowings are collateralized by Paycheck Protection Program (“PPP”) loans and must be paid down as the PPP loans are forgiven or paid down by customers.

We are utilizing the Paycheck Protection Program Liquidity Facility (“PPPLF”), which provides an additional source of low cost funding for the PPP loans, with a contractual interest rate of 0.35%.

The PPPLF borrowings are collateralized by Paycheck Protection Program (“PPP”) loans and must be paid down as the PPP loans are forgiven or paid down by customers.

Less commonly used sources of funding include borrowings from the Federal Reserve System (“Federal Reserve”) discount window, draws on established federal funds lines from unaffiliated commercial banks, brokered funds, which allows us to obtain deposits from sources that do not have a relationship with the Bank and can be obtained through certificate of deposit listing services, via the internet or through other advertising methods, or a one-way buy through an insured cash sweep (“ICS”) account, which allows us to obtain funds from other institutions that have deposited funds through ICS.

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If the borrower defaults, the loan is guaranteed by the SBA.

The PPP program closed to new loan applicants on August 8, 2020.

We accepted and processed requests for existing and new customers for the duration of the program.

Deferral on PPP payments was extended as we await final guidance on these loans;

however, we have begun accepting applications from customers for loan forgiveness.

The Company's Preparations and Responses to COVID-19 Pandemic

As part of its ongoing risk preparation and mitigation efforts, the Company had developed a detailed plan and action measures related to a possible pandemic scenario.

This pandemic plan was implemented on March 12, 2020 and continued through the second quarter and into third quarter of 2020.

The Company carefully executed the plan with limited operational disruptions, attention to ensure continued customer support, and with the utmost care to safeguard employees, customers and vendors.

This pandemic plan was implemented on March 12, 2020 and continued through the third quarter and into fourth quarter of 2020.

The Company carefully executed the plan with limited operational disruptions, with attention to ensure continued customer support, and with the utmost care to safeguard employees, customers and vendors.

Management continues to monitor and, when appropriate, make changes to our planned response.

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Dispersed workforce throughout facilities in order to maximize social distancing protocols, including successful employment of remote work solutions for many employees.

Continued participation in the SBA PPP with funded loans outstanding of $438.1 million, for 2,526 borrowers, impacting nearly 40,000 employees in our communities, as of June 30, 2020.

Continued participation in the SBA PPP with funded loans outstanding of $452.8 million, as of September 30, 2020.

Actively engaged borrowers and other businesses in discussion to identify short-term cash flow and other financial needs, and restructured payments on existing loans to alleviate financial hardship per regulatory guidance.

As of June 30, 2020, payments have been deferred on 215 loans representing $207.2 million.

Pledged 711 PPP loans, or $190.2 million as of June 30, 2020, which provides an additional source of funding for the PPP loans, through the PPPLF.

The borrowings must be paid down as they are forgiven or when the customers pay the loan down.

As of October 31, 2020, $9.2 million, or 10 loans, remain on deferred or modified payment status.

Pledged 820 PPP loans, or $202.6 million as of September 30, 2020, which provides an additional source of funding for the PPP loans, through the PPPLF.

The borrowings must be paid down as PPP loan amounts are forgiven or when the customers pay their loans down.

PPPLF is a low cost source of funding and liquidity for PPP loans, with an interest rate of 0.35%, and favorable capital treatment.

Enhanced credit monitoring on loan segments that have been most impacted by COVID-19, monitoring and tracking loan payment deferrals and customer liquidity.

Reviewed loans impacted by the temporary halting of non-essential construction projects resulting from the stay-at-home order issued by the Governor of Washington, working with borrowers and extending the construction period as appropriate to compensate for the work shutdown.

The majority of Washington State, and Snohomish County in particular, was under a stay-at-home order for much of the second quarter of 2020.

Majority of Washington State, including Snohomish County, migrated to Phase 2 in early June, after spending most of the second quarter of 2020 in Phase 1 of Washington State’s 4 phase approach to re-opening businesses.

We anticipate remaining in Phase 2 for the foreseeable future.

Phase 2 allows:

Phase 2 provides:

Gatherings of no more than 5 people outside one’s household per week

Limited non-essential travel in proximity of one’s home

Travel to counties that are in other phases of reopening to participate in non-essential activities is not allowed

Opens certain businesses with social distancing and capacity restrictions

Refreshed and analyzed the Company's liquidity, funding and capital stress forecasts and risk assumptions.

Comparison of Operating Results for the Three Months Ended June 30 , 2020 and June 30 , 201 9

During the quarter ended June 30, 2020, significant focus was placed on helping the small businesses in our communities through the PPP.

These loans have had a significant impact on our financial statements for the current quarter ended June 30, 2020 and will continue to impact our results in the future.

During the second and third quarters of 2020, focus was placed on helping the small businesses in our communities through the PPP.

These loans have had a significant impact on our financial statements for the quarter ended September 30, 2020 and will continue to impact our results in the future.

Throughout this discussion, we will address the impact of these loans, including borrowings received through PPPLF to help fund these loans and to aid in liquidity, increased customer deposit accounts from unused disbursements, and earnings and expenses related to these activities.

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The table below summarizes key information regarding the PPP loans as of the period indicated:

As of June 30, 2020

As of September 30, 2020

$50,0000.01 -

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$2,000,000.00

> 2,000,000.01

(Dollars in thousands;

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Net deferred fees

Total principal, net of deferred fees

Weighted average maturity (years)

Total principal, net of deferred

Weighted average maturity

Number of loans:

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Total loan count

Percent of total

Comparison of Operating Results for the Three Months Ended September 30, 2020 and September 30, 2019

Results of Operations

Net income for the three months ended June 30, 2020, was $3.7 million, or $0.30 per diluted share, compared to $3.3 million, or $0.27 per diluted share, for the three months ended June 30, 2019.

The increase in net income over the comparable period in the prior year was attributable to a $3.8 million increase in net interest income, largely related to PPP loans.

Interest and fee income related to PPP loans totaled $2.8 million for the three months ended June 30, 2020.

Net income for the three months ended September 30, 2020, was $4.1 million, or $0.34 per diluted share, compared to $3.5 million, or $0.29 per diluted share, for the three months ended September 30, 2019.

The increase in net income over the comparable period in the prior year was attributable to a $4.4 million increase in net interest income, largely related to increased interest earning assets, including PPP loans.

Interest and fee income related to PPP loans totaled $3.6 million for the three months ended September 30, 2020.

Net deferred fees on PPP loans will be earned over the life of the loan, as a yield adjustment.

Forgiveness of principal, early paydowns and payoffs on PPP loans will increase interest income earned in those periods.

The increase in net interest income was partially offset by a $1.4 million increase in the provision for loan losses, related to the growth in the loan portfolio along with an increase in qualitative factors related to the change in the economic outlook caused by the COVID-19 pandemic, and $1.3 million increase in noninterest expense, which includes $686,000 more in salaries and employee benefits, $181,000 more in legal and professional fees and $122,000 more in data processing expenses.

Salaries and employee benefits were increased largely as a result of hiring staff for our BaaS CCBX division and legal and professional expenses were increased due to development of contracts for CCBX customers and because of reporting related legal and professional services.

Data processing costs grow as we add new products, customers and branches.

Additionally, CCBX data processing expenses are included in this category and are expected to increase incrementally as the CCBX division develops.

The increase in net interest income was partially offset by a $1.6 million increase in the provision for loan losses, related to an increase in qualitative factors related to the change in the economic outlook caused by the COVID-19 pandemic along with the growth in the loan portfolio, and $1.9 million increase in noninterest expense, which includes $1.0 million more in salaries and employee benefits, $211,000 more in legal and professional fees, and $207,000 more in occupancy expenses.

Salaries and employee benefits were increased largely as a result of hiring staff for our BaaS CCBX division, legal and professional expenses increased due to development of contracts for CCBX customers and because of reporting related legal and professional services.

The increase in occupancy expense is related to a one-time $119,000 building operating expense and higher rent and depreciation expenses resulting from the opening of our Arlington branch in the second quarter of 2020 and our overall growth as a Company.

Net Interest Income

Net interest income for the three months ended June 30, 2020, was $14.0 million, compared to $10.2 million for the three months ended June 30, 2019, an increase of $3.8 million, or 37.4%.

Net interest income for the three months ended September 30, 2020, was $15.1 million, compared to $10.7 million for the three months ended September 30, 2019, an increase of $4.4 million, or 40.7%.

The increase in net interest income consisted of a $4.0 million, or 32.7%, increase in interest income coupled with a $330,000, or 20.3%, decrease in interest expense.

The increase in interest income was primarily attributable to a $ 522.3 million, or 64.3 %, increase in average loans outstanding for the three months ended June 30, 2020 , compared to the prior year period , partially offset by an 82-basis point decrease in yield on loans.

The decrease in loan yields , as compared to the prior year period , was the result of the Federal Open Market Committee (“FOMC”) lowering the Fed funds rate five times since Ju ne 2019, totaling 2.

25 % , resulting in lower rates on new and renewing loans as well as loans tied to indexes.

In addition, for the quarter ended June 30, 2020 there was an average of $335.2 million in PPP loans, which have a 1.0% interest rate and an approximate yield of 3.31% after the amortization of deferred fees and costs .

Contractu al loan yields approximated 3.91 % for the quarter ended June 30, 2020 compared to 5.

2 3 % f or the quarter ended June 30, 2019 .

Although we have rate floors in place for $ 349.1 million, or 23.9 %, in existing loans, the rate reductions by the FOMC have had a corresponding impact on loan yields and subsequently the net interest margin in future periods.

We have continued to focus on our loan growth initiatives, including the deepening of relationships with existing customers and developing new loan and deposit relationships with new customers and non- B ank PPP customers .

During the quarter ended June 30, 2020 , our focus was on working with small busin esses within our communities with PPP loan requests.

W e have experienced a significant increase in commercial and industrial SBA 7(a) loans during the second quarter 2020, as small business owners apply for relief via the PPP as prescribed in the CARES Act.

The decrease in interest expense for the three months ended June 30, 2020 was the result of a 33 basis point decrease in cost of funds, bringing it to 0.41% as of June 30, 2020, compared to 0.74% at June 30, 2019.

Much of the funding from the PPP loans was deposited into core deposit accounts, including noninterest bearing accounts, until customers use the funds, which helped contribute to the improved cost of funds for the quarter ended June 30, 2020, as compared to the prior year period.

The average balance of interest-bearing deposits increased $157.9 million, or 28.7%, compared to the prior year period, but the average rate paid on interest bearing deposits was 41 basis points less for the quarter ended June 30, 2020, compared to the quarter ended June 30, 2019.

As previously mentioned, the Fed funds rate reductions by the FOMC have impacted the rates that are paid on interest bearing accounts and management lowered deposit rates in response to these rate reductions.

The average rate paid on BaaS-brokered deposits decreased 195 basis points and NOW and money market accounts decreased 33 basis points for the three months ended June 30, 2020.

The average rate paid on BaaS-brokered deposits was higher in the three months ended June 30, 2019 as a result of the temporary negotiated rate for that period.

The increase in interest income was primarily attributable to a $627.4 million, or 72.5%, increase in average loans outstanding for the three months ended September 30, 2020, compared to the prior year period, partially offset by a 1.03% decrease in yield on loans.

The decrease in loan yields, as compared to the prior year period, was the result of the Federal Open Market Committee (“FOMC”) lowering the Fed funds rate five times since June 2019, totaling 2.25%, resulting in lower rates on our variable rate, new and renewing loans.

In addition, for the quarter ended September 30, 2020 there was an average of $448.3 million in PPP loans, which have a 1.0% interest rate and an approximate yield of 3.16% after including the amortization of deferred fees and costs, which contributed to the decline in loan yield.

Contractual loan yields approximated 3.61% for the quarter ended September 30, 2020 compared to 5.24% for the quarter ended September 30, 2019.

Excluding PPP loans, the contractual loan yield approximated 4.69% for the three months ended September 30, 2020.

A reconciliation of this non-GAAP measure is set forth in the section titled “ GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.

” Although there are rate floors in place for $361.8 million, or 23.8%, in existing loans, the rate reductions by the FOMC have had a corresponding impact on loan yields and subsequently the net interest margin in future periods.

We expect that the FOMC will maintain the Fed funds rate low for some time.

During the quarter ended September 30, 2020, our focus continued to be on working with small businesses within our communities as business owners navigate through the uncertainty and change resulting from the COVID-19 pandemic.

We experienced a significant increase in commercial and industrial SBA 7(a) loans during the second and into the third quarter of 2020, as small business owners applied for relief via the PPP as prescribed in the CARES Act.

The PPP program closed to new loan applicants on August 8, 2020, and the Bank is no longer originating any PPP loans.

The decrease in interest expense for the three months ended September 30, 2020 was the result of a 39 basis point decrease in cost of funds, bringing it to 0.33% as of September 30, 2020, compared to 0.72% at September 30, 2019.

In addition to the aforementioned rate reductions by the FOMC, which ultimately resulted in a lowering of the interest rate paid on interest-bearing deposit accounts, we gained new customer relationships by making PPP loans to noncustomers and they continued to move their banking/deposit relationships to the Bank.

These increases in noninterest bearing and low rate interest bearing deposits helped contribute to the improved cost of funds for the quarter ended September 30, 2020, as compared to the prior year period.

The increase in borrowed funds is largely the result of utilizing the PPPLF to help fund PPP loans.

The PPPLF extends low cost borrowing lines, 0.35% interest rate, to eligible financial institutions that originate PPP loans, taking the loans as collateral at face value.

Borrowings are required to be paid down as the pledged PPP loans are paid down or forgiven.

The average balance for the three months ended September 30, 2020 was $199.1 million, resulting in $176,000 in interest expense.

The average balance of interest-bearing deposits increased $1 95.1 million, or 35.1 %, compared to the prior year period, but the average rate paid on interest bearing deposits was 5 5 basis points less for the quarter ended September 30, 2020, compared to the quarter ended September 30, 2019.

A s previously mentioned, the Fed funds rate reductions by the FOMC have impacted the rates that are paid on interest bearing accounts and management lowered deposit rates in response to these rate reductions .

The average rate paid on BaaS-brokered deposits decreased 1 64 basis points and NOW and money market accounts de creased 51 basis points for the three months ended September 30, 2020 .

The average rate paid on BaaS-brokered deposits was higher in the three months ended September 30, 2019 as a result of a temporary negotiated rate for that period.

