EDGAR 10-K Filing

Company CIK: 1693577
Filing Year: 2022
Filename: 1693577_10-K_2022_0001564590-22-011471.json

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ITEM 1. BUSINESS
Item 1. Business
As used herein, the “Company,” “we,” “our,” and “us” refer to MainStreet Bancshares, Inc., and the “Bank” refers to MainStreet Bank.
Overview
MainStreet Bancshares, Inc. is a bank holding company that owns 100% of MainStreet Bank and MainStreet Community Capital, LLC. On October 12, 2021, the Company filed an election to be a financial holding company with the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Company elected financial holding company status in order to engage in a broader range of financial activities than are permitted for bank holding companies generally. We emphasize providing responsive and personalized services to our clients. Due to the consolidation of financial institutions in our primary market area, we believe there is a significant opportunity for a local bank to provide a full range of financial services. By offering highly professional, personalized banking products and service delivery methods and employing advanced banking technologies, we seek to distinguish ourselves from larger, regional banks operating in our market area and are able to compete effectively with other community banks.
MainStreet Bancshares, Inc.
MainStreet Bancshares Inc. is a bank holding company incorporated under the laws of the Commonwealth of Virginia whose principal activity is the ownership and management of MainStreet Bank and MainStreet Community Capital. The Company is authorized to issue 10,000,000 shares of common stock, par value $4.00 per share. Additionally, the Company is authorized to issue 2,000,000 shares of preferred stock, par value $1.00 per share. There were 7,595,781 shares of common stock outstanding and 28,750 shares of 7.50% Series A Fixed-Rate Non-Cumulative Perpetual Preferred Stock outstanding at December 31, 2021. At that date, there were also outstanding 1,150,000 depositary shares, each representing a 1/40th interest in a share of the Company’s Series A Preferred Stock, with a liquidation preference of $1,000 per share (equivalent to $25 per depositary share).
The Company is a registered bank holding company which is governed under the Bank Holding Company Act of 1956, as amended (the “Bank Holding Act”), that has elected to be a financial holding company. As such, is subject to inspection, examination, and supervision by the Federal Reserve.
The Company’s executive offices are located at 10089 Fairfax Boulevard, Fairfax, Virginia. Our telephone number is (703) 481-4567, and our internet address is www.mstreetbank.com. The information contained on our website shall not be considered part of this Form 10-K, and the reference to our website does not constitute incorporation by reference of the information contained on the website.
MainStreet Bank
MainStreet Bank is a community commercial bank incorporated in and chartered by the Commonwealth of Virginia. The Bank is a member of the Federal Reserve Bank of Richmond, and its deposits are insured by the FDIC. The Bank opened for business on May 26, 2004, and is headquartered in Fairfax, Virginia. We currently operate six Bank branches; located in Herndon, Fairfax, McLean, Clarendon, Leesburg Virginia, and one in Washington D.C.
The Bank is a community bank focused on serving the borrowing, cash management and depository needs of small to medium-sized businesses, and professional practices and retail customers. We believe we have a solid franchise that meets the financial needs of our clients and communities by providing an array of personalized products and services delivered by seasoned banking professionals with decisions made at the local level. We believe a significant customer base in our market prefers to do business with a local institution that has a local management team, a local Board of Directors and local founders and that this customer base may not be satisfied with the responsiveness of larger regional banks. By providing quality services, coupled with the opportunities provided by the economies in our market area, we have generated and expect to continue to generate organic growth.
We service Northern Virginia as well as the greater Washington, D.C. metropolitan area. Our goal is to deliver a customized and targeted mix of products and services that meets or exceeds customer expectations. To accomplish this goal, we have deployed a premium operating system that gives customers access to up-to-date banking technology. These systems and our skilled staff have allowed us to compete aggressively with larger financial institutions. We believe the combination of sophisticated technology and personal service sets us apart from our competition. We strive to be the leading community bank in our market.
We offer a full range of banking services to individuals, small to medium-sized businesses and professional service organizations through both traditional and electronic delivery. We were the first community bank in the Washington, D.C. metropolitan area to offer a full online business banking solution, including remote check scanners on a business customer’s desktop. We offer mobile banking apps for iPhones, iPads and Android devices that provide for remote deposit of checks. In addition, we were the first bank headquartered in the
Commonwealth of Virginia to offer CDARS, the Certificate of Deposit Account Registry Service, an innovative deposit insurance solution that provides Federal Deposit Insurance Corporation (“FDIC”) insurance on deposits up to $150 million. We believe that enhanced electronic delivery systems and technology increase profitability through greater productivity and cost control, and allow us to offer new and better products and services.
Our products and services include: business and consumer checking, premium interest-bearing checking, business account analysis, savings, certificates of deposit and other depository services, as well as a broad array of commercial, real estate and consumer loans. Internet account access is available for all personal and business accounts, internet bill payment services are available on most accounts, and a robust online cash management system is available for business customers.
Avenu
On October 25, 2021, MainStreet Bancshares, Inc. formally introduced AvenuTM, a division of MainStreet Bank. AvenuTM represents the Company’s suite of Banking as a Service (“BaaS”) solutions designed to meet the banking needs of Fintech customers. We believe our approach to providing a proprietary BaaS solution is unique. Our transformational subledger combined with our high-touch compliance training goes beyond the industry standards to ensure that our Fintech partners will prosper. This division of the MainStreet Bank currently serves money service businesses, payment processers, and Banking-as-a-Service customers and provides the Bank with valuable low-cost deposits and additional streams of fee income. Our BaaS software program is currently in development.
MainStreet Community Capital, LLC
In August 2021, the Company created a community development entity (“CDE”) subsidiary, MainStreet Community Capital, LLC, a Virginia limited liability company, to apply for New Market Tax Credit (“NMTC”) allocations from the U.S. Department of Treasury’s Community Development Financial Institutions Fund. To promote development in economically distressed areas, the NMTC program was established under the Community Renewal Tax Relief Act of 2000 to provide tax incentives for capital investment in disadvantaged market areas that have not experienced economic expansion. The program establishes a tax credit for investment in a CDE and ongoing compliance with the program is accomplished through a governing board and an advisory board which maintains accountability to residents and businesses in the aforementioned disadvantaged areas. This CDE will be an intermediary vehicle for the provision of loans and investments in Low-Income Communities (“LICs”). In January 2022, the Community Development Financial Institutions Fund (“CDFI”) of the United States Department of the Treasury certified MainStreet Community Capital, LLC as a registered CDE.
Emerging Growth Company Status
We qualify as an “emerging growth company” under the JOBS Act and as defined in Section 2(a) of the Securities Act of 1933. For as long as we are an emerging growth company, we may choose to take advantage of exemptions from various reporting requirements applicable to other public companies but not to emerging growth companies. See “Risk Factors-We are an emerging growth company, and any decision on our part to comply only with certain reduced reporting and disclosure requirements applicable to emerging growth companies could make our common stock less attractive to investors.”
As an emerging growth company:
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we may present as few as two years of audited financial statements and two years of related management discussion and analysis of financial condition and results of operations, in contrast to other reporting companies which must provide audited financial statements for three fiscal years;
•
we are exempt from the requirement to obtain an attestation and report from our auditors on management’s assessment of our internal control over financial reporting under the Sarbanes-Oxley Act of 2002;
•
we are permitted to provide less extensive disclosure about our executive compensation arrangements; and
•
we are permitted to include less extensive narrative disclosures than required of other reporting companies, particularly with respect to executive compensation.
In this Form 10-K we have elected to take advantage of the reduced disclosure requirements relating to executive compensation, and in the future we may take advantage of any or all of these exemptions for so long as we remain an emerging growth company. We will remain an emerging growth company until the earliest of (i) the end of the first fiscal year during which we have total annual gross revenues of $1.07 billion or more, (ii) the end of the fiscal year following the fifth anniversary of the completion of our initial registered public offering of common equity securities, which will be in August 2024, (iii) the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt and (iv) the date on which we are deemed to be a “large accelerated filer” as defined in Rule 12b-2 under the Securities Exchange Act of 1934 (the “Exchange Act”).
In addition to the relief described above, the JOBS Act permits us an extended transition period for complying with new or revised accounting standards affecting public companies. We have elected not to take advantage of this extended transition period, which means that
the financial statements included in this Form 10-K, as well as any financial statements that we file in the future, will be subject to all new or revised accounting standards generally applicable to public companies.
Nasdaq Listing
We were approved to list shares of our common stock on the Nasdaq Capital Market under our current symbol “MNSB” as of April 22, 2019. We were approved to list shares of our depositary shares on the Nasdaq Capital Market under the symbol “MNSBP” as of September 16, 2020.
Our Business
As of December 31, 2021, MainStreet Bancshares, Inc. had total consolidated assets of $1.6 billion, total net loans of $1.3 billion, total deposits of $1.4 billion and total stockholders’ equity of $188.8 million, and total equity to total assets was 11.46%. For the years ended December 31, 2021 and 2020, our return on average assets was 1.32% and 1.05%, respectively, and our return on average equity was 12.38% and 10.54%, respectively.
We are focused on growing business relationships and building core deposits, profitable loans and non-interest income. We believe that we have a solid franchise that meets the financial needs of our clients and communities by providing an array of personalized products and services delivered by seasoned banking professionals with decisions made at the local level. We strive to be the leading community bank in our markets.
We believe that our core lending and deposit business segments continue to perform well. For the fiscal years ended December 31, 2021 and December 31, 2020, our net charge-offs to average loans were 0.00% and 0.03%, respectively. As of December 31, 2021, we had no non-performing loans and $775,000 in non-performing assets which represented 0.05% of total assets.
Management believes that the Company is well positioned to build on its core performance to continue to grow profitably. Although we have successfully attracted new associates, providing depth and talent in key positions, additional employees and infrastructure are expected to be needed to manage the increasing customer relationships that would come with sustained growth.
We are a community-oriented financial institution. Our Bank offers a wide-range of commercial and consumer loan and deposit products, as well as mortgage services to individuals, and small and medium sized businesses in our market. We seek to be the provider of choice for financial solutions to customers who value exceptional personalized service, local decision making, and modern banking technology. Our business involves attracting deposits from local businesses and individual customers and using these deposits to originate commercial, mortgage, and consumer loans in our market area. We also invest in securities consisting primarily of obligations of U.S. government sponsored entities, municipal obligations, mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae, and the subordinated debt of other financial institutions. The Company is the owner and beneficiary of bank owned life insurance (BOLI) policies on certain current and former Bank employees. These policies generate income and can be liquidated, if necessary, with associated tax costs.
The Federal Reserve and the Virginia State Corporation Commission, through its Bureau of Financial Institutions (the “Bureau”), regulate and monitor operations of the Company and the Bank. We are required to file with the FDIC quarterly financial condition and performance reports. The Federal Reserve and the Bureau conduct periodic onsite and offsite examinations. We must comply with a wide variety of reporting requirements and banking regulations. The laws and regulations governing us generally have been promulgated to protect depositors and the federal deposit insurance funds and not to protect shareholders. Additionally, we must bear the cost of compliance with the reporting and regulations; these costs can be significant and may have an effect on our financial performance.
Our Market Area. We consider our primary market area to be the northern Virginia counties of Arlington, Fairfax, Loudoun, and Prince William, and the cities of Fairfax, Alexandria, Falls Church, Manassas and Manassas Park, as well as Washington DC and the greater Washington, DC metropolitan area. Our headquarters is located approximately 15 miles west of Washington, D.C., in Fairfax County, Virginia.
According to the U.S. Census Bureau, the Washington, D.C. Metropolitan Statistical area (MSAs) includes three of the wealthiest counties in the United States, as well as six of the top 20 wealthiest counties. Median household income growth projections range from 7% to almost 13% through 2025. Overall, the Washington D.C. MSA ranks sixth out of the largest 25 MSAs ranked by population estimates as of 2019 and fourth in largest population growth by MSA through 2019 according to the Census Bureau. Population growth for our market area has grown exponentially over the previous decade and is expected to remain high. We expect our strategies to benefit from the continued growth in population and high income of our market area’s residents.
Area
Total Population as of 2021 (Actual)
Population Change 2010-2021
Projected Population Change 2020-2025
Median Household Income 2021
Median Household Income Projected Change 2020-2025
Unemployment Rate as of November 2021
Unemployment Rate as of November 2020
District of Columbia
692,263
15.05
%
-1.41
%
$
102,806
13.15
%
8.2
%
8.4
%
Arlington County
245,022
18.01
%
5.03
%
128,907
7.71
%
1.9
%
4.6
%
Fairfax County
1,162,032
7.42
%
3.10
%
137,035
7.95
%
2.3
%
5.4
%
Loudoun County
440,122
40.92
%
6.65
%
162,430
9.20
%
2.1
%
4.6
%
Prince William County
486,453
21.01
%
5.39
%
116,502
7.94
%
2.6
%
5.8
%
United States
334,279,739
8.27
%
3.21
%
72,465
12.10
%
3.9
%
6.4
%
Source: U.S. Bureau of Labor Statistics, S&P Global Market Intelligence
The Washington, D.C. MSA is a desirable market for a broad range of companies in a variety of industries, including sixteen companies from the 2021 Fortune 500 list, and six of the United States’ largest 100 private companies, according to the 2021 Forbes list of largest private companies by revenue. According to the U.S Bureau of Labor Statistics, the Washington, D.C. MSA has a large and diversified economy. The following table provides an in-depth view of the distribution of employment within the Washington, D.C. MSA.
Washington, D.C. MSA Employment by Sector
Employment Sector by Percent
Mining, Lodging, and Construction
4.8%
Manufacturing
1.4%
Trade, Transportation, and Utilities
11.8%
Information
2.4%
Financial Activities
4.5%
Professional and Business Services
24.6%
Education and Health Services
13.1%
Leisure and Hospitality
8.6%
Other Services
6.4%
Government
22.4%
Source: U.S. Bureau of Labor Statistics, Data as of September 2021
Note: Data is not seasonally adjusted
As the home of the federal government, the broader Washington, D.C. region benefits from consistent population growth and remains well positioned to capitalize on any increase in government spending and infrastructure. Further, as banks in our market have experienced continued consolidation over the last few years, our opportunities to attract talented employees and capitalize on customer dislocation have improved. With its strong demographic characteristics, scale and robust economic activity we believe that the Washington, D.C. metropolitan area represents a strong geographic market for us to realize our continued growth strategies within our core business model.
The Company is active in community development activities that include support for affordable housing for low- or moderate-income (LMI) individuals, including multifamily rental housing, promoting economic development by financing small businesses or farms, revitalizing or stabilizing LMI geographies or designated disaster areas, and targeting support for community services to LMI individuals. The Company also makes qualified investments that target these initiatives within our geographic footprint. In addition, many of our employees and directors are involved in community activities as well as volunteer their time and expertise to local causes.
Competitive Strengths. We continually review our product offerings and based on these reviews may selectively add additional products to provide further diversification of our revenue sources and to capture our customers’ full banking relationships. We believe that the following business strengths have been instrumental to the success of our core operations and will enable us to continue profitable growth and to maximize value to our shareholders, while remaining fundamentally sound.
Community Banking Philosophy. We provide our clients with local decision making and individualized service coupled with products and services offered by our larger institutional competitors. As our business lenders, officers, and Bank directors are based in or reside in the communities we serve, we are able to maintain a high-level of involvement in local organizations and establish a strong understanding of the banking needs of the respective communities. We believe that our customer-centric business philosophy and sales approach enables us to build long-term relationships with desirable customers, which enhances the quality and stability of our funding and lending operations. Our mission and philosophy have positioned us well in the communities across our market area and have enabled us to attract and maintain a very talented and experienced management team.
Disciplined Credit Culture. We achieve our strong credit quality by adherence to sound underwriting and credit administration standards and by maintaining long-term customer relationships. All credit decisions between $250,000 and $750,000 require concurrence of a senior lender and the Bank’s Chief Credit Officer. Approvals of credits in excess of $750,000 require full consensus of the Officer’s Loan Committee. We maintain an independent loan review team, and senior management is actively involved with any credits requiring special attention.
Capital Position. The Bank exceeds the regulatory guidelines to be classified as “well capitalized.” Our capital position is strong and has consistently grown. At December 31, 2021, the Bank had a tier 1 leverage capital ratio of 12.90%, a common equity tier 1 risk-based capital ratio of 15.23%, a tier 1 risk-based capital ratio of 15.23%, and a total risk-based capital ratio of 16.06%. We believe that our capital position enhances our ability to grow organically because it enables the Bank to continue lending and to remain focused on our customers’ needs. For additional information, see Note 16 of Notes to Consolidated Financial Statements.
Technology. We have invested in the technology necessary to meet the developing demands of our commercial and retail customers. We utilize a strong core operating system that enables us to efficiently offer high-end deposit and loan products and have partnered with industry-leading internet banking, cash management, mobile banking, and application-based banking solutions to offer a complete banking experience to all customers, regardless of their preference. We participate in an international and nationwide automated teller machine network in order to offer our customers ATM transactions at over 55,000 locations in the United States, Canada, United Kingdom and Mexico.
Growth Opportunities. We believe that we can attract new customers and expand our total loans and deposits within our existing market areas through organic growth, online and mobile banking, strategic branching and possible acquisition opportunities. We expect our market will continue to create opportunities to attract new clients and, in some cases, may become the catalyst for mergers and acquisitions. We expect to grow our loan portfolio, open new branches and consider acquisitions only after rigorous due diligence and substantial quantitative analysis regarding the financial and capital impacts of any such transactions. We believe that maintaining our financial discipline will generate long-term shareholder value.
Lending Activities. The Bank’s primary market focus is on making loans to small businesses, professionals and other consumers in its local market area, along with various aspects of real estate finance. Owner-occupied and investment commercial real estate loans represent the largest segment’s of the Bank’s loan portfolio. The Bank’s primary lending activities are principally directed to its defined market area in Northern Virginia, as well as the greater Washington, D.C. metropolitan area.
We offer a diversified loan portfolio consisting primarily of commercial business and owner-occupied and investment commercial real estate loans with higher risk-adjusted returns, shorter maturities and more sensitivity to interest rate fluctuations, while still providing high quality loan products for single-family and multi-family residential borrowers.
We stress test our loan portfolio on a quarterly basis and measure the results against our capital profile. We multiply the total outstanding amount for each loan category by the highest quarter historical loss for that category in order to determine the stressed loss for commercial business loans, residential real estate lending, owner-occupied commercial real estate lending and consumer instalment lending. We stress test our investor-owned commercial real estate using three separate methodologies. If a property fails more than one of the three tests, we extend the highest exposure amount and add on 10% for selling costs.
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An immediate and sustained increase in interest rates, which would increase interest expense for the borrower;
•
An immediate and sustained increase in vacancy, which would decrease rental income; and
•
An immediate and sustained change in the capitalization rate, or “cap rate,” which would decrease properties’ collateral values.
We stress test the construction lending portfolio by applying exponential discounting (k factor) to each project based upon its percentage of completion. The project is stressed using the as-is and as-complete appraised values and assumes 10% selling costs.
The total estimated losses from the loan stress tests are subtracted from the capital account and the regulatory ratios are recalculated. As of December 31, 2021, the post-stress capital ratios were all in excess of regulatory requirements.
Commercial Business Lending. Commercial loans are written for a variety of business purposes, including government contract receivables, plant and equipment, general working capital, contract administration and acquisition lending. Our client base is diverse, and we do not have a concentration of commercial business loans in any specific industry segment.
Commercial Real Estate Lending. We finance owner-occupied and investment commercial real estate. Our underwriting policies and processes focus on the client’s ability to repay the loan as well as assessment of the underlying real estate. Risks inherent in managing a commercial real estate portfolio relate to sudden or gradual drops in property values as well as changes in the economic climate. We attempt to mitigate those risks by carefully underwriting loans of this type and by following appropriate loan-to-value standards. Commercial real estate loans represent the largest segment of the Bank’s loan portfolio. At December 31, 2021, approximately 12.7% of our loan portfolio related to owner occupied commercial real estate loans, and approximately 26.6% of our loan portfolio related to investment commercial real estate.
Real Estate Construction Lending. This segment of our portfolio is predominately residential in nature and is composed of loans with short durations. We offer real estate construction financing to customers that have in place a permanent loan “take-out,” either by the Bank or another institution. Our approach to this type of lending reduces our credit risk, yet offers a competitive product in the marketplace. We also offer construction financing to many local home builders. These loans are also short duration and carefully underwritten with an increased focus on the builder’s reputation and ability to deliver high quality homes on time and within budget.
We also stress test the construction lending portfolio based upon the percentage completion method by stressing the as-is and as-completed appraised values. For further details, see stress test methodology under lending activities.
Residential Real Estate Lending. The Bank offers a variety of consumer-oriented residential real estate loans both for purchase and refinancing, most of which are brokered to the secondary market. The bulk of our current residential portfolio is made up of home equity loans to individuals. Our home equity portfolio gives the Bank a diverse client base.
Consumer Installment Lending. We offer a broad array of consumer loans including term loans and overdraft protection.
Credit Policies and Administration. The Bank has adopted a comprehensive lending policy, which includes a well-defined risk tolerance and stringent underwriting standards for all types of loans. Management believes that it employs experienced lending officers, secures appropriate collateral and carefully monitors the financial conditions of its borrowers.
In addition to normal repayment risks, all loans in the Bank’s portfolio are subject to the state of the economy and the related effects on the borrower and/or the real estate market. Generally, longer-term loans have periodic interest rate adjustments and/or call provisions. Senior management monitors the loan portfolio closely minimize past due loans and swiftly address potential problem loans. In addition to the internal business processes employed in the credit administration area, the Bank engages an outside or independent credit review firm to review the loan portfolio annually. Results of the credit review are used to validate our internal loan ratings and to review independent commentary on specific loans and loan administration activities.
Lending Limit. As of December 31, 2021, our legal lending limit for loans to one borrower was approximately $34.1 million. The Bank “in-house” lending limit is 50% of the legal lending limit for all relationships unless the loan is owner occupied, 1 - 4 family/residential or a government contract line of credit.. If owner occupied, 1 - 4 family or a government contractor, the “in-house” lending limit is 90% of the legal lending limit for Good rated credits; 85% for Standard rated credits and 75% for Acceptable rated credits. Our loan policy prescribes a sub-limit to certain borrowers based upon our determination of each borrower’s credit quality. We routinely participate loan amounts in excess of our policy limits to other financial institutions.
For additional information, see Note 1 and Note 5 of Notes to Consolidated Financial Statements.
Investments and Funding. The Bank balances its liquidity needs based on loan and deposit growth through the investment portfolio and purchased funds. It is the Bank’s goal to provide adequate liquidity to support the loan growth of the Bank. In the event the Bank has excess liquidity, investment securities are used to generate additional income. In the event deposit growth does not fully support the Bank’s loan growth, the Bank will utilize deposit listing services, borrowed funds, or incorporate a combination of sales of investment securities, federal funds and other purchased/borrowed funds in order to augment the Bank’s funding position.
The current investment policy authorizes the Bank to invest in debt securities issued by the United States Government, agencies of the United States Government, or United States Government-sponsored enterprises. The policy permits investments in mortgage-backed securities, including pass-through securities, issued and guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae. The investment policy also permits investments in federal funds and deposits in other insured institutions. In addition, management is authorized to invest in investment grade state and municipal obligations, private mortgage-backed securities, and the subordinated debt of other financial institutions. The Bank does not engage in any hedging or trading activities in its investment portfolio. The Company is also the owner and beneficiary of bank owned life insurance (BOLI) policies on certain current and former Bank employees. These policies generate income and can be liquidated, if necessary, with associated tax costs.
Generally accepted accounting principles require that, at the time of purchase, the Bank designate a security as “held-to-maturity,” “available-for-sale,” or “trading,” depending on our ability and intent to hold such security. Debt securities available for sale are reported at fair value, while debt securities held to maturity are reported at amortized cost. The Bank does not maintain a trading portfolio. Establishing a trading portfolio would require specific authorization by the Board of Directors.
The investment portfolio is actively managed and consists of investments classified as available-for-sale and held-to-maturity. Under the available-for sale classification, investment instruments may be sold as deemed appropriate by management. On a monthly basis, the investment portfolio is marked to market as required by ASC 320. Additionally, the investment portfolio is used to balance the Bank’s asset and liability position. The Bank invests in fixed rate or floating rate instruments as necessary to reduce interest rate risk exposure.
At December 31, 2021, the held-to-maturity portfolio, which is primarily composed of municipal securities and is carried at amortized cost, totaled $20.3 million. At that date, the available-for-sale portfolio, which is composed of U.S. Treasury securities, collateralized mortgage-backed securities, subordinated debt of other financial institutions and U.S. Government agency securities and is carried at fair value, totaled $99.9 million. For additional information, see Note 3 of Notes to Consolidated Financial Statements.
Subordinated Notes. On December 30, 2016, the Company completed the issuance and sale of $14.3 million in aggregate principal amount of fixed-to-floating rate subordinated notes in a private placement transaction to various accredited investors. During the first quarter of 2017, an additional $700 thousand of subordinated notes was issued for a total issuance of $15.0 million. The net proceeds of the offering supported growth and were used for other general business purposes. The notes had a maturity date of December 31, 2026 and had an annual fixed interest rate of 6.25% until December 31, 2021 with an opportunity to call the debt at December 31, 2021.
The Company, taking advantage of the attractive rates in the debt market in 2021, effectively “refinanced” this debt by completing an issuance and sale of $30 million in fixed-to-floating subordinated notes in April 2021 with a similar structure as the previous issuance at an annual fixed interest rate of 3.75% until April 15, 2026. The net proceeds were used to fully call the subordinated notes issued in 2016 and to support additional growth for other general business purposes. After April 15, 2026, the notes will have a floating interest rate based on three-month SOFR rate plus 302 basis points (3.02%) (computed on the basis of a 360-day year of twelve 30-day months) from and including April 15, 2026 to the maturity date or any early redemption date. Interest will be paid semi-annually, in arrears, on July 1 and January 1 of each year during the time that the notes remain outstanding through the fixed interest rate period or earlier redemption date. Interest will be paid quarterly, in arrears, on April 15, July 15, October 15 and January 15 throughout the floating interest rate period or earlier redemption date
Deposit Activities. Deposits are the major source of funding for the Bank. The Bank offers a broad array of deposit products that include demand, NOW, money market and savings accounts as well as certificates of deposit. The Bank typically pays a competitive rate on the interest-bearing deposits. As a relationship-oriented organization, we seek generally to obtain deposit relationships with our loan clients.
We offer a full range of consumer and commercial deposit products, including on-line banking with bill pay, cash management, sweep accounts, wire transfer, check imaging, remote deposit capture and courier services.
As the Bank’s overall balance sheet positions dictate, we may become more or less competitive in our interest rate structure as our liquidity position changes. Additionally, we may use wholesale deposits through sources such as deposit listing services, school systems, government entities and other sources to augment our funding position.
We can also arrange for FDIC insurance for deposits up to $150 million through CDARS, the Certificate of Deposit Account Registry Service, which provides a convenient method for a depositor to enjoy full FDIC insurance on deposits up to $140 million through a single banking relationship.
For additional information on deposits, see Note 9 of Notes to Consolidated Financial Statements.
Banking-as-a-service (BaaS). Beginning in 2016, the Board and management identified an opportunity for alternative sources of low-cost deposits and fee income. We determined that Financial Technology (“FinTech”) companies were making significant inroads into banking and we expanded our strategic plan to include banking customers that require BaaS and other payment service solutions.
Consistent with our culture, we worked over the past six years with a small group of clients in order to understand the risks associated with this business line. We developed an infrastructure to identify, measure, monitor and control the risks associated with FinTechs, providing
BaaS, and payment systems in general. We designed and implemented comprehensive legal, strategic, procedural and policy documents to guide business opportunities.
We are designing AvenuTM to be a comprehensive solution that provides FinTechs with an array of banking services to offer their customers in a scalable cloud-based platform. We guide our FinTech partners through the complex maze of banking regulations by integrating compliance and fraud detection throughout the framework of our solution as well as in-person training for FinTech partners team members. We’ve developed a live sandbox for our FinTech partners to provide a proof of concept and allow for quick integration and time to market when they are ready to “go-live.”
Our transformational subledger combined with our high-touch compliance training goes beyond the industry standards to ensure that our FinTech partners will prosper. We believe partnering with FinTechs will provide an opportunity to access to untapped markets and become a fresh source for growth in low-cost deposits and fee income.
We will continue to support the FinTech industry. Consumers in the United States express more confidence banking with FinTechs than traditional banks in many cases. As a business-focused community bank, we see FinTechs as a natural way for us to expand our footprint into consumer banking opportunities.
Competition. We face significant competition for the origination of loans and the attraction of deposits. Our competition for loans comes primarily from financial institutions in our market area and, to a lesser extent, from other financial service providers, such as mortgage companies and mortgage brokers. Competition for loans also comes from the increasing number of non-depository financial service companies entering the mortgage market, such as insurance companies, securities companies and specialty finance companies. Our most direct competition for deposits has historically come from other financial institutions operating in our market area. We also face competition for investors’ funds from money market funds, mutual funds and other corporate and government securities.
Diversity and Inclusion
The Company has 138 full-time employees as of December 31, 2021. The Company’s goal is to always hire the most qualified individual. The Company is located in a diversely populated geography, and as a result, the Company has a very diverse workforce.
At the Board level, the Company has seven independent directors. Two of the independent directors self-identify as female and one as an African American male. Four of the independent directors self-identify as white males.
Diversity is one factor taken into account when considering candidates to serve on the Board of Directors. The Board believes that diversity supports its goal of best serving the Company and our shareholders, customers and employees. The matrix below summarizes the self-identified diversity attributes of our Board members. The categories listed below have the meanings defined in Nasdaq Listing Rule 5605(f)(1).
Board Size:
Total Number of Directors
Gender:
Male
Female
Non-Binary
Gender Undisclosed
Number of directors based on gender identity
-
-
Number of directors who identify in any of the categories below:
African American or Black
-
-
-
Alaskan Native or American Indian
-
-
-
-
Asian
-
-
-
-
Hispanic or Latinx
-
-
-
Native Hawaiian or Pacific Islander
-
-
-
-
White
-
-
Two or More Races or Ethnicities
-
-
-
-
LQBTQ+
-
Undisclosed
-
Seventy-five percent of the Company’s 138 employees self-identify as either female or ethnically diverse (defined as all Equal Employment Opportunity Commission classifications other than white).
Title
Ethnically Diverse Female
Ethnically Diverse Male
White
Female
White
Male
Independent Directors
0.0%
29.0%
29.0%
42.0%
CEO/Chairman
0.0%
0.0%
0.0%
100.0%
President
0.0%
50.0%
0.0%
50.0%
Exec. Vice Pres.
0.0%
20.0%
40.0%
40.0%
Senior Vice Pres.
12.0%
12.0%
18.0%
58.0%
Vice Pres.
16.0%
35.0%
26.0%
23.0%
Asst. Vice Pres.
29.0%
12.0%
24.0%
35.0%
Branch
58.0%
25.0%
17.0%
0.0%
Admin. Support
33.0%
19.0%
35.0%
13.0%
All Employees
26.0%
22.0%
27.0%
25.0%
The Company is focused on equal pay for equal work, and on developing all employees to reach their full potential. The Company realizes that hiring a diverse workforce that is representative of the diversity of the local population also allows us to better serve our marketplace.
Employee Age Diversity
Age Group
20 - 29
30 - 39
40 - 49
50 - 59
60 +
Number of Employees
Percentage of Total
8%
24%
28%
30%
10%
Average Tenure (Years)
1.75
4.25
5.50
5.25
8.50
The age distribution of our employee base is also appropriately diversified.
The Company celebrates diversity throughout the year and fosters opportunities to learn about different cultures, religious practices, traits and differences. The Company finds that doing so brings out the best in the team as we grow together to exceed customer expectations and create shareholder value.
Supervision, Regulation and Other Factors
General. The Company is a bank holding company that has elected status as a financial holding company. As such, the Company is subject to extensive regulation under the Bank Holding Company Act of 1956 and to the examination and reporting requirements of the Federal Reserve. The Company is also subject to the rules and regulations of the SEC under the federal securities laws.
As a Virginia-chartered bank that is a member of the Federal Reserve System, the Bank is subject to regulation, supervision and examination by the Bureau and the Federal Reserve. State and federal laws also govern the activities in which the Bank engages, the investments that it makes and the aggregate amount of loans that may be granted to one borrower. The Bureau and the Federal Reserve also regulate the branching authority of the Bank. In addition, various consumer and compliance laws and regulations affect the Bank’s operations.
The earnings of the Company’s subsidiaries, and therefore the earnings of the Company, are affected by general economic conditions, management policies, changes in state and federal legislation and actions of various regulatory authorities, including those referred to above. The following description summarizes some of the significant state and federal and state laws to which the Company and the Bank are subject. To the extent that statutory or regulatory provisions or proposals are described, the description is qualified in its entirety by reference to the particular statutory or regulatory provisions or proposals.
The statutes, regulations and policies that govern our operations are under continuous review and are subject to amendment from time to time by Congress, the Virginia legislature and federal and state regulatory agencies. Any such future statutory or regulatory changes could adversely affect our operations and financial condition.
Regulation of the Bank. The Bank is subject to regulation and supervision by the Bureau and by the Federal Reserve, which regulation and supervision extends to all aspects of its operations, including but not limited to requirements concerning an allowance for loan losses, lending and mortgage operations, interest rates received on loans and paid on deposits, the payment of dividends to the Company, loans to officers and directors, mergers and acquisitions, capital adequacy, and the opening and closing of branches.
As a state-chartered bank that is a member of the Federal Reserve System, the Bank is subject to periodic examinations by the Bureau and by the Federal Reserve Bank of Richmond. In these examinations, the examiners assess compliance with state and federal banking regulations and the safety and soundness standards in such matters as loan underwriting and documentation, asset quality, earnings standards, internal controls and audit systems, interest rate risk exposure, and employee compensation and benefits.
The Bureau and the Federal Reserve have enforcement responsibility over the Bank and the authority to bring actions against the Bank and certain institution-affiliated parties, including officers, directors, and employees, for violations of laws or regulations and for engaging in unsafe and unsound practices. Formal enforcement actions include the issuance of a capital directive or cease and desist order, civil money penalties, removal of officers and/or directors, and receivership or conservatorship of the institution.
Insurance of Deposit Accounts. The FDIC insures deposits at federally insured financial institutions like the Bank. Deposit accounts in the Bank are insured by the FDIC generally up to a maximum of $250,000 per separately insured depositor and up to a maximum of $250,000 for self-directed retirement accounts.
The FDIC charges insured depository institutions assessments to maintain the Deposit Insurance Fund. Assessment rates for small institutions (those with less than $10 billion in assets) are based on an institution’s weighted average CAMELS component ratings and certain financial ratios and are applied to the institution’s assessment base, which equals its average total assets minus its average tangible equity. The FDIC’s current assessment rates (which are subject to certain adjustments) range from 3 to 16 basis points for institutions with CAMELS composite ratings of 1 or 2, 6 to 30 basis points for those with a CAMELS composite score of 3, and 16 to 30 basis points for those with CAMELS Composite scores of 4 or 5.
The FDIC has authority to increase insurance assessments. Any significant increases would have an adverse effect on the operating expenses and results of operations of the Bank. We cannot predict what the FDIC assessment rates will be in the future.
Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. We do not know of any practice, condition or violation that may lead to termination of our deposit insurance.
Regulatory Capital Requirements. The Federal Reserve has promulgated capital adequacy requirements for state-chartered Federal Reserve member banks. Effective January 1, 2015, the federal banking agencies’ capital rules were substantially revised to conform to the international regulatory standards agreed to by the Basel Committee on Banking Supervision in the accord often referred to as “Basel III”. The Federal Reserve’s revised regulatory capital rule applies to all depository institutions as well as to all top-tier bank and savings and loan holding companies that are not subject to the Federal Reserve’s Small Bank Holding Company Policy Statement. The capital requirements are quantitative measures established by regulation that require the Bank to maintain minimum amounts and ratios of capital. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by bank regulators that, if undertaken, could have a direct material effect on the Company’s financial statements.
The currently effective capital rule requires the maintenance of “Common Equity Tier 1” (“CET1”) capital, Tier 1 capital and Total capital to risk-weighted assets of at least 4.5%, 6% and 8%, respectively. The rule also establishes a minimum leverage ratio of at least 4% Tier 1 capital to average consolidated assets. In addition to the above minimum requirements, the capital rule limits capital distributions and certain discretionary bonus payments if a banking organization does not hold a “capital conservation buffer” consisting of 2.5% of CET1 capital to risk-weighted assets above the amount necessary to meet its minimum risk-based capital requirements. The capital conservation buffer requirement effectively increases the minimum required risk-based capital ratios to 7% for CET1, 8.5% for Tier 1 capital and 10.5% for Total capital.
In determining the amount of risk-weighted assets for purposes of calculating risk-based capital ratios, a bank’s assets, including certain off-balance sheet assets (e.g., recourse obligations, direct credit substitutes and residual interests), are multiplied by a risk weight factor assigned by the capital regulations based on the risk deemed inherent in the type of asset. Higher levels of capital are required for asset categories believed to present greater risk. For example, a risk weight of 0% is assigned to cash and U.S. government securities, a risk weight of 50% is generally assigned to prudently underwritten first lien one- to four-family residential mortgages, a risk weight of 100% is assigned to commercial and consumer loans, a risk weight of 150% is assigned to non-residential mortgage loans that are 90 days past due or otherwise on non-accrual status, and a risk weight of between 0% to 600% is assigned to permissible equity interests, depending on certain specified factors.
Under applicable federal statute, the federal bank regulatory agencies are required to take “prompt corrective action” with respect to institutions that do not meet specified minimum capital requirements. For these purposes, the statute establishes five capital categories: well- capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Under the implementing regulations, in order to be considered well-capitalized, a bank must have a ratio of CET1 capital to risk-weighted assets of 6.5%, a ratio of Tier 1 capital to risk-weighted assets of 8%, a ratio of total capital to risk-weighted assets of 10%, and a leverage ratio of 5%. In order to be considered adequately capitalized, a bank must have the minimum capital ratios required by the regulatory capital rule described above. Institutions with lower capital ratios are assigned to lower capital categories. Based on safety and soundness concerns, a bank may be assigned to a lower capital category than would otherwise apply based on its capital ratios. A bank that is not well-capitalized is subject to certain restrictions on brokered deposits and interest rates on deposits. A bank that is not at least adequately capitalized is subject to numerous additional restrictions, and a guaranty by its holding company is required. A bank with a ratio of tangible equity to total assets of 2.0% or less is subject to the appointment of the FDIC as receiver if its capital level does not improve within 90 days.
As of December 31, 2021, the Bank was in compliance with all regulatory capital standards and qualified as “well-capitalized.” See Note 16 of Notes to Consolidated Financial Statements.
The Economic Growth, Regulatory Relief and Consumer Protection Act (the “Regulatory Relief Act”), enacted in May 2018, introduced an optional simplified measure of capital adequacy for qualifying community banking organizations with total consolidated assets of less than $10 billion by instructing the federal banking regulators to establish a single “Community Bank Leverage Ratio” of tangible equity capital divided by average consolidated assets (“CBLR”) of between 8 and 10 percent in satisfaction of any other leverage or capital requirements to which such organizations are subject.
The federal banking regulators jointly issued a final rule, effective January 1, 2020, which provided that a community banking organization with less than $10 billion in assets may elect to use the CBLR capital framework so long as the bank has a Tier 1 leverage ratio of greater than 9% and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A qualifying bank that elects to use the CBLR framework will be deemed to satisfy the generally applicable leverage and risk-based regulatory capital requirements, will be considered to have met the well-capitalized ratio requirements under the prompt corrective action regulations, and will not be required to report or calculate risk-based capital. The Bank has elected not to opt into the CBLR framework.
Transactions with Related Parties. The Bank is subject to the Federal Reserve’s Regulation W, which comprehensively implements the restrictions of Sections 23A and 23B of the Federal Reserve Act on transactions between a bank and its “affiliates.” The sole “affiliate” of the Bank, as defined in Regulation W, is the Company. Section 23A and the implementing provisions of Regulation W generally place limits on the amount of a bank’s loans or extensions of credit to, investments in, or certain other transactions with its affiliates, and on the amount of advances to third parties collateralized by the securities or obligations of affiliates. Section 23B and Regulation W generally require a bank’s
transactions with affiliates to be on terms substantially the same, or at least as favorable to the bank, as those prevailing at the time for comparable transactions with non-affiliated companies.
The Bank is also subject to certain restrictions on extensions of credit to executive officers, directors, certain principal shareholders and their related interests. Such extensions of credit must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties and must not involve more than the normal risk of repayment or present other unfavorable features.
Community Reinvestment Act and Fair Lending Laws. All insured depository institutions have a responsibility under the Community Reinvestment Act of 1977 (the “CRA”) and federal regulations thereunder to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. In connection with its examination of a state-chartered Federal Reserve member bank like the Bank, the Federal Reserve is required to assess our record of meeting the credit needs of our entire community. The CRA requires the Bank’s record of compliance with the CRA to be taken into account in the evaluation of applications by the Bank or the Company for approval of an expansionary proposal, such as a merger or other acquisition of another bank or the opening of a new branch office. The Bank received a “satisfactory” CRA rating in its most recent assessment received on October 10, 2019 by the Federal Reserve.
In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. A failure to comply with the Equal Credit Opportunity Act or the Fair Housing Act could result in enforcement actions by a bank’s principal federal regulatory agency, as well as by other federal regulatory agencies or the Department of Justice.
Other Consumer Protection Laws. The Bank’s lending and deposit-taking operations are subject to numerous other federal and state laws designed to protect consumers. The Consumer Financial Protection Bureau (“CFPB”) issues regulations and standards under the federal consumer protection laws, which include, among others, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the Truth in Lending Act, the Electronic Fund Transfer Act, the Truth in Savings Act, the Fair Credit Reporting Act, and the Dodd-Frank Wall Street Reform and Consumer Protection Act’s prohibition on unfair, deceptive or abusive acts or practices. The Bank’s consumer financial products and services are subject to examination by the Federal Reserve for compliance with these and other CFPB regulations and standards.
In addition, customer privacy statutes and regulations limit the ability of the Bank to disclose nonpublic consumer information to non-affiliated third parties. These laws require us to provide notice to our customers regarding privacy policies and practices and to give our customers an option to prevent their non-public personal information from being shared with non-affiliated third parties or with our affiliates.
Bank Secrecy Act / Anti-Money Laundering Laws. The Bank is subject to the Bank Secrecy Act and other anti-money laundering laws and regulations, including the USA PATRIOT Act of 2001. These laws and regulations require the Bank to implement policies, procedures, and controls to detect, prevent, and report money laundering and terrorist financing and to verify the identity of their customers. Violations of these requirements can result in substantial civil and criminal sanctions. In addition, provisions of the USA PATRIOT Act require the federal financial institution regulatory agencies to consider the effectiveness of a financial institution's anti-money laundering activities when reviewing mergers and acquisitions.
Commercial Real Estate Lending Concentrations. The federal banking agencies have issued guidance on sound risk management practices for concentrations in commercial real estate lending. The particular focus is on exposure to commercial real estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely to be sensitive to conditions in the commercial real estate market (as opposed to real estate collateral held as a secondary source of repayment or as an abundance of caution). The purpose of the guidance is not to limit a bank’s commercial real estate lending but to guide banks in developing risk management practices and capital levels commensurate with the level and nature of real estate concentrations. The guidance directs the federal banking agencies to focus their supervisory resources on institutions that may have significant commercial real estate loan concentration risk. A bank that has experienced rapid growth in commercial real estate lending, has notable exposure to a specific type of commercial real estate loan, or is approaching or exceeding the following supervisory criteria may be identified for further supervisory analysis with respect to real estate concentration risk:
•
Total reported loans for construction, land development and other land represent 100% or more of the bank’s total regulatory capital; or
•
Total commercial real estate loans (as defined in the guidance) represent 300% or more of the bank’s total regulatory capital and the outstanding balance of the bank’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months.
The guidance provides that the strength of an institution’s lending and risk management practices with respect to such concentrations will be taken into account in supervisory guidance on evaluation of capital adequacy.
Regulation of the Company. The Company is a bank holding company under the Bank Holding Company Act that has elected status as a financial holding company. As such, we are subject to regulation, supervision, and examination by the Federal Reserve. We are required to file quarterly reports with the Federal Reserve and provide such additional information as the Federal Reserve may require. The Federal Reserve has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money
penalties, to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices. We are also required to file certain reports with, and otherwise comply with the rules and regulations of, the SEC.
Regulatory Capital Requirements. The federal regulatory capital rules apply to all depository institutions as well as to bank holding companies with consolidated assets of $3 billion or more. However, the regulatory capital requirements generally do not apply on a consolidated basis to a bank holding company with total consolidated assets of less than $3 billion unless the holding company: (1) is engaged in significant nonbanking activities either directly or through a nonbank subsidiary; (2) conducts significant off-balance sheet activities (including securitization and asset management or administration) either directly or through a nonbank subsidiary; or (3) has a material amount of debt or equity securities outstanding (other than trust preferred securities) that are registered with the SEC. The Federal Reserve may apply the regulatory capital standards at its discretion to any bank holding company, regardless of asset size, if such action is warranted for supervisory purposes.
Because the Company has total consolidated assets of less than $3 billion and does not engage in activities that would trigger application of the federal regulatory capital rules, it is not at present subject to consolidated capital requirements under the such rules.
Acquisitions. Under the Bank Holding Company Act, we are required to obtain the prior approval of the Federal Reserve to acquire ownership or control of more than 5% of the voting shares or substantially all of the assets of any bank holding company or bank or merge or consolidate with another bank holding company. Federal law authorizes bank holding companies to make interstate acquisitions of banks without geographic limitation.
Permissible Activities. In general, the Bank Holding Company Act limits the activities of a bank holding company to those of banking, managing or controlling banks, or any other activity that the Federal Reserve has determined to be so closely related to banking or to managing or controlling banks that an exception is allowed for those activities. A bank holding company that qualifies and elects to be treated as a “financial holding company” may engage in a broad range of additional activities that are (i) financial in nature or incidental to such financial activities or (ii) complementary to a financial activity and do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. These activities include securities underwriting and dealing, insurance agency and underwriting, and making merchant banking investments. On October 12, 2021, the Company filed an election to be treated as a financial holding company.
Incentive Compensation. Federal banking agencies have issued guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. In accordance with federal statute, the federal banking agencies prohibit incentive-based compensation arrangements that encourage inappropriate risk taking by covered financial institutions (generally institutions that have over $1 billion in assets) and are deemed to be excessive, or that may lead to material losses.
The Federal Reserve will review, as part of its standard, risk-focused examination process, the incentive compensation arrangements of banking organizations (such as the Company) that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies. The scope and content of the U.S. banking regulators’ policies on executive compensation is likely to continue to evolve. It cannot be determined at this time whether compliance with such policies will adversely affect the Company’s ability to hire, retain and motivate its key employees.
Source of Strength. Under the Bank Holding Company Act, a bank holding company is required to act as a source of financial and managerial strength to each of its subsidiary banks and to commit resources to support each subsidiary bank. Under this source of strength doctrine, the Federal Reserve may require a bank holding company to make capital injections into a troubled subsidiary bank. The Federal Reserve may charge the bank holding company with engaging in unsafe and unsound practices if it fails to commit resources to such a subsidiary bank or if it undertakes actions that the Federal Reserve believes might jeopardize its ability to commit resources to such subsidiary bank. A capital injection may be required at times when the holding company does not have the resources to provide it.
In addition, any loans by a holding company to a subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company’s bankruptcy, the bankruptcy trustee will assume any commitment by the holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank. Moreover, the bankruptcy law provides that claims based on any such commitment will be entitled to a priority of payment over the claims of the institution’s general unsecured creditors, including the holders of its note obligations.
Payment of Dividends. The Company is subject to various restrictions relating to the payment of dividends. The Federal Reserve has issued guidance indicating that bank holding companies should generally pay dividends only if the company’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears consistent with the company’s capital needs, asset quality and overall financial condition. The Federal Reserve’s guidance also states that a bank holding company should inform and consult with its regional Federal Reserve Bank in advance of declaring or paying a dividend that exceeds earnings for the period for which the dividend is being paid or that could result in a material adverse change to the organization’s capital structure. In addition, under Virginia law, the Company generally may not pay dividends or distributions to holders of common stock if it would be unable to pay its debts as they become due in the ordinary course of business or if its total assets would be less than the sum of its total liabilities plus the amount of the liquidation preference of any class of shares with superior rights than common stock.
As the majority of the Company’s revenues result from dividends paid to the Company by the Bank, the Company’s ability to pay dividends to our shareholders largely depends on the receipt of such dividends from the Bank. The Bank is subject to various laws and regulations limiting the amount of dividends that it can pay. Under Virginia law, without the permission of the Virginia State Corporation Commission, a state bank may not pay dividends, except from retained earnings. Under federal law applicable to state-chartered Federal Reserve member banks, a bank may not declare or pay a dividend without prior Federal Reserve approval if the total of all dividends declared during the calendar year, including the proposed dividend, exceeds the sum of the bank’s net income during the current calendar year and the retained net income of the prior two calendar years. The Federal Reserve may also object to a proposed dividend based on safety and soundness concerns.
No insured depository institution may pay a dividend if, after paying the dividend, the institution would be undercapitalized. In addition, as noted above, if the Bank does not maintain the capital conservation buffer required by applicable regulatory capital rules, its ability to pay dividends to the Company will be limited.
Federal Securities Law. The Company’s common stock is registered under Section 12(b) of the Exchange Act, and the Company is subject to the periodic reporting and other requirements of the SEC under Section 12(b) of the Exchange Act and SEC regulations.

