EDGAR 10-K Filing

Company CIK: 1419536
Filing Year: 2021
Filename: 1419536_10-K_2021_0001419536-21-000058.json

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ITEM 1. BUSINESS
ITEM 1. BUSINESS
In this annual report, unless we state otherwise or the context otherwise requires, references to “we,” “our,” “us,” “the Company” and “Capital” refer to Capital Bancorp, Inc. and its wholly owned subsidiaries, Capital Bank, N.A., which we sometimes refer to as “Capital Bank,” “the Bank” or “our Bank,” and Church Street Capital, LLC. “Church Street Capital” or “CSC” refer to our wholly owned subsidiary, Church Street Capital, LLC.
We are Capital Bancorp, Inc., a bank holding company and a Maryland corporation established in 1998, operating primarily through our wholly owned subsidiary, Capital Bank, N.A., a commercial-focused community bank based in the Washington, D.C. and Baltimore metropolitan areas. We serve businesses, not-for-profit associations and entrepreneurs throughout the region. Capital Bank is headquartered in Rockville, Maryland and operates a branch-lite model through five commercial bank branches, four mortgage offices, one loan production office, a limited service branch, corporate offices and operations facilities located in key markets throughout our operating area. As of December 31, 2020, we had total assets of $1.9 billion, total loans held for investment of $1.3 billion, total deposits of $1.7 billion, and total stockholders’ equity of $159.3 million.
Capital Bank currently operates three divisions: Commercial Banking, Capital Bank Home Loans, and OpenSky®. Our Commercial Banking division operates in the Washington, D.C. and Baltimore metropolitan areas and focuses on providing personalized service to commercial clients throughout our area of operations. Capital Bank Home Loans and OpenSky® both leverage Capital Bank’s national banking charter to operate as national consumer business lines; Capital Bank Home Loans acts as our residential mortgage origination platform and OpenSky® provides nationwide, digitally-based, secured credit cards to under-banked populations and those looking to rebuild their credit scores.
In addition to the three divisions of Capital Bank, Church Street Capital also operates as a wholly owned subsidiary of Capital Bancorp, Inc. CSC originates and services a portfolio of mezzanine loans with certain characteristics that do not meet Capital Bank’s general underwriting standards, but command a higher rate of return. Until recently, CSC typically sold participation interests in these loans to third parties (including to certain of the Company’s and Bank's directors), and retained exposure of as little as 10 percent. Beginning in 2019, CSC more typically retained 100% of the exposures. In all cases CSC had retained servicing of the loans, thereby maintaining a relationship with the customer. All participations sold to directors were sold on terms no less favorable than terms generally available to
unaffiliated third parties. For additional information on participations sold to our directors, please see “Certain Relationships and Related Party Transactions-Loan Participations with the Bank.” At December 31, 2020, the net portfolio of retained loans for CSC amounted to approximately $4.6 million. All of these loans were originated in our operating markets in the Washington, D.C. and Baltimore metropolitan areas.
In addition to its subsidiaries discussed above, Capital Bank, N.A. and Church Street Capital, Capital Bancorp, Inc. owns all of the stock of Capital Bancorp (MD) Statutory Trust I (the “Trust”). The Trust is a special purpose non-consolidated entity organized for the sole purpose of issuing trust preferred securities.
Commercial Banking Division
As of December 31, 2020, our Commercial Banking division accounted for approximately 86.6%, or $1.6 billion, of Capital Bank’s total assets. The Commercial Banking division operates out of four full service banking locations which is in the Washington, D.C. Metropolitan Statistical Area (“MSA”) and its full service banking location in Columbia, Maryland in the Baltimore, Maryland MSA. Additionally, we have one loan production offices located in the Washington, D.C. and Baltimore metropolitan areas. Our Commercial Banking division’s commercial loan officers and commercial real estate loan officers provide commercial and industrial, or C&I, commercial real estate and construction lending solutions to business clients in Capital Bank’s operating markets.
Construction lending is a core competency of our Commercial Banking division. Construction loans have increased to $224.9 million as of December 31, 2020, compared to $198.7 million at December 31, 2019, a 13.2% increase. As a percent of total gross loans, construction loans have increased to 17.1% from 16.9% for the same period reported. Our construction loan portfolio provides Capital Bank with short duration and higher yield loans. Our construction lending is focused on commercial and residential construction projects within the Washington, D.C. and Baltimore-Columbia-Towson, Maryland metropolitan operating areas, with limited exposure to suburban subdivision tract development. Our construction lending team consists of long-term employees of Capital Bank who are responsible for sourcing and structuring all construction loans that are originated.
In addition to its loan officers, our Commercial Banking division currently has a team of business development officers concentrating on continuing to diversify Capital Bank’s funding sources away from wholesale funding and towards core deposit funding by focusing on core deposits and treasury management. These business development officers, in conjunction with our recently introduced incentive program based upon core deposit capture from lending customers, have successfully reduced Capital Bank’s net non-core funding dependence ratio from 17.4% at December 31, 2018 to 13.0% at December 31, 2020. We expect that our deposit gathering teams will continue to help decrease our wholesale funding dependence through improved low-cost core funding.
Capital Bank Home Loans Division
Capital Bank Home Loans(“CBHL”), formerly known as Church Street Mortgage, originates conventional and government-guaranteed residential mortgage loans on a national basis, for sale into the secondary market and in certain, limited circumstances for our loan portfolio. Loans sold into the secondary market are sold servicing released. Loans retained for our portfolio are generally adjustable rate mortgage loans on primary residences within Capital Bank’s operating markets to individuals who own businesses where Capital Bank may also pursue a commercial lending relationship and has a vested interest in maintaining full control of the lending relationship.
The following table presents, for the periods indicated, certain loan origination data for CBHL.
Years Ended December 31,
(Dollars are in thousands)
2020 2019 2018 2017 2016
Mortgage Metrics:
Origination of loans held for sale
$ 1,308,912 $ 593,189 $ 337,122 $ 418,912 $ 853,674
Net proceeds of loans held for sale (1)
$ 1,272,788 $ 540,686 $ 344,940 $ 441,960 $ 844,464
Purchase volume as a % of originations
31.90 % 51.89 % 79.43 % 52.50 % 18.79 %
Mortgage banking revenue
$ 40,649 $ 15,955 $ 9,477 $ 10,377 $ 15,373
Gain on sale as a % of loans sold
3.02 % 2.95 % 2.75 % 2.01 % 1.82 %
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(1) Net proceeds of loans held for sale is the origination of loans held for sale less mortgage banking revenue.
Historically, CBHL has relied heavily on refinance origination volume as opposed to purchase origination volume. In 2019, as a result of increases in the interest rate environment, purchase origination volume exceeded refinance origination volume. However, in 2020, market interest rates decreased and the Company experienced a 20.0% decline in purchase origination volume year over year. Purchase origination volume was 31.9% for the year ended December 31, 2020, compared to 51.9% for the year ended December 31, 2019.
Approximately 67.2% of CBHL loan originations by volume occur within Capital Bank’s operating markets in Maryland, Virginia and Washington, D.C. The remainder of originations are national in scope and occur primarily through a consumer direct channel utilizing consumer marketing, including through social media applications.
OpenSky® Secured Credit Card Division
The OpenSky® division provides secured credit cards (with a minimum initial deposit of $200 and maximum initial deposits of $3,000 per card and $5,000 per individual) on a nationwide basis to under-banked populations and those looking to rebuild their credit scores. In order to obtain a credit card from us, the customer must select a credit line amount that they are willing to secure with a matching deposit amount. A deposit equal to the full credit limit of the card is made, using a debit card, check, wire or Western Union transfer, into a noninterest bearing demand account with the Bank. Once the account is opened, the deposit is required to be maintained throughout the life of the card. The customer’s funding of the deposit account is collateral and it is not a consideration in the credit card approval process, but is a prerequisite to activating the credit line. Credit card eligibility is based on identity and income verification. Once the customer’s deposit account has been funded, the credit line is activated and the collateral funds are generally available to absorb any losses on the account that may occur. As of December 31, 2020, approximately 13.5% of our credit card portfolio was delinquent by 30 days or more. Based on our prior experience, approximately 20% of our new secured credit cards will experience a charge-off within the first year of issuance primarily due to the relative inexperience of this under-banked population in effectively managing credit card debt.
Additionally, using our proprietary scoring model, which considers credit score and repayment history (typically a minimum of six months of on-time repayments, but ultimately determined on a case-by-case basis), the Bank has recently begun to offer certain customers an unsecured line in excess of their secured line of credit. OpenSky® secured credit cards have floating interest rates, which are beneficial in a rising rate environment, and we believe the OpenSky® secured credit card product may provide a counter-cyclical benefit as more people enter its target segment of credit rebuilders during an economic downturn. At December 31, 2020, we had $92.5 million of unused unsecured lines of credit and $5.7 million of outstanding unsecured credit card advances.
Credit Card Loans and Deposits ($ in millions) Open Credit Card Accounts and
Average Monthly Account Openings
Capital Bank evaluates its OpenSky® customers using analytics that track consumer behaviors and score each customer on risk and behavior metrics. These real-time monitoring capabilities give our management insight into the credit trends of our portfolio on a consumer by consumer basis, allowing them to identify potential fraud situations and mitigate any associated losses quickly and efficiently, as well as to obtain insights into how to optimize the profitability and life cycle of each account. The model utilizes data proprietary to Capital Bank. We have invested heavily in technology and systems to prevent and detect fraudulent behavior and mitigate losses but such investments may not be adequate, and our systems may not adequately monitor or mitigate potential losses arising from these risks. See “Risk Factors-Risks Related to Our Business-Delinquencies and credit losses from our OpenSky® credit card division could adversely affect our business, financial condition and results of operations.”
OpenSky® cards operate on a fully digital and mobile platform with all marketing and application procedures conducted through its website or mobile application. Given the secured nature of the cards, credit checks are not required at the time of application; however, as each customer’s account ages, we obtain credit scores to baseline their improvement as an input into any decision to extend unsecured credit in the future.
COVID-19 Pandemic
The outbreak of COVID-19, which was declared a pandemic by the World Health Organization on March 11, 2020, has led to adverse impacts on economic conditions and created uncertainty in financial markets. In early March 2020, the Company began preparing for potential disruptions and government limitations on activity in the markets in which we serve. Our team activated our Business Continuity Program and was able to quickly execute on multiple initiatives to adjust our operations to protect the health and safety of our employees and clients. Currently, a significant portion of our workforce is working remotely without materially impacting our productivity while continuing to provide a high level of customer service. Since the beginning of the crisis, we have been in close contact with our clients, assessing the
level of impact on their businesses, and providing relief programs according to each client’s specific situation and qualifications. Currently, three of the Company’s branches are open and two remain temporarily closed. We have enhanced awareness of digital banking offerings and limited the number of customers in the branch and have taken steps to comply with various government directives regarding “social distancing,” as well as enhanced cleaning and disinfecting of all surface areas to protect our clients and employees.
Small Business Administration’s Paycheck Protection Program
We were able to quickly establish our process for participating in the Small Business Administration’s Paycheck Protection Program (“SBA-PPP”) that enabled our clients to utilize this valuable resource. SBA- PPP loans are designed to provide assistance for small businesses during the COVID-19 pandemic to help meet the costs associated with payroll, mortgage interest, rent and utilities. These loans are 100% guaranteed by the SBA and, under certain circumstances, forgiveness of the loan, by the SBA, is granted to the borrower. Forgiveness is based on the small business maintaining or quickly rehiring their employees and maintaining salary levels for their employees. SBA-PPP loans do not require any collateral or personal guarantees. Through December 31, 2020, approximately $238.7 million of SBA-PPP loans have been originated in the first and second rounds of the program. These efforts have allowed us to further strengthen and deepen our client relationships, while positively impacting thousands of individuals.
Short-term Modifications for Borrowers
In keeping with regulatory guidance to work with borrowers during this unprecedented situation and as outlined in Section 4013 of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), the Company is providing loan modifications where appropriate, including potential interest only payments or payment deferrals for clients that are adversely affected by the COVID-19 pandemic. Section 4013 of the CARES Act also addressed COVID-19 related modifications and specified that such modifications made on loans that were current as of December 31, 2019 are not TDRs. In accordance with interagency guidance issued in April 2020, these short-term modifications made to a borrower affected by the COVID-19 pandemic and governmental shutdown orders, such as payment deferrals, fee waivers and extensions of repayment terms, do not need to be identified as TDRs if the loans were current at the time a modification plan was implemented. Loans on which we deferred payments on a short-term basis for commercial and consumer loans were $30.5 million at December 31, 2020.
Our Business Strategy
Regulations, technology and competition have fundamentally impacted the economics of the banking sector. We believe that by using technology-enabled strategies and advice-based solutions, we can deliver attractive shareholder returns in excess of our cost of capital. We have adopted the following strategies that we believe will continue to drive growth while maintaining consistent profitability and enhancing shareholder value:
Deliver premium advice-based solutions that drive organic loan and core deposit growth with corresponding net interest margin
•Serve as financial partners to our customers, helping them to grow their businesses through advice-based financial solutions;
•Endeavor to provide comprehensive loan and deposit solutions to our customers that are tailored to their needs, leverage data, analytics, and financial technology to improve the customer experience;
•Scale our consumer fee based platforms by investing in fintech capabilities and digital marketing to deliver high impact products and services and differentiated customer experience;
•Capitalize on market dislocation from recent in-market acquisitions to continue to attract top sales talent, such as our Fiduciary Banking Team and the leader of our Business Banking group, and acquire new commercial banking relationships from local competitors; and
•Selectively add banking centers where sales teams have already proved an ability to capture market share and leverage customer relationships.
Leverage technology to improve the customer experience and loyalty and deliver operational efficiencies
•Use solution structuring and customized technology implementation as differentiators to add value to clients with complex needs and enhance our relationships within our existing customer base;
•Deploy technologies that better support our lending associates and simplify our processes;
•Maximize the potential of web-based and mobile banking applications to drive core funding while maintaining our branch-lite business model; and
•Enhance cross-selling capabilities among our OpenSky®, Capital Bank Home Loans and Commercial Banking division customers.
Increase scale in our consumer fee based platforms through delivery of high value products and services
•Utilize our customer acquisition system, Apollo, and leverage our investment in a new core processing system, together with our expertise in data, analytics and marketing, to deliver new products and services and grow our secured credit card business;
•Retain OpenSky® customers that “graduate” from our secured credit product through the limited use of partially unsecured credit products; and
•Expand our purchase-oriented mortgage loan sales both in-market and in adjacent markets through the hiring of high quality mortgage originators and continuing to improve on our direct to consumer marketing channels.
Pursue acquisitions opportunistically
•Seek strategic acquisitions in the Washington, D.C., Baltimore, Maryland, and surrounding metropolitan areas;
•Evaluate specialty finance company opportunities where we can add value through increasing interest and fee income and leveraging our management’s expertise and existing strategic assets; and
•Use our management’s and Board’s expertise to structure transactions that minimize the integration and execution risk for the Bank.
Summary Demographic and Other Market Data
According to the U.S. Census Bureau, the Washington, D.C. and Baltimore, Maryland, Metropolitan Statistical Areas (MSAs) include the four wealthiest counties in the United States, as well as five of the 10 wealthiest counties. Overall, the Washington, D.C. MSA ranks third out of the largest 25 MSAs (ranked by
population) in income levels with a current median household income of approximately $107 thousand, which is approximately 62.1% higher than the national average. Additionally, the Washington, D.C. MSA is currently the sixth largest MSA in the United States with a total population of more than 6.3 million people (and when combined with the Baltimore, Maryland MSA, the Washington, D.C. and Baltimore metropolitan areas are home to a population of more than 9.2 million). We expect our strategies to benefit from the continued growth in population and high income of our market area’s residents.
State Total
Population
(Actual) Population
Change
2010-2020 Projected
Population
Change
2019-2025 Median
Household
Income
2020 HH Income
Change
2012-2020 Unemployment Rate (May 2020)
Washington D.C. MSA 6,346,402 12.60 % 4.07 % $ 107,029 32.66 % 8.9 %
Baltimore, Maryland MSA 2,812,251 3.75 1.17 84,221 32.77 9.7
State of Maryland 6,076,498 5.25 1.85 87,818 30.77 9.7
District of Columbia 717,189 19.19 6.92 90,695 65.07 8.5
Counties of Operation (1)
2,548,906 8.90 2.70 356,348 24.87 25.4
United States 330,342,293 7.00 3.10 66,010 33.14 13.0
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Source: S&P Global Market Intelligence, U.S. Bureau of Labor Statistics
(1) Data consists of deposit-weighted average using county-level deposits.
According to the Bureau of Economic Analysis, the Washington, D.C. MSA has a large and diversified economy, with an annual gross domestic product of nearly $559.1 million. When combined with the Baltimore, Maryland MSA, the Washington, D.C. and Baltimore metropolitan areas in which we operate has a combined gross domestic product of more than $774.5 million, and this combined GDP has grown approximately 32% between 2010 and 2020. The Washington, D.C. MSA is a desirable market for a broad range of companies in a variety of industries, including 16 companies from the 2020 Fortune 500 list, and 7 of the United States’ largest 100 private companies, according to the 2020 Forbes list of largest private companies by revenue. The following table provides an in-depth view of the distribution of employment within the Washington, D.C. MSA.
Washington, D.C. MSA Employment By Sector
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Source: U.S. Bureau of Labor Statistics; Data as of December 2019
Note: Data not seasonally adjusted
As the home of the federal government, the broader Washington, D.C. region benefits from consistent population growth and remains well positioned to capitalize on any increase in government spending and infrastructure. Further, as banks in our market have experienced continued consolidation over the last few years, our opportunities to attract talented employees and capitalize on customer dislocation have improved.
With its strong demographic characteristics, scale and robust economic activity, we believe that the Washington, D.C. and Baltimore metropolitan areas represent a strong geographic market for us to realize our continued growth strategies within our Commercial Banking division. The Washington, D.C. area serves as a regional, national and global center for several industries, including:
Government Contracting
•The Washington, D.C. metro area received $65.9 billion in government contracting awards from October 2019 to September 2020, according to data from USASpending.gov.
•According to the Annual Review of Government Contracting of the National Contract Management Association, Virginia, Maryland and the District of Columbia represent three of the top five markets in the United States for annual government contracts awarded in 2020.
•The Washington, D.C. MSA is home to some of the largest defense contracting companies in the world, including Lockheed Martin (Bethesda, Maryland), Leidos (Reston, Virginia), General Dynamics (Falls Church, Virginia), and Northrop Grumman (Falls Church, Virginia).
Hospitality and Tourism
•The Washington, D.C. MSA is home to three of the world’s largest hotel and resort chains, Marriott International, Inc. (Bethesda, Maryland), Hilton Worldwide Holdings Inc. (McLean, Virginia) and Host Hotels & Resorts, Inc. (Bethesda, Maryland).
•Worldwide interest in Washington, D.C.’s monuments, museums, and diverse neighborhoods drives a strong interest in tourism in the area. According to Destination DC, the area was visited by more than 24.6 million domestic and international tourists in 2019. The high volume of tourists contributed to $8.2 billion of spending in the area in 2019, an increase of 4.1% from 2018. D.C’s total visitor volume in 2019 reached a record high; however, due to COVID-19 it drastically declined in 2020. The recovery in tourism is expected to be slow. The tourism industry supports 78,266 jobs in Washington, D.C
In addition to their diverse economies, we believe the Washington, D.C. and Baltimore, Maryland metropolitan areas provide a favorable environment for economic strength going forward. As the home of the federal government, the broader Washington, D.C. region benefits from consistent population growth and remains well positioned to capitalize on any increase in government spending and infrastructure. Further, as banks in our market have experienced continued consolidation over the last few years, our opportunities to attract talented employees and capitalize on customer dislocation have improved. There were 6 bank mergers in the Washington, D.C. and Baltimore, Maryland MSAs in 2020.With the shrinking number of locally headquartered community banks (seven of the top 10 banks in Washington, D.C. MSA by market share are not headquartered in the region), we believe that we have the ability to continue our historical growth by serving the middle market businesses and their owners in the Washington, D.C. and Baltimore, Maryland MSAs who prefer personalized service and local decision making that may be unavailable at some of the larger, out-of-market banking institutions.
With its unique demographic characteristics, scale and robust economic activity, we believe that the Washington, D.C. and Baltimore metropolitan areas are a strong geographic market in which we can realize our continued growth strategies for our Commercial Banking division.
Lending Activities
Overview. We maintain a diversified loan portfolio with various types of loan products and customer characteristics, and a focus on variable rate, shorter term and higher yielding products. Our lending services cover residential and commercial real estate loans, on an owner and non-owner-occupied basis, construction loans and commercial business loans. Secured credit card lines are substantially secured by a deposit at the Bank in an amount equal to the full credit limit of the credit card. Lending activities originate from the efforts of our bankers, with an emphasis on lending to individuals, professionals, small- to medium-sized businesses and commercial companies located in our market areas.
The following table presents the composition of our portfolio loans, by category, as of December 31, 2020.
PORTFOLIO LOAN PORTFOLIO COMPOSITION
Portfolio Loan Composition
(Dollars in thousands) Amount Percentage of
Total Loans
Real estate:
Residential $ 437,860 33 %
Commercial 392,550 30
Construction 224,904 17
Subtotal real estate 1,055,314 80
Commercial 157,127 12
Credit card 102,186 8
Other consumer 1,649 -
Total $ 1,316,276 100.0 %
Residential Real Estate Loans. We offer one-to-four family mortgage loans primarily on owner-occupied primary residences and, to a lesser extent, investor-owned residences. We also offer home equity lines of credit. Our residential real estate lending products are offered primarily to customers within our geographic markets. Our owner-occupied residential real estate loans usually have fixed rates for five to seven years and adjust on an annual basis after the initial term based on a typical maturity of 30 years. Our investor residential real estate loans are generally based on 25-year amortization terms with a balloon payment due after five years. In general, the required minimum debt service coverage ratio is 1.15.
Commercial Real Estate Loans. We offer real estate loans for commercial property that is owner-occupied as well as commercial property owned by real estate investors. Commercial loans that are secured by owner-occupied commercial real estate and primarily collateralized by operating cash flows are also included in this category of loans. As of December 31, 2020, we had approximately $200.3 million of owner-occupied commercial real estate loans, representing approximately 15.2% of our total loan portfolio. Commercial real estate loan terms are generally extended for 10 years or less and amortize generally over 25 years or less. The interest rates on our commercial real estate loans have initial fixed rate terms that adjust typically at 5 years and we routinely charge an origination fee for our services. We generally require personal guarantees from the principal owners of the business supported by a review of the principal owners’ personal financial statements and global debt service obligations. The real estate securing our existing commercial real estate loans includes a wide variety of property types, such as owner-occupied offices, warehouses, production facilities, office buildings, mixed-use residential/commercial property, retail centers and multifamily properties.
Construction Loans. Our construction loan portfolio primarily includes loans to builders for the construction of single-family homes, condominium and townhouse conversions or renovations and, to a lesser extent, loans to individual clients for construction of owner-occupied single-family homes in our market areas. Construction loans are generally made with a term of 12 to 18 months. According to our underwriting standards, the ratio of loan principal to collateral value, as established by an independent appraisal, cannot exceed 75% for investor-owned and 80% for owner-occupied properties. In general, loan proceeds are disbursed based on the completion of certain milestones and only after the project has been inspected by an experienced construction lender or third-party inspector.
Commercial Business Loans. In addition to our other loan products, we provide general commercial loans, including commercial lines of credit, working capital loans, term loans, equipment financing, letters of credit and other loan products, primarily in our target markets, underwritten based on each borrower’s
ability to service debt from income. We typically take as collateral a lien on general business assets including, among other things, available real estate, accounts receivable, promissory notes, inventory and equipment and we generally obtain a personal guaranty from the borrower or other principal. Other than lines of credit, our commercial loans generally have fixed interest rates and five to seven year terms depending on the type and size of the loan, the financial strength of the borrower/guarantor and the age, type and value of the collateral.
Credit Cards. Through our OpenSky® credit card division, we provide credit cards on a nationwide basis to under-banked populations and those looking to rebuild their credit scores through a fully digital and mobile platform. Substantially all of the lines of credit are secured by a noninterest bearing demand account at the Bank in an amount equal to the full credit limit of the credit card. In addition, using our proprietary scoring model, which considers credit score and repayment history (typically a minimum of six months of on-time repayments, but ultimately determined on a case-by-case basis), the Bank has recently begun to offer to qualified customers an unsecured line in excess of their secured line of credit.
Other Consumer Loans. On a case by case basis we also make loans to individuals, including secured and unsecured installment and term loans, car loans and boat loans. We offer consumer loans as an accommodation to our existing customers and do not market consumer loans to consumers who do not have a pre-existing relationship with us.
Credit Policies and Procedures
General. We strive to maintain asset quality through an emphasis on local market knowledge, long-term customer relationships, consistent and thorough underwriting, and a conservative credit culture. Our lending policies do not provide for any loans that are highly speculative, subprime or that have high loan-to-value ratios. These components, together with active credit management, are the foundation of our credit culture.
We have a service-driven, relationship-based, business-focused credit culture, rather than a price-driven, transaction-based culture. Substantially all of our commercial loans are made to borrowers located or operating in our primary market areas with whom we have ongoing relationships across various product lines. We have a limited number of loans secured by properties located in out-of-market areas.
Credit Concentrations. We actively manage the composition of our loan portfolio, including credit concentrations. Our loan approval policies establish concentration limits with respect to loan product types to enhance portfolio diversification. The Bank’s concentration management program couples quantitative data with a qualitative approach to provide an in-depth understanding of its loan portfolio concentrations. The Bank’s routine commercial real estate portfolio analysis tracks concentration trends by portfolio product type, overall commercial real estate growth trends, pool correlations, risk rating trends, policy and/or underwriting exceptions, non-performing trends, stress testing, market and submarket analysis and changing economic conditions. The portfolio concentration limits set forth in the Bank’s Credit Underwriting Guidelines are reviewed and approved by the Loan Committee of the Bank’s board of directors at least annually and are based on risk profile, strategic portfolio diversification goals, quality of the portfolio segment, overall budgeted growth goals and comparisons to our peers. Concentration levels are monitored by management and reported to the Bank’s board of directors periodically.
Loan Approval Process. As of December 31, 2020, the Bank had a legal lending limit of approximately $24.3 million for loans secured without readily marketable collateral, and its “in-house” lending limit was $15.0 million. The Bank’s lending activities are governed by written underwriting policies and procedures that have been approved by the Loan Committee of the Bank’s board of directors. The policies provide several levels of delegated lending authority to the Management Loan Committee, the Credit Loan Committee, senior management and loan officers of the Bank. The lending authority hierarchy varies depending on loan amount, collateral type and total borrower exposure. A multi-tiered
group level approach based on experience, capability and management position dictates lending authorities for senior management and loan officers.
We conduct weekly loan meetings, attended by substantially all of our loan officers, related loan production staff and credit administration staff at which asset quality and delinquencies are reviewed. Our evaluation and compensation program for our loan officers includes significant goals, such as the percentages of past due loans and charge-offs to total loans in the loan officer’s portfolio. We believe this program motivates loan officers to focus on the origination and maintenance of high quality credits consistent with our strategic focus on asset quality.
It is our policy to discuss each loan that has one or more past due payments at our weekly meetings with all lending personnel. Our policies require rapid notification of delinquency and prompt initiation of collection actions. Loan officers, credit administration personnel and senior management proactively support collection activities.
In accordance with our procedures, we perform annual asset reviews of our loan exposures in excess of $250,000. As part of these asset review procedures, we analyze recent financial statements of the property, borrower and any guarantor to determine the current level of occupancy, revenues and expenses and to investigate any deterioration in the value of the real estate collateral or in the borrower’s and any guarantor’s financial condition. Upon completion, we update the grade assigned to each loan. Loan officers are encouraged to bring potential credit issues to the attention of credit administration personnel. We maintain a list of loans that receive additional attention if we believe there may be a potential credit risk.
Loans in excess of $250,000 that are downgraded or classified undergo a quarterly review by the Special Asset Committee of the Bank’s board of directors. This review includes an evaluation of market conditions, the property’s trends, the borrower and guarantor status, the level of reserves required and loan accrual status. Additionally, we periodically have an independent, third-party review performed on our loan grades and our credit administration functions. Finally, we perform an annual stress test of our loan portfolio during which we evaluate the impact of declining economic conditions on the portfolio based on previous recessionary periods. Management reviews these reports and presents them to the Loan Committee of the Bank’s board of directors. These asset review procedures provide management with additional information for assessing our asset quality. In addition,we perform frequent evaluations and regular monitoring of business and personal loans that are not secured by real estate.
Deposits
Our deposits serve as the primary funding source for lending, investing and other general banking purposes. We provide a full range of deposit products and services, including a variety of checking and savings accounts, certificates of deposit, money market accounts, debit cards, remote deposit capture, online banking, mobile banking, e-Statements, bank-by-mail and direct deposit services. We also offer business accounts and cash management services, including business checking and savings accounts, and treasury management services. We solicit deposits through our relationship-driven team of dedicated and accessible bankers and through community-focused marketing. We also selectively seek to cross-sell deposit products at loan origination. We supplement our retail deposits with wholesale funding sources such as deposit listing services, CDARS and brokered deposits. We actively market our certificate of deposit products and rely primarily on competitive pricing policies to attract and retain these deposits. Our credit card customers are also a significant source of deposits.
Residential Mortgage Origination
We originate residential mortgages for sale on the secondary market through CBHL, the mortgage division of our Bank. We have developed a scalable platform for mortgage originations within this division and believe that we have significant opportunities to grow the business. We sell substantially all mortgage
loans we originate with servicing released to various investors in the secondary market. As a result of recent changes in the interest rate environment, our mortgage division is currently undergoing a transition from being heavily weighted toward refinance volume to being more weighted toward purchase volume and niche products with relatively higher margins. As part of this effort, we have established our Community Lending Group, which focuses on first-time home buyers, and our Renovation Group, which focuses on originating renovation focused loans, within the division, as well as hiring several new originators focused primarily on purchase originations. At December 31, 2020, we had a dedicated team and three mortgage loan offices to service this line of business.
Investments
We manage our securities portfolio and cash to maintain adequate liquidity and to ensure the safety and preservation of invested principal, with a secondary focus on yield and returns. Specific goals of our investment portfolio are as follows:
•to provide a ready source of balance sheet liquidity, ensuring adequate availability of funds to meet fluctuations in loan demand, deposit balances and other changes in balance sheet volumes and composition;
•to serve as a means for diversification of our assets with respect to credit quality, maturity and other attributes; and
•to serve as a tool for modifying our interest rate risk profile pursuant to our established policies.
Our investment portfolio is comprised primarily of U.S. government agency securities, high quality corporate and municipal debt, mortgage-backed securities backed by government-sponsored entities and equity securities.
Our investment policy is reviewed annually by our Asset/Liability Management Committee, or ALCO, and subsequently ratified by our board of directors. Overall investment goals are established by our board, CEO, CFO and members of our ALCO. Our board of directors has delegated the responsibility of monitoring our investment activities to our ALCO. Day-to-day activities pertaining to the securities portfolio are conducted under the supervision of our CFO. We actively monitor our investments on an ongoing basis to identify any material changes in our mix of securities. We also review our securities for potential impairment (other than temporary impairments) at least quarterly.
Competition
The banking and financial services industry is highly competitive, and we compete with a wide range of financial institutions within our markets, including local, regional and national commercial banks and credit unions. We also compete with mortgage companies, brokerage firms, consumer finance companies, mutual funds, securities firms, insurance companies, credit card companies, third-party payment processors, financial technology, or fintech, companies and other financial intermediaries for certain of our products and services. Some of our competitors are not subject to the regulatory restrictions and level of regulatory supervision applicable to us.
Interest rates on loans and deposits, as well as prices on fee-based services, are typically significant competitive factors within the banking and financial services industry. Many of our competitors are much larger financial institutions that have greater financial resources than we do and compete aggressively for market share. These competitors attempt to gain market share through their financial product mix, pricing strategies and banking center locations. Other important competitive factors in our industry and markets include office locations and hours, quality of customer service, community reputation, continuity of personnel and services, capacity and willingness to extend credit, and ability to offer sophisticated
banking products and services. While we seek to remain competitive with respect to fees charged, interest rates and pricing, we believe that our broad and sophisticated commercial banking product suite, our high quality customer service culture, our positive reputation and long-standing community relationships will enable us to compete successfully within our markets and enhance our ability to attract and retain customers.
Employees and Human Capital Resources
At December 31, 2020, we employed 247 persons, of which 239 were employed on a full-time basis. None of our employees are represented by any collective bargaining unit or are a party to a collective bargaining agreement. We believe the relationship with our employees to be excellent and were recently named a Best Bank to Work For by American Banker. Our ability to attract and retain employees is a key to our success. We offer a competitive total rewards program to our employees and monitor the competitiveness of our compensation and benefits programs in our various market areas.
The Company prides itself on being a values-driven organization, where employees are empowered to share Ideas that keep the organization connected. Our company core values guide each team member to:
•Act as an Owner
•Practice Balanced Risk Management
•Challenge the Norm
•Leverage the Team
We believe that these values enable our success with our customers and have helped us build a fun, vibrant and accountability driven culture. In addition, we are committed to developing our staff through internal/external training programs, availability of an unlimited online training resource, and continuing to implement leadership development programs to all levels of leadership within the organization.
The safety, health and wellness for our employees is a top priority and consists of policies, procedures, guidelines, and mandates all tasks be conducted in a safe and efficient manner complying with all local, state and federal safety and health regulations. Since the onset of the COVID-19 pandemic, we successfully moved to a virtual-workplace and today have 85% of our people working remotely. Those that have remained in the office by necessity or desire are subject to policies and procedures put in place to protect them including a full stock of PPE. The organization has continually provided guidelines to employees to promote healthy habits and ways to stay connected while working remotely.
Available Information
The Company provides access to its SEC filings through its web site at www.capitalbankmd.com. After accessing the web site, the filings are available upon selecting “Investor Relations.” Reports available include the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after the reports are electronically filed with or furnished to the SEC. Further, the SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov. The information on, or accessible through, our website or any other website cited in this Annual Report on Form 10-K is not part of, or incorporated by reference into, this Annual Report on Form 10-K and should not be relied upon in determining whether to make an investment decision.
SUPERVISION AND REGULATION
General
We are extensively regulated under both federal and state law. These laws restrict permissible activities and investments and require compliance with various consumer protection provisions applicable to lending, deposit, brokerage, and fiduciary activities. They also impose capital adequacy requirements and conditions on a bank holding company’s, or BHC, ability to repurchase stock or to receive dividends from its subsidiary banks. We are subject to comprehensive examination and supervision by the Federal Reserve, and the Bank is subject to comprehensive examination and supervision by the Office of the Comptroller of the Currency, or the OCC. We are required to file with the Federal Reserve quarterly and annual reports and such additional information as the Federal Reserve may require pursuant to the Bank Holding Company Act of 1956, as amended, or the BHC Act. The Federal Reserve may conduct examinations of BHCs and their subsidiaries. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation, or the FDIC, through the Deposit Insurance Fund, or DIF. As a result of this deposit insurance function, the FDIC also has certain supervisory authority and powers over the Bank as well as all other FDIC insured institutions. The Company’s and the Bank’s regulators generally have broad discretion to impose restrictions and limitations on our operations. Bank regulation is intended to protect depositors and consumers and not shareholders. This supervisory framework could materially impact the conduct and profitability of our activities.
To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to the text of the particular statutory and regulatory provisions. Legislative and regulatory initiatives, which necessarily impact the regulation of the financial services industry, are introduced from time to time. We cannot predict whether or when potential legislation or new regulations will be enacted, and if enacted, the effect that new legislation or any implemented regulations and supervisory policies would have on our financial condition and results of operations. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), by way of example, contains a comprehensive set of provisions designed to govern the practices and oversight of financial institutions and other participants in the financial markets. The Dodd-Frank Act made extensive changes in the regulation of financial institutions and their holding companies. Some of the changes brought about by the Dodd-Frank Act have been modified by the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 (the “Regulatory Relief Act”), signed into law on May 24, 2018. The Dodd-Frank Act has increased the regulatory burden and compliance costs of the Company. Moreover, bank regulatory agencies can be more aggressive in responding to concerns and trends identified in examinations, which could result in an increased issuance of enforcement actions to financial institutions requiring action to address credit quality, liquidity and risk management, and capital adequacy, as well as other safety and soundness concerns.
Regulation of Capital Bancorp, Inc.
We are registered as a BHC under the BHC Act and are subject to regulation and supervision by the Federal Reserve. The BHC Act requires us to secure the prior approval of the Federal Reserve before we own or control, directly or indirectly, more than 5% of the voting shares or substantially all of the assets of any bank or thrift, or merge or consolidate with another bank or thrift holding company. Further, under the BHC Act, our activities and those of any nonbank subsidiary are limited to: (i) those activities that the Federal Reserve determines to be so closely related to banking as to be a proper incident thereto, and (ii) investments in companies not engaged in activities closely related to banking, subject to quantitative limitations on the value of such investments. Prior approval of the Federal Reserve may be required before engaging in certain activities. In making such determinations, the Federal Reserve is required to weigh the expected benefits to the public, such as greater convenience, increased competition, and gains in efficiency, against the possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest, and unsound banking practices.
Subject to various exceptions, the BHC Act and the Change in Bank Control Act, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a BHC. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the BHC, and a rebuttable presumption arises if a person or company acquires 10% or more, but less than 25%, of any class of voting securities and either: (i) the BHC has registered securities under Section 12 of the Securities Act of 1933, as amended, or the Securities Act; or (ii) no other person owns a greater percentage of that class of voting securities immediately after the transaction. As a policy matter, the Federal Reserve expects a company that proposes to acquire more than 7.5% but less than 25% of a class of voting securities to consult with the agency. The Federal Reserve Board may require the company to enter into passivity and, if other companies are making similar investments, anti-association commitments.
The BHC Act was substantially amended by the Gramm-Leach-Bliley Act, or the GLBA, which, among other things, permits a “financial holding company” to engage in a broader range of non-banking activities, and to engage on less restrictive terms in certain activities than were previously permitted. These expanded activities include securities underwriting and dealing, insurance underwriting and sales, and merchant banking activities. To become a financial holding company, a BHC must certify that it and all depository institutions that it controls are both “well capitalized” and “well managed” (as defined by federal law), and that all subsidiary depository institutions have at least a “satisfactory” CRA rating. At this time, we have not elected to become a financial holding company, nor do we expect to make such an election in the foreseeable future.
There are a number of restrictions imposed on us by law and regulatory policy that are designed to minimize potential loss to depositors and to the DIF in the event that a subsidiary depository institution should become insolvent. For example, federal law requires a BHC to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so in the absence of the rule. The Federal Reserve also has the authority under the BHC Act to require a BHC to terminate any activity or to relinquish control of a non-bank subsidiary upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the BHC.
Any capital loan by a BHC to a subsidiary depository institution is subordinate in right of payment to deposits and certain other indebtedness of the institution. In addition, in the event of the BHC’s bankruptcy, any commitment made by the BHC to a federal banking regulatory agency to maintain the capital of its subsidiary depository institution(s) will be assumed by the bankruptcy trustee and entitled to a priority of payment.
The Federal Deposit Insurance Act, or FDIA, provides that, in the event of the “liquidation or other resolution” of an insured depository institution, the claims of depositors of the institution (including the claims of the FDIC as a subrogee of insured depositors) and certain claims for administrative expenses of the FDIC as a receiver will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, non-deposit creditors, including the institution’s holding company, with respect to any extensions of credit they have made to such insured depository institution.
Regulation of Capital Bank
The operations and investments of our Bank are subject to the supervision, examination, and reporting requirements of the National Bank Act and the regulations of the OCC as well as other federal banking statutes and regulations, including with respect to the level of reserves that our Bank must maintain against deposits, restrictions on the types, amount, and terms and conditions of loans it may originate, and limits on the types of other activities in which our Bank may engage and the investments that it may make. The OCC also has the power to prevent the continuance or development of unsafe or unsound banking practices and other violations of law. Because our Bank’s deposits are insured by the
FDIC to the maximum extent provided by law, it is also subject to certain FDIC regulations, and the FDIC has backup examination authority and some enforcement powers over our Bank. If, as a result of an examination of our Bank, the regulators should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of the Bank’s operations are unsatisfactory or that the Bank or our management is violating or has violated any law or regulation, various remedies are available to the regulators. Such remedies include the power to enjoin unsafe or unsound practices, require affirmative action to correct any conditions resulting from any violation or practice, issue an administrative order that can be judicially enforced, direct an increase in capital, to restrict growth, assess civil monetary penalties and remove officers and directors. The regulators also may request the FDIC to terminate the Bank’s deposit insurance.
Regulatory Relief Act
On May 24, 2018, President Trump signed into law the Regulatory Relief Act, which amends parts of the Dodd-Frank Act as well as other laws that involve regulation of the financial industry. While the Regulatory Relief Act keeps in place fundamental aspects of the Dodd-Frank Act’s regulatory framework, it does make regulatory changes that are favorable to depository institutions with assets under $10 billion, such as the Bank and to BHCs with total consolidated assets of less than $10 billion, such as the Company. The Regulatory Relief Act also makes changes to consumer mortgage and credit reporting regulations and to the authorities of the agencies that regulate the financial industry. Certain provisions of the Regulatory Relief Act favorable to the Company and the Bank require the federal banking agencies to either promulgate regulations or amend existing regulations, and it will likely take some time for these agencies to implement the necessary regulations.
Provisions That Are Favorable to Community Banks. There are several provisions in the Regulatory Relief Act that will have a favorable impact on community banks such as the Bank. These are briefly referenced below.
Increase in Small BHC Policy Threshold. The Regulatory Relief Act directs the Federal Reserve to increase the asset threshold for qualifying for the Federal Reserve’s “Small Bank Holding Company Policy Statement” (the “Policy”), from $1 billion to $3 billion. The Federal Reserve’s revisions to the Policy took effect on August 30, 2018. Small BHCs or SLHCs are excluded from the Policy if they are engaged in significant non-banking activities, engaged in significant off-balance sheet activities, or have a material amount of debt or equity registered with the Securities and Exchange Commission (“SEC”). The Federal Reserve also retains the authority to exclude any BHC or SLHC from the Policy if such action is warranted for supervisory purposes. The Policy allows covered BHCs to operate with higher levels of debt than would normally be permitted, subject to certain restrictions on dividends and the expectation that the BHC will reduce its reliance on debt over time. Also, BHCs that are subject to the Policy are exempt from the Federal Reserve’s consolidated risk-based and leverage capital rules implementing Basel III and are instead subject to the capital requirements that had been in place before the U.S. implementation of the Basel III standards, which are generally less onerous. BHCs subject to the Policy also have less extensive regulatory reporting requirements than apply to larger organizations. Management believes the Corporation meets the conditions of the Federal Reserve’s Policy and is therefore excluded from consolidated capital requirements at December 31, 2019; however the Bank remains subject to regulatory capital requirements administered by the federal banking agencies.
Increase in Asset Threshold for Requirement to Establish a Risk Committee. The Regulatory Relief Act raises the asset threshold for the requirement that a publicly-traded BHC establish a risk committee from $10 billion to $50 billion or more in total consolidated assets.
Increase in Asset Threshold for Qualifying for an 18-Month Examination Cycle. The Regulatory Relief Act increases the asset threshold for institutions qualifying for an 18-month on-site examination cycle from $1 billion to $3 billion in total consolidated assets.
Short Form Call Reports. The Regulatory Relief Act requires the federal banking agencies to promulgate regulations allowing an insured depository institution with less than $5 billion in total consolidated assets (and that satisfies such other criteria as determined to be appropriate by the agencies) to submit a short-form call report for its first and third quarters.
Transactions with Affiliates and Insiders
We are subject to federal laws, such as Sections 23A and 23B of the Federal Reserve Act (the “FRA”) that limit the size, number and terms of transactions that depository institutions may engage in with their affiliates. Under these provisions, covered transactions by a bank with nonbank affiliates (such as loans to or investments in an affiliate by the bank) must be on arms-length terms and generally be limited to 10% of the bank’s capital and surplus for all covered transactions with any one affiliate, and 20% of capital and surplus for all covered transactions with all affiliates. Any extensions of credit to affiliates, with limited exceptions, must be secured by eligible collateral in specified amounts. Banks are also prohibited from purchasing any “low quality” assets from an affiliate. The Dodd-Frank Act generally enhanced the restrictions on transactions with affiliates under Section 23A and 23B of the FRA, including an expansion of the definition of “covered transactions” to include derivatives transactions, repurchase agreements, reverse repurchase agreements and securities lending or borrowing transactions and an increase in the period of time during which collateral requirements regarding covered credit transactions must be satisfied. The Federal Reserve has promulgated Regulation W, which codifies prior interpretations under Sections 23A and 23B of the FRA and provides interpretive guidance with respect to affiliate transactions. Affiliates of a bank include, among other entities, a bank’s BHC parent and companies that are under common control with the bank. We are considered to be an affiliate of the Bank.
We are also subject to restrictions on extensions of credit to our executive officers, directors, shareholders who own more than 10% of our Common Stock, and their related interests. These extensions of credit must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties, and must not involve more than the normal risk of repayment or present other unfavorable features. Loans to such persons and certain affiliated entities of any of the foregoing, may not exceed, together with all other outstanding loans to such person and affiliated entities, the institution’s loans-to-one-borrower limit. Federal regulations also prohibit loans above amounts prescribed by the appropriate federal banking agency to directors, executive officers, and shareholders who own more than 10% of an institution, and their respective affiliates, unless such loans are approved in advance by a majority of the board of directors of the institution. Any “interested” director may not participate in the voting. The proscribed loan amount, which includes all other outstanding loans to such person, as to which such prior board of director approval is required, is the greater of $25,000 or 5% of capital and surplus up to $500,000. Furthermore, we are prohibited from engaging in asset purchases or sales transactions with our officers, directors, or principal shareowners unless the transaction is on market terms and, if the transaction represents greater than 10% of the capital and surplus of the bank, a majority of the bank’s disinterested directors has approved the transaction.
Indemnification payments to any director, officer or employee of either a bank or a BHC are subject to certain constraints imposed by the FDIC.
Incentive Compensation
Federal banking agencies have issued guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that appropriately balance risk and rewards in a manner that does not encourage imprudent risk-taking, (ii) be compatible with effective internal controls and risk management, and (iii) be supported
by strong corporate governance, including active and effective oversight by the organization’s board of directors. In accordance with the Dodd-Frank Act, the federal banking agencies prohibit incentive-based compensation arrangements that encourage inappropriate risk taking by covered financial institutions (generally institutions that have over $1 billion in assets) and are deemed to be excessive, or that may lead to material losses.
The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.
The scope and content of the U.S. banking regulators’ policies on executive compensation may continue to evolve in the future. It presently cannot be determined whether compliance with such policies will adversely affect the Company’s ability to hire, retain and motivate its key employees.
Deposit Insurance
Our deposits are insured up to applicable limits by the DIF of the FDIC. Deposit insurance is mandatory. We are required to pay assessments to the FDIC on a quarterly basis. The assessment amount is the product of multiplying the assessment base by the assessment amount.
The assessment base against which the assessment rate is applied to determine the total assessment due for a given period is the depository institution’s average total consolidated assets during the assessment period less average tangible equity during that assessment period. Tangible equity is defined in the assessment rule as Tier 1 Capital and is calculated monthly, unless the insured depository institution has less than $1 billion in assets, in which case the insured depository institution calculates Tier 1 Capital on an end-of-quarter basis. Parents or holding companies of other insured depository institutions are required to report separately from their subsidiary depository institutions.
The FDIC’s methodology for setting assessments for individual banks has changed over time, although the broad policy is that lower-risk institutions should pay lower assessments than higher-risk institutions. The FDIC now uses a methodology, known as the “financial ratios method,” that began to apply on July 1, 2016, in order to meet requirements of the Dodd-Frank Act. The statute established a minimum designated reserve ratio (the “DRR”) for the DIF of 1.35% of the estimated insured deposits and required the FDIC to adopt a restoration plan should the reserve ratio fall below 1.35%. The financial ratios took effect when the DRR exceeded 1.15%. The FDIC declared that the DIF reserve ratio exceeded 1.15% by the end of the second quarter of 2016. Accordingly, beginning July 1, 2016, the FDIC began to use the financial ratios method. This methodology assigns a specific assessment rate to each institution based on the institution’s leverage capital, supervisory ratings, and information from the institution’s call report. Under this methodology, the assessment rate schedules used to determine assessments due from insured depository institutions become progressively lower when the reserve ratio in the DIF exceeds 2% and 2.5%.
The Dodd-Frank Act also raised the limit for federal deposit insurance to $250,000 for most deposit accounts and increased the cash limit of Securities Investor Protection Corporation protection from $100,000 to $250,000.
The FDIC has authority to increase insurance assessments. A significant increase in insurance assessments would likely have an adverse effect on our operating expenses and results of operations. We cannot predict what insurance assessment rates will be in the future. Furthermore, deposit insurance may be terminated by the FDIC upon a finding that an insured depository institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC.
Dividends
Capital Bancorp, Inc. is a legal entity separate and distinct from Capital Bank. Our ability to pay dividends and make other distributions depends in part upon the receipt of dividends from the Bank and is limited by federal and state law. The specific limits depend upon a number of factors, including the bank’s recent earnings, recent dividends, level of capital, and regulatory status. The regulators are authorized, and under certain circumstances are required, to determine the payment of dividends or other distributions by a bank would be an unsafe or unsound practice and to prohibit that payment. For example, the FDIA generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be undercapitalized. Failure to satisfy the capital conservation buffer requirement may also result in limits on our ability to pay dividends. See “-Capital Adequacy Guidelines.”
A national bank generally may not withdraw, either in the form of a dividend or otherwise, any portion of its permanent capital and may not declare a dividend in excess of its retained net profits. Further, dividends that may be paid by a national bank without the express approval of the OCC are limited to an amount equal to the bank’s retained net profits for the preceding two calendar years plus retained net profits up to the date of any dividend declaration in the current calendar year. Retained net profits, as defined by the OCC, consist of net income, less dividends declared during the period. Dividend payments by the Bank in the future will require the generation of net income and could require regulatory approval if any proposed dividends are in excess of prescribed guidelines.
Capital Adequacy Guidelines
Bank holding companies and banks are subject to various regulatory capital requirements administered by state and federal agencies. These agencies may establish higher minimum requirements if, for example, a banking organization previously has received special attention or has a high susceptibility to interest rate risk. Risk-based capital requirements determine the adequacy of capital based on the risk inherent in various classes of assets and off-balance sheet items. Under the Dodd-Frank Act, the Federal Reserve must apply consolidated capital requirements to depository institution holding companies that are no less stringent than those currently applied to depository institutions. 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.
Under federal regulations, bank holding companies and banks must meet certain risk-based capital requirements. Effective as of January 1, 2015, the Basel III final capital framework, among other things, (i) introduces as a new capital measure “Common Equity Tier 1” (“CET1”), (ii) specifies that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements, (iii) defines CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1 and not to the other components of capital, and (iv) expands the scope of the adjustments as compared to existing regulations. Beginning January 1, 2016, financial institutions are required to maintain a minimum “capital conservation buffer” to avoid restrictions on capital distributions such as dividends and equity repurchases and other payments such as discretionary bonuses to executive officers. The minimum capital conservation buffer has been phased-in over a four year transition period with minimum buffers of 0.625%, 1.25%, 1.875%, and 2.50% during 2016, 2017, 2018, and 2019, respectively.
As fully phased-in on January 1, 2019, Basel III subjects banks to the following risk-based capital requirements:
•a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% capital conservation buffer, or 7%;
•a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer, or 8.5%;
•a minimum ratio of Total (Tier 1 plus Tier 2) capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer, or 10.5%; and
•a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures.
The Basel III final framework provides for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1. Basel III also includes, as part of the definition of CET1 capital, a requirement that banking institutions include the amount of Additional Other Comprehensive Income (“AOCI”), which primarily consists of unrealized gains and losses on available-for-sale securities, which are not required to be treated as other-than-temporary impairment, net of tax) in calculating regulatory capital. Banking institutions had the option to opt out of including AOCI in CET1 capital if they elected to do so in their first regulatory report following January 1, 2015. As permitted by Basel III, the Company and the Bank have elected to exclude AOCI from CET1.
In addition, goodwill and most intangible assets are deducted from Tier 1 capital. For purposes of applicable total risk-based capital regulatory guidelines, Tier 2 capital (sometimes referred to as “supplementary capital”) is defined to include, subject to limitations: perpetual preferred stock not included in Tier 1 capital, intermediate-term preferred stock and any related surplus, certain hybrid capital instruments, perpetual debt and mandatory convertible debt securities, allowances for loan and lease losses, and intermediate-term subordinated debt instruments. The maximum amount of qualifying Tier 2 capital is 100% of qualifying Tier 1 capital. For purposes of determining total capital under federal guidelines, total capital equals Tier 1 capital, plus qualifying Tier 2 capital, minus investments in unconsolidated subsidiaries, reciprocal holdings of bank holding company capital securities, and deferred tax assets and other deductions.
Basel III changed the manner of calculating risk-weighted assets. New methodologies for determining risk-weighted assets in the general capital rules are included, including revisions to recognition of credit risk mitigation, including a greater recognition of financial collateral and a wider range of eligible guarantors. They also include risk weighting of equity exposures and past due loans; and higher (greater than 100%) risk weighting for certain commercial real estate exposures that have higher credit risk profiles, including higher loan to value and equity components. In particular, loans categorized as “high-volatility commercial real estate” loans (“HVCRE loans”), as defined pursuant to applicable federal regulations, are required to be assigned a 150% risk weighting, and require additional capital support.
In addition to the uniform risk-based capital guidelines and regulatory capital ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios. Future changes in regulations or practices could further reduce the amount of capital recognized for purposes of capital adequacy. Such a change could affect our ability to grow and could restrict the amount of profits, if any, available for the payment of dividends.
In addition, the Dodd-Frank Act requires the federal banking agencies to adopt capital requirements that address the risks that the activities of an institution poses to the institution and the public and private stakeholders, including risks arising from certain enumerated activities.
Basel III became applicable to the Bank on January 1, 2015 and just recently to the Corporation due to the Corporation’s growth in excess of $3.0 billion. Overall, the Corporation believes that implementation of the Basel III Rule has not had and will not have a material adverse effect on the Corporation’s or the Bank’s capital ratios, earnings, shareholder’s equity, or its ability to pay dividends, effect stock repurchases or pay discretionary bonuses to executive officers.
In December 2017, the Basel Committee published standards that it described as the finalization of the Basel III post-crisis regulatory reforms (the standards are commonly referred to as “Basel IV”). Among other things, these standards revise the Basel Committee’s standardized approach for credit risk (including recalibrating risk weights and introducing new capital requirements for certain “unconditionally cancellable commitments,” such as unused credit card lines of credit) and provides a new standardized approach for operational risk capital. Under the Basel framework, these standards will generally be effective on January 1, 2022, with an aggregate output floor phasing in through January 1, 2027. Under the current U.S. capital rules, operational risk capital requirements and a capital floor apply only to advanced approaches institutions, and not to the Corporation or the Bank. The impact of Basel IV on us will depend on the manner in which it is implemented by the federal bank regulators.
In 2018, the federal bank regulatory agencies issued a variety of proposals and made statements concerning regulatory capital standards. These proposals touched on such areas as commercial real estate exposure, credit loss allowances under generally accepted accounting principles and capital requirements for covered swap entities, among others. Public statements by key agency officials have also suggested a revisiting of capital policy and supervisory approaches on a going-forward basis. In July 2019, the federal bank regulators adopted a final rule that simplifies the capital treatment for certain deferred tax assets, mortgage servicing assets, investments in non-consolidated financial entities and minority interests for banking organizations, such as the Corporation and the Bank, that are not subject to the advanced approaches requirements. We will be assessing the impact on us of these new regulations and supervisory approaches as they are proposed and implemented.
In February 2019, the U.S. federal bank regulatory agencies approved a final rule modifying their regulatory capital rules and providing an option to phase-in over a three-year period the Day 1 adverse regulatory capital effects of CECL accounting standard. Additionally, in March 2020, the U.S. Federal bank regulatory agencies issued an interim final rule that provides banking organizations an option to delay the estimated CECL impact on regulatory capital for an additional two years for a total transition period of up to five years to provide regulatory relief to banking organizations to better focus on supporting lending to creditworthy households and businesses in light of recent strains on the U.S. economy as a result of the COVID-19 pandemic. The capital relief in the interim is calibrated to approximate the difference in allowances under CECL relative to the incurred loss methodology for the first two years of the transition period using a 25% scaling factor. The cumulative difference at the end of the second year of the transition period is then phased in to regulatory capital at 25% per year over a three-year transition period. The final rule was adopted and became effective in September 2020. As a result, entities may gradually phase in the full effect of CECL on regulatory capital over a five-year transition period. The Corporation is not required to implement the CECL model until January 1, 2023.
Commercial Real Estate Concentration Guidelines
In December 2006, the federal banking regulators issued guidance entitled “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” to address increased concentrations in commercial real estate (“CRE”) loans. In addition, in December 2015, the federal bank agencies issued additional guidance entitled “Statement on Prudent Risk Management for Commercial Real Estate Lending.” Together, these guidelines describe the criteria the agencies will use as indicators
to identify institutions potentially exposed to CRE concentration risk. An institution that has (i) experienced rapid growth in CRE lending, (ii) notable exposure to a specific type of CRE, (iii) total reported loans for construction, land development, and other land representing 100% or more of the institution’s capital, or (iv) total non-owner-occupied CRE (including construction) loans representing 300% or more of the institution’s capital, and the outstanding balance of the institutions CRE portfolio has increased by 50% or more in the prior 36 months, may be identified for further supervisory analysis of the level and nature of its CRE concentration risk.
At December 31, 2020, the Bank’s construction to total risk based capital ratio was 149.4%, its total non-owner occupied commercial real estate (including construction) to total capital ratio was 298.6% and therefore do exceed the 100% and do not exceed the 300% regulatory guideline thresholds set forth in clauses (iii) and (iv) above.
Currently, loans categorized as “high-volatility commercial real estate” loans (“HVCRE loans”), are required to be assigned a 150% risk weighting, and require additional capital support. HVCRE loans are defined to include any credit facility that finances or has financed the acquisition, development or construction of real property, unless it finances: 1-4 family residential properties; certain community development investments; agricultural land used or usable for, and whose value is based on, agricultural use; or commercial real estate projects in which: (i) the loan to value is less than the applicable maximum supervisory loan to value ratio established by the bank regulatory agencies; (ii) the borrower has contributed cash or unencumbered readily marketable assets, or has paid development expenses out of pocket, equal to at least 15% of the appraised “as completed” value; (iii) the borrower contributes its 15% before the bank advances any funds; and (iv) the capital contributed by the borrower, and any funds internally generated by the project, is contractually required to remain in the project until the facility is converted to permanent financing, sold or paid in full.
The Regulatory Relief Act prohibits federal banking agencies from assigning heightened risk weights to HVCRE exposures, unless the exposures are classified as HVCRE acquisition, development and construction loans. The Federal banking agencies issued a proposal in September 2017 to simplify the treatment of HVCRE and to create a new category of commercial real estate loans called “high-volatility acquisition, development or construction” (“HVADC”) with a lower risk weight of 130%. A significant difference between the Regulatory Relief Act and the agencies’ HVADC proposal arises from the Regulatory Relief Act’s preservation of the exemption for projects where the borrower has contributed at least 15% of the real property’s appraised “as completed” value.
Prompt Corrective Action
The federal banking regulators are required to take “prompt corrective action” with respect to capital-deficient institutions. Federal banking regulations define, for each capital category, the levels at which institutions are “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” Under applicable regulations, the Bank was “well capitalized,” which means it had a common equity Tier 1 capital ratio of 6.5% or higher; a Tier I risk-based capital ratio of 8.0% or higher; a total risk-based capital ratio of 10.0% or higher; a leverage ratio of 5.0% or higher; and was not subject to any written agreement, order or directive requiring it to maintain a specific capital level for any capital measure.
As noted above, Basel III integrates the capital requirements into the prompt corrective action category definitions. As a result of the Federal Reserve’s revisions to the Policy raising the total consolidated asset limit in the Policy from $1 billion to $3 billion, Capital Bancorp is currently exempt from the consolidated capital requirements.
Capital
Category Total Risk-Based
Capital Ratio Tier 1 Risk-Based
Capital Ratio Common Equity
Tier 1 (CET1) 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 than 3% Less than 3% n/a n/a
Critically Undercapitalized
n/a n/a n/a n/a Less than 2% n/a
As of December 31, 2020, the Bank was “well capitalized” according to the guidelines as generally discussed above.
An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. An institution’s capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the institution’s overall financial condition or prospects for other purposes.
In the event an institution becomes “undercapitalized,” it must submit a capital restoration plan. The capital restoration plan will not be accepted by the regulators unless each company having control of the undercapitalized institution guarantees the subsidiary’s compliance with the capital restoration plan up to a certain specified amount. Any such guarantee from a depository institution’s holding company is entitled to a priority of payment in bankruptcy. The aggregate liability of the holding company of an undercapitalized bank is limited to the lesser of 5% of the institution’s assets at the time it became undercapitalized or the amount necessary to cause the institution to be “adequately capitalized.” The bank regulators have greater power in situations where an institution becomes “significantly” or “critically” undercapitalized or fails to submit a capital restoration plan. In addition to requiring undercapitalized institutions to submit a capital restoration plan, bank regulations contain broad restrictions on certain activities of undercapitalized institutions including asset growth, acquisitions, branch establishment and expansion into new lines of business. With certain exceptions, an insured depository institution is prohibited from making capital distributions, including dividends, and is prohibited from paying management fees to control persons if the institution would be undercapitalized after any such distribution or payment.
As an institution’s capital decreases, the regulators’ enforcement powers become more severe. A significantly undercapitalized institution is subject to mandated capital raising activities, restrictions on interest rates paid and transactions with affiliates, removal of management, and other restrictions. A regulator has limited discretion in dealing with a critically undercapitalized institution and is virtually required to appoint a receiver or conservator.
Banks with risk-based capital and leverage ratios below the required minimums may also be subject to certain administrative actions, including the termination of deposit insurance upon notice and hearing, or a temporary suspension of insurance without a hearing in the event the institution has no tangible capital.
Safety and Soundness Standards
The federal banking agencies have adopted guidelines designed to assist the federal banking agencies in identifying and addressing potential safety and soundness concerns before capital becomes impaired. The guidelines set forth operational and managerial standards relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) asset growth; (v) earnings; and (vi) compensation, fees and benefits.
In addition, the federal banking agencies have also adopted safety and soundness guidelines with respect to asset quality and for evaluating and monitoring earnings to ensure that earnings are sufficient for the maintenance of adequate capital and reserves. These guidelines provide six standards for establishing and maintaining a system to identify problem assets and prevent those assets from deteriorating. Under these standards, an insured depository institution should: (i) conduct periodic asset quality reviews to identify problem assets; (ii) estimate the inherent losses in problem assets and establish reserves that are sufficient to absorb estimated losses; (iii) compare problem asset totals to capital; (iv) take appropriate corrective action to resolve problem assets; (v) consider the size and potential risks of material asset concentrations; and (vi) provide periodic asset quality reports with adequate information for management and the board of directors to assess the level of asset risk.
Community Reinvestment Act
The CRA requires the federal banking regulatory agencies to assess all financial institutions that they regulate to determine whether these institutions are meeting the credit needs of the communities they serve, including their assessment area(s) (as established for these purposes in accordance with applicable regulations based principally on the location of branch offices). In addition to substantial penalties and corrective measures that may be required for a violation of certain fair lending laws, the federal banking agencies may take compliance with such laws and CRA into account when regulating and supervising other activities. Under the CRA, institutions are assigned a rating of “outstanding,” “satisfactory,” “needs to improve,” or “unsatisfactory.” An institution’s record in meeting the requirements of the CRA is based on a performance-based evaluation system, and is made publicly available and is taken into consideration in evaluating any applications it files with federal regulators to engage in certain activities, including approval of a branch or other deposit facility, mergers and acquisitions, office relocations, or expansions into non-banking activities. Our Bank received a “satisfactory” rating in its most recent CRA evaluation.
In April 2018, the U.S. Department of Treasury issued a memorandum to the federal banking regulators recommending changes to the CRA’s regulations to reduce their complexity and associated burden on banks, and in December 2019, the FDIC and the OCC proposed for public comment rules to modernize the agencies' regulations under the CRA. The OCC adopted its final rules in May 2020, and, to date, the FDIC has not adopted revised rules. In September 2020, the Board of Governors of the Federal Reserve System released for public comment its proposed rules to modernize CRA regulations. We will continue to evaluate the impact of any changes to the CRA regulations.
Anti-Terrorism, Money Laundering Legislation and OFAC
The Bank is subject to the Bank Secrecy Act and the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA Patriot Act”). These statutes and related rules and regulations impose requirements and limitations on specified financial transactions and accounts and other relationships intended to guard against money laundering and terrorism financing. The principal requirements for an insured depository institution include (i) establishment of an anti-money laundering program that includes training and audit components, (ii) establishment of a “know your customer” program involving due diligence to confirm the identities of persons seeking to open accounts and to deny accounts to those persons unable to demonstrate their identities, (iii) the filing of currency transaction reports for deposits and withdrawals of large amounts of cash and suspicious activities reports for activity that might signify money laundering, tax evasion, or other criminal activities, (iv) additional precautions for accounts sought and managed for non-U.S. persons and (v) verification and certification of money laundering risk with respect to private banking and foreign correspondent banking relationships. For many of these tasks a bank must keep records to be made available to its primary federal regulator. Anti-money laundering rules and policies are developed by a bureau within the Financial Crimes Enforcement Network, but compliance by individual institutions is overseen by its primary federal regulator.
The Bank has established appropriate anti-money laundering and customer identification programs. The Bank also maintains records of cash purchases of negotiable instruments, files reports of certain cash transactions exceeding $10,000 (daily aggregate amount), and reports suspicious activity that might signify money laundering, tax evasion, or other criminal activities pursuant to the Bank Secrecy Act. The Bank otherwise has implemented policies and procedures to comply with the foregoing requirements.
The Treasury Department’s Office of Foreign Assets Control (“OFAC”), administers and enforces economic and trade sanctions against targeted foreign countries and persons, as defined by various Executive Orders and Acts of Congress. OFAC publishes lists of persons that are the target of sanctions, including the List of Specially Designated Nationals and Blocked Persons. Financial institutions are responsible for, among other things, blocking accounts of and transactions with sanctioned persons and countries, prohibiting unlicensed trade and financial transactions with them and reporting blocked and rejected transactions after their occurrence. If the Company or the Bank finds a name or other information on any transaction, account or wire transfer that is on an OFAC list or that otherwise indicates that the transaction involves a target of sanctions, the Company or the Bank generally must freeze or block such account or transaction, file a suspicious activity report, and notify the appropriate authorities. Banking regulators examine banks for compliance with the economic sanctions regulations administered by OFAC.
The Bank has implemented policies and procedures to comply with the foregoing requirements.
Data Privacy and Cybersecurity
The GLBA and the implementing regulations issued by federal regulatory agencies require financial institutions (including banks, insurance agencies, and broker/dealers) to adopt policies and procedures regarding the disclosure of nonpublic personal information about their customers to non-affiliated third parties. In general, financial institutions are required to explain to customers their policies and procedures regarding the disclosure of such nonpublic personal information and, unless otherwise required or permitted by law, financial institutions are prohibited from disclosing such information except as provided in their policies and procedures. Specifically, the GLBA established certain information security guidelines that require each financial institution, under the supervision and ongoing oversight of its board of directors or an appropriate committee thereof, to develop, implement, and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, to protect against anticipated threats or hazards to the security or integrity of such information, and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer.
Recent cyber-attacks against banks and other financial institutions that resulted in unauthorized access to confidential customer information have prompted the federal banking regulators to issue extensive guidance on cybersecurity. Among other things, financial institutions are expected to design multiple layers of security controls to establish lines of defense and ensure that their risk management processes address the risks posed by compromised customer credentials, including security measures to authenticate customers accessing internet-based services. A financial institution also should have a robust business continuity program to recover from a cyberattack and procedures for monitoring the security of third-party service providers that may have access to nonpublic data at the institution.
The Consumer Financial Protection Bureau
The Dodd-Frank Act created the Consumer Financial Protection Bureau (the “CFPB”), which is an independent bureau with broad authority to regulate the consumer finance industry, including regulated financial institutions, non-banks and others involved in extending credit to consumers. The CFPB has authority through rulemaking, orders, policy statements, guidance, and enforcement actions to administer and enforce federal consumer financial laws, to oversee several entities and market segments not previously under the supervision of a federal regulator, and to impose its own regulations and pursue enforcement actions when it determines that a practice is unfair, deceptive, or abusive. The federal
consumer financial laws and all the functions and responsibilities associated with them, many of which were previously enforced by other federal regulatory agencies, were transferred to the CFPB on July 21, 2011. While the CFPB has the power to interpret, administer, and enforce federal consumer financial laws, the Dodd-Frank Act provides that the federal banking regulatory agencies continue to have examination and enforcement powers over the financial institutions that they supervise relating to the matters within the jurisdiction of the CFPB if such institutions have less than $10 billion in assets. The Dodd-Frank Act also gives state attorneys general the ability to enforce federal consumer protection laws.
Mortgage Loan Origination
The Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages, including a determination of the borrower’s ability to repay. Under the Dodd-Frank Act and the implementing final rule adopted by the CFPB, or the ATR/QM Rule, a financial institution may not make a residential mortgage loan to a consumer unless it first makes a “reasonable and good faith determination” that the consumer has a “reasonable ability” to repay the loan. In addition, the ATR/QM Rule limits prepayment penalties and permits borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage,” as defined by the CFPB. For this purpose, the ATR/QM Rule defines a “qualified mortgage” to include a loan with a borrower debt-to-income ratio of less than or equal to 43% or, alternatively, a loan eligible for purchase by Fannie Mae or Freddie Mac while they operate under federal conservatorship or receivership, and loans eligible for insurance or guarantee by the Federal Housing Administration, the Veterans Administration or the United States Department of Agriculture. Additionally, a qualified mortgage may not: (i) contain excess upfront points and fees; (ii) have a term greater than 30 years; or (iii) include interest only or negative amortization payments. The ATR/QM Rule specifies the types of income and assets that may be considered in the ability-to-repay determination, the permissible sources for verification, and the required methods of calculating the loan’s monthly payments. The ATR/QM Rule became effective in January 2014.
The Regulatory Relief Act provides that for certain insured depository institutions and insured credit unions with less than $10 billion in total consolidated assets, mortgage loans that are originated and retained in portfolio will automatically be deemed to satisfy the “ability to repay” requirement. To qualify for this, the insured depository institutions and credit unions must meet conditions relating to prepayment penalties, points and fees, negative amortization, interest-only features and documentation.
The Regulatory Relief Act directs federal banking agencies to issue regulations exempting certain insured depository institutions and insured credit unions with assets of $10 billion or less from the requirement to establish escrow accounts for certain residential mortgage loans.
Insured depository institutions and insured credit unions that originated fewer than 500 closed-end mortgage loans or 500 open-end lines of credit in each of the two preceding years are exempt from a subset of disclosure requirements (recently imposed by the CFPB) under the Home Mortgage Disclosure Act (“HMDA”), provided they have received certain minimum CRA ratings in their most recent examinations.
The Regulatory Relief Act also directs the OCC to conduct a study assessing the effect of the exemption described above on the amount of HMDA data available at the national and local level.
In addition, Section 941 of the Dodd-Frank Act amended the Exchange Act to require sponsors of asset-backed securities (“ABS”) to retain at least 5% of the credit risk of the assets underlying the securities and generally prohibits sponsors from transferring or hedging that credit risk. In October 2014, the federal banking regulatory agencies adopted a final rule to implement this requirement (the “Risk Retention Rule”). Among other things, the Risk Retention Rule requires a securitizer to retain not less than 5% of the credit risk of any asset that the securitizer, through the issuance of an ABS, transfers, sells, or conveys to a third party; and prohibits a securitizer from directly or indirectly hedging or otherwise
transferring the credit risk that the securitizer is required to retain. In certain situations, the final rule allows securitizers to allocate a portion of the risk retention requirement to the originator(s) of the securitized assets, if an originator contributes at least 20% of the assets in the securitization. The Risk Retention Rule also provides an exemption to the risk retention requirements for an ABS collateralized exclusively by Qualified Residential Mortgages (“QRMs”), and ties the definition of a QRM to the definition of a “qualified mortgage” established by the CFPB for purposes of evaluating a consumer’s ability to repay a mortgage loan. The federal banking agencies have agreed to review the definition of QRMs in 2019, following the CFPB’s own review of its “qualified mortgage” regulation. For purposes of residential mortgage securitizations, the Risk Retention Rule took effect on December 24, 2015. For all other securitizations, the rule took effect on December 24, 2016.
The Volcker Rule
On December 10, 2013, the federal regulators adopted final regulations to implement the proprietary trading and private fund prohibitions of the Volcker Rule under the Dodd-Frank Act. Under the final regulations, banking entities are generally prohibited, subject to significant exceptions from: (i) short-term proprietary trading as principal in securities and other financial instruments, and (ii) sponsoring or acquiring or retaining an ownership interest in private equity and hedge funds. Revisions to the Volcker Rule in 2019, that become effective in 2020, simplifies and streamlines the compliance requirements for banks that do not have significant trading activities. In 2020, the OCC, Federal Reserve, FDIC, SEC and Commodity Futures Trading Commission finalized further amendments to the Volcker Rule. The amendments include new exclusions from the Volcker Rule’s general prohibitions on banking entities investing in and sponsoring private equity funds, hedge funds, and certain other investment vehicles (collectively “covered funds”). The amendments in the final rule, which became effective on October 1, 2020, clarify and expand permissible banking activities and relationships under the Volcker Rule.
Other Provisions of the Dodd-Frank Act
The Dodd-Frank Act implements far-reaching changes across the financial regulatory landscape. In addition to the reforms previously mentioned, the Dodd-Frank Act also:
•requires BHCs and banks to be both well capitalized and well managed in order to acquire banks located outside their home state and requires any BHC electing to be treated as a financial holding company to be both well managed and well capitalized;
•eliminates all remaining restrictions on interstate banking by authorizing national and state banks to establish de novo branches in any state that would permit a bank chartered in that state to open a branch at that location; and
•repeals Regulation Q, the federal prohibition on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts.
Although a significant number of the rules and regulations mandated by the Dodd-Frank Act have been finalized, many of the requirements called for have yet to be implemented and will likely be subject to implementing regulations over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various agencies, the full extent of the impact such requirements will have on financial institutions’ operations is unclear.
Federal Home Loan Bank Membership
The Bank is a member of the FHLB. Each member of the FHLB is required to maintain a minimum investment in the Class B stock of the FHLB. The Board of Directors of the FHLB can increase the minimum investment requirements in the event it has concluded that additional capital is required to allow
it to meet its own regulatory capital requirements. Any increase in the minimum investment requirements outside of specified ranges requires the approval of the Federal Housing Finance Agency. Because the extent of any obligation to increase the level of investment in the FHLB depends entirely upon the occurrence of a future event, the Company is unable to determine the extent of future required potential payments to the FHLB. Additionally, if a member financial institution fails, the right of the FHLB to seek repayment of funds loaned to that institution will take priority (a super lien) over the rights of all other creditors.
Other Laws and Regulations
Our operations are subject to several additional laws, some of which are specific to banking and others of which are applicable to commercial operations generally. For example, with respect to our lending practices, we are subject to the following laws and regulations, among several others:
•Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
•HMDA, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
•Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed, or other prohibited factors in extending credit;
•Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act, governing the use and provision of information to credit reporting agencies, certain identity theft protections, and certain credit and other disclosures;
•Fair Debt Collection Practices Act, governing how consumer debts may be collected by collection agencies;
•Real Estate Settlement Procedures Act, requiring certain disclosures concerning loan closing costs and escrows, and governing transfers of loan servicing and the amounts of escrows for loans secured by one-to-four family residential properties;
•Rules and regulations established by the National Flood Insurance Program; and
•Rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.
Our deposit operations are subject to federal laws applicable to depository accounts, including:
•Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;
•Truth-In-Savings Act, requiring certain disclosures for consumer deposit accounts;
•Electronic Funds Transfer Act and Regulation E of the Federal Reserve, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services; and
•Rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.
We are also subject to a variety of laws and regulations that are not limited to banking organizations. For example, in lending to commercial and consumer borrowers, and in owning and operating our own
property, we are subject to regulations and potential liabilities under state and federal environmental laws. In addition, we must comply with privacy and data security laws and regulations at both the federal and state level.
We are heavily regulated by regulatory agencies at the federal and state levels. Like most of our competitors, we have faced and expect to continue to face increased regulation and regulatory and political scrutiny, which creates significant uncertainty for us, as well as for the financial services industry in general.
Enforcement Powers
The federal regulatory agencies have substantial penalties available to use against depository institutions and certain “institution-affiliated parties.” Institution-affiliated parties primarily include management, employees, and agents of a financial institution, as well as independent contractors and consultants, such as attorneys, accountants, and others who participate in the conduct of the financial institution’s affairs. An institution can be subject to an enforcement action due to the failure to timely file required reports, the filing of false or misleading information, or the submission of inaccurate reports, or engaging in other unsafe or unsound banking practices. Civil penalties may be as high as $1,924,589 per day for violations.
The Financial Institution Reform Recovery and Enforcement Act provided regulators with greater flexibility to commence enforcement actions against institutions and institution-affiliated parties and to terminate an institution’s deposit insurance. It also expanded the power of banking regulatory agencies to issue regulatory orders. Such orders may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnification, or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts, or take other actions as determined by the ordering agency to be appropriate. The Dodd-Frank Act increases regulatory oversight, supervision and examination of banks, BHCs, and their respective subsidiaries by the appropriate regulatory agency.

