EDGAR 10-K Filing

Company CIK: 1675644
Filing Year: 2022
Filename: 1675644_10-K_2022_0001675644-22-000019.json

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ITEM 1. BUSINESS
Item 1. Business
Overview
FVCBankcorp, Inc. (the "Company") is a registered bank holding company headquartered in Fairfax, Virginia. We operate primarily through our sole subsidiary, FVCbank, (the "Bank"), a community oriented, locally-owned and managed commercial bank organized under the laws of the Commonwealth of Virginia. We serve the banking needs of commercial businesses, nonprofit organizations, professional service entities, and their respective owners and employees located in the greater Washington, D.C. and Baltimore metropolitan areas. The Company was established as the holding company for the Bank in 2015.
Since the Bank began operations in November 2007, it has grown largely organically, through de novo branch expansion, banker and customer acquisition, and two whole-bank acquisitions. In 2012, we completed the acquisition of 1st Commonwealth Bank of Virginia ("1st Commonwealth"), a $58.9 million asset savings and loan association in Arlington, Virginia.
On October 12, 2018, we completed our acquisition of Colombo Bank ("Colombo"), which was headquartered in Rockville, Maryland, and added five banking locations in Washington, D.C., and Montgomery County and the City of Baltimore in Maryland.
Our acquisition of Colombo supported our business allowing us to expand our presence in adjacent markets where we lend, but in which we had no physical presence. Colombo's branch locations strengthened our strategy as they enabled us to add lenders and banking services in areas where we lend. Our strong infrastructure and wide range of products and services allowed us to develop deeper relationships with Colombo's customers, as well as enhance our platform for generating new relationships.
On August 31, 2021, we announced that the Bank made an investment in Atlantic Coast Mortgage, LLC ("ACM") for $20.4 million to obtain a 28.7% ownership interest in ACM. This ownership interest is subject to an earnback option of up to 3.7% over the next three years. In addition, the Bank provides a warehouse lending facility to ACM, which includes a construction-to-permanent financing line, and has developed portfolio mortgage products to diversify our held to investment loan portfolio.
Market Area
We operate in one of the most economically dynamic and wealthy regions of the Washington and Baltimore Metropolitan Statistical Areas ("MSA"), focusing primarily on the Virginia counties of Arlington, Fairfax, Loudoun and Prince William and the independent cities located within those counties, as well as Washington, D.C. and its Maryland suburbs and Baltimore, Maryland and its surrounding suburbs. As of June 30, 2021, the Washington MSA had total deposits of $286.7 billion, excluding deposits maintained by a national brokerage firm, and the Baltimore MSA had total deposits of $104.1 billion, based on Federal Deposit Insurance Corporation ("FDIC") data.
Our market area's unemployment rate has generally remained below the national average for the last several years. While the region continues to experience the economic effects of the COVID-19 pandemic, the region's unemployment rate remained below the national average as the region has the benefit of a highly trained and educated workforce concentrated in government and professional service businesses. These factors, along with the ability of the regional infrastructure to support remote working, have provided a greater amount of resiliency during the pandemic on the overall employment metrics for our market.
In addition to the presence of the federal government, the Washington MSA is defined by attractive market demographics, including strong household incomes, dense populations and the presence of a diverse group of large and small businesses. According to the U.S. Census Bureau, the region is home to four of the top ten most highly educated counties in the nation and four to the top ten most affluent counties, as measured by household income. As of December 31, 2020, the Washington MSA had a median household income of $106,415, which ranks as sixth highest among all MSAs nationally, and a population of 6.3 million. The Virginia and Maryland localities within the Washington MSA in which we primarily operate have higher median household incomes than the Washington MSA as a whole and have an unemployment rate of 4.0% as of December 2021. The significant presence of national and international businesses make
the Washington MSA one of the most economically vibrant and diverse markets in the country. The Washington MSA is currently home to 15 Fortune 500 companies, including eight based in Fairfax County.
The Baltimore MSA also has strong economic factors which enhance our business profile. As of December 31, 2020, the Baltimore MSA had a median household income of $83,811 which represented 3.3% growth over the previous year. The Baltimore MSA has an unemployment rate of 5.0% as of December 2021. With a population of 2.8 million, the top industries of the Baltimore MSA include health care, education, and professional, scientific and technical services.
Our business, financial condition, and results of operations have been profoundly affected by the pandemic, which will potentially have adverse effects on our future performance. Both globally and within the United States, the pandemic has resulted in negative impacts and a disruption to economic and commercial activity and financial markets. The local economy in which we operate began to strengthen and improve during 2021. This economic improvement resulted in lower unemployment, increased consumer confidence, and increased housing development and housing prices. However, our business opportunities may be tempered by concerns such as employment opportunities, the effects of remote work environments, the effect of current and proposed government stimulus, wage growth, and the strength of the dollar. Volatility in global economic markets, continued domestic political turmoil and various episodes of geopolitical unrest continue to provide a degree of uncertainty in financial markets. Aside from these challenges, we continue to be encouraged by the resiliency of the current economic environment and the prospects for continued growth of the Company.
Growth Strategy
Our approach features competitive customized financial services offered to customers and prospects in a personal relationship context by seasoned professionals. We provide a full range of banking services that become integral to our customers' business operations, which helps to enhance our ability to retain our relationships. We offer a better value proposition to our customers by providing high-touch service with few added fees. Our capabilities and reputation enable us to be selective in loan and customer selection, which contributes to our strong asset quality, and our ability to provide multiple services to customers.
We intend to continue expanding our market position through organic growth, through expansion of our relationships with our existing customers, acquisition of new customers and acquisition of seasoned bankers with strong customer relationships, through selective branching, and potentially opportunistic acquisitions or other strategic transactions, while increasing profitability, maintaining strong asset quality and a high level of customer service.
Our success has been driven by our mission to help our clients, communities and employees prosper. We strive to exceed our clients' expectations by delivering superior, personalized client service supported with high quality bank products and services. We invest in the growth of our employees and we give back to the communities in which we do business to foster a brighter future for everyone who lives there. Much of our early growth was the result of the active promotion by our organizing shareholders, our board of directors, our advisory board and our shareholders as many of our shareholders are customers. We receive referrals from existing customers and all employees are encouraged to promote the Company. We believe having such a large group of individuals actively promote us has and will continue to augment our ability to generate both deposits and loans through staff and management led marketing and calling campaigns. As we have grown, we have increased our reliance on management originated customer relationships, but believe that our strong network of personal, customer and shareholder relationships and referrals will continue to be a significant factor in our business development strategy.
Our vision is to be known as the number one community bank in experience and service in our community. Our passion is to provide the utmost banking experience for each of our clients, to create a positive and empowering work environment for our employees, to fulfill our obligation of corporate citizenship in the communities in which we operate and to ensure that our Bank increases profitability and grows prudently, ensuring its strength and continuity, and increasing shareholder value.
Our Products and Services
We emphasize providing commercial banking services to small and medium-sized businesses, professionals, non-profit organizations and associations, and investors living and working in and near our service area. We offer retail banking services to accommodate the individual needs of both corporate customers as well as the communities we serve. We also offer online banking, mobile banking and a remote deposit service, which allows clients to facilitate and expedite deposit transactions through the use of electronic devices. A sophisticated suite of treasury management products is a key feature
of our client focused, relationship driven marketing. We have partnered with experienced service providers in both insurance and merchant services to further augment the products available to our customers.
Lending Products
We provide a variety of lending products to small and medium-sized businesses, including (i) commercial real estate loans; (ii) commercial construction loans; (ii) commercial loans for a variety of business purposes such as for working capital, equipment purchases, lines of credit, and government contract financing; (iii) Small Business Administration ("SBA") lending; (iv) asset based lending and accounts receivable financing; (v) home equity loans, or home equity lines of credit; and (vi) consumer loans for constructive purposes. Through our partnership with ACM, we purchase residential mortgage loans originated in our market area that meet our product criteria and pricing, to help with the diversification of our loan portfolio. Although we do not generally actively originate them, we have acquired pools of other types of loans, student loans and other consumer loans, in order to diversify the loan portfolio, put capital to work before organic loan production requires it, and to increase margin. We may also purchase participations from other banks in our market. Any acquired loans must meet our standard underwriting requirements.
During 2020 and 2021, we participated in the SBA's Paycheck Protection Program ("PPP"), which provided forgivable loans to small businesses to enable them to maintain payroll, rehire employees who had been laid off, and cover applicable overhead. These loans are fully guaranteed by the SBA and provide for the full forgiveness of the loans during a specified forgiveness period that meet specific guidelines provided by the SBA. Loans that do not meet forgiveness criteria will enter a repayment period of either 2 or 5 years. At December 31, 2021, PPP loans totaled $28.1 million, net of fees, or 1.9% of total loans.
Commercial Real Estate Loans. Commercial real estate loans, which comprise the largest portion of the loan portfolio, are secured by both owner occupied and investor owned commercial properties, including multi-family residential real estate. Commercial real estate loans are structured using both variable and fixed rates and renegotiable rates which adjust in three to five years, with maturities of generally five to ten years. At December 31, 2021, owner occupied commercial real estate loans represented 12.7% of the loan portfolio. At December 31, 2021, non-owner occupied commercial real estate loans represented approximately 39.8% of the loan portfolio and multi-family residential real estate comprised 7.5% of the portfolio. We seek to mitigate lending risks typical of this type of loan such as declines in real estate values, changes in borrower cash flow and general economic conditions. We typically require a maximum loan to value of 80% and minimum cash flow and debt service coverages, of at least 1.20 to 1.00. Personal guarantees are generally required, but may be limited. We generally require that interest rates adjust not less frequently than five years. For purposes of geographic diversification, we will also make commercial real estate loans outside of our primary and secondary markets, in an area extending south to Richmond, Virginia, and north of Baltimore, Maryland, and between Winchester, Virginia and the Eastern Shore of Maryland.
Construction Loans. Commercial construction loans for the acquisition, development and construction of commercial real estate also comprise a significant and growing portion of the portfolio. At December 31, 2021, such loans represented 12.7% of the loan portfolio. Our typical commercial construction loan involves property that will ultimately be leased to a non-owner occupant. We will finance construction projects of a speculative nature, which are well-conceived and structured with appropriate interest reserves and analyzed fully. In underwriting commercial construction loans, we consider the expected costs of the transaction, the loan to value ratio, the credit history, cash flows and liquidity of the borrower, the project and the guarantors, the debt service coverage ratios (which are stressed prior to approval), take out sources for the permanent loan or repayment of the construction loan, the reputation, experience and qualifications of the borrower, the general contractor and others involved with the project and other factors. Commercial construction loans are generally made on a variable rate basis, typically based on the Wall Street Journal Prime Rate and subject to rate floors, for terms of 12 - 24 months. Generally, we do not make commercial construction loans outside of our primary or secondary market areas.
Commercial Loans, Government Contracting. Commercial loans, excluding PPP loans, for a variety of business purposes, including working capital, equipment purchases, lines of credit, and government contract financing and asset based lending and accounts receivable financing, comprise approximately 11.5% of our loan portfolio at December 31, 2021. The warehouse facility provided to ACM is also included in this loan type. We make commercial loans on a secured or unsecured basis. We generally require the owners, managing members, general partners and principals of the borrowing entity or that control more than 20% of the borrower to guaranty the loan, unless a combination of low leverage, significant income and debt service coverage ratios, and substantial experience in operating the business, strong management and internal controls and/or other factors are demonstrated. Commercial loans are typically made with variable or adjustable
rates. The cash flow of the borrower/borrower's operating business is often the principal source of debt service, with a secondary emphasis on other collateral.
We have developed a special expertise in government contract financing. We lend to government contractors or subcontractors headquartered in the Washington, D.C. metropolitan area. This area of lending encompasses lines of credit for working capital, financing of government leases, mergers and acquisition financing, and, less frequently term loans, to operating companies that recognize over 50% of their total revenues from services provided to federal government agencies or rated state and municipal governments. Our borrowers are typically engaged in technology or service businesses, but may also include construction and equipment providers, or entities working on "classified" projects. A government contractor borrower must have an acceptable level of eligible accounts receivable, provide appropriate security instruments perfecting our rights in the accounts receivable or other collateral, and are subject to periodic review and monitoring of their receivables, contract backlog and contract compliance. The contractor is typically required to have its primary deposit relationship with us. Advance rates will be up to 90% of prime eligible government receivables, and lower percentages depending on the nature of the receivables. At December 31, 2021, outstanding loans to government contractors represented 33.1% of our commercial and industrial segment. Total commitments to government contractors totaled $238.1 million at December 31, 2021. Government contract loans are typically made with variable or adjustable rates. Lines of credit typically have a one year term. As with other commercial loans, guarantees are typically required.
Consumer Residential. We actively originate loans for residential 1-4 family trust investment purposes and HELOCs in the communities we serve in the Washington and Baltimore MSAs. In addition, we have portfolio mortgage products that we developed for use by ACM to help diversify our total loan portfolio. Our HELOCs generally have a maximum loan to value of up to 85%, however, due to the favorable economic conditions and strong residential real estate market in these markets, actual loan to values are typically lower than the maximum. We provide HELOCs as a service to our customers and when we receive referrals from various mortgage brokers within our market area. As of December 31, 2021, HELOCs comprise 2.9% of total loans. Loans originated for residential 1-4 family trust investment purposes comprise 4.9% of total loans as of December 31, 2021. While we do not typically originate residential first mortgages, we will occasionally originate a mortgage loan meeting our investment preferences presented by a mortgage broker. We have also purchased portfolios of 1-4 family residential first mortgage loans on properties located in our market area for yield and diversification. At December 31, 2021, 1-4 family residential mortgage loans represented 5.5% of the loan portfolio.
Other Loans. We occasionally originate consumer loans both on an unsecured basis and secured by non-real estate collateral. We have also purchased pools of unsecured consumer loans and student loans from a third party for yield and diversification.
The lending activities in which we engage carry the risk that the borrowers will be unable to perform on their obligations. As such, interest rate policies of the Board of Governors of the Federal Reserve System (the "Federal Reserve") and general economic conditions, nationally and in our market areas, could have a significant impact on our results of operations. To the extent that economic conditions deteriorate, including as a result of the COVID-19 pandemic and related disruptions, business and individual borrowers may be less able to meet their obligations to us in full, in a timely manner, resulting in decreased earnings or losses. Economic conditions may also adversely affect the value and liquidity of property pledged as security for loans.
Our goal is to mitigate risks in the event of unforeseen threats to the loan portfolio as a result of economic downturn or other negative influences. Plans for mitigating inherent risks in managing loan assets include: carefully enforcing loan policies and procedures, evaluating each borrower's business plan during the underwriting process and throughout the loan term, identifying and monitoring primary and alternative sources for loan repayment, and obtaining collateral to mitigate economic loss in the event of liquidation. Specific loan reserves are established based upon credit and/or collateral risks on an individual loan basis. A risk rating system is employed to proactively estimate loss exposure and provide a measuring system for setting general and specific reserve allocations.
Our lending activities are subject to a variety of lending limits imposed by state and federal law. These limits will increase or decrease in response to increases or decreases in our level of capital. At December 31, 2021, the Bank had a legal lending limit of $34.2 million. At December 31, 2021, our average funded loan size outstanding, excluding PPP loans, for commercial real estate (including commercial construction) and commercial loans was $2.0 million and $930 thousand, respectively. In accordance with internal lending policies, we may sell participations of loans to other banks, which allows us to manage risk involved in these loans and to meet the lending needs of our clients.
Concentrations of Credit Risk. Most of our lending is conducted with businesses and individuals in the suburbs of Washington, D.C. Our loan portfolio consists primarily of commercial real estate loans, including construction and land loans, which totaled $1.09 billion and constituted 72.5% of total loans as of December 31, 2021, and commercial loans, including loans to government contractors and the ACM warehouse lending facility, which totaled $202.8 million and constituted 13.5% of total loans as of December 31, 2021. The geographic concentration of our loans subjects our business to the general economic conditions within our market area. The risks created by such concentrations have been considered by management in the determination of the adequacy of the allowance for loan losses. Management believes the allowance for loan losses is adequate to cover probable incurred losses in our loan portfolio as of December 31, 2021.
Comprehensive risk management practices and appropriate capital levels are essential elements of a sound commercial real estate lending program. A concentration in commercial real estate adds a dimension of risk that compounds the risk inherent in individual loans. The federal banking agencies have issued guidance governing financial institutions with concentrations in commercial real estate lending. The guidance provides that institutions that have (i) total reported loans for construction, land development, and other land which represent 100% or more of an institution's total risk-based capital; or (ii) total reported commercial real estate loans, excluding loans secured by owner-occupied commercial real estate, representing 300% or more of the institution's total risk-based capital and the institution's commercial real estate loan portfolio has increased 50% or more during the prior 36 months, are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital. We have a concentration in commercial real estate loans, and we have experienced significant growth in our commercial real estate portfolio in recent years. As of December 31, 2021, commercial real estate loans as defined for regulatory purposes represented 396% of our total risk-based capital. Of those loans, commercial construction, development and land loans represented 84% of our total risk based capital. Owner-occupied commercial real estate loans represented an additional 81% of our total risk based capital. Management has extensive experience in commercial real estate lending, and has implemented and continues to maintain heightened portfolio monitoring and reporting, and strong underwriting criteria with respect to our commercial real estate portfolio.
Deposit Products
We offer a wide array of deposit products for individuals, professionals, government contractors and other businesses, including interest and noninterest-bearing transaction accounts, certificates of deposit and money market accounts. We are a relationship based bank, and maintenance of significant deposit relationships is a factor in our decision to make loans and the pricing of our products.
Our sophisticated treasury management and online banking platform allows a commercial customer to view balances, initiate payments, pay bills (including positive pay), issue stop payments, reconcile accounts and set up custom alerts. Online wires, ACH (including positive authorization), remote capture, cash disbursement and cash concentration are additional payment options available to businesses. We provide customers with a sophisticated escrow management product which facilitates and simplifies management of multiple escrow balances. We also provide secure credit card processing and merchant services, with reporting tailored to customer needs. We also offer online and mobile banking products to our consumer depositors, to complement our branch network.
Other Services
Through third party networks, we offer our customers access to a full range of business insurance products and business and consumer credit card products.
Competition
We are one of the few remaining locally owned and managed independent community banks headquartered in Northern Virginia. We believe that this is an advantageous position and valuable quality which positively differentiates us from our competitors and positions us for future growth from individuals and small and mid-sized business customers who value the attention and customized services which a locally owned and managed community bank can provide.
As of June 30, 2021, there were approximately $286.7 billion in total deposits shared between banking institutions located in Washington MSA, according to the FDIC. As of that date, our deposit market share was approximately 0.58%, excluding deposits maintained in the Washington MSA by a national brokerage firm. Our strategic goal is to increase our market share through selective new branch additions, opportunistic acquisitions, and acquisitions of customers from larger
competitors. PNC Bank, Capital One, Wells Fargo Bank, Truist Bank, and Bank of America Corporation hold the primary market shares. However, we believe these large banks generally cannot provide the same level of attention and customization of services to small businesses that we seek to provide. Through correspondents, referrals to third parties with whom we have partnered, and our own capabilities, we are a full service financial provider, able to compete in substantially all areas of banking, except trust services. Additionally, we believe we provide competitively priced products, superior customer service, flexibility and responsiveness when compared to our larger competitors.
The banking business is highly competitive. We compete as a financial intermediary with other commercial banks, savings banks, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds, financial technology companies and other financial institutions operating in the Washington and Baltimore MSAs and elsewhere.
Our market area is a highly competitive, highly branched, banking market. Competition in our market area for loans to small and middle-market businesses and professionals, our target market, is intense and pricing is important. Several of our competitors have substantially greater resources and lending limits than we have, and offer certain services, such as extensive and established branch networks and trust services that we do not currently provide or currently expect to provide in the near future. Moreover, larger institutions operating in the Washington, D.C. metropolitan market have access to borrowed funds at lower cost than may be available to us. Additionally, deposit competition among institutions in the market area is strong. As a result, it is possible that we may pay above market rates to attract deposits.
Risk Management
We believe that effective risk management is of primary importance. Risk management refers to the activities by which we identify, measure, monitor, evaluate and manage the risks we face in the course of our banking activities. These include liquidity, interest rate, credit, operational, compliance, regulatory, strategic, financial and reputational risk exposures. Our board of directors and management team have created a risk-conscious culture that is focused on quality growth, which starts with capable and experienced risk management teams and infrastructure capable of addressing the evolving risks we face, as well as the changing regulatory and compliance landscape. Our risk management approach employs comprehensive policies and processes to establish robust governance. We believe a disciplined and conservative underwriting approach has been the key to our strong asset quality.
Our board of directors sets the tone at the top of our organization, adopting and overseeing the implementation of our risk management, establishing our overall risk appetite and risk management strategy. The board of directors approves our various operating policies, which include risk policies, procedures, limits, targets and reporting structured to guide decisions regarding the appropriate balance between risk and return considerations in our business. Our board of directors receives periodic reporting on the risks and control environment effectiveness and monitors risk levels in relation to the approved risk appetite.
Credit risk is the risk that borrowers or counterparties will be unable or unwilling to repay their obligations in accordance with the underlying contractual terms and the risk that credit assets will suffer significant deterioration in market value. We manage and control credit risk in our loan portfolio by adhering to well-defined underwriting criteria and account administration standards established by management, and approved by the board of directors. Our written loan policies document underwriting standards, approval levels, exposure limits and other limits or standards deemed necessary and prudent. Portfolio diversification at the obligor, product and geographic levels is actively managed to mitigate concentration risk. In addition, credit risk management includes an independent credit review process that assesses compliance with policies, risk rating standards and other critical credit information. In addition to implementing risk management practices that are based upon established and sound lending practices, we adhere to sound credit principles. We evaluate our customers' borrowing needs and capacity to repay, in conjunction with their character and history. Our management and board of directors place significant focus on maintaining a healthy risk profile and ensuring sustainable growth. Our risk appetite seeks to balance the risks necessary to achieve our strategic goals while ensuring that our risks are appropriately managed and remain within our defined limits.
Our management of interest rate and liquidity risk is overseen by our Asset and Liability Committee, based on a risk management infrastructure approved by our board of directors that outlines reporting and measurement requirements. In particular, this infrastructure reviews financial performance, trends, and significant variances to budget; reviews and recommends for board approval risk limits and tolerances; reviews ongoing monitoring and reporting regarding our performance with respect to these areas of risk, including compliance with board-approved risk limits and stress-testing; ensures annual back-testing and independent validation of models at a frequency commensurate with risk level; reviews all
hedging strategies and recommends changes as appropriate; reviews and recommends our contingency funding plan; establishes wholesale borrowing limits to be submitted to the board of directors; and acts as a second line of defense in reviewing information and reports submitted to the committee for the purpose of identifying, investigating, and assuring remediation, to its satisfaction, of errors or irregularities, if any.
Investment Portfolio
Our investment securities portfolio is primarily maintained as an on-balance sheet contingent source of liquidity to fund loans and meet the demands of depositors. It provides additional interest income and we seek to have limited interest rate risk and credit risk. We currently classify substantially all of our investment securities as available-for-sale. Our investment policy authorizes investment primarily in securities of the U.S. government and its agencies; mortgage backed securities and collateralized mortgage obligations issued and fully backed by U.S. government agencies, securities of municipalities and to a lesser extent corporate bonds and other obligations, in each case meeting identified credit standards. The securities portfolio, along with certain loans, may also be used to collateralize public deposits, Federal Home Loan Bank of Atlanta ("FHLB") borrowings, and Federal Reserve Bank of Richmond ("FRB") borrowings. We manage our investment portfolio according to written investment policies approved by our board of directors. Our investment strategy aims to maximize earnings while maintaining liquidity in securities with minimal credit risk and interest rate risk which is reflective in the yields obtained on those securities.
Employees
As of December 31, 2021, we had 126 full-time employees and 7 part-time employees. None of our employees are covered by a collective bargaining agreement. We consider our relationship with our employees to be good and have not experienced interruptions of operations due to labor disagreements.
Additional Information
Our common stock is currently listed on the Nasdaq Capital Market under the symbol "FVCB." We maintain a website at www.fvcbank.com.
We make available free of charge through our website all of our U.S. Securities and Exchange Commission ("SEC") filings, including our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports, as soon as reasonably practicable after electronically filing or furnishing such material to the SEC at www.sec.gov. Information on our website does not constitute part of, and is not incorporated into, this report or any other filing we make with the SEC.
SUPERVISION AND REGULATION
Our business and operations are subject to extensive federal and state governmental regulation and supervision. The following is a brief summary of certain statutes and rules and regulations that affect or may affect us. This summary is not intended to be an exhaustive description of the statutes or regulations applicable to our business. Supervision, regulation, and examination of the Company by the regulatory agencies are intended primarily for the protection of depositors and the Deposit Insurance Fund, rather than our shareholders.
The Company. The Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended ("the Act"), and is subject to regulation and supervision by the Board of Governors of the Federal Reserve System (the "Federal Reserve"). The Act and other federal laws subject bank holding companies to restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and actions, including regulatory enforcement actions for violations of laws and regulations and unsafe and unsound banking practices. As a bank holding company, the Company is required to file with the Federal Reserve an annual report and such other additional information as the Federal Reserve may require pursuant to the Act. The Federal Reserve may also examine the Company and each of its subsidiaries. As a small bank holding company under the Federal Reserve's Small Bank Holding Company Policy Statement, the Company is not subject to risk-based capital requirements adopted by the Federal Reserve, which are substantially identical to those applicable to the Bank, and which are described below.
The Act requires approval of the Federal Reserve for, among other things, a bank holding company's direct or indirect acquisition of control of more than five percent (5%) of the voting shares, or substantially all the assets, of any bank or the merger or consolidation by a bank holding company with another bank holding company. The Act also generally permits
the acquisition by a bank holding company of control, or substantially all of the assets of, any bank located in a state other than the home state of the bank holding company, except where the bank has not been in existence for the minimum period of time required by state law; but if the bank is at least 5 years old, the Federal Reserve may approve the acquisition.
With certain limited exceptions, a bank holding company is prohibited from acquiring control of any voting shares of any company which is not a bank or bank holding company and from engaging directly or indirectly in any activity other than banking or managing or controlling banks or furnishing services to or performing service for its authorized subsidiaries. A bank holding company may, however, engage in, or acquire an interest in a company that engages in, activities which the Federal Reserve has determined by order or regulation to be so closely related to banking or managing or controlling banks as to be properly incident thereto. In making such a determination, the Federal Reserve is required to consider whether the performance of such activities can reasonably be expected to produce benefits to the public, such as convenience, increased competition or gains in efficiency, which outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. Some of the activities that the Federal Reserve has determined by regulation to be closely related to banking include making or servicing loans, performing certain data processing services, acting as a fiduciary or investment or financial advisor, and making investments in corporations or projects designed primarily to promote community welfare. The Federal Reserve may order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company's continued ownership, activity or control constitutes a serious risk to the financial safety, soundness, or stability of it or any of its bank subsidiaries.
The Gramm Leach-Bliley Act of 1999 ("GLB Act"), allows a bank holding company or other company to certify its status as a financial holding company, which would allow such company to engage in activities that are financial in nature, that are incidental to such activities, or are complementary to such activities. The GLB Act enumerates certain activities that are deemed financial in nature, such as underwriting insurance or acting as an insurance principal, agent or broker, underwriting, dealing in or making markets in securities, and engaging in merchant banking under certain restrictions. It also authorizes the Federal Reserve to determine by regulation what other activities are financial in nature, or incidental or complementary thereto. The Company has not elected financial holding company status.
The Act and the Federal Deposit Insurance Act ("FDIA"), require a bank holding company to serve as a source of financial and managerial strength to its bank subsidiaries. As a result of a bank holding company's source of strength obligation, a bank holding company may be required to provide funds to a bank subsidiary in the form of subordinated capital or other instruments which qualify as capital under bank regulatory rules. Any loans from the holding company to such subsidiary banks likely would be unsecured and subordinated to such bank's depositors and perhaps to other creditors of the Bank. In addition, where a bank holding company has more than one FDIC-insured bank or thrift subsidiary, each of the bank holding company's subsidiary FDIC-insured depository institutions is responsible for losses to the FDIC as a result of an affiliated depository institution's failure.
A bank holding company is generally required to give the Federal Reserve prior written notice of any purchase or redemption of its own then outstanding equity securities. The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, Federal Reserve order or directive, or any condition imposed by, or written agreement with, the Federal Reserve.
As a Virginia corporation, the Company is subject to additional limitations and restrictions. For example, state law restrictions include limitations and restrictions relating to indemnification of directors, distributions to shareholders, transactions involving directors, officers or interested shareholders, maintenance of books, records, minutes, borrowing and the observance of corporate formalities.
The Bank. The Bank is a Virginia chartered commercial bank and a member of the Federal Reserve System, whose accounts are insured by the Deposit Insurance Fund of the FDIC up to the maximum legal limits of the FDIC. The Bank is subject to regulation, supervision and regular examination by the Virginia Bureau of Financial Institutions (the "VBFI") and the Federal Reserve. The regulations of these various agencies govern most aspects of the Bank's business, including required reserves against deposits, loans, investments, mergers and acquisitions, borrowing, dividends and location and number of branch offices.
The laws and regulations governing the Bank generally have been promulgated to protect depositors and the Deposit Insurance Fund, and not for the purpose of protecting shareholders.
Commercial banks, savings and loan associations and credit unions are generally able to engage in interstate banking or acquisition activities. As a result, banks in the Washington, D.C. metropolitan area can, subject to limited restrictions, acquire or merge with a bank in another jurisdiction, and can branch de novo in any jurisdiction.
Banking is a business, which depends on interest rate differentials. In general, the difference between the interest paid by a bank on its deposits and its other borrowings and the interest received by a bank on loans extended to its customers and on securities held in its investment portfolio constitutes the major portion of the Bank's earnings. Thus, the earnings and growth of the Bank are subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve, which regulates the supply of money through various means including open market dealings in United States government securities. The nature and timing of changes in such policies and their impact on the Bank cannot be predicted.
Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the bank holding company or any of its subsidiaries, or investments in the stock or other securities thereof, and on the taking of such stock or securities as collateral for loans to any borrower. Further, a bank holding company and any subsidiary bank are prohibited from engaging in certain tying arrangements in connection with the extension of credit. A subsidiary bank may not extend credit, lease or sell property, or furnish any services, or fix or vary the consideration for any of the foregoing on the condition that: (i) the customer obtain or provide some additional credit, property or services from or to such bank other than a loan, discount, deposit or trust service; (ii) the customer obtain or provide some additional credit, property or service from or to the Company or any other subsidiary of the Company; or (iii) the customer not obtain some other credit, property or service from competitors, except for reasonable requirements to assure the soundness of credit extended.
Branching and Interstate Banking. The federal banking agencies are authorized to approve interstate bank merger transactions without regard to whether such transaction is prohibited by the law of any state, unless the home state of one of the banks has opted out of the interstate bank merger provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, or the Riegle-Neal Act, by adopting a law after the date of enactment of the Riegle-Neal Act and prior to June 1, 1997 which applies equally to all out-of-state banks and expressly prohibits merger transactions involving out-of-state banks. Interstate acquisitions of branches are permitted only if the law of the state in which the branch is located permits such acquisitions. Such interstate bank mergers and branch acquisitions are also subject to the nationwide and statewide insured deposit concentration limitations described in the Riegle-Neal Act. Washington, D.C., Maryland and Virginia have each enacted laws, that permit interstate acquisitions of banks and bank branches. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") authorizes national and state banks to establish de novo branches in other states to the same extent as a bank chartered by that state would be permitted to branch.
The GLB Act made substantial changes in the historic restrictions on non-bank activities of bank holding companies, and allows affiliations between types of companies that were previously prohibited. The GLB Act also allows banks to engage in a wider array of nonbanking activities through "financial subsidiaries."
Brokered Deposits. A "brokered deposit" is any deposit that is obtained from or through the mediation or assistance of a deposit broker. Deposit brokers may attract deposits from individuals and companies throughout the United States and internationally whose deposit decisions are based primarily on obtaining the highest interest rates. Certain reciprocal deposits of up to the lesser of $5 billion or 20% of an institution's deposits are excluded from the definition of brokered deposits, where the institution is "well-capitalized" and has a composite rating of 1 or 2. We have used brokered deposits in the past, and we intend to continue to use brokered deposits as one of our funding sources to support future growth. There are risks associated with using brokered deposits. In order to continue to maintain our level of brokered deposits, we may be forced to pay higher interest rates than those contemplated by our asset-liability pricing strategy. In addition, banks that become less than "well-capitalized" under applicable regulatory capital requirements may be restricted in their ability to accept or renew, or prohibited from accepting or renewing, brokered deposits. If this funding source becomes more difficult to access, we will have to seek alternative funding sources in order to continue to fund our growth. This may include increasing our reliance on FHLB borrowings, attempting to attract additional non-brokered deposits, and selling loans. There can be no assurance that brokered deposits will be available, or if available, sufficient to support our continued growth. The unavailability of a sufficient volume of brokered deposits could have a material adverse effect on our business, financial condition and results of operations. The FDIC has proposed to adopt regulations that are intended to expand the ability of institutions to accept brokered deposits by, among other things, simplifying the process by which institutions and deposit brokers may obtain exemptions from the restriction or conditions on the acceptance of brokered deposits.
Anti-Money Laundering Laws and Regulations. The Company is subject to several federal laws that are designed to combat money laundering, terrorist financing, and transactions with persons, companies or foreign governments designated by U.S. authorities ("AML laws"). This category of laws includes the Bank Secrecy Act of 1970, the Money Laundering Control Act of 1986, the USA PATRIOT Act of 2001, and the Anti-Money Laundering Act of 2020.
The AML laws and their implementing regulations require insured depository institutions, broker-dealers, and certain other financial institutions to have policies, procedures, and controls to detect, prevent, and report money laundering and terrorist financing. The AML laws and their regulations also provide for information sharing, subject to conditions, between federal law enforcement agencies and financial institutions, as well as among financial institutions, for counter-terrorism purposes. Federal banking regulators are required, when reviewing bank holding company acquisition and bank merger applications, to take into account the effectiveness of the anti-money laundering activities of the applicants. To comply with these obligations, the Company has implemented appropriate internal practices, procedures, and controls.
Office of Foreign Assets Control. The United States has imposed economic sanctions that affect transactions with designated foreign countries, foreign nationals and others, which are administered by the U.S. Treasury Department's Office of Foreign Assets Control ("OFAC"). The OFAC-administered sanctions targeting countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on a "U.S. person" engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of a sanctioned country have an interest by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g. property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences.
Capital Adequacy. The Federal Reserve and the FDIC have adopted risk-based and leverage capital adequacy requirements, pursuant to which they assess the adequacy of capital in examining and supervising banks and bank holding companies and in analyzing bank regulatory applications. Risk-based capital requirements determine the adequacy of capital based on the risk inherent in various classes of assets and off-balance sheet items. The Dodd-Frank Act additionally requires capital requirements to be countercyclical so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, consistent with safety and soundness.
The federal banking agencies have adopted rules to implement the framework for strengthening international capital and liquidity regulation adopted by the Basel Committee on Banking Supervision ("Basel III"). The Basel III framework, among other things, (i) introduced the concept of common equity tier one capital ("CET1"), (ii) required that most adjustments to regulatory capital measures be made to CET1 and not to the other components of capital, (iii) expanded the scope of the adjustments to capital that may be made as compared to existing regulations, and (iv) specified that Tier 1 capital consists of CET1 and "Additional Tier 1 capital" instruments meeting specified requirements.
The Basel III rules require institutions to maintain: (i) a minimum ratio of CET1 to risk-weighted assets of 4.5%, plus a "capital conservation buffer" of 2.5%, or 7.0%; (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of 6.0%, plus the capital conservation buffer, or 8.5%; (iii) a minimum ratio of Total (Tier 1 plus Tier 2) capital to risk-weighted assets of 8.0%, plus the capital conservation buffer, or 10.5%; and (iv) a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (computed as the average of the month-end ratios each month during a calendar quarter).
Basel III also provides for a "countercyclical capital buffer," generally to be imposed when federal banking agencies determine that excess aggregate credit growth becomes associated with a buildup of systemic risk. This buffer would be a CET1 add-on to the capital conservation buffer of 2.5%. The current policy of the Federal Reserve is to maintain the countercyclical capital buffer at 0% in a normal risk environment.
Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the minimum plus the capital conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) may face constraints on their ability to pay dividends, effect equity repurchases, and pay discretionary bonuses to executive officers, which constraints vary based on the amount of the shortfall.
The Economic Growth, Regulatory Relief and Consumer Protection Act ("EGRRCPA") also directed the federal banking agencies to develop a "Community Bank Leverage Ratio" ("CBLR"), calculated by dividing tangible equity capital
by average consolidated total assets. In October 2019, the federal banking agencies adopted a CBLR of 9%. If a "qualified community bank," generally a depository institution or depository institution holding company with consolidated assets of less than $10 billion, has a leverage ratio which exceeds the CBLR, then such institution is considered to have met all generally applicable leverage and risk based capital requirements, the capital ratio requirements for "well capitalized" status under Section 38 of the FDIA, and any other leverage or capital requirements to which it is subject. An institution or holding company may be excluded from qualifying community bank status based on its risk profile, including consideration of its off-balance sheet exposures; trading assets and liabilities; total notional derivatives exposures; and such other facts as the appropriate federal banking agencies determine to be appropriate. These CBLR rules were modified in response to the COVID-19 pandemic. See "Coronavirus Aid, Relief, and Economic Security Act and Consolidated Appropriations Act, 2021" below. We adopted this simplified capital regime on January 1, 2020, but there can be no assurance that satisfaction of the CBLR will provide adequate capital for our operations and growth, or an adequate cushion against increased levels of nonperforming assets or weakened economic conditions.
As discussed below, the Basel III rules also integrate the new capital requirements into the prompt corrective action provisions under Section 38 of the FDIA.
The capital ratios described above are the minimum levels that the federal banking agencies expect. Our state and federal regulators have the discretion to require us to maintain higher capital levels based upon our concentrations of loans, the risk of our lending or other activities, the performance of our loan and investment portfolios and other factors. Failure to maintain such higher capital expectations could result in a lower composite regulatory rating, which would impact our deposit insurance premiums and could affect our ability to borrow and costs of borrowing, and could result in additional or more severe enforcement actions. In respect of institutions with high concentrations of loans in areas deemed to be higher risk, or during periods of significant economic stress, regulators may require an institution to maintain a higher level of capital, and/or to maintain more stringent risk management measures, than those required by these regulations.
In December 2017, the Basel Committee on Banking Supervision published the last version of the Basel III accord, generally referred to as "Basel IV." The Basel Committee stated that a key objective of the revisions incorporated into the framework is to reduce excessive variability of risk-weighted assets, which will be accomplished by enhancing the robustness and risk sensitivity of the standardized approaches for credit risk and operational risk, which will facilitate the comparability of banks' capital ratios; constraining the use of internally modeled approaches; and complementing the risk-weighted capital ratio with a finalized leverage ratio and a revised and robust capital floor. Leadership of the federal banking agencies who are tasked with implementing Basel IV supported the revisions. Although it is uncertain at this time, it is anticipated that some, if not all, of the Basel IV accord may be incorporated into the capital requirements framework applicable to the Bank.
In 2016, FASB issued the current expected credit losses ("CECL") model, which will become applicable to us on January 1, 2023. CECL requires financial institutions to estimate and establish a provision for credit losses over the lifetime of the asset, at the origination or the date of acquisition of the asset, as opposed to reserving for incurred or probable losses through the balance sheet date. Upon implementation, an institution would recognize a one-time cumulative effect adjustment to the allowance for credit losses. The Federal Reserve and FDIC have adopted a rule providing for an optional three-year phase-in period for the day-one adverse regulatory capital effects upon adopting the standard.
Prompt Corrective Action. Under Section 38 of the FDIA, each federal banking agency is required to implement a system of prompt corrective action for institutions that it regulates. The federal banking agencies have promulgated substantially similar regulations for this purpose. The following capital requirements currently apply to the Bank for purposes of Section 38.
Capital Category Total
Risk-Based
Capital Ratio Tier 1
Risk-Based
Capital Ratio Common
Equity Tier 1
Capital Ratio Leverage
Ratio Tangible
Equity to
Assets Supplemental
Leverage
Ratio
Well Capitalized 10% or greater 8% or greater 6.5% or greater 5% or greater n/a n/a
Adequately Capitalized 8% or greater 6% or greater 4.5% or greater 4% or greater n/a 3% or greater
Undercapitalized Less than 8% Less than 6% Less than 4.5% Less than 4% n/a Less than 3%
Significantly Undercapitalized Less than 6% Less than 4% Less than3% Less than 3% n/a n/a
Critically Undercapitalized n/a n/a n/a n/a Less than 2% n/a
An institution generally must file a written capital restoration plan which meets specified requirements with the appropriate federal banking agency within 45 days of the date the institution receives notice or is deemed to have notice
that it is undercapitalized, significantly undercapitalized or critically undercapitalized. The appropriate federal banking agency must provide the institution with written notice of approval or disapproval within 60 days after receiving a capital restoration plan, subject to extensions by the applicable agency.
Immediately upon becoming undercapitalized, an institution shall become subject to the provisions of Section 38 of the FDIA, which (i) restrict payment of capital distributions and management fees; (ii) require that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital; (iii) require submission of a capital restoration plan; (iv) restrict the growth of the institution's assets; and (v) require prior approval of certain expansion proposals. The appropriate federal banking agency for an undercapitalized institution also may take any number of discretionary supervisory actions if the agency determines that any of these actions is necessary to resolve the problems of the institution at the least possible long-term cost to the Deposit Insurance Fund, subject in certain cases to specified procedures. These discretionary supervisory actions include: requiring the institution to raise additional capital; restricting transactions with affiliates; requiring divestiture of the institution or the sale of the institution to a willing purchaser; and any other supervisory action that the agency deems appropriate. These and additional mandatory and permissive supervisory actions may be taken with respect to significantly undercapitalized and critically undercapitalized institutions.
Regulatory Enforcement Authority. Federal banking law grants substantial enforcement powers to the federal banking agencies. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions against banking organizations and institution-affiliated parties. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities.
The Dodd-Frank Act. The Dodd-Frank Act was signed into law on July 21, 2010. The Dodd-Frank Act significantly restructured the financial regulatory regime in the United States and has had a broad impact on the financial services industry as a result of the significant regulatory and compliance changes required under the act.
The EGRRCPA, which became effective May 24, 2018, amended the Dodd-Frank Act to provide regulatory relief for certain smaller and regional financial institutions, such as the Company and the Bank. The EGRRCPA, among other things, provides financial institutions with less than $10 billion in total consolidated assets with relief from certain capital requirements and exempts banks with less than $250 billion in total consolidated assets from the enhanced prudential standards and the company-run and supervisory stress tests required under the Dodd-Frank Act.
The Dodd-Frank Act has had, and may in the future have, a material impact on the Company’s operations, particularly through increased compliance costs resulting from new and possible future consumer and fair lending regulations. The future changes resulting from the Dodd-Frank Act may affect the profitability of business activities, require changes to certain business practices, impose more stringent regulatory requirements, or otherwise adversely affect the business and financial condition of the Company and the Bank. These changes may also require the Company to invest significant management attention and resources to evaluate and make necessary changes to comply with new statutory and regulatory requirements.
Consumer Financial Protection Bureau ("CFPB"). The Dodd-Frank Act created the CFPB, a new, independent federal agency with broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Practices Act, the consumer financial privacy provisions of the GLB Act and certain other statutes. The CFPB has examination and primary enforcement authority with respect to depository institutions with over $10 billion in assets. Smaller institutions, including the Bank, are subject to rules promulgated by the CFPB but continue to be examined and supervised by federal banking agencies for compliance with federal consumer protection laws and regulations. The CFPB also has authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.
The changes resulting from the Dodd-Frank Act and CFPB rulemakings and enforcement policies may impact the profitability of our business activities, limit our ability to make, or the desirability of making, certain types of loans, including non-qualified mortgage loans, require us to change our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect our business or profitability. The changes may also require us to dedicate significant management attention and resources to evaluate and make necessary changes to comply with the new statutory and regulatory requirements.
Mortgage Banking Regulation. The Bank is subject to rules and regulations related to mortgage loans that, among other things, establish standards for loan origination, prohibit discrimination, provide for inspections and appraisals of property, require credit reports on prospective borrowers, in some cases restrict certain loan features and fix maximum interest rates and fees, require the disclosure of certain basic information to mortgagors concerning credit and settlement costs, limit payment for settlement services to the reasonable value of the services rendered and require the maintenance and disclosure of information regarding the disposition of mortgage applications based on race, gender, geographical distribution and income level. The Bank is also subject to rules and regulations that require the collection and reporting of significant amounts of information with respect to mortgage loans and borrowers. The Bank’s mortgage origination activities are subject to the Federal Reserve’s Regulation Z, which implements the Truth in Lending Act. Certain provisions of Regulation Z require creditors to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms. To the extent that we make mortgage loans, we are required to comply with these rules, subject to available exceptions.
Fair and Responsible Banking. Banks and other financial institutions are subject to numerous laws and regulations intended to promote fair and responsible banking and prohibit unlawful discrimination and unfair, deceptive or abusive practices in banking. These laws include, among others, the Dodd-Frank Act, Section 5 of the Federal Trade Commission Act, the Equal Credit Opportunity Act, and the Fair Housing Act. Many states and local jurisdictions have consumer protection laws analogous, and in addition, to those listed above. These federal, state and local laws regulate the manner in which financial institutions deal with customers taking deposits, making loans or conducting other types of transactions. Failure to comply with these laws and regulations could give rise to regulatory sanctions, and actions by the U.S. Department of Justice and state attorneys general.
Financial Privacy. Under the Federal Right to Privacy Act of 1978, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records, financial institutions are required to disclose their policies for collecting and protecting confidential information. Consumers generally may prevent financial institutions from sharing personal financial information with nonaffiliated third parties except for third parties that market the institutions' own products and services. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing through electronic mail to consumers.
Community Reinvestment Act ("CRA"). The CRA requires that, in connection with examinations of insured depository institutions within their respective jurisdictions, the federal banking agencies evaluate the record of each financial institution in meeting the needs of its local community, including low- and moderate-income neighborhoods. The Bank's record of performance under the CRA is publicly available. A bank's CRA performance is also considered in evaluating applications seeking approval for mergers, acquisitions, and new offices or facilities. Failure to adequately meet these criteria could result in additional requirements and limitations being imposed on the Bank. Additionally, we must publicly disclose the terms of certain CRA-related agreements.
Concentration and Risk Guidance. The federal bank regulatory agencies have issued guidance governing financial institutions with concentrations in commercial real estate lending. The guidance provides that institutions that have (i) total reported loans for construction, land development, and other land which represent 100% or more of an institution's total risk-based capital; or (ii) total reported commercial real estate loans, excluding loans secured by owner-occupied commercial real estate, representing 300% or more of the institution's total risk-based capital and the institution's commercial real estate loan portfolio has increased 50% or more during the prior 36 months, are identified as having potential commercial real estate concentration risk. Institutions, which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital. We have determined that we have a concentration in commercial real estate lending, and while we believe we have implemented policies and procedures with respect to our commercial real estate lending consistent with the regulatory guidance, bank regulators could require us to implement additional policies and procedures consistent with their interpretation of the guidance that may result in additional costs to us.
FDIC Insurance Premiums. The deposits of the Bank are insured up to applicable limits by the FDIC’s Deposit Insurance Fund and are subject to deposit insurance assessments to maintain the Deposit Insurance Fund. The deposit insurance assessment base is based on average total assets minus average tangible equity, pursuant to a rule issued by the FDIC as required by the Dodd-Frank Act. Deposit insurance pricing is a “financial ratios method” based on “CAMELS” composite ratings to determine assessment rates for small established institutions with less than $10 billion in assets. The
CAMELS rating system is a supervisory rating system designed to take into account and reflect all financial and operational risks that a bank may face, including capital adequacy, asset quality, management capability, earnings, liquidity, and sensitivity to market risk (“CAMELS”). CAMELS composite ratings set a maximum assessment for CAMELS 1 and 2 rated banks, and set minimum assessments for lower rated institutions. In 2021 and 2020, the Company recorded expense of $770 thousand and $745 thousand, respectively, for FDIC insurance premiums.
Limitations on Incentive Compensation. The federal bank regulatory agencies have issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of financial institutions do not undermine the safety and soundness of such institutions by encouraging excessive risk-taking. The Interagency Guidance on Sound Incentive Compensation Policies, which covers all employees that have the ability to materially affect the risk profile of financial institutions, either individually or as part of a group, is based upon the key principles that a financial institution’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the institution’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 financial institution’s board of directors.
The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of financial institutions, such as the Company and the Bank, that are not “large, complex banking organizations.” These reviews will be tailored to each financial institution based on the scope and complexity of the institution’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 institution’s supervisory ratings, which can affect the institution’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a financial institution if its incentive compensation arrangements or related risk-management control or governance processes pose a risk to the institution’s safety and soundness, and the financial institution is not taking prompt and effective measures to correct the deficiencies. At December 31, 2021, the Company and the Bank have not been made aware of any instances of noncompliance with this guidance.
Cybersecurity. In March 2015, federal regulators issued two related statements regarding cybersecurity. One statement indicates that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institution. The other statement indicates that a financial institution's management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution's operations after a cyber-attack involving destructive malware. A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack. If we fail to observe the regulatory guidance, we could be subject to various regulatory sanctions, including financial penalties. On November 18, 2021, the federal bank regulatory agencies issued a final rule, effective April 1, 2022, imposing new notification requirements for cybersecurity incidents. The rule requires financial institutions to notify their primary federal regulator as soon as possible and no later than 36 hours after the institution determines that a cybersecurity incident has occurred that has materially disrupted or degraded, or is reasonably likely to materially disrupt or degrade, the institution’s: (i) ability to carry out banking operations, activities, or processes, or deliver banking products and services to a material portion of its customer base, in the ordinary course of business, (ii) business line(s), including associated operations, services, functions, and support, that upon failure would result in a material loss of revenue, profit, or franchise value, or (iii) operations, including associated services, functions and support, as applicable, the failure or discontinuance of which would pose a threat to the financial stability of the United States.
On March 9, 2022, the SEC issued a proposed rule intended to enhance and standardize disclosures regarding cybersecurity risk management, strategy, governance, and cybersecurity incident reporting by public companies, such as the Company, that are subject to the reporting requirements of the Securities Exchange Act of 1934. The proposed rule would require current reporting about material cybersecurity incidents and periodic disclosures about policies and procedures to identify and manage cybersecurity risks, management’s role in implementing cybersecurity policies and procedures, and the board of directors’ cybersecurity expertise and its oversight of cybersecurity risk.
To date, we have not experienced a significant compromise, significant data loss or any material financial losses related to cybersecurity attacks, but our systems and those of our customers and third-party service providers are under constant threat and it is possible that we could experience a significant event in the future. Risks and exposures related to cybersecurity attacks are expected to remain high for the foreseeable future due to the rapidly evolving nature and
sophistication of these threats, as well as due to the expanding use of Internet banking, mobile banking and other technology-based products and services by us and our customers.
Coronavirus Aid, Relief, and Economic Security Act and Consolidated Appropriations Act, 2021. In response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was signed into law on March 27, 2020 and the Consolidated Appropriations Act, 2021 ("Appropriations Act") was signed into law on December 27, 2020. Among other things, the CARES Act and Appropriations Act include the following provisions impacting financial institutions:
•Community Bank Leverage Ratio. The CARES Act directed federal banking agencies to adopt interim final rules to lower the threshold under the CBLR from 9% to 8% and to provide a reasonable grace period for a community bank that falls below the threshold to regain compliance, in each case until the earlier of the termination date of the national emergency or December 31, 2020. In April 2020, the federal bank regulatory agencies issued two interim final rules implementing this directive. One interim final rule provided that, as of the second quarter 2020, banking organizations with leverage ratios of 8% or greater (and that meet the other existing qualifying criteria) could elect to use the CBLR framework. It also established a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall below the 8% CBLR requirement, so long as the banking organization maintains a leverage ratio of 7% or greater. The second interim final rule provided a transition from the temporary 8% CBLR requirement to a 9% CBLR requirement. It established a minimum CBLR of 8% for the second through fourth quarters of 2020, 8.5% for 2021, and 9% thereafter, and maintained a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall no more than 100 basis points below the applicable CBLR requirement.
•Temporary Troubled Debt Restructurings Relief. The CARES Act allowed banks to elect to suspend requirements under U.S. generally accepted accounting principles ("GAAP") for loan modifications related to the COVID-19 pandemic (for loans that were not more than 30 days past due as of December 31, 2019) that would otherwise be categorized as a troubled debt restructuring ("TDR"), including impairment for accounting purposes, until the earlier of 60 days after the termination date of the national emergency or December 31, 2020. Federal banking agencies were required to defer to the determination of the banks making such suspension. The Appropriations Act extended this temporary relief until the earlier of 60 days after the termination date of the national emergency or January 1, 2022.
•Small Business Administration Paycheck Protection Program. The CARES Act created the SBA's PPP and it was extended by the Appropriations Act. Under the PPP, money was authorized for small business loans to pay payroll and group health costs, salaries and commissions, mortgage and rent payments, utilities, and interest on other debt. The loans were provided through participating financial institutions, such as the Bank, that processed loan applications and service the loans.

