ITEM 1A. RISK FACTORS
Investments in the Company’s common stock involves risks. In addition to the other information set forth in this Annual Report on Form 10-K, including the information addressed above under “Important Note Regarding Forward-Looking Statements,” investors in the Company’s common stock should carefully consider the risk factors discussed below. The following discussion highlights the risks that we believe are material to the Company, but the following discussion does not necessarily include all risks that we may face, and an investor in the Company’s common stock should not interpret the disclosure of a risk in the following discussion to state or imply that the risk has not already materialized. These factors could materially and adversely affect the Company’s business, financial condition, liquidity, results of operations, and capital position, and could cause the Company’s actual results to differ materially from its historical results or the results contemplated by the forward-looking statements contained in this Annual Report on Form 10-K, in which case, the trading price of the Company’s common stock could decline.
Risks Related to Credit
A large percentage of the Company’s commercial loans are secured by real estate, and an adverse change in the real estate market or in economic conditions more generally may result in losses and adversely affect our profitability.
Approximately 86.3% of the Company’s commercial loan portfolio as of December 31, 2022, was comprised of loans secured by real estate. An adverse change in the economy affecting occupancy and/or rental rates in the investment real estate market areas we serve could increase the likelihood of defaults. Real estate collateral securing the Company's loans are a secondary source of repayment in the event of unremedied defaults. The value of the Company's collateral could be impaired by changes in demand, rental rates and capitalization rates and could be insufficient to recover outstanding principal and interest. As a result, the Company’s profitability and financial condition could be negatively impacted by an adverse change in the real estate market.
The Company relies on independent appraisals to determine the value of the real estate which secures a significant portion of our loans, and the values indicated by such appraisals may not be realizable if foreclosure on such loans is forced.
A significant portion of the Company’s loan portfolio consists of loans secured by real estate. We rely on independent appraisers to provide professional opinions of the value of such real estate. Appraisals are only estimates of value and the independent appraisers may make mistakes of fact or judgment that adversely affect the reliability of their appraisals. In addition, events occurring after the initial appraisal may cause the value of the real estate to increase or decrease. As a result of any of these factors, the real estate securing some of the loans may be more or less valuable than anticipated at the time the loans were made. If a default occurs on a loan secured by real estate that is less valuable than originally estimated, the Company may not be able to recover the outstanding balance of the loan.
The Company’s level of credit risk is elevated due to the concentration of commercial real estate loans and commercial real estate construction loans in its portfolio.
As of December 31, 2022, the Company’s exposure to loans secured by commercial purpose real estate, including investment real estate loans related to hospitality, retail and multifamily apartments (but excluding construction) equated to $1.6 billion, or 50.6% of its total loan portfolio. The average balance of these loans are generally larger and these loans generally involve a more complex degree of financial and credit risk than loans secured by residential real estate. Repayment of these loans is dependent on the success of the borrower’s underlying business and/or the borrower’s ability to generate leases in order to receive sufficient cash flow to service its debts. The financial and credit risk associated with these loans is a result of several factors, including, but not limited to, macroeconomic conditions affecting supply, demand and property valuations, as well as larger balances in a smaller population of loans. The ongoing adverse economic effects of the COVID-19 pandemic could potentially exacerbate the financial and credit risk associated with these loans. In addition, a potential downturn in economic conditions could exacerbate the financial and credit risks associated with these loans.