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ITEM 1A. RISK FACTORS
ITEM 1A. RISK FACTORS.
Ownership of our common stock involves certain risks. The risks and uncertainties described below are not the only ones we face. You should carefully consider the risks described below, as well as all other information contained in this Annual Report on Form 10-K. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. If any of these risks actually occurs, our business, financial condition or results of operations could be materially, adversely affected.
Risks Related to Our Business
The recent COVID-19 pandemic has led to periods of significant volatility in financial, commodities and other markets and could harm our business and results of operations.
In December 2019, COVID-19 was first reported in Wuhan, Hubei Province, China. Since then, COVID-19 infections have spread to additional countries including the United States. In March 2020, the World Health Organization declared COVID-19 to be a pandemic. Given the ongoing and dynamic nature of the circumstances, it is difficult to predict the impact of the coronavirus pandemic on our business, and there is no guarantee that our efforts to address or mitigate the adverse impacts of the coronavirus will be effective. The impact to date has included periods of significant volatility in financial, commodities and other markets. This volatility has had and, if it continues, could continue to have an adverse impact on our customers and on our business, financial condition and results of operations as well as our growth strategy.
Our business is dependent upon the willingness and ability of our customers to conduct banking and other financial transactions. The spread of COVID-19 has caused and could continue to cause severe disruptions in the U.S. economy at large, and has resulted and may continue to result in disruptions to our customers’ businesses, and a decrease in consumer confidence and business generally. In addition, recent actions by US federal, state and local governments to address the pandemic, including travel bans, stay-at-home orders and school, business and entertainment venue closures, have had and may continue to have a significant adverse effect on our customers and the markets in which we conduct our business. The extent of impacts resulting from the coronavirus pandemic and other events beyond our control will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of the coronavirus pandemic and actions taken to contain the coronavirus or its impact, among others.
Disruptions to our customers could result in increased risk of delinquencies, defaults, foreclosures and losses on our loans. The escalation of the pandemic may also negatively impact regional economic conditions for a period of time, resulting in declines in local loan demand, liquidity of loan guarantors, loan collateral (particularly in real estate), loan originations and deposit availability. If the global response to contain COVID-19 escalates or is unsuccessful, we could experience a material adverse effect on our business, financial condition, results of operations and cash flows.
The spread of the COVID-19 outbreak and the governmental responses may disrupt banking and other financial activity in the areas in which we operate and could potentially create widespread business continuity issues for us.
The outbreak of COVID-19 and the U.S. federal, state and local governmental responses may result in a disruption in the services we provide. We rely on our third-party vendors to conduct business and to process, record, and monitor transactions. If any of these vendors are unable to continue to provide us with these services or experience interruptions in their ability to provide us with these services, it could negatively impact our ability to serve our customers. Furthermore, the coronavirus pandemic could negatively impact the ability of our employees and customers to engage in banking and other financial transactions in the geographic areas in which we operate and could create widespread business
continuity issues for us. We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to infection, quarantine or other effects and restrictions of a COVID-19 outbreak in our market areas. Although we have business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective. If we are unable to promptly recover from such business disruptions, our business and financial conditions and results of operations would be adversely affected. We also may incur additional costs to remedy damages caused by such disruptions, which could adversely affect our financial condition and results of operations.
Our participation in the SBA-PPP loan program exposes us to risks related to noncompliance with the SBA-PPP loan program, as well as litigation risk related to our administration of the SBA-PPP loan program, which could have a material adverse impact on our business, financial condition and results of operations.
The Company is a participating lender in the SBA-PPP, a loan program administered through the SBA, that was created to help eligible businesses, organizations and self-employed persons fund their operational costs during the COVID-19 pandemic. Under this program, the SBA guarantees 100% of the amounts loaned under the SBA-PPP. The SBA-PPP opened on April 3, 2020; however, because of the short window between the passing of the CARES Act and the opening of the SBA-PPP, there is some ambiguity in the laws, rules and guidance regarding the operation of the SBA-PPP, which exposes the Company to risks relating to noncompliance with the SBA-PPP. For instance, other financial institutions have experienced litigation related to their process and procedures used in processing applications for the SBA-PPP. Any financial liability, litigation costs or reputational damage caused by SBA-PPP related litigation could have a material adverse impact on our business, financial condition and results of operations. In addition, the Company may be exposed to credit risk on SBA-PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced. If a deficiency is identified, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from the Company.
Interest rate volatility stemming from COVID-19 could negatively affect our net interest income, lending activities, deposits and profitability.
Our net interest income, lending activities, deposits and profitability could be negatively affected by volatility in interest rates caused by uncertainties stemming from COVID-19. In March 2020, the Federal Reserve lowered the target range for the federal funds rate to a range from 0 to 0.25 percent, citing concerns about the impact of COVID-19 on markets and stress in the energy sector. A prolonged period of extremely volatile and unstable market conditions would likely increase our funding costs and negatively affect market risk mitigation strategies. Higher income volatility from changes in interest rates and spreads to benchmark indices could cause a loss of future net interest income and a decrease in current fair market values of our assets. Fluctuations in interest rates will impact both the level of income and expense recorded on most of our assets and liabilities and the market value of all interest-earning assets and interest-bearing liabilities, which in turn could have a material adverse effect on our net income, operating results, or financial condition.
We are subject to increasing credit risk as a result of the COVID-19 pandemic, which could adversely impact our profitability.
Our business depends on our ability to successfully measure and manage credit risk. As a commercial 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 resulting from changes in economic and industry conditions and risks inherent in dealing with individual loans and borrowers. As the overall economic climate in the U.S., generally, and in our market areas specifically, experiences material disruption due to the COVID-19 pandemic, our borrowers may experience difficulties in repaying their
loans and governmental actions may provide payment relief to borrowers affected by COVID-19 and preclude our ability to initiate foreclosure proceedings in certain circumstances and, as a result, the collateral we hold may decrease in value or become illiquid, and the level of our nonperforming loans, charge-offs and delinquencies could rise and require significant additional provisions for credit losses. Additional factors related to the credit quality of certain commercial real estate loans include the duration of state and local moratoriums on evictions for non-payment of rent or other fees. The payment on these loans that are secured by income producing properties are typically dependent on the successful operation of the related real estate property and may subject us to risks from adverse conditions in the real estate market or the general economy.
We are actively working to support our borrowers to mitigate the impact of the COVID-19 pandemic on them and on our loan portfolio, including through loan modifications that defer payments for those who experienced a hardship as a result of the COVID-19 pandemic. Although recent regulatory guidance provides that such loan modifications are exempt from the calculation and reporting of TDRs and loan delinquencies, we cannot predict whether such loan modifications may ultimately have an adverse impact on our profitability in future periods. Our inability to successfully manage the increased credit risk caused by the COVID-19 pandemic could have a material adverse effect on our business, financial condition and results of operations.
As a business operating in the financial services industry, our business and operations may be adversely affected in numerous and complex ways by weak economic conditions.
Our business and operations, which primarily consist of lending money to clients in the form of loans, borrowing money from clients in the form of deposits and investing in securities, are sensitive to general business and economic conditions in the United States. The affect of COVID-19 has already impacted our results and it is entirely uncertain how the crisis will be resolved. If the U.S. economy further weakens, our growth and the profitability from our lending, deposit and investment operations could be constrained. Uncertainty about the federal fiscal policymaking process, the medium- and long-term fiscal outlook of the federal government and future tax rates is a concern for businesses, consumers and investors in the United States. The COVID-19 pandemic has further complicated the economic picture and drove unemployment to multi decade highs while raising the fear of inflation.
Weak economic conditions are characterized by numerous factors, including deflation, fluctuations in debt and equity capital markets, a lack of liquidity and depressed prices in the secondary market for mortgage loans, increased delinquencies on mortgage, consumer and commercial loans, residential and commercial real estate price declines and lower home sales and commercial activity. The current economic environment is characterized by interest rates at near historically low levels, which may impact our ability to attract deposits and to generate attractive earnings through our loan and investment portfolios.
All of these factors can individually or in the aggregate be detrimental to our business, and the interplay between these factors can be complex and unpredictable. Adverse economic conditions could have a material adverse effect on our business, financial condition and results of operations.
Our commercial business and operations are concentrated in the Washington, D.C. and Baltimore metropolitan areas and we are more sensitive than our more geographically diversified competitors to adverse changes in the local economy.
As of December 31, 2020, approximately 71.9% of our loans held for investment (measured by dollar amount) were made to borrowers who live or conduct business in the Washington, D.C. and Baltimore metropolitan areas. Therefore, our success depends upon the general economic conditions in this area, which we cannot predict with certainty. A downturn in the local economy generally could make it more difficult for our borrowers to repay their loans and may lead to loan losses that are not offset by operations in other markets; it may also reduce the ability of our depositors to make or maintain deposits with us.
For these reasons, any regional or local economic downturn that affects the Washington, D.C. and Baltimore metropolitan areas, or existing or prospective borrowers or depositors in the Washington, D.C. and Baltimore metropolitan areas could have a material adverse effect on our business, financial condition and results of operations.
Our customers and businesses in the Washington, D.C. metropolitan area may be adversely impacted as a result of changes in government spending.
The Washington, D.C. metropolitan area is characterized by a significant number of businesses that are federal government contractors or subcontractors, or which depend on such businesses for a significant portion of their revenues. The impact of a decline in federal government spending, a reallocation of government spending to different industries or different areas of the country or a delay in payments to such contractors could have a ripple effect. Temporary layoffs, staffing freezes, salary reductions or furloughs of government employees or government contractors could have adverse impacts on other businesses in the Company’s market and the general economy of the greater Washington, D.C. metropolitan area, and may indirectly lead to a loss of revenues by the Company’s customers, including vendors and lessors to the federal government and government contractors or to their employees, as well as a wide variety of commercial and retail businesses and the local housing market. Accordingly, such potential federal government activities could lead to increases in past due loans, nonperforming loans, loan loss reserves and charge-offs, and to a corresponding decline in liquidity.
We may not be able to implement aspects of our growth strategy, which may adversely affect our ability to maintain our historical growth and earnings trends.
We have grown rapidly over the last several years, primarily through organic growth. We may not be able to execute on aspects of our expansion strategy, which may impair our ability to sustain our historical rate of growth or prevent us from growing at all. The success of our strategy also depends on our ability to manage our growth effectively, which depends on a number of factors, including our ability to adapt our credit, operational, technology and governance infrastructure to accommodate expanded operations. If we are successful in continuing our growth, we cannot be certain that further growth would offer the same levels of potential profitability, or that we would be successful in controlling costs and maintaining asset quality in the face of that growth. Accordingly, an inability to maintain growth, or an inability to effectively manage growth, could have an adverse effect on our business, financial condition and results of operations.
We may not be able to measure and limit our credit risk adequately, which could lead to unexpected losses.
The primary component of our business involves making loans to customers. The business of lending is inherently risky, including risks that the principal of or interest on any loan will not be repaid in a timely manner or at all or that the value of any collateral supporting the loan will be insufficient to cover our outstanding exposure. A failure to measure and limit the credit risk associated with our loan portfolio effectively could lead to unexpected losses and have an adverse effect on our business, financial condition and results of operations.
Our allowance for loan losses may prove to be insufficient to absorb potential losses in our loan portfolio.
We maintain an allowance for loan losses that represents management’s judgment of probable losses and risks inherent in our loan portfolio. As of December 31, 2020, our allowance for loan losses totaled $23.4 million, which represents approximately 1.78% of our total portfolio loans, excluding PPP. The level of the allowance reflects management’s continuing evaluation of general economic conditions, diversification and seasoning of the loan portfolio, historic loss experience, identified credit problems, delinquency levels and adequacy of collateral. The determination of the appropriate level of our
allowance for loan losses is inherently highly subjective and requires management to make significant estimates of and assumptions regarding current credit risks and future trends, all of which may undergo material changes. If we are required to materially increase our level of allowance for loan losses for any reason, such increase could adversely affect our business, financial condition and results of operations.
The small- to medium-sized businesses that we lend to may have fewer resources to weather adverse business developments, which may impair our borrowers’ ability to repay loans.
As of December 31, 2020, we had approximately $157.1 million of commercial and industrial loans to businesses, which represents approximately 11.9% of our total loan portfolio held for investment. Small- to medium-sized businesses frequently have smaller market shares than their competition, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete and may experience substantial volatility in operating results, any of which may impair a borrower’s ability to repay a loan. If our borrowers are unable to repay their loans, our business, financial condition and results of operations could be adversely affected.
Our commercial real estate and real estate construction loan portfolio exposes us to credit risks that may be greater than the risks related to other types of loans.
As of December 31, 2020, approximately $380.0 million, or 28.9%, of our total portfolio loans, excluding PPP loans, were nonresidential real estate loans (including owner-occupied commercial real estate loans) and approximately $224.9 million, or 17.1%, of our total loans held for investment were construction loans. Furthermore, as of December 31, 2020, our commercial real estate loans (excluding owner-occupied commercial real estate loans) totaled 119.4% of our total risk based capital. These loans typically involve repayment that depends upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service. Unexpected deterioration in the credit quality of our commercial real estate loan portfolio could require us to increase our allowance for loan losses, which would reduce our profitability and could have an adverse effect on our business, financial condition and results of operations.
Construction loans also involve risks because loan funds are secured by a project under construction and the project is of uncertain value prior to its completion. It can be difficult to accurately evaluate the total funds required to complete a project, and construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. If we are forced to foreclose on a project prior to completion, we may be unable to recover the entire unpaid portion of the loan. In addition, we may be required to fund additional amounts to complete a project, incur taxes, maintenance and compliance costs for a foreclosed property and may have to hold the property for an indeterminate period of time, any of which could adversely affect our business, financial condition and results of operations.
Because a significant portion of our loan portfolio held for investment is comprised of real estate loans, negative changes in the economy affecting real estate values and liquidity could impair the value of collateral securing our real estate loans and result in loan and other losses.
At December 31, 2020, approximately $1.1 billion, or 80.2%, of our total loans held for investment were loans with real estate as a primary or secondary component of collateral. Adverse developments affecting real estate values and the liquidity of real estate in our primary markets could increase the credit risk associated with our loan portfolio, and could result in losses that adversely affect credit quality, financial condition and results of operations. If real estate values decline, it is more likely that we would be required to increase our allowance for loan losses, which would adversely affect our business, financial condition and results of operations.
A portion of our loan portfolio is comprised of commercial loans secured by receivables, inventory, equipment or other commercial collateral, the deterioration in value of which could expose us to credit losses.
As of December 31, 2020, approximately $157.1 million, or 11.9%, of our total loans held for investment were commercial loans to businesses. In general, these loans are collateralized by general business assets, including, among other things, accounts receivable, inventory and equipment, and most are backed by a personal guaranty of the borrower or principal. Significant adverse changes in the economy or local market conditions in which our commercial lending customers operate could cause rapid declines in loan collectability and the values associated with general business assets resulting in inadequate collateral coverage that may expose us to credit losses and could adversely affect our business, financial condition and results of operations.
System failure or cybersecurity breaches of our network security could subject us to increased operating costs as well as litigation and other potential losses.
Our computer systems and network infrastructure could be vulnerable to hardware and cybersecurity issues. Any damage or failure that causes an interruption in our operations could have an adverse effect on our financial condition and results of operations.
Our operations are also dependent upon our ability to protect our computer systems and network infrastructure, including our digital, mobile and internet banking activities, against damage from physical break-ins, cybersecurity breaches and other disruptive problems caused by the internet or other users. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability, damage our reputation and inhibit the use of our internet banking services by current and potential customers. A breach of our security that results in unauthorized access to our data could expose us to a disruption or challenges relating to our daily operations, as well as to data loss, litigation, damages, fines and penalties, significant increases in compliance costs and reputational damage, any of which could have an adverse effect on our business, financial condition and results of operations.
Appraisals and other valuation techniques we use in evaluating and monitoring loans secured by real property, other real estate owned and repossessed personal property may not accurately describe the net value of the asset.
In considering whether to make a loan secured by real property, we generally require an appraisal of the property. However, an appraisal is only an estimate of the value of the property at the time the appraisal is made and, as real estate values may change significantly in value in relatively short periods of time (especially in periods of heightened economic uncertainty), this estimate may not accurately describe the net value of the real property collateral after the loan is made. As a result, we may not be able to recover the full amount of any remaining indebtedness when we foreclose on and sell the relevant property. In addition, we rely on appraisals and other valuation techniques to establish the value of our other real estate owned, or OREO, and personal property that we acquire through foreclosure proceedings and to determine certain loan impairments. If any of these valuations are inaccurate, our combined and consolidated financial statements may not reflect the correct value of our OREO, and our allowance for loan losses may not reflect accurate loan impairments. This could have an adverse effect on our business, financial condition or results of operations.
We engage in lending secured by real estate and may be forced to foreclose on the collateral and own the underlying real estate, subjecting us to the costs and potential risks associated with the
ownership of the real property, or consumer protection initiatives or changes in state or federal law may substantially raise the cost of foreclosure or prevent us from foreclosing at all.
Since we originate loans secured by real estate, we may have to foreclose on the collateral property to protect our investment and may thereafter own and operate such property, in which case we would be exposed to the risks inherent in the ownership of real estate. As of December 31, 2020, we held approximately $3.3 million in OREO that is currently marketed for sale. Our inability to manage the amount of costs or size of the risks associated with the ownership of real estate, or write-downs in the value of OREO, could have an adverse effect on our business, financial condition and results of operations.
Additionally, consumer protection initiatives or changes in state or federal law may substantially increase the time and expense associated with the foreclosure process or prevent us from foreclosing at all. If new state or federal laws or regulations are ultimately enacted that significantly raise the cost of foreclosure or raise outright barriers, such could have an adverse effect on our business, financial condition and results of operation.
A lack of liquidity could impair our ability to fund operations and adversely impact our business, financial condition and results of operations.
Liquidity is essential to our business. We rely on our ability to generate deposits and effectively manage the repayment and maturity schedules of our loans and investment securities, respectively, to ensure that we have adequate liquidity to fund our operations. An inability to raise funds through deposits, borrowings, sales of our investment securities, sales of loans or other sources could adversely impact our ability to originate loans, invest in securities, meet our expenses or fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could, in turn, have an adverse effect on our business, financial condition and results of operations.
We have several large depositor relationships, the loss of which could force us to fund our business through more expensive and less stable sources.
As of December 31, 2020, our 10 largest non-brokered depositors accounted for $318.1 million in deposits, or approximately 19.3% of our total deposits. Our board of directors, directly and indirectly, accounted for $146.0 million of deposits as of December 31, 2020. Withdrawals of deposits by any one of our largest depositors could force us to rely more heavily on borrowings and other sources of funding for our business, adversely affecting our net interest margin and results of operations. We may also be forced, as a result of any withdrawal of deposits, to rely more heavily on other, potentially more expensive and less stable funding sources. Consequently, the occurrence of any of these events could have a material adverse effect on our business, financial condition and results of operations.
Our mortgage banking division may not continue to provide us with significant noninterest income.
For the year ended December 31, 2020, the Bank originated $1.31 billion and sold $1.27 billion of residential mortgage loans net of mortgage banking revenue, and originated $593.2 million and sold $540.7 million in the same period of 2019. The residential mortgage business is highly competitive and highly susceptible to changes in market interest rates, consumer confidence levels, employment statistics, the capacity and willingness of secondary market purchasers to acquire and hold or securitize loans, and other factors beyond our control. Additionally, in many respects, the traditional mortgage origination business is relationship-based, and dependent on the services of individual mortgage loan officers. The loss of services of one or more loan officers could have the effect of reducing the level of our mortgage production, or the rate of growth of production. As a result of these factors, we cannot be certain that we will be able to maintain or increase the volume or percentage of revenue or net income produced by the residential mortgage business.
We earn income by originating residential mortgage loans for resale in the secondary mortgage market, and disruptions in that market could reduce our operating income.
Historically, as part of our focus on loan origination and sales activities, we enter into formal commitments and informal agreements with larger banking companies and mortgage investors earning the Bank income from these sales. Under these arrangements, we originate single-family mortgages that are priced and underwritten to conform to previously agreed criteria before loan funding and are delivered to the investor shortly after funding.
Disruptions in the secondary market may not only affect us but also the ability and desire of mortgage investors and other banks to purchase residential mortgage loans that we originate. As a result, we may not be able to maintain or grow the income we receive from originating and reselling residential mortgage loans. Additionally, we hold certain mortgage loans that we originated for sale, increasing our exposure to interest rate risk and adverse changes in the value of the residential real estate that serves as collateral for the mortgage loan prior to sale.
Our financial condition, earnings and asset quality could be adversely affected if we are required to repurchase loans originated for sale by our mortgage banking division.
The Bank originates residential mortgage loans for sale to secondary market investors, subject to contractually specified and limited recourse provisions. Because the loans are intended to be originated within investor guidelines, using designated automated underwriting and product-specific requirements as part of the loan application, the loans sold have a limited recourse provision. Should such loan repurchases become a material issue, our earnings and asset quality could be adversely impacted, which could adversely impact business, financial condition and results of operations.
Delinquencies and credit losses from our OpenSky® credit card division could adversely affect our business, financial condition and results of operations.
Our OpenSky® division provides secured credit cards on a nationwide basis to under-banked populations and those looking to rebuild their credit scores. Although OpenSky® credit cards are secured, losses may occur primarily as a result of fraud, or when the account exceeds its established limit or if a cardholder ceases to maintain the account in good standing. Fraud, such as identity fraud, payment fraud and funding fraud (where an individual funds a card using information from someone they know well, such as a relative or roommate) can result in substantial losses. In the case of an OpenSky® account that is funded through fraud on the part of an applicant, we are required by applicable laws to refund the amount of the original deposit, and we charge off balances which were subsequently charged on the card. Account balances of excess of established credit limits happen as a result of certain VISA membership policies that allow cardholders to incur certain charges even if they exceed their card limits, which include, but are not limited to, rental car charges, gas station charges and hotel deposits. If an OpenSky® cardholder exceeds his or her credit limit as a result of purchases in one of these categories, we may incur losses for amounts in excess of the collateral deposited if the borrower is unable to repay such excess amounts. Customers can also exceed their credit limit by making intra period payments to replenish their available lines. If the payments are made via AC and were fraudulent we could incur the cost of the payment. Finally, losses to our credit card portfolio may arise if cardholders cease to maintain the account in good standing with timely payments. For example, in the event a card becomes more than 120 days past due, the credit card balance is recovered against the corresponding deposit account and a charge-off is recorded for any related fees, accrued interest or other charges in excess of the deposit account balance. We have invested in technology and systems to prevent and detect fraudulent behavior and mitigate losses but such investments may not be adequate, and our systems may not adequately monitor or mitigate potential losses arising from these risks.
A high credit loss rate (the rate at which we charge off uncollectible loans) on either our secured or unsecured portfolio could adversely impact our overall financial performance. We maintain an allowance
for loan losses, which we believe to be adequate to cover credit losses inherent in our OpenSky® portfolio, but we cannot be certain that the allowance will be sufficient to cover actual credit losses. If credit losses from our OpenSky® portfolio exceed our allowance for loan losses, our revenues will be reduced by the excess of such credit losses.
The inability of our OpenSky® credit card division to continue its growth rate could adversely affect our earnings.
Our credit card portfolio has increased from $9.6 million at December 31, 2014 to $102.2 million at December 31, 2020 and certain corresponding fees have been a significant portion of our income. We do not know if we will be able to retain existing customers or attract new customers, or that we will be able to increase account balances for new or existing customers.
We hope the development and expansion of new credit card products and related cardholder service products will be an important contributor to our growth and earnings in the future; however, if we are unable to implement new cardholder products and features, our ability to grow will be negatively impacted. Declining sales of cardholder service products would likely result in reduced income from fees and interest.
Our business, financial condition and results of operations may be adversely affected by merchants’ increasing focus on the fees charged by credit card networks and by regulation and legislation impacting such fees.
Credit card interchange fees are generally one of the largest components of the costs that merchants pay in connection with the acceptance of credit cards and are a meaningful source of revenue for our OpenSky® division. Interchange fees are the subject of significant and intense legal, regulatory and legislative focus globally, and the resulting decisions, regulations and legislation may have an adverse impact on our business, financial condition and results of operations.
The heightened focus by merchants and regulatory and legislative bodies on the fees charged by credit and debit card networks, and the ability of certain merchants to negotiate discounts to interchange fees with MasterCard and Visa successfully or develop alternative payment systems could result in a reduction of interchange fees. Any resulting loss in income to us could have an adverse effect on our business, financial condition and results of operations.
By engaging in derivative transactions, we are exposed to additional credit and market risk.
As part of our mortgage banking activities, we enter into interest rate lock agreements with the consumer. These are commitments to originate loans at a specified interest rate and lock expiration which is set prior to closing.
Hedging interest rate risk is a complex process, requiring sophisticated models and routine monitoring. As a result of interest rate fluctuations, hedged assets and liabilities will appreciate or depreciate in market value. The effect of this unrealized appreciation or depreciation in assets (loans) will generally be offset by income or loss in the corresponding MBS derivative instruments that are linked to the hedged assets and liabilities. By engaging in derivative transactions, we are exposed to counterparty credit and market risk. If the counterparty fails to perform, credit risk exists to the extent of the fair value gain in the derivative. Market risk exists to the extent that interest rates change in ways that are significantly different from what was modeled when we entered into the derivative transaction. The existence of credit and market risk associated with our derivative instruments could adversely affect our mortgage banking revenue and, therefore, could have a material adverse effect on our business, financial condition and results of operations.
We are subject to interest rate risk as fluctuations in interest rates may adversely affect our earnings.
The majority of our banking assets and liabilities are monetary in nature and subject to risk from changes in interest rates. Like most financial institutions, our earnings are significantly dependent on our net interest income, the principal component of our earnings, which is the difference between interest earned by us from our interest earning assets, such as loans and investment securities, and interest paid by us on our interest bearing liabilities, such as deposits and borrowings. We expect that we will periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities, meaning that either our interest bearing liabilities will be more sensitive to changes in market interest rates than our interest earning assets, or vice versa. In either case, if market interest rates move contrary to our position, this gap will negatively impact our earnings. The impact on earnings is more adverse when the slope of the yield curve flattens; that is, when short-term interest rates increase more than long-term interest rates or when long-term interest rates decrease more than short-term interest rates. Many factors impact interest rates, including governmental monetary policies, inflation, recession, changes in unemployment, the money supply, international economic weakness and disorder and instability in domestic and foreign financial markets. As of December 31, 2020, approximately 45.0% of our interest earning assets and approximately 66.0% of our interest bearing liabilities had a variable interest rate.
Interest rate increases often result in larger payment requirements for our borrowers, which increases the potential for default and could result in a decrease in the demand for loans. At the same time, the marketability of the property securing a loan may be adversely affected by any reduced demand resulting from higher interest rates. In a declining interest rate environment, there may be an increase in prepayments on loans as borrowers refinance their loans at lower rates. In addition, in a low interest rate environment, loan customers often pursue long-term fixed rate credits, which could adversely affect our earnings and net interest margin if rates later increase. Changes in interest rates also can affect the value of loans, securities and other assets. An increase in interest rates that adversely affects the ability of borrowers to pay the principal or interest on loans may lead to an increase in nonperforming assets and a reduction of income recognized, which could have an adverse effect on our results of operations and cash flows. Further, when we place a loan on nonaccrual status, we reverse any accrued but unpaid interest receivable, which decreases interest income. At the same time, we continue to incur costs to fund the loan, which is reflected as interest expense, without any interest income to offset the associated funding expense. Thus, an increase in the amount of nonperforming assets would have an adverse impact on net interest income. If short-term interest rates remain at their historically low levels for a prolonged period and assuming longer-term interest rates fall further, we could experience net interest margin compression as our interest earning assets would continue to reprice downward while our interest bearing liability rates could fail to decline in tandem. Such an occurrence would have an adverse effect on our net interest income and could have an adverse effect on our business, financial condition and results of operations.
Uncertainty about the future of LIBOR may adversely affect our business.
On July 27, 2017, the United Kingdom’s Financial Conduct Authority, which regulates the LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calculation of LIBOR after 2021. The announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021.Uncertainty as to the nature of alternative reference rates and as to potential changes in other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans, and to a lesser extent securities in our portfolio, and may impact the availability and cost of hedging instruments and borrowings, including the rates we pay on our subordinated debentures and trust preferred securities. If LIBOR rates are no longer available or do not remain an acceptable market benchmark, any successor or replacement interest rates may perform differently, which may adversely affect our revenue or our expenses. We may incur significant costs to transition both our borrowing arrangements and the loan agreements with our customers from LIBOR, which may have an adverse effect on our results of operations. Further, we may face exposure to litigation over the nature
and performance of any replacement index. The impact of alternatives to LIBOR on the valuations, pricing and operation of our financial instruments is not yet known.
We face strong competition from financial services companies and other companies that offer banking services.
We operate in the highly competitive financial services industry and face significant competition for customers from financial institutions located both within and beyond our principal markets. We compete with commercial banks, savings banks, credit unions, nonbank financial services companies and other financial institutions operating within or near the areas we serve. In addition, many of our non-bank competitors are not subject to the same extensive regulations that govern our activities and may have greater flexibility in competing for business. Our inability to compete successfully in the markets in which we operate could have an adverse effect on our business, financial condition or results of operations.
Risks Related to the Regulation of Our Industry
We operate in a highly regulated environment and the laws and regulations that govern our operations, corporate governance, executive compensation and accounting principles, or changes in them, or our failure to comply with them, could adversely affect us.
Banking is highly regulated under federal and state law. As such, we are subject to extensive regulation, supervision and legal requirements that govern almost all aspects of our operations. Compliance with laws and regulations can be difficult and costly, and changes to laws and regulations often impose additional operating costs. Our failure to comply with these laws and regulations, even if the failure follows good faith effort or reflects a difference in interpretation, could subject us to restrictions on our business activities, enforcement actions and fines and other penalties, any of which could adversely affect our results of operations, regulatory capital levels and the price of our securities. Further, any new laws, rules and regulations, such as the Dodd-Frank Act, could make compliance more difficult or expensive or otherwise adversely affect our business, financial condition and results of operations.
Legislative and regulatory actions taken now or in the future may increase our costs and impact our business, governance structure, financial condition or results of operations.
Economic conditions that contributed to the financial crisis in 2008, particularly in the financial markets, resulted in government regulatory agencies and political bodies placing increased focus and scrutiny on the financial services industry. The Dodd-Frank Act, which was enacted in 2010 as a response to the financial crisis, significantly changed the regulation of financial institutions and the financial services industry. Compliance with the Dodd-Frank Act and its implementing regulations has and may continue to result in additional operating and compliance costs that could have a material adverse effect on our business, financial condition, results of operations and growth prospects.
Federal and state regulatory agencies frequently adopt changes to their regulations or change the manner in which existing regulations are applied. Regulatory or legislative changes to laws applicable to the financial industry, if enacted or adopted, may impact the profitability of our business activities, require more oversight or change certain of our business practices, including the ability to offer new products, obtain financing, attract deposits, make loans and achieve satisfactory interest spreads and could expose us to additional costs, including increased compliance costs. These changes also may require us to invest significant management attention and resources to make any necessary changes to operations to comply and could have an adverse effect on our business, financial condition and results of operations.
As a result of the Dodd-Frank Act and recent rulemaking, the Bank and the Company are subject to more stringent capital requirements.
In July 2013, the U.S. federal banking authorities approved the implementation of regulatory capital reforms of the Basel Committee on Banking Supervision, which is referred to as Basel III, and issued rules effecting certain changes required by the Dodd-Frank Act. Basel III is applicable to all U.S. banks that are subject to minimum capital requirements as well as to bank and saving and loan holding companies other than those subject to the Federal Reserve’s Small Bank Holding Company Policy Statement. The failure to meet applicable regulatory capital requirements could result in one or more of our regulators placing limitations or conditions on our activities, including our growth initiatives, or restricting the commencement of new activities, and could affect customer and investor confidence, our costs of funds and FDIC insurance costs, our ability to pay dividends on our common stock, our ability to make acquisitions, and our business, results of operations and financial condition.
Federal banking agencies periodically conduct examinations of our business, including compliance with laws and regulations, and our failure to comply with any supervisory actions to which we are or become subject as a result of such examinations could adversely affect us.
As part of the bank regulatory process, the OCC and the Federal Reserve, periodically conduct examinations of our business, including compliance with laws and regulations. If, as a result of an examination, one of these federal banking agencies were to determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, asset sensitivity, risk management or other aspects of any of our operations have become unsatisfactory, or that the Company, the Bank or their respective management were in violation of any law or regulation, it may take a number of different remedial actions as it deems appropriate. These actions include the power to enjoin “unsafe or unsound” practices, to require affirmative actions to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital levels, to restrict our growth, to assess civil monetary penalties against us, the Bank or their respective officers or directors, to remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to depositors, to terminate the Bank’s deposit insurance. If we become subject to such regulatory actions, our business, financial condition, results of operations and reputation could be adversely affected.
Monetary policies and regulations of the Federal Reserve could adversely affect our business, financial condition and results of operations.
In addition to being affected by general economic conditions, our earnings and growth are affected by the policies of the Federal Reserve. An important function of the Federal Reserve is to regulate the U.S. money supply and credit conditions. The monetary policies and regulations of the Federal Reserve have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. Although we cannot determine the effects of such policies on us at this time, such policies could adversely affect 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 bank regulatory agencies have indicated their view that banks with high concentrations of loans secured by commercial real estate are subject to increased risk and should implement robust risk management policies and maintain higher capital than regulatory minimums to maintain an appropriate cushion against loss that is commensurate with the perceived risk. Federal bank regulatory guidelines identify institutions potentially exposed to commercial real estate concentration risk as those that have (i) experienced rapid growth in commercial real estate lending, (ii) notable exposure to a specific type of commercial real estate, (iii) total reported loans for construction, land development and other land loans representing 100% or more of the institution’s capital, or (iv) total non-owner-occupied commercial real
estate (including construction) loans representing 300% or more of the institution’s capital if the outstanding balance of the institution’s non-owner-occupied commercial real estate (including construction) loan portfolio has increased 50% or more during the prior 36 months. At December 31, 2020, the Bank’s construction to total capital ratio was 147.7%, its total non-owner occupied commercial real estate (including construction) to total capital ratio was 341.6% and therefore exceeded the 100% and 300% regulatory guideline thresholds set forth in clauses (iii) and (iv) above. As a result, we are deemed to have a concentration in commercial real estate lending under applicable regulatory guidelines. Because a significant portion of our loan portfolio depends on commercial real estate, a change in the regulatory capital requirements applicable to us or a decline in our regulatory capital could limit our ability to leverage our capital as a result of these policies, which could have a material adverse effect on our business, financial condition and results of operations.
We cannot guarantee that any risk management practices we implement will be effective to prevent losses relating to our commercial real estate portfolio. Management has implemented controls to monitor our commercial real estate lending concentrations, but we cannot predict the extent to which this guidance will impact our operations or capital requirements.
Risks Related to Ownership of Our Common Stock
The price of our common stock, like many of our peers, has fluctuated significantly over the recent past and may fluctuate significantly in the future, which may make it difficult for you to resell your shares of common stock at times or at prices you find attractive.
Stock price volatility may make it difficult for holders of our common stock to resell their common stock when desired and at desirable prices. There are many factors that may affect the market price and trading volume of our common stock, including, without limitation, the risks discussed elsewhere in this “Risk Factors” section.
The stock market and, in particular, the market for financial institution stocks has experienced substantial fluctuations in recent years, which in many cases have been unrelated to the operating performance and prospects of particular companies. In addition, significant fluctuations in the trading volume in our common stock may cause significant price variations to occur. Increased market volatility may materially and adversely affect the market price of our common stock, which could make it difficult to sell your shares at the volume, prices and times desired.
The market price of our common stock could decline significantly due to actual or anticipated issuances or sales of our common stock in the future.
Our board of directors may determine from time to time that we need to raise additional capital by issuing additional shares of our common stock or other securities. We are not restricted from issuing additional shares of common stock, including securities that are convertible into or exchangeable for, or that represent the right to receive, common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of any future offerings, or the prices at which such offerings may be effected. Such offerings could be dilutive to common shareholders.
We cannot predict the size of future issuances of our common stock or the effect, if any, that future issuances and sales of our common stock will have on the market price of our common stock. Sales of substantial amounts of our common stock (including shares of our common stock issued in connection with an acquisition or under a compensation or incentive plan), or the perception that such sales could occur, may adversely affect prevailing market prices for our common stock and could impair our ability to raise capital through future sales of our securities.
Our management and board of directors have significant control over our business.
As of December 31, 2020, our directors, directors of the Bank, our named executive officers and their respective family members and affiliated entities beneficially owned an aggregate of 5,507,852 shares, or approximately 40.0% of our issued and outstanding common stock. Consequently, our management and board of directors may be able to significantly affect the outcome of the election of directors and the potential outcome of other matters submitted to a vote of our shareholders, such as mergers, the sale of substantially all of our assets and other extraordinary corporate matters. The interests of these insiders could conflict with the interests of our other shareholders, including you.
The holders of our existing debt obligations, as well as debt obligations that may be outstanding in the future, will have priority over our common stock with respect to payment in the event of liquidation, dissolution or winding up and with respect to the payment of interest.
In the event of any liquidation, dissolution or winding up of the Company, our common stock would rank below all claims of debt holders against us. As of December 31, 2020 we had outstanding approximately $10.0 million in aggregate principal amount of subordinated notes and $2.1 million in aggregate principal amount of junior subordinated debentures issued to a statutory trust that, in turn, issued $2.0 million of trust preferred securities. Payments of the principal and interest on the trust preferred securities are conditionally guaranteed by us. Our debt obligations are senior to our shares of common stock. As a result, we must make payments on our debt obligations before any dividends can be paid on our common stock. In the event of our bankruptcy, dissolution or liquidation, the holders of our debt obligations must be satisfied before any distributions can be made to the holders of our common stock. To the extent that we issue additional debt obligations, the additional debt obligations will be of equal rank with, or senior to, our existing debt obligations and senior to our shares of common stock.
We are dependent upon the Bank for cash flow, and the Bank’s ability to make cash distributions is restricted.
Our primary asset is Capital Bank. We depend upon the Bank for cash distributions (through dividends on the Bank’s common stock) that we use to pay our operating expenses and satisfy our obligations (including our subordinated debentures and our other debt obligations). Federal statutes, regulations and policies restrict the Bank’s ability to make cash distributions to us. These statutes and regulations require, among other things, that the Bank maintain certain levels of capital in order to pay a dividend. Further, the OCC has the ability to restrict the Bank’s payment of dividends by supervisory action. If the Bank is unable to pay dividends to us, we may not be able to satisfy our obligations or, if applicable, pay dividends on our common stock.
Our future ability to pay dividends is subject to restrictions.
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. We have not paid any cash dividends on our capital stock since inception. Any declaration and payment of dividends on common stock in the future will depend on regulatory restrictions, our earnings and financial condition, our liquidity and capital requirements, the general economic climate, contractual restrictions, our ability to service any equity or debt obligations senior to our common stock and other factors deemed relevant by our board of directors. Furthermore, consistent with our strategic plans, growth initiatives, capital availability, projected liquidity needs and other factors, we have made, and will continue to make, capital management decisions and policies that could adversely affect the amount of dividends, if any, paid to our common shareholders.
Provisions in our governing documents and Maryland law may have an anti-takeover effect, and there are substitutional regulatory limitations on changes of control of bank holding companies.
Our corporate organizational documents and provisions of federal and state law to which we are subject contain certain provisions that could have an anti-takeover effect and may delay, make more
difficult or prevent an attempted acquisition that you may favor or an attempted replacement of our board of directors or management.
Our Amended and Restated Articles of Incorporation, or Articles, and our Amended and Restated Bylaws, or Bylaws, may have an anti-takeover effect and may delay, discourage or prevent an attempted acquisition or change of control or a replacement of our board of directors or management. Our governing documents and Maryland law include provisions that:
•empower our board of directors, without shareholder approval, to issue preferred stock, the terms of which, including voting power, are to be set by our board of directors;
•divide our board of directors into three classes serving staggered three-year terms;
•provide that directors may be removed from office (i) without cause but only upon a 66.67% vote of shareholders and (ii) for cause but only upon a majority shareholder vote;
•eliminate cumulative voting in elections of directors;
•permit our board of directors to alter, amend or repeal our Bylaws or to adopt new bylaws;
•permit our board of directors to increase or decrease the number of authorized shares of our common stock and preferred stock;
•require the request of holders of at least a majority of the outstanding shares of our capital stock entitled to vote at a meeting to call a special shareholders’ meeting;
•require shareholders that wish to bring business before annual or special meetings of shareholders, or to nominate candidates for election as directors at our annual meeting of shareholders, to provide timely notice of their intent in writing; and
•enable our board of directors to increase, between annual meetings, the number of persons serving as directors and to fill the vacancies created as a result of the increase by a majority vote of the directors present at a meeting of directors.
In addition, certain provisions of Maryland law may delay, discourage or prevent an attempted acquisition or change in control. Furthermore, banking laws impose notice, approval, and ongoing regulatory requirements on any shareholder or other party that seeks to acquire direct or indirect “control” of an FDIC-insured depository institution or its holding company. These laws include the BHC Act and the Change in Bank Control Act, or the CBCA. These laws could delay or prevent an acquisition.
Our common stock is not insured by any governmental entity.
Our common stock is not a deposit account or other obligation of any bank and is not insured by the FDIC or any other governmental entity. Investment in our common stock is subject to risk, including possible loss.