The average rate paid on time deposits also decreased.

For time deposits less than $100,000 , the rate decreased 31 basis points and for time deposits over $100,000 , the average rate decreased 66 basis points, as compared to the prior year period.

The average rate paid on NOW, money market, and time deposit accounts in the quarter ended June 30, 2020 is the result of the recent decreased Fed funds rates and management lowering rates in response, which resulted in management lowering rates on these accounts.

Many deposit rates were either lowered late in the first quarter or at the start of the second quarter of 2020, so the impact of these reductions will continue to be seen in future periods.

The average balance of NOW and money market accounts grew $154.1 million, or 30.8%, in the three months ended June 30, 2020.

The average balance of BaaS-brokered deposits was $22.1 million for the three months ended June 30, 2020, which was up $1.9 million from the prior year period.

The average balance of savings accounts grew $15.5 million, or 25.5%, and the average balance of time deposits declined $13.6 million, or 16.0%, to $84.0 million in the three months ended June 30, 2020, compared to the three months ended June 30, 2019, in an intentional effort to focus more on core deposit growth.

The average rate paid on NOW , money market , and time deposit accounts in the quarter ended September 30, 2020 is the result of the recent decreased Fed funds rates and management lowering rates on these accounts in response .

We continue to evaluate rates and anticipate that additional rates reductions may occur in the fourth quarter .

Many deposit rates were either lowered late in the first quarter or at the start of the second quarter, and some rates were further lowered at the start of the third quarter of 2020, so the impact of these reductions were largely seen in the quarter ended September 30, 2020 and the full impact will continue to be seen in future periods.

The average balance of BaaS-brokered deposits was $ 21.7 million for the three mont hs ended September 30, 2020 , which was up $8.9 million from the prior year period.

T he average balance of savings accounts grew $ 21.4 million, or 40.8 %, and the average balance of time deposits declined $ 29.

6 million , or 30.8 % , to $ 66 .0 million in the three months ended September 30, 2020 , compared to the three months ended September 30, 2019, in an intentional effort to focus more on core deposit growth .

We do not regularly advertise time deposit rates or money market rates, although we occasionally advertise promotional rates in targeted portions of our market area.

Our branch managers, business development officers, and lenders collaborate to provide consistent and coordinated customer service and to seek deposits from new and existing customers.

For the three months ended June 30, 2020, net interest margin (annualized net interest income divided by average total interest earning assets) and net interest spread (average yield on total interest earning assets minus average cost of total interest bearing liabilities) were 3.78% and 3.49%, respectively, compared to 4.24% and 3.77%, respectively, for the three months ended June 30, 2019.

For the three months ended September 30, 2020, net interest margin (annualized net interest income divided by average total interest earning assets) and net interest spread (average yield on total interest earning assets minus average cost of total interest bearing liabilities) were 3.62% and 3.41%, respectively, compared to 4.29% and 3.81%, respectively, for the three months ended September 30, 2019.

The following table presents an analysis of the average balances of net interest income, net interest spread and net interest margin for the periods indicated.

Loan fees included in interest income totaled $ 2.2 million and $ 3 1 5 ,000 for the three months ended June 30, 2020 and 2019 , respectively.

The increase in loan fees for the quarter ended June 30, 2020 is due to the PPP loans.

For the three months ended June 30, 2020 and 2019 , the amount of interest income not recognized on nonaccrual loans was not material.

Loan fees included in interest income totaled $ 2.

7 million and $ 25 5 ,000 for the three months ended September 30, 2020 and 2019 , respectively.

A total of $2.4 million in PPP loan fees were recognized in the quarter ended September 30, 2020.

Yield on loans receivable was 4.33% for the three months ended September 30, 2020, compared to 5.36% for the three months ended September 30, 2019.

Excluding PPP loans, the yield on loans receivable was 4.78% for the three months ended September 30, 2020.

A reconciliation of this non-GAAP measure is set forth in the section titled “ GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.

” For the three months ended September 30, 2020 and 2019 , the amount of interest income not recognized on nonaccrual loans was not material.

Average Balance Sheets

For the Three Months Ended June 30,

For the Three Months Ended September 30,

(Dollars in thousands)

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The following table presents information regarding the dollar amount of changes in interest income and interest expense for the periods indicated for each major component of interest earning assets and interest bearing liabilities and distinguishes between the changes attributable to changes in volume and changes attributable to changes in interest rates.

The table illustra tes the $6.8 million increase in loan interest income is attributed to an increase in loan volume.

This increase is partially offset by a $2.2 million decrease in loan interest income due to lower interest rates, however that decrease is largely due to low rate PPP loans, which yielded approximately 3.16%, after including the amortization of the deferred fees and costs, for the three months ended September 30, 2020.

For purposes of this table, changes attributable to both rate and volume that cannot be segregated have been allocated to volume.

Three Months Ended June 30, 2020

Three Months Ended June 30, 2019

Three Months Ended September 30, 2020

Three Months Ended September 30, 2019

Increase (Decrease)

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For a description of the factors taken into account by our management in determining the allowance for loan losses see “—Financial Condition—Allowance for Loan Losses.”

The provision for loan losses for the three months ended June 30, 2020 was $1.9 million, compared to $547,000 for the three months ended June 30, 2019.

The allowance for loan losses as a percentage of loans was 1.03% at June 30, 2020, compared to 1.24% at June 30, 2019.

For the three months ended June 30, 2020, there were $438.1 million in PPP loans included in our portfolio.

These loans are 100% guaranteed by the SBA.

The provision for loan losses for the three months ended September 30, 2020 was $2.2 million, compared to $637,000 for the three months ended September 30, 2019.

The allowance for loan losses as a percentage of loans was 1.13% at September 30, 2020, compared to 1.25% at September 30, 2019.

For the three months ended September 30, 2020, there were $452.8 million in PPP loans included in our portfolio.

These loans are 100% guaranteed by the SBA, therefore we have not allocated any portion of our allowance to these 100% guaranteed loans.

The allowance for loan losses to loans receivable, excluding the guaranteed PPP loans, is 1.60%.

A reconciliation of this non-GAAP measure is set forth in the section titled “ GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.

” The provision for loan losses was increased due to loan growth and along with an increase in qualitative factors related to the change in economic outlook caused by the COVID-19 pandemic.

” The provision for loan losses was increased due to an increase in qualitative factors related to the change in economic outlook caused by the COVID-19 pandemic along with loan growth.

We are not required to implement the provisions of the Current Expected Credit Loss (“CECL”) accounting standard until January 1, 2023, therefore we are continuing to account for the allowance for loan losses under the incurred loss model.

Credit quality has remained stable through June 30, 2020, as demonstrated by the low level of charge-offs and nonperforming loan balance.

N onperforming assets to total assets was 0.26% at June 30, 2020 compared to 0.16% at June 30, 2019.

Credit quality has remained stable through September 30, 2020, as demonstrated by the low level of charge-offs and nonperforming loan balance.

Nonperforming loans increased $42,000 in the three months ended September 30, 2020, as compared to $4.4 million in the three months ended June 30, 2020.

N onperforming assets to total assets was 0.26% at September 30, 2020 compared to 0.12% at September 30, 2019.

For a description of the Company’s nonperforming assets see “—Financial Condition—Nonperforming Assets.”

Net charge-offs for the three months ended June 30, 2020 totaled $8,000, or 0.00% (annualized), of total average loans, as compared to $19,000, or 0.01% (annualized) of total average loans, for the three months ended June 30, 2019.

The short-term and long-term economic impact of the COVID-19 pandemic is unknown;

however, we remain diligent in our efforts to communicate and proactively work with borrowers to help mitigate potential credit deterioration.

Pursuant to federal guidance, the Company deferred and/or modified payments on loans to assist customers financially during the COVID-19 pandemic and economic shutdown.

The majority of those loans have successfully returned to active status.

At September 30, 2020, the Company had 44 loans, or $52.5 million, that remained outstanding with deferred or modified payments, compared to $207.2 million, or 215 loans, as of June 30, 2020.

All of the loans that have migrated to active status are current, with 128 loans or $93.1 million, successfully resuming payments and 65 loans or $76.0 million back on active status with an initial

payment due in the fourth quarter of 2020.

In addition, $3.0 million of deferred and/or modified loans paid-in-full or closed as of September 30, 2020 .

The purpose of this program was to provide cash flow relief for small businesses as they navigated through the uncertainty of the COVID-19 pandemic.

We believe that the Company’s deferral program was successful as evidenced by customers’ ability to migrate from deferral to active status and resume making payments as planned.

However, a s additional loans migrate to active status, we anticipate that there will be borrowers that are unable to resume making payments as planned.

There is uncertainty surrounding the economy, the continuation of unemployment benefits, stimulus payments, political uncertainty, and the continued restrictions on businesses, all of which lead to uncertainty with our customers and their ability to remain current on their financial obligations.

These factors all contributed to the additional reserve to loan losses that was made in the three months ended September 30, 2020.

Net charge-offs for the three months ended September 30, 2020 totaled $1,000, or 0.00% (annualized), of total average loans, as compared to $192,000, or 0.09% (annualized) of total average loans, for the three months ended September 30, 2019.

The full extent of the short-term and long-term economic impact of the COVID-19 pandemic is unknown;

however, we remain diligent in our efforts to communicate and proactively work with borrowers to help mitigate potential credit deterioration and loan losses.

Noninterest Income

Our primary sources of recurring noninterest income are deposit service charges and fees, BaaS fees, mortgage broker fees and loan referral fees.

Noninterest income does not include loan origination fees to the extent they exceed the direct loan origination costs, which are generally recognized over the life of the related loan as an adjustment to yield using the interest or similar method.

For the three months ended June 30, 2020 , noninterest income totaled $ 1.5 million, a de crease of $ 6 12 ,000, or 28.7 %, compared to $ 2.

1 million for the three months ended June 30, 2019 .

Noninterest income does not include loan origination fees including PPP loans fees, which to the extent they exceed the direct loan origination costs, are generally recognized over the life of the related loan as an adjustment to yield using the interest or similar method and recognized in interest and fees on loans as part of interest income.

For the three months ended September 30, 2020, noninterest income totaled $1.9 million, a decrease of $146,000, or 7.0%, compared to $2.1 million for the three months ended September 30, 2019.

The following table presents, for the periods indicated, the major categories of noninterest income:

Ended June 30,

Ended September30,

(Dollars in thousands)

Deposit service charges and fees

BaaS service fees

Mortgage broker fees

Loan referral fees

Mortgage broker fees

Gain on sales of loans, net

Gain on sale of securities, net

Total noninterest income

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Together they constitute one of the largest components of our noninterest income.

Deposit service charges were $677,000 for the three months ended June 30, 2020, a decrease of $104,000, or 13.3%, from $781,000 over the same period in the prior year.

The decrease in deposit service charges and fees was primarily the result of $57,000 less overdraft fee income in the quarter ended June 30, 2020 compared to the prior year period, combined with $17,000 less in point of sale fees, $16,000 less in merchant services revenue and $12,000 less in ATM income, all of which could be attributed to the stay-at-home order in place for Washington State during part of the second quarter, and overall reduced activity as a result of COVID-19 restrictions, stimulus payments distributed to tax payers and increased unemployment benefits.

Our CCBX division provides BaaS offerings that enable our broker dealer and digital financial service partners to offer their customers banking services.

Deposit service charges were $824,000 for the three months ended September 30, 2020, an increase of $29,000, or 3.6%, from $795,000 over the same period in the prior year.

The increase in deposit service charges and fees was primarily the result of $61,000 increase in point of sale fees partially offset by $32,000 less overdraft fee income in the quarter ended September 30, 2020 compared to the prior year period.

Our CCBX division provides BaaS offerings that enable our broker dealer and digital financial service providers to offer their customers banking services.

In exchange for providing these services, we earn fixed fees, volume-based fees and reimbursement of costs depending on the contract.

BaaS fee income for the three months ended June 30, 2020 was $475,000 compared to $502,000 for the three months ended June 30, 2019.

The decrease is the result of slower implementation times with new BaaS partners and modifications to fee arrangements with existing customers which reduced noninterest income in the quarter ended June 30, 2020 in exchange for increased fees in the future.

The decision to trade current revenue for ongoing future revenue was made to benefit the Company in the long term.

As of June 30, 2020, there were three active CCBX partners, two in friends and family trials, two in onboarding/implementation, three signed letters of intent and a solid pipeline.

As partnerships move to active status it is expected that BaaS fees will increase.

Mortgage Broker Fees .

We earn mortgage broker fees for residential real estate loans that we broker through mortgage lenders.

Mortgage broker fees increased $41,000 in the three months ended June 30, 2020 to $152,000, compared to $111,000 in the same period in 2019 as a result of increased demand from lower interest rates on mortgages.

BaaS fee income for the three months ended September 30, 2020 was $576,000 compared to $456,000 for the three months ended September 30, 2019.

The increase is the result of adding additional CCBX customers to active and implementation status.

As of September 30, 2020, there were four active CCBX relationships, one in friends and family trials, four in onboarding/implementation, two signed letters of intent and a solid pipeline of potential new relationships.

As more CCBX customers move to active status, we expect that BaaS fees will increase.

Loan Referral Fees .

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By facilitating interest rate swaps to our clients, we are able to provide them with a long-term, fixed interest rate without assuming the interest rate risk.

We had $70,000 in income from l oan referral fees for the three months ended June 30, 2020, compared to $473,000 in the same period in the prior year.

We had $180,000 in income from l oan referral fees for the three months

ended September 30, 2020 , compared to zero in the same period in the prior year.

Interest rate volatility, swap rates, and the timing of loan closings all impact the demand for long-term fixed rate swaps.

The recognition of loan referral fees fluctuates in response to these market conditions and as a result we may not recognize any, or recognize fewer, loan referral fees in some periods.

The recognition of loan referral fees fluctuates in response to these market conditions and as a result we may not recognize any , or recognize more or fewer, loan referral fees in some periods.

Mortgage Broker Fees .

We earn mortgage broker fees for residential real estate loans that we broker through mortgage lenders.

Mortgage broker fees decreased $15,000 in the three months ended September 30, 2020 to $125,000, compared to $140,000 in the same period in 2019 as a result of lower demand;

however, low mortgage rates continue to make homes more affordable and mortgage refinancing an attractive option.

Gain on Sales of Loans, net .

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This activity fluctuates based on SBA and USDA loan activity.

