OLD POINT FINANCIAL CORPORATION
FORM 10-K
INDEX
| PART I | | Page |
| | | |
| Item 1. | | 3 |
| Item 1A. | | 11 |
| Item 1B. | | 21 |
| Item 2. | | 21 |
| Item 3. | | 21 |
| Item 4. | | 21 |
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| PART II | | |
| | | |
| Item 5. | | 23 |
| Item 6. | | 23 |
| Item 7. | | 23 |
| Item 7A. | | 39
|
| Item 8. | | 39
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| Item 9. | | 77
|
| Item 9A. | | 77
|
| Item 9B. | | 78
|
| Item 9C. | | 78
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| | | |
| PART III | | |
| | | |
| Item 10. | | 78
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| Item 11. | | 78
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| Item 12. | | 78
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| Item 13. | | 79
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| Item 14. | | 79
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| | | |
| PART IV | | |
| | | |
| Item 15. | | 79
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| | | 79
|
| | | 80 |
| Item 16. | | 81 |
| | | 82 |
GLOSSARY OF DEFINED TERMS
| 2021 Form 10-K | Annual Report on Form 10-K for the year ended December 31, 2021 |
| ALLL | Allowance for Loan and Lease Losses |
| ASC | Accounting Standards Codification |
| ASU | Accounting Standards Update |
| Bank | The Old Point National Bank of Phoebus |
| BHCA | The Bank Holding Company Act, of 1956, as amended |
| The CARES Act | The Coronavirus Aid, Relief, and Economic Security Act |
| CET1 | Common Equity Tier 1 |
| Citizens | Citizens National Bank |
| Company | Old Point Financial Corporation and its subsidiaries |
| CBB | Community Bankers Bank |
| CBLRF | Community Bank Leverage Ratio Framework |
| COVID-19 | Novel coronavirus disease 2019 |
| EGRRCPA | Economic Growth, Regulatory Relief, and Consumer Protection Act |
| EPS | earnings per share |
| ESPP | Employee Stock Purchase Plan |
| Exchange Act | Securities Exchange Act of 1934, as amended |
| FASB | Financial Accounting Standards Board |
| FDIC | Federal Deposit Insurance Corporation |
| FHLB | Federal Home Loan Bank |
| Federal Reserve | Board of Governors of the Federal Reserve System |
| FRB | Federal Reserve Bank |
| GAAP | Generally Accepted Accounting Principles |
| Incentive Stock Plan | Old Point Financial Corporation 2016 Incentive Stock Plan |
| NIM | Net Interest Margin |
| Notes | The Company’s 3.50% fixed-to-floating rate subordinated notes due 2031 |
| OAEM | Other Assets Especially Mentioned |
| OREO | Other Real Estate Owned |
| PPP | Paycheck Protection Program |
| PPPLF | Paycheck Protection Program Liquidity Facility |
| SEC | Securities and Exchange Commission |
| SBA | Small Business Administration |
| SOFR | Secured overnight financing rate |
| TDR | Troubled Debt Restructuring |
| Wealth | Old Point Trust & Financial Services N.A. |
Cautionary Statement Regarding Forward-Looking Statements
This report contains statements concerning the Company’s expectations, plans, objectives or beliefs regarding future financial performance and other statements that are not historical facts. These statements may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on the beliefs of the Company’s management, as well as estimates and assumptions made by, and information currently available to, management. These statements are inherently uncertain, and there can be no assurance that the underlying beliefs, estimates, or assumptions will prove to be accurate. Actual results, performance, achievements, or trends could differ materially from historical results or those anticipated by such statements. Forward-looking statements in this Annual Report on Form 10-K may include, without limitation: statements regarding expected future operations and financial performance; current and future interest rate levels and fluctuations and potential impacts on the Company’s NIM; changes in economic conditions; performance of loan and securities portfolios; asset quality; future levels of the allowance for loan losses and the provision for loan losses; management’s belief regarding liquidity and capital resources; the Company’s technology and efficiency initiatives and anticipated completion timelines; changes in net interest margin and items affecting net interest margin; expected future recovery of investments in debt securities; expected impact of unrealized losses on earnings and regulatory capital of the Company or the Bank; asset quality; adequacy of allowances for loan losses and the level of future chargeoffs; liquidity and capital levels; cybersecurity risks; inflation; the effect of future market and industry trends.
These forward-looking statements are subject to significant risks and uncertainties due to factors that could have a material adverse effect on the operations and future prospects of the Company including, but not limited to, changes in:
| • | interest rates, such as increases or volatility in short-term interest rates or yields on U.S. Treasury bonds and increases or volatility in mortgage interest rates, and the impacts on macroeconomic conditions, customer and client behavior, the Company’s funding costs, and the Company’s loan and securities portfolios |
| • | inflation and its impacts on economic growth and customer and client behavior |
| • | general business conditions, as well as conditions within the financial markets |
| • | general economic conditions, including unemployment levels, supply chain disruptions, higher inflation, slowdowns in economic growth, and continuing economic impacts of the COVID-19 pandemic |
| • | monetary and fiscal policies of the U.S. Government, including policies of the U.S. Department of the Treasury and the Board of Governors of the Federal Reserve System (the Federal Reserve), the effect of these policies on interest rates and business in our markets and any changes associated with the current administration |
| • | the quality or composition of the loan or securities portfolios and changes therein |
| • | the value of securities held in the Company’s investment portfolios |
| • | the Company’s technology, efficiency, and other strategic initiatives |
| • | the legislative/regulatory climate, regulatory initiatives with respect to financial institutions, products and services, the Consumer Financial Protection Bureau (the CFPB) and the regulatory and enforcement activities of the CFPB |
| • | future levels of government defense spending particularly in the Company’s service areas |
| • | uncertainty over future federal spending or budget priorities, particularly in connection with the Department of Defense, on the Company’s service areas |
| • | the impact of potential changes in the political landscape and related policy changes, including monetary, regulatory and trade policies |
| • | the U. S. Government’s guarantee of repayment of student or small business loans purchased by the Company |
| • | potential claims, damages and fines related to litigation or government actions |
| • | demand for loan products and the impact of changes in demand on loan growth |
| • | changes in the volume and mix of interest-earning assets and interest-bearing liabilities |
| • | the effects of management’s investment strategy and strategy to manage the NIM |
| • | the level of net charge-offs on loans and the adequacy of our ALLL |
| • | performance of the Company’s dealer lending program |
| • | the Company’s branch realignment initiatives |
| • | the strength of the Company’s counterparties |
| • | competition from both banks and non-banks |
| • | demand for financial services in the Company’s market area |
| • | implementation of new technologies |
| • | the Company’s ability to develop and maintain secure and reliable electronic systems |
| • | any interruption or breach of security in the Company’s information systems or those of the Company’s third-party vendors or their service providers |
| • | reliance on third parties for key services |
| • | cyber threats, attacks or events |
| • | the impact of changes in the political landscape and related policy changes, including monetary, regulatory, and trade policies |
| • | potential adverse effects of unusual and infrequently occurring events, such as weather-related disasters, terrorist acts, financial crises, political crises, war and other geopolitical conflicts, such as the war between Russia and Ukraine, or public health events, such as the COVID-19 pandemic, and of governmental and societal responses thereto, on, among other things, the Company’s operations, liquidity and credit quality |
| • | the use of inaccurate assumptions in management’s modeling systems |
| • | technological risks and developments |
| • | the commercial and residential real estate markets |
| • | the demand in the secondary residential mortgage loan markets |
| • | expansion of the Company’s product offerings |
| • | effectiveness of expense reduction plans |
| • | changes in accounting principles, standards, rules and interpretations and elections made by the Company thereunder, and the related impact on the Company’s financial statements. |
These risks and uncertainties, and the factors discussed in more detail in Item 1A. “Risk Factors,” should be considered in evaluating the forward-looking statements contained herein. Forward-looking statements generally can be identified by the use of words such as “believe,” “expect,” “anticipate,” “estimate,” “plan,” “may,” “will,” “intend,” “should,” “could,” or similar expressions, are not statements of historical fact. Readers are cautioned not to place undue reliance on such statements. Any forward-looking statement speaks only as of the date on which it is made, and the Company does not intend or assume any obligation to update, revise or clarify any forward-looking statements that may be made from time-to-time or on behalf of the Company, whether as a result of new information, future events or otherwise, except as otherwise required by law. In addition, past results of operations are not necessarily indicative of future results.
Part I
GENERAL
Old Point Financial Corporation (the Company) was incorporated under the laws of Virginia on February 16, 1984, for the purpose of acquiring all the outstanding common stock of The Old Point National Bank of Phoebus (the Bank), in connection with the reorganization of the Bank into a one-bank holding company structure. At the annual meeting of the stockholders on March 27, 1984, the proposed reorganization was approved by the requisite stockholder vote. At the effective date of the reorganization on October 1, 1984, the Bank merged into a newly formed national bank as a wholly-owned subsidiary of the Company, with each outstanding share of common stock of the Bank being converted into five shares of common stock of the Company.
The Company completed a spin-off of its trust department as of April 1, 1999. The organization is chartered as Old Point Trust & Financial Services, N.A. (Wealth). Wealth is a nationally chartered trust company. The purpose of the spin-off was to have a corporate structure more ready to compete in the field of wealth management. Wealth is a wholly-owned subsidiary of the Company.
The Bank is a national banking association that was founded in 1922. As of the end of 2022, the Bank had 14 branch offices, serving the Hampton Roads localities of Hampton, Newport News, Norfolk, Virginia Beach, Chesapeake, Williamsburg/James City County, York County and Isle of Wight County. The Bank offers a complete line of consumer, mortgage and business banking services, including loan, deposit, and cash management services to individual and commercial customers.
The Company’s primary activity is as a holding company for the common stock of the Bank and Wealth. The principal business of the Company is conducted through its subsidiaries.
As of December 31, 2022, the Company had assets of $1.4 billion, gross loans of $1.0 billion, deposits of $1.2 billion, and stockholders’ equity of $98.7 million.
Human Capital Resources
The Company strives to foster a culture of respect, teamwork, ownership, responsibility, initiative, integrity, and service and believes our officers and employees are our most important assets. We believe our people are critical to the Company’s performance and the achievement of our strategic goals, and they represent a key element of how the Company’s businesses compete and succeed.
Acquiring and retaining strong talent is a top strategic priority for the Company. We provide a competitive compensation and benefits program to help meet the needs of our employees, including benefits that incentivize retention and reward longevity. We support the health and well-being of our employees through a comprehensive program designed to increase employee focus on wellness and prevention, including through the benefit plans and health incentives offered. We work to encourage and support the growth and development of our employees and, wherever possible, seek to fill positions by promotion and transfer from within the Company. We have created development plans that are designed to encourage an employee’s advancement and growth within our organization, and we aim to provide employees with the skills and opportunities needed to achieve their goals and become leaders in our businesses.
At December 31, 2022, the Company employed 296, or 294 full-time equivalent, employees. We consider relations with our employees to be strong. We strive for our workforce to reflect the diversity of the customers and communities we serve. Our selection and promotion processes are merit-based and include the active recruitment of minorities and women. At December 31, 2022, women represented 72% of our employees, and racial and ethnic minorities represented 28% percent of our employees. We also aim for our employees to develop their careers in our businesses. At December 31, 2022, 23% percent of our employees have been employed by the Company for at least 15 years.
MARKET AREA AND COMPETITION
The Company’s primary market area is located in Hampton Roads, situated in the southeastern corner of Virginia and boasting the world’s largest natural deepwater harbor. The Hampton Roads Metropolitan Statistical Area (MSA) is the 37th most populous MSA in the United States according to the U.S. Census Bureau’s 2020 census and the 3rd largest deposit market in Virginia, after Richmond and the Washington Metropolitan area, according to the Federal Deposit Insurance Corporation (FDIC). Hampton Roads includes the cities of Chesapeake, Hampton, Newport News, Norfolk, Poquoson, Portsmouth, Suffolk, Virginia Beach and Williamsburg, and the counties of Isle of Wight, Gloucester, James City, Mathews, York and Surry. The financial services industry remains highly competitive and is constantly evolving. The Company experiences strong competition from national, regional and other community financial institutions and credit unions, as well as finance companies, mortgage companies, wealth management companies, insurance companies, and fintech companies. The market area is serviced by 52 banks, savings institutions and credit unions and, in addition, branches of virtually every major brokerage house serve the Company’s market area. The Company continues to build a stronger presence, expanding into additional markets in the last three years, which include a Mortgage team based in Charlotte, North Carolina and a commercial loan production office based in Richmond, Virginia.
The banking business in Virginia, and in the Company’s primary service areas in the Hampton Roads MSA, is highly competitive and dominated by a relatively small number of large banks with many offices operating over a wide geographic area. As a result, the Bank faces intense competition in all areas of its business. Among the advantages such large banks have over the Company is their ability to finance wide-ranging advertising campaigns, and by virtue of their greater total capitalization, to have substantially higher lending limits than the Company. Factors such as interest rates offered, the number and location of branches and the types of products offered, as well as the reputation of the institution affect competition for deposits and loans. The Company competes by emphasizing customer service and technology, establishing long-term customer relationships and building customer loyalty, and providing products and services to address the specific needs of the Company’s customers. The Company targets individual and small-to-medium size business customers which generally establishes a more durable deposit base. Competition among providers of financial products and services continues to increase as technology advances have lowered the barriers to entry for financial technology companies, with customers having the opportunity to select from a growing variety of traditional and nontraditional alternatives, and from a growing selection of products and services at banking institutions that are based on new financial technology. The ability of non-banking financial institutions to provide services previously limited to commercial banks has intensified competition. Because nonbank financial institutions are not subject to the same regulatory restrictions as banks and bank holding companies, they can often operate with greater flexibility and lower cost structures. The Company also faces competitive pressure from large credit unions in the area.
Wealth faces intense competition in all aspects and areas of its business from both regulated and unregulated financial services organizations, including a broad range of financial institutions, investment firms, benefits consultants, wealth companies, insurance companies, investment counseling firms, and various financial technology companies. Because Wealth focuses on managing client investment assets to generate fee income, Wealth faces significant competition from financial technologies that offer products and services that automate asset management or asset selection and, in turn, may charge lower asset management or administrative fees. Wealth’s non-bank competitors are not subject to the same regulatory restrictions as Wealth, and therefore may be able to operate with greater flexibility and lower cost structures. Wealth competes by emphasizing proactive, holistic solutions and top-tier client service, and focuses on developing client relationships that serve as a source of recurring fee-based income.
The Company continues to build a strong presence in the business banking market, as well as expanding into other fee-based lines of business. In 2017, the Company purchased full ownership of Old Point Mortgage, LLC and launched Old Point Insurance, LLC. Through these comprehensive business services and new lines of business, the Company is able to service a lucrative market that offers increased opportunities for new fee-based revenue streams and to cross sell additional products.
AVAILABLE INFORMATION
The Company maintains a website on the Internet at www.oldpoint.com. The Company makes available free of charge, on or through its website, its proxy statements, annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission (SEC). This reference to the Company’s Internet address shall not, under any circumstances, be deemed to incorporate the information available at such Internet address into this Form 10-K or other SEC filings. The information available at the Company’s Internet address is not part of this Form 10-K or any other report filed by the Company with the SEC. The Company’s SEC filings can also be obtained on the SEC’s website on the Internet at www.sec.gov.
REGULATION AND SUPERVISION
General. Bank holding companies, banks and their affiliates are extensively regulated under both federal and state law. The following summary briefly describes significant provisions of currently applicable federal and state laws and certain regulations, proposed regulations, and the potential impact of such provisions. This summary is not complete and is qualified in its entirety by reference to the particular statutory or regulatory provisions or proposals. Because regulation of financial institutions changes regularly and is the subject of constant legislative and regulatory debate, no assurance can be given as to how federal and state regulation and supervision of financial institutions may change in the future and affect the Company’s, the Bank’s and Wealth’s operations.
As a public company, the Company is subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended (the Exchange Act), which include, but are not limited to, the filing of annual, quarterly and other reports with the SEC. The Company is also required to comply with other laws and regulations of the SEC applicable to public companies.
As a national bank, the Bank is subject to regulation, supervision and regular examination by the Office of the Comptroller of the Currency (the Comptroller). The prior approval of the Comptroller or other appropriate bank regulatory authority is required for a national bank to merge with another bank or purchase the assets or assume the deposits of another bank. In reviewing applications seeking approval of merger and acquisition transactions, the bank regulatory authorities will consider, among other things, the competitive effect and public benefits of the transactions, the capital position of the constituent organizations and the combined organization, the risks to the stability of the U.S. banking or financial system, the applicant’s performance record under the Community Reinvestment Act (the CRA) and fair housing initiatives, the data security and cybersecurity infrastructure of the constituent organizations and the combined organization, and the effectiveness of the subject organizations in combating money laundering activities. Each depositor’s account with the Bank is insured by the FDIC to the maximum amount permitted by law. The Bank is also subject to certain regulations promulgated by the FRB and applicable provisions of Virginia law, insofar as they do not conflict with or are not preempted by federal banking law.
As a non-depository national banking association, Wealth is subject to regulation, supervision and regular examination by the Comptroller. Wealth’s exercise of fiduciary powers must comply with regulations promulgated by the Comptroller at 12 C.F.R. Part 9 and with Virginia law.
The regulations of the FRB, the Comptroller and the FDIC govern most aspects of the Company’s business, including deposit reserve requirements, investments, loans, certain check clearing activities, issuance of securities, payment of dividends, branching, and numerous other matters. Further, the federal bank regulatory agencies have adopted guidelines and released interpretive materials that establish operational and managerial standards to promote the safe and sound operation of banks and bank holding companies. These standards relate to the institution’s key operating functions, including but not limited to internal controls, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings, compensation of management, information systems, data security and cybersecurity, and risk management. As a consequence of the extensive regulation of commercial banking activities in the United States, the Company’s business is particularly susceptible to changes in state and federal legislation and regulations, which may have the effect of increasing the cost of doing business, limiting permissible activities or increasing competition.
As a bank holding company, the Company is subject to the BHCA and regulation and supervision by the FRB. A bank holding company is required to obtain the approval of the FRB before making certain acquisitions or engaging in certain activities. Bank holding companies and their subsidiaries are also subject to restrictions on transactions with insiders and affiliates.
A bank holding company is required to obtain the approval of the FRB before it may acquire all or substantially all of the assets of any bank, and before it may acquire ownership or control of the voting shares of any bank if, after giving effect to the acquisition, the bank holding company would own or control more than 5 percent of the voting shares of such bank. The approval of the FRB is also required for the merger or consolidation of bank holding companies.
As a Virginia bank holding company, the Company is subject to the bank holding company laws of Virginia and is subject to regulation and supervision by the Virginia State Corporation Commission (the Virginia SCC). Applicable Virginia bank holding company laws generally limit the activities of a bank holding company to managing or controlling banks, or any other activity that is closely related to managing or controlling banks, and applicable Virginia law requires prior notice to the Virginia SCC before a bank holding company may acquire more than 5% of the shares of, or otherwise gain control of, any entity other than a bank, bank holding company or other financial institution.
On July 9, 2021, President Biden issued an Executive Order on Promoting Competition in the American Economy, which, among other initiatives, encouraged the review of current practices and adoption of a plan for the revitalization of merger oversight under the BHCA and the Bank Merger Act. On March 25, 2022, the FDIC published a Request for Information, seeking information and comments regarding the regulatory framework that applies to merger transactions involving one or more insured depository institution. Making any formal changes to the framework for evaluating bank mergers would require an extended process, and any such changes are uncertain and cannot be predicted at this time. However, the adoption of more expansive or stringent standards may have an impact on the Company’s acquisition activity. Additionally, this Executive Order could influence the federal bank regulatory agencies’ expectations and supervisory oversight for banking acquisitions.
Pursuant to the BHCA, the FRB has the power to order any bank holding company or its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when the FRB has reasonable grounds to believe that continuation of such activity or ownership constitutes a serious risk to the financial soundness, safety or stability of any bank subsidiary of the bank holding company.
The Company is required to file periodic reports with the FRB and provide any additional information the FRB may require. The FRB also has the authority to examine the Company and its subsidiaries, as well as any arrangements between the Company and its subsidiaries, with the cost of any such examinations to be borne by the Company. Banking subsidiaries of bank holding companies are also subject to certain restrictions imposed by federal law in dealings with their holding companies and other affiliates.