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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 headquarters are currently located at 2275 Research Boulevard, Suite 600, Rockville, Maryland 20850. The following table summarizes pertinent details of our commercial bank branch locations, mortgage banking offices, loan production offices, or LPOs, and our credit card operations office. Our mortgage offices typically contain both origination and operations professionals.
Location Owned/Leased Lease Expiration Type of office
One Church Street
Suite 100
Rockville, MD 20850 Leased
6/30/24
Commercial Branch
2275 Research Blvd.
Suite 600
Rockville, MD 20850 Sub-Leased
10/31/24
Corporate
1776 Eye Street
Washington, D.C. 20006 Leased
4/30/22
Commercial Branch
6000 Executive Boulevard
Suite 101
North Bethesda, MD 20852 Leased
9/30/21
Commercial Branch
6711 Columbia Gateway Drive
Suite 170
Columbia, MD 21046 Leased
5/31/22
Commercial Branch/Mortgage Office
110 Gibraltar Road
Suite 130
Horsham, PA 19044 Leased
5/31/23 OpenSky® Operations
185 Harry S. Truman Parkway
Suite 100
Annapolis, MD 21401 Leased
9/30/21
Mortgage Office
14231 Jarrettsville Pike
Phoenix, MD 21131 Leased
2/28/22
Mortgage Office
1801 E Jefferson St.
Rockville, MD 20852 Leased
Month-to-month
Limited Service Branch
818 Connecticut Ave
Suite 900
Washington, D.C. 20006 Sub-Leased
Month-to-month
LPO
10700 Parkridge Boulevard
Suite 180
Reston, VA 20191 Leased
10/31/2023
Commercial Branch and Mortgage Office

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

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ITEM 4. MINE SAFETY DISCLOSURE
ITEM 4. MINE SAFETY DISCLOSURES.
Not applicable.
PART II

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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Shareholder Information
The common stock of the Company has been publicly traded since September 2018 and is currently traded on the Nasdaq Global Select Market under the symbol CBNK. As of March 10, 2021, there were approximately 178 holders of record of our common stock.
Dividends
It is our policy to retain earnings, if any, to provide funds for use in our business. Although we have never declared or paid dividends on our common stock, our board of directors periodically reviews whether to declare or pay cash dividends taking into account, among other things, general business conditions, our financial results, future prospects, capital requirements, legal and regulatory restrictions, and such other factors as our board may deem relevant.
Our ability to pay dividends on our common stock is dependent on the Bank’s ability to pay dividends to the Company. Various statutory provisions restrict the amount of dividends that the Bank can pay without regulatory approval. For information on the statutory and regulatory limitations on the ability of the Company to pay dividends to its stockholders and on the Bank to pay dividends to the Company, see “Item 1. Business-Supervision and Regulation-Dividends” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity.
Equity Compensation Plan Information
The following table provides information as of December 31, 2020, with respect to options and RSUs outstanding and shares available for future awards under the Company’s active equity incentive plans.
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 (excluding securities reflected in column (a))
(a) (b) (c)
Equity compensation plans approved by security holders:
HCNB Bancorp, Inc. 2002 Stock Option Plan 172,976 $ 8.50 -
Capital Bancorp, Inc. 2017 Stock and Incentive Compensation Plan 996,437 12.86 144,049
Equity compensation plans not approved by security holders - - -
Total
1,169,413 $ 12.21 144,049
Unregistered Sales and Issuer Repurchases of Common Stock
There were no unregistered sales of the Company’s stock during the year ended December 31, 2020.
On April 25, 2019, the Company announced a stock repurchase program. The program enables the Company to repurchase up to $5.0 million of its outstanding common stock, and expired on December 31, 2020. During the year ended December 31, 2019 and the year ended December 31, 2020, the Company repurchased shares under the approved stock repurchase program, as reflected in the following table.
Periods Total Number of Shares Purchased Average price paid per share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
Through December 31, 2019 28,480 $ 13.00 28,480 $ 4,629,646
For the three months ended March 31, 2020 112,134 $ 11.41 112,134 $ 3,349,806
For the three months ended June 30, 2020 1,500 $ 9.41 1,500 $ 3,335,691
For the three months ended September 30, 2020 141,200 $ 10.40 141,200 $ 1,866,947
October 1, 2020 to October 31, 2020 11,946 $ 9.91 11,946 $ 1,748,899
November 1, 2020 to November 30, 2020 37,334 $ 10.92 37,334 $ 1,342,748
December 1, 2020 to December 31, 2020 - $ - - $ -
For the three months ended December 31, 2020 49,280 $ 10.67 49,280 $ 1,342,748
For the twelve months ended December 31, 2020 304,114 $ 10.81 304,114 $ 1,342,748
Total 332,594 332,594

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ITEM 6. SELECTED FINANCIAL DATA
ITEM 6. SELECTED FINANCIAL DATA
You should read the following selected historical consolidated financial and other data in conjunction with our consolidated financial statements and related notes and the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report. The following tables set forth selected historical consolidated financial and other data for the years ended December 31, 2020, 2019, 2018, 2017 and 2016. Selected financial data as of and for the years ended December 31, 2020 and 2019 have been derived from our audited financial statements included elsewhere in this report. We have derived the selected financial data as of and for the years ended December 31, 2018 2017 and 2016 from our audited financial statements not included in this filing. The information presented in the table below has been adjusted to give effect to a four-for-one stock split of our common stock completed effective August 15, 2018. The effect of the stock split on outstanding shares and per share figures has been retroactively applied to all periods presented below. Our historical results are not necessarily indicative of any future period. The performance ratios, asset quality and capital ratios, mortgage metrics and credit card portfolio metrics are unaudited and derived from our audited financial statements and other financial information as of and for the periods presented. Average balances have been calculated using daily averages. The selected historical consolidated financial and other data presented below contains certain financial measures that are not presented in accordance with accounting principles generally accepted in the United States and have not been audited. See “-GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.”
Years Ended December 31,
(Dollars are in thousands, except per share information)
2020 2019 2018 2017 2016
Statement of Income Data:
Interest income
$ 97,251 $ 82,180 $ 69,127 $ 56,666 $ 49,243
Interest expense
13,182 15,842 11,239 7,755 6,484
Net interest income
84,069 67,512 57,888 48,911 42,759
Provision for loan losses
11,242 2,791 2,140 2,655 4,291
Noninterest income
61,061 25,692 16,124 15,149 20,473
Noninterest expense
98,751 66,525 54,123 47,306 43,380
Income before income taxes
35,137 23,888 17,749 14,099 15,561
Income tax expense
9,314 5,819 4,982 6,990 6,120
Net income
25,823 16,895 12,767 7,109 9,441
Balance Sheet Data:
Cash and due from banks
$ 18,456 $ 10,530 $ 10,431 $ 8,189 $ 4,827
Investment securities available for sale
99,787 60,828 46,932 54,029 47,985
Mortgage loans held for sale
107,154 71,030 18,526 26,344 49,167
Loans, net of deferred fees and allowance
1,292,068 1,156,934 1,002,260 887,420 763,430
SBA-PPP loans receivable, net
201,018 - - - -
Assets
1,876,593 1,428,495 1,105,058 1,026,009 905,600
Deposits
1,652,128 1,225,421 955,240 904,899 790,924
FHLB advances and repurchase agreements
22,000 32,222 5,332 13,260 15,659
Subordinated debentures
14,016 15,423 15,393 15,361 15,327
Total liabilities
1,717,282 1,295,164 990,494 945,890 834,853
Total stockholders’ equity
159,311 133,331 114,564 80,119 70,748
Tangible common equity(1)
159,311 133,331 114,564 80,119 70,748
Years Ended December 31,
(Dollars are in thousands, except per share information)
2020 2019 2018 2017 2016
Selected Performance Ratios:
Return on average assets (ROAA)
1.56 % 1.38 % 1.22 % 0.74 % 1.13 %
Return on average equity (ROAE)
18.00 13.66 13.94 9.29 14.39
Net interest margin 5.14 5.60 5.59 5.12 5.18
Noninterest income / average assets
3.68 2.01 1.54 1.57 2.46
Noninterest expense / average assets
5.95 5.45 5.18 4.90 5.21
Net operating expense / average assets
2.27 3.44 3.63 3.33 2.75
Efficiency ratio (1)
68.04 72.29 73.13 73.85 68.60
Loan yield (5)
7.27 7.37 7.16 6.44 6.45
Loan yield, excluding credit card portfolio(2)
5.53 5.91 5.76 5.57 5.76
Per Share Data:(3)
Basic earnings per share
$ 1.87 $ 1.23 $ 1.05 $ 0.63 $ 0.86
Diluted earnings per share(4)
1.87 1.21 1.02 0.62 0.84
Book value per share
11.58 9.60 8.38 6.94 6.35
Tangible book value per share (1)
11.58 9.60 8.38 6.94 6.35
Common shares issued and outstanding
13,753,529 13,894,842 13,672,479 11,537,196 11,144,696
Basic weighted average shares outstanding
13,793,256 13,733,131 12,116,459 11,261,132 10,963,132
Diluted weighted average shares outstanding
13,800,176 13,968,585 12,462,138 11,428,000 11,289,044
Non-Performing Assets (“NPA”):
Non-performing loans (“NPL”) $ 9,237 $ 4,720 $ 4,679 $ 5,407 $ 4,518
Troubled debt restructurings 440 459 284 3,811 941
Foreclosed real estate
3,326 2,384 142 93 90
Non-performing assets 12,563 7,104 4,821 5,500 4,608
Asset Quality Ratios:
NPA / assets
0.67 % 0.50 % 0.44 % 0.54 % 0.51 %
NPL / loans (5)
0.61 0.40 0.47 0.61 0.59
NPA / loans (5) + foreclosed real estate
0.82 0.60 0.48 0.62 0.60
Net charge-offs (recoveries) to average loans(5)
0.09 0.08 0.09 0.15 0.33
Allowance for loan losses to total loans (5)
1.78 1.14 1.13 1.13 1.13
Allowance for loan losses to NPL
253.71 281.80 241.72 185.57 190.32
Bank Capital Ratios:
Tier 1 leverage ratio 7.45 % 8.65 % 9.06 % 8.55 % 8.86 %
Common equity tier 1 capital 11.34 10.73 11.00 10.78 11.12
Tier 1 risk-based capital 11.34 10.73 11.00 10.78 11.12
Total risk-based capital ratio 12.60 11.98 12.25 12.03 12.37
Common equity to total assets 8.49 9.33 8.89 8.46 8.94
Years Ended December 31,
(Dollars are in thousands, except per share information)
2020 2019 2018 2017 2016
Composition of Loans Held for Investment:
Portfolio Loans Receivable
Residential real estate
$ 437,860 $ 427,926 $ 407,844 $ 342,684 $ 286,332
Commercial real estate
392,550 348,091 278,691 259,853 234,869
Construction real estate
224,904 198,702 157,586 144,932 134,540
Commercial
157,127 151,109 122,264 108,982 87,563
Credit card
102,186 45,526 34,673 31,507 20,446
Other consumer
1,649 1,285 1,202 1,053 1,157
SBA - PPP Loans Receivable
204,920 - - - -
Composition of Deposits:
Noninterest bearing $ 608,559 $ 291,778 $ 293,378 $ 175,707 $ 141,525
Interest bearing demand 257,125 174,166 186,422 69,455 50,628
Savings 4,800 3,675 3,994 3,365 3,326
Money Markets 447,077 429,078 313,131 282,840 252,486
Time Deposits 334,566 326,725 315,520 315,979 264,626
Capital Bank Home Loan Metrics:
Origination of loans held for sale
$ 1,308,912 $ 593,189 $ 337,122 $ 418,912 $ 853,674
Proceeds from loans held for sale, net of mortgage banking revenue
1,272,788 540,686 344,940 441,960 844,464
Purchase volume as a % of originations
31.90 % 51.89 % 79.43 % 52.50 % 18.79 %
Mortgage banking revenue
$ 40,649 $ 15,955 $ 9,477 $ 10,377 $ 15,373
Gain on sale as a % of loan sold
3.02 % 2.95 % 2.75 % 2.01 % 1.82 %
OpenSky Credit Card Portfolio Metrics:
Total active customer accounts 568,373 223,379 169,981 149,226 96,404
Total loans $ 102,186 $ 45,526 $ 34,673 $ 31,507 $ 20,446
Total deposits at the Bank $ 192,520 $ 78,223 $ 59,954 $ 53,625 $ 39,062
_______________
(1) This financial measure is not recognized under GAAP and is therefore considered to be a non-GAAP measure. See “-GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures” for a reconciliation of this financial measure to its most comparable GAAP financial measure.
(2) Includes non-accrual loans and loans 90 days and more past due.
(3) Gives effect to a four-for-one stock split of our common stock completed effective August 15, 2018. The effect of the stock split on outstanding shares and per share figures has been retroactively applied to all periods presented.
(4) Calculations of diluted earnings per share before bargain purchase gain, diluted earnings per share and diluted earnings per share, as adjusted, include interest on convertible debt.
(5) Loans exclude loans held for sale at each of the dates presented.
GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures
Our accounting and reporting policies conform to GAAP and the prevailing practices in the banking industry. However, we also evaluate our performance based on certain additional financial measures discussed in this report as being “non-GAAP financial measures.” We classify a financial measure as a non-GAAP financial measure if that financial measure excludes or includes amounts, or is subject to adjustments that have the effect of excluding or including amounts, that are not included or excluded, as the case may be, in the most directly comparable measure calculated and presented in accordance with GAAP as in effect from time to time in the United States in our statements of income, balance sheets or statements of cash flows. Non-GAAP financial measures do not include operating and other statistical measures or ratios that are calculated using exclusively financial measures presented in accordance with GAAP.
We believe that these non-GAAP financial measures provide useful information to management and investors that is supplementary to our financial condition, results of operations and cash flows computed in accordance with GAAP. However, non-GAAP financial measures have a number of limitations, are not necessarily comparable to GAAP measures and should not be considered in isolation or viewed as a substitute for the most directly comparable or other financial measures calculated in accordance with GAAP. Moreover, the manner in which we calculate non-GAAP financial measures may differ from that of other companies reporting non-GAAP measures with similar names. You should understand how such other companies calculate their financial measures that may be similar or have names that are similar to the non-GAAP financial measures discussed herein when comparing such non-GAAP financial measures. Our management uses the non-GAAP financial measures set forth below in its analysis of our performance
•“Tangible common equity” is a non-GAAP measure defined as total stockholders’ equity, less intangible assets.
•“Tangible book value per share” is a non-GAAP measure defined as total stockholders’ equity, less intangible assets, divided by shares of common stock outstanding.
The following reconciliation table provides a more detailed analysis of these non-GAAP financial measures:
Years Ended December 31,
(Dollars are in thousands, except per share information)
2020 2019 2018 2017 2016
Tangible Common Equity:
Total stockholders’ equity
$ 159,311 $ 133,331 $ 114,564 $ 80,119 $ 70,748
Less: intangible assets
- - - - -
Tangible common equity $ 159,311 $ 133,331 $ 114,564 $ 80,119 $ 70,748
Tangible Book Value per Share:
Total stockholders’ equity
$ 159,311 $ 133,331 $ 114,564 $ 80,119 $ 70,748
Less: intangible assets - - - - -
Tangible common equity
$ 159,311 $ 133,331 $ 114,564 $ 80,119 $ 70,748
Divide by shares of common stock outstanding(1)
13,753,529 13,894,842 13,672,479 11,537,196 11,144,696
Tangible book value per share(1)
$ 11.58 $ 9.60 $ 8.38 $ 6.94 $ 6.35
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(1)Gives effect to a four-for-one stock split of our common stock completed effective August 15, 2018. The effect of the stock split on outstanding shares and per share figures has been retroactively applied to all periods presented.

