BNCCORP, INC.322 East Main AvenueBismarck, ND 58501(701) 250-3040www.bnccorp.com2019 ANNUAL REPORT | BNCCORP, INC.$5.09 $27.932010201120122013201420152016201720182019$30$25$20$15$10$5Performing & Transforming2019 ANNUAL REPORTBook Value Per Share Outstanding BNCCORP, INC. (BNCCORP or the Company) is a bank holding company registered under the Bank Holding Company Act of 1956 headquartered in Bismarck, North Dakota. It is the parent company of BNC National Bank (the Bank). The Company operates community banking and wealth management businesses in North Dakota, Arizona and Minnesota from 13 locations. BNC also conducts mortgage banking from 11 locations in Arizona, North Dakota, Illinois, Kansas, Michigan, and Missouri. CORPORATE PROFILE: THE BUSINESS OF BNC BNC (or the Company) is a diversified community bank with three primary areas of focus: commercial banking, retail and mortgage banking, and wealth management. Commercial Banking. We meet the needs of small to middle-market businesses with a range of commercial banking services, including: business financing, commercial real estate lending, SBA loans, business checking, cash management, corporate credit cards and merchant services. The core of our commercial banking relationships are in North Dakota, mainly in the capital region of Bismarck/Mandan. From Bismarck, and locations to the north and west, we serve communities in North Dakota that are economically influenced by oil and energy, and to a lesser extent, we serve the agricultural communities of central North Dakota. In recent years, our banking presence in Phoenix, Arizona has grown significantly. By operating banking locations in Phoenix and Minnesota we create further opportunities for growth while diversifying our credit exposure. Retail and Mortgage Banking. BNC’s services to consumers include retail banking, provided through a network of locations in North Dakota, Arizona and Minnesota. Among our broad array of retail banking services are personal checking and savings products, personal loans and card services. Our branch network is concentrated in North Dakota, where we are responsive to the preference of our customers for convenient face-to-face transactional banking. BNC has been rewarded with our customers’ loyalty as our deposit growth and retention has been remarkable. Our mortgage banking operations generate residential loans through a consumer direct channel, as well as a retail channel with locations in Arizona, Minnesota, North Dakota, Illinois, Kansas, Michigan and Missouri. The consumer direct channel emphasizes the use of technology, including internet-generated leads and a call center, to originate loans throughout the U.S. The retail channel is more traditional and emphasizes relationships to originate loans near our branch network. Wealth Management. A trusted partner for our clients as they plan for retirement and manage their investments, BNC’s wealth management solutions include: 401(k) and other retirement plans, trust services, and personal wealth advisory services. Many of our wealth management clients are derived from commercial banking relationships. For example, we administer retirement savings plans for the employees of our business clients. We are well positioned to help clients manage wealth and transfer assets in a manner that enables them to accomplish their financial goals. BNCCORP, INC. Annual Report 2019 1 Timothy J. Franz President and Chief Executive Officer We are pleased to note that tangible book value per common share rose more than four-fold between year-end 2010 and 2019 - from $5.09 to $27.39. TO OUR COMMUNITY, SHAREHOLDERS, CUSTOMERS AND EMPLOYEES: As we begin a new decade, this is a good time to reflect on the value of a community bank like BNC and on how we have continually evolved over the years to deliver on our commitments to our customers, shareholders, employees and community. Our progress during the last 10 years, and in fact since BNC’s inception, reflects a dual focus on performing and transforming. We believe that vibrant, entrepreneurial banks like BNC must perform each and every day by building relationships, providing high quality service, working to deliver solid financial results, and meeting the needs of our customers. At the same time, we must constantly transform our business for a changing marketplace to meet new customer needs, remain competitive, maintain financial strength, develop our employees’ talent, and promote sound corporate governance. As this letter is being written, individuals, businesses and governments around the world are contending with the impact of the COVID-19 pandemic. While it is too soon to assess the impact of this crisis on the health of people and the economy alike, our own response at BNC has been guided by a deep concern for the safety and well-being of our customers, employees and community. We have taken actions to safeguard the health of our teammates and customers, to be flexible in assisting clients who may be affected by the economic burdens of the coronavirus, and to provide support to our community wherever possible. We are a resilient institution, comprised of resourceful and compassionate people. We will emerge from this challenge more united in our purpose. A DECADE OF INCREASING VALUE The actions of the past 10 years have resulted in a significant increase in value for our shareholders. As the chart on the cover of this annual report shows, BNC’s tangible book value per common share rose more than four-fold between year-end 2010 and 2019 – from $5.09 to $27.39 – representing a 20.6% annual compounded growth rate. We are justifiably proud of this increase in a bedrock measure of shareholder value, and committed to maintaining the strategies that have led to these strong results. Our track record of growing value has attracted recognition. BNC was recently honored by OTC Markets Group Inc. as one of its “2020 OTCQX® Best 50” companies, a ranking of the top-performing companies traded on the OTCQX Best Market in the prior calendar year. This selection was based on total return to shareholders and growth in average daily volume during 2019. PERFORMING: IMPROVED 2019 EARNINGS BNC’s results in 2019 reflected notably improved financial performance and a commitment to embracing transformative change to drive value. Net income was $10.2 million, or $2.88 per diluted share, a sharp increase from $6.8 million, or $1.93 per diluted share, in 2018. This net income resulted in a return on average equity of 11.41% and a return on average assets of 1.01%. It is noteworthy that this level of net income has only been exceeded once in BNC’s history, in 2012, when earnings included significant non-recurring gains from a tax recovery and an insurance settlement. 2 BNCCORP, INC. Annual Report 2019 Earnings for 2019 reflected actions taken in the fourth quarter designed to enhance future performance. Specifically, we elected to sell securities at a loss in order to deleverage our balance sheet and redeem $10 million of subordinated debt. While these actions reduced fourth quarter results, the transactions will have a positive impact on 2020 and future years by reducing debt and interest expense and should create value for our shareholders. Excluding the transactions noted above, adjusted earnings (a non-GAAP measure) were $11.2 million. The adjusted return on average equity and adjusted return on average assets for 2019 (non-GAAP) were 12.53% and 1.10%, respectively. Asset quality and capital levels remained strong. Nonperforming assets were $2.0 million, or 0.21% of total assets, at December 31, 2019, modestly higher than $1.7 million, and 0.17% of total assets, at December 31, 2018. The Company’s consolidated Tier 1 leverage ratio was 10.65% at year-end 2019, up from 9.97% a year ago, while the Tier 1 leverage ratio of BNC Bank was 9.81% and significantly above the “Well Capitalized” ratio threshold. BNC’s tangible book value per common share rose sharply to $27.39 as of December 31, 2019, compared to $22.26 at year end 2018 and tangible common equity was 9.95% and 7.99% of total assets as of December 31, 2019 and 2018, respectively. R E T U R N O N AV E R A G E A S S E T S 3.74% 0.61% 1.07% 0.94% 1.01% 1.01% 0.78% 0.70% 0.50% 2011 2012 2013 2014 2015 2016 2017 2018 2019 Note that this includes the $1.5 mm impact of tax reform we changed for ROE chart R E T U R N O N AV E R A G E E Q U I T Y 76.77% 15.77% 14.77% 11.91% 11.26% 9.48% 8.15% 9.00% 11.64% 2011 2012 2013 2014 2015 2016 2017 2018 2019 Note that the 2017 ROE excludes the $1.5mm impact of the 2017 Tax Cut and Jobs Act BNCCORP, INC. Annual Report 2019 3 B O O K VA L U E P E R S H A R E O U T S TA N D I N G $30.00 $25.00 $20.00 $15.00 $10.00 $5.00 $0.00 $18.28 $14.49 $14.45 $5.09 $6.42 $27.39 $20.12 $21.47 $22.40 $22.26 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 BNC’s core banking business showed steady progress in 2019. Effective Mortgage Banking Channels. During the Great Recession we added a modest mortgage banking business to BNC. Since then we have built a platform that is significantly scaled up and improved. In 2019, as interest rates moved downward, our mortgage banking team capitalized on these conditions and generated significantly higher revenues, having a positive impact on earnings. We funded $1.3 billion of residential mortgage loans and generated $24.9 million of revenue in 2019, versus loans funded of $642.7 million and $10.0 million in revenue in 2018. BNC’s mortgage business benefits from our strategy of maintaining both a consumer direct channel and a more traditional retail channel. The consumer direct channel acquires leads and connects with customers to originate loans throughout the United States. When conditions are favorable, this channel can quickly monetize loan origination activity. The retail channel is relationship driven, with our originators capitalizing on local connections to originate loans. Cyclicality is inherent in mortgage banking, but housing finance is a durable industry. This division has been a significant contributor to shareholder value for most of the past decade, when interest rates were generally low or declining. As 2020 commences the housing market is strong and interest rates remain low, which gives us cause for optimism that our mortgage banking business will perform well in 2020. Diverse Commercial Lending Platform. BNC’s core banking business showed steady progress in 2019. We continue to benefit from our entrepreneurial approach and focus on serving the needs of small and medium-sized businesses in our communities. Loans and leases held for investment (LHFI) totaled $508.6 million at December 31, 2019, a record high for BNC. Our growth rate for LHFI of 8.6% in 2019 was notably above the community banking industry. The strongest growth areas were commercial and industrial (C&I) lending, commercial real estate, Small Business Administration (SBA) and consumer loans, with our teams in North Dakota and Arizona each contributing to this growth. 4 BNCCORP, INC. Annual Report 2019 L O A N T O D E P O S I T R AT I O 62.0% 55.1% 55.2% 52.4% 44.6% 44.0% 44.5% 48.7% 2012 2013 2014 2015 2016 2017 2018 2019 L O A N S H E L D F O R I N V E S T M E N T $360,789 $379,903 $317,928 $293,211 $289,469 $414,673 $428,325 $508,569 $468,468 70.0% 65.0% 60.0% 55.0% 50.0% 45.0% 40.0% - - - - 0.0% $600,000 $500,000 $400,000 $300,000 $200,000 $100,000 $0.00 2011 2012 2013 2014 2015 2016 2017 2018 2019 A Strong Deposit Franchise Complemented with Wealth Management. Building a deposit-rich franchise has been an important part of BNC’s value-creation strategy, as deposits contribute to our solid customer relationships and provide a stable source of cost-effective funding and build franchise value. Total deposits at December 31, 2019, totaled $825.1 million, decreasing 4.1% from a year ago. This decrease was intentional and related to our efforts to deleverage our balance sheet while maintaining valuable customer relationships. Our wealth management business has also contributed to our value. By offering such financial solutions as asset management, retirement plan administration, and trust services, we are able to strengthen the bonds between BNC and its customers as the vast majority of wealth management clients have multiple relationships with us. Trust assets under management or administration increased 17.9% during the past year, to $377.8 million at December 31, 2019. BNCCORP, INC. Annual Report 2019 5 $400,000 $350,000 $300,000 $250,000 $200,000 - - - - - - $0 A S S E T S U N D E R A D M I N I S T R AT I O N $377,782 $321,274 $320,414 $249,691 $257,400 $248,371 $273,643 $211,519 2012 2013 2014 2015 2016 2017 2018 2019 TRANSFORMING TO IMPROVE Throughout its existence, BNC has been entrepreneurial, flexible and resilient – able to transform our business to adapt, grow and thrive in a world of shifting customer demands, dynamic economic forces, changing regulations and new technologies. 2019 was no exception. As noted earlier, we made the decision to deleverage the balance sheet late in 2019. Accordingly, we sold securities and reduced deposits via reversible one- way sell mechanisms that allow us to retain relationships with the depositors. We then used the cash proceeds generated from these actions to redeem subordinated debt with a coupon of 6.35%. These actions were intended to enhance our financial flexibility and improve net income in 2020 and beyond. Over the years, BNC has demonstrated that, “the only constant is change.” We have consistently viewed change as a gateway to opportunity. Over the years, we have refined our branch network, exited asset-based lending and insurance businesses, expanded into Minnesota and Arizona, and created a home-grown direct mortgage platform, among many other initiatives. We have taken these actions with an eye toward remaining relevant to the needs of our customers, shareholders, employees and community. Look for us to continue transforming. SUSTAINING: GREAT PEOPLE SERVING CUSTOMERS AND THE COMMUNITY While we embrace transformation and continuous improvement, we remain committed to the timeless values that make community banks unique: the belief that talented people with a dedication to serving their neighbors help individuals, businesses and communities to prosper. • We are only as strong as our people – our team of highly professional and motivated employees who are at the center of our customer relationships and our pursuit of excellence. 6 BNCCORP, INC. Annual Report 2019 • We also see ourselves as partners with our customers, dedicated to helping them achieve their financial goals at every step in their development. • And, we are active citizens of and contributors to the communities where our colleagues and customers live and work. BNC actively supports organizations involved in community and youth services, education, the arts, and business development, while our team members devote their time and energy to numerous worthy causes. We are proud of our efforts to support many community organizations in the past year. In 2019, BNC was declared “Business of the Year” by the Mandan Progress Organization, which is a tribute to the spirit of service and community pride that is shared by all of our people across the Company. I would like to take this opportunity to thank BNC’s customers for placing their trust in us, our employees for their hard work and dedication, our Board for their insight and guidance, and our shareholders for their confidence in our business and ability to create value. In 2020 and beyond, we will continue to focus on performing and transforming in order to deliver greater value for all of BNC’s stakeholders. Sincerely, Timothy J. Franz President and Chief Executive Officer Forward-Looking Statements Statements included in this cover letter to our Annual Report which are not historical in nature are intended to be, and are hereby identified as “forward-looking statements” for purposes of the safe harbor provided by Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We caution readers that these forward-looking statements, including without limitation, those relating to our future business prospects, revenues, working capital, liquidity, capital needs, interest costs, income and expenses, are subject to certain risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements due to several important factors. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, but are not limited to: the impact of current and future regulation; the risks of loans and investments, including dependence on local and regional economic conditions; competition for our customers from other providers of financial services; possible adverse effects of changes in interest rates, including the effects of such changes on mortgage banking revenues and derivative contracts and associated accounting consequences; risks associated with our acquisition and growth strategies; and other risks which are difficult to predict and many of which are beyond our control. All statements in this news release, including forward- looking statements, speak only of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events. In addition, we encourage readers to review the financial information included in this cover letter in conjunction with the Consolidated Financial Statements of BNCCORP, INC. and Subsidiaries included in the accompanying Annual Report. BNCCORP, INC. Annual Report 2019 7 ____________________________ Year End Financial Report ____________________________ For the Year Ended December 31, 2019 BNCCORP, INC. (OTCQX: BNCC) 322 East Main Avenue Bismarck, North Dakota 58501 (701) 250-3040 8 BNCCORP, INC. Annual Report 2019 BNCCORP, INC. INDEX TO YEAR END FINANCIAL REPORT December 31, 2019 TABLE OF CONTENTS Selected Financial Data Operating Strategy Management’s Discussion and Analysis of Financial Condition and Results of Operations Quantitative and Qualitative Disclosures about Market Risk Consolidated Financial Statements Page 10 12 13 33 36 BNCCORP, INC. Annual Report 2019 9 Selected Financial Data The selected consolidated financial data presented below should be read in conjunction with our consolidated financial statements and the notes thereto (dollars in thousands, except share and per share data): For the Years Ended December 31, 2019 2018 2017 2016 2015 Income Statement Data: Total interest income Total interest expense Net interest income Provision (reduction) for credit losses Non-interest income Non-interest expense Income tax expense (1) Net income (1) Preferred stock costs Net income available to common shareholders Balance Sheet Data: (at end of period) Total assets Investments securities available for sale Loans held for sale-mortgage banking Loans and leases held for investment, net of unearned income Allowance for credit losses Total deposits Short-term borrowings Federal Home Loan Bank advances Long-term borrowings Guaranteed preferred beneficial interests in Company’s subordinated debentures Common stockholders’ equity $ 37,817 $ 34,478 $ 31,443 $ 29,346 $ $ $ $ $ $ $ 9,101 28,716 700 29,131 43,991 2,921 10,235 - 10,235 966,750 265,278 137,114 508,569 (8,141) 820,547 4,565 17,000 - 15,006 96,278 6,108 28,370 - 19,017 39,013 1,538 6,836 - 6,836 $ $ 971,027 $ 411,509 22,788 468,468 (7,692) 848,605 11,494 - 10,000 15,009 77,753 $ $ $ 3,578 27,865 350 19,499 39,116 3,020 4,878 - 4,878 946,150 411,917 36,601 428,325 (7,861) 817,806 18,043 - 10,000 15,011 77,626 $ $ $ 3,343 26,003 800 25,777 41,193 2,631 7,156 - 7,156 910,400 400,136 39,641 414,673 (8,285) 752,627 12,510 38,000 10,000 15,013 74,195 Book value per common share outstanding $ 27.39 $ 22.26 $ 22.40 $ 21.47 $ 9.95% 7.99% 8.18% 8.13% 27,915 2,570 25,345 (400) 24,950 37,544 3,945 9,206 1,656 7,550 904,246 419,346 50,445 379,903 (8,611) 780,449 13,851 7,300 10,000 15,015 68,988 20.12 7.62% Tangible common equity ratio Earnings Performance / Share Data: Return on average total assets (1) Return on average common stockholders’ equity, excluding accumulated other comprehensive income (1) Efficiency ratio Net interest margin Net interest spread Basic earnings per common share (1) Diluted earnings per common share (1) Average common shares outstanding Average common and common equivalent shares Shares outstanding at year end Other Key Ratios Nonperforming assets to total assets Nonperforming loans to total assets Nonperforming loans to loans and leases held for investment Allowance for credit losses to loans and leases held for investment 1.01% 0.70% 0.50% 0.78% 1.01% 11.41% 76.05% 3.00% 2.79% 8.33% 82.33% 3.08% 2.90% 6.45% 82.59% 3.05% 2.92% 10.35% 79.55% 3.03% 2.93% $ $ 2.90 2.88 $ $ 1.96 1.93 $ $ 1.40 1.38 $ $ 2.08 2.03 $ $ 3,526,096 3,557,585 3,514,770 3,487,846 3,539,755 3,493,298 3,474,988 3,540,698 3,465,992 3,447,635 3,520,818 3,456,008 0.21% 0.21% 0.40% 1.60% 0.17% 0.17% 0.36% 1.64% 0.21% 0.21% 0.46% 1.84% 0.29% 0.27% 0.59% 2.00% 12.21% 74.65% 2.96% 2.86% 2.23 2.16 3,386,600 3,497,740 3,428,416 0.09% 0.06% 0.15% 2.27% (1) The 2017 results include amounts linked to tax reform legislation aggregating $1.515 million. Excluding the impact of these amounts, the Company would have reported income tax expense of $1.505 million and net income of $6.393 million. Return on average total assets would have been 0.66% and Return on average common stockholder’s equity would have been 8.46%. Basic and diluted earnings per share would be $1.84 and $1.81, respectively. 