We did not sell the guaranteed portion of any SBA or USDA loans in the three months ended June 30, 2020, therefore our income decreased $132,000 from the three months ended June 30, 2019.

This category includes a variety of other income-producing activities, annuity broker fees, and SBA and USDA servicing fees.

Other noninterest income increased $13,000 in the three months ended June 30, 2020, compared to the same period in 2019 primarily from higher lease and sublease income.

Gain on sale of loans decreased $322,000, or 87.3%, to $47,000 for the three months ended September 30, 2020, compared to $369,000 for the same period in 2019 as a result of fewer SBA and USDA loans being originated and sold to the secondary market.

Our focus on loans in the second and third quarter of 2020 was on PPP loans administered by the SBA.

Gain on Sale of Securities, net .

In the third quarter of 2019, we restructured our investment portfolio to improve the rate of return, interest rate and pricing risk on the portfolio.

As a result of this restructuring we were able to recognize $171,000 in net gains on the securities sold during the three months ended September 30, 2019 while decreasing the overall weighted average maturity of the investment portfolio.

No securities were sold in the three months ended September 30, 2020.

This category includes a variety of other income-producing activities, lease and sublease income, annuity broker fees, and SBA and USDA servicing fees.

Other noninterest income increased $33,000 in the three months ended September 30, 2020, compared to the same period in 2019 primarily from higher SBA and USDA servicing fee income.

Noninterest Expense

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Noninterest expense also includes operational expenses, such as occupancy expense, data processing expense, legal and professional fees, director and staff expense and software licenses, maintenance and subscriptions.

For the three months ended June 30, 2020, noninterest expense totaled $8.9 million, an increase of $1.3 million, or 17.0%, compared to $7.6 million for the three months ended June 30, 2019.

For the three months ended September 30, 2020, noninterest expense totaled $9.7 million, an increase of $1.9 million, or 24.8%, compared to $7.7 million for the three months ended September 30, 2019.

The following table presents, for the periods indicated, the major categories of noninterest expense:

Ended June 30,

Ended September 30,

(Dollars in thousands)

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Director and staff expenses

FDIC assessments

Federal Deposit Insurance Corporation (“FDIC”) assessments

Business development

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Salaries and employee benefits are the largest component of noninterest expense and include payroll expense, incentive compensation costs, benefit plans, health insurance and payroll taxes.

Salaries and employee benefits were $5.2 million for the three months ended June 30, 2020, an increase of $686,000, or 15.1%, compared to $4.5 million for the three months ended June 30, 2019.

The increase was primarily due to continued hiring staff for our BaaS CCBX division and additional staff for our ongoing banking related growth initiatives, as well as employing temporary help to assist with operations related to the PPP loans.

The increase in expense was reduced as a result of an increase in deferred loan costs recorded as salary offsets, largely from originating PPP loans, which was $1.2 million higher and lowered expense by that same amount, for the quarter ended June 30, 2020, compared to the quarter ended June 30, 2019.

As our BaaS banking activities grow, we expect to continue to add employees to support this line of business.

As of June 30, 2020, we had 220 full-time equivalent employees, compared to 187 at June 30, 2019, a 17.6% increase.

Occupancy Expenses.

Occupancy expenses were $933,000 for the three months ended June 30, 2020, compared to $930,000 for the three months ended June 30, 2019.

This category includes building, leasehold, furniture, fixtures and equipment depreciation totaling $311,000 and $301,000 for the three months ended June 30, 2020 and 2019, respectively.

Occupancy expenses remained relatively flat year over year, but with the opening of our 15 th branch late in the second quarter of 2020, and as we continue to grow, we expect occupancy expenses to increase.

Salaries and employee benefits were $ 6.0 million for the three months ended September 30, 2020 , an increase of $ 1.0 million , or 20.1 %, compared to $ 5.0 million for the three months ended September 30, 2019 .

The increase was primarily due to continued hiring staff for our BaaS CCBX division and additional staff for our ongoing banking related growth initiatives , including hiring staff for opening our Arlington branch in J une 20 20, as well as employing temporary help to assist with operations related to the PPP loans .

A s our BaaS activities and customers grow , we expect to continue to add employees to support this line of business.

As of September 30, 2020 , we had 2 34 full-time equivalent employees, compared to 1 92 at September 30, 2019 , a 2 2.0 % increase .

Occupancy expenses were $1.1 million for the three months ended September 30, 2020, compared to $884,000 for the three months ended September 30, 2019.

This category includes building, leasehold, furniture, fixtures and equipment depreciation totaling $345,000 and $301,000 for the three months ended September 30, 2020 and 2019, respectively.

Occupancy expenses increased as a result of $119,000 in a one-time building operating expense, with the opening of our 15 th branch late in the second quarter of 2020 and as a result of the growth in CCBX.

As we continue to grow, we expect occupancy expenses to increase.

Data Processing.

Data processing costs were $621,000 for the three months ended June 30, 2020, compared to $499,000 for the three months ended June 30, 2019.

Data processing costs were $577,000 for the three months ended September 30, 2020, compared to $509,000 for the three months ended September 30, 2019.

Data processing costs include all of our customer transaction processing and data storage, computer processing, and network costs.

Data processing costs grow as we add new products, customers and branches.

Additionally, CCBX data processing expenses are included in this category and are expected to increase incrementally as the CCBX division expands.

Data processing costs grow as we grow and add new products, customers and branches.

Additionally, CCBX data processing expenses are included in this category and are expected to increase incrementally as the CCBX division grows.

Legal and Professional Fees.

Legal and professional costs were $474,000 for the quarter ended June 30, 2020, compared to $293,000 for the quarter ended June 30, 2019.

Legal and professional costs were $381,000 for the quarter ended September 30, 2020, compared to $170,000 for the quarter ended September 30, 2019.

Legal and professional costs fluctuate with the development of contracts for CCBX customers and are also impacted by our reporting cycle and timing of legal and professional services.

The increase in legal and professional expenses is associated with BaaS activities through CCBX operations and higher costs related to legal and accounting work related to reporting.

Software Licenses, Maintenance and Subscriptions.

Software licenses, maintenance and subscriptions includes expenses related to obtaining and maintaining software required for various functions throughout the Company.

Software licenses, maintenance and subscriptions were $311,000 for the quarter ended June 30, 2020, compared to $172,000 for the prior year period.

Late in 2019, we changed how we were expensing these costs, consolidating all related expenses to one category, which contributed to the increase over

the prior year period.

Software related expenses is expected to continue to increase as we grow product lines and expand our CCBX division.

Software licenses, maintenance and subscriptions were $337,000 for the quarter ended September 30, 2020, compared to $181,000 for the prior year period.

Late in 2019, we changed how we were expensing these costs, consolidating all related expenses to one category, which contributed to the increase over the prior year period.

Additionally, software related expenses are expected to continue to increase as we grow product lines and our CCBX division.

Excise Taxes.

Excise taxes were $262,000 for the three months ended June 30, 2020, compared to $180,000 for the three months ended June 30, 2019.

Excise taxes are based on gross income of $16.9 million and $13.9 million for the three months ended June 30, 2020 and 2019, respectively.

Excise taxes were $291,000 for the three months ended September 30, 2020, compared to $184,000 for the three months ended September 30, 2019.

Excise taxes are based on gross income of $18.4 million and $14.4 million for the three months ended September 30, 2020 and 2019, respectively.

Gross income is reduced by certain allowed deductions to arrive at the taxable base;

however, as gross income increases, so does the excise tax expense.

In addition, the tax rate that is applied to our industry increased 25 basis points effective April 1, 2020, which contributed to the increase in excise tax.

Director and Staff Expenses.

Director and staff expenses includes compensation for director service, continuing education for employees and other director and staff related expenses.

Director and staff expenses were $187,000 for the three months ended June 30, 2020, compared to $217,000 for the three months ended June 30, 2019, a decrease of $30,000 or 13.8%.

Decreased expenses related to employee travel as a result of restrictions related to the COVID-19 pandemic contributed to the decrease in the quarter ended June 30, 2020 compared to quarter ended June 30, 2019.

Marketing costs were $116,000 for the three months ended June 30, 2020, compared to $108,000 for the three months June 30, 2019.

Marketing costs were relatively flat year over year;

however, as we continue to offer new products and services and grow our brand, we would expect marketing costs to increase.

Director and staff expenses were $156,000 for the three months ended September 30, 2020, compared to $241,000 for the three months ended September 30, 2019, a decrease of 85,000 or 35.3%.

Decreased expenses related to employee travel as a result of restrictions related to the COVID-19 pandemic contributed to the decrease in the quarter ended September 30, 2020 compared to quarter ended September 30, 2019.

FDIC Assessments.

FDIC assessments are assessed to fund the Deposit Insurance Fund (“DIF”) to insure and protect the depositors of insured banks and to resolve failed banks.

The assessment rate is based on a number of factors and recalculated each quarter.

FDIC assessments were $148,000 for the three months ended September 30, 2020, compared to $4,000 credit for the three months ended September 30, 2019, an increase of $152,000.

The DIF’s reserve was in excess of the required ratio in 2019, resulting in a credit for the three months ended September 30, 2019 based on past activity and payments.

The DIF reserve ratio is currently below the required ratio.

Business Development.

Business development costs were $48,000 for the three months ended June 30, 2020, compared to $96,000 for the three months ended June 30, 2019.

Business development costs were $72,000 for the three months ended September 30, 2020, compared to $122,000 for the three months ended September 30, 2019.

Business development costs include sponsorships and other activities to cultivate business and community development.

As expected, these expenses were reduced as a result of restrictions on in person meetings and business related activities due to the COVID-19 pandemic.

Marketing costs were $52,000 for the three months ended September 30, 2020, compared to $98,000 for the three months ended September 30, 2019.

Marketing costs decreased year over year due to a conscious effort to reduce general advertising costs

during the COVID-19 pandemic.

The bank is using more cost-effective advertising options ;

however, we expect to see advertising expenses increase as we deploy more branding and targeted advertising.

This category includes dues and memberships, office supplies, mail services, telephone, examination fees, internal loan expenses, services charges from banks, operational losses, directors and officer’s insurance, donations, provision for unfunded commitments, and miscellaneous other expenses.

Other noninterest expense was $704,000 for the three months ended June 30, 2020, compared to $485,000 for the three months ended June 30, 2019.

The increase was largely due to a $39,000 increase in the reserve for unfunded commitments, $40,000 increase in bank examination fees, $23,000 increase in FRB and bank service changes, and overall growth for the three months ended June 30, 2020, as compared to the same period last year.

Other noninterest expense was $590,000 for the three months ended September 30, 2020, compared to $392,000 for the three months ended September 30, 2019.

The increase was largely due to a $191,000 increase in BaaS expenses and overall growth for the three months ended September 30, 2020, as compared to the same period last year.

Income Tax Expense

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Valuation allowances are established when necessary to reduce our deferred tax assets to the amount expected to be realized.

For the three months ended June 30, 2020, income tax expense totaled $967,000, compared to $854,000 for the three months ended June 30, 2019.

Our effective tax rates for the three months ended June 30, 2020 and 2019 were 20.8% and 20.7%, respectively.

Comparison of Operating Results for the Six Months Ended June 30, 2020 and June 30, 2019

For the three months ended September 30, 2020, income tax expense totaled $1.1 million, compared to $919,000 for the three months ended September 30, 2019.

Our effective tax rates for the three months ended September 30, 2020 and 2019 were 20.9% and 20.7%, respectively.

Comparison of Operating Results for the Nine months ended September 30, 2020 and September 30, 2019

Results of Operations

Net income for the six months ended June 30, 2020, was $6.4 million, or $0.52 per diluted share, compared to $6.1 million, or $0.50 per diluted share, for the six months ended June 30, 2019.

The increase in net income over the comparable period in the prior year was attributable to a $5.4 million increase in net interest income, largely related to organic loan growth combined with growth from PPP loans, partially offset by a $2.4 million increase in the provision for loan losses, related to the growth in the loan portfolio along with an increase in qualitative factors related to the change in the economic outlook caused by the COVID-19 pandemic, and $2.7 million increase in noninterest expense, which includes $1.8 million more in salaries and employee benefits and $144,000 more in data processing expenses.

Net income for the nine months ended September 30, 2020, was $10.5 million, or $0.86 per diluted share, compared to $9.6 million, or $0.79 per diluted share, for the nine months ended September 30, 2019.

The increase in net income over the comparable period in the prior year was attributable to a $9.8 million increase in net interest income, largely related to organic loan growth combined with growth from PPP loans, partially offset by a $4.0 million increase in the provision for loan losses, related to an increase in qualitative factors related to the change in the economic outlook caused by the COVID-19 pandemic along with the growth in the loan portfolio, and $4.6 million increase in noninterest expense, which includes $2.8 million more in salaries and employee benefits and $306,000 more in legal and professional fees.

Salaries and employee benefits were increased largely as a result of hiring staff for our BaaS CCBX division.

Data processing costs grow as we add new products, customers and branches.

Additionally, CCBX data processing expenses are included in this category and are expected to increase incrementally as the CCBX division develops.

Legal and professional fees increased due to BaaS activities through our CCBX division and as a result of higher costs related to legal and accounting work related to reporting.

Net Interest Income

Net interest income for the six months ended June 30, 2020, was $25.4 million, compared to $20.0 million for the six months ended June 30, 2019, an increase of $5.4 million, or 27.1%.

The increase in net interest income consisted of a $6.4 million, or 30.2%, in increased loan interest income as a result of higher volume and $206,000, or 7.2%, less in interest expense on deposits, partially offset by $150,000, or 38.6%, increase in interest on borrowed funds.

The increase in interest income was primarily attributable to a $353.2 million, or 44.3%, increase in average loans outstanding for the six months ended June 30, 2020, compared to the prior year period, partially offset by a 54 basis point decrease in yield on loans.

Net interest income for the nine months ended September 30, 2020, was $40.5 million, compared to $30.7 million for the nine months ended September 30, 2019, an increase of $9.8 million, or 31.9%.

The increase in net interest income consisted of $11.0 million, or 33.3%, in increased loan interest income.

An increase in loan volume drove income up, despite a decrease in interest rates.

Additionally, interest expense on deposits decreased $761,000, or 17.7%, and was partially offset by $375,000, or 64.4%, increase in interest on borrowed funds.

The increase in interest income was primarily attributable to a $445.1 million, or 54.2%, increase in average loans outstanding for the nine months ended September 30, 2020, compared to the prior year period, partially offset by a 73 basis point decrease in yield on loans.