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ITEM 1A. RISK FACTORS
Item 1A. RISK FACTORS
The material risks and uncertainties that management believes affect us are described below. Any of these risks, if they are realized, could materially adversely affect our business, financial condition and results of operations, and consequently, the market value of our common stock. Additional risks and uncertainties not currently known to us or that we currently believe to be immaterial may also materially and adversely affect us. This Form 10-K also contains forward-looking statements that involve risks and uncertainties. If any of the matters included in the following information about risk factors were to occur, our business, financial condition, results of operations, cash flows or prospects could be materially and adversely affected.
Risks Related to the COVID-19 Pandemic
The ongoing COVID-19 pandemic and measures intended to prevent its spread could adversely affect our business, financial condition and results of operations.
The COVID-19 pandemic has negatively impacted economic and commercial activity and financial markets, both globally and within the United States. Measures to contain the virus, such as stay-at-home orders, travel restrictions, closure of non-essential businesses, occupancy limitations and social distancing requirements, resulted in significant business and operational disruptions, including business closures, supply chain disruptions, and mass layoffs and furloughs. Though most restrictions have generally been lifted or eased and consumer and business spending and unemployment
levels have improved significantly, the economic recovery has been uneven, with industries such as travel, entertainment, hospitality and food service lagging, and as of December 31, 2021, many companies have not returned workers to their offices. Supply chain disruptions precipitated by the abrupt economic slowdown have contributed to increased costs, lost revenue, and inflationary pressures for many segments of the economy. Further, a significant number of workers left their jobs during the COVID-19 pandemic, leading to wage inflation in many industries as businesses attempt to fill vacant positions.
The extent to which the COVID-19 pandemic will ultimately affect our business is unknown and will depend, among other things, on the duration of the pandemic, the actions undertaken by national, state, and local governments and health officials to contain the virus or mitigate its effects, the safety and effectiveness of the vaccines that have been developed and the extent to which they are accepted by the public, the development of effective therapies, the permanence of operating conditions that have developed during the pandemic, and how quickly and to what extent economic conditions improve and normal business and operating conditions resume. The longer the pandemic persists, the more pronounced the ultimate effects are likely to be.
The continuation of the COVID-19 pandemic and the efforts to contain the virus, including effects of economic stimulus, and the exhaustion or expiration of stimulus benefits, could:
•reduce the demand for loans and other financial services;
•result in increases in loan delinquencies, problem assets, and foreclosures;
•cause the value of collateral for loans, especially real estate, to decline in value;
•reduce the availability and productivity of our employees;
•cause our vendors and counterparties to be unable to meet existing obligations to us;
•negatively impact the business and operations of third-party service providers that perform critical services for our business;
•cause the value of our investment securities portfolio to decline; and
•cause the net worth and liquidity of loan guarantors to decline, impairing their ability to honor commitments to us.
Any one of the combination of events described above could have a material, adverse effect on our business, financial condition, and results of operations.
Market Risks
Our business and operations may be materially adversely affected by weak economic conditions.
Our business and operations, which primarily consist of banking activities, including lending money to customers and borrowing money from customers in the form of deposits, are sensitive to general business and economic conditions in the U.S. generally, and in the Washington, D.C. metropolitan area in particular. The economic conditions in our local markets may be different from the economic conditions in the U.S. as a whole. If economic conditions in the U.S. or any of our markets weaken, our growth and profitability from our operations could be constrained. In addition, foreign economic and political conditions could affect the stability of global financial markets, which could hinder economic growth. The current economic environment is characterized by interest rates near historically low levels, which could impact our ability to attract deposits and to generate attractive earnings through our loan and investment portfolios. All these factors can individually or in the aggregate be detrimental to our business, and the interplay between these factors can be complex and unpredictable. Unfavorable market conditions, including as a result of events such as the COVID-19 pandemic and related disruptions, can result in a deterioration in the credit quality of our borrowers and the demand for our products and services, an increase in the number of loan delinquencies, defaults and charge-offs, additional provisions for loan losses, a decline in the value of our collateral, and an overall material adverse effect on the quality of our loan portfolio.
Our business is also significantly affected by monetary and related policies of the U.S. federal government and its agencies. Uncertainty about the federal fiscal policymaking process, the medium and long-term fiscal outlook of the federal
government, and future tax rates are concerns for businesses, consumers and investors in the U.S. Changes in any of these policies are influenced by macroeconomic conditions and other factors that are beyond our control. Adverse economic conditions and government policy responses to such conditions could have a material adverse effect on our business, financial conditions and results of operations.
We are subject to interest rate risk, which could adversely affect our profitability.
Our profitability, like that of most financial institutions, depends to a large extent on our net interest income, which is the difference between our interest income on interest-earning assets, such as loans and investment securities, and our interest expense on interest-bearing liabilities, such as deposits and borrowings.
Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the interest we pay on deposits and borrowings, but such changes could affect our ability to originate loans and obtain deposits, the fair value of our financial assets and liabilities, and the average duration of our assets. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. Any substantial, unexpected or prolonged change in market interest rates could have a material adverse impact on our business, financial condition and results of operations.
Our interest sensitivity profile was slightly asset sensitive as of December 31, 2021. As a result, we would expect increases in net interest income if interest rates rise, and declines in the event rates fall. However, such expectations are based on our assumptions as to deposit customer behavior in an increasing rate scenario. When short-term interest rates rise, the rate of interest we pay on our interest-bearing liabilities may rise more quickly than the rate of interest that we receive on our interest-earning assets, which may cause our net interest income to decrease. Additionally, a shrinking yield premium between short-term and long-term market interest rates, a pattern usually indicative of investors' waning expectations of future growth and inflation, commonly referred to as a flattening of the yield curve, typically reduces our profit margin as we borrow at shorter terms than the terms at which we lend and invest.
In addition, an increase in interest rates could also have a negative impact on our results of operations by reducing the ability of borrowers to repay their current loan obligations. These circumstances could not only result in increased loan defaults, foreclosures and charge-offs, but also reduce collateral values and necessitate further increases to the allowance for loan losses, which could have a material adverse effect on our business, financial condition and results of operations.
Changes to and replacement of the London Interbank Offered Rate ("LIBOR") may adversely affect our business, financial condition, and results of operations.
We have certain loans, interest rate swap agreements, investment securities, and debt obligations whose interest rate is indexed to LIBOR. In 2017, the Financial Conduct Authority (the authority that regulates LIBOR) announced its intention to stop compelling banks to submit rates for the calculation of LIBOR after 2021. In December 2020, the administrator of LIBOR announced its intention to (i) cease the publication of the one-week and two-month U.S. dollar LIBOR after December 31, 2021, and (ii) cease the publication of all other tenors of U.S. dollar LIBOR (one, three, six and 12 month LIBOR) after June 30, 2023. In October 2021, the federal bank regulatory agencies issued a Joint Statement on Managing the LIBOR Transition. In that guidance, the agencies offered their regulatory expectations and outlined potential supervisory and enforcement consequences for banks that fail to adequately plan for and implement the transition away from LIBOR. The failure to properly transition away from LIBOR may result in increased supervisory scrutiny.
The Alternative Reference Rates Committee ("ARRC"), has identified the Secured Overnight Financing Rate ("SOFR"), as the rate that represents best practice as the alternative to LIBOR for use in derivatives and other financial contracts that are currently indexed to LIBOR. Uncertainty as to the adoption, market acceptance or availability of SOFR or other alternative reference rates may adversely affect the value of LIBOR-based loans and securities in our portfolio and may impact the availability and cost of hedging instruments and borrowings. The language in our LIBOR-based contracts and financial instruments has developed over time and may have various events that trigger when a successor index to LIBOR would be selected. If a trigger is satisfied, contracts and financial instruments may give us or the calculation agent, as applicable, discretion over the selection of the substitute index for the calculation of interest rates. The implementation of a substitute index for the calculation of interest rates under our loan agreements may result in our incurring significant
expenses in effecting the transition and may result in disputes or litigation with customers over the appropriateness or comparability to LIBOR of the substitute index, any of which could have an adverse effect on our results of operations. To mitigate the risks associated with the expected discontinuation of LIBOR, we have ceased originating LIBOR-linked loans, implemented fallback language for LIBOR-linked commercial loans, adhered to the International Swaps and Derivatives Association 2020 Fallbacks Protocol for interest rate swap agreements, and have updated our systems to accommodate SOFR-linked loans. In accordance with regulatory guidance, we ceased entering into new LIBOR transactions at the end of 2021.
Credit Risks
We are subject to credit risk, which could adversely affect our profitability.
Our business depends on our ability to successfully measure and manage credit risk. As a lender, we are exposed to the risk that the principal of, or interest on, a loan will not be paid timely or at all or that the value of any collateral supporting a loan will be insufficient to cover our outstanding exposure. In addition, we are exposed to risks with respect to the period of time over which the loan may be repaid, risks relating to loan underwriting, risks resulting from changes in economic and industry conditions, and risks inherent in dealing with individual loans and borrowers. The creditworthiness of a borrower is affected by many factors including local market conditions and general economic conditions. If the overall economic climate in the U.S. generally, or in our market areas specifically, experiences material disruption, including as a result of the COVID-19 pandemic and related disruptions, our borrowers may experience difficulties in repaying their loans, the collateral we hold may decrease in value or become illiquid, and our level of nonperforming loans, charge-offs and delinquencies could rise and require significant additional provisions for loan losses.
Our risk management practices, such as monitoring the concentrations of our loans and our credit approval, review and administrative practices, may not adequately reduce credit risk, and our credit administration personnel, policies and procedures may not adequately adapt to changes in economic or any other conditions affecting related customers and the quality of the loan portfolio. Many of our loans are made to small businesses that are less able to withstand competitive, economic and financial pressures than larger borrowers. Consequently, we may have significant exposure if any of these borrowers becomes unable to pay their loan obligations as a result of economic or market conditions, or personal circumstances, such as divorce, unemployment or death. A failure to effectively measure and limit the credit risk associated with our loan portfolio may result in loan defaults, foreclosures and additional charge-offs, and may necessitate that we significantly increase our allowance for loan losses, each of which could adversely affect our net income. As a result, our inability to successfully manage credit risk could have a material adverse effect on our business, financial condition and results of operations.
A substantial portion of our loans are and will continue to be real estate related loans in the Washington, D.C. metropolitan area. Adverse changes in the real estate market or economy in this area could lead to higher levels of problem loans and charge-offs, adversely affecting our earnings and financial condition.
We make loans primarily to borrowers in the Washington, D.C. and Baltimore metropolitan areas, focusing on the Virginia counties of Arlington, Fairfax, Loudoun and Prince William and the independent cities located within those counties, Washington D.C., and its Maryland suburbs, and have a substantial portion of our loans secured by real estate. These concentrations expose us to the risk that adverse developments in the real estate market, or in the general economic conditions in such areas, or the continuation of such adverse developments, could increase the levels of nonperforming loans and charge-offs, and reduce loan demand and deposit growth. In that event, we would likely experience lower earnings or losses. Additionally, if economic conditions in the area deteriorate, or there is significant volatility or weakness in the economy or any significant sector of the area's economy, our ability to develop our business relationships may be diminished, the quality and collectability of our loans may be adversely affected, our provision for loan losses may increase, the value of collateral may decline and loan demand may be reduced.
Increases to our nonperforming assets or other problem assets will have an adverse effect on our earnings.
As of December 31, 2021, we had nonperforming loans and loans 90 days or more past due of $3.5 million, or 0.23% of total loans. At that date, we had one loan considered a troubled debt restructuring totaling $92 thousand, which is included in our nonperforming loan totals above. If loans become 90 or more days past due and still accruing and move to nonaccrual loans, we will not record interest income on such loans, and may be required to reverse prior accruals, thereby adversely affecting our earnings. If the level of our nonperforming or other problem assets increases, we may be required to make additional provisions for loan losses, which will negatively impact our earnings. If we are required to foreclose on
any collateral properties securing our loans, we will incur legal and other expenses in connection with the foreclosure and sale process and possible losses on the sale of OREO or other collateral. Additionally, the resolution of nonperforming assets, troubled debt restructurings and other problem assets requires the active involvement of management, which can distract management from its overall supervision of operations and other income producing activities.
Our concentrations of loans may create a greater risk of loan defaults and losses.
A substantial portion of our loans are secured by various types of real estate in the Washington, D.C. metropolitan area and substantially all of our loans are to borrowers in that area. At December 31, 2021, 85.9% of our total loans were secured by real estate; commercial real estate loans, excluding construction and land development, comprised the largest portion of these loans at 60.1% of our portfolio. This concentration exposes us to the risk that adverse developments in the real estate market, or the general economic conditions in our market, could increase our nonperforming loans and charge-offs, reduce the value of our collateral and adversely impact our results of operations and financial condition. Management believes that the commercial real estate concentration risk is mitigated by diversification among the types and characteristics of real estate collateral properties, sound underwriting practices, rigorous portfolio monitoring and ongoing market analysis. Construction and land development loans comprised 12.4% of total loans at December 31, 2021. Commercial and industrial loans, excluding PPP, comprised 11.5%, of total loans at December 31, 2021. These categories of loans have historically carried a higher risk of default than other types of loans, such as single family residential mortgage loans. The repayment of these loans often depends on the successful operation of a business or the sale or development of the underlying property, and, as a result, are more likely to be adversely affected by adverse conditions in the real estate market or the economy in general. While we believe that our loan portfolio is well diversified in terms of borrowers and industries, these concentrations expose us to the risk that adverse developments in the real estate market, or in the general economic conditions in the Washington, D.C. metropolitan area, could increase the levels of nonperforming loans and charge-offs, and reduce loan demand. In that event, we would likely experience lower earnings or losses. Additionally, if, for any reason, economic conditions in our market area deteriorate, or there is significant volatility or weakness in the economy or any significant sector of the area's economy, our ability to develop our business relationships may be diminished, the quality and collectability of our loans may be adversely affected, our provision for loan losses may increase, the value of collateral may decline and loan demand may be reduced.
Commercial real estate loans tend to have larger balances than single family mortgage loans and other consumer loans. Because the loan portfolio contains a significant number of commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans may cause a significant increase in nonperforming assets. An increase in nonperforming loans could result in a loss of earnings from these loans, an increase in the provision for loan losses, or an increase in loan charge-offs, which could have an adverse impact on our results of operations and financial condition.
Our portfolio of loans to small and mid-sized community-based businesses may increase our credit risk.
Many of our commercial business and commercial real estate loans are made to small business or middle market customers. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities and have a heightened vulnerability to economic conditions. If general economic conditions in the market area in which we operate negatively impact this important customer sector, our results of operations and financial condition may be adversely affected. Moreover, a portion of these loans have been made by us in recent years and the borrowers may not have experienced a complete business or economic cycle. The deterioration of our borrowers' businesses may hinder their ability to repay their loans with us, which could have a material adverse effect on our financial condition and results of operations.
Our government contractor customers, and businesses in the Washington, D.C. metropolitan area in general, may be adversely impacted by the federal government and a budget impasse.
At December 31, 2021, 11.5% of our total loans were outstanding to commercial and industrial customers. Of that, approximately 33.1% of outstanding commercial and industrial loans are to government contractors or their subcontractors specializing in the defense and homeland security and defense readiness sectors, and we have commitments of $238.1 million to such borrowers. We are actively seeking to expand our exposure to this business segment. While we believe that our loans to government contractor customers are unlikely to experience more than a delay in payment as a result of government shutdowns, the current emphasis on defense readiness presents an opportunity for many of our customers. In the event of a government shutdown, this could cause these customers to have their government contracts reduced or terminated for convenience, or have payments delayed, causing a loss of anticipated revenues or reduced cash flow, resulting in an increase in credit risk, and potentially defaults by such customers on their respective loans.
Our government contractor customers could also withdraw their deposit balances during a shutdown to fund current operations, resulting in additional liquidity risk. Additionally, temporary layoffs, salary reductions or furloughs of government employees or government contractors could have adverse impacts on other businesses in our market and the general economy of the Washington, D.C. metropolitan area, and may indirectly lead to a loss of revenues by our customers. As a result, a government shutdown could lead to an increase in the levels of past due loans, nonperforming loans, loan loss reserves and charge-offs, and a decline in liquidity.
We have extended off-balance sheet commitments to borrowers which expose us to credit and interest rate risk.
We enter into off-balance sheet arrangements in the normal course of business to meet the financing needs of our customers. These off-balance sheet arrangements include commitments to extend credit, standby letters of credit and guarantees which would impact our liquidity and capital resources to the extent customers accept or use these commitments. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and guarantees written is represented by the contractual or notional amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments.
Our allowance for loan losses may be inadequate to absorb losses inherent in the loan portfolio, which could have a material adverse effect on our business, financial condition and results of operations.
Experience in the banking industry indicates that a portion of our loans will become delinquent, and that some may only be partially repaid or may never be repaid at all. We may experience losses for reasons beyond our control, such as the impact of general economic conditions on customers and their businesses. In determining the size of our allowance for loan losses, we rely on an analysis of our loan portfolio considering historical loss experience, volume and types of loans, trends in classification, volume and trends in delinquencies and nonaccruals, economic conditions and other pertinent information. Although we endeavor to maintain our allowance for loan losses at a level adequate to absorb any inherent losses in the loan portfolio, the determination of the appropriate level of the allowance for loan losses is inherently highly subjective and requires us to make significant estimates of and assumptions regarding current credit risk and future trends, and the accuracy of our judgments depends on the outcome of future events. Further, despite our underwriting criteria and historical experience, we may be particularly susceptible to losses due to: (i) the geographic concentration of our loans, (ii) the concentration of higher risk loans, such as commercial real estate, and commercial and industrial loans, and (iii) the relative lack of seasoning of certain of our loans.
Deterioration of economic conditions affecting borrowers, new information regarding existing loans, inaccurate management assumptions, identification of additional problem loans and other factors, both within and outside of our control, may result in our experiencing higher levels of nonperforming assets and charge-offs, and incurring loan losses in excess of our current allowance for loan losses, requiring us to make material additions to our allowance for loan losses, which could have a material adverse effect on our business, financial condition and results of operations.
Our federal and state banking regulators, as an integral part of their supervisory function, periodically review the allowance for loan losses. These regulatory agencies may require us to increase our provision for loan losses or to recognize further loan charge-offs based upon their judgments, which may be different from ours. If we need to make significant and unanticipated increases in the loss allowance in the future, or take additional charge-offs for which we have not established adequate reserves, our results of operations and financial condition could be materially adversely affected at that time.
Lack of seasoning of our loan portfolio could increase risk of credit defaults in the future.
As a result of our organic growth over the past several years, as of December 31, 2021, approximately $741.8 million, or 49.2%, of the loans in our loan portfolio (excluding PPP loans) were first originated during the past three years. The average age by loan type for loans originated in the past three years is: commercial real estate loans-1.37 years; commercial and industrial loans-1.46 years; commercial construction loans-0.92 years; consumer residential loans-1.34 years; and consumer nonresidential loans-2.39 years. In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process referred to as "seasoning." As a result, a portfolio of older loans will usually behave more predictably than a newer portfolio. Therefore, the recent and current level of delinquencies and defaults may not represent the level that may prevail as the portfolio becomes more seasoned and may not serve as a reliable basis for predicting the health and nature of our loan portfolio, including net
charge offs and the ratio of nonperforming assets in the future. Our limited experience with these loans may not provide us with a significant history with which to judge future collectability or performance. However, we believe that our stringent credit underwriting process, our ongoing credit review processes, and our history of successful management of our loan portfolio, mitigate these risks. Nevertheless, if delinquencies and defaults increase, we may be required to increase our provision for loan losses, which could have a material adverse effect on our business, financial condition and results of operations.
Strategic Risks
We operate in a highly competitive market and face increasing competition from a variety of traditional and new financial services providers, which could adversely impact our profitability.
The banking business is highly competitive. We compete as a financial intermediary with other commercial banks, savings banks, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds and other financial institutions operating in the Washington, D.C. metropolitan area and elsewhere, as well as nontraditional competitors such as fintech companies and internet-based lenders, depositories and payment systems. Our profitability depends upon our continued ability to successfully compete with traditional and new financial services providers, some of which maintain a physical presence in our market areas and others of which maintain only a virtual presence.
Our primary market area is a highly competitive, highly branched, banking market. Competition in the market area for loans to small and middle-market businesses and professionals, our target market, is intense and pricing is important. Several of our competitors have substantially greater resources and lending limits than us, and offer certain services, such as extensive and established branch networks and trust services, that we do not currently provide or currently expect to provide in the near future. Moreover, larger institutions operating in the Washington, D.C. metropolitan area may have access to borrowed funds at lower cost than will be available to us. Additionally, deposit competition among institutions in the market area is strong. Increased competition could require us to increase the rates we pay on deposits or lower the rates that we offer on loans, which could reduce our profitability. Our failure to compete effectively in our market could restrain our growth or cause us to lose market share, which could have a material adverse effect on our business, financial condition and results of operations.
The success of our growth strategy depends, in part, on our ability to identify and retain individuals with experience and relationships in our market.
Our success depends, in large part, on our management team and key employees. The loss of any of our management team or our key employees could materially adversely affect our ability to execute our business strategy, and we may not be able to find adequate replacements on a timely basis, or at all. We cannot ensure that we will be able to retain the services of any members of our management team or other key employees. Failure to attract and retain a qualified management team and qualified key employees could have a material adverse effect on our business, financial condition and results of operations.
In order to continue to grow successfully, we must also identify and retain experienced loan officers with local expertise and relationships. We expect that competition for experienced loan officers will continue to be intense and that there will be a limited number of qualified loan officers with knowledge of, and experience in, the community banking industry in our market area. Even if we identify individuals that we believe could assist us in building our franchise, we may be unable to recruit these individuals away from their current banks. In addition, the process of identifying and recruiting loan officers with the combination of skills and attributes required to carry out our strategy is often lengthy. Our inability to identify, recruit and retain talented personnel could limit our growth and could adversely affect our business, financial condition and results of operations. The lack of acquisition opportunities in the future, or our inability to successfully bid for such opportunities as are available, could result in a slower pace of growth.
We may not be able to successfully manage continued growth.
As our capital base grows, so does our legal lending limit. We cannot be certain as to our ability to manage increased levels of assets and liabilities, or to successfully make and supervise higher balance loans. Further, we may not be able to maintain the relatively low number and level of nonperforming loans and charge-offs that we have experienced. We may be required to make additional investments in equipment, software, physical facilities and personnel to accumulate and manage higher asset levels and loan balances, which may adversely impact earnings, shareholder returns, and our
efficiency ratio. Increases in operating expenses or nonperforming assets may have an adverse impact on the value of our common stock.
There can be no assurance that we will be able to continue to grow and to remain profitable in future periods, or, if profitable, that our overall earnings will remain consistent with our prior results of operations, or increase in the future. A downturn in economic conditions in our market, particularly in the real estate market, heightened competition from other financial services providers, an inability to retain or grow our core deposit base, regulatory and legislative considerations, a failure to maintain adequate internal controls and compliance processes, and failure to attract and retain high-performing talent, among other factors, could limit our ability to grow assets, or increase profitability, as rapidly as we have in the past. Sustainable growth requires that we manage our risks by following prudent loan underwriting standards, balancing loan and deposit growth without materially increasing interest rate risk or compressing our net interest margin, maintaining more than adequate capital at all times, hiring and retaining qualified employees and successfully implementing our strategic initiatives. Our failure to sustain our historical rate of growth or adequately manage the factors that have contributed to our growth could have a material adverse effect on our earnings and profitability and therefore on our business, financial condition and results of operations.
Regulatory requirements affecting our loans secured by commercial real estate could limit our ability to leverage our capital and adversely affect our growth and profitability.
The federal banking agencies have issued guidance governing financial institutions that have concentrations in commercial real estate lending. The guidance provides that institutions which have (i) total reported loans for construction, land development, and other land loans which represent 100% or more of an institution's total risk-based capital; or (ii) total reported commercial real estate loans, excluding loans secured by owner-occupied commercial real estate, representing 300% or more of the institution's total risk-based capital, where the institution's commercial real estate loan portfolio has increased 50% or more during the prior 36 months, are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital. We have a concentration in commercial real estate loans, and we have experienced significant growth in our commercial real estate portfolio in recent years. As of December 31, 2021, commercial real estate loans, as defined for regulatory purposes, represented 396% of our total risk-based capital. Of those loans, commercial construction, development and land loans represented 84% of our total risk based capital. Owner-occupied commercial real estate loans represented an additional 81% of our total risk based capital. Management has extensive experience in commercial real estate lending, and has implemented and continues to maintain heightened portfolio monitoring and reporting, and strong underwriting criteria with respect to its commercial real estate portfolio. Nevertheless, we could be required to maintain higher levels of capital as a result of our commercial real estate concentration, which could limit our growth, require us to obtain additional capital, and have a material adverse effect on our business, financial condition and results of operations.
We may face risks with respect to future expansion or acquisition activity.
We selectively seek to expand our banking operations through limited de novo branching or opportunistic acquisition activities. We cannot be certain that any expansion activity, through de novo branching, acquisition of branches of another financial institution or a whole institution, or the establishment or acquisition of nonbanking financial service companies, will prove profitable or will increase shareholder value. The success of any acquisition will depend, in part, on our ability to realize the estimated cost savings and revenue enhancements from combining our business and that of the target company. Our ability to realize increases in revenue will depend, in part, on our ability to retain customers and employees, and to capitalize on existing relationships for the provision of additional products and services. If our estimates turn out to be incorrect or we are not able to successfully combine companies, the anticipated cost savings and increased revenues may not be realized fully or at all, or may take longer to realize than expected. It is possible that the integration process could result in the loss of key employees, the disruption of each company's ongoing business, diversion of management attention, or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with clients and employees or to achieve the anticipated benefits of the merger. As with any combination of banking institutions, there also may be disruptions that cause us to lose customers or cause customers to withdraw their deposits. Customers may not readily accept changes to their banking arrangements that we make as part of or following an acquisition. Additionally, the value of an acquisition to us is dependent on our ability to successfully identify and estimate the magnitude of any asset quality issues of acquired companies.
We may not be successful in overcoming these risks or other problems encountered in connection with potential acquisitions or other expansion activity. Our inability to overcome these risks could have an adverse effect on our ability to implement our business strategy and enhance shareholder value, which, in turn, could have a material adverse effect on our business, financial condition or results of operations.
Additionally, at December 31, 2021, we had $7.1 million of goodwill related to our acquisition of Colombo. Goodwill and other intangible assets are tested for impairment on an annual basis or when facts and circumstances indicate that impairment may have occurred. Our financial condition and results of operations may be adversely affected if that goodwill is determined to be impaired, which would require us to take an impairment charge.
New lines of business, products, product enhancements or services may subject us to additional risk.
From time to time, we may implement new lines of business or offer new products and product enhancements as well as new services within our existing lines of business. There are substantial risks and uncertainties associated with these efforts. In developing, implementing or marketing new lines of business, products, product enhancements or services, we may invest significant time and resources. We may underestimate the appropriate level of resources or expertise necessary to make new lines of business or products successful or to realize their expected benefits. We may not achieve the milestones set in initial timetables for the development and introduction of new lines of business, products, product enhancements or services, 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. Any new line of business, product, product enhancement or service could have a significant impact on the effectiveness of our system of internal controls. We may also decide to discontinue businesses or products, due to lack of customer acceptance or profitability. 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 a material adverse effect on our business, financial condition and results of operations.
Liquidity Risks
We may not be able to retain or grow our core deposit base, which could adversely impact our funding costs.
Like many financial institutions we rely on customer deposits as our primary source of funding for our lending activities, and we continue to seek customer deposits to maintain this funding base. Our future growth will largely depend on our ability to retain and grow our deposit base. As of December 31, 2021, we had $1.88 billion in deposits. Our deposits are subject to potentially dramatic fluctuations in availability or price due to certain factors outside of our control, such as increasing competitive pressures for deposits, changes in interest rates and returns on other investment classes, customer perceptions of our financial health and general reputation, adverse developments in general economic conditions of an individual's business, and a loss of confidence by customers in us or the banking sector generally, which could result in significant outflows of deposits within short periods of time or significant changes in pricing necessary to maintain current customer deposits or attract additional deposits. Any such loss of funds could result in lower loan originations, which could have a material adverse effect on our business, financial condition and results of operations.
Liquidity risk could impair our ability to fund operations and meet our obligations as they become due, and failure to maintain sufficient liquidity could materially adversely affect our growth, business, profitability and financial condition.
Liquidity is essential to our business. Liquidity risk is the potential that we will be unable to meet our obligations as they become due because of an inability to liquidate assets or obtain adequate funding at a reasonable cost, in a timely manner and without adverse conditions or consequences. We require sufficient liquidity to fund asset growth, meet customer loan requests, customer deposit maturities and withdrawals, payments on our debt obligations as they become due and other cash commitments under both normal operating conditions and other unpredictable circumstances, including events causing industry or general financial market stress. Liquidity risk can increase due to a number of factors, including an over-reliance on a particular source of funding or market-wide phenomena such as market dislocation and major disasters. Factors that could detrimentally impact access to liquidity sources include, but are not limited to, a decrease in the level of our business activity as a result of a slowdown in our market, adverse regulatory actions against us, or changes in the liquidity needs of our depositors. Market conditions or other events could also negatively affect the level or cost of funding, affecting our ongoing ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations, and fund asset growth and new business transactions at a reasonable cost, in a timely manner, and without adverse consequences. Our inability to raise funds through deposits, borrowings, the sale of loans, and other sources could
have a substantial negative effect on our business, and could result in the closure of the Bank. Our access to funding sources in amounts adequate to finance our activities or on acceptable terms could be impaired by factors that affect our organization specifically or the financial services industry or economy in general. Any substantial, unexpected, and/or prolonged change in the level or cost of liquidity could impair our ability to fund operations and meet our obligations as they become due and could have a material adverse effect on our business, financial condition and results of operations.
We rely on customer deposits, including brokered deposits, and to a lesser extent on advances from the FHLB to fund our operations. Although we have historically been able to replace maturing deposits and advances if desired, we may not be able to replace such funds in the future if our financial condition, the financial condition of the FHLB or market conditions were to change. FHLB borrowings and other current sources of liquidity may not be available or, if available, sufficient to provide adequate funding for operations.
Operational Risks
We depend on information technology and telecommunications systems of third parties, and any systems failures or interruptions could adversely affect our operations and financial condition.
Our business depends on the successful and uninterrupted functioning of our information technology and telecommunications systems. We outsource many of our major systems, such as data processing, deposit processing, loan origination, email and anti-money laundering monitoring systems. Of particular significance is our long-term contract for core data processing services with Fidelity National Information Services, Inc. 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, and we could experience difficulty in implementing replacement solutions. In many cases, our operations rely heavily on secured processing, storage and transmission of information and the monitoring of a large number of transactions on a minute-by-minute basis, and even a short interruption in service could have significant consequences. 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. If significant, sustained or repeated, a system failure or service denial 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 a material adverse effect on our business, financial condition and results of operations. In addition, failure of third parties to comply with applicable laws and regulations, or fraud or misconduct on the part of employees of any of these third parties, could disrupt our operations or adversely affect our reputation.
We are subject to cybersecurity risks and security breaches and may incur increasing costs in an effort to minimize those risks and to respond to cyber incidents, and we may experience harm to our reputation and liability exposure from security breaches.
Our business involves the storage and transmission of customers' proprietary information and security breaches could expose us to a risk of loss or misuse of this information, litigation and potential liability. While we have incurred no material cyber-attacks or security breaches to date, a number of other financial services and other companies have disclosed cyber-attacks and security breaches, some of which have involved intentional attacks. Attacks may be targeted at us, our customers or both. Although we devote significant resources to maintain, regularly update and backup our systems and processes that are designed to protect the security of our computer systems, software, networks and other technology assets and the confidentiality, integrity and availability of information belonging to us or our customers, our security measures may not be effective against all potential cyber-attacks or security breaches. Despite our efforts to ensure the integrity of our systems, it is possible that we may not be able to anticipate, or implement effective preventive measures against, all security breaches of these types, especially because the techniques used change frequently or are not recognized until launched, and because cyber-attacks can originate from a wide variety of sources, including persons who are involved with organized crime or associated with external service providers or who may be linked to terrorist organizations or hostile foreign governments. These risks may increase in the future as we continue to increase our internet-based product offerings and expand our internal usage of web-based products and applications. If an actual or perceived security breach occurs, customer perception of the effectiveness of our security measures could be harmed and could result in the loss of customers.
Failure to keep up with the rapid technological changes in the financial services industry could have a material adverse effect on our competitive position and profitability.
The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and reduce costs. Our future success will depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements than we have. We may not be able to implement new technology driven products and services effectively or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could harm our ability to compete effectively and could have a material adverse effect on our business, financial condition or results of operations. As these technologies are improved in the future, we may be required to make significant capital expenditures in order to remain competitive, which may increase our overall expenses and have a material adverse effect on our business, financial condition and results of operations.
A successful penetration or circumvention of the security of our systems, including those of third party providers or other financial institutions, or the failure to meet regulatory requirements for security of our systems, could cause serious negative consequences, including significant disruption of our operations, misappropriation of our confidential information or that of our customers, or damage to our computers or systems or those of our customers or counterparties, significant increases in compliance costs (such as repairing systems or adding new personnel or protection technologies), and could result in violations of applicable privacy and other laws, financial loss to us or to our customers, loss of confidence in our security measures, customer dissatisfaction, significant litigation and regulatory exposure, and harm to our reputation, all of which could have a material adverse effect on our business, financial condition and results of operations.
Our risk management framework may not be effective in mitigating risks and/or losses to us.
Our risk management framework is comprised of various processes, systems and strategies, and is designed to manage the types of risk to which we are subject, including, among others, credit, market, liquidity, interest rate and compliance. Our framework also includes financial or other modeling methodologies that involve management assumptions and judgment. Our risk management framework may not be effective under all circumstances and may not adequately mitigate any risk or loss to us. If our risk management framework is not effective, we could suffer unexpected losses and our business, financial condition, results of operations or growth prospects could be materially and adversely affected. We may also be subject to potentially adverse regulatory consequences.
We may be adversely affected by the soundness of other financial institutions.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services companies are interrelated as a result of trading, clearing, counterparty and other relationships. As a result, defaults by, or even rumors or questions about, one or more financial services companies, or the financial services industry generally, could lead to market-wide liquidity problems and losses or defaults by us or other institutions. These losses could have a material adverse effect on our business, financial condition and results of operations.
If we fail to design and maintain effective internal control over financial reporting, we may be unable to accurately report our financial results or prevent fraud, which could have a material adverse effect on us.
Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of the financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Effective internal control over financial reporting is necessary for us to provide reliable reports and prevent fraud.
We believe that a control system, no matter how well designed and managed, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. We may not be able to identify all significant deficiencies and/or material weaknesses in our internal control system in the future, and our failure to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act and FDIC regulations could have a material adverse effect on our business, financial condition and results of operations.
Litigation and regulatory actions, including possible enforcement actions, could subject us to significant fines, penalties, judgments or other requirements resulting in increased expenses or restrictions on our business activities.
In the normal course of business, from time to time, we may be named as a defendant in various legal actions, arising in connection with our current and/or prior business activities. Legal actions could include claims for substantial compensatory or punitive damages or claims for indeterminate amounts of damages. Further, we may in the future be subject to consent orders or other formal or informal enforcement agreements with our regulators. We may also, from time to time, be the subject of subpoenas, requests for information, reviews, investigations and proceedings (both formal and informal) by governmental agencies regarding our current and/or prior business activities. Any such legal or regulatory actions may subject us to substantial compensatory or punitive damages, significant fines, penalties, obligations to change our business practices or other requirements resulting in increased expenses, diminished income and damage to our reputation. Our involvement in any such matters, whether tangential or otherwise, and even if the matters are ultimately determined in our favor, could also cause significant harm to our reputation and divert management attention from the operation of our business. Further, any settlement, consent order, other enforcement agreement or adverse judgment in connection with any formal or informal proceeding or investigation by government agencies may result in litigation, investigations or proceedings as other litigants and government agencies begin independent reviews of the same activities. As a result, the outcome of legal and regulatory actions could have a material adverse effect on our business, financial condition and results of operations.
Increasing scrutiny and evolving expectations from customers, regulators, investors, and other stakeholders with respect to environmental, social and governance (“ESG”) practices may impose additional costs on us or expose us to new or additional risks.
Companies are facing increasing scrutiny from customers, regulators, investors, and other stakeholders related to ESG practices and disclosure. Investor advocacy groups, investment funds and influential investors are also increasingly focused on these practices, especially as they relate to climate risk, hiring practices, the diversity of the work force, and racial and social justice issues. Increased ESG related compliance costs could result in increases to our overall operational costs. Failure to adapt to or comply with regulatory requirements or investor or stakeholder expectations and standards could negatively impact our reputation, ability to do business with certain partners, and our stock price. New government regulations could also result in new or more stringent forms of ESG oversight and expanding mandatory and voluntary reporting, diligence, and disclosure.
Risks Related to Our Securities
We may need to raise additional capital in the future, and we may not be able to do so.
Access to sufficient capital is critical in order to enable us to implement our business plan, support our business, expand our operations and meet applicable capital requirements. The inability to have sufficient capital, whether internally generated through earnings or raised in the capital markets, could adversely impact our ability to support and to grow our operations. If we grow our operations faster than we generate capital internally, we will need to access the capital markets. We may not be able to raise additional capital in the form of additional debt or equity on acceptable terms, or at all. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, our financial condition and our results of operations. Economic conditions and a loss of confidence in financial institutions may increase our cost of capital and limit access to some sources of capital. Further, if we need to raise capital in the future, we may have to do so when many other financial institutions are also seeking to raise capital and would then have to compete with those institutions for investors. An inability to raise additional capital on acceptable terms when needed could have a material adverse impact on our business, financial condition and results of operations.
We have no current plans to pay cash dividends.
Holders of our common stock are entitled to receive only such dividends as our board of directors may declare out of funds legally available for such payments. The Bank is our primary operating business and the source of substantially all of our earnings, and our ability to pay dividends will be subject to the earnings, capital levels, capital needs and limitations relating to the payment of dividends by the Bank to us. The amount of dividends that a bank may pay is limited by state and federal laws and regulations. While we have sufficient retained earnings and expect our future earnings to be sufficient to pay cash dividends, our board of directors currently intends to retain earnings for the purpose of financing growth. In addition, we are a bank holding company, and our ability to declare and pay dividends to our shareholders is dependent on federal regulatory considerations, including the guidelines of the Federal Reserve regarding capital adequacy and dividends. It is the policy of the Federal Reserve that bank holding companies should generally pay dividends on common
stock only out of earnings, and only if prospective earnings retention is consistent with the organization's expected future needs, asset quality and financial condition.
Risks Related to Our Industry
Our industry is highly regulated, and the regulatory framework, together with any future legislative or regulatory changes, may have a materially adverse effect on our operations.
The banking industry is highly regulated and supervised under both federal and state laws and regulations that are intended primarily for the protection of depositors, customers, the public, the banking system as a whole or the FDIC Deposit Insurance Fund, not for the protection of our shareholders and creditors. We are subject to regulation and supervision by the Federal Reserve, and our Bank is subject to regulation and supervision by the Federal Reserve and the VBFI. Compliance with these laws and regulations can be difficult and costly, and changes to laws and regulations can impose additional compliance costs. The Dodd-Frank Act, which imposes significant regulatory and compliance changes on financial institutions, is an example of this type of federal regulation. The laws and regulations applicable to us govern a variety of matters, including permissible types, amounts and terms of loans and investments we may make, the maximum interest rate that may be charged, the amount of reserves we must hold against deposits we take, the types of deposits we may accept and the rates we may pay on such deposits, maintenance of adequate capital and liquidity, changes in control of us and our Bank, transactions between us and our Bank, handling of nonpublic information, restrictions on dividends and establishment of new offices. We must obtain approval from our regulators before engaging in certain activities, and there is risk that such approvals may not be granted, either in a timely manner or at all. These requirements may constrain our operations, and the adoption of new laws and changes to or repeal of existing laws may have a further impact on our business, financial condition and results of operations. Also, the burden imposed by those federal and state regulations may place banks in general, including our Bank in particular, at a competitive disadvantage compared to their non-bank competitors. Our failure to comply with any applicable laws or regulations, or regulatory policies and interpretations of such laws and regulations, could result in sanctions by regulatory agencies, civil money penalties or damage to our reputation, all of which could have a material adverse effect on our business, financial condition and results of operations.
Bank holding companies and financial institutions are extensively regulated and currently face an uncertain regulatory environment. Applicable laws, regulations, interpretations, enforcement policies and accounting principles have been subject to significant changes in recent years, and may be subject to significant future changes. Future changes may have a material adverse effect on our business, financial condition and results of operations.
Federal and state regulatory agencies may adopt changes to their regulations or change the manner in which existing regulations are applied. We cannot predict the substance or effect of pending or future legislation or regulation or the application of laws and regulations to us. Compliance with current and potential regulation, as well as regulatory scrutiny, may significantly increase our costs, impede the efficiency of our internal business processes, require us to increase our regulatory capital, and limit our ability to pursue business opportunities in an efficient manner by requiring us to expend significant time, effort and resources to ensure compliance and respond to any regulatory inquiries or investigations.
In addition, regulators may elect to alter standards or the interpretation of the standards used to measure regulatory compliance or to determine the adequacy of liquidity, risk management or other operational practices for financial service companies in a manner that impacts our ability to implement our strategy and could affect us in substantial and unpredictable ways, and could have a material adverse effect on our business, financial condition and results of operations. Furthermore, the regulatory agencies have extremely broad discretion in their interpretation of laws and regulations and their assessment of the quality of our loan portfolio, securities portfolio and other assets. If any regulatory agency's assessment of the quality of our assets, operations, lending practices, investment practices, capital structure or other aspects of our business differs from our assessment, we may be required to take additional charges or undertake, or refrain from taking, actions that could have a material adverse effect on our business, financial condition and results of operations.
We may be required to act as a source of financial and managerial strength for our Bank in times of stress.
Under federal law and long-standing Federal Reserve policy, we, as a bank holding company, are required to act as a source of financial and managerial strength to the Bank and to commit resources to support the Bank if necessary. We may be required to commit additional resources to the Bank at times when we may not be in a financial position to provide such resources or when it may not be in our, or our shareholders' or creditors', best interests to do so. A requirement to provide such support is more likely during times of financial stress for us and the Bank, which may make any capital we are
required to raise to provide such support more expensive than it might otherwise be. In addition, any capital loans we make to the Bank are subordinate in right of repayment to deposit liabilities of the Bank.
We are subject to an extensive body of accounting rules and best practices. Periodic changes to such rules may change the treatment and recognition of critical financial line items and affect our profitability.
The nature of our business makes us sensitive to the large body of accounting rules in the U.S. From time to time, the governing bodies that oversee changes to accounting rules and reporting requirements may release new guidance for the preparation of our financial statements. These changes can materially impact how we record and report our financial condition and results of operations. For example, we will be required to implement the CECL model on January 1, 2023, which will require us to calculate the allowance for loan losses on the basis of the current expected credit losses over the lifetime of our loans. In some instances, we could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements.These changes could adversely affect our capital, regulatory capital ratios, ability to make larger loans, earnings and performance metrics. Any such changes could have a material adverse effect on our business, financial condition and results of operations.
Regulatory initiatives regarding bank capital requirements may require heightened capital.
We are subject to capital adequacy guidelines and other regulatory requirements specifying minimum amounts and types of capital that we must maintain. From time to time, regulators implement changes to these regulatory capital adequacy guidelines. If we fail to meet these minimum capital guidelines and/or other regulatory requirements, our financial condition would be materially and adversely affected. The Basel III rules require bank holding companies and their subsidiaries to maintain significantly more capital as a result of higher required capital levels and more demanding regulatory capital risk weightings and calculations. The Bank must also comply with the capital requirements set forth in the “prompt corrective action” regulations pursuant to Section 38 of the FDIA. Satisfying capital requirements may require us to limit our banking operations, retain net income or reduce dividends to improve regulatory capital levels, which could negatively affect our business, financial condition and results of operations.
Our use of third party vendors and our other ongoing third party business relationships are subject to increasing regulatory requirements and attention.
We regularly use third party vendors in our business and we rely on some of these vendors for critical functions including, but not limited to, our core processing function. Third party relationships are subject to increasingly demanding regulatory requirements and attention by bank regulators. We expect our regulators to hold us responsible for deficiencies in our oversight or control of our third party vendor relationships and in the performance of the parties with which we have these relationships. As a result, if our regulators conclude that we have not exercised adequate oversight and control over our third party vendors or that such vendors have not performed adequately, we could be subject to administrative penalties or fines as well as requirements for consumer remediation, any of which could have a material adverse effect on our business, financial condition and results of operations.
General Risks
Severe weather, natural disasters, geopolitical conditions, acts of war or terrorism, public health issues, and other external events could significantly impact our business.
Severe weather, natural disasters, geopolitical conditions, acts of war or terrorism, public health issues, and other adverse external events could have a significant impact on our ability to conduct business. In addition, such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue, and/or cause us to incur additional expenses. The occurrence of any such event in the future could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.

