THE COMMUNITY FINANCIAL CORPORATION Critical Accounting Policies
Critical accounting policies are defined as those that involve significant judgments and uncertainties and could potentially result in materially different results under different assumptions and conditions. The Company considers its determination of the allowance for credit losses, goodwill impairment, and the valuation of deferred tax assets to be critical accounting policies. The Company's Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted inthe United States of America and the general practices ofthe United States banking industry. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements. Accordingly, as this information changes, the financial statements could reflect different estimates, assumptions and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When these sources are not available, management makes estimates based upon what it considers to be the best available information.
Allowance for Credit Losses
OnJanuary 1, 2022 , the Company adopted ASU 2016-13 Financial Instruments - Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments, which replaced the incurred loss methodology for determining the ACL with the CECL methodology. The measurement of expected credit losses under the CECL methodology applies to financial assets subject to credit losses and measured at amortized cost, and certain off-balance sheet credit exposures. This includes, but is not limited to, loans, leases, held-to-maturity securities, loan commitments, and financial guarantees. In addition, ASU 2016-13 made changes to the accounting for available-for-sale ("AFS") debt securities. Credit-related impairments of AFS debt securities are now recognized through an allowance for credit loss rather than a write-down of the securities' amortized cost basis when management does not intend to sell or believes that it is not likely that they will be required to sell the securities prior to recovery of the securities amortized cost basis.
Allowance for Credit Losses - Loans
The allowance for credit losses ("ACL") is an estimate of the expected credit
losses for loans held for investment and off-balance sheet exposures. ASU
2016-13 replaced the incurred loss model that recognized a loss when it became
probable that a credit loss had occurred, with a model that immediately
recognizes the credit loss expected to occur over the lifetime of a financial
asset whether originated or purchased.
The ACL includes quantitative estimates of losses for collectively and
individually evaluated loans. Qualitative adjustments to the quantitative
estimate may be made using information not considered in the quantitative model.
The ACL is measured on a collective basis when similar risk characteristics
exist. Generally, collectively assessed loans are grouped by loan type code or
product type codes and assigned to a corresponding portfolio segment.
The Bank uses data to estimate expected credit losses under CECL, including
information about past events, current conditions, and reasonable and
supportable forecasts relevant to assessing the collectability of the cash flows
of the loans. Historical loss experience serves as the foundation for our
estimated credit losses. Quantitative and qualitative adjustments to our
historical loss experience are made for differences in current loan portfolio
segment credit risk characteristics such as the impact of changing unemployment
rates, changes in U.S. Treasury yields, portfolio concentrations, the volume of
classified loans, inflation, and other prevailing economic conditions and
factors that may affect the borrower's ability to repay or reduce the estimated
value of underlying collateral. This evaluation is inherently subjective, as it
requires estimates that are susceptible to significant revision as more
information becomes available.
Loans that do not share common risk characteristics with other loans are
individually assessed. Such loans include non-accrual loans, TDRs, loans
classified as substandard or worse, loans that are greater than 89 days
delinquent and any other loan identified by management for individual
assessment. Reserves on individually assessed loans are measured on a
loan-by-loan basis using one of three acceptable methods: the present value of
expected future cash flows discounted at the loan's effective interest rate, the
loan's observable market price, or the fair value of the collateral if the loan
is collateral dependent. Management assesses the ability of the borrower to
repay the loan based upon all information available. Loans are examined to
determine a specific allowance based upon the borrower's payment history,
economic conditions specific to the loan or borrower and other factors that
would impact the borrower's ability to repay the loan on its contractual basis.
Depending on the assessment of the borrower's ability to pay and the type,
condition and value of collateral, management will establish an allowance amount
specific to the loan.
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Management uses a risk scale to assign grades to commercial relationships, which include commercial real estate, residential rentals, construction and land development, commercial loans and commercial equipment loans. All commercial loan relationships are graded at inceptions and at a minimum annually. Residential first mortgages, home equity and second mortgages and consumer loans are monitored on an ongoing basis based on borrower payment history. Consumer loans and residential real estate loans are classified as unrated unless they are part of a larger commercial relationship that requires grading or are troubled debt restructures or nonperforming loans with an Other Assets Especially Mentioned or higher risk rating due to a delinquent payment history.
The Company's commercial loan portfolio is periodically reviewed by regulators and independent consultants engaged by management.
Management has significant discretion in making the judgments inherent in the determination of the allowance for credit losses, including the valuation of collateral, assessing a borrower's prospects of repayment and in establishing loss factors on the general component of the allowance. Changes in loss factors have a direct impact on the amount of the provision and on net income. Errors in management's assessment of the global factors and their impact on the portfolio could result in the ACL not being adequate to cover losses in the portfolio and may result in additional provisions. For additional information regarding the allowance for credit losses, refer to Notes 1 and 3 of the Consolidated Financial Statements and the discussion in this MD&A.
Allowance for Credit Losses - AFS Debt securities
The Company does not presently hold any HTM debt securities and therefore is not presently required to apply a CECL methodology for an HTM investment portfolio.
The impairment model for AFS debt securities measures fair value. Although ASU
No. 2016-13 replaced the legacy other-than-temporary impairment ("OTTI") model
with a credit loss model, it retained the fundamental nature of the legacy OTTI
model for AFS securities. For AFS debt securities in an unrealized loss
position, the Company first assesses whether it intends to sell, or it is more
likely than not that it will be required to sell the security before recovery of
its amortized cost basis. If either criterion is met, the security's amortized
cost basis is written down to fair value through income. For AFS debt securities
that do not meet the aforementioned criteria, the Company evaluates whether the
decline in fair value has resulted from credit losses or other factors.
In making this assessment, management considers the extent to which fair value
is less than amortized cost, any changes to the rating of the security by a
rating agency, and adverse conditions specifically related to the security,
among other factors. If this assessment indicates that a credit loss exists, the
present value of cash flows expected to be collected are compared to the
amortized cost basis of the security. If the present value of cash flows
expected to be collected is less than the amortized cost basis, a credit loss
exists and a corresponding allowance for credit losses is recorded. Changes in
the allowance for credit losses are recorded as a provision for (or reversal of)
credit losses. Losses are charged against the allowance when management believes
the uncollectibility of an AFS security is confirmed or when either of the
criteria regarding intent or requirement to sell is met. Any impairment not
recorded through an allowance for credit loss is recognized in other
comprehensive income as a noncredit-related impairment.
The Company's allowance for credit losses and the resulting provision for credit
losses involves a significant amount of management judgment and are based on the
best information available at the time.
For additional information regarding the allowance for credit losses, refer to
Notes 1 and 2 of the Consolidated Financial Statements and the discussion in
this MD&A.
Goodwill
Goodwill represents the excess of the cost of businesses acquired over the fair
value of the net assets acquired. Goodwill is assigned to reporting units and
tested for impairment at least annually in the fourth quarter or on an interim
basis if an event occurs or circumstances changed that would more likely than
not reduce the fair value of the reporting unit below its carrying value. The
Bank is the only reporting unit of the Company with intangible assets.
As there were no triggering events in 2022, no interim goodwill impairment tests
were required and management performed an annual analysis during the fourth
quarter of 2022. As of December 31, 2022 , management concluded that goodwill was
not impaired as there were no market or financial conditions that would indicate
that it was more likely than not that goodwill was impaired.
It is possible that the Company's goodwill could become impaired in future
periods due to a sustained decline in the Company's stock price or other
financial or qualitative measures. In the event that the Company concludes that
all or a portion of its goodwill is impaired, a non-cash charge for the amount
of such impairment would be recorded to earnings in that quarter. Such a charge
would have no impact on tangible capital or regulatory capital.
For additional information regarding goodwill, refer to Notes 1 and 4 of the Consolidated Financial Statements.
Deferred Tax Assets
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The Company accounts for income taxes in accordance with FASB ASC 740, "Income Taxes," which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. FASB ASC 740 requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or the entire deferred tax asset will not be realized. Management periodically evaluates the ability of the Company to realize the value of its deferred tax assets. If management were to determine that it would not be more likely than not that the Company would realize the full amount of the deferred tax assets, it would establish a valuation allowance to reduce the carrying value of the deferred tax asset to the amount it believes would be realized. The factors used to assess the likelihood of realization are the Company's forecast of future taxable income and available tax-planning strategies that could be implemented to realize the net deferred tax assets. Failure to achieve forecasted taxable income might affect the ultimate realization of the net deferred tax assets. Factors that may affect the Company's ability to achieve sufficient forecasted taxable income include, but are not limited to, the following: increased competition, a decline in net interest margin, a loss of market share, decreased demand for financial services and national and regional economic conditions. The Company's provision for income taxes and the determination of the resulting deferred tax assets and liabilities involves a significant amount of management judgment and are based on the best information available at the time. The Company operates within federal and state taxing jurisdictions and is subject to audit in these jurisdictions.
For additional information regarding income taxes and deferred tax assets, refer to Notes 1 and 14 of the Consolidated Financial Statements.
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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
Reconciliation of US 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.
The Company's management discussion and analysis contains financial information
determined by methods other than in accordance with generally accepted
accounting principles, or 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.
For the Years Ended
(dollars in thousands, except per share amounts) December 31, 2022 December 31, 2021
Total assets $ 2,410,017 $ 2,327,306
Less: intangible assets
Goodwill 10,835 10,835
Core deposit intangible 634 1,032
Total intangible assets 11,469 11,867
Tangible assets $ 2,398,548 $ 2,315,439
Total common equity $ 187,011 $ 208,133
Less: intangible assets 11,469 11,867
Tangible common equity $ 175,542 $ 196,266
Common shares outstanding at end of period 5,648,435 5,718,528
GAAP common equity to assets 7.76 % 8.94 %
Non-GAAP tangible common equity to tangible assets 7.32 % 8.48 %
GAAP common book value per share $ 33.11 $ 36.40
Non-GAAP tangible common book value per share $ 31.08 $ 34.32
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RECONCILIATION OF NON-GAAP MEASURES
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.