Regulatory Reform. Enacted in 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) implemented far-reaching changes across the financial regulatory landscape, including changes that have significantly affected the business of all bank holding companies and banks, including the Company and the Bank. Several provisions of the Dodd-Frank Act remain subject to further rulemaking, guidance and interpretation by the federal banking agencies; moreover, certain provisions of the Dodd-Frank Act that were implemented have been revised or rescinded pursuant to legislative changes adopted by the U.S. Congress.
In May 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the EGRRCPA) was enacted to reduce the regulatory burden on certain banking organizations, including community banks, by modifying or eliminating certain federal regulatory requirements. While the EGRRCPA maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain aspects of the regulatory framework for small depository institutions with assets of less than $10 billion as well as for larger banks with assets above $50 billion. In addition, the EGRRCPA included regulatory relief for community banks regarding regulatory examination cycles, call reports, application of the Volcker Rule (proprietary trading prohibitions), mortgage disclosures, qualified mortgages, and risk weights for certain high-risk commercial real estate loans. However, federal banking regulators retain broad discretion to impose additional regulatory requirements on banking organizations based on safety and soundness and U.S. financial system stability considerations.
The Company and the Bank continues to experience ongoing regulatory reform. These regulatory changes could have a significant effect on how the Company and the Bank conduct its business. The specific implications of the Dodd-Frank Act, the EGRRCPA, and other potential regulatory reforms cannot yet be fully predicted and will depend to a large extent on the specific regulations that are to be adopted in the future. Certain aspects of the Dodd-Frank Act and the EGRRCPA are discussed in more detail below.
Capital Requirements and Prompt Corrective Action. The FRB, the Comptroller and the FDIC have adopted risk-based capital adequacy guidelines for bank holding companies and banks pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) and the Basel III Capital Accords. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources” in Item 7 of this report on Form 10-K.
The federal banking agencies have broad powers to take prompt corrective action to resolve problems of insured depository institutions. Under the FDICIA, there are five capital categories applicable to bank holding companies and insured institutions, each with specific regulatory consequences. The extent of the agencies’ powers depends on whether the institution in question is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” These terms are defined under uniform regulations issued by each of the federal banking agencies. If the appropriate federal banking agency determines that an insured institution is in an unsafe or unsound condition, it may reclassify the institution to a lower capital category (other than critically undercapitalized) and require the submission of a plan to correct the unsafe or unsound condition.
Failure to meet statutorily mandated capital guidelines or more restrictive ratios separately established for a financial institution could subject the Company and its subsidiaries to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting or renewing brokered deposits, limitations on the rates of interest that the institution may pay on its deposits, and other restrictions on its business. In addition, an institution may not make a capital distribution, such as a dividend or other distribution that is in substance a distribution of capital to the owners of the institution if following such a distribution the institution would be undercapitalized. Thus, if the making of such dividend would cause the Bank to become undercapitalized, it could not pay a dividend to the Company. Based on the Bank’s current financial condition, the Company does not expect that this provision will have any impact on its ability to receive dividends from the Bank.
Basel III Capital Framework. The federal bank regulatory agencies have adopted rules to implement the Basel III capital framework as outlined by the Basel Committee on Banking Supervision and standards for calculating risk-weighted assets and risk-based capital measurements (collectively, the Basel III Capital Rules). For purposes of these capital rules, (i) common equity Tier 1 capital (CET1) consists principally of common stock (including surplus) and retained earnings; (ii) Tier 1 capital consists principally of CET1 plus non-cumulative preferred stock and related surplus, and certain grandfathered cumulative preferred stock and trust preferred securities; and (iii) Tier 2 capital consists of other capital instruments, principally qualifying subordinated debt and preferred stock, and limited amounts of an institution’s allowance for loan losses. Each regulatory capital classification is subject to certain adjustments and limitations, as implemented by the Basel III Capital Rules. The Basel III Capital Rules also establish risk weightings that are applied to many classes of assets held by community banks, including, importantly, applying higher risk weightings to certain commercial real estate loans.
The Basel III Capital Rules also include a requirement that banks maintain additional capital, or a capital conservation buffer (as described below), which is designed to absorb losses during periods of economic stress. The Basel III Capital Rules require banks to maintain (i) a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% CET1 ratio, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7%), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio, effectively resulting in a minimum Tier 1 capital ratio of 8.5%), (iii) a minimum ratio of total (that is, Tier 1 plus Tier 2) capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio, effectively resulting in a minimum total capital ratio of 10.5%) and (iv) a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average adjusted assets, subject to certain adjustments and limitations.
As of December 31, 2022 the Bank met all capital adequacy requirements under the Basel III Final Rules, including the capital conservation buffer.
Community Bank Leverage Ratio. As required by the EGRRCPA, the federal banking agencies have implemented the Community Bank Leverage Ratio Framework (the CBLRF), which is based on the ratio of a bank’s tangible equity capital to average total consolidated assets. To qualify for the CBLRF, a bank must have less than $10 billion in total consolidated assets, limited amounts of off-balance sheet exposures and trading assets and liabilities, and a leverage ratio greater than 9%. A bank that elects the CBLRF and has a leverage ratio greater than 9% will be considered to be in compliance with Basel III capital requirements and exempt from the complex Basel III calculations and will also be deemed “well capitalized” under Prompt Corrective Action regulations, discussed above. As of December 31, 2022, the Bank has not elected to opt into the CBLRF.
Small Bank Holding Company. The EGRRCPA also expanded the category of bank holding companies that may rely on the FRB’s Small Bank Holding Company Policy Statement by raising the maximum amount of assets a qualifying bank holding company may have from $1 billion to $3 billion. In addition to meeting the asset threshold, a bank holding company must not engage in significant nonbanking activities, not conduct significant off-balance sheet activities, and not have a material amount of debt or equity securities outstanding and registered with the SEC (subject to certain exceptions). The FRB may, in its discretion, exclude any bank holding company from the application of the Small Bank Holding Company Policy Statement if such action is warranted for supervisory purposes.
In August 2018, the FRB issued an interim final rule to apply the Small Bank Holding Company Policy Statement to bank holding companies with consolidated total assets of less than $3 billion. The policy statement, which, among other things, exempts certain bank holding companies from minimum consolidated regulatory capital ratios that apply to other bank holding companies. Under the interim final rule, the Company is not subject to regulatory capital requirements. The Bank remains subject to the regulatory capital requirements described above.
Insurance of Accounts, Assessments and Regulation by the FDIC. The Bank’s deposits are insured by the Deposit Insurance Fund (DIF) of the FDIC up to the standard maximum insurance amount for each deposit insurance ownership category. The basic limit on FDIC deposit insurance coverage is $250,000 per depositor. Under the Federal Deposit Insurance Act (FDIA), the FDIC may terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations as an insured institution, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC, subject to administrative and potential judicial hearing and review processes. The FDIC may also suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance if the institution has no tangible capital. If deposit insurance is terminated, the deposits at the institution at the time of termination, less subsequent withdrawals, shall continue to be insured for a period from six months to two years, as determined by the FDIC. Management is aware of no existing circumstances that could result in termination of the Bank’s deposit insurance.
The DIF is funded by assessments on banks and other depository institutions calculated based on average consolidated total assets less average tangible equity (defined as Tier 1 capital). As required by the Dodd-Frank Act, the FDIC has adopted a large-bank pricing assessment scheme, set a target “designated reserve ratio” (described in more detail below) of 2% for the DIF and, in lieu of dividends, provides for a lower assessment rate schedule when the reserve ratio reaches 2% and 2.5%. An institution’s assessment rate is based on a statistical analysis of financial ratios that estimates the likelihood of failure over a three-year period, which considers the institution’s weighted average CAMELS composite rating, and is subject to further adjustments including those related to levels of unsecured debt and brokered deposits (not applicable to banks with less than $10 billion in assets). At December 31, 2022, total base assessment rates for institutions that have been insured for at least five years with assets of less than $10 billion range from 1.5 to 30 basis points.
The Dodd-Frank Act transferred to the FDIC increased discretion with regard to managing the required amount of reserves for the DIF, or the “designated reserve ratio.” The FDIA requires that the FDIC consider the appropriate level for the designated reserve ratio on at least an annual basis. On October 18, 2022, the FDIC adopted a final rule to increase initial base deposit insurance assessment rate schedules uniformly by 2 basis points, beginning in the first quarterly assessment period of 2023. As a result of this final rule, the total base assessment rates beginning with the first assessment period of 2023 for institutions with less than $10 billion in assets that have been insured for at least five years range from 2.5 to 32 basis points. This increase in assessment rate schedules is intended to increase the likelihood that the reserve ratio reaches 1.35 percent by the statutory deadline of September 30, 2028. The new assessment rate schedules will remain in effect unless and until the reserve ratio meets or exceeds 2 percent. Progressively lower assessment rate schedules will take effect when the reserve ratio reaches 2 percent, and again when it reaches 2.5 percent.
The scope of FDIC deposit insurance is under review by federal banking regulators and the United States Congress, in light of bank failures that occurred during March 2023 and the decision made to extend FDIC deposit insurance coverage to all deposits (with some very limited exceptions) at such banks. Any changes to FDIC deposit insurance or its impact on the Company or on the DIF are uncertain and cannot be predicted at this time.
Incentive Compensation. The FRB, the Comptroller and the FDIC have issued regulatory guidance 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 FRB 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.” The findings will be included in reports of examination, and deficiencies will be incorporated into the organization’s supervisory ratings. 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 Dodd-Frank Act requires the federal banking agencies and the SEC to establish joint regulations or guidelines prohibiting incentive-based payment arrangements at specified regulated entities with at least $1 billion in total consolidated assets, that encourage inappropriate risks by providing an executive officer, employee, director, or principal shareholder with excessive compensation, fees or benefits that could lead to material financial loss to the entity. In 2016, the SEC and the federal banking agencies proposed rules that prohibit covered financial institutions (including bank holding companies and banks) from establishing or maintaining incentive-based compensation arrangements that encourage inappropriate risk taking by providing covered persons (consisting of senior executive officers and significant risk takers, as defined in the rules) with excessive compensation, fees or benefits that could lead to material financial loss to the financial institution. The proposed rules outline factors to be considered when analyzing whether compensation is excessive and whether an incentive-based compensation arrangement encourages inappropriate risks that could lead to material loss to the covered financial institution, and establishes minimum requirements that incentive-based compensation arrangements must meet to be considered to not encourage inappropriate risks and to appropriately balance risk and reward. The proposed rules also impose additional corporate governance requirements on the boards of directors of covered financial institutions and impose additional record-keeping requirements. The comment period for these proposed rules has closed and a final rule has not yet been published. If the rules are adopted as proposed, they will restrict the manner in which executive compensation is structured.
Federal Home Loan Bank of Atlanta. The Bank is a member of the Federal Home Loan Bank (FHLB) of Atlanta, which is one of 12 regional FHLBs that provide funding to their members for making housing loans as well as for affordable housing and community development loans. Each FHLB serves as a reserve, or central bank, for the members within its assigned region. Each FHLB makes loans to members in accordance with policies and procedures established by the Board of Directors of the FHLB. As a member, the Bank must purchase and maintain stock in the FHLB. Additional information related to the Bank’s FHLB stock can be found in Note 14, Fair Value Measurements of the Notes to Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data,” of this report on Form 10-K.
Community Reinvestment Act. The Company is subject to the requirements of the CRA, which imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of their local communities, including low and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions. A financial institution’s efforts in meeting community credit needs are currently assessed based on specified factors. These factors also are considered in evaluating mergers, acquisitions and applications to open a branch or facility. At its last evaluation in 2022, the Bank received an “Outstanding” CRA rating.
The federal bank regulatory agencies have issued a joint proposal to strengthen and modernize regulations issued under the CRA, including but not limited to, incorporating online and mobile banking, branchless banking and hybrid models into CRA assessment areas. However, making any formal changes to CRA regulations would require an extended process, and any such changes are uncertain and cannot be predicted at this time.
Confidentiality and Required Disclosures of Consumer Information. The Company and the Bank are subject to various laws and regulations that address the privacy of nonpublic personal financial information of consumers. The Gramm-Leach-Bliley Act and certain regulations issued thereunder protect against the transfer and use by financial institutions of consumer nonpublic personal information. A financial institution must provide to its customers, at the beginning of the customer relationship and annually thereafter, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. These privacy provisions generally prohibit a financial institution from providing a customer’s personal financial information to unaffiliated third parties unless the institution discloses to the customer that the information may be so provided and the customer is given the opportunity to opt out of such disclosure.
In August 2018, the CFPB published its final rule to update Regulation P pursuant to the amended Gramm-Leach-Bliley Act. Under this rule, certain qualifying financial institutions are not required to provide annual privacy notices to customers. To qualify, a financial institution must not share nonpublic personal information about customers except as described in certain statutory exceptions which do not trigger a customer’s statutory opt-out right. In addition, the financial institution must not have changed its disclosure policies and practices from those disclosed in its most recent privacy notice. The rule sets forth timing requirements for delivery of annual privacy notices in the event that a financial institution that qualified for the annual notice exemption later changes its policies or practices in such a way that it no longer qualifies for the exemption.
The Company is also subject to various laws and regulations that attempt to combat money laundering and terrorist financing. The Bank Secrecy Act requires all financial institutions to, among other things, create a system of controls designed to prevent money laundering and the financing of terrorism, and imposes recordkeeping and reporting requirements. The USA Patriot Act facilitates information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering, and requires financial institutions to establish anti-money laundering programs. Regulations adopted under the Bank Secrecy Act impose on financial institutions customer due diligence requirements, and the federal banking regulators expect that customer due diligence programs will be integrated within a financial institution’s broader Bank Secrecy Act and anti-money laundering compliance program. The Office of Foreign Assets Control (OFAC), which is a division of the U.S. Department of the Treasury, is responsible for helping to ensure that United States entities do not engage in transactions with “enemies” of the United States, as defined by various Executive Orders and Acts of Congress. If the Bank finds a name of an “enemy” of the United States on any transaction, account or wire transfer that is on an OFAC list, it must freeze such account or place transferred funds into a blocked account, file a suspicious activity report with the Treasury and notify the FBI.
These laws and programs impose compliance costs and create obligations and, in some cases, reporting obligations, and compliance with these laws, regulations, and obligations may require significant resources of the Company and the Bank.
Corporate Transparency Act. On January 1, 2021, as part of the 2021 National Defense Authorization Act, Congress enacted the Corporate Transparency Act (CTA). The CTA is a significant update to federal Bank Secrecy Act/Anti-money Laundering (BSA/AML) regulations. The CTA aims to eliminate the use of shell companies that facilitate the laundering of criminal proceeds and, for that purpose, directs the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) to establish and maintain a national registry of beneficial ownership information for corporate entities. The CTA imposes additional reporting requirements on entities not previously subject to such beneficial ownership disclosure regulations and also contains exemptions for several different types of entities, including among others: (i) certain banks, bank holding companies, and credit unions; (ii) money transmitting businesses registered with FinCEN; and (iii) certain insurance companies. Reporting companies subject to the CTA will be required to provide specific information with respect to beneficial owner(s) – defined as an individual who, directly or indirectly exercises substantial control over the entity or owns or controls not less than 25% of the ownership interests of the entity – as well as satisfy initial filing obligations (for newly-formed reporting companies) and submit on-going periodic reports. Non-compliance with FinCEN regulations promulgated under the CTA may result in civil fines as well as criminal penalties.
In December 2021, FinCEN proposed the first of the three sets of rules that it will issue. Thereafter, on September 29, 2022, FinCEN issued the final rule to implement the beneficial ownership reporting requirements of the CTA, which will be effective January 1, 2024. This rule does not apply to the Company. Subsequent rulemakings are expected (i) to implement the CTA’s protocols for access to and disclosure of beneficial ownership information, and (ii) to revise the existing customer due diligence requirements that apply to the Company, the Bank and many other financial institutions, to ensure consistency between these requirements and the beneficial ownership reporting rules. The Company will continue to monitor regulatory developments related to the CTA, including future FinCEN rulemakings, and will continue to assess the ultimate impact of the CTA on the Company. The Bank continues to evaluate the impact of this final rule on the Bank’s BSA/AML policies and procedures.
Cybersecurity. The federal banking agencies have adopted guidelines for establishing information security standards and cybersecurity programs for implementing safeguards under the supervision of a financial institution’s board of directors. These guidelines, along with related regulatory materials, increasingly focus on risk management and processes related to information technology and the use of third parties in the provision of financial products and services. The federal banking agencies expect financial institutions to establish lines of defense and ensure that their risk management processes also address the risk posed by compromised customer credentials, and also expect financial institutions to maintain sufficient business continuity planning processes to ensure rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack. If the Company, the Bank or Wealth fails to meet the expectations set forth in this regulatory guidance, the Company, the Bank or Wealth could be subject to various regulatory actions and any remediation efforts may require significant resources. In addition, all federal and state bank regulatory agencies continue to increase focus on cybersecurity programs and risks as part of regular supervisory exams.
On November 18, 2021, the federal bank regulatory agencies issued a final rule to improve the sharing of information about cyber incidents that may affect the U.S. banking system. The rule requires a banking organization to notify its primary federal regulator of any significant computer-security incident as soon as possible and no later than 36 hours after the banking organization determines that a cyber incident has occurred. Notification is required for incidents that have materially affected—or are reasonably likely to materially affect—the viability of a banking organization’s operations, its ability to deliver banking products and services, or the stability of the financial sector. In addition, the rule requires a bank service provider to notify affected banking organization customers as soon as possible when the provider determines that it has experienced a computer-security incident that has materially affected or is reasonably likely to materially affect banking organization customers for four or more hours. The rule became effective on May 1, 2022. With increased focus on cybersecurity, the Company, the Bank and Wealth continue to monitor related legislative, regulatory and supervisory developments.
Consumer Laws and Regulations. The Company is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. While the list set forth herein is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act and the Fair Housing Act, among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions transact business with customers. The Company must comply with the applicable provisions of these consumer protection laws and regulations as part of its ongoing customer relations.
The CFPB is the federal regulatory agency responsible for implementing, examining and enforcing compliance with federal consumer financial laws for institutions with more than $10 billion of assets and, to a lesser extent, smaller institutions. The CFPB supervises and regulates providers of consumer financial products and services and has rulemaking authority in connection with numerous federal consumer financial protection laws (for example, but not limited to, the Truth in Lending Act and the Real Estate Settlement Procedures Act). As a smaller institution (i.e., with assets of $10 billion or less), most consumer protection aspects of the Dodd-Frank Act will continue to be applied to the Company by the FRB and to the Bank and Wealth by the Comptroller. However, the CFPB may include its own examiners in regulatory examinations by a smaller institution’s prudential regulators and may require smaller institutions to comply with certain CFPB reporting requirements. In addition, regulatory positions taken by the CFPB and administrative and legal precedents established by CFPB enforcement activities, including in connection with supervision of larger bank holding companies and banks, could influence how the FRB and Comptroller apply consumer protection laws and regulations to financial institutions that are not directly supervised by the CFPB. The precise effect of the CFPB’s consumer protection activities on the Company cannot be forecast at this time. As of January 1, 2023, the Company and the Bank are not subject to the direct supervision of the CFPB.
Mortgage Banking Regulation. In connection with making mortgage loans, the Bank is subject to rules and regulations that, among other things, establish standards for loan origination, prohibit discrimination, provide for inspections and appraisals of property, require credit reports on prospective borrowers, in some cases, restrict certain loan features and fix maximum interest rates and fees, require the disclosure of certain basic information to mortgagors concerning credit and settlement costs, limit payment for settlement services to the reasonable value of the services rendered and require the maintenance and disclosure of information regarding the disposition of mortgage applications based on race, gender, geographical distribution and income level. The Bank’s mortgage origination activities are subject to the Equal Credit Opportunity Act, Truth in Lending Act, Home Mortgage Disclosure Act, Real Estate Settlement Procedures Act, and Home Ownership Equity Protection Act, and the regulations promulgated under these acts, among other state and federal laws, regulations and rules.