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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
Our executive offices and the main office of the Bank are located at 11325 Random Hills Road, Fairfax, Virginia, 22030. In addition to our main office, we also maintain 9 additional branch offices in Arlington, Virginia; the independent city of Manassas, Virginia; Reston, Fairfax County, Virginia; and Springfield, Fairfax County, Virginia; Montgomery County and Baltimore, Maryland, and Washington, D.C. We also maintain an operations center in Manassas. We lease all but one of our office properties. We own our branch located in Baltimore, Maryland. We also lease a loan production office in Lutherville, Maryland.
We are committed to being highly selective in our branching decisions, and we intend to continue to explore opportunities for establishing additional strategically located branches in the Washington and Baltimore MSAs based primarily on commercial deposit and loan potential and demographic support. We typically establish branches as necessary to provide support for established business development people and lenders with substantial books of business and customer relationships.We believe that upon expiration of each of our leases we will be able to extend the lease on satisfactory terms or relocate to another acceptable location.

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ITEM 3. LEGAL PROCEEDINGS
Item 3. Legal Proceedings
In the ordinary course of our operations, we become party to various legal proceedings. Currently, we are not party to any material legal proceedings, and no such proceedings are, to management's knowledge, threatened against us.

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ITEM 4. MINE SAFETY DISCLOSURE
Item 4. Mine Safety Disclosures
None.
PART II

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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
Market Price for Common Stock and Dividends. Our common stock is currently listed on the Nasdaq Capital Market under the symbol "FVCB." As of March 18, 2021, there were 450 holders of record of our common stock and approximately 1,161 total beneficial shareholders.
Dividends
To date, we have not paid, and we do not currently intend to pay, a cash dividend on our common stock. Holders of our common stock are only entitled to receive dividends when, as and if declared by our board of directors out of funds legally available for dividends. As we are a bank holding company and do not engage directly in business activities of a material nature, our ability to pay dividends on our common stock depends, in large part, upon our receipt of dividends from the Bank. Any future determination relating to our dividend policy will be made by our 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 us to our shareholders or by the Bank to us, and such other factors as our board of directors may deem relevant.
Regulations of the Federal Reserve and Virginia law place limits on the amount of dividends the Bank may pay to the Company without prior approval. Prior regulatory approval is required to pay dividends which exceed the Bank's net profits for the current year plus its retained net profits for the preceding two calendar years, less required transfers to surplus. Under Virginia law, dividends may only be paid out of retained earnings. State and federal bank regulatory agencies also have authority to prohibit a bank from paying dividends if such payment is deemed to be an unsafe or unsound practice, and the Federal Reserve has the same authority over bank holding companies. 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 the common stock.
The Federal Reserve has established requirements with respect to the maintenance of appropriate levels of capital by registered bank holding companies. Compliance with such standards, as presently in effect, or as they may be amended from time to time, could possibly limit the amount of dividends that the Company may pay in the future. The Federal Reserve has issued guidance on the payment of cash dividends by bank holding companies. In the statement, the Federal Reserve expressed its view that a holding company experiencing earnings weaknesses should not pay cash dividends exceeding its net income, or which could only be funded in ways that weaken the holding company's financial health, such as by borrowing. Under Federal Reserve guidance, as a general matter, the board of directors of a holding company should inform the Federal Reserve and should eliminate, defer, or significantly reduce the dividends if: (i) the holding company's net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (ii) the holding company's prospective rate of earnings retention is not consistent with the capital needs and overall current and prospective financial condition; or (iii) the holding company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. As a depository institution, the deposits of which are insured by the FDIC, the Bank may not pay dividends or distribute any of its capital assets while it remains in default on any assessment due the FDIC. The Bank currently is not in default under any of its obligations to the FDIC.
Repurchases
No shares were repurchased during the three months ended December 31, 2021.
On February 4, 2020, we publicly announced that the Board of Directors had adopted a program to repurchase up to 8% of our outstanding shares of common stock at December 31, 2019; such program was set to expire on December 31, 2020. On January 21, 2021, we extended the share repurchase program and increased the number of shares subject to repurchase. Under the revised repurchase program, we may repurchase up to 1,080,860 shares of our common stock, or approximately 8% of our outstanding shares of common stock at December 31, 2020. The repurchase program expired on December 31, 2021. We have repurchased 487,531 shares of our common stock at a total cost of $7.3 million under the program. All of these shares have been cancelled and returned to the status of authorized but unissued.
On March 17, 2022, we publicly announced that the Board of Directors had adopted a program to repurchase up to 1,080,860 shares of our common stock, or approximately 8% of our outstanding shares of common stock at December 31, 2021, from April 1, 2022 to March 31, 2023. The timing and amount of repurchases, if any, will depend on market conditions, share price, trading volume, and other factors, and there is no assurance that we will purchase shares during any period. Shares may be repurchased in the open market or through privately negotiated transactions.