For the Years Ended
(dollars in thousands, except per share amounts) December
31, 2022
Net income (as reported) $ 28,317 $ 25,886 ROACE 14.76 % 12.65 % Average equity$ 191,872 $ 204,643
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.
For the Years Ended
(dollars in thousands) December 31, 2022 December 31, 2021
Net income (as reported) $ 28,317 $ 25,886
Core deposit intangible amortization (net of tax) 297 370
Net earnings applicable to common shareholders $ 28,614 $ 26,256
ROATCE 15.88 % 13.64 %
Average tangible common equity $ 180,197 $ 192,518
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COMPARISON OF RESULTS OF OPERATIONS
A comparison of the results of operations for the years ended
At or for the Years Ended
(dollars in thousands, except per share amounts) December 31, 2022 December 31, 2021
OPERATING DATA
Interest and dividend income $ 82,707 $ 70,559
Interest expenses 9,182 4,125
Net interest income ("NII") 73,525 66,434
Provision for credit losses 2,437 586
Provision for unfunded commitments 146 -
NII after provision for credit losses 70,942 65,848
Noninterest income 6,393 7,906
Noninterest expenses 39,434 39,152
Income before income taxes 37,901 34,602
Income taxes 9,584 8,716
Net income 28,317 25,886
Income available to common shares $ 28,317 $ 25,886
At or for the Years Ended
(dollars in thousands, except per share amounts) December 31, 2022 December 31, 2021
KEY OPERATING RATIOS
Return on average assets ("ROAA") 1.22 % 1.19 %
Return on average common equity ("ROACE") 14.76 12.65
Return on Average Tangible Common Equity ("ROATCE")** 15.88 13.64
Average total equity to average total assets 8.24 9.44
Interest rate spread 3.18 3.28
Net interest margin 3.38 3.34
Efficiency ratio (1) 49.34 52.67
Non-interest income to average assets 0.27 0.36
Non-interest expense to average assets 1.69 1.81
Net operating expense to average assets (2) 1.42 1.44
Average interest-earning assets to average
interest-bearing liabilities 147.05 130.61
Net charge-offs to average portfolio loans 0.03 0.11
_______________________________________
(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.
** Non-GAAP financial measure. See reconciliation of GAAP and NON-GAAP measures.
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Summary Financial Results
In 2022, profitability increased from increases in interest-earning asset yields and expense control, partially offset by increased interest expense from higher funding costs, lower non-interest income and higher provision for credit losses as the Bank transitioned from an incurred loss model to an expected loss model following the adoption of CECL in 2022. Although, the COVID-19 pandemic continued to present both economic and operational challenges in 2022, there were no customers with COVID-19 deferrals atDecember 31, 2022 . The Company improved credit quality by resolving multiple non-accrual loans, reducing nonperforming assets to 0.27% of total assets atDecember 31, 2022 compared to 0.35% atDecember 31, 2021 . During 2022, the Company delivered record earnings. We have solidified our market share and improved our deposit franchise inSouthern Maryland , establishing a strong foothold in and aroundFredericksburg, Virginia , had solid portfolio loan growth and added new technology initiatives in both markets. Net income for the year endedDecember 31, 2022 was$28.3 million or$5.00 per diluted share compared to net income of$25.9 million or$4.47 per diluted share for the year endedDecember 31, 2021 . The Company's ROAA and ROACE were 1.22% and 14.76% for the year endedDecember 31, 2022 compared to 1.19% and 12.65% for the year endedDecember 31, 2021 . The$2.4 million increase to net income in 2022 compared to 2021 included increased net interest income of$7.1 million for the comparable periods. This addition to net income was partially offset by increased loan loss provision of$1.9 million , decreased noninterest income of$1.5 million , increased income tax expense of$0.9 million , and increased noninterest expense of$0.3 million for the comparable periods. Net interest income increased in 2022 primarily due to growth in loans and increases in investment and loan yields partially offset by increased interest expense from higher funding costs. The loan loss provision increased due to loan portfolio growth and higher reserve percentages following the Company's adoption of CECL. Noninterest income decreased primarily due to the lack of gains on the sale of investment securities and reduced interest rate protection referral fee income, partially offset by a$0.7 million gain on the sale of the Bank's equity investment in Infinex. The increase in noninterest expense for the comparable periods was primarily due to increased expenses for occupancy, merger and acquisition costs, data processing and professional fees. These increases to noninterest expense were partially offset by decreased compensation, fraud losses and OREO expenses. The increase in income tax expense was due to higher pre-tax income. The Company's efficiency ratio improved (decreased) from 52.67% for the year endedDecember 31, 2021 to 49.34% for the year endedDecember 31, 2022 , as a result of expense control and increased net interest income. Management believes it is important to continue to focus on creating operating leverage. We believe our continued focus on new products and services will increase non-interest income as a percentage of revenues over time. Controlling expense growth and increasing noninterest income will better prepare the Company for changes in interest rates and credit cycles. Over the last several years, the Bank's technology strategy was instrumental in slowing the growth of expenses, expanding our customer base, and increasing profitability. Our technology goals include: protecting the data integrity of our platforms and customer information; enhancing operating efficiency; permitting management to quickly respond to unforeseen technology opportunities and challenges, and providing an improved experience for our digital customers.
Balance sheet financial highlights for 2022 include:
•OnDecember 14, 2022 , the Company entered into a definitive agreement to undertake a merger of equals pursuant to which the Company and Bank will merge into Shore Bancshares, Inc. (NASDAQ: SHBI) ("Shore") in an all-stock transaction. The combined company will have total assets of approximately$6.0 billion on a pro forma basis. Under the terms of the agreement, which was unanimously approved by the boards of directors of both companies, and which remains subject to shareholder and regulatory approval, as well as the satisfaction of customary closing conditions, holders of TCFC common stock will have the right to receive 2.3287 shares of Shore Bancshares, Inc. common stock. The merger is expected to close in the late second quarter or early third quarter of 2023.James M. Burke ,The Community Financial Corporation's current President and Chief Executive Officer, will serve as President and Chief Executive Officer of the combined company. •Gross portfolio loans increased 15.3% or$242.1 million to$1.82 billion atDecember 31, 2022 . The increase was driven by$117.3 million and$143.3 million of growth in our commercial real estate loan portfolio and residential rental loan portfolio, respectively. The increase was partially offset by a$18.3 million decrease in our construction and land development portfolio. •The Bank's expansion intoVirginia has significantly contributed to our growth over the last five years.Fredericksburg ,Spotsylvania and surrounding areas provide substantial opportunities for continued organic growth supported by our efficient operating model and ability to leverage technology. AtDecember 31, 2022 , loans in the greaterFredericksburg, Virginia area accounted for approximately 49% of the Bank's outstanding portfolio loans. In addition,Fredericksburg branch deposits were$103.7 million with an average cost of deposits of 46 basis points.
•Non-performing assets improved in 2022 comparing
•Classified assets as a percentage of assets decreased 3 basis points to 0.25%.
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•Non-accrual loans, OREO and TDRs to total assets decreased 8 basis points to 0.27%.
•Total deposits increased$32.3 million or 1.6% to$2.1 billion atDecember 31, 2022 . In 2021 and 2022, market disruptions caused by both the COVID-19 pandemic and industry consolidation assisted with organic growth and we believe industry consolidation will provide similar opportunities in 2023. The Company expects to service a wider customer base through the addition of the Bank's second full-service branch inVirginia that opened in the second quarter of 2022. Non-interest-bearing accounts and transaction accounts were 30.2% and 83.4% of deposits atDecember 31, 2022 and 21.7% and 84.1% atDecember 31, 2021 . •OnDecember 9, 2021 , the Company announced its Board of Directors approved the resumption of repurchases allowed under the stock repurchase plan originally adopted inOctober 2020 (the "2020 Repurchase Plan"). The Company was permitted to repurchase up to the 99,450 shares remaining under the 2020 Repurchase Plan using up to$4.0 million in the aggregate and up to$1.5 million in the aggregate on a quarterly basis. During 2022, the Company repurchased 90,713 shares at an average price of$39.19 per share and completed its authorization under the 2020 Repurchase Plan.
Balance sheet financial highlights for 2021 include:
•The Company's on-balance sheet liquidity improved in 2021. Total assets increased$300.9 million or 14.8% in 2021 to$2.33 billion atDecember 31, 2021 . Cash and cash equivalents increased$62.6 million , or 81.22%, to$139.7 million or 6.0% of the total assets and investments increased$251.7 million , or 100.19%, to$502.8 million or 21.6% of total assets. •Gross portfolio loans increased 5.0% or$74.7 million to$1.58 billion atDecember 31, 2021 . The increase was driven by$66.3 million and$56.0 million of growth in our commercial real estate loan portfolio and residential rental loan portfolio, respectively. The increase was partially offset by a$42.7 million decrease in our residential first mortgage portfolio.
•Non-performing assets improved in 2021 comparing
•Classified assets as a percentage of assets decreased 88 basis points to 0.22%. •Non-accrual loans, OREO and TDRs to total assets decreased 73 basis points to 0.35%.
•Total deposits increased
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 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.