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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 discussion and analysis is intended as a review of significant factors affecting the Company’s financial condition and results of operations for the periods indicated. This discussion and analysis should be read in conjunction with the accompanying consolidated financial statements and the related notes.
The discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Certain risks, uncertainties and other factors, including but not limited to those set forth under “Cautionary Note Regarding Forward-Looking Statements,” “Risk Factors” and elsewhere in this Form 10-K, may cause actual results to differ materially from those projected in the forward-looking statements. We assume no obligation to update any of these forward-looking statements
Results of Operations for the Years Ended December 31, 2020 and 2019
Net Income
The following table sets forth the principal components of net income for the periods indicated.
Years Ended December 31,
(in thousands) 2020 2019 % Change
Interest income $ 97,251 $ 82,180 18.3 %
Interest expense 13,182 15,842 (16.8) %
Net interest income 84,069 66,338 26.7 %
Provision for loan losses 11,242 2,791 302.8 %
Net interest income after provision
72,827 63,547 14.6 %
Noninterest income 61,061 25,692 137.7 %
Noninterest expense 98,751 66,525 48.4 %
Net income before income taxes 35,137 22,714 54.7 %
Income tax expense 9,314 5,819 60.1 %
Net income $ 25,823 $ 16,895 52.8 %
Net income for the year ended December 31, 2020 was $25.8 million, an increase of $8.9 million, or 53%, from net income for the year ended December 31, 2019 of $16.9 million. The increase in net interest income was primarily due to the $150.6 million increase in average loans outstanding year over year. The increase in loan volume resulted in an increase of $10.9 million of loan interest income which includes $4.5 million from SBA-PPP loans. The increase in non-interest income is primarily due to credit card fees of $9.4 million and $24.7 million in mortgage banking revenue when comparing year over year.
Net Interest Income and Net Margin Analysis
Net interest income is the difference between interest income on earning assets and the cost of funds supporting those assets. Earning assets are composed primarily of loans, loans held for sale, investment securities, and interest bearing deposits with banks. The cost of funds represents interest expense on deposits, and borrowings, which consist of federal funds purchased, advances from the FHLB and subordinated notes. Noninterest bearing deposits and capital also provide sources of funding.
We analyze our ability to maximize income generated from interest earning assets and control the interest expenses of our liabilities, measured as net interest income, through our net interest margin and net interest spread. Net interest margin is a ratio calculated as net interest income divided by average interest earning assets for the same period. Net interest spread is the difference between average interest rates earned on interest earning assets and average interest rates paid on interest bearing
liabilities.
Changes in market interest rates and the interest rates we earn on interest earning assets or pay on interest bearing liabilities, as well as in the volume and mix of interest earning assets, interest bearing and noninterest bearing liabilities and stockholders’ equity, are usually the largest drivers of periodic changes in net interest income, net interest margin and net interest spread. Fluctuations in market interest rates are driven by many factors, including governmental monetary policies, inflation, deflation, macroeconomic developments, changes in unemployment, the money supply, political and international conditions and conditions in domestic and foreign financial markets. Periodic changes in the volume and types of loans in our loan portfolio are affected by, among other factors, economic and competitive conditions in the Washington, D.C. and Baltimore metropolitan areas, as well as developments affecting the real estate, technology, government services, hospitality and tourism and financial services sectors within our target markets and throughout the Washington, D.C. and Baltimore metropolitan areas. Our ability to respond to changes in these factors by using effective asset-liability management techniques is critical to maintaining the stability of our net interest income and net interest margin as our primary sources of earnings.
The table below presents the average balances and rates of the major categories of the Company’s assets and liabilities for the years ended December 31, 2020, 2019 and 2018. Included in the table is a measurement of interest rate spread and margin. Interest rate spread is the difference (expressed as a percentage) between the interest rate earned on earning assets less the interest expense on interest bearing liabilities. While the interest rate spread provides a quick comparison of earnings rates versus cost of funds, management believes that the net interest margin may provide a better measurement of performance. The net interest margin (as compared to the net interest spread) includes the effect of noninterest bearing sources in its calculation and is net interest income expressed as a percentage of average earning assets. As the table shows, the increase in net interest income in 2020 as compared to 2019 was primarily a function of an increase in of earning assets.
AVERAGE BALANCE SHEET AND NET INTEREST ANALYSIS
Years Ended December 31,
2020 2019 2018
(in thousands) Average
Outstanding
Balance Interest Income/
Expense Average
Yield/
Rate Average
Outstanding
Balance Interest Income/
Expense Average
Yield/
Rate Average
Outstanding
Balance Interest Income/
Expense Average
Yield/
Rate
Assets
Interest earning assets:
Interest bearing deposits
$ 112,249 $ 343 0.31 % $ 47,762 $ 832 1.74 % $ 41,858 $ 687 1.64 %
Federal funds sold
3,128 4 0.12 % 2,733 50 1.83 % 1,537 27 1.76 %
Investment securities
58,071 1,292 2.22 % 41,130 924 2.25 % 50,074 1,041 2.08 %
Restricted investments
4,025 244 6.07 % 4,334 243 5.61 % 2,724 143 5.25 %
Loans held for sale
84,928 2,610 3.07 % 44,483 2,899 6.52 % 17,715 1,569 8.86 %
SBA-PPP loans receivable 157,630 4,479 2.84 % - - - -
Portfolio Loans(1)(2)
1,215,049 88,279 7.27 % 1,064,421 77,232 7.26 % 921,823 65,660 7.12 %
Total interest earning assets
1,635,080 97,251 5.95 % 1,204,863 82,180 6.82 % 1,035,731 69,127 6.67 %
Noninterest earning assets 24,923 15,046 10,001
Total assets
$ 1,660,003 $ 1,219,909 $ 1,045,732
Liabilities and Stockholders’ Equity
Interest bearing liabilities:
Interest bearing demand accounts
$ 195,794 $ 656 0.34 % $ 109,977 $ 672 0.61 % $ 72,523 $ 210 0.29 %
Savings
4,722 5 0.11 % 3,597 13 0.36 % 3,704 12 0.32 %
Money market accounts
480,218 4,786 1.00 % 344,272 5,822 1.69 % 286,257 3,797 1.33 %
Time deposits
297,997 6,077 2.04 % 302,149 7,182 2.38 % 326,827 5,773 1.77 %
Borrowed funds
42,471 1,658 3.90 % 59,387 2,153 3.63 % 34,558 1,447 4.19 %
Total interest bearing liabilities
1,021,202 13,182 1.29 % 819,382 15,842 1.93 % 723,869 11,239 1.56 %
Noninterest bearing liabilities:
Noninterest bearing liabilities
22,007 16,144 9,828
Noninterest bearing deposits
473,301 260,726 220,445
Stockholders’ equity
143,493 123,657 91,590
Total liabilities and stockholders’ equity
$ 1,660,003 $ 1,219,909 $ 1,045,732
Net interest spread(3)
4.66 % 4.89 % 5.11 %
Net interest income $ 84,069 $ 66,338 $ 57,888
Net interest margin(4) (5)
5.14 % 5.51 % 5.59 %
_______________
(1)Includes nonaccrual loans.
(2)Interest income includes amortization of deferred loan fees, net of deferred loan costs.
(3)Net interest spread is the difference between interest rates earned on interest earning assets and interest rates paid on interest bearing liabilities.
(4)Net interest margin is a ratio calculated as net interest income divided by average interest earning assets for the same period.
(5)For the twelve months ended December 31, 2020, SBA-PPP loans negatively impacted the margin by 25 basis points while credit card loans improved the margin by 136 basis points, taken together, the net impact was 125 basis points to the reported net interest margin. For the twelve months ended December 31, 2019 and December 31, 2018, credit card loans contributed 125 and 81 basis points of the reported net interest margin, respectively.
Rate/Volume Analysis of Net Interest Income
The rate/volume table below presents the composition of the change in net interest income for the periods indicated, as allocated between the change in net interest income due to changes in the volume of average earning assets and interest bearing liabilities, and the changes in net interest income due to changes in interest rates. The increase in net interest income in 2020 relative to 2019 was primarily due to an increase in volume of interest earning assets, and particularly loans. For purposes of this table, changes attributable to both rate and volume that cannot be segregated have been proportionately allocated to both volume and rate.
ANALYSIS OF CHANGES IN NET INTEREST INCOME
Year Ended December 31, 2020 Year Ended December 31, 2019
Compared to the
Compared to the
Year Ended December 31, 2019 Year Ended December 31, 2018
Change Due To
Interest Variance
Change Due To
Interest Variance
(In thousands) Volume
Rate
Volume
Rate
Interest Income:
Interest bearing deposits
$ (1,253) $ 765 $ (488) $ 101 $ 44 $ 145
Federal funds sold
8 (55) (47) 22 1 23
Investment securities
377 (9) 368 (213) 96 (117)
Restricted investments (8) 9 1 90 10 100
Loans held for sale
(691) 402 (289) 1,612 (282) 1,330
SBA-PPP loans 4,479 - 4,479 - - -
Portfolio loans 10,944 103 11,047 10,326 1,245 11,571
Total interest income
13,856 1,215 15,071 11,938 1,114 13,052
Interest Expense:
Interest bearing demand accounts
(38) 22 (16) 147 315 462
Savings
6 (14) (8) - 1 1
Money market accounts
25,897 (26,933) (1,036) 859 1,166 2,025
Time deposits
(97) (1,008) (1,105) (394) 1,802 1,408
Borrowed funds
(677) 183 (494) 868 (162) 706
Total interest expense
25,091 (27,750) (2,659) 1,480 3,122 4,602
Net interest income $ (11,235) $ 28,965 $ 17,730 $ 10,458 $ (2,008) $ 8,450
Net interest income increased by $17.7 million to $84.1 million for the year ended December 31, 2020 compared to 2019, primarily as a result of 35.7% growth in average earning assets. For the twelve months ended December 31, 2020, our average interest-earning assets increased by $430.2 million, compared to the prior year. In addition to the average earning asset growth in 2020, the average rate on interest bearing liabilities decreased by 64 basis points to 1.29%. Net interest margin decreased 37 basis points to 5.14% for the twelve months ended December 31, 2020 from 5.51% for the twelve months ended 2019. The Company’s average portfolio loan yield slightly decreased in 2020 to 7.27% as compared to 7.26% in 2019. The Company believes its net interest margin remains favorable as compared to its peer banking companies.
Average total interest earning assets were $1.6 billion for the year ended December 31, 2020 compared with $1.2 billion for the year ended December 31, 2019. The yield on those interest earning assets decreased 87 basis points to 5.95% for 2020 compared to 6.82% for 2019.
The increase in the average balance of interest earning assets for the year ended December 31, 2020 compared to December 31, 2019, was driven by $64.5 million growth in the average balances of
interest earning deposits, as well as growth in investment securities of $16.9 million, loans held for sale of $40.4 million, SBA-PPP loans of $157.6 million and portfolio loans of $150.6 million.
Average interest bearing liabilities increased by $201.8 million to $1.0 billion for the year ended December 31, 2020 from $819.4 million for the year ended December 31, 2019. The increase was due to an increase in the average balance of interest bearing demand accounts of $85.8 million, or 78.0%, an increase in money market accounts of $135.9 million, or 39.5% and a decrease in the average balance of borrowed funds of $16.9 million, or 28.5%. compared to the year ended December 31, 2019 balances. Deposits are the primary funding source for the Company. The average interest rate paid on interest bearing liabilities decreased to 1.29% for 2020 compared to 1.93% for 2019. While the average interest rate paid on interest bearing deposits decreased 27 basis points, the average interest rate paid on borrowed funds increased by 27 basis points. For the year ended December 31, 2020, the Company’s net interest margin was 5.14% and net interest spread was 4.66% compared to 5.51% and 4.89% for 2019.
Provision for Loan Losses
The provision for loan losses represents the amount of expense charged to current earnings to fund the allowance for loan losses. The amount of the allowance for loan losses is based on many factors which reflect management’s assessment of the risk in the loan portfolio. Those factors include historical losses, economic conditions and trends, the value and adequacy of collateral, volume and mix of the portfolio, performance of the portfolio, and internal loan processes of the Company and Bank. For a detailed description of the factors taken into account by our management in determining the allowance for loan losses see “Financial Condition- Allowance for Loan Losses.”
For the year ended December 31, 2020, the Company recorded a provision for loan losses of $11.2 million, compared to $2.8 million for the previous year. The increase in the provision for 2020 compared to 2019 was primarily due to the uncertainty surrounding the deterioration of the macro-economic environment related to the COVID-19 pandemic. Year over year our allowance for loan losses as a percent of total portfolio loans increased to 1.78% at December 31, 2020 from 1.14% at December 31, 2019. Net charge-offs for 2020 amounted to $1.1 million, representing 0.09% of average loans, compared to $799 thousand for 2019. Included in the net charge-offs for 2020 were $296 thousand for construction loans, $233 thousand for commercial loans and $588 thousand for credit cards. The credit card portfolio charge-offs represented 54.7% and 55.4% of total charge-offs, respectively, for the periods presented.
The maintenance of a high quality loan portfolio, with an adequate allowance for possible credit losses, will continue to be a primary management objective for the Company.
Noninterest Income
Our primary sources of recurring noninterest income are service charges on deposit accounts, credit card fees, such as interchange fees and statement fees, and gain on sale of residential mortgage loans and other mortgage banking revenue. Noninterest income does not include (i) loan origination fees to the extent they exceed the direct loan origination costs, which are generally recognized over the life of the related loan as an adjustment to yield using the interest method or (ii) annual, renewal and late fees related to our credit card portfolio, which are generally recognized over the twelve month life of the related loan as an adjustment to yield using the interest method.
The following table presents, for the periods indicated, the major categories of noninterest income:
NONINTEREST INCOME
Years Ended December 31,
(in thousands) 2020 2019 % Change
Noninterest income:
Service charges on deposit accounts
$ 520 $ 542 (4.1) %
Credit card fees
16,966 7,602 123.2 %
Mortgage banking revenue
40,649 15,955 154.8 %
Gain on sale of investment securities available for sale 20 26 (23.1) %
Other fees and charges
2,906 1,567 85.4 %
Total noninterest income
$ 61,061 $ 25,692 137.7 %
Noninterest income for the the year ended December 31, 2020 was $61.1 million, a $35.4 million or 137.7% increase compared to noninterest income of $25.7 million for the year ended December 31, 2019. This increase is largely due to increases in credit card fees and mortgage banking revenue. Credit card fees increased $9.4 million, or 123.2%, for the year ended December 31, 2020 to $17.0 million compared to $7.6 million for 2019 . This increase was primarily due to an increase in outstanding card accounts to 568 thousand at December 31, 2020, compared to 223 thousand at December 31, 2019, an increase of 345 thousand accounts, or 154.4%.
Mortgage banking revenue increased $24.7 million, or 154.8%, during 2020 to $40.6 million compared to 2019 revenue of $16.0 million, primarily as a result of an increase in mortgage origination volume driven by the favorable mortgage refinancing market in 2020. Year over year mortgage originations increased to $1.3 billion from prior year originations of $593.2 million, a 120.7% increase.
Mortgage loans sold are subject to repurchase in circumstances where documentation is deficient or the underlying loan becomes delinquent or pays off within a specified period following loan funding and sale. The Bank considers these potential recourse provisions to be a risk and has established a reserve under generally accepted accounting principles for possible repurchases. The reserve increased to $1.2 million at December 31, 2020, compared to $576 thousand for the same period in 2019 primarily due to the increase in volume. The Bank does not originate “sub-prime” loans and has no exposure to this market segment
Noninterest Expense
Generally, noninterest expense is composed of all employee expenses and costs associated with operating our facilities, obtaining and retaining customer relationships and providing bank services. The largest component of noninterest expense is salaries and employee benefits. Noninterest expense also includes operational expenses, such as occupancy and equipment expenses, professional fees, advertising expenses, loan processing expenses and other general and administrative expenses, including FDIC assessments, communications, travel, meals, training, supplies and postage.
The following table presents, for the periods indicated, the major categories of noninterest expense:
NONINTEREST EXPENSE
Years Ended December 31,
(in thousands) 2020 2019 % Change
Noninterest expense:
Salaries and employee benefits
$ 44,359 $ 32,586 36.1 %
Occupancy and equipment
5,170 4,360 18.6 %
Professional fees
4,900 2,871 70.7 %
Data processing
26,917 15,512 73.5 %
Advertising
2,530 2,066 22.5 %
Loan processing
3,811 1,894 101.2 %
Other real estate expense, net
69 122 (43.4) %
Other operating
10,995 7,114 54.6 %
Total noninterest expense
$ 98,751 $ 66,525 48.4 %
Noninterest expense was $98.8 million for the year ended December 31, 2020, an increase of $32.2 million, or 48.4%, compared to $66.5 million for 2019. The increase was driven primarily by increases in salaries and benefits, which includes commissions paid on mortgage originations. In 2020, as a result of robust mortgage originations, commissions were $10.9 million, compared to $5.4 million in 2019. The increase in professional fees resulted primarily from increased consultant and other outside services. Data processing increased primarily due to the increase in loan and credit card volume. Other operating expenses increased primarily a result of increases in marketing, credit expense and credit card related expenses.
Income Tax Expense
The amount of income tax expense we incur is influenced by our pre-tax income and our other nondeductible expenses. Deferred tax assets and liabilities are reflected at current income tax rates in effect for the period in which the deferred tax assets and liabilities are expected to be realized or settled. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized.
Income tax expense was $9.3 million for 2020 compared to $5.8 million for 2019. Our effective tax rates for those periods were 26.5% and 25.6%, respectively.
Financial Condition
Total assets at December 31, 2020 were $1.88 billion, a 31.5% increase as compared to $1.4 billion at December 31, 2019. Total portfolio loans (excluding mortgage loans held for sale) were $1.3 billion at December 31, 2020, an 11.7% increase as compared to $1.1 billion at December 31, 2019. Loans held for sale amounted to $107.2 million at December 31, 2020 as compared to $71.0 million for the same period in 2019, a 50.9% increase year over year.
Total borrowed funds at December 31, 2020, were $36.0 million compared to $47.6 million at December 31, 2019. In 2020, in an effort to reduce funding costs, manage liquidity and mitigate interest rate risk, the Company acquired a long term $22 million FHLB Fixed Rate Advance to pay off the FHLB Fixed Rate Principal Reducing long term debt incurred in 2019. As of December 31, 2020, $22.0 million of the advance remains outstanding.
Deposits were $1.7 billion at December 31, 2020, an increase of $426.7 million, a 34.8% as compared to $1.2 billion at December 31, 2019. The growth in the portfolio was primarily due to an increase in the non-interest bearing demand account category. The Company continues to execute on its strategic initiative to improve the deposit portfolio mix by reducing reliance on wholesale time deposits. Accordingly, wholesale time deposits decreased by $59.3 million or 35.5% to $107.7 million at December 31, 2020, from $167.0 million at December 31, 2019.
Stockholders’ equity increased $26.0 million, or 19%, to $159.3 million at December 31, 2020, compared to $133.3 million at December 31, 2019. The increase was primarily attributable to 2020 earnings of $25.8 million and proceeds from exercise of stock options of $0.8 million. Shares repurchased and retired in 2020 as part of the Company’s stock repurchase program totaled 304,114 shares at a weighted average price of $10.81 for a total cost of $3.3 million including commissions. As of December 31, 2020, the Bank’s capital ratios continued to exceed the regulatory requirements for a “well capitalized” institution.
Interest Bearing Deposits at Other Financial Institutions
As of December 31, 2020, interest bearing deposits at the Federal Reserve Bank of Richmond increased by $23.6 million, or 23.1%, to $126.1 million from a balance of $102.4 million at December 31, 2019.
Securities
The Company uses its securities portfolio to provide a source of liquidity, provide an appropriate return on funds invested, manage interest rate risk, meet collateral requirements and meet regulatory capital requirements.
Management classifies investment securities as either held to maturity or available for sale based on our intentions and the Company’s ability to hold such securities until maturity. In determining such classifications, securities that management has the positive intent and the Company has the ability to hold until maturity are classified as held to maturity and carried at amortized cost. All other securities are designated as available for sale and carried at estimated fair value with unrealized gains and losses included in stockholders’ equity on an after-tax basis. For the years presented, all securities were classified as available for sale.
Our investment portfolio totaled $99.8 million at December 31, 2020, a 64.0% increase from $60.8 million at December 31, 2019. To supplement interest income earned on our loan portfolio, the Company invests in high quality mortgage-backed securities, government agency bonds, asset-backed securities and high quality municipal and corporate bonds.
The following tables summarize the contractual maturities and weighted-average yields of investment securities at December 31, 2020 and the amortized cost and carrying value of those securities as of the indicated dates.
INVESTMENT PORTFOLIO
One Year or Less More Than One Year Through Five Years More Than Five Years Through 10 Years More Than 10 Years Total
At December 31, 2020 Book Value Weighted Average Yield Book Value Weighted Average Yield Book Value Weighted Average Yield Book Value Weighted Average Yield Book Value Fair Value Weighted Average Yield
(dollars in thousands)
Securities Available for Sale:
Asset-backed securities $ - - % $ - - % $ - - % $ 10,839 1.10 % $ 10,839 $ 10,881 1.10 %
Municipal - - % - - % - - % 10,836 1.94 % 10,836 10,927 1.94 %
Corporate bonds - - % - - % 5,500 5.13 % 259 3.29 % 5,759 5,767 4.83 %
Mortgage-backed securities
- - % 996 1.66 % 15,026 2.14 % 53,994 1.73 % 70,016 72,212 1.82 %
Total $ - - % $ 996 1.66 % $ 20,526 2.94 % $ 75,928 1.68 % $ 97,450 $ 99,787 1.93 %
December 31,
2020 2019 2018
Book Value Fair Value Book Value Fair Value Book Value Fair Value
(in thousands)
Securities Available for Sale:
U.S. government-sponsored agencies
$ - $ - $ 1,000 $ 999 $ 17,496 $ 17,360
Asset-backed securities 10,839 10,881 - - - -
Municipal
10,836 10,927 515 528 517 501
Corporate bonds 5,759 5,767 2,542 2,565 2,908 2,885
Mortgage-backed securities
70,016 72,212 56,754 56,736 26,836 26,186
Total $ 97,450 $ 99,787 $ 60,811 $ 60,828 $ 47,757 $ 46,932
Portfolio Loans
Our primary source of income is derived from interest earned on loans. Our loan portfolio consists of loans secured by real estate, commercial business loans and credit card loans, substantially all of which are secured by corresponding deposits at the Bank and, to a very limited extent, other consumer loans. Our loan customers primarily consist of small- to medium-sized businesses, professionals, real estate investors, small residential builders and individuals. Our owner-occupied and investment commercial real estate loans, residential construction loans and commercial business loans provide us with higher risk-adjusted returns, shorter maturities and more sensitivity to interest rate fluctuations, and are complemented by our relatively lower risk residential real estate loans to individuals. Our credit card portfolio supplements our traditional lending products with enhanced yields. Outside of credit cards, our lending activities are principally directed to our market area consisting of the Washington, D.C. and Baltimore metropolitan areas.
The following table summarizes our portfolio loans by type of loan as of the dates indicated:
COMPOSITION OF PORTFOLIO LOANS
December 31,
2020 2019 2018 2017 2016
(in thousands) Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
Real estate:
Residential
$ 437,860 33 % $ 427,926 36 % $ 407,844 41 % $ 342,684 39 % 286,332 37 %
Commercial
392,550 30 % 348,091 30 278,691 28 259,853 29 234,869 31
Construction
224,904 17 % 198,702 17 157,586 16 144,932 16 144,932 18
Commercial 157,127 12 % 151,109 13 122,264 12 108,982 12 87,563 11
Credit card 102,186 8 % 45,526 4 34,673 3 31,507 4 20,446 3
Other consumer 1,649 0 % 1,285 - 1,202 - 1,053 - 1,157 -
Total gross loans
1,316,276 100 % 1,172,639 100 % 1,002,260 100 % 889,011 100 % 764,907 100 %
Unearned income (774) (2,404) (1,992) (1,591) (1,477)
Total portfolio loans, net of unearned income 1,315,502 1,170,235 1,000,268 887,420 763,430
Allowance for loan losses
(23,434) (13,301) (11,308) (10,033) (8,597)
Total portfolio loans, net $ 1,292,068 $ 1,156,934 $ 988,960 $ 877,387 $ 754,832,503
Residential Real Estate Loans. We offer one-to-four family mortgage loans primarily on owner-occupied primary residences and, to a lesser extent, investor owned residences. Residential loans are originated through our commercial sales teams and our Capital Bank Home Loan division. Our residential loans also include home equity lines of credit. Our owner-occupied residential real estate loans usually have fixed rates for five to seven years and adjust on an annual basis after the initial term based on a typical maturity of 30 years. Our investor residential real estate loans are generally based on 25-year terms with a balloon payment due after five years. In general, the required minimum debt service coverage ratio is 1.15. Residential real estate loans have represented a stable and growing portion of our loan portfolio. The Company intends to continue to emphasize residential real estate lending.
Commercial Real Estate Loans. The Company originates both owner-occupied and non-owner-occupied commercial real estate loans. These loans may be adversely affected by conditions in the real estate markets or in the general economy. Commercial loans that are secured by owner-occupied commercial real estate and primarily collateralized by operating cash flows are also included in this category of loans. As of December 31, 2020, the Company had approximately $200.3 million of owner-occupied commercial real estate loans, representing approximately 15.2% of our total portfolio. Commercial real estate loan terms are generally extended for 10 years or less and amortize generally over 25 years or less. The interest rates on our commercial real estate loans generally have an initial fixed rate terms that adjust typically at 5 years. Origination fees are routinely charged for our services. The Company generally requires personal guarantees from the principal owners of the business, supported by a review of the principal owners’ personal financial statements and global debt service obligations. The properties securing the portfolio are diverse in terms of type. This diversity helps reduce the exposure to adverse economic events that affect any single industry.
Construction Loans. Our construction loans are offered within our Washington, D.C. and Baltimore, Maryland metropolitan operating areas to builders primarily for the construction of single-family homes, condominium and townhouse conversions or renovations and, to a lesser extent, to individuals. Our construction loans typically have terms of 12 to 18 months with the goal of transitioning the borrowers to permanent financing or re-underwriting and selling into the secondary market through Capital Bank Home Loan. According to our underwriting standards, the ratio of loan principal to collateral value, as established by an independent appraisal, cannot exceed 75% for investor-owned and 80% for owner-occupied properties. We conduct semi-annual stress testing of our construction loan portfolio and closely monitor underlying real estate conditions as well as our borrower’s trends of sales valuations as
compared to underwriting valuations as part of our ongoing risk management efforts. Borrowers’ progress is closely monitored during the course of construction buildout and our original underwriting guidelines for construction milestones and completion timelines are followed.
Commercial Business Loans. In addition to our other loan products, the Company provides general commercial loans, including commercial lines of credit, working capital loans, term loans, equipment financing, letters of credit and other loan products, primarily in our target markets, and underwritten based on each borrower’s ability to service debt from income. These loans are primarily made based on the identified cash flows of the borrower and secondarily, on the underlying collateral provided by the borrower. Most commercial business loans are secured by a lien on general business assets including, among other things, available real estate, accounts receivable, promissory notes, inventory and equipment, and we generally obtain a personal guaranty from the borrower or other principal.
Credit Cards. Through our OpenSky® credit card division, the Company provides credit cards on a nationwide basis to under-banked populations and those looking to rebuild their credit scores through a fully digital and mobile platform. Substantially all of the lines of credit are secured by a noninterest bearing demand account at the Bank in an amount equal to the full credit limit of the credit card. In addition, using our proprietary scoring model, which considers credit score and repayment history (typically a minimum of six months of on-time repayments, but ultimately determined on a case-by-case basis), the Bank offers certain customers an unsecured line in excess of their secured line of credit.
Other Consumer Loans. To a very limited extent and typically as an accommodation to existing customers, we offer personal consumer loans such as term loans, car loans or boat loans.
The repayment of loans is a source of additional liquidity for us. The following table details maturities and sensitivity to interest rate changes for our loan portfolio at December 31, 2020:
PORTFOLIO LOAN MATURITY AND SENSITIVITY TO CHANGES IN INTEREST RATES
As of December 31, 2020
(in thousands) Due in One Year
or Less Due in One to
Five Years Due After
Five Years Total
Real estate:
Residential
$ 100,897 $ 164,118 $ 172,845 $ 437,860
Commercial
55,026 193,777 143,747 392,550
Construction
198,529 26,375 - 224,904
Commercial 72,882 50,254 33,991 157,127
Credit card 102,186 - - 102,186
Other consumer 1,297 192 160 1,649
Total portfolio loans $ 530,817 $ 434,716 $ 350,743 $ 1,316,276
Amounts with fixed rates
$ 169,762 $ 313,101 $ 99,261 $ 582,124
Amounts with floating rates
$ 361,054 $ 121,616 $ 251,482 $ 734,152
Nonperforming Assets
Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on nonaccrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on nonaccrual status regardless of whether or not such loans are considered past due. In general, we place loans on nonaccrual status when they become 90 days past due. We also place loans on nonaccrual status if they are less than 90 days past due if the collection of principal or interest is in doubt. When interest accrual is discontinued, all unpaid accrued
interest is reversed from income. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are, in management’s opinion, reasonably assured. Any loan which the Bank deems to be uncollectible, in whole or in part, is charged off to the extent of the anticipated loss. Consumer credit card balances are moved into the charge off queue after they become more than 90 days past due and are charged off not later than 120 days after they become past due. Loans that are past due for 180 days or more are charged off unless the loan is well secured and in the process of collection.
The Company believes its disciplined lending approach and focused management of nonperforming assets has resulted in sound asset quality and timely resolution of problem assets. There are several procedures in place to assist the Company in maintaining the overall quality of our loan portfolio. The Company has established underwriting guidelines to be followed by our bankers, and monitor our delinquency levels for any negative or adverse trends. There can be no assurance, however, that our loan portfolio will not become subject to increasing pressures from deteriorating borrower credit.
Nonperforming loans were $9.2 million at December 31, 2020 and $4.7 million December 31, 2019. Nonperforming loans were 0.61% and 0.40% of total portfolio loans at the respective year ends. Foreclosed real estate increased to $3.3 million as of December 31, 2020 compared to $2.4 million, for the same period of 2019. The foreclosure of a construction loan with an outstanding balance of $2.1 million was the primary reason for the increase. The property is currently being marketed. As of December 31, 2020, we had $230 thousand of accruing loans past due 90 days. These loans were past due as a result of maturity date, not payment issues.
Total nonperforming assets were $12.6 million at December 31, 2020 compared to $7.1 million at December 31, 2019, or 0.67% and 0.50%, respectively, of corresponding total assets. Of the $12.6 million in total nonperforming assets, nonperforming loans represented $9.2 million and other real estate owned totaled $3.3 million. Nonperforming loans included five restructured loans totaling $440 thousand.
The following table presents information regarding nonperforming assets at the dates indicated:
NONPERFORMING ASSETS
December 31,
(in thousands) 2020 2019 2018 2017 2016
Nonaccrual loans
Real Estate:
Residential
$ 3,581 $ 2,193 $ 2,207 1,828 $ 1,822
Commercial
2,358 1,433 1,486 1,648 1,193
Construction
1,886 - - 499 -
Commercial 1,182 474 749 1,067 750
Accruing loans 90 or more days past due
230 620 237 365 753
Total nonperforming loans
9,237 4,720 4,679 5,407 4,518
Other real estate owned 3,326 2,384 142 93 90
Total nonperforming assets
$ 12,563 $ 7,104 $ 4,821 $ 5,500 $ 4,608
Restructured loans-nonaccrual
$ 440 $ 459 $ 284 $ 592 $ 941
Restructured loans-accruing
$ - $ - $ - 3,219 $ -
Nonperforming loans to total loans 0.61 % 0.40 % 0.47 % 0.61 % 0.59 %
Nonperforming assets to total assets
0.67 % 0.50 % 0.44 % 0.54 % 0.51 %
Potential Problem Loans
From a credit risk standpoint, we grade watchlist and problem loans into one of five categories: pass/watch, special mention, substandard, doubtful or loss. The classifications of loans reflect a judgment about the risks of default and loss associated with the loan. Credits ratings are reviewed regularly. Ratings are adjusted regularly to reflect the degree of risk and loss that our management believes to be appropriate for each credit. Our methodology is structured so that specific reserve allocations are increased in accordance with deterioration in credit quality (and a corresponding increase in risk and loss) or decreased in accordance with improvement in credit quality (and a corresponding decrease in risk and loss). Our lending policy requires the routine monitoring of weekly past due reports, daily overdraft reports, monthly maturing loans, monthly risk rating reports and internal loan review reports. The lending and credit management of the Bank meet several times a week to review loans rated pass/watch. The focus of each meeting is to identify and promptly determine any necessary required action with this loan population, which consists of loans that, although considered satisfactory and performing to terms, may exhibit special risk features that warrant management’s attention.
Loans that are deemed special mention, substandard, doubtful or loss are listed in the Bank’s Problem Loan Status Report. The Problem Loan Status Report provides a detailed summary of the borrower and guarantor status, loan accrual status, collateral evaluation and includes a description of the planned collection and administration program designed to mitigate the Bank’s risk of loss and remove the loan from problem status. The Special Asset Committee reviews the Problem Loan Status Report on a quarterly basis for borrowers with an overall loan exposure in excess of $250,000.
The Bank uses the following definitions for watch list risk ratings:
•Pass/Watch. Borrowers who are considered satisfactory and performing to terms, however exhibiting special risk features such as declining earnings, strained cash flow, increasing leverage, and/or weakening fundamentals that indicate above average risk.
•Special Mention. A special mention loan has potential weaknesses deserving of management’s attention. If uncorrected, such weaknesses may result in deterioration of the repayment prospects for the asset or in our credit position at some future date.
•Substandard. A substandard loan is inadequately protected by the current financial condition and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that we will sustain some loss if deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets that are classified as substandard.
•Doubtful. A doubtful loan has all weaknesses inherent in one classified as substandard, with the added characteristic that weaknesses make collection or liquidation in full, on the basis of existing facts, conditions, and values, highly questionable and improbable. The probability of loss is extremely high, but certain important and reasonably specific factors that may work to the advantage and strengthening of the asset exist. Therefore, its classification as an estimated loss is deferred until a more precise status may be determined by management. Pending factors include proposed merger, acquisition or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans.
•Loss. Credits rated as loss are charged-off. We have no expectation of the recovery of any payments in respect of credits rated as loss.
Loans not meeting the criteria above are considered to be pass-rated loans. The following tables present the portfolio loan balances by category as well as risk rating. No assets were classified as loss during the periods presented.
PORTFOLIO LOAN CLASSIFICATION
(in thousands)
Pass(1)
Special Mention Substandard Doubtful Total
December 31, 2020
Real estate:
Residential
$ 428,260 $ 5,150 $ 4,450 $ - $ 437,860
Commercial
383,311 6,881 2,358 - 392,550
Construction
220,057 1,112 3,735 - 224,904
Commercial 145,365 9,766 1,996 - 157,127
Credit card (2)
102,186 - - - 102,186
Other consumer 1,649 - - - 1,649
Total $ 1,280,828 $ 22,909 $ 12,539 $ - $ 1,316,276
December 31, 2019
Real estate:
Residential
$ 425,661 $ - $ 2,265 $ - $ 427,926
Commercial
340,313 6,345 1,433 - 348,091
Construction
198,702 - - - 198,702
Commercial 145,178 4,505 1,426 - 151,109
Credit card (2)
45,526 - - - 45,526
Other consumer 1,285 - - - 1,285
Total $ 1,156,665 $ 10,850 $ 5,124 $ - $ 1,172,639
_______________
(1)Category includes loans graded exceptional, very good, satisfactory and pass/watch.
(2)Credit cards are evaluated by past due not risk rating.
At December 31, 2020, the recorded investment in impaired loans was $9.2 million, $391 thousand of which required a specific reserve of $253 thousand compared to a recorded investment in impaired loans of $4.1 million including $273 thousand requiring a specific reserve of $119 thousand at December 31, 2019. Of the $9.2 million of impaired loans, $3.7 million was related to one loan relationship.
Impaired loans also include certain loans that have been modified as troubled debt restructurings (“TDRs”). At December 31, 2020, the Company had five loans amounting to $440 thousand that were considered to be TDRs, compared to five loans amounting to $459 thousand at December 31, 2019.
Allowance for Loan Losses
We maintain an allowance for loan losses that represents management’s best estimate of the loan losses and risks inherent in our loan portfolio. The amount of the allowance for loan losses should not be interpreted as an indication that charge-offs in future periods will necessarily occur in those amounts, or at all. In determining the allowance for loan losses, we estimate losses on specific loans, or groups of loans, where the probable loss can be identified and reasonably determined. The balance of the allowance for loan losses is based on internally assigned risk classifications of loans, historical loan loss rates, changes in the nature of our loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, current economic factors and the estimated impact of current economic conditions on certain historical loan loss rates.
The following table presents a summary of changes in the allowance for loan losses for the periods and dates indicated:
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
For the Years Ended December 31,
(in thousands) 2020 2019 2018 2017 2016
Allowance for loan losses at beginning of period
$ 13,301 $ 11,308 $ 10,033 $ 8,597 $ 6,573
Charge-offs:
Real estate:
Residential
- (40) (121) (190) (42)
Commercial
- - (22) (312) (62)
Construction
(296) - - - -
Commercial (233) (331) (147) (25) (1,765)
Credit card (637) (461) (806) (1,124) (640)
Other consumer - - - - -
Total charge-offs
(1,166) (832) (1,096) (1,651) (2,509)
Recoveries:
Real estate:
Residential
- - 3 - 7
Commercial
- 13 152 115 89
Construction
7 - - - -
Commercial - 2 34 3 8
Credit card 50 19 42 314 138
Other consumer - - - - -
Total recoveries
57 34 231 432 242
Net charge-offs (1,109) (798) (865) (1,219) (2,267)
Provision for loan losses 11,242 2,791 2,140 2,655 4,291
Allowance for loan losses at period end (1)
$ 23,434 $ 13,301 $ 11,308 $ 10,033 $ 8,597
Allowance for loan losses to period end portfolio loans (1)
1.78 % 1.14 % 1.13 % 1.13 % 1.13 %
Net charge-offs to average portfolio loans 0.09 % 0.08 % 0.09 % 0.15 % 0.33 %
_______________
(1)Allowance calculation excludes SBA-PPP loans.
Our allowance for loan losses at December 31, 2020 and December 31, 2019 was $23.4 million and $13.3 million, respectively, or 1.78% and 1.14% of portfolio loans for each respective period end. The allowance for loan losses at December 31, 2020 included specific reserves of $253 thousand set aside for impaired loans. Our charge-offs for the year ended December 31, 2020 were $1.2 million and were partially offset by recoveries of $57 thousand. The allowance for loan losses at December 31, 2019 included specific reserves of $119 thousand set aside for impaired loans. Our charge-offs for the year ended December 31, 2019 were $0.8 million and were partially offset by recoveries of $34 thousand. Total charge-offs for the years ended December 31, 2020 and 2019 were primarily due to credit card charge-offs resulting from growth in our credit card portfolio and certain charges in excess of credit limits. Additionally in 2019, there was a charge-off of a commercial and industrial loan in the amount of $233 thousand.
As the loan portfolio and allowance for loan losses review processes continue to evolve, there may be changes to elements of the allowance and this may have an effect on the overall level of the allowance maintained. Historically, the Bank has enjoyed a high quality loan portfolio with relatively low levels of net charge-offs and low delinquency rates. The maintenance of a high quality portfolio will continue to be a high priority for both management and the Board of Directors.
Management, being aware of the significant loan growth experienced by the Company, is intent on maintaining a strong credit review function and risk rating process. The Company has an experienced Credit Administration function, which provides independent analysis of credit requests and the management of problem credits. The Credit Department has developed and implemented analytical procedures for evaluating credit requests, has refined the Company’s risk rating system, and continues to adapt and enhance the monitoring of the loan portfolio. The loan portfolio analysis process is intended to contribute to the identification of weaknesses before they become more severe.
Although we believe we have established our allowance for loan losses in accordance with GAAP and that the allowance for loan losses was adequate to provide for known and inherent losses in the portfolio at all times shown above, future provisions for loan losses will be subject to ongoing evaluations of the risks in our loan portfolio.
The following table sets forth activity in the allowance for loan losses for the past five years for the categories and certain other information as of the dates indicated. The total allowance is available to absorb losses from any loan category.
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
December 31,
2020 2019 2018 2017 2016
(in thousands)
Amount Percent(1)
Amount Percent(1)
Amount Percent(1)
Amount Percent(1)
Amount Percent(1)
Real estate:
Residential
$ 7,153 31 % $ 4,135 31 % $ 3,541 30 % $ 3,137 31 % $ 2,664 30 %
Commercial
6,786 29 3,572 27 3,003 27 2,860 29 2,682 31
Construction
4,595 20 2,668 20 2,093 19 1,646 16 1,591 19
Commercial 2,417 10 1,548 12 1,578 14 1,497 15 1,174 14
Credit card 2,462 10 1,368 10 1,084 10 885 9 477 6
Other consumer 21 - 10 - 9 - 8 - 9 -
Total allowance for loan losses $ 23,434 100 % $ 13,301 100 % $ 11,308 100 % $ 10,033 100 % $ 8,597 100 %
_______________
(1) Loan category as a percentage of total portfolio loans which excludes SBA-PPP loans.
Deposits
Deposits are the major source of funding for the Company. We offer a variety of deposit products including interest bearing demand, savings, money market and time accounts all of which we actively market at competitive pricing. We generate deposits from our customers on a relationship basis and through the efforts of our commercial lending officers and our business banking officers. Year over year, deposits increased 34.8% with the largest increase occurring in non-interest bearing demand accounts. The Company continues to execute on its strategic initiative to improve the deposit portfolio mix by reducing reliance on wholesale time deposits. This is evident in the reduction in our wholesale time deposit portfolio of $59.3 million or 35.5%, to $107.7 million at December 31, 2020, from $167.0 million, or 13.6% at December 31, 2019. Our credit card customers are also a significant source of low cost deposits. As of December 31, 2020, our credit card customers accounted for $192.5 million, or 31.6%, of our total noninterest bearing deposit balances.
We supplement our deposits with wholesale funding sources such as brokered deposits as needed.
At December 31, 2020, interest bearing deposits were $1.0 billion, an increase of $109.9 million, or 11.8%, compared to $933.6 million at December 31, 2019. This increase was primarily due to the Company’s continued effort to improve the deposit mix by reducing reliance on wholesale time deposits.
During the same period, money market balances increased to $447.1 million, an $18.0 million or 4.2% change from the prior year’s balance of $429.1 million. In order to fund the loan growth of the Bank, we built upon our prior success of focusing our strategic efforts to grow core deposits through an expanded deposits sales force, incentives to our commercial loan team and increased marketing efforts. The average rate paid on interest bearing demand deposits decreased 27 basis points to 0.34% at December 31, 2020 from 0.61% for the same period in 2019. Rates paid on certificates of deposit and money market decreased 34 and 69 basis points, respectively, for the period presented. The decrease in the average rates was primarily due to decreases in market interest rates resulting from prolonged low level of the federal funds rate during 2020.
The following table presents the average balances and average rates paid on deposits for the periods indicated:
COMPOSITION OF DEPOSITS
December 31,
2020 2019 2018
(in thousands)
Average
Balance Average
Rate Average
Balance Average
Rate Average
Balance Average
Rate
Interest bearing demand accounts $ 195,794 0.34 % $ 109,977 0.61 % $ 72,523 0.29 %
Money market accounts
480,218 1.00 % 344,272 1.69 % 286,257 1.33 %
Savings accounts
4,722 0.11 % 3,597 0.36 % 3,704 0.32 %
Certificates of deposit
297,997 2.04 % 302,149 2.38 % 326,827 1.77 %
Total interest bearing deposits
978,731 1.18 % 759,995 1.80 % 689,311 1.42 %
Noninterest bearing demand accounts
473,301 260,726 220,445
Total deposits
$ 1,452,032 0.79 % $ 1,020,721 1.34 % $ 909,756 1.08 %
The following table presents the maturities of our certificates of deposit as of December 31, 2020.
MATURITIES OF CERTIFICATES OF DEPOSIT
(in thousands) Three
Months or
Less Over
Three
Through
Six
Months Over Six
Through
Twelve
Months Over
Twelve
Months Total
$100,000 or more $ 51,471 $ 46,704 $ 109,164 $ 91,516 $ 298,855
Less than $100,000 4,842 6,717 18,724 5,428 35,711
Total $ 56,313 $ 53,421 $ 127,888 $ 96,944 $ 334,566
Borrowings
We utilize short-term and long-term borrowings to supplement deposits to fund our lending and investment activities, each of which is discussed below.
FHLB Advances. The FHLB allows us to borrow up to 25% of our assets on a blanket floating lien status collateralized by certain securities and loans. As of December 31, 2020, approximately $222.0 million in real estate loans and $1.2 million in investment securities were pledged as collateral for our FHLB borrowings. We utilize these borrowings to meet liquidity needs and to fund certain fixed rate loans in our portfolio. As of December 31, 2020, we had $22.0 million in outstanding advances and $201.2 million in available borrowing capacity from the FHLB.
The following table sets forth certain information on our FHLB borrowings during the periods presented:
FHLB ADVANCES
Years Ended December 31,
(in thousands) 2020 2019 2018
Amount outstanding at period-end
$ 22,000 $ 32,222 $ 2,000
Weighted average interest rate at period-end 0.93 % 2.40 % 4.26 %
Maximum month-end balance during the period $ 31,111 $ 34,444 $ 17,000
Average balance outstanding during the period $ 25,917 $ 43,472 $ 8,101
Weighted average interest rate during the period 2.15 % 2.47 % 2.83 %
Other borrowed funds. The Company has also issued junior subordinated debentures and other subordinated notes. At December 31, 2020, these other borrowings amounted to $14.0 million.
At December 31, 2020, our junior subordinated debentures amounted to $2.1 million. The junior subordinated debentures were issued in June of 2006, mature on June 15, 2036, and may be redeemed prior to that date under certain circumstances. The principal amount of the debentures has not changed since issuance, and they accrue interest at a floating rate equal to the three-month LIBOR plus 1.87%.
On November 30, 2020, the Company issued $10.0 million in subordinated notes due in 2030 to replace the outstanding higher yielding $13.5 million, reducing interest expense. The notes have a ten year term and have a fixed rated of 5.00% for the first five years; thereafter, the rate resets quarterly to a benchmark rate plus 490 basis points. The notes may be redeemed, in part or whole, upon the occurrence of certain events.
Federal Reserve Bank of Richmond. The Federal Reserve Bank of Richmond has an available borrower in custody arrangement which allows us to borrow on a collateralized basis. The Company’s borrowing capacity under the Federal Reserve’s discount window program was $15.6 million as of December 31, 2020. Certain commercial loans are pledged under this arrangement. We maintain this borrowing arrangement to meet liquidity needs pursuant to our contingency funding plan. No advances were outstanding under this facility as of December 31, 2020.
The Company also has lines of credit of $76.0 million available with other correspondent banks at December 31, 2020, as well as access to certificate of deposit funding through a financial network which the Bank strives to limit to 15% of the Bank’s assets. There were no outstanding balances on the lines of credit from correspondent banks at December 31, 2020.
Liquidity
Liquidity is defined as the Bank’s capacity to meet its cash and collateral obligations at a reasonable cost. Maintaining an adequate level of liquidity depends on the Bank’s ability to meet both expected and unexpected cash flows and collateral needs efficiently without adversely affecting either daily operations or the financial condition of the Bank. Liquidity risk is the risk that we will be unable to meet our obligations as they become due because of an inability to liquidate assets or obtain adequate funding. The Bank’s obligations, and the funding sources used to meet them, depend significantly on our business mix, balance sheet structure and the cash flow profiles of our on- and off-balance sheet obligations. In managing our cash flows, management regularly confronts situations that can give rise to increased liquidity risk. These include funding mismatches, market constraints on the ability to convert assets into cash or in accessing sources of funds (i.e., market liquidity) and contingent liquidity events. Changes in
economic conditions or exposure to credit, market, operating, legal and reputational risks also could affect the Bank’s liquidity risk profile and are considered in the assessment of liquidity and asset/liability management.
Management has established a comprehensive management process for identifying, measuring, monitoring and controlling liquidity risk. Because of its critical importance to the viability of the Bank, liquidity risk management is integrated into our risk management processes. Critical elements of our liquidity risk management include: corporate governance consisting of oversight by the board of directors and active involvement by management; the application of strategies, policies, procedures, and limits used to manage and mitigate liquidity risk; liquidity risk measurement and monitoring systems (including assessments of the current and prospective cash flows or sources and uses of funds) that are commensurate with the complexity and business activities of the Bank; active management of intraday liquidity and collateral; an appropriately diverse mix of existing and potential future funding sources; adequate levels of highly liquid marketable securities free of legal, regulatory or operational impediments, that can be used to meet liquidity needs in stressful situations; comprehensive contingency funding plans that are believed to be adequate to address potential adverse liquidity events and emergency cash flow requirements; and internal controls and internal audit processes that are believed to be appropriate to assure the adequacy of the institution’s liquidity risk management process.
We expect funds to be available from a number of basic banking activity sources, including the core deposit base, the repayment and maturity of loans and investment security cash flows. Other potential funding sources include brokered certificates of deposit, deposit listing services, CDARS, borrowings from the FHLB and other lines of credit.
We had outstanding borrowings of $2.0 million with the Federal Reserve Bank of Richmond at December 31, 2020 as participation with the Paycheck Protection Program Liquidity Facility (“PPPLF”). The PPPLF extended credit to eligible financial institutions that originated SBA-PPP loans, using the loans as collateral. We have an available borrower custody arrangement with the Federal Reserve Bank of Richmond which allows us to borrow on an eligible collateralized basis. As of December 31, 2020, we had $201.2 million of available borrowing capacity from the FHLB, $15.6 million of available borrowing capacity from the Federal Reserve Bank of Richmond and available lines of credit of $76.0 million with other correspondent banks. Cash and cash equivalents were $146.9 million million at December 31, 2020 and $114.8 million at December 31, 2019. Accordingly, our liquidity resources were at sufficient levels to fund loans and meet other cash needs as necessary.
Capital Resources
Stockholders’ equity increased $26.0 million for the year ended December 31, 2020 largely due to net income of $25.8 million for the year. Stock options exercised, shares issued as compensation, shares sold and stock-based compensation increased common stock and additional paid-in capital aggregately by $1.8 million. These increases were offset by the repurchase of 304,114 shares aggregating $3.7 million during 2020, and net unrealized gains on available for sale securities and cash flow hedging derivative of $1.7 million.
The Company uses several indicators of capital strength. The most commonly used measure is average common equity to average assets (computed as average equity divided by average total assets), which was 8.64% at December 31, 2020 and 10.14% at December 31, 2019.
The following table shows the return on average assets (computed as net income divided by average total assets), return on average equity (computed as net income divided by average equity) and average equity to average assets ratios for the years ended December 31, 2020 and 2019.
December 31, 2020 December 31, 2019
Return on Average Assets 1.56 % 1.38 %
Return on Average Equity 18.00 % 13.66 %
Average Equity to Average Assets 8.64 % 10.14 %
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can precipitate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum ratios of common equity Tier 1, Tier 1, and total capital as a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 1250%. The Bank is also required to maintain capital at a minimum level based on quarterly average assets, which is known as the leverage ratio.
In July 2013, federal bank regulatory agencies issued a final rule that revised their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with certain standards that were developed by Basel III and certain provisions of the Dodd-Frank Act. The final rule applies to all depository institutions and bank holding companies and savings and loan holding companies with total consolidated assets of more than $1 billion. The Bank was required to implement the new Basel III capital standards (subject to the phase-in for certain parts of the new rules) as of January 1, 2015. In August of 2018 the Regulatory Relief Act directed the Federal Reserve Board to revise the Small BHC Policy Statement to raise the total consolidated asset limit in the Small BHC Policy Statement from $1 billion to $3 billion. The Company is currently exempt from the consolidated capital requirements.
The ability of the Company to continue to grow is dependent on its earnings and those of the Bank, the ability to obtain additional funds for contribution to the Bank’s capital, through additional borrowings, through the sale of additional common stock or preferred stock, or through the issuance of additional qualifying capital instruments, such as subordinated debt. The capital levels required to be maintained by the Company and Bank may be impacted as a result of the Bank’s concentrations in commercial real estate loans. See “Regulation” at page 18 and “Risk Factors” at page 33.
As of December 31, 2020, the Bank was in compliance with all applicable regulatory capital requirements to which it was subject and was classified as “well capitalized” for purposes of the prompt corrective action regulations. As we deploy our capital and continue to grow our operations, our regulatory capital levels may decrease depending on our level of earnings. However, we intend to monitor and control our growth in order to remain in compliance with all regulatory capital standards applicable to us.
The following table presents the regulatory capital ratios for the Company (as if such requirements applied to the Company) and the Bank as of the dates indicated.
(dollars in thousands) Actual Minimum Capital
Adequacy To Be Well
Capitalized Full Phase In
of Basel III
December 31, 2020 Amount Ratio Amount Ratio Amount Ratio Amount Ratio
The Company
Tier 1 leverage ratio (to average assets) $ 159,656 8.78 % $ 72,770 4.00 % N/A N/A $ 90,962 5.00 %
Tier 1 capital (to risk-weighted assets) 159,656 13.10 % 73,100 6.00 % N/A N/A 97,467 8.00 %
Common equity tier 1 capital ratio (to risk-weighted assets)
157,594 12.94 % 54,825 4.50 % N/A N/A 79,192 6.50 %
Total capital ratio (to risk-weighted assets) 185,008 15.19 % 97,467 8.00 % N/A N/A 121,834 10.00 %
The Bank
Tier 1 leverage ratio (to average assets) $ 135,527 7.44 % $ 72,770 4.00 % $ 90,962 5.00 % $ 90,962 5.00 %
Tier 1 capital (to risk-weighted assets) 135,527 12.06 % 71,731 6.00 % 95,642 8.00 % 95,642 8.00 %
Common equity tier 1 capital ratio (to risk-weighted assets)
135,527 12.06 % 53,798 4.50 % 77,709 6.50 % 77,709 6.50 %
Total capital ratio (to risk-weighted assets) 150,593 13.40 % 95,642 8.00 % 119,552 10.00 % 119,552 10.00 %
December 31, 2019
The Company
Tier 1 leverage ratio (to average assets) $ 135,380 9.96 % $ 54,397 4.00 % N/A N/A $ 67,996 5.00 %
Tier 1 capital (to risk-weighted assets) 135,380 12.31 % 66,011 6.00 % N/A N/A 88,015 8.00 %
Common equity tier 1 capital ratio (to risk-weighted assets)
133,318 12.12 % 49,508 4.50 % N/A N/A 71,512 6.50 %
Total capital ratio (to risk-weighted assets) 149,142 13.56 % 88,015 8.00 % N/A N/A 110,018 10.00 %
The Bank
Tier 1 leverage ratio (to average assets) $ 114,613 8.65 % $ 53,005 4.00 % $ 66,256 5.00 % $ 66,256 5.00 %
Tier 1 capital (to risk-weighted assets) 114,613 10.73 % 64,093 6.00 % 85,458 8.00 % 85,458 8.00 %
Common equity tier 1 capital ratio (to risk-weighted assets)
114,613 10.73 % 48,070 4.50 % 69,435 6.50 % 69,435 6.50 %
Total capital ratio (to risk-weighted assets) 127,976 11.98 % 85,458 8.00 % 106,822 10.00 % 106,822 10.00 %
Contractual Obligations
We have contractual obligations to make future payments on debt and lease agreements. While our liquidity monitoring and management consider both present and future demands for and sources of liquidity, the following table of contractual commitments focuses only on future obligations and summarizes our contractual obligations as of December 31, 2020.
CONTRACTUAL OBLIGATIONS
As of December 31, 2020
(in thousands) Due in One Year or Less Due After One Through Three Years Due After Three Through Five Years Due After 5 Years Total
FRB Borrowings $ - $ 1,954 $ - $ - $ 1,954
FHLB advances - - 22,000 - 22,000
Certificates of deposit $100,000 or more
207,339 90,872 644 - 298,855
Certificates of deposit less than $100,000
30,284 4,952 445 30 35,711
Lease payments 1,408 1,800 420 - 3,628
Subordinated debt - - - 12,062 12,062
Total $ 239,031 $ 99,578 $ 23,509 $ 12,092 $ 374,210
Off-Balance Sheet Items
In the normal course of business, we enter into various transactions that, in accordance with GAAP, are not included in our consolidated balance sheets. We enter into these transactions to meet the financing needs of our customers. These transactions include commitments to extend credit and issue letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in our consolidated balance sheets. Our exposure to credit loss is represented by the contractual amounts of these commitments. The same credit policies and procedures are used in making these commitments as for on-balance sheet instruments. We are not aware of any accounting loss to be incurred by funding these commitments; however, we maintain an allowance for off-balance sheet credit risk which is recorded in other liabilities on the consolidated balance sheet.
Our commitments associated with outstanding letters of credit and commitments to extend credit expiring by period as of the date indicated are summarized below. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements.
CREDIT EXTENSION COMMITMENTS
December 31,
(in thousands) 2020 2019
Unfunded lines of credit $ 331,576 $ 260,573
Commitments to originate residential loans held for sale
11,444 2,646
Letters of credit 5,102 5,305
Total credit extension commitments $ 348,122 $ 268,524
Unfunded lines of credit represent unused credit facilities to our current borrowers. Lines of credit generally have variable interest rates. Letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. In the event of nonperformance by the customer in accordance with the terms of the agreement with the third party, we would be required to fund the commitment. The maximum potential amount of future payments we could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, we would be
entitled to seek recovery from the customer from the underlying collateral, which can include commercial real estate, physical plant and property, inventory, receivables, cash and/or marketable securities. Our policies generally require that letter of credit arrangements contain security and debt covenants similar to those contained in loan agreements. The credit risk associated with issuing letters of credit is substantially the same as the risk involved in extending loan facilities to our customers.
We minimize our exposure to loss under letters of credit and credit commitments by subjecting them to the same credit approval and monitoring procedures as we do for on-balance sheet instruments. The effect on our revenue, expenses, cash flows and liquidity of the unused portions of these lines of credit commitments cannot be precisely predicted because there is no guarantee that the lines of credit will be used.
Commitments to extend credit are agreements to lend funds to a customer, as long as there is no violation of any condition established in the contract, for a specific purpose. Commitments generally have variable interest rates, fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being fully drawn, the total commitment amounts disclosed above do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if considered necessary by us, upon extension of credit is based on management’s credit evaluation of the customer.
We enter into forward commitments for the delivery of mortgage loans in our current pipeline. Interest rate lock commitments are entered into in order to economically hedge the effect of changes in interest rates resulting from our commitments to fund the loans. These commitments to fund mortgage loans, to be sold into the secondary market, (interest rate lock commitments) and forward commitments for the future delivery of mortgage loans to third party investors are considered derivatives.
Impact of Inflation
Our consolidated financial statements and related notes included elsewhere in this report have been prepared in accordance with GAAP. GAAP requires the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative value of money over time due to inflation or recession.
Unlike many industrial companies, substantially all of our assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Interest rates may not necessarily move in the same direction or in the same magnitude as the prices of goods and services. However, other operating expenses do reflect general levels of inflation.