10 BNCCORP, INC. Annual Report 2019 Quarterly Financial Data Interest income Interest expense Net interest income Provision for credit losses Net interest income after provision for credit losses Non-interest income Non-interest expense Income before income taxes Income tax expense Net income Basic earnings per common share Diluted earnings per common share Average common shares: Basic Diluted Interest income Interest expense Net interest income Provision for credit losses Net interest income after provision for credit losses Non-interest income Non-interest expense Income before income taxes Income tax expense Net income Basic earnings per common share Diluted earnings per common share Average common shares: Basic Diluted First Quarter Second Quarter 2019 Third Quarter Fourth Quarter YTD 9,128 2,173 6,955 - 6,955 4,502 9,682 1,775 337 1,438 0.41 0.40 $ $ $ $ 9,399 2,376 7,023 200 6,823 7,057 10,409 3,471 817 2,654 0.75 0.75 $ $ $ $ 9,698 2,389 7,309 300 7,009 11,938 12,871 6,076 1,450 4,626 1.31 1.30 $ $ $ $ 9,592 2,163 7,429 200 7,229 5,634 11,029 1,834 317 1,517 0.43 0.43 $ $ $ $ 37,817 9,101 28,716 700 28,016 29,131 43,991 13,156 2,921 10,235 2.90 2.88 3,518,390 3,555,845 3,519,478 3,556,842 3,529,999 3,558,354 3,536,277 3,558,994 3,526,096 3,557,585 First Quarter Second Quarter 2018 Third Quarter Fourth Quarter YTD 8,016 1,156 6,860 - 6,860 5,881 9,768 2,973 577 2,396 0.69 0.68 $ $ $ $ 8,520 1,458 7,062 - 7,062 5,727 10,014 2,775 630 2,145 0.61 0.60 $ $ $ $ 8,836 1,658 7,178 - 7,178 3,979 9,806 1,351 284 1,067 0.31 0.30 $ $ $ $ 9,106 1,836 7,270 - 7,270 3,430 9,425 1,275 47 1,228 0.35 0.35 $ $ $ $ 34,478 6,108 28,370 - 28,370 19,017 39,013 8,374 1,538 6,836 1.96 1.93 $ $ $ $ $ $ $ $ 3,487,155 3,547,427 3,496,135 3,548,350 3,497,426 3,549,793 3,507,426 3,550,207 3,487,846 3,539,755 BNCCORP, INC. Annual Report 2019 11 Operating Strategy BNC is a community bank that focuses on business banking, mortgage banking, and wealth management. We build value for shareholders by providing relationship-based financial services to small and mid-sized businesses, business owners, their employees and professionals. The key elements of our strategy include: Providing individualized, high-level customer service. We provide a high level of customer service to establish and maintain long-term relationships. We believe that many of our competitors emphasize retail banking or focus on large companies, leaving the small and mid-sized business market underserved. Our consistent focus on the needs of such small and mid-sized businesses allows us to compete effectively in this market segment. Diversification of products and services. We offer banking, mortgage banking, and wealth management products and services to meet the financial needs of our customers, establish new relationships and expand our business opportunities. We seek to leverage our existing relationships by cross-selling our products and services. Expand opportunistically. We emphasize organic growth within the markets that we serve and look to opportunistically expand into new lines of business and attractive markets. Organic growth in North Dakota is an emphasis as we believe in the viability of the energy and agricultural industries over the long term. In Arizona, our organic loan growth focuses on small businesses and the SBA arena. Managing risk. Community banking is faced with several forms of inherent risk. We strive to manage risk by balancing the potential costs of various risks and the various rewards of banking opportunities. Emphasize quality loan and deposit growth. Providing loans and gathering deposits is a key strategy as our products are good for customers, communities, and shareholders. Growing low-cost core deposits is a key strategy. Our platforms and technology offers us a strategic opportunity to deliver high level deposit services to the businesses and professionals we serve and permits us to attract funds at a low cost. 12 BNCCORP, INC. Annual Report 2019 Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview The following table summarizes selected income statement data and earnings per share data (in thousands, except per share data): Selected Income Statement Data Interest income Interest expense Net interest income Provision for credit losses Non-interest income Non-interest expense Income before income taxes Income tax expense Net income Earnings Per Share Data Basic earnings per common share Diluted earnings per common share 2019 2018 $ $ $ $ 37,817 9,101 28,716 700 29,131 43,991 13,156 2,921 10,235 2.90 2.88 $ $ $ $ 34,478 6,108 28,370 - 19,017 39,013 8,374 1,538 6,836 1.96 1.93 The following is a brief comparison of 2019 to 2018 net income: In 2019, net interest income increased 1.2% from 2018 as a result of higher average balances of loans combined with higher yields on earning assets, partially offset by lower average balance of investment securities, higher use of FHLB advances and increased average deposit balances and costs. Provision for loan losses increased $700 thousand in 2019 resulting in a 1.60% ratio of allowance for loan losses to loans held for investment. At December 31, 2019, non-performing assets were 0.21% of total assets, compared to 0.17% at December 31, 2018. Non-interest income increased $10.114 million, or 53.2%, when comparing 2019 to 2018. The increase primarily relates to a $14.870 million increase in mortgage banking revenue, net, partially offset by net losses on sales of securities in 2019 compared to net gains on sale of securities and SBIC income in 2018. Non-interest expense increased by $4.978 million, or 12.8%, in 2019. Salaries and employee benefits increased $2.385 million, or 11.9%, primarily driven by higher mortgage banking activity. Professional services expense increased $1.595 million, or 47.2%, primarily due to mortgage operating costs as well as legal, consulting costs, and other corporate matters being partially offset by lower audit fees. Marketing and promotion expenses increased $326 thousand, or 7.7%, largely attributed to increased purchase of mortgage leads. In 2019, the effective tax rate increased to 22.2% from 18.4% in 2018. The increase in the effective tax rate is due to increased pre-tax revenues and lower non-taxable interest income from municipal securities. BNCCORP, INC. Annual Report 2019 13 General Net income in 2019 was $10.235 million compared to net income of $6.836 million in 2018. Earnings per diluted share was $2.88 in 2019 and $1.93 in 2018. Net Interest Income The following table sets forth information relating to our average balance sheet, yields on interest-earning assets and costs on interest-bearing liabilities (dollars are in thousands): For the Year ended December 31, For the Year ended December 31, For the Year ended December 31, 2018 Interest earned or owed 2019 Interest earned or owed 2017 Interest earned or owed Average yield or cost Average yield or cost Average yield or cost Average balance Average balance Average balance Assets Interest-bearing due from banks Taxable investments Tax-exempt investments Loans held for sale-mortgage banking Loans and leases held for investment Allowance for credit losses Total interest-earning assets Non-interest-earning assets: $ 15,980 $ 362,093 32,382 74,900 480,389 (7,794) 957,950 401 9,347 868 2,624 24,577 - 37,817 2.51% $ 2.58% 2.67% 3.50% 5.12% 0.00% 3.95% 14,992 $ 371,177 63,049 25,772 454,215 (7,792) 921,413 260 9,233 1,699 1,069 22,217 - 34,478 1.74% $ 2.49% 2.69% 4.15% 4.89% 0.00% 3.72% 38,367 $ 345,621 90,324 27,271 420,906 (7,949) 914,540 416 7,546 2,695 1,009 19,777 - 31,443 1.08% 2.18% 2.98% 3.70% 4.70% 0.00% 3.42% Cash and due from banks Other Total assets 8,903 50,626 $ 1,017,479 8,961 48,972 979,346 $ 8,901 47,591 971,032 $ Liabilities and Stockholders’ Equity Deposits: Interest checking and money market accounts $ Savings Certificates of deposit Total interest-bearing deposits Borrowings: Short-term borrowings FHLB advances Long-term borrowings Subordinated debentures Total interest-bearing liabilities Non-interest-bearing demand accounts Total deposits and interest-bearing liabilities Other non-interest-bearing liabilities Total liabilities Stockholders’ equity Total liabilities and 542,700 $ 34,177 164,898 741,775 5,284 15,110 9,753 15,007 786,929 130,430 917,359 12,161 929,520 87,959 4,412 24 3,104 7,540 23 334 621 583 9,101 0.81% $ 0.07% 1.88% 1.02% 486,754 $ 35,276 171,531 693,561 0.44% 2.21% 6.36% 3.83% 1.16% 17,944 4,662 10,000 15,010 741,177 154,984 896,161 7,253 903,414 75,932 2,439 19 2,303 4,761 74 95 635 543 6,108 0.50% $ 0.05% 1.34% 0.69% 487,063 $ 35,067 158,266 680,396 0.41% 2.04% 6.35% 3.62% 0.82% 14,732 1,903 10,000 15,012 722,043 163,603 885,646 6,967 892,613 78,419 953 11 1,545 2,509 27 16 635 391 3,578 0.20% 0.03% 0.98% 0.37% 0.18% 0.84% 6.35% 2.60% 0.50% stockholders’ equity $ 1,017,479 $ 979,346 $ 971,032 Net interest income $ 28,716 $ 28,370 $ 27,865 Net interest spread Net interest margin 2.79% 3.00% 2.90% 3.08% 2.92% 3.05% Ratio of average interest-earning assets to average interest-bearing liabilities 121.73% 124.32% 126.66% 14 BNCCORP, INC. Annual Report 2019 The following table allocates changes in our interest income and interest expense between the changes related to volume and interest rates (in thousands): For the Years Ended December 31, 2019 Compared to 2018 For the Years Ended December 31, 2018 Compared to 2017 Change Due to Change Due to Volume Rate Total Volume Rate Total $ Interest Earned on Interest- Earning Assets Interest-bearing due from banks Taxable investments Tax-exempt investments Loans held for sale- mortgage banking Loans held for investment Total increase in interest income Interest Expense on Interest- Bearing Liabilities Interest checking and money market accounts Savings Certificates of Deposit Short-term borrowings FHLB advances Long-term borrowings Subordinated debentures Total increase in interest expense Increase (decrease) in net interest 18 (215) (822) 1,744 1,464 2,189 938 (1) 218 (55) 230 (16) - 1,314 $ $ 123 329 (9) (190) 897 1,150 1,035 6 583 4 9 2 40 1,679 141 114 (831) 1,554 2,361 3,339 1,973 5 801 (51) 239 (14) 40 2,993 $ $ (330) 583 (754) (58) 1,657 1,098 1 - 296 7 40 - - 344 $ 174 1,104 (242) 117 784 1,937 1,485 9 461 40 39 - 152 2,186 (156) 1,687 (996) 59 2,441 3,035 1,486 9 757 47 79 - 152 2,530 income $ 875 $ (529) $ 346 $ 754 $ (249) $ 505 Net interest income was $28.716 million in 2019 compared to $28.370 million in 2018, an increase of $346 thousand, or 1.2%. The net interest margin decreased to 3.00% for the year ended December 31, 2019 from 3.08% in 2018. Overall, yields on earning assets were 3.95% in 2019 and 3.74% in 2018. Average loans held for investment increased $26.2 million in 2019, or 5.8%, compared to 2018, while loans held for sale significantly influenced income growth achieving an average balance increase of $49.1 million during 2019. Average investments decreased $40.2 million in 2019, providing liquidity to fund loan growth. The cost of interest bearing deposits was 1.02% in 2019 and 0.69% in 2018. The cost of interest bearing liabilities increased to 1.16% in 2019 from 0.82% in 2018. After successfully managing rising interest rates in recent years, the Company enacted certain adjustments to deposit rates in the fourth quarter of 2018 in response to rate increases. Certain deposit rates were adjusted down in 2019 following Federal Reserve actions to lower rates. Increased use of FHLB advances as a source of liquidity in 2019 also increased interest expense. Net interest income was $28.370 million in 2018 compared to $27.865 million in 2017, an increase of $505 thousand, or 1.8%. The net interest margin increased to 3.08% for the year ended December 31, 2018 from 3.05% in 2017. Overall, yields on earning assets were 3.72% in 2018 and 3.42% in 2017. Average loans held for investment increased $33.3 million in 2018, or 7.9%, compared to 2017, while average loans held for sale decreased $1.5 million and average investments decreased $1.7 million. The cost of interest bearing deposits was 0.69% in 2018 and 0.37% in 2017. The cost of interest bearing liabilities increased to 0.82% in 2018 from 0.50% in 2017. After successfully managing rising interest rates in recent years, the Company enacted certain adjustments to deposit rates in the fourth quarter of 2018 in response to rate increases. BNCCORP, INC. Annual Report 2019 15 Non-interest Income The following table presents the major categories of our non-interest income (dollars are in thousands): For the Years Ended December 31, 2019 2018 Increase (Decrease) % $ Bank charges and service fees Wealth management revenues Mortgage banking revenues, net Gains on sales of loans, net (Losses) gains on sales of securities, net Other Total non-interest income $ $ 2,614 1,735 24,902 155 (1,296) 1,021 29,131 $ $ 2,687 1,810 10,032 187 2,293 2,008 19,017 $ $ (73) (75) 14,870 (32) (3,589) (987) 10,114 (3) % (4) % 148 % (a) (17) % (b) (157) % (c) (49) % (d) 53 % (a) Mortgage banking revenues were significantly higher in 2019, driven substantially by mortgage refinance activity in a declining rate environment. (b) Gains on sale of loans can vary significantly from period to period. Guaranteed portions of SBA loans have largely been retained in recent periods. (c) Net gains and losses on sales of securities may vary significantly from period to period. In 2019, the Company experienced net losses on sales of securities in order to generate liquidity that facilitated loan growth as well as executing deleveraging strategies. (d) Other income in 2019 was lower due to $1.2 million lower SBIC Income. Non-interest Expense The following table presents the major categories of our non-interest expense (dollars are in thousands): For the Years Ended December 31, 2019 2018 Increase (Decrease) % $ Salaries and employee benefits Professional services Data processing fees Marketing and promotion Occupancy Regulatory costs Depreciation and amortization Office supplies and postage Other Total non-interest expense Efficiency ratio $ $ 22,459 4,973 4,321 4,538 2,218 435 1,452 531 3,064 43,991 76.05% $ $ 20,074 3,378 4,027 4,212 2,408 540 1,545 574 2,255 39,013 82.33% $ $ 2,385 1,595 294 326 (190) (105) (93) (43) 809 4,978 (6.28)% 12 % (a) 47 % (b) 7 % (c) 8 % (d) (8) % (e) (19) % (f) (6) % (g) (7) % (h) 36 % (i) 13 % (a) Salaries and employee benefits increased due to higher mortgage banking activity. (b) Professional service expense is higher primarily due to mortgage operating costs as well as legal, consulting costs, and other corporate matters being partially offset by lower audit fees. (c) Data processing fees increased as standard core processing costs continue to increase along with additional infrastructure expense to expand our current platform in response to continued customer growth. (d) Marketing and promotion increased primarily due increased purchase of mortgage banking leads. (e) Occupancy decreased due to rent expense from consolidating certain mortgage production offices. (f) Regulatory costs decreased due to fourth quarter 2019 utilization of Small Bank Assessment Credits. (g) Depreciation and amortization was lower primarily due to depreciated IT assets outlasting depreciable lives. (h) Office supplies and postage decreased as the Company continues to more efficiently distribute hardcopy data. (i) Other expense increases include a mortgage warranty reserve related to significantly increased mortgage loan production and resolution of a litigation matter. 16 BNCCORP, INC. Annual Report 2019 Mortgage Banking Division Selected Data The following table sets forth information related to mortgage banking products funded and sold with servicing released by the bank. The following selected data is not intended to be interpreted as a statement of profit and loss as it excludes interest income, interest expense, shared service expenses, and tax expense. (dollars in thousands) 2019 2018 Number of funded mortgage loans held for sale Mortgage loans held for sale funded Year-to-date average loans held for sale-mortgage banking Year-end loans held for sale-mortgage banking Non-Interest Income: Gains on sale of loans held for sale, net of commission expense Unrealized gain (loss) on mortgage financial instruments (1) Direct non-interest income Direct non-interest expense 3,916 1,328,706 74,900 137,114 19,959 4,934 24,893 15,941 $ $ $ $ $ $ $ $ $ $ $ $ $ $ 2,107 642,695 25,772 22,788 10,760 (738) 10,022 12,050 (1) Includes changes in fair value of mortgage commitments, hedge instruments, and loans held for sale The Company’s mortgage banking division originates and sells a variety of conventional and government sponsored mortgage loan products with servicing released through two primary channels. The retail channel is a predominantly relationship driven with originators capitalizing on local relationships to originate loans through four retail bank branches and seven mid-west retail mortgage locations. The Consumer Direct channel is located in Overland Park, KS and is a call-center with internet sales focused on both purchase and refinance transactions across the country. The current low interest rate environment has generated a significant increase in mortgage loan activity in 2019 compared to 2018. Non-interest income includes gains on the sale of loans, changes in the fair value of loans held for sale, loans in the various stages of processing prior to funding, hedge instruments as well as commissions expense. Direct non-interest expenses include direct costs necessary to underwrite, process, fund and sell mortgage loans as well as the costs of technology and operational costs specifically identified as serving the mortgage division. Mortgage Banking Division Selected Data above excludes net-interest income earned on loans held-for-sale, tax expense and costs typically allocated to the mortgage division related to internal services shared with other divisions of the Bank. Income Tax Expense During 2019, we recorded tax expense of $2.921 million, which resulted in an effective tax rate of 22.2%. The increase in the effective tax rate is due to increased pre-tax revenues and lower non-taxable interest income from municipal securities. Subject to certain statutory limitations, the Company is able to carry forward state tax net operating losses aggregating $389 thousand as of December 31, 2019. The state net operating losses expire between 2024 and 2031. During 2018, we recorded tax expense of $1.538 million, which resulted in an effective tax rate of 18.4%. It is lower than the federal statutory rate primarily due to a portion of the Company’s pretax income being derived from tax- exempt securities in 2018. Subject to certain statutory limitations, the Company is able to carry forward state tax net operating losses aggregating $431 thousand as of December 31, 2018. The state net operating losses expire between 2024 and 2031. BNCCORP, INC. Annual Report 2019 17 Financial Condition and Fourth Quarter Deleveraging Activity During 2019, assets generally increased due to growth in loans held for investment, mortgage loans held for sale, In the fourth quarter of 2019, the Company sold investment securities at a pre-tax loss of and deposit growth. $3.316 million to provide liquidity to deleverage the balance sheet and redeem subordinated debt. The amount of investment securities sold in the fourth quarter 2019 was $114.8 million. Proceeds from such sales were used to redeem $10.0 million of subordinated debt, with a coupon rate of 6.35% per annum, and reduce deposit balances. The reduction in deposit balances primarily utilized one-way sell mechanisms allowing the Company to retain relationships with depositors. Assets The following table presents our assets by category (dollars are in thousands): As of December 31, 2019 2018 Increase (Decrease) % $ Cash and cash equivalents Investment securities available for sale Federal Reserve Bank and Federal Home $ Loan Bank Stock Loans held for sale-mortgage banking Loans and leases held for investment, net Premises and equipment, net Operating lease right of use asset Accrued interest receivable Other assets Total assets $ 10,523 265,278 $ 25,185 411,509 $ (14,662) (146,231) 3,651 137,114 500,428 16,401 2,638 3,681 27,036 966,750 $ 2,941 22,788 460,776 16,761 - 5,079 25,988 971,027 $ 710 114,326 39,652 (360) 2,638 (1,398) 1,048 (4,277) (58) % (a) (36) % (b) 24 % (c) 502 % (d) 9 % (e) (2) % 100 % (f) (28) % (g) 4 % (0) % (a) Cash balances can fluctuate significantly from period to period based on liquidity sources and uses of the business. (b) Investment balances have decreased as loan growth and deleveraging strategies have utilized bank liquidity. (c) Federal Reserve Bank and Federal Home Loan Bank of Des Moines stock will vary based on the Company’s utilization of Federal Home Loan Bank advances. (d) Loans held for sale increased as balances will fluctuate with the timing of loan funding and sales. During 2019, mortgage banking loan funding increased due to more favorable interest rates, particularly in the second half of 2019. (e) Loans held for investment increased as we continue to fund loans in our core markets. (f) Operating lease right of use asset was established through adoption of ASC 842, Leases – See Note 8 of our Consolidated Financial Statements. (g) Accrued interest receivable can fluctuate from period to period. The reduction in interest receivable is influenced by the notable decrease in investment securities available for sale in 2019. 18 BNCCORP, INC. Annual Report 2019 Investment Securities Available for Sale The following table presents the composition of the available-for-sale investment portfolio (in thousands): December 31, 2019 2018 Amortized cost Estimated fair market value Amortized cost Estimated fair market value $ 4,992 $ 4,994 $ 59,710 $ 58,794 5,634 53,873 21,120 68,353 21,625 56,530 12,810 19,873 264,810 $ 5,643 51,637 21,790 68,615 22,556 56,779 12,893 20,371 265,278 $ 10,221 10,132 158,430 150,966 63,149 52,635 - - 24,170 53,862 422,177 $ 62,257 51,779 - - 24,045 53,536 411,509 U.S. Treasury securities U.S. government agency mortgage-backed securities issued by FNMA or FHLMC U.S. government agency small business administration pools guaranteed by SBA Collateralized mortgage obligations guaranteed by GNMA Collateralized mortgage obligations issued by FNMA or FHLMC Commercial mortgage-backed securities issued by FHLMC Other commercial mortgage-backed securities Asset-backed securities State and municipal bonds Total investments $ There were no securities that management concluded were other-than-temporarily impaired during 2019 or 2018. See Note 2 of our Consolidated Financial Statements. BNCCORP, INC. Annual Report 2019 19 The following table presents contractual maturities for securities available for sale and yields thereon at December 31, 2019 (dollars are in thousands): Within 1 year After 1 but within 5 years After 5 but within 10 years After 10 years Total Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield 0.00% $ 4,992 1.59% $ - - 0.00% $ - 0.00% $ 4,992 1.59% 0.00% 5,634 3.08% 5,634 3.08% 0.00% $ U.S. Treasury securities(1) U.S. government agency mortgage-backed securities issued by FNMA or FHLMC(1) (2) U.S. government agency small business administration pools guaranteed by SBA(1) (2) Collateralized mortgage obligations guaranteed by GNMA(1) (2) Collateralized mortgage obligations issued by FNMA or FHLMC(1) (2) Commercial mortgage-backed securities issued by FHLMC(1) (2) Other commercial mortgage- backed securities(1) (2) Asset-backed securities(1) (2) State and municipal bonds(2) (3) Total book value of investment securities $ Net unrealized gain on securities available for sale Total investment in securities available for sale - - - - - - - - - - 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% - - - - - - - - 0.00% 20,226 2.33% 33,647 1.75% 53,873 1.97% 0.00% - 0.00% 21,120 3.69% 21,120 3.69% 0.00% 1,157 3.75% 67,196 3.13% 68,353 3.14% 0.00% 0.00% 0.00% 0.00% 21,625 3.05% - 0.00% 21,625 3.05% 19,371 2.56% 37,159 2.89% 56,530 2.77% 12,810 3.21% - 0.00% 12,810 3.21% - 0.00% 19,873 3.51% 19,873 3.51% 0.00% $ 4,992 1.59% $ 75,189 2.77% $ 184,629 2.93% 264,810 2.86% 468 $ 265,278 2.86% (1) Based on amortized cost rather than fair value. (2) Maturities are based on contractual maturities. Actual cash flows from securities may vary from contractual maturities due to call options, cash flow structures of securitizations, and prepayments. (3) Yields include adjustment for tax exempt income. As of December 31, 2019, we had $265.3 million of available-for-sale securities in the investment portfolio compared to $411.5 million at December 31, 2018. In 2019, available-for-sale investment securities decreased as compared to 2018. Investment securities were sold to generate liquidity to support increases in loans held for investment and loans held for sale and to provide liquidity to deleverage the balance sheet, including redemption of subordinated debt. At December 31, 2019, all classifications of investment securities available for sale with the exception of U.S. Treasury securities and U.S. government agency mortgage-backed securities issued by FNMA/FHLMC exceeded 10% of stockholders’ equity. A portion of our investment securities portfolio was pledged as collateral. See Note 2 of our Consolidated Financial Statements for more information about investment securities. Federal Reserve Bank and Federal Home Loan Bank Our equity securities consisted of $1.8 million of Federal Reserve Bank (“FRB”) stock and $1.9 million of Federal Home Loan Bank (“FHLB”) stock as of December 31, 2019 and $1.8 million of FRB stock and $1.1 million of FHLB stock as of and December 31, 2018. 