The decrease in loan yields, as compared to the prior year period, was the result of the FOMC lowering rates five times since June 2019, totaling 2.25%, which resulted in lower rates on new and renewing loans as well as loans tied to indexes.

In addition, for the six months ended June 30, 2020 there was an average of $167.6 million in PPP loans, which have a 1.0% interest rate and an approximate yield of 3.31% after the amortization of deferred fees and costs.

Contractual loan yields approximated 4.40% for the six months ended June 30, 2020 compared to 5.23% for the six months ended June 30, 2019.

In addition, for the nine months ended September 30, 2020 there was an average of $261.9 million in PPP loans, which have a 1.0% interest rate and an approximate yield of 3.23% after including the amortization of deferred fees and costs.

Contractual loan yields approximated 4.08% for the nine months ended September 30, 2020 compared to 5.23% for the nine months ended September 30, 2019.

Excluding PPP loans, the contractual loan yield approximated 4.86%.

A reconciliation of this non-GAAP measure is set forth in the section titled “ GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.

” Although we have rate floors in place for $361.8 million, or 23.8%, in existing loans, the rate reductions by the FOMC have had a corresponding impact on loan yields and subsequently the net interest margin in future periods.

We have continued to focus on our loan growth initiatives, but most recently our focus has been on working with small businesses within our communities, providing assistance to existing and new customers, through PPP loans.

We have experienced a significant increase in commercial and industrial loans, as small business owners apply for financial assistance via the PPP through the SBA as prescribed in the CARES Act.

The slight decrease in interest expense for the six months ended June 30, 2020 was the result of a $206,000 decrease in interest expense on deposit accounts partially offset by a $150,000 increase in interest on borrowed funds.

Cost of funds decreased 21 basis points to 0.54% as of June 30, 2020, compared to 0.75% at June 30, 2019.

Much of the funding from the PPP loans was deposited into core deposit accounts, including noninterest bearing accounts, until customers use the funds, which contributed to the improved cost of funds for the six months ended June 30, 2020, as compared to the prior year period.

The average balance of interest-bearing deposits increased $107.5 million, or 19.2%, compared to the prior year period, but the average rate paid on interest bearing deposits was 23 basis points less for the six months ended June 30, 2020, compared to the six months ended June 30, 2019.

We expect that the FOMC will maintain the Fed funds rate low for some time.

We have continued to focus on our loan growth initiatives, but most recently much of our focus has been on working with small businesses within our communities, providing assistance as business owners navigate through the uncertainty and change resulting from the COVID-19 pandemic.

We experienced a significant increase in commercial and industrial loans during the second and third quarters of 2020, as small business owners applied for financial assistance via the PPP through the SBA as prescribed in the CARES Act.

The decrease in interest expense for the nine months ended September 30, 2020 was the result of a $761,000 decrease in interest expense on deposit accounts partially offset by a $375,000 increase in interest on borrowed funds.

Cost of funds decreased 29 basis points to 0.45% as of September 30, 2020, compared to 0.74% at September 30, 2019.

The increases in noninterest bearing and low rate interest bearing deposits helped contribute to the improved cost of funds for the nine months ended September 30, 2020, as compared to the prior year period.

We gained new customer relationships by making PPP loans to noncustomers and they continued to move their banking/deposit relationships to the Bank.

The increase in borrowed funds is largely the result of utilizing the PPPLF to help fund PPP loans as disbursements are withdrawn from deposit accounts.

The PPPLF extends low cost borrowing lines, 0.35% interest rate, to eligible financial institutions that originate PPP loans, taking the loans as collateral at face value.

Borrowings are required to be paid down as the pledged PPP loans are paid down or forgiven.

The average balance for the nine months ended September 30, 2020 was $102.5 million, resulting in $269,000 in interest expense.

The average balance of interest-bearing deposits increased $136.9 million, or 24.5%, compared to the prior year period, but the average rate paid on interest bearing deposits was 35 basis points less for the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019.

As previously discussed, the Fed funds rate reductions by the FOMC have impacted the rates that are paid on interest bearing accounts and management lowered deposit rates in response to these rate reductions.

The average rate paid on BaaS-brokered deposits decreased 165 basis points and NOW and money market accounts decreased four basis points for the six months ended June 30, 2020.

The average rate paid on BaaS-brokered deposits was higher in the six months ended June 30, 2019 as a result of the temporary increase in BaaS-brokered deposits for that period.

The average rate

paid on BaaS-brokered deposits decreased 1.72% and NOW and money market accounts decreased 21 basis points for the nine months ended September 30, 2020.

The average rate paid on BaaS-brokered deposits was higher in the nine months ended September 30, 2019 as a result of the temporary rate negotiated for BaaS-brokered deposits for that period.

The average rate paid on time deposits also decreased.

For time deposits less than $100,000 the rate decreased 1 9 basis points and for time deposits over $100,000 the average rate decreased 36 basis points, as compared to the prior year period .

The average rate paid on NOW, money market, and time deposit accounts in the six months ended June 30, 2020 is the result of the recent decreased Fed funds rates, which resulted in management lowering rates on these accounts.

Many deposit rates were either lowered late in the first quarter or at the start of the second quarter of 2020, so the impact of these reductions will continue to be seen in future periods.

The average balance of NOW and money market accounts grew $135.9 million, or 37.2%, in the six months ended June 30, 2020, compared to the six months ended June 30, 2019.

The average balance of BaaS-brokered deposits was $21.9 million for the six months ended June 30, 2020, which was down $25.1 million, or

53.3%, from the prior year period.

The higher balance in the prior year period was the result of temporary increase in BaaS deposits for that period , and a subsequent planned exit of balances .

T he average balance of savings accounts grew $ 8.5 million, or 16.3 %, and the average balance of time deposits declined $1 1.9 million, or 12.3 % , to $84.

4 million in the six months ended June 30, 2020, compared to the six months ended June 30, 2019, in an intentional effort to focus on more on core deposit growth .

The average rate paid on NOW, money market, and time deposit accounts in the nine months ended September 30, 2020 is the result of the recent decreased Fed funds rate and management lowering rates in response.

We continue to evaluate rates and anticipate that additional rates reductions may occur in the fourth quarter.

Many deposit rates were either lowered late in the first quarter or at the start of the second quarter of 2020, and some were further decreased at the start of the third quarter, so the impact of these reductions will continue to be seen in future periods.

The average balance of NOW and money market accounts grew $ 1 55.5 million, or 41.4 %, in the nine months ended September 30, 2020 , compared to the nine months ended September 30, 2019 .

The average balance of BaaS-brokered deposits was $2 1.

8 million for the nine months ended September 30, 2020, which was down $ 13.6 million , or 38.4 %, from the prior year period.

The higher balance in the prior year period was the result of a temporary increase in BaaS deposits for that period , and a subsequent planned exit of balances .

T he average balance of savings accounts grew $ 12.8 million, or 24.5 %, and the average balance of time deposits declined $ 17.8 million, or 18.5 % , to $ 78.2 million in the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019, in an intentional effort to focus on more on core deposit growth .

We do not regularly advertise time deposit rates or money market rates, although we occasionally advertise promotional rates in targeted portions of our market area.

Our branch managers, business development officers, and lenders collaborate to provide consistent and coordinated customer service and to seek deposits from new and existing customers.

For the six months ended June 30, 2020, net interest margin and net interest spread were 3.93% and 3.58%, respectively, compared to 4.19% and 3.73%, respectively, for the six months ended June 30, 2019.

For the nine months ended September 30, 2020, net interest margin and net interest spread were 3.81% and 3.51%, respectively, compared to 4.22% and 3.76%, respectively, for the nine months ended September 30, 2019.

The following table presents an analysis of the average balances of net interest income, net interest spread and net interest margin for the periods indicated.

Loan fees included in interest income totaled $2.6 million and $666,000 for the six months ended June 30, 2020 and 2019, respectively.

The increase in loan fees for the six months ended June 30, 2020 is due to the PPP loans.

For the six months ended June 30, 2020 and 2019, the amount of interest income not recognized on nonaccrual loans was not material.

Loan fees included in interest income totaled $5.3 million and $920,000 for the nine months ended September 30, 2020 and 2019, respectively.

The increase in loan fees for the nine months ended September 30, 2020 is due to the PPP loans.

Yield on loans receivable was 4.65% for the nine months ended September 30, 2020, compared to 5.38% for the nine months ended September 30, 2019.

Excluding PPP loans, the yield on loans receivable was 4.99% for the nine months ended September 30, 2020.

A reconciliation of this non-GAAP measure is set forth in the section titled “ GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.

” For the nine months ended September 30, 2020 and 2019, the amount of interest income not recognized on nonaccrual loans was not material.

Average balance sheets

For the Six Months Ended June 30,

For the Nine Months Ended September 30,

(Dollars in thousands)

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This table illustrates the $15.5 million increase in loan interest income as a result of increased loan volume was significantly more than the $4.5 million decrease in interest income due to lower interest rates on loans , resulting in an overall increase in loan interest income for the nine months ended September 30, 2020, compared to the n i ne months ended September 30, 2019.

Similarly, the volume of interest bearing deposits has increased by $702,000 , but the reduced interest rate paid on interest bearing deposits resulted in an overall decrease in interest expense on interest bearing deposits for the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019.

For purposes of this table, changes attributable to both rate and volume that cannot be segregated have been allocated to volume.

Six Months Ended June 30, 2020

Six Months Ended June 30, 2019

Nine Months Ended September 30, 2020

Nine Months Ended September 30, 2019

Increase (Decrease)

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For a description of the factors taken into account by our management in determining the allowance for loan losses see “—Financial Condition—Allowance for Loan Losses.”

The provision for loan losses for the six months ended June 30, 2020 was $3.5 million, compared to $1.1 million for the six months ended June 30, 2019.

The allowance for loan losses as a percentage of loans was 1.03% at June 30, 2020, compared to 1.24% at June 30, 2019.

For the six months ended June 30, 2020, there were $438.1 million in PPP loans in our portfolio.

These loans are 100% guaranteed by the SBA.

The provision for loan losses for the nine months ended September 30, 2020 was $5.7 million, compared to $1.7 million for the nine months ended September 30, 2019.

The allowance for loan losses as a percentage of loans was 1.13% at September 30, 2020, compared to 1.25% at September 30, 2019.

As of September 30, 2020, there were $452.8 million in PPP loans in our portfolio.

These loans are 100% guaranteed by the SBA and we have not allocated any portion of our allowance to these 100% guaranteed loans.

The allowance for loan losses to loans receivable, excluding the guaranteed PPP loans, is 1.60%.

A reconciliation of this non-GAAP measure is set forth in the section titled “ GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.

” The provision for loan losses was increased due to loan growth and along with an increase in qualitative factors related to the change in economic outlook caused by the COVID-19 pandemic.

” The provision for loan losses was increased due to an increase in qualitative factors related to the change in economic outlook caused by the COVID-19 pandemic along with loan growth.

We are not required to implement the provisions of the CECL accounting standard until January 1, 2023, therefore we are continuing to account for the allowance for loan losses under the incurred loss model.

We are working with customers impacted by COVID-19 and have deferred or restructured payments in accordance with federal guidance on $207.2 million as of June 30, 2020.

Credit quality has remained stable through June 30, 2020, as demonstrated by the low level of charge-offs and nonperforming loan balance.

N onperforming assets to total assets was 0.26% at June 30, 2020 compared to 0.16% at June 30, 2019.

We are working with customers impacted by COVID-19 and have deferred or modified payments in accordance with federal guidance on $52.5 million as of September 30, 2020, compared to $207.2 million as of June 30, 2020.

Credit quality has remained stable through September 30, 2020, as demonstrated by the low level of charge-offs and nonperforming loan balance.

N onperforming assets to total assets was 0.26% at September 30, 2020 compared to 0.12% at September 30, 2019.

For a description of the Company's nonperforming assets, see "—Financial Condition—Nonperforming Assets."

As of June 30, 2020, there were $207.2 million, or 215 customers, on deferred payments, with $7.2 million, or 24 customers, moving to active status during the month of June 2020.

Of the customers moving to active status from deferrals, all were able to successfully resume making payments.

As additional loans migrate to active status, we anticipate that there will be borrowers that are unable to resume making payments as planned.

There is uncertainty surrounding the economy, the continuation of unemployment benefits, stimulus payments and the continued restrictions on businesses, all of which lead to uncertainty with our customers and their ability to remain current on their financial obligations.

These factors all contributed to the additional reserve to loan losses that was made in the six months ended June 30, 2020.

Net charge-offs for the six months ended June 30, 2020 totaled $131,000, or 0.02% (annualized) of total average loans, as compared to $51,000, or 0.01% (annualized) of total average loans, for the six months ended June 30, 2019.

The short-term and long-term

economic impact of the COVID-19 pandemic is unknown;

Pursuant to federal guidance, the Company deferred and/or modified payments on loans to assist customers financially during the COVID-19 pandemic and economic shutdown.

The majority of those loans have successfully returned to active status.

At September 30, 2020, the Company had 44 loans, or $52.5 million, that remained outstanding with deferred or modified payments, compared to $207.2 million, or 215 loans, as of June 30, 2020.

All of the loans that have migrated to active status are current, with

128 loans or $93.1 million, successfully resuming payments and 65 loans or $76.0 million back on active status with an initial payment due in the fourth quarter of 2020.

In addition, $3.0 million of deferred and/or modified loans paid-in-full or closed as of September 30, 2020 .

The purpose of this program was to provide cash flow relief for small businesses as they navigated through the uncertainty of the COVID-19 pandemic.

We believe that the Company’s deferral program was successful as evidenced by customers ’ ability to migrate from deferral to active status and resume making payments as planned.

However, a s additional loans migrate to active status, we anticipate that there will be borrowers that are unable to resume making payments as planned.

There is uncertainty surrounding the economy, the continuation of unemployment benefits, stimulus payments , political uncertainty, and the continued restrictions on businesses, all of which lead to uncertainty with our customers and their ability to remain current on their financial obligations.

These factors all contributed to the additional reserve to loan losses that was made in the nine months ended September 30, 2020.

Net charge-offs for the nine months ended September 30, 2020 totaled $132,000, or 0.01% (annualized) of total average loans, as compared to $243,000, or 0.04% (annualized) of total average loans, for the nine months ended September 30, 2019.