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Many assumptions are used to calculate the impact of interest rate fluctuations on our net interest income, such as asset prepayments, non-maturity deposit price sensitivity and decay rates, and key rate drivers. Because of the inherent use of these estimates and assumptions in the model, our actual results may, and most likely will, differ from our static earnings at risk (“EAR”) results. In addition, static EAR results do not include actions that our management may undertake to manage the risks in response to anticipated changes in interest rates or client behavior. For example, as part of our asset/liability management strategy, management has the ability to increase asset duration and decrease liability duration in order to reduce asset sensitivity, or to decrease asset duration and increase liability duration in order to increase asset sensitivity.
The following table summarizes the results of our EAR analysis in simulating the change in net interest income and fair value of equity over a 12-month horizon as of December 31, 2020:
IMPACT ON NET INTEREST INCOME UNDER A STATIC BALANCE SHEET, PARALLEL INTEREST RATE SHOCK
Earnings at Risk -200 bps -100 bps Flat +100 bps +200 bps +300 bps
December 31, 2020 (2.9) % (1.8) % 0.0 % 2.6 % 6.9 % 11.6 %
Utilizing an economic value of equity (“EVE”) approach, we analyze the risk to capital from the effects of various interest rate scenarios through a long-term discounted cash flow model. This measures the difference between the economic value of our assets and the economic value of our liabilities, which is a proxy for our liquidation value. While this provides some value as a risk measurement tool, management believes EAR is more appropriate to the application of the going concern principle.
The following table illustrates the results of our EVE analysis as of December 31, 2020.
ECONOMIC VALUE OF EQUITY ANALYSIS UNDER A STATIC BALANCE SHEET, PARALLEL INTEREST RATE SHOCK
Economic Value of Equity -200 bps -100 bps Flat +100 bps +200 bps +300 bps
December 31, 2020 (12.8) % (6.0) % 0.0 % 8.8 % 15.5 % 21.4 %
Interest Rate Sensitivity and Market Risk
A fundamental risk in banking is exposure to market risk, since a bank’s net income is largely dependent on net interest income. The Bank’s ALCO formulates and monitors the management of interest rate risk through policies and guidelines established by it and the full Board of Directors and through review of detailed reports discussed quarterly. In its consideration of risk limits, the ALCO considers the impact on earnings and capital, the level and direction of interest rates, liquidity, local economic conditions, outside threats and other factors. Banking is generally a business of managing the maturity and repricing mismatch inherent in its asset and liability cash flows and to provide net interest income growth consistent with the Company’s profit objectives.
Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on most of our assets and liabilities, and the market value of all interest earning assets and interest bearing liabilities, other than those that have a short term to maturity. Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time optimizing income.
We manage our exposure to interest rates by structuring our balance sheet in the ordinary course of business. We do not enter into instruments such as leveraged derivatives, financial options or financial future contracts for the purpose of reducing interest rate risk. We do hedge the interest rate risks of our available for sale mortgage pipeline by using mortgage-backed securities short positions, and of our subordinated debentures by utilizing an interest rate swap. Based on the nature of our operations, we are not subject to foreign exchange or commodity price risk. We do not own any trading assets.
The ALCO committee meets regularly to review, among other things, the sensitivity of assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses, purchase and sale activities, commitments to originate loans and the maturities of investments and borrowings. Additionally, the committee reviews liquidity, cash flow flexibility, maturities of deposits and consumer and commercial deposit activity. Management employs methodologies to manage interest rate risk, which include an analysis of relationships between interest earning assets and interest bearing liabilities and an interest rate shock simulation model.
The following table indicates that, for periods less than one year, rate-sensitive assets exceeded rate-sensitive liabilities, resulting in an asset-sensitive position. For a bank with an asset-sensitive position, or positive gap, rising interest rates would generally be expected to have a positive effect on net interest income, and falling interest rates would generally be expected to have the opposite effect.
INTEREST SENSITIVITY GAP
December 31, 2020 Within One Month After One Month Through Three Months After Three Through Twelve Months Within One Year Greater Than One Year or Non-Sensitive Total
(in thousands)
Assets
Interest earning assets
Loans (1)
$ 515,414 $ 317,129 $ 272,577 $ 1,105,120 $ 520,620 $ 1,625,740
Securities
4,083 - 2,000 6,083 93,704 99,787
Interest bearing deposits at other financial institutions
126,081 - - 126,081 - 126,081
Federal funds sold
2,373 - - 2,373 - 2,373
Total earning assets
$ 647,951 $ 317,129 $ 274,577 $ 1,239,657 $ 614,324 $ 1,853,981
Liabilities
Interest bearing liabilities
Interest bearing deposits
$ 709,002 $ - $ - $ 709,002 $ - $ 709,002
Time deposits
7,577 48,747 181,309 237,633 96,934 334,567
Total interest bearing deposits
716,579 48,747 181,309 946,635 96,934 1,043,569
FHLB Advances
- - - 22,000 22,000
Other borrowed funds
- - - - 14,016 14,016
Total interest bearing liabilities
$ 716,579 $ 48,747 $ 181,309 $ 946,635 $ 132,950 $ 1,079,585
Period gap
$ (68,628) $ 268,382 $ 93,268 $ 293,022 $ 481,374 $ 774,396
Cumulative gap $ (68,628) $ 199,754 $ 293,022 $ 293,022 $ 774,396
Ratio of cumulative gap to total earning assets
(3.70) % 10.77 % 15.81 % 15.81 % 41.77 %
_______________
(1)Includes loans held for sale.
We use quarterly EAR simulations to assess the impact of changing interest rates on our earnings under a variety of scenarios and time horizons. These simulations utilize both instantaneous and parallel changes in the level of interest rates, as well as non-parallel changes such as changing slopes and twists of the yield curve. Static simulation models are based on current exposures and assume a constant balance sheet with no new growth. Dynamic simulation models are also utilized that rely on detailed assumptions regarding changes in existing lines of business, new business, and changes in management and client behavior.
We also use economic value-based methodologies to measure the degree to which the economic values of the Bank’s positions change under different interest rate scenarios. The economic-value approach focuses on a longer-term time horizon and endeavors to capture all future cash flows expected from existing assets and liabilities. The economic value model utilizes a static approach in that the analysis does not incorporate new business; rather, the analysis shows a snapshot in time of the risk inherent in the balance sheet.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors of Capital Bancorp, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Capital Bancorp, Inc. and Subsidiaries (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for the years then ended, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, 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 audit 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/ Elliott Davis, PLLC
We have served as the Company’s auditor since 2017.
Raleigh, North Carolina
March 15, 2021
Capital Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheets
As of December 31, 2020 and 2019
(dollars in thousands) 2020 2019
Assets
Cash and due from banks $ 18,456 $ 10,530
Interest bearing deposits at other financial institutions 126,081 102,447
Federal funds sold 2,373 1,847
Total cash and cash equivalents
146,910 114,824
Investment securities available for sale 99,787 60,828
Restricted investments
3,958 3,966
Loans held for sale 107,154 71,030
U.S. Small Business Administration ("SBA") Payroll Protection Program ("PPP") loans receivable, net of fees 201,018 -
Portfolio loans receivable, net of deferred fees and costs and net of allowance for loan losses of $23,434 and $13,301
1,292,068 1,156,934
Premises and equipment, net
4,464 6,092
Accrued interest receivable 8,134 4,770
Deferred tax asset 6,818 4,263
Foreclosed real estate 3,326 2,384
Other assets 2,956 2,518
Total assets
$ 1,876,593 $ 1,427,609
Liabilities
Deposits
Noninterest-bearing, including related party balances of $17,848 and $16,009
$ 608,559 $ 291,777
Interest-bearing, including related party balances of $130,586 and $125,304
1,043,569 933,644
Total deposits
1,652,128 1,225,421
Federal Home Loan Bank advances 22,000 32,222
Other borrowed funds 14,016 15,423
Accrued interest payable 1,134 1,801
Other liabilities 28,004 19,411
Total liabilities
1,717,282 1,294,278
Stockholders' equity
Common stock, $.01 par value; 49,000,000 shares authorized; 13,753,529 and 13,894,842 issued and outstanding
138 139
Additional paid-in capital 50,602 51,561
Retained earnings 106,854 81,618
Accumulated other comprehensive income 1,717 13
Total stockholders' equity
159,311 133,331
Total liabilities and stockholders' equity
$ 1,876,593 $ 1,427,609
See Notes to Consolidated Financial Statements
Capital Bancorp, Inc. and Subsidiaries
Consolidated Statements of Income
For the Years Ended December 31, 2020 and 2019
(dollars in thousands except per share data) 2020 2019
Interest income
Loans, including fees $ 95,367 $ 80,131
Investment securities available for sale 1,292 924
Federal funds sold and other 592 1,125
Total interest income 97,251 82,180
Interest expense
Deposits, includes interest expense paid to related parties of $1,015 and $1,727
11,524 13,689
Borrowed funds 1,658 2,153
Total interest expense 13,182 15,842
Net interest income 84,069 66,338
Provision for loan losses 11,242 2,791
Net interest income after provision for loan losses
72,827 63,547
Noninterest income
Service charges on deposits 520 542
Credit card fees 16,966 7,602
Mortgage banking revenue 40,649 15,955
Gain on sale of investment securities available for sale 20 26
Other fees and charges 2,906 1,567
Total noninterest income 61,061 25,692
Noninterest expenses
Salaries and employee benefits 44,359 32,586
Occupancy and equipment 5,170 4,360
Professional fees 4,900 2,871
Data processing 26,917 15,512
Advertising 2,530 2,066
Loan processing 3,811 1,894
Other real estate expenses, net 69 122
Other operating expenses 10,995 7,114
Total noninterest expenses 98,751 66,525
Income before income taxes 35,137 22,714
Income tax expense 9,314 5,819
Net income $ 25,823 $ 16,895
Basic earnings per share $ 1.87 $ 1.23
Diluted earnings per share $ 1.87 $ 1.21
Weighted average common shares outstanding:
Basic 13,793,256 13,733,131
Diluted 13,800,176 13,968,585
See Notes to Consolidated Financial Statements
Capital Bancorp, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income
For the Years Ended December 31, 2020 and 2019
(in thousands) 2020 2019
Net income $ 25,823 $ 16,895
Other comprehensive income (loss):
Unrealized gain on investment securities available for sale 2,340 868
Reclassification of realized gain on sales of investment securities available for sale (20) (26)
Unrealized loss on cash flow hedging derivative - (5)
2,320 837
Income tax expense relating to the items above (616) (229)
Other comprehensive income 1,704 608
Comprehensive income $ 27,527 $ 17,503
See Notes to Consolidated Financial Statements
Capital Bancorp, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders’ Equity
For the Years Ended December 31, 2020, 2019 and 2018
Common Stock Additional
Paid-in
Capital Retained
Earnings Accumulated Other Comprehensive Income (Loss) Total
Stockholders'
Equity
(dollars in thousands) Shares Amount
Balance, December 31, 2018 13,672,479 137 49,321 65,701 (595) 114,564
Adoption of lease standard (54) (54)
Net income - - - 16,895 - 16,895
Unrealized gain on investment securities available for sale, net of income taxes - - - - 612 612
Unrealized loss on cash flow hedging derivative, net of income taxes
- - - - (4) (4)
Stock options exercised, including tax benefit
221,710 2 1,515 (924) - 593
Shares issued as compensation
29,133 - 301 - - 301
Stock-based compensation
- - 795 - - 795
Shares repurchased and retired (28,480) - (371) - - (371)
Balance, December 31, 2019 13,894,842 139 51,561 81,618 13 133,331
Net income - - - 25,823 - 25,823
Unrealized gain on investment securities available for sale, net of income taxes
- - - - 1,704 1,704
Stock options exercised, including tax benefit
142,901 2 1,083 (163) - 922
Shares issued as compensation
19,900 - 268 - - 268
Stock-based compensation
- - 983 - - 983
Shares repurchased and retired (304,114) (3) (3,293) (424) - (3,720)
Balance, December 31, 2020 13,753,529 $ 138 $ 50,602 $ 106,854 $ 1,717 $ 159,311
See Notes to Consolidated Financial Statements
Capital Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2020 and 2019
(dollars in thousands) 2020 2019
Cash flows from operating activities
Net income $ 25,823 $ 16,895
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 11,242 2,791
Provision for mortgage put-back reserve 598 184
Provision for off balance sheet credit risk 550 173
Net amortization on investments 297 160
Premises and equipment depreciation 844 1,113
Lease asset amortization 1,050 1,238
Stock-based compensation expense 983 795
Director and employee compensation paid in Company stock 268 301
Deferred income tax benefit (3,170) (839)
Amortization of debt issuance cost 139 30
Gain on sale of securities available for sale (20) (26)
Mortgage banking revenue (40,649) (15,955)
Proceeds from sales of loans held for sale 1,313,437 556,640
Originations of loans held for sale (1,308,912) (593,189)
Changes in assets and liabilities:
Accrued interest receivable (3,364) (308)
Prepaid income taxes and taxes payable - 81
Other assets (438) (418)
Accrued interest payable (667) 236
Other liabilities 7,446 2,886
Net cash provided by operating activities 5,457 (27,212)
Cash flows from investing activities
Purchases of securities available for sale (53,926) (38,587)
Proceeds from maturities, calls and principal paydowns of securities available for sale 16,045 22,119
Proceeds from sale of securities available for sale 965 3,280
Sales (purchases) of restricted investments 8 (1,463)
Net increase in SBA-PPP loans receivable (201,018) -
Net increase in loans receivable (147,319) (173,076)
Net purchases of premises and equipment (267) (303)
Proceeds from sales of foreclosed real estate - 49
Net cash used in investing activities (385,512) (187,981)
See Notes to Consolidated Financial Statements
Capital Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2020 and 2019
(dollars in thousands) 2020 2019
Cash flows from financing activities
Net increase (decrease) in:
Noninterest bearing deposits
316,782 49,518
Interest bearing deposits
109,925 220,662
Securities sold under agreements to repurchase - (3,332)
Federal funds purchased - (2,000)
Federal Home Loan Bank advances, net (10,222) 30,222
Other borrowed funds (1,546) -
Repurchase of common stock (3,720) (371)
Proceeds from exercise of stock options 922 595
Net cash provided by financing activities 412,141 295,294
Net increase in cash and cash equivalents 32,086 80,101
Cash and cash equivalents, beginning of year 114,824 34,723
Cash and cash equivalents, end of year $ 146,910 $ 114,824
Noncash investing and financing activities:
Loans transferred to foreclosed real estate $ 942 $ 2,291
Change in unrealized gains on investments $ 2,320 $ 842
Change in fair value of loans held for sale $ 5,669 1,420
Change in fair value of cash flow hedging derivative $ - (5)
Establishment of right of use asset $ - $ 5,158
Establishment of lease liability $ - $ 5,358
Cash paid during the period for:
Taxes $ 11,998 $ 5,451
Interest $ 13,849 $ 15,606
See Notes to Consolidated Financial Statements
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 1 - Nature of Business and Basis of Presentation
Nature of Business
Capital Bancorp, Inc. is a Maryland corporation and bank holding company (the “Company”) for Capital Bank, N.A. (the “Bank”). The Company's primary operations are conducted by the Bank, which operates branches in Rockville, Columbia and North Bethesda, Maryland, Reston, Virginia, and the District of Columbia. The Bank is principally engaged in the business of investing in commercial, real estate, and credit card loans and attracting deposits. The Company originates residential mortgages for sale in the secondary market through Capital Bank Home Loans, our residential mortgage banking arm, and issues credit cards through OpenSky®, a secured, digitally-driven, nationwide credit card platform.
The Company formed Church Street Capital, LLC (“Church Street Capital”) in 2014 to provide short-term secured real estate financing to Washington, D.C. area investors and developers that may not meet all Bank credit criteria.
In addition, the Company owns all of the stock of Capital Bancorp (MD) Statutory Trust I (the “Trust”). The Trust is a special purpose non-consolidated entity organized for the sole purpose of issuing trust preferred securities.
Basis of Presentation
The accompanying consolidated financial statements include the activity of the Company and its wholly-owned subsidiaries, the Bank and Church Street Capital. All intercompany transactions have been eliminated in consolidation. The Company reports its activities as a four business segments: commercial banking; mortgage lending; credit cards; and corporate activities. In determining the appropriateness of segment definition, the Company considers components of the business about which financial information is available and regularly evaluated relative to resource allocation and performance assessment. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), and conform to general practices within the banking industry.
Significant Accounting Policies:
The preparation of consolidated financial statements in accordance with GAAP requires estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. The basis of the estimates is on historical experience and on various other assumptions that are believed to be reasonable under current circumstances, results of which form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily available from other sources. Estimates are evaluated on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.
Cash and cash equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest bearing deposits with banks and federal funds sold. Generally, federal funds are sold for one-day periods.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 1 - Nature of Business and Basis of Presentation (continued)
Investment securities
Investment securities are classified as available for sale and carried at fair value with unrealized gains and losses included in stockholders’ equity on an after-tax basis. Premiums and discounts on investment securities are amortized or accreted using the interest method. Changes in the fair value of debt securities available for sale are included in stockholder’s equity as unrealized gains and losses, net of the related tax effect. Unrealized losses are periodically reviewed to determine whether the loss represents an other than temporary impairment. Any unrealized losses judged to be other than a temporary impairment will be charged to income.
Loans held for sale
Mortgage loans originated and intended for sale are recorded at fair value, determined individually, as of the balance sheet date. Fair value is determined based on outstanding investor commitments, or in the absence of such commitments, based on current investor yield requirements. Gains and losses on loan sales are determined by the specific-identification method. The Company’s current practice is to sell residential mortgage loans on a servicing released basis, and, therefore, it has no intangible asset recorded for the value of such servicing. Interest on loans held for sale is credited to income based on the principal amounts outstanding.
Upon sale and delivery, loans are legally isolated from the Company and the Company has no ability to restrict or constrain the ability of third-party investors to pledge or exchange the mortgage loans. The Company does not have the entitlement or ability to repurchase the mortgage loans or unilaterally cause third-party investors to put the mortgage loans back to the Company. Unrealized and realized gains on loan sales are determined using the specific-identification method and are recognized through mortgage banking activity in the Consolidated Statements of Income.
The Company elected to measure loans held for sale at fair value to better align reported results with the underlying economic changes in value of the loans on the Company’s balance sheet.
Portfolio loans and the allowance for loan losses
Loans are stated at the principal amount outstanding, adjusted for deferred origination fees, deferred origination costs, discounts on loans acquired, and the allowance for loan losses. Interest is accrued based on the loan principal balances and stated interest rates. Origination fees and costs are recognized as an adjustment to the related loan yield using approximate interest methods.
The Company has provided short-term deferrals of loan principal and/or interest payments for customers who have been affected by the COVID-19 pandemic. Customers receiving payment deferrals must meet certain criteria, such as being in good standing and not more than 30 days past due prior to the pandemic. In most cases, the deferred principal and/or interest amounts will be collected at the end of the life of the loan and will not accrue additional interest. The granting of a deferral of principal and/or interest under the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, which was enacted on March 27, 2020, and based on interagency guidelines, does not subject the loan to the past due, non-accrual, or troubled debt restructurings (“TDR”) policies described below. Upon exiting the loan modification deferral program, the measurement of loan delinquency will resume based in the number of days of delinquency as at the date of modification. The following discussions of past due, non-accrual and TDR policies remain valid for situations not covered by the CARES Act.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 1 - Nature of Business and Basis of Presentation (continued)
Outstanding portfolio loans deferred due to COVID-19, which decreased by 78.9 percent from $144.0 million at June 30, 2020 to $30.5 million at December 31, 2020, are shown in the table below:
Loan Modifications (1)
(dollars in millions)
December 31, 2020 June 30, 2020
Deferred Loans Deferred Loans
Sector Total Loans Outstanding Balance # of Loans Deferred Balance # of Loans Deferred
Accommodation & Food Services $ 89.1 $ 14.7 16 $ 42.6 36
Real Estate and Rental Leasing 508.7 5.5 10 45.6 67
Other Services Including Private Households 174.2 1.1 3 17.3 36
Educational Services 20.9 - - 9.8 6
Construction 260.1 - - 4.2 6
Professional, Scientific, and Technical Services 86.3 1.4 3 5.0 11
Arts, Entertainment & Recreation 39.0 0.7 2 5.0 9
Retail Trade 24.6 0.3 1 3.0 8
Healthcare & Social Assistance 88.5 0.9 1 4.7 11
Wholesale Trade 13.6 - - 0.9 1
All other (1)
216.1 5.9 7 5.9 13
Total $ 1,521.1 $ 30.5 43 $ 144.0 204
_______________
(1) Excludes the minor modifications and deferrals made for OpenSky® secured card customers.
The Company generally discontinues the accrual of interest when any portion of the principal and interest is 90 days past due and collateral is insufficient to discharge the debt in full. Generally, interest payments on nonaccrual loans are recorded as a reduction of the principal balance.
Loans are considered impaired when, based on current information, management believes the Company will not collect all principal and interest payments according to contractual terms. Generally, loans are reviewed for impairment when the risk grade for a loan is downgraded to a classified asset category. The loans are evaluated for appropriate classification, accrual, impairment, and troubled debt restructure status. If collection of principal is evaluated as doubtful, all payments are applied to principal. A modification of a loan is considered a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Company may consider interest rate reductions, changes to payment terms, extensions of maturities and/or principal reductions.
Loans are generally charged-off in part or in full when management determines the loan to be uncollectible. Factors for charge-off that may be considered include: repayments deemed to be projected beyond reasonable time frames, client bankruptcy and lack of assets, and/or collateral deficiencies.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 1 - Nature of Business and Basis of Presentation (continued)
The allowance for loan losses is estimated to adequately provide for probable future losses on existing loans. The allowance consists of specific and general components. For loans that are classified as impaired, an allowance is established when the collateral value, if the loan is collateral dependent, or the discounted cash flows of the impaired loan, is lower than the carrying value of that loan. The general component covers pools of nonclassified loans and is based on historical loss experience adjusted for qualitative factors. There may be an unallocated component of the allowance, which reflects the margin of the imprecision inherent in the underlying assumptions used in the method for estimating specific and general losses in the portfolio. Actual loan performance may differ from those estimates. A loss is recognized as a charge to the allowance when management believes that collection of the loan is unlikely. Collections of loans previously charged off are added to the allowance at the time of recovery.
The components of the allowance for loan losses represent an estimation done pursuant to ASC Topic 450, “Contingencies,” or ASC Topic 310,“Receivables.” Specific allowances are established in cases where management has identified significant conditions or circumstances related to a specific credit that management believes indicate the probability that a loss may be incurred. The process for determining an appropriate allowance for loan losses is based on a comprehensive, well-documented, and consistently applied analysis of the loan portfolio. The analysis considers significant factors that affect the collectibility of the portfolio and supports the loan losses estimated by this process. It is important to recognize that the related process, methodology, and underlying assumptions require a substantial degree of judgment.
Management believes that the allowance for loan losses is adequate; however, determination of the allowance is inherently subjective and requires significant estimates. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. Evaluation of the potential effects of these factors on estimated losses involves a high degree of uncertainty, including the strength and timing of economic cycles and concerns over the effects of a prolonged economic downturn in the current cycle. In addition, various banking agencies,as an integral part of their examination process, and independent consultants engaged by the Bank, periodically review the Bank’s loan portfolio and allowance for loan losses. Such review may result in recognition of additions to the allowance based on their evaluation of information available to them at the time of their examination. The review of the adequacy of the allowance for loan losses includes an assessment of the fair value adjustment for acquired loans in accordance with generally accepted accounting principles.
Premises and equipment
Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the related property generally over two to seven years. Leasehold improvements are amortized over the estimated term of the respective leases, which may include renewal options where management has the positive intent to exercise such options, or the estimated useful lives of the improvements, whichever is less. Expenditures for maintenance, repairs, and minor replacements are charged to noninterest expenses as incurred. The costs of major renewals and improvements are capitalized, these costs would be included as a component of premises and equipment expenses.
Leases
During the first quarter of 2019, the Company adopted Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 applies a right-of-use (“ROU”) model that requires a lessee to record, for all leases with a lease term of more than 12 months, an asset representing its right to use the underlying asset and a liability to make lease payments. The Company elected to apply the practical expedients permitting entities to not reassess: 1) whether any expired or existing contracts are or contain leases; 2) the lease classification for any expired or existing leases; and
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 1 - Nature of Business and Basis of Presentation (continued)
3) initial direct costs for any existing leases. Additionally, as provided by ASU 2016-02, the Company elected not to apply the recognition requirements of ASC 842 to short-term leases, defined as leases with a term of 12 months or less, and to recognize the lease payments in net income on short-term leases on a straight-line basis over the lease term.
The Company has adopted the guidance using the modified retrospective approach on January 1, 2019 and elected the practical expedients for transition including the transition option provided in ASU 2018-11, Leases (Topic 842) Targeted Improvements, which allowed the Company to initially apply the new leases standard at the adoption date. Consequently, the reporting for the comparative periods presented continued to be in accordance with ASC Topic 840, Leases. Therefore, the 2018 financial results and disclosures have not been adjusted.
The Company accounts for our existing operating leases consistent with prior guidance except for the incremental balance sheet recognition for leases. The adoption of this standard resulted in the Company recognizing lease right-of-use assets and related lease liabilities totaling $5.2 million and $5.4 million, respectively, as of January 1, 2019. The difference between the lease assets and the lease liabilities was $146 thousand of deferred rent, which was reclassified to lease liabilities, and the remainder was recorded as an adjustment to retained earnings in the amount of $54 thousand. The adoption of this ASU did not have a significant impact on the Company’s consolidated statement of income. Additional information is included in Note 7 - Leases.
Derivative Financial Instruments
The Company enters into commitments to fund residential mortgage loans (interest rate locks) with the intention of selling them in the secondary market. The Company also enters into forward sales agreements for certain funded loans and loan commitments. Unfunded commitments intended for loans held for sale and forward sales agreements are recorded at fair value with changes in fair value recorded as a component of mortgage banking revenue. Loans originated and intended for sale in the secondary market are carried at fair value. For pipeline loans which are not pre-sold to an investor, the Company manages the interest rate risk on rate lock commitments by entering into forward sale contracts, whereby the Company obtains the right to deliver securities to investors in the future at a specified price, Such contracts are accounted for as derivatives and are recorded at fair value as derivative assets or liabilities, with changes in fair value recorded in mortgage banking revenue.
The Company accounts for derivative instruments and hedging activities according to guidelines established in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 815-10, Accounting for Derivative Instruments and Hedging Activities, as amended. The Company recognizes all derivatives as either assets or liabilities on the balance sheet and measures those instruments at fair value. Changes in fair value of derivatives designated and accounted for as cash flow hedges, to the extent they are effective as hedges, are recorded in other comprehensive income, net of deferred taxes. Any hedge ineffectiveness would be recognized in the income statement line item pertaining to the hedged item.
Fair Value Measurements
Fair value is the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market inputs. For financial instruments that are traded actively and have quoted market prices or observable market inputs, there is minimal subjectivity involved in measuring fair value. However, when quoted market prices or observable market inputs are not fully available, significant
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 1 - Nature of Business and Basis of Presentation (continued)
management judgment may be necessary to estimate fair value. In developing our fair value estimates, we strive to maximize the use of observable inputs and minimize the use of unobservable inputs.
The fair value hierarchy defines Level 1 valuations as those based on quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 valuations include inputs based on quoted prices for similar assets or liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 3 valuations are based on at least one significant assumption not observable in the market, or significant management judgment or estimation, some of which may be internally developed.
Financial assets that are recorded at fair value on a recurring basis include investment securities available for sale, loans held for sale, and derivative financial instruments. Financial liabilities that are recorded at fair value on a recurring basis are comprised of derivative financial instruments. See the Fair Value note to our consolidated financial statements.
Income Taxes
The Company employs the asset and liability method of accounting for income taxes as required by ASC Topic 740, “Income Taxes.” Under this method, deferred tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities (i.e. temporary timing differences) and are measured at the enacted rates that will be in effect when these differences reverse. The Company utilizes statutory requirements for its income tax accounting, and limits risks associated with potentially problematic tax positions that may incur challenge upon audit, where an adverse outcome is more likely than not. Therefore, no provisions are necessary for either uncertain tax positions nor accompanying potential tax penalties and interest for underpayments of income taxes in the Company’s tax reserves. In accordance with ASC Topic 740, the Company may establish a valuation allowance against deferred tax assets in those cases where realization is less than certain.
Earnings per share
Earnings per share is computed by dividing net income available to common stockholders by the weighted average number of shares outstanding. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares outstanding, adjusted for the dilutive effect of stock options and restricted stock using the treasury stock method. At December 31, 2020 and 2019, there were 504,861 and 7,628 stock options, respectively, that were not included in the calculation as their effect would have been anti-dilutive.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 1 - Nature of Business and Basis of Presentation (continued)
The following is a reconciliation of the numerators and denominators used in computing basic and diluted earnings per common share:
Earnings Per Share For the Years Ended December 31,
2020 2019
(dollars in thousands, except per share information) Income Weighted Average Shares Per Share
Amount Income Weighted Average Shares Per Share
Amount
Basic EPS
Net income available to common stockholders $ 25,823 13,793,256 $ 1.87 $ 16,895 13,733,131 $ 1.23
Effect of dilutive securities - 6,920 - 235,454
Dilutive EPS per common share $ 25,823 13,800,176 $ 1.87 $ 16,895 13,968,585 $ 1.21
Comprehensive income
The Company reports as comprehensive income all changes in stockholders' equity during the year from sources other than stockholders. Other comprehensive income refers to all components (income, expenses, gains, and losses) of comprehensive income that are excluded from net income.
The Company's only two components of other comprehensive income are unrealized gains and losses on investment securities available for sale, net of income taxes, and unrealized gains and losses on cash flow hedges, net of income taxes. Information concerning the Company's accumulated other comprehensive income as of December 31, 2020, and 2019 are as follows:
Comprehensive Income For the Years Ended December 31,
(in thousands) 2020 2019
Unrealized gains on securities available for sale $ 2,337 $ 18
Deferred tax expense (620) (5)
Total accumulated comprehensive income $ 1,717 $ 13
Recently issued accounting pronouncements:
In June 2016, the FASB issued guidance to change the accounting for loan losses and modify the impairment model for certain debt securities. In October 2019, the FASB voted to delay implementation and the new standard is now effective for fiscal years beginning after December 15, 2022, including the interim periods within those fiscal years. The Company expects the provisions of this standard to impact the Company’s consolidated financial statements, in particular, the level of the reserve for loan losses. The Company is continuing to evaluate the extent of the potential impact and expects that portfolio composition and economic conditions at the time of adoption will be a factor.
The Company will apply the amendments to the ASU through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. While early adoption was permitted, the Company did not elect that option. In addition to our allowance for loan losses, the Company will also record an allowance for credit losses on held-to-maturity debt securities instead of applying the impairment model currently utilized. The amount of the adjustments will be impacted by each portfolio’s composition and credit quality at the adoption date as well as economic conditions and forecasts at that time.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 1 - Nature of Business and Basis of Presentation (continued)
In April 2019, the FASB issued codification improvements to ASU Topic 326 - Financial Instruments - Credit Loss, Topic 815 - Derivatives and Hedging, and Subtopic 825-10 - Financial Instruments. This codification provides technical corrections and clarifies issues related to fair value hedges. The Company early adopted this guidance upon issuance, and it did not have a material impact on the Company’s Consolidated Financial Statements.
In November 2019, the FASB issued guidance to defer the effective dates for private companies, not-for-profit organizations, and certain smaller reporting companies applying standards on current expected loan losses (CECL). The new effective dates will be fiscal years beginning after December 15, 2022 including interim periods within those fiscal years. In addition, the FASB issued guidance that addresses issues raised by stakeholders during the implementation of ASU 2016-13, Financial Instruments-loan losses (Topic 326): Measurement of loan losses on Financial Instruments. The amendments affect a variety of Topics in the Accounting Standards Codification. For entities that have not yet adopted the amendments in ASU 2016-13, the amendments are effective for fiscal years beginning after December 15, 2022 including interim periods within those fiscal years. Early adoption is permitted in any interim period as long as an entity has adopted the amendments in ASU 2016-13. The Company does not expect these amendments to have a material effect on its financial statements.
In December 2019, the FASB issued guidance to simplify accounting for income taxes by removing specific technical exceptions that often produce information investors have a hard time understanding. The amendments also improve consistent application of and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance. The amendments are effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.
In March 2020, the FASB released ASU 2020-04 - Reference Rate Reform, Topic 848, which provides guidance to provide temporary guidance to ease the potential accounting burden in accounting for, or recognizing the effects from, reference rate reform on financial reporting. The new standard is a result of London Interbank Offered Rate (“LIBOR”) likely being discontinued as an available benchmark rate. The standard is elective and provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, or other transactions that reference LIBOR, or another reference rate expected to be discontinued. The amendments in the update are effective for all entities between March 12,2020 and December 31, 2022. The Company is currently evaluating products and preparing to offer new rates. The adoption of this guidance is not expected to have a material impact on the Company’s financial statements.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company's financial position, results of operations or cash flows.
Reclassifications:
Certain reclassifications have been made to the amounts reported in prior periods to conform to the current period presentation. The reclassifications had no effect on net income or total stockholders' equity.
Note 2 - Cash and Cash Equivalents
Cash and cash equivalents include cash and due from banks, interest bearing deposits and federal funds sold. The Bank is required by regulations to maintain an average cash reserve balance based on a percentage of deposits. At December 31, 2020 and 2019, the requirements were satisfied by amounts on deposit with the Federal Reserve Bank and cash on hand.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2019 and 2018
Note 3 - Investment Securities
The investment securities portfolio consists primarily of U.S. government sponsored entity securities, asset-backed securities, securities issued by states, counties and municipalities, corporate bonds and mortgage backed securities (“MBS”). The asset-backed securities are comprised of student loan collateral issued by the Federal Family Education Loan Program (“FFELP”) which includes a minimum of a 97% government repayment guarantee, as well as additional support in excess of the government guaranteed portion.
Note 3 - Investment Securities (continued)
The amortized cost and estimated fair value of investment securities at December 31, 2020 and 2019 are summarized as follows:
Investment Securities Available for Sale
Amortized
Cost Unrealized
Gains Unrealized
Losses Fair
Value
(in thousands)
December 31, 2020
Asset-backed securities $ 10,839 $ 42 $ - $ 10,881
Municipal 10,836 108 (17) 10,927
Corporate 5,759 30 (22) 5,767
Mortgage-backed securities 70,016 2,208 (12) 72,212
$ 97,450 $ 2,388 $ (51) $ 99,787
December 31, 2019
U.S. government-sponsored agencies $ 1,000 $ - $ (1) $ 999
Municipal 515 13 - 528
Corporate 2,542 46 (23) 2,565
Mortgage-backed securities 56,754 117 (135) 56,736
$ 60,811 $ 176 $ (159) $ 60,828
Proceeds from sales of the security sold during the year ended December 31, 2020 and 2019 were $1.0 million and $3.3 million respectively, and resulted in aggregate realized gains of $20 thousand for December 31, 2020 and aggregate realized gains of $26 thousand for the same period in 2019.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Information related to unrealized losses in the investment portfolio as of December 31, 2020 and 2019 are as follows:
Investment Securities Unrealized Losses
Less than 12 months 12 months or longer Total
Fair
Value Unrealized
Losses Fair
Value Unrealized
Losses Fair
Value Unrealized
Losses
(in thousands)
December 31, 2020
Asset-backed securities $ - $ - $ - $ - $ - $ -
Municipal 3,151 (17) - - 3,151 (17)
Corporate 1,994 (6) 244 (16) 2,238 (22)
Mortgage-backed securities
2,410 (12) - - 2,410 (12)
$ 7,555 $ (35) $ 244 $ (16) $ 7,799 $ (51)
December 31, 2019
U.S. government-sponsored agencies $ - $ - $ 999 $ (1) $ 999 $ (1)
Municipal - - - - - -
Corporate - - 519 (23) 519 (23)
Mortgage-backed securities
21,487 (78) 5,246 (57) 26,733 (135)
$ 21,487 $ (78) $ 6,764 $ (81) $ 28,251 $ (159)
At December 31, 2020, there was one corporate security that has been in a loss position for greater than twelve months. Management believes that all unrealized losses have resulted from temporary changes in interest rates and current market conditions and not as a result of credit deterioration. Management has the ability and the intent to hold these investment securities until maturity or until they recover in value.
Note 3 - Investment Securities (continued)
A summary of pledged securities at December 31, 2020 and 2019 is shown below:
Pledged Securities
For the Years Ended December 31,
2020 2019
(in thousands) Amortized
Cost Fair
Value Amortized
Cost Fair
Value
Federal Home Loan Bank advances 1,142 1,189 1,508 1,522
$ 1,142 $ 1,189 $ 1,508 $ 1,522
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Contractual maturities of U.S. government-sponsored agencies, asset-backed, municipal, corporate and mortgage-backed securities at December 31, 2020 and 2019 are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Investment Securities - Contractual Maturities
For the Years Ended December 31,
2020 2019
(in thousands) Amortized
Cost Fair
Value Amortized
Cost Fair
Value
Within one year $ - $ - $ 1,542 $ 1,518
Over one to five years - - - -
Over five to ten years 5,500 5,524 2,000 2,046
Over ten years 21,934 22,051 515 528
Mortgage-backed securities(1)
70,016 72,212 56,754 56,736
$ 97,450 $ 99,787 $ 60,811 $ 60,828
_____
(1) Mortgage-backed securities are due in monthly installments.
Note 4 - SBA-PPP Loans
Pursuant to the CARES Act, the SBA-PPP provides forgivable loans to small businesses to enable them to maintain payroll, hire back employees who have been laid off, and cover applicable overhead. SBA-PPP loans have an interest rate of 1%, have 2 and 5 year terms, and carry a 100% guarantee of the SBA.
The allowance for loan losses for SBA-PPP loans was separately evaluated given the explicit government guarantee. This analysis, which incorporated historical experience with similar SBA guarantees and underwriting, concluded the likelihood of loss was remote and therefore no allowance for loan losses was assigned to these loans.
At December 31, 2020, SBA-PPP loans receivable, which totaled $204.9 million, are all rated as pass credits, not past due, nonaccrual, TDR, or otherwise impaired. Earned fees for the year are $2.8 million and unearned net fees associated with the SBA-PPP loans amounted to $3.9 million at December 31, 2020. There were no outstanding commitments to extend additional SBA-PPP loans at December 31, 2020.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 5 - Portfolio Loans Receivable
Major categories of portfolio loans are as follows:
Portfolio Loan Categories
December 31,
(in thousands) 2020 2019
Real estate:
Residential $ 437,860 $ 427,926
Commercial 392,550 348,091
Construction 224,904 198,702
Commercial 157,127 151,109
Credit card 102,186 45,526
Other consumer 1,649 1,285
1,316,276 1,172,639
Deferred origination fees, net (774) (2,404)
Allowance for loan losses (23,434) (13,301)
Portfolio loans receivable, net $ 1,292,068 $ 1,156,934
The Company makes loans to customers located primarily in the Washington, D.C. metropolitan area. Although the loan portfolio is diversified, its performance will be influenced by the regional economy. The Company’s portfolio loan categories are described below.
Residential Real Estate Loans. One-to-four family mortgage loans are primarily on owner-occupied primary residences and, to a lesser extent, investor owned residences. Residential loans are originated through the commercial sales teams and Capital Bank Home Loan division. Residential loans also include home equity lines of credit. Owner-occupied residential real estate loans usually have fixed rates for five or seven years and adjust on an annual basis after the initial term based on a typical maturity of 30 years. Investor residential real estate loans are generally based on 25-year terms with a balloon payment due after five years. Generally, the required minimum debt service coverage ratio is 1.15. Residential real estate loans have represented a stable and growing portion of the loan portfolio.
Commercial Real Estate Loans. Commercial real estate loans are originated on owner-occupied and non-owner-occupied properties. These loans may be more adversely affected by conditions in the real estate markets or in the general economy. Commercial loans that are secured by owner-occupied commercial real estate and primarily collateralized by operating cash flows are also included in this category of loans. As of December 31, 2020, there were approximately $200.3 million of owner-occupied commercial real estate loans, representing approximately 15.2% of the total loan portfolio. Commercial real estate loan terms are generally extended for 10 years or less and amortize generally over 25 years or less. The interest rates on commercial real estate loans have initial fixed rate terms that adjust typically at 5 years and origination fees are routinely charged for services. Personal guarantees from the principal owners of the business are generally required, supported by a review of the principal owners’ personal financial statements and global debt service obligations. The properties securing the portfolio are generally diverse in terms and type. This diversity helps reduce the exposure to adverse economic events that affect any single industry.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 5 - Portfolio Loans Receivable (continued)
Construction Loans. Construction loans are offered within the Company’s Washington, D.C. and Baltimore, Maryland metropolitan operating areas to builders primarily for the construction of single-family homes and condominium and townhouse conversions or renovations and, to a lesser extent, to individuals. Construction loans typically have terms of 12 to 18 months, the Company generally transitions the end purchaser to permanent financing or re-underwriting and selling into the secondary market through Capital Bank Home Loan. According to underwriting standards, the ratio of loan principal to collateral value, as established by an independent appraisal, cannot exceed 75% for investor-owned and 80% for owner-occupied properties. Semi-annual stress testing of the construction loan portfolio is conducted, and underlying real estate conditions are closely monitored as well as the borrower’s trends of sales valuations as compared to underwriting valuations as part of the ongoing risk management efforts. The borrowers’ progress in construction buildout is closely monitored and the original underwriting guidelines for construction milestones and completion timelines are enforced.
Commercial Business Loans. In addition to other loan products, general commercial loans, including commercial lines of credit, working capital loans, term loans, equipment financing, letters of credit and other loan products are offered, primarily in target markets, and underwritten based on each borrower’s ability to service debt from income. These loans are primarily made based on the identified cash flows of the borrower and secondarily, on the underlying collateral provided by the borrower. Most commercial business loans are secured by a lien on general business assets including, among other things, available real estate, accounts receivable, promissory notes, inventory and equipment, and personal guaranties from the borrower or other principal are generally obtained.
Credit Cards. Through the OpenSky® credit card division, the Company offers credit cards on a nationwide basis to under-banked populations and those looking to rebuild their credit scores through a fully digital and mobile platform. Substantially all of the lines of credit are secured by a noninterest bearing demand account at the Bank in an amount equal to the full credit limit of the credit card. In addition, using a proprietary scoring model, which considers credit score and repayment history (typically a minimum of six months of on-time repayments, but ultimately determined on a case-by-case basis), the Bank has recently begun to offer certain customers an unsecured line in excess of their secured line of credit. Approximately $98.5 million and $43.3 million of the credit card balances were secured by savings deposits held by the Bank as of December 31, 2020 and 2019, respectively.
Other Consumer Loans. To a limited extent and typically as an accommodation to existing customers, personal consumer loans such as term loans, car loans or boat loans are offered.
Acquired loans through acquisitions are recorded at estimated fair value on their purchase date with no carryover of the related allowance for loan losses. In estimating the fair value of loans acquired, certain factors were considered, including the remaining lives of the acquired loans, payment history, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, and the net present value of cash flows expected. Discounts on loans that were not considered impaired at acquisition were recorded as an accretable discount, which will be recognized in interest income over the terms of the related loans. For loans considered to be impaired, the difference between the contractually required payments and expected cash flows was recorded as a nonaccretable discount. The remaining nonaccretable discounts on loans acquired were $285 thousand at December 31, 2020 and 2019. Loans with nonaccretable discounts had a carrying value of $0.8 million and $0.9 million as of December 31, 2020 and 2019, respectively.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 5 - Portfolio Loans Receivable (continued)
The activity in the accretable discounts on loans acquired was as follows:
Accretable Discounts on Loans Acquired
December 31,
(in thousands) 2020 2019
Accretable discount at beginning of period $ 429 $ 438
Accretion and payoff of loans (208) (9)
Accretable discount at end of period $ 221 $ 429
The allowance for loan losses consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component covers non-impaired loans and is based on historical loss experience adjusted for current economic factors. The following tables present, by class and reserving methodology, the allocation of the allowance for loan losses and the gross investment in loans as of December 31, 2020 and 2019.
Allowance for Loan Losses
(in thousands) Provision for
Loan Losses Allowance for Loan Losses
Ending Balance Evaluated
for Impairment: Outstanding Loan
Balances Evaluated
for Impairment:
December 31, 2020 Beginning
Balance Charge-Offs Recoveries Ending
Balance Individually Collectively Individually Collectively
Real estate:
Residential $ 4,135 $ 3,018 $ - $ - $ 7,153 $ - $ 7,153 $ 4,687 $ 433,173
Commercial 3,572 3,214 - - 6,786 - 6,786 2,358 390,192
Construction 2,668 2,216 (296) 7 4,595 - 4,595 1,736 223,168
Commercial 1,548 1,102 (233) - 2,417 253 2,164 1,182 155,945
