GLEN BURNIE BANCORP FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. Such statements
include projections, predictions, expectations or statements as to beliefs or
future events or results, or refer to other matters that are not purely
statements of historical facts. Forward-looking statements are subject to known
and unknown risks, uncertainties and other factors that could cause the actual
results to differ materially from those contemplated by the statements. The
forward-looking statements contained in this Annual Report are based on various
factors and were derived using numerous assumptions. In some
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cases, you can identify these forward-looking statements by words like "may", "will", "should", "expect", "plan", "anticipate", "intend", "believe", "estimate", "predict", "potential", or "continue" or the negative of those words and other comparable words. You should be aware that those statements reflect only our predictions. If known or unknown risks or uncertainties should materialize, or if underlying assumptions should prove inaccurate, actual results could differ materially from past results and those anticipated, estimated or projected. Further, factors or events that could cause our actual results to differ from our forward-looking statements may emerge from time to time, and it is not possible for us to predict all of them. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Factors that might cause such differences include, but are not limited to:
? changes in our plans and strategies and the results thereof;
? the impact of acquisitions and other strategic transactions;
? unexpected changes in the housing market, business markets, and/or general
economic conditions in our market area;
? unexpected changes in market interest rates or monetary policy;
? the impact of new laws, regulations and governmental policies and guidelines
that might require changes to our business model;
changes in laws, regulations and governmental policies and guidelines that
? might impact our ability to collect on outstanding loans or otherwise
negatively impact our business;
? higher than anticipated credit losses or the insufficiency of the allowance for
credit losses;
? our potential exposure to various types of market risks, such as interest rate
risk and credit risk;
? our ability to recover the fair values of available for sale securities;
? our obligation to fund commitments to extend credit and unused lines of credit;
? changes in consumer confidence, spending and savings habits relative to the
services we provide;
? continued relationships with major customers;
competition from other financial institutions in originating loans, attracting
? deposits, and providing various financial services that may affect our
profitability;
? the ability to continue to grow our business internally and through acquisition
and successful integration of bank entities while controlling our costs;
changes in competitive, governmental, regulatory, accounting, technological and
? other factors that may affect us specifically or the banking industry
generally, including as a result of the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (the "Dodd-Frank Act");
? changes in our sources and availability of liquidity;
? the impact of pending and future legal proceedings; and
? losses that we may realize from off-balance sheet arrangements.
You should also carefully consider additional factors that could cause our
actual results to differ from those set forth in the forward-looking statements
and could materially and adversely affect our business, operating results and
financial condition.
The forward-looking statements speak only as of the date on which they are made,
and, except to the extent required by federal securities laws, we undertake no
obligation to update any forward-looking statement to reflect events or
circumstances after the date on which the statement is made or to reflect the
occurrence of unanticipated events. In
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addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
OVERVIEW
This section is intended to help investors understand the financial performance of the Company through a discussion of the factors affecting our financial condition atDecember 31, 2022 and 2021 and our results of operations for the years endedDecember 31, 2022 and 2021. This section should be read in conjunction with the consolidated financial statements and notes thereto that appear elsewhere in this Annual Report on Form 10-K. Net interest income was$11.9 million for the year endedDecember 31, 2022 , and$12.4 million for the year endedDecember 31, 2021 . Total interest income decreased from$13.5 million in 2021 to$12.7 million in 2022, a 5.96% decrease. Interest expense for 2022 totaled$0.9 million , a 20.58% decrease from$1.1 million in 2021. Net income atDecember 31, 2022 was$1.7 million and$2.5 million atDecember 31, 2021 .
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED
General. For the year endedDecember 31, 2022 , the Company reported consolidated net income of$1.7 million ($0.61 per basic and diluted earnings per share) compared to consolidated net income of$2.5 million ($0.88 per basic and diluted earnings per share) for the year endedDecember 31, 2021 . The$771,000 decrease in the 2022 consolidated net income as compared to 2021 was primarily due to an$805,000 decrease in interest income, an$863,000 decrease in the release of credit loss provision for loans and a$388,000 increase in noninterest expenses, offset by a$221,000 decrease in interest expense and a$727,000 increase in noninterest income. Annualized return on average assets was 0.41% atDecember 31, 2022 compared to 0.58% atDecember 31, 2021 . Annualized return on average equity was 7.26% and 6.99% atDecember 31, 2022 and 2021, respectively. The dividend payout ratio was 65% atDecember 31, 2022 and 45% atDecember 31, 2021 . The equity to asset ratio was 4.21% and 8.08% atDecember 31, 2022 and 2021, respectively. Net Interest Income. The primary component of the Company's net income is its net interest income, which is the difference between income earned on assets and interest paid on the deposits and borrowings used to fund income producing assets. Net interest income is determined by the spread between the yields earned on the Company's interest-earning assets and the rates paid on interest-bearing liabilities as well as the relative amounts of such assets and liabilities.
The Company's net interest margin is determined by dividing net interest income by the Company's average interest-earning assets.
Net interest income is affected by the mix of loans in the Bank's loan portfolio. Currently, a majority of the Bank's loans are residential and commercial mortgage loans secured by real estate, and indirect automobile loans secured by automobiles.
Consolidated net interest income for the year endedDecember 31, 2022 was$11.9 million and$12.4 million for the year endedDecember 31, 2021 . Total interest income decreased from$13.5 million in 2021 to$12.7 million in 2022, a$805,000 , or 5.96% decrease, primarily due to a$2.3 million decrease in interest and fees on loans, offset by a$1.5 million increase in interest and dividends on securities and interest on deposits with banks. Total interest expense decreased from$1.1 million in 2021 to$0.9 million in 2022, a$221,000 or 20.58% decrease, primarily due to a$138,000 decrease in interest on deposits and an$83,000 decrease in interest on short- and long-term borrowings. Net interest margin for the year endedDecember 31, 2022 was 2.81% compared to 3.00% for the year endedDecember 31, 2021 . 19
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The following table allocates changes in income and expense attributable to the
Company's interest-earning assets and interest-bearing liabilities for the
periods indicated between changes due to changes in rate and changes in volume.
Changes due to rate/volume are allocated to changes due to volume.