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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 following presents management's discussion and analysis of our consolidated financial condition at December 31, 2021 and 2020 and the results of our operations for the years ended December 31, 2021 and 2020. This discussion should be read in conjunction with our consolidated financial statements and the notes thereto appearing elsewhere in this report.
In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause results to differ materially from management's expectations.
Overview
We are a bank holding company headquartered in Fairfax County, Virginia. Our sole subsidiary, FVCbank, was formed in November 2007 as a community-oriented, locally-owned and managed commercial bank under the laws of the Commonwealth of Virginia. The Bank offers a wide range of traditional bank loan and deposit products and services to both our commercial and retail customers. Our commercial relationship officers focus on attracting small and medium sized businesses, commercial real estate developers and builders, including government contractors, non-profit organizations, and professionals. Our approach to our market features competitive customized financial services offered to customers and prospects in a personal relationship context by seasoned professionals.
On August 31, 2021, we announced that the Bank made an investment in ACM for $20.4 million to obtain a 28.7% ownership interest in ACM. This ownership interest is subject to an earnback option of up to 3.7% over the next three years. In addition, the Bank provides a warehouse lending facility to ACM, which includes a construction-to-permanent financing line, and has developed portfolio mortgage products to diversify our held to investment loan portfolio.
On October 12, 2018, we completed our acquisition of Colombo Bank ("Colombo"). Colombo, which was headquartered in Rockville, Maryland, merged into FVCbank effective October 12, 2018, adding five banking locations in Washington, D.C., and Montgomery County and the City of Baltimore in Maryland.
Net interest income is our primary source of revenue. We define revenue as net interest income plus noninterest income. As discussed further in "Quantitative and Qualitative Disclosures About Market Risk" below, we manage our balance sheet and interest rate risk exposure to maximize, and concurrently stabilize, net interest income. We do this by monitoring our liquidity position and the spread between the interest rates earned on interest-earning assets and the interest rates paid on interest-bearing liabilities. We attempt to minimize our exposure to interest rate risk, but are unable to eliminate it entirely. In addition to managing interest rate risk, we also analyze our loan portfolio for exposure to credit risk. Loan defaults and foreclosures are inherent risks in the banking industry, and we attempt to limit our exposure to these risks by carefully underwriting and then monitoring our extensions of credit. In addition to net interest income, noninterest income is a complementary source of revenue for us and includes, among other things, service charges on deposits and loans, income from minority membership interest in ACM, merchant services fee income, insurance commission income, income from bank owned life insurance ("BOLI"), and gains and losses on sales of investment securities available-for-sale.
On October 13, 2020, we completed our private placement of $20.0 million of our 4.875% fixed-to-floating subordinated notes due 2030 (the "Notes") to certain qualified institutional buyers and accredited investors. The Notes have a maturity date of October 15, 2030 and carry a fixed rate of interest of 4.875% for the first five years. Thereafter, the Notes will pay interest at 3-month SOFR plus 471 basis points, resetting quarterly. The Notes include a right of prepayment without penalty on or after October 15, 2025. The Notes have been structured to qualify as Tier 2 capital for regulatory purposes. The proceeds from the placement of the Notes have been used for general corporate purposes, including to support the capital ratios at the Bank, and the repayment of the $25.0 million outstanding subordinated debt which was called in full on September 30, 2021.
Critical Accounting Policies
General
The accounting principles we apply under GAAP are complex and require management to apply significant judgment to various accounting, reporting and disclosure matters. Management must use assumptions, judgments and estimates when applying these principles where precise measurements are not possible or practical. These policies are critical because they are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such judgments, assumptions and estimates may have a significant impact on the consolidated financial statements. Actual results, in fact, could differ from initial estimates.
The accounting policies we view as critical are those relating to judgments, assumptions and estimates regarding the determination of the allowance for loan losses, accounting for purchase credit-impaired loans, and fair value measurements.
Allowance for Loan Losses
We maintain the allowance for loan losses at a level that represents management's best estimate of known and inherent losses in our loan portfolio. We are not required to implement the provisions of the CECL until January 1, 2023, and are continuing to account for the allowance for loan losses under the incurred loss model. Both the amount of the provision expense and the level of the allowance for loan losses are impacted by many factors, including general and industry-specific economic conditions, actual and expected credit losses, historical trends and specific conditions of individual borrowers. Unusual and infrequently occurring events, such as weather-related disasters and health related events, such as COVID-19 pandemic and associated efforts to restrict the spread of the disease, may impact our assessment of possible credit losses. As a part of our analysis, we use comparative peer group data and qualitative factors such as levels of and trends in delinquencies, nonaccrual loans, charged-off loans, changes in volume and terms of loans, effects of changes in lending policy, experience and ability and depth of management, national and local economic trends and conditions and concentrations of credit, competition, and loan review results to support estimates.
The allowance for loan losses is based first on a segmentation of the loan portfolio by general loan type, or portfolio segments. For originated loans, certain portfolio segments are further disaggregated and evaluated collectively for impairment based on loan segments, which are largely based on the type of collateral underlying each loan. For purposes of this analysis, we categorize loans into one of five categories: commercial and industrial, commercial real estate, commercial construction, consumer residential, and consumer nonresidential loans. Typically, financial institutions use their historical loss experience and trends in losses for each loan category which are then adjusted for portfolio trends and economic and environmental factors in determining their allowance for loan losses. Since the Bank's inception in 2007, we have experienced minimal loss history within our loan portfolio. Because of this, our allowance model uses the average loss rates of similar institutions (our custom peer group) as a baseline which is then adjusted based on our particular qualitative loan portfolio characteristics and environmental factors. The indicated loss factors resulting from this analysis are applied for each of the five categories of loans.
Our peer group is defined by selecting commercial banking institutions of similar size within Virginia, Maryland and the District of Columbia. This is known as our custom peer group. The commercial banking institutions comprising the custom peer group can change based on certain factors including but not limited to the characteristics, size, and geographic footprint of the institution. We have identified 22 banks for our custom peer group which are within $1 billion to $3 billion in total assets, the majority of whom are geographically concentrated in the Washington, D.C. metropolitan area in which we operate, as this area has experienced more stable economic conditions than many other areas of the country. These baseline peer group loss rates are then adjusted based on an analysis of our loan portfolio characteristics, trends, economic considerations and other conditions that should be considered in assessing our credit risk. Our peer loss rates are updated on a quarterly basis.
The allowance for loan losses consists of specific and general components. The specific component relates to loans that are determined to be impaired and, therefore, individually evaluated for impairment. We individually assign loss factors to all loans that have been identified as having loss attributes, as indicated by deterioration in the financial condition of the borrower or a decline in underlying collateral value if the loan is collateral dependent. We evaluate the impairment of certain loans on a loan by loan basis for those loans that are adversely risk rated. Measurement of impairment is based on the expected future cash flows of an impaired loan, which are discounted at the loan's effective interest rate, or measured on an observable market value, if one exists, or the fair value of the collateral underlying the loan, discounted to consider estimated costs to sell the collateral for collateral-dependent loans. If the net collateral value is less than the loan
balance (including accrued interest and any unamortized premium or discount associated with the loan) we recognize an impairment and establish a specific reserve for the impaired loan.
Credit losses are an inherent part of our business and, although we believe the methodologies for determining the allowance for loan losses and the current level of the allowance are appropriate, it is possible that there may be unidentified losses in the portfolio at any particular time that may become evident at a future date pursuant to additional internal analysis or regulatory comment. Additional provisions for such losses, if necessary, would be recorded, and would negatively impact earnings.
Allowance for Loan Losses - Acquired Loans
Acquired loans accounted for under Accounting Standards Codification ("ASC") 310-30
For our acquired loans, to the extent that we experience a deterioration in borrower credit quality resulting in a decrease in our expected cash flows subsequent to the acquisition of the loans, an allowance for loan losses would be established based on our estimate of future credit losses over the remaining life of the loans through provision for loan loss expense.
Acquired loans accounted for under ASC 310-20
Subsequent to the acquisition date, we establish our allowance for loan losses through a provision for loan losses based upon an evaluation process that is similar to our evaluation process used for originated loans. This evaluation, which includes a review of loans on which full collectability may not be reasonably assured, considers, among other factors, the estimated fair value of the underlying collateral, economic conditions, historical net loan loss experience, carrying value of the loans, which includes the remaining net purchase discount or premium, and other factors that warrant recognition in determining our allowance for loan losses.
Purchased Credit-Impaired Loans
Purchased credit-impaired ("PCI") loans, which are the loans acquired in our acquisition of Colombo, are loans acquired at a discount (that is due, in part, to credit quality). These loans are initially recorded at fair value (as determined by the present value of expected future cash flows) with no allowance for loan losses. We account for interest income on all loans acquired at a discount (that is due, in part, to credit quality) based on the acquired loans' expected cash flows. The acquired loans may be aggregated and accounted for as a pool of loans if the loans being aggregated have common risk characteristics. A pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flow. The difference between the cash flows expected at acquisition and the investment in the loans, or the "accretable yield," is recognized as interest income utilizing the level-yield method over the life of each pool. Increases in expected cash flows subsequent to the acquisition are recognized prospectively through adjustment of the yield on the pool over its remaining life, while decreases in expected cash flows are recognized as impairment through a loss provision and an increase in the allowance for loan losses. Therefore, the allowance for loan losses on these impaired pools reflect only losses incurred after the acquisition (representing the present value of all cash flows that were expected at acquisition but currently are not expected to be received). At December 31, 2021, we had no specific reserves for any acquired loan within our allowance for loan losses that had further deteriorated post acquisition.
We periodically evaluate the remaining contractual required payments due and estimates of cash flows expected to be collected. These evaluations, performed quarterly, require the continued use of key assumptions and estimates, similar to the initial estimate of fair value. Changes in the contractual required payments due and estimated cash flows expected to be collected may result in changes in the accretable yield and non-accretable difference or reclassifications between accretable yield and the non-accretable difference. On an aggregate basis, if the acquired pools of PCI loans perform better than originally expected, we would expect to receive more future cash flows than originally modeled at the acquisition date. For the pools with better than expected cash flows, the forecasted increase would be recorded as an additional accretable yield that is recognized as a prospective increase to our interest income on loans.
Fair Value Measurements
We determine the fair values of financial instruments based on the fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value. Our investment securities available-for-
sale are recorded at fair value using reliable and unbiased evaluations by an industry-wide valuation service. This service uses evaluated pricing models that vary based on asset class and include available trade, bid, and other market information. Generally, the methodology includes broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs. Depending on the availability of observable inputs and prices, different valuation models could produce materially different fair value estimates. The values presented may not represent future fair values and may not be realizable.
LIBOR and Other Benchmark Rates
We have certain loans, interest rate swap agreements, investment securities, and debt obligations whose interest rate is indexed to LIBOR. In 2017, the Financial Conduct Authority (the authority that regulates LIBOR) announced its intention to stop compelling banks to submit rates for the calculation of LIBOR after 2021. In December 2020, the administrator of LIBOR announced its intention to (i) cease the publication of the one-week and two-month U.S. dollar LIBOR after December 31, 2021, and (ii) cease the publication of all other tenors of U.S. dollar LIBOR (one, three, six and 12 month LIBOR) after June 30, 2023. In October 2021, the federal bank regulatory agencies issued a Joint Statement on Managing the LIBOR Transition. In that guidance, the agencies offered their regulatory expectations and outlined potential supervisory and enforcement consequences for banks that fail to adequately plan for and implement the transition away from LIBOR. The failure to properly transition away from LIBOR may result in increased supervisory scrutiny.
Central banks and regulators around the world have commissioned working groups to find suitable replacements for Interbank Offered Rates ("IBOR") and other benchmark rates and to implement financial benchmark reforms more generally. These actions have resulted in uncertainty regarding the use of alternative reference rates ("ARRs") and could cause disruptions in a variety of markets, as well as adversely impact our business, operations and financial results.
To facilitate an orderly transition from IBORs and other benchmark rates to ARRs, we have established an enterprise-wide initiative led by senior management. The objective of this initiative is to identify, assess and monitor risks associated with the expected discontinuation or unavailability of benchmarks, including LIBOR, achieve operational readiness and engage impacted clients in connection with the transition to ARRs.To mitigate the risks associated with the expected discontinuation of LIBOR, we have ceased originating LIBOR-linked loans, implemented fallback language for LIBOR-linked commercial loans, adhered to the International Swaps and Derivatives Association 2020 Fallbacks Protocol for interest rate swap agreements, and have updated our systems to accommodate loans linked to the Secured Overnight Financing Rate ("SOFR"). In accordance with regulatory guidance, we ceased entering into new LIBOR transactions at the end of 2021 and have selected SOFR, as the rate that best represents an alternative to LIBOR. Uncertainty as to the adoption, market acceptance or availability of SOFR or other alternative reference rates may adversely affect the value of LIBOR-based loans and securities in our portfolio and may impact the availability and cost of hedging instruments and borrowings.
Financial Overview
For the years ended December 31, 2021 and 2020, we expanded our market area through continued organic growth, capitalizing on new customer relationships we obtained through our participation in the 2020 and 2021 PPP assistance.
•Total assets increased to $2.20 billion compared to $1.82 billion at December 31, 2021 and 2020, respectively, an increase of $381.4 million, or 20.9%. The increase in total assets is primarily attributable to our increase in deposits, which increased $351.3 million during 2021.
•Total loans, net of deferred fees, increased $37.8 million, or 2.6%, from December 31, 2020 to December 31, 2021. Excluding PPP loans, which decreased $124.8 million as a result of loan forgiveness, net loan growth was $162.6 million for the year ended December 31, 2021. Asset quality remains sound with nonperforming loans and loans past due 90 days or more as a percentage of total assets being 0.16% at December 31, 2021, compared to 0.31% at December 31, 2020.
•Total deposits increased $351.3 million, or 22.9%, from December 31, 2020 to December 31, 2021, the increase attributable to a combination of deposits from new customer relationships (many acquired through PPP originations) as well as growth in existing customer deposits.
•Tangible book value per share at December 31, 2021 was $14.70, an increase from $13.41 at December 31, 2020.
•Net income was $21.9 million for the year ended December 31, 2021 compared to $15.5 million for the same period of 2020. Our 2021 results were impacted by merger-related expenses totaling $1.4 million, which were associated with our previously announced proposed merger with Blue Ridge Bankshares, Inc. ("Blue Ridge"), which was mutually terminated by us and Blue Ridge on January 20, 2022. We also recorded one-time accelerated debt issuance costs of $380 thousand associated with the redemption of our 2016 subordinated debt issuance during the third quarter of 2021 and a gain on the sale of other real estate owned ("OREO") of $236 thousand during the fourth quarter of 2021. Excluding the merger-related expenses, accelerated debt issuance costs and gain on OREO, we would have recorded net income of $23.2 million for the year ended December 31, 2021. Our 2020 results were impacted by branch closure charges totaling $676 thousand, and excluding these charges, we would have recorded $16.0 million in net income for the year ended December 31, 2020. For a reconciliation of this non-GAAP information which excludes the effect of merger-related expenses, accelerated debt issuance costs, gain on sale of OREO and the impairment from branch closures, please refer to the table below.
Reconciliation of Net Income (GAAP) to Operating Earnings (Non-GAAP)
Years Ended December 31, 2021 and 2020
(Dollars in thousands, except per share data)
2021 2020
Net income (as reported) $ 21,933 $ 15,501
Add: impairment on branch closures - 676
Add: merger and acquisition expense 1,445 -
Add: Accelerated debt issuance costs 380 -
Subtract: Gains on sales of other real estate owned (236) -
Less: provision for income taxes associated with impairment and merger and acquisition expense (358) (142)
Non-GAAP Operating Earnings, excluding above items $ 23,164 $ 16,035
Earnings per share - basic (GAAP net income) $ 1.61 $ 1.14
Earnings per share - Non-GAAP expenses including provision for income taxes $ 0.09 $ 0.04
Earnings per share - basic (non-GAAP net income) $ 1.70 $ 1.18
Earnings per share - diluted (GAAP net income) $ 1.50 $ 1.10
Earnings per share - Non-GAAP expenses including provision for income taxes $ 0.09 $ 0.03
Earnings per share - diluted (non-GAAP net income) $ 1.59 $ 1.13
Return on average assets (GAAP net income) 1.11 % 0.91 %
Non-GAAP expenses including provision for income taxes 0.06 % 0.03 %
Return on average assets (non-GAAP net income) 1.17 % 0.94 %
Return on average equity (GAAP net income) 10.92 % 8.48 %
Non-GAAP expenses including provision for income taxes 0.61 % 0.29 %
Return on average equity (non-GAAP net income) 11.53 % 8.77 %
Below shows selected financial data for the periods ended December 31, 2021 and 2020.
Selected Financial Data
(Dollars and shares in thousands, except per share data)
Years Ended December 31,
Income Statement Data: 2021 2020
Interest income $ 68,428 $ 67,103
Interest expense 10,481 14,483
Net interest income 57,947 52,620
Provision for (reversal of) loan losses (500) 5,016
Net interest income after provision for (reversal of) loan losses 58,447 47,604
Non-interest income 4,302 2,891
Non-interest expense 34,540 30,838
Net income before income taxes 28,209 19,657
Provision for income taxes 6,276 4,156
Net income $ 21,933 $ 15,501
Balance Sheet Data:
Total assets $ 2,202,924 $ 1,821,481
Loans receivable, net of fees 1,503,849 1,466,083
Allowance for loan losses (13,829) (14,958)
Total investment securities 358,038 126,415
Total deposits 1,883,769 1,532,493
Other borrowed funds 44,510 69,085
Total shareholders' equity 209,796 189,500
Common shares outstanding 13,727 13,511
Per Common Share Data:
Basic net income $ 1.61 $ 1.14
Fully diluted net income 1.50 1.10
Book value 15.28 14.03
Tangible book value(1)
14.70 13.41
Performance Ratios:
Return on average assets 1.11 % 0.91 %
Return on average equity 10.92 8.48
Net interest margin(2)
3.09 3.28
Efficiency ratio(3)
55.49 55.55
Non-interest income to average assets 0.22 0.17
Non-interest expense to average assets 1.75 1.80
Loans receivable, net of fees to total deposits 79.83 95.67
Asset Quality Ratios:
Net charge-offs (recoveries) to average loans receivable, net of fees 0.04 % 0.02 %
Nonperforming loans to loans receivable, net of fees 0.23 0.38
Nonperforming assets to total assets 0.16 0.52
Allowance for loan losses to nonperforming loans 394.21 266.11
Allowance for loan losses to loans receivable, net of fees 0.92 1.02
Capital Ratios (Bank Only):
Tier 1 risk-based capital NA% NA%
Total risk-based capital NA NA
Common Equity Tier 1 capital NA NA
Leverage capital ratio 10.55 11.65
Other:
Average shareholders' equity to average total assets 10.15 % 10.70 %
Average loans receivable, net of fees to average total deposits 86.80 % 98.51 %
Average common shares outstanding:
Basic 13,650 13,542
Diluted 14,581 14,134
_________________________
(1)Tangible book value is calculated as total stockholders' equity, less goodwill and other intangible assets, divided by common shares outstanding.
(2)Net interest margin is calculated as net interest income divided by total average earning assets.
(3)Efficiency ratio is calculated as total non-interest expense divided by the total of net interest income and non-interest income.
Years Ended December 31,
Non-GAAP Reconciliation
(Dollars in thousands, except per share data) 2021 2020
Total stockholders' equity $ 209,796 $ 189,500
Less: goodwill and intangibles, net (8,052) (8,357)
Tangible Common Equity $ 201,744 $ 181,143
Book value per common share $ 15.28 $ 14.03
Less: intangible book value per common share (0.58) (0.62)
Tangible book value per common share $ 14.70 $ 13.41
Results of Operations-Years Ended December 31, 2021 and December 31, 2020
Overview
We recorded net income of $21.9 million, or $1.50 per diluted common share, for the year ended December 31, 2021, compared to net income of $15.5 million, or $1.10 per diluted common share for the year ended December 31, 2020. Our 2021 results were impacted by merger-related expenses totaling $1.4 million. We also recorded one-time accelerated debt issuance costs of $380 thousand associated with our redemption of our 2016 subordinated debt issuance during the third quarter of 2021 and a gain on the sale of OREO of $236 thousand. Excluding the merger-related expenses, accelerated debt issuance costs and gain on OREO and their related tax effects, we would have recorded net income of $23.2 million, or $1.59 per diluted common share, for the year ended December 31, 2021. Our 2020 results were impacted by one-time branch closure costs of $676 thousand and increased provision for loan losses. Excluding the branch closure costs, we would have recorded income of $16.0 million, or $1.13 per diluted common share, for the year ended December 31, 2020. See above table for a reconciliation of GAAP net income to operating earnings (non-GAAP).
Net interest income increased $5.3 million to $57.9 million for the year ended December 31, 2021, compared to $52.6 million for the year ended December 31, 2020, primarily as a result of decreases in the costs of interest-bearing deposits. For the year ended December 31, 2021, we released provision for loan losses totaling $500 thousand, compared to recording provision expense of $5.0 million for the same period of 2020 which was elevated primarily as a result of qualitative factors related to the COVID-19 pandemic. Noninterest income increased $1.4 million to $4.3 million for the year ended December 31, 2021 as compared to $2.9 million for 2020, primarily attributable to the Bank's income associated with its investment in ACM, recording $1.5 million during the year ended December 31, 2021. Noninterest expense was $34.5 million for the year ended December 31, 2021 compared to $30.8 million for the same period of 2020. Noninterest expense increased during 2021 primarily as a result of merger-related expenses totaling $1.4 million and additions to business development staffing and associated increases in incentive accruals.
The return on average assets for the years ended December 31, 2021 and 2020 was 1.11% and 0.91%, respectively. The return on average equity for the years ended December 31, 2021 and 2020 was 10.92% and 8.48%, respectively. Excluding merger-related expenses, accelerated debt issuance costs, and gain on sale of OREO recorded during 2021, return on average assets and return on average equity would have been 1.17% and 11.53%, respectively. Excluding branch closure costs and the associated taxes recorded during 2020, return on average assets and return on average equity for the year ended December 31, 2020 would have been 0.94% and 8.77%, respectively. See above table for a reconciliation of GAAP net income to operating earnings (non-GAAP).
Net Interest Income/Margin
The following table presents average balance sheet information, interest income, interest expense and the corresponding average yields earned and rates paid for the years ended December 31, 2021 and 2020.
Average Balance Sheets and Interest Rates on Interest-Earning Assets and Interest-Bearing Liabilities
Years Ended December 31, 2021 and 2020
(Dollars in thousands)
2021 2020
Average
Balance Interest
Income/
Expense Average
Yield/
Rate Average
Balance Interest
Income/
Expense Average
Yield/
Rate
Assets
Interest-earning assets:
Loans(1):
Commercial real estate $ 832,138 $ 35,104 4.22 % $ 777,545 $ 35,064 4.51 %
Commercial and industrial 135,017 6,127 4.54 % 107,980 5,891 5.46 %
Paycheck protection program 105,980 5,410 5.11 % 114,344 2,993 2.62 %
Commercial construction 209,957 9,790 4.66 % 222,708 10,343 4.64 %
Consumer residential 169,168 6,685 3.95 % 178,479 7,760 4.35 %
Consumer nonresidential 11,569 858 7.41 % 15,325 1,159 7.56 %
Total loans(1) 1,463,829 63,974 4.37 % 1,416,381 63,210 4.46 %
Investment securities(2) 204,952 3,878 1.89 % 120,074 3,185 2.65 %
Loans held for sale, at fair value - - - % 3,431 236 6.87 %
Restricted stock 6,269 328 5.24 % 6,331 342 5.41 %
Deposits at other financial institutions 197,987 260 0.13 % 60,587 153 0.25 %
Total interest-earning assets and interest income 1,873,037 68,440 3.65 % 1,606,804 67,126 4.18 %
Noninterest-earning assets:
Cash and due from banks 18,556 17,252
Premises and equipment, net 1,578 1,880
Accrued interest and other assets 99,562 95,346
Allowance for loan losses (14,513) (12,420)
Total assets $ 1,978,220 $ 1,708,862
Liabilities and Stockholders' Equity
Interest - bearing liabilities:
Interest - bearing deposits:
Interest checking $ 587,151 $ 3,224 0.55 % $ 363,408 $ 2,839 0.78 %
Savings and money markets 303,317 1,421 0.47 % 264,987 1,819 0.69 %
Time deposits 230,668 2,783 1.21 % 317,850 6,447 2.03 %
Wholesale deposits 37,657 173 0.46 % 100,885 1,228 1.22 %
Total interest - bearing deposits 1,158,793 7,601 0.66 % 1,047,130 12,333 1.18 %
Other borrowed funds 62,878 2,880 4.58 % 57,915 2,150 3.71 %
Total interest-bearing liabilities and interest expense 1,221,671 10,481 0.86 % 1,105,045 14,483 1.31 %
Noninterest-bearing liabilities:
Demand deposits 527,675 390,672
Other liabilities 27,988 30,327
Common stockholders' equity 200,886 182,818
Total liabilities and stockholders' equity $ 1,978,220 $ 1,708,862
Net interest income and net interest margin $ 57,959 3.09 % $ 52,643 3.28 %
________________________
(1)Non-accrual loans are included in average balances and do not have a material effect on the average yield. Interest income on non-accruing loans was not material for the years presented.
(2)The average yields for investment securities are reported on a fully taxable-equivalent basis at a rate of 21% for 2021 and 2020.
The level of net interest income is affected primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates. See "Quantitative and Qualitative Disclosures About Market Risk" below for further information. The following table shows the effect that these factors had on the interest earned from our interest-earning assets and interest incurred on our interest-bearing liabilities.
Rate and Volume Analysis
Years Ended December 31, 2021 and 2020
(Dollars in thousands)
2021 Compared to 2020
Average
Volume(3)
Average
Rate Increase
(Decrease)
Interest income:
Loans(1):
Commercial real estate $ 2,462 $ (2,422) $ 40
Commercial and industrial 1,475 (1,239) 236
Paycheck protection program (219) 2,636 2,417
Commercial construction (592) 39 (553)
Consumer residential (405) (670) (1,075)
Consumer nonresidential (284) (17) (301)
Total loans(1) 2,437 (1,673) 764
Investment securities(2) 2,251 (1,558) 693
Loans held for sale, at fair value (236) - (236)
Restricted stock (3) (11) (14)
Deposits at other financial institutions 347 (240) 107
Total interest income 4,796 (3,482) 1,314
Interest expense:
Interest - bearing deposits:
Interest checking 1,748 (1,363) 385
Savings and money markets 263 (661) (398)
Time deposits (1,768) (1,896) (3,664)
Wholesale deposits (770) (285) (1,055)
Total interest - bearing deposits (527) (4,205) (4,732)
Other borrowed funds 184 546 730
Total interest expense (343) (3,659) (4,002)
Net interest income $ 5,139 $ 177 $ 5,316
_________________________
(1)Non-accrual loans are included in average balances and do not have a material effect on the average yield. Interest income on non-accruing loans was not material for the years presented.
(2)The average yields for investment securities are reported on a fully taxable-equivalent basis at a rate of 21% for 2021 and 2020.
(3)Changes attributable to rate/volume have been allocated to volume.
Net interest income, on a tax equivalent basis, is a financial measure that we believe provides a more accurate picture of the interest margin for comparative purposes. To derive our net interest margin on a tax equivalent basis, net interest income is adjusted to reflect tax-exempt income on an equivalent before tax basis with a corresponding increase in income tax expense. For purposes of this calculation, we use our federal and state statutory tax rates for the periods presented. This measure ensures comparability of net interest income arising from taxable and tax-exempt sources.
The following table provides a reconciliation of our GAAP net interest income to our tax equivalent net interest income.
Supplemental Financial Data and Reconciliations to GAAP Financial Measures
Years Ended December 31, 2021 and 2020
(Dollars in thousands)
2021 2020
GAAP Financial Measurements:
Interest income:
Loans $ 63,974 $ 63,446
Deposits at other financial institutions 260 153
Investment securities available-for-sale 3,860 3,156
Investment securities held-to-maturity 6 6
Restricted stock 328 342
Total interest income 68,428 67,103
Interest expense:
Interest-bearing deposits 7,601 12,333
Other borrowed funds 2,880 2,150
Total interest expense 10,481 14,483
Net interest income $ 57,947 $ 52,620
Non-GAAP Financial Measurements:
Add: Tax benefit on tax-exempt interest income - securities 12 23
Total tax benefit on interest income $ 12 $ 23
Tax equivalent net interest income $ 57,959 $ 52,643
Net interest margin on a tax-equivalent basis 3.09 % 3.28 %
Net interest income for the year ended December 31, 2021 was $58.0 million on a fully taxable-equivalent basis, compared to $52.6 million for the year ended December 31, 2020, an increase of $5.3 million, or 10.1%. The increase in net interest income was primarily a result of a decrease in the cost of interest-bearing deposits, reflecting our efforts to decrease deposit rates in light of the current rate environment. During March 2020, in response to market conditions as the economy was impacted by COVID-19, the Federal Open Market Committee of the Federal Reserve reduced its targeted fed funds rate an unprecedented 150 basis points. We responded quickly by reducing deposit rates substantially to offset the repricing of the variable rate portion of our loan portfolio. During 2021, we continued to review interest rates on deposits and other borrowed funds and reduced rates where possible.
Our net interest margin, on a tax equivalent basis, for the years ended December 31, 2021 and 2020 was 3.09% and 3.28%, respectively. The decrease in our net interest margin was primarily a result of the decreased rate environment during 2021, which decreased the yields on interest-earning assets, partially offset by our decrease in the cost of our interest-bearing liabilities.
The yield on interest-earning assets decreased 53 basis points to 3.65% for the year ended December 31, 2021, compared to 4.18% for the same period of 2020, a result of the decreased rate environment during 2021. In addition, our excess liquidity, which was caused by the increase in our deposits and PPP forgiveness, contributed to the reduction of our net interest margin an additional 12 basis points for 2021. Offsetting this decrease in yields on earning assets was a 45 basis point decrease in the cost of interest-bearing liabilities, reflecting the decreases in rates we made to help offset the decreased yields on our earning assets during 2021.
Average interest-earning assets increased by 16.6% to $1.87 billion at December 31, 2021 compared to $1.61 billion at December 31, 2020, which resulted in an increase in total interest income on a tax equivalent basis of $1.3 million, to $68.4 million for the year ended December 31, 2021 compared to $67.1 million for the year ended December 31, 2020. While volume increased during 2021, contributing $4.8 million in additional interest income, the decreases in average rate significantly impacted interest income earned, decreasing interest income by $3.5 million.
Average loans receivable increased $47.4 million to $1.46 billion for the year ended December 31, 2021, compared to $1.42 billion for the year ended December 31, 2020. The yield on average loans decreased 9 basis points to 4.37% for the year ended December 31, 2021. The increase in average volume of loans receivable contributed $2.4 million to interest income. However, the increase in interest income on loans was impacted by a decrease in yields earned on the loan portfolio, which decreased interest income $1.7 million. Average balances of nonperforming loans, which consist of nonaccrual loans, are included in the net interest margin calculation and did not have a material impact on our net interest margin in 2021 and 2020.
Average investment securities increased $84.9 million to $205.0 million for the year ended December 31, 2021, compared to $120.1 million for the year ended December 31, 2020. The significant increase in average investment securities was primarily a result of the increase in liquidity at the Bank as a result of PPP loan forgiveness and an increase in deposits during 2021. This excess liquidity was invested in fixed income securities which increased interest income $693 thousand on a tax equivalent basis for the year ended December 31, 2021. The yield on average investment securities decreased 76 basis points to 1.89% for the year ended December 31, 2021, primarily as a result of purchasing securities at lower average yields relative to the average yield of the portfolio.
Average interest-earning deposits at other financial institutions, consisting primarily of excess cash reserves maintained at the FRB, increased $137.4 million to $198.0 million for the year ended December 31, 2021, compared to $60.6 million for the year ended December 31, 2020. The significant increase in average was primarily a result of our deposit growth during 2021. The yield on average interest-earning deposits decreased 12 basis points to 0.13% for the year ended December 31, 2021.
Total average interest-bearing deposits increased $111.7 million to $1.16 billion at December 31, 2021 compared to $1.05 billion at December 31, 2020. Average noninterest-bearing deposits increased $137.0 million, or 35.1%, to $527.7 million at December 31, 2021, compared to $390.7 million at December 31, 2020. The increase in total deposits, and specifically noninterest-bearing deposits, reflects a combination of new customer relationships (primarily from PPP originations) as well as growth in average deposit balances from existing customers. The largest increase in average interest-bearing deposit balances was in our interest checking accounts, which increased $223.7 million compared to 2020. Average time deposits decreased $87.2 million to $230.7 million as of December 31, 2021 compared to $317.9 million at December 31, 2020, as customers now prefer short-term deposit options such as interest checking accounts as a result of the low interest rate environment. Average wholesale deposits decreased $63.2 million to $37.7 million as of December 31, 2021 compared to $100.9 million as of December 31, 2020, as we have been able to reduce our reliance on wholesale funding due to other core sources of liquidity. This change in the mix of our interest-bearing liabilities, in addition to the action taken by the Bank to reduce deposit rates during 2020 and 2021, have contributed to the decrease in our cost of interest-bearing deposits to 0.66% in 2021 from 1.18% in 2020.
The cost of other borrowed funds, which include federal funds purchased, FHLB advances, and our subordinated notes, increased 87 basis points to 4.58% for the year ended December 31, 2021, from 3.71% for the same period in 2020, a result of the subordinated debt we issued during the fourth quarter of 2020 at 4.88% and the recognition of accelerated debt issuance costs of $380 thousand recorded during 2021.
Provision Expense and Allowance for Loan Losses
Our policy is to maintain the allowance for loan losses at a level that represents our best estimate of inherent losses in the loan portfolio. Both the amount of the provision and the level of the allowance for loan losses are impacted by many factors, including general and industry-specific economic conditions, actual credit losses, historical trends and specific conditions of individual borrowers. We are not required to implement the provisions of CECL until January 1, 2023, and we are continuing to account for the allowance for losses under the incurred loss model.
We recorded a release of provision for loan losses of $500 thousand for the year ended December 31, 2021 compared to a provision for loan losses of $5.0 million for the same period of 2020. The allowance for loan losses at December 31, 2021 was $13.8 million compared to $15.0 million at December 31, 2020. Our allowance for loan loss ratio as a percent of
total loans, net of deferred fees and costs, for December 31, 2021 and 2020 was 0.92% and 1.02%, respectively. The decrease in provision for loan losses during 2021 as compared to 2020 primarily reflects changes in certain qualitative factors as a result of the improvement in local economic conditions and the credit quality metrics of our loan portfolio during 2021 as well as a reduction in specific reserves on impaired loans. During 2021, we continued to evaluate our exposure to certain credit risks within industry segments in our loan portfolio that are most impacted by the pandemic and for those loans that have deferred payments. Industry subgroups such as retail, hotels, churches, and other commercial real estate loans were isolated within our allowance model, in addition to those loans deferring payments, and qualitative factors were adjusted to increase reserves for these loans as a result of their risk profiles during 2020. As a result of the improvement in the performance of these pandemic impacted loans, we eliminated the additional reserves recorded for these loans during 2021. Specific reserves decreased $1.9 million to $186 thousand for the year ended December 31, 2021, compared to $2.1 million at December 31, 2020, as a result of the impairment analysis completed for impaired loans during 2021.
See "Asset Quality" section below for additional information on the credit quality of the loan portfolio.
Noninterest Income
The following table provides detail for non-interest income for the years ended December 31, 2021 and 2020.
Non-Interest Income
Years Ended December 31, 2021 and 2020
(Dollars in thousands)
Change from Prior Year
2021 2020 Amount Percent
Service charges on deposit accounts $ 1,028 $ 1,008 $ 20 2.0 %
Fees on loans 110 511 (401) (78.5) %
Gain on sale of securities available-for-sale - 141 (141) (100.0) %
Loss on loans held for sale - (451) 451 100.0 %
BOLI income 994 1,109 (115) (10.4) %
Income from minority membership interest 1,464 - 1,464 100.0 %
Other fee income 706 573 133 23.2 %
Total non-interest income $ 4,302 $ 2,891 $ 1,411 48.8 %
Noninterest income includes service charges on deposits and loans, loan swap fee income, income from our membership interest in ACM, income from our BOLI policies, and other fee income, and continues to supplement our operating results. Noninterest income for the years ended December 31, 2021 and 2020 was $4.3 million and $2.9 million, respectively, an increase of $1.4 million, or 48.8%. The increase in noninterest income for the year ended December 31, 2021 was primarily attributable to the Bank's income associated with its investment in ACM, recording $1.5 million during 2021. Fee income from service charges on deposits and other fee income was $1.7 million for the year ended December 31, 2021, an increase of 9.7%, as compared $1.6 million for the same period of 2020, primarily a result of an increase in customer deposit relationships over the past year. There were no loan swap fees for the year ended December 31, 2021 compared to $378 thousand for the year ended December 31, 2020. Income from BOLI decreased 10.4% to $994 thousand for the year ended December 31, 2021 as compared to $1.1 million for the year ended December 31, 2020. Noninterest income for the year ended December 31, 2020 included gains on the sale of securities available-for-sale totaling $141 thousand. These securities were sold as they had larger premiums susceptible to prepayment risk, decreasing future interest income. There were no gains on security sales during 2021. Noninterest income for 2020 were impacted by losses on loans held for sale totaling $451 thousand. Loans held for sale were comprised of consumer unsecured loans which were transferred to held for sale at the end of 2019. On April 1, 2020, we transferred these loans back to held for investment at the lower of cost or market as the market for these types of loans receded due to market volatility as a result of the COVID-19 pandemic.
Noninterest Expense
The following table reflects the components of non-interest expense for the years ended December 31, 2021 and 2020.
Non-Interest Expense
Years Ended December 31, 2021 and 2020
(Dollars in thousands)
Change from Prior Year
2021 2020 Amount Percent
Salaries and employee benefits $ 18,980 $ 16,815 $ 2,165 12.9 %
Occupancy and equipment expense 3,290 3,329 (39) (1.2) %
Data processing and network administration 2,203 2,028 175 8.6 %
State franchise taxes 1,983 1,864 119 6.4 %
Audit, legal and consulting fees 1,489 986 503 51.0 %
Merger and acquisition expense 1,445 - 1,445 100.0 %
Loan related expenses 1,247 1,087 160 14.7 %
FDIC insurance 770 748 22 2.9 %
Marketing, business development and advertising 220 222 (2) (0.9) %
Director fees 651 554 97 17.5 %
Postage, courier and telephone 190 178 12 6.7 %
Internet banking 542 517 25 4.8 %
Dues, memberships & publications 174 131 43 32.8 %
Bank insurance 411 373 38 10.2 %
Printing and supplies 104 149 (45) (30.2) %
Bank charges 118 72 46 63.9 %
State assessments 167 209 (42) (20.1) %
Core deposit intangible amortization 305 345 (40) (11.6) %
Gain on sale of other real estate owned (236) - (236) (100.0) %
Impairment on branch closures - 676 (676) (100.0) %
Other operating expenses 487 555 (68) (12.3) %
Total non-interest expense $ 34,540 $ 30,838 $ 3,702 12.0 %
Noninterest expense includes, among other things, salaries and benefits, occupancy and equipment costs, professional fees, data processing, insurance and miscellaneous expenses. Noninterest expense was $34.5 million and $30.8 million for the years ended December 31, 2021 and 2020, respectively, an increase of $3.7 million, or 12.0%.
Salaries and benefits expense increased $2.2 million to $19.0 million for the year ended December 31, 2021 compared to $16.8 million for the same period in 2020, which was primarily related to additions to business development staff and associated accruals for incentive compensation during 2021. Merger-related expenses associated with our proposed merger totaled $1.4 million for the year ended December 31, 2021. Audit, legal and consulting fees increased $503 thousand to $1.5 million for the year ended December 31, 2021 as compared to the same period of 2020, primarily as a result of expenses incurred as a result of our membership interest purchase of ACM. Offsetting a portion of these increases is recorded gains of $236 thousand related to our sale of our OREO property during the fourth quarter of 2021.
During the third quarter of 2020, we closed two branch office locations. Because of the COVID-19 pandemic, more clients have transitioned to our electronic banking products, reducing the need to have physical branch locations to serve our customers. The right-of-use assets and leasehold improvements written off as a result of closing these locations totaled $676 thousand. Annual costs savings for the closure of these locations related to occupancy expense is expected to be approximately $350 thousand, of which, we began to see a portion of those cost savings during the fourth quarter of 2020, which contributed to the decrease in occupancy expense year-over-year. Other savings of approximately $250 thousand
include salaries and benefits expense as the employees for each of these locations filled other vacant positions with the Bank, reducing the need to hire additional personnel.
Income Taxes
We recorded a provision for income tax expense of $6.3 million for the year ended December 31, 2021, an increase of $2.1 million, or 51.0%, compared to $4.2 million for the year ended December 31, 2020. Our effective tax rate for December 31, 2021 was 22.2%, compared to 21.1% for 2020. Our effective tax rate for 2021 is more than the statutory rate of 21% as a result of nondeductible merger expenses recorded during 2021.
Discussion and Analysis of Financial Condition
Overview
At December 31, 2021, total assets were $2.20 billion, an increase of 20.9%, or $381.4 million, from $1.82 billion at December 31, 2020. Total loans receivable, net of deferred fees and costs, increased 2.6%, or $37.8 million, to $1.50 billion at December 31, 2021, from $1.47 billion at December 31, 2020. Total investment securities increased by $231.6 million, or 183.2%, to $358.0 million at December 31, 2021, from $126.4 million at December 31, 2020. Total deposits increased 22.9%, or $351.3 million, to $1.88 billion at December 31, 2021, from $1.53 billion at December 31, 2020. From time to time, we may utilize other borrowed funds such as federal funds purchased and FHLB advances as an additional funding source for the Bank. The Bank had FHLB advances outstanding of $25.0 million at each of December 31, 2021 and 2020. At December 31, 2021, we had $19.5 million in subordinated notes, a decrease of $24.6 million, as we redeemed in full our 2016 issuance of subordinated debt totaling $25.0 million on September 30, 2021.
Loans Receivable, Net
Total loans receivable, net of deferred fees and costs, were $1.50 billion at December 31, 2021, an increase of $37.8 million, or 2.6%, compared to $1.47 billion at December 31, 2020. Excluding PPP loans, which decreased $124.8 million as a result of loan forgiveness, net loan growth was $162.6 million for the year ended December 31, 2021. During the second quarter of 2021, we began originating loans under a warehouse lending facility to ACM, which contributed $72.0 million to our loan growth during 2021.
PPP loans, net of deferred fees and costs, totaled $28.1 million at December 31, 2021, a decrease from $153.0 million at December 31, 2020. Loans forgiven during 2021 totaled $193.3 million. Net deferred fees associated with PPP loans totaled $568 thousand at December 31, 2021.
Commercial real estate loans totaled $906.1 million at December 31, 2021, or 60.1% of total loan receivable, compared to $790.0 million at December 31, 2020, an increase of $116.1 million, or 14.7%. Owner-occupied commercial real estate loans were $191.8 million at December 31, 2021 compared to $182.9 million at December 31, 2020. Nonowner-occupied commercial real estate loans were $714.3 million at December 31, 2021 compared to $607.5 million at December 31, 2020. Construction loans totaled $187.6 million at December 31, 2021, or 12.5% of total loans receivable. Of the $187.6 million in construction loans, $47.6 million are collateralized by land, and lot acquisition and development loans (which have a higher degree of credit risk than the remaining portion of the construction portfolio) totaled $5.0 million at December 31, 2021. Our commercial real estate portfolio, including construction loans, is diversified by asset type and geographic concentration. We plan to manage this portion of our portfolio in a disciplined manner. We have comprehensive policies to monitor, measure, and mitigate our loan concentrations within this portfolio segment, including rigorous credit approval, monitoring and administrative practices.
Commercial and industrial loans, excluding PPP loans, increased $54.5 million to $174.1 million at December 31, 2021, from $119.5 million at December 31, 2020. Consumer residential loans increased $32.7 million to $200.6 million at December 31, 2021, from $167.9 million at December 31, 2020, the increase primarily a result of ACM warehouse lending facility activity, which is secured by individual real estate loans. These loans are repurchased by ACM if not sold to ultimate investor within 60 days of settlement.
The following table sets forth the repricing characteristics and sensitivity to interest rate changes of our loan portfolio at December 31, 2021.
Loan Maturities and Interest Rate Sensitivity
At December 31, 2021
(Dollars in thousands)
One Year
or Less Between One
and Five Years Between Five and Fifteen Years After Fifteen Years Total
Commercial real estate $ 48,594 $ 403,051 $ 454,127 $ 340 $ 906,112
Commercial and industrial 37,444 87,404 6,165 43,038 174,051
Paycheck protection program 6,338 22,361 - - 28,699
Commercial construction 53,735 100,205 33,675 - 187,615
Consumer residential 50,356 66,719 60,031 23,498 200,604
Consumer nonresidential 5,307 902 1,175 2,920 10,304
Total loans receivable $ 201,774 $ 680,642 $ 555,173 $ 69,796 $ 1,507,385
Fixed-rate loans $ 105,679 $ 439,438 $ 364,406 $ 9,977 $ 919,500
Floating-rate loans 96,095 241,204 190,767 59,819 587,885
$ 201,774 $ 680,642 $ 555,173 $ 69,796 $ 1,507,385
________________________
*Payments due by period are based on the repricing characteristics and not contractual maturities.
Asset Quality
Nonperforming assets, defined as nonaccrual loans, loans contractually past due 90 days or more as to principal or interest and still accruing, and OREO at December 31, 2021 were $3.5 million compared to $9.5 million at December 31, 2020. Our ratio of nonperforming assets to total assets was 0.16% at December 31, 2021 compared to 0.52% at December 31, 2020. TDRs, as of December 31, 2021 and 2020 totaled $92 thousand and $97 thousand, respectively.
Nonperforming loans, which are primarily commercial real estate and commercial and industrial loans, decreased $2.1 million during 2021 as compared to 2020. Loans that we have classified as nonperforming are a result of customer specific deterioration, mostly financial in nature, and not a result of economic, industry, or environmental causes that we might see as a pattern for possible future losses within our loan portfolio. For each of our criticized assets, we conduct an impairment analysis to determine the level of additional or specific reserves required for any portion of the loan that may result in a loss. As a result of the analysis completed, we have specific reserves totaling $186 thousand and $2.1 million at December 31, 2021 and 2020, respectively. Because these loans are individually evaluated for impairment, nonperforming loans are excluded from the general reserve allocation.
We categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, collateral adequacy, credit documentation, and current economic trends, among other factors. We analyze loans individually by classifying the loans as to credit risk. This analysis includes, larger non-homogeneous loans such as commercial real estate and commercial and industrial loans. This analysis is performed on an ongoing basis as new information is obtained. At December 31, 2021, we had $3.0 million in loans identified as special mention within the originated loan portfolio, a decrease of $9.1 million from December 31, 2020. Special mention rated loans are loans that have a potential weakness that deserves management's close attention; however, the borrower continues to pay in accordance with their contract. The decrease from December 31, 2020 is a result of a significant number of loans being either upgraded or having been paid off during 2021. These loans do not have a specific reserve and are considered well-secured.
At December 31, 2021, we had $19.0 million in loans identified as substandard within the originated loan portfolio, an increase of $1.9 million from December 31, 2020. Substandard rated loans are loans that are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. For each of these substandard loans, a liquidation analysis is completed. At December 31, 2021, specific reserves on originated and acquired loans totaling $186 thousand, have been allocated within the allowance for loan losses to supplement any shortfall of collateral.
We recorded annualized net charge-offs of 0.04% and 0.02% for the years ended December 31, 2021 and 2020, respectively. The following tables provide additional information on our asset quality for the periods presented.
Nonperforming Assets
At December 31, 2021 and 2020
(Dollars in thousands)
2021 2020
Nonperforming assets:
Nonaccrual loans $ 3,485 $ 5,349
Loans contractually past-due 90 days or more 23 272
Total nonperforming loans (NPLs) $ 3,508 $ 5,621
Other real estate owned (OREO) - 3,866
Total nonperforming assets (NPAs) $ 3,508 $ 9,487
Performing troubled debt restructurings (TDRs) $ 92 $ 97
NPLs/Total Assets 0.16 % 0.31 %
NPAs/Total Assets 0.16 % 0.52 %
NPAs and TDRs/Total Assets 0.16 % 0.53 %
Allowance for loan losses/NPLs 394.21 % 266.11 %
At December 31, 2021 and 2020, there were no performing loans considered a potential problem loan. Potential problem loans are defined as loans that are not included in the 90 day past due, nonaccrual or adversely classified or restructured categories, but for which known information about possible credit problems causes management to be uncertain as to the ability of the borrowers to comply with the present loan repayment terms which may in the future result in disclosure in the past due, nonaccrual or restructured loan categories. We take a conservative approach with respect to risk rating loans in our portfolio. Based upon the status as a potential problem loan, these loans receive heightened scrutiny and ongoing intensive risk management. Additionally, our loan loss allowance methodology incorporates increased reserve factors for certain loans that are adversely rated but not impaired as compared to the general portfolio.
We have evaluated our exposure to credit risks directly related to the COVID-19 pandemic. During 2020, as a result of the COVID-19 pandemic, we implemented loan payment deferral programs to allow customers who were required to close or reduce business operations to defer loan principal and interest payments primarily for 90 days. During the first and second quarters of 2020, we modified 277 loans for a total outstanding principal balance of $360.2 million, or 24.4% of the total loan portfolio. At December 31, 2021, remaining payment deferred loans totaled $10.6 million, or 0.71% of the total loan portfolio, comprising two loans. One loan is a hotel participation loan totaling $9.7 million and the second is a commercial real estate mixed use loan totaling $955 thousand.
We believe that as a result of our conservative underwriting discipline at loan origination coupled with the active dialogue we have had with our borrowers, we have the ability and necessary flexibility to assist our customers through this pandemic.
At December 31, 2020, we had one OREO property with a fair value of $3.9 million. In 2021, we sold this property and recognized a gain of approximately $236,000.
While our loan growth has continued to be strong, unexpected changes in economic growth could adversely affect our loan portfolio, including causing increases in delinquencies and default rates, which would adversely impact our charge-offs and provision for loan losses. Deterioration in real estate values, employment data and household incomes may also result in higher credit losses for us. Also, in the ordinary course of business, we may also be subject to a concentration of credit risk to a particular industry, counterparty, borrower or issuer. At December 31, 2021, our commercial real estate portfolio (including construction lending) was 72.6% of our total loan portfolio. A deterioration in the financial condition or prospects of a particular industry or a failure or downgrade of, or default by, any particular entity or group of entities could negatively impact our business, perhaps materially, and the systems by which we set limits and monitor the level of our credit exposure to individual entities and industries, may not function as we have anticipated.
See "Critical Accounting Policies" above for more information on our allowance for loan losses methodology.
The following tables present additional information pertaining to the activity in and allocation of the allowance for loan losses by loan type and the percentage of the loan type to the total loan portfolio. The allocation of the allowance for loan losses to a category of loans is not necessarily indicative of future losses or charge-offs, and does not restrict the use of the allowance to any specific category of loans.
Allowance for Loan Losses
Years Ended December 31, 2021 and 2020
(Dollars in thousands)
2021 2020
Net (charge-offs) recoveries Percentage of net charge-offs (annualized) to average loans outstanding during the year Net (charge-offs) recoveries Percentage of net charge-offs (annualized) to average loans outstanding during the year
Commercial real estate $ (453) (0.03) % $ (106) (0.01) %
Commercial and industrial (117) (0.01) % 62 - %
Consumer residential 35 - % (39) - %
Consumer nonresidential (94) (0.01) % (206) (0.01) %
Total $ (629) (0.04) % $ (289) (0.02) %
Average loans outstanding during the period $ 1,463,829 $ 1,416,381
Allowance for loan losses to loans receivable, net of fees 0.92 % 1.02 %
Allowance for loan losses to loans receivable, net of fees, excluding PPP 0.94 % 1.14 %
Allocation of the Allowance for Loan Losses
At December 31, 2021 and 2020
(Dollars in thousands)
2021 2020
Allocation % of Total*
Allocation % of Total*
Commercial real estate $ 8,995 60.11 % $ 9,291 53.69 %
Commercial and industrial 1,827 11.55 % 2,546 8.12 %
Paycheck protection program - 1.90 % - 10.59 %
Commercial construction 2,009 12.45 % 1,960 15.11 %
Consumer residential 781 13.31 % 690 11.41 %
Consumer nonresidential 217 0.68 % 471 1.08 %
Unallocated - 0.00 % - 0.00 %
Total allowance for loan losses $ 13,829 100.00 % $ 14,958 100.00 %
___________________
*Percentage of loan type to the total loan portfolio.
Investment Securities
Our investment securities portfolio is used as a source of income and liquidity. The investment portfolio consists of investment securities available-for-sale and investment securities held-to-maturity. Investment securities available-for-sale are those securities that we intend to hold for an indefinite period of time, but not necessarily until maturity. These securities are carried at fair value and may be sold as part of an asset/liability strategy, liquidity management or regulatory capital management. Investment securities held-to-maturity were $264 thousand at each of December 31, 2021 and 2020, and are those securities that we have the intent and ability to hold to maturity and are carried at amortized cost. The fair value of our investment securities available-for-sale was $357.8 million at December 31, 2021, an increase of $231.6 million, or 183.6%, from $126.2 million at December 31, 2020. During 2021, we purchased $245.7 million in available-for-sale investment securities to invest excess liquidity and reinvest cashflows received from the investment portfolio and PPP forgiveness.
As of December 31, 2021 and 2020, the majority of the investment securities portfolio consisted of securities rated AAA by a leading rating agency. Investment securities that carry a AAA rating are judged to be of the best quality and carry the smallest degree of investment risk. All of our mortgage-backed securities are guaranteed by either the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, or the Government National Mortgage Association. Investment securities that were pledged to secure public deposits totaled $85.6 million and $9.2 million at December 31, 2021 and December 31, 2020, respectively.
We complete reviews for other-than-temporary impairment at least quarterly. At December 31, 2021 and December 31, 2020, only investment grade securities were in an unrealized loss position. Investment securities with unrealized losses are a result of pricing changes due to recent and negative conditions in the current market environment and not as a result of permanent credit impairment. Contractual cash flows for the agency mortgage-backed securities are guaranteed and/or funded by the U.S. government. Municipal securities have third party protective elements and there are no negative indications that the contractual cash flows will not be received when due. We do not intend to sell nor do we believe we will be required to sell any of our temporarily impaired securities prior to the recovery of the amortized cost.
No other-than-temporary impairment has been recognized for the securities in our investment portfolio as of December 31, 2021, and December 31, 2020.
We hold restricted investments in equities of the FRB and FHLB. At December 31, 2021, we owned $1.8 million in FHLB stock and $4.4 million in FRB stock. At December 31, 2020, we owned $2.4 million in FHLB stock and $4.0 million in FRB stock.
The following table presents the weighted average yields of our investment portfolio for each of the maturity ranges at December 31, 2021 and 2020.
Investment Securities by Stated Maturity
At December 31, 2021 and 2020
(Dollars in thousands)
Within One Year One to Five Years Five to Ten Years Over Ten Years Total
Weighted
Average
Yield Weighted
Average
Yield Weighted
Average
Yield Weighted
Average
Yield Weighted
Average
Yield
Held-to-maturity
Securities of state and local municipalities tax exempt - - 2.32 % - 2.32 %
Total held-to-maturity securities - - 2.32 % - 2.32 %
Available-for-sale
Securities of U.S. government and federal agencies - - 1.49 % - 1.49 %
Securities of state and local municipalities - 2.25 % - % 2.92 % 2.45 %
Corporate bonds - 3.98 % 4.15 % - 4.12 %
Mortgaged-backed securities - - 2.21 % 1.53 % 1.57 %
Total available-for-sale securities - 3.27 % 2.51 % 1.53 % 1.68 %
Total investment securities - 3.27 % 2.51 % 1.53 % 1.68 %
Within One Year One to Five Years Five to Ten Years Over Ten Years Total
Weighted
Average
Yield Weighted
Average
Yield Weighted
Average
Yield Weighted
Average
Yield Weighted
Average
Yield
Held-to-maturity
Securities of state and local municipalities tax exempt - - 2.32 % - 2.32 %
Total held-to-maturity securities - - 2.32 % - 2.32 %
Available-for-sale
Securities of state and local municipalities - 2.29 % 2.25 % 2.98 % 2.58 %
Corporate bonds - 2.77 % 5.26 % - 4.88 %
Mortgaged-backed securities - - 2.19 % 2.08 % 2.09 %
Total available-for-sale securities - 2.53 % 3.37 % 2.09 % 2.40 %
Total investment securities - 2.53 % 3.36 % 2.09 % 2.40 %
Deposits and Other Borrowed Funds
The following table sets forth the average balances of deposits and the percentage of each category to total average deposits for the years ended December 31, 2021 and 2020:
Average Balance
(Dollars in thousands) 2021 2020
Noninterest-bearing demand $ 527,675 31.29 % $ 390,672 27.17 %
Interest-bearing deposits
Interest checking 587,151 34.82 % 363,408 25.28 %
Savings and money markets 303,317 17.99 % 264,987 18.43 %
Certificate of deposits, $100,000 to $249,999 58,453 3.47 % 82,626 5.75 %
Certificate of deposits, $250,000 or more 172,215 10.21 % 235,224 16.36 %
Other time deposits 37,657 2.22 % 100,885 7.01 %
Total $ 1,686,468 100.00 % $ 1,437,802 100.00 %
Total deposits were $1.88 billion at December 31, 2021, an increase of $351.3 million, or 22.9%, from $1.53 billion at December 31, 2020. Noninterest-bearing deposits totaled $581.3 million at December 31, 2021, comprising 30.9% of total deposits and increased $182.2 million, or 45.7%, compared to December 31, 2020. The increase in total deposits during 2021 reflects a combination of new customer relationships (including those new customers we assisted in their PPP loan originations) as well as growth in deposit balances from existing customers.
Wholesale deposits decreased to $35.0 million at December 31, 2021, from $50.0 million at December 31, 2020. In addition, we are a member of the IntraFi Network ("IntraFi"), which gives us the ability to offer Certificates of Deposit Account Registry Service ("CDARS"), and Insured Cash Sweep ("ICS"), products to our customers who seek to maximize FDIC insurance protection. When a customer places a large deposit with us for IntraFi, funds are placed into certificates of deposit or other deposit products with other banks in the CDARS and ICS networks in increments of less than $250 thousand so that principal and interest are eligible for FDIC insurance protection. These deposits are part of our core deposit base. At December 31, 2021 and December 31, 2020, we had $186.0 million and $138.9 million, respectively, in either CDARS reciprocal or ICS reciprocal products. The increase from December 31, 2020 is a result of certain customers wanting additional FDIC insurance protection as a result of the pandemic in addition to increases in customer deposit activity in these products.
As of December 31, 2021 and 2020, the estimated amount of total uninsured deposits were $901.1 million and $653.2 million, respectively. The estimate of uninsured deposits generally represents the portion of deposit accounts that exceed the FDIC insurance limit of $250,000 and is calculated based on the same methodologies and assumptions used for purposes of the Bank's regulatory reporting requirements. The following table reports maturities of the estimated amount of uninsured certificates of deposit at December 31, 2021.
Certificates of Deposit Greater than $250,000
At December 31, 2021
(Dollars in thousands)
Three months or less $ 18,554
Over three months through six months 18,856
Over six months through twelve months 37,867
Over twelve months 14,418
$ 89,695
Other borrowed funds, which include federal funds purchased, FHLB advances, and our subordinated notes, were $44.5 million at December 31, 2021, and $69.1 million at December 31, 2020. For each of December 31, 2021 and 2020, we had $25.0 million in FHLB advances. Subordinated debt, net of unamortized issuance costs, totaled $19.5 million and $44.1 million at December 31, 2021 and 2020, respectively. For each of December 31, 2021 and 2020, we had no federal funds purchased.
At September 30, 2021, we redeemed our 2016 subordinated debt which totaled $25.0 million. As such, our subordinated debt at December 31, 2021 decreased to $19.5 million from $44.1 million at December 31, 2020.
On October 13, 2020, we completed our private placement of $20 million of our 4.875% fixed-to-floating rate subordinated notes due 2030 to certain qualified institutional buyers and accredited investors. The Notes have a maturity date of October 15, 2030 and carry a fixed rate of interest of 4.875% for the first five years. Thereafter, the Notes will pay interest at 3-month SOFR plus 471 basis points, resetting quarterly. The Notes include a right of prepayment without penalty on or after October 15, 2025. The Notes have been structured to qualify as Tier 2 capital for regulatory purposes. We have used the proceeds from the placement of the Notes for general corporate purposes, including to support our capital ratios at the Bank, and the repayment of our $25.0 million outstanding subordinated debt which was called on September 30, 2021.
Capital Resources
Capital adequacy is an important measure of financial stability and performance. Our objectives are to maintain a level of capitalization that is sufficient to sustain asset growth and promote depositor and investor confidence.
Regulatory agencies measure capital adequacy utilizing a formula that takes into account the individual risk profile of the financial institution. The minimum capital requirements are: (i) CET1 capital ratio of 4.5%; (ii) a Tier 1 to risk-based assets capital ratio of 6%; (iii) a total risk based capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. Additionally, a capital conservation buffer requirement of 2.5% of risk-weighted assets is designed to absorb losses during periods of economic stress and is applicable to our CET1 capital, Tier 1 capital and total capital ratios. Including the conservation buffer, we currently consider our minimum capital ratios to be as follows: 7.00% for CET1; 8.50% for Tier 1 capital; and 10.50% for Total capital. Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the minimum plus the conservation buffer will face constraints on dividends, equity repurchases, and compensation.
On January 1, 2020, the federal banking agencies adopted a CBLR, which is calculated by dividing tangible equity capital by average consolidated total assets. If a "qualified community bank," generally a depository institution or depository institution holding company with consolidated assets of less than $10 billion, opts into the CBLR framework and has a leverage ratio that exceeds the CBLR threshold, which was initially set at 9%, then such bank will be considered to have met all generally applicable leverage and risk based capital requirements under Basel III, the capital ratio requirements for "well capitalized" status under Section 38 of the FDIA, and any other leverage or capital requirements to which it is subject. A bank or holding company may be excluded from qualifying community bank status base on its risk profile, including consideration of its off-balance sheet exposures; trading assets and liabilities; total notional derivatives exposures and such other facts as the appropriate federal banking agencies determine to be appropriate.
At January 1, 2020, we qualified for and adopted this simplified capital structure, however, there can be no assurance that satisfaction of the CBLR will provide adequate capital for our operations and growth, or an adequate cushion against increased levels of nonperforming assets or weakened economic conditions.
Stockholders' equity at December 31, 2021 was $209.8 million, an increase of $20.3 million, compared to $189.5 million at December 31, 2020. The increase in stockholders' equity was primarily attributable to the recognition of net income of $21.9 million for the year ended December 31, 2021. Common stock issued as a result of option exercises increased stockholders' equity by $1.2 million for the year ended December 31, 2021. Accumulated other comprehensive income (loss) decreased $3.9 million during 2021, primarily as a result of a decrease in the market value of our available-for-sale investment securities portfolio.
Total stockholders' equity to total assets for December 31, 2021 was 9.52% and for December 31, 2020 was 10.4%. Tangible book value per shares (a non-GAAP financial measure which is defined in the table below) at December 31, 2021 and December 31, 2020 was $14.70 and $13.41, respectively. The Bank's CBLR at December 31, 2021 and 2020 was 10.53% and 11.65%, respectively. Accordingly, we were considered "well capitalized" for regulatory purposes at December 31, 2021 and December 31, 2020.
As noted above, regulatory capital levels for the bank meets those established for "well capitalized" institutions. While we are currently considered "well capitalized," we may from time to time find it necessary to access the capital markets to meet our growth objectives or capitalize on specific business opportunities.
As the Company is a bank holding company with less than $3 billion in assets, and which does not (i) conduct significant off balance sheet activities, (ii) engage in significant non-banking activities, and (iii) have a material amount of securities registered under the Securities Exchange Act of 1934 (the "Exchange Act"), it is not currently subject to risk-based capital requirements adopted by the Federal Reserve, pursuant to the small bank holding company policy statement. The Federal Reserve has not historically deemed a bank holding company ineligible for application of the small bank holding company policy statement solely because its common stock is registered under the Exchange Act. There can be no assurance that the Federal Reserve will continue this practice.
The following tables shows the minimum capital requirement and our capital position at December 31, 2021 and December 31, 2020 for the Bank.
Capital Components
At December 31, 2021 and 2020
(Dollars in thousands)
Actual For Capital Adequacy
Purposes
Amount Ratio
Amount Ratio
At December 31, 2021
Leverage capital ratio $ 214,442 10.55 % $ 172,732 ≥ 8.50 %
At December 31, 2020
Leverage capital ratio $ 209,359 11.65 % $ 143,823 ≥ 8.00 %
Reconciliation of Book Value (GAAP) to Tangible Book Value (non-GAAP)
At December 31, 2021 and 2020
(Dollars in thousands, except per share data)
2021 2020
Total stockholders' equity (GAAP) $ 209,796 $ 189,500
Less: goodwill and intangibles, net (8,052) (8,357)
Tangible Common Equity (non-GAAP) $ 201,744 $ 181,143
Book value per common share (GAAP) $ 15.28 $ 14.03
Less: intangible book value per common share (0.58) (0.62)
Tangible book value per common share (non-GAAP) $ 14.70 $ 13.41
Liquidity
Liquidity in the banking industry is defined as the ability to meet the demand for funds of both depositors and borrowers. We must be able to meet these needs by obtaining funding from depositors or other lenders or by converting non-cash items into cash. The objective of our liquidity management program is to ensure that we always have sufficient resources to meet the demands of our depositors and borrowers. Stable core deposits and a strong capital position provide the base for our liquidity position. We believe we have demonstrated our ability to attract deposits because of our convenient branch locations, personal service, technology and pricing.
In addition to deposits, we have access to the different wholesale funding markets. These markets include the brokered certificate of deposit market and the federal funds market. We are a member of the IntraFi Network, which allows banking customers to access FDIC insurance protection on deposits through our Bank which exceed FDIC insurance limits. We also have one-way authority with IntraFi for both their CDARs and ICS products which provides the Bank the ability to access additional wholesale funding as needed. We also maintain secured lines of credit with the FRB and the FHLB for which we can borrow up to the allowable amount for the collateral pledged. Having diverse funding alternatives reduces our reliance on any one source for funding.
Cash flow from amortizing assets or maturing assets also provides funding to meet the needs of depositors and borrowers.
We have established a formal liquidity contingency plan which establishes a liquidity management team and provides guidelines for liquidity management. For our liquidity management program, we first determine our current liquidity position and then forecast liquidity based on anticipated changes in the balance sheet. In this forecast, we expect to maintain a liquidity cushion. We also stress test our liquidity position under several different stress scenarios, from moderate to severe. Guidelines for the forecasted liquidity cushion and for liquidity cushions for each stress scenario have been established. We believe that we have sufficient resources to meet our liquidity needs.
Our primary and secondary sources of liquidity remain strong. Liquid assets, which include cash and due from banks, federal funds sold and investment securities available for sale, totaled $598.7 million at December 31, 2021, or 27.2% of total assets, an increase from $267.2 million, or 14.7%, at December 31, 2020. To maintain ready access to the Bank's secured lines of credit, the Bank has pledged a portion of its commercial real estate and residential real estate loan portfolios to the FHLB and FRB. Additional borrowing capacity at the FHLB at December 31, 2021 was approximately $127.6 million. Borrowing capacity with the FRB was approximately $77.4 million at December 31, 2021. These facilities are subject to the FHLB and the FRB approving disbursement to us. We also have unsecured federal funds purchased lines of $265.0 million available to us. We anticipate maintaining liquidity at a level sufficient to protect depositors as we endure through this pandemic, provide for reasonable growth, and fully comply with all regulatory requirements.
Liquidity is essential to our business. Our liquidity could be impaired by an inability to access the capital markets or by unforeseen outflows of cash, including deposits. This situation may arise due to circumstances that we may be unable to control, such as general market disruption, negative views about the financial services industry generally, or an operational problem that affects a third party or us. Our ability to borrow from other financial institutions on favorable terms or at all could be adversely affected by disruptions in the capital markets or other events. While we believe we have a healthy liquidity position and do not anticipate the loss of deposits of any of the significant deposit customers, any of the factors discussed above could materially impact our liquidity position in the future.
Financial Instruments with Off-Balance-Sheet Risk and Credit Risk
We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet.
The Bank's maximum exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. We evaluate each customer's credit worthiness on a case-by-case basis and require collateral to support financial instruments when deemed necessary. The amount of collateral obtained upon extension of credit is based on management's evaluation of the counterparty. Collateral held varies but may include deposits held by us, marketable securities, accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates up to one year or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. These instruments represent obligations to extend credit or guarantee borrowings and are not recorded on the consolidated statements of financial condition. The rates and terms of these instruments are competitive with others in the market in which we do business.
Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. Those lines of credit may not be drawn upon to the total extent to which we have committed.
Standby letters of credit are conditional commitments we issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. We hold certificates of deposit, deposit accounts, and real estate as collateral supporting those commitments for which collateral is deemed necessary.
With the exception of these off-balance sheet arrangements, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, results of operations, changes in financial condition, revenue, expenses, capital expenditures, or capital resources, that is material to the business of the Company.
At December 31, 2021 and December 31, 2020, unused commitments to fund loans and lines of credit totaled $183.1 million and $166.3 million, respectively. Commercial and standby letters of credit totaled $8.9 million and $5.5 million at December 31, 2021 and December 31, 2020, respectively.