The Bank’s mortgage origination activities are also subject to Regulation Z, which implements the Truth in Lending Act. Certain provisions of Regulation Z require mortgage lenders to make a reasonable and good faith determination, based on verified and documented information, that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms. Alternatively, mortgage lenders can originate “qualified mortgages”, which are generally defined as mortgage loans without negative amortization, interest-only payments, balloon payments, terms exceeding 30 years, and points and fees paid by a consumer equal to or less than 3% of the total loan amount. Under the EGRRCPA, most residential mortgages loans originated and held in portfolio by a bank with less than $10 billion in assets will be designated as “qualified mortgages.” Higher-priced qualified mortgages (e.g., subprime loans) receive a rebuttable presumption of compliance with ability-to-repay rules, and other qualified mortgages (e.g., prime loans) are deemed to comply with the ability-to-repay rules. The Bank originates first mortgage loans that comply with Regulation Z’s “qualified mortgage” rules. The Bank also originates second mortgages, or equity loans, and these loans do not conform to the qualified mortgage criteria but comply with applicable ability-to-repay rules.
Volcker Rule. The Dodd-Frank Act prohibits bank holding companies and their subsidiary banks from engaging in proprietary trading except in limited circumstances, and places limits on ownership of equity investments in private equity and hedge funds (the Volcker Rule). The EGRRCPA, and final rules adopted to implement the EGRRCPA, exempt all banks with less than $10 billion in assets (including their holding companies and affiliates) from the Volcker Rule, provided that the institution has total trading assets and liabilities of five percent or less of total assets, subject to certain limited exceptions. The Company believes that its financial condition and its operations are not and will not be significantly affected by the Volcker Rule, amendments thereto, or its implementing regulations.
Call Reports and Examination Cycle. All institutions, regardless of size, submit a quarterly call report that includes data used by federal banking agencies to monitor the condition, performance, and risk profile of individual institutions and the industry as a whole. The EGRRCPA contained provisions expanding the number of regulated institutions eligible to use streamlined call report forms. In June 2019, consistent with the provisions of the EGRRCPA, the federal banking agencies issued a final rule to permit insured depository institutions with total assets of less than $5 billion that do not engage in certain complex or international activities to file the most streamlined version of the quarterly call report, and to reduce data reportable on certain streamlined call report submissions.
In December 2018, consistent with the provisions of the EGRRCPA, the federal banking agencies jointly adopted final rules that permit banks with up to $3 billion in total assets, that received a composite CAMELS rating of “1” or “2,” and that meet certain other criteria (including not having undergone any change in control during the previous 12-month period, and not being subject to a formal enforcement proceeding or order), to qualify for an 18-month on-site examination cycle.
Effect of Governmental Monetary Policies.
As with other financial institutions, the earnings of the Company and the Bank are affected by general economic conditions as well as by the monetary policies of the Federal Reserve Board. Such policies, which include regulating the national supply of bank reserves and bank credit, can have a major effect upon the source and cost of funds and the rates of return earned on loans and investments. The Federal Reserve Board exerts a substantial influence on interest rates and credit conditions, primarily through establishing target rates for federal funds, open market operations in U.S. Government securities, varying the discount rate on member bank borrowings and setting cash reserve requirements against deposits. Changes in monetary policy, including changes in interest rates, will influence the origination of loans, the purchase of investments, the generation of deposits, and rates received on loans and investment securities and paid on deposits. Fluctuations in the Federal Reserve Board’s monetary policies have had a significant impact on the operating results of commercial banks, including the Company and the Bank and are expected to continue to do so in the future.
Future Regulation. From time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and the operating environment of the Company in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. The Company cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would have on the financial condition or results of operations of the Company. A change in statutes, regulations or regulatory policies applicable to the Company, the Bank, or Wealth could have a material effect on our business.
In addition to the other information contained in this report, including the information contained in “Cautionary Statement Regarding Forward-Looking Statements,” investors in the Company’s securities should carefully consider the factors discussed below. An investment in the Company’s securities involves risks. The factors below, among others, could materially and adversely affect the Company’s business, financial condition, results of operations, liquidity or capital position, or cause the Company’s results to differ materially from its historical results or the results expressed or implied in the forward-looking statements contained in this report, in which case the trading price of the Company’s common stock could decline. The risk factors discussed below highlight the risks that the Company believes are material to the Company, but do not necessarily include all risk that an investor may face, and investors should not interpret the disclosure of a risk to state or imply that the risk has not already materialized.
Risk Factors Related to our Lending Activities and Economic Conditions
Weaknesses in economic or market conditions could pose challenges for the Company and could adversely affect the results of operations, liquidity and financial condition. Deterioration in, or uncertain, economic conditions could adversely affect the Company’s business which is directly affected by general economic and market conditions; broad trends in industry and finance; legislative and regulatory changes; changes in governmental monetary and fiscal policies; and inflation, all of which are beyond the Company’s control. Prolonged periods of inflation may impact profitability by negatively impacting fixed costs and expenses, including increasing funding costs and expense related to talent acquisition and retention, and negatively impacting the demand for products and services. Additionally, inflation may lead to a decrease in consumer and commercial purchasing power and increase default rates on loans. A deterioration in economic conditions, in particular a prolonged economic slowdown within the Company’s geographic region or a broader disruption in the economy, possibly as a result of a pandemic or other widespread public health emergency, acts of terrorism, or outbreak of domestic or international hostilities (including the ongoing war between Russia and Ukraine), unanticipated financial events such as the closure of Silicon Valley Bank by the California Department of Financial Protection and Innovation, which appointed the FDIC as receiver, the closure of Signature Bank by the New York State Department of Financial Services, which also appointed the FDIC as receiver and the winding down and voluntary liquidation of Silvergate Capital Corp., could result in the following consequences, any of which could hurt business materially: declines in real estate values and home sales and increases in the financial stress on borrowers and unemployment rates, all of which could lead to increases in loan delinquencies, problem assets and foreclosures, and a deterioration in the value of collateral for loans made by our various business segments; an increase in the level of loan losses exceeding the level the Company has provided in its allowance for loans losses, which would reduce the Company’s earnings; a decline in demand for our products and services;; changes in the fair value of financial instruments held by the Company or its subsidiaries; or declines in available sources or amounts of liquidity and funding.
Weaknesses in the commercial real estate markets could negatively affect the Company’s financial performance due to the Company’s concentration in commercial real estate loans. At December 31, 2022, the Company had $534.5 million, or 52.0%, of total loans concentrated in commercial real estate, which includes, for purposes of this concentration, all construction loans, loans secured by multifamily residential properties, loans secured by farmland and loans secured by nonfarm, nonresidential properties. Commercial real estate loans expose the Company to a greater risk of loss than residential real estate and consumer loans. Commercial real estate loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to residential real estate and consumer loans. Consequently, an adverse development with respect to one commercial real estate loan or credit relationship exposes the Company to a significantly greater risk of loss compared to an adverse development with respect to one residential real estate loan. Commercial real estate loans carry risks associated with the successful operation of a business if the properties are owner occupied. If the properties are non-owner occupied, the repayment of these loans may be dependent upon the profitability and cash flow from rent receipts. Repayment of commercial real estate loans may, to a greater extent than residential real estate loans, be subject to adverse conditions in the real estate market or economy. Weak economic or market conditions may impair a borrower’s business operations, slow the execution of new leases and lead to turnover in existing leases. The combination of these factors could result in deterioration in value of some of the Company’s loans. The deterioration of one or more of the Company’s significant commercial real estate loans could cause a significant increase in nonaccrual loans. An increase in nonaccrual loans could result in a loss of interest income from those loans, an increase in the provision for loan losses, and an increase in loan charge-offs, all of which could have a material adverse effect on the Company’s financial performance.
The Company’s profitability depends significantly on local economic conditions and changes in the federal government’s military or defense spending may negatively affect the local economy. The Company’s success depends primarily on the general economic conditions of the markets in which the Company operates. Unlike larger financial institutions that are more geographically diversified, the Company provides banking and financial services to customers primarily in the Hampton Roads MSA. The local economic conditions in this area have a significant impact on the demand for loans, the ability of the borrowers to repay these loans and the value of the collateral securing these loans. A significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, an outbreak of hostilities or other international or domestic calamities, unemployment or other factors beyond the Company’s control could impact these local economic conditions.
In addition, Hampton Roads is home to one of the largest military installations in the world and one of the largest concentrations of Department of Defense personnel in the United States. Some of the Company’s customers may be particularly sensitive to the level of federal government spending on the military or on defense-related products. Federal spending is affected by numerous factors, including macroeconomic conditions, presidential administration priorities, and the ability of the federal government to enact relevant appropriations bills and other legislation. Any of these factors could result in future cuts to military or defense spending or increased uncertainty about federal spending, which could have a severe negative impact on individuals and businesses in the Company’s primary service area. Any related increase in unemployment rates or reduction in business development activities in the Company’s primary service area could lead to reductions in loan demand, increases in loan delinquencies, problem assets and foreclosures and reductions in loan collateral value, which could have a material adverse effect on the Company’s operating results and financial condition.
The Company also invests in the debt securities of corporate issuers, primarily financial institutions, that the Company views as having a strong financial position and earnings potential. However, a deterioration in economic or other conditions in the localities in which these institutions do business in could adversely affect their financial condition and results of operations, and therefore adversely affect the value of our investment.
Declines in loans outstanding could have a material adverse impact on the Company’s operating results and financial condition. Growing and diversifying the loan portfolio is part of the Company’s strategic initiative. If quality loan demand does not continue to increase and the Company’s loan portfolio begins to decline, the Company expects that excess liquidity will be invested in marketable securities. Because loans typically yield higher returns than the Company’s securities portfolio, a shift towards investments in the Company’s asset mix would likely result in an overall reduction in net interest income and the net interest margin. The principal source of earnings for the Company is net interest income, and as discussed above, the Company’s net interest margin is a major determinant of the Company’s profitability. The effects of a reduction in net interest income and the net interest margin may be exacerbated by the intense competition for quality loans in the Company’s primary service area and by rate reductions on loans currently held in the portfolio. As a result, a reduction in loans could have a material adverse effect on the Company’s operating results and financial condition.
The small-to-medium size businesses the Company targets may have fewer financial resources to weather a downturn in the economy, which could materially harm operating results. The Company targets individual and small-to-medium size business customers. Small-to-medium size businesses frequently have smaller market shares than their competitors, may be more vulnerable to economic downturns or periods of significant inflation, often need substantial additional capital to expand and compete and may experience significant volatility in operating results. Any one or more of these factors may impair a borrower’s ability to repay a loan. In addition, the success of a small-to-medium size business often depends on the management talents and efforts of one person or a small group of persons, and the death, disability or resignation of one or more of these persons could have a material adverse impact on the business and its ability to repay a loan. Economic downturns and other events that negatively impact businesses in the Company’s primary service area could have a proportionately greater impact on small-to-medium-size businesses and accordingly could cause the Company to incur substantial credit losses that could negatively affect its results of operations and financial condition.
The allowance for loan losses may not be adequate to cover actual losses. A significant source of risk arises from the possibility that losses could be sustained because borrowers, guarantors, and related parties may fail to perform in accordance with the terms of their loans and leases. There is no precise method to predict loan losses. Like all financial institutions, the Company maintains an allowance for loan losses (ALL) to provide for loan defaults and non-performance. Accounting measurements related to impairment and the allowance for loan losses require significant estimates that are subject to uncertainty and changes relating to new information and changing circumstances. The allowance for loan losses may not be adequate to cover actual loan losses. In addition, future provisions for loan losses could materially and adversely affect, and have in recent years materially and adversely affected, the Company’s operating results.
The allowance for loan losses is determined by analyzing historical loan losses, current trends in delinquencies and charge-offs, plans for problem loan resolutions, changes in the size and composition of the loan portfolio and industry information. Also included in management’s estimates for loan losses are considerations with respect to the impact of economic events that management believes may cause future losses to deviate from historical experience, the outcome of which are uncertain. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and judgment. The amount of future losses is susceptible to changes in economic and other conditions, including changes in interest rates, that may be beyond the Company’s control and these future losses may exceed current estimates. If management’s assumptions prove to be incorrect or if the Company experiences significant loan losses in future periods, the current level of the allowance for loan losses may not be adequate to cover actual loan losses and adjustments may be necessary. In addition, federal regulatory agencies, as an integral part of their examination process, review the Company’s loans and allowance for loan losses and may require an increase in the allowance for loan losses or recognition of additional loan charge-offs, based on judgments different from those of management. While management believes that the Company’s allowance is adequate to cover current losses, the Company cannot assure investors that it will not need to increase the allowance or that regulators will not require the allowance to be increased. Either of these occurrences could materially and adversely affect earnings and profitability.
On January 1, 2023, the Company adopted Accounting Standards Codification (ASC) Topic 326, “Financial Instruments—Credit Losses” (ASC 326), which replaces existing accounting principles for the recognition of loan losses based on losses that have been incurred with a requirement to record an allowance for credit losses that represents expected credit losses over the lifetime of all loans in the Company’s portfolio. Under ASC 326, the Company’s estimate of expected credit losses will be based on reasonable and supportable forecasts of future economic conditions and loan performance. While the adoption of ASC 326 will not affect ultimate loan performance or cash flows of the Company from making loans, the period in which expected credit losses affect net income of the Company may not be similar to the recognition of loan losses under current accounting guidance, and recognizing an allowance based on expected credit losses may create more volatility in the level of the allowance for credit losses and the Company’s results of operations, including based on volatility in economic forecasts and expectations of loan performance in future periods, as actual results may differ materially from those estimates. If the Company is required to materially increase the level of allowance for credit losses for any reason, such increase could adversely affect the Company’s business, financial condition, and results of operations.
Risk Factors Related to our Industry
The Company is subject to interest rate risk and variations in interest rates may negatively affect its financial condition and results of operations. The Company’s profitability depends in substantial part on its net interest margin, which is the difference between the rates received on loans and investments and the rates paid for deposits and other sources of funds. The net interest margin depends on many factors that are partly or completely outside of the Company’s control, including competition; federal economic, monetary and fiscal policies; market interest rates; and economic conditions. Because of the differences in the maturities and repricing characteristics of interest-earning assets and interest-bearing liabilities, changes in interest rates do not produce equivalent changes in interest income earned on interest-earning assets and interest paid on interest-bearing liabilities. To combat rising inflation, since the beginning of 2022, the Federal Reserve has very rapidly raised its benchmark federal funds interest rate, increasing 425 basis points during 2022. Additionally, the Federal Reserve raised the federal funds benchmark rate by 25 basis points in February of 2023 and an additional 25 basis points in March of 2023. If market rates continue to rise to combat inflation or otherwise, the Company may experience more competitive pressures to increase the rates paid on deposits, which may decrease net interest income, a change in the mix of noninterest and interest-bearing accounts, reduced demand for loans or increases in the rate of default on existing loans. In addition, the Company could experience net interest margin compression if it is unable to maintain the current level of loans outstanding by continuing to originate new loans in the current higher rate environment, or if it experiences a decrease in deposit balances, which would require the Company to seek funding from other sources at relatively higher rates of interest. It is possible that significant or unexpected changes in interest rates may take place in the future, and the Company may not be able to accurately predict the nature or magnitude of such changes or how such changes may affect business or results of operations.
The Company’s investment portfolio consists of fixed income debt securities, classified as available for sale, whose market values fluctuate with changes in interest rates. Available for sale debt securities are carried at estimated fair value with the corresponding unrealized gains and losses recognized in other comprehensive income. Gains or losses are only recognized in net income upon the sale of the security. Additionally, under ASC 326 a loss is recognized for expected credit losses on available for sale debt securities or when the Company does not expect to recover its investment in a debt security, to the extent that the carrying amount of the security exceeds its market value. As a result of increases in market interest rates during 2022, the market value of the Company’s investment portfolio declined significantly. While the Company does not intend to sell any of its securities prior to maturity, the portfolio serves as a source of liquidity and consists of securities available for sale, which may be sold in response to changes in market interest rates, changes in prepayment risk, increases in loan demand, changes in deposit balances, general liquidity needs and other similar factors. If the Company sells any of its securities while in an unrealized loss position or determines that there is a credit loss with respect to any of the Company’s securities, the loss or impairment charge would be recognized in net income, which could have a material adverse effect on the Company’s financial condition and results of operations. The process for determining whether impairment is other-than-temporary generally requires difficult, subjective judgments, including with respect to the issuer’s future financial performance and any collateral underlying the security in order to evaluate the probability of receiving all payments on the security. Although the Company concluded that no other-than-temporary impairment existed in its securities portfolio at December 31, 2022 and no other-than-temporary impairment loss has been recognized in net income, changing economic and market conditions resulting in interest rate fluctuations, the financial conditions of the issuers of the securities and the performance of the underlying collateral, among other factors, may cause the Company to recognize impairment charges in the future, which could have a material adverse effect on the Company’s financial condition and results of operations. Additionally, while the regulatory capital of the Company or the Bank is currently not expected to be impacted by unrealized losses on securities, tangible common equity, a non-GAAP financial measure, is reduced for unrealized losses on securities, and regulatory capital would be reduced for any losses recognized in net income.
The Company generally seeks to maintain a neutral position in terms of the volume of assets and liabilities that mature or re-price during any period so that it may reasonably maintain its net interest margin; however, interest rate fluctuations, loan prepayments, loan production, deposit flows, and competitive pressures are constantly changing and influence the ability to maintain a neutral position. Generally, the Company’s earnings will be more sensitive to fluctuations in interest rates depending upon the variance in volume of assets and liabilities that mature and re-price in any period. The extent and duration of the sensitivity will depend on the cumulative variance over time, the velocity and direction of changes in interest rates, shape and slope of the yield curve, and whether the Company is more asset sensitive or liability sensitive. Accordingly, the Company may not be successful in maintaining a neutral position and, as a result, the Company’s net interest margin may be affected.
The Company relies substantially on deposits obtained from customers in our target markets to provide liquidity and support growth, and liquidity risk could harm the Company’s ability to fund its operations, which could have a material adverse impact on the Company’s financial condition. Liquidity is essential to the Company’s business. While the Company relies on different sources to meet potential liquidity demands, the Bank’s business strategies are primarily based on access to funding from local customer deposits. Deposit levels may be affected by a number of factors, including interest rates paid by competitors, general interest rate levels, returns available to customers on alternative investments and general economic conditions that affect savings levels and the amount of liquidity in the economy, including government stimulus efforts in response to economic crises. If deposit levels fall, reliance on a relatively low-cost source of funding could be reduced and interest expense would likely increase as alternative funding is obtained to replace lost deposits. If local customer deposits are not sufficient to fund normal operations and growth, the Company will look to outside sources, such as borrowings from the FHLB, which is a secured funding source. Ability to access borrowings from the FHLB will be dependent upon whether and the extent to which collateral is held or can be provided to secure FHLB borrowings. Other sources may be federal funds purchased and brokered deposits, although the use of brokered deposits may be limited or discouraged by our banking regulators. The Company may also seek to raise funds through the issuance of shares of common stock, or other equity or equity-related securities, or debt securities including subordinated notes as additional sources of liquidity.
The Company’s access to funding sources in amounts sufficient to support business operations and growth strategies or on acceptable terms to the Company could be impaired by factors that affect the Company specifically, or the financial services industry or economy generally, including, without limitation, adverse regulatory action against the Company, disruptions in the financial markets, deterioration in credit markets, and negative views and expectations about the prospects for the financial services industry (including due to the closure of Silicon Valley Bank by the California Department of Financial Protection and Innovation, which appointed the FDIC as receiver, the closure of Signature Bank by the New York State Department of Financial Services, which also appointed the FDIC as receiver and the winding down and voluntary liquidation of Silvergate Capital Corp.). If the Company is unable to access funding sufficient to support business operations and growth strategies or is unable to access such funding on acceptable terms to the Company, this could have a substantial negative effect on the Company’s liquidity. We may not be able to implement our business strategies, originate loans, invest in securities, pay our expenses, distribute dividends to our stockholders, or fulfill our debt obligations or deposit withdrawal demands. A lack of liquidity also could result in the Company being forced to sell securities in an unrealized loss position. All of these factors could have a material adverse impact on financial performance, financial condition and results of operations.
The Company’s liquidity could be impaired by an inability to access short-term funding or the inability to monetize liquid assets. If significant volatility or disruptions occur in the wholesale funding or investment securities markets, the Company’s ability to access short-term liquidity could be materially impaired. In addition, other factors outside of the Company’s control could limit the Company’s ability to access short-term funding or to monetize liquid assets, including by selling investment securities at an attractive price or at all, such as operational issues that impact third parties in the funding or securities markets or unforeseen significant deposit outflows. The Company’s inability to access short-term funding or inability to monetize liquid assets could impair the Company’s ability to make new loans or meet existing lending commitments and could adversely impact the Company’s overall liquidity and regulatory capital.