Year Ended December 31,
2022 VS. 2021
Change Due To:
Increase/
(dollars in thousands) Decrease Rate Volume
ASSETS:
Interest-earning assets:
Interest-bearing deposits w/ banks & fed funds $ 755 $ 481 Investment securities: Investment securities available for sale 745 745
-
Restricted equity securities (4) 3 (7)
Total investment securities 741 748 (7)
Loans, net of unearned income
Loans Secured by Real Estate
Construction and land 18 - 18
Farmland - - -
Single-family residential (140) (140) -
Multi-family (40) (40) -
Commercial (1,058) (555) (503)Total loans secured by real estate (1,220) (735)
(485) Commercial and Industrial Commercial and industrial (8) - (8) SBA guaranty (375) (283) (92) Comm SBA PPP (56) (8) (48)
Total commercial and industrial loans (439) (291)
(148) Consumer Loans Consumer (6) - (6) Automobile (636) (636) - Total consumer loans (642) (636) (6) Total gross loans(1) (2,301) (1,662) (639)
Total interest-earning assets$ (805) $ (433)
(372)
LIABILITIES:
Interest-bearing deposits: Interest-bearing checking and savings$ 8 $ 2
$ 6 Money market 1 - 1 Other time deposits (147) (92) (55)
Total interest-bearing deposits (138) (90)
(48)
Borrowed funds (80) (87)
7
Total interest-bearing liabilities$ (218) $ (177)
$ (41) 20 Table of Contents The following table provides information for the designated periods with respect to the average balances, income and expense and annualized yields and costs associated with various categories of interest-earning assets and interest-bearing liabilities. Year Ended December 31, 2022 2021 Average Yield/ Average Yield/ Balance Interest Cost Balance Interest Cost (dollars In thousands) ASSETS: Interest-earning assets: Interest-bearing deposits w/ banks & fed funds$ 53,914 $ 833 1.44 %$ 34,921 $ 79 0.12 % Investment securities: Investment securities available for sale 168,990 3,403 2.05 145,496 2,657 1.85 Restricted equity securities 926 39 4.18 1,092 43 3.90
Total investment securities 169,916 3,442 2.06 146,588 2,700 1.87
Loans Secured by Real Estate Construction and land 4,178 138 3.29 3,640 120 3.30 Farmland 338 17 5.04 347 17 5.04 Singlefamily residential 78,865 3,260 4.13 79,768 3,400 4.26 Multifamily 4,902 271 5.52 5,322 311 5.84 Commercial 46,248 2,423 5.24 55,838 3,481 6.23 Total loans secured by real estate 134,531 6,109 4.54 144,915 7,329 5.06 Commercial and Industrial Commercial and industrial 9,261 300 3.24 9,518 308 3.23 SBA guaranty 6,123 372 6.08 7,631 747 9.79 Comm SBA PPP 405 4 0.92 5,674 60 1.06 Total commercial and industrial loans 15,789 676 4.28 22,823 1,115 4.88 Consumer Loans Consumer 2,032 24 1.18 2,560 30 1.18 Automobile 46,582 1,628 3.50 63,658 2,264 3.56 Total consumer loans 48,614 1,652 3.40 66,218 2,294 3.46 Total gross loans(1) 198,934 8,437 4.24 233,956 10,738 4.59 Total interest-earning assets 422,764 12,712 3.01 415,465 13,517 3.25 Cash and due from banks 2,144 2,181 Allowance for credit losses (2,308) (2,838) Other assets 2,392 16,361 Total assets$ 424,992 $ 431,169 LIABILITIES AND STOCKHOLDERS' EQUITY: Interest-bearing deposits: Interest-bearing checking and savings$ 149,776 70 0.05 %$ 137,861 62 0.05 % Money market 23,573 12 0.05 21,557 11 0.05 Certificates of deposit 57,213 389 0.68 65,358 536 0.82 Total interest-bearing deposits 230,562 471 0.20 224,776 609 0.27 Borrowed funds: Federal funds purchased - - - 308 1 0.44 PPPLF Term Funding - - - 1 - - FHLB advances 16,613 382 2.30 20,000 464 2.32 Total interest-bearing liabilities 247,175 853 0.35 245,085 1,074 0.44 Non-interest-bearing deposits 151,602 147,182 Other liabilities 2,173 2,892 Stockholders' equity 24,042 36,010 Total liabilities and equity$ 424,992 $ 431,169 Net interest income$ 11,859 $ 12,443 Net interest spread 2.66 % 2.81 % Net interest margin 2.81 % 3.00 %
1 Nonaccrual loans included in average balance.
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Allowance for Credit Losses. EffectiveJanuary 1, 2021 , the Company applied ASU 2016-13, Financial Instruments - Credit Losses ("ASC 326"), such that the allowance calculation is based on the CECL methodology. Prior toJanuary 1, 2021 , the calculation was based on incurred loss methodology. The Company maintains an allowance for credit losses ("ACL") for the expected credit losses of the loan portfolio as well as unfunded loan commitments. The amount of ACL is based on ongoing, quarterly assessments by management. The CECL methodology requires an estimate of the credit losses expected over the life of an exposure (or pool of exposures) and replaces the incurred loss methodology's threshold that delayed the recognition of a credit loss until it was probable a loss event was incurred. The ACL consists of the allowance for credit losses - loans and the reserve for unfunded commitments. The estimate of expected credit losses under the CECL methodology is based on relevant information about past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amounts. Historical loss experience is generally the starting point for estimating expected credit losses. We then consider whether the historical loss experience should be adjusted for asset-specific risk characteristics or current conditions at the reporting date that did not exist over the period that historical experience was based for each loan type. Finally, we consider forecasts about future economic conditions or changes in collateral values that are reasonable and supportable. Portfolio segment is defined as the level at which the Company develops and documents a systematic methodology to determine its ACL. The Company has designated three loan portfolio segments: loans secured by real estate, commercial and industrial loans, and consumer loans. These loan portfolio segments are further disaggregated into classes, which represent loans of similar type, risk characteristics, and methods for monitoring and assessing credit risk. The loans secured by real estate portfolio segment is disaggregated into five classes: construction and land, farmland, single-family residential, multi-family, and commercial. The commercial and industrial loan portfolio segment is disaggregated into two classes: commercial and industrial, and SBA guaranty. The risk of loss for the commercial and industrial loan portfolio segment is generally most indicated by the credit risk rating assigned to each borrower. Commercial and industrial loan risk ratings are determined by experienced senior credit officers based on specific facts and circumstances and are subject to periodic review by an independent internal team of credit specialists. The consumer loan portfolio segment is disaggregated into two classes: consumer and automobile. The risk of loss for the consumer loan portfolio segment is generally most indicated by delinquency status and general economic factors. Each of the three loan portfolio segments may also be further segmented based on risk characteristics. For most of our loan portfolio classes, the historical loss experience is determined using the Average Charge-Off Method. This method pools loans into groups ("cohorts") sharing similar risk characteristics and tracks each cohort's net charge-offs over the lives of the loans. The Average Charge-Off Method uses historical values by period (20-year look-back) to calculate losses and then applies the historical average to future balances over the life of the account. The historical loss rates for each cohort are then averaged to calculate an overall historical loss rate which is applied to the current loan balance to arrive at the quantitative baseline portion of the allowance for credit losses for the respective loan portfolio class. For certain loan portfolio classes, the Company determined there was not sufficient historical loss information to calculate a meaningful historical loss rate using the average charge-off methodology. For any such loan portfolio class, peer group history contributes to the Company's weighted average loss history. The peer group data is included in the weighted average loss history that is developed for each loan pool. The Company also considers qualitative adjustments to the historical loss rate for each loan portfolio class. The qualitative adjustments for each loan class consider the conditions over the 20-year look-back period from which historical loss experience was based and are split into two components: 1) asset or class specific risk characteristics or current conditions at the reporting date related to portfolio credit quality, remaining payments, volume and nature, credit culture and management, business environment or other management factors; and 2) reasonable and supportable forecast of future economic conditions and collateral values. The Company performs a quarterly asset quality review which includes a review of forecasted gross charge-offs and recoveries, nonperforming assets, criticized loans, risk rating migration, delinquencies, etc. The asset quality review is performed by management and the results are used to consider a qualitative overlay to the quantitative baseline. 22
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When management deems it to be appropriate, the Company establishes a specific reserve for individually evaluated loans that do not share similar risk characteristics with the loans included in each respective loan pool. These individually evaluated loans are removed from their respective pools and typically represent collateral dependent loans but may also include other non-performing loans or troubled debt restructurings ("TDRs").