The Company’s exposure to hospitality at December 31, 2022 equated to approximately $360.4 million, or 11.4% of its total loan portfolio. These were mostly loans secured by upscale or top tier flagged hotels, which have historically exhibited low leverage and strong operating cash flows. In 2020 and 2021, the COVID-19 pandemic significantly impacted demand for both leisure and business travel resulting in overall declines in occupancy and room rates. The Company offered an assistance
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program that deferred payments in order to alleviate the financial pressures related to depressed revenues caused by the COVID-19 pandemic. The Company closely monitored these borrowers, identified underperforming operators and de-risked the portfolio through note sales. During 2022, conditions in the hospitality industry, and especially leisure travel, improved despite the fact that the COVID-19 pandemic is ongoing. While we believe business travel is still depressed, but is improving, when compared to conditions prior to COVID-19, we believe borrowers focused on business travel were able to survive, in part due to the Company’s deferral programs. These programs ended on June 30, 2021 and these borrowers have returned to contractual payments and continue to perform. Property values have generally not deteriorated and, in certain circumstances, have increased. These developments, together with widespread labor shortages and additional shocks to economic conditions could generally impact operations and property valuations in hospitality and other commercial real estate exposures. As a result, our capital levels and results of operations could be adversely affected.
The Company’s exposure to commercial real estate construction loans at December 31, 2022 equated to approximately $379.6 million, or 12.1% of total portfolio loans. Construction loans are inherently risky. These risks include, but are not limited to, potential adverse changes in material costs resulting in cost overruns, and the potential that the general contractors develop financial stress and are unable to complete projects and the speculative nature of lease up risk. A severe downturn in real estate could affect demand for leases, capitalization rates and property valuations, which could adversely affect our financial condition and results of operations.
Our allowance for credit losses may be insufficient.
The measure of our allowance for credit losses is dependent on the interpretation and application of the CECL methodology, which the Company adopted effective January 1, 2021, and which replaced the incurred loss methodology that was used by the Company and the Bank under GAAP prior to that date. The CECL methodology reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. Accordingly, the implementation of the CECL model changed the Company’s current method of providing allowance for credit losses (“ACL”) and resulted in material changes in the Company’s accounting for credit losses on financial instruments. The CECL model may create more volatility in the Company’s level of ACL, which, if materially increased, could adversely affect our business, financial condition, and results of operations.
We will implement further enhancements or changes to our methodology, models and the underlying assumptions, estimates and assessments, as needed. If the assumptions or estimates we use in adopting the new standard are incorrect or we need to change our underlying assumptions and estimates, there may be a material adverse impact on our results of operation and financial condition. We maintain an ACL at a level we believe is adequate to absorb expected losses in our loan portfolio as of the corresponding balance sheet date. The process to determine the ACL uses models and assumptions that require us to make difficult and complex judgments that are often interrelated, including how borrowers will perform in changing economic and market conditions. Also, we may fail to accurately identify the appropriate economic indicators, to accurately estimate the timing of future changes in economic or market conditions, or to estimate accurately the impacts of future changes in economic or market conditions on our borrowers. Any of these failures could significantly impact the accuracy of our loss forecasts and allowance estimates and the sufficiency of our ACL.
If the models, estimates, and assumptions we use to establish reserves or the judgments we make in extending credit to our borrowers prove inaccurate in predicting future events, we may suffer unexpected losses. There is no guarantee that our ACL will be sufficient to address credit losses, particularly if the economic outlook deteriorates significantly and quickly. In such an event, we may need to increase our ACL, which would result in provisions for credit losses that would reduce our earnings. Additionally, to the extent that credit losses are worse than expected, which could be caused by persistent inflation or an economic recession that negatively impacts borrowers, we may need to increase our provision for loan losses.
Our real estate lending business can result in increased costs associated with Other Real Estate Owned (“OREO”).
Because we originate loans secured by real estate, we may have to foreclose on the collateral property to protect our investment and may thereafter own and operate such property, in which case we are exposed to the risks inherent in the ownership of real estate. We use methods for valuing collateral for individually evaluated loans and OREO that are in compliance with Accounting Standards Codification (“ASC”) Topic 310 Receivables. The methods require the use of assumptions that are subject to change based on events impacting real estate values. The amount that we may realize after a default is dependent upon factors outside of our control, including, but not limited to, general or local economic conditions, environmental cleanup liability, neighborhood values, interest rates, real estate tax rates, operating expenses of the mortgaged properties, and supply of
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and demand for properties. Certain expenditures associated with the ownership of income producing real estate, principally real estate taxes and maintenance costs, may adversely affect the net cash flows generated by the real estate. Therefore, the cost of operating income-producing real property may exceed the rental income earned from such property, and we may have to advance funds to protect our investment or we may be required to dispose of the real property at a loss.
Risks Related to Our Operations and Technology
A failure in or breach of our operational or security systems or infrastructure, or those of third parties, could disrupt the Company’s businesses, and adversely impact our results of operations, liquidity and financial condition, as well as cause reputational harm.
The Company’s operational and security systems, infrastructure, including our computer systems, data management, and internal processes, as well as those of third parties, are integral to our business. We rely on our associates and third parties in our day-to-day and ongoing operations, who may, as a result of human error, misconduct or malfeasance, or failure or breach of third-party systems or infrastructure, expose us to risk. We have taken measures to implement backup systems and other safeguards to support our operations, but our ability to conduct business may be adversely affected by any significant disruptions to us or to third parties with whom we interact. In addition, our ability to implement backup systems and other safeguards with respect to third-party systems is more limited than with our own systems.
The Company handles a substantial volume of customer and other financial transactions every day. Our financial, accounting, data processing, check processing, electronic funds transfer, loan processing, online and mobile banking, backup or other operating or security systems and infrastructure may fail to operate properly or become disabled or damaged as a result of a number of factors including events that are wholly or partially beyond our control. This could adversely affect our ability to process these transactions or provide these services. There could be sudden increases in customer transaction volume, electrical, telecommunications or other major physical infrastructure outages, natural disasters, events arising from local or larger scale political or social matters, including terrorist acts, and cyber-attacks. We continuously update these systems to support our operations and growth. This updating entails significant costs and creates risk associated with implementing new systems and integrating them with existing ones. Operational risk exposures could adversely impact our results of operations, liquidity and financial condition, and cause reputational harm.
A cyber-attack, information or security breach, or a technology failure of ours or of a third-party could adversely affect the Company’s ability to conduct business or manage exposure to risk, resulting in the disclosure or misuse of confidential or proprietary information, increase costs to maintain and update our operational systems, security systems, and infrastructure, and adversely impact results of operations, liquidity and financial condition, as well as cause reputation harm.
The Company’s business is highly dependent on the security and efficacy of our infrastructure, computer and data management systems, as well as those of third parties with whom we interact. Cyber security risks for financial institutions have significantly increased in recent years in part because of the proliferation of new technologies, the use of the internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties, including foreign state actors. Our operations rely on the secure processing, transmission, storage and retrieval of confidential, proprietary and other information in our computer and data management systems and networks, and in the computer and data management systems and networks of third parties. We rely on digital technologies, computer, database and email systems, software, and networks to conduct our operations. In addition, to access our network, products and services, our customers and third parties may use personal mobile devices or computing devices that are outside of our network environment.
Financial services institutions have been subject to, and are likely to continue to be the target of, cyber-attacks, including computer viruses, malicious or destructive code, phishing attacks, denial of service or other security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of confidential, proprietary and other information of the institution, its associates or customers or of third parties, or otherwise materially disrupt network access or business operations. For example, denial of service attacks have been launched against a number of large financial institutions and several large retailers have disclosed substantial cyber security breaches affecting debit and credit card accounts of their customers. We have not experienced material cyber security incidents in the past, but there is no assurance that we will not experience an attack in the future. Technology failures, cyber-attacks or other information or security breaches can cause material losses or other material consequences, and even with all reasonable security efforts, not every system or network
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breach can be prevented or even detected. Furthermore, because some of our employees are working remotely from their homes, there is an increased risk of disruption to our operations because our employees’ residential networks and infrastructure may not be as secure as our office environment.
In addition to external threats, insider threats also represent a risk to us. Insiders, having legitimate access to our systems and the information contained in them, have the opportunity to make inappropriate use of the systems and information. We have policies, procedures and controls in place designed to prevent or limit this risk, but we cannot guarantee that such policies, procedures and controls fully mitigate this risk.
As cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify and enhance our protective measures or to investigate and remediate any information security vulnerabilities or incidents. Any of these matters could result in loss of customers and business opportunities, significant disruption to our operations and business, misappropriation or destruction of our confidential information and/or that of our customers, damage to computers or systems of our customers and/or third parties, violation of applicable privacy laws and other laws, litigation, regulatory fines, penalties or intervention, loss of confidence in our security measures, reputational damage, reimbursement or other compensatory costs, and additional compliance costs. In addition, any of the matters described above could adversely impact our results of operations and financial condition.
The Company relies on third-party providers and other suppliers for a number of services that are important to our business. An interruption or cessation of an important service by any third-party could have a material adverse effect on our business.
The Company is dependent for the majority of our technology, including our core operating system, on third-party providers. If these companies were to discontinue providing services to us, we may experience significant disruptions to our business. In addition, each of these third parties faces the risk of a cyber-attack, information breach or loss, or technology failure and there is no assurance that they have not or will not experience a system or network breach. If any of our third-party service providers experience such difficulties, or if there is any other disruption in our relationships with them, we may be required to find alternative sources of such services, which may not be on comparable or commercially reasonable terms. We are dependent on these third-party providers securing their information systems, over which we have no control, and any failure to maintain performance, reliability and security of these systems could have a significant adverse effect on our financial condition or results of operations. A breach of our third-party providers’ information systems could adversely affect our ability to process transactions, service our clients or manage our exposure to risk and could result in the disclosure of sensitive, personal customer information, which could have a material adverse impact on our business through damage to our reputation, loss of customer business, remedial costs, additional regulatory scrutiny or exposure to civil litigation and possible financial liability. Assurance cannot be provided that we could negotiate terms with alternative service sources that are as favorable or could obtain services with similar functionality as found in our existing systems without the need to expend substantial resources, if at all, thereby resulting in a material adverse impact on our business and results of operations.
The Company is dependent on its management team, and the loss of its senior executive officers or other key associates could impair its relationship with its customers and adversely affect its business and financial results.
We believe that our growth and future success will depend in large part on the skills of our executive officers. We also depend upon the experience of the senior officers and other key personnel and their relationship with the communities they serve. The loss of the services of one or more of these officers or key personnel could have an adverse impact on the business of the Company because of their skills, knowledge of the market, years of industry experience and the difficulty promptly finding qualified replacement personnel.
The success of our business strategies depends on our ability to identify and recruit individuals with experience and relationships in our primary markets.
The successful implementation of our business strategy will require us to continue to attract, hire, motivate and retain skilled personnel to develop new customer relationships as well as new financial products and services. The market for qualified management personnel is competitive, which has contributed to salary and employee benefit costs that have risen and are expected to continue to rise, which may have an adverse effect on the Company’s net income (loss). In addition, the process of identifying and recruiting individuals with the combination of skills and attributes required to carry out our strategy is often lengthy, and we may not be able to effectively integrate these individuals into our operations. Our inability to identify, recruit
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and retain talented personnel to manage our operations effectively and in a timely manner could limit our growth or impair our ability to implement our business strategy effectively and efficiently, which could materially adversely affect our business.
Risks Related to Market Conditions, Interest Rates and Investments
The Company’s business is subject to interest rate risk and fluctuations in interest rates may adversely affect its earnings and capital levels.
The majority of our assets are monetary in nature and, as a result, we are subject to significant risk from changes in interest rates. Changes in interest rates can impact our net interest income as well as the valuation of our assets and liabilities. Also, our earnings are significantly dependent on net interest income, which is the difference between interest income on interest-earning assets, such as loans and securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings. We expect we will experience “gaps” in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to our position, this “gap” will work against us and our earnings may be negatively affected.