Consumers may increasingly decide not to use banks to complete their financial transactions, which could have a material adverse impact on the Company’s financial condition and operations. Technology and other changes are allowing parties to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts, mutual funds, general-purpose reloadable prepaid cards, or in other types of assets, including crypto currencies or other digital assets. Consumers can also complete transactions such as paying bills or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the loss of deposits as a lower cost source of funds could have a material adverse effect on our financial condition and results of operations.
Competition from other financial institutions and financial intermediaries may adversely affect the Company’s future success, profitability, financial condition and results of operations. The Company faces substantial competition in all phases of its operations, including originating loans and attracting deposits, from a variety of competitors. Growth and success depend on the Company’s ability to compete effectively in this highly competitive financial services environment. The competition in originating loans and attracting deposits comes principally from other banks, mortgage banking companies, consumer finance companies, savings associations, credit unions, brokerage firms, insurance companies and other institutional lenders and purchasers of loans, and includes firms that attract customers primarily through digital and online products which may offer greater convenience to customers than traditional banking products and services. Many competitors offer products and services that are not offered by the Company, and many have substantially greater resources, name recognition and market presence that benefit them in attracting business. In addition, larger competitors may be able to price loans and deposits more aggressively and may have larger lending limits that would allow them to serve the credit needs of larger clients. Moreover, technological innovation continues to contribute to greater competition in financial services markets as technological advances enable more companies, including financial technology start-ups, to provide financial products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Some of the financial services organizations with which the Company competes are not subject to the same degree of regulation as bank holding companies and federally insured national banks, and may have broader geographic service areas and lower cost structures. As a result, these competitors may have certain advantages over the Company in accessing funding and providing various services. The financial services industry could become even more competitive as a result of legislative, regulatory and technology changes and continued consolidation. Increased competition could require an increase of rates paid on deposits or lower the rates offered on loans, which could adversely affect the Company’s profitability. In addition, failure to compete effectively to attract new and retain current customers in the Company’s markets could cause it to lose market share, slow its growth rate and may have an adverse effect on its financial condition and results of operations.
The soundness of other financial institutions may adversely affect the Company. Financial services institutions are interrelated due to certain relationships, including trading, clearing and counterparty relationships. The Company has exposure to a variety of industries and counterparties, and routinely executes transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks and institutional clients. Many of these transactions expose the Company to credit risk in the event of a default by a counterparty or client. In the past, defaults by, or even speculation about, one or more financial services institutions or the financial services industry generally have led to market-wide liquidity problems, which could result in defaults and, as a result, impair the confidence of the Company’s counterparties and ultimately affect the Company’s ability to effect transactions. Additionally, confidence in the safety and soundness of regional and community banks specifically or the banking system generally could impact where customers choose to maintain deposits, which could materially adversely impact the Company’s liquidity, loan funding capacity, ability to raise funds and results of operations. The Company could also be impacted by current or future negative perceptions about the prospects for the financial services industry, which could worsen over time and result in downward pressure on, and continued or accelerated volatility of, bank securities.
Market risk affects the earnings of Wealth. The fee structure of Wealth is generally based upon the market value of accounts under administration. Most of these accounts are invested in equities of publicly traded companies and debt obligations of both government agencies and publicly traded companies. As such, fluctuations in the equity and debt markets in general have had a direct impact upon the earnings of Wealth.
The Basel III Capital Rules require higher levels of capital and liquidity, which could adversely affect the Company’s net income and return on equity. The Basel III Capital Rules require bank holding companies and banks to meet capital adequacy guidelines, liquidity requirements and other regulatory requirements specifying minimum amounts and types of capital that must be maintained. The Basel III Capital Rules apply to the Bank but, because the Company qualifies under the Federal Reserve’s Small Bank Holding Company Policy Statement, the Company is not subject to the Basel III Capital Rules. The capital adequacy standards applicable to the Bank impose stricter capital requirements and leverage limits than the requirements to which the Bank was subject in the past. The standardized calculations of risk-weighted assets are complex and may create additional compliance burdens for the Company, if ultimately applied to the Company. The Basel III Capital Rules apply higher risk weightings to many types of loans and securities. This may result in the Bank being forced to limit originations of certain types of commercial and mortgage loans, thereby reducing the amount of credit available to borrowers and limiting opportunities to earn interest income from the loan portfolio, which could have a detrimental impact on the Company’s net income.
If the Company were to require additional capital, including to fund additional capital contributions to the Bank, as a result of the Basel III Capital Rules, it could be required to access the capital markets on short notice and in relatively weak economic conditions, which could result in raising capital that significantly dilutes existing stockholders. Additionally, the Company may be forced to limit banking operations and activities, and growth of loan portfolios and interest income, to focus on retention of earnings to improve capital levels. Higher capital levels may also lower the Company’s return on equity.
Risk Factors Related to our Operations and Technology
The Company and its subsidiaries are subject to operational risk, which could adversely affect business, financial condition and results of operation. The Company and its subsidiaries, like all businesses, are subject to operational risk, including the risk of loss resulting from human error, fraud or unauthorized transactions due to inadequate or failed internal processes and systems, and external events that are wholly or partially beyond the Company’s control (including, for example, sudden increases in customer transaction volume, electrical or telecommunications outages, natural disasters, and cyber-attacks). Operational risk also encompasses compliance (legal) risk, which is the risk of loss from violations of, or noncompliance with, laws, rules, regulations, prescribed practices or ethical standards. The Company and its subsidiaries have established a system of internal controls to address these risks, but there are inherent limitations to such risk management strategies as there may exist, or develop in the future, risks that are not anticipated, identified or monitored. Any losses resulting from operational risk could take the form of explicit charges, increased operational costs, litigation costs, harm to reputation or forgone opportunities, loss of customer business, or the unauthorized release, misuse, loss or destruction of proprietary information, any and all of which could have a material adverse effect on the Company’s business, financial condition and results of operations.
System failures, interruptions, breaches of security, or the failure of a third-party provider to perform its obligations could adversely impact the Company’s business operations and financial condition. Communications and information systems are essential to the conduct of the Company’s businesses, as such systems are used to manage customer relationships, general ledger, deposits and loans. While the Company has established policies and procedures to prevent or limit the impact of systems failures, interruptions and security breaches, the Company’s information, security, and other systems may stop operating properly or become disabled or damaged as a result of a number of factors, including events beyond the Company’s control, such as sudden increases in customer transaction volume, electrical or telecommunications outages, natural disasters, and cyber-attacks. Information security risks have increased in recent years and hackers, activists and other external parties have become more technically sophisticated and well-resourced. These parties use a variety of methods to attempt to breach security systems and access the data of financial services institutions and their customers. One such event occurred during September 2022, when in a cybersecurity incident an email account of the Company was accessed by an unauthorized user, which may have compromised certain information about the Company and its customers. The Company may not have the resources or technical sophistication to anticipate or prevent rapidly evolving types of cyber-attacks. In addition, any compromise of the security systems could deter customers from using the Bank’s website and online banking service, both of which involve the transmission of confidential information. The security and authentication precautions imposed by the Company and the Bank may not protect the systems from compromises or breaches of security, which would adversely affect the Company’s results of operations and financial condition.
In addition, the Company outsources certain data processing to certain third-party providers. Accordingly, the Company’s operations are exposed to risk that these third-party providers will not perform in accordance with the contracted arrangements under service agreements. If the third-party providers encounter difficulties, or if the Company has difficulty in communicating with them, the Company’s ability to adequately process and account for customer transactions could be affected, and the Company’s business operations could be adversely impacted. Further, a breach of a third-party provider’s technology may cause loss to the Company’s customers. Replacing these third-party providers could also create significant delay and expense. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.
The occurrence of any systems failure, interruption or breach of security, or the failure of a third-party provider to perform its obligations, could expose the Company to risks of data loss or data misuse, could result in violations of applicable privacy and other laws, could damage the Company’s reputation and result in a loss of customers and business, could subject it to additional regulatory scrutiny or could expose it to civil litigation, possible financial liability and costly response measures. Any of these occurrences could have a material adverse effect on the Company’s financial condition and results of operations.
The Company and its subsidiaries, including the Bank, and its and their employees and customers may in the future be the target of criminal cyberattacks; and we could be exposed to liability and remedial costs, and our reputation and business could suffer. Like many major financial institutions, we are, from time to time, a target of criminal cyber-attacks, phishing schemes and similar fraudulent activity and cyber incidents, and we expect these threats to continue. As the numerous and evolving cybersecurity threats, including advanced and persistent cyber-attacks and schemes, utilized by cybercriminals in attempts to obtain unauthorized access to our systems or our customers’ accounts have become increasingly more complex and sophisticated and may be difficult to detect for periods of time, we may – like many other major financial institutions – not anticipate, safeguard against, or respond to, these acts adequately. As these threats continue to evolve and increase, we – like many other major financial institutions – may be required to devote significant additional resources in order to modify and enhance our security controls and to identify and remediate any security vulnerabilities.
Though it is difficult to determine what, if any, harm may directly result from any specific cyber incident or cyber-attack, any failure to maintain the security of, or any actual or perceived loss or unauthorized disclosure or use of, customer or account information likely may lead to our customers losing wealth and confidence in us. Damage to our reputation could adversely affect deposits and loans and otherwise negatively affect the Company’s business, financial condition and results of operations. In addition, it is possible that a cyber incident and any material fraudulent activity, cyber-attacks, breaches of our information security or successful penetration or circumvention of our system security may cause us significant negative consequences, including loss of Bank customers and financial assets and business opportunities, disruption to our operations and business, or misappropriation of our and/or our customers’ confidential information, and may expose us to additional regulatory scrutiny or may result in a violation of applicable privacy laws and other laws, litigation exposure, regulatory fines, penalties or intervention, loss of confidence in our security measures, reputational damage, reimbursement or other compensatory costs, devotion of substantial management time, increased costs to maintain insurance coverage (including increased deposit insurance premiums), or additional compliance costs, all of which could adversely impact our business, financial condition, liquidity and results of operations.
The Company’s accounting estimates and risk management processes rely on analytical and forecasting models. Processes that management uses to measure the fair value of financial instruments, as well as the processes used to estimate the effects of changing interest rates and other market measures on the Company’s earnings performance and liquidity, depend upon the use of analytical and forecasting models. These models reflect assumptions that may not be accurate, particularly in times of market stress or other unforeseen circumstances. Even if these assumptions are accurate, the models may prove to be inadequate or inaccurate because of other flaws in their design or their implementation.
If the models that management uses for interest rate risk and asset-liability management are inadequate, the Company may incur increased or unexpected losses upon changes in market interest rates or other market measures and may be unable to maintain sufficient liquidity. If the models that management uses to measure the fair value of financial instruments are inadequate, the fair value of such financial instruments may fluctuate unexpectedly or may not accurately reflect what the Company could realize upon sale or settlement of such financial instruments. Any such failure in management’s analytical or forecasting models could have a material adverse effect on the Company’s business, financial condition and results of operations.
The Company is dependent on key personnel and the loss of one or more of those key personnel could harm its business. The banking business in Virginia, and in the Company’s primary service area in the Hampton Roads MSA, is highly competitive and dominated by a relatively small number of large banks. Competition for qualified employees and personnel in the banking industry is intense and there are a limited number of qualified persons with knowledge of and experience in the Virginia community banking industry, which could increase labor costs. In addition, the Company’s ability to attract and retain employees could be impacted by changing workforce concerns, expectations, practices and preferences, including remote and hybrid work preferences brought on by the COVID-19 pandemic, and labor shortages. The Company’s success depends to a significant degree upon its ability to attract and retain qualified management, loan origination, administrative, marketing and technical personnel and upon the continued contributions of and customer relationships developed by management and other key personnel. In particular, the Company’s success is highly dependent upon the capabilities of its senior executive management. The Company believes that its management team, comprised of individuals who have worked in the banking industry for many years, is integral to implementing the Company’s business plan. The loss of any of the Company’s senior executive management could have a material adverse effect on the Company’s ability to build on the efforts they have undertaken, and the Company may not be able to find adequate replacements. The Company has not entered into employment agreements with any of its executive management employees, and the loss of the services of one or more of them could harm the Company’s business.
The Company may not be able to compete effectively without the appropriate use of current technology. The use of technology in the financial services market, including the banking industry, evolves frequently. The Company may be unable to attract and maintain banking relationships with certain customers if it does not offer appropriate technology-driven products and services. In addition to better serving customers, the effective use of technology may increase efficiency and reduce costs. Developing or acquiring access to new technologies and incorporating those technologies into the Company’s products and services, or using them to expand the Company’s products and services, may require significant investments, may take considerable time to complete, and ultimately may not be successful. The Company may not be able to effectively implement new technology-driven products or services or be successful in marketing these products and services to its customers. As a result, the Company’s ability to compete effectively may be impaired, which could lead to a material adverse effect on the Company’s financial condition and results of operations, and could lead to the incurrence of additional expense.
Risks Related to the Regulation of the Company
The Company may be adversely affected by changes in government monetary policy. As a bank holding company, the Company’s business is affected by the monetary policies established by the FRB, which regulates the national money supply in order to mitigate recessionary and inflationary pressures. In setting its policy, the FRB may utilize techniques such as the following: (i) engaging in open market transactions in U.S. Government securities; (ii) setting the rate on member bank borrowings; and (iii) determining reserve requirements.
These techniques determine, to a significant extent, the Company’s cost of funds for lending and investing. These techniques, all of which are outside the Company’s control, may have an adverse effect on deposit levels, net interest margin, loan demand or the Company’s business and operations.
The Company and its subsidiaries are subject to extensive regulation which could adversely affect them. The Company is subject to extensive regulation by federal, state and local governmental authorities and is subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of its operations, including those referenced above. Regulations adopted by these agencies, which are generally intended to protect depositors and customers rather than to benefit stockholders, govern a comprehensive range of matters including, without limitation, ownership and control of the Company’s shares, acquisition of other companies and businesses, permissible activities that the Company and its subsidiaries may engage in, maintenance of adequate capital levels and other aspects of operations. These regulations are costly to comply with and could limit the Company’s growth by restricting certain of its activities. The laws, rules and regulations applicable to the Company are subject to regular modification and change. Regulatory changes could subject the Company to more demanding regulatory compliance requirements, which could affect the Company in unpredictable and adverse ways. Such changes could subject the Company to additional costs, limit the types of financial services and products it may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Legislation or regulation may also impose unexpected or unintended consequences, the impact of which is difficult to predict. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or damage to the Company’s reputation, which could have a material adverse effect on the Company’s business, financial condition and results of operations. Legislation and regulatory initiatives containing wide-ranging proposals for altering the structure, regulation and competitive relationship of financial institutions are introduced regularly. The extent and timing of any regulatory reforms, as well as any effects on the Company’s business and results of operations, are uncertain.
The CFPB may increase our regulatory compliance burden and could affect the consumer financial products and services that the Company offers. The CFPB significantly influences consumer financial laws, regulation and policy through rulemaking related to enforcement of the Dodd-Frank Act’s prohibitions against unfair, deceptive and abusive consumer finance products or practices, which are directly affecting the business operations of financial institutions offering consumer financial products or services, including the Company. This agency’s broad rulemaking authority includes identifying practices or acts that are unfair, deceptive or abusive in connection with any consumer financial transaction, financial product or service. Although the CFPB has jurisdiction over banks with $10 billion or greater in assets, rules, regulations and policies issued by the CFPB may also apply to the Company or its subsidiaries by virtue of the adoption of such policies and practices by the Federal Reserve and the FDIC. Further, the CFPB may include its own examiners in regulatory examinations by the Company’s primary regulators. The limitations and restrictions imposed by the CFPB may produce significant, material effects on our business, financial condition and results of operations.
Increased scrutiny and evolving expectations from customers, regulators, investors, and other stakeholders with respect to environmental, social and governance (ESG) practices may impose additional costs on the Company or expose it to new or additional risks. As a regulated financial institution and a publicly traded company, the Company is facing increasing scrutiny from customers, regulators, investors, and other stakeholders related to ESG practices and disclosure. Investor advocacy groups, investment funds, influential investors, and regulators are increasingly focused on these practices, especially as they relate to climate risk, hiring practices, the diversity of the work force, and racial and social justice issues. Failure to adapt to or comply with regulatory requirements or investor or stakeholder expectations and standards could negatively impact the Company’s reputation, ability to do business with certain partners, and stock price. New government regulations could also result in new or more stringent forms of ESG oversight and expanded mandatory and voluntary reporting, diligence, and disclosure. ESG-related costs, including with respect to compliance with any additional regulatory or disclosure requirements or expectations, could adversely impact our results of operations.
Failure to comply with the USA Patriot Act, OFAC, the Bank Secrecy Act and related FinCEN guidelines and related regulations could have a material impact on the Company. Bank regulatory agencies routinely examine financial institutions for compliance with the USA Patriot Act, OFAC, the Bank Secrecy Act and related FinCEN guidelines and related regulations. Failure to maintain and implement adequate programs as required by these obligations to combat terrorist financing, elder abuse, human trafficking, anti-money laundering and other suspicious activity and to fully comply with all of the relevant laws or regulations, could have serious legal, financial and reputational consequences for the Company. Such a failure could cause a bank regulatory agency not to approve a merger or acquisition transaction or to prohibit such a transaction even if formal approval is not required. In addition, such a failure could result in a regulatory authority imposing a formal enforcement action or civil money penalty for regulatory violations.
Risks Related to Our Common Stock
The Company’s common stock price may be volatile, which could result in losses to investors. The common stock price has been volatile in the past, and several factors could cause the price to fluctuate in the future. These factors include, but are not limited to, actual or anticipated variations in earnings, changes in analysts’ recommendations or projections with regard to the Company’s common stock or the markets and businesses in which the Company operates, operations and stock performance of other companies deemed to be peers, and reports of trends and concerns and other issues related to the financial services industry. Fluctuations in our common stock price may be unrelated to the Company’s performance. General market declines or market volatility in the future, especially in the financial institutions sector, could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices.
The Company’s substantial dependence on dividends from its subsidiaries may prevent it from paying dividends to its stockholders and adversely affect its business, results of operations or financial condition. The Company is a separate legal entity from its subsidiaries and does not have significant operations or revenues of its own. The Company substantially depends on dividends from its subsidiaries to pay dividends to stockholders and to pay its operating expenses. The availability of dividends from the subsidiaries is limited by various statutes and regulations. It is possible, depending upon the financial condition of the Company and other factors, that the Comptroller could assert that payment of dividends by the subsidiaries is an unsafe or unsound practice. In the event the subsidiaries are unable to pay dividends to the Company, the Company may not be able to pay dividends on the Company’s common stock, service debt or pay operating expenses. Consequently, the inability to receive dividends from the subsidiaries could adversely affect the Company’s financial condition, results of operations, cash flows and limit stockholders’ return, if any, to capital appreciation.
Future sales of the Company’s common stock by stockholders or the perception that those sales could occur may cause the common stock price to decline. Although the Company’s common stock is listed for trading on the NASDAQ stock market, the trading volume in the common stock may be lower than that of other larger financial institutions. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of the common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which the Company has no control. Given these factors, a stockholder may have difficult selling shares of the Company’s common stock at an attractive price (or at all). Additionally, stockholders may not be able to sell a substantial number of the Company’s common stock shares for the same price at which stockholders could sell a smaller number of shares. Given the potential for lower relative trading volume in the common stock, significant sales of the common stock in the public market, or the perception that those sales may occur, could cause the trading price of the Company’s common stock to decline or to be lower than it otherwise might be in the absence of these sales or perceptions.
Future issuances of the Company’s common stock could adversely affect the market price of the common stock and could be dilutive. The Company may issue additional shares of common stock or securities that are convertible into or exchangeable for, or that represent the right to receive, shares of the Company’s common stock. Issuances of a substantial number of shares of common stock, or the expectation that such issuances might occur, could materially adversely affect the market price of the common stock and could be dilutive to stockholders. Any decision the Company makes to issue common stock in the future will depend on market conditions and other factors, and the Company cannot predict or estimate the amount, timing, or nature of possible future issuances of common stock. Accordingly, holders of the Company’s common stock bear the risk that future issuances of securities will reduce the market price of the common stock and dilute their stock holdings in the Company.
Risk Factors Related to the COVID-19 Pandemic
The Company’s results of operations and financial condition may be adversely affected by the COVID-19 pandemic. The outbreak of the COVID-19 pandemic, the widespread government response and the impact on consumers and businesses caused significant disruption in the United States and international economies and financial markets and had a significant impact on consumers and businesses in our market area and the operations and financial performance of the Company. Although conditions regarding the spread of the illness are improving, COVID-19’s ultimate impact on economic conditions and activity remains uncertain, and it is possible that new variants will emerge that could cause further outbreaks or more severe outbreaks in the future, resulting in additional lockdowns, economic disruptions, or other unknown impacts.