Credit card (1)
1,368 1,681 (637) 50 2,462 - 2,462 - 102,186
Other consumer (1)
10 11 - - 21 - 21 - 1,649
$ 13,301 $ 11,242 $ (1,166) $ 57 $ 23,434 $ 253 $ 23,181 $ 9,963 $ 1,306,313
December 31, 2019
Real estate:
Residential $ 3,541 $ 634 $ (40) $ - $ 4,135 $ - $ 4,135 $ 2,192 $ 425,734
Commercial 3,003 556 - 13 3,572 - 3,572 1,433 346,658
Construction 2,093 575 - - 2,668 - 2,668 - 198,702
Commercial 1,578 299 (331) 2 1,548 119 1,429 474 150,635
Credit card (1)
1,084 726 (461) 19 1,368 - 1,368 - 45,526
Other consumer (1)
9 1 - - 10 - 10 - 1,285
$ 11,308 $ 2,791 $ (832) $ 34 $ 13,301 $ 119 $ 13,182 $ 4,099 $ 1,168,540
_______________
(1) Credit cards loans are collectively evaluated by past due status and as such are not individually risk rated.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 5 - Portfolio Loans Receivable (continued)
Past due portfolio loans, segregated by delinquency and class of loans, as of December 31, 2020 and 2019 were as follows:
Portfolio Loans Past Due Loans
90 or More
Days
Past Due Total
Past Due
Loans Current
Loans Total
Loans Accruing
Loans 90 or
More days
Past Due Nonaccrual
Loans
Loans
30-89 Days
Past Due
(in thousands)
December 31, 2020
Real estate:
Residential $ 1,029 $ 3,539 $ 4,568 $ 433,292 $ 437,860 $ - $ 3,581
Commercial 36 2,583 2,619 389,931 392,550 225 2,358
Construction 1,444 442 1,886 223,018 224,904 - 1,886
Commercial 486 741 1,227 155,900 157,127 - 1,182
Credit card 13,811 6 13,817 88,369 102,186 6 -
Other consumer - - - 1,649 1,649 - -
$ 16,806 $ 7,311 $ 24,117 $ 1,292,159 $ 1,316,276 $ 231 $ 9,007
Acquired loans included above
$ 36 $ 565 $ 601 $ 4,675 $ 5,276 $ 225 $ 381
December 31, 2019
Real estate:
Residential $ 704 $ 2,436 $ 3,140 $ 424,786 $ 427,926 $ 374 $ 2,192
Commercial 275 1,671 1,946 346,145 348,091 237 1,433
Construction 756 - 756 197,946 198,702 - -
Commercial 172 353 525 150,584 151,109 - 474
Credit card 5,526 8 5,534 39,992 45,526 8 -
Other consumer - - - 1,285 1,285 - -
$ 7,433 $ 4,468 $ 11,901 $ 1,160,738 $ 1,172,639 $ 619 $ 4,099
Acquired loans included above
$ 305 $ 1,243 $ 1,548 $ 4,873 $ 6,421 $ 464 $ 880
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 5 - Portfolio Loans Receivable (continued)
Impaired loans also include acquired loans for which management has recorded a nonaccretable discount. Impaired loans as of December 31, 2020 and 2019 were as follows:
Impaired Portfolio Loans
Unpaid
Contractual
Principal
Balance Recorded
Investment
with no
Allowance Recorded
Investment
with
Allowance Total
Recorded
Investment Related
Allowance Average
Recorded
Investment Interest
Recognized
(in thousands)
December 31, 2020
Real estate
Residential $ 3,960 $ 3,726 $ - $ 3,726 $ - $ 3,982 $ 136
Commercial 2,490 2,358 - 2,358 - 2,519 46
Construction 1,996 1,886 - 1,886 - 1,809 15
Commercial 1,344 791 391 1,182 253 1,826 58
$ 9,790 $ 8,761 $ 391 $ 9,152 $ 253 $ 10,136 $ 255
Acquired loans included above $ 548 $ 381 $ - $ 381 $ - $ 555 $ 3
December 31, 2019
Real estate
Residential $ 2,309 $ 2,192 $ - $ 2,192 $ - $ 2,510 $ 8
Commercial 1,477 1,433 - 1,433 - 1,620 18
Commercial 574 201 273 474 119 777 9
$ 4,360 $ 3,826 $ 273 $ 4,099 $ 119 $ 4,907 $ 35
Acquired loans included above $ 1,148 $ 880 - $ 880 $ - $ 1,164 $ 18
There were $175 thousand and $481 thousand, respectively, of loans secured by one to four family residential properties in the process of foreclosure as of December 31, 2020 and 2019.
Credit quality indicators
As part of the ongoing monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends related to the risk grade of loans, the level of classified loans, net charge-offs, nonperforming loans, and the general economic conditions in the Company’s market.
The Company utilizes a risk grading matrix to assign a risk grade to each of its loans. A description of the general characteristics of loans characterized as classified is as follows:
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 5 - Portfolio Loans Receivable (continued)
Special Mention
A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Company’s credit position at some future date. Special mention loans are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.
Borrowers may exhibit poor liquidity and leverage positions resulting from generally negative cash flow or negative trends in earnings. Access to alternative financing may be limited to finance companies for business borrowers and may be unavailable for commercial real estate borrowers.
Substandard
A substandard loan is inadequately protected by the current financial condition and paying capacity of the obligor or of the collateral pledged, if any. Substandard loans have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
Borrowers may exhibit recent or unexpected unprofitable operations, an inadequate debt service coverage ratio, or marginal liquidity and capitalization. These loans require more intense supervision by Company management.
Doubtful
A doubtful loan has all the weaknesses associated with a substandard loan with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 5 - Portfolio Loans Receivable (continued)
The following table presents the balances of classified loans based on the risk grade. The Company grades all credit cards loans as Pass. Classified loans include Special Mention, Substandard, and Doubtful loans:
Classified Loans
(in thousands) Pass(1)
Special Mention Substandard Doubtful Total
December 31, 2020
Real estate:
Residential
$ 428,260 $ 5,150 $ 4,450 $ - $ 437,860
Commercial
383,311 6,881 2,358 - 392,550
Construction
220,057 1,112 3,735 - 224,904
Commercial 145,365 9,766 1,996 - 157,127
Credit card 102,186 - - - 102,186
Other consumer 1,649 - - - 1,649
Total $ 1,280,828 $ 22,909 $ 12,539 $ - $ 1,316,276
December 31, 2019
Real estate:
Residential
$ 425,661 $ - $ 2,265 $ - $ 427,926
Commercial
340,313 6,345 1,433 - 348,091
Construction
198,702 - - - 198,702
Commercial 145,178 4,505 1,426 - 151,109
Credit card 45,526 - - - 45,526
Other consumer 1,285 - - - 1,285
Total $ 1,156,665 $ 10,850 $ 5,124 $ - $ 1,172,639
________________________
(1) Pass includes loans graded exceptional, very good, good, satisfactory and pass/watch, in addition to credit card loans which are not individually graded.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 5 - Portfolio Loans Receivable (continued)
Impaired loans also include certain loans that have been modified in troubled debt restructurings (“TDRs”) where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months. The status of TDRs is as follows:
Troubled Debt Restructurings
Number of
Contracts Recorded Investment
(dollars in thousands) Performing Nonperforming Total
December 31, 2020
Real estate:
Residential
3 $ - $ 145 $ 145
Commercial 2 - 294 294
Total 5 $ - $ 439 $ 439
Acquired loans included above 3 $ - $ 145 $ 145
December 31, 2019
Real estate:
Residential
3 $ - $ 145 $ 145
Commercial 2 - 314 314
Total 5 $ - $ 459 $ 459
Acquired loans included above
3 $ - $ 145 $ 145
During the year ended December 31, 2020, the Company did not incur any new TDR loans. The Company had no defaulted TDR loans in the twelve months ended December 31, 2020. Of the five loans designated as TDR at December 31, 2019, three loans were classified as TDR due to changes in interest rates and payment terms, and two loans had a principal payment adjustment.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 5 - Portfolio Loans Receivable (continued)
Outstanding loan commitments were as follows:
Loan Commitments
For the Year Ended December 31,
(in thousands) 2020 2019
Unused lines of credit
Commercial $ 15,973 $ 13,754
Commercial real estate 32,398 26,407
Residential real estate 20,848 31,411
Home equity 118,843 114,999
Commercial and industrial 50,877 36,442
Credit Card 92,452 37,517
Personal 185 43
Construction commitments:
Residential real estate - -
Commercial real estate - -
$ 331,576 $ 260,573
Commitments to originate residential loans held for sale $ 11,444 $ 2,646
Letters of credit $ 5,102 $ 5,305
Lines of credit are agreements to lend to a customer as long as there is no violation of any condition of the contract. Lines of credit generally have variable interest rates. Such lines do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time. Loan commitments generally have variable interest rates, fixed expiration dates, and may require payment of a fee. Letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. In the event of nonperformance by the customer in accordance with the terms of the agreement with the third party, the Company would be required to fund the commitment.
The Company's maximum exposure to credit loss in the event of nonperformance by the customer is the contractual amount of the credit commitment. Loan commitments and lines of credit are made on the same terms, including collateral, as outstanding loans. The Company is not aware of any accounting loss to be incurred by funding these loan commitments.
As of December 31, 2020 and 2019, respectively, the Company had an allowance for off-balance-sheet credit risk of $1.8 million and $1.2 million, recorded in other liabilities on the consolidated balance sheet.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 5 - Portfolio Loans Receivable (continued)
The Company maintains a reserve for off-balance sheet items such as unfunded lines of credit. Activity for this account is as follows:
Off-Balance Sheet Reserve
(in thousands) 2020 2019
Balance at beginning of period $ 1,226 $ 1,053
Add: Provision 550 173
Add: Recoveries - -
Less: Charge-offs - -
Balance at end of period $ 1,776 $ 1,226
The Company makes representations and warranties that loans sold to investors meet their program's guidelines and that the information provided by the borrowers is accurate and complete. In the event of a default on a loan sold, the investor may make a claim for losses due to document deficiencies, program non-compliance, early payment default, and fraud or borrower misrepresentations.
The Company maintains a reserve for potential losses on mortgage loans sold. Activity in this reserve is as follows for the periods presented:
Mortgage Loan Put-back Reserve
(in thousands) 2020 2019
Balance at beginning of period $ 576 $ 501
Add: Provision 598 184
Add: Recoveries - -
Less: Charge-offs (14) (109)
Balance at end of period $ 1,160 $ 576
Note 6 - Premises and Equipment
Premises and equipment and the related depreciation and amortization consist of the following:
Premises and Equipment
(in thousands) 2020 2019
Leasehold improvements $ 1,694 $ 1,688
Furniture and equipment 4,635 4,622
Vehicle 54 54
Software 2,518 2,517
Construction in progress 6 -
8,907 8,881
Less: Accumulated depreciation and amortization 7,554 6,709
Premises and equipment 1,353 2,172
Net lease asset 3,111 3,920
Premises and equipment, net $ 4,464 $ 6,092
Depreciation and amortization expense $ 844 $ 1,113
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 7 - Leases
On January 1, 2019, the Company adopted ASU 2016-02, Leases, as further explained in Note 1 - Nature of Business and Basis of Presentation. The Company’s primary leasing activities relate to certain real estate leases entered into in support of the Company’s branch operations and back office operations. As of January 1, 2019, the Company had leased five of its full service branches and five other locations for corporate/administration activities, operations, and loan production. All property leases under lease agreements have been been designated as operating leases. The Company does not have leases designated as finance leases.
The Company determines if an arrangement is a lease at inception. Operating lease right-of-use (“ROU”) assets are included in premises and equipment, and operating lease liabilities are included as other liabilities in the consolidated balance sheets. ROU assets represent the right to use an underlying asset for the lease term and lease liabilities represent the obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As the Company's leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The weighted average discount rate used was 2.23%. The operating lease ROU asset also includes any lease pre-payments. The Company's lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. The Company has lease agreements with lease and non-lease components, which the Company has elected to account for separately as the non-lease component amounts are readily determinable under most leases.
As of December 31, 2020, the Company’s lease ROU assets and related lease liabilities were $3.1 million and $3.4 million, respectively, and have remaining terms ranging from 1 - 6 years, including extension options that the Company is reasonably certain will be exercised. As of December 31, 2020, the Company had not entered into any material leases that have not yet commenced. The Company’s lease information is summarized as follows:
Leases
(in thousands) December 31, 2020
Lease Right-of-Use Asset
Lease asset 5,399
Less: Accumulated amortization (2,288)
Net lease asset 3,111
Lease Liability
Lease liability $ 5,577
Less: Accumulated amortization (2,137)
Net lease liability $ 3,440
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 7 - Leases (continued)
Future minimum payments for operating leases with initial or remaining terms of one year or more are as follows:
Lease Payment Obligations
(in thousands) December 31, 2020
Amounts due in:
2021 $ 1,408
2022 1,023
2023 777
2024 420
Total lease payments $ 3,628
Operating lease and rent expense was $1.6 million and $1.3 million for the years ended December 31, 2020 and 2019, respectively.
Note 8 - Derivative Financial Instruments
As part of its mortgage banking activities, the Company enters into interest rate lock commitments, which are commitments to originate loans whereby the interest rate on the loan is determined prior to funding and the customers have locked into that interest rate. The Company then either locks the loan and rate in with an investor and commits to deliver the loan if settlement occurs (Best Efforts) or commits to deliver the locked loan to an investor in a binding (Mandatory) delivery program. Certain loans under rate lock commitments are covered under forward sales contracts. Forward sales contracts are recorded at fair value with changes in fair value recorded in mortgage banking revenue. Interest rate lock commitments and commitments to deliver loans to investors are considered derivatives. The market value of interest rate lock commitments and best efforts contracts are not readily ascertainable with precision because they are not actively traded in stand-alone markets. The Company determines the fair value of rate lock commitments and delivery contracts by measuring the fair value of the underlying asset, which is impacted by current interest rates and takes into consideration the probability that the rate lock commitments will close or will be funded.
On January 7, 2015, the Company entered into an interest rate swap transaction with a notional amount of $2 million. The swap qualifies as a derivative and is designated as a hedging instrument. The swap fixed the interest rate the Company paid on the floating rate junior subordinated debentures for four years beginning on March 16, 2015 and matured on March 16, 2019. Based on the notional amount, the Company paid its counterparty quarterly interest at a fixed rate, and the counterparty paid the Company interest at a rate of three-month LIBOR plus 1.87%.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 8 - Derivative Financial Instruments (continued)
The following table reports the commitment and fair value amounts on the outstanding derivatives:
Derivatives
(in thousands) December 31, 2020 December 31, 2019
Notional amount of open forward sales agreements $ 38,000 $ 61,000
Fair value of open forward delivery sales agreements (179) (125)
Notional amount of open mandatory delivery commitments 15,531 22,888
Fair value of open mandatory delivery commitments 179 122
Notional amount of interest rate lock commitments 34,827 32,365
Fair value of interest rate lock commitments 148 115
Note 9 - Interest-Bearing Deposits
Major categories of interest bearing deposits are as follows:
Interest-Bearing Deposits
(in thousands) 2020 2019
Interest-bearing demand accounts $ 257,126 $ 174,166
Money market accounts 447,077 429,078
Savings 4,800 3,675
Certificates of deposit of $250,000 or more 134,752 115,311
Other time deposits 199,814 211,414
Total interest-bearing deposits $ 1,043,569 $ 933,644
The aggregate amount of brokered certificates of deposit was $45.1 million and $88.8 million at December 31, 2020 and 2019, respectively. The aggregate amount of Certificate of Deposit Account Registry Service (“CDARS”) deposits was $10.7 million and $5.0 million at December 31, 2020 and 2019, respectively. As of December 31, 2020, the Company’s certificates of deposit from listing services amounted to $62.5 million or 3.8% of our deposits.
Certificates of deposit, as of December 31, 2020, mature as follows:
Maturities of Certificates of Deposit
(in thousands)
2021 $ 237,623
2022 93,909
2023 1,915
2024 760
2025, and thereafter 359
$ 334,566
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 10 - Securities Sold Under Agreements to Repurchase
The Company formerly sold securities under repurchase agreements to provide cash management services to commercial account customers. These borrowings are summarized as follows:
Securities Sold Under Agreements to Repurchase
(dollars in thousands) 2020 2019
Average amount outstanding $ - $ 1,287
Average rate paid during the year - % 1.75 %
Maximum amount outstanding at month end $ - $ 3,400
Investment securities pledged to secure the underlying agreements at year end:
Amortized cost $ - $ -
Fair value - -
Note 11 - Borrowed Funds
As of December 31, 2020 and 2019, the Company was indebted as follows:
Borrowed Funds
2020 2019
(dollars in thousands) Balance Interest Balance Interest
FHLB fixed rate advance due October 16, 2025 $ 22,000 0.93 % $ - - %
FHLB principal reducing advance due May 10, 2022 - - 32,222 2.40
Total - FHLB advances $ 22,000 $ 32,222
Junior subordinated debentures due June 15, 2036 $ 2,062 2.09 % $ 2,062 3.76 %
Other subordinated notes due November 30, 2030 10,000 5.00 - -
Other subordinated notes due December 1, 2025 - - 13,500 6.95
FRB advances under the SBA-PPP Liquidity Facility 1,954 - - -
Less: Unamortized debt issuance costs - (139)
Total - Other borrowed funds $ 14,016 $ 15,423
Federal Home Loan Bank Advances
The Federal Home Loan Bank fixed rate advance accrues interest on a daily basis and is paid semi-annually.
Junior subordinated debentures
In June 2006, the Company formed Capital Bancorp (MD) Statutory Trust I (the “Trust”) and on June 15, 2006, the Trust issued 2,000 floating Rate Capital Securities (the “Capital Securities”) with an aggregate liquidation value of $2,000,000 to a third party in a private placement. Concurrent with the issuance of the Capital Securities, the Trust issued trust common securities to the Company in the aggregate liquidation value of $62,000.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 11 - Borrowed Funds (Continued)
The proceeds of the issuance of the Capital Securities and trust common securities were invested in the Company’s Floating Rate Junior Subordinated Deferrable Interest Debentures (the “Floating Rate Debentures”). The Floating Rate Debentures for the Trust will mature on June 15, 2036, which may be shortened if certain conditions are met (including the Company having received prior approval of the Board of Governors of the Federal Reserve System and any other required regulatory approvals). These Floating Rate Debentures, which are the only assets of the Trust, are subordinate and junior in right of payment to all present and future senior indebtedness (as defined in the Indenture dated June 15, 2006) of the Company. The Floating Rate Debentures for the Trust accrue interest at a floating rate equal to the three-month LIBOR plus 1.89%, payable quarterly. As of December 31, 2020 and 2019, the rate for the Trust was 2.09% and 3.76%, respectively. The quarterly distributions on the Capital Securities will be paid at the same rate that interest is paid on the Floating Rate Debentures.
The Company has fully and unconditionally guaranteed the Trust’s obligation under the Capital Securities. The Trust must redeem the Capital Securities when the Floating Rate Debentures are paid at maturity or upon any earlier prepayment of the Floating Rate Debentures. The Floating Rate Debentures may be prepaid if certain events occur, including a change in the tax status or regulatory capital treatment of the Capital Securities, or a change in existing laws that requires the Trust to register as an investment company.
The junior subordinated debentures are treated as Tier 1 capital by the Company, to a limited extent, by the Federal Reserve.
Other subordinated notes
On November 24, 2015, the Company issued $13.5 million of subordinated notes. The notes had a maturity date of December 1, 2025 and were called December 1, 2020. The notes bear interest at 6.95% for the first five years, then adjust to the three-month LIBOR plus 5.33% adjusted on March 1, June 1, September 1, and December 1 of each year. Interest is payable quarterly. There were related debt issuance costs incurred totaling $278,231. The costs were amortized to interest expense through the maturity date of the notes.
On November 30, 2020, the Company issued $10.0 million of subordinated notes. The notes mature on November 30, 2030 and are redeemable in whole or part on November 30, 2025. The notes bear interest at a fixed annual rate of 5.00% for the first five years, then adjust quarterly to an interest rate per annum equal to a benchmark rate, which is expected to be the three-month SOFR, plus 490 basis points. There were related debt issuance costs incurred totaling $50,000 which were fully expensed at the time of issuance. The Company used the proceeds from the offering to redeem the outstanding $13.5 million, 6.95% fixed-to-floating rate subordinated notes.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 11 - Borrowed Funds (Continued)
Available lines of credit
The Company has available lines of credit of $76.0 million with other correspondent banks. There were no outstanding line of credit balances at December 31, 2020 and December 31, 2019.
The Company may borrow up to 25% of its assets from the FHLB, based on collateral available to pledge to secure the borrowings. Borrowings from the FHLB are secured by a portion of the Company’s loan and/or investment portfolio. As of December 31, 2020 and 2019, the Company had pledged loans providing borrowing capacity of $222.0 million and $193.7 million, respectively. As of December 31, 2020 and 2019, the Company had pledged investment securities with a fair value of $1.2 million and $1.5 million, respectively, to the FHLB. As of December 31, 2020 and 2019, the Company had available borrowing capacity, net of advances and amounts pledged for letters of credit, from the FHLB of $201.2 million and $140.5 million, respectively.
As of December 31, 2020 and 2019, the Company had pledged commercial loans to the Federal Reserve Bank of Richmond to secure a borrowing capacity totaling $15.6 million and $12.5 million, respectively, under its discount window program. In addition, the Company had the ability to borrow from the SBA-PPP Liquidity Facility by pledging SBA-PPP loans. As of December 31, 2020 the company pledged $2.0 million under this facility and had the funds advanced. Additionally, there was $201.0 million of SBA-PPP loans remaining available to pledge as collateral to enable the Company to borrow under the program. l
The Company limits its certificate of deposit funding through financial networks to 15% of the Bank’s assets, or approximately $277.1 million and $209.5 million as of December 31, 2020 and 2019, respectively. Amounts outstanding were $45.1 million and $88.8 million as of December 31, 2020 and 2019, respectively.
Note 12 - Retirement Plan
The Company provides a defined contribution plan qualifying under Section 401(k) of the Internal Revenue Code to eligible employees. The Company contributes 3% of eligible compensation on behalf of all full-time employees up to limits prescribed by the Internal Revenue Code. The Company’s contribution to the plan was $879 thousand in 2020 and $691 thousand in 2019.
Note 13 - Related-Party Transactions
Certain executive officers and directors of the Company and Bank, and companies with which they are affiliated, are clients of and have banking transactions with the Company in the ordinary course of business. These transactions are conducted on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with persons not related to the Company.
Activity in related-party loans during 2020 and 2019 is shown below:
Related Party Loans
(in thousands) 2020 2019
Balance at beginning of year $ 22,112 $ 13,221
Add: New loans 99 14,583
Less: Amounts collected (2,936) (5,692)
Balance at end of year $ 19,275 $ 22,112
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 13 - Related-Party Transactions (continued)
Deposits from officers and directors and their related interests were $148.4 million at December 31, 2020, and $141.3 million at December 31, 2019.
A director of the Company owns an interest in an entity from which the Company leases space for one of its Rockville, Maryland locations. Payments made in accordance with the lease were $76 thousand and $74 thousand in 2020 and 2019, respectively.
Company directors, or their related interests, held $3.3 million of the subordinated notes outstanding as of December 31, 2020. These notes hold a fixed rate of interest until November 30, 2025, after which it converted to variable rate.
Company directors, or their related interests, did not hold any participation loans from the Bank as of December 31, 2020 and held $171 thousand as of December 31, 2019. Company and Bank directors, or their related interests, held $121 thousand and $364 thousand of participation loans from Church Street Capital as of December 31, 2020 and 2019, respectively.
Note 14 - Income Taxes
The components of income tax expense are as follows:
Income Tax Expense
For the Years Ended December 31,
(in thousands) 2020 2019
Current:
Federal $ 9,489 $ 5,151
State 2,995 1,507
Total current expense 12,484 6,658
Deferred tax benefit (3,170) (839)
Total income tax expense $ 9,314 $ 5,819
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 14 - Income Taxes (continued)
The components of the net deferred tax asset at December 31, 2020 and 2019 are:
Net Deferred Tax Asset
(in thousands) 2020 2019
Deferred tax assets:
Allowance for loan and credit losses $ 6,666 $ 3,977
Reserve for recourse on mortgage loans sold 308 158
Nonaccrual interest 18 19
Foreclosed real estate write-downs 22 3
Stock-based compensation 276 251
Long-term incentive program 302 266
Core deposit intangible 17 21
Lease liability net of right-of-use asset 87 -
Net operating loss carryforward 123 178
7,819 4,873
Deferred tax liabilities:
Unrealized gains on investment securities available for sale 620 5
Unrealized gain on loans held for sale 67 72
Accumulated depreciation 190 355
Deferred casualty gain 1 1
878 433
Net deferred tax asset before valuation allowance 6,941 4,440
Less: Valuation allowance 123 177
Net deferred tax asset $ 6,818 $ 4,263
The differences between the federal income tax rate and the effective tax rate for the Company are reconciled as follows:
Reconciliation of Federal Tax Rate to the Effective Rate
2020 2019
Statutory federal income tax rate 21.00 % 21.00 %
Increase (decrease) resulting from:
State income taxes, net of federal income tax benefit 5.40 6.02
Nondeductible expenses 0.49 0.73
Tax exempt income (0.01) (0.03)
Other (0.37) (2.10)
Effective Tax Rate 26.51 % 25.62 %
Deferred tax assets represent the future tax benefit of deductible differences and, if it is more likely than not that a tax asset will not be realized, a valuation allowance is required to reduce the net deferred tax assets to net realizable value. As of December 31, 2020, management has determined that it is more likely than not that the majority of the deferred tax asset from continuing operations will be realized. At December 31, 2020 and 2019, a valuation allowance of $123 thousand and $177 thousand was recognized, respectively, for a State of Maryland net operating loss carryforward that may not be realizable.
The Company does not have material uncertain tax positions and did not recognize any adjustments for unrecognized tax benefits. The Company remains subject to examination of income tax returns for the years ending after December 31, 2017 .
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 15 - Capital Standards
The Company and Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting, and other factors.
Quantitative measures established and defined by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of Total, Tier 1 and Common Equity Tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets. As of December 31, 2020 and 2019, the capital levels of the Company and the Bank substantially exceeded all applicable capital adequacy requirements.
As of December 31, 2020 the most recent notification from the OCC has categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain ratios as set forth in the table. There have been no conditions or events since that notification that management believes have changed the Bank’s category.
The following table presents actual and required capital ratios as of December 31, 2020 and 2019 for the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of December 31, 2020 and 2019 based on the phase-in provisions of the Basel III Capital Rules. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. Based on recent changes to the Federal Reserve’s definition of a “Small Bank Holding Company” that increased the threshold to $3 billion in assets, the Company is not currently subject to separate minimum capital measurements. At such time as the Company reaches the $3 billion asset level, it will again be subject to capital measurements independent of the Bank. For comparison purposes, the Company’s ratios are presented in the following table as well, all of which would have exceeded the “well-capitalized” level had the Company been subject to separate capital minimums.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 15 - Capital Standards (continued)
Regulatory Capital
Actual Minimum Capital
Adequacy To Be Well
Capitalized Full Phase In of Basel III
(Dollar amounts in thousands) Amount Ratio Amount Ratio Amount Ratio Amount Ratio
December 31, 2020
The Company
Tier 1 leverage ratio (to average assets) $ 159,656 8.78 % $ 72,770 4.00 % N/A N/A $ 90,962 5.00 %
Tier 1 capital (to risk-weighted assets) 159,656 13.10 % 73,100 6.00 % N/A N/A 97,467 8.00 %
Common equity tier 1 capital ratio (to risk-weighted assets)
157,594 12.94 % $ 54,825 4.50 % N/A N/A 79,192 6.50 %
Total capital ratio (to risk-weighted assets) 185,008 15.19 % $ 97,467 8.00 % N/A N/A 121,834 10.00 %
The Bank
Tier 1 leverage ratio (to average assets) $ 135,527 7.44 % $ 72,770 4.00 % $ 90,962 5.00 % $ 90,962 5.00 %
Tier 1 capital (to risk-weighted assets) 135,527 12.06 % 71,731 6.00 % 95,642 8.00 % 95,642 8.00 %
Common equity tier 1 capital ratio (to risk-weighted assets)
135,527 12.06 % 53,798 4.50 % 77,709 6.50 % 77,709 6.50 %
Total capital ratio (to risk-weighted assets) 150,593 13.40 % 95,642 8.00 % 119,552 10.00 % 119,552 10.00 %
December 31, 2019
The Company
Tier 1 leverage ratio (to average assets) $ 135,380 9.96 % $ 54,397 4.00 % N/A N/A $ 67,996 5.00 %
Tier 1 capital (to risk-weighted assets) 135,380 12.31 % 66,011 6.00 % N/A N/A 88,015 8.00 %
Common equity tier 1 capital ratio (to risk-weighted assets)
133,318 12.12 % 49,508 4.50 % N/A N/A 71,512 6.50 %
Total capital ratio (to risk-weighted assets) 149,142 13.56 % 88,015 8.00 % N/A N/A 110,018 10.00 %
The Bank
Tier 1 leverage ratio (to average assets) $ 114,613 8.65 % $ 53,005 4.00 % $ 66,256 5.00 % $ 66,256 5.00 %
Tier 1 capital (to risk-weighted assets) 114,613 10.73 % 64,093 6.00 % 85,458 8.00 % 85,458 8.00 %
Common equity tier 1 capital ratio (to risk-weighted assets)
114,613 10.73 % 48,070 4.50 % 69,435 6.50 % 69,435 6.50 %
Total capital ratio (to risk-weighted assets) 127,976 11.98 % 85,458 8.00 % 106,822 10.00 % 106,822 10.00 %
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 16 - Stock-Based Compensation
Compensation cost is recognized for stock options and restricted stock awards issued to employees. Compensation cost is measured as the fair value of these awards on their date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Company’s common stock at the date of grant is used as the fair value of restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period for stock option awards and as the restriction period for restricted stock awards. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.
The expense recognition of employee stock option and restricted stock awards resulted in net expense of approximately $1.0 million and $858 thousand during the years ended December 31, 2020 and 2019, respectively.
Stock options:
The Company currently has two incentive compensation plans with outstanding stock options, the 2002 Stock Option Plan and the 2017 Stock and Incentive Compensation Plan (“the Plan”). Only the Plan, which authorizes the use of stock options, stock appreciation rights, restricted stock and/or restricted stock, is available to grant options and shares to employees and directors. At inception the Plan allowed for up to 1,120,000 shares of common stock to be issued. As of December 31, 2020, there are 144,049 shares available for future grant. Shares of common stock related to any unexercised or unvested award granted under the Plan that terminate or expire, or are subsequently forfeited or cancelled for any reason, become available for re-grant under the Plan. Option prices are equal to or greater than the estimated fair value of the common stock at the date of grant. Options outstanding vest over a four-year period, whereby 25% of the options become exercisable on each anniversary of the grant date.
Information with respect to options outstanding during the years ended December 31, 2020 and 2019 is as follows:
Stock Options Outstanding
2020 2019
Shares Weighted Average Exercise Price Shares Weighted Average Exercise Price
Outstanding at beginning of year 1,308,047 $ 11.00 1,431,860 $ 9.38
Add: Granted 205,100 13.95 249,300 14.29
Less: Exercised (142,901) 7.72 (221,710) 6.88
Less: Retired on exercise (137,334) 7.90 (141,955) 6.90
Less: Expired/cancelled/forfeited (63,499) 11.60 (9,448) 10.89
Outstanding at end of year 1,169,413 $ 12.21 1,308,047 $ 11.00
Exercisable at end of year 567,593 $ 11.13 592,782 $ 9.40
The weighted average fair value of options granted during the years ended December 31, 2020 and 2019, was $7.37 and $4.30, respectively.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 16 - Stock-Based Compensation (continued)
A summary of information about stock options outstanding is as follows:
Stock Option Summary
Weighted Average Exercise Price Average Remaining Life (years) Outstanding Shares Exercisable Shares
December 31, 2020
$ 8.50 1.00 172,976 172,976
10.70 4.30 2,500 -
11.13 4.30 500 -
11.38 3.00 306,437 152,953
11.41 4.00 20,000 5,000
12.38 2.00 238,100 177,450
12.80 2.80 7,000 3,500
13.89 5.00 177,100 -
14.38 4.10 5,000 -
14.54 4.00 219,800 55,714
14.89 4.00 20,000 -
Total outstanding options 12.21 3.00 1,169,413 567,593
Intrinsic value on December 31, 2020 2,164,598 1,620,892
December 31, 2019
$ 7.50 1.0 236,212 231,212
8.50 2.0 202,435 142,885
11.38 4.0 346,500 86,635
11.41 4.0 20,000 -
12.38 3.0 266,600 130,300
12.80 3.8 7,000 1,750
14.54 5.0 229,300 -
Total outstanding options 11.00 3.1 1,308,047 592,782
Intrinsic value on December 31, 2019 5,089,032 3,256,491
The aggregate intrinsic value as presented in the preceding tables is the difference between the estimated fair value of the stock as of December 31, 2020 and 2019, and the exercise price of the option multiplied by the number of options outstanding. Stock options with exercise prices greater than the estimated fair value of the stock are not included in this calculation.
Total unrecognized compensation expense related to stock options to be recognized over the next five years was $0.8 million and $1.7 million at December 31, 2020 and 2019, respectively.
The intrinsic value of stock options exercised was $0.9 million and $1.8 million during the years ended December 31, 2020 and 2019, respectively.
The weighted average fair value of options granted during 2020 and 2019 were estimated using the
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 16 - Stock-Based Compensation (continued)
Black-Scholes option-pricing model with the following weighted average assumptions:
Stock Option Pricing Assumptions
2020 2019
Dividend yield 0.00% 0.00%
Risk free interest rate 0.43% 1.75%
Expected volatility 64.46% 34.79%
Expected life in years 5 5
Restricted stock:
The Company from time-to-time also grants shares of restricted stock to key employees. These awards help align the interests of these employees with the interests of the stockholders of the Company by providing economic value directly related to increases in the value of the Company’s stock. These awards typically hold service requirements over various vesting periods. The value of the stock awarded is established as the fair market value of the stock at the time of the grant. The Company recognizes expense, equal to the total value of such awards, ratably over the vesting period of the stock grants.
All restricted stock agreements are conditioned upon continued employment. Termination of employment prior to a vesting date, as described below, would terminate any interest in non-vested shares. All restricted shares will fully vest in the event of change in control of the Company.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 16 - Stock-Based Compensation (continued)
Nonvested restricted stock for the years ended December 31, 2020 and 2019 is summarized in the following table.
Restricted Stock Summary
2020 2019
Shares Weighted Average Grant-Date Fair Value Shares Weighted Average Grant-Date Fair Value
Nonvested at beginning of year 19,500 $ 12.38 38,000 $ 10.32
Add: Granted 16,713 14.36 - -
Less: Vested (5,500) 12.38 (18,500) 8.16
Less: Forfeited - - - -
Nonvested at end of year 30,713 $ 13.46 19,500 $ 12.38
The vesting schedule of restricted shares as of December 31, 2020 is as follows:
Restricted Stock Vesting Schedule
Year Shares
2021 9,678
2022 9,678
2023 7,178
2024 4,179
30,713
There was $121 thousand and $176 thousand of total unrecognized compensation expense related to nonvested restricted stock at December 31, 2020 and 2019, respectively.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 17 - Parent Company Financial Information
The balance sheets as of December 31, 2020 and 2019 and statements of income and cash flows for the years then ended, for Capital Bancorp, Inc. (Parent only) are presented below.
Parent Company Only Balance Sheets
(in thousands) 2020 2019
Assets
Cash and cash equivalents $ 2,777 $ 2,391
Investment in Bank 137,244 114,626
Investment in Church Street Capital 4,161 3,755
Investment in Trust 62 62
Loans receivable, net of allowance for loan losses of $258 at both December 31, 2020 and 2019, respectively
26,999 28,044
Accrued interest receivable 300 98
Due from subsidiaries - 16
Prepaid income taxes - 9
Deferred income taxes 86 65
Total assets $ 171,629 $ 149,066
Liabilities and Stockholders’ Equity
Borrowed funds $ 12,062 $ 15,423
Accrued interest payable 43 82
Other liabilities 213 230
Total liabilities 12,318 15,735
Stockholders’ equity
Common stock 138 139
Additional paid-in capital 50,602 51,561
Retained earnings 106,854 81,618
Accumulated other comprehensive income 1,717 13
Total stockholders’ equity
159,311 133,331
Total liabilities and stockholders’ equity $ 171,629 $ 149,066
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 17 - Parent Company Financial Information (continued)
Parent Company Only Statements of Income
(in thousands) 2020 2019
Interest and dividend income $ 1,662 $ 1,650
Dividend from Bank 5,500 3,500
Total interest and dividend revenue 7,162 5,150
Interest expense 1,095 1,054
Net interest income 6,067 4,096
Provision for loan losses - 50
Net interest income after provision for loan losses 6,067 4,046
Noninterest income 3 5
Noninterest expenses 334 180
Income before income taxes 5,736 3,871
Income tax expense 50 78
Income before undistributed net income of subsidiaries 5,686 3,793
Undistributed net income of subsidiaries 20,137 13,102
Net income $ 25,823 $ 16,895
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 17 - Parent Company Financial Information (continued)
Parent Company Only Statements of Cash Flows
(in thousands) 2020 2019
Cash flows from operating activities
Net Income
25,823 16,895
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses - 50
Undistributed net income of subsidiaries (20,137) (13,102)
Decrease in receivable from Bank 16 38
Stock-based compensation expense 983 795
Director and employee compensation paid in Company stock 268 301
Deferred income tax benefit (21) (47)
Amortization of debt issuance costs 139 30
Changes in assets and liabilities:
Accrued interest receivable (202) 8
Prepaid income taxes 9 81
Other assets - (663)
Accrued interest payable (39) 1
Other liabilities (17) 195
Net cash provided by operating activities 6,822 4,582
Cash flows from investing activities
Net increase in loans receivable
1,045 (1,062)
Capital contributions to subsidiaries (1,183) (5,120)
Net cash provided by investing activities (138) (6,182)
Cash flows from financing activities
Repayment of debt (3,500) -
Repurchase of common stock (3,720) (371)
Proceeds from exercise of stock options 922 594
Net cash provided used in financing activities (6,298) 223
Net increase (decrease) in cash and cash equivalents 386 (1,377)
Cash and cash equivalents, beginning of year 2,391 3,768
Cash and cash equivalents, end of year $ 2,777 $ 2,391
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 18 - Fair Value
Generally accepted accounting principles define fair value, establish a framework for measuring fair value, recommend disclosures about fair value, and establish a hierarchy for determining fair value measurement. The hierarchy includes three levels and is based upon the valuation techniques used to measure assets and liabilities. The three levels are as follows:
Level 1 - Inputs to the valuation method are quoted prices (unadjusted) for identical assets or liabilities in active markets;
Level 2 - Inputs to the valuation method include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument; and
Level 3 - Inputs to the valuation method are unobservable and significant to the fair value measurement.
Fair value measurements on a recurring basis
Investment securities available for sale - The fair values of the Company's investment securities available for sale are provided by an independent pricing service. The fair values of the Company's securities are determined based on quoted prices for similar securities under Level 2 inputs.
Loans held for sale - The fair value of loans held for sale is determined using Level 2 inputs of quoted prices for a similar asset, adjusted for specific attributes of that loan.
Derivative financial instruments - Derivative instruments used to hedge residential mortgage loans held for sale and the related interest rate lock commitments include forward commitments to sell mortgage loans and are reported at fair value utilizing Level 2 inputs. The fair values of derivative financial instruments are based on derivative market data inputs as of the valuation date and the underlying value of mortgage loans for rate lock commitments.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 18 - Fair Value (continued)
The Company has categorized its financial instruments measured at fair value on a recurring basis as of December 31, 2020 and December 31, 2019 as follows:
Fair Value of Financial Instruments
(in thousands) Total Level 1 Inputs Level 2 Inputs Level 3 Inputs
December 31, 2020
Investment securities available for sale
U.S. government-sponsored enterprises $ 10,881 $ - $ 10,881 $ -
Municipal 10,927 - 10,927 -
Corporate 5,767 - 5,767 -
Mortgage-backed securities 72,212 - 72,212 -
$ 99,787 $ - $ 99,787 $ -
Loans held for sale $ 107,154 $ - $ 107,154 $ -
Derivative assets $ 327 $ - $ 327 $ -
Derivative liabilities $ 179 $ - $ 179 $ -
December 31, 2019
Investment securities available for sale
U.S. government-sponsored enterprises $ 999 $ - $ 999 $ -
Municipal 528 - 528 -
Corporate 2,565 - 2,565 -
Mortgage-backed securities 56,736 - 56,736 -
$ 60,828 $ - $ 60,828 $ -
Loans held for sale $ 71,030 $ - $ 71,030 $ -
Derivative assets $ 237 $ - $ 237 $ -
Derivative liabilities $ 125 $ - $ 125 $ -
Financial instruments recorded using FASB ASC 825-10
Under FASB ASC 825-10, the Company may elect to report most financial instruments and certain other items at fair value on an instrument-by-instrument basis with changes in fair value reported in net income. After the initial adoption, the election is made at the acquisition of an eligible financial asset, financial liability or firm commitment or when certain specified reconsideration events occur. The fair value election, with respect to an item, may not be revoked once an election is made.
The following table reflects the difference between the fair value carrying amount of loans held for sale, measured at fair value under FASB ASC 825-10, and the aggregate unpaid principal amount the Company is contractually entitled to receive at maturity:
Fair Value of Loans Held for Sale
(in thousands) December 31, 2020 December 31, 2019
Aggregate fair value $ 107,154 $ 71,030
Contractual principal 99,362 $ 67,118
Difference $ 7,792 $ 3,912
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 18 - Fair Value (continued)
As of December 31, 2020 and December 31, 2019, the Company elected to account for loans held for sale at fair value to eliminate the mismatch that would occur by recording changes in market value on derivative instruments used to hedge loans held for sale while carrying the loans at the lower of cost or market.
Fair value measurements on a nonrecurring basis
Impaired loans - The Company has measured impairment generally based on the fair value of the loan's collateral and discounted cash flow analysis. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values. As of December 31, 2020 and December 31, 2019, the fair values consist of loan balances of $9.2 million and $4.1 million, with valuation allowances of $253 thousand and $119 thousand, respectively.
Foreclosed real estate - The Company's foreclosed real estate is measured at fair value less cost to sell. Fair value was determined based on offers and/or appraisals. Cost to sell the real estate was based on standard market factors. The Company has categorized its foreclosed real estate as Level 3.
Fair Value of Impaired Loans and Foreclosed Real Estate
(in thousands)
December 31, 2020 December 31, 2019
Impaired loans
Level 1 Inputs $ - $ -
Level 2 Inputs - -
Level 3 Inputs 8,899 3,980
Total $ 8,899 $ 3,980
Foreclosed real estate
Level 1 Inputs - -
Level 2 Inputs - -
Level 3 Inputs 3,326 2,384
Total $ 3,326 $ 2,384
The following table provides information describing the unobservable inputs used in Level 3 fair value measurements at December 31, 2020 and 2019:
Inputs
Valuation Technique Unobservable Inputs General Range of Inputs
Impaired Loans Appraised Value/Discounted Cash Flows Discounts to appraisals or cash flows for estimated holding and/or selling costs 0 - 25%
Foreclosed Real Estate Appraised Value/Comparable Sales Discounts to appraisals for estimated holding and/or selling costs 0 - 25%
Fair value of financial instruments
Fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practical to estimate the value is based upon the characteristics of the instruments and relevant market information. Financial instruments include cash, evidence of ownership in an entity, or contracts that convey or impose on an entity that contractual right or obligation to either receive or deliver cash for another financial instrument.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 18 - Fair Value (continued)
The information used to determine fair value is highly subjective and judgmental in nature and, therefore, the results may not be precise. Subjective factors include, among other things, estimates of cash flows, risk characteristics, credit quality, and interest rates, all of which are subject to change. Since the fair value is estimated as of the balance sheet date, the amounts that will actually be realized or paid upon settlement or maturity on these various instruments could be significantly different.
As of December 31, 2020, the technique used by the Company to estimate the exit price of the loan portfolio consists of similar procedures to those used as of December 31, 2019, but with added emphasis on both illiquidity risk and credit risk not captured by the previously applied entry price notion. The fair value of the Company’s loan portfolio has always included a credit risk assumption in the determination of the fair value of its loans. This credit risk assumption is intended to approximate the fair value that a market participant would realize in a hypothetical orderly transaction. The Company’s loan portfolio is initially fair valued using a segmented approach. The Company divides its loan portfolio into the following categories: variable rate loans, impaired loans, and all other loans. The results are then adjusted to account for credit risk as described above. However, under the new guidance, the Company believes a further credit risk discount must be applied through the use of a discounted cash flow model to compensate for illiquidity risk, based on certain assumptions included within the discounted cash flow model, primarily the use of discount rates that better capture inherent credit risk over the lifetime of a loan. This consideration of enhanced credit risk provides an estimated exit price for the Company’s loan portfolio.
For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values approximate carrying values. Fair values for impaired loans are estimated using discounted cash flow models or based on the fair value of the underlying collateral.
The fair value of cash and cash equivalents, interest bearing deposits at other financial institutions, federal funds sold and restricted investments is the carrying amount. Restricted stock includes equity of the Federal Reserve and other banker’s banks.
The fair value of noninterest bearing deposits and securities sold under agreements to repurchase is the carrying amount.
The fair value of checking and savings deposits, and money market accounts, is the amount payable on demand at the reporting date. Fair value of fixed maturity term accounts and individual retirement accounts is estimated using rates currently offered for accounts of similar remaining maturities.
The fair value of certificates of deposit in other financial institutions is estimated based on interest rates currently offered for deposits of similar remaining maturities.
The fair value of borrowings is estimated by discounting the value of contractual cash flows using current market rates for borrowings with similar terms and remaining maturities.
The fair value of outstanding loan commitments, unused lines of credit, and letters of credit are not included in the table since the carrying value generally approximates fair value. These instruments generate fees that approximate those currently charged to originate similar commitments.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 18 - Fair Value (continued)
The table below presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments (in thousands).
Fair Value of Financial Assets and Liabilities
December 31, 2020 December 31, 2019
(in thousands) Carrying Amount Fair Value Carrying Amount Fair Value
Financial assets
Level 1
Cash and due from banks
$ 18,456 $ 18,456 $ 10,530 $ 10,530
Interest bearing deposits at other financial institutions
126,081 126,081 102,447 102,447
Federal funds sold
2,373 2,373 1,847 1,847
Restricted investments
3,958 3,958 3,966 3,966
Level 3
Loans receivable, net
$ 1,493,086 $ 1,499,073 $ 1,156,934 $ 1,155,922
Financial liabilities
Level 1
Noninterest-bearing deposits
$ 608,559 $ 608,559 $ 291,777 $ 291,777
Level 3
Interest-bearing deposits
$ 1,043,569 $ 1,048,728 $ 933,644 $ 934,349
FHLB advances and other borrowed funds
36,016 37,067 47,645 47,678
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 19 - Segments
The Company’s reportable segments represent product line divisions and are viewed separately for strategic planning purposes by management. The four segments include Commercial Banking, Capital Bank Home Loans (the Company’s mortgage loan division), and OpenSky® (the Company’s credit card division) and the Corporate Office. The following schedule presents financial information for each reportable segment at December 31, 2020.
Segments
(in thousands) Commercial Bank CBHL OpenSky® Corporate Eliminations Consolidated
Interest income $ 66,373 $ 2,611 $ 25,907 $ 2,481 $ (121) $ 97,251
Interest expense 10,396 1,691 - 1,216 (121) 13,182
Net interest income 55,977 920 25,907 1,265 - 84,069
Provision for loan losses 9,461 - 1,681 100 - 11,242
Noninterest income 822 43,250 16,966 23 - 61,061
Noninterest expense(1)
35,790 27,530 35,013 418 - 98,751
Net income before taxes $ 11,548 $ 16,640 $ 6,179 $ 770 $ - $ 35,137
Total assets $ 1,624,280 $ 107,507 $ 113,244 $ 178,569 $ (147,006) $ 1,876,593
_______________
(1)Noninterest expense includes $10.9 million in commissions expense in CBHL’s segment and $24.5 million in data processing in Open Sky’s segment.
Note 20 - Litigation
The Company is involved in legal proceedings occurring in the ordinary course of business. The aggregate effect of these, in management’s opinion, would not be material to the results of operations or financial condition of the Company.
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2020 and 2019
Note 21 - Quarterly Results of Operations (unaudited)
The following table presents condensed unaudited information relating to quarterly periods in 2020 and 2019.
Quarterly Results of Operations
(in thousands)
2020 2019
Dec 31 Sept 30 Jun 30 Mar 31 Dec 31 Sept 30 Jun 30 Mar 31
Interest Income $ 28,318 $ 25,189 $ 22,000 $ 21,744 $ 21,219 $ 22,354 $ 20,289 $ 18,318
Interest Expense 2,599 3,150 3,376 4,057 4,339 4,170 3,758 3,574
Net Interest Income 25,719 22,039 18,624 17,687 16,880 18,184 16,531 14,744
Provision for Loan Losses 2,033 3,500 3,300 2,409 921 1,071 677 121
Noninterest Income 19,437 21,146 13,899 6,579 8,453 7,221 5,927 4,092
Noninterest Expense 30,086 28,119 22,703 17,843 17,757 18,228 16,210 14,330
Income Before Provision for Income Taxes 13,037 11,566 6,520 4,014 6,654 6,106 5,571 4,385
Provision for Income Taxes 3,347 3,128 1,759 1,080 1,581 1,625 1,548 1,066
Net Income $ 9,690 $ 8,438 $ 4,761 $ 2,934 $ 5,073 $ 4,481 $ 4,023 $ 3,319
Basic earnings per common share $ 0.71 $ 0.61 $ 0.34 $ 0.21 $ 0.37 $ 0.33 $ 0.30 $ 0.24
Diluted earnings per common share $ 0.71 $ 0.61 $ 0.34 $ 0.21 $ 0.36 $ 0.32 $ 0.29 $ 0.24
Note 22 - Subsequent Events
Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Non-recognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.

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ITEM 9A. CONTROLS AND PROCEDURES
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Company’s management, including our Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e)) under the Exchange Act as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act is (i) recorded, processed, summarized and reported as and when required and (ii) accumulated and communicated to our management, including our Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Report by Management on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining an effective system of internal control over financial reporting. The Company’s system of internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. There are inherent limitations in the effectiveness of any system of internal control over financial reporting, including the possibility of human error and circumvention or overriding of controls. Accordingly, even an effective system of internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
Management has assessed the Company’s internal control over financial reporting as of December 31, 2020 This assessment was based on criteria for effective internal control over financial reporting described in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that, as of December 31, 2020, the Company maintained effective internal control over financial reporting based on those criteria.
Elliott Davis, PLLC, the independent registered public accounting firm, audited the consolidated financial statements of the Company included in this Annual Report on Form 10-K. Their report is included in Part II, Item 8. Financial Statements and Supplementary Data under the heading “Report of Independent Registered Public Accounting Firm.” The Annual Report on Form 10-K does not include an attestation report on the Company’s internal control over financial reporting from the Company’s independent registered public accounting firm due to the transition period established by the SEC for an Emerging Growth Company.
Changes in Internal Control over Financial Reporting
There has been no change in the Company’s internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) during the fourth quarter of 2020 to which this report relates 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.
PART III

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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this Item with respect to our directors and certain corporate governance practices is contained in our Proxy Statement for our 2021 Annual Meeting of Shareholders (the “Proxy Statement”) to be filed with the SEC within 120 days after the end of the Company’s fiscal year ended December 31, 2020. Such information is incorporated herein by reference.

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ITEM 11. EXECUTIVE COMPENSATION
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by reference to our Proxy Statement to be filed with the SEC within 120 days after the end of the Company’s fiscal year ended December 31, 2020.

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this Item regarding security ownership of certain beneficial owners and management is incorporated by reference to our Proxy Statement to be filed with the SEC within 120 days after the end of the Company’s fiscal year ended December 31, 2020.
Information relating to securities authorized for issuance under the Company’s equity compensation plans is included in Part II of this Annual Report on Form 10-K under “Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities.”

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is incorporated herein by reference to our Proxy Statement to be filed with the SEC within 120 days after the end of the Company’s fiscal year ended December 31, 2020.

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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item is incorporated herein by reference to our Proxy Statement to be filed with the SEC within 120 days after the end of the Company’s fiscal year ended December 31, 2020.
PART IV

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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1), (2) and (c) The following financial statements are incorporated by reference from Item 8 hereof:
Report of Independent Registered Public Accounting Firm.
Consolidated Balance Sheets as of December 31, 2020 and 2019.
Consolidated Statements of Income for the Years Ended December 31, 2020 and 2019.
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2020 and 2019.
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2020 and 2019.
Consolidated Statements of Cash Flows for the Years Ended December 31, 2020 and 2019.
Notes to Consolidated Financial Statements.
(a)(3) and (b) Exhibits required to be filed by Item 601 of Regulation S-K.
INDEX TO EXHIBITS
Exhibit Number Description
3.1 Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the Company’s Form S-1 filed on August 31, 2018)
3.2 Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to the Company’s Form S-1 filed on August 31, 2018)
4.1 Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the Company’s Form S-1/A filed on September 17, 2018)
4.2 Long-term borrowing instruments are omitted pursuant to Item 601(b)(4)(iii) of Regulation S-K. The Company undertakes to furnish copies of such instruments to the SEC upon request.
10.1 Capital Bancorp, Inc. 2017 Stock and Incentive Compensation Plan (incorporated by reference to Exhibit 10.1 to the Company’s Form S-1 filed on August 31, 2018)
10.2 Form of Restricted Stock Award Agreement under the Capital Bancorp, Inc. 2017 Stock and Incentive Compensation Plan (incorporated by reference to Exhibit 10.2 to the Company’s Form S-1/A filed on September 17, 2018)
10.3 Form of Restricted Stock Unit Award Agreement under the Capital Bancorp, Inc. 2017 Stock and Incentive Compensation Plan (incorporated by reference to Exhibit 10.3 to the Company’s Form S-1/A filed on September 17, 2018)
10.4 Form of Incentive Stock Option Award Agreement under the Capital Bancorp, Inc. 2017 Stock and Incentive Compensation Plan (incorporated by reference to Exhibit 10.4 to the Company’s Form S-1/A filed on September 17, 2018)
10.5 Form of Non-Qualified Stock Option Award Agreement under the Capital Bancorp, Inc. 2017 Stock and Incentive Compensation Plan (incorporated by reference to Exhibit 10.5 to the Company’s Form S-1/A filed on September 17, 2018)
10.6 Form of Stock Appreciation Right Award Agreement under the Capital Bancorp, Inc. 2017 Stock and Incentive Compensation Plan (incorporated by reference to Exhibit 10.6 to the Company’s Form S-1/A filed on September 17, 2018)
10.7 Employment Agreement, effective January 1, 2019, by and among Capital Bancorp, Inc., Capital Bank, N.A. and Edward F. Barry (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed on January 10, 2019)
10.8 Employment Agreement dated January 1, 2013 between Capital Bank, N.A. and Scot R. Browning (incorporated by reference to Exhibit 10.7 to the Company’s Form S-1 filed on August 31, 2018)
10.9 Employment Contract, dated November 17, 2017, by and among Capital Bancorp, Inc., Capital Bank, N.A. and Alan W. Jackson (incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2019, filed on May 14, 2019)
10.1 Employment Contract, dated April 30, 2018, by and among Capital Bank, N.A. and Karl F. Dicker (incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2020, filed on May 11, 2020)
21.0 Subsidiaries of Capital Bancorp, Inc. (reference is made to “Item 1. Business” for the required information)
23.1 Consent of Elliott Davis, PLLC
31.1 Rule 13a-14(a) Certification of the Principal Executive Officer
31.2 Rule 13a-14(a) Certification of the Principal Financial Officer
32 Section 1350 Certification of Chief Executive Officer and Chief Financial Officer
101 The following materials from the Annual Report on Form 10-K of Capital Bancorp, Inc. for the year ended December 31, 2020, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statement of Changes in Shareholders’ Equity, (v) Consolidated Statements of Cash Flows and (vi) Notes to Unaudited Consolidated Financial Statements.
104 Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)