20 BNCCORP, INC. Annual Report 2019 Loans The following table presents our loan portfolio as of December 31 (dollars are in thousands): 2019 2018 2017 2016 2015 Amount % Amount % Amount % Amount % Amount % Loans held for sale- mortgage banking $ 137,114 100.0 $ 22,788 100.0 $ 36,601 100.0 $ 39,641 100.0 $ 50,445 100.0 Loans Held for Investment: Commercial and industrial $ 162,592 Commercial real estate 193,203 SBA Consumer Land and land development Construction 46,799 82,498 10,449 12,656 32.0 38.0 9.2 16.2 2.0 2.5 149,886 32.0 $ 126,169 29.4 $ 123,604 29.8 $ 125,009 174,868 32,505 78,055 11,398 21,257 37.3 6.9 16.7 2.4 4.5 177,429 25,064 71,876 14,168 13,167 41.4 5.9 16.8 3.3 3.1 171,972 31,518 59,183 15,982 12,215 41.5 7.6 14.3 3.9 2.9 149,099 25,860 47,073 17,627 15,187 32.9 39.3 6.8 12.4 4.6 4.0 508,197 99.9 467,969 99.9 427,873 99.9 414,474 100.0 379,855 100.0 Unearned income and net unamortized deferred fees and costs Loans, net of unearned income and unamortized fees and costs 372 0.1 499 0.1 452 0.1 199 - 48 - $ 508,569 100.0 $ 468,468 100.0 $ 428,325 100.0 $ 414,673 100.0 $ 379,903 100.0 The following table presents the change in our loan portfolio (dollars are in thousands): $ $ Loans held for sale-mortgage banking Loans Held for Investment: Commercial and industrial Commercial real estate SBA Consumer Land and land development Construction Unearned income and net unamortized deferred fees and costs Loans, net of unearned income and December 31, Increase (Decrease) 2019 2018 $ % 137,114 $ 22,788 $ 114,326 501.7 % (a) $ 162,592 193,203 46,799 82,498 10,449 12,656 508,197 372 $ 149,886 174,868 32,505 78,055 11,398 21,257 467,969 12,706 18,335 14,294 4,443 (949) (8,601) 40,228 8.5 % 10.5 % 44.0 % (b) 5.7 % (c) (8.3) % (40.5) % 8.6 % 499 (127) (25.5) % unamortized fees and costs $ 508,569 $ 468,468 $ 40,101 8.6 % (d) (a) Loans held for sale increased as balances will fluctuate with the timing of loan funding and sales. In 2019, balances grew due to more favorable interest rates, especially in the second half of 2019. (b) The Company, in recent periods, began retaining rather than selling the guaranteed portion of SBA loans as the premiums investors are willing to pay have compressed. (c) Consumer loans increased primarily due to indirect vehicle lending in the North Dakota market. (d) Loans held for investment increased due to continued loan production in our core markets. BNCCORP, INC. Annual Report 2019 21 Loan Participations Pursuant to our lending policy, loans may not exceed 85% of the Bank’s legal lending limit (except to the extent collateralized by U.S. Treasury securities or Bank deposits and, accordingly, excluded from the Bank’s legal lending limit) unless the Chief Credit Officer and the Executive Credit Committee grant prior approval. To accommodate customers whose financing needs exceed lending limits and internal loan concentration limits, the Bank sells loan participations to outside participants without recourse. Loan participations sold on a nonrecourse basis to outside financial institutions were as follows as of December 31 (in thousands): 2019 2018 2017 2016 2015 $ 152,163 166,291 176,733 182,224 176,439 Concentrations of Credit The following table summarizes the location of our borrowers as of December 31 (dollars are in thousands): North Dakota Arizona Minnesota Other Total gross loans held for investment 2019 347,179 101,244 33,594 26,180 508,197 $ $ 68 % 20 % 7 % 5 % 100 % $ $ 2018 325,646 80,896 32,215 29,212 467,969 70 % 17 % 7 % 6 % 100 % Our borrowers use loan proceeds for projects in various geographic areas. The following table summarizes the locations where our borrowers are using loan proceeds as of December 31 (dollars are in thousands): $ North Dakota Arizona Minnesota California Colorado Ohio Other Total gross loans held for investment $ 2019 306,609 122,192 27,777 18,541 15,297 7,477 10,304 508,197 60 % 24 % 5 % 4 % 3 % 2 % 2 % 100 % $ $ 2018 302,813 99,394 25,870 12,521 9,266 7,814 10,291 467,969 65 % 21 % 5 % 3 % 2 % 2 % 2 % 100 % 22 BNCCORP, INC. Annual Report 2019 The following table presents loans by type as of December 31 (in thousands): North Dakota Commercial and industrial Construction Agricultural Land and land development Owner-occupied commercial real estate Commercial real estate Small business administration Consumer Subtotal Consolidated Commercial and industrial Construction Agricultural Land and land development Owner-occupied commercial real estate Commercial real estate Small business administration Consumer Subtotal 2019 Total Loans and Leases Held for Investment 2018 Total Loans and Leases Held for Investment $ $ $ $ 51,483 897 29,909 6,373 38,127 106,835 4,737 68,248 306,609 77,706 12,656 29,914 10,449 54,972 193,203 46,799 82,498 508,197 $ $ $ $ 45,241 4,439 25,525 7,932 42,591 109,829 5,044 62,212 302,813 66,545 21,257 26,425 11,398 56,916 174,868 32,505 78,055 467,969 Loan Maturities (1) The following table sets forth the remaining maturities of loans in our portfolio as of December 31, 2019 (in thousands): Over 1 year through 5 years Over 5 years One year or less Fixed Rate Indexed Rate Fixed Rate Indexed Rate Commercial and industrial Commercial real estate SBA Consumer Land and land development Construction Total principal amount of loans $ $ 23,893 1,763 2,471 992 1,834 326 31,279 $ $ 6,466 2,912 2,606 390 330 696 13,400 $ $ 10,842 $ 5,084 7,611 3,966 121 11,634 39,258 $ 56,760 $ 32,415 4,029 67,788 5,805 - 166,797 $ 64,631 $ 151,029 30,082 9,362 2,359 - 257,463 $ Total Loans and Leases Held for Investment 162,592 193,203 46,799 82,498 10,449 12,656 508,197 (1) Maturities are based on contractual maturities. Indexed rate loans include loans that would reprice prior to maturity if base rates change. Actual maturities may differ from the contractual maturities shown above as a result of renewals and prepayments. Loan renewals are evaluated in substantially the same manner as new credit applications. BNCCORP, INC. Annual Report 2019 23 Provision for Credit Losses We provide for credit losses to maintain our allowance for credit losses at a level adequate to cover estimated probable losses inherent in the portfolio as of each balance sheet date. In 2019, a $700 thousand provision for credit losses was recorded, compared to $0 in 2018. Allowance for Credit Losses See Notes 1 and 5 of our Consolidated Financial Statements and “Significant Accounting Policies” for further information concerning accounting policies associated with the allowance for credit losses. Analysis of Allowance for Credit Losses The following table summarizes activity in the allowance for credit losses and certain ratios (dollars are in thousands): Balance of allowance for credit losses, beginning of period Charge-offs: Commercial and industrial Commercial real estate SBA Consumer Land and land development Construction Total charge-offs Recoveries: Commercial and industrial Commercial real estate SBA Consumer Land and land development Construction Total recoveries Net (charge-offs) recoveries Provision (reduction) for credit losses charged to operations Balance of allowance for credit losses, end of For the Years ended December 31, 2019 2018 2017 2016 2015 $ 7,692 $ 7,861 $ 8,285 $ 8,611 $ 8,601 (125) - (82) (97) - - (304) - 13 11 29 - - 53 (251) 700 (71) (1) (59) (129) - - (260) 40 16 4 31 - - 91 (169) - (84) - (566) (123) (103) - (876) - 12 48 40 2 - 102 (774) 350 (1,004) - (71) (99) - - (1,174) - 13 15 20 - - 48 (1,126) (47) - (145) (43) - - (235) 7 551 68 19 - - 645 410 800 (400) period $ 8,141 $ 7,692 $ 7,861 $ 8,285 $ 8,611 Ratio of net (charge-offs) recoveries to average loans and leases held for investment Average gross loans and leases held for (0.052)% (0.037)% (0.184)% (0.282)% 0.117% investment $ 480,389 $ 454,215 $ 420,906 $ 399,669 $ 350,840 Ratio of allowance for credit losses to loans and leases held for investment Ratio of nonperforming loans to total assets 1.60% 0.21% 1.64% 0.17% 1.84% 0.21% 2.00% 0.27% 2.27% 0.06% 24 BNCCORP, INC. Annual Report 2019 Allocation of the Allowance for Credit Losses The table below presents an allocation of the allowance for credit losses among the various loan categories and sets forth the percentage of loans in each category to gross loans as of December 31 (dollars are in thousands). 2019 2018 2017 2016 2015 Loans as a % of Gross Loans Held for Investment Allocation of Allowance Loans as a % of Gross Loans Held for Investment Allocation of Allowance Loans as a % of Gross Loans Held for Investment Allocation of Allowance Loans as a % of Gross Loans Held for Investment Allocation of Allowance Loans as a % of Gross Loans Held for Investment Allocation of Allowance Commercial and industrial $ 2,366 32% $ 1,937 32% $ 2,158 30% $ 2,323 30% $ 3,205 Commercial real estate SBA Consumer Land and land development Construction 3,502 1,131 853 187 102 38% 9% 16% 2% 3% 3,558 845 928 225 199 37% 7% 17% 2% 5% 3,471 834 914 358 126 41% 6% 17% 3% 3% 3,231 1,433 772 413 113 41% 8% 14% 4% 3% 1,999 1,578 640 1,041 148 33% 39% 7% 12% 5% 4% Total $ 8,141 100% $ 7,692 100% $ 7,861 100% $ 8,285 100% $ 8,611 100% The amount of the allowance for losses can vary depending on macroeconomic conditions and risk in the portfolio. The allocation of the allowance for losses can vary depending on relative volume of asset groups in the portfolio and risks therein. The allocation of the allowance for credit losses as shown in the table above should neither be interpreted as an indication of future charge-offs, nor as an indication that charge-offs in future periods will necessarily occur in these amounts or in the indicated proportions. Allowance for Credit Losses; Impact on Earnings We have established the allowance for credit losses to cover probable losses inherent within the loan and lease portfolio at the balance sheet dates. The allowance for credit losses is an estimate based upon several judgmental factors. We are not aware of known trends, commitments or other events that could reasonably occur that would materially affect our methodology or the assumptions used to estimate the allowance for credit losses. However, changes in qualitative and quantitative factors could occur at any time and such changes could be of a material nature. In addition, economic situations, financial conditions of borrowers, and other factors we consider in arriving at our estimates may change. To the extent that these matters have negative developments, our future earnings could be reduced by provisions for credit losses. See the Concentrations of Credit section within this report for additional information. BNCCORP, INC. Annual Report 2019 25 Nonperforming Loans and Assets The following table sets forth nonperforming assets, the allowance for credit losses and certain related ratios (dollars are in thousands): Nonperforming loans: $ $ $ Loans 90 days or more delinquent and still accruing interest Non-accrual loans Total nonperforming loans Other real estate and repossessed assets, net Total nonperforming assets Allowance for credit losses Ratio of total nonperforming loans to total loans Ratio of total nonperforming loans to loans and leases held for investment Ratio of total nonperforming assets to total assets Ratio of total nonperforming loans to total assets Ratio of allowance for credit losses to total nonperforming loans 2019 2018 As of December 31, 2017 2016 2015 $ $ $ - 2,033 2,033 - 2,033 8,141 0.31% 0.40% 0.21% 0.21% $ $ $ - 1,686 1,686 - 1,686 7,692 0.34% 0.36% 0.17% 0.17% $ $ $ 26 1,952 1,978 - 1,978 7,861 0.43% 0.46% 0.21% 0.21% $ $ $ 20 2,425 2,445 218 2,663 8,285 0.54% 0.59% 0.29% 0.27% 175 390 565 242 807 8,611 0.13% 0.15% 0.09% 0.06% 400% 456% 397% 339% 1,524% Nonperforming Loans The following table sets forth information concerning our nonperforming loans as of December 31 (in thousands): Balance, beginning of period Additions to nonperforming Charge-offs Reclassified back to performing Principal payments received Transferred to repossessed assets Transferred to other real estate owned Balance, end of period 2019 2018 1,686 1,179 (148) (242) (186) (46) (210) 2,033 $ $ 1,978 349 (194) (26) (409) (12) - 1,686 $ $ The following table indicates the effect on income if interest on non-accrual and restructured loans outstanding at year end had been recognized at original contractual rates during the year ended December 31 (in thousands): Interest income that would have been recorded Interest income recorded Effect on interest income 2019 2018 $ $ 327 75 252 $ $ 436 88 348 Loans 90 days or more delinquent and still accruing interest include loans over 90 days past due which we believe, based on our specific analysis of the loans, do not present doubt about the collection of interest and principal in accordance with the loan contract. Loans in this category must be well secured and in the process of collection. 26 BNCCORP, INC. Annual Report 2019 Non-accrual loans include loans on which the accrual of interest has been discontinued. Accrual of interest is discontinued when we believe that the borrower’s financial condition is such that the collection of interest is doubtful. A delinquent loan is generally placed on non-accrual status when it becomes 90 days or more past due unless the loan is well secured and in the process of collection. When a loan is placed on non-accrual status, accrued but uncollected interest income applicable to the current reporting period is reversed against interest income. Accrued but uncollected interest income applicable to previous reporting periods is charged against the allowance for credit losses. No additional interest is accrued on the loan balance until the collection of both principal and interest becomes reasonably certain. Troubled Debt Restructuring (TDR) The table below summarizes the amounts of restructured loans as of December 31 (in thousands): $ 2019 2018 2017 2016 2015 Total Accrual Non-accrual $ 3,245 3,348 1,908 2,153 2,197 $ 1,448 1,779 1,801 1,845 1,884 1,797 1,569 107 308 313 See Note 5 of our Consolidated Financial Statements for information on troubled debt restructuring. Other real estate owned and repossessed assets represent properties and other assets acquired through, or in lieu of, loan foreclosure, and property transferred from premises and equipment. They are initially recorded at fair value less cost to sell at the date of acquisition establishing a new cost basis. Write-downs to fair value at the time of acquisition are charged to the allowance for credit losses. After foreclosure, we perform valuations periodically and the real estate is recorded at fair value less cost to sell. Reductions to other real estate owned and repossessed assets are considered valuation allowances. Expenses incurred to record valuation allowances subsequent to foreclosure are charged to non-interest expense. See Note 6 of our Consolidated Financial Statements for information on other real estate owned. Impaired loans See Note 5 of our Consolidated Financial Statements for information on impaired loans. Potential Problem Loans We attempt to quantify potential problem loans with more immediate credit risk. The table below summarizes the amounts of potential problem loans as of December 31 (in thousands): Impaired $ 1,448 - - - - Watch List Other Total $ $ 7,713 5,206 1,730 8,125 7,945 9,161 5,206 1,730 8,125 7,945 Impaired $ 514 106 52 6 11 Substandard Other $ 7,247 9,069 9,062 10,511 9,398 $ Total 7,761 9,175 9,114 10,517 9,409 2019 2018 2017 2016 2015 A significant portion of these potential problem loans are not in default but may have characteristics such as recent adverse operating cash flows or general risk characteristics that the loan officer feels might jeopardize the future timely collection of principal and interest payments. The ultimate resolution of these credits is subject to changes in economic conditions and other factors. These loans are closely monitored to ensure that our position as creditor is protected to the fullest extent possible. BNCCORP, INC. Annual Report 2019 27 Liabilities and Stockholders’ Equity The following table presents our liabilities and stockholders’ equity (dollars are in thousands): Deposits: Non-interest-bearing Interest-bearing- Savings, interest checking and money market Time deposits Short-term borrowings Federal Home Loan Bank advances Long-term borrowings Guaranteed preferred beneficial interests in Company's subordinated debentures Accrued interest payable Accrued expenses Operating lease liabilities Other liabilities Total liabilities Stockholders' equity As of December 31, 2019 2018 Increase (Decrease) $ % $ 136,313 $ 157,663 $ (21,350) (14) % (a) 514,869 169,365 4,565 17,000 - 15,006 1,685 7,580 2,822 1,267 870,472 96,278 542,735 148,207 11,494 - 10,000 15,009 1,277 5,700 - 1,189 893,274 77,753 (27,866) 21,158 (6,929) 17,000 (10,000) (3) 408 1,880 2,822 78 (22,802) 18,525 (5) % (a) 14 % (b) (60) % (c) 100 % (d) (100) % (e) (0) % 32 % (f) 33 % (g) 100 % (h) 7 % (i) (3) % 24 % (j) Total liabilities and stockholders’ equity $ 966,750 $ 971,027 $ (4,277) (0) % (a) Demand deposits have declined as interest-bearing deposits have become more attractive due to higher market rates. (b) Time deposits have increased as customers seek to increase account earnings as rates increased. (c) During 2019, a significant portion of our customers transferred funds into traditional interest-bearing accounts. Short-term borrowings will vary depending on our customers need to use repurchase agreements. (d) The Company has borrowed on a short-term basis from the Federal Home Loan Bank as an efficient source of liquidity. (e) Long-term borrowings decreased due to redemption of subordinated debt as part of the Company’s deleveraging strategy. (f) Accrued interest payable increased primarily due to increased time deposit balances and increased cost of deposits. (g) The increase is primarily due to the increased accrued mortgage commissions and mortgage incentive compensation. (h) Operating lease liabilities were established through adoption of ASC 842, Leases – See Note 8 of our Consolidated Financial Statements. (i) The increase primarily relates to increased taxes payable resulting from increased pre-tax income in 2019. (j) Stockholders’ equity increased due to $10.235 million net income and $8.398 increase in accumulated other comprehensive income, net. Included in accrued expenses is an estimate of mortgage banking reimbursement obligations which aggregated $906 thousand and $982 thousand at December 31, 2019 and 2018, respectively. Although we sell mortgage banking loans without recourse, industry standards require standard representations and warranties which require sellers to reimburse investors for economic losses if loans default or prepay after the sale. Repurchase risk is also evident within the mortgage banking industry as disputes arise between lenders and investors. Such requests for repurchase are commonly due to purported fraudulent or faulty representations and generally emerge at varied timeframes subsequent to the original sale of the loan. To estimate the obligation, we track historical reimbursements and calculate the ratio of reimbursement to loan production volumes. Using reimbursement ratios and recent production levels, we estimate the future reimbursement amounts and record the estimated obligation. See Note 20 of our Consolidated Financial Statements for a description of financial instruments with off-balance-sheet risk. 28 BNCCORP, INC. Annual Report 2019 Deposits The following table sets forth, for the periods indicated, the distribution of our average deposit account balances and average cost of funds rates on each category of deposits (dollars are in thousands): For the Years Ended December 31, 2019 Percent Wgtd. avg. rate of deposits 2018 Percent Wgtd. avg. rate of deposits 2017 Percent Wgtd. avg. rate of deposits Average balance Average balance Average balance $ 542,700 62.2% 0.81% $ 486,754 57.4% 0.50% $ 487,063 57.7% 0.20% 34,177 164,898 3.9% 0.07% 18.9% 1.88% 35,276 171,531 4.2% 0.05% 20.2% 1.34% 35,067 158,266 4.1% 0.03% 18.8% 0.98% 741,775 85.0% 1.02% 693,561 81.7% 0.69% 680,396 80.6% 0.37% 130,430 15.0% 0.00% 154,984 18.3% 0.00% 163,603 19.4% 0.00% Interest checking and MMDAs Savings deposits Time deposits Total interest-bearing deposits Non-interest-bearing demand deposits Total deposits (1) $ 872,205 100.0% 0.86% $ 848,545 100.0% 0.56% $ 843,999 100.0% 0.30% (1) Included in average total deposits are $0, $18.2 million, and $0 of average brokered deposits for the years ending 2019, 2018, and 2017, respectively. During periods of higher energy prices our North Dakota deposits grew rapidly. In 2017, a ND Bakken branch with $14.0 million of deposits was sold for a gain of $864 thousand. Excluding the effect of the sold branch, ND Bakken deposits rose slightly compared to December 2016. In recent periods, deposits in North Dakota and Arizona have grown significantly. Deposit balanced decreased in 2019 due to deleveraging activities. The table below shows total deposits since 2014 (in thousands): 2019 2018 As of December 31, 2017 2016 2015 ND Bakken Branches ND Non-Bakken Branches Total ND Branches Brokered Time Deposits Other Total Deposits $ $ 190,286 403,337 593,623 - 226,924 820,547 $ $ 185,713 431,246 616,959 - 231,646 848,605 $ $ 168,981 435,255 604,236 - 213,570 817,806 $ $ 178,677 384,476 563,153 - 189,474 752,627 $ $ 190,670 388,630 579,300 33,363 167,786 780,449 Time deposits, in denominations of $250,000 and over, totaled $45.7 million at December 31, 2019 as compared to $34.2 million at December 31, 2018. The following table sets forth the amount and maturities of time deposits of $250,000 and over as of December 31, 2019 (in thousands): Maturing in: 3 months or less Over 3 months through 6 months Over 6 months through 12 months Over 12 months $ $ 7,237 6,818 20,809 10,794 45,658 BNCCORP, INC. Annual Report 2019 29 Borrowed Funds The following table provides a summary of our short-term borrowings and related cost information as of, or for the years ended, December 31 (dollars are in thousands): Short-term borrowings outstanding at period end Weighted average interest rate at period end Maximum month end balance during the period Average borrowings outstanding for the period Weighted average interest rate for the period 2019 2018 2017 $ $ $ 4,565 0.21% 10,681 5,283 0.44% $ $ $ 11,494 0.84% 19,955 17,944 0.41% $ $ $ 18,043 0.25% 24,671 14,732 0.18% Note 10 of our Consolidated Financial Statements summarizes the general terms of our short-term borrowings outstanding at December 31, 2019 and 2018. FHLB advances totaled $17.0 million at December 31, 2019 and $0 at December 31, 2018. Notes 11, 12 and 13 of our Consolidated Financial Statements summarize the general terms of our FHLB advances, long-term borrowings, and other borrowings at December 31, 2019 and 2018. Guaranteed Preferred Beneficial Interests in Company’s Subordinated Debentures See Note 14 of our Consolidated Financial Statements for a description of the subordinated debentures. Capital Resources Tier 1 leverage (Consolidated) Total risk based capital (Consolidated) Common equity tier 1 risk based capital (Consolidated) Tier 1 risk based capital (Consolidated) Tangible common equity (Consolidated) Tier 1 leverage (BNC Bank) Total risk based capital (BNC Bank) Common equity tier 1 risk based capital (BNC Bank) Tier 1 risk based capital (BNC Bank) 2019 10.65% 17.13% 13.76% 15.95% 9.95% 9.81% 15.88% 14.69% 14.69% 2018 2017 2016 2015 9.97% 20.26% 14.67% 17.28% 7.99% 9.92% 18.44% 17.19% 17.19% 9.53% 19.98% 14.15% 16.90% 8.18% 9.62% 18.31% 17.06% 17.06% 9.47% 19.96% 13.90% 16.78% 8.13% 9.67% 18.41% 17.16% 17.16% 9.00% 20.07% 13.57% 16.72% 7.62% 9.45% 18.71% 17.45% 17.45% See Note 15 and Note 16 of our Consolidated Financial Statements for a discussion of stockholders equity and regulatory capital and the current operating environment. The Common equity tier 1 (CET 1) ratio, which is generally a comparison of a bank’s core equity capital with its total risk weighted assets, is a measure of the current risk profile of our asset base from a regulatory perspective. The Tier 1 leverage ratio, which is calculated by dividing Tier 1 capital by average total assets, does not consider the mix of risk weighted assets. Regulators have required Tier 1 ratios that significantly exceed the “Well Capitalized” ratio levels. As such, we are managing our Tier 1 leverage ratio to levels significantly above the “Well Capitalized” thresholds. Although Tangible Common Equity (TCE) is not a regulatory capital measure, TCE is a ratio that is commonly used to assess the capital strength of banking entities. Accordingly, we have included the ratio in the regulatory capital table below. During the fourth quarter of 2019, as part of a deleveraging strategy, BNC National Bank paid a $10.0 million dividend to BNCCORP, INC., which was used to redeem $10.0 million of subordinated debt. The deleveraging strategy, along with earnings in 2019, impacted the capital ratios at BNC Bank and the Company. The Company routinely evaluates the sufficiency of its capital in order to insure compliance with regulatory capital standards and be a source of strength for the Bank. We manage capital by assessing the composition of capital and amounts available for growth, risk or other purposes. Management will continue to evaluate capital requirements 30 BNCCORP, INC. Annual Report 2019 and prudent capital management opportunities. See Note 14 of our Consolidated Financial Statements for a detailed description of Subordinated Debentures. Off-Balance-Sheet Arrangements In the normal course of business, we are a party to various financial instruments with off-balance-sheet risk. These instruments include commitments to extend credit, standby and commercial letters of credit, and performance and financial standby letters of credit. Such instruments help us to meet the needs of our customers, manage our interest rate risk and effectuate various transactions. These instruments and commitments, which we enter into for purposes other than trading, carry varying degrees of credit, interest rate or liquidity risk. See Note 20 of our Consolidated Financial Statements for a detailed description of each of these instruments. Contractual Obligations, Contingent Liabilities and Commitments We are a party to financial instruments with risks that can be subdivided into three categories: Cash financial instruments, generally characterized as on-balance-sheet items, include investments, loans, mortgage-backed securities, deposits and debt obligations. Credit-related financial include such instruments as commitments to extend credit, commitments to sell mortgage loans, commercial letters of credit and performance and financial standby letters of credit. See Note 20 of our Consolidated Financial Statements. instruments, generally characterized as off-balance-sheet items, Investment-related financial instruments, characterized as an off-balance-sheet item, include potential