Although the scope, duration and full effects of the pandemic are evolving and cannot be fully known at this time, consequences of the pandemic have included and may include further market volatility, interest rate fluctuations, disrupted trade and supply chains, increased unemployment, rising prices, inflation and reduced economic activity. Developments related to COVID-19 and certain responses thereto have driven higher inflation in the United States during 2022 and early 2023, and ultimately, may contribute to the development of a disruptive period of high inflation in the United States and globally, while efforts to combat this inflation could result in an economic recession. The period of recovery from the negative economic effects of the pandemic cannot be predicted and may be protracted. As loan payment deferral programs and government stimulus or relief efforts, such as the Paycheck Protection Program (PPP), have largely ended, signs of credit deterioration that were masked or obscured may emerge, and the Company can give no assurance that loan performance or net charge-offs will continue at the levels experienced in 2022, 2021 and 2020.
The extent to which the COVID-19 pandemic impacts our business, results of operations and financial condition will depend on future developments, which are highly uncertain and cannot be predicted, including, but not limited to the duration and severity of the COVID-19 pandemic, the acceptance and continued effectiveness of vaccines and treatments for COVID-19, the effects of the pandemic on our customers and vendors, and the short- and long-term health impacts of the pandemic. There can be no assurance that any efforts by the Company to address the adverse impacts of the COVID-19 pandemic will be effective. Additionally, the Company may continue to experience adverse impacts to our business as a result of changes in the behavior of customers, businesses and their employees prompted or accelerated by the COVID-19 pandemic. Furthermore, the financial condition of our customers and vendors may be adversely impacted, which may result in an elevated level of loan losses, a decrease in demand for products and services, or reduced availability of services provided by third parties on which we rely. Any of these events may, in turn, have a material adverse impact our business, results of operations and financial condition.
General Risk Factors
Negative public opinion could damage the Company’s reputation and adversely impact the Company’s business, financial condition and results of operation. Reputation risk, or the risk to the Company’s business, financial condition and results of operation from negative public opinion, is inherent in the financial services industry. Negative public opinion can result from actual or alleged conduct in any number of activities, including lending or foreclosure practices, regulatory compliance, corporate governance and sharing or inadequately protecting customer information, and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion could adversely affect the Company’s ability to keep and attract customers and employees, could impair the confidence of counterparties and business parties, could expose it to litigation and regulatory action, and could adversely affect its access to the capital markets. Damage to the Company’s reputation could adversely affect deposits and loans and otherwise negatively affect the Company’s business, financial condition and results of operation.
The Company may need to raise additional capital in the future and such capital may not be available when needed or at all. The Company may need to raise additional capital in the future to provide it with sufficient capital resources and liquidity to meet its commitments and business needs, particularly if its asset quality or earnings were to deteriorate significantly. Economic conditions and the loss of confidence in financial institutions may increase the Company’s cost of funding and limit access to certain customary sources of capital, including inter-bank borrowings, repurchase agreements and borrowings from the Federal Reserve Bank’s discount window. The Company’s ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of the Company’s control, and the Company’s financial performance.
The Company cannot assure that such capital will be available on acceptable terms or at all. Any occurrence that may limit the Company’s access to the capital markets, such as a decline in the confidence of debt purchasers, depositors of the Bank or counterparties participating in the capital markets, or a downgrade of the parent company or the Bank’s ratings, may adversely affect the Company’s capital costs and its ability to raise capital and, in turn, its liquidity. Moreover, if the Company needs to raise capital in the future, it may have to do so when many other financial institutions are also seeking to raise capital and would have to compete with those institutions for investors. An inability to raise additional capital on acceptable terms when needed could have a material adverse effect on the Company’s liquidity, business, financial condition and results of operations.
Natural disasters, severe weather events, acts of war or terrorism, pandemics or endemics, climate change and other external events could significantly impact our business. Natural disasters, including severe weather events of increasing strength and frequency due to climate change, acts of war (including the war in Ukraine) or terrorism, pandemics (including the COVID-19 pandemic) or endemics and other adverse external events could have a significant adverse impact on the business operations of the Company, third parties who perform operational services for the Company or its customers and the Company’s borrowers and customers. Such events could affect the stability of the Company’s deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in lost revenue or cause the Company to incur additional expenses. Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on the Company’s business, which, in turn, could have a material adverse effect on the Company’s financial condition and results of operations.
| Item 1B. | Unresolved Staff Comments |
None.
As of December 31, 2022, the Company owned and leased buildings in the normal course of business. It owns its main office, which represents its corporate headquarters and includes a branch at 101 East Queen Street, Hampton, Virginia. As of March 15, 2023, the Bank operated fourteen branches in the Hampton Roads area of Virginia.
For more information concerning the amounts recorded for premises and equipment and commitments under current leasing agreements, see Note 4, Premises and Equipment and Note 5, Leases of the Notes to Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data” of this report on Form 10-K.
Neither the Company nor any of its subsidiaries is a party to any material pending legal proceedings before any court, administrative agency, or other tribunal.
| Item 4. | Mine Safety Disclosures |
None.
INFORMATION ABOUT OUR EXECUTIVE OFFICERS
| Name (Age) And Present Position | Served as an Executive Officer Since | Principal Occupation During Past Five Years |
Robert F. Shuford, Jr. (58) | | |
Chairman, President & Chief Executive Officer
Old Point Financial Corporation | 2003 | Chairman of the Board, President & Chief Executive Officer of the Company and the Bank since 2020. Executive Vice President/Bank of the Company since 2015; Chief Operating Officer & Senior Vice President/Operations of the Company from 2003 to 2015
President & Chief Executive Officer of the Bank since 2015; Senior Executive Vice President & Chief Operating Officer of the Bank from 2012 to 2015; Executive Vice President & Chief Operating Officer of the Bank from 2003 to 2012; Chairman of the Board of the Bank |
| | | |
Elizabeth T. Beale (50) | | |
Chief Financial Officer & Senior Vice President/Finance
Old Point Financial Corporation | 2019 | Chief Financial Officer & Senior Vice President/Finance of the Company; a Certified Public Accountant; Senior Vice President & Chief Accounting Officer of the Bank from 2018 to 2019; Executive Vice President and Chief Financial Officer for Citizens National Bank (formerly CNB Bancorp, Inc.) from 2003 to 2018
Chief Financial Officer & Executive Vice President of the Bank |
| | | |
Donald S. Buckless (58) | | |
Chief Lending Officer & Senior Vice President
Old Point Financial Corporation | 2016 | Chief Lending Officer & Senior Vice President of the Company since 2016
Chief Lending Officer & Executive Vice President of the Bank since 2016; Chief Lending Officer & Senior Vice President of the Bank from 2015 to 2016 |
| | | |
Thomas L. Hotchkiss (67) | | |
Chief Credit Officer & Executive Vice President
Old Point National Bank | 2019 | Chief Credit Officer & Executive Vice President of the Bank since 2019; Chief Credit Officer of finanical institution in Maryland from February 2015 to February 2019 |
| | | |
A. Eric Kauders, Jr. (53) | | |
Senior Vice President/Trust
Old Point Financial Corporation | 2021 | Senior Vice President/Trust of the Company since September 2021
President and Chief Executive Officer of Trust since September 2021; Managing Director at Bank of America Private Bank from 2008 to 2021 |
| | | |
Susan R. Ralston (59) | | |
Chief Operating Officer & Executive Vice President
Old Point National Bank | 2019 | Chief Operating Officer & Executive Vice President of the Bank since 2019; President & Founder of Ralston Coaching and Consulting, LLC from 2018 to 2019; Chief Operating Officer & Senior Vice President of Dollar Bank from 2016 to 2018 |
| | | |
Joseph R. Witt (62) | | |
Executive Vice President/Financial Service
Old Point Financial Corporation | 2008 | Executive Vice President/Financial Services since 2020. Chief Business Development Officer & Senior Vice President of the Company since 2015; Chief Administrative Officer & Senior Vice President/Administration of the Company from 2012 to 2015; Senior Vice President/Corporate Banking/Human Resources of the Company from 2010 to 2012; Senior Vice President/Corporate Banking of the Company from 2008 to 2010
Chief Strategy Officer & President, Financial Services of the Bank beginning in 2020. Senior Executive Vice President & Chief Business Development Officer of the Bank from 2015 to 2019; Senior Executive Vice President & Chief Administrative Officer of the Bank from 2012 to 2015; Executive Vice President/Corporate Banking & Human Resources Director of the Bank from 2010 to 2012 |
Part II
| Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
The common stock of the Company is quoted on the NASDAQ Capital Market under the symbol “OPOF”. The approximate number of stockholders of record as of March 14, 2023 was 1,560. On that date, the closing price of the Company’s common stock on the NASDAQ Capital Market was $24.57. Additional information related to restrictions on funds available for dividend declaration can be found in Note 15, Regulatory Matters of the Notes to Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data” of this report on Form 10-K.
The Company had a share repurchase program which was authorized by the Board of Directors in October 2021 to repurchase up to 10% of the Company’s issued and outstanding common stock through November 30, 2022. Pursuant to the repurchase program, the Company repurchased approximately 268,000 shares for approximately $6.7 million during 2022. The Company did not execute any repurchases under this plan during the fourth quarter of 2022.
Pursuant to the Company’s equity compensation plans, participants may exercise stock options by surrendering shares of the Company’s common stock that the participants already own. Additionally, participants may also surrender shares upon the vesting of restricted stock awards to pay certain taxes. Shares surrendered by participants of these plans are valued at current market prices pursuant to the terms of the applicable awards. No such surrenders occurred during 2022.
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following discussion is intended to assist readers in understanding and evaluating the financial condition, changes in financial condition and the results of operations of the Company, consisting of the parent company (the Parent) and its wholly-owned subsidiaries, the Bank and Wealth. This discussion should be read in conjunction with the Consolidated Financial Statements and other financial information contained elsewhere in this report. In addition to current and historical information, the following discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to future business, financial condition or results of operations. For a description of certain factors that may have a significant impact on the Company’s future business, financial condition or results of operations, see “Cautionary Statement Regarding Forward-Looking Statements” prior to Item 1. “Business.”
Overview
The Company’s primary goals are to maximize earnings by maintaining strong asset quality and deploying capital in profitable growth initiatives that will enhance long-term stockholder value. The Company operates in three principal business segments: the Bank, Wealth, and the Company as a separate segment, the Parent. Revenues from the Bank’s operations consist primarily of interest earned on loans and investment securities, fees earned on deposit accounts, debit card interchange, and treasury and commercial services and mortgage banking income. Wealth’s operating revenues consist principally of income from fiduciary and asset management fees. The Parent’s revenues are mainly fees and dividends received from the Bank and Wealth.
Net income for 2022 was $9.1 million ($1.80 per diluted share) compared to $8.4 million ($1.61 per diluted share) in 2021. Assets as of December 31, 2022 were $1.4 billion, an increase of $17.2 million or 1.3% compared to assets as of December 31, 2021.
Key factors affecting comparisons of consolidated net income for the years ended December 31, 2022 and 2021 are discussed below: Comparisons are to prior year unless otherwise stated.
| • | Loans held for investment (net of deferred fees and costs), excluding PPP (non-GAAP), increased 24.5%. |
| • | Average earning assets increased $37.8 million, or 3.2%. |
| • | Interest income increased $5.8 million, or 13.7%. |
| • | Interest expense increased $147,000, or 4.3%, due primarily to increased expense from short-term FHLB borrowings and a full year of subordinated notes interest partially offset by shifts in funding to lower cost deposits. |
| • | Consolidated net interest margin (NIM) was 3.62% for 2022 compared to 3.26%. |
| • | Net PPP fees of $699 thousand were recognized in 2022, compared to $3.2 million in 2021. |
| • | Mortgage banking income decreased $1.8 million or 78.2% due to rising mortgage interest rates and a decline in mortgage industry volume. |
For more information about financial measures that are not calculated in accordance with GAAP, please see “Non-GAAP Financial Measures” below.
Capital Management and Dividends
Total equity was $98.7 million at December 31, 2022, compared to $120.8 million at December 31, 2021. Total capital decreased $22.1 million at December 31, 2022 compared to December 31, 2021 due to net unrealized losses on available-for-sale securities (net of tax), a component of accumulated comprehensive (loss) income, repurchase of shares under the Company’s share repurchase program, and the payment of dividends to shareholders, partially offset by earnings. The decline in market value for the securities available-for-sale during 2022 was a result of rising market interest rates. The Company expects to recover its investments in debt securities through scheduled payments of principal and interest through maturity and unrealized losses are not expected to affect net income or regulatory capital of the Company or its subsidiaries.
For the year ended December 31, 2022, the Company declared dividends of $0.52 per share. Annual dividends per share increased 4.0% over dividends of $0.50 per share declared in 2021. The Board of Directors of the Company continually reviews the amount of cash dividends per share and the resulting dividend payout ratio. The Company’s principal goals related to the maintenance of capital are to provide adequate capital to support the Company’s risk profile consistent with the board approved risk appetite, provide financial flexibility to support future growth and client needs, comply with relevant laws, regulations, and supervisory guidance, and provide a competitive return to stockholders. Risk-based capital ratios, which include CET1 capital, Tier 1 capital and Total capital for the Bank are calculated based on regulatory guidance related to the measurement of capital and risk-weighted assets.
The Company had a share repurchase program which was authorized by the Board of Directors in October 2021 to repurchase up to 10% of the Company’s issued and outstanding common stock through November 30, 2022. During the year ended December 31, 2022, the Company repurchased 268,095 shares, or $6.7 million of its common stock under the repurchase program. At the expiration of the repurchase program, the Company has made aggregate stock repurchases of 274,695 shares for an aggregate cost of $6.8 million.
At December 31, 2022, the book value per share of the Company’s common stock was $19.75, and tangible book value per share (non-GAAP) was $19.37, compared to $23.06 and $22.69, respectively, at December 31, 2021. Refer to “Non-GAAP Financial Measures,” below, for information about non-GAAP financial measures, including a reconciliation to the most directly comparable financial measures calculated in accordance with U.S. GAAP.
Critical Accounting Estimates
The accounting and reporting policies of the Company are in accordance with U.S. generally accepted accounting principles (GAAP) and conform to general practices within the banking industry. The Company’s financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in the Company’s consolidated financial position and/or results of operations. Those accounting policies with the greatest uncertainty and that require management’s most difficult, subjective or complex judgments affecting the application of these policies, and the greatest likelihood that materially different amounts would be reported under different conditions, or using different assumptions, are described below.
Allowance for Loan Losses
The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. Loan losses are charged against the allowance when it is believed the collection of the principal is unlikely. Subsequent recoveries of losses previously charged against the allowance are credited to the allowance. The allowance represents an amount that, in the Company’s judgment, will be adequate to absorb probable and estimable losses inherent in the loan portfolio. The judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs for relevant periods of time, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective because it requires estimates that are susceptible to significant revision as more information becomes available. In evaluating the level of the allowance, management considers a range of possible assumptions and outcomes related to the various factors identified above. Under alternative assumptions that we considered in developing our estimate of an allowance that will be adequate to absorb probable and estimable losses inherent in the loan portfolio at December 31, 2022, our estimate of the allowance varied between $9 million and $11 million.
For further information concerning accounting policies and the Company’s adoption of ASC 326, effective January 1, 2023, refer to Note 1, Significant Accounting Policies of the Notes to Consolidated Financial Statements included in Item 8. “Financial Statements and Supplementary Data” of this report on Form 10-K.
Results of Operations
Net Interest Income
The principal source of earnings for the Company is net interest income. Net interest income is the difference between interest and fees generated by earning assets and interest expense paid to fund them. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as their respective yields and rates, have a significant impact on the level of net interest income. The NIM is calculated by dividing net interest income by average earning assets, or on a fully tax-equivalent net interest income by average earning assets.
Net interest income was $44.4 million in 2022, an increase of $5.6 million from 2021. The NIM was 3.60% in 2022 as compared to 3.24% in 2021. Net interest income, on a fully tax-equivalent basis (non-GAAP), was $44.7 million in 2022, an increase of $5.7 million from 2021. On a fully tax-equivalent basis (non-GAAP), NIM was 3.62% in 2022 as compared to 3.26% in 2021. Year-over-year, average investment yields were higher by 57 basis points, average loan yields decreased slightly due primarily to lower accelerated recognition of deferred fees and costs related to PPP forgiveness, and average interest-bearing liability costs increased 1 basis point. Loan fees and costs related to PPP loans are deferred at the time of loan origination, are amortized into interest income over the remaining terms of the loans and accelerated upon forgiveness or repayment of the PPP loans. Net PPP fees of $699 thousand and $3.2 million were recognized in 2022 and 2021, respectively. Year-over-year NIM was also impacted by subordinated debt interest expense related to the timing of issuance in 2021, which resulted in the associated expense impacting the full year of 2022 compared to the partial impact in 2021. During 2022, market interest rates increased, and short-term rates are expected to continue to rise moving into 2023, which the Company expects to continue to result in increases in asset yields and cost of funds; however, the extent to which rising interest rates will ultimately affect the Company’s NIM is uncertain. For more information about these FTE financial measures, please see “Non-GAAP Financial Measures” below.
Average loans, which includes both loans held for investment and loans held for sale, increased $78.2 million to $920.0 million for the year ended December 31, 2022, compared to 2021. Average loans held for investment included $5.2 million and $53.5 million of average balances of loans originated under the PPP for 2022 and 2021, respectively. The increase in average loans outstanding 2022 compared to 2021 was due primarily to growth in the real estate mortgage, commercial real estate, and consumer segments of the loan portfolio. Average securities available for sale increased $29.6 million for 2022, compared to 2021, due primarily to higher purchases of securities. The average yield on the securities portfolio on a taxable-equivalent basis increased 57 basis points for 2022, compared to 2021, due primarily to rising interest rates during 2022 and purchases of securities at higher average yields relative to the average yield of the portfolio as a whole. Average interest-bearing deposits in other banks, consisting primarily of excess cash reserves maintained at the Federal Reserve Bank, decreased $70.3 million during 2022, compared to 2021, due primarily to utilizing cash to fund growth in higher yielding loans and securities. The average yield on interest-bearing deposits in other banks increased 64 basis points for 2022, compared to 2021. The Federal Reserve Bank increased the interest rate on excess cash reserve balances from 0.10 percent at the end of 2020 to 0.15 percent by the end of 2021 and to 4.40 percent by the end of 2022.
Average money market, savings and interest-bearing demand deposits increased $30.2 million and average time deposits decreased $20.4 million, for the year ended 2022, respectively, compared to the same periods in 2021, due to growth in consumer and business deposits and a shift from time deposits. Average noninterest-bearing demand deposits increased $31.2 million for the year ended December 31, 2022 compared to December 31, 2021. The average cost of interest-bearing deposits decreased 10 basis points for 2022 compared to the same 2021 period, due primarily to lower rates on deposits and a shift in composition from time deposits. Offered rates on interest-bearing deposit accounts have increased in response to changes in market interest rates during the fourth quarter of 2022.While changes in rates take effect immediately for interest checking, money market and savings accounts, changes in the average cost of time deposits lag changes in pricing based on the repricing of time deposits at maturity.
Average borrowings increased $13.3 million year-over-year due primarily to the full year impact of long term borrowings in 2022. The average cost of borrowings increased 146 basis points during 2022 compared to 2021 due primarily to the full-year impact of the subordinated notes during 2022 and an increase in short-term advances during the fourth quarter of 2022.
The Company believes that higher interest rates will continue to have a positive effect on yields of cash reserves, variable rate loans, new loan originations and purchases of securities available for sale. Although the Company expects the cost of deposits and borrowings to increase in connection with higher rates, the extent to which higher interest rates affect net interest margin will depend on a number of factors, including (1) the Company’s ability to continue to grow loans because of competition for loans, (2) the continued availability of funding through low-cost deposits, the level of competition for deposits and other lower-cost funding sources, and the Company’s ability to compete for deposits, and (3) the level of mortgage loan production and loans held for sale. The Company can give no assurance as to the timing or extent of further increases in market interest rates or the impact of rising interest rates or any other factor on the Company’s net interest margin. Alternatively, if market interest rates begin to decline, the Company believes that its net interest margin would be adversely affected as the Company generally expects its assets to reprice more quickly than its deposits and borrowings.