During the year endedDecember 31, 2022 , the Company recognized a release of credit loss provision - loans of$0.1 million , compared to a release of$1.0 million for the year endedDecember 31, 2021 . The decrease was primarily driven by a decrease in the size of the loan portfolio, and lower CECL loss percentage due to the overall credit-quality of the loan portfolio. The allowance for credit losses - loans was$2.2 million , or 1.16% of total loans atDecember 31, 2022 , compared to$2.5 million , or 1.17% of total loans atDecember 31, 2021 . AtDecember 31, 2022 , the allowance for credit losses - loans equaled 434.0% of nonaccrual and past due loans compared to 700.3% atDecember 31, 2021 . During the year endedDecember 31, 2022 , the Company recorded net charge offs of$0.2 million compared to net recoveries$0.4 million during the year endedDecember 31, 2021 . Noninterest Income. Noninterest income includes service charges on deposit accounts, other fees and commissions, net gains/losses on investment securities sold, gain on sale of other real estate, income on life insurance policies and gain on unwind of derivative contracts. Noninterest income increased from$0.6 million in 2021 to$1.4 million in 2022, a$0.7 million , or 115.95% increase. The increase was primarily due to a$0.6 million loss on investment securities that were sold in 2021, and a$0.2 million gain on unwind of derivative swap contracts that was recognized in 2022. Noninterest Expenses. Noninterest expenses increased from$11.0 million in 2021 to$11.3 million in 2022, a$0.4 million or 3.54% increase. Salary and employee benefits decreased by$0.1 million , or 1.52%, to$6.4 million atDecember 31, 2022 , compared to$6.5 million atDecember 31, 2021 due to increases in the number of employees, offset by lower benefits costs. Legal, accounting and other professional fees increased from$0.7 million in 2021 to$1.0 million in 2022, a$0.3 million , or 48.93%, increase. Other expenses increased from$1.1 million atDecember 31, 2021 to$1.3 million atDecember 31, 2022 , an increase of$0.2 million , or 17.51%. Income Taxes. During the year endedDecember 31, 2022 , the Company recorded an income tax expense of$0.24 million , compared to$0.58 million for the year endedDecember 31, 2021 , a$0.3 million or 58.46% decrease. This decrease was primarily due to$1.1 million lower income before taxes in 2022.
FINANCIAL CONDITION
Total assets decreased by$60.6 million , or 13.72% to$381.4 million atDecember 31, 2022 , compared to$442.1 million atDecember 31, 2021 . The decrease was primarily a result of decreases in interest-bearing deposit in other financial institutions and declines in loan portfolio balances. Cash and cash equivalents atDecember 31, 2022 were$30.1 million compared to$62.2 million atDecember 31, 2021 . At year-end 2022, investment securities had decreased 7.56% to$144.1 million compared to year end 2021. Loans, net atDecember 31, 2022 were$184.3 million compared to$207.9 million atDecember 31, 2021 . AtDecember 31, 2022 , total deposits were$362.9 million compared to$383.2 million at the end of 2021, a 5.30% decrease during the period. Total borrowings were$0 atDecember 31, 2022 compared to$20.0 million atDecember 31, 2021 . Cash Cash and cash equivalents decreased by$32.1 million primarily due to a$20.3 million decrease in deposit balances,$20.0 million decrease in borrowings and$15.9 million increase in investment securities, offset by$24.0 million decrease in loans net of deferred fees and costs. 23 Table of ContentsInvestment Securities The Company's investment policy authorizes management to invest in traditional securities instruments in order to provide ongoing liquidity, income and a ready source of collateral that can be pledged in order to access other sources of funds. The investment portfolio consists solely of securities available for sale. Securities available for sale are those securities that we intend to hold for an indefinite period of time but not necessarily until maturity. These securities are carried at fair value and may be sold as part of an asset/liability management strategy, liquidity management, interest rate risk management, regulatory capital management or other similar factors. The investment portfolio consists primarily ofU.S. Treasury securities,U.S. Government agency securities, residential mortgage-backed securities, corporate and state and municipal obligations. The income from state and municipal obligations may be taxable or tax-exempt from federal and state income tax. State and municipal obligations from theState of Maryland are exempt from state income taxes. We use the investment portfolio as a source of both liquidity and earnings. Management continuously evaluates investment options that will produce income without assuming significant credit or interest rate risk and looks for opportunities to use liquidity from maturing investments to reduce our use of high-cost time deposits and borrowed funds. During 2022, the Company's investment securities portfolio totaled$144.1 million , an$11.8 million , or 7.56% decrease from$155.9 million atDecember 31, 2021 . This decrease was primarily driven by a$28.6 million increase in the unrealized loss on available for sale securities and$14.2 million of paydowns and redemptions of investment securities, offset by$31.5 million of purchases of available for sale securities. In anticipation of theFederal Open Market Committee's plan to begin tapering its bond purchase program, the Company began restructuring its bond portfolio by lowering the overall duration of the portfolio. OnOctober 1, 2021 andOctober 28, 2021 , the Company entered into trade agreements to sell government agency securities totaling approximately$28,700,000 and$4,700,000 , respectively. These trades resulted in pre-tax losses of approximately$345,300 and$246,000 , respectively, which are reflected in noninterest income in the 2021 income statement.
The composition of investment securities, at carrying value, at
2022 2021
(dollars in thousands) Amount % Amount %
Available for sale securities: U.S. Treasury$ 6,783 4.7 % $ - - % U.S. Government agency 36,580 25.4 % 31,351 20.1 % Residential mortgage-backed securities 67,148 46.6 % 77,877
49.9 % State and municipal 32,297 22.4 % 45,225 29.0 % Corporate securities 1,325 0.9 % 1,474 1.0 % Total debt securities$ 144,133 100.0 %$ 155,927 100.0 % AtDecember 31, 2022 , the Bank had municipal securities from 10 single issuers that, individually, were more than 10% of stockholders' equity, which totaled$23.9 million . 24 Table of Contents
Maturities and weighted average yields for investment securities at
2022
Amortized Fair Yield
(dollars in thousands) Cost Value (1), (2)
Maturing Available for sale securities:
Within one year $ - $ - - %
Over one to five years 24,687 23,827 2.41 %
Over five to ten years 38,880 34,440 1.98 %
Over ten years 109,886 85,866 2.42 %
Total debt securities $ 173,453 $ 144,133
________________________
(1) Yields are stated as book yields which are adjusted for amortization and
accretion of purchase premiums and discounts, respectively.
(2) Yields on tax-exempt obligations have been computed on a tax-equivalent
basis.