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
As a financial institution, we are exposed to various business risks, including interest rate risk. Interest rate risk is the risk to earnings and value arising from volatility in market interest rates. Interest rate risk arises from timing differences in the repricings and maturities of interest-earning assets and interest-bearing liabilities, changes in the expected maturities of assets and liabilities arising from embedded options, such as borrowers' ability to prepay loans and depositors' ability to redeem certificates of deposit before maturity, changes in the shape of the yield curve where interest rates increase or decrease in a nonparallel fashion, and changes in spread relationships between different yield curves, such as U.S. Treasuries and LIBOR. Our goal is to maximize net interest income without incurring excessive interest rate risk. Management of net interest income and interest rate risk must be consistent with the level of capital and liquidity that we maintain. We manage interest rate risk through an asset and liability committee ("ALCO"). ALCO is responsible for managing our interest rate risk in conjunction with liquidity and capital management.
We employ an independent consulting firm to model our interest rate sensitivity. We use a net interest income simulation model as our primary tool to measure interest rate sensitivity. Many assumptions are developed based on expected activity in the balance sheet. For maturing assets, assumptions are created for the redeployment of these assets. For maturing liabilities, assumptions are developed for the replacement of these funding sources. Assumptions are also developed for assets and liabilities that could reprice during the modeled time period. These assumptions also cover how we expect rates to change on non-maturity deposits such as interest checking, money market checking, savings accounts as well as certificates of deposit. Based on inputs that include the current balance sheet, the current level of interest rates and the developed assumptions, the model then produces an expected level of net interest income assuming that market rates remain unchanged. This is considered the base case. Next, the model determines what net interest income would be based on specific changes in interest rates. The rate simulations are performed for a two year period and include ramped rate changes of down 100 basis points to 400 basis points and up 100 basis points to 400 basis points. In both the up and down scenarios, the model assumes a parallel shift in the yield curve. The results of these simulations are then compared to the base case.
Stress testing the balance sheet and net interest income using instantaneous parallel shock movements in the yield curve of 100 to 400 basis points is a regulatory and banking industry practice. However, these stress tests may not represent a realistic forecast of future interest rate movements in the yield curve. In addition, instantaneous parallel interest rate shock modeling is not a predictor of actual future performance of earnings. It is a financial metric used to manage interest rate risk and track the movement of the Bank's interest rate risk position over a historical time frame for comparison purposes.
At December 31, 2021, our asset/liability position was slightly asset sensitive based on our interest rate sensitivity model in the one-year time frame and asset sensitive in the two-year time frame. Our net interest income would increase by 2.0% in an up 100 basis point scenario and would increase by 8.6% in an up 400 basis point scenario over a one-year time frame. In the two-year time horizon, our net interest income would increase by 2.7% in an up 100 basis point scenario and would increase by 11.5% in an up 400 basis point scenario. This neutral asset/liability position is caused by the increase in non-interest demand deposits we have experienced during 2021. At December 31, 2021 and December 31, 2020, all interest rate risk stress tests measures were within our board policy established limits in each of the increased rate scenarios.
Additional information on our interest rate sensitivity for a static balance sheet over a one-year time horizon as of December 31, 2021 and December 31, 2020 can be found below.
Interest Rate Risk to Earnings (Net Interest Income)
December 31, 2021 December 31, 2020
Change in interest
rates (basis points) Percentage change in
net interest income Change in interest
rates (basis points) Percentage change in
net interest income
+400 8.57% +400 (0.62)%
+300 6.47% +300 (0.55)%
+200 4.24% +200 (0.63)%
+100 1.99% +100 (0.54)%
0 - 0 -
-100 (0.49)% -100 (0.07)%
-200 (2.85)% -200 (1.58)%
Economic value of equity ("EVE"), measures the period end market value of assets less the market value of liabilities and the change in this value as rates change. It models simultaneous parallel shifts in market interest rates, implied by the forward yield curve. The EVE model calculates the market value of capital by taking the present value of all asset cash flows less the present value of all liability cash flows.
The interest rate risk to capital at December 31, 2021 and December 31, 2020 is shown below and reflects that our market value of capital is in an asset position in which an increase in short-term interest rates is expected to generate higher market values of capital. At December 31, 2021 and December 31, 2020, all EVE stress tests measures were within our board policy established limits.
Interest Rate Risk to Capital
December 31, 2021 December 31, 2020
Change in interest
rates (basis points) Percentage change in
economic value of equity Change in interest
rates (basis points) Percentage change in
economic value of equity
+400 (3.77) % +400 6.64 %
+300 (2.46) % +300 6.14 %
+200 (1.08) % +200 4.84 %
+100 (0.37) % +100 2.68 %
0 - 0 -
-100 (3.58) % -100 (4.15) %
-200 (6.59) % -200 (3.41) %

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Item 8. Financial Statements and Supplementary Data
FVCBankcorp, Inc. and Subsidiary
Fairfax, Virginia
CONSOLIDATED FINANCIAL REPORT
December 31, 2021
CONTENTS
Page
REPORT OF INDEPENDENT REGISTERED ACCOUNTING FIRM
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated statements of condition
Consolidated statements of income
Consolidated statements of comprehensive income
Consolidated statements of cash flows
Consolidated statements of changes in stockholders' equity
Notes to consolidated financial statements
71 - 109
Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors
FVCBankcorp, Inc.
Fairfax, Virginia
Opinion on the Financial Statements
We have audited the accompanying consolidated statements of condition of FVCBankcorp, Inc. and its subsidiary (the Company) as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, cash flows and changes in stockholders’ equity 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 2007.
Winchester, Virginia
March 24, 2022
FVCBankcorp, Inc. and Subsidiary
Consolidated Statements of Condition
December 31, 2021 and 2020
(In thousands, except share data)
2021 2020
Assets
Cash and due from banks $ 24,613 $ 20,835
Interest-bearing deposits at other financial institutions 216,345 120,228
Securities held-to-maturity (fair value of $0.3 million for both December 31, 2021 and 2020, respectively)
264 264
Securities available-for-sale, at fair value 357,774 126,151
Restricted stock, at cost 6,372 6,563
Loans, net of allowance for loan losses of $13.8 million and $15.0 million at December 31, 2021 and 2020, respectively
1,490,020 1,451,125
Premises and equipment, net 1,584 1,654
Accrued interest receivable 8,074 9,135
Prepaid expenses 1,393 621
Deferred tax assets, net 8,629 8,552
Goodwill and intangibles, net 8,052 8,357
Bank owned life insurance (BOLI) 39,171 38,178
Other real estate owned (OREO) - 3,866
Operating lease right-of-use assets 10,167 11,125
Other assets 30,466 14,827
Total assets $ 2,202,924 $ 1,821,481
Liabilities and Stockholders' Equity
Liabilities
Deposits:
Noninterest-bearing $ 581,293 $ 399,062
Interest-bearing checking, savings and money market 1,071,059 820,378
Time deposits 231,417 313,053
Total deposits $ 1,883,769 $ 1,532,493
FHLB advances $ 25,000 $ 25,000
Subordinated notes, net of issuance costs 19,510 44,085
Accrued interest payable 1,034 685
Operating lease liabilities 11,111 12,123
Accrued expenses and other liabilities 52,704 17,595
Total liabilities $ 1,993,128 $ 1,631,981
Commitments and Contingent Liabilities
Stockholders' Equity
2021 2020
Preferred stock, $0.01 par value
Shares authorized 1,000,000 1,000,000
Shares issued and outstanding - -
Common stock, $0.01 par value
Shares authorized 20,000,000 20,000,000
Shares issued and outstanding 13,727,045 13,510,760 $ 137 $ 135
Additional paid-in capital 121,798 119,568
Retained earnings 89,904 67,971
Accumulated other comprehensive (loss) income, net (2,043) 1,826
Total stockholders' equity $ 209,796 $ 189,500
Total liabilities and stockholders' equity $ 2,202,924 $ 1,821,481
See Notes to Consolidated Financial Statements.
FVCBankcorp, Inc. and Subsidiary
Consolidated Statements of Income
For the years ended December 31, 2021 and 2020
(In thousands, except per share data)
2021 2020
Interest and Dividend Income
Interest and fees on loans $ 63,974 $ 63,446
Interest and dividends on securities held-to-maturity 6 6
Interest and dividends on securities available-for-sale 3,860 3,156
Dividends on restricted stock 328 342
Interest on deposits at other financial institutions 260 153
Total interest and dividend income $ 68,428 $ 67,103
Interest Expense
Interest on deposits $ 7,601 $ 12,333
Interest on federal funds purchased - 81
Interest on short-term debt 346 267
Interest on subordinated notes 2,534 1,802
Total interest expense $ 10,481 $ 14,483
Net Interest Income $ 57,947 $ 52,620
Provision for (reversal of) loan losses (500) 5,016
Net interest income after provision for (reversal of) loan losses $ 58,447 $ 47,604
Noninterest Income
Service charges on deposit accounts $ 1,028 $ 1,008
Gain on sale of securities available-for-sale - 141
Loss on loans held for sale - (451)
BOLI income 994 1,109
Income from minority membership interest 1,464 -
Other income 816 1,084
Total noninterest income $ 4,302 $ 2,891
Noninterest Expenses
Salaries and employee benefits $ 18,980 $ 16,815
Occupancy and equipment expense 3,290 3,329
Data processing and network administration 2,203 2,028
State franchise taxes 1,983 1,864
Audit, legal and consulting fees 1,489 986
Merger and acquisition expense 1,445 -
Loan related expenses 1,247 1,087
FDIC insurance 770 748
Director fees 651 554
Core deposit intangible amortization 305 345
Gain on sale of other real estate owned (236) -
Impairment on branch closures - 676
Other operating expenses 2,413 2,406
Total noninterest expenses $ 34,540 $ 30,838
Net income before income tax expense $ 28,209 $ 19,657
Income tax expense 6,276 4,156
Net income $ 21,933 $ 15,501
Earnings per share, basic $ 1.61 $ 1.14
Earnings per share, diluted $ 1.50 $ 1.10
See Notes to Consolidated Financial Statements.
FVCBankcorp, Inc. and Subsidiary
Consolidated Statements of Comprehensive Income
For the years ended December 31, 2021 and 2020
(In thousands)
2021 2020
Net income $ 21,933 $ 15,501
Other comprehensive (loss) income:
Unrealized (loss) gain on securities available for sale, net of tax expense (benefit) of $(1,226) and $473 in 2021 and 2020, respectively.
(4,404) 1,780
Unrealized gain (loss) on interest rate swaps, net of tax expense (benefit) of $142 and $(142) in 2021 and 2020, respectively.
535 (532)
Reclassification adjustment for losses realized in income, net of tax expense of $0 and $29 for 2021 and 2020, respectively.
- (112)
Total other comprehensive (loss) income $ (3,869) $ 1,136
Total comprehensive income $ 18,064 $ 16,637
See Notes to Consolidated Financial Statements.
FVCBankcorp, Inc. and Subsidiary
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2021 and 2020
(In thousands)
2021 2020
Cash Flows From Operating Activities
Net income $ 21,933 $ 15,501
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation 555 615
Provision for (reversal of) loan losses (500) 5,016
Net amortization of premium of securities 528 497
Net accretion of deferred loan fees, costs, and purchase premiums (5,830) (2,782)
Net accretion of acquisition accounting adjustments (442) (1,073)
Gain on sale of other real estate owned (236) -
Gain on sale of available-for-sale securities - (141)
Loss on loans held for sale - 451
Impairment loss on long lived assets - 676
Payments received on loans held for sale, net - 1,107
Amortization of subordinated debt issuance costs 488 88
Core deposits intangible amortization 305 345
Equity-based compensation expense 1,011 690
BOLI income (994) (1,109)
Income from minority membership interest (1,464) -
Deferred income tax expense (benefit) 1,007 (1,159)
Changes in assets and liabilities:
Decrease (increase) in accrued interest receivable, prepaid expenses and other assets 9,480 (10,061)
(Decrease) increase in accrued interest payable, accrued expenses and other liabilities (6,396) 6,204
Net cash provided by operating activities $ 19,445 $ 14,865
Cash Flows From Investing Activities
Increase in interest-bearing deposits at other financial institutions $ (96,117) $ (102,002)
Purchases of securities available-for-sale (245,731) (34,796)
Proceeds from sales of securities available-for-sale - 13,239
Proceeds from maturities and calls of securities available-for-sale 6,996 4,250
Proceeds from paydowns of securities available-for-sale 41,016 34,237
Decrease (increase) in restricted stock 191 (546)
Net increase in loans (32,110) (182,331)
Proceeds from sale of OREO 4,102 -
Purchase of minority membership interest (22,200) -
Purchases of premises and equipment, net (485) (353)
Net cash used in investing activities $ (344,338) $ (268,302)
Cash Flows From Financing Activities
Net increase in noninterest-bearing, interest-bearing checking, savings, and money market deposits $ 432,912 $ 356,057
Net decrease in time deposits (81,649) (109,306)
Redemption of subordinated debt, net (23,813) -
Decrease in federal funds purchased - (10,000)
Net increase in FHLB advances - 10,000
Issuance of subordinated notes, net - 19,510
Repurchase of shares of common stock - (7,280)
Common stock issuance 1,221 375
Net cash provided by financing activities $ 328,671 $ 259,356
Net increase in cash and cash equivalents $ 3,778 $ 5,919
Cash and cash equivalents, beginning of year 20,835 14,916
Cash and cash equivalents, end of year $ 24,613 $ 20,835
See Notes to Consolidated Financial Statements.
FVCBankcorp, Inc. and Subsidiary
Consolidated Statements of Changes in Stockholders' Equity
For the years ended December 31, 2021 and 2020
(In thousands)
Shares Common
Stock Additional
Paid-in
Capital Retained
Earnings Accumulated
Other
Comprehensive
Income (Loss) Total
Balance at December 31, 2019
13,902 $ 139 $ 125,779 $ 52,470 $ 690 $ 179,078
Net income - - - 15,501 - 15,501
Other comprehensive income - - - - 1,136 1,136
Repurchase of common stock (487) (5) (7,275) - - (7,280)
Common stock issuance for options exercised 62 1 374 - - 375
Vesting of restricted stock grants 34 - - - - -
Stock-based compensation expense - - 690 - - 690
Balance at December 31, 2020
13,511 $ 135 $ 119,568 $ 67,971 $ 1,826 $ 189,500
Net income - - - 21,933 - 21,933
Other comprehensive loss - - - - (3,869) (3,869)
Common stock issuance for options exercised 182 2 1,219 - - 1,221
Vesting of restricted stock grants 34 - - - - -
Stock-based compensation expense - - 1,011 - - 1,011
Balance at December 31, 2021
13,727 $ 137 $ 121,798 $ 89,904 $ (2,043) $ 209,796
See Notes to Consolidated Financial Statements.
Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)
Note 1. Organization and Summary of Significant Accounting Policies
Organization
FVCBankcorp, Inc. (the "Company"), a Virginia corporation, was formed in 2015 and is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. The Company is headquartered in Fairfax, Virginia. The Company conducts its business activities through the branch offices of its wholly owned subsidiary bank, FVCbank (the "Bank"). The Company exists primarily for the purposes of holding the stock of its subsidiary, the Bank.
The Bank was organized under the laws of the Commonwealth of Virginia to engage in a general banking business serving the Washington, D.C. metropolitan area. The Bank commenced regular operations on November 27, 2007 and is a member of the Federal Reserve System. It is subject to the regulations of the Board of Governors of the Federal Reserve System (the "Federal Reserve") and the State Corporation Commission of Virginia. Consequently, it undergoes periodic examinations by these regulatory authorities.
On August 31, 2021, the Bank made an investment in Atlantic Coast Mortgage, LLC ("ACM") for $20.4 million to obtain a 28.7% ownership interest in ACM. This ownership interest is subject to an earnback option of up to 3.7% over the next three years. In addition, the Bank provides a warehouse lending facility to ACM, which includes a construction-to-permanent financing line, and has developed portfolio mortgage products to diversify the Bank's held to investment loan portfolio. The investment is accounted for using the equity method of accounting.
Note 2. Summary of Significant Accounting Policies
The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry.
(a) Principles of Consolidation
The consolidated financial statements include the accounts of the Company. All material intercompany balances and transactions have been eliminated in consolidation.
(b) Use of Estimates
In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates, judgments, and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and contingent liabilities, at of the date of the consolidated financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to accounting for business combinations and impairment testing of goodwill, the allowance for loan losses, the valuation of deferred tax assets, and other-than-temporary impairment.
(c) Accounting for Business Combinations
Business combinations are accounted for under the acquisition method. The acquisition method requires that the assets acquired and liabilities assumed be recorded, based on their estimated fair values at the date of acquisition. The excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed, including identifiable intangibles, is recorded as goodwill.
(d) Cash and Cash Equivalents
For purposes of the statements of cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are purchased and sold for one day periods.
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
(e) Investment Securities
Debt securities are classified as held-to-maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Debt securities are classified as available-for-sale when they might be sold before maturity. Securities available-for-sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax. Equity securities are carried at fair value, with changes in fair value reported in net income. Equity securities without readily determinable fair values are carried at cost, minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment.
Gains and losses on the sale of securities are determined using the specific identification method.
The Company regularly evaluates its securities whose values have declined below their amortized cost to assess whether the decline in fair value is other-than-temporary. The Company considers various factors in determining whether a decline in fair value is other-than-temporary including the issuer's financial condition and/or future prospects, the effects of changes in interest rates or credit spreads, the expected recovery period and other quantitative and qualitative information. The valuation of securities for impairment is a process subject to estimation, judgment and uncertainty and is intended to determine whether declines in the fair value of investments should be recognized in current period earnings. The risks and uncertainties include changes in general economic conditions and future changes in assessments of the aforementioned factors. It is expected that such factors will change in the future, which may result in future other-than-temporary impairments. For impairments of debt securities that are deemed to be other-than-temporary, the credit portion of an other-than-temporary impairment loss is recognized in earnings and the non-credit portion is recognized in accumulated other comprehensive income in those situations where the Company does not intend to sell the security and it is more likely than not that the Company will not be required to sell the security prior to recovery.
Interest income and dividends on securities are recognized in interest income on an accrual basis. Premiums and discounts are recognized in interest income using the effective interest method. Prepayments of the mortgages securing mortgage-backed securities may affect the yield to maturity. The Company uses actual principal prepayment experience and estimates of future principal prepayments in calculating the yield necessary to apply the effective interest method.
(f) Loans and Allowance for Loan Losses
Loans receivable that management has the intent and ability to hold for the foreseeable future or until loan maturity or pay-off are reported at their outstanding principal balance adjusted for any charge-offs, and net of the allowance for loan losses and deferred fees and costs. Loan origination fees and certain direct origination costs are deferred and amortized as an adjustment of the yield using the payment terms required by the loan contract.
During 2019, as a result of the Company's acquisition of Colombo, the loan portfolio was segregated between loans initially accounted for under the amortized cost method (referred to as "originated" loans) and loans acquired (referred to as "acquired" loans). The loans segregated to the acquired loan portfolio were initially measured at fair value and subsequently accounted for under either Accounting Standards Codification ("ASC") Topic 310-30 or ASC Topic 310-20.
Purchased credit-impaired ("PCI") loans, which are the non-performing loans acquired in the Company's acquisition of Colombo, are loans acquired at a discount (that is due, in part, to credit quality). These loans are initially recorded at fair value (as determined by the present value of expected future cash flows) with no allowance for loan losses. The Company accounts for interest income on all loans acquired at a discount (that is due, in part, to credit quality) based on the acquired loans' expected cash flows. The acquired loans may be aggregated and accounted for as a pool of loans if the loans being aggregated have common risk characteristics. A pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flow. The difference between the cash flows expected at acquisition and the investment in the loans, or the "accretable yield," is recognized as interest income utilizing the level-yield method over the life of each pool. Increases in expected cash flows subsequent to the acquisition are recognized prospectively through adjustment to any previously recognized allowance for loan loss for that pool of loans and then through an increase in the yield on the pool over its remaining life, while decreases in expected cash flows are recognized as impairment through a loss provision and an increase in the allowance for loan losses. Therefore, the allowance for loan losses on these impaired pools reflect only losses incurred after the acquisition (representing the present value of all cash flows that were expected at acquisition but currently are not expected to be received).
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
The Company periodically evaluates the remaining contractual required payments due and estimates of cash flows expected to be collected for PCI loans. These evaluations, performed quarterly, require the continued use of key assumptions and estimates, similar to the initial estimate of fair value. Changes in the contractual required payments due and estimated cash flows expected to be collected may result in changes in the accretable yield and non-accretable difference or reclassifications between accretable yield and the non-accretable difference. On an aggregate basis, if the acquired pools of PCI loans perform better than originally expected, the Company would expect to receive more future cash flows than originally modeled at the acquisition date. For the pools with better than expected cash flows, the forecasted increase would be recorded as an additional accretable yield that is recognized as a prospective increase to the Company's interest income on loans.
Loans are generally placed into nonaccrual status when they are past-due 90 days as to either principal or interest or when, in the opinion of management, the collection of principal and/or interest is in doubt. A loan remains in nonaccrual status until the loan is current as to payment of both principal and interest or past-due less than 90 days and the borrower demonstrates the ability to pay and remain current. Loans are charged-off when a loan or a portion thereof is considered uncollectible. When cash payments are received, they are applied to principal first, then to accrued interest. It is the Company's policy not to record interest income on nonaccrual loans until principal has become current. In certain instances, accruing loans that are past due 90 days or more as to principal or interest may not go on nonaccrual status if the Company determines that the loans are well secured and are in the process of collection.
Nonperforming assets include nonaccrual loans, loans past-due 90 days or more and other real estate owned ("OREO").
The allowance for loan losses is increased or decreased by provisions for or reversals of loan losses, increased by recoveries of previously charged-off loans, and decreased by loan charge-offs.
The Company maintains the allowance for loan losses at a level that represents management's best estimate of known and inherent losses in the loan portfolio. Both the amount of the provision expense and the level of the allowance for loan losses are impacted by many factors, including general and industry-specific economic conditions, actual and expected credit losses, historical trends and specific conditions of the individual borrowers. Unusual and infrequently occurring events, such as weather-related disasters or disease epidemics or pandemics, may impact management's assessment of possible credit losses. As a part of the analysis, the Company uses comparative peer group data and qualitative factors such as levels of and trends in delinquencies, nonaccrual loans, charged-off loans, changes in volume and terms of loans, effects of changes in lending policy, experience and ability and depth of management, national and local economic trends and conditions and concentrations of credit, competition, and loan review results to support estimates.
For purposes of monitoring the performance of the loan portfolio and estimating the allowance for loan losses, the Company's loans receivable portfolio is segmented as follows: commercial real estate, commercial and industrial, commercial construction, consumer residential, and consumer nonresidential.
Commercial Real Estate Loans. Commercial real estate loans are secured by both owner occupied and investor owned commercial properties, including multi-family residential real estate. Collateral for this loan type includes various types of commercial real estate, including office, retail, warehouse, industrial and other non-residential types of properties.
These loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the repayment of loans secured by income-producing properties is typically dependent upon the successful operation of a business or real estate project and thus may be subject to adverse conditions in the commercial real estate market or in the general economy. The Company generally requires personal guarantees or endorsements with respect to these loans and loan-to-value ratios for real estate-commercial loans generally do not exceed 80%.
Commercial and Industrial Loans. The Company makes commercial loans to qualified businesses within its market area. The commercial lending portfolio consists primarily of commercial and industrial loans for a variety of business purposes, including working capital and the financing of accounts receivable, property, plant and equipment. The Company has a government contract lending group which provides secured lending to government contracting firms and businesses based primarily on receivables from the federal government.
Commercial and industrial loans generally have a higher degree of risk than other certain types of loans. Commercial loans typically are made on the basis of the borrower's ability to repay the loan from the cash flow from its business and are
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
secured by business assets, such as commercial real estate, accounts receivable, equipment and inventory, the values of which may fluctuate over time and generally cannot be appraised with as much precision as residential real estate. As a result, the availability of funds for the repayment of commercial loans may be substantially dependent upon the commercial success of the business itself. To manage these risks, the Company's policy is to secure commercial loans originated with both the assets of the business, which are subject to the risks described above, and other additional collateral and guarantees that may be available.
Commercial Construction Loans. The Company's commercial construction loan portfolio consists of acquisition, development, and construction of commercial real estate, including multi-family properties. Our typical commercial construction loan involves property that will ultimately be leased to a non-owner occupant. Construction lending entails significant additional risks as they often involve larger loan balances concentrated with single borrowers or groups of related borrowers. Construction loans also involve additional risks since funds are advanced while the property is under construction, which property has uncertain value prior to the completion of construction. Thus, it is more difficult to accurately evaluate the total loan funds required to complete a project and related loan-to-value ratios. To reduce the risks associated with construction lending, the Company generally limits loan-to-value ratios to 80% of when-completed appraised values for owner-occupied residential or commercial properties and for investor-owned residential or commercial properties. Construction loan agreements may include provisions which allow for the payment of contractual interest from an interest reserve. Amounts drawn from an interest reserve increase the amount of the outstanding balance of the construction loan. This is an industry standard practice.
Consumer Residential. This portfolio consists primarily of home equity lines of credit ("HELOCs") that we originate in our market areas. Our HELOCs generally have a maximum loan to value of up to 85%, however, actual loan to values are typically lower than the maximum. We have also purchased portfolios of 1-4 family residential first mortgage loans on properties located in our market area for yield and diversification.
Consumer Nonresidential. The Company's consumer nonresidential loans consist primarily of installment loans made to individuals for personal, family and household purposes. In addition, we have purchased pools of unsecured consumer loans and student loans from a third party for yield and diversification.
Consumer loans may entail greater risk than certain other types of loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciable assets, such as automobiles.
The Company's policy for consumer loans is to accept moderate risk while minimizing losses, primarily through a careful credit and financial analysis of the borrower. In evaluating consumer loans, the Company requires its lending officers to review the borrower's collateral and stability of income, past credit history, amount of debt currently outstanding and the impact of these factors on the ability of the borrower to repay the loan in a timely manner.
The Company's allowance for loan losses is based first on a segmentation of its loan portfolio by general loan type, or portfolio segments. For originated loans, certain portfolio segments are further disaggregated and evaluated collectively for impairment based on loan segments, which are largely based on the type of collateral underlying each loan. For purposes of this analysis, the Company categorizes loans into one of five categories: commercial and industrial, commercial real estate, commercial construction, consumer residential, and consumer nonresidential loans. Typically, financial institutions use their historical loss experience and trends in losses for each loan category which are then adjusted for portfolio trends and economic and environmental factors in determining their allowance for loan losses. Since the Bank's inception in 2007, the Bank has experienced minimal loss history within its loan portfolio. Because of this, the allowance model uses the average loss rates of similar institutions (a custom peer group) as a baseline which is then adjusted based on the Company's particular qualitative loan portfolio characteristics and environmental factors. The indicated loss factors resulting from this analysis are applied for each of the five categories of loans.
The Company also maintains an allowance for loan losses for acquired loans when: (i) for loans accounted for under ASC 310-30, there is deterioration in credit quality subsequent to acquisition, and (ii) for loans accounted for under ASC 310-20, the inherent losses in the loans exceed the remaining discount recorded at the time of acquisition.
The allowance for loan losses consists of specific and general components. The specific component relates to loans that are determined to be impaired and, therefore, individually evaluated for impairment. The Company determines and recognizes impairment of certain loans when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the loan agreement. A loan is not considered impaired during a period of
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
delay in payment if the Company expects to collect all amounts due, including past-due interest. The Company individually assigns loss factors to all loans that have been identified as having loss attributes, as indicated by deterioration in the financial condition of the borrower or a decline in underlying collateral value if the loan is collateral dependent. The Company evaluates the impairment of certain loans on a loan by loan basis for those loans that are adversely risk rated. Measurement of impairment is based on the expected future cash flows of an impaired loan, which are discounted at the loan's effective interest rate, or measured on an observable market value, if one exists, or the fair value of the collateral underlying the loan, discounted to consider estimated costs to sell the collateral for collateral-dependent loans. If the net collateral value is less than the loan balance (including accrued interest and any unamortized premium or discount associated with the loan) an impairment is recognized and a specific reserve is established for the impaired loan. Loans classified as loss loans are fully reserved or charged-off.
In addition, various regulatory agencies, as part of their examination process, periodically review the Company's allowance for loan losses. These agencies may require the Company to recognize additions to the allowance based on their risk evaluation and credit judgment. Management believes that the allowance for loan losses at December 31, 2021 and 2020 is a reasonable estimate of known and inherent losses in the loan portfolio at those dates.
Loans considered to be troubled debt restructuring ("TDRs") are loans that have their terms restructured (e.g., interest rates, loan maturity date, payment and amortization period, etc.) in circumstances that provide payment relief to a borrower experiencing financial difficulty. All restructured loans are considered impaired loans and may either be in accruing status or nonaccruing status. Nonaccruing restructured loans may return to accruing status provided doubt has been removed concerning the collectability of principal and interest as evidenced by a sufficient period of payment performance in accordance with the restructured terms. Loans may be removed from the restructured category in the year subsequent to the restructuring if their revised loan terms are considered to be consistent with terms that can be obtained in the credit market for loans with comparable risk and if they meet certain performance criteria.
(g) Premises and Equipment
Land is carried at cost. Premises, furniture, equipment, and leasehold improvements are carried at cost less accumulated depreciation and amortization. Depreciation of premises, furniture and equipment is computed using the straight-line method over estimated useful lives from three to seven years. Amortization of leasehold improvements is computed using the straight-line method over the useful lives of the improvements or the lease term, whichever is shorter. Purchased computer software which is capitalized is amortized over estimated useful lives of one to three years.
The Company follows ASU No. 2016-02 "Leases (Topic 842)" and all subsequent ASUs that modified Topic 842. Contracts are evaluated to determine whether they are or contain a lease in accordance with Topic 842. The Company elected the practical expedient provided by Topic 842 not to allocate consideration in a contract between lease and non-lease components. The Company also elected, as provided by the standard, not to recognize right-of-use assets and lease liabilities for short-term leases, defined by the standard as leases with terms of 12 months or less.
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. 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.
Lease payments for short-term leases are recognized as lease expense on a straight-line basis over the lease term, or for variable lease payments, in the period in which the obligation was incurred. Payments for leases with terms longer than twelve months are included in the determination of the lease liability. Payments may be fixed for the term of the lease or variable. If the lease agreement provides a known escalator, such as a specified percentage increase per year or a stated increase at a specified time, the variable payment is included in the cash flows used to determine the lease liability. If the variable payment is based upon an unknown escalator, such as the consumer price index at a future date, the increase is not included in the cash flows used to determine the lease liability. The Company's leases provide known escalators that are included in the determination of the lease liability, with the exception of three lease agreements.
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
The Company's leases offer the option to extend the lease term. For each of the leases, the Company is reasonably certain it will exercise the options and has included the additional time and lease payments in the calculation of the lease liability. None of the Company's leases provide for residual value guarantees and none provide restrictions or covenants that would impact dividends or require incurring additional financial obligations.
During 2020, the Company closed two branch office locations, which resulted in an impairment loss on right-of-use assets of $508 thousand and derecognition of right-of-use assets and lease liabilities of $458 thousand. No branch office locations were closed during 2021.
(h) Goodwill and Intangible Assets
Goodwill, which represents the excess of purchase price over fair value of net assets acquired, is not amortized but is evaluated at least annually for impairment by comparing its fair value with its carrying amount. Impairment is indicated when the carrying amount of a reporting unit exceeds its estimated fair value.
Goodwill arises from business combinations and is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually or more frequently if events and circumstances exist; that indicate that a goodwill impairment test should be performed. The Company performs the impairment test annually during the fourth quarter. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on our balance sheet.
No impairment was recorded for 2021 and 2020.
(i) Other Real Estate Owned
Assets acquired through, or in lieu of, loan foreclosure are held for sale. At the time of acquisition, these properties are recorded at fair value less estimated selling costs, with any write down charged to the allowance for loan losses and any gain on foreclosure recorded in net income, establishing a new cost basis. Subsequent to foreclosure, valuations of the assets are periodically performed by management, and these assets are subsequently accounted for at lower of cost or fair value less estimated selling costs. Adjustments are made for subsequent decline in the fair value of the assets less selling costs. Revenue and expenses from operations and valuation changes are charged to operating income in the year of the transaction.
(j) Bank Owned Life Insurance
The Company has purchased life insurance policies on certain key employees. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance date, which is the cash surrender value. The increase in the cash surrender value over time is recorded as other non-interest income. The Company monitors the financial strength and condition of the counterparty.
(k) 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 surrendered when (1) the assets have been isolated from the Company - 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 Company 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.
(l) Income Taxes
Deferred taxes are provided on a liability method whereby deferred tax assets and liabilities are recognized for deductible temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management's judgment. The Company had no such liability recorded as of December 31, 2021 and 2020. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.
(m) Comprehensive Income (Loss)
Comprehensive income consists of net income and other comprehensive income. Other comprehensive income (loss) includes unrealized gains (losses) on securities available-for-sale and interest rate swaps for 2021 and 2020, which are also recognized as separate components of equity. Items reclassified out of accumulated other comprehensive income (loss) to net income relate solely to realized gains (losses) on sales of securities available-for-sale and appear under the caption "Gain on sale of securities available-for-sale" in the Company's consolidated statements of income.
(n) 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 16. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.
(o) Equity-based Compensation
The Company recognizes in the income statement the grant date fair value of stock options and other equity-based compensation. The Company classifies stock awards as either an equity award or a liability award. Equity classified awards are valued as of the grant date using either an observable market price or a valuation methodology. Liability classified awards are valued at fair value at each reporting date. For the years presented, all of the Company's stock options are classified as equity awards.
The fair value related to forfeitures of stock options and other equity-based compensation are recorded to the income statement as they occur, reducing equity-based compensation expense in that period. During 2018, the Company began granting restricted stock units which are granted at the fair market value of the Company's common stock on the grant date. Most restricted stock units vest in one-quarter increments on the anniversary date of the grant. The Company did not grant stock options in the years ended December 31, 2021 and 2020.
(p) 401(k) Plan
Employee 401(k) plan expense is the amount of matching contributions paid by the Company. 401(k) plan expense was $377 thousand and $350 thousand for the years ended December 31, 2021 and 2020, respectively.
(q) Earnings Per Share
Basic earnings per share represent income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional 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. Common stock equivalents that may be issued by the Company consist primarily of outstanding stock options and restricted stock units, and the dilutive potential common shares resulting from outstanding stock options and restricted stock units are determined using the treasury method. The effects of anti-dilutive common stock equivalents are excluded from the calculation of diluted earnings per share.
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
(r) Reclassifications
Certain prior year amounts have been reclassified to conform to the current year's method of presentation. None of these reclassifications were significant.
(s) Recent 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 ASUs 2019-04, 2019-05, 2019-10, 2019-11, 2020-02, and 2020-03. These ASUs 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"), such as the Company, 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 has identified a third party vendor to assist in the measurement of expected credit losses under this standard. The implementation committee has completed the data collection process, validated the data inputs, determined its allowance methodology and is running the model parallel to the Company's incurred loss model.
Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin ("SAB") 119. SAB 119 updated portions of SEC interpretative guidance to align with FASB Accounting Standards Codification ("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 FASB issued 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 the London Interbank Offered Rate ("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 FASB issued ASU 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 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 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. To facilitate an orderly transition from interbank offered rates and other benchmark rates to alternative reference rates ("ARRs"), the Company has established an enterprise-wide initiative led by senior management. The objective of this initiative is to identify, assess and monitor risks associated with the expected discontinuation or unavailability of benchmarks, including LIBOR, achieve operational readiness and engage impacted clients in connection with the transition to ARRs. 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 2020, the FASB issued ASU No. 2020-06 "Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity's Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity's Own Equity." The ASU simplifies accounting for convertible instruments by
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
removing major separation models required under current GAAP. Consequently, more convertible debt instruments will be reported as a single liability instrument and more convertible preferred stock as a single equity instrument with no separate accounting for embedded conversion features. The ASU removes certain settlement conditions that are required for equity contracts to qualify for the derivative scope exception, which will permit more equity contracts to qualify for it. The ASU also simplifies the diluted earnings per share calculation in certain areas. In addition, the amendment updates the disclosure requirements for convertible instruments to increase the information transparency. For public business entities, excluding smaller reporting companies, the amendments in the ASU are effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. For all other entities, including the Company, the standard will be effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of ASU 2020-06 to have a material impact on its consolidated financial statements.
In May 2021, the FASB issued ASU 2021-04, "Earnings Per Share (Topic 260), Debt - Modifications and Extinguishments (Subtopic 470-50), Compensation - Stock Compensation (Topic 718), and Derivatives and Hedging - Contracts in Entity's Own Equity (Subtopic 815-40): Issuer's Accounting for Certain Modifications or Exchanges of Freestanding Equity - Classified Written Call Options (a consensus of the FASB Emerging Issues Task Force)." The ASU addresses how an issuer should account for a modification or an exchange of freestanding written call options classified as equity that is not within the scope of another Topic. For both public and private companies, the ASU is effective for fiscal years beginning after December 15, 2021. Transition is prospective. Early adoption is permitted. The Company does not expect the adoption of ASU 2021-04 to have a material impact on its consolidated financial statements.
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.
In October 2021, the FASB issued ASU 2021-08, "Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers." The ASU requires entities to apply Topic 606 to recognize and measure contract assets and contract liabilities in a business combination. The amendments improve comparability after the business combination by providing consistent recognition and measurement guidance for revenue contracts with customers acquired in a business combination and revenue contracts with customers not acquired in a business combination. The ASU is effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2022. Entities should apply the amendments prospectively and early adoption is permitted. The Company does not expect the adoption of ASU 2021-08 to have a material impact on its consolidated financial statements.
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
Note 3. Investment Securities and Other Investments
Amortized cost and fair values of securities held-to-maturity and securities available-for-sale as of December 31, 2021 and 2020, are as follows:
December 31, 2021
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
(Losses)
Fair
Value
Held-to-maturity
Securities of state and local municipalities tax exempt $ 264 $ 6 $ - $ 270
Total Held-to-maturity Securities $ 264 $ 6 $ - $ 270
Available-for-sale
Securities of U.S. government and federal agencies
$ 13,719 $ - $ (283) $ 13,436
Securities of state and local municipalities tax exempt 1,393 58 - 1,451
Securities of state and local municipalities taxable 607 - (11) 596
Corporate bonds 13,970 259 (78) 14,151
SBA pass-through securities 107 1 - 108
Mortgage-backed securities 316,313 1,352 (3,827) 313,838
Collateralized mortgage obligations 14,230 113 (149) 14,194
Total Available-for-sale Securities $ 360,339 $ 1,783 $ (4,348) $ 357,774
December 31, 2020
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
(Losses)
Fair
Value
Held-to-maturity
Securities of state and local municipalities tax exempt $ 264 $ 10 $ - $ 274
Total Held-to-maturity Securities $ 264 $ 10 $ - $ 274
Available-for-sale
Securities of state and local municipalities tax exempt $ 3,398 $ 95 $ - $ 3,493
Securities of state and local municipalities taxable 804 14 - 818
Corporate bonds 12,974 80 (237) 12,817
SBA pass-through securities 138 3 - 141
Mortgage-backed securities 81,296 2,479 (61) 83,714
Collateralized mortgage obligations 24,476 718 (26) 25,168
Total Available-for-sale Securities $ 123,086 $ 3,389 $ (324) $ 126,151
The Company had securities with a market value of $5.8 million and $9.2 million pledged with the Federal Reserve Bank of Richmond (the "FRB") for the years ended December 31, 2021 and 2020, respectively.
The Company had securities with a market value of $79.7 million pledged with the Treasury Board of Virginia at the Community Bankers' Bank at December 31, 2021. There were no securities pledged with the Treasury Board of Virginia at the Community Bankers' Bank at December 31, 2020.
The following table shows fair value and gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2021 and 2020, respectively. The reference point for determining when securities are in an unrealized loss position is month-end.
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
Therefore, it is possible that a security's market value exceeded its amortized cost on other days during the prior twelve-month period. Securities that have been in a continuous unrealized loss position are as follows:
Less Than 12 Months 12 Months or Longer Total
At December 31, 2021
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Securities of U.S. government and federal agencies $ 13,275 $ (283) $ - $ - $ 13,275 $ (283)
Securities of state and local municipalities taxable 595 (11) - - 595 (11)
Corporate bonds 3,922 (78) - - 3,922 (78)
Mortgage-backed securities 216,278 (3,175) 19,225 (652) 235,503 (3,827)
Collateralized mortgage obligations 3,362 (82) 1,814 (67) 5,176 (149)
Total $ 237,432 $ (3,629) $ 21,039 $ (719) $ 258,471 $ (4,348)
Less Than 12 Months 12 Months or Longer Total
At December 31, 2020
Fair
Value Unrealized
Losses Fair
Value Unrealized
Losses Fair
Value Unrealized
Losses
Corporate bonds $ 4,240 $ (10) $ 2,000 $ (227) $ 6,240 $ (237)
Mortgage-backed securities 17,504 (61) - - 17,504 (61)
Collateralized mortgage obligations 2,098 (26) - - 2,098 (26)
Total $ 23,842 $ (97) $ 2,000 $ (227) $ 25,842 $ (324)
Securities of U.S. government and federal agencies: The unrealized losses on three available-for-sale securities were caused by interest rate increases. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments.
Securities of state and local municipalities taxable: The unrealized loss on one of the investment in securities of state and local municipalities were caused by interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. The investment carries an S&P investment grade rating of AAA.
Corporate bonds: The unrealized losses on the Company's investments in four corporate bonds were caused by interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. One of these investments carries an S&P investment grade rating of BBB+. The remaining three investments do not carry a rating.
Mortgage-backed securities: The unrealized losses on the Company's investment in thirty-nine mortgage-backed securities were caused by interest rate increases. The contractual cash flows of those investments are guaranteed by an agency of the U.S. Government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost basis of the Company's investments. Because the decline in market value is attributable to changes in interest rates and not credit quality, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2021.
Collateralized mortgage obligations (CMOs): The unrealized loss associated with nine CMOs was caused by interest rate increases. The contractual cash flows of these investments are guaranteed by an agency of the U.S. Government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost basis of the Company's investments. Because the decline in market value is attributable to changes in interest rates and not credit quality, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2021.
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
The amortized cost and fair value of securities available-for-sale as of December 31, 2021, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations without penalties.
Held-to-maturity Available-for-sale
Amortized
Cost Fair
Value Amortized
Cost Fair
Value
After 1 year through 5 years $ - $ - $ 3,393 $ 3,437
After 5 years through 10 years 264 270 44,617 45,153
After 10 years - - 312,329 309,184
Total $ 264 $ 270 $ 360,339 $ 357,774
For the years ended December 31, 2021 and 2020, proceeds from principal repayments of securities were $48.0 million and $38.5 million, respectively. No securities were sold during 2021. For the year ended December 31, 2020, proceeds from sales of securities amounted to $13.2 million, respectively, and gross realized gains amounted to $141 thousand. There were no realized losses in 2021 and 2020.
The Company has other investments in the form of restricted stock totaling $6.4 million and $6.6 million at December 31, 2021 and 2020, respectively. The following table discloses the types of investments included in other investments:
2021 2020
Federal Reserve stock $ 4,378 $ 3,973
FHLB stock 1,847 2,443
Community Bankers' Bank stock 122 122
Atlantic Bankers' Bank stock 25 25
$ 6,372 $ 6,563
As members of the FRB and the FHLB, the Company's banking subsidiary is required to hold stock in these entities. Stock membership in Community Bankers' Bank allows the Company to secure overnight funding and participate in other services offered by this institution. These investments are carried at cost since no active trading markets exist.
Note 4. Loans and Allowance for Loan Losses
A summary of loan balances by type follows:
2021 2020
Originated Acquired Total Originated Acquired Total
Commercial real estate $ 887,310 $ 18,802 $ 906,112 $ 761,876 $ 28,149 $ 790,025
Commercial and industrial 199,040 3,710 202,750 271,039 4,295 275,334
Commercial construction 186,572 1,043 187,615 220,845 1,474 222,319
Consumer real estate 176,682 23,922 200,604 133,940 33,932 167,872
Consumer nonresidential 10,277 27 10,304 15,802 33 15,835
$ 1,459,881 $ 47,504 $ 1,507,385 $ 1,403,502 $ 67,883 $ 1,471,385
Less:
Allowance for loan losses 13,829 - 13,829 14,333 625 14,958
Unearned income and (unamortized premiums), net 3,536 - 3,536 5,302 - 5,302
Loans, net $ 1,442,516 $ 47,504 $ 1,490,020 $ 1,383,867 $ 67,258 $ 1,451,125
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
During 2018, as a result of the Company's acquisition of Colombo, the loan portfolio was segregated between loans initially accounted for under the amortized cost method (referred to as "originated" loans) and loans acquired (referred to as "acquired" loans).
The loans segregated to the acquired loan portfolio were initially measured at fair value and subsequently accounted for under either ASC Topic 310-30 or ASC 310-20. The outstanding principal balance and related carrying amount of acquired loans included in the consolidated statement of condition as of December 31, 2021 and 2020 are as follows:
Purchased credit impaired acquired loans evaluated individually for future credit losses
Outstanding principal balance $ 207
Carrying amount -
Other acquired loans
Outstanding principal balance 48,049
Carrying amount 47,504
Total acquired loans
Outstanding principal balance 48,256
Carrying amount 47,504
Purchased credit impaired acquired loans evaluated individually for future credit losses
Outstanding principal balance $ 4,010
Carrying amount 3,064
Other acquired loans
Outstanding principal balance 65,656
Carrying amount 64,819
Total acquired loans
Outstanding principal balance 69,666
Carrying amount 67,883
The following table presents changes for the year ended December 31, 2021 and 2020 in the accretable yield on purchased credit impaired loans for which the Company applies ASC 310-30.
Balance at January 1, 2021 $ 216
Accretion (217)
Reclassification of nonaccretable difference due to improvement in expected cash flows 54
Other changes, net (50)
Balance at December 31, 2021
$ 3
Balance at January 1, 2020 $ 371
Accretion (878)
Reclassification of nonaccretable difference due to improvement in expected cash flows 691
Other changes, net 32
Balance at December 31, 2020
$ 216
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
An analysis of the allowance for loan losses for the years ended December 31, 2021 and 2020 follows:
Commercial
Real Estate Commercial and
Industrial Commercial
Construction Consumer Real
Estate Consumer
Nonresidential Total
Allowance for loan losses:
Beginning Balance $ 9,291 $ 2,546 $ 1,960 $ 690 $ 471 $ 14,958
Charge-offs (477) (117) - - (255) (849)
Recoveries 24 - - 35 161 220
Provision (reversal) 157 (602) 49 56 (160) (500)
Ending Balance $ 8,995 $ 1,827 $ 2,009 $ 781 $ 217 $ 13,829
Commercial
Real Estate Commercial and
Industrial Commercial
Construction Consumer Real
Estate Consumer
Nonresidential Total
Allowance for loan losses:
Beginning Balance $ 6,399 $ 1,275 $ 2,067 $ 417 $ 73 $ 10,231
Charge-offs (115) - - (41) (254) (410)
Recoveries 9 62 - 2 48 121
Provision (reversal) 2,998 1,209 (107) 312 604 5,016
Ending Balance $ 9,291 $ 2,546 $ 1,960 $ 690 $ 471 $ 14,958
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
The following table presents the recorded investment in loans and impairment method as of December 31, 2021 and 2020, by portfolio segment:
Allowance for Loan Losses
Commercial
Real Estate Commercial
and Industrial Commercial
Construction Consumer
Real Estate Consumer
Nonresidential Total
Allowance for loan losses:
Ending Balance:
Individually evaluated for impairment $ - $ 181 $ - $ 5 $ - $ 186
Purchased credit impaired - - - - - -
Collectively evaluated for impairment 8,995 1,646 2,009 776 217 13,643
$ 8,995 $ 1,827 $ 2,009 $ 781 $ 217 $ 13,829
Loans Receivable
Commercial
Real Estate Commercial
and Industrial Commercial
Construction Consumer
Real Estate Consumer
Nonresidential Total
Financing receivables:
Ending Balance
Individually evaluated for impairment $ 11,915 $ 5,214 $ 1,557 $ 343 $ - $ 19,029
Purchased credit impaired loans - - - - - -
Collectively evaluated for impairment 894,197 197,536 186,058 200,261 10,304 1,488,356
$ 906,112 $ 202,750 $ 187,615 $ 200,604 $ 10,304 $ 1,507,385
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
Allowance for Loan Losses
Commercial
Real Estate Commercial
and Industrial Commercial
Construction Consumer
Real Estate Consumer
Nonresidential Total
Allowance for loan losses:
Ending Balance:
Individually evaluated for impairment $ 625 $ 1,450 $ - $ 25 $ - $ 2,100
Purchased credit impaired loans - - - - - -
Collectively evaluated for impairment 8,666 1,096 1,960 665 471 12,858
$ 9,291 $ 2,546 $ 1,960 $ 690 $ 471 $ 14,958
Loans Receivable
Commercial
Real Estate Commercial
and Industrial Commercial
Construction Consumer
Real Estate Consumer
Nonresidential Total
Financing receivables:
Ending Balance
Individually evaluated for impairment $ 13,379 $ 7,086 $ - $ 254 $ - $ 20,719
Purchased credit impaired loans 3,007 - - 57 - 3,064
Collectively evaluated for impairment 773,639 268,248 222,319 167,561 15,835 1,447,602
$ 790,025 $ 275,334 $ 222,319 $ 167,872 $ 15,835 $ 1,471,385
Impaired loans by class excluding purchased credit impaired, as of December 31, 2021 and 2020 are summarized as follows:
Impaired Loans - Originated Loan Portfolio
Recorded
Investment Unpaid
Principal
Balance Related
Allowance Average
Recorded
Investment Interest
Income
Recognized
With an allowance recorded:
Commercial real estate $ - $ - $ - $ - $ -
Commercial and industrial 1,678 1,688 181 1,711 95
Commercial construction - - - - -
Consumer real estate 93 93 5 95 7
Consumer nonresidential - - - - -
$ 1,771 $ 1,781 $ 186 $ 1,806 $ 102
With no related allowance:
Commercial real estate $ 11,915 $ 11,915 $ - $ 11,947 $ 581
Commercial and industrial 3,536 3,536 - 3,660 238
Commercial construction 1,557 1,596 - 1,597 174
Consumer real estate 250 250 - 250 28
Consumer nonresidential - - - - -
$ 17,258 $ 17,297 $ - $ 17,454 $ 1,021
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
Impaired Loans - Acquired Loan Portfolio
Recorded
Investment Unpaid
Principal
Balance Related
Allowance Average
Recorded
Investment Interest
Income
Recognized
With an allowance recorded:
Commercial real estate $ - $ - $ - $ - $ -
Commercial and industrial - - - - -
Commercial construction - - - - -
Consumer real estate - - - - -
Consumer nonresidential - - - - -
$ - $ - $ - $ - $ -
With no related allowance:
Commercial real estate $ - $ - $ - $ - $ -
Commercial and industrial - - - - -
Commercial construction - - - - -
Consumer real estate - - - - -
Consumer nonresidential - - - - -
$ - $ - $ - $ - $ -
Impaired Loans - Originated Loan Portfolio
Recorded
Investment Unpaid
Principal
Balance Related
Allowance Average
Recorded
Investment Interest
Income
Recognized
With an allowance recorded:
Commercial real estate $ - $ - $ - $ - $ -
Commercial and industrial 5,287 5,287 1,450 5,682 358
Commercial construction - - - - -
Consumer real estate 97 97 25 99 6
Consumer nonresidential - - - - -
$ 5,384 $ 5,384 $ 1,475 $ 5,781 $ 364
With no related allowance:
Commercial real estate $ 9,926 $ 9,930 $ - $ 9,938 $ 133
Commercial and industrial 1,799 1,799 - 2,433 148
Commercial construction - - - - -
Consumer real estate - - - - -
Consumer nonresidential - - - - -
$ 11,725 $ 11,729 $ - $ 12,371 $ 281
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
Impaired Loans - Acquired Loan Portfolio
Recorded
Investment Unpaid
Principal
Balance Related
Allowance Average
Recorded
Investment Interest
Income
Recognized
With an allowance recorded:
Commercial real estate $ 3,303 $ 4,316 $ 625 $ 4,811 $ 267
Commercial and industrial - - - - -
Commercial construction - - - - -
Consumer real estate - - - - -
Consumer nonresidential - - - - -
$ 3,303 $ 4,316 $ 625 $ 4,811 $ 267
With no related allowance:
Commercial real estate $ 150 $ 164 $ - $ 164 $ 13
Commercial and industrial 157 215 - 215 12
Commercial construction - - - - -
Consumer real estate - - - - -
Consumer nonresidential - - - - -
$ 307 $ 379 $ - $ 379 $ 25
No additional funds are committed to be advanced in connection with the impaired loans. There were no nonaccrual loans excluded from the impaired loan disclosure.
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, collateral adequacy, credit documentation, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis typically includes larger, non-homogeneous loans such as commercial real estate and commercial and industrial loans. This analysis is performed on an ongoing basis as new information is obtained. The Company uses the following definitions for risk ratings:
Pass - Loans listed as pass include larger non-homogeneous loans not meeting the risk rating definitions below and smaller, homogeneous loans not assessed on an individual basis.
Special Mention - Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution's credit position at some future date.
Substandard - Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the enhanced possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful - Loans classified as doubtful include those loans which have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, based on currently known facts, conditions and values, improbable.
Loss - Loans classified as loss include those loans which are considered uncollectible and of such little value that their continuance as loans is not warranted. Even though partial recovery may be achieved in the future, it is neither practical nor desirable to defer writing off these loans.
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
Based on the most recent analysis performed, the risk category of loans by class of loans was as follows as of December 31, 2021 and 2020:
2021 - Originated Loan Portfolio
Commercial Real
Estate Commercial and
Industrial Commercial
Construction
Consumer Real
Estate
Consumer
Nonresidential
Total
Grade:
Pass $ 875,395 $ 193,426 $ 182,497 $ 176,271 $ 10,277 $ 1,437,866
Special mention - 400 2,518 68 - 2,986
Substandard 11,915 5,214 1,557 343 - 19,029
Doubtful - - - - - -
Loss - - - - - -
Total $ 887,310 $ 199,040 $ 186,572 $ 176,682 $ 10,277 $ 1,459,881
2021 - Acquired Loan Portfolio
Commercial Real
Estate Commercial and
Industrial Commercial
Construction
Consumer Real
Estate
Consumer
Nonresidential
Total
Grade:
Pass $ 18,802 $ 3,710 $ 1,043 $ 23,922 $ 27 $ 47,504
Special mention - - - - - -
Substandard - - - - - -
Doubtful - - - - - -
Loss - - - - - -
Total $ 18,802 $ 3,710 $ 1,043 $ 23,922 $ 27 $ 47,504
2020 - Originated Loan Portfolio
Commercial Real
Estate Commercial and
Industrial Commercial
Construction
Consumer Real
Estate
Consumer
Nonresidential
Total
Grade:
Pass $ 741,570 $ 262,355 $ 220,845 $ 133,750 $ 15,802 $ 1,374,322
Special mention 10,380 1,598 - 93 - 12,071
Substandard 9,926 7,086 - 97 - 17,109
Doubtful - - - - - -
Loss - - - - - -
Total $ 761,876 $ 271,039 $ 220,845 $ 133,940 $ 15,802 $ 1,403,502
2020 - Acquired Loan Portfolio
Commercial Real
Estate Commercial and
Industrial Commercial
Construction
Consumer Real
Estate
Consumer
Nonresidential
Total
Grade:
Pass $ 24,696 $ 4,295 $ 1,474 $ 33,844 $ 33 $ 64,342
Special mention - - - - - -
Substandard 3,453 - - 88 - 3,541
Doubtful - - - - - -
Loss - - - - - -
Total $ 28,149 $ 4,295 $ 1,474 $ 33,932 $ 33 $ 67,883
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, collateral adequacy, credit documentation, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes, larger non-homogeneous loans such as commercial real estate and commercial and industrial loans. This analysis is performed on an ongoing basis as new information is obtained. At December 31, 2021, the Company had $3.0 million in loans identified as special mention within the originated loan
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
portfolio, a decrease of $9.1 million from December 31, 2020. Special mention rated loans are loans that have a potential weakness that deserve management's close attention. These loans do not have a specific reserve and are considered well-secured. At December 31, 2021, the Company had $19.0 million in loans identified as substandard within the originated loan portfolio, an increase of $1.9 million from December 31, 2020. Substandard rated loans are loans that are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. For each of these substandard loans, a liquidation analysis is completed. As of December 31, 2021, specific reserves on originated and acquired loans totaling $0.2 million, has been allocated within the allowance for loan losses to supplement any shortfall of collateral.
Past due and nonaccrual loans presented by loan class were as follows as of December 31, 2021 and 2020:
2021 - Originated Loan Portfolio
30-59 days past
due 60-89 days past
due
90 days or more
past due
Total past due Current Total loans 90 days past due
and still accruing Nonaccruals
Commercial real estate $ - $ - $ - $ - $ 887,310 $ 887,310 $ - $ -
Commercial and industrial - - 1,678 1,678 197,362 199,040 - 1,678
Commercial construction - - 1,557 1,557 185,015 186,572 - 1,557
Consumer real estate - - 250 250 176,432 176,682 - 250
Consumer nonresidential 14 21 18 53 10,224 10,277 18
Total $ 14 $ 21 $ 3,503 $ 3,538 $ 1,456,343 $ 1,459,881 $ 18 $ 3,485
2021 - Acquired Loan Portfolio
30-59 days past
due 60-89 days past
due
90 days or more
past due
Total past due Current Total loans 90 days past due
and still accruing Nonaccruals
Commercial real estate $ - $ - $ - $ - $ 18,802 $ 18,802 $ - $ -
Commercial and industrial - - - - 3,710 3,710 - -
Commercial construction - - - - 1,043 1,043 - -
Consumer real estate 234 - 5 239 23,683 23,922 5 -
Consumer nonresidential 2 - - 2 25 27 - -
Total $ 236 $ - $ 5 $ 241 $ 47,263 $ 47,504 $ 5 $ -
2020 - Originated Loan Portfolio
30-59 days past
due 60-89 days past
due
90 days or more
past due
Total past due Current Total loans 90 days past due
and still accruing Nonaccruals
Commercial real estate $ - $ 88 $ - $ 88 $ 761,788 $ 761,876 $ - $ -
Commercial and industrial - - 2,883 2,883 268,156 271,039 - 2,883
Commercial construction - 13 - 13 220,832 220,845 - -
Consumer real estate 347 76 - 423 133,517 133,940 - -
Consumer nonresidential - - 44 44 15,758 15,802 44 -
Total $ 347 $ 177 $ 2,927 $ 3,451 $ 1,400,051 $ 1,403,502 $ 44 $ 2,883
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
2020 - Acquired Loan Portfolio
30-59 days past
due 60-89 days past
due
90 days or more
past due
Total past due Current Total loans 90 days past due
and still accruing Nonaccruals
Commercial real estate $ 694 $ - $ 2,309 $ 3,003 $ 25,146 $ 28,149 $ - $ 2,309
Commercial and industrial - - - - 4,295 4,295 - -
Commercial construction 111 - - 111 1,363 1,474 - -
Consumer real estate 353 108 385 846 33,086 33,932 228 157
Consumer nonresidential - - - - 33 33 - -
Total $ 1,158 $ 108 $ 2,694 $ 3,960 $ 63,923 $ 67,883 $ 228 $ 2,466
There were overdrafts of $58 thousand and $72 thousand at December 31, 2021 and 2020, respectively, which have been reclassified from deposits to loans. At December 31, 2021 and 2020, loans with a carrying value of $290.3 million and $132.6 million were pledged to the FHLB.
There were no defaults of TDRs where the default occurred within twelve months of the restructuring during the years ended December 31, 2021 and December 31, 2020.
No TDRs were originated during the year ended December 31, 2021. The following table presents the TDRs originated during the year ended December 31, 2020:
Troubled Debt Restructurings Number of
Contracts
Pre-Modification
Outstanding
Recorded
Investment
Post-Modification
Outstanding
Recorded
Investment
Commercial real estate 1 $ 97 $ 97
Total 1 $ 97 $ 97
For each of December 31, 2021 and 2020, the Company had a recorded investment in TDRs of $92 thousand and $97 thousand, respectively.
The concessions made in TDRs were extensions of the maturity dates or reductions in the stated interest rate for the remaining life of the debt. The payment deferrals that were made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs.
Note 5. Other Real Estate Owned
The Company had no OREO property at December 31, 2021 compared to $3.9 million at December 31, 2020. OREO totaling $3.9 million was sold during 2021 and the Company recognized a gain on sale of OREO of $236 thousand. There was no activity in 2020. There were no foreclosed residential real estate properties recorded in OREO as a result of obtaining physical possession of the property at December 31, 2021 and 2020. There were no consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process as of December 31, 2021 and 2020. The Company recorded no impairment charges during 2021 and 2020.
Note 6. Goodwill and Intangibles
As a result of the Company's acquisition of Colombo in October 2018, the Company recognized goodwill and core deposit intangibles.
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
Information concerning amortizable intangibles follows:
Acquisition of 1st Commonwealth Acquisition of Colombo Bank Total
Gross Carrying
Amount Accumulated
Amortization Gross Carrying
Amount Accumulated
Amortization Gross Carrying
Amount Accumulated
Amortization
Balance at December 31, 2019
$ 204 $ 145 $ 1,950 $ 463 $ 2,154 $ 608
2020 activity:
1st Commonwealth amortization - 20 - - - 20
Colombo Bank amortization - - - 326 - 326
Balance at December 31, 2020
$ 204 $ 165 $ 1,950 $ 789 $ 2,154 $ 954
2021 activity:
1st Commonwealth amortization - 20 - - - 20
Colombo Bank amortization - - - 285 - 285
Balance at December 31, 2021
$ 204 $ 185 $ 1,950 $ 1,074 $ 2,154 $ 1,259
The aggregate amortization expense was $305 thousand for 2021 and $345 thousand for 2020. The estimated amortization expense for the next five years and thereafter is as follows:
2022 $ 262
2023 205
2024 165
2025 125
2026 85
Thereafter 53
The carrying amount of goodwill for the years ended December 31, 2021 and 2020 were as follows:
Balance at December 31, 2021 and 2020 $ 7,157
Note 7. Premises and Equipment
A summary of the cost and accumulated depreciation of premises and equipment follows:
2021 2020
Leasehold improvements $ 3,039 $ 2,715
Furniture, fixtures and equipment 4,163 4,081
Computer software 1,275 1,233
Land 61 61
Buildings 196 196
Vehicles 47 -
$ 8,781 $ 8,286
Less: accumulated depreciation 7,197 6,632
$ 1,584 $ 1,654
For the years ended December 31, 2021 and 2020, depreciation expense was $555 thousand and $615 thousand, respectively.
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
The Company has entered into operating leases for office space over various terms. The leases cover an agreed upon period of time and generally have options to renew and are subject to annual increases as well as allocations for real estate taxes and certain operating expenses.
The following tables present information about leases as of December 31, 2021 and 2020:
2021 2020
Right-of-Use-Asset $ 10,167 $ 11,125
Lease Liability $ 11,111 $ 12,123
Weighted Average Remaining Lease Term (Years) 8.9 9.8
Weighted Average discount rate 3.20 % 3.22 %
Years Ended December 31,
2021 2020
Operating Lease Expense $ 1,626 $ 1,694
Cash paid for amounts included in lease liabilities $ 1,559 $ 1,582
Impairment loss on right-of-use asset - 508
Derecognition of right-of-use asset and lease liabilities - 458
Right-of-use assets obtained in exchange for operating lease liabilities 207 59
The following table presents a maturity schedule of undiscounted cash flows that contribute to the lease liability:
2022 $ 1,667
2023 1,666
2024 1,596
2025 1,441
2026 1,343
Thereafter 5,123
Total $ 12,836
Less: discount (1,725)
$ 11,111
Note 8. Deposits
Remaining maturities on certificates of deposit are as follows:
2022 $ 191,589
2023 27,508
2024 7,458
2025 3,375
2026 1,487
$ 231,417
Total time deposits greater than $250,000 were $89.7 million and $100.8 million at December 31, 2021 and 2020, respectively.
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
At December 31, 2021 and 2020, the Company had one customer relationship whose related balance on deposit exceeded 5% of outstanding deposits. This customer relationship comprises 17% of outstanding deposits at December 31, 2021 and 10% of outstanding deposits at December 31, 2020.
Brokered deposits totaled $35.0 million and $50.0 million at December 31, 2021 and 2020, respectively.
Note 9. Other Borrowed Funds
Other borrowed funds at December 31, 2021 and 2020 consist of the following:
FHLB Advances Subordinated Debt, net
2021 2020 2021 2020
Balance Outstanding at December 31 $ 25,000 $ 25,000 $ 19,510 $ 44,085
Maximum balance at any month end during the year $ 25,000 $ 25,000 $ 44,157 $ 44,085
Average balance for the year $ 25,000 $ 23,115 $ 37,856 $ 28,790
Weighted average rate on borrowings at year end 0.20 % 0.23 % 4.88 % 5.50 %
The Company had $25 million of FHLB advances at each of December 31, 2021 and December 31, 2020. The FHLB advances outstanding at December, 31, 2021 mature during the first quarter of 2022. At December 31, 2021, 1-4 family residential loans with a lendable value of $23.2 million, multi-family residential loans with a lendable value of $42.8 million, home equity lines of credit with a lendable value of $8.1 million and commercial real estate loans with a lendable value of $129.5 million were pledged against an available line of credit with the FHLB totaling $203.6 million as of December 31, 2021. The Bank has a letter of credit with the FHLB in the amount of $51.0 million for the purpose of providing collateral for Virginia public deposits. The remaining lendable collateral value at December 31, 2021 totaled $127.6 million.
The Company has unsecured lines of credit with correspondent banks totaling $265.0 million at December 31, 2021 and $269.0 million at December 31, 2020, available for overnight borrowing. At December 31, 2021 and 2020, none of these lines of credit with correspondent banks were drawn upon.
On June 20, 2016, the Company issued $25.0 million in fixed-to-floating rate subordinated notes due June 30, 2026 in a private placement transaction. Interest was payable at 6.00% per annum, from and including June 20, 2016 to, but excluding June 30, 2021, payable semi-annually in arrears. From and including June 30, 2021 to the maturity date or early redemption date, the interest rate was to reset quarterly to an interest rate per annum equal to the then current three-month LIBOR rate plus 487 basis points, payable quarterly in arrears.
The Company had the option, on any scheduled interest payment date on or after June 30, 2021, to redeem the subordinated notes, in whole or in part, upon not fewer than 30 nor greater than 60 days' notice to holders, at a redemption price equal to 100% of the principal amount of the subordinated notes to be redeemed plus accrued and unpaid interest to, but excluding, the date of redemption. In August 2021, the Company provided a redemption notice to each holder of the subordinated notes that the notes would be redeemed in full on September 30, 2021 or such later date as the holder returned its note to the Company. $23.8 million of principal was redeemed and paid during the year ended December 31, 2021. The remaining principal balance of $1.2 million as of December 31, 2021 is included in other liabilities. The remaining note holders redeemed their notes in February 2022. The notes stopped accruing interest effective as of September 30, 2021 redemption date.
On October 13, 2020, the Company completed its private placement of $20 million of its 4.875% fixed-to-floating subordinated notes due 2030 (the "Notes") to certain qualified institutional buyers and accredited investors. The Notes have a maturity date of October 15, 2030 and carry a fixed rate of interest of 4.875% for the first five years. Thereafter, the Notes will pay interest at the then current three-month Secured Overnight Financing Rate plus 471 basis points, resetting quarterly. The Notes include a right of prepayment without penalty on or after October 15, 2025. The Notes have been structured to qualify as Tier 2 capital for regulatory purposes. The Company used the proceeds from the placement of the Notes for general corporate purposes, including to support capital ratios at the Bank, and the repayment of the $25.0 million outstanding subordinated debt called in August 2021.
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
The Notes qualify as Tier 2 capital for the Company to the fullest extent permitted under the Basel III capital rules. When contributed to the capital of the Bank, the proceeds of the subordinated notes may be included in Tier 1 capital for the Bank.
Note 10. Income Taxes
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2021 and 2020 are presented below:
2021 2020
Deferred Tax Assets:
Allowance for loan losses $ 3,131 $ 3,365
Net operating loss carryforward - federal and state 2,785 3,204
Bank premises and equipment 184 224
Nonqualified stock options and restricted stock 611 546
Organizational and start-up expenses 22 34
Acquisition accounting adjustments 258 181
Non-accrual loan interest 24 66
Deferred loan costs 801 1,193
Lease liability 2,516 2,728
Unrealized loss on securities available for sale 582 -
Unrealized loss on interest rate swap 17 158
$ 10,931 $ 11,699
Deferred Tax Liabilities:
Right-of-use assets $ (2,302) $ (2,503)
Unrealized gain on securities available for sale - (644)
$ (2,302) $ (3,147)
Net Deferred Tax Assets $ 8,629 $ 8,552
The income tax expense charged to operations for the years ended December 31, 2021 and 2020 consists of the following:
2021 2020
Current tax expense $ 5,269 $ 5,315
Deferred tax expense (benefit) 1,007 (1,159)
$ 6,276 $ 4,156
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
Income tax expense differed from amounts computed by applying the U.S. federal income tax rate to income, before income tax expense as a result of the following:
2021 2020
Computed "expected" tax expense $ 5,924 $ 4,128
Increase (decrease) in income taxes resulting from:
State income tax expense 472 294
Non-deductible expense 231 31
Tax free income (217) (251)
Tax benefits from exercise of stock options (163) (89)
Other 29 43
$ 6,276 $ 4,156
The Company files income tax returns in the U.S. federal jurisdiction. With few exceptions, the Company is no longer subject to U.S. federal examination by tax authorities for years prior to 2018.
Under the provisions of the Internal Revenue Code, the Company has $11.7 million of net operating loss carryforwards acquired from Colombo which can be offset against future taxable income. The carryforwards expire through December 31, 2037. The full realization of tax benefits associated with carryforwards depends predominately upon the recognition of ordinary income during the carryforward period. The federal portion of net operating loss carryforwards available to offset taxable income is limited to $762 thousand annually under Internal Revenue Code section 382. The Company believes it will generate sufficient future taxable income to fully utilize the remaining deferred tax assets.
Note 11. Derivative Financial Instruments
The Company enters into interest rate swap agreements ("swap agreements") to facilitate the risk management strategies needed in order to accommodate the needs of its banking customers. The Company mitigates the risk of entering into these loan agreements by entering into equal and offsetting swap agreements with highly-rated third party financial institutions. These back-to-back swap agreements are free-standing derivatives and are recorded at fair value in the Company's consolidated statements of condition (asset positions are included in other assets and liability positions are included in other liabilities) as of December 31, 2021. The Company is party to master netting arrangements with its financial institution counterparty; however, the Company does not offset assets and liabilities under these arrangements for financial statement presentation purposes. The master netting arrangements provide for a single net settlement of all swap agreements, as well as collateral, in the event of default on, or termination of, any one contract. Parties to a centrally cleared over-the-counter derivative exchange daily payments that reflect the daily change in value of the derivative. These payments, commonly referred to as variation margin, are recorded as settlements of the derivatives' mark-to-market exposure rather than collateral against the exposures, which effectively results in any centrally cleared derivative having a Level 2 fair value that approximates zero on a daily basis, and therefore, these swap agreements were not included in the offsetting table in the Fair Value Measurement section. As of December 31, 2021, the Company entered into 19 interest rate swap agreements which were collateralized by $6.7 million in cash. As of December 31, 2020, the Company entered into 21 interest rate swap agreements which were collateralized by $14.0 million in cash.
The notional amount and fair value of the Company's derivative financial instruments as of December 31, 2021 and 2020 were as follows:
December 31, 2021
Notional Amount Fair Value
Interest Rate Swap Agreements
Receive Fixed/Pay Variable Swaps $ 80,643 $ 6,052
Pay Fixed/Receive Variable Swaps 80,643 (6,052)
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
December 31, 2020
Notional Amount Fair Value
Interest Rate Swap Agreements
Receive Fixed/Pay Variable Swaps $ 97,658 $ 12,880
Pay Fixed/Receive Variable Swaps 97,658 (12,880)
Interest Rate Risk Management-Cash Flow Hedging Instruments
The Company uses FHLB advances and other wholesale funding from time to time as a source of funds for use in the Company's lending and investment activities and other general business purposes. This wholesale funding exposes the Company to increased interest rate risk as a result of the variability in cash flows (future interest payments). The Company believes it is prudent to reduce this interest rate risk. To meet this objective, the Company entered into interest rate swap agreements whereby the Company reduces the interest rate risk associated with the Company's variable rate advances (or other wholesale funding) from the designation date and going through the maturity date.
At December 31, 2021 and 2020, the information pertaining to outstanding interest rate swap agreements used to hedge variability in cash flows is as follows:
(Dollars in thousands) 2021 2020
Notional amount $ 60,000 $ 60,000
Weighted average pay rate 0.87 % 0.87 %
Weighted average receive rate 0.21 % 0.24 %
Weighted average maturity in years 1.10 years 2.10 years
Unrealized loss relating to interest rate swaps $ (77) $ (754)
These agreements provided for the Company to receive payments determined by a specific index (three month LIBOR) in exchange for making payments at a fixed rate. At December 31, 2021 and 2020, the unrealized loss relating to interest rate swaps designated as hedging instruments of the variability of cash flows associated with wholesale funds are reported in other comprehensive income (loss). These amounts are subsequently reclassified into interest expense as a yield adjustment in the same period in which the related interest on the advance affects earnings. The Company measures cash flow hedging relationships for effectiveness on a monthly basis, and at December 31, 2021 and 2020, the hedges were highly effective and the amount of ineffectiveness reflected in earnings was de minimus.
Note 12. Financial Instruments with Off-Balance Sheet Risk
The Company is party to credit-related financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet.
The Company's exposure to credit loss is represented by the contractual amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance sheet instruments.
At December 31, 2021 and 2020, the following financial instruments were outstanding which contract amounts represent credit risk:
2021 2020
Commitments to grant loans $ 90,591 $ 13,598
Unused commitments to fund loans and lines of credit 183,145 166,259
Commercial and standby letters of credit 8,930 5,529
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management's credit evaluation of the customer.
Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Company is committed. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management's credit evaluation of the customer.
Commercial and standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Substantially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company generally holds collateral supporting those commitments, if deemed necessary.
The Company maintains its cash accounts with the FRB and correspondent banks. The total amount of cash on deposit in correspondent banks exceeding the federally insured limits was $32.8 million and $25.3 million at December 31, 2021 and 2020, respectively.
Note 13. Minimum Regulatory Capital Requirements
Banks and bank holding companies are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, financial institutions must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. A financial institution’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
In August, 2018, the Federal Reserve updated the Small Bank Holding Company Policy Statement (the “Statement”), in compliance with the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018 (“EGRRCPA”). The Statement, among other things, exempts bank holding companies that have assets below a specified asset threshold from the consolidated regulatory capital requirements. The rule expanded the exemption to bank holding companies with consolidated total assets of less than $3 billion. Prior to August 2018, the statement exempted bank holding companies with consolidated total assets of less than $1 billion. As a result of the rule, the Company qualifies as a small bank holding company and is no longer subject to regulatory capital requirements on a consolidated basis.
The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. banks (“Basel III”) became effective for the Bank on January 1, 2015 with full compliance with all of the requirements being fully phased in January 1, 2019. As a part of the requirements, the Common Equity Tier 1 Capital ratio is calculated and utilized in the assessment of capital for all institutions. Under the Basel III rules, institutions must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios.
Prompt corrective action regulations, which also apply to the Bank, provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required.
Pursuant to the EGRRCPA, federal banking agencies have provided for an optional, simplified measure of capital adequacy, the community bank leverage ratio (“CBLR”) framework, for qualifying community bank organizations with less than $10 billion in consolidated total assets. Organizations that qualify could opt in to the CBLR framework beginning January 1, 2020 or any time thereafter. An institution that maintains a leverage ratio that exceeds the CBLR is considered to have met all generally applicable leverage and risk based capital requirements (including the Basel III rules), the capital ratio requirements for “well capitalized” status under the prompt corrective action regulations, and any other leverage or capital requirements to which it is subject. On January 1, 2020, the Company opted in to the CBLR framework.
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
The Coronavirus Aid, Relief, and Economic Security Act, passed in response to the COVID-19 pandemic, directed federal banking agencies to adopt interim final rules to lower the threshold under the CBLR from 9% to 8% and to provide a reasonable grace period for a community bank that falls below the threshold to regain compliance, in each case until the earlier of the termination date of the national emergency or December 31, 2021. In April 2020, the federal banking agencies issued two interim final rules implementing this directive. One interim final rule provided that, as of the second quarter of 2021, banking organizations with leverage ratios of 8% or greater (and that meet the other existing qualifying criteria) could elect to use the CBLR framework. It also established a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall below the 8% CBLR requirement, so long as the banking organization maintains a leverage ratio of 7% or greater. The second interim final rule provided a transition from the temporary 8% CBLR requirement to a 9% CBLR requirement. It established a minimum CBLR of 8% for the second through fourth quarters of 2021, 8.5% for 2021, and 9% thereafter, and maintained a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall no more than 100 basis points below the applicable CBLR requirement. As of December 31, 2021 and 2020, the Bank meets all capital adequacy requirements to which it is subject and is considered well capitalized under the prompt corrective action regulations.
The capital ratios for the Bank as of December 31, 2021 and 2020 are shown in the following table.
Actual Minimum
Capital Requirement
Amount Ratio Amount Ratio
As of December 31, 2021:
Tier 1 Capital (to Average Assets) $ 214,442 10.55 % $ 172,732 8.500 %
As of December 31, 2020:
Tier 1 Capital (to Average Assets) $ 209,359 11.65 % $ 143,823 8.000 %
Dividend Restrictions - The Company's principal source of funds for dividend payments is dividends received from the Bank. Banking regulations limit the amounts of dividends that may be paid without approval of regulatory agencies. As of December 31, 2021, $36.9 million of retained earnings is available to pay dividends.
Note 14. Related Party Transactions
Officers, directors and their affiliates had borrowings of $19.5 million and $14.3 million at December 31, 2021 and 2020, respectively, with the Company. During the years ended December 31, 2021 and 2020, total principal additions were $9.0 million and $476 thousand, respectively, and total principal payments were $3.8 million and $608 thousand, respectively.
Related party deposits amounted to $31.7 million and $43.7 million at December 31, 2021 and 2020, respectively.
Note 15. Stock-Based Compensation Plan
The Company's Amended and Restated 2008 Option Plan (the "Plan"), which is shareholder-approved, was adopted to advance the interests of the Company by providing selected key employees of the Company, their affiliates, and directors with the opportunity to acquire shares of common stock. In June 2018, the shareholders approved an amendment to the Amended and Restated 2008 Plan to extend the term of the plan until 2028 and increase the number of shares authorized for issuance under the Plan by 200,000 shares.
The maximum number of shares with respect to which awards may be made is 2,529,296 shares of common stock, subject to adjustment for certain corporate events. Option awards are generally granted with an exercise price equal to the market price of the Company's stock at the date of grant, generally vest annually over four years of continuous service and have ten years contractual terms. At December 31, 2021, 50,295 shares were available to grant under the Plan.
No options were granted during 2021 and 2020. For the year ended December 31, 2021, no shares were withheld from issuance upon exercise of options in order to cover the cost of the exercise by the participant. For the year ended
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
December 31, 2020, 2,737 shares were withheld from issuance upon exercise of options in order to cover the cost of the exercise by the participant.
A summary of option activity under the Plan as of December 31, 2021, and changes during the year then ended is presented below:
Options Shares Weighted
Average
Exercise
Price Weighted
Average
Remaining
Contractual
Term Aggregate
Intrinsic
Value (1)
Outstanding at January 1, 2020 1,727,945 $ 8.14 3.17 -
Granted - -
Exercised (182,292) 6.70
Forfeited or expired (760) 10.76
Outstanding and Exercisable at December 31, 2021
1,544,893 $ 8.31 2.46 $ 17,566,446
________________________
(1)The aggregate intrinsic value of stock options represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on December 31, 2021. This amount changes based on changes in the market value of the Company's stock.
As of December 31, 2021, all outstanding shares of the Plan are fully vested and amortized. Tax benefits recognized for qualified and non-qualified stock option exercises during 2021 and 2020 totaled $163 thousand and $89 thousand, respectively.
A summary of the Company's restricted stock grant activity as of December 31, 2021 is shown below.
Number of
Shares Weighted Average
Grant Date
Fair Value
Nonvested at January 1, 2020 72,743 $ 18.82
Granted 117,238 17.51
Vested (33,993) 18.44
Forfeited (4,585) 17.84
Balance at December 31, 2021
151,403 $ 17.92
The compensation cost that has been charged to income for the plan was $1.0 million and $690 thousand for 2021 and 2020, respectively. As of December 31, 2021, there was $2.1 million of total unrecognized compensation cost related to nonvested restricted shares granted under the Plan. The cost is expected to be recognized over a weighted-average period of 33 months.
Note 16. Fair Value Measurements
Determination of Fair Value
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with Fair Value Measurements and Disclosures topic of FASB ASC, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a 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 Company'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
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
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 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 most representative of fair value under current market conditions.
Fair Value Hierarchy
In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
Level 1 - Valuation is based on quoted prices in active markets for identical assets and liabilities.
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 Company 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).
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2021 and 2020:
Fair Value Measurements at
December 31, 2021 Using
Balance as of
December 31, 2021
Quoted Prices
in Active
Markets for
Identical
Assets Significant
Other
Observable
Inputs Significant
Unobservable
Inputs
Description (Level 1) (Level 2) (Level 3)
Assets
Available-for-sale
Securities of U.S. government and federal agencies $ 13,436 $ - $ 13,436 $ -
Securities of state and local municipalities tax exempt 1,451 - 1,451 -
Securities of state and local municipalities taxable 596 - 596 -
Corporate bonds 14,151 - 14,151 -
SBA pass-through securities 108 - 108 -
Mortgage-backed securities 313,838 - 313,838 -
Collateralized mortgage obligations 14,194 - 14,194 -
Total Available-for-Sale Securities $ 357,774 $ - $ 357,774 $ -
Fair Value Measurements at
December 31, 2020 Using
Balance as of
December 31, 2020
Quoted Prices
in Active
Markets for
Identical
Assets Significant
Other
Observable
Inputs Significant
Unobservable
Inputs
Description (Level 1) (Level 2) (Level 3)
Assets
Available-for-sale
Securities of state and local municipalities tax exempt $ 3,493 $ - $ 3,493 $ -
Securities of state and local municipalities taxable 818 - 818 -
Corporate bonds 12,817 - 12,817 -
SBA pass-through securities 141 - 141 -
Mortgage-backed securities 83,714 - 83,714 -
Collateralized mortgage obligations 25,168 - 25,168 -
Total Available-for-Sale Securities $ 126,151 $ - $ 126,151 $ -
Certain financial 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 Company to measure certain financial assets recorded at fair value on a nonrecurring basis in the financial statements:
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
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. 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. Fair value is measured based on the value of the collateral securing the loans. 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 a market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction, has the value derived by discounting comparable sales due to lack of similar properties, or is discounted by the Company due to 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's financial statements if not considered significant using observable market data. 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: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which are updated no less frequently than annually. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach with data from comparable properties. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available, which results in a Level 3 classification of the inputs for determining fair value. OREO properties are evaluated regularly for impairment and adjusted accordingly.
The following table summarizes the Company's assets that were measured at fair value on a nonrecurring basis at December 31, 2021 and December 31, 2020:
Fair Value Measurements
Using
Balance as of
December 31, 2021
Quoted Prices
in Active
Markets for
Identical
Assets Significant
Other
Observable
Inputs Significant
Unobservable
Inputs
Description (Level 1) (Level 2) (Level 3)
Assets
Impaired loans
Commercial and industrial $ 1,497 $ - $ - $ 1,497
Consumer residential 88 - - 88
Total Impaired loans $ 1,585 $ - $ - $ 1,585
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
Fair Value Measurements
Using
Balance as of
December 31, 2020
Quoted Prices
in Active
Markets for
Identical
Assets Significant
Other
Observable
Inputs Significant
Unobservable
Inputs
Description (Level 1) (Level 2) (Level 3)
Assets
Impaired loans
Commercial real estate $ 2,678 $ - $ - $ 2,678
Commercial and industrial 3,837 - - 3,837
Consumer residential 72 - - 72
Total Impaired loans $ 6,587 $ - $ - $ 6,587
Other real estate owned $ 3,866 $ - $ - $ 3,866
The following table displays quantitative information about Level 3 Fair Value Measurements for December 31, 2021 and 2020:
Quantitative information about Level 3 Fair Value Measurements for December 31, 2021
Assets Fair Value Valuation Technique(s) Unobservable input Range
(Avg.)
Impaired loans
Commercial and industrial $ 1,497 Discounted appraised value Marketability/Selling costs 8% - 8%
8.00 %
Consumer residential 88 Discounted appraised value Marketability/Selling costs 8% - 8%
8.00 %
Total Impaired loans $ 1,585 Discounted appraised value Marketability/Selling costs 8% - 8%
8.00 %
Quantitative information about Level 3 Fair Value Measurements for December 31, 2020
Assets Fair Value Valuation Technique(s) Unobservable input Range
(Avg.)
Impaired loans
Commercial real estate $ 2,678 Discounted appraised value Marketability/Selling costs 0% - 6%
4.42 %
Commercial and industrial $ 3,837 Discounted appraised value Marketability/Selling costs 7% - 8 %
7.81 %
Consumer residential $ 72 Discounted appraised value Marketability/Selling costs 8% - 8%
8.00 %
Total Impaired loans $ 6,587 Discounted appraised value Marketability/Selling costs 0% - 8%
6.23 %
Other real estate owned $ 3,866 Discounted appraised value Selling costs 10.51%
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
The following presents the carrying amount, fair value and placement in the fair value hierarchy of the Company's financial instruments as of December 31, 2021 and 2020. Fair values for December 31, 2021 and 2020 are estimated under the exit price notion in accordance with the prospective adoption of ASU 2016-01, "Recognition and Measurement of Financial Assets and Financial Liabilities."
Fair Value Measurements as of December 31, 2021 using
Carrying
Amount
Quoted Prices in
Active Markets
for Identical
Assets
Significant
Unobservable
Inputs Significant
Unobservable
Inputs
Level 1 Level 2 Level 3
Financial assets:
Cash and due from banks $ 24,613 $ 24,613 $ - $ -
Interest-bearing deposits at other institutions 216,345 216,345 - -
Securities held-to-maturity 264 - 270 -
Securities available-for-sale 357,774 - 357,774 -
Restricted stock 6,372 - 6,372 -
Loans, net 1,490,020 - - 1,493,185
Bank owned life insurance 39,171 - 39,171 -
Accrued interest receivable 8,074 - 8,074 -
Financial liabilities:
Checking, savings and money market accounts $ 1,652,352 $ - $ 1,652,352 $ -
Time deposits 231,417 - 232,837 -
FHLB advances 25,000 - 25,000 -
Subordinated notes 19,510 - 18,133 -
Accrued interest payable 1,034 - 1,034 -
Fair Value Measurements as of December 31, 2020 using
Carrying
Amount
Quoted Prices in
Active Markets
for Identical
Assets
Significant
Unobservable
Inputs Significant
Unobservable
Inputs
Level 1 Level 2 Level 3
Financial assets:
Cash and due from banks $ 20,835 $ 20,835 $ - $ -
Interest-bearing deposits at other institutions 120,228 120,228 - -
Securities held-to-maturity 264 - 274 -
Securities available-for-sale 126,151 - 126,151 -
Restricted stock 6,563 - 6,563 -
Loans, net 1,451,125 - - 1,463,270
Bank owned life insurance 38,178 - 38,178 -
Accrued interest receivable 9,135 - 9,135 -
Financial liabilities:
Checking, savings and money market accounts $ 1,219,440 $ - $ 1,219,440 $ -
Time deposits 313,053 - 316,341 -
FHLB advances 25,000 - 25,000 -
Subordinated notes 44,085 - 42,438 -
Accrued interest payable 685 - 685 -
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
Note 17. Earnings Per Share
Basic earnings per share ("EPS") 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 contracts to issue common stock were exercised or converted into common stock, or resulted in the issuance of stock which then shared in the earnings of the Company. Weighted average shares - diluted includes only the potential dilution of stock options and unvested restricted stock units as of as of December 31, 2021 and 2020, respectively.
The following shows the weighted average number of shares used in computing earnings per share and the effect of weighted average number of shares of dilutive potential common stock. Dilutive potential common stock has no effect on income available to common shareholders. There were no anti-dilutive shares for each of the years ended December 31, 2021 and 2020.
The holders of restricted stock do not share in dividends and do not have voting rights during the vesting period.
Years Ended
December 31,
2021 2020
Net income $ 21,933 $ 15,501
Weighted average shares - basic 13,650 13,542
Effect of dilutive securities 931 592
Weighted average shares - diluted 14,581 14,134
Basic EPS $ 1.61 $ 1.14
Diluted EPS $ 1.50 $ 1.10
Note 18. Supplemental Cash Flow Information
For the Years Ended
December 31,
2021 2020
Supplemental Disclosure of Cash Flow Information:
Cash paid for:
Interest on deposits and borrowed funds $ 9,361 $ 14,295
Income taxes 4,735 3,505
Noncash investing and financing activities:
Unrealized (loss) gain on securities available-for-sale (5,630) 2,112
Unrealized gain (loss) on interest rate swaps 677 (674)
Transfer of loans held for sale to loans, net - 9,641
Right-of-use assets obtained in the exchange for lease liabilities during the current period 207 59
Derecognition of right-of-use assets and lease liability - 458
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
Note 19. Accumulated Other Comprehensive Income (Loss)
Changes in accumulated other comprehensive income ("AOCI") for the years ended December 31, 2021 and 2020 are shown in the following table. The Company has two components of AOCI, which are available-for-sale securities and cash flow hedges, for each of the years ended December 31, 2021 and 2020.
Available-for-
Sale Securities Cash Flow
Hedges Total
Balance, beginning of period $ 2,421 $ (595) $ 1,826
Net unrealized (losses) gains during the period (4,404) 535 (3,869)
Other comprehensive (loss) income, net of tax (4,404) 535 (3,869)
Balance, end of period $ (1,983) $ (60) $ (2,043)
Available-for-
Sale Securities Cash Flow
Hedges Total
Balance, beginning of period $ 753 $ (63) $ 690
Net unrealized gains (losses) during the period 1,780 (532) 1,248
Net reclassification adjustment for gains realized in income (112) - (112)
Other comprehensive income (loss), net of tax 1,668 (532) 1,136
Balance, end of period $ 2,421 $ (595) $ 1,826
The following table presents information related to reclassifications from accumulated other comprehensive income.
Amount Reclassified from AOCI
into Income
For the Years Ended December 31,
Affected Line Item
in the Consolidated
Statements of
Income
Details about AOCI 2021 2020
Gain on sale of available-for-sale securities $ - $ (141) Gain on sale of securities available-for-sale
Income tax expense - 29 Income tax benefit
Total $ - $ (112) Net of tax
Note 20. Revenue Recognition
The Company recognizes revenue in accordance with ASU No. 2014-09 "Revenue from Contracts with Customers" (Topic 606) and all subsequent ASUs that modified Topic 606 in recognizing revenue.
Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain noninterest income streams such as fees associated with mortgage servicing rights, gain on sale of securities, BOLI income, financial guarantees, derivatives, and certain credit card fees are also not in scope of the new guidance. Topic 606 is applicable to noninterest revenue streams such as trust and asset management income, deposit related fees, interchange fees, merchant income, and insurance commissions. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Substantially all of the Company's revenue is generated from contracts with customers. Noninterest revenue streams in-scope of Topic 606 are discussed below.
Service Charges on Deposit Accounts
Service charges on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business and personal checking accounts), monthly service fees, check orders, and other deposit account related fees. The Company's performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account related fees are largely transactional based, and therefore, the Company's performance obligation is satisfied, and related revenue
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers' accounts.
Fees, Exchange and Other Service Charges
Fees, exchange, and other service charges are primarily comprised of debit and credit card income, ATM fees, merchant services income, and other service charges and are included in other income on our consolidated statements of income. Debit and credit card income is primarily comprised of interchange fees earned whenever the Company's debit and credit cards are processed through card payment networks such as Visa. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. Other service charges include revenue from processing wire transfers, bill pay service, cashier's checks, and other services. The Company's performance obligation for fees, exchange, and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month. This income is reflected in other income on the Company's consolidated statements of income.
Other Income
Other noninterest income consists of loan swap fees, insurance commissions, and other miscellaneous revenue streams not meeting the criteria above. When the Company enters into an interest rate swap agreement, the Company may receive an additional one-time payment fee which is recognized as income when received. The Company receives monthly recurring commissions based on a percentage of premiums issued and revenue is recognized when received. Any residual miscellaneous fees are recognized as they occur, and therefore, the Company determined this consistent practice satisfies the obligation for performance.
The following presents noninterest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the years ended December 31, 2021 and 2020:
Years Ended December 31,
2021 2020
Noninterest Income
In-scope of Topic 606
Service Charges on Deposit Accounts $ 1,028 $ 1,008
Fees, Exchange, and Other Service Charges 369 345
Other income 191 76
Noninterest Income (in-scope of Topic 606) 1,588 1,429
Noninterest Income (out-scope of Topic 606) 2,714 1,462
Total Noninterest Income $ 4,302 $ 2,891
Contract Balances
A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity's obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company's noninterest revenue streams are largely based on transactional activity. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances. As of December 31, 2021 and 2020, the Company did not have any significant contract balances.
Contract Acquisition Costs
Under Topic 606, an entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. The Company did not capitalize any contract acquisition cost during the years ended December 31, 2021 or 2020.
Gain on sale of other real estate owned
The Company records a gain/loss from the sale of other real estate owned when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Company finances the sale of the property to a buyer, the Company assesses whether the buyer is committed to perform the obligations under the contract and whether collectability of the transaction price is probable. In determining the gain (loss) on the sale, the Company adjusts the transaction price and the related gain or loss on sale if a significant financing component is present. The Company recorded a gain on sale of other real estate owned of $236 thousand in 2021 and $0 in 2020. Gain on sale of other real estate owned is reflected in the consolidated statements of income under Noninterest Expense and is not reflected in the table below.
Note 21. Parent Company Only Financial Statements
The FVCBankcorp, Inc. (Parent Company only) condensed financial statements are as follows:
PARENT COMPANY ONLY CONDENSED STATEMENTS OF CONDITION
December 31, 2021 and 2020
Assets 2021 2020
Cash and cash equivalents $ 1,882 $ 8,016
Securities available-for-sale 1,005 1,012
Investment in subsidiary 223,043 222,531
Other assets 3,903 2,162
Total assets $ 229,833 $ 233,721
Liabilities and Stockholders' Equity
Subordinated notes $ 19,510 $ 44,085
Other liabilities 527 136
Total liabilities $ 20,037 $ 44,221
Total stockholders' equity $ 209,796 $ 189,500
Total liabilities and stockholders' equity $ 229,833 $ 233,721
Notes to Consolidated Financial Statements (Continued)
(Dollars in thousands, except per share data)
PARENT COMPANY ONLY CONDENSED STATEMENTS OF INCOME
For the Years Ended December 31, 2021 and 2020
2021 2020
Income:
Interest on securities available-for-sale $ 65 $ 65
Dividend income 20,820 3,500
Total income $ 20,885 $ 3,565
Expense:
Interest on subordinated notes 2,534 1,802
Salaries and employee benefits 1,021 699
Occupancy and equipment 83 83
Audit, legal and consulting fees 320 365
Other operating expenses 249 217
Total expense 4,207 3,166
Net income before income tax benefit and equity in undistributed earnings of subsidiary $ 16,678 $ 399
Income tax benefit (879) (643)
Equity in undistributed earnings of subsidiary 4,376 14,459
Net income $ 21,933 $ 15,501
PARENT COMPANY ONLY CONDENSED STATEMENTS OF CASH FLOWS
For The Years Ended December 31, 2021 and 2020
2021 2020
Cash Flows From Operating Activities
Net income $ 21,933 $ 15,501
Equity in undistributed earnings of subsidiary (4,376) (14,459)
Deferred income tax benefit - (6)
Amortization of subordinated debt issuance costs 488 88
Stock-based compensation expense 1,011 690
Change in other assets and liabilities (2,598) 176
Net cash provided by operating activities $ 16,458 $ 1,990
Cash Flows From Investing Activities
Pushdown of capital to banking subsidiary $ - $ (12,000)
Net cash used in investing activities $ - $ (12,000)
Cash Flows From Financing Activities
Issuance of subordinated notes, net $ - $ 19,510
Repayment of subordinated notes, net (23,813) -
Repurchase of shares of common stock - (7,280)
Common stock issuance 1,221 375
Net cash (used in) provided by financing activities $ (22,592) $ 12,605
Net (decrease) increase in cash and cash equivalents $ (6,134) $ 2,595
Cash and cash equivalents, beginning of year 8,016 5,421
Cash and cash equivalents, end of year $ 1,882 $ 8,016

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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
No changes in the Company's independent registered public accounting firm or disagreements on accounting and financial disclosure required to be reported hereunder have taken place.

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ITEM 9A. CONTROLS AND PROCEDURES
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to provide assurance that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods required by the Securities and Exchange Commission and that such information is accumulated and communicated to the Company's management including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. An evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of the end of the period covered by this report was carried out under the supervision and with the participation of management, including the Company's Chief Executive Officer and Chief Financial Officer. Based on the evaluation, the aforementioned officers concluded that the Company's disclosure controls and procedures were effective as of the end of such period.
Management's Report on Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Company's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of the Company's financial reporting and the preparation of published financial statements in accordance with generally accepted accounting principles.
Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2021. In making this assessment, management used the 2013 criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control-Integrated Framework. Based on management's assessment, management believes that as of December 31, 2021, the Company's internal control over financial reporting was effective based on criteria set forth by COSO in its 2013 Internal Control-Integrated Framework.
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 under Public Company Accounting Oversight Board standards. 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 YHB. 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 representations made to the independent registered public accounting firm were valid and appropriate. The resulting report from YHB accompanies the consolidated financial statements.
Changes in Internal Control Over Financial Reporting
There was no change in the Company's internal control over financial reporting identified in connection with the evaluation of internal controls that occurred during the fourth quarter of 2021 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

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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
Pursuant to General Instruction G(3) of Form 10-K, the information contained under the captions "Election of Directors," "Executive Officers," "Ownership of Company Securities - Delinquent Section 16(a) Reports" and "Corporate Governance and The Board of Directors" in the Company's Proxy Statement for the 2022 Annual Meeting of Stockholders is incorporated by reference.

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ITEM 11. EXECUTIVE COMPENSATION
Item 11. Executive Compensation
Pursuant to General Instruction G(3) of Form 10-K, the information contained under the captions "Executive Compensation," "Corporate Governance and The Board of Directors - Director Compensation" and "Corporate Governance and The Board of Directors - "Compensation Committee Interlocks and Insider Participation" in the Company's Proxy Statement for the 2022 Annual Meeting of Stockholders is incorporated by reference.

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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
Security Ownership of Certain Beneficial Owners and Management. Pursuant to General Instruction G(3) of Form 10-K, the information contained under the caption "Ownership of Company Securities - Security Ownership of Directors , Executive Officers and Certain Beneficial Owners" in the Company's Proxy Statement for the 2022 Annual Meeting of Stockholders is incorporated by reference.
Equity Compensation Plan Information. The following table sets forth information as of December 31, 2021, with respect to compensation plans under which shares of our Common Stock are authorized for issuance.
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 Number of Securities
Remaining Available
for Future Issuance
Under Equity
Compensation Plans(1)
Equity Compensation Plans Approved by Stockholders:
Amended and Restated 2008 Stock Plan 1,544,893 $ 8.31 50,295
Equity Compensation Plans Not Approved by Stockholders (2) - - -
Total 1,544,893 $ 8.31 50,295
________________________
(1)Amounts exclude any securities to be issued upon exercise of outstanding options, warrants and rights.
(2)The Company does not have any equity compensation plans that have not been approved by stockholders.

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item 13. Certain Relationships and Related Transactions, and Director Independence
Pursuant to General Instruction G(3) of Form 10-K, the information contained under the captions "Executive Compensation - Certain Relationships and Related Transactions" and "Corporate Governance and The Board of Directors - Director Independence" in the Company's Proxy Statement for the 2022 Annual Meeting of Stockholders is incorporated by reference.

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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Item 14. Principal Accountant Fees and Services
Pursuant to General Instruction G(3) of Form 10-K, the information contained under the captions "Audit information - Fees of Independent Registered Public Accountants" and "Audit Information - Audit Committee Pre-Approval Policies and Procedures" in the Company's Proxy Statement for the 2022 Annual Meeting of Stockholders is incorporated by reference.

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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Item 15. Exhibits and Financial Statement Schedules
(a)Exhibits
Number Description
3.1 Articles of Incorporation of FVCBankcorp, Inc. (incorporated by reference to Exhibit 3.1 of the Registration Statement on Form S-1 filed on August 20, 2018 (Registration No. 333-226942))
3.2 Amendment, dated May 11, 2018, to Articles of Incorporation of FVCBankcorp, Inc. (incorporated by reference to Exhibit 3.2 of the Registration Statement on Form S-1 filed on August 20, 2018 (Registration No. 333-226942))
3.3 Bylaws of FVCBankcorp, Inc., as amended (incorporated by reference to Exhibit 3.1 of the Current Report on Form 8-K filed on April 9, 2020)
4.1 Specimen Certificate for Common Stock (incorporated by reference to Exhibit 4.1 of the Registration Statement on Form S-1 filed on August 20, 2018 (Registration No. 333-226942))
4.2 Form of Subordinated Note due October 15, 2030 (incorporated by referenced to Exhibit 4.1 of the Current Report on Form 8-K filed on October 14, 2020).
4.3 Description of FVCBankcorp, Inc.'s Securities.
10.1 Amended and Restated Employment Agreement, dated as of March 16, 2021, by and among FVCBankcorp, Inc., FVCbank and David W. Pijor (incorporated by reference to Exhibit 10.1 of the Registration Statement on Form S-1 filed on August 20, 2018 (Registration No. 333-226942))
10.2 Amended and Restated Change in Control Agreement, dated as of March 16, 2021, by and among FVCBankcorp, Inc., FVCbank and Patricia A. Ferrick (incorporated by reference to Exhibit 10.2 of the Registration Statement on Form S-1 filed on August 20, 2018 (Registration No. 333-226942))
10.3 Form of Subordinated Note Purchase Agreement dated October 13, 2020 (incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K filed on October 14, 2020)
10.4 FVCBankcorp, Inc. Amended and Restated 2008 Stock Incentive Plan (incorporated by reference to Exhibit 10.5 of the Registration Statement on Form S-1 filed on August 20, 2018 (Registration No. 333-226942))
10.5 1st Commonwealth Bank of Virginia 2009 Stock Option Plan (incorporated by reference to Exhibit 10.6 of the Registration Statement on Form S-1 filed on August 20, 2018 (Registration No. 333-226942))
21 Subsidiaries of the Registrant
23.1 Consent of Yount, Hyde & Barbour, P.C.
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
32.1 Statement of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350
32.2 Statement of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350
101 Interactive data files pursuant to Item 405 of Regulation S-T
(i) Consolidated Statements of Condition at December 31, 2021 and 2020
(ii) Consolidated Statement of Income for the years ended December 31, 2021 and 2020
(iii) Consolidated Statement of Comprehensive Income for the years ended December 31, 2021 and 2020
(iv) Consolidated Statement of Changes in Stockholders' Equity for the years ended December 31, 2021 and 2020
(v) Consolidated Statement of Cash Flows for the years ended December 31, 2021 and 2020
(vi) Notes to the Consolidated Financial Statements
104 The cover page from the Company's Annual Report on Form 10-K for the year ended December 31, 2021, formatted in Inline Extensible Business Reporting Language (included with Exhibit 101).