The full extent of the short-term and long-term economic impact of the COVID-19 pandemic is unknown;

however, we remain diligent in our efforts to communicate and proactively work with borrowers to help mitigate potential credit deterioration and future losses.

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Our primary sources of recurring noninterest income are deposit service charges and fees, loan referral fees, BaaS fees, and mortgage broker fees.

Noninterest income does not include loan origination fees, which are generally recognized over the life of the related loan as an adjustment to yield using the interest or similar method.

For the six months ended June 30, 2020, noninterest income totaled $4.2 million, a decrease of $75,000, or 1.8%, compared to $4.1 million for the six months ended June 30, 2019.

Noninterest income does not include loan origination fees, including PPP loan fees, which are generally recognized over the life of the related loan as an adjustment to yield using the interest or similar method and recognized in interest and fees on loans as part of interest income.

For the nine months ended September 30, 2020, noninterest income totaled $6.1 million, a decrease of $71,000, or 1.1%, compared to $6.2 million for the nine months ended September 30, 2019.

The following table presents, for the periods indicated, the major categories of noninterest income:

Ended June 30,

Ended September 30,

(Dollars in thousands)

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Loan referral fees

BaaS service fees

Mortgage broker fees

Gain on sales of loans, net

Gain on sales of securities, net

Total noninterest income

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Together they constitute one of the largest components of our noninterest income.

Deposit service charges were $1.4 million for the six months ended June 30, 2020, a decrease of $107,000, or 7.1%, from $1.5 million over the same period in the prior year.

The decrease in deposit service charges and fees was primarily the result of $86,000 less overdraft fee income in the six months ended June 30, 2020 compared to the prior year period, combined with $12,000 less in point of sale fees, $11,000 less in merchant services revenue and $8,000 less in ATM income, all of which may be attributed to the stay-at-home order in place for Washington State during part of the first half of 2020, and overall reduced activity as a result of COVID-19 restrictions, stimulus payments distributed to tax payers and increased unemployment benefits.

Deposit service charges were $2.2 million for the nine months ended September 30, 2020, a decrease of $78,000, or 3.5%, from $2.3 million over the same period in the prior year.

The decrease in deposit service charges and fees was primarily the result of $118,000 less overdraft fee income in the nine months ended September 30, 2020 compared to the prior year period which may be attributed to the stay-at-home order in place for Washington State during part of the first half of 2020, and overall reduced activity as a result of COVID-19 restrictions.

An increase in point-of-sale fees of $49,000 partially offset some of these reductions.

Our CCBX division provides BaaS offerings that enable our broker dealer and digital financial service providers to offer their customers banking services.

In exchange for providing these services, we earn fixed fees, volume-based fees and reimbursement of costs depending on the contract.

BaaS fee income for the nine months ended September 30, 2020 was $1.6 million compared to $1.4 million for the nine months ended September 30, 2019.

The increase is the result of increased relationships with broker dealers and digital financial service providers.

At September 30, 2020 there were four active CCBX relationships, one in friends and family trials, four in onboarding/implementation, two signed letters of intent and a solid pipeline of potential new relationships.

As more CCBX customers move to active status, we expect that BaaS fees will increase.

Loan Referral Fees .

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By facilitating interest rate swaps to our clients, we are able to provide them with a long-term, fixed interest rate without assuming the interest rate risk.

We had $1.1 million in income from l oan referral fees for the six months ended June 30, 2020 and 2019.

3 million in income from l oan referral fees for the nine months ended September 30, 2020 compared to $1.1 million for the nine months ended September 30, 2019.

Interest rate volatility, swap rates, and the timing of loan closings all impact the demand for long-term fixed rate swaps.

The recognition of loan referral fees fluctuates in response to these market conditions and as a result we may not recognize any, or recognize fewer, loan referral fees in some periods.

Our CCBX division provides BaaS offerings that enable our broker dealer and digital financial service partners to offer their customers banking services.

In exchange for providing these services, we earn fixed fees, volume-based fees and reimbursement of costs depending on the contract.

BaaS fee income for the six months ended June 30, 2020 was $1.1 million compared to $948,000 for the six months ended June 30, 2019.

The increase is the result of increased partnerships with broker dealers and digital financial service partners.

At June 30, 2020 there were three active CCBX partners, two in friends and family trials, two in onboarding/implementation, three signed letters of intent and a solid pipeline.

The recognition of loan referral fees fluctuates in response to these market conditions and as a result we may not recognize any , or recognize more or fewer, loan referral fees in some periods.

Mortgage Broker Fees .

We earn mortgage broker fees for residential real estate loans that we broker through mortgage lenders.

Mortgage broker fees increased $103,000 in the nine months ended September 30, 2020 to $439,000, compared to $336,000 in the same period in 2019 as a result of increased demand from lower interest rates on mortgages which continue to make homes more affordable and mortgage refinancing an attractive option.

Gain on Sales of Loans, net .

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This activity fluctuates based on SBA and USDA loan activity.

We did not sell the guaranteed portion of any SBA or USDA loans in the six months ended June 30, 2020, therefore our income decreased $121,000 from the six months ended June 30, 2019.

Mortgage Broker Fees .

We earn mortgage broker fees for residential real estate loans that we broker through mortgage lenders.

Mortgage broker fees increased $118,000 in the six months ended June 30, 2020 to $314,000, compared to $196,000 in the same period in 2019 as a result of increased demand from lower interest rates on mortgages.

Income from the sale of loans was $47,000 for the nine months ended September 30, 2020, compared to $490,000 for the nine months ended September 30, 2019, a decrease of $443,000 or 90.4%, as a result of fewer SBA and USDA loans being originated and sold to the secondary market.

Gain on Sale of Securities, net.

In the third quarter of 2019, we restructured our investment portfolio to improve the rate of return, interest rate and pricing risk on the portfolio.

As a result of this restructuring we were able to recognize $171,000 in net gains on the securities sold during the nine months ended September 30, 2019 while decreasing the overall weighted average maturity of the investment portfolio.

No securities were sold in the nine months ended September 30, 2020 .

This category includes a variety of other income-producing activities, annuity broker fees, and SBA and USDA servicing fees.

Other noninterest income increased $62,000 in the six months ended June 30, 2020, compared to the same period in 2019 primarily as a result of higher SBA and USDA servicing fees and higher lease and sublease income.

Other noninterest income increased $95,000 in the nine months ended September 30, 2020, compared to the same period in 2019 primarily as a result of higher SBA and USDA servicing fees and higher lease and sublease income.

Noninterest Expense

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For the six months ended June 30, 2020, noninterest expense totaled $18.0 million, an increase of $2.7 million, or 17.4%, compared to $15.3 million for the six months ended June 30, 2019.

For the nine months ended September 30, 2020, noninterest expense totaled $27.6 million, an increase of $4.6 million, or 19.9%, compared to $23.1 million for the nine months ended September 30, 2019.

The following table presents, for the periods indicated, the major categories of noninterest expense:

Ended June 30,

Ended September 30,

(Dollars in thousands)

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Director and staff expenses

Business development

FDIC assessments

Business development

Total noninterest expense

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Salaries and employee benefits are the largest component of noninterest expense and include payroll expense, incentive compensation costs, benefit plans, health insurance and payroll taxes.

Salaries and employee benefits were $10.9 million for the six months ended June 30, 2020, an increase of $1.8 million, or 19.9%, compared to $9.1 million for the six months ended June 30, 2019.

Salaries and employee benefits were $ 1 6.9 million for the nine months ended September 30, 2020 , an increase of $ 2 .8 million , or 2 0.0 %, compared to $ 14.1 million for the nine months ended September 30, 2019 .

The increase was primarily due to continued hiring staff for our BaaS CCBX division and additional staff for our ongoing banking related growth initiatives , as well as employing temporary help to assist with operations related to the PPP loans.

The increase in expense would have been greater if not for an increase in deferred loan costs recorded as salary offsets, largely from originating PPP loans, which was $1.2 million higher and lowered expense by that same amount, for the six months ended June 30, 2020, compared to the six months ended June 30, 2019.

The increase in expense would have been greater if not for an increase in deferred loan costs recorded as salary offsets, largely from originating PPP loans, which was $1.

4 million higher and lowered expense by that same amount, for the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019.

As our BaaS banking activities grow, we expect to continue to add employees to support this line of business.

As of June 30, 2020, we had 220 full-time equivalent employees, compared to 187 at June 30, 2019, a 17.6% increase.

Occupancy Expenses.

Occupancy expenses were $1.9 million for the six months ended June 30, 2020 and 2019.

This category includes building, leasehold, furniture, fixtures and equipment depreciation totaling $620,000 and $606,000 for the six months ended June 30, 2020 and 2019, respectively.

As of September 30, 2020 , we had 2 34 full-time equivalent employees, compared to 1 92 at September 30, 2019, a 22.0 % increase.

Occupancy expenses were $3.0 million for the nine months ended September 30, 2020 compared to $2.8 million for the nine months ended September 30, 2019, an increase of $143,000 or 5.1%.

This category includes building, leasehold, furniture, fixtures and equipment depreciation totaling $965,000 and $907,000 for the nine months ended September 30, 2020 and 2019, respectively.

Occupancy expenses increased $143,000 year over year largely as the result of the opening of our 15 th branch late in the second quarter of 2020.

As we continue to grow, we expect occupancy expenses to increase.

Data Processing.

Data processing costs were $ 1.2 million for the six months ended June 30, 2020, compared to $ 1.0 million for the six months ended June 30, 2019 .

Data processing costs were $1.7 million for the nine months ended September 30, 2020, compared to $1.5 million for the nine months ended September 30, 2019.

Data processing costs include all of our customer transaction processing and data storage, computer processing, and network costs.

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Legal and Professional Fees.

Legal and professional costs were $797,000 for the six months ended June 30, 2020 compared to $702,000 for the six months ended June 30, 2019.

Legal and professional costs were $1.2 million for the nine months ended September 30, 2020 compared to $872,000 for the nine months ended September 30, 2019.

Legal and professional costs fluctuate with the development of contracts for CCBX customers and are also impacted by our reporting cycle and timing of legal services.

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Software licenses, maintenance and subscriptions includes expenses related to obtaining and maintaining software required for various functions throughout the Company.

Software licenses, maintenance and subscriptions were $582,000 for the quarter ended June 30, 2020, compared to $320,000 for the prior year period.

Software licenses, maintenance and subscriptions were $919,000 for the quarter ended September 30, 2020, compared to $501,000 for the prior year period.

Late in 2019, we changed how we were expensing these costs, consolidating all related expenses to one category, which contributed to the increase over the prior year period.

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Excise Taxes.

Excise taxes were $465,000 for the six months ended June 30, 2020, compared to $345,000 for the six months ended June 30, 2019.

Excise taxes are based on gross income of $32.7 million and $27.3 million for the six months ended June 30, 2020 and 2019, respectively.

Excise taxes were $756,000 for the nine months ended September 30, 2020, compared to $529,000 for the nine months ended September 30, 2019.

Excise taxes are based on gross income of $51.1 million and $41.8 million for the nine months ended September 30, 2020 and 2019, respectively.

Gross income is reduced by certain allowed deductions to arrive at the taxable base;

however, as gross income increases, so does the excise tax expense.

In addition, the tax rate that is applied to our industry increased 25 basis points effective April 1, 2020, which contributed to the increase in excise taxes.

Director and Staff Expenses.

Director and staff expenses includes compensation for director service, continuing education for employees and other director and staff related expenses.

Director and staff expenses were $457,000 for the six months ended June 30, 2020 and 2019.

Increased director fees from adding an additional director in May of 2019 and higher employee training costs were offset by decreased expenses related to employee travel expenses as a result of restrictions related to COVID-19 in the six months ended June 30, 2020, compared to quarter ended June 30, 2019.

Marketing costs were $228,000 for the six months ended June 30, 2020, compared to $202,000 for the six months ended June 30, 2019.

Marketing costs were relatively flat year over year;

however, as we continue to offer new products and services and grow our brand, we expect marketing costs to increase.

Director and staff expenses were $613,000 for the nine months ended September 30, 2020 and $698,000 for the nine months ended September 30, 2019, a decrease of $85,000.

The decrease is the result of decreased expenses related to employee travel expenses as a result of restrictions related to COVID-19 partially offset by increased training expenses in the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019.

FDIC Assessments.

FDIC assessments are assessed to fund the DIF to insure and protect the depositors of insured banks and to resolve failed banks.

The assessment rate is based on a number of factors and is recalculated each quarter.

FDIC assessments were $292,000 for the nine months ended September 30, 2020, compared to $205,000 for the nine months ended September 30, 2019, an increase of $87,000.

The DIF’s reserve was in excess of the required ratio in 2019, resulting in a credit for the third quarter of 2019, reducing the amount assessed.

Marketing costs were $280,000 for the nine months ended September 30, 2020, compared to $300,000 for the nine months ended September 30, 2019.

Marketing costs decreased year over year due to a conscious effort to reduce general advertising costs during the COVID-19 pandemic.

The bank is using more cost-effective advertising options;

however, we expect to see advertising expenses increase as we deploy more branding and targeted advertising.

Business Development.

Business development costs were $173,000 for the six months ended June 30, 2020, compared to $198,000 for the six months ended June 30, 2019.

Business development costs include sponsorships and other activities to cultivate business and community development.

Business development costs were $245,000 for the nine months ended September 30, 2020, compared to $320,000 for the nine months ended September 30, 2019.

Business development costs include sponsorships and other activities to

cultivate business and community development.

As expected, these expenses were reduced as a result of restrictions on in person meetings and business related activities due to the COVID-19 pandemic .

Other noninterest expenses were $1.2 million for the six months ended June 30, 2020, compared to $833,000 for the six months ended June 30, 2019.

The increase was largely due to a $90,000 increase in bank examination fees and overall growth for the six months ended June 30, 2020, as compared to the same period last year.

Other noninterest expenses were $1.8 million for the nine months ended September 30, 2020, compared to $1.2 million for the nine months ended September 30, 2019.

The increase was largely due to a $108,000 increase in bank examination fees, $56,000 increase in telephone costs, $47,000 increase in service charges from banks, $42,000 increase in operational losses, $32,000 increase in donations and overall increases resulting from growth for the nine months ended September 30, 2020, as compared to the same period last year.

Income Tax Expense

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Valuation allowances are established when necessary to reduce our deferred tax assets to the amount expected to be realized.