The following table shows an analysis of average earning assets, interest-bearing liabilities and rates and yields. Nonaccrual loans are included in loans outstanding.
TABLE 1: AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND RATES
| | | For the years ended December 31, | |
| | | 2022 | | | 2021 | | | 2020 | |
| (dollars in thousands) | | Average Balance | | | Income/ Expense | | | | | | Average Balance | | | | | | | | | | | | | | | | |
| ASSETS | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans* | | $ | 919,990 | | | $ | 41,440 | | | | 4.50 | % | | $ | 841,748 | | | $ | 37,960 | | | | 4.51 | % | | $ | 834,247 | | | $ | 36,061 | | | | 4.32 | % |
| Investment securities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Taxable | | | 192,639 | | | | 4,936 | | | | 2.56 | % | | | 173,661 | | | | 3,284 | | | | 1.89 | % | | | 145,029 | | | | 3,068 | | | | 2.12 | % |
| Tax-exempt* | | | 42,792 | | | | 1,258 | | | | 2.94 | % | | | 32,158 | | | | 953 | | | | 2.96 | % | | | 18,270 | | | | 654 | | | | 3.58 | % |
| Total investment securities | | | 235,431 | | | | 6,194 | | | | 2.63 | % | | | 205,819 | | | | 4,237 | | | | 2.06 | % | | | 163,299 | | | | 3,722 | | | | 2.28 | % |
| Interest-bearing due from banks | | | 75,111 | | | | 598 | | | | 0.80 | % | | | 145,425 | | | | 230 | | | | 0.16 | % | | | 91,160 | | | | 267 | | | | 0.29 | % |
| Federal funds sold | | | 2,694 | | | | 21 | | | | 0.77 | % | | | 2,932 | | | | 3 | | | | 0.09 | % | | | 841 | | | | 12 | | | | 1.45 | % |
| Other investments | | | 1,554 | | | | 87 | | | | 5.63 | % | | | 1,104 | | | | 70 | | | | 6.35 | % | | | 3,020 | | | | 134 | | | | 4.43 | % |
| Total earning assets | | | 1,234,780 | | | $ | 48,340 | | | | 3.91 | % | | | 1,197,028 | | | $ | 42,500 | | | | 3.55 | % | | | 1,092,567 | | | $ | 40,196 | | | | 3.68 | % |
| Allowance for loan losses | | | (9,958 | ) | | | | | | | | | | | (9,621 | ) | | | | | | | | | | | (9,723 | ) | | | | | | | | |
| Other nonearning assets | | | 99,272 | | | | | | | | | | | | 98,597 | | | | | | | | | | | | 104,414 | | | | | | | | | |
| Total assets | | $ | 1,324,094 | | | | | | | | | | | $ | 1,286,004 | | | | | | | | | | | $ | 1,187,258 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS’ EQUITY |
| Time and savings deposits: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing transaction accounts | | $ | 78,167 | | | $ | 10 | | | | 0.01 | % | | $ | 71,841 | | | $ | 13 | | | | 0.02 | % | | $ | 55,667 | | | $ | 12 | | | | 0.02 | % |
| Money market deposit accounts | | | 385,067 | | | | 697 | | | | 0.18 | % | | | 372,193 | | | | 879 | | | | 0.24 | % | | | 307,190 | | | | 1,012 | | | | 0.33 | % |
| Savings accounts | | | 125,310 | | | | 39 | | | | 0.03 | % | | | 114,285 | | | | 46 | | | | 0.04 | % | | | 96,149 | | | | 56 | | | | 0.06 | % |
| Time deposits | | | 159,889 | | | | 1,403 | | | | 0.88 | % | | | 180,255 | | | | 1,941 | | | | 1.08 | % | | | 209,727 | | | | 3,337 | | | | 1.59 | % |
| Total time and savings deposits | | | 748,433 | | | | 2,149 | | | | 0.29 | % | | | 738,574 | | | | 2,879 | | | | 0.39 | % | | | 668,733 | | | | 4,417 | | | | 0.66 | % |
Federal funds purchased, repurchase agreements and other borrowings | | | 6,170 | | | | 69 | | | | 1.12 | % | | | 14,178 | | | | 35 | | | | 0.25 | % | | | 33,846 | | | | 150 | | | | 0.44 | % |
| Federal Home Loan Bank advances | | | 5,606 | | | | 207 | | | | 3.69 | % | | | - | | | | - | | | | 0.00 | % | | | 38,942 | | | | 725 | | | | 1.86 | % |
| Long term borrowings | | | 29,469 | | | | 1,180 | | | | 4.01 | % | | | 13,784 | | | | 544 | | | | 3.95 | % | | | - | | | | - | | | | 0.00 | % |
| Total interest-bearing liabilities | | | 789,678 | | | | 3,605 | | | | 0.46 | % | | | 766,536 | | | | 3,458 | | | | 0.45 | % | | | 741,521 | | | | 5,292 | | | | 0.71 | % |
| Demand deposits | | | 422,849 | | | | | | | | | | | | 391,673 | | | | | | | | | | | | 325,596 | | | | | | | | | |
| Other liabilities | | | 5,221 | | | | | | | | | | | | 7,473 | | | | | | | | | | | | 5,055 | | | | | | | | | |
| Stockholders’ equity | | | 105,345 | | | | | | | | | | | | 120,322 | | | | | | | | | | | | 115,086 | | | | | | | | | |
| Total liabilities and stockholders’ equity | | $ | 1,323,093 | | | | | | | | | | | $ | 1,286,004 | | | | | | | | | | | $ | 1,187,258 | | | | | | | | | |
| Net interest margin | | | | | | $ | 44,735 | | | | 3.62 | % | | | | | | $ | 39,042 | | | | 3.26 | % | | | | | | $ | 34,904 | | | | 3.19 | % |
*Computed on a fully tax-equivalent (non-GAAP) basis using a 21% rate, adjusting interest income by $297 thousand, $248 thousand, and $187 thousand, respectively.
Interest income and expense are affected by fluctuations in interest rates, by changes in volume of earning assets and interest-bearing liabilities, and by the interaction of rate and volume factors. The following table shows the direct causes of the year-to-year changes in the components of net interest income. The Company calculates the rate and volume variances using a formula prescribed by the SEC. Rate/volume variances, the third element in the calculation, are not show separately in the table, but are allocated to the rate and volume variances in proportion to the absolute dollar amounts of each.
TABLE 2: VOLUME AND RATE ANALYSIS*
| | | 2022 vs. 2021 Increase (Decrease) | | | 2021 vs. 2020 Increase (Decrease) | |
| | | Due to Changes in: | | | | | | Due to Changes in: | | | | |
| (dollars in thousands) | | Volume | | | Rate | | | Total | | | Volume | | | Rate | | | Total | |
| EARNING ASSETS | | | | | | | | | | | | | | | | | | |
| Loans* | | $ | 3,528 | | | $ | (48 | ) | | $ | 3,480 | | | $ | 324 | | | $ | 1,575 | | | $ | 1,899 | |
| Investment securities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Taxable | | | 359 | | | | 1,293 | | | | 1,652 | | | | 607 | | | | (391 | ) | | | 216 | |
| Tax-exempt* | | | 315 | | | | (10 | ) | | | 305 | | | | 497 | | | | (198 | ) | | | 299 | |
| Total investment securities | | | 674 | | | | 1,283 | | | | 1,957 | | | | 1,104 | | | | (589 | ) | | | 515 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Federal funds sold | | | - | | | | 18 | | | | 18 | | | | 30 | | | | (39 | ) | | | (9 | ) |
| Other investments** | | | (82 | ) | | | 467 | | | | 385 | | | | 72 | | | | (173 | ) | | | (101 | ) |
| Total earning assets | | | 4,120 | | | | 1,720 | | | | 5,840 | | | | 1,531 | | | | 773 | | | | 2,304 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| INTEREST-BEARING LIABILITIES | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing transaction accounts | | | 1 | | | | (4 | ) | | | (3 | ) | | | 3 | | | | (2 | ) | | | 1 | |
| Money market deposit accounts | | | 30 | | | | (212 | ) | | | (182 | ) | | | 215 | | | | (348 | ) | | | (133 | ) |
| Savings accounts | | | 4 | | | | (11 | ) | | | (7 | ) | | | 11 | | | | (21 | ) | | | (10 | ) |
| Time deposits | | | (219 | ) | | | (319 | ) | | | (538 | ) | | | (469 | ) | | | (927 | ) | | | (1,396 | ) |
| Total time and savings deposits | | | (184 | ) | | | (546 | ) | | | (730 | ) | | | (240 | ) | | | (1,298 | ) | | | (1,538 | ) |
| Federal funds purchased, repurchase | | | | | | | | | | | | | | | | | | | | | | | | |
| agreements and other borrowings | | | (20 | ) | | | 54 | | | | 34 | | | | (87 | ) | | | (28 | ) | | | (115 | ) |
| Federal Home Loan Bank advances | | | - | | | | 207 | | | | 207 | | | | (724 | ) | | | (1 | ) | | | (725 | ) |
| Long term borrowings | | | 619 | | | | 17 | | | | 636 | | | | - | | | | 544 | | | | 544 | |
| Total interest-bearing liabilities | | | 415 | | | | (268 | ) | | | 147 | | | | (1,051 | ) | | | (783 | ) | | | (1,834 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Change in net interest income | | $ | 3,705 | | | $ | 1,988 | | | $ | 5,693 | | | $ | 2,582 | | | $ | 1,556 | | | $ | 4,138 | |
* Computed on a fully tax-equivalent basis, non-GAAP, using a 21% rate.
** Other investments include interest-bearing balances due from banks.
The Company believes NIM may be affected in future periods by several factors that are difficult to predict, including (1) changes in interest rates, which may depend on the severity of adverse economic conditions, inflationary pressures, the timing and extent of any economic recovery, which are inherently uncertain; (2) possible changes in the composition of earning assets which may result from decreased loan demand as a result of the current economic environment; and (3) possible changes in the composition of interesting-bearing liabilities, which may result from decreased deposit balances or increased competition for deposits, or from changes in the availability of certain types of wholesale funding.
Discussion of net interest income for the year ended December 31, 2020 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Net Interest Income” in the
Company’s 2021 Form 10-K, which was filed with the SEC on March 31, 2022, and is incorporated herein by reference.
Provision for Loan Losses
The provision for loan losses is a charge against earnings necessary to maintain the allowance for loan losses at a level consistent with management’s evaluation of the portfolio. This expense is based on management’s estimate of probable credit losses inherent in the loan portfolio. Management’s evaluation included credit quality trends, collateral values, discounted cash flow analysis, loan volumes, geographic, borrower and industry concentrations, the findings of internal credit quality assessments and results from external regulatory examinations. These factors, as well as identified impaired loans, historical losses and current economic and business conditions including uncertainties associated with the COVID-19 pandemic, were used in developing estimated loss factors for determining the loan loss provision. Based on its analysis of the adequacy of the allowance for loan losses, management concluded that the provision was appropriate.
The provision for loan losses was $1.7 million for the year ended December 31, 2022, as compared to $794 thousand for 2021. The increased level is primarily due to the increase in loans held for investment, excluding PPP (non-GAAP). Charged-off loans totaled $2.0 million in 2022, compared to $1.1 million in 2021. Recoveries amounted to $977 thousand in 2022 and $649 thousand in 2021. The Company’s net loans charged off to average loans were 0.12% in 2022 as compared to 0.06% in 2021.
The state of the local economy can have a significant impact on the level of loan charge-offs. If the economy begins to contract, nonperforming assets could increase as a result of declines in real estate values and home sales or increases in unemployment rates and financial stress on borrowers. Increased nonperforming assets would increase charge-offs and reduce earnings due to larger contributions to the loan loss provision.
Noninterest Income
Unless otherwise noted, all comparisons in this section are between the twelve months ended December 31, 2022 and the twelve months ended December 31, 2021.
Noninterest income decreased $1.4 million or 9.3% for the year ended December 31, 2022, as compared to the year ended December 31, 2021. In 2022, decreases in mortgage banking income ($1.8 million or 78.2%), fiduciary and asset management fees ($101 thousand or 2.4%), and bank-owned life insurance income ($105 thousand or 10.4%), were partially offset by increases in service charges on deposit accounts ($372 thousand or 13.8%), other service charges, commissions and fees ($45 thousand or 1.0%), and other operating income ($372 thousand or 104.0%). Gains on sales of fixed assets and losses on sales of available-for-sale securities impacted the year-over-year comparatives. During 2022, the Company recognized gains on sales of fixed assets of $1.7 million. The Company also recognized losses of $1.9 million on sales of available-for-sale securities in a reinvestment strategy which increased yield on the asset base over 300 basis points.
Mortgage banking income decreased due to declines in the volume of mortgage originations attributable to changes in mortgage market conditions; fiduciary and asset management fees decreased primarily due to lower income tax preparation revenue; and bank-owned life insurance income decreased due to a specific event which occurred in 2021. Service charges on deposit accounts increased primarily due to increases in analysis charges and NSF charges and other operating income increased primarily due to interest rate swap fees.
The Company continues to focus on diversifying noninterest income through efforts to expand Wealth, insurance, and mortgage banking activities, and a continued focus on business checking and other corporate services.
Discussion of noninterest income for the year ended December 31, 2020 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Noninterest Income” in the
Company’s 2021 Form 10-K which was filed with the SEC on March 31, 2022, and is incorporated by reference herein.
Noninterest Expense
Unless otherwise noted, all comparisons in this section are between the twelve months ended December 31, 2022 and the twelve months ended December 31, 2021.
The Company’s noninterest expense increased $2.5 million or 5.8%. Year-over-year increases were primarily related to salaries and employee benefits, customer development, professional services, and employee professional development related to recruiting. The increase in salary and benefits was primarily driven by the addition of revenue producing officers, a return to normalized position vacancy levels, incentive compensation expense, and lower deferred loan costs.
The Company completed negotiations with a major vendor relationship during the fourth quarter of 2022 which is expected to reduce existing cost structures beginning in 2023 as well as provide an opportunity for operational leverage for future growth at fixed cost levels. Several other major vendor contracts and relationships continue to be assessed and negotiated as a key component of efforts to reduce noninterest expense levels while improving operational efficiency.
The Company also continues to focus on balance sheet repositioning, exploring disposition opportunities of under-utilized real estate and branch optimization with two branch closures completed in the first quarter of 2022, as well as digital initiatives that complement this repositioning.
The provision for income taxes is based upon the results of operations, adjusted for the effect of certain tax-exempt income, non-deductible expenses, and tax credits. In addition, certain items of income and expense are reported in different periods for financial reporting and tax return purposes. The tax effects of these temporary differences are recognized currently in the deferred income tax provision or benefit. Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the applicable enacted marginal tax rate.
The effective tax rates for the years ended December 31, 2022 and 2021 were 13.9% and 13.3%, respectively. The effective tax rate was affected by higher pre-tax income.
Discussion of noninterest expense and income taxes for the year ended December 31, 2020 has been omitted as such discussion was provided in Part II, Item 7. “Management’s Discussion and Analysis,” under the heading “Noninterest Expense” i
n the Company’s 2021 Form 10-K, which was filed with the SEC on March 31, 2022, and in incorporated by reference herein.
Balance Sheet Review
At December 31, 2022, the Company had total assets of $1.4 billion, an increase of $17.2 million or 1.3% compared to assets as of December 31, 2021.
Net loans held for investment increased $182.9 million or 21.9%, from $833.7 million at December 31, 2021 to $1.0 billion at December 31, 2022. Loans held for investment, excluding PPP (non-GAAP), grew 24.5%, or $202.0 million, driven by diversified loan growth in the following segments: commercial real estate of $47.2 million, construction, land development, and other land loans of $19.3 million, residential real estate of $47.7 million, and indirect automobile of $77.9 million. Cash and cash equivalents decreased $168.7 million or 89.8% from December 31, 2021 to December 31, 2022 as lower yielding liquidity was redeployed primarily into higher yielding loans. Securities available for sale decreased $8.8 million or 3.8% over the same period.
Total deposits of $1.2 billion as of December 31, 2022 decreased $21.1 million, or 1.8%, from December 31, 2021. Noninterest-bearing deposits decreased $2.9 million, or 0.7%, savings deposits decreased $1.9 million, or 0.3%, and time deposits decreased $16.2 million, or 9.6%. Overnight repurchase agreements, federal funds purchased, and short-term Federal Home Loan Bank advances increased to $62.5 million at December 31, 2022 from $4.5 million at December 31, 2021. At December 31, 2022, the Company had FHLB advances of $46.1 million.
Securities Portfolio
When comparing December 31, 2022 to December 31, 2021, securities available-for-sale decreased $8.8 million, or 3.8%. The investment portfolio plays a primary role in the management of the Company’s interest rate sensitivity. In addition, the portfolio serves as a source of liquidity and is used as needed to meet collateral requirements. The investment portfolio consists of securities available for sale, which may be sold in response to changes in market interest rates, changes in prepayment risk, increases in loan demand, general liquidity needs and other similar factors. These securities are carried at estimated fair value. At December 31, 2022 and 2021, all securities in the Company’s investment portfolio were classified as available for sale.
The following table sets forth a summary of the securities portfolio in dollar amounts at fair value and as a percentage of the Company’s total securities available for sale as of the dates indicated:
TABLE 3: SECURITIES PORTFOLIO
| | | December 31, | |
| (Dollars in thousands) | | 2022 | | | | | | 2021 | | | | |
| U.S. Treasury securities | | $ | 7,671 | | | | 3 | % | | $ | 14,904 | | | | 6 | % |
| Obligations of U.S. Government agencies | | | 42,399 | | | | 19 | % | | | 38,558 | | | | 16 | % |
| Obligations of state and political subdivisions | | | 59,384 | | | | 26 | % | | | 65,803 | | | | 28 | % |
| Mortgage-backed securities | | | 88,913 | | | | 39 | % | | | 89,058 | | | | 38 | % |
| Money market investments | | | 1,816 | | | | 1 | % | | | 2,413 | | | | 1 | % |
| Corporate bonds and other securities | | | 25,335 | | | | 11 | % | | | 23,585 | | | | 10 | % |
| | | | 225,518 | | | | 99 | % | | | 234,321 | | | | 100 | % |
| Restricted securities: | | | | | | | | | | | | | | | | |
| Federal Home Loan Bank stock | | $ | 2,709 | | | | 1 | % | | | 383 | | | | 0 | % |
| Federal Reserve Bank stock | | | 683 | | | | - | | | | 609 | | | | - | |
| Community Bankers’ Bank stock | | | 42 | | | | - | | | | 42 | | | | - | |
| | | | 3,434 | | | | | | | | 1,034 | | | | | |
| Total Securities | | $ | 228,952 | | | | 100 | % | | $ | 235,355 | | | | 100 | % |
In order to utilize excess liquidity rather than holding excess cash reserves, the Company invested in U.S. government agencies and corporations, obligations of states and political subdivisions, and mortgage-backed securities. Net unrealized losses on the market value of securities available for sale were $26.3 million at December 31, 2022 and net unrealized gains on the market value of securities available for sale were $2.1 million at December 31, 2021. The decline in market value of securities available for sale during 2022 was primarily a result of increases in market interest rates.
The Company seeks to diversify its portfolio to minimize risk, including by purchasing (1) shorter-duration mortgage backed-securities to reduce interest rate risk and for cash flow and reinvestment opportunities and (2) securities issued by states and political subdivisions due to the tax benefits and the higher tax-adjusted yield obtained from these securities. All of the Company’s mortgage-backed securities are direct issues of United States government agencies or government-sponsored enterprises. Collectively, these entities provide a guarantee, which is either explicitly or implicitly supported by the full faith and credit of the U.S. government, that investors in such mortgage-backed securities will receive timely principal and interest payments. The Company also invests in the debt securities of corporate issuers, primarily financial institutions, that the Corporation views as having a strong financial position and earnings potential.