Restricted Equity Securities Restricted equity securities were
Loans
A comparison of the loan portfolio for the years indicated is presented in the
following table:
December 31,
2022 2021 2020 2019 2018
(dollars in
thousands) $ % $ % $ % $ % $ %
Loans Secured by
Real Estate
Construction and
land $ 4,499 2 % $ 4,087 2 % $ 2,553 1 % $ 6,565 2 % $ 3,949 1 %
Farmland 333 - 342 - 350 - 357 - 364 -
Single-family
residential 80,251 43 78,119 37 82,520 33 88,214 32 92,104 31
Multi-family 5,304 3 5,428 3 6,105 2 6,397 2 5,664 2
Commercial 42,936 23 48,729 23 57,027 22 63,337 22 61,659 21
Total loans secured
by real estate 133,323 71 136,705 65 148,555 58 164,870 58 163,740 55
Commercial and
Industrial
Commercial and
industrial 8,990 5 10,003 5 10,800 4 11,012 4 11,675 4
SBA guaranty 6,158 3 6,397 3 7,200 3 3,917 1 3,851 1 Comm SBA PPP - - 1,047 - 9,912 4 - - - - Total commercial and industrial
loans 15,148 8 17,447 8 27,912 11 14,929 5 15,526 5 Consumer Loans Consumer 1,521 1 2,090 1 3,063 1 3,267 1 3,498 1 Automobile 36,448 20 54,150 26 74,242 30 101,672 36 116,356 39 Total consumer loans 37,969 21 56,240 27 77,305 31 104,939 37 119,854 40 Gross loans 186,440 100 % 210,392 100 % 253,772 100 % 284,738 100 % 299,120 100 % Allowance for credit losses (2,162) (2,470) (1,476) (2,066) (2,541) Net loans$ 184,278 $ 207,922 $ 252,296 $ 282,672 $ 296,579 The Company's net loan receivables decreased by$23.6 million to$184.3 million atDecember 31, 2022 from$207.9 million atDecember 31, 2021 primarily due to$59.0 million in pay downs outpacing$35.0 million in new originations. This change in the composition of the loan portfolio resulted primarily from a$3.4 million decrease in loans secured by real estate, a$2.3 million decrease in commercial and industrial loans and a$18.3 million decrease in consumer loans. 25 Table of Contents The following table summarizes the scheduled repayments of our loan portfolio, both by loan category and by fixed and adjustable rates, atDecember 31, 2022 . Demand loans and loans which have no stated maturity, are treated as due in
one
year or less:
Due Within Due Over One To Due Over
One Year Five Years Five Years Total
(dollars in thousands)
By Loan Category:
Loans Secured by Real Estate
Construction and land $ 483 $ - $ 4,016 $ 4,499
Farmland - - 333 333
Single-family residential 76 2,091 78,084 80,251
Multi-family - 153 5,151 5,304
Commercial 1,584 4,522 36,830 42,936
Total loans secured by real estate 2,143 6,766 124,414 133,323
Commercial and Industrial
Commercial and industrial 2,337 4,061 2,592 8,990
SBA guaranty - 456 5,702 6,158
Comm SBA PPP - - - -
Total commercial and industrial loans 2,337 4,517 8,294 15,148
Consumer Loans
Consumer 54 274 1,193 1,521
Automobile 7,475 24,900 4,073 36,448
Total consumer loans 7,529 25,174 5,266 37,969
Gross loans $ 12,009 $ 36,457 $ 137,974 $ 186,440
By Rate Term:
Fixed rate 9,842 33,073 103,988 146,903
Adjustable rate 243 1,127 38,167 39,537
Total $ 10,085 $ 34,200 $ 142,155 $ 186,440 Loans are placed on nonaccrual status when they are past due 90 days as to
either principal or interest or when, in the opinion of management, the
collection of all interest and/or principal is in doubt. Placing a loan on
nonaccrual status means that we no longer accrue interest on such loan and
reverse any interest previously accrued but not collected. Management may grant
a waiver from nonaccrual status for a 90 day past due loan that is both well
secured and in the process of collection. An asset is "well secured" if it is
secured by (1) collateral in the form of liens on or pledges of real or personal
property, including securities that have a realizable value sufficient to
discharge the debt (including accrued interest) in full, or (2) the guarantee of
a financially responsible party. An asset is "in the process of collection" if
collection of the asset is proceeding in due course either (1) through legal
action, including judgment enforcement procedures, or (2) in appropriate
circumstances, through collection efforts not involving legal action which are
reasonably expected to result in prepayment of the debt or in its restoration to
a current status in the near future. A loan remains on nonaccrual status until
the loan is current as to payment of both principal and interest and the
borrower demonstrates the ability to make payments in accordance with the terms
of the loan and remains current.
A loan is considered to be impaired when, based on current information and
events, it is probable that we will be unable to collect all amounts due
according to the contractual terms of the loan agreement. Impaired loans are
measured based on the fair value of the collateral for collateral dependent
loans and at the present value of expected future cash flows using the loans'
effective interest rates for loans that are not collateral dependent.
The Bank seeks to control delinquencies through diligent collection efforts. For
consumer loans, the Bank sends out payment reminders on the seventh and twelfth
days after a payment is due. If a consumer loan becomes 15 days past due, the
account is transferred to the Bank's collections department, which will contact
the borrower by
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telephone and/or letter before the account becomes 30 days past due. If a
consumer loan becomes more than 30 days past due, the Bank will continue its
collection efforts and will move to repossession or foreclosure by the 45th day
if the Bank has reason to believe that the collateral may be in jeopardy or the
borrower has failed to respond to prior communications. The Bank may move to
repossess or foreclose in all instances in which a consumer loan becomes more
than 60 days delinquent. After repossession of a motor vehicle, the borrower has
a 15-day statutory right to redeem the vehicle and is entitled to 10 days'
notice before the sale of a repossessed vehicle. The Bank sells the vehicle as
promptly as feasible after the expiration of these periods. If the amount
realized from the sale of the vehicle is less than the loan amount, the Bank may
seek a deficiency judgment against the borrower. The Bank follows similar
collection procedures with respect to commercial loans.
Our current charge-off policy is as follows:
When the probability for full payment of a loan is unlikely, the Bank will initiate a full charge-off or a partial write-down of the asset based upon the status of the loan. The following guidelines apply:
Consumer loans less than
? interest are past due ninety (90) days are charged-off and referred for
collection. Consumer loans of
or partial write-down at the discretion of Bank management.
Any other loan over 120 days past due shall be evaluated for charge-off or
? partial write-down at the discretion of Bank management. Any non-consumer
unsecured loan more than 180 days delinquent in payment of principal and/or
interest (or sooner if deemed uncollectible) is charged-off in full.
If secured, a charge-off is made to reduce the loan balance to a level equal to
? the anticipated liquidation value of the collateral when payment of principal
and/or interest is more than 180 days delinquent, or prior to that if deemed
uncollectible.
Generally, real estate secured loans are charged-off on a deficiency basis
after liquidation of the collateral. In some cases, Bank management may
? determine that a charge-off or write-down is appropriate prior to liquidation
of the collateral, when the full loan balance is clearly uncollectible and some
loss is anticipated. In order to make this determination, an updated evaluation
or appraisal of the property is obtained.
The Bank experienced a
As of December 31,
2022 2021 2020 2019 2018
(dollars in thousands)
Nonaccrual loans $ 488 $ 338 $ 4,512 $ 4,127 $ 1,947 TDR loans excluding those in nonaccrual loans - - - - 204 Accruing loans past due 90+ days 10 15
18 21 26
Total nonperforming loans 498 353 4,530 4,148 2,177
Real estate acquired through foreclosure - -
575 705 705 Total nonperforming assets$ 498 $ 353 $ 5,105 $ 4,853 $ 2,882
Nonperforming loans to gross loans 0.3 % 0.2 %
1.8 % 1.5 % 0.7 %
Allowance for credit losses to nonperforming loans 434.0 % 700.3 % 32.6 % 49.8 % 116.7 %
Nonperforming assets, which consist of nonaccrual loans, troubled debt
restructurings, accruing loans past due 90 days or more, and real estate
acquired through foreclosure, increased
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million at December 31, 2021 to $0.5 million at December 31, 2022 . Nonperforming
assets represented 0.13% of total assets at December 31, 2022 , compared to 0.08%
at December 31, 2021 . Management has worked diligently to identify borrowers
that may be facing difficulties in order to restructure terms where appropriate,
secure additional collateral or pursue foreclosure and other secondary sources
of repayment.