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Average Balances and Yields:
The following tables set forth average balances, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effects thereof were 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. There was$0.2 million and$0.4 million of accretion interest during the years endedDecember 31, 2022 and 2021, respectively. For the Years Ended December 31, 2022 2021 Average Average (dollars in thousands) Average Balance Interest Yield/Cost Average Balance Interest Yield/Cost
Assets
Commercial real estate$ 1,179,776 $ 50,706 4.30 %$ 1,085,823 $ 43,536 4.01 % Residential first mortgages 83,485 2,889 3.46 % 107,011 3,250 3.04 % Residential rentals 234,800 9,509 4.05 % 151,606 6,180 4.08 % Construction and land development 27,947 1,496 5.35 % 36,891 1,658 4.49 % Home equity and second mortgages 25,774 1,298 5.04 % 28,051 977 3.48 % Commercial loans 42,303 2,708 6.40 % 46,390 2,032 4.38 % Commercial equipment loans 71,416 2,937 4.11 % 60,845 2,567 4.22 % SBA PPP loans 8,770 960 10.95 % 82,901 5,203 6.28 % Consumer loans 4,590 235 5.12 % 1,783 73 4.09 % Allowance for credit losses (21,593) - - % (18,788) - - % Loan portfolio 1,657,268 72,738 4.39 % 1,582,513 65,476 4.14 % Taxable investment securities 469,393 9,046 1.93 % 336,267 4,623 1.37 % Nontaxable investment securities 20,325 442 2.17 % 17,515 369 2.11 % Interest-bearing deposits in other banks 24,844 319 1.28 % 33,095 70 0.21 % Federal funds sold 6,371 162 2.54 % 20,916 21 0.10 % Interest-Earning Assets ("IEAs") 2,178,201 82,707 3.80 % 1,990,306 70,559 3.55 % Cash and cash equivalents 43,993 78,849 Goodwill 10,835 10,835 Core deposit intangible 840 1,290 Other assets 94,732 86,579 Total Assets$ 2,328,601 $ 2,167,859 42
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Average Balances and Yields: (Continued)
For the Years Ended December 31,
2022 2021
Average Average
(dollars in thousands) Average Balance Interest Yield/Cost Average Balance Interest Yield/Cost
Liabilities and Stockholders' Equity
Noninterest-bearing demand deposits $ 634,805 $ - - % $ 417,935 $ - - %
Interest-bearing deposits
Savings 121,975 92 0.08 % 108,189 54 0.05 %
Demand deposits 621,755 5,133 0.83 % 660,330 345 0.05 %
Money market deposits 376,039 523 0.14 % 358,006 397 0.11 %
Certificates of deposit 313,429 1,463 0.47 % 342,755 1,805 0.53 %
Total interest-bearing deposits 1,433,198 7,211 0.50 % 1,469,280 2,601 0.18 %
Total Deposits 2,068,003 7,211 0.35 % 1,887,215 2,601 0.14 %
Long-term debt 3,848 48 1.25 % 23,072 219 0.95 %
Short-term borrowings 12,696 426 3.36 % - - - %
Subordinated notes 19,536 1,006 5.15 % 19,488 1,006 5.16 %
Guaranteed preferred beneficial interest
in junior subordinated debentures 12,000 491 4.09 % 12,000 299 2.49 %
Total Debt 48,080 1,971 4.10 % 54,560 1,524 2.79 %
Interest-Bearing Liabilities ("IBLs") 1,481,278 9,182 0.62 % 1,523,840 4,125 0.27 %
Total funds 2,116,083 9,182 0.43 % 1,941,775 4,125 0.21 %
Other liabilities 20,646 21,441
Stockholders' equity 191,872 204,643
Total Liabilities and Stockholders'
Equity $ 2,328,601 $ 2,167,859
Net interest income $ 73,525 $ 66,434
Interest rate spread 3.18 % 3.28 %
Net yield on interest-earning assets 3.38 % 3.34 %
Average loans to average deposits 80.14 % 83.85 %
Average transaction deposits to total
average deposits ** 84.84 % 81.84 %
Ratio of average IEAs to average IBLs 147.05 % 130.61 %
_______________________________________
** Transaction deposits exclude time deposits.
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The tables below summarize changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to (1) changes in volume (changes in volume multiplied by old rate); and (2) changes in rate (changes in rate multiplied by old volume). Changes in rate-volume (changes in rate multiplied by the change in volume) have been allocated to changes due to volume. Years Ended December 31, 2022 and December 31, 2021 Changes Due To (dollars in thousands) Volume Rate Total Interest income: Loan portfolio Commercial real estate$ 4,040 $ 3,130 $ 7,170 Residential first mortgages (814) 453 (361) Residential rentals 3,369 (40) 3,329 Construction and land development (479) 317 (162) Home equity and second mortgages (115) 436 321 Commercial loans (261) 937 676 Commercial equipment loans 434 (64) 370 SBA PPP loans (8,117) 3,874 (4,243) Consumer loans 144 18 162 Taxable investment securities 2,569 1,854 4,423 Nontaxable investment securities 61 12 73 Interest-bearing deposits in other banks (106) 355 249 Federal funds sold (369) 510 141 Total interest-earning assets$ 356
Interest-bearing liabilities: Savings$ 11 $ 27 $ 38 Demand deposits (320) 5,108 4,788 Money market deposits 25 101 126 Certificates of deposit (138) (204) (342) Long-term debt (240) 69 (171) Short-term borrowings 427 (1) 426 Subordinated notes 2 (2) -
Guaranteed preferred beneficial interest in junior subordinated debentures
- 192 192
Total interest-bearing liabilities $ (233) Net change in net interest income$ 589
Net interest income totaled$73.5 million for the year endedDecember 31, 2022 , which represents a 10.7% increase from$66.4 million for the year endedDecember 31, 2021 . Net interest income increased during 2022 compared to the prior year as the positive impacts of higher yields earned on loans and investments and average interest-earning asset growth, outpaced the negative impact of increased funding costs and decreasedU.S. SBA PPP loan income. The Bank continues to concentrate our efforts to expand the number of lower cost transaction deposits balances and relationships. Non-interest bearing accounts and transaction accounts represented 30.2% and 83.4% of deposits atDecember 31, 2022 compared to 21.7% and 84.1% atDecember 31, 2021 . Net interest margin of 3.38% for the year endedDecember 31, 2022 , was 4 basis points higher than the 3.34% for the year endedDecember 31, 2021 . Increased net interest margin resulted primarily from the Company's interest earning asset yields (25 basis points) increasing at a slightly faster rate than overall funding costs (22 basis points). The sharp increase in interest rates in 2022 due to theFederal Open Market Committee ("FOMC") actions resulted in increased interest income on floating-rate loans and liquid interest-earning assets and investments. TheFOMC actions also enhanced competitive pressures and depositor expectations concerning deposit interest rates. Management expects that interest-bearing deposit accounts will reprice faster than loans and investments in the first six months of 2023 based on late fourth quarter 2022 trends. This expectation is primarily based on the assumption that theFederal Reserve will discontinue interest rate increases in the second half of 2022. Based on this assumption, margins could compress to between 3.10% and 3.40% in the first half of 2023 before stabilizing in the second half of 2023.
Average total earning assets increased 9.4%, for the year ended
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endedDecember 31, 2021 . Average loans increased a$74.8 million with growth in commercial real estate and residential rental loans, partially offset by reductions inU.S. SBA PPP and residential first mortgage loans. Interest income increased$12.1 million for the year endedDecember 31, 2022 compared to the same period of 2021. The increase in interest income resulted from higher interest yields accounting for$11.8 million , and larger average balances of interest-earning assets contributing$0.4 million . Average total interest-bearing liabilities decreased 2.8%, for the year endedDecember 31, 2022 to$1.48 billion compared to$1.52 billion for the year endedDecember 31, 2021 . Interest expense increased$5.1 million for the year endedDecember 31, 2022 compared to the same period of 2021. Interest expense increased$5.3 million due to higher interest rates, partially offset by$0.2 million reduction from decreased balances of interest-bearing liabilities. The Bank's success at increasing transaction accounts, and in particular the increases in noninterest-bearing accounts, was an important factor in managing net interest margin in 2022. In addition, the decrease in time deposits positively impacted margins. During the year endedDecember 31, 2022 , average noninterest-bearing demand deposits increased$216.9 million , or 51.9% to$634.8 million . Average transaction accounts increased$210.1 million or 13.6% to$1.75 billion from$1.54 billion for the year endedDecember 31, 2021 . During the same timeframe average time deposits decreased$29.3 million or 8.6%, to$313.4 million for the year endedDecember 31, 2022 . Funding costs increased at a faster rate as the percentage of funding coming from transaction accounts increased from 79.5% for the year endedDecember 31, 2021 to 82.9% for the year endedDecember 31, 2022 . Interest income accretion on acquired loans contributed$0.2 million and$0.4 million to interest income in 2022 and 2021, respectively.U.S. SBA PPP interest income contributed$1.0 million in 2022 compared to$5.2 million in 2021. For the year endedDecember 31, 2022 , net interest margin increased four basis points as a result of netU.S. SBA PPP loan interest income recognition compared to increased net interest margin of 13 basis points for the year endedDecember 31, 2021 . In the last six months of 2021, interest expense increased by$0.1 million due to prepayment fees recognized on the early repayment of$15.0 million of higher-rate long-term FHLB advances. There were no comparable transactions in 2022. Interest rates increased in 2022 as theFOMC worked to mitigate the impact of inflation on theU.S. economy. TheFOMC increased the Fed Funds rate from 0% atDecember 2021 to the current rate of 4.50% to 4.75% inMarch 2023 . The below table illustrates how the Company's average rates responded during the five quarters endingDecember 31, 2022 and provides a summary of the Company's margins throughout 2022:
Three Months Ended
December 31, 2022 September
30, 2022
3.24 % 3.26 % 3.14 % 3.05 % 3.17 %
Net interest margin 3.64 % 3.47 % 3.25 % 3.12 % 3.22 %
Loan Yields 4.92 % 4.46 % 4.13 % 3.99 % 4.13 %
Cost of funds 0.89 % 0.43 % 0.23 % 0.17 % 0.17 %
Cost of deposits 0.77 % 0.36 % 0.16 % 0.10 % 0.11 %
Provision for Credit Losses
The following table shows the provision for credit losses for the periods
presented.
