THE COMMUNITY FINANCIAL CORPORATION CRITICAL ACCOUNTING POLICIES
Critical accounting policies are defined as those that involve significant
judgments and uncertainties and could result in materially different results
under different assumptions and conditions. The Company considers its
determination of the allowance for credit losses ("ACL"), goodwill impairment,
and the valuation of deferred tax assets to be critical accounting policies. The
Company believes that the most critical accounting policies upon which its
financial condition and results of operation depend, and which involve the most
complex subjective decisions or assessments, are included in the discussion
entitled "Critical Accounting Policies" in Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations," in the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 2021 , as filed
with the SEC .
For additional information regarding the ACL, Goodwill , and the valuation of
deferred taxes, refer to Notes 1, 3, 4, and 14 in the Consolidated Financial
Statements as presented in the Company's Form 10-K for the year ended
December 31, 2021 .
On January 1, 2022 , the Company adopted FASB ASU 2016-13, which changes the
accounting for the allowance for credit losses. For a discussion of this new
accounting policy, refer to Note 1 "Basis of Presentation" to the Consolidated
Financial Statements.
OVERVIEW
Community Bank of the Chesapeake (the "Bank") is headquartered in Southern
Maryland with 12 branches located in Maryland and Virginia . The Bank is a
wholly-owned subsidiary of The Community Financial Corporation (the "Company").
The Company provides financial services to individuals and businesses through
its offices in Southern Maryland and Fredericksburg, Virginia . Its primary
deposit products are demand, savings and time deposits, and its primary lending
products are commercial and residential mortgage loans, commercial loans,
construction and land development loans, home equity and second mortgages and
commercial equipment loans.
Our customer focus is to serve small and medium sized commercial businesses as
well as local municipal agencies and not-for-profits. Relationship teams provide
customers with specific banker contacts and a support team to address product
and service demands. The Bank believes that its ability to offer fast, flexible,
local decision-making will continue to attract significant new business
relationships. Our structure provides a consistent and superior level of
professional service and excelling at customer service is a critical part of our
culture. The Bank's marketing is directed towards increasing its balances of
transactional deposit accounts. The Bank believes that increases in these
account types will lessen the Bank's dependence on higher-cost funding, such as
certificates of deposit and borrowings.
The Company's income is primarily earned from interest received on its loans and
investments. The Company's primary source of funds for making these loans and
investments is its deposits. One of the key measures of the Company's success is
its net interest income, or the difference between the income on loans and
investments, and the expense on deposits and borrowings. Another key measure is
the spread between the yield the Company earns on interest-earning assets and
the rate the Company pays on interest-bearing liabilities, which is called net
interest spread. In addition to earning interest on loans and investments, the
Company earns income through fees and other charges for services to clients.
Management will continue to focus on growth and operating efficiency to deliver
strong results during 2022. During the first nine months of 2022, we had robust
portfolio loan growth, and strong non-interest bearing deposit growth, while
continuing to optimize our branch and virtual banking operations.
•The Company reported record net income for the three months ended September 30,
2022 of $7.6 million , or $1.34 per diluted common share compared to net income
of $6.4 million or $1.12 per diluted common share for the quarter ended
September 30, 2021 . The Company also reported record net income for the nine
months ended September 30, 2022 of $20.7 million or diluted earnings per share
of $3.65 compared to net income for the comparable 2021 period of $19.1 million
or diluted earnings per share of $3.29 .
•Portfolio loan end of period contractual rates increased by 57 basis points to
4.41% at September 30, 2022 compared to December 31, 2021 . The loan portfolio is
positioned for rising rates with $467.8 million or 27% of loans, excluding the
allowance for credit losses, scheduled to reprice monthly or in the next three
months and an additional $76.6 million or 4% repricing within the following nine
months. The Bank's effective duration on the loan portfolio was 2.1 years at
September 30, 2022 .
•Total portfolio loans increased $164.5 million or 13.9% annualized to $1,743.3
million from December 31, 2021 , as the Company maintained its market dominance
in Southern Maryland and continued to gain market share in Virginia . The loan
pipeline at September 2022 was $153.0 million , which is expected to provide
solid loan growth in the fourth quarter.
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•Non-interest-bearing accounts increased$201.7 million to$647.4 million or 30.45% of deposits atSeptember 30, 2022 , from 21.68% of deposits atDecember 31, 2021 . Transaction deposits increased$105.4 million , or 8.13% annualized, to$1,834.2 million in the first nine months of 2022. The Company's change in funding mix has well positioned the balance sheet for a rising rate environment. In addition, increased non-interest bearing accounts of 30.45% as a percentage of deposits also better positions the Company for a rising rate environment. •As ofSeptember 30, 2022 , theFOMC had increased the federal funds target rate range to between 3.00%-3.25%. As a result of the Company's balance sheet being asset sensitive, net interest margin increased 22 basis points to 3.47% for the three months endedSeptember 30, 2022 compared to the second quarter of 2022. •Total stockholders' equity decreased$29.0 million during the nine months endedSeptember 30, 2022 . The decrease in equity was primarily due to an increase of$42.0 million in accumulated other comprehensive loss ("AOCL") related to unrealized losses in the Bank's AFS securities portfolio due to changes in market interest rates, partially offset by net income of$20.7 million . Management intends and has the ability to hold its AFS securities until maturity. See discussion in Liquidity and Capital Resources section of this MD&A. •The Company's common equity to assets ratio decreased to 7.59% atSeptember 30, 2022 from 8.94% atDecember 31, 2021 . The Company's ratio of tangible common equity ("TCE") to tangible assets decreased to 7.14% atSeptember 30, 2022 from 8.48% atDecember 31, 2021 (see Non-GAAP reconciliation schedules) due primarily to increases in AOCL. Regulatory capital was not impacted by the increase in AOCL and Tier 1 capital to average asset ratios at the Bank and the Company remain strong. •Asset quality continues to improve as non-accrual loans, OREO and TDRs were$6.7 million or 0.28% of total assets atSeptember 2022 compared to$8.1 million or 0.35% of total assets atDecember 31, 2021 . •The Bank opened its secondVirginia branch inMay 2022 inFredericksburg . Additionally, with ourVirginia lending team managing over 40% of the Bank's loans, the Bank intends to open a loan production office inCharlottesville in the fourth quarter of 2022 to support our existing efforts. Management believes the greaterFredericksburg area provides significant opportunities for continued organic growth supported by our efficient operating model and ability to leverage technology.
Subsequent events
The Company has evaluated subsequent events for potential recognition and/or disclosure through the date the unaudited Consolidated Financial Statements included in this Quarterly Report on Form 10-Q were issued.
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USE OF NON-GAAP FINANCIAL MEASURES
Statements included in management's discussion and analysis include non-GAAP financial measures and should be read along with the accompanying tables, which provide a reconciliation of non-GAAP financial measures to GAAP financial measures. The Company's management uses these non-GAAP financial measures and believes that non-GAAP financial measures provide additional useful information that allows readers to evaluate the ongoing performance of the Company. Non-GAAP financial measures should not be considered as an alternative to any measure of performance or financial condition as promulgated under GAAP, and investors should consider the Company's performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the Company. Non-GAAP financial measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analysis of the results or financial condition as reported under GAAP. See Non-GAAP reconciliation schedules that immediately follow:
RECONCILIATION OF NON-GAAP MEASURES (UNAUDITED)
Reconciliation ofU.S. GAAP total assets, common equity, common equity to assets and book value to Non-GAAP tangible assets, tangible common equity, tangible common equity to tangible assets and tangible book value. This Form 10-Q, including the accompanying financial statement tables, contains financial information determined by methods other than in accordance with GAAP. This financial information includes certain performance measures, which exclude intangible assets. These non-GAAP measures are included because the Company believes they may provide useful supplemental information for evaluating the underlying performance trends of the Company. (dollars in thousands, except per share amounts) September 30, 2022 December 31, 2021 September 30, 2021 Total assets$ 2,359,621 $ 2,327,306 $ 2,278,692 Less: intangible assets Goodwill 10,835 10,835 10,835 Core deposit intangible 725 1,032 1,147 Total intangible assets 11,560 11,867 11,982 Tangible assets$ 2,348,061 $ 2,315,439 $ 2,266,710 Total common equity $ 179,154 $ 208,133 $ 204,128 Less: intangible assets 11,560 11,867 11,982 Tangible common equity $ 167,594 $ 196,266 $ 192,146 Common shares outstanding at end of period 5,644,186 5,718,528 5,724,011 GAAP common equity to assets 7.59 % 8.94 % 8.96 % Non-GAAP tangible common equity to tangible assets 7.14 % 8.48 % 8.48 % GAAP common book value per share $ 31.74 $ 36.40 $ 35.66 Non-GAAP tangible common book value per share $ 29.69 $ 34.32 $ 33.57 43
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RECONCILIATION OF NON-GAAP MEASURES (UNAUDITED)
Return on Average Common Equity ("ROACE")
The ROACE is a financial ratio that measures the profitability of a company in
relation to the average shareholders' equity. This financial metric is expressed
in the form of a percentage which is equal to net income after tax divided by
the average shareholders' equity for a specific period of time.
Three Months Ended September 30, Nine Months Ended September 30,
(dollars in thousands) 2022 2021 2022 2021
Net income (as reported) $ 7,580 $ 6,404 $ 20,702 $ 19,135
ROACE 15.97 % 12.45 % 14.17 % 12.53 %
Average equity $ 189,838 $ 205,723 $ 194,741 $ 203,597 Return on Average Tangible Common Equity ("ROATCE")
ROATCE is computed by dividing net earnings applicable to common shareholders by
average tangible common shareholders' equity. Management believes that ROATCE is
meaningful because it measures the performance of a business consistently,
whether acquired or internally developed. ROATCE is a non-GAAP measure and may
not be comparable to similar non-GAAP measures used by other companies.
Three Months Ended September 30, Nine Months Ended September 30,
(dollars in thousands) 2022 2021 2022 2021
Net income (as reported) $ 7,580 $ 6,404 $ 20,702 $ 19,135
Core deposit intangible amortization
(net of tax) 74 91 231 284
Net earnings applicable to common
shareholders $ 7,654 $ 6,495 $ 20,933 $ 19,419
ROATCE 17.18 % 13.41 % 15.25 % 13.53 %
Average tangible common equity $ 178,215 $ 193,662 $ 183,017 $ 191,411
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SUMMARY OF OPERATING RESULTS
A comparison of the results of operations for the three and nine months ended
(Unaudited) (Unaudited)
Three Months Ended September 30, Nine Months Ended September 30,
(dollars in thousands, except per
share amounts) 2022 2021 2022 2021
OPERATING DATA
Interest and dividend income $ 21,345 $ 17,659 $ 57,455 $ 52,781
Interest expenses 2,288 1,050 4,361 3,228
Net interest income ("NII") 19,057 16,609 53,094 49,553
Provision for credit losses 694 - 1,569 586
Provision for unfunded commitments 6 - 1 -
NII after provision for credit
losses and unfunded commitments 18,357 16,609 51,524 48,967
Noninterest income 1,229 1,400 4,104 5,616
Noninterest expenses 9,626 9,447 28,044 28,973
Income before income taxes 9,960 8,562 27,584 25,610
Income taxes 2,380 2,158 6,882 6,475
Net income 7,580 6,404 20,702 19,135
Income available to common shares $ 7,580 $ 6,404 $ 20,702 $ 19,135
(Unaudited) (Unaudited)
Three Months Ended September 30, Nine Months Ended September 30,
2022 2021 2022 2021
KEY OPERATING RATIOS
Return on average assets ("ROAA") 1.31 % 1.17 % 1.19 % 1.20 %
Return on average common equity
("ROACE") 15.97 12.45 14.17 12.53
Return on Average Tangible Common
Equity ("ROATCE") 17.18 13.41 15.25 13.53
Average total equity to average
total assets 8.17 9.40 8.42 9.58
Interest rate spread 3.26 3.22 3.15 3.31
Net interest margin 3.47 3.28 3.28 3.38
Efficiency ratio(1) 47.45 52.46 49.03 52.52
Non-interest income to average
assets 0.21 0.26 0.24 0.35
Non-interest expense to average
assets 1.66 1.73 1.62 1.82
Net operating expense to average
assets(2) 1.45 1.47 1.38 1.47
COMMON SHARE DATA
Basic net income per common share $ 1.34 $ 1.12 $ 3.66 $ 3.29
Diluted net income per common share $ 1.34 $ 1.12 $ 3.65 $ 3.29
Cash dividends paid per common share $ 0.175 $ 0.150 $ 0.525 $ 0.425
Common dividend payout ratio 13.06 % 13.37 % 14.35 % 12.91 %
_______________________________________
(1) Efficiency ratio is noninterest expense divided by the sum of net interest income and noninterest income.
(2) Net operating expense is the sum of non-interest expense offset by non-interest income.
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COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED
Summary of Financial Results The Company reported net income for the three months endedSeptember 30, 2022 of$7.6 million or diluted earnings per share of$1.34 compared to net income of$6.4 million or$1.12 per diluted earnings per share for the three months endedSeptember 30, 2021 . The Company's ROAA and ROACE were 1.31% and 15.97% for the three months endedSeptember 30, 2022 compared to 1.17% and 12.45% inSeptember 30, 2021 . Net income in the third quarter of 2022 increased 18.4% compared to the same quarter in 2021, primarily due to increased net interest income partially offset by lower noninterest income. Three Months Ended September 30, (dollars in thousands) 2022 2021 $ Change % Change Interest and dividend income $ 21,345$ 17,659 $ 3,686 20.9 % Interest expense 2,288 1,050 1,238 117.9 % Net interest income 19,057 16,609 2,448 14.7 % Provision for credit losses 694 - 694 0.0 % Provision for unfunded commitments 6 - 6 0.0 % Noninterest income 1,229 1,400 (171) (12.2) % Noninterest expense 9,626 9,447 179 1.9 % Income before income taxes 9,960 8,562 1,398 16.3 % Income tax expense 2,380 2,158 222 10.3 % Net income $ 7,580$ 6,404 $ 1,176 18.4 % Net Interest Income Net interest income is the difference between income earned on assets and interest paid on the deposits and borrowings used to fund them. Net interest income is affected by the difference 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. Net interest income, divided by average interest-earning assets, represents the Company's net interest margin. The following table shows the components of net interest income and the dollar and percentage changes for the periods presented. Three Months Ended September 30, (dollars in thousands) 2022 2021 $ Change % Change Interest and Dividend Income Loans, including fees $ 18,735$ 16,342 $ 2,393 14.6 % Taxable interest and dividends on investment securities 2,454 1,296 1,158 89.4 % Interest on deposits with banks 156 21 135 642.9 % Total Interest and Dividend Income 21,345 17,659 3,686 20.9 % Interest Expenses Deposits 1,850 594 1,256 211.4 % Short-term borrowings 52 - 52 - % Long-term debt 386 456 (70) (15.4) % Total Interest Expenses 2,288 1,050 1,238 117.9 % Net Interest Income (NII) $ 19,057$ 16,609 $ 2,448 14.7 % 46
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Average Balances and Yields
The following table sets forth average balances, average yields and costs, and
certain other information for the periods indicated. No tax-equivalent yield
adjustments were made, as the effect thereof was not material. All average
balances are daily average balances. Non-accrual loans were included in the
computation of average balances. The yields set forth below include the effect
of deferred fees, discounts and premiums that are amortized or accreted to
interest income or expense.
Three Months Ended September 30,
2022 2021
(dollars in thousands) Average Balance Interest Average Yield/Cost Average Balance Interest Average Yield/Cost
Assets
Commercial real estate $ 1,205,675 $ 13,117 4.35 % $ 1,094,089 $ 10,977 4.01 %
Residential first mortgages 82,336 715 3.47 % 100,195 742 2.96 %
Residential rentals 223,532 2,286 4.09 % 154,481 1,565 4.05 %
Construction and land development 27,770 386 5.56 % 34,810 399 4.58 %
Home equity and second mortgages 25,612 352 5.50 % 27,751 246 3.55 %
Commercial loans 52,280 865 6.62 % 44,881 547 4.88 %
Commercial equipment loans 76,392 781 4.09 % 59,964 614 4.10 %
U.S. SBA PPP loans 2,595 160 24.66 % 71,751 1,236 6.89 %
Consumer loans 5,082 73 5.75 % 1,742 16 3.67 %
Allowance for credit losses (21,667) - - % (18,852) - - %
Loan portfolio (1) 1,679,607 18,735 4.46 % 1,570,812 16,342 4.16 %
Taxable investment securities 464,560 2,338 2.01 % 370,498 1,212 1.31 %
Nontaxable investment securities 21,225 116 2.19 % 16,204 84 2.07 %
Interest-bearing deposits in other banks 18,930 85 1.80 % 36,516 16 0.18 %
Federal funds sold 11,163 71 2.54 % 30,266 5 0.07 %
Interest-Earning Assets ("IEAs") 2,195,485 21,345 3.89 % 2,024,296 17,659 3.49 %
Cash and cash equivalents 18,975 66,292
Goodwill 10,835 10,835
Core deposit intangible 788 1,226
Other assets 96,232 85,340
Total Assets $ 2,322,315 $ 2,187,989
Liabilities and Stockholders' Equity
Noninterest-bearing demand deposits $ 644,606 $ - - % $ 434,316 $ - - %
Interest-bearing demand deposits
Savings 121,450 15 0.05 % 110,873 14 0.05 %
Demand deposits 620,109 1,499 0.97 % 659,628 75 0.05 %
Money market deposits 378,251 99 0.10 % 358,017 100 0.11 %
Certificates of deposit 304,361 237 0.31 % 341,672 405 0.47 %
Total interest-bearing deposits 1,424,171 1,850 0.52 % 1,470,190 594 0.16 %
Total Deposits 2,068,777 1,850 0.36 % 1,904,506 594 0.12 %
Long-term debt - - - % 25,625 131 2.04 %
Short-term borrowings 8,310 52 2.50 % - - - %
Subordinated Notes 19,543 252 5.16 % 19,487 251 5.15 %
Guaranteed preferred beneficial interest in
junior subordinated debentures ("TRUPs") 12,000 134 4.47 % 12,000 74 2.47 %
Total Debt 39,853 438 4.40 % 57,112 456 3.19 %
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