Allowance for Credit Losses - Loans and Credit Risk Management
Credit risk is the risk of loss arising from the inability of a borrower to meet his or her obligations and entails both general risks, which are inherent in the process of lending, and risks specific to individual borrowers. Credit risk is mitigated through portfolio diversification, which limits exposure to any single customer, industry, or collateral type. Residential mortgage and home equity loans and lines generally have the lowest credit loss experience. Loans secured by personal property, such as auto loans, generally experience medium credit losses. Unsecured loan products, such as personal revolving credit, have the highest credit loss experience and for that reason, the Bank has chosen not to engage in a significant amount of this type of lending. Credit risk in commercial lending can vary significantly, as losses as a percentage of outstanding loans can shift widely during economic cycles and are particularly sensitive to changing economic conditions. Generally, improving economic conditions result in improved operating results on the part of commercial customers, enhancing their ability to meet their particular debt service requirements. Improvements, if any, in operating cash flows can be offset by the impact of rising interest rates that may occur during improved economic times. Inconsistent economic conditions may have an adverse effect on the operating results of commercial customers, reducing their ability to meet debt service obligations. OnJanuary 1, 2021 , the Company early adopted ASU 2016-13, Financial Instruments - Credit Losses ("ASC 326") which replaces the "incurred loss approach" for estimating credit losses with an expected loss methodology. The incurred loss model delayed the recognition of credit losses until it was probable that a loss had occurred, while the CECL model requires the immediate recognition of expected credit losses over the contractual term for financial instruments that fall within the scope of CECL at the date of origination or purchase of the financial instrument. The CECL model, which is applicable to the measurement of credit losses on financial assets measured at amortized cost and certain off-balance sheet credit exposures, affects the Company's estimates of the allowance for credit losses for our loan portfolio and the reserve for our off-balance sheet credit exposures related to loan commitments. The allowance for credit losses is established through a provision for credit losses charged to expense. Loans are charged against the allowance for credit losses when management believes that the collectability of the principal is unlikely. The allowance, based on all available information from internal and external sources, relevant to assessing the collectability of loans over their contractual terms, adjusted for expected prepayments when appropriate, is an amount that management believes will be adequate to absorb possible losses on existing loans that may become uncollectible. The evaluations are performed for each class of loans and take into consideration factors such as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, value of collateral securing the loans and current economic conditions and trends that may affect the borrowers' ability to pay. For example, delinquencies in unsecured loans and indirect automobile installment loans will be reserved for at significantly higher ratios than loans secured by real estate. Finally, the Company considers forecasts about future economic conditions or changes in collateral values that are reasonable and supportable. Based on that analysis, the Bank deems its allowance for credit losses in proportion to the total nonaccrual loans and past due loans to be sufficient. The allowance was$2.2 million atDecember 31, 2022 , compared to$2.5 million atDecember 31, 2021 . The allowance as a percentage of total portfolio loans was 1.16% atDecember 31, 2022 and 1.17% atDecember 31, 2021 . During the year endedDecember 31, 2022 , the Company recorded net charge offs of$0.2 million , compared to net recoveries of$0.4 million during the year endedDecember 31, 2021 . 28 Table of Contents The following table reflects activity in the allowance for credit losses - loans for the periods indicated: Year Ended December 31, 2022 2021 2020 2019 2018 (dollars in thousands) Beginning Balance$ 2,470 $ 1,476 $ 2,066 $ 2,541 $ 2,589 Impact of ASC 326 adoption - 1,574 - - - Loans charged-off Loans Secured by Real Estate Construction and land - - - - - Farmland - - - - - Single-family residential - - - 16 589 Multi-family - - - - - Commercial - - - - 13
Total loans secured by real estate - -
- 16 602 Commercial and Industrial Commercial and industrial 200 - - 27 - SBA guaranty 9 - - - - Comm SBA PPP - - - - -
Total commercial and industrial loans 209 -
- 27 - Consumer Loans Consumer 14 2 - - 68 Automobile 169 251 392 573 481 Total consumer loans 183 253 392 573 549 Total 392 253 392 616 1,151 Recoveries Loans Secured by Real Estate Construction and land - - - - - Farmland - - - - - Single-family residential - 408 266 4 2 Multi-family - - - - - Commercial - - - - - Total loans secured by real estate - 408 266 4 2 Commercial and Industrial Commercial and industrial - - 20 10 14 SBA guaranty - - - - - Comm SBA PPP - - - - - Total commercial and industrial loans - - 20 10 14 Consumer Loans Consumer 8 - 6 10 6 Automobile 188 240 199 232 225 Total consumer loans 196 240 205 242 231 Total 196 648 491 256 247 Net charge offs (recoveries) 196 (1,969) (99) 360 904 (Release) provisions for credit loss (112) (975) (689) (115) 856 Balance at end of year$ 2,162 $ 2,470 $
1,476
Allowance as a percentage of total
loans at the end of the year 1.16 % 1.17 % 0.58 % 0.73 % 0.85 %
Net charge offs (recoveries) as a
percentage of
average loans during the year 0.10 % (0.84) % (0.04) % 0.12 % 0.32 %
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The following table reflects the amount and percentage of credit loss allowance for each category for the periods indicated:
At December 31,
2022 2021
Percentage Percentage
Of Loans Of Loans
Allowance In Each Allowance In Each
For Each Category To For Each Category To
Portfolio Category Total Loans Category Total Loans
(dollars in thousands)
Loans Secured by Real
Estate
Construction and land $ 44 2.05 % $ 5 0.21 %
Farmland 20 0.91 11 0.43
Single-family residential 1,230 56.87 1,357 54.97
Multi-family 103 4.76 105 4.24
Commercial 221 10.24 278 11.25
Total loans secured by
real estate 1,618 74.83 1,756 71.10
Commercial and Industrial
Commercial and industrial 174 8.05 115 4.67
SBA guaranty 22 1.02 30 1.23
Total commercial and
industrial loans 196 9.07 145 5.90
Consumer Loans
Consumer 23 1.05 36 1.44
Automobile 325 15.05 533 21.56
Total consumer loans 348 16.10 569 23.00
Total $ 2,162 100.00 % $ 2,470 100.00 %
Deposits
The funds needed by the Bank to make loans are primarily generated by deposit
accounts solicited from the communities in Anne Arundel County . The Bank's
deposit products include savings accounts, money market deposit accounts, demand
deposit accounts, NOW checking accounts, IRA and SEP accounts and certificates
of deposit. The Bank does not solicit brokered deposits. Variations in service
charges, terms and interest rates are used to target specific markets. Ancillary
products and services for deposit customers include safe deposit boxes, money
orders, night depositories, automated clearinghouse transactions, wire
transfers, ATMs, electronic banking (telephone banking, online banking, bill
pay, card management and control, mobile app, merchant source capture, mobile
deposit capture, Zelle®, etc.). The Bank is a member of the Accel(R) and
MoneyPass(R) ATM networks.