For the six months ended June 30, 2020, income tax expense totaled $1.7 million, compared to $1.6 million for the six months ended June 30, 2019.

Our effective tax rates for the six months ended June 30, 2020 and 2019 was 20.8%.

For the nine months ended September 30, 2020, income tax expense totaled $2.8 million, compared to $2.5 million for the nine months ended September 30, 2019.

Our effective tax rates for the nine months ended September 30, 2020 and 2019, was 20.9% and 20.8%, respectively.

Financial Condition

The Company’s total assets increased $550.4 million, or 48.8%, to $1.68 billion at June 30, 2020 from $1.13 billion at December 31, 2019.

The increase is primarily the result of $508.0 million in gross loan growth during the six months ended June 30, 2020.

The Company’s total assets increased $621.1 million, or 55.0%, to $1.75 billion at September 30, 2020 from $1.13 billion at December 31, 2019.

The increase is primarily the result of $570.3 million in gross loan growth during the nine months ended September 30, 2020.

Included in the loan growth is $452.8 million in PPP loans.

These PPP loans are 100% guaranteed by the SBA and have a rate of 1.0%, an approximate yield of 3.23%.

Interest earning deposits with other banks also increased $36.4 million, compared to June 30, 2019.

Interest earning deposits with other banks also increased $56.8 million, compared to September 30, 2019.

Loan Portfolio

The quarter ended June 30, 2020 closed with the global COVID-19 pandemic continuing to impact the economic health of our community and nation.

The provision for loan losses allowances was $3.5 million during the six months ended June 30, 2020, as a result of loan growth and an increase in qualitative factors related to the economic outlook.

As a preferred SBA lender, we worked diligently with the SBA to offer assistance to small businesses as provided in the CARES Act.

The quarter ended September 30, 2020 closed with the global COVID-19 pandemic continuing to impact the economic health of our community and nation.

The provision for loan losses allowances was $5.7 million during the nine months ended September 30, 2020, as a result of an increase in qualitative factors related to uncertainties in the economic outlook from the COVID-19 pandemic and loan growth.

As a preferred SBA lender, we worked diligently with the SBA in the second quarter and third quarters of 2020 to offer assistance to small businesses as provided in the CARES Act, which significantly increased our loan totals.

These SBA loans are discussed further in this section under “Commercial and Industrial Loans”.

As part of our ongoing commitment to our customers we have been proactive in contacting customers impacted by the stay-at-home order in Washington State, temporary business closures, or that have otherwise been impacted by the COVID-19 pandemic and responses thereto.

In addition to the PPP loans we made to assist customers, as of June 30, 2020, we have $207.2 million in deferred or restructured payments, pursuant to federal guidance, representing 215 loans.

Of the 215 loans that remain on deferral, 92 loans, or $77.1 million, received a loan extension as part of the deferral and restructuring process.

During the quarter ended June 30, 2020, there were 24 loans, representing $7.2 million, that moved back to active status from deferral status, with all of them successfully resuming payments.

The charts below show more detail regarding the payment modifications and deferrals.

The graphs below indicate the percentage of loans that were granted a deferral related to the COVID-19 pandemic.

This illustration is based on total loans outstanding as of March 31, 2020 to approximate the impact to our portfolio, pre-COVID-19;

also presented is deferred loans compared to total loans outstanding as of June 30, 2020.

Deferrals remaining as of June 30, 2020:

Remaining deferrals by industry as of Ju ne 30 , 2020:

As a result of proactively reaching out to customers to offer deferment to help reduce cash flow pressure through the stay-at-home order, we did not see material downgrades in credit during the six months ended June 30, 2020.

In addition to the PPP loans we made to assist customers, as of September 30, 2020, we have $52.5 million in deferred or modified payments, pursuant to federal guidance, representing 44 loans.

During the quarter ended September 30, 2020, there were an additional 7 loans, or $10.2 million, that were granted deferred or modified payments and 169 loans, representing $161.9 million, that moved back to active status from deferral status.

In total, we have deferred or modified payments on 245 loans, or $224.6 million.

As of September 30, 2020, $93.1 million, or 128 loans, have successfully resumed payments as scheduled, $76.0 million, or 65 loans, have moved to active status and have a payment due in the fourth quarter of 2020, $3.0 million, or 8 loans, have closed and paid-in-full, leaving $52.5 million, or 44 loans, on deferral.

All of the loans on deferred or modified status as of September 30, 2020 are scheduled to return to active status in the fourth quarter of 2020.

The graph below illustrates the status of all the loans that were part of the COVID-19 deferral program:

The graph below indicates the percentage of loans that remain on a COVID-19 deferral.

This illustration is based on total loans outstanding as of as of September 30, 2020.

Remaining deferrals by industry as of September 30, 2020:

As a result of proactively reaching out to customers to offer deferment to help reduce cash flow pressure we did not see material downgrades in credit during the nine months ended September 30, 2020.

We will continue to be diligent in monitoring credit and changes in the economy, keeping the lines of communication open with our customers, but the full impact of these challenging economic times on our financial condition and liquidity remains to be seen at this time.

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Our loan portfolio represents the highest yielding component of our earning assets.

As of June 30, 2020, gross loans totaled $1.45 billion, an increase of $508.0 million, or 54.1%, compared to December 31, 2019.

The increase was largely due to our efforts to provide community assistance through the PPP loans, which resulted in $438.1 million in PPP loans as of June 30, 2020.

Loans as a percentage of deposits were 110.8% as of June 30, 2020, compared to 97.0% as of December 31, 2019.

As of September 30, 2020, gross loans totaled $1.51 billion, an increase of $570.3 million, or 60.7%, compared to December 31, 2019.

The increase was largely due to our efforts to provide community assistance through the PPP loans, which resulted in $452.8 million in PPP loans as of September 30, 2020, coupled with an additional $117.5 million in loan growth.

Loans as a percentage of deposits were 1 1 1.0 % as of September 30, 2020 , compared to 9 7.0 % as of December 31, 2019 .

We are focused on serving our communities and markets by growing loans and funding those loans with customer deposits.

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The following table summarizes our loan portfolio by type of loan as of the dates indicated:

As of June 30, 2020

As of September 30, 2020

As of December 31, 2019

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Commercial and Industrial Loans.

Commercial and industrial loans increased $440.1 million, or 395.1%, to $551.6 million as of June 30, 2020, from $111.4 million as of December 31, 2019.

Commercial and industrial loans increased $477.8 million, or 428.9%, to $589.2 million as of September 30, 2020, from $111.4 million as of December 31, 2019.

Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and effectively.

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Most commercial and industrial loans are secured by the assets being financed or other business assets, such as accounts receivable, inventory or equipment, and we generally obtain personal guarantees on these loans.

Included in this balance is $12.0 million in capital call lines resulting from relationships with our BaaS partners as of June 30, 2020.

We are working with the SBA to help small businesses as provided in the CARES Act.

Included in commercial and industrial loans are $438.1 million in PPP loans, with $10.6 million in net deferred fees.

This includes 2,526 current loans, helping nearly 40,000 employees in our communities.

Included in this balance is $ 43.8 million in capital call lines resulting from relationships with our BaaS customers as of September 30, 2020.

Our work with the SBA to help small businesses as provided in the CARES Act resulted in $452.8 million in PPP loans, with $8.6 million in net unearned deferred fees, which are included in commercial and industrial loans.

This includes 2,879 loans, helping over 40,600 employees in our communities.

We were able to provide loans to our existing customers and also provide assistance to new customers, by taking a proactive approach and reaching out to the communities we serve to offer aid through the PPP.

We have or will receive approximately $13.9 million in loan fees from the SBA for originating and servicing the PPP loans.

These SBA 7(a) loans allow small business owners to apply for financial relief under the PPP.

This program allows business owners that are impacted by the COVID-19 pandemic to apply for and receive financial relief to help pay for employee wages and certain other expenses.

These short-term loans, two to five years, bear a 1.0% interest rate and may be forgiven by the government if certain criteria are met.

We have received approximately $14.5 million in loan fees from the SBA for originating and servicing the PPP loans, net of fees paid to agents.

These SBA 7(a) loans allowed small business owners to apply for financial relief under the PPP.

This program allowed business owners that are impacted by the COVID-19 pandemic to apply for and receive financial relief to help pay for employee wages and certain other expenses.

PPP loans have a maximum maturity of five years;

however, the majority of our PPP loans are two years, bear a 1.0% interest rate and may be forgiven by the government if certain criteria are met.

These fees are or will be recognized in interest income over the life of the loans;

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These fees are recognized as interest income and will provide a source of income to the Company as we navigate through these changes in our business and economy, so we may continue to provide financial services to our customers and communities.

On July 4, 2020, the President signed legislation extending the June 30, 2020 deadline to August 8, 2020, and we will accept and process requests for the duration of the program.

We accepted and processed requests through the duration of the program, which ended on August 8, 2020.

We have begun accepting applications from customers for loan forgiveness;

however, we are awaiting further guidance and cannot approve an application or submit it to the SBA until the specific criteria has been disclosed.

however, we are awaiting further guidance and cannot approve an application or submit it to the SBA until the specific criteria have been disclosed.

In order to obtain loan forgiveness, a PPP borrower must submit a forgiveness application to us, which we must review and forward to the SBA.

It is still uncertain what the final criteria will be, but we anticipate that the third quarter of 2020 will be busy as we migrate through this next stage of the PPP loans.

Customers with two-year loans can work with their lender to extend to a five year maturity, which we anticipate could be a good option for customers that are not eligible for forgiveness.

In October 2020, we started to receive some forgiveness payments from the SBA.

It is still uncertain how quickly the SBA will be processing forgiveness requests, but we anticipate that forgiveness of PPP loans will begin in fourth quarter 2020, and the pace of forgiveness will increase in the first half of 2021.

The initial payment deferral period on PPP loans was extended and customers with two-year loans can work with their lender to extend to a five year maturity, which we anticipate could be a good option for customers that are not eligible for forgiveness.

Commercial Real Estate Loans.

Commercial real estate loans increased $64.9 million, or 10.6%, to $678.3 million as of June 30, 2020, from $613.4 million as of December 31, 2019.

Commercial real estate loans increased $91.8 million, or 15.0%, to $705.2 million as of September 30, 2020, from $613.4 million as of December 31, 2019.

We make commercial mortgage loans collateralized by owner-occupied and non-owner-occupied real estate, as well as multi-family residential loans.

The real estate securing our existing commercial real estate loans includes a wide variety of property types, such as manufacturing and processing facilities, business parks, warehouses, retail centers, convenience stores, hotels and motels, office buildings, mixed-use residential and commercial, and other properties.

convenience stores, hotels and motels, office buildings, mixed-use residential and commercial, and other properties.

We originate both fixed- and adjustable-rate loans with terms up to 20 years.

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Adjustable-rate loans are generally based on the prime rate and adjust with the prime rate or are based on term equivalent FHLB rates.

At June 30, 2020, approximately 43.1% of the commercial real estate loan portfolio consisted of fixed rate loans.

Commercial real estate loans represented 46.5% of our loan portfolio at June 30, 2020 and are historically our largest source of revenue.

At September 30, 2020 , approximately 39.3 % of the commercial real estate loan portfolio consisted of fixed rate loans.

Commercial real estate loans represented 46.

4 % of our loan portfolio at September 30, 2020 and are historically our largest source of revenue.

The addition of the $ 452.8 million in PPP loans as commercial and industrial loans has significantly impacted the composition of our loan portfolio ;

without the PPP loans, commercial real estate loans would represent

approximately 66.4% of the loan portfolio, which is more in line with what it has been historically.

without the PPP loans, commercial real estate loans would represent approximately 66.

1 % of the loan portfolio, which is more in line with what it has been historically.

The Bank actively seek s commercial real estate loans in our markets and our lenders are experienced in originating and competing for these loans.

1 unchanged sentence

Construction, Land and Land Development Loans.

Construction, land and land development loans increased $5.4 million, or 5.6%, to $102.4 million as of June 30, 2020, from $97.0 million as of December 31, 2019.

We have a number of construction loans that have been approved, primarily for commercial projects, where the borrower has not requested the funds, resulting in our unfunded construction and development commitments increasing to $77.5 million at June 30, 2020, from $63.7 million at December 31, 2019.

Although we have seen a strong commercial and residential real estate market in the Puget Sound region thus far in 2020, the short-term and long-term effects of the COVID-19 pandemic remain to be seen.

As part of the stay-at-home order issued by the Governor of Washington in March 2020, non-essential construction projects were temporarily halted.

The Bank worked with our contractors and extended the construction period as appropriate to compensate for the work shutdown.

As projects start or resume, we expect that more of the available commitments will be utilized.

Construction, land and land development loans increased $3.9 million, or 4.0%, to $101.0 million as of September 30, 2020, from $97.0 million as of December 31, 2019.

We have a number of construction loans that have been approved, primarily for commercial projects, where the borrower has not requested the funds, resulting in our unfunded construction and development commitments increasing to $76.3 million at September 30, 2020, from $63.7 million at December 31, 2019.

Although we have seen a strong commercial and residential real estate market in the Puget Sound region thus far in 2020, the full extent of the short-term and long-term effects of the COVID-19 pandemic remain to be seen.

We anticipate that as projects continue we will see drawdowns on the available commitments.

Residential Real Estate Loans.

Our residential loans increased $7.9 million, or 6.9%, from $115.0 million at December 31, 2019 to $122.9 million at June 30, 2020.

Our residential loans increased $6.1 million, or 5.3%, from $115.0 million at December 31, 2019 to $121.1 million at September 30, 2020.

We originate one-to-four adjustable-rate mortgage (“ARM”), loans for our portfolio and operate as a mortgage broker for mortgage lenders we have agreements with for customers who want a 15-year to 30-year, fixed-rate mortgage loan.

As of June 30, 2020, the balance of our ARM portfolio loans was $14.3 million, compared to $11.7 million at December 31, 2019.

As of September 30, 2020, the balance of our ARM portfolio loans was $14.0 million, compared to $11.7 million at December 31, 2019.

Our ARM loans typically do not meet the guidelines for sale in the secondary market due to characteristics of the property, the loan terms or exceptions from agency underwriting guidelines, which enables us to earn a higher interest rate.

We also purchase residential mortgages originated by other financial institutions to hold for investment with the intent to diversify our residential mortgage loan portfolio, meet certain regulatory requirements and increase our interest income.

As of June 30, 2020, we held $24.7 million in purchased residential real estate mortgage loans, compared to $28.6 million at December 31, 2019.