Years Ended December 31,
(dollars in thousands) 2022 2021
Provision for credit losses $ 2,437 $ 586
The provision for credit losses is a function of the calculation of the
allowance for credit losses on the Company's end of period loan portfolios. See
further discussion of the provision and the allowance under the caption "Asset
Quality" in the Comparison of Financial Condition section of this MD&A.
See further discussion of the provision under the Asset Quality section in the Comparison of Financial Condition section of MD&A.
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Noninterest Income
The following table shows the components of noninterest income and the dollar and percentage changes for the periods presented.
Years Ended December 31,
(dollars in thousands) 2022 2021 $ Change % Change
Noninterest Income
Loan appraisal, credit, and miscellaneous
charges $ 422 $ 528 $ (106) (20.1) %
Gain on sale of assets 695 68 627 922.1 %
Net gains on sale of investment securities - 586 (586) (100.0)
Unrealized (loss) gain on equity securities (555) (139) (416) 299.3 %
Loss on premises and equipment held for sale - (25) 25 (100.0)
Income from bank owned life insurance 870 871 (1) (0.1) %
Service charges 4,379 4,301 78 1.8 %
Referral fee income 375 1,822 (1,447) (79.4)
Net (loss) gain on sale of loans originated
for sale (2) 85 (87) (102.4)
Gain (loss) on sale of loans 209 (191) 400 (209.4)
Total Noninterest Income $ 6,393 $ 7,906 $ (1,513) (19.1) %
Noninterest income for the year ended December 31, 2022 decreased compared to
the year ended December 31, 2021 primarily due to gains on the sale of
investment securities in 2021, decreased referral fee income and unrealized
losses on securities invested in a Community Reinvestment Act mutual fund that
was impacted by increases in interest rates. These reductions for the comparable
periods were partially offset by a $0.7 million gain on the sale of the Bank's
equity investment in Infinex, and an increase in noninterest income related to
the sale of impaired loans. Noninterest income decreased from 0.36% of average
assets in 2021 to 0.27% of average assets in 2022.
There were $11.9 million of securities sold during the year ended December 31,
2021 for net gains of $0.6 million . There were no comparable sales during the
year ended December 31, 2022 .
The Bank refers customers to a third-party financial institution that offers
interest rate protection for the length of a loan. This product has enabled the
Bank to be more rate competitive with larger institutions in our market area
without increasing interest rate risk. The rapid increase in interest rates
during 2022 impacted interest rate protection agreement referral fee
opportunities. As a result, referral fee income decreased 79% from 2021 to 2022.
In the first quarter of 2021, the Bank sold non-accrual and classified
commercial real estate and residential mortgage loans and recognized a loss on
the sale of $0.2 million , and in the second quarter of 2022, impaired loan sales
resulted in a gain of $0.2 million .
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Noninterest Expense
The following tables show the components of noninterest expense and the dollar and percentage changes for the periods presented.
Years Ended December 31,
(dollars in thousands) 2022 2021 $ Change % Change
Noninterest Expense
Compensation and benefits $ 20,806 $ 21,035 $ (229) (1.1) %
OREO valuation allowance and expenses 6 1,456 (1,450) (99.6) %
Merger and acquisition costs 1,004 - 1,004 - %
Sub-total 21,816 22,491 (675) (3.0) %
Operating Expenses
Occupancy expense 3,212 2,836 376 13.3 %
Advertising 549 500 49 9.8 %
Data processing expense 4,126 3,772 354 9.4 %
Professional fees 3,490 2,857 633 22.2 %
Depreciation of premises and equipment 657 558 99 17.7 %
FDIC insurance 701 602 99 16.4 %
Core deposit intangible amortization 398 495 (97) (19.6) %
Fraud losses 286 1,260 (974) (77.3) %
Other expenses 4,199 3,781 418 11.1 %
Total Operating Expenses $ 17,618 $ 16,661 $ 957 5.7 %
Total Noninterest Expense $ 39,434 $ 39,152 $ 282 0.7 %
The 0.7% increase in non-interest expense for the comparable periods was
primarily due to increased expenses for merger and acquisition costs, occupancy,
data processing and professional fees. These increases to noninterest expense
were partially offset by decreased compensation, fraud losses and OREO expenses.
Compensation and benefits were lower for the comparative periods due to lower
health insurance claims, a lower average full time equivalent ("FTE") count than
the prior year and decreases in certain compensation plan accruals. The decrease
attributed to the lower average FTE count was partially offset by the Company's
decision in the second quarter of 2022 to increase base compensation by 4% and
its minimum starting wage to $20.00 per hour for non-executive employees to
address local wage pressure caused by inflation and to attract and retain our
employees. In addition, compensation and benefits expense has benefited from the
Company's increased use of technology. The Bank's overall full time equivalent
("FTE") head count fluctuated between 190 and 199 employees for the year ended
December 31, 2022 .
During 2022, data processing, professional fees, and occupancy costs increased
substantially compared to the prior year due in large part to the increased cost
of labor and materials due to inflation. Additionally, the occupancy costs
increased during the second half of 2022 with the opening of a new branch in
Fredericksburg - Harrison Crossing , Virginia . These increases were partially
offset by a decrease of $0.8 million in OREO expense recognized in the fourth
quarter of 2021.
Fraud losses in 2021 include a $1.2 million charge, net of a partial recovery,
related to an isolated wire transfer fraud incident that occurred in the first
quarter of 2021. Our investigation found no evidence that information systems of
the Bank were compromised or that employee fraud was involved.
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The following is a breakdown of OREO expense for the years endedDecember 31, 2022 and 2021: Years Ended December 31, (dollars in thousands) 2022 2021 $ Change % Change Valuation allowance $ -$ 1,387 $ (1,387) (100.0) % Losses (gains) on dispositions - (17) 17 (100.0) % Operating expenses 6 86 (80) (93.0) %$ 6 $ 1,456 $ (1,450) (99.6) %
The decreased OREO expense during the year ended
For the year endedDecember 31, 2022 the efficiency ratio and net operating expense to average asset ratio were 49.34% and 1.42%, respectively compared to 52.67% and 1.44%, respectively, for the year endedDecember 31, 2021 . Management remains committed to controlling expenses through leveraging technology to employ scalable solutions. For the years endedDecember 31, 2022 and 2021, the Company recorded income tax expense of$9.6 million and$8.7 million , respectively. The Company's consolidated effective tax rate for 2022 was 25.3% compared to 25.2% for the year endedDecember 2021 . 48
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COMPARISON OF FINANCIAL CONDITION AT
The following table shows selected historical consolidated financial data for
the Company, which has been derived from our audited consolidated financial
statements. You should read this table together with our consolidated financial
statements and related notes included in this Annual 10-K report.
At or for the Years Ended
(dollars in thousands, except per share amounts) December 31, 2022 December 31, 2021
FINANCIAL CONDITION DATA
Total assets $ 2,410,017 $ 2,327,306
Loans receivable, net 1,798,517 1,586,791
Investment securities 467,239 502,818
Goodwill 10,835 10,835
Core deposit intangible 634 1,032
Deposits 2,088,463 2,056,164
Borrowings 79,000 12,231
Junior subordinated debentures 12,000 12,000
Subordinated notes - 4.75%, net of debt issuance costs 19,566 19,510
Stockholders' equity - common 187,011 208,133
At or for the Years Ended
(dollars in thousands, except per share amounts) December 31, 2022 December 31, 2021
COMMON SHARE DATA
Basic earnings per common share $ 5.01 $ 4.47
Diluted earnings per common share 5.00 4.47
Dividends declared per common share 0.70 0.58
Common dividend payout ratio 13.97 12.86
Book value per common share 33.11 36.40
Tangible book value per common share 31.08 34.32
Common shares outstanding at end of period 5,648,435 5,718,528
Basic weighted average common shares 5,652,189 5,788,003
Diluted weighted average common shares 5,659,629 5,797,525
OTHER DATA
Full-time equivalent employees 196 186
Full-service offices 12 11
Loan Production Offices 4 4
CAPITAL RATIOS
Tier 1 capital to average assets (Leverage) 9.60 % 9.23 %
Tier 1 common capital to risk-weighted assets 11.26 11.92
Tier 1 capital to risk-weighted assets 11.87 12.64
Total risk-based capital to risk-weighted assets 14.08 14.92
Common equity to assets 7.76 8.94
Tangible common equity to tangible assets 7.32 8.48
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Assets
Total assets increased$82.7 million or 3.55% to$2.41 billion atDecember 31, 2022 fromDecember 31, 2021 primarily due to net loan growth. Cash decreased$114.2 million , or 81.76%, to$25.5 million and was used to fund net loan growth. Available for sale ("AFS") securities, which are reported at fair value, decreased$35.6 million , or 7.08%, to$467.2 million , primarily due to unrealized losses from rising interest rates during 2022. Correspondingly, deferred tax assets increased$15.6 million to$24.7 million primarily due to increases in unrealized losses of the Bank's AFS investment portfolio related to changes in interest rates. Deferred tax assets also increased due to the adoption of the current expected credit losses ("CECL") accounting standard onJanuary 1, 2022 . Cash and Cash Equivalents Cash and cash equivalents totaled$25.5 million atDecember 31, 2022 , compared to$139.7 million atDecember 31, 2021 . Total cash and cash equivalents fluctuate due to transactions in process and other liquidity demands. Management believes liquidity needs are satisfied by the current balance of cash and cash equivalents, readily available access to traditional and wholesale funding sources, and the portions of the investment and loan portfolios that mature within one year.