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The following deposit table presents the composition of deposits at December 31,
2022 and 2021:
2022 2021 2022 vs 2021
Amount in % of Amount in % of $ %
thousands Total thousands
Total Change Change
Noninterest-bearing deposits
Interest-bearing deposits: Checking 40,086 10.9 % 37,305 9.7 % 2,781 7.5 % Savings 113,101 31.2 % 106,818 28.0 % 6,283 5.9 % Money market 15,791 4.4 % 23,103 6.0 % (7,312) (31.6) % Total interest-bearing checking, savings and money market deposits 168,978 46.5 % 167,226 43.7 % 1,752 1.0 % Time deposits under$100,000 30,708 8.5 % 35,773 9.3 % (5,065) (14.2) % Time deposits of$100,00 or more 19,999 5.5 % 24,624 6.4 % (4,625) (18.8) % Total time deposits 50,707 14.0 % 60,397
15.7 % (9,690) (16.0) %
Total interest-bearing deposits 219,685 60.5 % 227,623 59.4 % (7,938) (3.5) %
Total Deposits$ 362,947 100.0 %$ 383,247
100.0 %
Total deposits were$362.9 million atDecember 31, 2022 , a decrease of$20.3 million , or 5.3%, when compared to the$383.2 million recorded atDecember 31, 2021 . Within the deposit base, noninterest bearing deposit balances decreased$12.4 million , or 7.9%, interest bearing checking account balances increased$2.8 million , or 7.5%, interest bearing savings account balances increased by$6.3 million , or 5.9%, money market balances decreased$7.3 million , or 31.6%, and time deposit balances decreased by$9.7 million , or 16.0%, when compared to the amounts atDecember 31, 2021 .
The following table presents the maturity distribution for time deposits of
(dollars in thousands) Amount Three months or less$ 1,853 Over three months through twelve months 8,318
Over twelve months through twenty-four months 7,340 Over twenty-four months
2,488
Total Time Deposits of
Borrowings
The Bank uses borrowings from theFederal Home Loan Bank ("FHLB") ofAtlanta , of which it is a member, to supplement funding from deposits. The Bank's total credit availability is$103.9 million atDecember 31, 2022 and it may draw$31.7 million which is secured by a floating lien on the Bank's residential first mortgage loans.
The Bank has available unsecured federal funds lines of credit from two
financial institutions for
CAPITAL RESOURCES
Ample capital is necessary to sustain growth, provide a measure of protection against unanticipated declines in asset values and safeguard the funds of depositors. Capital also provides a source of funds to meet loan demand and enables us to manage assets and liabilities effectively.
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Stockholders' equity decreased to$16.1 million atDecember 31, 2022 , compared to$35.7 million atDecember 31, 2021 . The$19.7 million , or 55.05%, decrease for the year endedDecember 31, 2022 , resulted primarily from$20.4 million increase in net unrealized losses on the available for sale bond portfolio, offset by a$602,000 increase in retained earnings and$114,000 stock issuances under the dividend reinvestment program. The book value of the Company's common stock was$5.60 atDecember 31, 2022 and$12.51 atDecember 31, 2021 . The Bank is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. The capital requirements to which the Bank is subject are known as theBasel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. These Basel III Capital Rules and have been applicable to the Bank sinceJanuary 1, 2015 .
Specifically, the rule imposes the following minimum capital requirements to be considered adequately capitalized:
? A common equity Tier 1 risk-based capital ratio of 4.50%;
? A Tier 1 risk-based capital ratio of 6.00%;
? A total risk-based capital ratio of 8.00%; and
? A leverage ratio of 4.00%.
Under the rule, common equity Tier 1 capital includes accumulated other comprehensive income (which includes all unrealized net gains and losses on available for sale debt and equity securities and all unrealized net gain or loss on defined benefit pension plan), subject to a one-time opt-out election. The Bank elected to opt-out of this provision. As such, accumulated comprehensive income is not included in determining the Bank's regulatory capital ratios. The rule also includes risk weights of assets to reflect credit risk and other risk exposures. These include a 150% risk weight for certain high volatility commercial real estate acquisitions, development and construction loans and non-residential mortgage loans that are 90 days past due or otherwise on nonaccrual status, a 20% credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable, a 250% risk weight (up from 100%) for deferred tax assets that are not deducted from capital and increased risk weights (from 0% to up to 600%) for certain equity exposures. Finally, the rule limits capital distributions and certain discretionary bonus payments if the banking organization does not hold a "capital conservation buffer" consisting of 2.50% of common equity Tier 1 capital to risk weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements. For regulatory capital purposes, deferred tax assets that arise from net operating loss and tax credit carryforwards (net of any related valuations allowances and net of deferred tax liabilities) are excluded from regulatory capital, in addition to certain overall limits on net deferred tax assets as a percentage of common equity Tier 1 capital. AtDecember 31, 2022 , none of the Bank's net deferred tax asset was excluded from common equity Tier 1, Tier 1 and total regulatory capital. We will continue to evaluate the realizability of our net deferred tax asset on a quarterly basis for both financial reporting and regulatory capital purposes. This evaluation may result in the inclusion of a deferred tax asset in regulatory capital in an amount that is different from the amount determined under GAAP. 32 Table of Contents In addition, the Bank is required to maintain a minimum level of Tier 1 capital to average total assets excluding intangibles. This measure is known as the leverage ratio. The current regulatory minimum for the leverage ratio for institutions to be considered "well capitalized" is 5.00%, but an individual institution could be required to maintain a higher level. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain amounts and ratios (set forth in the table below) of total, common equity Tier 1 and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and a leverage ratio of Tier 1 capital (as defined) to average tangible assets (as defined). AtDecember 31, 2022 and 2021, the Bank had regulatory capital in excess of that required under each requirement and was classified as "well capitalized".
Actual capital amounts and ratios for the Bank are presented in the following tables (dollars in thousands):
To Be Well Capitalized
To Be Considered Under Prompt Corrective
Actual Adequately Capitalized Action Provisions
(dollars in thousands) Amount Ratio Amount Ratio Amount
Ratio
As of December 31, 2022
Common Equity Tier 1 Capital $ 37,963 16.45 % $ 10,383 4.50 %$ 14,998 6.50 %Total Risk-Based Capital $ 39,866 17.28 %$ 18,459 8.00 %$ 23,074 10.00 % Tier 1 Risk-Based Capital$ 37,963 16.45 %$ 13,845 6.00 %$ 18,459 8.00 % Tier 1 Leverage$ 37,963 9.53 %$ 15,938 4.00 %$ 19,922 5.00 % To Be Well Capitalized To Be Considered Under Prompt Corrective Actual Adequately Capitalized Action Provisions
(dollars in thousands) Amount Ratio Amount Ratio Amount
Ratio
As of December 31, 2021
Common Equity Tier 1 Capital $ 37,592 15.32 % $ 11,044 4.50 %$ 15,952 6.50 %Total Risk-Based Capital $ 39,329 16.03 %$ 19,634 8.00 %$ 24,542 10.00 % Tier 1 Risk-Based Capital$ 37,592 15.32 %$ 14,725 6.00 %$ 19,634 8.00 % Tier 1 Leverage$ 37,592 8.40 %$ 17,910 4.00 %$ 22,388 5.00 % Federal bank regulatory agencies are required to take certain supervisory actions against an undercapitalized bank, the severity of which depends upon the bank's degree of capitalization. Failure to maintain an appropriate level of capital could cause the regulator to take any one or more of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.