The following table summarizes the contractual maturity of the securities portfolio and their weighted average yields as of December 31, 2022:
TABLE 4: MATURITY OF SECURITIES
| (Dollars in thousands) | | | | | 1-5 years | | | 5-10 years | | | Over 10 years | | | Total | |
| U.S. Treasury securities | | $ | - | | | $ | 7,671 | | | $ | - | | | $ | - | | | $ | 7,671 | |
| Weighted average yield | | | - | | | | 2.75 | % | | | - | | | | - | | | | 2.75 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Obligations of U.S. Government agencies | | $ | 387 | | | $ | 4,580 | | | $ | 1,842 | | | $ | 35,590 | | | $ | 42,399 | |
| Weighted average yield | | | 0.30 | % | | | 1.99 | % | | | 3.17 | % | | | 5.19 | % | | | 4.71 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Obligations of state and policitcal subdivisions | | $ | - | | | $ | 1,422 | | | $ | 18,586 | | | $ | 39,376 | | | $ | 59,384 | |
| Weighted average yield | | | - | | | | 2.71 | % | | | 2.21 | % | | | 2.75 | % | | | 2.58 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Mortgage-backed securities | | $ | - | | | $ | 5,302 | | | $ | 10,887 | | | $ | 72,724 | | | $ | 88,913 | |
| Weighted average yield | | | - | | | | 3.71 | % | | | 2.28 | % | | | 2.83 | % | | | 2.81 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Money market investments | | $ | 1,816 | | | $ | - | | | $ | - | | | $ | - | | | $ | 1,816 | |
| Weighted average yield | | | 1.25 | % | | | - | | | | - | | | | - | | | | 1.25 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Corporate bonds and other securities | | $ | 485 | | | $ | - | | | $ | 24,850 | | | $ | - | | | $ | 25,335 | |
| Weighted average yield | | | 3.44 | % | | | - | | | | 4.44 | % | | | - | | | | 4.42 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Federal Home Loan Bank stock | | $ | - | | | $ | - | | | $ | - | | | $ | 2,709 | | | $ | 2,709 | |
| Weighted average yield | | | - | | | | - | | | | - | | | | 4.81 | % | | | 4.81 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Federal Reserve Bank stock | | $ | - | | | $ | - | | | $ | - | | | $ | 683 | | | $ | 683 | |
| Weighted average yield | | | - | | | | - | | | | - | | | | 6.00 | % | | | 6.00 | % |
| | | | | | | | | | | | | | | | | | | | | |
| Community Bankers’ Bank stock | | $ | - | | | $ | - | | | $ | - | | | $ | 42 | | | $ | 42 | |
| Weighted average yield | | | - | | | | - | | | | - | | | | 0.00 | % | | | 0.00 | % |
| Total Securities | | $ | 2,688 | | | $ | 18,975 | | | $ | 56,165 | | | $ | 151,124 | | | $ | 228,952 | |
| Weighted average yield | | | 1.08 | % | | | 2.83 | % | | | 3.24 | % | | | 3.38 | % | | | 3.28 | % |
The table above is based on maturity; therefore, it does not reflect cash flow from principal payments or prepayments prior to maturity. The weighted average life of the $88.9 million in mortgage-backed securities as of December 31, 2022 was 6.4 years. The weighted average yield is calculated on a fully tax-equivalent basis using a 21% rate on a pro rata basis for each security based on its relative amortized cost.
Loan Portfolio
The following table shows a breakdown of total loans by segment at December 31, 2022 and 2021:
TABLE 5: LOAN PORTFOLIO
| | | December 31, | |
| (Dollars in thousands) | | 2022 | | | 2021 | |
| Commercial and industrial | | $ | 72,578 | | | $ | 68,690 | |
| Real estate-construction | | | 77,944 | | | | 58,440 | |
| Real estate-mortgage (1) | | | 259,091 | | | | 206,368 | |
| Real estate-commercial | | | 429,863 | | | | 382,603 | |
| Consumer | | | 185,269 | | | | 118,441 | |
| Other | | | 2,340 | | | | 8,984 | |
| Ending Balance | | $ | 1,027,085 | | | $ | 843,526 | |
(1) The real estate-mortgage segment included residential 1-4 family, multi-family, second mortgages and equity lines of credit.
As of December 31, 2022, the total loan portfolio increased by $183.6 million or 21.8% from December 31, 2021 due to increases diversified over each segment besides Other. PPP loans outstanding decreased $18.5 million to $530 thousand at December 31, 2022 from $19.0 million at December 31, 2021. Net loans held for investment increased 21.9% from December 31, 2021 to December 31, 2022. Loans held for investment (net of deferred fees and costs), excluding PPP (non-GAAP), grew 24.5%
The maturity distribution and rate sensitivity of the Company’s loan portfolio at December 31, 2022 is presented below:
TABLE 6: MATURITY/REPRICING SCHEDULE OF LOAN PORTFOLIO
| | | As of December 31, 2022 | | | | |
| (Dollars in thousands) | | Commercial and industrial | | | Real estate-construction | | | Real estate-mortgage (1) | | | Real estate-commercial | | | Consumer | | | Other | | | Total | |
| Variable Rate: | | | | | | | | | | | | | | | | | | | | | |
| Within 1 year | | $ | 1,931 | | | $ | 7,076 | | | $ | 6,271 | | | $ | 21,783 | | | $ | 2,545 | | | $ | 83 | | | $ | 39,689 | |
| 1 to 5 years | | | 19,096 | | | | 17,599 | | | | 38,558 | | | | 188,794 | | | | 61,857 | | | | - | | | | 325,904 | |
| 5 to 15 years | | | 34,301 | | | | 3,733 | | | | 34,153 | | | | 140,351 | | | | 103,009 | | | | 309 | | | | 315,856 | |
| After 15 years | | | - | | | | 45 | | | | 54,956 | | | | 5,533 | | | | 10,008 | | | | - | | | | 70,542 | |
| Fixed Rate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Within 1 year | | $ | 16,739 | | | $ | 46,227 | | | $ | 66,707 | | | $ | 46,322 | | | $ | 7,814 | | | $ | 1,582 | | | $ | 185,391 | |
| 1 to 5 years | | | 511 | | | | 1,985 | | | | 15,271 | | | | 23,703 | | | | - | | | | 366 | | | | 41,836 | |
| 5 to 15 years | | | - | | | | 793 | | | | 43,175 | | | | 3,377 | | | | 36 | | | | - | | | | 47,381 | |
| After 15 years | | | - | | | | 486 | | | | - | | | | - | | | | - | | | | - | | | | 486 | |
| | | $ | 72,578 | | | $ | 77,944 | | | $ | 259,091 | | | $ | 429,863 | | | $ | 185,269 | | | $ | 2,340 | | | $ | 1,027,085 | |
(1) The real estate-mortgage segment included residential 1-4 family, multi-family, second mortgages and equity lines of credit.
Nonperforming Assets
Nonperforming assets consist of nonaccrual loans, loans past due 90 days or more and accruing interest, nonperforming restructured loans, and other real estate owned (OREO). Restructured loans are loans with terms that were modified in a troubled debt restructuring (TDR) for borrowers experiencing financial difficulties. Refer to Note 3, Loans and Allowance for Loan Losses of the Notes to Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data” of this report Form 10-K for more information.
Nonperforming assets increased by $580 thousand or 38.6%, from $1.5 million at December 31, 2021 to $2.1 million at December 31, 2022. The 2022 total consisted of $840 thousand in loans still accruing interest but past due 90 days or more and $1.2 million in nonaccrual loans. All of the nonaccrual loans are classified as impaired and 88.4% of the nonaccrual loans at December 31, 2022 were secured by real estate. Impaired loans are a component of the allowance for loan losses. When a loan changes from “90 days past due but still accruing interest” to “nonaccrual” status, the loan is normally reviewed for impairment. If impairment is identified, then the Company records a charge-off based on the value of the collateral or the present value of the loan’s expected future cash flows, discounted at the loan’s effective interest rate. If the Company is waiting on an appraisal to determine the collateral’s value, management allocates funds to cover the deficiency to the allowance for loan losses based on information available to management at the time.
The recorded investment in impaired loans increased to $1.9 million as of December 31, 2022 from $1.3 million as of December 31, 2021 as detailed in Note 3, Loans and Allowance for Loan Losses of the Notes to Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data” of this report on Form 10-K. The majority of these loans were collateralized.
The following table presents information concerning the aggregate amount of nonperforming assets, which includes nonaccrual loans, past due loans, TDRs and OREO:
TABLE 7: NONPERFORMING ASSETS
| | | December 31, | |
| (dollars in thousands) | | 2022 | | | 2021 | |
| Nonaccrual loans | | | | | | |
| Commercial and industrial | | $ | 144 | | | $ | 174 | |
| Real estate-construction | | | 945 | | | | - | |
| Real estate-mortgage (1) | | | 154 | | | | 191 | |
| Real estate-commercial | | | - | | | | 113 | |
| Total nonaccrual loans | | $ | 1,243 | | | $ | 478 | |
| | | | | | | | | |
| Loans past due 90 days or more and accruing interest | | | | | | | | |
| Commercial and industrial | | $ | 23 | | | $ | 169 | |
| Real estate-mortgage (1) | | | 525 | | | | - | |
| Consumer loans (2) | | | 292 | | | | 846 | |
| Other | | | - | | | | 10 | |
| Total loans past due 90 days or more and accruing interest | | $ | 840 | | | $ | 1,025 | |
| | | | | | | | | |
| Restructured loans | | | | | | | | |
| Real estate-construction | | $ | 75 | | | $ | 79 | |
| Real estate-mortgage (1) | | | 279 | | | | 450 | |
| Real estate-commercial | | | 358 | | | | 413 | |
| Total restructured loans | | $ | 712 | | | $ | 942 | |
| Less nonaccrual restructured loans (included above) | | | 154 | | | | 191 | |
| Less restructured loans currently in compliance (3) | | | 558 | | | | 751 | |
| Net nonperforming, accruing restructured loans | | $ | - | | | $ | - | |
| Nonperforming loans | | $ | 2,083 | | | $ | 1,503 | |
| | | | | | | | | |
| Total nonperforming assets | | $ | 2,083 | | | $ | 1,503 | |
| | | | | | | | | |
| Interest income that would have been recorded under original loan terms on nonaccrual loans above | | $ | 111 | | | $ | 11 | |
| | | | | | | | | |
| Interest income recorded for the period on nonaccrual loans included above | | $ | 15 | | | $ | 2 | |
| | | | | | | | | |
| Total loans | | $ | 1,027,085 | | | $ | 843,526 | |
| ALLL | | $ | 10,526 | | | $ | 9,865 | |
| Nonaccrual loans to total loans | | | 0.12 | % | | | 0.06 | % |
| ALLL to total loans | | | 1.02 | % | | | 1.17 | % |
| ALLL to nonaccrual loans | | | 846.82 | % | | | 2063.81 | % |
| | | | | | | | | |
| For the year ended December 31: | | | | | | | | |
| Provision for loan losses | | $ | 1,706 | | | $ | 794 | |
| Net charge-offs to average total loans | | | 0.11 | % | | | 0.06 | % |
(1) The real estate-mortgage segment includes residential 1 – 4 family, second mortgages and equity lines of credit.
(2) Amounts listed include student loans and small business loans with principal and interest amounts that are 97 - 100% guaranteed by the federal government. The past due principal portion of these guaranteed loans totaled $38 thousand at December 31, 2022 and $711 thousand at December 31, 2021. For additional information, refer to Note 3, Loans and Allowance for Loan Losses of the Notes to Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data” of this report on Form 10-K.
(3) Amounts listed represent restructured loans that are in compliance with their modified terms as of the date presented.
As shown in the table above, as of December 31, 2022 compared to December 31, 2021, the nonaccrual loan category increased by $765 thousand or 88.4% and the 90-days past due and still accruing interest category decreased by $185 thousand or 18.0%.
The nonaccrual loans at December 31, 2022 were related to five credit relationships. All loans in these relationships have been analyzed to determine whether the cash flow of the borrower and the collateral pledged to secure the loans is sufficient to cover outstanding principal balances. The Company has set aside specific allocations for those loans without sufficient cash flow or collateral and charged off any balance that management does not expect to collect.
In the loans past due 90 days or more and still accruing interest at December 31, 2022, $38 thousand were student loans. The federal government has provided guarantees of repayment of these student loans in an amount ranging from 97% to 98% of the total principal and interest of the loans; as such, management does not expect even a significant increase in past due small business or student loans to have a material effect on the Company.
Management believes the Company has excellent credit quality review processes in place to identify problem loans quickly. For a detailed discussion of the Company’s nonperforming assets, refer to Note 3, Loans and Allowance for Loan Losses of the Notes to Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data” of this report on Form 10-K.
The Allowance for Loan Losses
The allowance for loan losses is based on several components. In evaluating the adequacy of the allowance, each segment of the loan portfolio is divided into several pools of loans:
1. Specific identification (regardless of risk rating)
2. Pool–substandard
3. Pool–other assets especially mentioned (OAEM) (rated just above substandard)
4. Pool–pass loans (all other rated loans)
The first component of the allowance for loan losses is determined based on specifically identified loans that may become impaired. These loans are individually analyzed for impairment and include nonperforming loans and both performing and nonperforming TDRs. This component may also include loans considered impaired for other reasons, such as outdated financial information on the borrower or guarantors or financial problems of the borrower, including operating losses, marginal working capital, inadequate cash flow, or business interruptions. Changes in TDRs and nonperforming loans affect the dollar amount of the allowance. Increases in the impairment allowance for TDRs and nonperforming loans are reflected as an increase in the allowance for loan losses except in situations where the TDR or nonperforming loan does not require a specific allocation (i.e., the discounted present value of expected future cash flows or the collateral value is considered sufficient).
The majority of the Company’s TDRs and nonperforming loans are collateralized by real estate. When reviewing loans for impairment, the Company obtains current appraisals when applicable. If the Company has not yet received a current appraisal on loans being reviewed for impairment, any loan balance that is in excess of the estimated appraised value is allocated in the allowance. As of December 31, 2022 and December 31, 2021, the impaired loan component of the allowance for loan losses amounted to $30 thousand and $128 thousand, respectively. The decrease in the impaired loan component is due primarily to the resolution of one credit relationship. The impaired loan component of the allowance for loan losses is reflected as a valuation allowance related to impaired loans in Note 3, Loans and Allowance for Loan Losses of the Notes to Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data” of this report on Form 10-K.
Historical loss is the second component of the allowance for loan losses. The calculation of the historical loss component is conducted on loans evaluated collectively for impairment and uses migration analysis with eight migration periods covering twelve quarters each on pooled segments. These segments are based on the loan classifications set by the Federal Financial Institutions Examination Council in the instructions for the Call Report applicable to the Bank.
The final component of the allowance consists of qualitative factors and includes items such as economic conditions, growth trends, loan concentrations, changes in certain loans, changes in underwriting, changes in management and legal and regulatory changes.
Consumer loans not secured by real estate and made to individuals for household, family and other personal expenditures are segmented into pools based on whether the loan’s payments are current (including loans 1 – 29 days past due), 30 – 59 days past due, 60 – 89 days past due, or 90 days or more past due. All other loans, including loans to consumers that are secured by real estate, are segmented by the Company’s internally assigned risk grades: substandard, other assets especially mentioned (rated just above substandard), and pass (all other loans). The Company may also assign loans to the risk grades of doubtful or loss, but as of December 31, 2022 and December 31, 2021, the Company had no loans in these categories.
The overall historical loss rate from December 31, 2021 to December 31, 2022, improved 9 basis points as a percentage of loans evaluated collectively for impairment as a result of overall improving asset quality combined with continued improvement in non-performing assets. For the same period, the qualitative factor components decreased 8 basis points as a percentage of loans evaluated collectively for impairment overall. This decrease was primarily due to reduction of certain qualitative factor adjustments related to the COVID-19 pandemic partially offset by changes in volume for certain segments. While there have not been significant changes in overall credit quality of the loan portfolio from December 31, 2021 to December 31, 2022, management will continue to monitor economic recovery challenges at macro and micro levels, including levels of inflation, changes in the interest rate environment, supply chain disruption, and employment levels, which may be delaying signs of credit deterioration. If there are further challenges to the economic recovery, elevated levels of risk within the loan portfolio may require additional increases in the allowance for loan losses.
On a combined basis, the historical loss and qualitative factor components amounted to $10.5 million as of December 31, 2022 and $9.7 million at December 31, 2021. Management is monitoring portfolio activity, such as levels of deferral and/or modification requests, concentration levels by collateral, as well as industry concentration levels to identify areas within the loan portfolio which may create elevated levels of risk should the economic environment present indications of economic instability that is other than temporary in nature.
Overall Change in Allowance
As a result of management’s analysis, the Company added, through the provision, $1.7 million to the ALLL for the year ended December 31, 2022. The ALLL, as a percentage of year-end loans held for investment, was 1.02% in 2022 and 1.17% in 2021. The decrease in the ALLL as a percentage of loans held for investment at December 31, 2022 compared to the prior year was primarily attributable to continued improvement in historical loss rates and a reduction of qualitative factor adjustments related to the COVID-19 pandemic partially offset by certain segment qualitative factor adjustments for volume trends. Excluding PPP loans, the ALLL as a percentage of loans held for investment was 1.03% and 1.20% at December 31, 2022 and 2021, respectively. Loans held for investment excluding PPP loans is a non-GAAP financial measure. For more information about financial measures that are not calculated in accordance with GAAP, please see “Non-GAAP Financial Measures” below. Management believes that the allowance has been appropriately funded for losses on existing loans, based on currently available information. Low levels of past dues, NPAs, and year-over-year quantitative historical loss rates continue to demonstrate improvement. The Company will continue to monitor the loan portfolio, levels of nonperforming assets, and the sustainability of improving asset quality trends experienced closely and make changes to the allowance for loan losses when necessary. Management believes the level of the allowance for loan losses is sufficient to absorb possible and estimable losses inherent in the loan portfolio; however, if elevated levels of risk are identified, provision for loan losses may increase in future periods.
The allowance for loan losses represents an amount that, in management’s judgement, will be adequate to absorb probable and estimable losses inherent in the loan portfolio. The provision for loan losses increases the allowance and loans charged-off, net of recoveries, reduce the allowance. The following table presents the Company’s loan loss experience for the periods indicated:
TABLE 8: ALLOWANCE FOR LOAN LOSSES
| For the Year ended December 31, 2022 | |
| (Dollars in thousands) | | Commercial and Industrial | | | Real Estate Construction | | | Real Estate - Mortgage (1) | | | Real Estate - Commercial | | | Consumer | | | Other | | | Unallocated | | | Total | |
| Allowance for loan losses: | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance, beginning | | $ | 683 | | | $ | 459 | | | $ | 2,390 | | | $ | 4,787 | | | $ | 1,362 | | | $ | 184 | | | $ | - | | | $ | 9,865 | |
| Charge-offs | | | (297 | ) | | | - | | | | (25 | ) | | | - | | | | (1,368 | ) | | | (332 | ) | | | - | | | | (2,022 | ) |
| Recoveries | | | 134 | | | | - | | | | 61 | | | | 22 | | | | 648 | | | | 112 | | | | - | | | | 977 | |
| Provision for loan losses | | | 153 | | | | 93 | | | | 149 | | | | (310 | ) | | | 1,423 | | | | 192 | | | | 6 | | | | 1,706 | |
| Ending Balance | | $ | 673 | | | $ | 552 | | | $ | 2,575 | | | $ | 4,499 | | | $ | 2,065 | | | $ | 156 | | | $ | 6 | | | $ | 10,526 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Average loans | | | 69,329 | | | | 67,570 | | | | 233,758 | | | | 405,970 | | | | 136,596 | | | | 5,729 | | | | | | | | 918,952 | |
| Ratio of net charge-offs to average loans | | | 0.24 | % | | | 0.00 | % | | | -0.02 | % | | | -0.01 | % | | | 0.53 | % | | | 3.84 | % | | | | | | | 0.11 | % |
| For the Year ended December 31, 2021 | |
| (Dollars in thousands) | | Commercial and Industrial | | | Real Estate Construction | | | Real Estate - Mortgage (1) | | | Real Estate - Commercial | | | Consumer | | | Other | | | Unallocated | | | Total | |
| Allowance for loan losses: | | | | | | | | | | | | | | | | | | | | | | | | |
| Balance, beginning | | $ | 650 | | | $ | 339 | | | $ | 2,560 | | | $ | 4,434 | | | $ | 1,302 | | | $ | 123 | | | $ | 133 | | | $ | 9,541 | |
| Charge-offs | | | (27 | ) | | | - | | | | (14 | ) | | | - | | | | (800 | ) | | | (278 | ) | | | - | | | | (1,119 | ) |
| Recoveries | | | 41 | | | | - | | | | 76 | | | | 44 | | | | 390 | | | | 98 | | | | - | | | | 649 | |
| Provision for loan losses | | | 19 | | | | 120 | | | | (232 | ) | | | 309 | | | | 470 | | | | 241 | | | | (133 | ) | | | 794 | |
| Ending Balance | | $ | 683 | | | $ | 459 | | | $ | 2,390 | | | $ | 4,787 | | | $ | 1,362 | | | $ | 184 | | | $ | - | | | $ | 9,865 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Average loans | | | 101,016 | | | | 52,811 | | | | 199,904 | | | | 356,643 | | | | 117,343 | | | | 7,911 | | | | | | | | 835,628 | |
| Ratio of net charge-offs to average loans | | | -0.01 | % | | | 0.00 | % | | | -0.03 | % | | | -0.01 | % | | | 0.35 | % | | | 2.28 | % | | | | | | | 0.06 | % |
(1) The real estate-mortgage segment included residential 1-4 family, multi-family, second mortgages and equity lines of credit.
The following table shows the amount of the allowance for loan losses allocated to each category and the ratio of corresponding outstanding loan balances at December 31 of the years presented. Although the allowance for loan losses is allocated into these categories, the entire allowance for loan losses is available to cover loan losses in any category.
TABLE 9: ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
| | | December 31, | |
| | | 2022 | | | 2021 | |
| (Dollars in thousands) | | Amount | | | Percent of Loans to Total Loans | | | Amount | | | Percent of Loans to Total Loans | |
| Commercial and industrial | | $ | 673 | | | | 7.07 | % | | $ | 683 | | | | 8.14 | % |
| Real estate-construction | | | 552 | | | | 7.59 | % | | | 459 | | | | 6.93 | % |
| Real estate-mortgage (1) | | | 2,575 | | | | 25.23 | % | | | 2,390 | | | | 24.46 | % |
| Real estate-commercial | | | 4,499 | | | | 41.85 | % | | | 4,787 | | | | 45.36 | % |
| Consumer | | | 2,065 | | | | 18.04 | % | | | 1,362 | | | | 14.04 | % |
| Other | | | 156 | | | | 0.23 | % | | | 184 | | | | 1.07 | % |
| Unallocated | | | 6 | | | | - | | | | - | | | | - | |
| Ending Balance | | $ | 10,526 | | | | 100.00 | % | | $ | 9,865 | | | | 100.00 | % |
(1) The real estate-mortgage segment included residential 1-4 family, multi-family, second mortgages and equity lines of credit.
Deposits
The following table shows the average balances and average rates paid on deposits for the periods presented.
| | | Years ended December 31, | |
| | | 2022 | | | 2021 | | | 2020 | |
| (Dollars in thousands) | | Average
Balance | | | | | | | | | | | | | | | | |
| Interest-bearing transaction | | $ | 78,167 | | | | 0.01 | % | | $ | 71,841 | | | | 0.02 | % | | $ | 55,667 | | | | 0.02 | % |
| Money market | | | 385,067 | | | | 0.18 | % | | | 372,193 | | | | 0.24 | % | | | 307,190 | | | | 0.33 | % |
| Savings | | | 125,310 | | | | 0.03 | % | | | 114,285 | | | | 0.04 | % | | | 96,149 | | | | 0.06 | % |
| Time deposits | | | 159,889 | | | | 0.88 | % | | | 180,255 | | | | 1.08 | % | | | 209,727 | | | | 1.59 | % |
| Total interest bearing | | | 748,433 | | | | 0.29 | % | | | 738,574 | | | | 0.39 | % | | | 668,733 | | | | 0.66 | % |
| Demand | | | 422,849 | | | | | | | | 391,673 | | | | | | | | 325,596 | | | | | |
| Total deposits | | $ | 1,171,282 | | | | | | | $ | 1,130,247 | | | | | | | $ | 994,329 | | | | | |
The Company’s average total deposits were $1.2 billion for the year ended December 31, 2022, an increase of $41.0 million or 3.6% from average total deposits for the year ended December 31, 2021. Demand deposit and money market account categories had the largest increases, totaling $31.2 million and $12.9 million, respectively. Average time deposits, which is the Company’s most expensive deposit category, decreased by a total of $20.4 million as seen in the table above. This increase in demand and savings deposits was due in part to a shift in balances from time deposits toward lower-cost savings, money market and demand deposits. Deposits as of December 31, 2022 decreased $26.3 million compared to September 30, 2022, which is consistent with changes in deposit balances experienced by many regional and community banks in the latter part of 2022.
The average rate paid on interest-bearing deposits by the Company in 2022 was 0.29% compared to 0.39% in 2021. The Company remains focused on increasing lower-cost deposits by actively targeting new noninterest-bearing deposits and savings deposits.
As of December 31, 2022 and 2021, the estimated amounts of total uninsured deposits were $254.7 million and $271.7 million, respectively. The following table shows maturities of the estimated amounts of uninsured time deposits at December 31, 2022. The estimate of uninsured deposits generally represents the portion of deposit accounts that exceed the FDIC insurance limit of $250,000 and is calculated based on the same methodologies and assumptions used for purposes of the Bank’s regulatory reporting requirements.
TABLE 11: MATURITIES OF UNINSURED TIME DEPOSITS
| | | As of December 31, | |
| (dollars in thousands) | | 2022 | | | 2021 | |
| Maturing in: | | | | | | |
Within 3 months | | $ | 13,369 | | | $ | 17,994 | |
4 through 6 months | | | 1,264 | | | | 2,330 | |
7 through 12 months | | | 8,307 | | | | 9,476 | |
Greater than 12 months | | | 22,861 | | | | 10,123 | |
| | $ | 45,801 | | | $ | 39,923 | |
Capital Resources
Total stockholders’ equity as of December 31, 2022 was $98.7 million, down 18.3% from $120.8 million on December 31, 2021. During 2022, the Corporation declared common stock dividends of $0.52 per share, compared to $0.50 per share declared in 2021.
The assessment of capital adequacy depends on such factors as asset quality, liquidity, earnings performance, and changing competitive conditions and economic forces. The adequacy of the Company’s and the Bank’s capital is regularly reviewed. The Company targets regulatory capital levels that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses. While the Company will continue to look for opportunities to invest capital in profitable growth, the Company will also consider investing capital in other transactions, such as share repurchases, that facilitate improving shareholder return, as measured by ROE and EPS.
The Bank’s capital position remains strong as evidenced by the regulatory capital measurements. Under the banking regulations, Total Capital is composed of core capital (Tier 1) and supplemental capital (Tier 2). Tier 1 capital consists of common stockholders’ equity less goodwill. Tier 2 capital consists of certain qualifying debt and a qualifying portion of the allowance for loan losses. In addition, the Bank has made the one-time irrevocable election to continue treating accumulated other comprehensive income (AOCI) under regulatory standards that were in place prior to the Basel III Capital Rules in order to eliminate volatility of regulatory capital that can result from fluctuations in accumulated other comprehensive (loss) income and the inclusion of accumulated other comprehensive (loss) income in regulatory capital, as would otherwise be required under the Basel III Capital Rule. As a result of this election, changes in accumulated other comprehensive (loss) income, including unrealized losses on securities available for sale, do not affect regulatory capital amounts shown in the table below for the Bank.
Pursuant to applicable regulations and regulatory guidance, the Company is treated as a small bank holding company and will not be subject to regulatory capital requirements. For more information, refer to “Regulation and Supervision” included in Item 1, “Business” of this report on Form 10-K.
On September 17, 2019 the FDIC finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio (CBLR) framework), as required by the EGRRCPA. The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework.
In order to qualify for the CBLR framework, a community banking organization must have a Tier 1 leverage ratio of greater than 9%, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations and will not be required to report or calculate risk-based capital. The CBLR framework was available for banks to begin using in their March 31, 2020, Call Report. The Bank did not opt into the CBLR framework.
The following is a summary of the Bank’s capital ratios for the past two years. As shown below, these ratios were all well above the recommended regulatory minimum levels.
TABLE 12: REGULATORY CAPITAL
| | | | | December 31, 2022 | | | | | | December 31, 2021 | |
| Common Equity Tier 1 Capital to Risk-Weighted Assets | | | 4.500 | % | | | 10.80 | % | | | 4.500 | % | | | 12.57 | % |
| Tier 1 Capital to Risk-Weighted Assets | | | 6.000 | % | | | 10.80 | % | | | 6.000 | % | | | 12.57 | % |
| Tier 1 Leverage to Average Assets | | | 4.000 | % | | | 9.43 | % | | | 4.000 | % | | | 9.09 | % |
| Total Capital to Risk-Weighted Assets | | | 8.000 | % | | | 11.70 | % | | | 8.000 | % | | | 13.61 | % |
| Capital Conservation Buffer | | | 2.500 | % | | | 3.70 | % | | | 2.500 | % | | | 5.61 | % |
| Risk-Weighted Assets (in thousands) | | | | | | $ | 1,177,600 | | | | | | | $ | 952,218 | |
On July 14, 2021, the Company issued $30.0 million in aggregate principal amount of 3.50% fixed-to-floating rate subordinated notes due 2031 (the Notes) in a private placement transaction. The Notes initially bear interest at a fixed rate of 3.50% for five years and convert to three-month SOFR plus 286 basis points, resetting quarterly, thereafter. The Notes were structured to qualify as Tier 2 capital for regulatory purposes and are included in the Company’s Tier 2 capital as of December 31, 2021.
The Company’s capital resources are impacted by its share repurchase program which was authorized by the Board of Directors in October 2021 and authorized repurchase of up to 10% of the Company’s issued and outstanding common stock through November 30, 2022. During the year ended December 31, 2022, the Company repurchased 268,095 shares, or $6.7 million of its common stock under the program.
Year-end book value per share was $19.75 in 2022 and $23.06 in 2021. The common stock of the Company has not been extensively traded. The stock is quoted on the NASDAQ Capital Market under the symbol “OPOF.” There were 1,560 stockholders of record of the Company as of March 14, 2023. This stockholder count does not include stockholders who hold their stock in a nominee registration.
On January 1, 2023, the Company adopted Accounting Standards Codification (ASC) Topic 326, “Financial Instruments—Credit Losses” (ASC 326), which replaces existing accounting principles for the recognition of loan losses based on losses that have been incurred with a requirement to record an allowance for credit losses that represents expected credit losses over the lifetime of all loans in the Company’s portfolio. The adoption of ASC 326 will result in significant changes to the Corporation’s consolidated financial statements. Regulatory capital rules permit the Bank to phase-in the day-one effects of adopting ASC 326 over a 3-year transition period. The Bank expects not to take the phase-in but rather to reduce its regulatory capital in the first quarter of 2023 for the day-one effects of adopting ASC 326 in the reasonable range of $1 million to $2 million.
Liquidity
Liquidity is the ability of the Company to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Additional sources of liquidity available to the Corporation include cash flows from operations, loan payments and payoffs, deposit growth, maturities, calls and sales of securities, the issuance of brokered certificates of deposit and the capacity to borrow additional funds. Liquid assets include cash, interest-bearing deposits with banks, federal funds sold, investments in securities and loans maturing within one year.
The Company’s major source of liquidity is its large, stable deposit base. In addition, secondary liquidity sources are available through the use of borrowed funds if the need should arise, including secured advances from the FHLB and FRB. As of December 31, 2022, the Company had $392.1 million in FHLB borrowing availability. The Company believes that the availability at the FHLB is sufficient to meet future cash-flow needs. As of year-end 2022 and 2021, the Company had $115.0 million available in federal funds lines of credit to address any short-term borrowing needs, respectively.
As a result of the Company’s management of liquid assets, the availability of borrowed funds and the ability to generate liquidity through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors’ requirements and to meet its customers’ future borrowing needs. The Bank also participates in the IntraFi Cash Sweep, a product which provides the Bank the capability of providing additional deposit insurance to customers through three types of account arrangements. The Company experienced a change in liquidity mix during the fourth quarter as short-term FHLB borrowings were utilized to fund loan growth. Notwithstanding the foregoing, the Company’s ability to maintain sufficient liquidity may be affected by numerous factors, including economic conditions nationally and in the Company’s markets. Depending on its liquidity levels, its capital position, conditions in the capital markets and other factors, the Company may from time to time consider the issuance of debt, equity, other securities or other possible capital markets transactions, the proceeds of which could provide additional liquidity for the Company’s operations
The following table sets forth information relating to the Company’s sources of liquidity and the outstanding commitments for use of liquidity at December 31, 2022 and December 31, 2021. Dividing the total short-term sources of liquidity by the outstanding commitments for use of liquidity derives the liquidity coverage ratio.
TABLE 13: LIQUIDITY SOURCES AND USES
| | | December 31, | |
| | | 2022 | | | 2021 | |
| (dollars in thousands) | | Total | | | In Use | | | Available | | | Total | | | In Use | | | Available | |
| Sources: | | | | | | | | | | | | | | | | | | |
| Federal funds lines of credit | | $ | 115,000 | | | $ | 11,378 | | | $ | 103,622 | | | $ | 115,000 | | | $ | - | | | $ | 115,000 | |
| Federal Home Loan Bank advances | | | 392,628 | | | | 46,100 | | | | 346,528 | | | | 391,287 | | | | - | | | | 391,287 | |
| Federal funds sold & balances at the Federal Reserve | | | | | | | | | | | 1,777 | | | | | | | | | | | | 159,346 | |
| Securities, available for sale and unpledged at fair value | | | | | | | | | | | 141,145 | | | | | | | | | | | | 172,562 | |
| Total short-term funding sources | | | | | | | | | | $ | 593,072 | | | | | | | | | | | $ | 838,195 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Uses: (1) | | | | | | | | | | | | | | | | | | | | | | | | |
| Unfunded loan commitments and lending lines of credit | | | | | | | | | | | 84,261 | | | | | | | | | | | | 69,215 | |
| Letters of credit | | | | | | | | | | | 271 | | | | | | | | | | | | 1,085 | |
| Total potential short-term funding uses | | | | | | | | | | | 84,532 | | | | | | | | | | | | 70,300 | |
| Liquidity coverage ratio | | | | | | | | | | | 701.6 | % | | | | | | | | | | | 1192.3 | % |
(1) Represents partial draw levels based on loan segment.
The fair value of unpledged available-for-sale securities decreased from December 31, 2021 to December 31, 2022 primarily due to changes in market values in the securities portfolio.
As a result of the ability to generate liquidity through liability funding and management of liquid assets, management believes the Company maintains overall liquidity sufficient to satisfy operational requirements and contractual obligations. The Company’s internal sources of liquidity are deposits, loan and investment repayments and securities available-for-sale. The Company’s primary external source of liquidity is advances from the FHLB.
The Company’s operating activities provided $17.6 million of cash during the year ended December 31, 2022, compared to $23.2 million provided during 2021. The Company’s investing activities used $213.4 million of cash during 2022, compared to $60.7 million of cash used during 2021. The Company’s financing activities provided $27.2 million of cash during 2022 compared to $105.0 million of cash provided during 2021.
In the ordinary course of business, the Company has entered into contractual obligations and has made other commitments to make future payments. For further information concerning the Company’s expected timing of such payments as of December 31, 2022, refer to Note 5, Leases, Note 8, Borrowings, and Note 13, Commitments and Contingencies of the Notes to Consolidated Financial Statements included in Item 8. “Financial Statements and Supplementary Data” of this report on Form 10-K.
Off-Balance Sheet Arrangements
To meet the financing needs of customers, the Company is a party, in the normal course of business, to financial instruments with off-balance-sheet risk. These financial instruments include commitments to extend credit, commitments to sell loans and standby letters of credit. These instruments involve elements of credit and interest rate risk in addition to the amount on the balance sheet. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit written is represented by the contractual amount of these instruments. The same credit policies are used in making these commitments and conditional obligations as used for on-balance-sheet instruments. Collateral is obtained based on the credit assessment of the customer in each circumstance.
Loan commitments are agreements to extend credit to a customer provided that there are no violations of the terms of the contract prior to funding. Commitments have fixed expiration dates or other termination clauses and may require payment of a fee by the customer. Since many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The total amount of unused loan commitments at the Bank was $206.6 million at December 31, 2022, and $167.1 million at December 31, 2021.
Standby letters of credit are written conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The total contract amount of standby letters of credit was $904 thousand at December 31, 2022 and $3.6 million at December 31, 2021.
Management believes that the Company has the liquidity and capital resources to handle these commitments in the normal course of business. See Note 13 of the Notes to Consolidated Financial Statements included in Item 8, “Financial Statements and Supplementary Data” of this report on Form 10-K.
RECENT ACCOUNTING PRONOUNCEMENTS
Recent accounting pronouncements affecting the Corporation are described in Item 8. “Financial Statements and Supplementary Data” under the heading “Note 1: Summary of Significant Accounting Policies-Recent Significant Accounting Pronouncements.”
Non-GAAP Financial Measures
In reporting the results of the year ended December 31, 2022, the Company has provided supplemental financial measures on a tax-equivalent or an adjusted basis. These non-GAAP financial measures are a supplement to GAAP, which is used to prepare the Company’s financial statements, and should not be considered in isolation or as a substitute for comparable measures calculated in accordance with GAAP. In addition, the Company’s non-GAAP financial measures may not be comparable to non-GAAP financial measures of other companies. The Company uses the non-GAAP financial measures discussed herein in its analysis of the Company’s performance. The Company’s management believes that these non-GAAP financial measures provide additional understanding of ongoing operations and enhance comparability of results of operations with prior periods presented without the impact of items or events that may obscure trends in the Company’s underlying performance. A reconciliation of the non-GAAP financial measures used by the Company to evaluate and measure the Company’s performance to the most directly comparable GAAP financial measures is presented below.
TABLE 14: Non-GAAP FINANCIAL MEASURES
| | Years Ended December 31, | |
| (dollars in thousands, except share and per share data) | | 2022 | | | 2021 | |
| Fully Taxable Equivalent Net Interest Income | | | | | | |
| Net interest income (GAAP) | | $ | 44,438 | | | $ | 38,794 | |
| FTE adjustment | | | 297 | | | | 248 | |
| Net interest income (FTE) (non-GAAP) | | $ | 44,735 | | | $ | 39,042 | |
| Noninterest income (GAAP) | | | 13,505 | | | | 14,885 | |
| Total revenue (FTE) (non-GAAP) | | $ | 58,240 | | | $ | 53,927 | |
| Noninterest expense (GAAP) | | | 45,655 | | | | 43,149 | |
| | | | | | | | | |
| Average earning assets | | $ | 1,234,780 | | | $ | 1,197,028 | |
| Net interest margin | | | 3.60 | % | | | 3.24 | % |
| Net interest margin (FTE) (non-GAAP) | | | 3.62 | % | | | 3.26 | % |
| | | | | | | | | |
| Efficiency ratio | | | 78.79 | % | | | 80.38 | % |
| Efficiency ratio (FTE) (non-GAAP) | | | 78.39 | % | | | 80.01 | % |
| | | | | | | | | |
| Tangible Book Value Per Share | | | | | | | | |
| Total Stockholders Equity (GAAP) | | $ | 98,734 | | | $ | 120,818 | |
| Less goodwill | | | 1,650 | | | | 1,650 | |
| Less core deposit intangible | | | 231 | | | | 275 | |
| Tangible Stockholders Equity (non-GAAP) | | $ | 96,853 | | | $ | 118,893 | |
| | | | | | | | | |
| Shares issued and outstanding, including nonvested restricted stock | | | 4,999,083 | | | | 5,239,707 | |
| | | | | | | | | |
| Book value per share | | $ | 19.75 | | | $ | 23.06 | |
| Tangible book value per share | | $ | 19.37 | | | $ | 22.69 | |
| | | | | | | | | |
| ALLL as a Percentage of Loans Held for Investment | | | | | | | | |
| Loans held for investment (net of deferred fees and costs) (GAAP) | | $ | 1,027,085 | | | $ | 843,526 | |
| Less PPP originations | | | 530 | | | | 19,008 | |
| Loans held for investment, (net of deferred fees and costs), excluding PPP (non-GAAP) | | $ | 1,026,555 | | | $ | 824,518 | |
| | | | | | | | | |
| ALLL | | $ | 10,526 | | | $ | 9,865 | |
| | | | | | | | | |
| ALLL as a Percentage of Loans Held for Investment | | | 1.02 | % | | | 1.17 | % |
| ALLL as a Percentage of Loans Held for Investment, net of PPP originations | | | 1.03 | % | | | 1.20 | % |
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
Not required.
| Item 8. | Financial Statements and Supplementary Data |
The Consolidated Financial Statements and related footnotes of the Company are presented below followed by the financial statements of the Parent.