As of September 30, 2020, we held $17.9 million in purchased residential real estate mortgage loans, compared to $28.6 million at December 31, 2019.

These loans purchased typically have a fixed rate with a term of 15 to 30 years and are collateralized by one-to-four family residential real estate.

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We also make one-to-four family loans to investors to finance their rental properties and to business owners to secure their business loans.

As of June 30, 2020, residential real estate loans made to investors and business owners totaled $72.8 million .

As of September 30, 2020, residential real estate loans made to investors and business owners totaled $75.6 million .

Like our commercial real estate loans, our residential real estate loans are secured by real estate, the value of which may fluctuate significantly over a short period of time as a result of market conditions in the area in which the real estate is located.

1 unchanged sentence

Consumer and Other.

Consumer and other loans totaled $4.7 million as of June 30, 2020, increasing $521,000 from $4.2 million at December 31, 2019.

Consumer and other loans totaled $3.9 million as of September 30, 2020, decreasing $287,000 from $4.2 million at December 31, 2019.

Our consumer and other loans are comprised of personal lines of credit, automobile, boat, and recreational vehicle loans, and secured term loans.

1 unchanged sentence

We have a diversified loan portfolio, representing a wide variety of industries.

Three of our largest categories of loans are commercial real estate, commercial and industrial, and construction, land and land development loans.

Three of our largest categories of our loans are commercial real estate, commercial and industrial, and construction, land and land development loans.

Together they represent $942.5 million in outstanding loan balances, or 88.3% of total gross loans outstanding, excluding PPP loans of $452.8 million.

1 unchanged sentence

Commercial Real Estate Loans.

Commercial real estate represents the largest segment of our loans, comprising 66.4% of our total balance of outstanding loans, excluding PPP loans, as of June 30, 2020.

Unused commitments to extend credit represents an additional $13.5 million, the combined total exposure in commercial real estate loans represents $691.9 million, or 56.1%, of our total outstanding loans and loan commitments, excluding PPP loans.

The following table summarizes our concentration by industry for our commercial real estate loan portfolio as of June 30, 2020:

(Dollars in thousands)

Commercial real estate represents the largest segment of our loans, comprising 66.1% of our total balance of outstanding loans, excluding PPP loans, as of September 30, 2020.

Unused commitments to extend credit represents an

additional $15.6 million, the combined total exposure in commercial real estate loans represents $720.8 million, or 54.6 % of our total outstanding loans and loan commitments, excluding PPP loans.

The following table summarizes our concentration by industry for our commercial real estate loan portfolio as of September 30, 2020:

(Dollars in thousands, unaudited)

Outstanding Balance

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Commercial and Industrial Loans.

Commercial and industrial loans comprise 11.1% of our total balance of outstanding loans, excluding PPP loans, as of June 30, 2020.

Commercial and industrial loans comprise 12.8% of our total balance of outstanding loans, excluding PPP loans, as of September 30, 2020.

Unused commitments to extend credit represents an additional $140.5 million, the combined total exposure in commercial and industrial loans represents $276.9 million, or 21.0% of our total outstanding loans and loan commitments, excluding PPP loans.

The following table summarizes our concentration by industry for our commercial and industrial loan portfolio as of June 30, 2020:

(Dollars in thousands)

The following table summarizes our concentration by industry for our commercial and industrial loan portfolio as of September 30, 2020:

(Dollars in thousands, unaudited)

Outstanding Balance

7 unchanged sentences

Construction/Contractor

Financial Institutions

Family and Social Services

Manufacturing

Medical / Dental /

Family and Social Services

Financial Institutions

Groups < 1.0% of total

Construction, Land and Land Development Loans.

Construction, land and land development loans comprise 10.0% of our total balance of outstanding loans, excluding PPP loans, as of June 30, 2020.

Unused commitments to extend credit represents an additional $77.5 million, the combined total exposure in construction, land and land development loans represents $180.0 million , or 14.6% , of our total outstanding loans and loan commitments.

The following table details our concentration for our construction, land and land development loan portfolio as of June 30, 2020:

(Dollars in thousands)

Construction, land and land development loans comprise 9.5% of our total balance of outstanding loans, excluding PPP loans, as of September 30, 2020.

Unused commitments to extend credit represents an additional $76.3 million, the combined total exposure in construction, land and land development loans represents $177.3 million, or 13.4% of our total outstanding loans and loan commitments , excluding PPP loans.

The following table details our concentration for our construction, land and land development loan portfolio as of September 30, 2020:

(Dollars in thousands, unaudited)

Outstanding Balance

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We actively manage problem assets to reduce our risk for loss.

We had $4.4 million in nonperforming assets, as of June 30, 2020, compared to $1.0 million as of December 31, 2019.

There were no loans more than 90 days past due and still accruing interest as of June 30, 2020 and December 31, 2019.

Our nonperforming loans to loans receivable ratio was 0.31% at June 30, 2020, compared to 0.11% at December 31, 2019.

Commercial and industrial nonaccrual loans totaled $689,000 at June 30, 2020 and consisted of three lending relationships.

During the second quarter of 2020, there was $11,000 in charge-offs on one nonperforming loan.

Two loans moved to nonperforming status during the second quarter, which included $3.3 million in construction, land and land development loans and $413,000 in commercial real estate loans.

The addition of these loans to nonperforming status in the second quarter was partially offset by the aforementioned charge-off and principal reductions and resulted in an overall increase in our ratios of nonperforming loans and nonperforming assets to total assets compared to December 31, 2019.

We had $4.5 million in nonperforming assets, as of September 30, 2020, compared to $1.0 million as of December 31, 2019.

There were no loans more than 90 days past due and still accruing interest as of September 30, 2020 and December 31, 2019.

Our nonperforming loans to loans receivable ratio was 0.30% at September 30, 2020, compared to 0.11% at December 31, 2019.

Construction, land and land development loans totaled $3.3 million, representing one loan that was added in the second quarter of 2020.

Commercial and industrial nonaccrual loans totaled $625,000 at September 30, 2020 and consisted of three lending relationships.

Commercial real estate loans totaled $405,000, representing one loan, which was added during the second quarter of 2020.

During the third quarter of 2020, one loan for $117,000 in residential real estate moved to nonperforming status.

The addition of this loan to nonperforming status in the third quarter was partially offset by principal reductions and resulted in an overall increase in our ratios of nonperforming loans and nonperforming assets to total assets compared to December 31, 2019.

Credit quality has remained stable in 2020 thus far as demonstrated by the low level of charge-offs and nonperforming loan balance.

The short-term and long-term economic impact of the COVID-19 pandemic is unknown;

The full extent of the short-term and long-term economic impact of the COVID-19 pandemic is unknown;

however, we remain diligent in our efforts to communicate and proactively work with borrowers to help mitigate potential credit deterioration.

1 unchanged sentence

The following table presents information regarding nonperforming assets at the dates indicated:

September 30,

(Dollars in thousands)

26 unchanged sentences

for construction, land and land development loans, the perceived market feasibility of the project including the ability to sell developed lots or improvements constructed for resale or the ability to lease property constructed for lease, the quality and nature of contracts for presale or prelease, if any, experience and ability of the developer and loan-to-value ratio.

As of June 30, 2020, the allowance for loan losses totaled $14.8 million, or 1.03% of total loans.

As of September 30, 2020, the allowance for loan losses totaled $17.0 million, or 1.13% of total loans.

As of December 31, 2019, the allowance for loan losses totaled $11.5 million, or 1.22% of total loans.

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A reconciliation of this non-GAAP measure is set forth in the section titled “ GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.

” Our allowance for loan losses as of June 30, 2020 increased by $3.4 million, or 29.4%, compared to December 31, 2019, due to growth in our loan portfolio along with an increase in our qualitative factors primarily related to the current economic environment from the COVID-19 pandemic on our loan portfolio.

” Our allowance for loan losses as of September 30, 2020 increased by $5.6 million, or 48.6%, compared to December 31, 2019, due to an increase in our qualitative factors primarily related to the current economic environment from the COVID-19 pandemic on our loan portfolio and loan growth.

The following table present s , as of and for the periods indicated, an analysis of the allowance for loan losses and other related data:

As of or for the Three

As of or for the Six

As of and for the Three

As of and for the Nine

September 30,

(Dollars in thousands)

3 unchanged sentences

Real estate loans:

Residential real estate loans

Commercial real estate

9 unchanged sentences

Net charge-offs to average loans (1)

(1) Ratios for the three and six months ended June 30, 2020 and 2019 are annualized.

(1) Ratios for the three and nine months ended September 30, 2020 and 2019 are annualized.

Although we believe that we have established our allowance for loan losses in accordance with GAAP and that the allowance for loan losses was adequate to provide for known and inherent losses in the portfolio at all times shown above, future provisions for loan losses will be subject to ongoing evaluations of the risks in our loan portfolio.

As a result of the COVID-19 pandemic and the subsequent impact to the economy, we increased our provision during the six months ended June 30, 2020.

As a result of the COVID-19 pandemic and the subsequent impact to the economy, we increased our provision during the nine months ended September 30, 2020.

If the COVID-19 pandemic worsens or continues indefinitely, preventing businesses and consumers from conducting business, the state and Puget Sound region may experience a continued economic downturn, and our asset quality could deteriorate, which may require material additional provisions for loan losses.

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We use our securities portfolio primarily as a source of liquidity and collateral that can be readily sold or pledged for public deposits or other business purposes.

At June 30, 2020, 82.4% of our investment portfolio consisted of U.S.

At September 30, 2020, 83.9% of our investment portfolio consisted of U.S.

Treasury securities.

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Because we target a loan-to-deposit ratio in the range of 90% to 100%, we prioritize liquidity over the earnings of our securities portfolio.

At June 30, 2020, our loan-to-deposit ratio was 110.8%, which is elevated as a result of the PPP loans.

At September 30, 2020, our loan-to-deposit ratio was 111.0%, which is elevated as a result of the PPP loans.

Our securities portfolio represented less than 2% of assets.

To the extent our securities represent more than 5% of assets, absent an immediate need for liquidity, we anticipate investing excess funds to provide a higher return.

As of June 30, 2020, the carrying amount of our investment securities totaled $24.3 million, a decrease of $8.4 million, or 25.7%, compared to $32.7 million as of December 31, 2019.

As of September 30, 2020 , the carrying amount of our investment securities totaled $ 2 3.8 million, a de crease of $ 8.

9 million , or 2 7 .

3 %, compared to $ 3 2 .

7 million as of December 31, 2019 .

The decrease in the securities portfolio was due to maturities and principal paydowns .

We purchased short-term six-month U.S.

Treasury Securities during the quarter ended June 30, 2020, for pledging purposes.

We do not expect to purchase securities to replace decreases, except as needed for pledging purposes.

Our investment portfolio consists of securities classified as available for sale and, to a lesser amount, held to maturity.

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The following table summarizes the amortized cost and estimated fair value of our investment securities as of the dates shown:

June 30, 2020

September 30, 2020

December 31, 2019

13 unchanged sentences

In addition, we recently added reciprocal deposits to our product offering.

This enables us to extend Federal Deposit Insurance Corporation (“FDIC”) insurance to customers that have balances in excess of the FDIC insurance limit.

This service trades our customer’s funds as CDs or interest bearing demand deposits in increments under the FDIC insured amount to other participating financial institutions and in exchange we receive CD or interest bearing demand investments from participating financial institutions in a reciprocal agreement.

This enables us to extend FDIC insurance to customers that have balances in excess of the FDIC insurance limit.

This service trades our customers’ funds as CDs or interest bearing demand deposits in increments under the FDIC insured amount to other participating financial institutions and in exchange we receive CD or interest bearing demand investments from participating financial institutions in a reciprocal agreement.

We rely primarily on competitive pricing policies, convenient locations, electronic delivery channels (Internet and mobile), and personalized service to attract new deposits and retain existing deposits.

Total deposits as of June 30, 2020 were $1.31 billion, an increase of $338.5 million, or 35.0%, compared to $968.0 million as of December 31, 2019.

Total deposits as of September 30, 2020 were $1.36 billion, an increase of $392.1 million, or 40.5%, compared to $968.0 million as of December 31, 2019.

The increase was largely in core deposits, which increased $407.7 million to $1.27 billion from $862.5 million at December 31, 2019.

A portion of the funds from PPP loans were deposited directly into existing or new deposit accounts, thus elevating those deposit account balances until such time that the funds were, or are, used.

We expect our deposit totals to decline as customers use the funds obtained through the PPP loans.

The increase in core deposits is primarily the result of expanding and growing banking relationships with new customers, including deposit relationships from PPP loans made to noncustomers moving their banking relationship to the Bank.

We define core deposits as all deposits except time deposits and BaaS-brokered deposits.

We focus on growing core deposits and our branch managers, business development officers, treasury service personnel and lenders work together to grow deposits from existing and new customers.

Funds from PPP loans were frequently deposited directly into existing or new customer accounts during the quarter ended June 30, 2020.

This includes approximately 842 new deposit relationships that were established as a result of funding PPP loans for business owners in the communities we serve.

The time and effort spent working with these new customers throughout the PPP process has resulted in increased deposits and new relationships that the Company will work to grow and retain into the future.

Noninterest bearing deposits as of June 30, 2020 were $563.8 million, an increase of $192.5 million, or 51.9%, compared to $371.2 million as of December 31, 2019.

The increase is largely attributed to the aforementioned PPP funds being deposited and held in customer accounts until the funds are used.

Noninterest bearing deposits represent 43.2% and 38.4% of total deposits for June 30, 2020 and December 31, 2019, respectively.

Total interest bearing account balances, excluding time deposits, as of June 30, 2020 were $674.9 million, an increase of $160.1 million, or 31.1%, from $514.9 million as of December 31, 2019.

Noninterest bearing deposits as of September 30, 2020 were $570.7 million, an increase of $199.4 million, or 53.7%, compared to $371.2 million as of December 31, 2019.

The increase is primarily the result of expanding and growing banking relationships with new customers, including deposit relationships from PPP loans made to noncustomers, who moved their banking relationship to the Bank.

Noninterest bearing deposits represent 42.0% and 38.4% of total deposits for September 30, 2020 and December 31, 2019, respectively.

Total interest bearing account balances, excluding time deposits, as of September 30, 2020 were $724.5 million, an increase of $209.6 million, or 40.7%, from $514.9 million as of December 31, 2019.