LIQUIDITY
Liquidity describes our ability to meet financial obligations, including lending commitments and contingencies, which arise during the normal course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of the Company's customers, as well as to meet current and planned expenditures. Management monitors the liquidity position daily. Our liquidity is derived primarily from our deposit base, scheduled amortization and prepayments of loans and investment securities, funds provided by operations and capital. Additionally, liquidity is provided through our portfolios of cash and interest-bearing deposits in other banks, federal funds sold and securities available for sale. While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by market interest rates, economic conditions, and rates offered by the Bank's competitors. The borrowing requirements of customers include commitments to extend credit and the unused portion of lines of credit, which totaled$30.7 million atDecember 31, 2022 . Management notes that, historically, a small percentage of unused lines of credit are actually drawn down by customers within a 12-month period. 33 Table of Contents Our most liquid assets are cash and assets that can be readily converted into cash, including interest-bearing deposits with banks and federal funds sold, and investment securities. AtDecember 31, 2022 , we had$2.0 million in cash and due from banks,$28.1 million in interest-bearing deposits with banks and federal funds sold, and$144.1 million in investment securities available for sale. The Bank also has external sources of funds through the FHLB,Federal Reserve Discount Window and newly formed Bank Term Funding Program which can be drawn upon when required. The Bank has a line of credit totaling approximately$103.9 million with the FHLB of which$103.9 million was available to be drawn onDecember 31, 2022 , based on qualifying loans and securities pledged as collateral. The lines of credit with theFederal Reserve are limited to the amount of qualifying collateral pledged.
Additionally, the Bank has unsecured federal funds lines of credit totaling
To further aid in managing liquidity, the Bank's Board of Directors has approved
and formed an Asset/Liability Management Committee ("ALCO") and Investment
Committee to review and discuss recommendations for the use of available cash
and to maintain an investment portfolio. By limiting the maturity of securities
and maintaining a conservative investment posture, management can rely on the
investment portfolio to help meet any short-term funding needs.
We believe the Bank has adequate cash on hand and available through liquidation
of investment securities and available borrowing capacity to meet our liquidity
needs. Although we believe sufficient liquidity exists, if economic conditions
and consumer confidence deteriorate, this liquidity could be depleted, which
would then materially affect our ability to meet operating needs and to raise
additional capital.
OFF-BALANCE SHEET ARRANGEMENTS
The Bank is a party to financial instruments in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated financial statements. Loan commitments and lines of credit are agreements to lend to customers as long as there is no violation of any conditions of the contracts. Loan commitments generally have interest rates fixed at current market amounts, fixed expiration dates, and may require payment of a fee. Lines of credit generally have variable interest rates. Many of the loan commitments and lines of credit are expected to expire without being drawn upon; accordingly, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral or other security obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation. Collateral held varies but may include deposits held in financial institutions,U.S. Treasury securities, other marketable securities, accounts receivable, inventory, property and equipment, personal residences, income-producing commercial properties, and land under development. Personal guarantees are also obtained to provide added security for certain commitments. Letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to guarantee the installation of real property improvements and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds collateral and obtains personal guarantees supporting those commitments for which collateral or other securities is deemed necessary.
The Bank's exposure to credit loss in the event of nonperformance by the customer is the contractual amount of the commitment.
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Currently, we break-out our unfunded commitments into the following categories:
? Unfunded Construction Commitments
? Unfunded Commercial Lines of Credit and Other
? Unfunded Home Equity LOC
? Unfunded Demand Deposit Overdraft LOC
? Committed Loans Which Have Not Closed
? Letters of Credit
Loan commitments, lines of credit, and letters of credit are made on the same terms, including collateral, as outstanding loans. As ofDecember 31, 2022 , the Bank has accrued$477,215 as a reserve for credit losses on unfunded commitments, an increase of$106,535 from the$370,680 accrued as ofDecember 31, 2021 . Unfunded commitments related to these financial instruments with off balance sheet risk, are included in "other liabilities". The additional provision amount is included in 'other expense'.
MARKET RISK MANAGEMENT
Our primary market risk is interest rate fluctuation. Interest rate risk results primarily from the traditional banking activities in which the Bank engages, such as gathering deposits and extending loans. Many factors, including economic and financial conditions, movements in interest rates and consumer preferences affect the difference between the interest earned on our assets and the interest paid on liabilities. Our interest rate risk represents the level of exposure we have to fluctuations in interest rates and is primarily measured as the change in earnings and the theoretical market value of equity that results from changes in interest rates. The Investment Committee oversees our management of interest rate risk. The objective of the management of interest rate risk is to maximize stockholder value, enhance profitability and increase capital, serve customer and community needs, and protect us from any material financial consequences associated with changes in interest rate risk. Interest rate risk is that risk to earnings or capital arising from movement of interest rates. It arises from differences between the timing of rate changes and the timing of cash flows (repricing risk); from changing rate relationships across yield curves that affect bank activities (basis risk); from changing rate relationships across the spectrum of maturities (yield curve risk); and from interest rate related options embedded in certain bank products (option risk). Changes in interest rates may also affect a bank's underlying economic value. The value of a bank's assets, liabilities, and interest-rate related, off-balance sheet contracts is affected by a change in rates because the present value of future cash flows, and in some cases the cash flows themselves, is changed.
We believe that accepting some level of interest rate risk is necessary in order to achieve realistic profit goals. Management and the Board have chosen an interest rate risk profile that is consistent with our strategic business plan.
The Company's Board of Directors has established a comprehensive interest rate risk management policy, which is administered by the Investment Committee. The policy establishes limits on risk, which are quantitative measures of the percentage change in net interest income (a measure of net interest income at risk) and the fair value of equity capital (a measure of economic value of equity or "EVE" at risk) resulting from a hypothetical change inU.S. Treasury interest rates. We measure the potential adverse impacts that changing interest rates may have on our short-term earnings, long-term value, and liquidity by employing simulation analysis through the use of computer modeling. The simulation model captures optionality factors such as call features and interest rate caps and floors imbedded in investment and loan portfolio contracts. As with any method of gauging interest rate risk, there are certain shortcomings inherent in the interest rate modeling methodology we employ. When interest rates change, actual movements in different categories of interest-earning assets and interest-bearing liabilities, loan prepayments, and withdrawals of time and other deposits, may deviate significantly from assumptions used in the model. Finally, the methodology does not measure or reflect the impact that higher rates may have on adjustable-rate loan customers' ability to service their debts, or the impact of rate changes on demand for loan and deposit products. 35 Table of Contents We prepare a current base case and up to eight alternative simulations at least once a quarter and report the analysis to the Board of Directors. In addition, more frequent forecasts may be produced when interest rates are particularly uncertain or when other business conditions or strategy analysis so dictate. The statement of condition is subject to quarterly testing for up to eight alternative interest rate shock possibilities to indicate the inherent interest rate risk. Average interest rates are shocked by +/ - 100, 200, 300, and 400 basis points ("bp"), although we may elect not to use particular scenarios that we determine are impractical in the current rate environment. It is our goal to structure the balance sheet so that net interest-earnings at risk over a twelve-month period and the economic value of equity at risk do not exceed policy guidelines at the various interest rate shock levels. AtDecember 31, 2022 , we were in an asset sensitive position. Management continuously strives to reduce higher costing fixed rate funding instruments, while increasing assets that are more fluid in their repricing. An asset sensitive position, theoretically, is favorable in a rising rate environment since more assets than liabilities will reprice in a given time frame as interest rates rise. Similarly, a liability sensitive position, theoretically, is favorable in a declining interest rate environment since more liabilities than assets will reprice in a given time frame as interest rates decline. Management works to maintain a consistent spread between yields on assets and costs of deposits and borrowings, regardless of the direction of interest rates. Static Balance Sheet/Immediate Change in Rates Estimated Changes in Net Interest Income `-200 bp
`-100 bp `+100 bp `+200 bp
Policy Limit -15 % -10 % -10 % -15 %
December 31, 2022 -12 % -6 % 1 % 3 %
December 31, 2021 -11 % -7 % 9 % 20 %
As shown above, measures of net interest income at risk were slightly less
favorable at
Falling Rates: If market rates decline in a parallel fashion (i.e. down 100 or
200 bp over 12 months), projected NII levels quickly fall beneath the base rates
scenario and present potential exposure to NII over the life of the simulation
as the asset base is assumed to be recycled into lower rates while the low cost
nature of the current funding base severely limits the amount of relief it can
provide to asset yield pressures.