To combat rising inflation, in April, May, June, July, September, November and December of 2022, the Federal Reserve raised the federal funds benchmark rate by 25 basis point, 50 basis points, 75 basis points, 75 basis points and 75 basis points, 75 basis points and 50 basis points, respectively, for a total of 425 basis points in 2022. The Federal Reserve further raised the federal funds target range to 4.5% to 4.75% in February 2023. Although further increases to the target federal funds rate by the Federal Reserve are expected in 2023 to combat recent inflationary trends, if interest rates do not rise, or if the Federal Reserve lowers the target federal funds rate to below 0%, such low rates could limit our interest rate spread and may adversely affect our business forecasts. Moreover, if the interest rates on our interest-bearing liabilities increase at a faster pace than the interest rates on our interest-earning assets, the result would be a reduction in net interest income and with it, a reduction in net earnings. Further increases in the general level of interest rates, to combat inflation or otherwise, may also, among other things, result in a change in the mix of noninterest and interest-bearing accounts, reduce the demand for loans or increase the rate of default on existing loans. Conversely, a decrease in the general level of interest rates may, among other things, lead to an increase in prepayments on loans and increased competition for deposits. Accordingly, changes in the general level of market interest rates may affect net yield on interest-earning assets, loan origination volume, loan portfolios, and funding costs which impact our overall results.
Although our asset-liability management strategy is designed to control our risk from changes in the general level of market interest rates, market interest rates will be affected by many factors outside of our control, including inflation, recession, changes in unemployment, other economic conditions, money supply and international disorder and instability in domestic and foreign financial markets. We are unable to predict changes in interest rates, which are affected by factors beyond our control, including inflation, deflation, recession, unemployment, money supply and other changes in financial markets. It is possible that significant or unexpected changes in interest rates may take place in the future, and we cannot always accurately predict the nature or magnitude of such changes or how such changes may affect our business or results of operations.
The Value of our Investment Securities Could Decline.
Changes in interest rates could cause the value of our investment securities to decline. We hold available-for-sale investment securities, which are carried at fair value, the majority of which are high-quality, liquid fixed income securities. The determination of fair value for certain of these securities requires significant judgment of management. Therefore, the market price we receive for our investment securities could be less than the carrying value for such securities. Further, the value of our investment portfolio could decline for numerous reasons, many of which are outside our control, including general market conditions, volatility in the securities market, changes in market interest rates, and inflation rates or expectations of inflation. For example, increases in interest rates or changes in interest rate spreads may negatively impact the fair value of our investment securities and may adversely affect accumulated other comprehensive income and, thus, our equity levels.
Changes in interest rates could adversely affect our income and cash flows and may result in higher defaults and lower collateral values in a rising rate environment.
Changes in interest rates will influence the origination of loans, the prepayment of loans, the fair value of existing assets and liabilities, the purchase of investments, the retention and generation of deposits, the rates received on loans and investment
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securities, and the rates paid on deposits or other sources of funding. In general, periods of rising interest rates and other inflationary pressures can have a significant negative effect on our borrowers, and particularly on borrowers that operate businesses that generate revenue to pay principal and interest on commercial loans. Periods of rising interest rates and other inflationary pressures could cause the values of collateral securing our loans to decline. If either our borrowers are negatively impacted by rising interest rates or other inflationary pressures, or if the value of collateral securing our loans declines, our financial performance may be negatively impacted.
The replacement of LIBOR as a financial benchmark presents risk to certain financial instruments that we own or to which we are a party.
By June 2023, the LIBOR interest rate index is scheduled to be discontinued and the continued availability of the LIBOR index is no longer guaranteed. We cannot predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or will provide LIBOR quotations to market participants, or whether any additional reforms to LIBOR or other reference rates may be enacted. The market transition away from LIBOR to alternative reference rates is a complex process and could have a range of effects on our business, financial condition, and results of operations, including but not limited to by (i) adversely affecting the interest rates received or paid on the revenues and expenses associated with, or the value of our LIBOR-based assets and liabilities; (ii) adversely affecting the interest rates paid on or received from other securities or financial arrangements, or (iii) resulting in disputes, litigation or other actions with borrowers or other counterparties about the interpretation or enforceability of certain fallback language contained in LIBOR-based loans, securities or other contracts. The discontinuation of LIBOR could also result in operational, legal and compliance risks, and if we are unable to adequately manage such risks, they could have an adverse effect on our financial condition and results of operations.