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ITEM 1A. RISK FACTORS
Item 1A. Risk Factors
This section highlights the material risks that the Company currently faces. Any of the risks described below could materially adversely affect our business, financial condition, and results of operations.
Risks Related to Our Business
Pandemic Risks
Pandemic risks, such as the one we are currently experiencing due to COVID-19, can have an impact on every risk outlined in the paragraphs below. We have learned that pandemic risks can, in-and-of-themselves, cause serious national and even global financial and economic distress. The results of that financial distress and the associated health concerns can and will impact businesses as ongoing concerns, the health and well-being of a population, and the financial capabilities of consumers, businesses and government entities. Pandemic risks can and will impact our business and financial results.
The COVID-19 pandemic has created, and may continue to create, significant disruption of the global economy and financial markets. Governments, businesses, and the public are taking actions to contain the spread of COVID-19 and to mitigate its effects, including quarantines, travel bans, “stay at home” orders, cancellation of events and travel, closures of businesses and schools, fiscal stimulus, and legislation intended to provide monetary aid and other relief. While the scope, duration, and full effect of COVID-19 continue to evolve and are not fully known, the pandemic and related efforts to contain it have disrupted global economic activity, adversely affected the functioning of financial markets, impacted interest rates, increased economic and market uncertainty, and disrupted trade and supply chains.
Credit and Lending Risks
Our business, like that of most banking organizations, is highly susceptible to credit risk.
As a lender, the Bank is exposed to the risk that customers will be unable to repay their loans according to terms of the loan agreements and that the collateral securing payment of the loans (if any) may not be sufficient to assure repayment. Credit losses could have a material adverse effect on our operating results and financial condition.
We have significant exposure to risks associated with commercial and residential real estate.
A substantial portion of our loan portfolio consists of commercial and residential real estate-related loans, including construction and residential and commercial mortgage loans. As of December 31, 2021, we had approximately $173.1 million of owner-occupied and $361.1million of investment commercial real estate loans outstanding, which represented approximately 12.7% and 26.6%, respectively, of our loan portfolio as of December 31, 2021. As of that same date, we had approximately $337.2 million of construction real estate loans and $300.4 million of residential real estate loans, which represent 24.8% and 22.1% respectively.
The adverse consequences from real estate-related credit risks tend to be cyclical and are often driven by local and national economic developments that are not controllable or entirely foreseeable by us or our borrowers. As a result:
•
we have a greater risk of loan defaults and losses in the event of economic weaknesses associated with commercial and residential real estate in our market area and nationally, which may have a negative effect on the ability of our borrowers to timely repay their loans; and
•
loan concentrations and the associated risks related to commercial and residential real estate may pose additional regulatory credit risk concerns, including interest rate risk due to maturity considerations, liquidity risk due to funding considerations and risks to earnings and capital.
Since we engage in lending secured by real estate and may be forced to foreclose on the collateral property and own the underlying real estate, we may be subject to the increased costs and risks associated with the ownership of real property, which could have an adverse effect on our business and results of operations.
A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans, in which event we become exposed to the risks inherent in the ownership of real estate. The amount that we, as a mortgagee, may realize after a default is dependent upon factors outside of our control, including:
•
general or local economic conditions;
•
environmental clean-up liabilities;
•
neighbourhood values;
•
interest rates;
•
real estate tax rates;
•
operating expenses of the foreclosed properties;
•
supply of and demand for rental units or properties;
•
ability to obtain and maintain adequate occupancy of the properties;
•
zoning laws;
•
governmental rules, regulations and fiscal policies; and
•
extreme weather conditions or other natural or man-made disasters.
Certain expenditures associated with the ownership of real estate, principally real estate taxes and maintenance costs, may also adversely affect our operating expenses.
Commercial and industrial loans may expose us to greater financial and credit risk than other loans.
Commercial and industrial loans generally carry larger loan balances and can involve a greater degree of financial and credit risk than other loans, including less collateral at liquidation. Any significant failure to pay on time by our customers would hurt our earnings. The increased financial and credit risks associated with these types of loans result from several factors, including the concentration of principal in a limited number of loans and borrowers, the size of loan balances, the effects of general economic conditions on income-producing properties and the increased difficulty of evaluating and monitoring these types of loans. In addition, when underwriting a commercial or industrial loan, we may take a security interest in commercial real estate, and, in some instances upon a default by the borrower, we may foreclose on and take title to the property, which may lead to additional risks for us under applicable environmental laws.
The small-to-midsized businesses that we lend to may have fewer resources to weather adverse business developments, which may impair a borrower’s ability to repay a loan, and such impairment could have a material adverse effect on our business, financial condition and results of operations.
We focus our business development and marketing strategy primarily on small-to-midsized businesses. These businesses frequently have smaller market shares than their competition, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete and may experience substantial volatility in operating results, any of which may impair a borrower’s ability to repay a loan. In addition, the success of a small-to-midsized business often depends on the management skills, talents and efforts of one or two people or a small group of people, and the death, disability or resignation of one or more of these people could have an adverse impact on the business and its ability to repay its loan. If general economic conditions negatively impact the markets in which we operate and small-to-midsized businesses are adversely affected or our borrowers are otherwise harmed by adverse business developments, this, in turn, could have a material adverse effect on our business, financial condition and results of operations.
The borrowing needs of our customers may increase, especially during a challenging economic environment, which could result in increased borrowing against our contractual obligations to extend credit.
A commitment to extend credit is a formal agreement to lend funds to a customer as long as there is no violation of any condition established under the agreement. The actual borrowing needs of our customers under these credit commitments have historically been lower than the contractual amount of the commitments. A significant portion of these commitments expire without being drawn upon. Because of the credit profile of our customers, we typically have a substantial amount of total unfunded credit commitments, which is not reflected on our balance sheet. As of December 31, 2021 we had $304.3 million in unfunded credit commitments to our customers. Actual borrowing needs of our customers may exceed our expectations, especially during a challenging economic environment when our customers’ companies may be more dependent on our credit commitments due to the lack of available credit elsewhere, the increasing costs of credit, or the limited availability of financings from venture firms. This could adversely affect our liquidity, which could impair our ability to fund operations and meet obligations as they become due and could have a material adverse effect on our business, financial condition and results of operations.
Our allowance for loan losses may not be adequate to cover actual future losses.
We maintain an allowance for loan losses to cover estimable and observable loan losses inherent in our portfolio. Every loan we make carries a certain risk of non-repayment, and we make various assumptions and judgments about the collectability of our loan portfolio including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of loans. Through a periodic review of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of customers relative to their financial obligations with us. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and these losses may exceed current estimates. We cannot fully predict the amount or timing of losses or whether the loss allowance will be adequate in the future. If our assumptions prove to be incorrect, our allowance for loan losses may not
be sufficient to cover losses inherent in our loan portfolio, resulting in additions to the allowance. Excessive loan losses could have a material adverse impact on our financial condition and results of operations.
We may be required to increase our provisions for loan losses and to charge off loans in the future, which increases and charges could materially adversely affect us.
There is no precise method of predicting the timing of loan losses. We can give no assurance that our allowance for loan losses is or will be sufficient to absorb actual loan losses. We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, that represents management’s estimable and observable losses within the existing portfolio of loans. The level of the allowance reflects management’s evaluation of, among other factors, the status of specific impaired loans, trends in historical loss experience, delinquency trends, credit concentrations and economic conditions within our market area. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and judgment and requires us to make significant estimates of current credit risks and future trends, all of which may undergo subsequent material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require us to increase our allowance for loan losses. Increases in nonperforming loans have a significant impact on our allowance for loan losses.
In addition, bank regulatory agencies periodically review our allowance for loan losses and may require us to increase the provision for loan losses or to recognize further loan charge-offs, based on judgments that differ from those of management. If loan charge-offs in future periods exceed our allowance for loan losses, we will need to record additional provisions to increase our allowance for loan losses. Furthermore, growth in our loan portfolio would generally lead to an increase in the provision for loan losses. Generally, increases in our allowance for loan losses will result in a decrease in net income and shareholders’ equity, and may have a material adverse effect on our financial condition, results of operations and cash flows. Material additions to our allowance could also materially decrease our net income.
The implementation of the Current Expected Credit Loss accounting standard could require the Company to increase its allowance for credit losses.
In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which replaces the incurred loss model with an expected loss model, which is referred to as the current expected credit loss model, or “CECL.” This standard requires earlier recognition of expected credit losses on loans and certain other instruments, compared to the incurred loss model. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration.
The revised methodology required by ASU 2016-13, which will be effective for the Company in the fiscal year beginning after December 15, 2022, represents a significant change from existing GAAP and may result in material changes to the Company’s accounting for financial instruments. For most debt securities, the transition approach requires a cumulative-effect adjustment to the statement of financial position as of the beginning of the first reporting period the guidance is effective. For other-than-temporarily impaired debt securities, the guidance will be applied prospectively. The Company will record a one-time adjustment to its credit loss allowance, as of the beginning of the first quarter of 2023, equal to the difference between the amounts of its credit loss allowance under the incurred loss methodology and under CECL. The Company cannot yet determine the magnitude of any such one-time cumulative adjustment or of the overall impact of the new standard on its financial condition or results of operations. In anticipation of the implementation of CECL, the Company is working with a third party to compile data and develop an estimate using historical and qualitative data based on the requirements of ASU 2016-13.
A significant portion of our loan portfolio is unseasoned.
Since December 31, 2016, our loan portfolio has increased approximately 191.6%, from $464 million at December 31, 2016 to $1.4 billion at December 31, 2021. While we believe our underwriting standards are designed to manage normal lending risks, it is difficult to assess the future performance of our loan portfolio due to the recent origination of many of our loans. As a result, it is difficult to determine whether these loans will become non-performing or delinquent, or whether we will hold non-performing or delinquent loans that may adversely affect our future performance.
We extend credit to a variety of customers based on internally established standards and judgment. We manage credit risk through a program of underwriting standards, the review of certain credit decisions and an on-going process of assessment of the quality of the credit already extended. Our credit standards and ongoing process of credit assessment might not protect us from significant credit losses.
We take credit risk by virtue of making loans, extending loan commitments and letters of credit and, to a lesser degree, purchasing non-governmental securities. Our exposure to credit risk is managed through the use of consistent underwriting standards, and we avoid highly leveraged transactions as well as excessive industry and other concentrations. Our credit administration function employs risk management techniques to ensure that loans adhere to corporate policy and problem loans are promptly identified. While these procedures are designed to provide us with the information needed to implement policy adjustments where necessary, and to take proactive corrective actions, there can be no assurance that such measures will be effective in avoiding undue credit risk.
We are subject to environmental liability risk associated with our lending activities.
In the course of our business, we may purchase real estate, or we may foreclose on and take title to real estate. Although we exercise prudent due diligence when making loans, we could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination or may be required to investigate or clean up hazardous or toxic substances or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. Any significant environmental liabilities could cause an adverse effect on our business, financial condition and results of operations.
Interest Rate Risks
Changes in interest rates may negatively affect our earnings, income and financial condition as well as the value of our assets.
Our earnings and cash flows depend substantially upon our net interest income. Net interest income is the difference between interest income earned on interest-earning assets, such as loans and investment securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are sensitive to many factors that are beyond our control, including general economic conditions, competition and policies of various governmental and regulatory agencies and, in particular, the policies of the Federal Reserve.
In an attempt to help the overall economy, the Federal Reserve has kept interest rates low through its targeted Fed Funds rate. During 2020, the Federal Reserve decreased the targeted Fed Funds rate to 0 - 25 basis points. The Federal Reserve has indicated that further changes would be subject to economic conditions. As the Federal Reserve increases and decreases the targeted Fed Funds rate, overall interest rates will likely be impacted.
Changes in monetary policy, including changes in interest rates, not only could influence the interest we receive on loans and investment securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect: (1) our ability to originate loans and obtain deposits; (2) the fair value of our financial assets and liabilities, including our securities portfolio; and (3) the average duration of our interest-earning assets. Interest-earning assets may be more responsive to changes in interest rates than interest-bearing liabilities, or vice versa (repricing risk), individual interest rates or rate indices underlying various interest-earning assets and interest-bearing liabilities may not change in the same degree over a given time period (basis risk), and interest rate relationships may change across the spectrum of interest-earning asset and interest-bearing liability maturities (yield curve risk), including a prolonged flat or inverted yield curve environment. Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations.
Our business may be adversely affected by the transition from the London InterBank Offered Rate (LIBOR) as a reference rate..
The London Interbank Offered Rate (LIBOR) is used extensively in the United States and globally as a reference rate for various commercial and financial contracts, including adjustable rate mortgages, corporate debt, interest rate swaps and other derivatives. LIBOR is set based on interest rate information reported by certain banks, which may stop reporting such information after 2021. In 2017, the United Kingdom’s Financial Conduct Authority (FCA) announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. On November 30, 2020, to facilitate an orderly LIBOR transition, the United States financial institution regulatory agencies jointly announced that entering into new contracts using LIBOR as a reference rate after December 31, 2021, would create a safety and soundness risk. On March 5, 2021, the FCA announced that all LIBOR settings will either cease to be provided by any administrator or no longer be representative immediately after December 31, 2021, in the case of 1-week and 2-month LIBOR, and immediately after June 30, 2023, in the case of the remaining LIBOR settings.
In the United States, while there is no consensus on what rate or rates will become the accepted alternatives to LIBOR, a group of market participants convened by the Federal Reserve, the Alternative Reference Rate Committee (ARRC), has selected the Secured Overnight Financing Rate (SOFR) as its recommended alternative to LIBOR. SOFR is different from LIBOR in that it is a backward-looking secured rate rather than a forward-looking unsecured rate. These differences could lead to a greater disconnect between our costs to raise funds for SOFR as compared to LIBOR. For cash products and loans, ARRC has also recommended Term SOFR, which is a forward-looking rate based on SOFR futures and may in part reduce differences between SOFR and LIBOR. There are operational issues that may create a delay in the transition to SOFR or other substitute indices, leading to uncertainty across the industry.
Until replacement rates are established and all agreements have been addressed, we will continue to have a number of loans, derivative contracts, and other financial instruments with attributes that are directly or indirectly dependent on LIBOR.
Liquidity Risk
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition.
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities, or on terms that are acceptable to us, could be impaired by factors that affect us specifically or the financial services industry or the economy in general. Factors that could detrimentally affect our access to liquidity sources include, among other things, a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated and an adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry.
Among other sources of funds, we rely heavily on deposits for funds to make loans and provide for our other liquidity needs. However, our loan demand has historically exceeded the rate at which we have been able to build core deposits for which there is substantial competition from a variety of different competitors, so we have relied on interest-sensitive deposits, including wholesale deposits, as sources of funds. Those deposits may not be as stable as other types of deposits and, in the future, depositors may not renew those deposits when they mature, or we may have to pay a higher rate of interest to attract or retain them or to replace them with other deposits or with funds from other sources. Not being able to attract deposits, or to retain or replace them as they mature, would adversely affect our liquidity. Paying higher deposit rates to attract, retain or replace those deposits could have a negative effect on our interest margin and operating results.
Operational Risks
New lines of business, products, product enhancements or services may subject us to additional risks.
From time to time, we implement new lines of business, or offer new products and product enhancements as well as new services within our existing lines of business and we will continue to do so in the future. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In implementing, developing or marketing new lines of business, products, product enhancements or services, we may invest significant time and resources, although we may not assign the appropriate level of resources or expertise necessary to make these new lines of business, products, product enhancements or services successful or to realize their expected benefits. Further, initial timetables for the introduction and development of new lines of business, products, product enhancements or services may not be achieved, and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives and shifting market preferences, may also impact the ultimate implementation of a new line of business or offerings of new products, product enhancements or services. Furthermore, any new line of business, product, product enhancement or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or offerings of new products, product enhancements or services could have an adverse impact on our business, financial condition or results of operations.
In 2016, we added a new funding source by way of facilitating payment services. We are continuing to identify and solicit new customers in need of these specialized services. The primary reasons for expanding into payment services are to secure an additional source of low-cost deposits and to capture additional fee income. A bank’s risks when dealing with a processor account are similar to risks from other activities in which customers conduct transactions through the bank on behalf of the customers’ clients. It is necessary for a bank to implement an adequate processor approval, monitoring and auditing program that extends beyond credit risk management and is conducted on an ongoing basis. When a bank is not able to identify and understand the nature and source of transactions processed through accounts, the bank’s risks and the likelihood of suspicious activity can increase. Without these precautions, a bank could be vulnerable to processing illicit or sanctioned transactions.
We face risks related to our operational, technological and organizational infrastructure.
Our ability to grow and compete is dependent on the Bank’s ability to build or acquire the necessary operational and technological infrastructure and to manage the cost of that infrastructure as we expand. In our case, operational risk can manifest itself in many ways, such as errors related to failed or inadequate processes, faulty or disabled computer systems, fraud by employees or outside persons and exposure to external events. As discussed below, we are dependent on our operational infrastructure to help manage these risks. In addition, we are heavily dependent on the strength and capability of our technology systems that the Bank uses both to interface with customers and to manage internal financial and other systems. Our ability to develop and deliver new products that meet the needs of our existing customers and attract new ones depends on the functionality of our technology systems. Additionally, our ability to run our business in compliance with applicable laws and regulations is dependent on these infrastructures.
We continuously monitor our operational and technological capabilities and make modifications and improvements as circumstances warrant. In some instances, the Bank may build and maintain these capabilities itself. We outsource many of these functions to third parties. These third parties may experience errors or disruptions that could adversely impact the Bank and over which it may have limited control. We also face risk from the integration of new infrastructure platforms and/or new third-party providers of such platforms into the Bank’s existing businesses.
Many of our larger competitors have substantially greater resources to invest in technological improvements. As a result, they may be able to offer additional or superior technologies compared to those that we will be able to provide, which could put us at a competitive
disadvantage. Accordingly, we may lose customers seeking new technology-driven products and services to the extent we are unable to compete effectively.
A failure in our operational systems or infrastructure, or those of third parties, could impair our liquidity, disrupt our business, result in the unauthorized disclosure of confidential information, damage our reputation and cause financial losses.
Our business is dependent on our ability to process and monitor, on a daily basis, a number of transactions. These transactions, as well as the information technology services we provide to clients, often must adhere to client-specific guidelines, as well as legal and regulatory standards. Developing and maintaining our operational systems and infrastructure is challenging, particularly as a result of rapidly evolving legal and regulatory requirements and technological shifts. Our financial, accounting, data processing or other operating systems and facilities may fail to operate properly or become disabled as a result of events that are wholly or partially beyond the Bank’s control, such as a spike in transaction volume, cyber-attack or other unforeseen catastrophic events, which may adversely affect our ability to process these transactions or provide services.
In addition, our operations rely on the secure processing, storage and transmission of confidential and other information on our computer systems and networks. Although we take protective measures to maintain the confidentiality, integrity and availability of our and our clients’ information across all geographic and product lines, and endeavor to modify these protective measures as circumstances warrant, the nature of the threats continues to evolve. As a result, our computer systems, software and networks may be vulnerable to unauthorized access, loss or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses or other malicious code, cyber-attacks and other events that could have an adverse security impact. Despite the defensive measures we take to manage our internal technological and operational infrastructure, these threats may originate externally from third parties such as foreign governments, organized crime and other hackers, and outsource or infrastructure-support providers and application developers, or may originate internally from within our organization. Given the increasingly high volume of our transactions, certain errors may be repeated or compounded before they can be discovered and rectified.
We also face the risk of operational disruption, failure, termination or capacity constraints of any of the third parties that facilitate our business activities, including exchanges, clearing agents, clearing houses or other financial intermediaries. Such parties could also be the source of an attack on, or breach of, our operational systems, data or infrastructure. In addition, as interconnectivity with our clients grows, we increasingly face the risk of operational failure with respect to our clients’ systems.
We rely on vendors to support our operations. We also rely on vendors to provide part of our services we deliver to customers. While we have a vendor management program policy in place and believe we have selected our vendors appropriately, we cannot directly control their employees or their operating environments. A breach or failure of a chosen vendor could have a material impact on our operating environment.
Our services and technology solutions rely on the internet more and more. Computers connected to the internet are vulnerable to many types of threats by cyber criminals. Although none of these types of attacks have had a material impact on our business to date, we anticipate that the efforts to attack our systems, and those of our customers and vendors, will grow in complexity and volume. As such, we have developed an incident response plan to coordinate the efforts following the identification of an attack.
Failure to maintain a secure computing environment, stay up to date on security vulnerabilities or deploy adequate technologies to protect against attacks, may subject our information and systems to security breaches that could compromise confidential information and damage our reputation and business. We rely on industry-standard encryption and authentication security systems to provide the security required to protect our data. Periodically our systems are subjected to scans, exploitations and audits by a qualified independent third party to evaluate the effectiveness of our security controls and system configurations.
Cyber criminals may attempt to trick employees, customers or vendors through phishing schemes or other methods to disclose sensitive information. Employees receive annual security training and are periodically assessed through simulated attack tools to assist with behavior shaping and coaching against social engineering threats.
If one or more of these events occurs, it could potentially jeopardize the confidential, proprietary and other information processed and stored in, and transmitted through, the Bank’s computer systems and networks, or otherwise cause interruptions or malfunctions in our, as well as our clients’ or other third parties’ operations, which could result in damage to our reputation, substantial costs, regulatory penalties and/or client dissatisfaction or loss.
Potential costs of a cyber incident may include, but would not be limited to, remediation costs, increased protection costs, lost revenue from the unauthorized use of proprietary information or the loss of current and/or future customers, and litigation.
We maintain an insurance policy through the Bank’s blanket bond at the maximum of currently available limits. However, we cannot assure you that this policy would be sufficient to cover all financial losses, damages, penalties, including lost revenues, should the Bank experience any one or more of our or a third party’s systems failing or experiencing attack.
We rely on third parties to provide key components of our business infrastructure, and a failure of these parties to perform for any reason could disrupt our operations.
Third parties provide key components of our business infrastructure such as data processing, internet connections, network access, core application processing, statement production and account analysis. Our business depends on the successful and uninterrupted functioning of our information technology and telecommunications systems and third-party servicers. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. Replacing vendors or addressing other issues with our third-party service providers could entail significant delay and expense. If we are unable to efficiently replace ineffective service providers, or if we experience a significant, sustained or repeated system failure or service denial, it could compromise our ability to operate effectively, damage our reputation, result in a loss of customer business, and subject us to additional regulatory scrutiny and possible financial liability, any of which could have an adverse effect on our business, financial condition and results of operations.
Reputational risk and social factors may impact our results.
Our ability to originate and maintain accounts is highly dependent upon consumer and other external perceptions of our business practices and/or our financial health. Adverse perceptions could damage our reputation in both the customer and funding markets, leading to difficulties in generating and maintaining accounts as well as in financing them. Adverse developments with respect to the consumer or other external perceptions regarding the practices of our competitors, or our industry as a whole, may also adversely impact our reputation. In addition, adverse reputational impacts on third parties with whom we have important relationships may also adversely impact our reputation. Adverse impacts on our reputation, or the reputation of our industry, may also result in greater regulatory and/or legislative scrutiny, which may lead to laws or regulations that may change or constrain the manner in which the Bank engages with its customers and the products the Bank offers. Adverse reputational impacts or events may also increase our litigation risk. We carefully monitor internal and external developments for areas of potential reputational risk and have established governance structures to assist in evaluating such risks in our business practices and decisions.
We could be subject to losses, regulatory action or reputational harm due to fraudulent and negligent acts on the part of loan applicants, our employees and vendors.
In deciding whether to extend credit or enter into other transactions with clients and counterparties, and the terms of any such transaction, we may rely on information furnished by or on behalf of clients and counterparties, including financial statements, property appraisals, title information, employment and income documentation, account information and other financial information. We may also rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. Any such misrepresentation or incorrect or incomplete information, whether fraudulent or inadvertent, may not be detected prior to funding. In addition, one or more of our employees or vendors could cause a significant operational breakdown or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates our loan documentation, operations or systems. Whether a misrepresentation is made by the applicant or another third party, we generally bear the risk of loss associated with the misrepresentation. A loan subject to a material misrepresentation is typically unsellable or subject to repurchase if it is sold prior to detection of the misrepresentation. The sources of the misrepresentations may also be difficult to locate, and we may be unable to recover any of the monetary losses we may suffer as a result of the misrepresentations. Any of these developments could have an adverse effect on our business, financial condition and results of operations.
We are subject to claims and litigation pertaining to intellectual property.
Banking and other financial services companies, such as ours, rely on technology companies to provide information technology products and services necessary to support their day-to-day operations. Technology companies frequently enter into litigation based on allegations of patent infringement or other violations of intellectual property rights. In addition, patent holding companies seek to monetize patents they have purchased or otherwise obtained. Competitors of our vendors, or other individuals or companies, may from time to time claim to hold intellectual property sold to us by our vendors. Such claims may increase in the future as the financial services sector becomes more reliant on information technology vendors. The plaintiffs in these actions frequently seek injunctions and substantial damages.
Regardless of the scope or validity of such patents or other intellectual property rights, or the merits of any claims by potential or actual litigants, we may have to engage in protracted litigation. Such litigation is often expensive, time-consuming, disruptive to our operations and distracting to management. If we are found to infringe one or more patents or other intellectual property rights, we may be required to pay substantial damages or royalties to a third party. In certain cases, we may consider entering into licensing agreements for disputed intellectual property, although no assurance can be given that such licenses can be obtained on acceptable terms or that litigation will not occur. These licenses may also significantly increase our operating expenses. If legal matters related to intellectual property claims were resolved against us or settled, we could be required to make payments in amounts that could have an adverse effect on our business, financial condition and results of operations.
The decreased soundness of other financial institutions could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led in the past to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral that we hold cannot be realized upon or is liquidated at prices insufficient to recover the full amount of the loan. We cannot assure you that any such losses would not materially and adversely affect our business, financial condition or results of operations.
Strategic Risks
Strong competition within our market area could reduce our profits and slow growth.
We face competition in making loans, attracting deposits and hiring and retaining experienced employees. Price competition for loans and deposits may result in our charging lower interest rates on loans and paying higher interest rates on deposits, thereby reducing our net interest income. Price competition also may limit our ability to originate loans. Competition makes it more difficult and costly to attract and retain qualified employees.
Our financial performance will be negatively affected if we are unable to execute our growth strategy.
Our stated growth strategy is to grow organically and supplement that growth with select acquisitions, if available. Our success depends primarily on generating loans and deposits of acceptable risk and expense. There can be no assurance that we will be successful in continuing our organic, or internal, growth strategy. Our ability to identify appropriate markets for expansion, recruit and retain qualified personnel, and fund growth at reasonable cost, depends upon prevailing economic conditions, maintenance of sufficient capital, competitive factors, changes in banking laws, and other factors.
We cannot be certain as to our ability to manage increased levels of assets and liabilities without increased expenses and higher levels of nonperforming assets. We may be required to make additional investments in equipment and personnel to manage higher asset levels and loan balances, which may adversely affect earnings, shareholder returns, and our efficiency ratio. Increases in operating expenses or nonperforming assets may decrease our earnings and the value of the Company’s capital stock.
We may face increasing deposit-pricing pressures, which may, among other things, reduce our profitability.
Deposit pricing pressures may result from competition as well as changes to the interest rate environment. Current economic conditions have intensified competition for deposits. The competition has had an impact on interest rates paid to attract deposits as well as fees charged on deposit products. In addition to the competitive pressures from other depository institutions, we face heightened competition from non-depository financial products such as securities and other alternative investments.
Furthermore, technology and other market changes have made it more convenient for bank customers to transfer funds for investing purposes. Bank customers also have greater access to deposit vehicles that facilitate spreading deposit balances among different depository institutions to maximize FDIC insurance coverage. In addition to competitive forces, we also are at risk from market forces as they affect interest rates. It is not uncommon when interest rates transition from a low interest rate environment to a rising rate environment, for deposit and other funding costs to rise in advance of yields on earning assets. In order to keep deposits required for funding purposes, it may be necessary to raise deposit rates without commensurate increases in asset pricing in the short term.
Historically low interest rates may adversely affect our net interest income and profitability.
In recent years it has been the policy of the Federal Reserve to maintain interest rates at historically low levels through its targeted federal funds rate and the purchase of mortgage-backed securities. As a result, market rates on the loans we have originated and the yields on securities we have purchased have been at historically low levels. As discussed above, rates are fluctuating, and due to a number of factors including changes in monetary policies of the Federal Reserve, will likely continue to fluctuate.
External and Market-Related Risks
Changes in general business, economic and political conditions, especially in Northern Virginia, could adversely affect our earnings.
Our success depends, to a certain extent, upon economic and political conditions, local and national, as well as governmental monetary policies. Conditions such as inflation, recession, unemployment, changes in interest rates, money supply and other factors beyond our control may adversely affect our asset quality, deposit levels and loan demand and, therefore our earnings. In addition, there are continuing ocncerns
related to, among other things, the level of U.S. government debt and fiscal actions that may be taken to address that debt, a potential resurgence of economic and political tensions with China or an escalation of tensions between Russia and Ukraine, all of which may have a destabilizing effect on financial markets and economic activity. Economic pressure on consumers, businesses and overall economic uncertainty may result in changes in spending, borrowing, and saving habits. These economic conditions and other negative developments in the domestic or international credit markets and economies may significantly affect the markets in which we do business. Because we have a significant amount of real estate loans, decreases in real estate values could adversely affect the value of property used as collateral and our ability to sell the collateral upon foreclosure. Adverse changes in the economy may also have a negative effect on the ability of our borrowers to make timely repayments of their loans, which would have an adverse impact on our earnings. If during a period of reduced real estate values we are required to liquidate the collateral securing a loan to satisfy the debt or to increase our allowance for loan losses, it could materially reduce our profitability and adversely affect our financial condition. The substantial majority of our loans are to individuals and businesses in the Northern Virginia and Washington D.C metropolitan area. Consequently, significant declines in the economy in the Northern Virginia and Washington D.C. metropolitan area could have a materially adverse effect on our financial condition and results of operations.
Additionally, the emergence of widespread health emergencies or pandemics, such as coronavirus (“COVID-19”), could lead to quarantines, business shutdowns, increases in unemployment, labor shortages, disruptions to supply chains, and overall economic instability. Events such as these may become more common in the future and could cause significant damage such as disrupt power and communication services, impact the stability of our facilities and result in additional expenses, impair the ability of our borrowers to repay their loans, reduce the value of collateral securing the repayment of our loans, which could result in the loss of revenue. While we have established and regularly test disaster recovery procedures, the occurrence of any such event could have a material adverse effect on our business, operations and financial condition.
If we do not adjust to rapid changes in the financial services industry, our financial performance may suffer.
We face substantial competition for customer relationships, as well as other sources of funding in the communities it serves. Competing providers include other banks, savings institutions and trust companies, insurance companies, mortgage banking operations, credit unions, finance companies, title companies, money market funds and other financial and nonfinancial companies which may offer products functionally equivalent to those offered by the Bank. Many competing providers have greater financial resources than we do and offer services within and outside the market areas we serve. In addition to this challenge of attracting and retaining customers for traditional banking services, our competitors include securities dealers, brokers, mortgage bankers, investment advisors and finance and insurance companies who seek to offer one-stop financial services to their customers that may include services that financial institutions have not been able or allowed to offer to their customers in the past. The increasingly competitive environment is primarily a result of changes in regulation, changes in technology and product delivery systems and the accelerating pace of consolidation among financial service providers. If we are unable to adjust both to increased competition for traditional banking services and changing customer needs and preferences, our financial performance and your investment in our capital stock could be adversely affected.
Additional required capital may not be available.
We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. In addition, we may elect to raise additional capital to support our business or to finance acquisitions, if any, or we may otherwise elect or be required to raise additional capital. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside of our control, and on our financial performance. Accordingly, there can be no assurance that we can raise additional capital if needed or on terms acceptable to us. If we cannot raise additional capital when needed, it may have a material adverse effect on our financial condition, results of operations and prospects.
Compliance and Regulatory Risks
We operate in a highly regulated environment, and we may be adversely affected by changes in laws and regulations.
We are subject to extensive regulation, supervision and examination by the Federal Reserve, our primary federal regulator, the Virginia Bureau of Financial Institutions, our chartering authority and the FDIC, as insurer of our deposits. Such regulation and supervision govern the activities in which we and the Bank may engage, and are intended primarily for the protection of the insurance fund and the depositors and borrowers of the Bank rather than for holders of our common stock. Various consumers and compliance laws also affect our operations.
Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations. The earnings of the Bank, and therefore the earnings of the Company, are affected by changes in federal and state legislation and actions of various regulatory authorities.
The Bank has become subject to more stringent regulatory capital requirements.
The Bank is subject to the comprehensive, consolidated supervision and regulation of the FRB and the Bureau of Financial Institutions, including risk-based and leverage capital requirements. The Bank must maintain certain risk-based and leverage capital ratios as required by our banking regulators, which can change depending on general economic conditions and on the Bank’s particular condition, risk profile and growth plans. If at any time we fail to meet minimum regulatory capital standards or other regulatory requirements, our financial condition would be materially and adversely affected.
In addition, the capital requirements implemented by the federal banking regulators under Basel III could, among other things, result in lower returns on invested capital, adversely affect our ability to pay dividends or repurchase shares, require the raising of additional capital, and result in regulatory actions if we were to be unable to comply with such requirements. Compliance with current or new capital requirements may limit operations that require the intensive use of capital and could adversely affect our ability to expand or maintain present business levels. Additional information, including the Bank’s compliance with applicable capital requirements at December 31, 2021, is provided in Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations.
The Tax Cuts and Jobs Act may have an unanticipated impact on our business.
The Tax Cuts and Jobs Act (the “Act”), enacted in 2017, contains the most extensive amendments to the Internal Revenue Code in over 30 years. The primary change for the Company was the Act’s reduction of the federal corporate tax rate from a maximum of 35% to a flat 21%. Among other sweeping changes for individual taxpayers, the Act doubles the standard deduction for individuals, limits the deductibility of state and local income, property and sales taxes by individuals to $10,000 per year, eliminates the deductibility of interest on home equity loans, and eliminates the deductibility of interest on new home mortgages in excess of $750,000 (down from $1.0 million previously). The Act also eliminates loss carrybacks and limits the deductibility of loss carryforwards to 80% of current-year taxable income. The Act allows 100% expensing for all non-real property capital expenditures for five years but limits the deductibility of net interest expense (interest expense minus interest income) to 30% of taxable income for businesses with average annual gross receipts of more than $25 million.
While we expect to benefit from the lower federal tax rate in the future, the lower tax rate reduced the value of existing other deferred tax assets, which we were required to revalue during the 2017 fiscal year. Lower tax rates will also reduce the attractiveness of certain tax-advantaged bank investments such as municipal bonds and bank-owned life insurance. Various other provisions of the Act could have unanticipated effects on the business of the Bank. By reducing the tax advantages of home ownership through its limits on the deductibility of mortgage interest and property taxes and the elimination of the deductibility of interest on certain home equity loans, the Act could affect demand for housing and residential mortgages in the future. The value of the properties securing loans in our loan portfolio may be adversely impacted as a result of the changing economics of home ownership, as such an impact could require an increase in our provision for loan losses, which would reduce our profitability and could materially adversely affect our business, financial condition and results of operations. The higher standard deduction could also affect mortgage financing by reducing the number of taxpayers who itemize deductions and therefore benefit from these deductions. Furthermore, the lower corporate tax rates and new limits on the deductibility of net interest expense may reduce demand for loans from larger business borrowers and increase competition for lending to smaller business borrowers.
Risks Associated with Our Common Stock
The market price for the Company’s common stock price may be volatile.
The market price of our common stock may be highly volatile, which may make it difficult for you to resell your shares at the volume, prices and times desired. There are many factors that may impact the market price and trading volume of our common stock, including, without limitation:
•
actual or anticipated fluctuations in our operating results, financial condition or asset quality;
•
operating results that vary from the expectations of management, securities analysts and investors;
•
changes in expectations as to our future financial performance;
•
operating and stock price performance of companies that investors deem comparable to us;
•
future issuances of our common stock or other securities;
•
changes in general economic or business conditions;
•
changes in the credit, mortgage and housing markets, the markets for securities relating to mortgages or housing, and developments with respect to financial institutions generally;
•
proposed or adopted changes in laws, regulations or policies affecting us;
•
significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving our competitors or us; and
•
other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services.
There is not an active or consistent trading market in our common stock, and we cannot assure you that a more active or consistent trading market in the common stock will develop. As a result, relatively small trades could have a significant impact on the price of our common stock.
Our common stock is subordinate to our existing and future preferred stock and to our subordinated notes.
The Company has outstanding preferred stock that is senior to the common stock and could adversely affect the ability of the Company to declare or pay dividends or distributions of common stock. In addition, the terms of the Company’s outstanding fixed-to-floating rate subordinated notes prohibit it from declaring or paying any dividends, or purchasing, acquiring, or making a liquidation payment with respect to, its capital stock, during an event of default under the subordinated note purchase agreement. Furthermore, if the Company experiences a material deterioration in its financial condition, liquidity, capital, results of operations or risk profile, the Company’s regulators may not permit it to make future payments on its preferred stock, thereby preventing the payment of dividends on the common stock.
We are an emerging growth company, and any decision on our part to comply only with certain reduced reporting and disclosure requirements applicable to emerging growth companies could make our common stock less attractive to investors.
We are an emerging growth company, and, for as long as we continue to be an emerging growth company, we may choose to take advantage of exemptions from various reporting requirements applicable to other public companies but not to emerging growth companies, including, but not limited to, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. As an emerging growth company, we also will not be subject to Section 404(b) of the Sarbanes Oxley Act of 2002, which would require that our independent auditors review and attest as to the effectiveness of our internal control over financial reporting. In this Form 10-K, we have elected to take advantage of the reduced disclosure requirements relating to executive compensation, and in the future we may take advantage of any or all of these exemptions for so long as we remain an emerging growth company. In addition to the relief described above, the JOBS Act permits us an extended transition period for complying with new or revised accounting standards affecting public companies. We have elected not to take advantage of this extended transition period, which means that the financial statements included in this Form 10-K, as well as any financial statements that we file in the future, will be subject to all new or revised accounting standards generally applicable to public companies.
We will cease to be an emerging growth company upon the earliest of: (i)the first fiscal year after our annual gross revenues are $1.07 billion or more; (i)the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt securities; or (i)the end of any fiscal year in which the market value of our common stock held by non-affiliates exceeded $700 million as of the end of the second quarter of that fiscal year, or five years after completing our initial public offering. Investors may find our common stock less attractive if we choose to rely on these exemptions. If some investors find our common stock less attractive as a result of any choices to reduce future disclosure, there may be a less active trading market for our common stock and the price of our common stock may be more volatile.
General Risk Factors
We will depend on our management team to implement our business strategy and execute successful operations, and we could be harmed by the loss of their services.
We are dependent upon the services of the members of our senior management team who direct our strategy and operations. Members of our senior management team, as well as commercial lending specialists who possess expertise in our markets and key business relationships, could be difficult to replace. The loss of these persons, or our inability to hire additional qualified personnel, could impact our ability to implement our business strategy and could have a material adverse effect on our results of operations and our ability to compete in our markets.
We may not be able to attract and retain skilled people.
Our success depends, in large part, on our ability to attract and retain key people. Competition for the best people in most activities in which we engage can be intense, and we may not be able to retain or hire the people we want or need. In order to attract and retain qualified employees, we must compensate our employees at market levels. If we are unable to continue to attract and retain qualified employees, or do so at rates necessary to maintain our competitive position, our performance, including our competitive position, could suffer, and, in turn, adversely affect our business, financial condition and results of operations. The number of experienced banking professionals in our markets may not be the same as in certain other markets.
We may be subject to increased litigation which could result in legal liability and damage to our reputation.
We may be named from time to time as a defendant in litigation relating to its business and activities. Litigation may include claims for substantial compensatory or punitive damages or claims for indeterminate amounts of damages. We are also involved from time to time in other reviews, investigations and proceedings (both formal and informal) by governmental and self- regulatory agencies regarding its business. These matters also could result in adverse judgments, settlements, fines, penalties, injunctions or other relief.
In addition, in recent years, a number of judicial decisions have upheld the right of borrowers to sue lending institutions on the basis of various evolving legal theories, collectively termed “lender liability.” Generally, lender liability is founded on the premise that a lender has either violated a duty, whether implied or contractual, of good faith and fair dealing owed to the borrower or has assumed a degree of control over the borrower resulting in the creation of a fiduciary duty owed to the borrower or its other creditors or shareholders.
Substantial legal liability or significant regulatory action against the Company could materially adversely affect its business, financial condition or results of operations, or cause significant harm to our reputation.
Our reported financial results depend on management’s selection of accounting methods and certain assumptions and estimates.
Our accounting policies and assumptions are fundamental to the Company’s reported financial condition and results of operations. Management must exercise judgment in selecting and applying many of these accounting policies and methods so that they comply with generally accepted accounting principles and reflect management’s judgment of the most appropriate manner to report our financial condition and results. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which may be reasonable under the circumstances, yet may result in the Company’s reporting materially different results than would have been reported under an alternative method.
The obligations associated with being a public company require significant resources and management attention.
As a public company, we face increased legal, accounting, administrative and other costs and expenses that we have not previously incurred, particularly after we are no longer an emerging growth company. We are subject to the reporting requirements of the Exchange Act, which requires that we file annual, quarterly and current reports with respect to our business and financial condition and proxy and other information statements, and the applicable rules and regulations implemented by the SEC, the Sarbanes-Oxley Act, the Dodd-Frank Act, the PCAOB and the Nasdaq Stock Market, each of which imposes additional reporting and other obligations on public companies.
As a public company, we are required to:
•
prepare and distribute periodic reports, proxy statements and other shareholder communications in compliance with the federal securities laws and rules;
•
expand the roles and duties of our board of directors and committees thereof;
•
institute more comprehensive financial reporting and disclosure compliance procedures;
•
involve and retain to a greater degree outside counsel and accountants in the activities listed above;
•
enhance our investor relations function;
•
establish new internal policies, including those relating to trading in our securities and disclosure controls and procedures;
•
retain additional personnel;
•
comply with Nasdaq Stock Market listing standards; and
•
comply with applicable requirements of the Sarbanes-Oxley Act.
We expect these rules and regulations and changes in laws, regulations and standards relating to corporate governance and public disclosure, which have created uncertainty for public companies, to increase legal and financial compliance costs and make some activities more time consuming and costly. These laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. Our investment in compliance with existing and evolving regulatory requirements will result in increased administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities, which could have an adverse effect on our business, financial condition and results of operations. These increased costs could require us to divert a significant amount of money that we could otherwise use to expand our business and achieve our strategic objectives.

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ITEM 1B. UNRESOLVED STAFF COMMENTS
Item 1B. Unresolved Staff Comments
None.

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ITEM 2. PROPERTIES
Item 2. Properties
As of December 31, 2021, the net book value of our office properties was $9.1 million, and the net book value of our furniture, fixtures and equipment was $1.6 million. The following table sets forth information regarding our offices.
Net Book Value
Leased or
Year Acquired
of Real
Location
Owned
or Leased
Property
(In thousands)
Headquarters:
10089 Fairfax Blvd.
Fairfax, VA 22030
Owned
$
5,413
Other Properties:
Herndon Branch
727 Elden Street
Leased
-
Herndon, VA 20170
Operations Center
22980 Shaw Road
Leased
-
Sterling, VA, 20166
McLean Branch
1354 Old Chain Bridge Road
Owned
1,214
McLean, VA 22101
Clarendon Branch
1000 N. Highland Street
Owned
Arlington, VA 22201
Leesburg Branch
307 E. Market Street
Owned
1,992
Leesburg, VA 20176
Washington D.C. Branch
1130 Connecticut Avenue, N.W.
Leased
-
Washington , D.C. 20036
We believe that current facilities are adequate to meet our present and foreseeable needs, subject to possible future expansion. See Note 7 of Notes to the December 31, 2021, Consolidated Financial Statements, for additional disclosures related to the Company’s properties.

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ITEM 3. LEGAL PROCEEDINGS
Item 3. Legal Proceedings
From time to time, we are a party to various litigation matters incidental to our ordinary conduct of our business. Management believes that none of these legal proceedings, individually or in the aggregate, will have a material adverse impact on the results of operations or financial condition of the Company.

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ITEM 4. MINE SAFETY DISCLOSURE
Item 4. Mine Safety Disclosures
Not Applicable

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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Common Stock
Our common stock is traded on the Nasdaq Capital Market under the symbol “MNSB.” At December 31, 2021 the Company had approximately 245 shareholders of record. This total does not reflect shares held in nominee or “street name” accounts through various firms.
Dividends
Holders of our common stock are only entitled to receive dividends when, as and if declared by the Board of Directors out of funds legally available for dividends. As the Company is a financial holding company and does not engage directly in business activities of a material nature, its ability to pay dividends on our common stock will depend, in large part, upon the receipt of dividends from the Bank. Any future determination relating to our dividend policy will be made by the Board of Directors and will depend on a number of factors, including general and economic conditions, industry standards, our financial condition and operating results, our available cash and current and anticipated cash needs, capital requirements, our ability to service debt obligations senior to our common stock, banking regulations, contractual, legal, tax and regulatory restrictions, and limitations on the payment of dividends by the Company to its shareholders or by the Bank, and such other factors as the Board of Directors may deem relevant. On January 19, 2022, the Company declared its first cash dividend to be paid to common shareholders on February 10, 2022.
Holders of the common stock are subject to priority dividend rights of any holders of preferred stock then outstanding. There were 28,750 shares of preferred stock outstanding at December 31, 2021.
A discussion of applicable regulatory restrictions on dividends by the Company and the Bank is provided in Item 1 (“Business”) under “Supervision, Regulation and Other Factors - Payment of Dividends.”
Securities Authorized For Issuance Under Equity Compensation Plans
The following table provides information concerning securities authorized for issuance under equity compensation plans, the weighted average price of such securities and the number of securities remaining available for future issuance, as of December 31, 2021.
Equity Compensation Plan Category
Number of
securities to be
issued upon
exercise of
outstanding
options,
warrants
and rights
Weighted-
average
exercise
price of
outstanding
options,
warrants
and rights (1)
Number of
securities
remaining and
available for
future
issuance (2)
Plans approved by shareholders
229,257
$
-
404,434
Plans not approved by shareholders
-
-
-
Total
229,257
$
-
404,434
(1)
Restricted stock shares were not included when calculating the weighted-average exercise price.
(2)
Remaining shares available for issuance include 404,434 shares under the 2019 Equity Incentive Plan (“2019 Plan”). Shares remaining to be issued subsequent to December 31, 2021 under the 2019 Plan can be issued either as a restricted stock grant or upon exercise of stock options.
Unregistered Sales and Issuer Repurchases of Common Stock
Unregistered Sales of Common Stock
Set forth below is information concerning sales of common stock by the Company during the past 3 years that were not registered under the Securities Act.
On August 24, 2018, the Company issued and sold 2,368,421 shares of common stock at $19.00 per share, for a total of $49,999,999, to accredited investors. The Company relied upon the exemption from registration under Section 4(a)(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder. Sales commissions of $1,899,212 were paid to FIG Partners, LLC, the sole placement agent. See Note 23 of Notes to Consolidated Financial Statements.
In 2016, the Board of Directors of the Bank and the Bank’s shareholders approved the MainStreet Bank 2016 Equity Incentive Plan (the “2016 Plan”), to provide officers, other selected employees and directors with additional incentives to promote growth and performance. The terms and conditions of the 2016 Plan were subsequently converted into and deemed to be the terms and conditions of a substantially identical Company incentive compensation plan. A total of 204,971 shares of restricted common stock were awarded under the 2016 Plan. The Bank relied on the exemption from registration under Section 3(a)(2) of the Securities Act. The Company relied upon the exemption from registration under Rule 701 promulgated under the Securities Act. See Note 18 of Notes to Consolidated Financial Statements.
In 2019, the Board of Directors of the Bank and the Bank’s shareholders approved the MainStreet Bank 2019 Equity Incentive Plan (the “2019 Plan”), to provide officers, other selected employees and directors with additional incentives to promote growth and performance. The terms and conditions of the 2019 Plan were subsequently converted into and deemed to be the terms and conditions of a substantially identical Company incentive compensation plan. To date, a total of 245,566 shares of restricted common stock have been awarded under the 2019 Plan. During 2021, 84,117 shares of restricted common stock vested from shares issued under both the 2016 and 2019 Plans. See Note 18 of Notes to Consolidated Financial Statements. In August 2019, the Company registered with the SEC, on Form S-8, the shares of common stock that would then be issuable under the 2019 Plan. As a result of the stockholders’ approval of the 2019 Plan, no additional awards have been or will be made under the Bank’s 2016 Plan, although all awards that were outstanding under the 2016 Plan as of July 17, 2019 remained outstanding in accordance with their terms.
Repurchases of Common Stock
On October 22, 2020, the Company announced that the Board of Directors had authorized a new plan to repurchase up to $17.0 million of the Company’s outstanding common stock in open market transactions or privately negotiated transactions, including pursuant to a trading plan in accordance with Rule 10b-18 under the Securities Exchange Act of 1934. The new stock repurchase program replaces the Company’s previous program. During the year ended December 31, 2020, the Company repurchased 895,785 shares. The Company did not repurchase any common shares during the year ended December 31, 2021.
Preferred Stock and Depositary Shares
On September 15, 2020, the Company closed its underwritten public offering of 1,000,000 depositary shares, each representing 1/40th of a share of 7.50% Series A Fixed-Rate Non-Cumulative Perpetual Preferred Stock, par value $1.00 per share (the “Series A Preferred Stock”). On September 25, 2020, the Company completed the sale of an additional 150,000 depositary shares pursuant to the underwriters’ full exercise of their over-allotment option to purchase additional depositary shares.
Trading the depositary shares on the Nasdaq Capital Market commenced on September 16, 2020, under the symbol “MNSBP.”
The Board of Directors declared a quarterly cash dividend on the outstanding shares of the Series A Preferred Stock each quarter in agreement with the depositary share offering. Each declared cash dividend equated to approximately $0.47 per depositary share, or $18.75 per share of Series A Preferred Stock outstanding.