Rising Rates: In all rising rate scenarios, regardless of the degree and pace of
rate increases, projected NII shows immediate benefit in comparison to the base
rates scenario. NII trends upward at a faster pace due to the short to
intermediate term asset base that is relatively quick to recycle into the higher
rate environment that is funded primarily with core deposits that are assumed to
be less rate sensitive in nature.
The measures of equity value at risk indicate the ongoing economic value of the
Company by considering the effects of changes in interest rates on all of the
Company's cash flows, and by discounting the cash flows to estimate the present
value of assets and liabilities. The difference between these discounted values
of the assets and liabilities is the economic value of equity, which, in theory,
approximates the fair value of the Company's net assets.
Static Balance Sheet/Immediate Change in Rates
Estimated Changes in Economic Value of
Equity (EVE) `-200 bp `-100 bp `+100 bp `+200 bp
Policy Limit -20 % -10 % -10 % -20 %
December 31, 2022 4 % 3 % -6 % -12 %
December 31, 2021 -40 % -18 % 6 % 9 %
The EVE at risk declined atDecember 31, 2022 when compared toDecember 31, 2021 in the down interest rate shock levels and increased in the up interest rate shock levels. The Company's economic value of equity has a positive effect in a declining interest rate environment and a negative effect in an increasing interest rate environment because the liabilities reprice at a much slower rate than our assets, and our interest earning assets are much greater than our interest-bearing liabilities. The Company's economic value of equity improves in declining interest rate environments as the 36
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majority of our liabilities cannot continue to decrease from their current low levels thus the economic value of our liabilities and our assets both worsen in a declining rate environment.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and notes thereto presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, nearly all of the Company's assets and liabilities are monetary in nature. As a result, interest rates have a greater impact on the Company's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements are prepared in accordance withU.S. generally accepted accounting principles (GAAP) and follow general practices within the industries in which we operate. All intercompany transactions are eliminated in consolidation and certain reclassifications are made when necessary in order to conform the previous year's financial statements to the current year's presentation. Application of these principles requires management to make estimates or judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates or judgments reflect management's view of the most appropriate manner in which to record and report our overall financial performance. Because these estimates or judgments are based on current circumstances, they may change over time or prove to be inaccurate based on actual experience. As such, changes in these estimates, judgments, and/or assumptions may have a significant impact on our financial statements. All accounting policies are important, and all policies described in Part II, Item 8, Financial Statements and Supplementary Data, Note 1, should be reviewed for a greater understanding of how our financial performance is recorded and reported. We have identified the following three policies as being critical because they require management to make particularly difficult, subjective, and/or complex estimates or judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies relate to the determination of the allowance for credit losses - loans, fair value measurements and the accounting for income taxes. Management believes it has used the best information available to make the estimations or judgments necessary to value the related assets and liabilities. Actual performance that differs from estimates or judgments and future changes in the key variables could change future valuations and impact net income. Management has reviewed the application of these policies with the Audit Committee of the Board of Directors. Following is a discussion of the areas we view as our most critical accounting policies, including the identification of the variables most important in the estimation process.
Allowance for Credit Losses - Loans
The Company maintains an allowance for credit losses ("ACL") for the expected
credit losses of the loan portfolio as well as unfunded loan commitments. The
amount of ACL is based on ongoing, quarterly assessments by management. The CECL
methodology requires an estimate of the credit losses expected over the life of
an exposure (or pool of exposures) and replaces the incurred loss methodology's
threshold that delayed the recognition of a credit loss until it was probable a
loss event was incurred. The Company also considers qualitative adjustments to
the historical loss rate for each loan portfolio class. The qualitative
adjustments for each loan class consider the conditions over the 20-year
look-back period from which historical loss experience was based and are split
into two components: 1) asset or class specific risk characteristics or current
conditions at the reporting date related to portfolio credit quality, remaining
payments, volume and nature, credit culture and management, business environment
or other management factors; and 2) reasonable and supportable forecast of
future economic conditions and collateral values. Our accounting policy related
to the reserve is disclosed in Note 1 under the heading "Allowance for Credit
Losses - Loans."
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Fair Value Measurements
We use fair value measurements to record certain financial instruments and to determine fair value disclosures. Available for sale securities and interest rate swap agreements are financial instruments recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other financial assets on a nonrecurring basis. These nonrecurring fair value adjustments typically involve write-downs of, or specific reserves against, individual assets. GAAP establishes a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used in the measurement are observable or unobservable. Observable inputs reflect market-driven or market-based information obtained from independent sources, while unobservable inputs reflect our estimates about market data. The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market data. For financial instruments that trade actively and have quoted market prices or observable market data, there is minimal subjectivity involved in measuring fair value. When observable market prices and data are not fully available, management judgment is necessary to estimate fair value. In addition, changes in the market conditions may reduce the availability of quoted prices or observable data. For example, reduced liquidity in the capital markets or changes in secondary market activities could result in observable market inputs becoming unavailable. Therefore, when market data is not available, we use valuation techniques that require more management judgment to estimate the appropriate fair value measurement. Fair value is discussed further in Note 1 under the heading "Fair Value Measurements" and in Note 15, "Fair Value of Financial Instruments".
Accounting for Income Taxes
We use the liability method of accounting for income taxes. Under the liability method, deferred tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities (i.e., temporary differences) and are measured at the enacted rates in effect when these differences reverse. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. We exercise significant judgment in the evaluation of the amount and timing of the recognition of the resulting tax assets and liabilities. The judgments and estimates required for the evaluation are updated based upon changes in business factors and the tax laws. If actual results differ from the assumptions and other considerations used in estimating the amount and timing of tax recognized, there can be no assurance that additional expenses will not be required in future periods. Realization of deferred tax assets is dependent on generating sufficient taxable income in the future. Other significant accounting policies are presented in Note 1 to the consolidated financial statements that appear elsewhere in this Annual Report on Form 10K. We have not substantively changed any aspect of our overall approach in the application of the foregoing policies.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DICLOSURES ABOUT MARKET RISK
Not applicable.
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