funding for investments in Small Business Investment Companies (SBIC). See Note 21 of our Consolidated Financial Statements. At December 31, 2019, the aggregate contractual obligations (excluding bank deposits) and commitments were as follows (in thousands): Contractual Obligations: Total borrowings Commitments to sell loans Lease liabilities under non-cancelable operating leases Total Other Commitments: Commitments to originate loans Commitments to sell loans Standby and commercial letters of credit Commitments to fund SBIC $ $ $ Payments due by period Less than 1 year 1 to 3 years 3 to 5 years After 5 years Total 21,565 133,977 670 156,212 $ $ - - 1,001 1,001 $ $ - - 831 831 $ $ 15,006 - 320 15,326 $ $ 36,571 133,977 2,822 173,370 Amount of Commitment - Expiration by Period Less than 1 year 1 to 3 years 3 to 5 years After 5 years Total 269,274 342,034 $ $ 24,988 - $ 5,216 - 372 - 366 800 - - 1,255 - - 1,317 2,572 $ 300,733 342,034 738 2,117 $ 645,622 Total $ 611,680 $ 26,154 $ 5,216 $ BNCCORP, INC. Annual Report 2019 31 Liquidity Risk Management Liquidity risk is the possibility of being unable to meet all present and future financial obligations in a timely manner. Liquidity risk management encompasses our ability to meet all present and future financial obligations in a timely manner. The objectives of our liquidity management policies are to maintain adequate liquid assets, liability diversification among instruments, maturities and customers and a presence in both the wholesale purchased funds market and the retail deposit market. The Consolidated Statements of Cash Flows in the Consolidated Financial Statements present data on cash and cash equivalents provided by and used in operating, investing and financing activities. In addition to liquidity from core deposit growth, together with repayments and maturities of loans and investments, we utilize brokered deposits, sell securities under agreements to repurchase and borrow overnight Federal funds. The Bank is a member of the FHLB of Des Moines. Advances from the FHLB are collateralized by the Bank’s mortgage loans and various investment securities. We have also obtained funding through the issuance of subordinated notes, subordinated debentures and long-term borrowings. Our liquidity is defined by our ability to meet our cash and collateral obligations at a reasonable cost and with a minimum loss of income. Given the uncertain nature of our customers’ demands as well as our desire to take advantage of earnings enhancement opportunities, we must have adequate sources of on- and off-balance-sheet funds that can be acquired in time of need. We measure our liquidity position on an as needed basis, but no less frequently than monthly. We measure our liquidity position using the total of the following items: 1. Estimated liquid assets and certain off-balance sheet considerations less estimated volatile liabilities using the aforementioned methodology ($140.3 million as of December 31, 2019); 2. Borrowing capacity from the FHLB ($131.0 million as of December 31, 2019); and 3. Capacity to issue brokered deposits with maturities of less than 12 months ($138.2 million as of December 31, 2019). On an on-going basis, we use a variety of factors to assess our liquidity position including, but not limited to, the following items: Stability of our deposit base, Amount of pledged investments, Amount of unpledged investments, Liquidity of our loan portfolio, and Potential loan demand. Our liquidity assessment process segregates our balance sheet into liquid assets along with certain off-balance sheet considerations and short-term liabilities assumed to be vulnerable to non-replacement over a 30 day horizon in abnormally stringent conditions. Assumptions for the vulnerable short-term liabilities are based upon historical factors. We have a targeted range for our liquidity position over this horizon and manage operations to achieve these targets. We further project cash flows over a 12 month horizon based on our assets and liabilities and sources and uses of funds for anticipated events. Pursuant to our contingency funding plan, we also estimate cash flows over a 12 month horizon under a variety of stressed scenarios to identify potential funding needs and funding sources. Our contingency plan identifies actions that could be taken in response to adverse liquidity events. We believe this process, combined with our policies and guidelines, should provide for adequate levels of liquidity to fund the anticipated needs of on- and off- balance sheet items. 32 BNCCORP, INC. Annual Report 2019 Forward-Looking Statements Statements included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” which are not historical in nature are intended to be, and are hereby identified as “forward-looking statements” for purposes of the safe harbor provided by Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We caution readers that these forward-looking statements, including without limitation, those relating to our future business prospects, revenues, working capital, liquidity, capital needs, interest costs, income and expenses, are subject to certain risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements due to several important factors. These factors include, but are not limited to: risks of loans and investments, including dependence on local and regional economic conditions; the impact of lower oil prices in our major market; competition for our customers from other providers of financial services; possible adverse effects of changes in interest rates including the effects of such changes on derivative contracts and associated accounting consequences; risks associated with our acquisition and growth strategies; and other risks which are difficult to predict and many of which are beyond our control. Recently Issued and Adopted Accounting Pronouncements Note 1 of our Consolidated Financial Statements includes a summary of recently issued and adopted accounting pronouncements and their related or anticipated impact on the Company. Accounting Policies Note 1 of our Consolidated Financial Statements includes a summary of our accounting policies and their related impact on the Company. Quantitative and Qualitative Disclosures About Market Risk Market risk arises from changes in interest rates, exchange rates, and commodity prices and equity prices and represents the possibility that changes in future market rates or prices will have a negative impact on our earnings or value. Our principal market risk is interest rate risk. Interest rate risk arises from changes in interest rates. Interest rate risk can result from: (1) Repricing risk – timing differences in the maturity/repricing of assets, liabilities, and off-balance-sheet contracts; (2) Options risk – the effect of embedded options, such as loan prepayments, interest rate caps/floors, and deposit withdrawals; (3) Basis risk – risk resulting from unexpected changes in the spread between two or more different rates of similar maturity, and the resulting impact on the behavior of lending and funding rates; and (4) Yield curve risk – risk resulting from unexpected changes in the spread between two or more rates of different maturities from the same type of instrument. We have risk management policies to monitor and limit exposure to interest rate risk. To date we have not conducted trading activities as a means of managing interest rate risk. Our asset/liability management process is utilized to manage our interest rate risk. The measurement of interest rate risk associated with financial instruments is meaningful only when all related and offsetting on-and off-balance-sheet transactions are aggregated, and the resulting net positions are identified. Our interest rate risk exposure is actively managed with the objective of managing the level and potential volatility of net interest income in addition to the long-term growth of equity, bearing in mind that we will always be in the business of taking on rate risk and that rate risk immunization is not entirely possible. Also, it is recognized that as exposure to interest rate risk is reduced, so too may the overall level of net interest income and equity. In general, the assets and liabilities generated through ordinary business activities do not naturally create offsetting positions with respect to repricing or maturity characteristics. Access to the derivatives market can be an important element in maintaining our interest rate risk position within policy guidelines. Using derivative instruments, principally interest rate floors, caps, and interest rate swaps, the interest rate sensitivity of specific transactions, as well as pools of assets or liabilities, can be adjusted to maintain the desired interest rate risk profile. See Note 1 of our Consolidated Financial Statements for a summary of our accounting policies pertaining to such instruments. Our primary tool for measuring and managing interest rate risk is net interest income simulation. This exercise includes our assumptions regarding the changes in interest rates and the impact on our current balance sheet. Interest rate caps and floors are included to the extent that they are exercised in the 12-month simulation period. Additionally, changes in prepayment behavior of the residential mortgage, CMOs, and mortgage-backed securities portfolios in each rate environment are captured using industry estimates of prepayment speeds for various coupon segments of the portfolio. For purposes of this simulation, projected month end balances of the various balance sheet accounts are held constant at their December 31, 2019 levels. Cash flows from a given account are reinvested BNCCORP, INC. Annual Report 2019 33 back into the same account so as to keep the month end balance constant at its December 31, 2019 level. The static balance sheet assumption is made so as to project the interest rate risk to net interest income embedded in the existing balance sheet. With knowledge of the balance sheet’s existing net interest income profile, more informed strategies and tactics may be developed as it relates to the structure/mix of growth. We monitor the results of net interest income simulation on a regular basis. Net interest income is generally simulated for the upcoming 12-month horizon in seven interest rate scenarios. The scenarios generally modeled are parallel interest rate ramps of +/- 100bp, 200bp, and 300bp along with a rates unchanged scenario. Given the current low absolute level of interest rates as of December 31, 2019, the downward scenarios for interest rate movements is limited to -200bp. The parallel movement of interest rates means all projected market interest rates move up or down by the same amount. A ramp in interest rates means that the projected change in market interest rates occurs over the 12-month horizon on a pro-rata basis. For example, in the +100bp scenario, the projected Prime rate is projected to increase from 4.75% to 5.75% 12 months later. The Prime rate in this example will increase 1/12th of the overall increase of 100 basis points each month. The net interest income simulation result for the 12-month horizon that covers the calendar year of 2020 is shown below: Net Interest Income Simulation Movement in interest rates Projected 12-month net interest income Dollar change from unchanged scenario Percentage change from unchanged scenario -200bp -100bp Unchanged +100bp +200bp +300bp $ $ 30,510 (1,016) $ $ (341) 31,185 $ 31,526 (3.22)% (1.08)% $ $ 31,263 (263) $ $ 31,026 (500) $ $ 30,777 (749) (0.83)% (1.59)% (2.38)% - - Since there are limitations inherent in any methodology used to estimate the exposure to changes in market interest rates, these analyses are not intended to be a forecast of the actual effect of changes in market interest rates such as those indicated above on the Company. Further, these analyses are based on our assets and liabilities as of December 31, 2019 (without forward adjustments for planned growth and anticipated business activities) and do not contemplate any actions we might undertake in response to changes in market interest rates. Static gap analysis is another tool that may be used for interest rate risk measurement. The net differences between the amount of assets, liabilities, equity and off-balance-sheet instruments repricing within a cumulative calendar period is typically referred to as the “rate sensitivity position” or “gap position.” The following table sets forth our rate sensitivity position as of December 31, 2019. Assets and liabilities are classified by the earliest possible repricing date or maturity, whichever occurs first. 34 BNCCORP, INC. Annual Report 2019 Interest Sensitivity Gap Analysis Estimated maturity or repricing at December 31, 2019 0–3 Months 4–12 Months 1–5 Years (dollars are in thousands) Over 5 years Interest-earning assets: Interest-bearing deposits with banks $ Investment securities (a) FRB and FHLB stock Loans held for sale-mortgage banking, fixed rate Loans held for investment, fixed rate Loans held for investment, indexed rate 10,523 51,256 3,651 137,114 19,386 106,191 $ - $ - $ - $ 18,533 61,927 114,448 - - 51,186 45,206 - - 103,230 158,947 - - 18,611 5,812 Total 10,523 246,164 3,651 137,114 192,413 316,156 Total interest-earning assets $ 328,121 $ 114,925 $ 324,104 $ 138,871 $ 906,021 Interest-bearing liabilities: Interest checking and money market accounts $ 479,733 $ Savings Time deposits Short-term borrowings FHLB advances Long-term borrowings Subordinated debentures 35,136 36,574 4,565 17,000 - - Total interest-bearing liabilities Interest rate gap Cumulative interest rate gap at December 31, 2019 Cumulative interest rate gap to total assets $ $ $ 573,008 (244,887) (244,887) (25.33%) $ $ $ - - - 15,000 108,683 6,242 (238,645) (24.69%) $ $ $ $ - - $ - - 93,683 38,943 - - - - $ $ $ 38,943 285,161 46,516 4.81% $ $ 171 138,700 185,216 19.16% - - 165 - - - 6 $ 479,733 35,136 169,365 4,565 17,000 - 15,006 720,805 185,216 (a) Values for investment securities reflect the timing of the estimated principal cash flows from the securities based on par values, which vary from the amortized cost and fair value of our investments. The table assumes that all savings and interest-bearing demand deposits reprice in the earliest period presented, however, we believe a significant portion of these accounts constitute a core component and are generally not rate sensitive. Our position is supported by the fact that reductions in interest rates paid on these deposits historically have not caused notable reductions in balances in net interest income because the repricing of certain assets and liabilities is discretionary and is subject to competitive and other pressures. As a result, assets and liabilities indicated as repricing within the same period may in fact reprice at different times and at different rate levels. Static gap analysis does not fully capture the impact of embedded options, lagged interest rate changes, administered interest rate products, or certain off-balance-sheet sensitivities to interest rate movements. Therefore, this tool generally cannot be used in isolation to determine the level of interest rate risk exposure in banking institutions. Since there are limitations inherent in any methodology used to estimate the exposure to changes in market interest rates, these analyses are not intended to be a forecast of the actual effect of changes in market interest rates such as those indicated above on the Company. Further, these analyses are based on our assets and liabilities as of December 31, 2019 and do not contemplate any actions we might undertake in response to changes in market interest rates. BNCCORP, INC. Annual Report 2019 35 BNCCORP, INC. AND SUBSIDIARIES Consolidated Financial Statements December 31, 2019 and 2018 (With Independent Auditors’ Report Thereon) 36 BNCCORP, INC. Annual Report 2019 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Independent Auditors’ Report Consolidated Balance Sheets as of December 31, 2019 and 2018 Consolidated Statements of Income for the Years Ended December 31, 2019 and 2018 Consolidated Statements of Comprehensive (Loss) Income for the Years Ended December 31, 2019 and 2018 Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2019 and 2018 Consolidated Statements of Cash Flows for the Years Ended December 31, 2019 and 2018 Notes to Consolidated Financial Statements Page 38 04 41 42 43 44 46 BNCCORP, INC. Annual Report 2019 37 INDEPENDENT AUDITORS’ REPORT Audit Committee and Board of Directors BNCCORP, Inc. and Subsidiaries Bismarck, North Dakota We have audited the accompanying consolidated financial statements of BNCCORP, Inc. and Subsidiaries, which comprise the consolidated balance sheet as of December 31, 2019, and the related consolidated statements of income, comprehensive income (loss), stockholders’ equity, and cash flows for the year then ended, and the related notes to the consolidated financial statements. Management’s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditors’ Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in judgment, the consolidated financial statements. The procedures selected depend on the auditors’ including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. 38 BNCCORP, INC. Annual Report 2019 Audit Committee and Board of Directors BNCCORP, Inc. and Subsidiaries Opinion In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of BNCCORP, Inc. and Subsidiaries as of December 31, 2019, and the results of their operations and their cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America. Other Matter The 2018 financial statements of BNCCORP, Inc. and Subsidiaries were audited by other auditors whose report dated March 26, 2019, expressed an unmodified opinion on those statements. CliftonLarsonAllen LLP Minneapolis, Minnesota March 20, 2020 BNCCORP, INC. Annual Report 2019 39 BNCCORP, INC. AND SUBSIDIARIES Consolidated Balance Sheets As of December 31 (In thousands, except share data) ASSETS CASH AND CASH EQUIVALENTS INVESTMENT SECURITIES AVAILABLE FOR SALE FEDERAL RESERVE BANK AND FEDERAL HOME LOAN BANK STOCK LOANS HELD FOR SALE-MORTGAGE BANKING LOANS AND LEASES HELD FOR INVESTMENT ALLOWANCE FOR CREDIT LOSSES Net loans and leases held for investment PREMISES AND EQUIPMENT, net OPERATING LEASE RIGHT OF USE ASSET ACCRUED INTEREST RECEIVABLE OTHER Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY DEPOSITS: Non-interest-bearing Interest-bearing – Savings, interest checking and money market Time deposits Total deposits SHORT-TERM BORROWINGS FEDERAL HOME LOAN BANK ADVANCES LONG-TERM BORROWINGS GUARANTEED PREFERRED BENEFICIAL INTERESTS IN COMPANY’S SUBORDINATED DEBENTURES ACCRUED INTEREST PAYABLE ACCRUED EXPENSES OPERATING LEASE LIABILITIES OTHER Total liabilities STOCKHOLDERS’ EQUITY: Common stock, $.01 par value – Authorized 11,300,000 shares; 3,514,770 and 3,493,298 shares issued and outstanding Capital surplus – common stock Retained earnings Treasury stock (153,883 and 175,355 shares, respectively) Accumulated other comprehensive income, net Total stockholders’ equity Total liabilities and stockholders’ equity 2019 2018 10,523 265,278 3,651 137,114 508,569 (8,141) 500,428 16,401 2,638 3,681 27,036 966,750 $ $ 25,185 411,509 2,941 22,788 468,468 (7,692) 460,776 16,761 - 5,079 25,988 971,027 136,313 $ 157,663 514,869 169,365 820,547 4,565 17,000 - 15,006 1,685 7,580 2,822 1,267 870,472 35 25,831 71,057 (2,115) 1,470 96,278 966,750 $ 542,735 148,207 848,605 11,494 - 10,000 15,009 1,277 5,700 - 1,189 893,274 35 25,990 61,042 (2,386) (6,928) 77,753 971,027 $ $ $ $ See accompanying notes to consolidated financial statements. 40 BNCCORP, INC. Annual Report 2019 BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Income For the Years Ended December 31 (In thousands, except per share data) INTEREST INCOME: Interest and fees on loans Interest and dividends on investments Taxable Tax-exempt Dividends Total interest income INTEREST EXPENSE: Deposits Short-term borrowings Federal Home Loan Bank advances Long-term borrowings Subordinated debentures Total interest expense Net interest income PROVISION FOR CREDIT LOSSES NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES NON-INTEREST INCOME: Bank charges and service fees Wealth management revenues Mortgage banking revenues, net Gains on sales of loans, net (Losses) gains on sales of securities, net Other Total non-interest income NON-INTEREST EXPENSE: Salaries and employee benefits Professional services Data processing fees Marketing and promotion Occupancy Regulatory costs Depreciation and amortization Office supplies and postage Other Total non-interest expense Income before income taxes Income tax expense Net income Basic earnings per common share Diluted earnings per common share 2019 2018 $ 27,201 $ 9,567 868 181 37,817 7,540 23 334 621 583 9,101 28,716 700 28,016 2,614 1,735 24,902 155 (1,296) 1,021 29,131 22,459 4,973 4,321 4,538 2,218 435 1,452 531 3,064 43,991 13,156 2,921 10,235 2.90 2.88 $ $ $ $ $ $ 23,286 9,339 1,699 154 34,478 4,761 74 95 635 543 6,108 28,370 - 28,370 2,687 1,810 10,032 187 2,293 2,008 19,017 20,074 3,378 4,027 4,212 2,408 540 1,545 574 2,255 39,013 8,374 1,538 6,836 1.96 1.93 See accompanying notes to consolidated financial statements. BNCCORP, INC. Annual Report 2019 41 BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Income (Loss) For the Years Ended December 31 (In thousands) 2019 $ 10,235 2018 $ 6,836 NET INCOME Unrealized gain (loss) on investment securities available for sale Reclassification adjustment for losses (gains) on sales of securities, net, included in net income Other comprehensive income (loss) before tax Income tax (expense) benefit related to items of other comprehensive income (loss) Other comprehensive income (loss) $ $ 9,840 1,296 11,136 (2,738) 8,398 $ (6,966) (2,293) (9,259) 2,277 (6,982) 8,398 $ TOTAL COMPREHENSIVE INCOME (LOSS) $ 18,633 See accompanying notes to consolidated financial statements. (6,982) (146) $ 42 BNCCORP, INC. Annual Report 2019 BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders’ Equity For the Years Ended December 31 (In thousands, except share data) Capital Surplus Accumulated Other Common Stock Common Retained Treasury Comprehensive Shares Amount Stock Earnings Stock Income (Loss), net Total BALANCE, December 31, 2017 3,465,992 $ 35 $ 26,072 $ 54,206 $ (2,741) $ 54 $ 77,626 Net income Other comprehensive loss Share-based compensation - - 27,306 - - - - - (82) 6,836 - - - - 355 - (6,982) - 6,836 (6,982) 273 BALANCE, December 31, 2018 3,493,298 $ 35 $ 25,990 $ 61,042 $ (2,386) $ (6,928) $ 77,753 Net income Other comprehensive income Share-based compensation Cumulative effect adjust for adoption of ASC 842 - Leases - - 21,472 - - - - - - - (159) 10,235 - - - (220) - - 271 - - 8,398 - - 10,235 8,398 112 (220) BALANCE, December 31, 2019 3,514,770 $ 35 $ 25,831 $ 71,057 $ (2,115) $ 1,470 $ 96,278 See accompanying notes to consolidated financial statements. BNCCORP, INC. Annual Report 2019 43 BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows For the Years Ended December 31 (In thousands) OPERATING ACTIVITIES: Net income Adjustments to reconcile net income to net cash provided by operating 2019 2018 $ 10,235 $ 6,836 activities - Provision for credit losses Depreciation and amortization Net amortization of premiums and (discounts) on investment securities and subordinated debentures Share-based compensation Change in accrued interest receivable and other assets, net Gain on sale of other real estate Gain on sale of bank premises and equipment Net realized losses (gains) on sales of investment securities Increase in deferred taxes Change in other liabilities, net Funding of loans held for sale, mortgage banking Proceeds from sales of loans held for sale, mortgage banking Fair value adjustment for loans held for sale, mortgage banking Fair value adjustment on mortgage banking derivatives Proceeds from sales of loans Gains on sales of loans, net Net cash (used in) provided by operating activities INVESTING ACTIVITIES: 700 1,452 7,170 112 (1,903) (35) (10) 1,296 (96) 4,185 (1,328,706) 1,216,900 (2,844) (2,090) 1,710 (155) (92,079) - 1,545 7,778 273 355 - 21 (2,293) (88) 248 (642,695) 656,003 505 233 2,209 (187) 30,743 Purchases of investment securities available for sale (172,304) (129,930) Proceeds from sales of investment securities available for sale Proceeds from maturities of investment securities available for sale Purchases of Federal Reserve and Federal Home Loan Bank Stock Sales of Federal Reserve and Federal Home Loan Bank Stock Net increase in loans and leases held for investment Proceeds from sales of other real estate Proceeds from sales of premises and equipment Purchases of premises and equipment Net cash provided by (used in) investing activities 263,218 57,872 (30,430) 29,720 (41,907) 316 22 (1,103) 105,404 62,516 53,077 (15,456) 15,412 (42,334) - 2,307 (1,230) (55,638) See accompanying notes to consolidated financial statements. 44 BNCCORP, INC. Annual Report 2019 BNCCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows, continued For the Years Ended December 31 (In thousands) 2019 2018 FINANCING ACTIVITIES: Net (decrease) increase in deposits Net decrease in short-term borrowings Decrease in long-term borrowings Repayments of Federal Home Loan Bank advances Proceeds from Federal Home Loan Bank advances Net cash (used in) provided by financing activities NET DECREASE IN CASH AND CASH EQUIVALENTS CASH AND CASH EQUIVALENTS, beginning of period CASH AND CASH EQUIVALENTS, end of period SUPPLEMENTAL CASH FLOW INFORMATION: Interest paid Income taxes paid SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Additions to other real estate in the settlement of loans $ (28,058) $ (6,929) (10,000) (804,400) 821,400 (27,987) (14,662) 25,185 10,523 8,693 3,527 $ $ $ 30,799 (6,549) - (395,000) 395,000 24,250 (645) 25,830 25,185 3,945 1,102 281 $ - $ $ $ $ See accompanying notes to consolidated financial statements. BNCCORP, INC. Annual Report 2019 45 BNCCORP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements NOTE 1. Description of Business and Significant Accounting Policies Description of Business BNCCORP, INC. (BNCCORP, BNC, or Company) is a registered bank holding company incorporated under the laws of Delaware. It is the parent company of BNC National Bank (the Bank or BNC Bank). BNC Bank operates community banking and wealth management businesses in North Dakota, Arizona and Minnesota from 13 locations. The Bank also conducts mortgage banking through a consumer-direct channel complemented by retail channels from 11 locations in Arizona, North Dakota, Illinois, Kansas, Missouri, and Michigan. The consumer direct channel emphasizes technology (internet leads and call center) to originate mortgage loans throughout the United States. The retail channel is primarily relationship driven and originations are generally near mortgage banking locations. With respect to group concentrations of credit risk, most of the Company’s business activity is with customers in North Dakota. At December 31, 2019, the Company did not have any significant credit concentrations in any particular industry. The consolidated financial statements included herein are for BNCCORP and subsidiaries. The accounting and reporting policies of BNCCORP and subsidiaries (collectively, the Company) conform to U.S. generally accepted accounting principles and general practices within the financial services industry. The more significant accounting policies are summarized below. Principles of Consolidation The accompanying consolidated financial statements include the accounts of BNCCORP and its wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. Use of Estimates The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles 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. Significant items subject to such estimates and assumptions include the allowance for credit losses, valuation of other real estate, reserves for mortgage banking reimbursement obligations, fair value measurements for financial instruments (including derivatives), impairment of long-lived assets, contingencies, and income taxes. Ultimate results could materially differ from those estimates. SIGNIFICANT ACCOUNTING POLICIES Cash and Cash Equivalents Cash and cash equivalents include cash on hand, cash due from banks and federal funds sold. Investment Securities Investment securities that the Bank intends to hold indefinitely as part of its asset/liability strategy, or that may be sold in response to changes in interest rates, liquidity needs, or prepayment risk are classified as available for sale. Available for sale securities are carried at fair value. Net unrealized gains and losses, net of deferred income taxes, on securities available for sale are reported as a separate component of stockholders’ equity until realized (see Comprehensive Income (Loss)). All securities were classified as available for sale as of December 31, 2019 and 2018, except for Federal Reserve Bank (FRB) and Federal Home Loan Bank (FHLB) stocks, which have indeterminable maturities. Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to yield using the effective interest method. Dividend and interest income is recognized when earned. Realized gains and losses on the sale of investment securities are determined using the specific-identification method and recognized in non-interest income on the trade date. 46 BNCCORP, INC. Annual Report 2019 Other-Than-Temporary Impairment Declines in the fair value of individual available-for-sale securities below amortized cost, which are deemed other- than-temporary, result in a charge to earnings and establishment of a new cost basis. The Company assesses available information about is other-than-temporary. The its securities to determine whether impairment information the Company considers includes, but is not limited to, the following: Financial condition of issuers or guarantors; Seniority of invested tranches and subordinated credit support; Recent and expected performance of the securities; Recent cash flows; Vintage of origination; Location of collateral; Ratings of securities; Value of underlying collateral; Delinquency and foreclosure data; Historical losses and estimated severity of future losses; Credit surveillance data which summarize retrospective performance; and Anticipated future cash flows and prospective performance assessments. Determining whether other-than-temporary impairment has occurred requires judgment of factors that may indicate an impairment loss has incurred. The Company follows the guidance on other-than-temporary impairments Accounting Standards Codification (ASC) 320, Investments – Debt Securities. Any credit-related impairments are recognized through a charge to earnings. The amount of non-credit related impairments is recognized through comprehensive (loss) income, net of income taxes. Note 2 to these consolidated financial statements includes a summary of investment securities in a loss position at December 31, 2019 and 2018. Federal Reserve Bank and Federal Home Loan Bank Investments in Federal Reserve Bank and Federal Home Loan Bank stock qualify as restricted stock, which is not subject to investment security accounting treatment, and are reported at cost, subject to impairment. Loans Held For Sale-Mortgage Banking Loans held for sale-mortgage banking are accounted for at fair value pursuant to the fair value option permitted by ASC 825, Financial Instruments. Gains and losses from the changes in fair value are included in mortgage banking revenues, net. Loans and Leases Held For Investment Loans and leases held for investment are stated at their outstanding principal amount net of unearned income, unamortized deferred fees and costs, and an allowance for credit losses. Interest income is recognized on the accrual basis using the interest method prescribed in the loan agreement except when collectability is in doubt. Loans and leases are reviewed regularly by management and are placed on non-accrual status when the collection of interest or principal is 90 days or more past due, unless the loan or lease is adequately secured and in the process of collection. When a loan or lease is placed on non-accrual status, uncollected interest accrued in prior years is charged off against the allowance for credit losses, unless collection of the principal and interest is assured. Interest accrued and uncollected in the current year is reversed against interest income in the current period. Interest payments received on non-accrual loans and leases are generally applied to principal unless the remaining principal balance has been determined to be fully collectable. Accrual of interest may be resumed when it is determined that all amounts due are expected to be collected and the loan has exhibited a sustained level of performance, generally at least six months. A loan is considered impaired when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans are reviewed for impairment on an individual basis. Impaired BNCCORP, INC. Annual Report 2019 47 loans are measured at the present value of expected future cash flows discounted at the loan’s initial effective interest rate. The fair value of collateral of an impaired collateral-dependent loan or an observable market price of the loan is also used as an alternative to discounting cash flows. If the measure of the impaired loan is less than the recorded investment in the loan, impairment will be recognized as a charge-off through the allowance for credit losses or a valuation allowance is established for the difference. Troubled debt restructured loans are loans for which concessions, including a reduced interest rate or a deferral of interest or principal, have been granted due to the borrower’s weakened financial condition. Once a loan is restructured, interest is accrued at the restructured rates when no loss of principal is anticipated. A loan that has performed in accordance with restructured terms for one year is no longer reported as a restructured loan, but will continue to be reported as impaired. Loan Origination Fees and Costs; Other Lending Fees For Loans and Leases Held for Investment, origination fees and costs incurred to extend credit are deferred and amortized over the term of the loan as an adjustment to yield using the interest method, except where the net amount is deemed to be immaterial. The Company occasionally originates lines of credit where the customer is charged a non-usage fee if the line of credit is not used. In such instances, the Company periodically reviews use of lines on a retrospective basis and recognizes non-usage fees in non-interest income. Loan Servicing and Transfers of Financial Assets The Bank sells commercial business loans to third parties. The loans are generally sold on a non-recourse basis. Sold loans are not included in the accompanying consolidated balance sheets. The sales of loans are accounted for pursuant to ASC 860, Transfers and Servicing of Financial Assets. Allowance for Credit Losses The Bank maintains its allowance for credit losses at a level considered adequate to provide for probable losses related to the loan and lease portfolio as of the consolidated balance sheet dates. The loan and lease portfolio and other credit exposures are reviewed regularly to evaluate the adequacy of the allowance for credit losses. The methodology used to establish the allowance for credit losses incorporates quantitative and qualitative risk considerations. Quantitative factors include the Bank’s historical loss experience, delinquency information, charge- off trends, collateral values, changes in nonperforming loans and other factors. Quantitative factors also incorporate known information about including sensitivity to interest rate movements or other quantifiable external factors. individual borrowers, Qualitative factors include the general economic environment, the state of certain industries and factors unique to the Bank’s market areas. Size, complexity of individual credits, loan structure, variances from loan policies and pace of portfolio growth are other qualitative factors that are considered when the Bank estimates the allowance for credit losses. The Bank’s methodology has been consistently applied. However, the Bank enhances its methodology as circumstances dictate. The allowance for credit losses has three components as follows: Specific Reserves. The amount of specific reserves is determined through a loan-by-loan analysis of problematic loans over a minimum size. Included in problem loans are non-accrual or restructured loans that meet the impairment criteria in ASC 310, Receivables. A loan is impaired when, based on current information, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Any allowance on impaired loans is generally based on one of three methods: the present value of expected cash flows at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral of the loan. Specific reserves may also be established for credits that have been internally 48 BNCCORP, INC. Annual Report 2019 classified as credits requiring management’s attention due to underlying problems in the borrower’s business or collateral concerns. Reserves for Homogeneous Loan Pools. The Bank makes a significant number of loans and leases that, due to their underlying similar characteristics, are assessed for loss as “homogeneous” pools. Included in the homogeneous pools are loans which have been excluded from the specific reserve allocation. The Company’s methodology incorporates an estimated loss emergence period for each risk group. The loss emergence period is the period of time from when a borrower experiences a loss event and when the actual loss is recognized in the consolidated financial statements, generally at the time of initial charge-off of the loan balance. Qualitative Reserve. Management also allocates reserves for other circumstances pertaining to the measurement period. The factors considered include, but are not limited to, prevailing trends, economic conditions, geographic influence, industry segments within the portfolio, management’s assessment of credit risk inherent in the loan portfolio, delinquency data, historical loss experience and peer-group information. Monitoring loans and analysis of loss components are the principal means by which management determines estimated credit losses are reflected in the Bank’s allowance for credit losses on a timely basis. This analysis also considers regulatory guidance in addition to the Bank’s own experience. Various regulatory agencies, as an integral part of their examination process, periodically review the allowance for credit losses. Such agencies may require additions to the allowance based on their judgment about information available to them at the time of their examination. Loans, leases and other extensions of credit deemed uncollectable are charged off against the allowance for credit losses. Subsequent recoveries, if any, are credited to the allowance. The allowance for credit losses is highly dependent upon variables affecting valuation, including appraisals of collateral, evaluations of performance as well as the amounts and timing of future cash flows expected to be received on impaired loans. These variables are reviewed periodically. For nonperforming or impaired loans, appraisals are generally performed annually or whenever circumstances warrant a new appraisal. Management regularly evaluates the appraised value and costs to liquidate in order to estimate fair value. A provision for credit losses is made to adjust the allowance for credit losses to the amount determined appropriate through application of the above processes. Actual credit losses may materially vary from the current estimated allowance for credit losses. Other Real Estate Owned and Repossessed Assets, net Real estate properties and other assets acquired through loan foreclosures are recorded at fair value less estimated costs to sell. If the carrying amount of an asset acquired through foreclosure is in excess of the fair value less estimated costs to sell, the excess amount is charged to the allowance for credit losses. Fair value is primarily determined based upon appraisals of the assets involved and management periodically assesses appraised values to ascertain continued relevancy of the valuation. Net operating income from and gains on disposition of these assets are included in other non-interest income. Net operating expenses, losses on disposition, and subsequent declines in the estimated fair value of these assets are charged to other non-interest expense. Premises and Equipment Land is carried at cost. Premises and equipment are reported at cost less accumulated depreciation and amortization. Depreciation and amortization for financial reporting purposes is charged to non-interest expense using the straight- line method over the estimated useful lives of the assets. Estimated useful lives are up to 40 years for buildings and three to 10 years for furniture and equipment. Leasehold improvements are capitalized and amortized over the shorter of the lease term or the estimated useful life of the improvement. Maintenance and repairs, as well as gains and losses on dispositions of premises and equipment, are included in non-interest income or expense as incurred. Impairment of Long-Lived Assets The Company reviews long-lived assets for impairment periodically or whenever events or changes in circumstances indicate that the carrying amount of any such asset may not be recoverable. The impairment review includes a comparison of future cash flows (undiscounted and without interest charges) expected to be generated by the assets to their current carrying value. If impairment is identified, the assets are written down to their fair value through a charge to non-interest expense. BNCCORP, INC. Annual Report 2019 49 Securities Sold Under Agreements to Repurchase From time to time, the Bank enters into sales of securities under agreements to repurchase, generally for periods of less than 90 days. These agreements are treated as financings, and the obligations to repurchase securities sold are reflected as a liability in the consolidated balance sheets as short-term borrowings. The costs of securities underlying the agreements remain in the asset accounts. Fair Value Several accounting standards require recording assets and liabilities based on their fair values. Determining the fair value of assets and liabilities can be highly subjective. The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. The Company determines fair value based on assumptions that market participants would use in pricing an asset or liability in the principal or most advantageous market. ASC 820, Fair Value Measurement, defines fair value and establishes a framework for measuring fair value of assets and liabilities using a hierarchy system consisting of three levels based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are: Level 1: Valuation is based upon quoted prices for identical instruments traded in active markets that the Company has the ability to access. Level 2: Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are less active, and model-based valuation techniques for which significant assumptions are observable in the market. Level 3: Valuation is generated from model-based techniques that use significant assumptions not observable in the market and are used only to the extent that observable inputs are not available. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset or liability. Management assigns levels to assets and liabilities accounted for at fair value. Fair Values of Financial Instruments The Company is required to disclose the estimated fair value of financial instruments. Fair value estimates are subjective in nature, involving uncertainties and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. The following methods and assumptions are used by the Company in estimating fair value disclosures for its financial instruments. Investment Securities Available for Sale. The fair value of the Company’s securities, other than U.S. Treasury securities, are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are less active, and model-based valuation techniques for which significant assumptions are observable in the market. U.S. Treasury securities are based upon quoted prices for identical instruments traded in active markets. Loans Held for Sale-Mortgage Banking. Loans held for sale-mortgage banking are accounted for at fair value pursuant to the fair value option permitted by ASC 825, Financial Instruments. Fair value measurements on loans held for sale are based on quoted market prices for similar loans in the secondary market, market quotes from anticipated sales contracts and commitments, or contract prices from firm sales commitments. Derivative Financial Instruments. The fair value of the Company’s derivatives are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are less active, and model-based valuation techniques for which significant assumptions are observable in the market. 50 BNCCORP, INC. Annual Report 2019 Financial Instruments with Off-Balance-Sheet Risk. The fair values of the Company’s commitments to extend credit and commercial and standby letters of credit are estimated using fees currently charged to enter into similar agreements. Derivative Financial Instruments ASC 815, Derivatives and Hedging, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. Accordingly, the Company records all derivatives at fair value. The Company enters into interest rate lock commitments on certain mortgage loans related to mortgage banking operations on a best efforts basis, which are commitments to originate loans whereby the interest rate on the loan is determined prior to funding. The Company also has corresponding forward sales contracts related to these interest rate lock commitments. Both the mortgage loan commitments and the related forward sales contracts are accounted for as derivatives and carried at fair value in other assets with changes in fair value recorded in mortgage banking revenues, net. The Company also commits to originate and sell certain loans related to mortgage banking operations on a mandatory delivery basis. To hedge interest rate risk the Company sells short positions in mortgage backed securities related to the loans sold on a mandatory delivery basis. The commitments to originate and short positions are accounted for as derivatives and carried at fair value in other liabilities with changes in fair value recorded in mortgage banking revenues, net. Share-Based Compensation ASC 718, Compensation – Stock Compensation, requires the Company to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award on the grant date. At December 31, 2019, the Company had four stock-based compensation plans, which are described more fully in Note 25 and Note 26 to these consolidated financial statements. Revenue from Contracts with Customers The majority of the Company’s performance obligations for revenue from contracts with customers are satisfied at a point in time and are typically collected from customers at the time of the transaction or shortly thereafter. The following is a description of the principal activities from which the Company generates revenue that are within the scope of ASC 606: Service charges on deposits – Service charges on deposit accounts represent daily and monthly analysis fees recognized for the services related to customer deposit accounts, including account maintenance, overdraft fees, and depository transactions processing fees. Depository accounts charge fees in accordance with the customer’s pricing schedule or may be assessed a flat service fee per month. The Company satisfies the performance obligation related to providing depository accounts daily as transactions are processed and deposit service charge revenue is recognized daily. Bankcard fees – Bankcard fees primarily represent income earned from interchange revenue from Visa for the Company’s processing of debit card transactions. The performance obligation for interchange revenue is the processing of each transaction through the Company’s access to the banking system. This performance obligation is completed for each individual transaction and revenue is recognized per transaction in accordance with interchange rates established by Visa. Wealth management revenue – Wealth management revenue consists of fees earned on personal trust accounts, retirement plan administration, and wealth management services. The performance obligations related to this revenue include items such as performing trustee service administration, investment management services, custody and record-keeping services, retirement plan administration, and tax services. These fees are part of contractual agreements and the performance obligations are satisfied upon completion of services. The fees are generally a fixed flat annual rate or based on a percentage of the account’s market value per the contract with the customer and revenue is recognized over time as earned. BNCCORP, INC. Annual Report 2019 51 Other income – The Company recognizes other miscellaneous income through a variety of other revenue streams, the most material of which include revenue from investments in Small Business Investment Companies (SBIC), gains on sales of financial assets, and bank-owned life insurance income. These revenue streams are outside of the scope of ASC 606 and are recognized in accordance with the applicable U.S. generally accepted accounting principles. The remainder of Other income is primarily earned through transactions with personal banking customers, including stop payment charges and fees for cashier’s checks. The performance obligations of these types of fees are satisfied as transactions are completed and revenue is recognized upon transaction execution according to established fee schedules with the customers. Note 17 to these consolidated financial statements includes disclosure of revenue from contracts with customers. Income Taxes The Company files consolidated federal and unitary state income tax returns where allowed. The determination of current and deferred income taxes is based on analyses of many factors including interpretation of federal and state income tax laws, differences between tax and financial reporting basis of assets and liabilities, expected reversals of temporary differences, estimates of amounts due or owed and current financial accounting standards. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income taxes. Deferred income taxes are accounted for using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effects of changes in tax rates on deferred tax assets and liabilities are recognized in income in the period of enactment regardless of the balance sheet classification of the underlying deferred tax asset or liability. Management evaluates deferred tax assets to determine whether they are realizable based upon accounting standards and specific facts and circumstances. A valuation allowance is established to reduce deferred tax assets to amounts that are more likely than not expected to be realized. Earnings Per Share Basic earnings per share (EPS) excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during the applicable period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. Such potential dilutive instruments include stock options and contingently issuable stock. Note 23 to these consolidated financial statements includes disclosure of the Company’s EPS calculations. Comprehensive (Loss) Income Comprehensive income is the total of net income and other comprehensive (loss) income, which for the Company, is generally comprised of unrealized losses and gains on securities available for sale, net of corresponding tax effects. 52 BNCCORP, INC. Annual Report 2019 RECENTLY ISSUED OR ADOPTED ACCOUNTING PRONOUNCEMENTS In February 2016, the FASB issued ASU 2016-02, Leases – Accounting Standards Codification (ASC) Topic 842. The amended guidance requires lessees to recognize leases on-balance sheet and disclose key information about leasing arrangements. ASC Topic 842 (ASC 842) establishes a right of use (ROU) model that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases are required to be classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement. The Company adopted ASC 842 using a modified retrospective transition approach as of January 1, 2019. As a result, the Company was not required to adjust its comparative period financial information for effects of the standard or make the new required lease disclosures for periods prior to January 1, 2019. The adoption of ASC 842 did not have a material impact to the Company’s consolidated balance sheet or the consolidated statement of income. As a result of adopting ASC 842, the Company recognized operating lease liabilities of $4.0 million with corresponding ROU assets of $3.8 million and a cumulative effect adjustment to equity of $220 thousand as of January 1, 2019. See Note 8 to the consolidated financial statements. losses with a current expected credit ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments, replaces the current incurred loss methodology for recognizing credit loss model, which requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. This amended guidance broadens the information that an entity must consider in developing its expected credit loss estimates. Additionally, this update amends the accounting for credit losses for available-for-sale debt securities and purchased financial assets with a more-than-insignificant amount of credit deterioration since origination. This update requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of a company’s loan portfolio. This update is effective for fiscal years beginning after December 15, 2022. This update requires the use of the modified retrospective adoption approach and the Company is currently evaluating the impact that this amended guidance will have on its consolidated financial statements and disclosures. BNCCORP, INC. Annual Report 2019 53 NOTE 2. Investment Securities Available For Sale Investment securities have been classified in the consolidated balance sheets according to management’s intent. The Company had no securities designated as trading or held-to-maturity in its portfolio at December 31, 2019 or 2018. The carrying amount of investment securities available for sale securities and their estimated fair values were as follows as of December 31 (in thousands): 2019 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value U.S. Treasury securities U.S. government sponsored entity mortgage- backed securities issued by FNMA/FHLMC U.S. government agency small business administration pools guaranteed by SBA Collateralized mortgage obligations guaranteed by GNMA Collateralized mortgage obligations issued by FNMA or FHLMC Commercial mortgage-backed securities issued by FHLMC Other commercial mortgage-backed securities Asset-backed securities State and municipal bonds $ 4,992 $ 5,634 53,873 21,120 68,353 21,625 56,530 12,810 19,873 2 16 - 671 523 931 921 83 948 $ - $ 4,994 (7) (2,236) (1) (261) - (672) - (450) 5,643 51,637 21,790 68,615 22,556 56,779 12,893 20,371 $ 264,810 $ 4,095 $ (3,627) $ 265,278 2018 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value $ 59,710 $ - $ (916) $ 58,794 10,221 158,430 63,149 52,635 24,170 53,862 $ 422,177 $ 32 - 274 47 - 434 787 (121) (7,464) (1,166) (903) (125) (760) 10,132 150,966 62,257 51,779 24,045 53,536 $ (11,455) $ 411,509 U.S. Treasury securities U.S. government sponsored entity mortgage- backed securities issued by FNMA/FHLMC U.S. government agency small business administration pools guaranteed by SBA Collateralized mortgage obligations guaranteed by GNMA Collateralized mortgage obligations issued by FNMA or FHLMC Asset-backed securities State and municipal bonds 54 BNCCORP, INC. Annual Report 2019 The amortized cost and estimated fair value of investment securities available for sale classified according to their contractual maturities at December 31, 2019, were as follows (in thousands): Amortized Cost Estimated Fair Value Due in one year or less Due after one year through five years Due after five years through ten years Due after ten years Total $ $ - 4,992 75,189 184,629 264,810 $ $ - 4,994 75,733 184,551 265,278 The table above is not intended to reflect actual maturities, cash flows, or interest rate risk. Actual maturities may differ from the contractual maturities shown above as a result of prepayments. Investment securities available for sale with estimated fair values of $80.6 million and $113.9 million at December 31, 2019 and 2018, respectively, were pledged as collateral for public and trust deposits and borrowings, including borrowings from the FHLB and repurchase agreements with customers. Sales proceeds and gross realized gains and losses on available for sale securities were as follows for the years ended December 31 (in thousands): Sales proceeds Gross realized gains Gross realized losses Net realized (losses) gains 2019 2018 $ $ 263,218 3,389 (4,685) (1,296) $ $ 62,516 2,513 (220) 2,293 BNCCORP, INC. Annual Report 2019 55 The following table shows the Company’s gross unrealized losses and fair value of investment securities available for sale aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31 (in thousands): Less than 12 months 12 months or more Total 2019 Description of Securities Fair Value Unrealized Loss # - 1 U.S. Treasury securities U.S. government sponsored entity mortgage-backed securities issued by FNMA/FHLMC U.S. government agency small business administration pools guaranteed by SBA Collateralized mortgage obligations guaranteed by GNMA 1 Collateralized mortgage obligations issued by FNMA or FHLMC Other commercial mortgage- backed securities 5 2 3 Asset-backed securities State and municipal bonds Total temporarily impaired securities Description of Securities U.S. Treasury securities U.S. government sponsored entity mortgage-backed securities issued by FNMA/FHLMC U.S. government agency small business administration pools guaranteed by SBA Collateralized mortgage obligations guaranteed by GNMA Collateralized mortgage obligations issued by FNMA or FHLMC Asset-backed securities State and municipal bonds Total temporarily impaired securities - 3 # 2 - 5 - 3 4 9 $ - $ - 4,779 (7) 14,140 (142) 507 (1) 35,047 25,756 - 13,780 (261) (672) - (450) Fair Value Unrealized Loss $ $ - - - - 37,493 (2,094) - - - - - - - - - - # - - 5 - - - - - # - 1 7 1 5 3 - 3 Fair Value Unrealized Loss $ - $ - 4,779 (7) 51,633 (2,236) 507 (1) 35,047 25,756 - 13,780 (261) (672) - (450) 15 $ 94,009 $ (1,533) 5 $ 37,493 $ (2,094) 20 $ 131,502 $ (3,627) 2018 Less than 12 months 12 months or more Total Fair Value Unrealized Loss $ 19,652 $ (55) - - Fair Value Unrealized Loss $ 39,142 $ (861) 4,132 (121) # 2 3 # 4 3 Fair Value Unrealized Loss $ 58,794 $ (916) 4,132 (121) 28,836 (1,444) 40 122,130 (6,020) 45 150,966 (7,464) - - 13,965 14,752 30,441 (88) (46) (402) 5 8 4 6 40,146 (1,166) 5 40,146 (1,166) 34,583 9,293 16,575 (815) (79) (358) 11 8 15 91 48,548 24,045 47,016 (903) (125) (760) $ 373,647 $ (11,455) 23 $ 107,646 $ (2,035) 68 $ 266,001 $ (9,420) Management regularly evaluates each security with unrealized losses to determine whether losses are other-than- temporary. When determining whether a security is other-than-temporarily impaired, management assesses whether it has the intent to sell the security or whether it is more likely than not that it will be required to sell the security before a recovery of amortized cost. When evaluating a security, management considers several factors including, but not limited to, the amount of the unrealized loss, the length of time the security has been in a loss position, guarantees provided by third parties, ratings on the security, cash flow from the security, the level of credit support provided by subordinate tranches, and the collateral underlying the security. There were no securities that management concluded were other-than-temporarily impaired during 2019 or 2018. 56 BNCCORP, INC. Annual Report 2019 NOTE 3. Federal Reserve Bank and Federal Home Loan Bank Stock The carrying amounts of FRB and FHLB stock, which approximate their fair values, consisted of the following as of December 31 (in thousands): Federal Reserve Bank Stock, at cost Federal Home Loan Bank, at cost Total 2019 2018 $ $ 1,807 1,844 3,651 $ $ 1,807 1,134 2,941 There is no contractual maturity on these investments; the investments are required by counterparties. NOTE 4. Loans and Leases The composition of loans and leases is as follows at December 31 (in thousands): Loans held for sale-mortgage banking Commercial and industrial Commercial real estate SBA Consumer Land and land development Construction Gross loans and leases held for investment Unearned income and net unamortized deferred fees and costs Loans, net of unearned income and unamortized fees and costs Allowance for credit losses Net loans and leases held for investment 2019 2018 137,114 162,592 193,203 46,799 82,498 10,449 12,656 508,197 372 508,569 (8,141) 500,428 $ $ $ 22,788 149,886 174,868 32,505 78,055 11,398 21,257 467,969 499 468,468 (7,692) 460,776 $ $ $ To accommodate customers whose financing needs exceed the Bank’s lending limits, BNC sells loan participations on a nonrecourse basis to outside financial institutions and derecognizes the portion of the loan balance sold. At December 31, 2019 and 2018, loan participations sold on a nonrecourse basis to outside financial institutions totaled $152.2 million and $166.3 million, respectively. Loans to Related Parties Note 24 to these consolidated financial statements includes information relating to loans to executive officers, directors, principal shareholders and associates of such persons. Loans Pledged as Collateral The table below present’s loans pledged as collateral to the FHLB, FRB, and the Bank of North Dakota as of December 31(in thousands): Commercial and industrial Commercial real estate Consumer Total 2019 2018 51,641 110,597 31,894 194,132 $ $ 43,130 97,788 32,357 173,275 $ $ BNCCORP, INC. Annual Report 2019 57 NOTE 5. Allowance for Credit Losses Transactions in the allowance for credit losses were as follows for the years ended December 31 (in thousands): Commercial and industrial Commercial real estate SBA Consumer Land and land development Construction Total 2019 $ 1,937 $ 3,558 $ 845 $ 928 $ 225 $ 199 $ 7,692 554 (125) - (69) - 13 357 (82) 11 (7) (97) 29 (38) - - (97) - - 700 (304) 53 $ 2,366 $ 3,502 $ 1,131 $ 853 $ 187 $ 102 $ 8,141 Commercial and industrial Commercial real estate SBA Consumer Land and land development Construction Total 2018 $ 2,158 $ 3,471 $ 834 $ 914 $ 358 $ 126 $ 7,861 (190) (71) 40 72 (1) 16 66 (59) 4 112 (129) 31 (133) - - 73 - - - (260) 91 $ 1,937 $ 3,558 $ 845 $ 928 $ 225 $ 199 $ 7,692 Balance, beginning of period Provision (reduction) Loans charged off Loan recoveries Balance, end of period Balance, beginning of period Provision (reduction) Loans charged off Loan recoveries Balance, end of period The following table shows the balance in the allowance for credit losses at December 31, 2019, and December 31, 2018, and the related loan balances, segregated on the basis of impairment methodology (in thousands). Impaired loans are loans on nonaccrual status and troubled debt restructurings, which are individually evaluated for impairment, and other loans deemed to have similar risk characteristics. All other loans are collectively evaluated for impairment. December 31, 2019 Commercial and industrial Commercial real estate SBA Consumer Land and land development Construction Total December 31, 2018 Commercial and industrial Commercial real estate SBA Consumer Land and land development Construction Total $ $ $ Allowance For Credit Losses Gross Loans and Leases Held for Investment Impaired Other Total Impaired Other Total $ 497 172 59 - - - $ 1,869 3,330 1,072 853 187 102 $ 2,366 3,502 1,131 853 187 102 1,610 1,448 380 37 5 - $ 160,982 $ 191,755 46,419 82,461 10,444 12,656 162,592 193,203 46,799 82,498 10,449 12,656 728 $ 7,413 $ 8,141 $ 3,480 $ 504,717 $ 508,197 246 $ 73 62 6 - - $ 1,691 3,485 $ 1,937 3,558 783 922 225 199 845 928 225 199 1,758 1,496 104 80 28 - $ 148,128 173,372 $ 149,886 174,868 32,401 77,975 11,370 21,257 32,505 78,055 11,398 21,257 $ 387 $ 7,305 $ 7,692 $ 3,466 $ 464,503 $ 467,969 58 BNCCORP, INC. Annual Report 2019 Performing and non-accrual loans The Bank’s key credit quality indicator is the loan’s performance status, defined as accrual or non-accrual. Performing loans are considered to have a lower risk of loss and are on accrual status. Accrual of interest on loans is discontinued when the Bank believes that the borrower’s financial condition is such that the collection of principal and interest is doubtful. A delinquent loan is generally placed on non-accrual status when it becomes 90 days or more past due unless the loan is well secured and in the process of collection. When a loan is placed on non-accrual status, accrued but uncollected interest income applicable to the current reporting period is reversed against interest income. Accrued but uncollected interest income applicable to previous reporting periods is charged against the allowance for credit losses. No additional interest is accrued on the loan balance until the collection of both principal and interest becomes reasonably certain. Delinquent balances are determined based on the contractual terms of the loan adjusted for charge-offs and payments applied to principal. The following table sets forth information regarding the Bank’s performing and non-accrual loans at December 31 (in thousands): 2019 Current 31-89 Days Past Due 90 Days or More Past Due And Accruing Total Performing Non-accrual Total Commercial and industrial: Business loans $ 75,907 $ Agriculture Owner-occupied commercial real estate Commercial real estate SBA Consumer: Automobile Home equity 1st mortgage Other Land and land development Construction 29,877 54,947 193,203 46,382 24,118 9,650 12,678 35,884 10,444 12,656 Total loans held for investment 505,746 Loans held for sale 137,114 $ 189 37 25 - 36 47 - - 84 - - 418 - Total gross loans $ 642,860 $ 418 $ - - - - - - - - - - - - - - $ 76,096 $ 1,610 $ 29,914 54,972 193,203 46,418 24,165 9,650 12,678 35,968 10,444 12,656 - - - 381 15 - - 22 5 - 77,706 29,914 54,972 193,203 46,799 24,180 9,650 12,678 35,990 10,449 12,656 506,164 2,033 508,197 137,114 - 137,114 $ 643,278 $ 2,033 $ 645,311 BNCCORP, INC. Annual Report 2019 59 2018 Current 31-89 Days Past Due 90 Days or More Past Due And Accruing Total Performing Non-accrual Total Commercial and industrial: Business loans $ 64,437 $ 644 $ Agriculture Owner-occupied commercial real estate Commercial real estate SBA Consumer: Automobile Home equity 1st mortgage Other Land and land development Construction 26,425 56,916 174,868 32,343 22,377 8,567 12,505 34,265 11,370 21,257 Total loans held for investment 465,330 Loans held for sale 22,788 - - - 47 10 - 229 23 - - 953 - Total gross loans $ 488,118 $ 953 $ - - - - - - - - - - - - - - $ 65,081 $ 1,464 $ 26,425 56,916 174,868 32,390 22,387 8,567 12,734 34,288 11,370 21,257 - - - 115 55 - - 24 28 - 66,545 26,425 56,916 174,868 32,505 22,442 8,567 12,734 34,312 11,398 21,257 466,283 1,686 467,969 22,788 - 22,788 $ 489,071 $ 1,686 $ 490,757 The following table indicates the effect on interest income on loans if interest on non-accrual loans outstanding at year end had been recognized at original contractual rates during the year ended December 31 (in thousands): Interest income that would have been recorded Interest income recorded Effect on interest income on loans 2019 2018 $ $ 140 - 140 $ $ 123 - 123 Credit Risk by Internally Assigned Grade The Company maintains an internal risk rating process in order to increase the precision and effectiveness of credit risk management. Loans are assigned one of the following four internally assigned grades: pass, watch list, substandard, and doubtful. At December 31, 2019, the Company had $489.8 million of loans categorized as pass rated loans. This compares to $452.0 million at December 31, 2018. Loans designated as watch list are loans that possess some credit deficiency that deserves close attention due to emerging problems. Such loans pose unwarranted financial risk that, if left uncorrected, may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. At December 31, 2019, the Company had $9.2 million of loans categorized as watch list loans compared to $5.2 million at December 31, 2018. Loans graded as Substandard or Doubtful are considered “Classified” loans for regulatory purposes. Loans classified as substandard are loans that are generally inadequately protected by the current net worth and paying capacity of the obligor, or by the collateral pledged, if any. Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the loan. Substandard loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loans classified as doubtful have the weaknesses of those classified as substandard, with additional characteristics that make collection 60 BNCCORP, INC. Annual Report 2019 in full on the basis of currently existing facts, conditions and values questionable, and there is a higher probability of loss. At December 31, 2019, the Company had $7.8 million of substandard loans and $1.5 million of doubtful loans. This compares to $9.2 million of substandard loans and $1.6 million doubtful loans as of December 31, 2018. Impaired loans Impaired loans include loans the Bank will not be able to collect all amounts due in accordance with the terms of the loan agreement. Impaired loans include non-accrual loans and loans that have been modified in a troubled debt restructuring. All loans are individually reviewed for impairment. The following table summarizes impaired loans and related allowances as of and for the years ended December 31, 2019 and 2018 (in thousands): 2019 Unpaid Principal Recorded Investment Related Allowance Average Recorded Balance Interest Income Recognized (12 months) Impaired loans with an allowance recorded: Commercial and industrial: Business loans Agriculture Owner-occupied commercial real estate Commercial real estate SBA Consumer: Automobile Home equity 1st mortgage Other Land and land development Construction Loans held for sale Total impaired loans with an allowance recorded Impaired loans without an allowance recorded: Commercial and industrial: Business loans Agriculture Owner-occupied commercial real estate Commercial real estate $ $ SBA Consumer: Automobile Home equity 1st mortgage Other Land and land development Construction Loans held for sale $ 2,004 $ 1,417 $ 497 $ 1,429 $ - - 1,762 121 - - - - - - - - - 1,448 101 - - - - - - - - - 172 59 - - - - - - - - - 1,476 103 - - - - - - - - - - 75 - - - - - - - - 3,887 $ 2,966 $ 728 $ 3,008 $ 75 248 $ 193 $ - - - 338 18 - - 42 137 - - - - - 279 15 - - 22 5 - - - - - - - - - - - - - - - 728 $ 221 $ - - - 280 16 - - 27 16 - - $ $ 560 3,568 $ $ - - - - - - - - - - - - - 75 Total impaired loans without an allowance recorded TOTAL IMPAIRED LOANS $ $ 783 4,670 $ $ 514 3,480 $ $ BNCCORP, INC. Annual Report 2019 61 Impaired loans with an allowance recorded: Commercial and industrial: Business loans Agriculture Owner-occupied commercial real estate Commercial real estate SBA Consumer: Automobile Home equity 1st mortgage Other Land and land development Construction Loans held for sale Total impaired loans with an allowance recorded Impaired loans without an allowance recorded: Commercial and industrial: Business loans Agriculture Owner-occupied commercial real estate Commercial real estate $ $ SBA Consumer: Automobile Home equity 1st mortgage Other Land and land development Construction Loans held for sale 2018 Unpaid Principal Recorded Investment Related Allowance Average Recorded Balance Interest Income Recognized (12 months) $ 1,996 $ 1,454 $ 246 $ 1,484 $ - - 1,795 143 16 - - - - - - - - 1,496 115 12 - - - - - - - - 73 62 6 - - - - - - - - 1,497 117 15 - - - - - - - - - 76 - - - - - - - - 3,950 $ 3,077 $ 387 $ 3,113 $ 76 1,915 $ 294 $ - - - - 62 - - 45 150 - - - - - - 43 - - 24 28 - - - - - - - - - - - - - - - 387 $ 305 $ 12 - - - - 44 - - 26 40 - - - - - - - - - - - - - $ $ 415 3,528 $ $ 12 88 Total impaired loans without an allowance recorded TOTAL IMPAIRED LOANS $ $ 2,172 6,122 $ $ 389 3,466 $ $ 62 BNCCORP, INC. Annual Report 2019 Troubled Debt Restructuring (TDR) Included in net loans and leases held for investment, are certain loans that have been modified in order to maximize collection of loan balances. If the Company, for legal or economic reasons related to the borrower’s financial difficulties, grants a concession that would not otherwise be considered, compared to the original terms and conditions of the loan, the modified loan is considered a troubled debt restructuring. The table below summarizes the amounts of restructured loans as of December 31 (in thousands): Commercial and industrial: Business loans Agriculture Owner-occupied commercial real estate Commercial real estate SBA Consumer: Automobile Home equity 1st mortgage Other Land and land development Construction Loans held for sale Commercial and industrial: Business loans Agriculture Owner-occupied commercial real estate Commercial real estate SBA Consumer: Automobile Home equity 1st mortgage Other Land and land development Construction Loans held for sale Accrual Non-accrual Total Allowance 2019 $ $ $ - - - 1,448 - - - - - - - - $ 1,417 $ 1,417 $ - - - 380 - - - - - - - - - 1,448 380 - - - - - - - 172 - - 497 59 - - - - - - - 1,448 $ 1,797 $ 3,245 $ 728 Accrual Non-accrual Total Allowance 2018 284 $ 1,454 $ 1,738 $ - - 1,496 - - - - - - - - - - - 115 - - - - - - - - - 1,496 115 - - - - - - - 244 - - 73 63 - - - - - - - $ 1,780 $ 1,569 $ 3,349 $ 380 TDR concessions can include reduction of interest rates, extension of maturity dates, forgiveness of principal and/or interest due, or acceptance of real estate or other assets in full or partial satisfaction of the debt. Loan modifications are not reported as TDR’s after 12 months if the loan was modified at a market rate of interest for comparable risk loans, and the loan is performing in accordance with the terms of the restructured agreement for at least six months. When a loan is modified as a TDR, there may be a direct, material impact on the loan balances, as principal balances may be partially forgiven. For the year ended December 31, 2019, there was one new TDRs with a pre-modification BNCCORP, INC. Annual Report 2019 63 and post modification balance of $279 thousand. For the year ended December 31, 2018, there were three new TDRs with a pre-modification and post modification balance of $1.5 million. Loans that were non-accrual prior to modification remain on non-accrual for at least six months following modification. Non-accrual TDR loans that have performed according to the modified terms for six months may be returned to accruing status. Loans that were accruing prior to modification remain on accrual status after the modification as long as the loan continues to perform under the new terms. The following table indicates the effect on interest income on loans if interest on restructured loans outstanding at year end had been recognized at original contractual rates during the year ended December 31 (in thousands): Interest income that would have been recorded Interest income recorded Effect on interest income on loans 2019 2018 $ $ 187 75 112 $ $ 313 88 225 There were no additional funds committed to borrowers who are in TDR status at December 31, 2019 and December 31, 2018. TDRs are evaluated separately in the Bank’s allowance methodology based on the expected cash flows or collateral values for loans in this status. As of December 31, 2019 and December 31, 2018, the Bank had no restructured loans that were modified in a troubled-debt restructuring within the previous 12 months for which there was a payment default (i.e. 90 days delinquent). NOTE 6. Other Real Estate, net Other real estate (ORE), net includes property acquired through foreclosure, property in judgment and in-substance foreclosures. ORE is carried at fair value less estimated selling costs. Each property is evaluated regularly and the amounts provided to decrease the carrying amount are included in non-interest expense. A summary of the activity related to ORE is presented below for the years ended December 31 (in thousands): Balance, beginning of period Transfers from nonperforming loans Real estate sold Net gains on sale of assets (Provision) reduction Balance, end of period 2019 2018 $ $ - 281 (316) 35 - - $ $ - - - - - - NOTE 7. Premises and Equipment, net Premises and equipment, net consisted of the following at December 31 (in thousands): Land and improvements Buildings and improvements Leasehold improvements Furniture, fixtures, and equipment Total cost Less accumulated depreciation and amortization Net premises and equipment 2019 2018 $ 2,853 17,735 436 9,632 30,656 (14,255) 16,401 $ 2,853 17,534 543 9,825 30,755 (13,994) 16,761 $ $ 64 BNCCORP, INC. Annual Report 2019 Depreciation and amortization expense totaled $1.452 million and $1.545 million for the years ended December 31, 2019 and 2018, respectively. NOTE 8. Leases The Company has operating leases, primarily for office space, that expire over the next eight years. These leases generally contain renewal options for periods ranging from one to five years. The Company has evaluated each individual lease to determine if exercising the renewal option was probable and considered the renewal into determining the lease term and associated payments. The Company’s leases generally do not include termination options for either party to the lease or restrictive financial or other covenants. Payments due under the lease contracts include both fixed and variable payments. The variable payments are for the Company’s proportionate share of the building’s property taxes, insurance, and common area maintenance. As most of the Company’s leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at the lease commencement date in determining the present value of the lease payments. The components of lease cost for the years ended December 31 were as follows (in thousands): Operating lease costs Variable lease costs Short-term lease costs Total lease costs 2019 969 45 17 1,031 $ $ Rental expense for operating leases for the year ending December 31, 2018 amounted to $1.3 million. Amounts reported in the consolidated balance sheet as of December 31, 2019 are as follows (in thousands): Operating lease right of use asset Operating lease liabilities As of December 31, 2019 $ 2,638 2,822 Other information related to leases as of December 31 was as follows (dollars are in thousands): Cash paid for amounts included in the measurement of lease liabilities ROU Assets obtained in exchange for lease obligations Reductions to ROU assets resulting from reduction in lease obligations 2019 $ 987 175 1,034 Weighted Average remaining lease term Weighted Average discount rate As of December 31, 2019 4.94 years 6.00% BNCCORP, INC. Annual Report 2019 65 Maturities of lease liabilities under non-cancellable leases as of December 31, 2019 are as follows (in thousands): 2020 2021 2022 2023 2024 Thereafter Total lease liabilities NOTE 9. Deposits Operating Leases 670 506 495 474 357 320 2,822 $ $ The scheduled maturities of time deposits as of December 31, 2019 are as follows (in thousands): $ 2020 2021 2022 2023 2024 Thereafter 130,236 27,882 5,242 3,726 2,090 189 $ 169,365 At December 31, 2019 and 2018, the Bank had no time deposits that had been acquired through a traditional broker channel. The Company had $108.0 million and $101.3 million of interest-bearing deposits that meet the regulatory definition of a brokered deposit as of December 31, 2019 and 2018, respectively. At December 31, 2019 and 2018, the Bank had $45.7 million and $34.2 million, respectively, in time deposits greater than $250 thousand. The following table shows a summary of interest expense by product type as of December 31 (in thousands): Savings Interest checking Money market Time deposits 2019 2018 $ $ 24 1,288 3,124 3,104 7,540 $ $ 19 160 2,279 2,303 4,761 Deposits Received from Related Parties Note 24 to these consolidated financial statements includes information relating to deposits received from executive officers, directors, principal shareholders and associates of such persons. 66 BNCCORP, INC. Annual Report 2019 NOTE 10. Short-Term Borrowings The following table sets forth selected information for short-term borrowings (borrowings with an original maturity of less than one year) as of December 31 (in thousands): Federal reserve borrowings Repurchase agreements with customers, renewable daily, interest payable monthly, rates ranging from 0.20% to 0.40% and 0.20% to 1.50%, respectively, secured by U.S. Treasury securities and general obligations of municipalities 2019 2018 $ $ - 4,565 4,565 $ $ - 11,494 11,494 The weighted average interest rate on short-term borrowings outstanding as of December 31, 2019 and 2018 was 0.21% and 0.84%, respectively. Customer repurchase agreements are used by the Bank to acquire funds from customers where the customers are required, or desire, to have their funds supported by collateral consisting of U.S. government, U.S. government agency or other types of securities. The repurchase agreement is a promise to sell these securities to a customer at a certain price and repurchase them at a future date at that same price plus interest accrued at an agreed upon rate. The Bank uses customer repurchase agreements in its liquidity plan as well as an accommodation to customers. At December 31, 2019, the $4.6 million of securities sold under repurchase agreements, with a weighted average interest rate of 0.21%, were collateralized by U.S. Treasury securities and collateralized mortgage obligations issued by FNMA having a fair value of $7.9 million and unamortized principal balances of $7.4 million. At December 31, 2018, the $11.5 million of securities sold under repurchase agreements, with a weighted average interest rate of 0.84%, were collateralized by U.S. Treasury securities having a fair value of $32.0 million and unamortized principal balances of $32.7 million. NOTE 11. Federal Home Loan Bank Advances As of December 31, 2019, the Bank had $17.0 million FHLB advances outstanding. At December 31, 2019, the Bank had loans with unamortized principal balances of approximately $171.6 million and securities with unamortized principal balances of approximately $46.8 million pledged as collateral to the FHLB. As of December 31, 2018, the Bank had no FHLB advances outstanding. At December 31, 2018, the Bank had loans with unamortized principal balances of approximately $170.3 million and securities with unamortized principal balances of approximately $32.9 million pledged as collateral to the FHLB. As of December 31, 2019, the Bank has the ability to draw advances up to approximately $131.0 million based upon the aggregate collateral that is currently pledged, subject to a requirement to purchase additional FHLB stock, based upon collateral pledged. NOTE 12. Long-Term Borrowings The following table sets forth selected information for long-term borrowings (borrowings with an original maturity of greater than one year) as of December 31 (in thousands): Note payable, interest due quarterly, beginning on April 1, 2016 ending October 19, 2025, interest payable at a fixed rate of 6.35% $ - $ 10,000 The Company redeemed the long-term borrowing of $10.0 million in December of 2019. The long-term borrowing was subordinated debt that had qualified as Tier 2 capital for the Company. 2019 2018 BNCCORP, INC. Annual Report 2019 67 NOTE 13. Other Borrowings The following table presents selected information regarding other borrowings at December 31 (in thousands): Unsecured Borrowing Lines: 2019 BNC National Bank Lines (1) $ 34,500 $ - $ 34,500 Line Outstanding Available Secured Borrowing Lines: BNC National Bank Line $ 2,271 $ 2,157 $ BNC Line 102,955 10,000 $ - - 2,157 10,000 Collateral Pledged Line Outstanding Available Total 12,157 (1) The unsecured BNC National Bank Lines consists of three separate lines with three institutions in individual amounts of $12.5 million, $10 105,226 12,157 $ $ $ $ - million, and $12 million. At December 31, 2019, the pledged collateral for the secured BNC National Bank Line was comprised of commercial real estate loans and the pledged collateral for the secured BNC Line is the common stock of BNC National Bank. Unsecured Borrowing Lines: 2018 BNC National Bank Lines (1) $ 34,500 $ - $ 34,500 Line Outstanding Available Secured Borrowing Lines: BNC National Bank Line $ 2,377 $ 2,162 $ BNC Line 92,633 10,000 $ - - 2,162 10,000 Collateral Pledged Line Outstanding Available Total 12,162 (1) The unsecured BNC National Bank Lines consists of three separate lines with three institutions in individual amounts of $12.5 million, $10 95,010 12,162 $ $ $ $ - million, and $12 million. At December 31, 2018, the pledged collateral for the secured BNC National Bank Line was comprised of commercial real estate loans and the pledged collateral for the secured BNC Line is the common stock of BNC National Bank. 68 BNCCORP, INC. Annual Report 2019 NOTE 14. Guaranteed Preferred Beneficial Interests in Company’s Subordinated Debentures In July 2007, BNC issued $15.0 million of floating rate subordinated debentures. The interest rate paid on the securities is equal to the three month LIBOR plus 1.40%. The interest rate at December 31, 2019 and 2018 was 3.50% and 3.80%, respectively. The subordinated debentures mature on October 1, 2037. The subordinated debentures may be redeemed at par and the corresponding debentures may be prepaid at the option of BNC, subject to approval by the Federal Reserve Board. The payment of interest and ultimate redemption of these debentures is primarily dependent upon the ability of the Bank to transfer funds to BNC in the form of cash dividends, which are subject to regulatory restrictions disclosed in Note 15 to these consolidated financial statements. Pursuant to the subordinated debentures agreement, BNC may defer the payment of interest on the subordinated debentures for up to 20 consecutive quarterly periods. BNC did not defer the payment of interest on the subordinated debentures during the years ended December 31, 2019 and 2018. BNC fully and unconditionally guarantees the Company’s subordinated debentures. NOTE 15. Stockholders’ Equity Regulatory restrictions exist regarding the ability of the Bank to transfer funds to BNCCORP in the form of cash dividends. Approval of the Office of the Comptroller of the Currency (OCC), the Bank’s principal regulator, is required for the Bank to pay dividends to BNCCORP in excess of the Bank’s net profits from the current year plus retained net profits for the preceding two years. On May 30, 2001, BNCCORP’s Board of Directors adopted a Rights Agreement intended to protect stockholder interests in the event BNCCORP becomes the subject of a takeover initiative. The Rights Agreement expired on April 15, 2019. NOTE 16. Regulatory Capital and Current Operating Environment BNC and BNC Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet capital requirements mandated by regulators can trigger certain mandatory and discretionary actions by regulators. Such actions, if undertaken, could have a direct material adverse effect on the Company’s financial condition and results of operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, BNC and BNC Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Regulators continue to impose capital requirements that are specific to individual institutions. The requirements are generally above the statutory ratios. At December 31, 2019, the capital ratios exceeded all regulatory capital thresholds and maintained sufficient capital conservation buffers to avoid limitations on certain types of capital distributions. BNCCORP, INC. Annual Report 2019 69 The capital amounts and ratios presented below for December 31, 2019 and December 31, 2018 were as follows (dollars in thousands): Actual For Capital Adequacy Purposes To be Well Capitalized Amount in Excess of Well Capitalized Amount Ratio Amount Ratio Amount Ratio Amount Ratio 2019 Total Risk Based Capital: Consolidated $ 117,817 17.13 % $ 55,023 ≥8.0 % $ N/A N/A % $ N/A BNC National Bank 109,044 15.88 54,940 ≥8.0 68,675 10.0 40,369 Tier 1 Risk Based Capital: Consolidated BNC National Bank Common Equity Tier 1 Risk Based Capital: Consolidated BNC National Bank Tier 1 Leverage Capital: Consolidated BNC National Bank Tangible Common Equity (to total assets): (a) 109,675 100,902 15.95 14.69 84,669 100,902 109,675 100,902 13.76 14.69 10.65 9.81 Consolidated BNC National Bank 96,159 102,837 9.95 10.65 2018 Total Risk Based Capital: 41,268 41,205 30,951 30,904 41,205 41,142 N/A N/A ≥6.0 ≥6.0 ≥4.5 ≥4.5 ≥4.0 ≥4.0 N/A N/A N/A 54,940 N/A 44,639 N/A 51,427 N/A N/A N/A 8.0 N/A 6.5 N/A 5.0 N/A N/A N/A 45,962 N/A 56,263 N/A 49,475 N/A N/A Consolidated $ 116,734 20.26 % $ 46,091 ≥8.00 % $ N/A N/A % $ N/A BNC National Bank 106,154 18.44 46,053 ≥8.00 57,566 10.00 48,588 N/A% 5.88 N/A 6.69 N/A 8.19 N/A 4.81 N/A N/A N/A% 8.44 Tier 1 Risk Based Capital: Consolidated BNC National Bank Common Equity Tier 1 Risk Based Capital: Consolidated BNC National Bank Tier 1 Leverage Capital: Consolidated BNC National Bank Tangible Common Equity (to total assets): (a) Consolidated BNC National Bank 99,527 98,952 17.28 17.19 34,568 34,540 ≥6.00 ≥6.00 84,518 98,952 99,527 98,952 77,611 92,490 14.67 17.19 9.97 9.92 7.99 9.53 25,926 25,905 39,930 39,890 ≥4.50 ≥4.50 ≥4.00 ≥4.00 N/A N/A N/A N/A N/A 46,053 N/A 37,418 N/A 49,862 N/A N/A N/A 8.00 N/A 6.50 N/A 5.00 N/A N/A N/A 52,899 N/A 9.19 N/A 61,534 N/A 49,090 N/A N/A N/A 10.69 N/A 4.92 N/A N/A (a) Tangible common equity is calculated by dividing common equity, less intangible assets, by total period end assets. The most recent notifications from the OCC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. Management believes the Bank remains well capitalized through the date for which subsequent events have been evaluated. 70 BNCCORP, INC. Annual Report 2019 NOTE 17. Revenue from Contracts with Customers The following table disaggregates non-interest income subject to ASC 606 (in thousands): Service charges on deposits Bankcard fees Bank charges and service fees not within scope of ASC 606 Total bank charges and service fees Wealth management revenue Wealth management revenue not within the scope of ASC 606 Total wealth management revenues Other Other not within the scope of ASC 606 (a) Total other Other non-interest income not within the scope of ASC 606 (a) Total non-interest income 2019 2018 $ $ $ 760 998 856 2,614 1,708 27 1,735 49 972 1,021 23,761 29,131 $ 727 1,031 929 2,687 1,810 - 1,810 53 1,955 2,008 12,512 19,017 (a) This revenue is not within the scope of ASC 606, and includes fees related to mortgage banking operations, gains on sale of loans, net gains (losses) on sale of securities, revenue from investments in SBIC, and various other transactions. The Company had no material contract assets or remaining performance obligations as of December 31, 2019. Total receivables from revenue recognized under the scope of ASC 606 were $460 thousand and $417 thousand as of December 31, 2019 and December 31, 2018, respectively. These receivables are included as part of the Other assets line on the Company’s Consolidated Balance Sheets. NOTE 18. Fair Value Measurements The following table summarizes the financial assets and liabilities of the Company for which fair values are determined on a recurring basis as of December 31 (in thousands): Carrying Value at December 31, 2019 Twelve Months Ended December 31, 2019 Total Level 1 Level 2 Level 3 Total gains/(losses) ASSETS Investment securities available for sale Loans held for sale Commitments to originate mortgage loans Total assets at fair value LIABILITIES Commitments to sell mortgage loans Mortgage banking short positions Total liabilities at fair value $ $ $ $ 265,278 137,114 4,358 406,750 21 299 320 $ $ $ $ 4,994 - - 4,994 - - - $ $ $ $ 260,284 137,114 4,358 401,756 21 299 320 $ $ $ $ - - - - - - - $ $ $ $ (1,296) 2,844 2,051 3,599 128 (89) 39 BNCCORP, INC. Annual Report 2019 71 Carrying Value at December 31, 2018 Twelve Months Ended December 31, 2018 Total Level 1 Level 2 Level 3 Total gains/(losses) ASSETS Investment securities available for sale Loans held for sale Commitments to originate mortgage loans Total assets at fair value LIABILITIES Commitments to sell mortgage loans Mortgage banking short positions Total liabilities at fair value $ $ $ $ 411,509 22,788 1,479 435,776 148 210 358 $ $ $ $ 58,794 - - 58,794 - - - $ $ $ $ 352,715 22,788 1,479 376,982 148 210 358 $ $ $ $ - - - - - - - $ $ $ $ 2,293 (505) 71 1,859 (198) (106) (304) The Company sells short positions in mortgage-backed securities to manage interest rate risk on the loans committed for mandatory delivery. The commitments to originate and sell mortgage banking loans and the short positions are derivatives and are recorded at fair value. For the periods presented, U.S. Treasury Securities were considered to be Level 1 while all other assets and liabilities recorded at fair value were considered to be Level 2. There were no transfers into or out of the respective levels during the periods presented. The Company may also be required from time to time to measure certain other assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These adjustments to fair value usually result from the application of the lower of cost or market accounting or write-down of individual assets. For assets measured at fair value on a nonrecurring basis the following table provides the level of valuation assumptions used to determine the carrying value at December 31 (in thousands): Impaired loans(1) Other real estate(2) Total Impaired loans(1) Other real estate(2) Total Total Level 1 $ $ $ $ 2,752 - 2,752 Total 3,079 - 3,079 $ $ $ $ Level 1 2019 Level 2 - - - 2018 Level 2 3,079 - 3,079 $ $ $ $ - - - - - - $ $ $ $ Level 3 Total gains/(losses) 2,752 - 2,752 $ $ (473) 35 (438) Level 3 Total gains/(losses) - - - $ $ 36 - 36 (1) The carrying value represents the book value less allocated reserves. The gain or loss reported is the change in the reserve balances allocated on individual impaired loans in addition to the actual write-downs for the period presented. (2) The carrying value represents the fair value of the collateral less estimated selling costs and is based upon appraised values. The gain or loss reported is a combination of gains and/or losses on sales of other real estate and provisions for other real estate losses. While the overall loan portfolio is not carried at fair value, reserves are allocated, on certain loans, to reflect fair value based on the external appraised value of the underlying collateral, less anticipated costs to sell, or through present value of future cash flow models for impaired loans that are not collateral dependent. The external appraisals are generally based on a sales, income, or cost approach, which are then adjusted for the unique characteristics of the property being valued. The valuation of impaired loans are reviewed on a quarterly basis. Because many of these inputs are not observable, the measurements are classified as Level 3. 72 BNCCORP, INC. Annual Report 2019 As of December 31, 2018, impaired loans were considered to be Level 2. During the first quarter of 2019, the Company transferred impaired loans from Level 2 to Level 3. NOTE 19. Fair Value of Financial Instruments The estimated fair values of the Company’s financial instruments are as follows as of December 31 (in thousands): Assets: Cash and cash equivalents Investment securities available for sale Investment securities available for sale Federal Reserve Bank and Federal Home Loan Bank stock Loans held for sale-mortgage banking Commitments to originate mortgage loans Gross Loans and leases held for investment Gross Loans and leases held for investment Accrued interest receivable Liabilities and Stockholders’ Equity: Deposits, noninterest-bearing Deposits, interest-bearing Borrowings and advances Accrued interest payable Accrued expenses Commitments to sell mortgage loans Mortgage banking short positions Guaranteed preferred beneficial interests in Company’s subordinated debentures Financial instruments with off-balance- sheet risk: Commitments to extend credit Standby and commercial letters of credit Level in Fair Value Measurement Hierarchy December 31, 2019 December 31, 2018 Carrying Amount Fair Value Carrying Amount Fair Value Level 1 Level 1 Level 2 Level 2 Level 2 Level 2 Level 2 Level 3 Level 2 Level 2 Level 2 Level 2 Level 2 Level 2 Level 2 Level 2 $ 10,523 $ 10,523 $ 4,994 260,284 3,651 137,114 4,994 260,284 3,651 137,114 4,358 4,358 25,185 58,794 352,715 2,941 22,788 1,479 $ 25,185 58,794 352,715 2,941 22,788 1,479 504,717 505,156 467,969 463,780 3,480 3,681 2,752 3,681 - 5,079 - 5,079 $ 932,802 $ 932,513 $ 936,950 $ 932,761 $ 136,313 684,234 21,565 1,685 7,580 21 299 $ 136,313 684,215 21,565 1,685 7,580 21 299 $ 157,663 690,942 21,494 1,277 5,700 148 210 $ 157,663 689,213 21,467 1,277 5,700 148 210 Level 2 15,006 10,834 15,009 10,208 $ 866,703 $ 862,512 $ 892,443 $ 885,886 Level 2 Level 2 $ $ - - $ $ 225 8 $ $ - - $ $ 169 9 The Company discloses the estimated fair value of financial instruments as it is useful to the reader of financial statements. Fair value estimates are subjective in nature, involving uncertainties and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. BNCCORP, INC. Annual Report 2019 73 NOTE 20. Financial Instruments with Off-Balance-Sheet Risk In the normal course of business, the Company is a party to various financial instruments with off-balance-sheet risk, primarily to meet the needs of customers as well as to manage interest rate risk. These instruments, which are issued by the Company for purposes other than trading, carry varying degrees of credit, interest rate or liquidity risk in excess of the amounts reflected in the consolidated balance sheets. Commitments to Extend Credit Commitments to extend credit are agreements to lend to a customer, which are binding, provided there is no violation of any condition in the contract, and generally have fixed expiration dates or other termination clauses. The contractual amount represents the Bank’s exposure to credit losses in the event of default by the borrower. At December 31, 2019, based on current information, no losses were anticipated as a result of these commitments. The Bank manages this credit risk by using the same credit policies it applies to loans. Collateral is obtained to secure commitments based on management’s credit assessment of the borrower. The collateral may include marketable securities, receivables, inventory, equipment or real estate. Since the Bank expects many of the commitments to expire without being drawn, total commitment amounts do not necessarily represent the Bank’s future liquidity requirements related to such commitments. In the mortgage banking operations, the Bank commits to extend credit for purposes of originating residential loans. The Bank underwrites these commitments to determine whether each loan meets criteria established by the secondary market for residential loans. See Note 1 and 18 to these consolidated financial statements for more information on financial instruments and derivatives related to mortgage banking operations. Standby and Commercial Letters of Credit Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Commercial letters of credit are issued on behalf of customers to ensure payment or collection in connection with trade transactions. In the event of a customer’s nonperformance, the Bank’s credit loss exposure is up to the letter’s contractual amount. At December 31, 2019, based on current information, no losses were anticipated as a result of these commitments. Management assesses the borrower’s creditworthiness to determine the necessary collateral, which may include marketable securities, real estate, accounts receivable and inventory. Since the conditions requiring the Bank to fund letters of credit may not occur, the Bank expects the liquidity requirements related to such letters of credit to be less than the total outstanding commitments. The contractual amounts of these financial instruments were as follows as of December 31 (in thousands): 2019 2018 Fixed Rate Variable Rate Fixed Rate Variable Rate Commitments to extend credit Standby and commercial letters of credit $ 15,872 85 $ 79,941 653 $ 10,407 18 $ 67,894 877 In addition to the amounts in the table above, mortgage banking commitments to fund loans totaled $204.9 million at December 31, 2019 and $70.8 million at December 31, 2018. Mortgage banking commitments to sell loans totaled $338.9 million at December 31, 2019 and $93.3 million at December 31, 2018. Performance and Financial Standby Letters of Credit As of December 31, 2019 and 2018, the Bank had outstanding $0 and $13 thousand, respectively, of performance standby letters of credit and $3.4 million and $3.7 million, respectively, of financial standby letters of credit. Performance standby letters of credit are irrevocable obligations to the beneficiary on the part of the Bank to make payment on account in an event of default by the account party in the performance of a nonfinancial or commercial obligation. Financial standby letters of credit are irrevocable obligations to the beneficiary on the part of the Bank to repay money for the account of the account party or to make payment on account of any indebtedness undertaken by the account party, in the event that the account party fails to fulfill its obligation to the beneficiary. Under these arrangements, the Bank could, in the event of the account party’s nonperformance, be required to pay a maximum of the amount of issued letters of credit. The Bank has recourse against the account party up to and including the 74 BNCCORP, INC. Annual Report 2019 amount of the performance standby letter of credit. The Bank evaluates each account party’s creditworthiness on a case-by-case basis and the amount of collateral obtained varies and is based on management’s credit evaluation of the account party. Mortgage Banking Obligations Through its mortgage banking operations, the Company originates and sells residential mortgage loans servicing released to third parties. These loans are sold without recourse to the Company. Although the Company sells mortgage banking loans without recourse, industry standards require standard representations and warranties which require sellers to reimburse investors for economic losses if loans default or prepay after the sale. Repurchase risk is also evident within the mortgage banking industry as continued disputes arise between lenders and investors. Such requests for repurchase are commonly due to faulty representation and generally emerge at varied timeframes subsequent to the original sale of the loan. To estimate the contingent obligation, the Company tracks historical reimbursements and calculates the ratio of reimbursement to loan production volumes. Using reimbursement ratios and recent production levels, the Company estimates the future reimbursement amounts and records the estimated obligation. The following is a summary of activity related to mortgage banking reimbursement obligations at December 31 (in thousands): Balance, beginning of period Provision Write offs, net Balance, end of period 2019 2018 982 200 (276) 906 $ $ 1,103 - (121) 982 $ $ NOTE 21. Commitments and Contingencies Small Business Investment Companies (SBIC) The Bank has made investments in the Small Business Administration’s SBIC program to enhance small business access to venture capital. At December 31, 2019, the Bank may be required to fund $2.1 million of additional capital calls related to its SBIC investments. Legal Proceedings From time to time, the Company may be a party to legal proceedings arising from lending, deposit operations or other activities. While the Company is not aware of any such actions or allegations that should reasonably give rise to any material adverse effect, it is possible that the Company could be subject to such a claim in an amount that could be material. Based upon a review with legal counsel, the Company believes that the ultimate disposition of any such litigation will not have a material effect on the Company’s financial condition, results of operations or cash flows. NOTE 22. Income Taxes Income tax expense (benefit) consists of the following for the years ended December 31 (in thousands): Current: Federal State Deferred: Federal State Total 2019 2018 $ $ 2,398 619 3,017 (75) (21) (96) 2,921 $ $ 1,281 345 1,626 (72) (16) (88) 1,538 BNCCORP, INC. Annual Report 2019 75 The reconciliation between income tax expense computed by applying the statutory federal income tax rate of 21.0% are as follows for the years ended December 31 (in thousands): Statutory federal income tax expense $ 2,763 $ State income taxes, net of federal income tax 2019 2018 benefit Tax-exempt interest income Tax-exempt life insurance Other, net Total $ 460 (170) (92) (40) 2,921 $ 1,759 260 (325) (91) (65) 1,538 Temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that result in significant portions of the Company’s deferred tax assets and liabilities are as follows as of December 31 (in thousands): Deferred tax assets: Loans, primarily due to credit losses Compensation Unrealized loss on investment securities available for sale Acquired intangibles Net operating loss carryforwards Other Deferred tax assets Deferred tax liabilities: Unrealized gain on investment securities available for sale Discount accretion on securities Premises and equipment Other Deferred tax liabilities Valuation allowance Net deferred tax assets 2019 2018 2,137 501 - 122 17 318 3,095 121 68 460 312 961 2,134 (14) 2,120 $ $ 1,975 446 2,624 122 19 174 5,360 - 47 395 134 576 4,784 (14) 4,770 $ $ Subject to certain limiting statutes, the Company is able to carry forward state tax net operating losses aggregating $389 thousand as of December 31, 2019. The state net operating losses expire between 2024 and 2031. Tax years ended December 31, 2016 through 2019 remain open to federal examination. Tax years ended December 31, 2015 through 2019 remain open to state examinations. The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by taxing authorities, based upon the technical merits of the position. The tax benefit recognized in the consolidated financial statements from such a position would be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Also, interest and penalties expense would be recognized on the full amount of deferred benefits for uncertain tax positions. The Company’s policy is to include interest and penalties related to unrecognized tax benefits in income tax expense within the consolidated statements of income. At December 31, 2019 and 2018, the Company did not have any uncertain tax positions. 76 BNCCORP, INC. Annual Report 2019 NOTE 23. Earnings Per Share The following table shows the amounts used in computing per share results (in thousands, except share and per share data): Denominator for basic earnings per share: Average common shares outstanding Dilutive effect of share-based compensation Denominator for diluted earnings per share Numerator (in thousands): Net income Basic earnings per common share Diluted earnings per common share NOTE 24. Related-Party Transactions 2019 2018 3,526,096 31,489 3,557,585 $ $ $ 10,235 2.90 2.88 $ $ $ 3,487,846 51,909 3,539,755 6,836 1.96 1.93 The Bank has entered into transactions with related parties, such as opening deposit accounts for and extending credit to employees of the Company. The related party transactions have been made under terms substantially the same as those offered by the Bank to unrelated parties. In the normal course of business, loans are granted to, and deposits are received from, executive officers, directors, principal stockholders and associates of such persons. The aggregate dollar amount of these loans was $734 thousand and $897 thousand at December 31, 2019 and 2018, respectively. Advances of loans to related parties in 2019 and 2018 totaled $610 thousand and $247 thousand, respectively. Loan pay downs and other reductions by related parties in 2019 and 2018 were $773 thousand and $475 thousand, respectively. Commitments to extend credit to related parties decreased to $202 thousand at December 31, 2019 from $289 thousand at December 31, 2018. The total amount of deposits received from these parties was $1.1 million at December 31, 2019 and $1.0 million at December 31, 2018. Loans to, and deposits received from, these parties were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than the normal risk of collection. The Federal Reserve Act limits amounts of, and requires collateral on, extensions of credit by the Bank to BNCCORP, and with certain exceptions, its non-bank affiliates. There are also restrictions on the amounts of investment by the Bank in stocks and other subsidiaries of BNCCORP and such affiliates and restrictions on the acceptance of their securities as collateral for loans by the Bank. As of December 31, 2019, BNCCORP and its affiliates were in compliance with these requirements. NOTE 25. Benefit Plans BNCCORP has a qualified 401(k) savings plan covering all employees of BNCCORP and subsidiaries who meet specified age and service requirements. Under the plan, eligible employees may elect to defer up to 75% of compensation each year not to exceed the dollar limits set by law. At their discretion, BNCCORP and its subsidiaries may provide matching contributions to the plan. In 2019 and 2018, BNCCORP and subsidiaries made matching contributions of up to 50% of eligible employee deferrals up to a maximum employer contribution of 5% of employee compensation. Generally, all participant contributions and earnings are fully and immediately vested. The Company makes its matching contribution during the first calendar quarter following the last day of each calendar year and an employee must be employed by the Company on the last day of the calendar year in order to receive the current year’s employer matching contribution. The anticipated matching contribution is expensed monthly over the course of the calendar year based on employee contributions made throughout the year. The Company made matching contributions of $779,000 and $646,000 for 2019 and 2018, respectively. Under the investment options BNCCORP, INC. Annual Report 2019 77 available under the 401(k) savings plan, prior to January 28, 2008, employees could elect to invest their salary deferrals in BNCCORP common stock. At December 31, 2019, the assets in the plan totaled $32.6 million and included $876,000 (25,000 shares) invested in BNCCORP common stock. At December 31, 2018, the assets in the plan totaled $25.4 million and included $544,000 (27,000 shares) invested in BNCCORP common stock. On January 28, 2008, the Company voluntarily delisted from the NASDAQ Global Market and deregistered its common stock under the Securities Exchange Act of 1934 (as amended). As a result, the participants are prohibited from making new investments of the Company’s common stock in the plan. During 2015, the Company adopted a non-qualified deferred compensation plan for the benefit of select employees. The plan structure permits the Company to make discretionary awards into an in-service account or a retirement account of a plan participant established under the plan. BNC recognizes the expense for discretionary awards in the period it commits to such awards. Additionally, plan participants may defer some or all of their annual cash incentive awards into their in-service accounts. Company discretionary awards to the participant’s in-service account are generally vested 50% upon initial participation with the remainder vesting ratably over 5 years. A participant’s retirement account generally vests 50% upon an initial contribution and ratably thereafter over 10 years. Participants may allocate their in-service account balance among a fixed number of investment options. The value of the payout from the in-service account will depend on the performance of such investment options. Company discretionary awards into a participant’s retirement account are denominated in shares of BNC common stock and upon retirement, the plan participant will receive the number of shares of BNC common stock credited to the participant’s retirement account at that time. A separate Rabbi Trust has been established by the Company to offset the change in value of this liability. Assets in the trust offsetting in-service liabilities are recorded in other assets. BNC common stock held in the trust related to the Company’s retirement account obligation is recorded in treasury stock and equates to 27,192 shares as of December 31, 2019 and December 31, 2018. As of December 31, 2019, the plan obligation totaled $1.0 million and $985 thousand as of December 31, 2018. In December of 2015, the Company adopted a non-qualified deferred compensation plan for directors of BNCCORP. Effective with 2016 service, a director may voluntarily make contributions of earned director compensation to a deferred account that is ultimately payable with BNC common stock at the time of separation from service with the Company. The deferred shares of BNC common stock were 9,289 shares and 8,298 shares as of December 31, 2019 and 2018, respectively. NOTE 26. Share-Based Compensation The Company has four share-based plans for certain key employees and directors whereby shares of BNC common stock have been reserved for awards in the form of stock options, restricted stock, or common stock equivalent awards. Pursuant to each plan, the compensation committee may grant options at prices equal to the fair value of BNC common stock at the grant date. The Company generally issues shares held in treasury when options are exercised and restricted stock is granted. Total shares in plan and total shares available as of December 31, 2019 are as follows: Total Shares in Plan Total Shares Available 1995 250,000 45,951 2002 125,000 - 2010 250,000 250,000 2015 50,000 38,425 Total 675,000 334,376 The Company recognized share-based compensation expense of $20,000 and $21,000 for the years ended December 31, 2019 and 2018, respectively, related to restricted stock. The tax benefits associated with share-based compensation was approximately $5,000 for the year ended December 31, 2019 and was approximately $7,000 for the year ended December 31, 2018. At December 31, 2019, the Company had $40,000 of unamortized restricted stock compensation, which is expected to be recognized over a period of two years. Restricted shares of stock granted have vesting and amortization periods of four years. 78 BNCCORP, INC. Annual Report 2019 Following is a summary of restricted stock activities for the years ended December 31: Non-vested, beginning of year Granted Vested Forfeited Non-vested, end of year Number Restricted Stock Shares 2,100 - (700) - 1,400 2019 $ Weighted Average Grant Date Fair Value 28.78 - 28.78 - 28.78 Number Restricted Stock Shares 3,467 - (1,367) - 2,100 2018 $ Weighted Average Grant Date Fair Value 26.45 - 22.86 - 28.78 Following is a summary of vested stock options and options expected to vest as of December 31, 2019: Number Weighted-average exercise price Weighted-average remaining contractual term Stock Options Outstanding 21,000 $3.00 0.20 years Stock Options Currently Exercisable 21,000 $3.00 0.20 years Stock Options Vested and Expected to Vest 21,000 $3.00 0.20 years Following is a summary of stock option transactions for the years ended December 31: Outstanding, beginning of year Granted Exercised Forfeited Outstanding, end of year Exercisable, end of year 2019 2018 Options to Purchase Shares 42,600 - (21,600) - 21,000 21,000 Weighted Average Exercise Price $ 3.00 - 3.00 - 3.00 3.00 Options to Purchase Shares 68,600 - (26,000) - 42,600 42,600 Weighted Average Exercise Price $ 3.00 - 3.00 - 3.00 3.00 The total intrinsic value of options exercised during the years ended December 31, 2019 and 2018 was $581 thousand and $585 thousand, respectively. The aggregate intrinsic value of options exercisable as of December 31, 2019 was $665 thousand. BNCCORP, INC. Annual Report 2019 79 NOTE 27. Condensed Financial Information-Parent Company Only Condensed financial information of BNCCORP, INC. on a parent company only basis is as follows: Parent Company Only Condensed Balance Sheets As of December 31 (In thousands, except per share data) Assets: Cash and cash equivalents Investment in subsidiaries Receivable from subsidiaries Other Total assets Liabilities and stockholders’ equity: Subordinated debentures Long-term borrowings Payable to subsidiaries Accrued expenses and other liabilities Total liabilities Common stock, $.01 par value – Authorized 11,300,000 shares; 3,514,770 and 3,493,298 shares issued and outstanding Capital surplus – common stock Retained earnings Treasury stock (153,883 and 175,355 shares, respectively) Accumulated other comprehensive (loss) income, net Total stockholders’ equity Total liabilities and stockholders’ equity 2019 2018 6,736 103,421 1,674 1,015 112,846 15,006 - 70 1,492 16,568 35 25,831 71,057 (2,115) 1,470 96,278 112,846 $ $ $ $ 10,442 93,098 481 437 104,458 15,009 10,000 69 1,627 26,705 35 25,990 61,042 (2,386) (6,928) 77,753 104,458 $ $ $ $ 80 BNCCORP, INC. Annual Report 2019 Parent Company Only Condensed Statements of Income For the Years Ended December 31 (In thousands) 2019 2018 $ 2,034 $ 1,990 Income: Management fee income Interest Other Total income Expenses: Interest Salaries and benefits Legal and other professional Other Total expenses Loss before income tax benefit and equity in earnings of subsidiaries Income tax benefit Loss before equity in earnings of subsidiaries Equity in earnings of subsidiaries Net income $ 37 18 2,089 1,222 1,453 1,157 789 4,621 (2,532) 621 (1,911) 12,146 10,235 $ 24 4 2,018 1,195 1,345 678 718 3,936 (1,918) 476 (1,442) 8,278 6,836 BNCCORP, INC. Annual Report 2019 81 Parent Company Only Condensed Statements of Cash Flows For the Years Ended December 31 (In thousands) Operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities - Equity in earnings of subsidiaries Dividend paid by subsidiaries Share-based compensation Change in other assets Change in other liabilities Net cash provided by operating activities Financing activities: Decrease in long-term borrowings Net cash used in financing activities Net (decrease) increase in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year Supplemental cash flow information: Interest paid Income taxes paid 2019 2018 $ 10,235 $ 6,836 (12,146) 10,000 112 (1,772) (135) 6,294 (10,000) (10,000) (3,706) 10,442 6,736 1,392 3,043 $ $ $ $ $ $ (8,278) 2,500 273 2,325 236 3,892 - - 3,892 6,550 10,442 1,151 990 82 BNCCORP, INC. Annual Report 2019 NOTE 28. Subsequent Events Subsequent to year-end, the World Health Organization declared the spread of Coronavirus Disease (COVID-19) a worldwide pandemic. The COVID-19 pandemic is having significant effects on global markets, supply chains, businesses, and communities. Specific to the Company, COVID-19 may impact various parts of its 2020 operations and financial results including, but not limited to, additional loan loss reserves, costs for emergency preparedness, or potential shortages of personnel. The Company is taking actions to mitigate the negative impact. However, the full impact of COVID-19 is unknown and cannot be reasonably estimated as these events occurred subsequent to year-end and are still developing as of the March 20, 2020 report date. BNCCORP, INC. Annual Report 2019 83 This Page Intentionally Left Blank 84 BNCCORP, INC. Annual Report 2019 BNC National Bank BANK BRANCHES – ND: Bismarck Main(2) 322 East Main Avenue Bismarck, ND 58501 Bismarck South 219 South 3rd Street Bismarck, ND 58504 Bismarck North(2) 801 East Century Avenue Bismarck, ND 58503 Bismarck Sunrise(2) 3000 Yorktown Drive Bismarck, ND 58503 Primrose Assisted Living Apartments 1144 College Drive Bismarck, ND 58501 Crosby 206 South Main Street Crosby, ND 58730 Garrison 92 North Main Garrison, ND 58540 Linton 104 North Broadway Linton, ND 58552 Stanley 210 South Main Stanley, ND 58784 Watford City 205 North Main Watford City, ND 58854 Mandan(2) 2711 Sunset Drive NW Mandan, ND 58554 BANK BRANCHES - AZ BANK BRANCHES - MN Glendale – Charter Address 20175 North 67th Ave Glendale, AZ 85308 Golden Valley 650 North Douglas Drive Golden Valley, MN 55422 MORTGAGE BANKING OFFICES: Glendale 6685 W. Beardsley Glendale, AZ 85383 Wichita 8558 W 21st Street N Wichita, KS 67205 Wichita 12031 East 13th Street Wichita, KS 67206 Overland Park 7007 College Boulevard Overland Park, KS 66211 Moline 800 36th Avenue Moline, IL 61265 Lebanon 1403 West Elm Street Lebanon, Missouri 65336 Farmington Hills 35055 West 12 Mile Road, Suite 140 Farmington Hills, MI 48331 (2) Bank branches offering mortgage banking services. CORPORATE DATA Investor Relations Email Inquiries: corp@bncbank.com General Inquiries: BNCCORP, INC. 322 East Main Avenue, Bismarck, North Dakota 58501 Telephone (701) 250-3040 | Facsimile (701) 222-3653 Daniel J. Collins Chief Financial Officer (612)-305-2210 Timothy J. Franz President/CEO (612)-305-2213 Annual Meeting The 2020 annual meeting of stockholders will be held on Thursday, June 18, 2020 at 8:30 a.m. (Central Daylight Time) at BNC National Bank, Second Floor Conference Room, 322 East Main Avenue, Bismarck, ND 58501. Independent Public Accountants CliftonLarsonAllen LLP 220 South Sixth Street, Suite 300 Minneapolis, MN 55402-1436 Securities Listing BNCCORP, INC.’s common stock is traded on the OTCQX Markets under the symbol: “BNCC”. COMMON STOCK PRICES For the Years Ended December 31, First Quarter Second Quarter Third Quarter Fourth Quarter 2019(1) 2018(1) High $28.35 $30.25 $34.50 $35.20 Low $20.50 $26.90 $27.80 $31.50 High $31.00 $27.25 $28.10 $27.90 Low $26.00 $25.41 $25.66 $19.20 (1) The quotes represent the high and low closing sales prices as reported by OTCQX Markets. Stock Transfer Agent and Registrar American Stock Transfer & Trust Company, LLC 6201 15th Avenue Brooklyn, NY 11219 (800) 937-5449 Corporate Broker D.A. Davidson Community Banking and Wealth Management Group 1-800-288-2811 | cbwm@dadco.com Directors, BNCCORP, INC. Michael M. Vekich Chairman of the Board and CEO, Vekich Chartered Timothy J. Franz President and Chief Executive Officer of BNCCORP, INC. Nathan P. Brenna Owner, Brenna Farm and Ranch Former Attorney Gaylen Ghylin Retired EVP, Secretary and CFO of Tiller Corporation d/b/a Barton Sand & Gravel Co., Commercial Asphalt Co. and Barton Enterprises, Inc. John W. Palmer Principal and Managing Member, PL Capital Advisors, LLC Tom Redmann Retired Loan Officer, Bank of North Dakota Tracy J. Scott Retired Co-Founder of BNCCORP, INC. Directors, BNC National Bank Nathan P. Brenna Timothy J. Franz Gaylen Ghylin Dave Hoekstra John W. Palmer Tom Redmann Tracy J. Scott Michael M. Vekich BNCCORP, INC.322 East Main AvenueBismarck, ND 58501(701) 250-3040www.bnccorp.com2019 ANNUAL REPORT | BNCCORP, INC.$5.09 $27.932010201120122013201420152016201720182019$30$25$20$15$10$5Performing & Transforming2019 ANNUAL REPORTBook Value Per Share Outstanding