Included in interest bearing account balances is $24.9 million in BaaS-brokered deposits, an increase of $1.3 million from December 31, 2019.

1 unchanged sentence

In 2019 we introduced reciprocal deposits as a product available for time deposit customers and beginning in 2020 we added an interest bearing demand reciprocal deposit product.

Total time deposit balances as of June 30, 2020 were $67.7 million, a decrease of $14.2 million, or 17.3%, from $81.9 million as of December 31, 2019.

The decrease is a conscious effort to not replace maturing time deposits, but rather to grow and retain less

expensive core deposits .

Total time deposit balances as of September 30, 2020 were $ 64.9 million, a de crease of $ 17.0 million, or 20.7 % , from $ 81.9 million as of December 31, 2019 .

The de crease is a conscious effort to not replace maturing time deposits, but rather to grow and retain less expensive core deposits .

We have s een competitors continue to offer higher rates on time deposits , and we have not globally matched their rates in response as we have been able to grow and retain less costly core deposits.

The following table sets forth deposit balances at the dates indicated.

June 30, 2020

September 30, 2020

December 31, 2019

8 unchanged sentences

(Dollars in thousands)

September 30,

Maturity Period:

4 unchanged sentences

Weighted average maturity (in years)

Average deposits for the three and six months ended June 30, 2020 were $1.25 billion and $1.12 billion, respectively, an increase of 45.5% and 29.8%, respectively , compared to the three and six months ended June 30, 2019.

The increase in average deposits was primarily due to an increase in core deposits, both in noninterest bearing deposits and in interest bearing deposits.

Included in this increase is funds from PPP loan disbursements which were primarily deposited and held in customer accounts until they used the funds.

Continued growth in our primary market areas and the increase in commercial lending relationships for which we also seek deposit balances and the results of business development efforts by our business development officers, branch managers and lenders continue to contribute to deposit growth.

The average rate paid on total deposits was 0.35% and 0.48%, respectively, for the three and six months ended June 30, 2020, compared to 0.66% and 0.67%, for the three and six months ended June 30, 2019, respectively.

The average rate paid on BaaS-brokered deposits decreased 1.95% and 1.65% for the three and six months ended June 30, 2020, respectively, compared to the prior year periods, and NOW and money market accounts decreased 34 basis points and four basis points, for the three and six months ended June 30, 2020, respectively.

The average rate paid on NOW and money market accounts in the three and six months ended June 30, 2020 is the result of the recent decreased Fed funds rates and the impact of these rate decreases will continue to be reflected in future periods.

Average deposits for the three and nine months ended September 30, 2020 were $1.32 billion and $1.18 billion, respectively, an increase of 49.0% and 36.4%, respectively , compared to the three and nine months ended September 30, 2019.

The increase in average deposits was primarily due to an increase in core deposits, both in noninterest bearing deposits and in low rate interest bearing deposits.

Included in this increase is deposit relationships gained from PPP loans made to noncustomers that moved their banking/deposit relationship to the Bank.

We expect deposit to grow with continued growth in our primary market areas, the increase in commercial lending relationships for which we also seek deposit balances and the results of business development efforts by our business development officers, branch managers and lenders.

The average rate paid on total deposits was 0.27% and 0.40%, respectively, for the three and nine months ended September 30, 2020, compared to 0.64% and 0.66%, for the three and nine months ended September 30, 2019, respectively.

The average rate paid on BaaS-brokered deposits decreased 1.64% and 1.72% for the three and nine months ended September 30, 2020, respectively, compared to the prior year periods, and NOW and money market accounts decreased 51 basis points and 21 basis points, for the three and nine months ended September 30, 2020, respectively.

The average rate paid on NOW and money market accounts in the three and nine months ended September 30, 2020 is the result of the decreased Fed funds rates since June 2019;

the impact of these rate decreases will continue to be reflected in future periods.

Any further changes to the Fed funds rate along with competition are expected to continue to impact future cost of deposits and our pricing strategies.

The following table presents the average balances and average rates paid on deposits for the periods indicated:

For the Three Months Ended June 30,

For the Six Months Ended June 30,

For the Three Months Ended September 30,

For the Nine Months Ended September 30,

(Dollars in thousands)

5 unchanged sentences

Total deposits

The ratio of average noninterest bearing deposits to average total deposits for the three and six months ended June 30, 2020 was 43.3% and 40.1%, respectively, compared to 35.9% and 34.7% for the three and six months ended June 30, 2019, respectively.

The ratio of average noninterest bearing deposits to average total deposits for the three and nine months ended September 30, 2020 was 43.1% and 41.2%, respectively, compared to 37.3% and 35.6% for the three and nine months ended September 30, 2019, respectively.

We have the ability to utilize short-term to long-term borrowings to supplement deposits to fund our lending and investment activities, each of which is discussed below.

1 unchanged sentence

The Federal Reserve allows us to borrow against our line of credit through a borrower in custody agreement utilizing the discount window, which is collateralized by certain loans.

As of June 30, 2020, and December 31, 2019, total borrowing capacity of $19.5 and $21.4 million, respectively, was available under this arrangement.

As of June 30, 2020, and December 31, 2019, Federal Reserve advances totaled zero.

As of September 30, 2020, and December 31, 2019, total borrowing capacity of $20.8 and $21.4 million, respectively, was available under this arrangement.

As of September 30, 2020 and December 31, 2019, Federal Reserve advances totaled zero.

Paycheck Protection Program Liquidity Facility.

To bolster the effectiveness of the SBA’s PPP loan program, the Federal Reserve is supplying liquidity to participating financial institutions through term financing backed by PPP loans to small businesses.

The PPP provides loans to small businesses so that they can keep their employees on the payroll and pay for other allowed expenses.

The PPP provided loans to small businesses so that they can keep their employees on the payroll and pay for other allowed expenses.

If the borrowers meet certain criteria, the loan may be forgiven.

1 unchanged sentence

The interest rate is 0.35% and as PPP loans are paid down, the borrowing line must also be paid down.

As of June 30, 2020, there was $190.2 million outstanding in PPPLF advances.

As of September 30, 2020, there was $202.6 million outstanding in PPPLF advances.

This is a new borrowing arrangement that has favorable capital treatment and is specific to the PPP loan program, and therefore there was no balance at December 31, 2019.

1 unchanged sentence

As of and For the Three

As of and For the Six

As of and For the Nine

September 30,

(Dollars in thousands)

12 unchanged sentences

The FHLB allows us to borrow against our line of credit, which is collateralized by certain loans.

As of June 30, 2020, and December 31, 2019, we had borrowing capacity of $88.7 million and $84.9 million, respectively, under this arrangement.

As of June 30, 2020, we borrowed a total of $25.0 million in FHLB long term advances.

As of September 30, 2020, and December 31, 2019, we had borrowing capacity of $92.7 million and $84.9 million, respectively, under this arrangement.

As of September 30, 2020, we borrowed a total of $25.0 million in FHLB long term advances.

This includes $10.0 million for a 2.50-year remaining term and $15.0 million advance with a 4.50-year remaining term.

FHLB advances totaled $25.0 million as of June 30, 2020 and $10.0 million as of December 31, 2019.

There was $63.7 million and $74.9 million borrowing capacity remaining as of June 30, 2020, and December 31, 2019, respectively.

Although there are no immediate plans to borrow additional funds, additional borrowing capacity of $63.7 million was available under this arrangement as of June 30, 2020.

FHLB advances totaled $25.0 million as of September 30, 2020 and $10.0 million as of December 31, 2019.

There was $67.7 million and $74.9 million borrowing capacity remaining as of September 30, 2020, and December 31, 2019, respectively.

Although there are no immediate plans to borrow additional funds, additional borrowing capacity of $67.7 million was available under this arrangement as of September 30, 2020.

The table below provides details on FHLB short term borrowings for the periods indicated:

As of and For the Three

As of and for the Six

As of and For the Nine

September 30,

(Dollars in thousands)

12 unchanged sentences

As of and For the Three

As of and For the Six

As of and For the Nine

September 30,

(Dollars in thousands)

15 unchanged sentences

The debentures bear interest at a rate per annum equal to the 3-month LIBOR plus 2.10%.

The effective rate as of June 30, 2020, and December 31, 2019, was 2.41 % and 3.99%, respectively.

The effective rate as of September 30, 2020, and December 31, 2019, was 2.35 % and 3.99%, respectively.

We generally have the right to defer payment of interest on the debentures at any time or from time to time for a period not exceeding five years provided that no extension period may extend beyond the stated maturity of the debentures.

1 unchanged sentence

The Trust’s preferred securities are mandatorily redeemable upon maturity of the debentures, or upon earlier redemption as provided in the indenture, subject to Federal Reserve approval.

debentures are redeemed prior to maturity, the redemption price will be the principal amount and any accrued but unpaid interest.

We unconditionally guarantee payment of accrued and unpaid distributions required to be paid on the Trust s ecurities subject to certain exceptions, the redemption price with respect to any Trust securities called for redemption and amounts due if the Trust is liquidated or terminated.

If the debentures are redeemed prior to maturity, the redemption price will be the principal amount and any accrued but unpaid interest.

We unconditionally guarantee payment of accrued and unpaid distributions required to be paid on the Trust securities subject to certain

ex ceptions, the redemption price with respect to any Trust securities called for redemption and amounts due if the Trust is liquidated or terminated.

Subordinated Debt .

29 unchanged sentences

We are also participating in the PPPLF, which provides an additional source of low cost funding, at a 0.35% interest rate, and favorable capital treatment for the PPP loans.

We have pledged 711 of these loans, or $190.2 million, as of June 30, 2020.

We have pledged 820 of these loans, or $202.6 million, as of September 30, 2020.

Under the terms of the agreement, the borrowings will be paid down as the loans are forgiven or paid down by the customer.

4 unchanged sentences

The Company has consistently retained a portion of the funds from equity and debt offerings so that is has sufficient funds for its operating and debt costs for the next few years.

The Company down-streamed $7.5 million in capital to the Bank during the first quarter of 2020, bringing the Company’s cash holding to $5.8 million at June 30, 2020.

The Company down-streamed $7.5 million in capital to the Bank during the first quarter of 2020, bringing the Company’s cash holding to $5.6 million at September 30, 2020.

The Company uses approximately $1.3 million for debt servicing and operating purposes each year, leaving about $3.0 million for other purposes after deducting $2.6 million to cover operating purposes for the next two years.

2 unchanged sentences

We believe that these limitations will not impact the ability of the Bank to pay dividends to the Company to meet ongoing operating needs.

For contingency purposes, the Company maintains a minimum level of cash to fund one year’s projected operating cash flow needs and the Bank established a minimum

liquidity ratio of 5 % of assets.

For contingency purposes, the Company maintains a minimum level of cash to fund one year’s projected operating cash flow needs and the Bank established a minimum liquidity ratio of 5% of assets.

Both of these minimum liquidity levels are on-balance sheet sources.

Per policy and the Bank’s liquidity contingency plan, in event of a liquidity emergency the Bank can utilize wholesale funds in an amount up to 30% of assets.

Per policy and the Bank’s liquidity contingency plan, in event of a liquidity emergency the Bank can utilize wholesale funds in an amount up to 30% of

Since the Bank uses only a small portion of its borrowing or wholesale funding capacity, the Bank has access to funds if needed in a liquidity emergency.

10 unchanged sentences

however, the Company could downstream additional funds to the Bank in the future, if necessary.

As of June 30, 2020, and December 31, 2019, the Bank was in compliance with all applicable regulatory capital requirements, and the Bank was classified as “well capitalized” for purposes of the Federal Reserve’s prompt corrective action regulations.

As of September 30, 2020, and December 31, 2019, the Bank was in compliance with all applicable regulatory capital requirements, and the Bank was classified as “well capitalized” for purposes of the Federal Reserve’s prompt corrective action regulations.

As we deploy our capital and continue to grow our operations, our regulatory capital levels may decrease depending on our level of earnings.

7 unchanged sentences

(dollars in thousands)

June 30, 2020

September 30, 2020

Leverage Capital (to average assets)

10 unchanged sentences

Contractual Obligations

The following table summarizes contractual obligations and other commitments to make future payments (other than non-time deposit obligations), which consist of future cash payments associated with our contractual obligations, as of June 30, 2020.

Payments Due by Period

16 unchanged sentences

Since commitments associated with commitments to extend credit and letters of credit may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements.

September 30,

(Dollars in thousands)

28 unchanged sentences

Three Months Ended

Six months ended

Nine Months Ended

September 30,

December 31, 2019

September 30, 2019

September 30, 2020

September 30, 2019

Return on average assets (1)

17 unchanged sentences

Loans receivable to deposits

(1) Annualized calculations shown for quarterly and six month periods presented.

(2) A reconciliation of the non-GAAP measures are set forth in the section " GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures ."

(1) Annualized calculations shown for quarterly and nine month periods presented.

(2) A reconciliation of the non-GAAP measures are set forth in “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures”.

GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures

12 unchanged sentences

As of and for the

Six Months Ended

Nine Months Ended

(Dollars in thousands, unaudited)

September 30,

Pre-tax, pre-provision net income and pre-tax, pre-provision return on average assets:

1 unchanged sentence

Total net income

provision for loan losses

provision for income

provision for loan

provision for

Pre-tax, pre-provision net

Return on average assets

Pre-tax, pre-provision return

on average assets:

Pre-tax, pre-provision

return on average

The following non-GAAP financial measures are presented to illustrate and identify the impact of PPP loans on loans receivable related measures.

12 unchanged sentences

Three Months Ended

Six Months Ended

Nine Months Ended

(Dollars in thousands, unaudited)

June 30, 2020

September 30, 2020

Adjusted allowance for loan losses to loans receivable:

15 unchanged sentences

Adjusted yield on loans receivable:

Adjusted contractual yield on loans receivable, excluding earned fees:

Adjusted contractual yield on loans receivable, excluding earned fees and interest on PPP loans:

Total average loans receivable

1 unchanged sentence

average deferred fees on PPP loans

Adjusted total average loans receivable, excluding earned fees

Adjusted total average loans receivable,

excluding earned fees

Interest and earned fee income on loans

2 unchanged sentences

Adjusted interest income on loans

Contractual yield on loans receivable, excluding earned fees

Adjusted contractual yield on loans receivable, excluding earned fees:

Contractual yield on loans receivable,

excluding earned fees

Adjusted contractual yield on loans receivable,

excluding earned fees and interest on PPP loans:

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis