COASTAL FINANCIAL CORP 10-Q

Item 1. Financial Statements COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) (dollars in thousands) ASSETS September 30, December 31, 2020 2019 Cash and due from banks $ 14,136 $ 16,555 Interest earning deposits with other banks (restricted cash of $ 0 and $ 27,355 at September 30, 2020 and December 31, 2019, respectively) 168,034 111,259 Investment securities, available for sale, at fair value 20,428 28,360 Investment securities, held to maturity, at amortized cost 3,354 4,350 Other investments 5,951 4,505 Loans receivable 1,509,389 939,103 Allowance for loan losses ( 17,046 ) ( 11,470 ) Total loans receivable, net 1,492,343 927,633 Premises and equipment, net 16,881 13,108 Operating lease right-of-use assets 7,379 8,493 Accrued interest receivable 8,216 2,980 Bank-owned life insurance, net 7,031 6,882 Deferred tax asset, net 2,722 2,743 Other assets 3,144 1,658 Total assets $ 1,749,619 $ 1,128,526 LIABILITIES AND SHAREHOLDERS’ EQUITY LIABILITIES Deposits $ 1,360,011 $ 967,959 Federal Home Loan Bank (“FHLB”) advances 24,999 10,000 Paycheck Protection Program Liquidity Facility 202,595 - Subordinated debt Principal amount $ 10,000 (less unamortized debt issuance costs of $ 11 and $ 21 at September 30, 2020 and December 31, 2019, respectively) 9,989 9,979 Junior subordinated debentures Principal amount $ 3,609 (less unamortized debt issuance costs of $ 25 and $ 26 at September 30, 2020 and December 31, 2019, respectively) 3,584 3,583 Deferred compensation 891 974 Accrued interest payable 481 308 Operating lease liabilities 7,579 8,679 Other liabilities 4,258 2,871 Total liabilities 1,614,387 1,004,353 SHAREHOLDERS’ EQUITY Preferred stock, no par value: Authorized: 25,000,000 shares at September 30, 2020 and December 31, 2019; issued and outstanding: zero shares at September 30, 2020 and December 31, 2019 - - Common stock, no par value: Authorized: 300,000,000 shares at September 30, 2020 and December 31, 2019; 11,930,243 voting shares at September 30, 2020 issued and outstanding and 11,913,885 voting shares at December 31, 2019 issued and outstanding 87,479 86,983 Retained earnings 47,707 37,222 Accumulated other comprehensive income (loss), net of tax 46 ( 32 ) Total shareholders’ equity 135,232 124,173 Total liabilities and shareholders’ equity $ 1,749,619 $ 1,128,526 See accompanying Notes to Condensed Consolidated Financial Statements. 4 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (dollars in thousands, except for per share data) Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 INTEREST AND DIVIDEND INCOME Interest and fees on loans $ 16,244 $ 11,691 $ 44,025 $ 33,027 Interest on interest earning deposits with other banks 99 486 587 1,946 Interest on investment securities 27 168 199 481 Dividends on other investments 24 10 129 99 Total interest income 16,394 12,355 44,940 35,553 INTEREST EXPENSE Interest on deposits 880 1,435 3,530 4,291 Interest on borrowed funds 418 193 957 582 Total interest expense 1,298 1,628 4,487 4,873 Net interest income 15,096 10,727 40,453 30,680 PROVISION FOR LOAN LOSSES 2,200 637 5,708 1,724 Net interest income after provision for loan losses 12,896 10,090 34,745 28,956 NONINTEREST INCOME Deposit service charges and fees 824 795 2,224 2,302 BaaS fees 576 456 1,630 1,404 Loan referral fees 180 - 1,303 1,106 Mortgage broker fees 125 140 439 336 Sublease and lease income 30 16 91 36 Gain on sales of loans, net 47 369 47 490 Gain on sales of securities, net - 171 - 171 Other income 160 141 399 359 Total noninterest income 1,942 2,088 6,133 6,204 NONINTEREST EXPENSE Salaries and employee benefits 5,971 4,971 16,869 14,058 Occupancy 1,091 884 2,951 2,808 Data processing 577 509 1,749 1,537 Director and staff expenses 156 241 613 698 Excise taxes 291 184 756 529 Marketing 52 98 280 300 Legal and professional fees 381 170 1,178 872 Federal Deposit Insurance Corporation (“FDIC”) assessments 148 ( 4 ) 292 205 Business development 72 122 245 320 Other expense 927 573 2,697 1,726 Total noninterest expense 9,666 7,748 27,630 23,053 Income before provision for income taxes 5,172 4,430 13,248 12,107 PROVISION FOR INCOME TAXES 1,082 919 2,763 2,514 NET INCOME $ 4,090 $ 3,511 $ 10,485 $ 9,593 Basic earnings per common share $ 0.34 $ 0.30 $ 0.88 $ 0.81 Diluted earnings per common share $ 0.34 $ 0.29 $ 0.86 $ 0.79 Weighted average number of common shares outstanding: Basic 11,919,850 11,901,873 11,915,513 11,893,734 Diluted 12,181,272 12,188,507 12,183,845 12,193,071 See accompanying Notes to Condensed Consolidated Financial Statements. 5 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) (dollars in thousands) Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 NET INCOME $ 4,090 $ 3,511 $ 10,485 $ 9,593 OTHER COMPREHENSIVE INCOME, before tax Securities available-for-sale Unrealized holding (loss) gain during the period ( 6 ) 61 99 1,396 Income tax benefit (expense) related to unrealized holding (loss) gain 1 ( 12 ) ( 21 ) ( 293 ) Reclassification adjustment for net gain from sale of investment securities available for sale included in income - 171 - 171 Income tax provision related to net gain from sale of investment securities available for sale included in income - ( 36 ) - ( 36 ) OTHER COMPREHENSIVE (LOSS) INCOME, net of tax ( 5 ) 184 78 1,238 COMPREHENSIVE INCOME $ 4,085 $ 3,695 $ 10,563 $ 10,831 See accompanying Notes to Condensed Consolidated Financial Statements. 6 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED) (dollars in thousands) Shares of Common Stock Amount of Common Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Total BALANCE, June 30, 2019 11,908,185 $ 86,730 $ 30,103 $ ( 242 ) $ 116,591 Net income - - 3,511 - 3,511 Exercise of stock options 3,930 25 - - 25 Stock-based compensation - 111 - - 111 Other comprehensive income - - - 184 184 BALANCE, September 30, 2019 11,912,115 $ 86,866 $ 33,614 $ ( 58 ) $ 120,422 BALANCE, June 30, 2020 11,926,263 $ 87,309 $ 43,617 $ 51 $ 130,977 Net income - - 4,090 - 4,090 Exercise of stock options 3,980 26 - - 26 Stock-based compensation - 144 - - 144 Other comprehensive loss - - - ( 5 ) ( 5 ) BALANCE, September 30, 2020 11,930,243 $ 87,479 $ 47,707 $ 46 $ 135,232 BALANCE, December 31, 2018 11,893,203 $ 86,431 $ 24,021 $ ( 1,296 ) $ 109,156 Net income - - 9,593 - 9,593 Issuance of restricted stock awards 2,352 - - - - Forfeiture of restricted stock awards ( 1,200 ) - - - - Exercise of stock options 17,760 110 - - 110 Stock-based compensation - 325 - - 325 Other comprehensive income - - - 1,238 1,238 BALANCE, September 30, 2019 11,912,115 $ 86,866 $ 33,614 $ ( 58 ) $ 120,422 BALANCE, December 31, 2019 11,913,885 $ 86,983 $ 37,222 $ ( 32 ) $ 124,173 Net income - - 10,485 - 10,485 Issuance of restricted stock awards 6,248 - - - - Forfeiture of restricted stock awards ( 3,500 ) - - - - Exercise of stock options 13,610 82 - - 82 Stock-based compensation - 414 - - 414 Other comprehensive income - - - 78 78 BALANCE, September 30, 2020 11,930,243 $ 87,479 $ 47,707 $ 46 $ 135,232 S ee accompanying Notes to Condensed Consolidated Financial Statements. 7 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (dollars in thousands) Nine Months Ended September 30, 2020 2019 CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 10,485 $ 9,593 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 5,708 1,724 Depreciation and amortization 965 907 Loss on disposition of fixed assets 12 5 Decrease in operating lease right-of-use assets 1,129 756 Decrease in operating lease liabilities ( 1,115 ) ( 702 ) Gain on sales of loans ( 47 ) ( 490 ) Gain on sale of securities, net - ( 171 ) Net premium amortization (discount accretion) on investment securities 36 ( 36 ) Stock-based compensation 414 325 Increase in bank-owned life insurance value ( 149 ) ( 144 ) Deferred tax benefit - ( 18 ) Net change in other assets and liabilities ( 5,234 ) ( 2,413 ) Total adjustments 1,719 ( 257 ) Net cash provided by operating activities 12,204 9,336 CASH FLOWS FROM INVESTING ACTIVITIES Net increase in interest earning deposits with other banks ( 84,130 ) ( 21,007 ) Purchase of investment securities available for sale ( 14,989 ) ( 19,948 ) Purchase of investment securities held-to-maturity - ( 3,182 ) Proceeds from sale of available for sale securities - 30,026 Change in other investments, net ( 1,446 ) ( 639 ) Principal paydowns of investment securities available-for-sale 35 41 Principal paydowns of investment securities held-to-maturity 945 64 Maturities and calls of investment securities available-for-sale 23,000 - Purchase of participation loans - ( 7,238 ) Proceeds from sale of loans 694 1,581 Increase in loans receivable, net ( 571,065 ) ( 100,309 ) Purchases of premises and equipment, net ( 4,750 ) ( 912 ) Net cash used by investing activities ( 651,706 ) ( 121,523 ) CASH FLOWS FROM FINANCING ACTIVITIES Net increase in demand deposits, NOW and money market, and savings 409,017 124,363 Net decrease in time deposits ( 16,965 ) ( 5,728 ) Net repayments from short term FHLB borrowing ( 10,000 ) - Net advances from long term FHLB borrowing 24,999 - Net advances from Paycheck Protection Program Liquidity Facility 202,595 - Proceeds from exercise of stock options 82 110 Net cash provided by financing activities 609,728 118,745 NET CHANGE IN CASH, DUE FROM BANKS AND RESTRICTED CASH ( 29,774 ) 6,558 CASH, DUE FROM BANKS AND RESTRICTED CASH, beginning of year 43,910 40,319 CASH, DUE FROM BANKS AND RESTRICTED CASH, end of quarter $ 14,136 $ 46,877 SUPPLEMENTAL SCHEDULE OF OPERATING AND INVESTING ACTIVITIES Interest paid $ 4,314 $ 4,849 Income taxes paid 4,985 2,940 SUPPLEMENTAL SCHEDULE OF NONCASH TRANSACTIONS Fair value adjustment of securities available-for-sale, gross $ 99 $ 1,568 In conjunction with ASU 2016-02 as detailed in Note 6 to the Unaudited Consolidated Financial Statements, the following assets and liabilities were recognized: Operating lease right-of-use assets $ - $ 9,421 Operating lease liabilities $ - $ 9,591 See accompanying Notes to Condensed Consolidated Financial Statements. 8 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 1 - Description of Business and Summary of Significant Accounting Policies Nature of operations - Coastal Financial Corporation (“Corporation” or “Company”) is a registered bank holding company whose wholly owned subsidiaries are Coastal Community Bank (“Bank”) and Arlington Olympic LLC (“LLC”). The Company is a Washington state corporation that was organized in 2003. The Bank was incorporated and commenced operations in 1997 and is a Washington state-chartered commercial bank and Federal Reserve System (“Federal Reserve”) state member bank. Arlington Olympic LLC was formed in 2019 and owns the Company’s Arlington branch, which the Bank leases from the LLC. The Company provides a full range of banking services to small and medium-sized businesses, professionals, and individuals throughout the greater Puget Sound area through its 15 branches in Snohomish, Island, and King Counties, the Internet, and its mobile banking application. The Company opened its 15 th branch in Arlington, Washington during the second quarter 2020. The Bank’s main branch and the headquarters of the Bank and Company are located in Everett, Washington. The Bank’s deposits are insured in whole or in part by the FDIC. The Bank’s loans and deposits are primarily within the greater Puget Sound area, and the Bank’s primary funding source is deposits from customers. The Bank also provides banking as a service (“BaaS”) that allow the Company’s broker dealers and digital financial service providers to offer their customers banking services. In 2021, the Bank expects to introduce a digital bank offering in collaboration with Google. The Bank is subject to regulation by the Federal Reserve and the Washington State Department of Financial Institutions Division of Banks. The Federal Reserve also has supervisory authority over the Company. Financial statement presentation - The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim reporting requirements and with instructions to Form 10-Q and Article 10 of Regulation S-X, and therefore do not include all the information and notes included in the annual consolidated financial statements in conformity with GAAP. These interim condensed consolidated financial statements and accompanying notes should be read in conjunction with the Company’s audited consolidated financial statements and accompanying notes included in the Company’s Annual report on Form 10-K as filed with the U.S. Securities and Exchange Commission (“SEC”) on March 12, 2020. Operating results for the three and nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for future periods. Amounts presented in the consolidated financial statements and footnote tables are rounded and presented in thousands of dollars except per-share amounts, which are presented in dollars. In the narrative footnote discussion, amounts are rounded to thousands and presented in dollars. In management’s opinion, all accounting adjustments necessary to accurately reflect the financial position and results of operations on the accompanying consolidated financial statements have been made. These adjustments include normal and recurring accruals considered necessary for a fair and accurate presentation. Principles of consolidation - The consolidated financial statements include the accounts of the Company and the Bank. All significant intercompany accounts have been eliminated in consolidation. Estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management believes that its critical accounting policies include determining the allowance for loan losses, the valuation of the Company’s deferred tax assets, and fair value of financial instruments. Actual results could differ significantly from those estimates. Subsequent Events - The Company has evaluated events and transactions subsequent to September 30, 2020 for potential recognition or disclosure. To the extent any events and conditions exist, disclosures are made regarding the nature of events and the estimated financial effects for those events and conditions. The Company is not aware of any subsequent events which would require recognition or disclosure in the consolidated financial statements. 9 Reclassifications - Certain amounts reported in prior quarters' consolidated financial statements have been reclassified to conform to the current presentation with no effect on stockholders’ equity or net income. Note 2 - Recent accounting standards Recent Accounting Guidance In March 2020, various regulatory agencies, including the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, (the “agencies”) issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by the COVID-19. The interagency statement was effective immediately and impacted accounting for loan modifications. Under Accounting Standards Codification 310-40, Receivables – Troubled Debt Restructurings by Creditors , a restructuring of debt constitutes a troubled debt restructuring (“TDR”) if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The agencies confirmed with the staff of the Financial Accounting Standards Board (“FASB”) that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not to be considered TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. To be eligible a loan modification must be (1) related to COVID-19; (2) executed on a loan that was not more than 30 days past due as of December 31, 2019; and (3) executed between March 1, 2020, and the earlier of (A) 60 days after the date of termination of the federal National Emergency or (B) December 31, 2020. See Note 4 of the Condensed Consolidated Financial Statements of this Report for disclosure of the impact to date . Recent Accounting Guidance Not Yet Effective In September 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments . The amendments replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The amendment is effective for annual periods beginning after December 15, 2019 and interim period within those annual periods. As a smaller reporting company, the Company’s implementation will be effective January 1, 2023. The Company is actively assessing the data and the model needs and are evaluating the impact of adopting the amendment. The Company expects to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period, January 2023, in which the new standard is effective, but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements. Note 3 - Investment Securities The amortized cost and fair values of investment securities at the date indicated are as follows: Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (dollars in thousands) September 30, 2020 Available-for-sale U.S. Treasury securities $ 19,996 $ 45 $ - $ 20,041 U.S. Agency collateralized mortgage obligations 108 5 - 113 U.S. Agency residential mortgage-backed securities 11 - - 11 Municipal bonds 255 8 - 263 Total available-for-sale securities 20,370 58 - 20,428 Held-to-maturity U.S. Agency residential mortgage-backed securities 3,354 116 - 3,470 Total investment securities $ 23,724 $ 174 $ - $ 23,898 10 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (dollars in thousands) December 31, 2019 Available-for-sale U.S. Treasury securities $ 24,988 $ 1 $ ( 44 ) $ 24,945 U.S. Government agencies 3,000 - ( 1 ) 2,999 U.S. Agency collateralized mortgage obligations 129 - - 129 U.S. Agency residential mortgage-backed securities 27 - - 27 Municipal bonds 257 3 - 260 Total available-for-sale securities 28,401 4 ( 45 ) 28,360 Held-to-maturity U.S. Agency residential mortgage-backed securities 4,350 - ( 21 ) 4,329 Total investment securities $ 32,751 $ 4 $ ( 66 ) $ 32,689 The amortized cost and fair value of debt securities at September 30, 2020, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers or the underlying borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities and collateralized mortgage obligations are shown separately, since they are not due at a single maturity date. Available-for-Sale Held-to-Maturity Amortized Cost Fair Value Amortized Cost Fair Value (dollars in thousands) September 30, 2020 Amounts maturing in One year or less $ 19,996 $ 20,041 $ - $ - After one year through five years 255 263 - - 20,251 20,304 - - U.S. Agency residential mortgage-backed securities and collateralized mortgage obligations 119 124 3,354 3,470 $ 20,370 $ 20,428 $ 3,354 $ 3,470 Investment securities with carrying values of $ 21,958,000 and $ 16,843,000 at September 30, 2020 and December 31, 2019, respectively, were pledged to secure public deposits and for other purposes as required or permitted by law. 11 There were no sales of available for sale securities during the three or nine months ended September 30, 2020. There were five securities sold totaling $ 30.0 million during the three and nine months ended September 30, 2019, resulting in gross gains of $ 242,000 and gross losses of $ 71,000 . There were no gross unrealized losses as of September 30, 2020. Information pertaining to securities with gross unrealized losses at the date indicated, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows: Less Than 12 Months 12 Months or Greater Total Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses (dollars in thousands) December 31, 2019 Available-for-sale U.S. Treasury securities $ 9,994 $ ( 3 ) $ 4,956 $ ( 41 ) $ 14,950 $ ( 44 ) U.S. Government agencies - - 2,999 ( 1 ) 2,999 ( 1 ) Total available-for-sale securities 9,994 ( 3 ) 7,955 ( 42 ) 17,949 ( 45 ) Held-to-maturity U.S. Agency residential mortgage-backed securities 3,140 ( 14 ) 1,189 ( 7 ) 4,329 ( 21 ) Total investment securities $ 13,134 $ ( 17 ) $ 9,144 $ ( 49 ) $ 22,278 $ ( 66 ) At September 30, 2020 and December 31, 2019, there were zero and six securities in an unrealized loss position, respectively. Unrealized losses have not been recognized into income because management does not intend to sell and does not expect that it will be required to sell the investments. The decline is largely due to changes in market conditions and interest rates, rather than credit quality. The fair value is expected to recover as the underlying securities in the portfolio approach maturity date and market conditions improve. The Company did no t consider these securities to be other than temporarily impaired at December 31, 2019. Note 4 - Loans and Allowance for Loan Losses The composition of the loan portfolio is as follows as of the periods indicated: September 30, December 31, 2020 2019 Commercial and industrial loans $ 589,204 $ 111,401 Real estate loans: Construction, land, and land development 100,955 97,034 Residential real estate 121,147 115,011 Commercial real estate 705,186 613,398 Consumer and other loans 3,927 4,214 Gross loans receivable 1,520,419 941,058 Net deferred origination fees and premiums ( 11,030 ) ( 1,955 ) Loans receivable $ 1,509,389 $ 939,103 Included in consumer and other loans are overdrafts of $ 11,000 and $ 26,000 at September 30, 2020 and December 31, 2019, respectively. The Company has pledged loans totaling $ 378,645,000 and $ 163,522,000 at September 30, 2020 and December 31, 2019, respectively, for borrowing lines at the FHLB and Federal Reserve Bank (“FRB”). The balance of Small Business Administration (“SBA”) and United States Department of Agriculture (“USDA”) loans was $ 487,536,000 and $ 36,592,000 at September 30, 2020 and December 31, 2019, respectively. Paycheck Protection Plan (“PPP”) loans totaling $ 452,846,000 at September 30, 2020 are included in the commercial and industrial loans balance. Net deferred origination fees and premiums include $ 8,586,000 of net fees from PPP loans as of September 30, 2020. Included in these totals are SBA and USDA loans serviced for others amounting to $ 20,700,000 and $ 21,498,000 at September 30, 2020 and December 31, 2019, respectively . 12 The Company, at times, purchases individual loans at fair value as of the acquisition date. Purchased loans with remaining balances totaled $ 20,920,000 and $ 32,937,000 as of September 30, 2020 and December 31, 2019, respectively. Unamortized premiums totaled $ 324,000 and $ 527,000 as of September 30, 2020 and December 31, 2019, respectively, and are amortized into interest income over the life of the loans. The Company has purchased participation loans with remaining balances totaling $ 41,465,000 and $ 31,352,000 as of September 30, 2020 and December 31, 2019, respectively. The following is a summary of the Company’s loan portfolio segments: Commercial and industrial loans - Commercial and industrial loans are secured by business assets including inventory, receivables and machinery and equipment of businesses located generally in the Company’s primary market area. Loan types include revolving lines of credit, term loans, and loans secured by liquid collateral such as cash deposits or marketable securities. The Company also issues letters of credit on behalf of its customers. Risk arises primarily due to the difference between expected and actual cash flows of the borrowers. In addition, the recoverability of the Company’s investment in these loans is also dependent on other factors primarily dictated by the type of collateral securing these loans. The fair value of the collateral securing these loans may fluctuate as market conditions change. In the case of loans secured by accounts receivable, the recovery of the Company’s investment is dependent upon the borrower’s ability to collect amounts due from its customers. Also included in this category are SBA 7(a) loans, which allow small business owners to apply for financial assistance via the PPP as prescribed in the CARES Act. These loans have a contractual rate of 1.0 %, with maturity terms of two to five years , are unsecured, 100 % guaranteed and loan proceeds may be forgiven by the U.S. Government / SBA if used for certain purposes. 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 Paycheck Protection Program Liquidity Facility extends credit to eligible financial institutions that originate PPP loans, taking the loans as collateral at face value. The interest rate is 0.35 % and as PPP loans are paid down, the borrowing line must also be paid down. Construction, land and land development loans – The Company originates loans for the construction of 1-4 family, multifamily, and Commercial Real Estate (“CRE”) properties in the Company’s market area. Construction loans are considered to have higher risks due to construction completion and timing risk, the ultimate repayment being sensitive to interest rate changes, government regulation of real property and the availability of long-term financing. Additionally, economic conditions may impact the Company’s ability to recover its investment in construction loans, as adverse economic conditions may negatively impact the real estate market, which could affect the borrower’s ability to complete and sell the project. Additionally, the fair value of the underlying collateral may fluctuate as market conditions change. The Company occasionally originates land loans for the purpose of facilitating the ultimate construction of a home or commercial building. The primary risks include the borrower’s ability to pay and the inability of the Company to recover its investment due to a material decline in the fair value of the underlying collateral. Residential real estate loans - Residential real estate loans include various types of loans for which the Company holds real property as collateral. Included in this segment are first lien single family loans, which are occasionally purchased to diversify the Company’s loan portfolio, and rental portfolios secured by one-to-four family homes. The primary risks of residential real estate loans include the borrower’s inability to pay, material decreases in the value of the collateral, and significant increases in interest rates which may make the loan unprofitable. Commercial real estate (includes owner occupied and nonowner occupied) loans - Commercial real estate loans include various types of loans for which the Company holds real property as collateral. The primary risks of commercial real estate loans include the borrower’s inability to pay, material decreases in the value of the collateralized real estate and significant increases in interest rates, which may make the real estate loan unprofitable. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. Consumer and other loans – The Company originates a limited number of consumer loans, generally for banking customers only, which consist primarily of home equity lines of credit, saving account secured loans, and auto loans. This loan category also includes overdrafts. Repayment of these loans is dependent on the borrower’s ability to pay and the fair value of the underlying collateral. 13 The following table illustrates an age analysis of past due loans as of the dates indicated: 30-89 Days Past Due 90 Days or More Past Due Total Past Due Current Total Loans Recorded Investment 90 Days or More Past Due and Still Accruing (dollars in thousands) September 30, 2020 Commercial and industrial loans $ - $ 625 $ 625 $ 588,579 $ 589,204 $ - Real estate loans: Construction, land and land development - 3,269 3,269 97,686 100,955 - Residential real estate - 61 61 121,086 121,147 - Commercial real estate - 405 405 704,781 705,186 - Consumer and other loans - - - 3,927 3,927 - $ - $ 4,360 $ 4,360 $ 1,516,059 $ 1,520,419 $ - Less net deferred origination fees and premiums ( 11,030 ) Loans receivable $ 1,509,389 30-89 Days Past Due 90 Days or More Past Due Total Past Due Current Total Loans Recorded Investment 90 Days or More Past Due and Still Accruing (dollars in thousands) December 31, 2019 Commercial and industrial loans $ 143 $ 965 $ 1,108 $ 110,293 $ 111,401 $ - Real estate loans: Construction, land and land development - - - 97,034 97,034 - Residential real estate - 65 65 114,946 115,011 - Commercial real estate 417 - 417 612,981 613,398 - Consumer and other loans 4 - 4 4,210 4,214 - $ 564 $ 1,030 $ 1,594 $ 939,464 941,058 $ - Less net deferred origination fees and premiums ( 1,955 ) Loans receivable $ 939,103 14 A summary of information pertaining to impaired loans as of the period indicated: Unpaid Contractual Principal Balance Recorded Investment With No Allowance Recorded Investment With Allowance Total Recorded Investment Related Allowance (dollars in thousands) September 30, 2020 Commercial and industrial loans $ 922 $ 625 $ - $ 625 $ - Real estate loans: Construction, land and land development 3,269 3,269 - 3,269 - Residential real estate 190 178 - 178 - Commercial real estate 413 405 - 405 - Total $ 4,794 $ 4,477 $ - $ 4,477 $ - December 31, 2019 Commercial and industrial loans $ 1,431 $ 965 $ - $ 965 $ - Real estate loans: Residential real estate 73 65 - 65 - Consumer 2 - 2 2 2 Total $ 1,506 $ 1,030 $ 2 $ 1,032 $ 2 The following tables summarize the Company’s average recorded investment and interest income recognized on impaired loans by loan class for the three and nine months ended September 30, 2020 and 2019: Three Months Ended September 30, 2020 September 30, 2019 Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized (dollars in thousands) Commercial and industrial loans $ 657 $ - $ 1,406 $ - Real estate loans: Construction, land and land development 3,270 - - - Residential real estate 151 - 68 - Commercial real estate 409 - - - Total $ 4,487 $ - $ 1,474 $ - Nine Months Ended September 30, 2020 September 30, 2019 Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized (dollars in thousands) Commercial and industrial loans $ 748 $ - $ 933 $ - Real estate loans: Construction, land and land development 1,666 - - - Residential real estate 153 - 71 - Commercial real estate 204 - 315 - Total $ 2,771 $ - $ 1,319 $ - The Company grants restructurings in response to borrower financial difficulty, and generally provides for a temporary modification of loan repayment terms. The restructured loans on accrual status represent the only impaired loans accruing interest. In order for a restructured loan to be considered for accrual status, the loan’s collateral coverage generally will be greater than or equal to 100 % of the loan balance, the loan is current on payments, and the borrower must either prefund an interest reserve or demonstrate the ability to make payments from a verified source of cash flow for an extended period of time, usually at least six months in duration. 15 No loans were restructured in the three or nine months ended September 30, 2020 and September 30, 2019 that qualified as troubled debt restructurings (“TDRs”). The Company has no commitments to loan additional funds to borrowers whose loans were classified as TDRs at September 30, 2020, as there were no outstanding TDRs at September 30, 2020. The Company is in contact with borrowers with existing loans that have been impacted by COVID-19. The Company has modified payments for loan customers during this uncertain time to help alleviate financial hardships. There are 44 loans, representing $ 52.5 million in outstanding loans, and $ 1.4 million in unused commitments, that remain on deferred or modified payment status as of September 30, 2020. In accordance with GAAP and interagency guidance issued on March 22, 2020, these short-term modifications, six months or less, made on a good faith basis in response to COVID-19 to borrowers that were current prior to any relief, are not considered troubled debt restructurings. When loans are placed on nonaccrual status, all accrued interest is reversed from current period earnings. Payments received on nonaccrual loans are generally applied as a reduction to the loan principal balance. If the likelihood of further loss is removed, the Company will recognize interest on a cash basis only. Loans may be returned to accruing status if the Company believes that all remaining principal and interest is fully collectible and there has been at least six months of sustained repayment performance since the loan was placed on nonaccrual. An analysis of nonaccrual loans by category consisted of the following at the periods indicated: September 30, December 31, 2020 2019 (dollars in thousands) Commercial and industrial loans $ 625 $ 965 Real estate loans: Construction, land and land development 3,269 - Residential real estate 178 65 Commercial real estate 405 - Total nonaccrual loans $ 4,477 $ 1,030 Credit Quality and Credit Risk Federal regulations require that the Company periodically evaluate the risks inherent in its loan portfolio. In addition, the Company’s regulatory agencies have authority to identify problem loans and, if appropriate, require them to be reclassified. There are three classifications for problem loans: Substandard, Doubtful, and Loss. Substandard loans have one or more defined weaknesses and are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Doubtful loans have the weaknesses of loans classified as Substandard, with additional characteristics that suggest the weaknesses make collection or recovery in full after liquidation of collateral questionable on the basis of currently existing facts, conditions, and values. There is a high possibility of loss in loans classified as Doubtful. A loan classified as Loss is considered uncollectible and of such little value that continued classification of the credit as a loan is not warranted. If a loan or a portion thereof is classified as Loss, it must be charged-off, meaning the amount of the loss is charged against the allowance for loan losses, thereby reducing that reserve. The Company also classifies some loans as Watch or Other Loans Especially Mentioned (“OLEM”). Loans classified as Watch are performing assets and classified as pass credits but have elements of risk that require more monitoring than other performing loans and are reported in the OLEM column in the following table. Loans classified as OLEM are assets that continue to perform but have shown deterioration in credit quality and require close monitoring. 16 Loans by credit quality risk rating are as follows as of the periods indicated: Pass Other Loans Especially Mentioned Sub- Standard Doubtful Total (dollars in thousands) September 30, 2020 Commercial and industrial loans $ 578,128 $ 9,594 $ 1,482 $ - $ 589,204 Real estate loans: Construction, land, and land development 97,686 - 3,269 - 100,955 Residential real estate 120,559 410 178 - 121,147 Commercial real estate 688,621 16,160 405 - 705,186 Consumer and other loans 3,927 - - - 3,927 $ 1,488,921 $ 26,164 $ 5,334 $ - 1,520,419 Less net deferred origination fees ( 11,030 ) Loans receivable $ 1,509,389 December 31, 2019 Commercial and industrial loans $ 104,911 $ 4,740 $ 1,750 $ - $ 111,401 Real estate loans: Construction, land, and land development 97,034 - - - 97,034 Residential real estate 114,823 123 65 - 115,011 Commercial real estate 608,773 4,625 - - 613,398 Consumer and other loans 4,212 - 2 4,214 $ 929,753 $ 9,488 $ 1,817 $ - 941,058 Less net deferred origination fees ( 1,955 ) Loans receivable $ 939,103 Allowance for Loan Losses The Company’s allowance for loan losses (“ALLL”) covers estimated credit losses on individually evaluated loans that are determined to be impaired as well as estimated probable losses inherent in the remainder of the loan portfolio. The ALLL is prepared using the information provided by the Company’s credit review process together with economic information gathered from published sources. Qualitative factors that are included in the analysis include industry data and data from peer institutions. The loan portfolio is segmented into groups of loans with similar risk profiles. Each segment possesses varying degrees of risk based on the type of loan, the type of collateral, and the sensitivity of the borrower or industry to changes in external factors such as economic conditions. An estimated loss rate calculated from the Company’s actual historical loss rates adjusted for current portfolio trends, economic conditions, and other relevant internal and external factors, is applied to each group’s aggregate loan balances. The $ 452.8 million in PPP loans as of September 30, 2020 are 100% guaranteed and were not subject to the allowance analysis or assigned an allowance. The Company’s provision for credit losses of $ 2.2 million and $ 5.7 million during the three and nine months ended September 30, 2020, respectively, is related to an increase in qualitative factors primarily related to the uncertainties in the economic outlook from the COVID-19 pandemic and growth in the loan portfolio. The Company is not required to implement the provisions of the Current Expected Credit Loss (“CECL”) accounting standard until January 1, 2023 and is continuing to account for the allowance for loan losses under the incurred loss model. 17 The following tables summarize the allocation of the ALLL, as well as the activity in the ALLL attributed to various segments in the loan portfolio, as of and for the three and nine months ended September 30, 2020: Commercial and Industrial Construction, Land, and Land Development Residential Real Estate Commercial Real Estate Consumer and Other Unallocated Total (dollars in thousands) Three Months Ended September 30, 2020 ALLL balance, June 30, 2020 $ 2,853 $ 3,378 $ 2,669 $ 5,235 $ 140 $ 572 $ 14,847 Provision for loan losses or (recapture) 27 234 222 1,929 ( 9 ) ( 203 ) 2,200 2,880 3,612 2,891 7,164 131 369 17,047 Loans charged-off - - - - ( 2 ) - ( 2 ) Recoveries of loans previously charged-off - - - - 1 - 1 Net (charge-offs) recoveries - - - - ( 1 ) - ( 1 ) ALLL balance, September 30, 2020 $ 2,880 $ 3,612 $ 2,891 $ 7,164 $ 130 $ 369 $ 17,046 Nine Months Ended September 30, 2020 ALLL balance, December 31, 2019 $ 2,366 $ 2,745 $ 2,069 $ 3,126 $ 104 $ 1,060 $ 11,470 Provision for loan losses or (recapture) 639 867 822 4,038 33 ( 691 ) 5,708 3,005 3,612 2,891 7,164 137 369 17,178 Loans charged-off ( 130 ) - - - ( 9 ) - ( 139 ) Recoveries of loans previously charged-off 5 - - - 2 - 7 Net (charge-offs) recoveries ( 125 ) - - - ( 7 ) - ( 132 ) ALLL balance, September 30, 2020 $ 2,880 $ 3,612 $ 2,891 $ 7,164 $ 130 $ 369 $ 17,046 As of September 30, 2020 ALLL amounts allocated to Individually evaluated for impairment $ - $ - $ - $ - $ - $ - $ - Collectively evaluated for impairment 2,880 3,612 2,891 7,164 130 369 17,046 ALLL balance September 30, 2020 $ 2,880 $ 3,612 $ 2,891 $ 7,164 $ 130 $ 369 $ 17,046 Loans individually evaluated for impairment $ 625 $ 3,269 $ 178 $ 405 $ - $ 4,477 Loans collectively evaluated for impairment 588,579 97,686 120,969 704,781 3,927 1,515,942 Loan balance, September 30, 2020 $ 589,204 $ 100,955 $ 121,147 $ 705,186 $ 3,927 $ 1,520,419 18 The following tables summarize the allocation of the ALLL , as well as the activity in the ALLL attributed to various segments in the loan portfolio, as of and for the three and nine months ended September 30 , 2019 : Commercial and Industrial Construction, Land, and Land Development Residential Real Estate Commercial Real Estate Consumer and Other Unallocated Total (dollars in thousands) Three months ended September 30, 2019 Balance, June 30, 2019 $ 2,482 $ 2,386 $ 1,814 $ 2,845 $ 67 $ 849 $ 10,443 Provision for loan losses or (recapture) 195 136 140 107 22 37 637 2,677 2,522 1,954 2,952 89 886 11,080 Loans charged-off ( 118 ) ( 75 ) - - ( 3 ) - ( 196 ) Recoveries of loans previously charged-off 2 - - - 2 - 4 Net (charge-offs) recoveries ( 116 ) ( 75 ) - - ( 1 ) - ( 192 ) Balance, September 30, 2019 $ 2,561 $ 2,447 $ 1,954 $ 2,952 $ 88 $ 886 $ 10,888 Nine months ended September 30, 2019 Balance, December 31, 2018 $ 2,039 $ 1,806 $ 1,647 $ 2,648 $ 77 $ 1,190 $ 9,407 Provision for loan losses or (recapture) 643 716 307 333 29 ( 304 ) 1,724 2,682 2,522 1,954 2,981 106 886 11,131 Loans charged-off ( 125 ) ( 75 ) - ( 29 ) ( 23 ) - ( 252 ) Recoveries of loans previously charged-off 4 - - - 5 - 9 Net (charge-offs) recoveries ( 121 ) ( 75 ) - ( 29 ) ( 18 ) - ( 243 ) Balance, September 30, 2019 $ 2,561 $ 2,447 $ 1,954 $ 2,952 $ 88 $ 886 $ 10,888 As of September 30, 2019 ALLL amounts allocated to Individually evaluated for impairment $ 230 $ - $ - $ - $ - $ - $ 230 Collectively evaluated for impairment 2,331 2,447 1,954 2,952 88 886 10,658 ALLL balance, September 30, 2019 $ 2,561 $ 2,447 $ 1,954 $ 2,952 $ 88 $ 886 $ 10,888 Loans individually evaluated for impairment $ 1,233 $ - $ 67 $ - $ - $ 1,300 Loans collectively evaluated for impairment 104,401 86,919 100,751 578,607 3,720 874,398 Loan balance, September 30, 2019 $ 105,634 $ 86,919 $ 100,818 $ 578,607 $ 3,720 $ 875,698 The following table summarizes the allocation of the ALLL attributed to various segments in the loan portfolio as of December 31, 2019. Commercial and Industrial Construction, Land, and Land Development Residential Real Estate Commercial Real Estate Consumer and Other Unallocated Total (dollars in thousands) As of December 31, 2019 ALLL amounts allocated to Individually evaluated for impairment $ - $ - $ - $ - $ 2 $ - $ 2 Collectively evaluated for impairment 2,366 2,745 2,069 3,126 102 1,060 11,468 ALLL balance, December 31, 2019 $ 2,366 $ 2,745 $ 2,069 $ 3,126 $ 104 $ 1,060 $ 11,470 Loans individually evaluated for impairment $ 965 $ - $ 65 $ - $ 2 $ 1,032 Loans collectively evaluated for impairment 110,436 97,034 114,946 613,398 4,212 940,026 Loan balance, December 31, 2019 $ 111,401 $ 97,034 $ 115,011 $ 613,398 $ 4,214 $ 941,058 19 Note 5 - Deposits The composition of consolidated deposits consisted of the following at the periods indicated: September 30, December 31, 2020 2019 (dollars in thousands) Demand, noninterest bearing $ 570,664 $ 371,243 NOW and money market 624,891 437,908 Savings 74,694 53,365 BaaS-brokered deposits 24,870 23,586 Time deposits less than $250,000 41,676 51,644 Time deposits $250,000 and over 23,216 30,213 Total deposits $ 1,360,011 $ 967,959 The following table presents the maturity distribution of time deposits as of September 30, 2020 (dollars in thousands): Twelve months $ 52,266 One to two years 8,013 Two to three years 2,531 Three to four years 974 Four to five years 1,108 $ 64,892 Note 6 - Leases The Company has committed to rent premises used in business operations under non-cancelable operating leases and determines if an arrangement meets the definition of a lease upon inception. The Company adopted the provisions of ASU 2016-02 (Topic 842) on January 1, 2019. Operating lease right-of-use (“ROU”) assets represent a right to use an underlying asset for the contractual lease term. Operating lease liabilities represent an obligation to make lease payments arising from the lease. Operating lease ROU assets and operating lease liabilities were recognized in the Company’s Unaudited Consolidated Balance Sheets for leases that existed at the adoption date, based on the present value of lease payments over the remaining lease term. ROU assets were further adjusted for lease incentives. Operating leases entered into after the adoption date were recognized as an operating lease ROU asset and operating lease liability at the commencement date of the new lease. The Company’s leases do not provide an implicit interest rate, therefore the Company used its incremental collateralized borrowing rates commensurate with the underlying lease terms to determine the present value of operating lease liabilities. There were no new leases during the period. The Company’s operating lease agreements contain both lease and non-lease components, which are generally accounted for separately. The Company’s lease agreements do not contain any residual value guarantees. Operating leases with terms of 12 months or less are not included in ROU assets and operating lease liabilities recorded in the Company’s consolidated balance sheets. Operating lease terms include options to extend when it is reasonably certain that the Company will exercise such options, determined on a lease-by-lease basis . As of September 30, 2020, the Company does no t have any leases that have not yet commenced. At September 30, 2020, lease expiration dates ranged from six months to 25 years , with additional renewal options on certain leases typically ranging from 5 to 10 years . At September 30, 2020, the weighted average remaining lease term for the Company’s operating leases was 10.5 years. Rental expense for operating leases is recognized on a straight-line basis over the lease term and amounted to $ 461,000 and $ 342,000 , respectively, for the three months ended September 30, 2020 and 2019 and $ 1.1 million for both the nine months ended September 30, 2020 and 2019. Variable lease components, such as inflation adjustments, are expensed as incurred and not included in ROU assets and operating lease liabilities. 20 The following table presents the minimum annual lease payments under the terms of these leases, inclusive of renewal options that the Company is reasonably certain to renew, at September 30, 2020: September 30, (dollars in thousands) 2020 October 1, 2020 to December 31, 2020 $ 318 2021 1,254 2022 1,258 2023 1,269 2024 864 2025 and thereafter 3,922 Total lease payments 8,885 Less: amounts representing interest 1,306 Present value of lease liabilities $ 7,579 The following table presents the components of total lease expense and operating cash flows for the nine months ended September 30, 2020: September 30, (dollars in thousands) 2020 Lease expense: Operating lease expense $ 983 Variable lease expense 239 Total lease expense (1) $ 1,222 Cash paid: Cash paid reducing operating lease liabilities $ 1,206 (1) Included in net occupancy expense in the Condensed Consolidated Statements of Income (Unaudited). Note 7 - Stock-Based Compensation Stock Options and Restricted Stock On April 30, 2018, the Company’s shareholders approved the Coastal Financial Corporation 2018 Omnibus Incentive Plan (“2018 Plan”). The 2018 Plan authorizes the Company to grant awards, including but not limited to, stock options restricted stock units, and restricted stock awards, to eligible employees, directors or individuals that provide service to the Company, up to an aggregate of 500,000 shares of common stock. The 2018 Plan replaces both the Company’s 2006 Stock Option and Equity Compensation Plan (“2006 Plan”) and its Directors’ Stock Bonus Plan. Existing awards under the previous plans will vest under the terms granted and no further awards will be made under these plans. Shares available to be granted under the 2018 Plan totaled 275,323 at September 30, 2020. Stock Option Awards In January 2019, the Company granted 26,737 nonqualified stock options under the 2018 Plan to an employee, which vest ratably over 10 years. In January 2019, the Company also granted 99,100 qualified stock options under the 2018 Plan to employees, which vest ratably over 10 years. The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model that uses the assumptions noted in the following table. Expected volatilities are based on historical volatility of the Company’s stock and other factors. The Company uses the vesting term and contractual life to determine the expected life. The risk-free interest rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. Compensation expense related to unvested stock option awards is reversed at date of forfeiture. 21 The following assumptions were used to estimate the value of options granted under the 2018 Plan as applicable in the period indicated. There were no new stock options granted in the nine months ended September 30, 2020: Nine months ended September 30, 2019 Expected term 10.0 years Expected stock price volatility 48.79 % Risk-free interest rate 2.74 % Expected dividends Zero Weighted average grant date fair value $ 9.22 A summary of stock option activity under the 2018 Plan and 2006 Plan during the nine months ended September 30, 2020: Options Shares Weighted- Average Exercise Price Weighted- Average Remaining Contractual Term (Years) Aggregate Intrinsic Value (dollars in thousands, except per share amounts) Outstanding at December 31, 2019 784,217 $ 7.73 5.95 $ 6,587 Granted - - - Exercised ( 13,610 ) 6.07 - Forfeited or expired ( 1,000 ) 14.91 - Outstanding at September 30, 2020 769,607 $ 7.75 5.21 $ 3,825 Vested or expected to vest at September 30, 2020 769,607 $ 7.75 5.21 $ 3,825 Exercisable at September 30, 2020 333,933 $ 6.43 3.89 $ 1,984 The total or aggregate intrinsic value (which is the amount by which the stock price exceeds the exercise price) of options exercised during the three and nine months ended September 30, 2020 was $ 28,000 and $ 121,000 , respectively, and was $ 35,000 and $ 170,000 for the three and nine months ended September 30, 2019, respectively. As of September 30, 2020, there was $ 2.0 million of total unrecognized compensation cost related to nonvested stock options granted under the 2018 Plan and 2006 Plan. Total unrecognized compensation costs are adjusted for unvested forfeitures. The Company expects to recognize that cost over a weighted-average period of approximately 6.8 years. Compensation expense recorded related to stock options was $ 94,000 and $ 281,000 for the three and nine months ended September 30, 2020, respectively, and $ 101,000 and $ 295,000 for the three and nine months ended September 30, 2019, respectively. Restricted Stock Units In February 2020, the Company granted 78,756 restricted stock units under the 2018 Plan to employees, which vest ratably over 10 years . In April 2020, the Company granted 1,490 restricted stock units under the 2018 Plan to an employee, which vest ratably over 10 years. In July 2020, the Company granted 6,902 restricted stock units under the 2018 Plan to employees, which cliff vest after 5 years. The fair value of restricted stock units is equal to the fair value of the Company’s stock at the date of grant. Compensation expense is recognized over the vesting period that the awards are based. Restricted stock units are nonparticipating securities. As of September 30, 2020, there was $ 1.3 million of total unrecognized compensation cost related to nonvested restricted stock units. The Company expects to recognize that cost over the remaining weighted-average vesting period of approximately 9.2 years. Compensation expense recorded related to restricted stock units was $ 39,000 and $ 96,000 for the three and nine months ended September 30, 2020, respectively. There were no restricted stock units and no compensation expense recorded related to restricted stock units for the three and nine months ended September 30, 2019. 22 A summary of the Company’s nonvested shares at September 30, 2020 and changes during the nine-month period is presented below: Nonvested shares Shares Weighted- Average Grant Date Fair Value Total or Aggregate Intrinsic Value (dollars in thousands, except per share amounts) Nonvested shares at December 31, 2019 - $ - $ - Granted 87,148 17.47 Forfeited ( 2,808 ) 17.81 Vested - - Nonvested shares at September 30, 2020 84,340 $ 17.47 $ - Restricted Stock Awards Employees In February 2020, there were 4,000 shares granted to an employee at an estimated fair value of $ 17.81 per share, vesting over eight years . The fair value of restricted stock awards is equal to the fair value of the Company’s stock at the date of grant. Compensation expense is recognized over the vesting period that the awards are based. Restricted stock awards are participating securities. As of September 30, 2020, there was $ 65,000 of total unrecognized compensation cost related to nonvested restricted stock awards. The Company expects to recognize that cost over the remaining weighted-average vesting period of approximately 7.3 years. Compensation expense recorded related to restricted stock awards was $ 2,000 and $ 5,000 for the three and nine months ended September 30, 2020, respectively, and was $ 2,000 and $ 5,000 for the three and nine months ended September 30, 2019, respectively. Director’s Stock Bonus The Company adopted and subsequently amended the Director’s Stock Bonus Plan (“Bonus Plan”). The Bonus Plan would have expired on May 31, 2018 but was replaced on April 30, 2018, when the shareholders approved the 2018 Plan. Stock is granted to directors who attended at least 75 % of the scheduled board meetings during the prior year. Grants cliff vest over two years from date awarded, contingent on the director still being a director of the Company. During the vesting period, the grants are considered participating securities. Awards previously granted under the Bonus Plan will vest under the term granted. Under the 2018 Plan, eligible directors are granted stock with a total market value of $ 5,000 . Directors unable to receive stock will receive cash in lieu upon completion of the vesting period. Cash awards are recognized over the vesting period and recorded in other liabilities until paid. In February 2020, there were 2,248 shares granted to eight directors at an estimated fair value of $ 17.81 per share. In January 2019, there were 2,352 shares granted to seven directors at an estimated fair value of $ 14.91 per share. Compensation expense recorded related to the 2018 Plan totaled $ 8,000 and $ 26,000 for the three and nine months ended September 30, 2020, respectively, and $ 8,000 and $ 25,000 for the three and nine months ended September 30, 2019, respectively. 23 A summary of the Company’s nonvested shares at September 30, 2020 and changes during the nine-month period is presented below: Nonvested shares Shares Weighted- Average Grant Date Fair Value Total or Aggregate Intrinsic Value (dollars in thousands, except per share amounts) Nonvested shares at December 31, 2019 10,257 $ 11.71 $ 48,864 Granted 6,248 17.81 Forfeited ( 3,500 ) 15.35 Vested ( 5,022 ) 7.23 Nonvested shares at September 30, 2020 7,983 $ 17.08 $ - Note 8 - Fair Value Measurements The following tables present estimated fair values of the Company’s financial instruments as of the period indicated, whether or not recognized or recorded in the consolidated balance sheets at the period indicated: September 30, 2020 Fair Value Measurements Using Carrying Value Estimated Fair Value Level 1 Level 2 Level 3 (dollars in thousands) Financial assets Cash and due from banks $ 14,136 $ 14,136 $ 14,136 $ - $ - Interest earning deposits with other banks 168,034 168,034 168,034 - - Investment securities 23,782 23,897 20,040 3,857 - Other investments 5,951 5,951 - 5,201 750 Loans receivable 1,509,389 1,494,299 - - 1,494,299 Accrued interest receivable 8,216 8,216 - 8,216 - Financial liabilities Deposits $ 1,360,011 1,360,349 $ - $ 1,360,349 $ - FHLB advances 24,999 24,936 - 24,936 - Paycheck Protection Program Liquidity Facility 202,595 202,595 202,595 Subordinated debt 9,989 9,895 - 9,895 - Junior subordinated debentures 3,584 3,057 - 3,057 - Accrued interest payable 481 481 - 481 - December 31, 2019 Fair Value Measurements Using Carrying Value Estimated Fair Value Level 1 Level 2 Level 3 (dollars in thousands) Financial assets Cash and due from banks $ 16,555 $ 16,555 $ 16,555 $ - $ - Interest earning deposits with other banks 111,259 111,259 111,259 - - Investment securities 32,710 32,689 24,945 7,744 - Other investments 4,505 4,505 - 4,005 500 Loans receivable, net 927,633 922,046 - - 922,046 Accrued interest receivable 2,980 2,980 - 2,980 - Financial liabilities Deposits $ 967,959 $ 967,804 $ - $ 967,804 $ - FHLB advances 10,000 10,000 - 10,000 - Subordinated debt 9,979 9,879 - 9,879 - Junior subordinated debentures 3,583 3,214 - 3,214 - Accrued interest payable 308 308 - 308 - The Company measures and discloses certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date 24 (that is, not a forced liquidation or distressed sale). GAAP establishes a consistent framework for measuring fair value and disclosure requirements about fair value measurements. Among other things, the accounting standard requires the reporting entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s estimates for market assumptions. These two types of inputs create the following fair value hierarchy: • Level 1 – Quoted prices in active markets for identical instruments. An active market is a market in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available. • Level 2 – Observable inputs other than Level 1 including quoted prices in active markets for similar instruments, quoted prices in less active markets for identical or similar instruments, or other observable inputs that can be corroborated by observable market data. • Level 3 – Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation; also includes observable inputs from nonbinding single dealer quotes not corroborated by observable market data. The estimated fair value amounts of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize at a future date. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. In addition, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates that must be made given the absence of active secondary markets for certain financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values. Items measured at fair value on a recurring basis – The following fair value hierarchy table presents information about the Company’s assets that are measured at fair value on a recurring basis at the dates indicated: Level 1 Level 2 Level 3 Total Fair Value (dollars in thousands) September 30, 2020 Available-for-sale U.S. Treasury securities $ 20,041 $ - $ - $ 20,041 U.S. Agency collateralized mortgage obligations - 113 - 113 U.S. Agency residential mortgage-backed securities - 11 - 11 Municipals - 263 - 263 $ 20,041 $ 387 $ - $ 20,428 December 31, 2019 Available-for-sale U.S. Treasury securities $ 24,945 $ - $ - $ 24,945 U.S. Government agencies - 2,999 - 2,999 U.S. Agency collateralized mortgage obligations - 129 - 129 U.S. Agency residential mortgage-backed securities - 27 - 27 Municipals - 260 - 260 $ 24,945 $ 3,415 $ - $ 28,360 The following methods were used to estimate the fair value of the class of financial instruments above: Investment securities - The fair value of securities is based on quoted market prices, pricing models, quoted prices of similar securities, independent pricing sources, and discounted cash flows. Limitations: The fair value estimates presented herein are based on pertinent information available to management as of September 30, 2020 and December 31, 2019. The factors used in the fair values estimates are subject to change subsequent to the dates the fair value estimates are completed, therefore, current estimates of fair value may differ significantly from the amounts presented herein. 25 Assets measured at fair value using significant unobservable inputs (Level 3) The following table provides a description of the valuation technique, unobservable inputs, and qualitative information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and measured at fair value on a nonrecurring basis at the dates indicated: Valuation Technique Unobservable Inputs September 30, 2020 Weighted Average Rate December 31, 2019 Weighted Average Rate Impaired loans Collateral valuations Discount to appraised value 8 % 10 % Items measured at fair value on a nonrecurring basis – The following table presents financial assets and liabilities measured at fair value on a nonrecurring basis and the level within the fair value hierarchy of the fair value measurements for those assets at the dates indicated: Level 1 Level 2 Level 3 Total Fair Value (dollars in thousands) September 30, 2020 Impaired loans $ - $ - $ 4,477 $ 4,477 Total $ - $ - $ 4,477 $ 4,477 December 31, 2019 Impaired loans $ - $ - $ 1,030 $ 1,030 Total $ - $ - $ 1,030 $ 1,030 The amounts disclosed above represent the fair values at the time the nonrecurring fair value measurements were made, and not necessarily the fair value as of the dates reported on. Impaired loans - A loan is considered impaired when it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement. Impairment is measured based on the fair value of the underlying collateral or the discounted cash expected future cash flows. Subsequent changes in the value of impaired loans are included within the provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the provision that would otherwise be reported. Impaired loans are evaluated quarterly to determine if valuation adjustments should be recorded. The need for valuation adjustments arises when observable market prices or current appraised values of collateral indicate a shortfall in collateral value compared to current carrying values of the related loan. If the Company determines that the value of the impaired loan is less than the carrying value of the loan, the Company either establishes an impairment reserve as a specific component of the allowance for loan losses or charges off the impairment amount. These valuation adjustments are considered nonrecurring fair value adjustments. 26 Note 9 - Earnings Per Common Share The following is a computation of basic and diluted earnings per common share at the periods indicated: Three months ended Nine months ended September 30, 2020 September 30, 2019 September 30, 2020 September 30, 2019 (dollars in thousands, except share data) Net Income $ 4,090 $ 3,511 $ 10,485 $ 9,593 Basic weighted average number common shares outstanding 11,919,850 11,901,873 11,915,513 11,893,734 Dilutive effect of share-based compensation 261,422 286,634 268,332 299,337 Diluted weighted average number common shares outstanding 12,181,272 12,188,507 12,183,845 12,193,071 Basic earnings per share $ 0.34 $ 0.30 $ 0.88 $ 0.81 Diluted earnings per share $ 0.34 $ 0.29 $ 0.86 $ 0.79 Antidilutive stock options and restricted stock outstanding 224,177 138,689 224,177 138,689 Under the two-class method, earnings available to common shareholders for the period are allocated between common shareholders and participating securities according to dividends declared (or accumulated) and participation rights in undistributed earnings, however the difference in the two-class method was not significant. 27