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ITEM 6. SELECTED FINANCIAL DATA
Item 6. [Reserved]

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The purpose of this discussion is to focus on significant changes in the financial condition and results of operations of the Company during the years ended December 31, 2021 and 2020. The following discussion supplements and provides information about the major components of the results of operations, financial condition, liquidity and capital resources of the Company. This discussion and analysis should be read in conjunction with the accompanying consolidated financial statements.
Forward-Looking Statements
This Annual Report on Form 10-K contains certain forward-looking statements and information relating to the Company within the meaning of the Private Securities Litigation Reform Act of 1995 that are based on the beliefs of management as well as assumptions made by and information currently available to management. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words like “believe,” “expect,” “anticipate,” “estimate,” and “intend” or future or conditional verbs such as “will,” “should,” “could,” or “may” and similar expressions or the negative thereof. Important factors that could cause actual results to differ materially from those in the forward-looking statements included herein include, but are not limited to:
•
the impact of the novel coronavirus disease (COVID-19) outbreak and measures taken in response for which future developments are highly uncertain and difficult to predict;
•
general economic conditions, either nationally or in our market area, that are worse than expected;
•
competition among depository and other financial institutions, particularly intensified competition for deposits;
•
inflation and an interest rate environment that may reduce our margins or reduce the fair value of financial instruments;
•
adverse changes in the securities markets;
•
changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory structure and in regulatory fees and capital requirements;
•
our ability to enter new markets successfully and capitalize on growth opportunities;
•
our ability to successfully integrate acquired entities;
•
changes in consumer spending, borrowing and savings habits;
•
changes in accounting policies and practices;
•
changes in our organization, compensation and benefit plans;
•
our ability to attract and retain key employees;
•
changes in our financial condition or results of operations that reduce capital;
•
changes in the financial condition or future prospects of issuers of securities that we own;
•
the concentration of our business in the Northern Virginia as well as the greater Washington, DC metropolitan area and the effect of changes in the economic, political and environmental conditions on this market;
•
adequacy of our allowance for loan losses;
•
deterioration of our asset quality;
•
cyber threats, attacks or events
•
reliance on third parties for key services
•
future performance of our loan portfolio with respect to recently originated loans;
•
additional risks related to new lines of business, products, product enhancements or services;
•
results of examination of us by our regulators, including the possibility that our regulators may require us to increase our allowance for loan losses or to write-down assets or take other supervisory action;
•
the effectiveness of our internal controls over financial reporting and our ability to remediate any future material weakness in our internal controls over financial reporting;
•
liquidity, interest rate and operational risks associated with our business;
•
implications of our status as a smaller reporting company and as an emerging growth company; and
•
a work stoppage, forced quarantine, or other interruption or the unavailability of key employees.
Should one or more of these risks or uncertainties materialize or should underlying assumptions prove incorrect, actual results may vary materially from those described herein. We caution readers not to place undue reliance on forward-looking statements. The Company disclaims any obligation to revise or update any forward-looking statements contained in this Form 10-K to reflect future events or developments. The discussion of the critical accounting policies and analysis set forth below is intended to supplement and highlight information contained in the accompanying Consolidated Financial Statements and the selected financial data presented elsewhere in this Form 10-K.
COVID-19 Pandemic
The effects of the COVID-19 pandemic and resulting economic conditions have impacted our business and financial results and could continue to impact our business and results of operations in a number of ways in the future, including without limitation in areas related to credit, collateral, customer demand, operations, interest rate risk, liquidity and litigation, as described in more detail below. The extent to which the Company’s business will continue to be negatively affected by the pandemic will depend on future developments, which are highly uncertain and cannot be reasonably predicted.
Credit Risk. The risk of timely loan repayment and the value of collateral supporting our loans are affected by the strength of our borrowers’ businesses. Concern about the spread of COVID-19 has caused, and is likely to continue to cause, business shutdowns, limitations on commercial activity and financial transactions, labor shortages, supply chain interruptions, increased unemployment and commercial property vacancy rates, reduced profitability and ability for property owners to make mortgage payments, and overall economic and financial market instability, all of which may cause our customers to be unable to make scheduled loan payments. If the effects of COVID-19 result in widespread and sustained repayment shortfalls on loans in our portfolio, we could incur significant delinquencies, foreclosures and credit losses, particularly if the available collateral is not sufficient to cover our exposure. The future effects of COVID-19 on economic activity could negatively affect the collateral values associated with our existing loans, our ability to liquidate real estate collateral securing our residential and commercial real estate loans, our ability to maintain loan origination volume and to obtain additional financing, the future demand for, or profitability of, our lending and services, and the financial condition and credit risk of our customers. Further, in the event of delinquencies, regulatory changes and policies designed to protect borrowers may slow or prevent us from making business decisions or may delay our taking certain remediation actions. In addition, we have unfunded commitments to extend credit to customers. Increased borrowings under these commitments could adversely impact our liquidity.
In an effort to support our communities during the pandemic, we participated in the Paycheck Protection Program (“PPP”), a program established by the CARES Act to provide loans to small businesses for payroll and other basic expenses during the COVID-19 pandemic. PPP loans are fully guaranteed by the Small Business Administration (“SBA”) and provide for full forgiveness of the loans during a specified forgiveness period that meet specific guidelines provided by the SBA. The deadline to apply for PPP loans was initially June 30, 2020 and was later extended to August 8, 2020; the Consolidated Appropriations Act of 2021 (the “CAA”), enacted in December 2020, reopened and expanded the PPP. Small businesses and other entities and individuals could have applied for PPP loans from existing SBA lenders and other approved regulated lenders that enrolled in the program, subject to numerous limitations and eligibility criteria.
PPP loans are subject to regulatory requirements that would require forbearance of loan payments for a specified time or that could limit our ability to pursue all available remedies in the event of a loan default. If the borrower under the PPP loan fails to qualify for loan forgiveness, or if the borrower defaults and the SBA determines there is a deficiency in the manner in which any PPP loans were originated, funded or serviced by the Bank, we would be subject to repayment risk as well as the heightened risk of holding these loans at unfavorable interest rates as compared to loans that we would have otherwise made.
Business Continuity Planning Risk. Our financial condition and results of operations may be affected by a variety of external factors that may affect the price or marketability of our products and services, changes in interest rates that may increase our funding costs, reduced demand for our financial products due to economic conditions and the various responses of governmental and nongovernmental authorities. The COVID-19 pandemic has significantly increased economic and demand uncertainty and has led to severe disruption and volatility in capital markets. Furthermore, many of the governmental actions in response to the pandemic have been directed toward curtailing household and business activity to contain COVID-19. These actions have been rapidly changing. Future effects of COVID-19 on economic activity could negatively affect the future banking products we provide and could result in a decline in loan originations.
Operational Risk. Current and future restrictions on our workforce’s access to our facilities could limit our ability to meet customer servicing expectations and have a material adverse effect on our operations. We rely on business processes and branch activity that largely depend on people and technology, including access to information technology systems as well as information, applications, payment systems and other services provided by third parties. In response to COVID-19, we have modified our business practices with a portion of our employees working remotely from their homes to minimize interruptions of our operations. Technology in employees’ homes may be more limited or less reliable than in our offices. The continuation of these work-from-home measures also introduces additional operational risk, including increased cybersecurity risk.
We rely on many third parties in our business operations. Many of these parties may limit the availability and access of their services. If third-party service providers continue to have limited capacities for a prolonged period or if additional limitations or potential disruptions in these services materialize, it may negatively affect our operations.
Interest Rate Risk. Our net interest income, lending activities, deposits, investment portfolio, cash flows and profitability are and are likely to continue to be negatively affected by volatility in interest rates caused by uncertainties stemming from COVID-19. On March 15, 2020 the Federal Reserve lowered its target range for the federal funds rate to a range from 0 to 0.25 percent, and has since maintained that range, citing concerns about the impact of COVID-19 on markets and stress in the energy sector. A prolonged period of extremely volatile and unstable market conditions would likely increase our funding costs and negatively affect market risk mitigation strategies. Higher income volatility from changes in interest rates and spreads to benchmark indices will likely cause a loss of future net interest income and a decrease in current fair market values of our investment portfolio and other assets. Fluctuations in interest rates will impact both the level of income and expense recorded on most of our assets and liabilities and the market value of all interest-earning assets and interest-bearing liabilities, which in turn could have a material adverse effect on our net income, operating results, or financial condition.
Liquidity. Federal, state and local governments have mandated or encouraged financial institutions to accommodate borrowers and other customers affected by the COVID-19 pandemic. Legal and regulatory responses to concerns about the COVID-19 pandemic could result in additional regulation or restrictions affecting the conduct of our business in the future. In addition to our measures to address the potential effects from negative economic conditions noted above, the Company has instituted a program to help COVID-19 impacted customers. This program includes waiving certain fees and charges and offering payment deferment and other loan relief, as appropriate, for customers impacted by COVID-19. The Company’s liquidity could be negatively impacted if a significant number of customers apply and are approved for the deferral of payments or request additional deferrals. In addition, if these deferrals are not effective in mitigating the effect of COVID-19 on our customers, the negative effects on our business and results of operations may be more substantial and may continue over a longer period of time.
Litigation Risk. Although the Company has taken and continues to take precautions to protect the safety and well-being of its employees, no assurance can be given that the steps being taken will be adequate or appropriate. Concerns have been expressed regarding possible employee lawsuits for tort claims related to the COVID-19 pandemic, including class action lawsuits alleging that unsafe workplaces have caused employees to contract COVID-19 or subjected them to the risk of exposure. Possible statutory defenses may mitigate the risk of liability in any such lawsuits; however, the availability of such defenses is uncertain and cannot be predicted at this time.
The PPP has also attracted interest from federal and state enforcement authorities, oversight agencies, regulators and Congressional committees. Offices of state attorneys general and other federal and state agencies may assert that they are not subject to the provisions of the CARES Act and the PPP regulations that entitle the Bank to rely on borrower certifications, and they may take more aggressive actions against the Bank for alleged violations of the provisions governing the Bank’s participation in the PPP. Federal and state regulators can impose or request that we consent to substantial sanctions, restrictions and requirements if they determine there are violations of laws, rules or regulations or weaknesses or failures with respect to general standards of safety and soundness, which could adversely affect our business, reputation, results of operation and financial condition.
Since the opening of the PPP, several larger banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP. The Company and the Bank may be exposed to the risk of litigation, from both clients and non-clients that solicited the Bank for PPP loans, regarding its process and procedures used to process applications for the PPP. If any such litigation is filed against the Company or the Bank and is not resolved in a manner favorable to the Company or the Bank, it may result in significant financial liability or adversely affect the Company’s reputation. Any financial liability, litigation costs or reputational damage caused by PPP-related litigation could have a material adverse impact on our business, financial condition and results of operations.
Critical Accounting Policies
The accounting and financial reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Accordingly, the financial statements require certain estimates, judgments, and assumptions, which are believed to be reasonable, based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the periods presented. Critical accounting policies comprise those that management believes are the most critical to aid in fully understanding and evaluating our reported financial results. These policies require numerous estimates or economic assumptions that may prove inaccurate or may be subject to variations which may significantly affect our reported results and financial condition for the current period or in future periods.
The accounting principles followed by the Company and the methods of applying these principles conform with accounting principles generally accepted in the United States of America and with general practices within the banking industry. The Company’s critical accounting policies relate to (1) the allowance for loan losses, (2) fair value of financial instruments, (3) income taxes, (4) computer software, and (5) derivative financial instruments. These critical accounting policies require the use of estimates, assumptions and judgments which are based on information available as of the date of the financial statements. Accordingly, as this information changes, future financial statements could reflect the use of different estimates, assumptions and judgments. Certain determinations 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.
Allowance for Loan Losses: Management’s policy is to maintain the allowance for loan losses at a level sufficient to absorb estimated probable incurred losses inherent in the loan portfolio. Management performs periodic and systematic detailed reviews of its loan portfolio to identify trends and to assess the overall collectability of the loan portfolio. Accounting standards require that loan losses be recorded when management determines it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated.
The allowance consists of a specific component and a general component. The specific component relates to loans that are classified as impaired, and is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. For impaired collateral dependent loans, an updated appraisal will typically be ordered if a current one is not on file. Appraisals are performed by independent third-party appraisers with relevant industry experience. Adjustments to the appraised value may be made based on recent sales of like properties or general market conditions when appropriate. The general component covers non-classified or performing loans and those loans classified as substandard or special mention that are not impaired. The general component is based on historical loss experience adjusted for qualitative factors, such as current economic conditions, including current home sales and foreclosures, unemployment rates and retail sales. Non-impaired classified loans are assigned a higher allowance factor based on an internal migration analysis, which increases with the severity of classification, than non-classified loans.
Estimates for the allowance for loan losses are determined by analyzing historical losses, historical migration to charge-off experience, current trends in delinquencies and charge-offs, the results of regulatory examinations and changes in the size, composition and risk assessment of the loan portfolio. Also included in management’s estimate for the allowance for loan losses are considerations with respect to the impact of current economic events. These events may include, but are not limited to, fluctuations in overall interest rates, political conditions, legislation that may directly or indirectly affect the banking industry and economic conditions affecting specific geographical areas and industries in which the Company conducts business.
While management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses and methodology may be necessary if economic or other conditions differ substantially from the assumptions used in making the estimates. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels vary from previous estimates. A detailed discussion of the methodology used in determining the allowance for loan losses is included in Note 1, Basis of Presentation, in Notes to Consolidated Financial Statements.
Fair Value of Financial Instruments: A portion of the Company’s assets and liabilities is carried at fair value, with changes in fair value recorded either in earnings or accumulated other comprehensive income (loss). These include investment securities available for sale and interest rate loan swaps on qualifying commercial loans. Periodically, the estimation of fair value also affects investment securities held to maturity when it is determined that an impairment write-down is other than temporary. Fair value determination is also relevant for certain other assets such as other real estate owned, which is recorded at the lower of the recorded balance or fair value, less estimated costs to sell. The determination of fair value also impacts certain other assets that are periodically evaluated for impairment using fair value estimates, including impaired loans.
Fair value is generally based upon quoted market prices, when available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use observable market-based parameters as inputs. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the Company’s creditworthiness, among other things, as well as other unobservable parameters. Any such valuation adjustments are applied consistently over time. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
See Note 20, Fair Value Presentation, in Notes to Consolidated Financial Statements for a detailed discussion of determining fair value, including pricing validation processes.
Income Taxes: The Company’s income tax expense, deferred tax assets and liabilities, and reserves for unrecognized tax benefits reflect management’s best assessment of estimated taxes due. The calculation of each component of the Company’s income tax provision is complex and requires the use of estimates and judgments in its determination. As part of the Company’s evaluation and implementation of business strategies, consideration is given to the regulations and tax laws that apply to the specific facts and circumstances for any tax positions under evaluation. Management closely monitors tax developments on both the federal and state level in order to evaluate the effect they may have on the Company’s overall tax position and the estimates and judgments used in determining the income tax provision and records adjustments as necessary.
Deferred income taxes arise from temporary differences between the tax and financial statement recognition of revenue and expenses. In evaluating the Company’s ability to recover its deferred tax assets within the jurisdiction from which they arise, the Company must consider all available evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and the results of recent operations. A valuation allowance is recognized for a deferred tax asset if, based on the available evidence, it is more likely than not that some portion or all of a deferred tax asset will not be realized. See Note 11, Income Taxes, in Notes to Consolidated Financial Statements for additional information.
Computer Software: The Company incurs certain costs to develop commercial software. For software that is to be sold, significant areas of judgment include: establishing when technological feasibility has been met and costs should be capitalized, determining the appropriate period over which to amortize the capitalized costs based on the estimated useful lives, estimating the marketability of the commercial software product and related future revenues, and assessing the unamortized cost balances for impairment. Costs incurred prior to establishing technological feasibility are expensed as incurred. Amortization begins on the date of general release and the appropriate amortization period is based on estimates of future revenues from sales of the products. We consider various factors to project marketability and future revenues, including an assessment of alternative solutions or products, current demand for the product, and anticipated changes in technology that may make the product obsolete.
The Bank’s computer software developments are described more fully in Note 8 in the December 31, 2021, Consolidated Financial Statements.
Derivative Financial Instruments: The Bank recognizes derivative financial instruments at fair value as either other assets or other liabilities in the consolidated balance sheet. The Bank’s derivative financial instruments include interest rate swaps with certain qualifying commercial loan customers and dealer counterparties. Because the interest rate swaps with loan customers and dealer counterparties are not designated as hedging instruments, adjustments to reflect unrealized gains and losses resulting from changes in fair value of these instruments are reported as noninterest income or noninterest expense, as applicable. The Bank’s interest rate swaps with loan customers and dealer counterparties are described more fully in Note 19 in the December 31, 2021, Consolidated Financial Statements.
Selected Financial Data
The following table sets forth summarized historical consolidated financial information for each of the periods indicated. This information should be read together with the accompanying consolidated financial statements included in this Form 10-K. The historical information indicated as of and for the years ended December 31, 2021 2020 and 2019, has been derived from the Company's audited consolidated financial statements for the years ended December 31, 2021, 2020 and 2019. Historical results set forth below and elsewhere in this Form 10-K are not necessarily indicative of future performance
At December 31,
(In thousands)
Selected Financial Condition Data:
Total assets
$
1,647,402
$
1,643,165
Total cash and cash equivalents
93,199
107,528
Total investment securities
120,262
169,934
Loans held for sale
-
57,006
Loans receivable, net
1,341,760
1,230,379
Bank-owned life insurance
36,241
25,341
Premises and equipment, net
14,863
14,289
Computer software, net of amortization
2,493
-
Total deposits
1,411,963
1,438,246
FHLB advances and other borrowings
-
-
Subordinated debt
29,294
14,834
Total stockholders’ equity
188,788
167,665
For the year ended December 31,
(In thousands)
Selected Operating Data:
Interest income
$
64,199
$
62,072
Interest expense
10,663
16,095
Net interest income
53,536
45,977
Provision for (recovery of) loan losses
(1,175
)
3,610
Net interest income after provision for (recovery of) loan losses
54,711
42,367
Total non-interest income
6,110
7,493
Total non-interest expenses
32,865
30,300
Income before income taxes
27,956
19,560
Income tax expense
5,785
3,843
Net income
22,171
15,717
Less: Preferred stock dividends
2,156
Net income available to common shareholders
$
20,015
$
15,082
Basic and diluted net income per common share
$
2.65
$
1.85
At or For the Years Ended December 31,
Performance Ratios:
Return on average assets
1.32
%
1.05
%
Return on average equity
12.38
%
10.54
%
Interest rate spread
2.94
%
2.69
%
Net interest margin
3.33
%
3.21
%
Efficiency ratio
55.10
%
56.67
%
Non-interest expense to average assets
1.95
%
2.02
%
Average interest-earning assets to average interest-bearing liabilities
159.31
%
146.99
%
Per share Data and Shares Outstanding
Earnings per common share (basic and diluted)
$
2.65
$
1.85
Book value per common share
$
21.27
$
18.86
Market value per common share
$
24.59
$
16.91
Weighted average common shares (basic and diluted)
7,559,310
8,131,334
Common shares outstanding at end of period
7,595,781
7,443,842
Capital Ratios (Bank)
Common equity tier 1(CET1) capital to risk-weighted assets
15.23
%
13.61
%
Total risk-based capital to risk-weighted assets
16.06
%
14.60
%
Tier 1 capital to risk-weighted assets
15.23
%
13.61
%
Tier 1 capital to average assets
12.90
%
10.78
%
Asset Quality Ratios
Allowance for loan losses as a percentage of total loans
0.86
%
1.03
%
Allowance for loan losses as a percentage of total loans, excluding PPP loans (1)
0.90
%
1.16
%
Allowance for loan losses to non-performing assets
15.09
9.68
Net charge-offs to average outstanding loans during the period
0.00
%
0.03
%
Non-performing loans as a percentage of total loans
0.00
%
0.01
%
Non-performing assets as a percentage of total assets
0.05
%
0.08
%
Other Data:
Common equity / total assets
9.80
%
8.54
%
Total equity / total assets
11.46
%
10.20
%
Average equity to average assets
10.63
%
9.96
%
Number of offices
Number of full-time equivalent employees
(1)
Non-GAAP; refer to Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section “Non-GAAP Measures” of this Form 10-K.
Analysis of Results of Operations for the Years Ended December 31, 2021 and 2020
Net Income
The following table sets forth the principal components of net income for the periods indicated.
For the Year Ended December 31,
% Change
(In thousands)
Interest income
$
64,199
$
62,072
3.43
%
Interest expense
10,663
16,095
-33.75
%
Net interest income
53,536
45,977
16.44
%
Provision for (recovery of) loan losses
(1,175
)
3,610
-132.55
%
Net interest income after provision
54,711
42,367
29.14
%
Non-interest income
6,110
7,451
-18.00
%
Non-interest expense
32,865
30,258
8.62
%
Net income before income taxes
27,956
19,560
42.92
%
Income tax expense
5,785
3,843
50.53
%
Net income
22,171
15,717
41.06
%
Less: Preferred stock dividends
2,156
239.53
%
Net income available to common shareholders
$
20,015
$
15,082
32.71
%
Net income for the year ended December 31, 2021, was $22.2 million, an increase of $6.5 million, or 41.1% compared to $15.7 million earned during the year ended December 31, 2020. The increase in net income was due to $7.6 million of additional net interest income, primarily driven by increased volume of loans and decrease in interest rates on interest-bearing deposits, as well as a recovery of loan loss provision of $1.2 million. The increase in non-interest expenses was due to a $1.4 million increase in salaries and employee benefits and increases in general operating expenses.
Net Interest Income and Net Interest Margin
Net interest income is the principal component of the Company’s income stream and represents the difference, or spread, between interest and fee income generated from earning assets and the interest expense paid on deposits and borrowed funds. Net interest margin, stated as a percentage, is the yield obtained by dividing the difference between interest income generated on earning assets and the interest expense paid on all funding sources by average earning assets. Fluctuations in interest rates as well as changes in the volume and mix of earning assets and interest-bearing liabilities can impact net interest income and net interest margin.
Net interest income before provision for or recovery of loan losses totaled $53.5 million for the year ended December 31, 2021, compared to $46.0 million for the year ended December 31, 2020. The increase in net interest income was driven by an increase in loan production and decrease in interest rates on interest-bearing deposits during the year for the year ended December 31, 2021.
The net interest margin was 3.33% for the year ended December 31, 2021, compared to 3.21% for the year ended December 31, 2020. The increase in net interest margin primarily resulted from a decrease in average rates on our cost of funds, primarily in wholesale deposits, money market deposits and other borrowings. The increase from lower cost deposits were offset by set continued margin pressure on our loan portfolio and other interest earning assets. In addition, loans associated with the Paycheck Protection Program (“PPP”) carried a below market rate of 1.00%.
The yield for the year ended December 31, 2021 for the loan portfolio was 4.79% compared to 4.89% for the year ended December 31, 2020. The decrease primarily reflects the maturity of higher yielding loans and lower yields on new loans based on lower interest rates originated during the year. The Federal Reserve decreased its targeted benchmark interest rate to 0-25 basis points in the prior year, which impacted yields obtained on new loans.
For the year ended December 31, 2021, the yield on the total investment securities portfolio was 2.32% compared to 2.63% for the year ended December 31, 2020. The decrease of 31 basis points was primarily due to rates on variable securities decreasing with the current rate environment and lower yields on investment securities purchased during the period.
The rate paid on interest bearing deposits decreased to 0.90% during the year ended December 31, 2021, from 1.58% during the year ended December 31, 2020. This decrease was a result of lower rates paid on all outstanding deposits in conjunction with the decreasing rate environment throughout the year.
The rate paid on FHLB borrowings for the year ended December 31, 2021 was negligible compared to 1.73% for the corresponding period in 2020. This decrease was due to no outstanding balances for these types of borrowings.
The following table sets forth the major components of net interest income and the related yields and rates for the year ended December 31, 2021, compared to the year ended December 31, 2020.
Average Balances, Net Interest Income, Yields Earned and Rates Paid
The following table shows for the periods indicated the total dollar amount of interest from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. All average balances are based on daily balances.
For the Year Ended December 31,
Average
Balance
Interest
Income/
Expense
Yield/
Cost
Average
Balance
Interest
Income/
Expense
Yield/
Cost
(Dollars in thousands)
Interest-earning assets:
Loans (1)
$
1,289,445
$
61,743
4.79
%
$
1,219,525
$
59,634
4.89
%
Investment securities
99,902
2,322
2.32
%
76,414
2,007
2.63
%
Federal funds sold
73,171
0.09
%
22,722
0.37
%
Interest-bearing deposits
143,265
0.05
%
$
112,966
0.31
%
Total interest-earning assets
$
1,605,783
$
64,199
4.00
%
1,431,627
$
62,072
4.34
%
Non-interest-earning assets
79,357
66,561
Total assets
$
1,685,140
$
1,498,188
Interest-bearing liabilities:
Interest-bearing demand deposits
$
67,897
$
0.34
%
$
37,431
$
0.85
%
Money market deposits
333,160
0.23
%
314,398
2,162
0.69
%
Savings and NOW deposits
74,975
0.22
%
66,028
0.33
%
Time deposits
498,001
7,613
1.53
%
535,116
12,322
2.30
%
Total interest-bearing deposits
$
974,033
$
8,779
0.90
%
$
952,973
$
15,022
1.58
%
Federal Home Loan Bank advances
-
-
0.00
%
6,189
1.73
%
Subordinated debt
33,953
1,884
5.55
%
14,820
6.52
%
Total interest-bearing liabilities
$
1,007,986
$
10,663
1.06
%
$
973,982
$
16,095
1.65
%
Non-interest-bearing liabilities:
Demand deposits and other liabilities
498,031
375,046
Total liabilities
$
1,506,017
$
1,349,028
Stockholders’ Equity
179,123
149,160
Total liabilities and stockholders’
equity
$
1,685,140
$
1,498,188
Net interest income
$
53,536
$
45,977
Interest rate spread (2)
2.94
%
2.69
%
Net interest-earning assets (3)
$
597,797
$
457,645
Net interest margin (4)
3.33
%
3.21
%
Net interest margin, excluding PPP loans(5)
3.19
%
3.21
%
Average interest-earning assets to
average interest-bearing liabilities
159.31
%
146.99
%
(1)
Includes loans classified as non-accrual, average PPP balances of $123.5 million, average balances of loans held for sale and related interest income of approximately $1.2 million for the year ended December 31, 2021.
(2)
Interest rate spread represents the difference between the average yield on average interest-earning assets and the average cost of average interest-bearing liabilities.
(3)
Net interest earning assets represent total average interest-earning assets less total interest-bearing liabilities.
(4)
Net interest margin represents net interest income divided by total average interest-earning assets.
(5)
Non-GAAP; refer to Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section “Non-GAAP Measures” of this Form 10-K.
Rate/ Volume Analysis
The following table presents the effects of changing rates and volumes on net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately, based on the changes due to rate and the changes due to volume.
For the Twelve Months Ended
December 31, 2021 and 2020
Increase (Decrease) Due to
Total Increase
Volume
Rate
(Decrease)
(In thousands)
Interest-earning assets:
Loans
$
3,353
$
(1,244
)
$
2,109
Investment securities
(255
)
Federal funds and interest-bearing deposits
(470
)
(297
)
Total interest-bearing assets
$
4,096
$
(1,969
)
$
2,127
Interest-bearing liabilities:
Interest-bearing demand deposits
$
$
(257
)
$
(88
)
Money market deposit accounts
(1,513
)
(1,390
)
Savings and NOW deposits
(82
)
(56
)
Time deposits
(808
)
(3,901
)
(4,709
)
Total deposits
$
(490
)
$
(5,753
)
$
(6,243
)
Federal Home Loan Bank advances
(107
)
-
(107
)
Subordinated debt
1,081
(163
)
Total interest-bearing liabilities
(5,916
)
(5,432
)
Change in net interest income
$
3,612
$
3,947
$
7,559
Provision for Loan Losses
We establish a provision for loan losses, which is charged to operations, in order to maintain the allowance for loan losses at a level we consider necessary to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimated at the balance sheet date. In determining the level of the allowance for loan losses, we consider past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan and the levels of non-performing loans. The amount of the allowance is based on estimates, and actual losses may vary from such estimates as more information becomes available or economic conditions change.
This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as circumstances change as more information becomes available. The allowance for loan losses is assessed on a monthly basis and provisions are made for loan losses as required in order to maintain the allowance.
The provision for loan losses decreased to a recovery of loan loss provision of $1.2 million for the year ended. The decrease is as a direct result of recovering the special COVID-19 pandemic provision that was provisioned for in 2020. After assessing the impact that the COVID-19 pandemic had our loan portfolio and analyzing the credit strength we have been able to maintain, management believes we no longer needed the special COVID-19 provision we assessed in 2020. The portfolio continues to consistently perform well as management monitors key economic indicators that could have an impact on our loan profile. Offsetting this decrease were increases in loan loss provision due to normal loan growth. Loan originations increased $166.2 million, which totalled $409.4 million for the year ended December 31, 2020 compared to loan originations of $575.6 million for the year ended December 31, 2021. Loan originations included $52.0 million in PPP loans during the year ended December 31, 2021. Non-performing loans were $149,000 at December 31, 2020 and $0 at December 31, 2021. During the year ended December 31, 2021, substandard loans increased $3.2 million for a balance of $5.3 million. During the year ended December 31, 2021, special mention loans increased $15.5 million, however this increase is attributable to one relationship in the hospitality industry and is being actively managed. Management does not believe any loss currently exists in these loans but due to the disproportionate impact COVID-19 has had on the hospitality industry, the Bank is managing these credits closely. During the year ended December 31, 2021, there were $32,000 in charge-offs and recoveries of $27,000 were received. During the year ended December 31, 2020, there were $1.9 million in charge-offs recorded and recoveries received of $1.5 million.
Non-Interest Income
Our primary sources of non-interest income are service charges on deposit accounts, such as interchange fees and statement fees, income earned on bank owned life insurance, fees earned from executing interest rate swaps on commercial loans, and gains realized on the sale of the guaranteed portion of Small Business Administration (“SBA”) loans.
The following table presents, for the period indicated, the major categories of non-interest income:
For the Year Ended December 31,
% Change
(In thousands)
Non-interest income
Deposit account service charges
$
2,426
$
1,916
26.62
%
Bank owned life insurance income
15.53
%
Loan swap fee income
3,510
-97.64
%
Net gain on called held-to-maturity securities
-
-100.00
%
Net gain on sale of loans
2466.67
%
Other fee income
1,848
1,213
52.35
%
Total non-interest income
$
6,110
$
7,451
-18.00
%
Non-interest income decreased $1.3 million, or 18.0%, to $6.1 million for the year ended December 31, 2021 from $7.5 million for the year ended December 31, 2020. The decrease in non-interest income was primarily due to a decrease in fees earned from executing interest rate swaps on commercial loans for the year ended December 31, 2021. Fees earned on interest rate swaps for commercial loans decreased $3.4 million, or 97.6%, to $83,000 for the year ended December 31, 2021 from $3.5 million for the year ended December 31, 2020. This increase was purely related to the volume of interest rate swaps entered into during 2020 compared to 2021. This decrease was offset by an increase in service fees on our business accounts of $510,000 for the year ended December 31, 2021. Gains on sale of loans increased $814,000 compared the same period in 2020, this increase was attributed to the sale of loans held for sale and the guaranteed portion of SBA loans. Bank owned life insurance income increased $121,000 for the year ended December 31, 2021 compared to the year ended December 31, 2020, due to additional policies purchased later in the prior year and being able to realize the income for a full year.
Non-Interest Expense
Generally, non-interest expense is composed of all employee expenses and costs associated with operating our facilities, obtaining and retaining customer relationships and providing bank services. The largest component of non-interest expense is salaries and employee benefits. Non-interest expense also includes operational expenses, such as occupancy and equipment expenses, professional fees, advertising expenses and other general and administrative expenses, including FDIC assessments, communications, travel, meals, training, supplies and postage. The following table presents, for the periods indicated, the major categories of non-interest expense:
For the Year Ended December 31,
% Change
(In thousands)
Non-interest expense
Salaries and employee benefits
$
19,305
$
17,937
7.63
%
Occupancy expenses
1,541
1,270
21.34
%
Furniture and equipment expenses
2,468
2,128
15.98
%
Advertising and marketing
1,565
1,003
56.03
%
Outside services
1,394
45.36
%
Administrative expenses
1.63
%
Franchise tax
1,544
1,370
12.70
%
FDIC insurance
1,051
1,329
-20.92
%
Data processing
1,189
1,242
-4.27
%
Other real estate expenses, net
-81.70
%
Other operating expenses
2,039
1,887
8.06
%
Total non-interest expense
$
32,865
$
30,258
8.62
%
Non-interest expense increased $2.6 million or 8.6% to $32.9 million for the year ended December 31, 2021 from $30.3 million for the year ended December 31, 2020 primarily as a result of increases in salary and employee benefits of $1.4 million, advertising and marketing expenses of $562,000 and outside services of $435,000. Salaries and employee benefits expense increased by $1.4 million to $19.3 million for the year ended December 31, 2021 from $17.9 million for the year ended December 31, 2020 primarily as a result of increasing our personnel team members by 12 employees. Advertising and marketing increased $562,000, or 56.0%, to $1.5 million for the year ended December 31, 2021 from $1.0 million for the year ended December 31, 2021. Outside service expenses increased $435,000, or 45.4%, to $1.4 million for the year ended December 31, 2021, due to investments in the Company’s payments division and other technological infrastructure. Offsetting these increases, our FDIC insurance decreased approximately $278,000 to $1.1 million for the year ended December 31, 2021 from $1.3 million for the year ended December 31, 2020. This decrease was attributed to continued financial strength that resulted in a reduction of FDIC assessments.
Income Tax Expense
Income tax expense increased $1.9 million, or 50.5%, to $5.8 million for the year ended December 31, 2021 from $3.8 million for the year ended December 31, 2020. The increase in federal income tax expense for the year ended December 31, 2021 compared to the same period a year ago was driven by the increase in income before income taxes of $8.4 million, or 42.9%, to $28.0 million as of December 31, 2021 compared to $19.6 million for the same period in the prior year. As a result of tax regulation, the Company has included assessments in income tax expense for state tax liabilities during 2021. For the year ended December 31, 2021, the Bank had an effective tax rate of 20.7%, compared to effective federal tax rate of 19.6% for the year ended December 31, 2020.
a division of MainStreet Bank
Analysis of Results of Operations for the Year Ended December 31, 2021
Net Income
The following table sets forth the principal components of net income for Avenu for the period indicated. All amounts set forth are included in the Results of Operations for the Year Ended December 31, 2021 for MainStreet Bancshares, Inc.
For the Year Ended December 31,
(In thousands)
Income Statement
Service charge income
$
Other income
Total income
Salaries and employee benefits
Outside services
Data processing
Other operating expenses
Total expense
Net income before taxes
$
Net income for the year ended December 31, 2021, was $81,000 and serves as a “value-add” to MainStreet Bank. Net income of $81,000 does not include transfer pricing on the $68.7 million in non-interest bearing deposits that greatly enhances the overall value Avenu brings to the Company. Avenu is developing a comprehensive hosted BaaS software platform that will provide Fintechs with a subledger integrated within a regulatory compliant framework, easily connectable APIs, and access to banking payment networks. Avenu expects to deploy this platform in 2022.
Comparison of Statements of Financial Condition at December 31, 2021 and at December 31, 2020
Total Assets
Total assets increased $4.2 million, or 0.3%, to $1.6 billion at December 31, 2021 from $1.6 billion at December 31, 2020. The increase was primarily the result of increases of $109.5 million in gross loans receivable, $11.0 million restricted securities, and $10.9 million in bank owned life insurance. These increases were offset by decreases in cash equivalents and other assets of $14.3 million and $8.8 million, respectively.
Investment Securities
We use our securities portfolio to provide a source of liquidity, provide an appropriate return on funds invested, manage interest rate risk, meet collateral requirements and meet regulatory capital and liquidity requirements. Our investment policy is established and reviewed annually by the Board of Directors. We are permitted under federal law to invest in various types of liquid assets, including United States Government obligations, securities of various federal agencies and of state and municipal governments, mortgage-backed securities, time deposits of federally insured institutions, subordinated debt of other financial institutions, certain bankers’ acceptances and federal funds.
Our investment objectives are to maintain high asset quality, to provide and maintain liquidity, to establish an acceptable level of interest rate and credit risk, to provide an alternate source of low-risk investments when demand for loans is weak and to generate a favorable return. The Board of Directors has the overall responsibility for the investment portfolio, including approval of our investment policy. The Board of Directors is also responsible for implementation of the investment policy and monitoring investment performance. The Board of Directors reviews the status of the investment portfolio on a quarterly basis, or more frequently if warranted.
Generally accepted accounting principles require that, at the time of purchase, we designate a security as held to maturity, available-for-sale, or trading, depending on our ability and intent to hold such security. Debt securities available for sale are reported at fair value, while debt securities held to maturity are reported at amortized cost. We do not maintain a trading portfolio. Establishing a trading portfolio would require specific authorization by the Board of Directors.
The total investment securities portfolio, including both investment securities available for sale and investment securities held to maturity, was $120.3 million at December 31, 2021, a decrease of $49.7 million compared with December 31, 2020. At December 31, 2021, the investment securities portfolio includes $99.9 million of investment securities available for sale and $20.3 million of investment securities held to maturity compared to $147.4 million of investment securities available for sale and $22.5 million of investment securities held to maturity at December 31, 2020.
The Company did not sell any securities within the investment portfolio for the year ended December 31, 2021 or 2020.
While all securities are reviewed by the Company for other-than-temporary impairments (“OTTI”), the securities that typically are impacted by credit impairment are non-agency collateralized mortgage obligations and asset-backed securities. Refer to Note 3, in Notes to Consolidated Financial Statements for further details. To date, we have had no OTTI.
Portfolio Maturities and Yields. The composition and maturities of the investment securities portfolio at December 31, 2021, are summarized in the following table. Maturities are based on the final contractual payment date, and do not reflect the effect of scheduled principal repayments, prepayments, or early redemptions that may occur. Adjustable-rate mortgage-backed securities are included in the period in which interest rates are next scheduled to adjust. The Company does invest in both taxable and non-taxable municipal securities. No material changes occurred in the non-taxable security portfolio for the year ended December 31, 2021.
More than One Year
More than Five Years
More than
One Year or Less
through Five Years
through Ten Years
Ten Years
Total
Weighted
Weighted
Weighted
Weighted
Weighted
Amortized
Average
Amortized
Average
Amortized
Average
Amortized
Average
Amortized
Fair
Average
Cost
Yield (1)
Cost
Yield (1)
Cost
Yield (1)
Cost
Yield (1)
Cost
Value
Yield (1)
(Dollars in thousands)
Securities available for sale:
U.S. Treasury Securities
$
20,000
-
$
-
-
$
-
-
$
-
-
$
20,000
$
20,000
-
Collateralized Mortgage Securities
4.62
%
-
-
-
-
31,519
1.21
%
31,521
30,882
1.21
%
Subordinated Debt
-
-
-
-
8,720
3.91
%
-
-
8,720
8,704
3.91
%
Municipal Securities
Taxable
-
-
1,002
2.69
%
1,425
1.55
%
8,277
2.43
%
10,704
10,557
2.34
%
Tax-exempt
-
-
-
-
4.48
%
22,196
3.43
%
22,978
24,143
3.46
%
U.S. Government Agencies
-
-
-
-
-
-
5,725
2.04
%
5,725
5,627
2.04
%
Total
$
20,002
-
$
1,002
2.69
%
$
10,927
3.64
%
$
67,717
2.16
%
$
99,648
$
99,913
2.37
%
Securities held to maturity:
Municipal Securities
Tax-exempt
$
-
-
$
1,329
3.76
%
$
8,273
3.81
%
$
8,247
3.87
%
$
17,849
$
18,644
3.84
%
Subordinated Debt
-
-
-
-
2,500
5.60
%
-
-
2,500
2,500
5.60
%
Total
$
-
-
$
1,329
3.76
%
$
10,773
4.23
%
$
8,247
3.87
%
$
20,349
$
21,144
4.05
%
(1)
Yields are reported on a taxable equivalent basis using the statutory federal corporate tax rate of 21%
Loan Portfolio
Our primary source of income is derived from interest earned on loans. Our loan portfolio consists of loans secured by real estate as well as commercial business loans and consumer loans, substantially all of which are secured by corresponding deposits at the Bank. Our loan customers primarily consist of small- to medium-sized businesses, professionals, real estate investors, small residential builders and individuals. Our owner occupied and investment commercial real estate loans, residential construction loans and commercial business loans provide us with higher risk-adjusted returns, shorter maturities and more sensitivity to interest rate fluctuations, and are complemented by our relatively lower risk residential real estate loans to individuals. Our lending activities are principally directed to our market area consisting of the Washington, D.C. and Northern Virginia metropolitan areas.
Loan Portfolio Maturities and Yields. The following table summarizes the scheduled repayments of our loan portfolio at December 31, 2021. Demand loans, having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less. Maturities are based on the final contractual payment date and do not reflect the impact of prepayments and scheduled principal amortization.
As of December 31, 2021
Single-Family
Multi-Family
Farmland
Owner
Occupied
Non-owner
Occupied
(In thousands)
Amounts due in:
One year or less
$
35,627
$
2,621
$
$
7,447
$
46,318
After one year through two years
7,869
25,977
1,158
39,186
After two years through three years
5,236
47,446
-
16,895
20,128
After three years through five years
26,206
22,968
-
21,833
39,138
After five years through fifteen years
68,472
38,693
119,126
216,254
After fifteen years
17,952
-
-
6,627
Total
$
161,362
$
137,705
$
1,323
$
173,086
$
361,101
Construction
and Land
Development
Commercial
and Industrial
Consumer
Total
Amounts due in:
(In thousands)
One year or less
$
188,339
$
36,799
$
$
317,889
After one year through two years
41,864
9,691
3,055
129,470
After two years through three years
2,333
2,844
5,627
100,509
After three years through five years
4,813
68,104
8,231
191,293
After five years through fifteen years
99,824
46,576
6,008
595,118
After fifteen years
-
-
-
24,656
Total
$
337,173
$
164,014
$
23,171
$
1,358,935
The following table sets forth our fixed and adjustable-rate loans at December 31, 2021 that are contractually due after December 31, 2021.
Due After December 31, 2021
Fixed
Adjustable
Rates
Rates
Total
(In thousands)
Residential real estate:
Single family
$
33,247
$
128,115
$
161,362
Multifamily
89,988
47,717
137,705
Farmland
1,323
Commercial real estate:
Owner occupied
74,450
98,636
173,086
Non-owner occupied
90,614
270,487
361,101
Construction and land development
18,253
318,920
337,173
Commercial - non-real estate:
Commercial and industrial
105,913
58,101
164,014
Consumer - non-real estate:
Unsecured
-
Secured
21,539
1,447
22,986
Totals
$
435,024
$
923,911
$
1,358,935
The following table shows our loan originations, participations, purchases, sales and repayment activities for the periods indicated.
Years Ended December 31,
(In thousands)
Total loans at beginning of year:
$
1,249,435
$
1,042,146
Loans originated:
Real estate loans:
Residential real estate:
Single family
61,578
45,993
Multifamily
85,890
28,149
Farmland
-
Commercial real estate:
Owner occupied
49,593
17,581
Non-owner occupied
70,672
52,154
Construction and land development
194,797
118,241
Commercial - non-real estate:
Commercial and industrial
110,929
146,847
Consumer - non-real estate:
Unsecured
Secured
1,427
Total loans originated:
575,559
409,407
Loan principal repayments:
Principal repayments
492,105
144,750
Loans transferred to other real estate owned:
Transfers to other real estate owned
-
Loans transferred to (from) loans held for sale:
Transfers to (from) loans held for sale
(26,046
)
57,006
Net loan activity
109,500
207,289
Total loans at the end of year
$
1,358,935
$
1,249,435
Loans, net of unearned income, totaled $1.4 billion at December 31, 2021, an increase of $109.5 million from December 31, 2020. The increase in total loans was primarily driven by growth in the overall loan portfolio, with significant increases in multifamily residential real estate, as well as the non-owner occupied commercial real estate portfolio.
Asset Quality
The Company’s asset quality remained strong during the year ended December 31, 2021. Nonperforming assets, which includes nonaccrual loans, accruing loans 90 days past due, accruing troubled debt restructured (“TDR”) loans 90 days past due, and other real estate owned totaled $775,000 at December 31, 2021 and $1.3 million at December 31, 2020.
A loan’s past due status is based on the contractual due date of the most delinquent payment due. All loans which are 30 or more days past due at the end of the month are reported to the Board of Directors. Commercial loans are generally placed on nonaccrual status when the collection of principal or interest is 90 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value of the collateral and the financial strength of the borrower. Consumer loans are generally placed on nonaccrual status when the collection of principal or interest is 120 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value of the collateral and the financial strength of the borrower. Loans greater than 90 days past due may remain on accrual status if management determines it has adequate collateral to cover the principal and interest. For those loans that are carried on nonaccrual status, payments are first applied to principal outstanding. A loan may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed.
The Company may identify loans for potential restructure primarily through direct communication with the borrower and evaluation of the borrower’s financial statements, revenue projections, tax returns, and credit reports. Even if the borrower is not presently in default,
management will consider the likelihood that cash flow shortages, adverse economic conditions and negative trends may result in a payment default in the near future.
As a percentage of total assets, nonperforming assets were 0.05% at December 31, 2021 compared with 0.08% at December 31, 2020. As of December 31, 2021, the Company had no loans placed on nonaccrual status.
See Note 1, Organization, Basis of Presentation, and Impact of Recently Issued Accounting Pronouncements and Note 5, Allowance for Loan Losses, in Notes to Consolidated Financial Statements for further information on the Company’s credit grade categories, which are derived from standard regulatory rating definitions.
The following table summarizes asset quality information at December 31, 2021 and December 31, 2020.
December 31,
December 31,
(Dollars in thousands)
Non-accrual loans:
Residential real estate
Single family
$
-
$
Total non-accrual loans
-
Total non-performing loans
-
Other real estate owned
1,180
Total non-performing assets
$
$
1,329
Ratios:
Total non-performing loans to gross loans receivable
0.00
%
0.01
%
Total non-performing loans to total assets
0.00
%
0.01
%
Total non-performing assets to total assets
0.05
%
0.08
%
Interest income that would have been recorded for the years ended December 31, 2021 and 2020 had non-accruing loans been current according to their original terms amounted to $0 and $45 respectively. We did not recognize any interest income for these loans for the years ended December 31, 2021 and 2020, respectively.
According to United States generally accepted accounting principles, restructuring a debt constitutes a TDR if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The CARES Act states that from March 1, 2020, until the end of the year (unless the President terminates the COVID-19 emergency declaration sooner), financial institutions may elect to suspend the TDR accounting principles for loan modifications related to COVID-19. The Consolidated Appropriations Act of 2021, enacted in December 2020, extended this relief to the earlier of January 1, 2022 or the first day of a bank’s fiscal year that begins after the national emergency ends.
The suspension applies during the modification. A modification can be a forbearance agreement, a new repayment plan, interest rate modification, or any other arrangement that defers or delays the payment of principal or interest. This provision applies only to loans that were current or less than 30 days past due on payments as of December 31, 2019.
The agencies are to defer to the financial institutions to suspend the TDR requirements. Financial institutions may presume that borrowers current on payments are not experiencing financial difficulties at modification to determine TDR status, and no further TDR analysis is required for each loan modification in the program. Examiners will exercise judgment in reviewing loan modifications, including TDRs, will not automatically adversely risk rate credits affected by COVID-19, and will not criticize prudent efforts to modify the terms on existing loans to affected customers.
As of December 31, 2021, there were no loans not disclosed in the above table, where known information about possible credit problems of borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms.
Analysis and Determination of the Allowance for Loan Losses. The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb probable and estimable credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. Because of uncertainties associated with regional economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that management’s estimate of probable credit losses inherent in the loan portfolio and the related allowance may change materially in the near-term. The allowance is increased by a provision for loans losses which is charged to expense and reduced by full and partial charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Management’s periodic evaluation of the adequacy of the allowance is
based on various factors, including, but not limited to, management’s ongoing review and grading of loans, facts and issues related to specific loans, historical loan loss or loan pools, the fair value of the underlying collateral, current economic conditions and other qualitative and quantitative factors which could affect potential credit losses. An integral part of their examination process, the Federal Reserve Board will periodically review our allowance for loan losses, and as a result of such reviews, we may have to adjust our allowance for loan losses.
The following table sets forth activity in our allowance for loan losses for the periods indicated.
For the Year Ended December 31,
For the Year Ended December 31,
(Dollars in thousands)
Balance at beginning of year
$
12,877
$
9,584
Charge-offs:
Commercial real estate
-
(1
)
Commercial industrial
-
(1,792
)
Consumer
(32
)
(60
)
Total charge-offs
(32
)
(1,853
)
Recoveries:
Residential real estate
-
Commercial and industrial
1,526
Consumer
Total recoveries
1,536
Net charge-offs
(5
)
(317
)
Provision for (recovery of) loan losses
(1,175
)
3,610
Balance at end of period
$
11,697
$
12,877
Ratios:
Net charge offs to average loans outstanding (annualized)
0.00
%
0.03
%
Allowance for loan losses to non-performing loans at end of
period
N/A
8,642.28
Allowance for loan losses to gross loans at end of period
0.86
%
1.03
%
At December 31, 2021, our allowance for loan losses represented 0.86 % of total loans and had no non-performing loans. The allowance for loan losses decreased to $11.7 million at December 31, 2021 from $12.9 million at December 31, 2020 primarily as a direct result of recovering provisions for loan losses in response to the COVID-19 pandemic that were assessed as no longer necessary. These provision recoveries were offset by provision expense on newly originated loans. There were $5,000 and $317,000 in net loan charge-offs during the years ended December 31, 2021 and December 31, 2020, respectively.
Allocation of Allowance for Loan Losses. The following table sets forth the allowance for loan losses allocated by loan category and the percent of the allowance in each category to the total allocated allowance at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.
At December 31,
(Dollars in thousands)
Allowance
for Loan
Losses
Percent of
Allowance
in Each
Category
to Total
Allocated
Allowance
Percent of
Loans
in Each
Category to
Total Loans
Allowance for
Loan Losses
Percent of
Allowance
in Each
Category
to Total
Allocated
Allowance
Percent of
Loans
in Each
Category to
Total Loans
Residential Real Estate:
Single family
$
1,119
9.57
%
11.87
%
$
1,019
7.91
%
11.15
%
Multifamily
4.71
%
10.13
%
1.58
%
3.39
%
Farmland
0.02
%
0.10
%
0.01
%
0.07
%
Commercial Real Estate:
Owner occupied
1,859
15.89
%
12.74
%
1,878
14.58
%
11.35
%
Non-owner occupied
3,830
32.74
%
26.57
%
4,674
36.30
%
26.10
%
Construction and Land Development
2,697
23.06
%
24.81
%
3,326
25.83
%
26.00
%
Commercial - Non Real Estate:
Commercial and industrial (1)
1,540
13.17
%
12.07
%
1,405
10.91
%
18.41
%
Consumer - Non Real Estate:
Unsecured
0.27
%
0.01
%
0.09
%
0.02
%
Secured
0.57
%
1.70
%
2.80
%
3.51
%
Total
$
11,697
100.0
%
100.0
%
$
12,877
100.0
%
100.0
%
(1)
No allowance assigned to $58.3 million in PPP loans due to SBA guarantee
Funding Activities
Deposits are the primary source of funds for lending and investing activities and their cost is the largest category of interest expense. The Company also utilizes brokered deposits as a funding source in addition to customer deposits. Scheduled payments, as well as prepayments, and maturities from portfolios of loans and investment securities also provide a stable source of funds. FHLB advances, other secured borrowings, federal funds purchased, and other short-term borrowed funds, as well as longer-term debt issued through the capital markets, all provide supplemental liquidity sources. The Company’s funding activities are monitored and governed through the Company’s asset/liability management process
Deposits
Total deposits increased by $146.2 million from December 31, 2020 to December 31, 2021. Brokered deposits, which are included in the table below, totaled $245.5 million and $279.9 million at December 31, 2021 and December 31, 2020, respectively. The following table presents the Company’s average deposits segregated by major category for the year ended December 31, 2021:
At December 31,
Average
Balance
Percent
Weighted
Average
Rate
Average
Balance
Percent
Weighted
Average
Rate
(Dollars in thousands)
Deposit type:
Interest-bearing demand
$
67,897
4.67
%
0.34
%
$
37,431
2.86
%
0.85
%
Money market
333,160
22.93
%
0.23
%
$
314,398
24.06
%
0.69
%
Savings and NOW
74,975
5.16
%
0.22
%
$
66,028
5.05
%
0.33
%
Time deposits
498,001
34.28
%
1.53
%
$
535,116
40.96
%
2.30
%
Interest-bearing deposits
974,033
67.05
%
0.90
%
952,973
72.94
%
1.58
%
Non-interest bearing demand
478,727
32.95
%
353,591
27.06
%
Total deposits
$
1,452,760
100.00
%
0.60
%
$
1,306,564
100.00
%
1.15
%
The overall increase in total deposits was primarily driven by an increase in non-interest bearing demand deposits and money market deposits largely due to our deposit gather strategies as well as balances related to the PPP initiative. The increase was partially offset by a
decrease in time deposits. Time deposits decreased from December 31, 2021 compared to December 31, 2020 primarily as a result of decreasing our more expensive wholesale deposits and replacing them with low cost and non-interest bearing deposits.
The Company had $682.2 million in total deposits in excess of the FDIC insurance limit of $250,000.
Certificates of deposit in amounts in excess of the FDIC insurance limit of $250,000 totaled approximately $249.9 million. The following table sets forth the maturity of these certificates as of December 31, 2021.
December 31,
(In thousands)
Maturity period:
Three months or less
$
9,916
Over three through six months
37,662
Over six through twelve months
17,708
Over twelve months through three years
184,004
Over three years
Total
$
249,894
The following table sets forth all of our time deposits classified by interest rate as of the dates indicated.
At December 31,
(In thousands)
Interest Rate Range:
0.01 - 0.99%
$
274,274
$
156,499
1.00 - 1.99%
19,596
61,188
2.00 - 2.99%
144,731
247,456
3.00 and greater
20,547
31,600
Total
$
459,148
$
496,743
The following table sets forth by interest rate ranges information concerning the maturities of our certificates of deposit as of December 31, 2021.
Period to Maturity
Less Than
or Equal to
One Year
More Than
One to Two
Years
More Than
Two to
Three
Years
More Than
Three Years
Total
Percent of
Total
Certificate
Accounts
(Dollars in thousands)
Interest Rate Range:
0.01 - 0.99%
$
126,141
$
116,497
$
11,636
$
20,000
$
274,274
59.74
%
1.00 - 1.99%
17,312
1,518
19,596
4.27
%
2.00 - 2.99%
58,727
44,605
40,737
144,731
31.52
%
3.00 and greater
5,084
13,307
2,156
-
20,547
4.47
%
Total
$
207,264
$
175,927
$
54,540
$
21,417
$
459,148
100.00
%
Borrowed Funds
We may obtain advances from the Federal Home Loan Bank of Richmond upon the security of the common stock we own in that bank and certain of our residential mortgage loans, provided certain standards related to creditworthiness have been met. These advances are made pursuant to several credit programs, each of which has its own interest rate and range of maturities. Federal Home Loan Bank advances are generally available to meet seasonal and other withdrawals of deposit accounts and to permit increased lending.
At December 31, 2021 and 2020, we were permitted to borrow up to an aggregate total of $414.0 million and $407.7 million, respectively, from the Federal Home Loan Bank of Richmond. There were Federal Home Loan Bank borrowings outstanding of $0 at December 31, 2021 and December 31, 2020. Additionally, we had credit availability of $104.0 million with correspondent banks for short-term liquidity needs, if necessary. No borrowings were outstanding at December 31, 2021 and 2020, under this facility.
Liquidity and Capital Resources
Liquidity is the ability of the Company to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management involves maintaining the Company’s ability to meet the day-to-day cash flow requirements of its customers, whether they are depositors wishing to withdraw funds or borrowers requiring funds to meet their credit needs. Without proper liquidity management, the Company would not be able to perform the primary function of a financial intermediary and would, therefore, not be able to meet the needs of the communities it serves.
The Company assesses liquidity needs on a daily basis using a sophisticated monitoring system that identifies daily sources and uses for a rolling 30-day period. The Company also assesses liquidity needs under various scenarios of market conditions, asset growth and changes in credit ratings. The assessment includes liquidity stress testing which measures various sources and uses of funds under the different scenarios. The assessment provides regular monitoring of unused borrowing capacity and available sources of contingent liquidity to prepare for unexpected liquidity needs and to cover unanticipated events that could affect liquidity.
The asset portion of the balance sheet provides liquidity primarily through unencumbered debt securities available for sale, loan principal and interest payments, maturities and prepayments of investment securities held to maturity and, to a lesser extent, sales of investment debt securities available for sale. Other short-term investments such as federal funds sold and maturing interest- bearing deposits with other banks, are additional sources of liquidity.
The liability portion of the balance sheet provides liquidity through various customers’ interest-bearing and noninterest-bearing deposit accounts and through FHLB and other borrowings. Brokered deposits, federal funds purchased, and other short-term borrowings are additional sources of liquidity and, basically, represent the Company’s incremental borrowing capacity. These sources of liquidity are used as necessary to fund asset growth and meet short-term liquidity needs.
In addition to the Company’s financial performance and condition, liquidity may be impacted by the Company’s structure as a bank holding company that is a separate legal entity from the Bank. The Company requires cash for various operating needs that could include payment of dividends to its stockholder, the servicing of debt, and the payment of general corporate expenses. The primary source of liquidity for the Company is dividends paid by the Bank. Applicable federal and state statutes and regulations impose restrictions on the amount of dividends that may be paid by the Bank. In addition to the formal statutes and regulations, regulatory authorities also consider the adequacy of the Bank’s total capital in relation to its assets, deposits and other such items. Any future dividends must be set forth in the Company's capital plans before any dividends can be paid.
The Company’s ability to raise funding at competitive prices is affected by the rating agencies’ views of the Company’s credit quality, liquidity, capital and earnings. Management meets with the rating agencies on a routine basis to discuss the current outlook for the Company.
The Board of Director and the Asset Liability Committee (ALCO) are responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we have enough sources of liquidity to satisfy our short and long-term liquidity needs as of December 31, 2021.
We monitor and adjust our investments in liquid assets based upon our assessment of: (1) expected loan demand; (2) expected deposit flows; (3) yields available on interest-earning deposits and securities; and (4) the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits and short-and intermediate-term securities.
While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. Our most liquid assets are cash and cash equivalents, which include federal funds sold and interest-earning deposits in other banks. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At December 31, 2021, cash and cash equivalents totaled $93.2 million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $99.9 million at December 31, 2021.
Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities. Net cash provided by operating activities was $60.4 million and $17.0 million for the twelve months ended December 31, 2021 and December 31, 2020, respectively. Net cash used in investing activities, which consists primarily of disbursements for loan originations and the purchase of securities, offset by principal collections on loans and proceeds from maturing securities, was $60.5 million and $313.8 million for the twelve months ended December 31, 2021 and December 31, 2020, respectively. There were no sales of available-for-sale debt securities in 2021 or 2020. Net cash used in financing activities was $14.2 million and provided by financing activities was $339.4 million for the twelve months ended December 31, 2021 and 2020, respectively, which consisted primarily of decreases in interest bearing and increases in non-interest bearing deposits for the twelve months ended December 31, 2021. There were no net repayments from the Federal Home Loan Bank for year ended 2021.
We are committed to maintaining a strong liquidity position. We monitor our liquidity position on a daily basis. We anticipate that we will have sufficient funds to meet our current funding commitments. Certificates of deposit due within one year of December 31, 2021, totaled $207.3 million of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds in the normal course of business, including other deposits and Federal Home Loan Bank advances. Depending on market conditions, we may be required to pay higher rates on such deposits or borrowings than we currently pay. We believe, however, based on past experience that a significant portion of such deposits will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered. Management believes that the current sources of liquidity are adequate to meet the Company’s requirements and plans for continued growth.
Regulatory Capital
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
The federal regulatory capital rules apply to all depository institutions as well as to bank holding companies with consolidated assets of $3 billion or more. However, the regulatory capital requirements generally do not apply on a consolidated basis to a bank holding company with total consolidated assets of less than $3 billion unless the holding company: (1) is engaged in significant nonbanking activities either
directly or through a nonbank subsidiary; (2) conducts significant off-balance sheet activities (including securitization and asset management or administration) either directly or through a nonbank subsidiary; or (3) has a material amount of debt or equity securities outstanding (other than trust preferred securities) that are registered with the Securities and Exchange Commission. The Federal Reserve may apply the regulatory capital standards at its discretion to any bank holding company, regardless of asset size, if such action is warranted for supervisory purposes.
Because the Company has total consolidated assets of less than $3 billion and does not engage in activities that would trigger application of the federal regulatory capital rules, it is not at present subject to consolidated capital requirements under the such rules.
The Basel III Capital Rules, a comprehensive capital framework for U.S. banking organizations, became effective for the Company and the Bank on January 1, 2015 (subject to a phase-in period for certain provisions). Under the Basel III rules, the Company must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The capital conservation buffer was phased in from 0.0% for 2015 to 2.50% by 2019. The capital conservation buffer for 2021 and 2020 is 2.50%. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios of Total capital, Common Equity Tier 1 capital, and Tier 1 capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2021, the Company and the Bank meets all capital adequacy requirements to which it is subject.
As of December 31, 2021 and 2020, the most recent notification from the Federal Reserve Bank of Richmond categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Common Equity Tier 1 risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Bank’s category.
The Bank’s actual regulatory capital amounts and ratios as of December 31, 2021 and 2020 are presented in the table below.
Actual
Capital Adequacy
Purposes
To Be Well Capitalized
Under the Prompt
Corrective Action
Provision
(Dollars in thousands)
Amount
Ratio
Amount
Ratio
Amount
Ratio
As of December 31, 2021
Total capital (to risk-weighted assets)
$
227,359
16.06
%
$
113,249
≥ 8.0%
$
141,562
≥ 10.0%
Common equity tier 1 capital (to risk-weighted assets)
$
215,662
15.23
%
$
63,703
≥ 4.5%
$
113,249
≥ 8.0%
Tier 1 capital (to risk-weighted assets)
$
215,662
15.23
%
$
84,937
≥ 6.0%
$
113,249
≥ 8.0%
Tier 1 capital (to average assets)
$
215,662
12.90
%
$
66,898
≥ 4.0%
$
83,622
≥ 5.0%
As of December 31, 2020
Total capital (to risk-weighted assets)
$
189,534
14.60
%
$
103,872
≥ 8.0%
$
129,840
≥ 10.0%
Common equity tier 1 capital (to risk-weighted assets)
$
176,657
13.61
%
$
58,428
≥ 4.5%
$
103,872
≥ 8.0%
Tier 1 capital (to risk-weighted assets)
$
176,657
13.61
%
$
77,904
≥ 6.0%
$
103,872
≥ 8.0%
Tier 1 capital (to average assets)
$
176,657
10.78
%
$
65,557
≥ 4.0%
$
81,946
≥ 5.0%
Non-GAAP Measures
In reporting the results of December 31, 2021, the Company has provided supplemental performance measures on an operating basis. These measures are a supplement to GAAP used to prepare the Company’s financial statements and should not be considered in isolation or as a substitute for comparable measures calculated in accordance with GAAP. In addition, the Company’s non-GAAP measures may not be comparable to non-GAAP measures of other companies. The Company uses the non-GAAP measures discussed herein in its analysis of the Company’s performance.
Net interest margin excluding PPP loans, which is used in computing net interest margin, provides valuable additional insight into the net interest margin and the impact the Paycheck Protection Program has had on our financial metrics. The entire PPP adjustment is attributable to the interest received on PPP loans, which is lower than normal market rates, and fees recognized on PPP loans that are amortized ratably over the life of the loan.
The Company believes that Allowance for loan losses, excluding PPP to total loans is a meaningful supplement to GAAP financial measures and useful to investors because it measures the reserves placed aside to absorb possible credit losses inherent in the loan portfolio. PPP loans are backed by the full faith of the SBA and as such, we have not set aside reserves for this segment of the loan portfolio.
The following table reconciles these non-GAAP measures from their respective GAAP basis measures for the years ended December 31,
For the year ended December 31,
(Dollars in thousands)
Paycheck Protection Program adjustment impact
Loans held for investment (GAAP)
$
1,358,935
$
1,249,435
Less: PPP loans
58,339
135,180
Loans held for investment, excluding PPP (non-GAAP)
1,300,596
1,114,255
Average loans held for investment (GAAP)
$
1,289,445
$
1,219,525
Less: Average PPP loans
123,538
116,690
Average loans held for investment, excluding PPP (non-GAAP)
1,165,907
1,102,835
Net interest margin adjustment
Net interest income (GAAP)
$
53,536
$
45,977
Less: PPP fees recognized
4,973
2,598
Less: PPP interest income earned
1,235
1,167
Net interest income, excluding PPP income (non-GAAP)
47,328
42,212
Average interest earning assets (GAAP)
$
1,605,783
$
1,431,627
Less: average PPP loans
123,538
116,690
Average interest earning assets, excluding PPP (non-GAAP)
1,482,245
1,314,937
Net interest margin (GAAP)
3.33
%
3.21
%
Net interest margin, excluding PPP (non-GAAP)
3.19
%
3.21
%
Allowance for loan losses, adjusted
Allowance for loan losses (GAAP)
$
11,697
$
12,877
Total gross loans (GAAP)
1,358,935
1,249,435
Less: PPP loans
58,339
135,180
Total gross loans, excluding PPP loans (non-GAAP)
1,300,596
1,114,255
Allowance for loan losses to total loans, excluding PPP (non-GAAP)
0.90
%
1.16
%

---

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market Risk Management
The effective management of market risk is essential to achieving the Company’s strategic financial objectives. As a financial institution, the Company’s most significant market risk exposure is interest rate risk in its balance sheet; however, market risk also includes product liquidity risk, price risk and volatility risk in the Company’s lines of business. The primary objectives of market risk management are to minimize any adverse effect that changes in market risk factors may have on net interest income, and to offset the risk of price changes for certain assets recorded at fair value.
Interest Rate Market Risk
The Company’s net interest income and the fair value of its financial instruments are influenced by changes in the level of interest rates. The Company manages its exposure to fluctuations in interest rates through policies established by its Asset/Liability Committee. The Asset/Liability Committee meets regularly and has responsibility for approving asset/liability management policies, formulating strategies to improve balance sheet positioning and/or earnings and reviewing the interest rate sensitivity of the Company.
We estimate what our net interest income would be for a 12-month period. We then calculate what the net interest income would be for the same period under different interest rate assumptions. These estimates require certain assumptions to be made, including loan and mortgage-related investment prepayment speeds, reinvestment rates, and deposit maturity and decay rates. These assumptions are inherently uncertain. As a result, no simulation model can precisely predict the impact of changes in interest rates on our net interest income.
The table below sets forth, as of December 31, 2021, the calculation of the estimated changes in our net interest income that would result from changes in market interest rates over one year if we take no action from our current plan.
Basis Point Change in
Net Interest Income
Year 1 Change
Interest Rates
Year 1 Forecast
From Level
(Dollars in thousands)
+400
$
40,073
62.83
%
+300
$
36,207
47.12
%
+200
$
32,141
30.60
%
+100
$
28,364
15.25
%
Level
$
24,611
-
$
23,315
-5.24
%
$
22,363
-9.13
%
Economic Value of Equity (“EVE”). We analyze the sensitivity of our financial condition to changes in interest rates through our economic value of equity model. This analysis measures the difference between predicted changes in the fair value of our assets and predicted changes in the present value of our liabilities assuming various changes in current interest rates. The table below represents an analysis of our interest rate risk as measured by the estimated changes in our economic value of equity, resulting from an instantaneous and sustained parallel shift in the yield curve at December 31, 2021.
Estimated Increase
EVE as a Percentage of Fair
(Decrease) EVE
Value of Assets(3)
Basis Point
Increase
Change in
Estimated
EVE
(Decrease)
Interest Rates(1)
EVE(2)
Amount
Percent
Ratio(4)
Basis Points
(Dollars in thousands)
+400
$
232,003
$
25,475
12.33
%
20.70
%
+300
$
230,612
$
24,083
11.66
%
17.80
%
+200
$
224,272
$
17,744
8.59
%
12.66
%
+100
$
218,453
$
11,925
5.77
%
7.67
%
Level
$
206,528
$
-
-
-
-
$
187,628
$
(18,900
)
(9.15
)%
(11.16
)%
(140
)
$
174,405
$
(32,123
)
(15.55
)%
(19.20
)%
(241
)
(1)
Assumes an immediate uniform change in interest rates at all maturities.
(2)
EVE is the fair value of expected cash flows from assets, less fair value of the expected cash flows arising from our liabilities adjusted for the value of off-balance sheet contracts.
(3)
Fair value of assets represents the amount at which an asset could be exchanged between knowledgeable and willing parties in an arms-length transaction.
(4)
EVE Ratio represents EVE divided by the fair value of assets.
Market Interest Rate Shift
The financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles in the United States of America which require the measurement of financial position and operating results in terms of historical dollars without considering changes in relative purchasing power of money over time due to inflation.
The majority of assets and liabilities of a financial institution are monetary in nature; therefore, a financial institution differs greatly from most commercial and industrial companies, which have significant investments in fixed assets or inventories that are greatly impacted by inflation. However, inflation does have an important impact on the growth of total assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity-to-assets ratio. Inflation also affects other expenses that tend to rise during periods of general inflation.
Management believes the most significant potential impact of inflation on financial results is a direct result of the Company’s ability to manage the impact of changes in interest rates. Management attempts to maintain a balanced position between rate-sensitive assets and liabilities in order to minimize the impact of interest rate fluctuations on net interest income. However, this goal can be difficult to completely achieve in times of rapidly changing interest rates and is one of many factors considered in determining the Company’s interest rate positioning. The Company is asset sensitive as of December 31, 2021. Refer to the Net Interest Income Sensitivity table for additional details on the Company’s interest rate sensitivity.
The Bank also uses derivative financial instruments to manage risk to the Bank associated with changing interest rates, and to assist customers with their risk management objectives. The Bank enters into interest rate swaps with certain qualifying commercial loan customers to meet their interest rate risk management needs. The net result of these interest rate swaps is that the customer pays a fixed rate of interest and the Bank receives a floating rate thus allowing the Bank another tool to further manage the interest rate risk for certain products. These back-to-back loan swaps qualify as financial derivatives with fair values reported in “Other assets” and “Other liabilities” in the Consolidated Balance Sheet.
We believe that our current interest rate exposure is manageable and does not indicate any significant exposure to interest rate changes.

---

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors
MainStreet Bancshares, Inc.
Fairfax, Virginia
Opinion on the Financial Statements
We have audited the accompanying consolidated statements of financial condition of MainStreet Bancshares, Inc. and Subsidiaries (the Company) as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for the years then ended, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Yount, Hyde & Barbour, P.C.
We have served as the Company's auditor since 2008.
Winchester, Virginia
March 23, 2022
Item 8 - Financial Statements and Supplementary Data
Consolidated Financial Statements
Consolidated Statements of Financial Condition as of December 31, 2021 and December 31, 2020 (Dollars in thousands, except per share data)
At December 31,
At December 31,
Assets
Cash and due from banks
$
61,827
$
75,935
Federal funds sold
31,372
31,593
Cash and cash equivalents
93,199
107,528
Investment securities available-for-sale, at fair value
99,913
147,414
Investment securities held-to-maturity, at amortized cost
20,349
22,520
Restricted securities, at cost
15,609
4,616
Loans held for sale
-
57,006
Loans, net of allowance for loan losses of $11,697 and $12,877, respectively
1,341,760
1,230,379
Premises and equipment, net
14,863
14,289
Other real estate owned, net
1,180
Accrued interest and other receivables
7,701
9,604
Computer software, net of amortization
2,493
-
Bank owned life insurance
36,241
25,341
Other assets
14,499
23,288
Total Assets
$
1,647,402
$
1,643,165
Liabilities and Stockholders’ Equity
Liabilities
Non-interest bearing deposits
$
530,678
$
370,497
Interest bearing demand deposits
69,232
70,307
Savings and NOW deposits
85,175
74,099
Money market deposits
267,730
426,600
Time deposits
459,148
496,743
Total deposits
1,411,963
1,438,246
Subordinated debt, net
29,294
14,834
Other liabilities
17,357
22,420
Total Liabilities
1,458,614
1,475,500
Commitments and contingencies (Note 13)
Stockholders’ Equity
Preferred stock, $1.00 par value, 2,000,000 shares authorized non-cumulative perpetual;
28,750 issued and outstanding as of December 31, 2021 and December 31, 2020
27,263
27,263
Common stock, $4.00 par value, 10,000,000 shares authorized; issued and outstanding
7,595,781 shares (including 229,257 nonvested shares) for December 31, 2021 and
7,443,842 shares (including 161,435 nonvested shares) for December 31, 2020
29,466
29,130
Capital surplus
67,668
66,116
Retained earnings
64,194
44,179
Accumulated other comprehensive income
Total Stockholders’ Equity
188,788
167,665
Total Liabilities and Stockholders’ Equity
$
1,647,402
$
1,643,165
See Notes to the Consolidated Financial Statements
Consolidated Statements of Income for the Years Ended December 31, 2021 and 2020 (Dollars in thousands, except per share data).
For the Year
Ended December 31,
Interest Income
Interest and fees on loans
$
61,743
$
59,634
Interest and dividends on investment securities
Taxable securities
1,262
Tax-exempt securities
1,060
1,117
Interest on federal funds sold
Total Interest Income
64,199
62,072
Interest Expense
Interest on interest bearing DDA deposits
Interest on savings and NOW deposits
Interest on money market deposits
2,162
Interest on time deposits
7,613
12,322
Interest on Federal Home Loan Bank advances
-
Interest on subordinated debt
1,884
Total Interest Expense
10,663
16,095
Net Interest Income
53,536
45,977
Provision for (recovery of) loan losses
(1,175
)
3,610
Net interest income after provision for (recovery of) loan losses
54,711
42,367
Non-Interest Income
Deposit account service charges
2,426
1,916
Bank owned life insurance income
Loan swap fee income
3,510
Net gain on held-to-maturity securities
-
Net gain on sale of loans
Other fee income
1,848
1,213
Total Non-Interest Income
6,110
7,451
Non-Interest Expense
Salaries and employee benefits
19,305
17,937
Furniture and equipment expenses
2,468
2,128
Advertising and marketing
1,565
1,003
Occupancy expenses
1,541
1,270
Outside services
1,394
Franchise tax
1,544
1,370
FDIC insurance
1,051
1,329
Data processing
1,189
1,242
Administrative expenses
Other real estate expenses, net
Other operating expenses
2,039
1,887
Total Non-Interest Expense
32,865
30,258
Income before income taxes
27,956
19,560
Income Tax Expense
5,785
3,843
Net Income
$
22,171
$
15,717
Preferred Stock Dividends
2,156
Net Income available to Common Shareholders
$
20,015
$
15,082
Net Income per common share:
Basic
$
2.65
$
1.85
Diluted
$
2.65
$
1.85
See Notes to the Consolidated Financial Statements
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2021 and 2020 (Dollars in thousands)
For the Year
Ended December 31,
Comprehensive Income, net of taxes
Net Income
$
22,171
$
15,717
Other comprehensive income (loss), net of tax expense (benefit):
Unrealized gains (losses) on available for sale securities arising
during the period (net of tax expense (benefit), ($223) and $145, respectively)
(800
)
Add: reclassification adjustment for amortization of unrealized
losses on securities transferred from available for sale to held
to maturity (net of tax, $5 and $5, respectively)
Other comprehensive income (loss)
(780
)
Comprehensive Income
$
21,391
$
16,271
See Notes to the Consolidated Financial Statements
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2021 and 2020 (Dollars in thousands).
Accumulated
Other
Preferred
Common
Capital
Retained
Comprehensive
Stock
Stock
Surplus
Earnings
Income
Total
Balance, December 31, 2019
$
-
$
32,397
$
75,117
$
29,097
$
$
137,034
Preferred stock issued, net
27,263
-
-
-
-
27,263
Vesting of restricted stock
-
(316
)
-
-
-
Stock based compensation expense
-
-
1,529
-
-
1,529
Common stock repurchased
-
(3,583
)
(10,214
)
-
-
(13,797
)
Dividends on preferred stock
-
-
-
(635
)
-
(635
)
Net income
-
-
-
15,717
-
15,717
Other comprehensive income
-
-
-
-
Balance, December 31, 2020
$
27,263
$
29,130
$
66,116
$
44,179
$
$
167,665
Accumulated
Other
Preferred
Common
Capital
Retained
Comprehensive
Stock
Stock
Surplus
Earnings
Income (Loss)
Total
Balance, December 31, 2020
$
27,263
$
29,130
$
66,116
$
44,179
$
$
167,665
Vesting of restricted stock
-
(336
)
-
-
-
Stock based compensation expense
-
-
1,888
-
-
1,888
Dividends on preferred stock
-
-
-
(2,156
)
-
(2,156
)
Net income
-
-
-
22,171
-
22,171
Other comprehensive loss
-
-
-
-
(780
)
(780
)
Balance, December 31, 2021
$
27,263
$
29,466
$
67,668
$
64,194
$
$
188,788
See Notes to the Consolidated Financial Statements
Consolidated Statements of Cash Flows (Dollars in thousands)
Year Ended December 31,
Cash Flows from Operating Activities
Net income
$
22,171
$
15,717
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization, and accretion, net
1,893
1,746
Amortization of right-of-use assets
Deferred income tax (benefit)
(1,752
)
Writedown of other real estate owned
Loss (gain) on transfer or sale of other real estate owned
(43
)
Provision for (recovery of) loan losses
(1,175
)
3,610
Stock based compensation expense
1,888
1,529
Income from bank owned life insurance
(900
)
(779
)
Subordinated debt amortization expense
Gain on disposal of premises and equipment
(57
)
(36
)
Gain on loans held for sale
(847
)
-
Gain on called held-to-maturity securities
(6
)
-
Proceeds from sale of loans
31,264
-
Change in:
Accrued interest receivable and other receivables
1,903
(4,184
)
Other assets
8,224
(8,167
)
Other liabilities
(5,063
)
8,524
Net cash provided by operating activities
60,388
17,016
Cash Flows from Investing Activities
Activity in available-for-sale securities:
Payments
7,635
8,931
Maturities, sales, called, refunded
417,000
235,000
Purchases
(378,619
)
(298,352
)
Activity in held-to-maturity securities:
Purchases
-
(1,005
)
Maturities, called, refunded
2,040
2,260
Purchases of equity securities
(10,651
)
-
Purchases of restricted investment in bank stock
(758
)
(1,222
)
Redemption of restricted investment in bank stock
2,763
Net increase in loan portfolio
(83,617
)
(260,932
)
Proceeds from sale of other real estate owned
-
Purchases of bank owned life insurance
(10,000
)
-
Proceeds from sale of premises and equipment
Purchases of premises and equipment
(1,806
)
(1,282
)
Computer software developed
(2,493
)
-
Net cash used in investing activities
(60,515
)
(313,786
)
Cash Flows from Financing Activities
Net increase in non-interest deposits
160,181
117,790
Net increase (decrease) in interest bearing demand, savings, and time deposits
(186,464
)
248,833
Net decrease in Federal Home Loan Bank advances and other borrowings
-
(40,000
)
Net increase in subordinated debt
14,237
-
Issuance of preferred stock, net
-
27,263
Cash dividends paid on preferred stock
(2,156
)
(635
)
Repurchase of common stock
-
(13,797
)
Net cash provided by (used in) financing activities
(14,202
)
339,454
Increase (decrease) in Cash and Cash Equivalents
(14,329
)
42,684
Cash and Cash Equivalents, beginning of period
107,528
64,844
Cash and Cash Equivalents, end of period
$
93,199
$
107,528
Supplementary Disclosure of Cash Flow Information
Cash paid during the period for interest
$
10,165
$
16,358
Cash paid during the period for income taxes
$
6,838
$
4,618
Right of use assets obtained in exchange for new operating lease liabilities
$
1,922
$
-
Transfers from loans to other real estate owned
$
-
$
Transfers from loans receivable to loans held for sale, at carrying value
$
-
$
57,006
Transfers from loans held for sale to loans receivable
$
26,046
$
-
Net unrealized gain (loss) on securities available-for-sale
$
(1,023
)
$
See Notes to the Consolidated Financial Statements
MAINSTREET BANCSHARES, INC. AND SUBSIDIARY
Notes to Unaudited Consolidated Financial Statements
Note 1. Organization, Basis of Presentation and Impact of Recently Issued Accounting Pronouncements
Organization
MainStreet Bancshares Inc. (the “Company”) is a bank holding company incorporated under the laws of the Commonwealth of Virginia whose principal activity is the ownership and management of MainStreet Bank. On May 18, 2016, the stockholders of MainStreet Bank (the “Bank”) approved a Reorganization Agreement and Plan of Share Exchange (“Reorganization”) whereby the Bank would reorganize into a holding company structure. The Plan of Share Exchange called for each outstanding share of Bank common stock to be automatically converted into and exchanged for one share of the Company’s common stock, and the common stockholders of the Bank would become the common stockholders of the Company on the effective date of the Reorganization. On October 12, 2021, the Company filed an election with the Federal Reserve Board to be a financial holding company in order to engage in a broader range of financial activities than are permitted for bank holding companies generally. The Company is authorized to issue 10,000,000 shares of common stock with a par value of $4.00 per share. Additionally, the Company is authorized to issue 2,000,000 shares of preferred stock at a par value $1.00 per share. There are currently 28,750 shares of preferred stock outstanding.
On July 15, 2016, the Reorganization became effective, and the Bank became a wholly-owned subsidiary of the Company. The holding company is regulated under the Bank Holding Company Act of 1956, as amended, and is subject to inspection, examination, and supervision by the Federal Reserve Board.
On April 18, 2019, the Company completed the registration of its common stock with the Securities Exchange Commission through its filing of a General Form for Registration of Securities on Form 10 (“Form 10”), pursuant to Section 12(b) of the Securities Exchange Act of 1934. The Company is considered an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012, or the “JOBS Act,” and as defined in Section 2(a) of the Securities Act of 1933, as amended, or the “Securities Act.” We are also a “smaller reporting company” as defined in Exchange Act Rule 12b-2. As such, we may elect to comply with certain reduced public company reporting requirements in future reports that we file with the Securities and Exchange Commission, or the “SEC.”
We were approved to list shares of our common stock on the Nasdaq Capital Market under our current symbol “MNSB” as of April 22, 2019. We were approved to list depositary shares of preferred stock on the Nasdaq Capital Market on the symbol “MNSBP” as of September 16, 2020. Each depositary share represents a 140th interest in a share of 7.50% Series A Fixed-Rate Non-Cumulative Perpetual Preferred Stock.
In August 2021, the Company created a community development entity (“CDE”) subsidiary, MainStreet Community Capital, LLC, a Virginia limited liability company to promote development in economically distressed areas. This CDE will be an intermediary vehicle for the provision of loans and investments in Low-Income Communities (“LICs”). In January 2022, the Community Development Financial Institutions Fund (“CDFI”) of the United States Department of the Treasury certified MainStreet Community Capital, LLC as a registered CDE.
MainStreet Bank is headquartered in Fairfax, Virginia where it also operates a branch. The Bank was incorporated on March 28, 2003 and received its charter from the Bureau of Financial Institutions of the Commonwealth of Virginia (the “Bureau”) on March 16, 2004. The Bank commenced regular operations on May 26, 2004 and is supervised by the Bureau and the Federal Reserve Bank of Richmond. The Bank is a member of the Federal Reserve System and the Federal Deposit Insurance Corporation. The Bank places special emphasis on serving the needs of individuals, and small and medium-sized business and professional concerns in the Washington, D.C. metropolitan area.
Basis of Presentation
The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“US GAAP”) as applicable to a smaller reporting company.
Principles of Consolidation - The consolidated financial statements include accounts of the Company and its wholly-owned subsidiaries, the Bank and MainStreet Community Capital, LLC. All significant intercompany transactions and balances have been eliminated in consolidation.
Cash and cash equivalents - For the purpose of presentation in the Statements of Cash Flows, the Bank has defined cash and cash equivalents as those amounts included in the balance sheet captions “Cash and due from banks” and “Federal funds sold.”
Investment securities - The Bank’s investment debt securities are classified as either held to maturity, available for sale or trading. At December 31, 2021 and December 31, 2020, the Bank held approximately $20.3 million and $22.5 million, respectively, in securities classified as held to maturity. The Bank held no securities classified as trading.
Debt securities which are not classified as held to maturity or trading are classified as securities available for sale. Debt securities available for sale are reported at fair value. Any unrealized gain or loss, net of applicable income taxes, is reported as a separate addition to or reduction
from stockholders’ equity. Gains and losses arising from the sale of debt securities available for sale are recognized based on the specific identification method on a trade-date basis and included in results of operations.
Debt securities held to maturity includes securities purchased with the ability and positive intent to hold to maturity. Debt securities are stated at historical cost adjusted for amortization of premiums and accretion of discount. Any investment security, for which there has been a value impairment deemed by management to be other than temporary, is written down to its estimated fair value with a charge to current operations.
Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held to maturity and available for sale debt securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In determining whether other-than-temporary impairment exists, management considers many factors, including (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether the Bank intends to sell the security, whether it is more likely than not that the Bank will be required to sell the security before recovery of its amortized cost basis, and whether the Bank expects to recover the security’s entire amortized cost basis. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
Restricted equity securities consist of the Federal Reserve Bank and Federal Home Loan Bank of Atlanta (“FHLB”) stock in the amount of $4.1 million and $826,000 respectively, as of December 31, 2021, compared to $3.3 million and $1.1 million, respectively, as of December 31, 2020. Restricted equity securities also consisted of $126,800 in Community Bankers Bank stock at December 31, 2021 and December 31, 2020. This restricted stock is recorded at cost because its ownership is restricted and it lacks a market for resale. The Bank is required to maintain Federal Reserve Bank stock at a level of 6% of capital and surplus. The FHLB requires the Bank to maintain stock, at a minimum, in an amount equal to 4.5% of outstanding borrowings and 0.20% of total assets. When evaluating restricted stock for impairment, its value is based on ultimate recoverability of the par value rather than by recognizing temporary declines in value. The Bank does not consider these investments to be impaired at December 31, 2021 or December 31, 2020 and no previous impairment has been recognized. Restricted equities include $4.9 million in Low-Income Housing Tax Credits (“LIHTC”) that are carried at amortized cost through the proportional amortization method. Restricted equities also include $5.7 million of nonmarketable securities as of December 31, 2021 that do not qualify for equity method accounting. These investments are recorded at cost because the ownership is restricted and lacks a market for resale. There were no nonmarketable equities as of December 31, 2020.
Loans held for sale - Loans intended for sale are recorded at the lower aggregate cost or fair value as of the balance sheet date. Gains and losses on loan sales are determined by the specific-identification method.
Loans - The Bank makes commercial and consumer loans to customers. Our recorded investment in loans that management has the intent and ability to hold for the foreseeable future, or until maturity or pay-off, generally are reported at their unpaid principal balances adjusted for charge-offs, unearned discounts, any deferred fees or costs on originated loans, and the allowance for loan losses. Interest on loans is credited to operations based on the principal amount outstanding. Loan fees and origination costs are deferred and the net amount is amortized as an adjustment of the related loan’s yield using the effective interest method. The Bank is amortizing these amounts over the contractual life of the related loans.
A loan’s past due status is based on the contractual due date of the most delinquent payment due. All loans which are 30 or more days past due at the end of the month are reported to the Board of Directors. Commercial loans are generally placed on nonaccrual status when the collection of principal or interest is 90 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value of the collateral and the financial strength of the borrower. Consumer loans are generally placed on nonaccrual status when the collection of principal or interest is 120 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value of the collateral and the financial strength of the borrower. Loans greater than 90 days past due may remain on accrual status if management determines it has adequate collateral to cover the principal and interest. For those loans that are carried on nonaccrual status, payments are first applied to principal outstanding. A loan may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed. It is Bank policy to charge-off loans whose collectability is sufficiently questionable and can no longer be justified as an asset on the balance sheet. To determine if a loan should be charged-off, all possible sources of repayment are analysed, including: (1) the potential for future cash flow, (2) the value of the Bank’s collateral, and (3) the strength of co-makers or guarantors. All principal and previously accrued interest is charged to the allowance for loan losses. All future payments received on the loan are credited to the allowance for loan losses as a recovery. These policies are applied consistently across our loan portfolio.
Impairment of a loan - The Bank considers a loan impaired when it is probable that the Bank will be unable to collect all interest and principal payments as scheduled in the loan agreement when due. A loan is not considered impaired during a period of an insignificant delay in payment if the ultimate collectability of all amounts due is expected. Impairment is measured on a loan by loan basis for all commercial, construction and residential loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent. Consistent with the Bank’s method for nonaccrual loans, payments on impaired loans are first applied to principal outstanding. Smaller balance consumer loans are not individually evaluated for impairment.
Troubled Debt Restructuring (TDR) occurs when the Bank agrees to modify the original terms of a loan due to the deterioration in the financial condition of the borrower. TDRs are considered impaired loans. Upon designation as a TDR, the Bank evaluates the borrower’s payment history, past due status and ability to make payments based on the revised terms of the loan. If a loan was accruing prior to being modified as a TDR and if the Bank concludes that the borrower is able to continue making such payments, and there are no other factors or circumstances that would cause it to conclude otherwise, the loan will remain on an accruing status. If a loan was on nonaccrual status at the time of the TDR, the loan will remain on nonaccrual status following the modification and may be returned to accrual status based on the policy for returning loans to accrual status as noted above. Restructured loans for which there was no rate concession, and therefore made at a market rate of interest, may be eligible to be removed from TDR status in periods subsequent to the restructuring depending on the performance of the loan. As of December 31, 2021, and December 31, 2020, the Bank had zero loans classified as TDR.
Allowance for Loan Losses - The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. Loan losses are charged against the allowance for loan losses for the difference between the carrying value of the loan and the estimated net realizable value or fair value of the collateral, if collateral dependent, when:
•
Management believes that the collectability of the principal is unlikely regardless of delinquency status.
•
The loan is a consumer loan and is 120 days past due.
•
The loan is a non-consumer loan, unless the loan is well secured and recovery is probable.
•
The borrower is in bankruptcy, unless the debt has been reaffirmed, is well secured and recovery is probable.
Subsequent recoveries, if any, are credited to the allowance.
The allowance represents an amount that, in management’s judgment, will be adequate to absorb probable and estimable losses inherent in the loan portfolio. Management’s judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. The evaluation also considers the following risk characteristics of each loan portfolio segment:
•
Real estate residential mortgage loans, including equity lines of credit, carry risks associated with the continued credit-worthiness of the borrower and the changes in the value of the collateral.
•
Real estate construction loans and land improvement carry risks that the project will not be finished according to schedule, the project will not be finished according to budget and the value of the collateral may, at any point in time, be less than the principal amount of the loan. Construction loans also bear the risk that the general contractor, who may or may not be a loan customer, may be unable to finish the construction project as planned because of financial pressure unrelated to the project.
•
Commercial real estate loans carry risks of the client’s ability to repay the loan from the cash flow derived from the underlying real estate. Risks inherent in managing a commercial real estate portfolio relate to sudden or gradual drops in property values as well as changes in the economic climate. Real estate security diminishes risks only to the extent that a market exists for the subject collateral. These risks are attempted to be mitigated by carefully underwriting loans of this type and by following appropriate loan-to-value standards.
•
Commercial and industrial loans carry risks associated with the successful operation of a business or a real estate project, in addition to other risks associated with the ownership of real estate, because the repayment of these loans may be dependent upon the profitability and cash flows of the business or project. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time and cannot be appraised with as much precision.
•
Consumer secured loans (indirect lending) carry risks associated with the continued credit-worthiness of the borrower and the value of the collateral (e.g., rapidly-depreciating assets such as automobiles). These risks are attempted to be mitigated by following appropriate loan-to-value standards and an experienced management team for this type of portfolio.
The allowance consists of specific and general components. The specific component relates to loans that are classified as impaired and is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. For collateral dependent loans, an updated appraisal will be ordered if a current one is not on file. Appraisals are performed by independent third-party appraisers with the relevant industry experience. Adjustments to the appraised value may be made based on recent sales of like properties or general market conditions when appropriate. The general component covers non-classified or performing loans and those loans classified as substandard or special mention that are not impaired. The general component is based on historical loss experience adjusted for qualitative factors, such as current economic conditions, including current home sales and foreclosures, unemployment rates and retail sales. Non-impaired classified loans are assigned a higher allowance factor based on an internal migration analysis, which increases with the severity of classification, than non-classified loans. The characteristics of the loan ratings are as follows:
•
Pass rated loans are to persons or business entities with an acceptable financial condition, appropriate collateral margins, appropriate cash flow to service the existing loan, and an appropriate leverage ratio. The borrower has paid all obligations as
agreed and it is expected that this type of payment history will continue. When necessary, acceptable personal guarantors support the loan.
•
Watch rated loans have all the characteristics of pass rated loans but show signs of emerging financial weaknesses which the Bank will continue monitoring more closely. Watch rated loans are still performing as agreed.
•
Special mention loans have a specific defined weakness in the borrower’s operations and the borrower’s ability to generate positive cash flow on a sustained basis. The borrower’s recent payment history is characterized by late payments. The Bank’s risk exposure is mitigated by collateral supporting the loan. The collateral is considered to be well-margined, well maintained, accessible and readily marketable.
•
Substandard loans are considered to have specific and well-defined weaknesses that jeopardize the viability of the Bank’s credit extension. The payment history for the loan has been inconsistent and the expected or projected primary repayment source may be inadequate to service the loan. The estimated net liquidation value of the collateral pledged and/or ability of the personal guarantor(s) to pay the loan may not adequately protect the Bank. There is a distinct possibility that the Bank will sustain some loss if the deficiencies associated with the loan are not corrected in the near term. A substandard loan would not automatically meet our definition of impaired unless the loan is significantly past due and the borrower’s performance and financial condition provide evidence that it is probable that the Bank will be unable to collect all amounts when due.
•
Doubtful rated loans have all the weaknesses inherent in a loan that is classified substandard but with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high.
•
Loss rated loans are not considered collectible under normal circumstances and there is no realistic expectation for any future payment on the loan. Loss rated loans are fully charged off.
Other Real Estate Owned (“OREO”) - Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less costs to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, management periodically performs valuations of the foreclosed assets based on updated appraisals, general market conditions, and recent sales of like properties, length of time the properties have been held and our ability and intention with regard to continued ownership of the properties. The Bank may incur additional write-downs of foreclosed assets to fair value less costs to sell if valuations indicate a further deterioration in market values. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets and improvements are capitalized.
Interest income on loans - Interest on loans is accrued and credited to income on daily balances of the principal amount outstanding. The accrual of interest on loans is discontinued when, in the opinion of management, there is an indication that the borrower may be unable to meet payments as they become due. Upon such discontinuance, all unpaid accrued interest is reversed.
Generally, the Bank will return a loan to accrual status when all delinquent interest and principal becomes current and remains current for six consecutive months under the terms of the loan agreement or the loan is well-secured or in process of collection. Upon returning to accrual status, interest payments applied to the principal balance of a loan while in nonaccrual status are recognized as a yield adjustment over the remaining life.
Loan origination and commitment fees and certain related direct costs - Loan origination and commitment fees charged by the Bank and certain direct loan origination costs are deferred and the net amount is amortized as a yield adjustment. The Bank amortizes these net amounts over the life of the related loans or, in the case of demand loans, over the estimated life. Net fees related to standby letters of credit are recognized over the commitment period.
Premises and equipment - Land is carried at cost. Premises and equipment are stated at cost, less accumulated depreciation and amortization computed principally on the straight-line basis over the estimated useful life of each asset, which ranges from 3 to 39 years. Leasehold improvements are amortized over the shorter of the related lease term or the estimated useful lives of the improvements. Construction in progress includes assets which will be reclassified and depreciated once placed into service.
Computer software development - The Company capitalizes new product development costs incurred for software to be sold from the point at which technological feasibility has been established through the point at which the product is ready for general availability. Software development costs that are capitalized are evaluated annually for impairment and are assigned an estimated economic life based on the type of product, market characteristics, and maturity of the market for that particular product. These costs are amortized on a straight-line basis. All of this amortization expense is included within components of operating income.
Income taxes - The Bank uses an asset and liability approach in financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future. The principal items relate primarily to differences between the allowance for loan losses, deferred loan fees, and accumulated depreciation and amortization. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense (benefit) is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. As of December 31, 2021, and December 31, 2020, there were no such liabilities recorded.
Interest and penalties associated with unrecognized tax benefits, if any, would be classified as additional income taxes in the statement of income.
Comprehensive income - Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although, certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.
Stock compensation plans - Stock compensation accounting guidance (FASB ASC 718, “Compensation - Stock Compensation”) requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the grant date fair value of the equity or liability instruments issued.
The stock compensation accounting guidance requires that compensation cost for all stock awards be calculated and recognized over the employees’ service period, generally defined as the vesting period. For awards with graded-vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. A Black-Sholes model is used to estimate the fair value of stock options, while the market price of the Bank’s common stock at the date of grant is used for restricted stock awards. No stock options were granted during 2021 and 2020.
Earnings per common share - Net income per common share has been determined under the provisions of FASB ASC 260, “Earnings Per Share” and has been computed based on the weighted average common shares outstanding during the year ended December 31, (7,559,310 for 2021 and 8,131,334 for 2020). Diluted earnings per share reflect additional potential common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance.
The only potential dilutive stock of the Bank as defined in FASB ASC 260 would be stock options granted to various directors, officers, and employees of the Bank. There were no such options outstanding at December 31, 2021 or December 31, 2020. Restricted stock is included in the computation of basic earnings per share as the holder is entitled to full benefits of a stockholder during the vesting period.
Off-balance sheet instruments - In the ordinary course of business, the Bank has entered into off-balance sheet financial instruments consisting of commitments to extend credit, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded, or related fees are incurred or received.
Advertising and marketing expense - Advertising and marketing costs are expensed as incurred.
Use of estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from the estimates.
The Company’s critical accounting policies relate to (1) the allowance for loan losses, (2) fair value of financial instruments, (3) derivative financial instruments, and (4) income taxes. These critical accounting policies require the use of estimates, assumptions and judgments which are based on information available as of the date of the financial statements. Accordingly, as this information changes, future financial statements could reflect the use of different estimates, assumptions and judgments. Certain determinations 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. In connection with the determination of the allowances for losses on loans, management obtains independent appraisals for significant properties.
Fair value of financial instruments - Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 20. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.
Derivative Financial Instruments - The Bank recognizes derivative financial instruments at fair value as either an other asset or other liability in the consolidated balance sheet. The Bank’s derivative financial instruments include interest rate swaps with certain qualifying commercial loan customers and dealer counterparties. Because the interest rate swaps with loan customers and dealer counterparties are not designated as hedging instruments, adjustments to reflect unrealized gains and losses resulting from changes in fair value of these instruments are reported as noninterest income or noninterest expense, as applicable. The Bank’s interest rate swaps with loan customers and dealer counterparties are described more fully in Note 19.
Transfers of financial assets - Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Bank - put presumptively beyond reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.
Risks and uncertainties - The outbreak of COVID-19 has adversely impacted a broad range of industries in which the Company’s customers operate and could impair their ability to fulfil their financial obligations to the Company. The World Health Organization has declared COVID-19 to be a global pandemic indicating that almost all public commerce and related business activities must be, to varying degrees, curtailed with the goal of decreasing the rate of new infections. The spread of the outbreak has caused disruptions in the U.S. economy and has disrupted banking and other financial activity in the areas in which the Company operates. While there has been no material impact to the Company’s employees to date, COVID-19 could also potentially create widespread business continuity issues for the Company. The Company’s business is dependent upon the willingness and ability of its employees and customers to conduct banking and other financial transactions. If the global response to contain COVID-19 escalates further or is unsuccessful, the Company could experience a material adverse effect on its business, financial condition, results of operations and cash flows. While it is not possible to know the full universe or extent that the impact of COVID-19, and resulting measures to curtail its spread, will have on the Company’s operations, the Company is disclosing potentially material items of which it is aware.
Revenue Recognition
Most revenue associated with the Company’s financial instruments, including interest income and gains/losses on investment securities, derivatives and sales of financial instruments are outside the scope of ASC Topic 606. The Company’s services that fall within the scope of ASC Topic 606 are presented within noninterest income and are recognized as revenue. A description of the primary revenue streams accounted for under ASC Topic 606 follows:
Service Charges on Deposit Accounts. The Company earns fees from its deposit customers for overdraft and account maintenance services. Overdraft fees are recognized when the overdraft occurs. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the company satisfies the performance obligation.
Other Service Charges and Fees. The Company earns fees from its customers for transaction-based services. Such services include safe deposit box, ATM, stop payment, wire transfer, mortgage origination and interest rate swap fees. In each case, these service charges and fees are recognized in income at the time or within the same period that the Company’s performance obligation is satisfied.
Interchange Income. The Company earns interchange fees from debit and credit cardholder transactions conducted through various payment networks. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services.
Impact of Recently Issued Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The FASB has issued multiple updates to ASU 2016-13 as codified in Topic 326, including ASU’s 2019-04, 2019-05, 2019-10, 2019-11, 2020-02, and 2020-03. These ASU’s have provided for various minor technical corrections and improvements to the codification as well as other transition matters. Smaller reporting companies who file with the U.S. Securities and Exchange Commission (SEC) and all other entities who do not file with the SEC are required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements. The Company has formed a Committee to oversee the accounting impact of this ASU. In anticipation of the ASU, the Company is running parallel calculations simultaneously and preliminary analysis indicates there will not be a significant adjustment upon implementation.
Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin (SAB) 119. SAB 119 updated portions of SEC interpretative guidance to align with FASB ASC 326, “Financial Instruments - Credit Losses.” It covers topics including (1) measuring current expected credit losses; (2) development, governance, and documentation of a systematic methodology; (3) documenting the results of a systematic methodology; and (4) validating a systematic methodology.
In March 2020, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. Subsequently, in January 2021, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2021-01 “Reference Rate Reform (Topic 848): Scope.” This ASU clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity may elect to apply ASU No. 2021-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications from any date within the interim period that includes or is subsequent to January 7, 2021, up to the date that financial statements are available to be issued. An entity may elect to apply ASU No. 2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includes March 12, 2020, and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020. The Company has inventoried its exposure to instruments that include a reference to LIBOR and have included amendments to transition to an appropriate comparable rate. The Company has also discontinued using LIBOR as a primary rate reference. The Company is assessing ASU 2020-04 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments.
In August 2021, the FASB issued ASU 2021-06, “'Presentation of Financial Statements (Topic 205), Financial Services-Depository and Lending (Topic 942), and Financial Services-Investment Companies (Topic 946): Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No. 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No. 33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants. This ASU incorporates recent SEC rule changes into the FASB Codification, including SEC Final Rule Releases No. 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No. 33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants”. The ASU is effective upon addition to the FASB Codification. The Company does not expect the adoption of ASU 2021-06 to have a material impact on its consolidated financial statements.
Recently Adopted Accounting Developments
In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740) - Simplifying the Accounting for Income Taxes.” The ASU is expected to reduce cost and complexity related to the accounting for income taxes by removing specific exceptions to general principles in Topic 740 (eliminating the need for an organization to analyze whether certain exceptions apply in a given period) and improving financial statement preparers’ application of certain income tax-related guidance. This ASU is part of the FASB’s simplification initiative to make narrow-scope simplifications and improvements to accounting standards through a series of short-term projects. ASU 2019-12 was effective for the Company on January 1, 2021. There was no material impact on the Company’s consolidated financial statements.
In January 2020, the FASB issued ASU 2020-01, “Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) - Clarifying the Interactions between Topic 321, Topic 323, and Topic 815.”
The ASU is based on a consensus of the Emerging Issues Task Force and is expected to increase comparability in accounting for these transactions. ASU 2016-01 made targeted improvements to accounting for financial instruments, including providing an entity the ability to measure certain equity securities without a readily determinable fair value at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Among other topics, the amendments clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting. ASU 2020-01 was effective for the Company on January 1, 2021. There was no material impact on the Company’s consolidated financial statements.
In October 2020, the FASB issued ASU 2020-08, “Codification Improvements to Subtopic 310-20, Receivables - Nonrefundable fees and Other Costs.” This ASU clarifies that an entity should re-evaluate whether a callable debt security is within the scope of ASC paragraph 310-20-35-33 for each reporting period. ASU 2020-08 was effective for the Company on January 1, 2021. There was no material impact on the Company’s consolidated financial statements.
In December 2020, the Consolidated Appropriations Act of 2021 (the “CAA”) was passed. Under Section 541 of the CAA, Congress extended or modified many of the relief programs first created by the CARES Act, including the PPP loan program and treatment of certain loan modifications related to the COVID-19 pandemic. There was no material impact on the Company’s consolidated financial statements.
Note 2. Restrictions on Cash
To comply with Federal Reserve regulations, the Bank is required to maintain certain average cash reserve balances. The daily average cash reserve requirements were $0 as of December 31, 2021 and December 31, 2020.
On March 15, 2020, the Federal Reserve reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirements for all depository institutions. Prior to the change, reserve requirement ratios on net transactions accounts differed based on the amount of net transactions accounts at the depository institution.
A certain amount of net transaction accounts, known as the "reserve requirement exemption amount," was subject to a reserve requirement ratio of zero percent. Net transaction account balances above the reserve requirement exemption amount and up to a specified amount, known as the "low reserve tranche," were subject to a reserve requirement ratio of 3 percent. Net transaction account balances above the low reserve tranche were subject to a reserve requirement ratio of 10 percent. The reserve requirement exemption amount and the low reserve tranche are indexed each year pursuant to formulas specified in the Federal Reserve Act
Note 3. Investment Securities
Investment securities available-for-sale was comprised of the following:
December 31, 2021
(Dollars in thousands)
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
U.S. Treasury Securities
$
20,000
$
-
$
-
$
20,000
Collateralized Mortgage Backed
31,521
(790
)
30,882
Subordinated Debt
8,720
(47
)
8,704
Municipal Securities
Taxable
10,704
(160
)
10,557
Tax-exempt
22,978
1,182
(17
)
24,143
U.S. Governmental Agencies
5,725
-
(98
)
5,627
Total
$
99,648
$
1,377
$
(1,112
)
$
99,913
Investment securities held-to-maturity was comprised of the following:
December 31, 2021
(Dollars in thousands)
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
Municipal Securities
Tax-exempt
$
17,849
$
$
-
$
18,644
Subordinated Debt
2,500
-
-
2,500
Total
$
20,349
$
$
-
$
21,144
Investment securities available-for-sale was comprised of the following:
December 31, 2020
(Dollars in thousands)
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
U.S. Treasury Securities
$
90,000
$
-
$
-
$
90,000
Collateralized Mortgage Backed
24,743
(129
)
24,896
Subordinated Debt
3,250
(1
)
3,278
Municipal Securities
Taxable
6,220
-
6,271
Tax-exempt
15,128
1,206
-
16,334
U.S. Governmental Agencies
6,785
-
(150
)
6,635
Total
$
146,126
$
1,568
$
(280
)
$
147,414
Investment securities held-to-maturity was comprised of the following:
December 31, 2020
(Dollars in thousands)
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
Municipal Securities
Tax-exempt
$
20,015
$
1,058
$
-
$
21,073
Subordinated Debt
2,505
-
-
2,505
Total
$
22,520
$
1,058
$
-
$
23,578
The scheduled maturities of securities available-for-sale and held-to-maturity at December 31, 2021 were as follows:
December 31, 2021
Available-for-Sale
Held-to-Maturity
(Dollars in thousands)
Amortized
Cost
Fair Value
Amortized
Cost
Fair Value
Due in one year or less
$
20,002
$
20,002
$
-
$
-
Due from one to five years
1,002
1,006
1,329
1,372
Due from after five to ten years
10,927
10,957
10,773
11,174
Due after ten years
67,717
67,948
8,247
8,598
Total
$
99,648
$
99,913
$
20,349
$
21,144
Securities with a fair value of $410,492 and $269,075 at December 31, 2021 and December 31, 2020, respectively, were pledged to secure FHLB advances.
There were no securities sold from the available-for-sale portfolio during the year ended December 31, 2021 and 2020.
The following tables summarize the fair value and unrealized losses at December 31, 2021 and December 31, 2020, aggregated by investment category and length of time that individual securities have been in a continuous loss position:
December 31, 2021
Less than 12 Months
12 Months or Longer
Total
(Dollars in thousands)
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Available-for-sale:
Collateralized Mortgage Backed
$
11,922
$
(215
)
$
12,043
$
(575
)
$
23,965
$
(790
)
Subordinated Debt
4,673
(47
)
-
-
4,673
(47
)
Municipal Securities
Taxable
5,484
(63
)
3,482
(97
)
8,966
(160
)
Tax-exempt
2,594
(17
)
-
-
2,594
(17
)
U.S Governmental Agencies
-
-
5,445
(98
)
5,445
(98
)
Total
$
24,673
$
(342
)
$
20,970
$
(770
)
$
45,643
$
(1,112
)
December 31, 2020
Less than 12 Months
12 Months or Longer
Total
(Dollars in thousands)
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Available-for-sale:
Collateralized Mortgage Backed
$
14,971
$
(129
)
$
-
$
-
$
14,971
$
(129
)
Subordinated Debt
(1
)
-
-
(1
)
U.S Government Agencies
-
-
6,785
(150
)
6,785
(150
)
Total
$
15,720
$
(130
)
$
6,785
$
(150
)
$
22,505
$
(280
)
The factors considered in evaluating securities for impairment include whether the Bank intends to sell the security, whether it is more likely than not that the Bank will be required to sell the security before recovery of its amortized cost basis, and whether the Bank expects to recover the security’s entire amortized cost basis. These unrealized losses are primarily attributable to current financial market conditions for these types of investments, particularly changes in interest rates, causing bond prices to decline, and are not attributable to credit deterioration.
At December 31, 2021, there were seven collateralized mortgage backed securities with fair values totaling $11.9 million, ten municipal securities with a fair value of $8.1 million and eleven subordinated debt securities with fair values of $4.7 million considered temporarily impaired and in an unrealized loss position of less than 12 months. At December 31, 2021, there were nine U.S. government agencies with fair values totaling approximately $5.4 million, one collateralized mortgage backed security with a fair value totaling $12.0 million and two municipal securities with a fair value of $3.5 million that were in an unrealized loss position of more than 12 months. The Bank does not consider any of the securities in the available for sale portfolio to be other-than-temporarily impaired at December 31, 2021 and December 31, 2020. There were no securities sold during 2021 or 2020.
All municipal securities originally purchased as available for sale were transferred to held to maturity during 2013. The unrealized loss on the securities transferred to held to maturity is being amortized over the expected life of the securities. The unamortized, unrealized loss, before tax, at December 31, 2021 and December 31, 2020 was $29,016 and $54,836, respectively.
Note 4. Loans Receivable
Loans receivable were comprised of the following:
(Dollars in thousands)
December 31,
December 31,
Residential Real Estate:
Single family
$
161,362
$
139,338
Multifamily
137,705
43,332
Farmland
1,323
Commercial Real Estate:
Owner-occupied
173,086
141,813
Non-owner occupied
361,101
325,085
Construction and Land Development
337,173
324,906
Commercial - Non Real-Estate:
Commercial & industrial
164,014
230,027
Consumer - Non Real Estate:
Unsecured
Secured
22,986
43,832
Total Gross Loans
1,358,935
1,249,435
Less: unearned fees
(5,478
)
(6,178
)
Less: unamortized discount on consumer secured loans
-
(1
)
Less: allowance for loan losses
(11,697
)
(12,877
)
Net Loans
$
1,341,760
$
1,230,379
The unsecured consumer loans above include $185,135 and $241,064 of overdrafts reclassified as loans for the years ended December 31, 2021 and December 31, 2020, respectively.
There were no loans held for sale at December 31, 2021. The Bank held $57.0 in commercial real estate loans for sale at December 31, 2020.
The following table presents nonaccrual loans by classes of the loan portfolio as of December 31, 2021 and December 31, 2020:
(Dollars in thousands)
December 31,
December 31,
Residential Real Estate:
Single Family
$
-
$
Total
$
-
$
The following tables present the segments of the loan portfolio summarized by aging categories as of December 31, 2021 and December 31, 2020:
December 31, 2021
(Dollars in thousands)
30-59
Days Past
Due
60-89
Days Past
Due
Greater
than 90
Days
Total
Past Due
Current
Total
Loans
Receivable
Nonaccrual
Residential Real Estate:
Single Family
$
-
$
-
$
-
$
-
$
161,362
$
161,362
$
-
Multifamily
-
-
-
-
137,705
137,705
-
Farmland
-
-
-
-
1,323
1,323
-
Commercial Real Estate:
Owner occupied
-
-
-
-
173,086
173,086
-
Non-owner occupied
-
-
-
-
361,101
361,101
-
Construction & Land Development
-
-
-
-
337,173
337,173
-
Commercial - Non Real Estate:
Commercial & industrial
-
-
-
-
164,014
164,014
-
Consumer - Non Real Estate:
Unsecured
-
-
-
-
-
Secured
-
22,915
22,986
-
Total
$
$
$
-
$
$
1,358,864
$
1,358,935
$
-
December 31, 2020
(Dollars in thousands)
30-59
Days Past
Due
60-89
Days Past
Due
Greater
than 90
Days
Total
Past Due
Current
Total
Loans
Receivable
Nonaccrual
Residential Real Estate:
Single Family
$
-
$
-
$
-
$
-
$
139,189
$
139,338
$
Multifamily
-
-
-
-
42,300
42,300
-
Farmland
-
-
-
-
-
Commercial Real Estate:
Owner occupied
-
-
-
-
141,813
141,813
-
Non-owner occupied
-
-
-
-
326,117
326,117
-
Construction & Land Development
-
-
-
-
324,906
324,906
-
Commercial - Non Real Estate:
Commercial & industrial
-
-
-
-
230,027
230,027
-
Consumer - Non Real Estate:
Unsecured
-
-
-
-
-
Secured
-
-
43,764
43,832
-
Total
$
$
-
$
-
$
$
1,249,218
$
1,249,435
$
No loans were modified under the terms of a TDR during the years ended December 31, 2021 and 2020, and there were no loans modified as TDR’s that subsequently defaulted during the years ended December 31, 2021 and 2020 that were modified as TDR’s within the twelve months prior to default.
Note 5. Allowance for Loan Losses
The following tables summarize the activity in the allowance for loan losses by loan class for the twelve months ended December 31, 2021 and 2020:
Allowance for Credit Losses By Portfolio Segment
For the twelve months ended December 31, 2021
Real Estate
Residential
Commercial
Construction
Consumer
Commercial
Total
Beginning Balance
$
1,223
$
6,552
$
3,326
$
$
1,405
$
12,877
Charge-offs
-
-
-
(32
)
-
(32
)
Recoveries
-
-
-
Provision
(863
)
(629
)
(256
)
(1,175
)
Ending Balance
$
1,672
$
5,689
$
2,697
$
$
1,540
$
11,697
Ending Balance:
Individually evaluated for Impairment
$
-
$
-
$
-
$
-
$
-
$
-
Collectively evaluated for Impairment
$
1,672
$
5,689
$
2,697
$
$
1,540
$
11,697
Allowance for Credit Losses By Portfolio Segment
For the twelve months ended December 31, 2020
Real Estate
Residential
Commercial
Construction
Consumer
Commercial
Total
Beginning Balance
$
1,030
$
4,254
$
2,180
$
$
1,552
$
9,584
Charge-offs
-
(1
)
-
(60
)
(1,792
)
(1,853
)
Recoveries
-
-
$
1,526
1,536
Provision
2,299
1,146
(145
)
3,610
Ending Balance
$
1,223
$
6,552
$
3,326
$
$
1,405
$
12,877
Ending Balance:
Individually evaluated for Impairment
$
-
$
-
$
-
$
-
$
-
$
-
Collectively evaluated for Impairment
$
1,223
$
6,552
$
3,326
$
$
1,405
$
12,877
The Company maintains a general allowance for loan losses based on evaluating known and inherent risks in the loan portfolio, including management’s continuing analysis of the factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, actual loan loss experience, and current and anticipated economic conditions. The reserve is an estimate based upon factors and trends identified by management at the time the financial statements are prepared.
The following tables summarize information in regards to the recorded investment in loans receivable by loan class as of December 31, 2021 and December 31, 2020:
December 31, 2021
Loans Receivable
(Dollars in thousands)
Ending
Balance
Ending
Balance:
Individually
Evaluated
for
Impairment
Ending
Balance:
Collectively
Evaluated
for
Impairment
Residential Real Estate
$
300,390
$
$
300,243
Commercial Real Estate
534,187
1,076
533,111
Construction and Land Development
337,173
-
337,173
Commercial & Industrial(1)
164,014
164,006
Consumer
23,171
-
23,171
Total
$
1,358,935
$
1,231
$
1,357,704
(1)
No allowance assigned to the $58.3 in PPP loans due to SBA guarantee
December 31, 2020
Loans Receivable
(Dollars in thousands)
Ending
Balance
Ending
Balance:
Individually
Evaluated
for
Impairment
Ending
Balance:
Collectively
Evaluated
for
Impairment
Residential Real Estate
$
182,499
$
$
182,198
Commercial Real Estate
467,930
1,088
466,842
Construction and Land Development
324,906
-
324,906
Commercial & Industrial(1)
230,027
229,969
Consumer
44,073
-
44,073
Total
$
1,249,435
$
1,447
$
1,247,988
(1)
No allowance assigned to the $135.2 in PPP loans due to SBA guarantee
The following table summarizes information in regard to impaired loans by loan portfolio class as of December 31, 2021 and December 31, 2020:
December 31, 2021
December 31, 2020
(Dollars in thousands)
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
With no related allowance recorded
Residential Real Estate:
Single family
$
$
$
-
$
$
$
-
Commercial Real Estate:
Non-owner occupied
1,076
1,076
-
1,088
1,088
-
Commercial & Industrial
-
-
Total
$
1,231
$
1,231
$
-
$
1,447
$
1,447
$
-
The following table presents additional information regarding the impaired loans for the years ended December 31, 2021 and 2020.
Years Ended
December 31, 2021
December 31, 2020
(Dollars in thousands)
Average
Record
Investment
Interest
Income
Recognized
Average
Record
Investment
Interest
Income
Recognized
With no related allowance recorded
Residential Real Estate:
Single family
$
$
$
$
Commercial Real Estate:
Non-owner occupied
1,080
1,097
Commercial & Industrial
Total
$
1,321
$
$
1,465
$
No additional funds are committed to be advanced in connection with impaired loans. There were no nonaccrual loans at December 31, 2021 and December 31, 2020 excluded from the impaired loan disclosure.
Credit quality risk ratings include regulatory classifications of Pass, Watch, Special Mention, Substandard, Doubtful and Loss. Loans classified as Pass have quality metrics to support that the loan will be repaid according to the terms established. Loans classified as Watch have similar characteristics as Pass loans with some emerging signs of financial weaknesses that should be monitored closer. Loans classified as Special Mention have potential weaknesses that deserve management’s close attention. If uncorrected, the potential weaknesses may result in deterioration of prospects for repayment. Loans classified substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are charged to the allowance for loan losses. Loans not classified are rated pass.
The following tables summarize the aggregate Pass and criticized categories of Watch, Special Mention, Substandard and Doubtful within the Company’s internal risk rating system as of December 31, 2021 and December 31, 2020:
December 31, 2021
(Dollars in thousands)
Pass
Watch
Special
Mention
Substandard
Doubtful
Total
Residential Real Estate:
Single Family
$
160,234
$
-
$
$
$
-
$
161,362
Multifamily
137,705
-
-
-
-
137,705
Farmland
1,323
-
-
-
-
1,323
Commercial Real Estate:
Owner occupied
168,352
4,734
-
-
-
173,086
Non-owner occupied
297,873
46,379
15,275
1,574
-
361,101
Construction & Land Development
317,846
19,327
-
-
-
337,173
Commercial - Non Real Estate:
Commercial & industrial
159,634
3,378
-
164,014
Consumer - Non Real Estate:
Unsecured
-
-
-
-
Secured
22,986
-
-
-
-
22,986
Total
$
1,266,138
$
70,585
$
16,866
$
5,346
$
-
$
1,358,935
December 31, 2020
(Dollars in thousands)
Pass
Watch
Special
Mention
Substandard
Doubtful
Total
Residential Real Estate:
Single Family
$
137,937
$
-
$
$
$
-
$
139,338
Multifamily
43,332
-
-
-
-
43,332
Farmland
-
-
-
-
Commercial Real Estate:
-
Owner occupied
136,257
5,556
-
-
-
141,813
Non-owner occupied
264,546
59,453
-
1,086
-
325,085
Construction & Land Development
322,149
2,757
-
-
-
324,906
Commercial - Non Real Estate:
-
Commercial & industrial
225,012
4,059
-
230,027
Consumer - Non Real Estate:
-
Unsecured
-
-
-
-
Secured
43,832
-
-
-
-
43,832
Total
$
1,174,167
$
71,825
$
1,329
$
2,114
$
-
$
1,249,435
Note 6. Related Party Transactions
The Bank grants loans and letters of credit to its executive officers, directors and their affiliated entities. Such loans are made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with unrelated persons, and, in the opinion of management, do not involve more than normal risk or present other unfavorable features.
The aggregate amount of such loans outstanding at December 31, 2021 was approximately $642,640 compared to $648,806 at December 31, 2020. During 2021, new loans and line of credit advances to such related parties was approximately $50,971 compared to $146,025 during 2020. Repayments on loans to directors and officers were $57,137 and $357,065 during 2021 and 2020, respectively. The Bank maintains deposit accounts with some of its executive officers, directors and their affiliated entities. Such deposit accounts at December 31, 2021 and December 31, 2020 amounted to approximately $2.3 million and $1.4 million, respectively.
Note 7. Premises and Equipment
Premises and equipment are summarized as follows at December 31:
(Dollars in thousands)
Cost
Building
$
12,765
$
12,765
Land
2,856
2,856
Leasehold improvements
1,083
Furniture, fixtures and equipment
3,680
2,741
Computer software and equipment
1,458
1,165
21,842
20,523
Less accumulated depreciation
(7,121
)
(6,261
)
Construction in progress
Premises and equipment, net
$
14,863
$
14,289
Depreciation and amortization charged to operations were $1.2 million and $1.1 million during the years ended December 31, 2021 and December 31, 2020, respectively.
Note 8. Intangible Assets
The carrying amount of computer software developed was $2.5 million and $0 at December 31, 2021 and December 31, 2020, respectively. The following table presents the changes in the carrying amount of computer software developed during the twelve months ended December 31, 2021.
Years Ended
December 31, 2021
December 31, 2020
(Dollars in thousands)
Gross Carrying Amount
Accumulated Amortization
Gross Carrying Amount
Accumulated Amortization
Amortizable intangible assets:
Computer software
$
2,493
$
-
$
-
$
-
Total
$
2,493
$
-
$
-
$
-
The Company is still in the development stage of the computer software where costs are capitalized. Capitalization ceases when the software is substantially complete and ready for its intended use. At that time the intangible asset will be amortized on a straight-line bases over the estimated useful life of the asset. As of December 31, 2021, the Company has not recorded any amortization on its intangible computer software.
Note 9. Deposits
Time deposits in denominations of $250,000 or more totaled approximately $289.7 million and $219.0 million at December 31, 2021 and 2020, respectively.
At December 31, 2021, maturities of time deposits are as follows:
(Dollars in thousands)
Year ended
December 31,
$
207,264
175,928
54,539
20,440
Thereafter
Total
$
459,148
Brokered deposits, as defined by the FDIC, totaled approximately $245.1 million and $279.5 million at December 31, 2021 and December 31, 2020, respectively.
Note 10. Borrowed Funds
The Bank also has a credit availability agreement with the FHLB based on a percentage of total assets. As of December 31, 2021, the credit availability with FHLB is approximately $414.0 million. This credit availability agreement provides the Bank with access to a myriad of advance products offered by the FHLB. The rate of interest charged is based on market conditions. At December 31, 2021, there were commercial real estate, residential 1-4 and multi-family loans totaling $762.3 million were used to collateralize FHLB advances. There was one security pledged as collateral to secure FHLB advances for the amount of $410,492 at December 31, 2021.
The Bank did not have any FHLB advances at December 31, 2021 or December 31, 2020.
The average balance on FHLB advances for the years ended December 31, 2021 and December 31, 2020 was approximately $0 and $6.2 million, respectively. The weighted average interest rate paid at December 31, 2021 and 2020 was 0% and 1.73%, respectively.
Note 11. Income Taxes
The Company files tax returns in the U.S. federal jurisdiction and required states. With few exceptions, the Bank is no longer subject to tax examination by tax authorities for years prior to 2017.
The Commonwealth of Virginia assesses a Bank Franchise Tax on banks instead of a state income tax. The Bank Franchise Tax expense is reported in non-interest expense and the tax’s calculation is unrelated to taxable income.
The provision for income taxes consists of the following components:
(Dollars in thousands)
Current expense
$
5,449
$
5,595
Deferred expense (benefit)
(1,752
)
Total
$
5,785
$
3,843
Income tax expense for the years ended December 31, 2021 and 2020 differed from the federal statutory rate applied to income before income taxes for the following reasons:
Year ended December 31,
(Dollars in thousands)
Computed “expected” income tax expense
$
5,871
$
4,108
Increase (decrease)in income taxes resulting from:
Non-deductible expense
Tax exempt Interest
(230
)
(259
)
BOLI Income
(189
)
(164
)
Low Income Housing Investment
-
State Income Taxes
Restricted Stock Adjustment
(95
)
Federal tax credits
(64
)
-
Other Adjustments
Total
$
5,785
$
3,843
The tax effects of temporary differences result in deferred tax assets and liabilities as presented below:
December 31,
(Dollars in thousands)
Deferred tax assets:
Allowance for loan losses
$
2,591
$
2,851
Restricted stock
OREO adjustment
Net loan fees
1,214
1,368
Organizational costs
Right-of-use liability
1,718
1,463
Accrued compensation
-
Unrealized losses on securities transferred to held to maturity
-
Gross deferred tax assets
6,113
6,108
Deferred tax liabilities:
Depreciation
Unrealized gain on securities available for sale
Prepaid expense
Right-of-use asset
1,585
1,371
Other
-
Gross deferred tax liabilities
2,067
1,943
Net deferred tax asset
$
4,046
$
4,165
Note 12. Earnings Per Common Share
Basic earnings per share excludes dilution and is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock which then shared in the earnings of the Bank. There were no such potentially dilutive securities outstanding in 2021 or 2020.
The weighted average number of shares used in the calculation of basic and diluted earnings per share includes unvested restricted shares of the Company’s common stock outstanding. Applicable guidance requires that outstanding unvested share-based payment awards that contain voting rights and rights to non-forfeitable dividends participate in undistributed earnings with common stockholders.
For the Year Ended December 31,
(Dollars in thousands)
Net income
$
22,171
$
15,717
Preferred stock dividends
(2,156
)
(635
)
Net income available to common shareholders
$
20,015
$
15,082
Weighted average number of shares issued,
basic and diluted
7,559,310
8,131,334
Net income per common share:
Basic and diluted income available to common shareholders
$
2.65
$
1.85
Note 13. Commitments and Contingencies
The Bank’s financial statements do not reflect various commitments and contingent liabilities which arise in the normal course of business and which involve elements of credit risk, interest risk and liquidity risk. These commitments and contingent liabilities are commitments to extend credit and standby letters of credit.
The amounts of loan commitments and standby letters of credit are set forth in the following table as of December 31, 2021 and 2020:
December 31,
(Dollars in thousands)
Loan commitments
$
304,335
$
219,414
Standby letters of credit
$
$
1,062
Commitments to extend credit and standby letters of credit all include exposure to some credit loss in the event of nonperformance of the customer. The Bank’s credit policies and procedures for credit commitments and financial guarantees are the same as those for extensions of credit that are recorded on the statements of financial condition. Because these instruments have fixed maturity dates, and because many of them expire without being drawn upon, they do not generally present any significant liquidity risk to the Bank. The Bank has not incurred any losses on commitments in 2021 or 2020.
During 2020, the Bank made a commitment of $5.0 million to the Housing Equity Fund of Virginia XXIV, L.L.C. This commitment will be funding through capital calls from the fund and we expect our investment to be fully funded by December 31, 2023.
During 2020, the Bank made a commitment of $2.0 million to the Washington Housing Initiative Impact Pool, L.L.C. This commitment will be funding through capital calls from the fund. As of December 31, 2021, approximately $656,000 have been deployed, with a remaining unfunded balance of approximately $1.3 million.
From time to time, we are a party to various litigation matters incidental to our ordinary conduct of our business. Management believes that none of these legal proceedings, individually or in the aggregate, will have a material adverse impact on the results of operations or financial condition of the Company.
Note 14. Leases
The right-of-use assets and lease liabilities are included in other assets and other liabilities, respectively, in the Consolidated Balance Sheets.
Lease liabilities represent the Company’s obligation to make lease payments and are presented at each reporting date as the net present value of the remaining contractual cash flows. Cash flows are discounted at the Company’s incremental borrowing rate in effect at the commencement date of the lease. The incremental borrowing rate was equal to the rate of borrowing from the FHLB that aligned with the term of the lease contract. Right-of-use assets represent the Company’s right to use the underlying asset for the lease term and are calculated as the sum of the lease liability and if applicable, prepaid rent, initial direct costs and any incentives received from the lessor.
The Company’s long-term lease agreements are classified as operating leases. Certain of these leases offer the option to extend the lease term and the Company has included such extensions in its calculation of the lease liabilities to the extent the options are reasonably assured of being exercised. The lease agreements do not provide for residual value guarantees and have no restrictions or covenants that would impact dividends or require incurring additional financial obligations.
Cash paid for amounts included in the measurement of lease liabilities during the twelve months ended December 31, 2021 was $590,000 and $399,000 for the same period in 2020. During twelve months ended December 31, 2021 and 2020, the Company recognized lease expense of $693,000 and $590,000, respectively.
As of December 31,
(Dollars in thousands)
Lease liabilities
$
7,753
$
6,607
Right-of-use assets
$
7,154
$
6,195
Weighted-average remaining lease term - operating leases
(in months).
173.2
187.5
Weighted-average discount rate - operating leases
2.81
%
3.12
%
For the year ended December 31,
(Dollars in thousands)
Lease Cost
Operating lease cost
$
$
Total lease costs
$
$
Cash paid for amounts included in measurement of lease
liabilities
$
$
The Company is the lessor for three operating leases. One lease is extended on a month-to-month basis while two of these leases have arrangements for over twelve months with an option to extend the lease terms. The lease agreements do not provide for residual value guarantees and have no restrictions or covenants that would impact dividends or require incurring additional financial obligations. Total rent income on these operating leases is approximately $6,000 per month.
As of December 31, 2021, all of the Company’s lease obligations are classified as operating leases. The Company does not have any finance lease obligations.
A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total of operating lease liabilities as of December 31, 2021 is as follows:
(Dollars in thousands)
$
Thereafter
6,268
Total undiscounted cash flows
9,527
Discount
(1,774
)
Lease liabilities
$
7,753
Note 15. Significant Concentrations of Credit Risk
Substantially all the Bank’s loans, commitments and standby letters of credit have been granted to customers located in the greater Washington, D.C. Metropolitan Area. The concentrations of credit by type of loan are set forth in Note 4.
The Bank maintains its cash and federal funds sold in correspondent bank deposit accounts. The amount on deposit at December 31, 2021 exceeded the insurance limits of the Federal Deposit Insurance Corporation by $51.2 million. The Bank has not experienced any losses in such accounts and believes it is not exposed to any significant credit risks.
Note 16. Regulatory Matters
Information presented for December 31, 2021 and December 31, 2020, reflects the Basel III capital requirements that became effective January 1, 2015 for the Bank. Under these capital requirements and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk- weightings and other factors.
The Basel III Capital Rules, a comprehensive capital framework for U.S. banking organizations, became effective for the Company and the Bank on January 1, 2015 (subject to a phase-in period for certain provisions). Under the Basel III rules, the Company must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The capital conservation buffer was phased in from 0.0% for 2015 to 2.50% by 2019. The capital conservation buffer for 2020 and 2021 is 2.50%. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios of Total capital, Common Equity Tier 1 capital, and Tier 1 capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2021, the Company and the Bank meets all capital adequacy requirements to which it is subject.
The Bank’s actual capital amounts and ratios are presented in the table (dollars in thousands):
Actual
Capital Adequacy
Purposes
To Be Well Capitalized
Under the Prompt
Corrective Action
Provision
(Dollars in thousands)
Amount
Ratio
Amount
Ratio
Amount
Ratio
As of December 31, 2021
Total capital (to risk-weighted assets)
$
227,359
16.06
%
$
113,249
≥ 8.0%
$
141,562
≥ 10.0%
Common equity tier 1 capital (to risk-weighted assets)
$
215,662
15.23
%
$
63,703
≥ 4.5%
$
113,249
≥ 8.0%
Tier 1 capital (to risk-weighted assets)
$
215,662
15.23
%
$
84,937
≥ 6.0%
$
113,249
≥ 8.0%
Tier 1 capital (to average assets)
$
215,662
12.90
%
$
66,898
≥ 4.0%
$
83,622
≥ 5.0%
As of December 31, 2020
Total capital (to risk-weighted assets)
$
189,534
14.60
%
$
103,872
≥ 8.0%
$
129,840
≥ 10.0%
Common equity tier 1 capital (to risk-weighted assets)
$
176,657
13.61
%
$
58,428
≥ 4.5%
$
103,872
≥ 8.0%
Tier 1 capital (to risk-weighted assets)
$
176,657
13.61
%
$
77,904
≥ 6.0%
$
103,872
≥ 8.0%
Tier 1 capital (to average assets)
$
176,657
10.78
%
$
65,557
≥ 4.0%
$
81,946
≥ 5.0%
Note. 17 Defined Contribution Benefit Plan
The Bank adopted a 401(k) defined contribution plan on October 1, 2004, which is administered by Principal Investments. Participants have the right to contribute up to a maximum of 15% of pretax annual compensation or the maximum allowed by the Internal Revenue Code, whichever is less. The Bank began making a matching contribution to the plan on January 1, 2010. The Bank matches dollar for dollar up to 3% of the employee’s contribution and then fifty cents on the dollar on the next two percentage points up to the employee contribution of 5%. The total amount the Bank matched during 2021 and 2020 was $492,578 and $478,960, respectively.
Note 18. Stock Based Compensation Plan
ASC Topic 718, Compensation - Stock Compensation, requires the Bank to recognize expense related to the fair value of share-based compensation awards in net income. Total compensation expense for restricted stock recorded for the years ended December 31, 2021 and December 31, 2020 were $1.9 million and $1.5 million, respectively.
On July 17, 2019, the Board of Directors of the Bank adopted, and the Bank’s shareholders subsequently approved, the MainStreet Bank 2019 Equity Incentive Plan (the “2019 Plan”), to provide officers, other selected employees and directors of the Bank with additional incentives to promote the growth and performance of the Bank. During the year ended December 31, 2021, there were 153,636 restricted shares awarded, 1,697 restricted shares were forfeited, and no stock options were awarded under the 2019 Plan. The restricted shares awarded during 2021 vest equally on an annual basis over a three, five, or ten year period. As a result of the stockholders’ approval of the 2019 Plan, no additional awards have been or will be made under the Bank’s 2016 Plan, although all awards that were outstanding under the 2016 Plan as of July 17, 2019 remained outstanding in accordance with their terms.
A summary of the status of the Bank’s nonvested restricted stock shares as of December 31, 2021 and changes during the year ended December 31, 2021 is presented below:
Nonvested Restricted Stock Shares
Shares
Weighted
Average Grant
Date Fair Value
Nonvested at January 1, 2021
161,435
$
18.36
Granted
153,636
19.38
Vested
(84,117
)
17.53
Forfeited
(1,697
)
20.04
Nonvested at December 31, 2021
229,257
$
19.33
As of December 31, 2021, there was $2.7 million of total unrecognized compensation cost related to nonvested restricted stock awards. The cost is expected to be recognized over approximately ten years. The total fair value of shares vested during the years ended December 31, 2021 and 2020 was $1.5 million and $1.2 million, respectively.
Note 19. Derivatives and Risk Management Activities
The Bank uses derivative financial instruments (or “derivatives”) primarily to assist customers with their risk management objectives. The Bank classifies these items as free standing derivatives consisting of customer accommodation interest rate loan swaps (or “interest rate loan swaps”). The Bank enters into interest rate swaps with certain qualifying commercial loan customers to meet their interest rate risk management needs. The Bank simultaneously enters into interest rate swaps with dealer counterparties, with identical notional amounts and terms. The net result of these interest rate swaps is that the customer pays a fixed rate of interest and the Bank receives a floating rate. These back-to-back interest rate loan swaps qualify as financial derivatives with fair values reported in “Other assets” and “Other liabilities” in the consolidated financial statements. Changes in fair value are recorded in other noninterest expense and net to zero because of the identical amounts and terms of the interest rate loan swaps.
The following tables summarize key elements of the Banks’s derivative instruments as of December 31, 2021 and December 31, 2020.
December 31, 2021
Customer-related interest rate
contracts
(Dollars in thousands)
Notional
Amount
Positions
Assets
Liabilities
Collateral
Pledges
Matched interest rate swap with borrower
$
210,793
$
2,097
-
$
15,120
Matched interest rate swap with counterparty
$
210,793
-
$
2,097
$
15,120
December 31, 2020
Customer-related interest rate
contracts
(Dollars in thousands)
Notional
Amount
Positions
Assets
Liabilities
Collateral
Pledges
Matched interest rate swap with borrower
$
210,314
$
12,152
-
$
15,120
Matched interest rate swap with counterparty
$
210,314
-
$
12,152
$
15,120
The Company is able to recognize fee income upon execution of the interest rate swap contract. Interest rate swap fee income for the twelve months ended December 31, 2021 and 2020 was $83,000 and $3.5 million, respectively.
Note 20. Fair Value Presentation
In accordance with FASB ASC 820, “Fair Value Measurements and Disclosure”, the Bank uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability (“an exit price”) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Bank’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
The fair value guidance provides a consistent definition of fair value, which focuses on exit price in the principal or most advantageous market for the asset or liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is the most representative of fair value under current market conditions.
In accordance with the guidance, a hierarchy of valuation techniques is based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Bank’s market assumptions. The three levels of the fair value hierarchy under FASB ASC 820 based on these two types of inputs are as follows:
Level 1 -Valuation is based on quoted prices in active markets for identical assets and liabilities that the reporting entity has the ability to access at the measurement date.
Level 2 -Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
Level 3 -Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.
The following describes the valuation techniques used by the Bank to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:
Securities available for sale
Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. As of December 31, 2021, and December 31, 2020, the Bank’s entire portfolio of available for sale securities are considered to be Level 2 securities.
Derivative asset (liability) - interest rate swaps on loans
As discussed in “Note 19: Derivatives and Risk Management Activities”, the Bank recognizes interest rate swaps at fair value on a recurring basis. The Bank has contracted with a third party vendor to provide valuations for these interest rate swaps using standard valuation techniques and therefore classifies such interest rate swaps as Level 2.
The following tables provide the fair value for assets required to be measured and reported at fair value on a recurring basis as of December 31, 2021 and December 31, 2020:
December 31, 2021
(Dollars in thousands)
Level 1
Level 2
Level 3
Total
Assets:
Investment securities available-for-sale:
U.S. Treasury Securities
$
-
$
20,000
$
-
$
20,000
Collateralized Mortgage Backed
-
30,882
-
30,882
Subordinated Debt
-
8,704
-
8,704
Municipal Securities
Taxable
-
10,557
-
10,557
Tax-exempt
-
24,143
-
24,143
U.S. Government Agencies
-
5,627
-
5,627
Derivative asset - interest rate swap on loans
-
2,097
-
2,097
Total
$
-
$
102,010
$
-
$
102,010
Liabilities:
Derivative liability - interest rate swap on loans
-
2,097
-
2,097
Total
$
-
$
2,097
$
-
$
2,097
December 31, 2020
(Dollars in thousands)
Level 1
Level 2
Level 3
Total
Assets:
Investment securities available-for-sale:
U.S. Treasury Securities
$
-
$
90,000
$
-
$
90,000
Collateralized Mortgage Backed
-
24,896
-
24,896
Subordinated Debt
-
3,278
-
3,278
Municipal Securities
Taxable
-
6,271
-
6,271
Tax-exempt
-
16,334
-
16,334
U.S. Government Agencies
-
6,635
-
6,635
Derivative asset - interest rate swap on loans
-
12,152
-
12,152
Total
$
-
$
159,566
$
-
$
159,566
Liabilities:
Derivative liability - interest rate swap on loans
-
12,152
-
12,152
Total
$
-
$
12,152
$
-
$
12,152
Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.
The following describes the valuation techniques used by the Bank to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:
Impaired loans
Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected when due. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Bank using observable market data (Level 2). However, if the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Bank because of marketability, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Statements of Income.
Other real estate owned
Other real estate owned (“OREO”) is measured at fair value less cost to sell, based on an appraisal conducted by an independent, licensed appraiser outside of the Bank. If the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Bank because of marketability, then the fair value is considered Level 3. OREO is measured at fair value on a nonrecurring basis. Any initial fair value adjustment is charged against the Allowance for Loan Losses. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense on the Statements of Income.
The following table summarizes the value of the Bank’s assets as of December 31, 2021 and December 31, 2020 that were measured at fair value on a nonrecurring basis during the period:
December 31, 2021
(Dollars in thousands)
Level 1
Level 2
Level 3
Total
Assets:
Other Real Estate Owned
$
-
$
-
$
$
Total
$
-
$
-
$
$
December 31, 2020
(Dollars in thousands)
Level 1
Level 2
Level 3
Total
Assets:
Other Real Estate Owned
$
-
$
-
$
1,180
$
1,180
Total
$
-
$
-
$
1,180
$
1,180
The following table presents quantitative information about Level 3 fair value measurements for financial assets measured at fair value on a nonreoccuring basis as of December 31, 2021
Fair Value Measurements at December 31, 2021
(Dollars in thousands)
Fair Value
Valuation Technique(s)
Unobservable Inputs
Range of
Inputs
Other Real Estate Owned, net
$
Appraisals
Discount to reflect current market
conditions and estimated selling costs
6% - 10%
Total
$
Fair Value of Financial Instruments
FASB ASC 825, Financial Instruments, requires disclosure about fair value of financial instruments, including those financial assets and financial liabilities that are not required to be measured and reported at fair value on a recurring or nonrecurring basis. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company. Additionally, in accordance with ASU 2016-01, which the Company adopted on January 1, 2018 on a prospective basis, the Company uses the exit price notion, rather than the entry price notion, in calculation the fair values of financial instruments not measured at fair value on a recurring basis.
The following tables reflect the carrying amounts and estimated fair values of the Company’s financial instruments whether or not recognized on the Consolidated Balance Sheets at fair value.
December 31, 2021
Carrying
Estimated
Quoted
Prices in
Active
Markets for
Identical
Assets
Significant
Other
Observable
Inputs
Significant
Unobservable
Inputs
(Dollars in thousands)
Amount
Fair Value
Level 1
Level 2
Level 3
Assets:
Cash and cash equivalents
$
93,199
$
93,199
$
93,199
$
-
$
-
Restricted equity securities
15,609
15,609
-
15,609
-
Securities:
Available for sale
99,913
99,913
-
99,913
-
Held to maturity
20,349
21,144
-
21,144
-
Loans, net
1,341,760
1,346,048
-
-
1,346,048
Derivative asset - interest rate swap on loans
2,097
2,097
-
2,097
-
Bank owned life insurance
36,241
36,241
-
36,241
-
Accrued interest receivable
6,735
6,735
-
6,735
-
Liabilities:
Deposits
$
1,411,963
$
1,415,551
$
-
$
952,815
$
462,736
Subordinated debt, net
29,294
29,570
-
29,570
-
Derivative liability - interest rate swaps on loans
2,097
2,097
-
2,097
-
Accrued interest payable
-
-
December 31, 2020
Carrying
Estimated
Quoted
Prices in
Active
Markets for
Identical
Assets
Significant
Other
Observable
Inputs
Significant
Unobservable
Inputs
(Dollars in thousands)
Amount
Fair Value
Level 1
Level 2
Level 3
Assets:
Cash and cash equivalents
$
107,528
$
107,528
$
107,528
$
-
$
-
Restricted equity securities
4,616
4,616
-
4,616
-
Securities:
Available for sale
147,414
147,414
-
147,414
-
Held to maturity
22,520
23,578
-
23,578
-
Loans, net
1,230,379
1,259,671
-
-
1,259,671
Loans held for sale
57,006
58,930
-
-
58,930
Derivative asset - interest rate swap on loans
12,152
12,152
-
12,152
-
Bank owned life insurance
25,341
25,341
-
25,341
-
Accrued interest receivable
9,154
9,154
-
9,154
-
Liabilities:
Deposits
$
1,438,246
$
1,451,708
$
-
$
941,503
$
510,205
Subordinated debt, net
14,834
14,834
-
14,834
-
Derivative liability - interest rate swaps on loans
12,152
12,152
-
12,152
-
Accrued interest payable
-
-
Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Bank’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Bank’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment, and therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on-balance sheet and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets that are not considered financial assets include deferred income taxes and bank premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.
The above information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. There were no changes in methodologies or transfers between levels at December 31, 2021 from December 31, 2020.
Note 21. Other Real Estate Owned
At December 31, 2021 and 2020, Other Real Estate Owned was $775,000 and $1.2 million, respectively. OREO is comprised of non-residential property associated with a commercial relationship and located in Virginia. Changes in the balance for OREO are as follows:
(Dollars in thousands)
Balance, beginning of year
$
1,180
$
1,207
Loss on valuation, net
(22
)
(432
)
Sale of other real estate owned
(383
)
-
Transfers between loans and other real estate owned
-
Gain on transfer of real estate
-
Balance, end of year
$
$
1,180
Expenses applicable to other real estate owned include the following:
(Dollars in thousands)
Net loss (gain) on transfer or sale of real estate
$
$
(43
)
Loss on valuation, net
Operating expenses, net of rental income
Balance, end of year
$
$
As of December 31, 2021, there were no real estate loans in the process of foreclosure.
Note 22. Accumulated Other Comprehensive Income
The following table presents the cumulative balances of the components of accumulated other comprehensive income net of deferred taxes, as of December 31, 2021 and December 31, 2020:
(Dollars in thousands)
Unrealized gain on securities
$
$
1,287
Unrealized loss on securities transferred to HTM
(29
)
(55
)
Securities gains included in net income
-
-
Tax effect
(39
)
(255
)
Total accumulated other comprehensive income
$
$
Note 23. Capital
On September 18, 2019, the Board of Directors of the Company authorized a common stock repurchase program to repurchase up to $10.0 million of the Company’s common stock at the discretion of management. The Company did not repurchase any of its shares during the year ended December 31, 2019.
On September 15, 2020, the Company issued 1,000,000 depositary shares, each representing a 1/40th interest in a share of the Company’s Fixed Rate Series A Noncumulative Perpetual Preferred Stock, par value $1.00 per share, with a liquidation preference of $1,000 per share (equivalent to $25 per depositary share). Dividends will accrue on the depositary shares at a fixed rate equal to 7.50% per annum. On September 25, 2020, the Company completed the sale of an additional 150,000 depositary shares, pursuant to the underwriters’ full exercise of their over-allotment option to purchase additional depositary shares.
On October 22, 2020, the Board of Directors of the Company authorized a common stock repurchase program to repurchase up to $17.0 million of the Company’s common stock at the discretion of management. The new common stock repurchase program replaced the Company’s previous repurchase plan which was authorized on September 18, 2019. The Company repurchased approximately $13.8 million of common stock during the year ended December 31, 2020.
The Company did not repurchase any common stock during the year ended December 31, 2021.
Note 24. Subordinated Notes
On December 30, 2016, the Company completed the issuance of $14.3 million in aggregate principal amount of fixed-to-floating rate subordinated notes in a private placement transaction to various accredited investors. During the first quarter 2017, an additional $700,000 of subordinated notes was issued for a total issuance of $15.0 million. The net proceeds of the offering supported growth and were used for other general business purposes. The notes had a maturity date of December 31, 2026 and an annual fixed interest rate of 6.25% until December 31, 2021. Thereafter, the notes were to have a floating interest rate based on three-month LIBOR rate plus 425 basis points (4.25%) (computed on the basis of a 360-day year of twelve 30-day months) from and including January 1, 2022 to the maturity date or any early redemption date. Interest was paid semi-annually, in arrears, on July 1 and January 1 of each year during the time that the notes remain outstanding.
On April 6, 2021, the Company completed the issuance of $30.0 million in aggregate principal amount of fixed-to-floating rate subordinated notes in a private placement transaction to various accredited investors. The net proceeds of the offering are intended to retire the subordinated debt issued in 2016, to support growth and be used for other general business purposes. The notes have a maturity date of April 15, 2031 and have an annual fixed interest rate of 3.75% until April 15, 2026. Thereafter, the notes will have a floating interest rate based on three-month SOFR rate plus 302 basis points (3.02%) (computed on the basis of a 360-day year of twelve 30-day months) from and including April 15, 2026 to the maturity date or any early redemption date. Interest will be paid semi-annually, in arrears, on April 15 and October 15 of each year during the time that the notes remain outstanding through the fixed interest rate period or earlier redemption date. Interest will be paid quarterly, in arrears, on April 15, July 15, October 15 and January 15 throughout the floating interest rate period or earlier redemption date.
On March 1, 2022, the Company completed the issuance of $43.8 million in aggregate principal amount of fixed-to-floating rate subordinated notes in a private placement transaction to various accredited investors. The net proceeds of the offering will be used to support growth and for other general business purposes. The notes have a maturity date of March 15, 2032 and have an annual fixed interest rate of 4.00% until March 15, 2027. Thereafter, the notes will have a floating interest rate based on three-month SOFR rate plus 233 basis points (2.33%) (computed on the basis of a 360-day year of twelve 30-day months) from and including March 15, 2027 to the maturity date or any early redemption date. Interest will be paid semi-annually, in arrears, on March 15 and September 15 of each year during the time that the notes remain outstanding through the fixed interest rate period or earlier redemption date. Interest will be paid quarterly, in arrears, on March 15, June 15, September 15 and December 15 throughout the floating interest rate period or earlier redemption date.
Note 25. Condensed Parent Company Financial Statements
Condensed financial statements pertaining only to the Company are presented below. The investment in subsidiary is accounted for using the equity method of accounting.
The payment of dividends by the subsidiary is restricted by various regulatory limitations. Banking regulations also prohibit extensions of credit to the parent company unless appropriately secured by assets.
Condensed Parent Company Only
Condensed Balance Sheet
(Dollars in thousands)
December 31,
ASSETS
Cash on deposit with subsidiary
$
$
3,754
Investment in subsidiary
215,858
177,634
Other assets
2,138
1,560
Total Assets
$
218,372
$
182,948
Liabilities:
Other liabilities
$
$
Subordinated debt, net of debt issuance costs
29,294
14,834
Stockholders’ equity
188,788
167,665
Total Liabilities and Stockholders’ Equity
$
218,372
$
182,948
Condensed Statement of Income
(Dollars in thousands)
For the Year Ended December 31,
Income
Dividends from subsidiary
$
2,156
$
Expenses
Subordinated debt interest expense
1,884
Non-interest expense
-
Total expenses
1,884
Undistributed earnings of subsidiary
21,504
15,848
Net income before income taxes
21,776
15,513
Income tax benefit
(395
)
(204
)
Net income
$
22,171
$
15,717
Less: preferred stock dividends
(2,156
)
(635
)
Net income available to common shareholders
$
20,015
$
15,082
Condensed Statement of Cash Flows
(Dollars in thousands)
Year Ended December 31,
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income
$
22,171
$
15,717
Adjustments to reconcile net income to net cash provided by
operating activities:
Equity in undistributed earnings of subsidiary
(21,504
)
(15,848
)
Stock based compensation
1,888
1,529
Subordinated debt amortization expense
Decrease (increase) in other assets
(578
)
Increase (decrease) in other liabilities
(159
)
Net cash provided by operating activities
2,041
2,088
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in bank subsidiary
(17,500
)
(12,500
)
Net cash used in investing activities
(17,500
)
(12,500
)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repurchase of common stock
-
(13,797
)
Issuance of preferred stock, net
-
27,263
Cash dividends paid on preferred stock
(2,156
)
(635
)
Net increase in subordinated debt
14,237
-
Net cash provided by financing activities
12,081
12,831
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS
(3,378
)
2,419
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR
3,754
1,335
CASH AND CASH EQUIVALENTS, END OF YEAR
$
$
3,754

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.

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ITEM 9A. CONTROLS AND PROCEDURES
Item 9A. Controls and Procedures
Disclosure Controls and Procedures. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of December 31, 2021. Based on their evaluation of the Company’s disclosure controls and procedures, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and regulations are designed and operating in an effective manner.
Management’s Report on Internal Control over Financial Reporting. Management of the Company is also responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management, including the Company’s principal executive and principal financial officer, assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2021. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework (2013). Based on our assessment, we believe that, as of December 31, 2021, the Company’s internal control over financial reporting was effective based on those criteria.
The Company’s annual report does not include an attestation report of the Company’s independent registered public accounting firm, Yount, Hyde, & Barbour. P.C. (YHB), regarding internal control over financial reporting. Management’s report was not subject to attestation by YHB pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in its annual report.
The 2021 consolidated financial statements have been audited by the independent registered public accounting firm of Yount, Hyde, & Barbour. P.C. Personnel from YHB were given unrestricted access to all financial records and related data, including minutes of all meetings of the Board of Directors and Committees thereof. Management believes that all representation made to the independent auditors were valid and appropriate. The resulting report from YHB accompanies the consolidated financial statements.
Changes in Internal Controls. There were no changes in the Company’s internal control over financial reporting during the Company’s fourth quarter ended December 31, 2021 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

---

ITEM 9B. OTHER INFORMATION
Item 9B. Other Information
None.

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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Item 10. Directors, Executive Officers and Corporate Governance
The information required by this Item with respect to our directors and certain corporate governance practices is contained in our Proxy Statement for our 2022 Annual Meeting of Shareholders (the “Proxy Statement”) to be filed with the SEC within 120 days after the end of the Company’s fiscal year ended December 31, 2021. Such information is incorporated herein by reference.

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ITEM 11. EXECUTIVE COMPENSATION
Item 11. Executive Compensation
The information required by this Item is incorporated herein by reference to our Proxy Statement to be filed with the SEC within 120 days after the end of the Company’s fiscal year ended December 31, 2021.

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item regarding security ownership of certain beneficial owners and management is incorporated by reference to our Proxy Statement to be filed with the SEC within 120 days after the end of the Company’s fiscal year ended December 31, 2021.

---

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item is incorporated herein by reference to our Proxy Statement to be filed with the SEC within 120 days after the end of the Company’s fiscal year ended December 31, 2021.

---

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Item 14. Principal Accountant Fees and Services
The information required by this Item is incorporated herein by reference to our Proxy Statement to be filed with the SEC within 120 days after the end of the Company’s fiscal year ended December 31, 2021.

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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Item 15. Exhibits and Financial Statement Schedules
Exhibit
Number
Description
2.1
Agreement and Plan of Reorganization (incorporated by reference to Exhibit 2.1 to the Company’s Form 10-12B filed on February 15, 2019)
3.1
Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K filed on November 19, 2020)
3.2
Bylaws (incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K filed on February 18, 2021)
4.1
Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the Company’s Form 10-12B filed on February 15, 2019)
4.2
Description of the Registrant’s Securities Registered pursuant to section 12 of the Securities Exchange Act of 1934 (incorporated by reference to Exhibit 4.3 to the Company’s Form 10-K filed on March 23, 2021)
4.3
Deposit Agreement, dated as of September 15,2020, by and among the Company, American Stock Transfer and Trust Company, LLC, and the holder from time to time of the Depositary Receipts decided therein (incorporated by reference to Exhibit 4.1 to the Company’s Form 8-K filed on September 15, 2020)
4.4
Form of Depositary Receipt representing the Depositary Shares (incorporated by reference to Exhibit 4.2 to the Company’s Form 8-K filed on September 15, 2020)
4.5
Form of Fixed-to-Floating Rate Subordinated Notes Due 2031 (incorporated by reference to Exhibit 4.1 to the Company’s Form 8-K filed on April 7, 2021)
4.6
Form of 4.00% Fixed-to-Floating Rate Subordinated Notes Due 2032 (incorporated by reference to Exhibit 4.1 to the Company’s Form 8-K filed on March 2, 2022)
10.1
2016 Equity Incentive Plan (incorporated by reference to Exhibit 10.1 to the Company’s Form 10-12B filed on February 15, 2019)
10.2
Form of Restricted Stock Award Agreement (incorporated by reference to Exhibit 10.2 to the Company’s Form 10-12B filed on February 15, 2019)
10.3
Employment Agreement with Jeff W. Dick (incorporated by reference to Exhibit 10.3 to the Company’s Form 10-12B filed on February 15, 2019)
10.4
Employment Agreement with Charles C. Brockett (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed on July 20, 2020)
10.5
Employment Agreement with Thomas J. Chmelik (incorporated by reference to Exhibit 10.5 to the Company’s Form 10-12B filed on February 15, 2019)
10.6
2019 Equity Incentive Plan (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed on July 19, 2019)
10.7
Subordinated Note Purchase Agreement Dated as of April 6, 2021 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed on April 7, 2021)
10.8
Form of Subordinated Note Purchase Agreement, dated March 1, 2022, between the Company and certain accredited investors and qualified institutional buyers (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed on March 2, 2022)
21.1
Subsidiaries of the Registrant
23.1
Consent of Yount, Hyde & Barbour, P.C.
31.1
Rule 13a-14(a) Certification of the Chief Executive Officer
31.2
Rule 13a-14(a) Certification of the Chief Financial Officer
32.0
Section 1350 Certification
101.INS
Inline XBRL Instance Document: The XBRL Instance Document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
101.SCH
Inline XBRL Taxonomy Extension Schema
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase
The following materials from the Company’s Annual Report on Form 10-K for the year ended December 31, 2021 formatted in Inline XBRL, filed herewith: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Stockholders’ Equity, (v) the Consolidated Statements of Cash Flows and (vi) the Notes to Consolidated Financial Statements
Cover Page Interactive Data File: The cover page XBRL tags are embedded within the Inline XBRL document and are contained within the Exhibit 101.