Investment securities and FHLB stock at
Management monitors and manages investment portfolio performance and liquidity through monthly reporting including analyses of expected cash inflows and outflows from investment securities. Management believes the risk characteristics inherent in the investment portfolio are acceptable. The Company did not hold any noninvestment grade securities atDecember 31, 2022 andDecember 31, 2021 . AFS securities are evaluated quarterly to determine whether a decline in their value is the result of a deterioration in credit quality. A reserve for credit losses was not recorded for the periods reported. Gross unrealized losses atDecember 31, 2022 andDecember 31, 2021 for AFS securities were$58.4 million and$6.0 million , respectively, of amortized cost of$521.0 million and$500.5 million , respectively (see Note 2 in Consolidated Financial Statements). The change in unrealized losses was the result of changes in interest rates and other non-credit related factors, while credit risks remained stable. The Company intends to, and has the ability to, hold investment securities with unrealized losses until they mature, at which time the Company will receive full value for the securities. Management believes that the investment securities with unrealized losses will either recover in market value or be paid off as agreed. The Bank holds 68.0% or$354.2 million (amortized cost) of its AFS investment securities, as asset-backed securities issued by GSEs orU.S. Agencies, GSE agency bonds orU.S. government obligations. In addition, the Company's investment of$49.6 million (amortized cost) in student loan trusts, which represent 9.5% of the AFS investment portfolio, are 97%U.S. government guaranteed. AtDecember 31, 2022 , the Company also had$99.8 million or 19.2% of AFS investments in municipal bonds. AtDecember 31, 2022 andDecember 31, 2021 , AFS asset-backed securities issued and guaranteed by GSEs andU.S. Agencies had average lives of 6.02 years and 6.91 years, and average durations of 5.00 years and 6.41 years, respectively. AtDecember 31, 2022 andDecember 31, 2021 , AFS asset-backed securities issued by student loan trust and others had an average life of 6.01 years and 6.24 years, and an average duration of 4.83 years and 6.03 years, respectively. AFS municipal bonds issued by states, political subdivisions or agencies had an average life of 10.51 years and 8.75 years and an average duration of 8.72 years and 7.83 years atDecember 31, 2022 andDecember 31, 2021 , respectively. 50
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The amortized cost of AFS investment securities by contractual maturity atDecember 31, 2022 are shown below. Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties. The maturities and weighted average yields atDecember 31, 2022 are shown below. One year or Less After One Through Five Years After Five Through Ten Years After Ten Years Total Investment
Securities
Amortized Average Average Average Average
(dollars in thousands) Cost Yield Amortized Cost Yield Amortized Cost Yield Amortized Cost Yield Amortized Cost Fair Value
AFS Investment securities:
Asset-backed securities issued
by GSEs and U.S. Agencies $ 21,592 3.51 % $ 83,129 3.48 % $ 139,511 3.37 % $ 73,192 3.10 % $ 317,424 $ 285,439
Asset-backed securities issued by Others 4,228 4.26 % 16,278 4.21 % 27,320 3.98 % 14,333 3.45 % 62,159 59,518 Municipal securities 6,786 2.50 % 26,127 2.50 % 43,849 2.50 % 23,004 2.90 % 99,766 79,618 Corporate bonds 331 4.03 % 1,274 4.03 % 2,137 4.03 % 1,121 - % 4,863 4,404U.S. Treasury bonds 2,504 1.17 % 9,641 1.24 % 16,180 1.23 % 8,488 - % 36,813 33,767 Total AFS investment securities$ 35,441 3.24 %$ 136,449 3.21 %$ 228,997 3.11 %$ 120,138 3.08 %$ 521,025 $ 462,746 The tables below present theStandard & Poor's ("S&P") or equivalent credit rating from other major rating agencies for AFS investment securities by carrying value atDecember 31, 2022 andDecember 31, 2021 . The Company considers noninvestment grade securities rated BB+ or lower as classified assets for regulatory and financial reporting. GSE asset-backed securities and GSE agency bonds with S&P AA+ ratings were treated asAAA based on regulatory guidance. December 31, 2022 December 31, 2021 Credit Rating Amount Credit Rating Amount (dollars in thousands) (dollars in thousands) AAA$ 425,907 AAA$ 456,162 AA 32,297 AA 41,455 A 138 A 222 BBB 4,404 BB - Total$ 462,746 Total$ 497,839 51
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Loan Portfolio and
The Bank's primary market areas consist of the tri-county area inSouthern Maryland , the city ofFredericksburg, Virginia andSpotsylvania ,Stafford andOrange counties inVirginia . In 2021, the Bank increased lending inVirginia in the cities and surrounding areas ofCulpeper ,Orange andCharlottesville . The Bank opened a loan production office inCharlottesville, Virginia in 2022. AtDecember 31, 2022 , loans inMaryland andVirginia are almost evenly distributed with approximately 49% of the Bank's outstanding portfolio loans in our expandingVirginia market. Management is optimistic that theVirginia market will continue to provide opportunities for organic growth. In 2022, net loans increased$211.7 million primarily due to growth in commercial and residential rental portfolios being offset byU.S. SBA PPP loan forgiveness and decreases in construction and land development and residential first mortgages portfolios. Total portfolio loans which include all loans except theU.S. SBA PPP loans, grew to$1.82 billion as ofDecember 31, 2022 from$1.58 billion as ofDecember 31, 2021 , with commercial portfolios increasing$250.1 million or 17.1% and consumer and residential mortgages portfolios decreasing$8.0 million or 6.7%.
During 2020 and 2021, the Company originated 1,532
The following is a breakdown of the Company's loan portfolio, net of deferred
costs and fees at
At December 31,
2022 2021
(dollars in thousands) Balance % Balance % $ Change % Change
Portfolio Loans:
Commercial real estate $ 1,232,826 67.69 % $ 1,113,793 70.54 % $ 119,033 10.69 %
Residential first mortgages 79,872 4.39 % 92,710 5.87 % (12,838) (13.85) %
Residential rentals 338,292 18.58 % 194,911 12.35 % 143,381 73.56 %
Construction and land
development 17,259 0.95 % 35,502 2.25 % (18,243) (51.39) %
Home equity and second
mortgages 25,602 1.41 % 25,661 1.63 % (59) (0.23) %
Commercial loans 42,055 2.31 % 50,512 3.20 % (8,457) (16.74) %
Consumer loans 6,272 0.34 % 3,015 0.19 % 3,257 108.03 %
Commercial equipment 78,890 4.33 % 62,706 3.97 % 16,184 25.81 %
Total portfolio loans 1,821,068 100.00 % 1,578,810 100.00 % 242,258 15.34 %
Less: Allowance for credit
losses (22,890) (1.26) % (18,417) (1.17) % (4,473) 24.29 % Total net portfolio loans 1,798,178 1,560,393 237,785 15.24 % U.S. SBA PPP loans 339 26,398 (26,059) (1) Total net loans$ 1,798,517 $ 1,586,791 $ 211,726 -
_______________________________________
**
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Maturity of Loan Portfolio
The following table sets forth information atDecember 31, 2022 regarding the dollar amount of loans maturing in the Bank's portfolio based on their contractual terms to maturity. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less.December 31, 2022 Due After 5 (dollars in thousands) Due in 1 Year Due After 1 Year Years Through 15 Due After 15 Total Loans and Description of Asset or Less Through 5 Years Years Years Leases Real Estate Loans Commercial$ 111,521 $ 241,698 $ 649,900 $ 229,707 $ 1,232,826 Residential first mortgage 4,644 14,374 41,360 19,494 79,872 Residential rentals 7,357 48,197 122,205 160,533 338,292 Construction and land development 13,608 3,651 - - 17,259 Home equity and second mortgage 1,404 3,994 14,536 5,668 25,602 Commercial loans 42,055 - - - 42,055 Consumer loans 4,999 984 289 - 6,272 Commercial equipment 20,097 55,601 3,192 - 78,890 Total portfolio loans$ 205,685 $ 368,499 $ 831,482 $ 415,402 $ 1,821,068 U.S. SBA PPP loans 103 236 - - 339 Total portfolio loans$ 205,788 $ 368,735 $ 831,482 $ 415,402 $ 1,821,407
The following table sets forth the dollar amount of all loans due after one year
from
December 31, 2022 (dollars in thousands) Floating or Description of Asset Fixed Rates Adjustable Rates Total Real Estate Loans Commercial$ 142,475 $ 978,830 $ 1,121,305 Residential first mortgage 61,585 13,643 75,228 Residential rentals 31,482 299,453 330,935 Construction and land development 3,582 69 3,651 Home equity and second mortgage 8 24,190 24,198 Consumer loans 1,273 - 1,273 Commercial equipment 17,293 41,500 58,793 Gross portfolio loans$ 257,698 $ 1,357,685 $ 1,615,383 U.S. SBA PPP loans 236 - 236 Total portfolio loans$ 257,934 $ 1,357,685 $ 1,615,619 Loan Concentrations AtDecember 31, 2022 and 2021 commercial loans, which include commercial real estate, residential rentals, commercial equipment and commercial loans, represented 92.9% and 90.1%, respectively, of total portfolio loans. The Bank's commercial loans are concentrated in our market area; however, these loans are distributed among many different borrowers in numerous industries. Non-owner-occupied commercial real estate as a percentage of risk-based capital atDecember 31, 2022 and 2021 were$1,032.6 million or 380.9% and$813.0 million or 331.4%, respectively. Construction loans as a percentage of risk-based capital atDecember 31, 2022 and 2021 were$135.0 million or 49.8% and$140.4 million or 57.2%, respectively. 53
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Asset Quality
The following table shows asset quality information and ratios at and for the
years ended
At or for the Years Ended December 31,
(dollars in thousands) 2022 2021
SELECTED ASSET QUALITY DATA
Gross portfolio loans $ 1,821,068 $ 1,578,943
Classified assets 6,115 5,211
Allowance for credit losses 22,890 18,417
Past due loans - 31 to 89 days 604 568
Past due loans >=90 days (1) 438 961
Total past due loans 1,042 1,529
Non-accrual loans (2) 6,115 7,631
Accruing troubled debt restructures (TDRs) (3) 429 447
Other Real Estate Owned (OREO) - -
Non-accrual loans, OREO and TDRs $ 6,544 $ 8,078
SELECTED ASSET QUALITY RATIOS (4)
Classified assets to total assets 0.25 % 0.22 %
Classified assets to risk-based capital 2.23 2.10
Allowance for credit losses to portfolio loans 1.26 1.17
Allowance for credit losses to non-accrual loans 374.33 241.34
Past due loans - 31 to 89 days to portfolio loans 0.03 0.04
Past due loans >=90 days to portfolio loans 0.02 0.06
Total past due (delinquency) to portfolio loans 0.06 0.10
Non-accrual loans to portfolio loans 0.34 0.48
Non-accrual loans and TDRs to portfolio loans 0.36 0.51
Non-accrual loans and OREO to total assets 0.25 0.33
Non-accrual loans and OREO to portfolio loans and OREO 0.34 0.48
Non-accrual loans, OREO and TDRs to total assets 0.27 0.35
___________________________________________
(1) Nonperforming loans include all loans that are 90 days or more delinquent. (2) Non-accrual loans include all loans that are 90 days or more delinquent and loans that are non-accrual due to the operating results or cash flows of a customer. (3) TDR loans include both non-accrual and accruing performing loans. All TDR loans are included in the calculation of asset quality financial ratios. Non-accrual TDR loans are included in the non-accrual balance and accruing TDR loans are included in the accruing TDR balance. (4) Portfolio loans include all loan portfolios except theU.S. SBA PPP loan portfolio. Asset quality ratios for loans excludeU.S. SBA PPP loans. 54
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Allowance for Credit Losses ("ACL") and Provision for Credit Losses ("PCL")
The following is a breakdown of the Company's general and specific allowances as
a percentage of total portfolio loans at
Breakdown of general and specific allowance as a percentage of total portfolio
loans (1)
December 31, 2022 December 31, 2021
General allowance $ 22,781 $ 18,151
Specific allowance 109 266
$ 22,890 $ 18,417
General allowance 1.25 % 1.15 %
Specific allowance 0.01 % 0.02 %
Allowance to total portfolio loans (1) 1.26 % 1.17 %
Allowance to non-acquired total portfolio loans (2) n/a 1.20 %
Total acquired loans (2) n/a $ 42,182
Non-acquired loans**(2) n/a $ 1,536,761
Total portfolio loans $ 1,821,068 $ 1,578,943 ____________________________________
**Non-acquired loans include loans transferred from acquired pools following release of acquisition accounting FMV adjustments. Non-acquired loans excludeU.S. SBA PPP loans. (1)Portfolio loans include all loan portfolios except theU.S. SBA PPP loan portfolio. (2)Allowance to non-acquired loans is no longer relevant as the ACL considers all portfolio loans. OnJanuary 1, 2022 , the Company adopted ASU 2016-13 and implemented the current expected credit loss model ("CECL"). The ACL is a valuation account that is deducted from loans' amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged-off against the allowance when management believes the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. The Bank uses data to estimate expected credit losses under CECL, including information about past events, current conditions, and reasonable and supportable forecasts relevant to assessing the collectability of the cash flows of the loans. Historical loss experience serves as the foundation for our estimated credit losses. Adjustments to our historical loss experience are made for differences in current loan portfolio segment credit risk characteristics such as the impact of changing unemployment rates, changes inU.S. Treasury yields, portfolio concentrations, the volume of classified loans, and other prevailing economic conditions and factors that may affect the borrower's ability to repay, or reduce the estimated value of any underlying collateral. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.
We adopted ASU 2016-13 using the modified retrospective method. Results for
reporting periods beginning after
Upon the adoption of ASC 326, the Company recorded a$2.5 million increase to the ACL. ACL balances increased to 1.26% of portfolio loans atDecember 31, 2022 compared to 1.17% atDecember 31, 2021 . AtDecember 31, 2022 , the Company's ACL increased$4.5 million or 24.3% to$22.9 million from$18.4 million atDecember 31, 2021 . The increase in the general allowance was primarily related to the impact of adoption of ASC 326 and portfolio loan growth. The Company recorded a provision for credit losses of$2.4 million for the year endedDecember 31, 2022 compared to$0.6 million for the year endedDecember 31, 2021 . Net charge-offs decreased$1.1 million from$1.6 million or 0.11% of average loans for the year endedDecember 31, 2021 to$0.5 million or 0.03% of average loans for the year endedDecember 31, 2022 . During the year endedDecember 31, 2021 , the Bank sold non-accrual and classified commercial real estate and residential mortgage loans with an amortized cost of$9.1 million , net of charge-offs of$1.4 million , and recognized a loss on the sale of$0.2 million . During the year endedDecember 31, 2022 , the Bank sold non-accrual and classified commercial real estate and residential mortgage loans with an amortized cost of$3.4 million , net of charge-offs of$0.4 million , and recognized a gain on the sale of$0.2 million . Management believes that the allowance is adequate atDecember 31, 2022 . The ACL as a percent of total loans may increase or decrease in future periods based on economic conditions. Management's determination of the adequacy of the allowance is based on a periodic 55
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evaluation of the portfolio. For additional information regarding the allowance for credit losses, refer to Notes 1 and 3 of the Consolidated Financial Statements and the Critical Accounting Policy section of the MD&A.
The following table allocates the allowance for credit losses by portfolio loan
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.
At December 31,
2022 2021
(dollars in thousands) Amount % (1) Amount % (1)
Commercial real estate $ 17,650 67.69 % $ 13,095 70.66 %
Residential first mortgages 207 4.39 % 1,002 5.77 %
Residential rentals 3,061 18.58 % 2,175 12.35 %
Construction and land development 160 0.95 % 260 2.25 %
Home equity and second mortgages 126 1.41 % 274 1.62 %
Commercial loans 190 2.31 % 582 3.20 %
Consumer loans 154 0.34 % 58 0.19 %
Commercial equipment 1,342 4.33 % 971 3.96 %
U.S. SBA PPP loans - - % - - %
Total allowance for credit losses
100.00 %
_______________________________________
(1) Percent of loans in each category to total portfolio loans
The following table indicates net charge-offs by average portfolio loan category for the years ended as indicated:
At or for the Years Ended
2022 2021
(dollars in thousands) Net Charge-off Average Balance % Net Charge-off Average Balance %
Commercial real estate $ 264 $ 1,179,776 0.02 % $ 1,914 $ 1,085,823 0.18 %
Residential first mortgages 97 83,485 0.12 142 107,011 0.13
Residential rentals - 234,800 - 46 151,606 0.03
Construction and land
development - 27,947 - - 36,891 -
Home equity and second mortgages (1) 25,774 - (5) 28,051 (0.02)
Commercial loans 97 42,303 0.23 (467) 46,390 (1.01)
Consumer loans 49 4,590 1.07 - 1,783 -
Commercial equipment (46) 71,416 (0.06) (37) 60,845 (0.06)
460 1,670,091 0.03 1,593 1,518,400 0.10
Allowance for credit losses - (21,593) - - (18,788) -
Total net charge-off and average
portfolio loans $ 460 $ 1,648,498 0.03 % $ 1,593 $ 1,499,612 0.11 %
Off Balance Sheet Credit Exposure Reserve
The Company's reserve for off balance sheet credit exposures was$0.4 million and increased due to impact of the ASC 326 adoption and growth in unfunded commitments for residential rental loans. The Company is monitoring line of credit usage and has not seen substantive increases in usage or expected usage. Management believes that many of the Bank's customers presently have sufficient liquidity due to COVID-19 government stimulus programs. The Company will continue to monitor activity for potential increases in the off-balance sheet reserve in future quarters as customers use available liquidity. 56
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Classified Assets and Special Mention Assets
Classified assets increased$0.9 million from$5.2 million atDecember 31, 2021 to$6.1 million atDecember 31, 2022 . Management considers classified assets to be an important measure of asset quality. The Company's risk rating process for classified loans is an important input into the Company's allowance methodology. Risk ratings are expected to be an important input into the Company's ACL qualitative framework. The following is a breakdown of the Company's classified and special mention assets atDecember 31, 2022 and 2021, respectively: As of (dollars in thousands) December 31, 2022 December 31, 2021 Classified loans Substandard $ 6,115 $ 5,211 Doubtful - - Loss - - Total classified loans 6,115 5,211 Special mention loans 4,361 - Total classified and special mention loans $ 10,476 $ 5,211 Classified loans $ 6,115 $ 5,211 Classified securities - - Other real estate owned - - Total classified assets $ 6,115 $ 5,211 Total classified assets and special mention loans $
10,476 $ 5,211
Total classified assets as a percentage of total assets 0.25 % 0.22 % Total classified assets as a percentage of Risk Based Capital 2.23 % 2.10 % Non-Performing Assets The following table sets forth information with respect to the Bank's non-performing assets. AtDecember 31, 2022 andDecember 31, 2021 there were$0.1 million and zero loans, respectively, 90 days or more past due that were still accruing interest. 57
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December 31,
(dollars in thousands) 2022 2021
Non-accrual loans:
Commercial real estate $ 4,602 $ 4,890
Residential first mortgages - 450
Residential rentals 1,142 942
Home equity and second mortgages 206 601
Commercial equipment 165 691
U.S. SBA PPP loans - 57
Total non-accrual loans (1) 6,115 7,631
OREO - -
TDRs: (1) (2)
Commercial real estate - -
Residential first mortgages - -
Commercial equipment 457 447
Total TDRs 457 447
Total Accrual TDRs 429 447
Total non-accrual loans, OREO and Accrual TDRs $
6,544
Interest income due at stated rates, but not recognized on non-accruals
$ 22 $ 102
___________________________________________
(1) Non-accrual loans include all loans, excluding credit card loans, that are 90 days or more delinquent and loans that are non-accrual due to the operating results or cash flows of a customer. (2) TDR loans include both non-accrual and accruing performing loans. All TDR loans are included in the calculation of asset quality financial ratios. Non-accrual TDR loans are included in the non-accrual balance and accruing TDR loans are included in the accruing TDR balance. Non-accrual loans and OREO to total assets decreased from 0.33% atDecember 31, 2021 to 0.25% atDecember 31, 2022 . Non-accrual loans, OREO and TDRs to total assets decreased from 0.35% atDecember 31, 2021 to 0.27% atDecember 31, 2022 . All interest accrued but not collected from loans that are placed on non-accrual or charged-off is reversed against interest income. Interest income is recognized on a cash-basis or cost-recovery method, until qualifying for return to accrual status. Loans are reviewed on a regular basis and are placed on non-accrual status when, in the opinion of management, the collection of additional interest is doubtful. The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in the process of collection. Non-accrual loans include certain loans that are current with all loan payments and are placed on non-accrual status due to customer operating results and cash flows. Non-accrual loans are considered impaired and evaluated for impairment on a loan-by-loan basis. AtDecember 31, 2022 , there were$5.5 million (89%) of non-accrual loans current with all payments of principal and interest with specific reserves of$0.1 million . Delinquent non-accrual loans were$0.7 million (11%) of with no specific reserves atDecember 31, 2022 . AtDecember 31, 2021 , there were$6.1 million (98.0%) of non-accrual loans current with all payments of principal and interest with no impairment and$0.1 million (2.0%) of delinquent non-accrual loans with a total of$29,000 specifically reserved. There was one non-accrual TDRs atDecember 31, 2022 , which was fully reserved. Non-accrual loans atDecember 31, 2021 included zero TDRs. These loans were classified solely as non-accrual for the calculation of financial ratios.
Other Real Estate Owned
There were no OREO balances atDecember 31, 2022 and atDecember 31, 2021 . For additional information on OREO, refer to Note 5 of the Consolidated Financial Statements. 58
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Deposits and Borrowings - Funding
The Bank has access to both retail deposits and wholesale funding. Wholesale funding includes long-term debt and short-term borrowings of advances from the FHLB ofAtlanta and brokered deposits. Retail deposits totaled$2.03 billion or 93.8% of funding atDecember 31, 2022 compared to$2.05 billion or 99.0% of funding atDecember 31, 2021 . In addition to funding for operations, the Company had junior subordinated debentures of$12.0 million and fixed to floating subordinated notes of$20.0 million at 4.75% atDecember 31, 2022 and 2021. The following is a breakdown of the Company's deposit portfolio atDecember 31, 2022 and 2021: December 31, (dollars in thousands) 2022 % 2021 % $ Change % Change Noninterest-bearing demand$ 630,120 30.17 %$ 445,778 21.68 %$ 184,342 41.35 % Interest-bearing: Savings 124,533 5.96 % 119,767 5.82 % 4,766 3.98 % Demand deposits 638,876 30.59 % 790,481 38.45 % (151,605) (19.18) % Money market deposits 347,872 16.66 % 372,717 18.13 % (24,845) (6.67) % Certificates of deposit 347,062 16.62 % 327,421 15.92 % 19,641 6.00 % Total interest-bearing 1,458,343 69.83 % 1,610,386 78.32 % (152,043) (9.44) % Total Deposits$ 2,088,463 100.00 %$ 2,056,164 100.00 %$ 32,299 1.57 % Transaction accounts$ 1,741,401 83.38 %$ 1,728,743 84.08 %$ 12,658 0.73 % Total deposits increased atDecember 31, 2022 compared toDecember 31, 2021 . During the same period, noninterest bearing demand deposits and total transaction deposits increased in dollars and noninterest bearing demand deposits increased as a percentage of deposits. Non-interest-bearing demand deposits increased$184.3 million to$630.1 million atDecember 31, 2022 , representing 30.2% of deposits, compared to 21.7% of deposits atDecember 31, 2021 . The Company's business development efforts continue to focus on increasing non-interest bearing and lower cost transaction accounts. ForFDIC call reporting purposes reciprocal deposits are classified as brokered deposits when they exceed 20% of a bank's liabilities or$5.0 billion . Reciprocal deposits increased$38.7 million to$522.3 million atDecember 31, 2022 compared to$483.5 million atDecember 31, 2021 . Reciprocal deposits as a percentage of the Bank's liabilities atDecember 31, 2022 andDecember 31, 2021 were 23.8% and 23.1%, respectively. For call reporting purposes,$83.9 million of reciprocal deposits were considered brokered atDecember 31, 2022 compared to$65.7 million atDecember 31, 2021 .
The following table sets forth for the periods indicated the average balances outstanding and average interest rates for each major category of deposits.
For the Years Ended December 31,
2022 2021
(dollars in thousands) Average Balance Average Rate Average Balance Average Rate
Savings $ 121,975 0.08 % $ 108,189 0.05 %
Demand deposits 621,755 0.83 % 660,330 0.05 %
Money market deposits 376,039 0.14 % 358,006 0.11 %
Certificates of deposit 313,429 0.47 % 342,755 0.53 %
Total interest-bearing deposits 1,433,198 0.50 % 1,469,280 0.18 %
Noninterest-bearing demand deposits 634,805 417,935
$ 2,068,003 0.35 % $ 1,887,215 0.14 %
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The following table indicates that 33.1% of the Bank's certificates of deposit and other time deposits, by account, meet or exceed theFDIC insurance limit (currently,$250,000 ), by time remaining until maturity as ofDecember 31, 2022 . (dollars in thousands) At December 31, 2022 Time Deposit Maturity Period Three months or less $ 58,704 Three through six months 9,172 Six through twelve months 27,297 Over twelve months 19,520 Total $ 114,693 Uninsured deposits, which are the portion of deposit accounts that exceed theFDIC insurance limits, currently set at$250,000 were approximately$398.3 million and$496.0 million atDecember 31, 2022 andDecember 31, 2021 , respectively. These amounts were estimated based on the same methodologies and assumptions used for regulatory reporting.
Note 7 includes the scheduled contractual maturities of total certificates of
deposits of
Stockholders' Equity
The following table shows the Company's equity and the dollar and percentage changes for the periods presented.
December 31, December 31,
(dollars in thousands) 2022 2021 $ Change % Change
Common Stock at par of $0.01 $ 56 $ 57 $ (1) (1.8) %
Additional paid in capital 97,986 96,896 1,090 1.1 %
Retained earnings 132,235 113,448 18,787 16.6 %
Accumulated other comprehensive loss (43,092) (1,952) (41,140) 2,107.6 %
Unearned ESOP shares (174) (316) 142 (44.9) %
Total Stockholders' Equity $ 187,011 $ 208,133 $ (21,122) (10.1) %
Total stockholders' equity decreased $21.1 million during the year ended
December 31, 2022 . Equity increased due to net income of $28.3 million and net
stock related activities in connection with stock-based compensation and ESOP
activity of $1.0 million . These increases to stockholders' equity were offset by
common stock repurchases of $3.6 million , common dividends paid of $3.8 million ,
and an increase in accumulated other comprehensive loss of $41.1 million .
At December 31, 2022 , the Company had a book value of $33.11 per common share
compared to $36.40 at December 31, 2021 . The Company's tangible book value was
$31.08 at December 31, 2022 compared to $34.32 at December 31, 2021 . The
Company's common equity to assets ratio decreased to 7.76% at December 31, 2022
from 8.94% at December 31, 2021 . The Company's ratio of tangible common equity
("TCE") to tangible assets decreased to 7.32% at December 31, 2022 from 8.48% at
December 31, 2021 . The decrease in the TCE ratio was due primarily to increased
unrealized losses in the Bank's AFS investment portfolio. The Company's common
equity Tier 1 ("CET1") ratio was 11.26% at December 31, 2022 compared to 11.92%
at December 31, 2021 . The Company remains well capitalized at December 31, 2022
with a Tier 1 capital to average assets (leverage ratio) of 9.60% compared to
9.23% at December 31, 2021 .
The ESOP has promissory notes with the Company for the purchase of TCFC common
stock for the benefit of the participants in the Plan of $0.2 million and $0.3
million at December 31, 2022 and 2021, respectively. Loan terms are at prime
rate plus one-percentage point and amortize over seven years. As principal is
repaid, common shares are allocated to participants based on the participant
account allocation rules described in the Plan. The Bank is a guarantor of the
ESOP debt with the Company. Unencumbered shares held by the ESOP are treated as
outstanding in computing earnings per share. Shares issued to the ESOP but
pledged as collateral for loans obtained to provide funds to acquire the shares
are not treated as outstanding in computing earnings per share.
During the year ended December 31, 2022 , $0.1 million or 4,150 Employee Stock
Ownership Plan ("ESOP") shares were allocated with the payment of promissory
notes and there were no offsetting ESOP purchases of shares. During the year
ended December 31, 2021 , $0.1 million or 4,150 ESOP shares were allocated with
the payment of promissory notes.
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LIQUIDITY AND CAPITAL RESOURCES
Liquidity is our ability to fund operations and meet present and future financial obligations through the sale or repayment of existing assets or by obtaining additional funding through liability management. Cash needs may come from loan demand, deposit withdrawals or acquisition opportunities. Potential obligations resulting from the issuance of standby letters of credit and commitments to fund future borrowings to our loan customers are other factors affecting our liquidity needs. Many of these obligations and commitments are expected to expire without being drawn upon; therefore, the total commitment amounts do not necessarily represent future cash requirements affecting our liquidity position. The Company's principal sources of liquidity are cash on hand and dividends received from the Bank. The Bank's most liquid assets are cash, cash equivalents and federal funds sold. The levels of such assets are dependent on the Bank's operating, financing and investment activities at any given time. The variations in levels of cash and cash equivalents are influenced by deposit flows and anticipated future deposit flows. Customer deposits are considered the primary source of funds supporting the Bank's lending and investment activities. Liquidity is provided by access to funding sources, which include core depositors and brokered deposits. Other sources of funds include our ability to borrow, such as purchasing federal funds from correspondent banks, sales of securities under agreements to repurchase and advances from the FHLB ofAtlanta . The Bank uses wholesale funding (brokered deposits and other sources of funds) to supplement funding when loan growth exceeds core deposit growth and for asset-liability management purposes. AtDecember 31, 2022 and 2021, the Bank had$45.0 million and$64.0 million , respectively, in loan commitments outstanding,$25.0 million and$22.0 million , respectively, in letters of credit and approximately$278.0 million and$242.0 million , respectively, available under lines of credit. Certificates of deposit due within one year ofDecember 31, 2022 and 2021 totaled$258.1 million or 74.36% and$256.9 million , or 78.45%, respectively, of total certificates of deposit outstanding. If maturing deposits do not remain, the Bank will be required to seek other sources of funds, or use on balance sheet cash and investments. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposits. We believe, however, based on past experience that a significant portion of our certificates of deposit will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered. Management has increased oversight and review of customer line of credit usage. If we were to experience increases in draws on customer lines of credit or decreased deposit levels in future periods as a result of the distressed economic conditions in our market areas relating to a potential recession, our level of borrowed funds could increase.
At
Advances from the FHLB are secured by the Bank's stock in the FHLB, a portion of the Bank's loan portfolio and certain investments. Generally, the Bank's ability to borrow from the FHLB ofAtlanta is limited by its available collateral and also by an overall limitation of 30% of assets. FHLB long-term debt consists of adjustable-rate advances with rates based upon LIBOR, fixed-rate advances, and convertible advances. AtDecember 31, 2022 and 2021, 100% of the Bank's long-term debt was fixed for rate and term, as the conversion optionality of the advances have either been exercised or expired. In addition, the Bank has established unsecured and secured lines of credit with theFederal Reserve Bank and commercial banks. For a discussion of these agreements including collateral see Note 8 in the Consolidated Financial Statements. The Bank's principal sources of funds for investment and operations are net income, deposits, sales of loans, borrowings, principal and interest payments on loans, principal and interest received on investment securities and proceeds from the maturity and sale of investment securities. The Bank's principal funding commitments are for the origination or purchase of loans, the purchase of securities and the payment of maturing deposits.
The Bank is subject to various regulatory restrictions on the payment of dividends.
Comparison of Cash Flows for the Years Ending
During the year endedDecember 31, 2022 , all financing activities provided$91.9 million in cash compared to$285.4 million in cash provided for the same period in 2021. The Company was provided$193.5 million less cash from financing activities compared to the prior year, primarily due to decreased deposit growth of$278.3 million . The Company used$2.8 million less cash in 2022 compared to 2021 for net long-term debt activity and short-term borrowings activity provided$79.0 million more cash in 2022 compared to 2021. The Company used$2.9 million less in cash for stock related activities in 2022 compared to 2021. The decrease was primarily due to a$3.5 million decrease in common stock repurchased. The Bank's principal use of cash has been in investing activities including its investments in loans, investment securities and other assets. In 2022, the level of net cash used in investing decreased to$241.5 million from$256.0 million in 2021. The decrease in cash used was primarily the result of less cash used for purchases of investment securities partially offset by an increase in cash used for loan activities. 61
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Cash used for loan activities increased$218.6 million from$4.3 million , for the year endedDecember 31, 2021 to cash used of$214.2 million for the year endedDecember 31, 2022 . Cash used for the purchase of investment securities decreased$249.3 million from$327.7 million for the year endedDecember 31, 2021 to$78.4 million for the year endedDecember 31, 2022 . Cash used increased$15.9 million as total proceeds from sales and principal payments of securities for year endedDecember 31, 2022 decreased compared to the year endedDecember 31, 2021 .
Operating activities provided cash of
Capital Resources The Company has no business other than holding the stock of the Bank and does not currently have any material funding requirements, except for the payment of dividends on common stock, and the payment of interest on subordinated debentures and subordinated notes, and noninterest expense. The Company evaluates capital resources by the ability to maintain adequate regulatory capital ratios. The Company and the Bank annually update a three-year strategic capital plan. In developing its plan, the Company considers the impact to capital of asset growth, income accretion, dividends, holding company liquidity, investment in markets and people and stress testing. Federal banking regulations require the Company and the Bank to maintain specified levels of capital. As ofDecember 31, 2022 and 2021, the Company and Bank were well-capitalized under the regulatory framework for prompt corrective action under the Basel III Capital Rules. Management believes, as ofDecember 31, 2022 and 2021, that the Company and the Bank met all capital adequacy requirements to which they were subject. See Note 11 of the Consolidated Financial Statements. OnMarch 31, 2015 , the Bank made the election to continue to exclude most accumulated other comprehensive income ("AOCI") from capital in connection with its quarterly financial filings and, in effect, to retain the AOCI treatment under the capital rules prior to Basel III.
OFF-BALANCE SHEET ARRANGEMENTS
In the normal course of operations, we engage in a variety of financial transactions that, in accordance with accounting principles generally accepted inthe United States of America and to general practices within the banking industry, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers' requests for funding and take the form of loan commitments, letters of credit and lines of credit. For a discussion of these agreements, including collateral and other arrangements, see Note 18 in the Consolidated Financial Statements. For the years endedDecember 31, 2022 and 2021, the Company did not engage in any off-balance sheet transactions reasonably likely to have a material effect on its financial condition, results of operations or cash flows.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and notes thereto presented herein have been prepared in accordance with accounting principles generally accepted inthe United States of America and general practices within the banking industry, 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. 62
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Item 7A. Quantitative and Qualitative Disclosure about Market Risk
Interest rate risk is defined as the exposure to changes in net interest income
and capital that arises from movements in interest rates. Depending on the
composition of the balance sheet, increasing or decreasing interest rates can
negatively affect the Company's results of operations and financial condition.
The Company measures interest rate risk over the short and long term. The
Company measures interest rate risk as the change in net interest income ("NII")
caused by a change in interest rates over twelve and twenty-four months. The
Company's NII simulations provide information about short-term interest rate
risk exposure. The Company also measures interest rate risk by measuring changes
in the values of assets and liabilities due to changes in interest rates. The
economic value of equity ("EVE") is defined as the present value of future cash
flows from existing assets, minus the present value of future cash flows from
existing liabilities. EVE simulations reflect the interest rate sensitivity of
assets and liabilities over a longer time period, considering the maturities,
average life and duration of all balance sheet accounts.
The Board of Directors has approved the Company's interest rate risk policy and
assigned oversight to the Board Risk Oversight Committee ("BROC"). The policy
establishes limits on risk, which are quantitative measures of the percentage
change in NII and EVE resulting from changes in interest rates. Both NII and EVE
simulations assist in identifying, measuring, monitoring and controlling
interest rate risk and along with mitigating strategies are used by management
to maintain interest rate risk exposure within Board policy guidelines.
The Company's interest rate risk ("IRR") model uses assumptions which include
factors such as call features, prepayment options and interest rate caps and
floors included in investment and loan portfolio contracts. The IRR model
estimates the lives and interest rate sensitivity of the Company's non-maturity
deposits. These assumptions have a significant effect on model results. The
assumptions are developed primarily based upon historical behavior of Bank
customers. The Company also considers industry and regional data in developing
IRR model assumptions. There are inherent limitations in the Company's IRR model
and underlying assumptions. When interest rates change, actual movements 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.
The Company prepares a current base case and several alternative simulations at
least quarterly. Current interest rates are shocked by +/- 100, 200, 300, and
400 basis points ("bp"). In addition, the Company simulates additional rate
curve scenarios (e.g., bear flattener). The Company may elect not to use
particular scenarios that it determines are impractical in a current rate
environment.
The Company's internal limits for parallel shock scenarios are as follows:
Net Interest Income Economic Value of Equity
Shock in Basis Points ("NII") ("EVE")
+ - 400 25% 40%
+ - 300 20% 30%
+ - 200 15% 20%
+ - 100 10% 10%
It is management's goal to manage the Bank's portfolios so that net interest
income at risk over twelve and twenty-four-month periods and the economic value
of equity at risk do not exceed policy guidelines at the various interest rate
shock levels. As of December 31, 2022 , and 2021, the Company did not exceed any
Board approved sensitivity limits for percentage change in net interest income.
As of December 31, 2022 , the Company did not exceed any Board approved limits
for the percentage change in economic value of equity. As of December 31, 2021 ,
the percentage change in economic value of equity exceeded policy guidelines due
to already low level of rates on non-maturing deposit instruments Management
determined that due to the level of market rates at December 31, 2021 , interest
rate shocks of -100, -200, -300, and -400 basis points left the Bank with near
zero down to negative rate instruments and were not considered practical or
informative. Measures of net interest income at risk produced by simulation
analysis are indicators of an institution's short-term performance in
alternative rate environments. The below schedule estimates the changes in net
interest income over a twelve-month period for parallel rate shocks for up 200,
100 and down 100 scenarios:
Estimated Changes in Net Interest Income ("NII")
Change in Interest Rates: + 200bp + 100bp - 100bp
Policy Limit (15.00) % (10.00) % (10.00) %
December 31, 2022 (2.65) % (0.97) % 0.46 %
December 31, 2021 (1.54) % (0.74) % (1.13) %
Measures of equity value at risk indicate the ongoing economic value of the Company by considering the effects of changes in interest
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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 below schedule
estimates the changes in the economic value of equity at parallel shocks for up
200, 100 and down 100 scenarios:
Estimated Changes in Economic Value of Equity ("EVE")
Change in Interest Rates: + 200bp + 100bp - 100bp
Policy Limit (20.00) % (10.00) % (10.00) %
December 31, 2022 7.85 % 5.01 % (8.17) %
December 31, 2021 24.45 % 15.16 % (25.07) %
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