We have multiple alternative reference rates that we can use when entering into financial transactions with our customers and other counterparties. However, because there can be no assurances regarding which reference rate may become the primary replacement to LIBOR for all purposes, following LIBOR’s discontinuation there may be uncertainty or differences in the calculation of applicable interest rates or payment amounts, and we may incur significant additional costs associated with the transition away from LIBOR to a new reference rate.
Risks Related to Liquidity
We rely substantially on deposits obtained from customers in our target markets to provide liquidity and support growth, and impairment of our access to funding may negatively affect our financial performance.
Our primary funding and liquidity source to support our business strategies is a stable customer deposit base. 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. If our deposit levels fall, we could lose a relatively low-cost source of funding and our interest expense would likely increase as we obtain alternative funding to replace lost deposits. If local customer deposits are not sufficient to fund our normal operations and growth, we will look to outside sources, such as fed funds lines with other financial institutions or borrowings with the FHLB and we have access to the institutional CD market and the brokered deposit market. We may also seek to raise funds through the issuance of shares of our common stock, or other equity or equity-related securities, or debt securities including subordinated notes as additional sources of liquidity. A number of factors, many of which are outside the Company’s control, could make accessing such financing more difficult or more expensive, or could make such financing unavailable altogether, including the financial condition of the Company, rate disruptions in the capital markets, the attractiveness of investing in or lending to financial services companies generally, and competition for funding from other banks, holding companies or similar financial service companies, some of which could be substantially larger or have stronger credit ratings or profiles. If we are unable to access funding sufficient to support our business operations and growth strategies or are only able to access such funding on unattractive terms, we may not be able to implement our business strategies which may negatively affect our financial performance.
Our ability to meet contingency funding needs, in the event of a crisis that causes a disruption to our core deposit base, is dependent on access to wholesale markets, including funds provided by the FHLB of Atlanta.
We own stock in the FHLB of Atlanta, in order to qualify for membership in the FHLB system, which enables us to borrow on our line of credit with the FHLB that is secured by a blanket lien on select commercial loans, multifamily loans, residential mortgages and investment securities available-for-sale and is estimated to be equal to 25% of our assets approximating $1.0 billion, with available borrowing capacity subject to the amount of eligible collateral pledged at any given time. Changes or
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disruptions to the FHLB or the FHLB system in general may materially impact our ability to meet short and long-term liquidity needs or meet growth plans. Additionally, we cannot be assured that the FHLB will be able to provide funding to us when needed, nor can we be certain that the FHLB will provide funds specifically to us, should our financial condition and/or our regulators prevent access to our line of credit. The inability to access this source of funds could have a materially adverse effect on our ability to meet our customer’s needs. Our financial flexibility could be severely constrained if we were unable to maintain our access to funding or if adequate financing is not available at acceptable interest rates.
We rely on dividends from our subsidiaries for most of our revenue .
The Company is a separate and distinct legal entity from the Bank. A substantial portion of the Company’s revenue comes from dividends from the Bank. Various federal and Virginia laws and regulations limit the amount of dividends that the Bank may pay to us. Also, in the event the Bank is unable to pay dividends to the Company, the Company may not be able to service any debt that is outstanding, pay obligations, or pay any future dividends on its common stock. The inability to receive dividends from the Bank could have a material adverse effect on our business, financial condition, and results of operations.
Risks Related to Owning Our Stock
The market price of our common stock may fluctuate significantly in response to a number of factors.
Our operating results may fluctuate due to a variety of factors, many of which are outside of our control, including the changing U.S. economic environment and changes in the commercial and residential real estate market, any of which may cause our stock price to fluctuate. If our operating results fall below the expectation of investors or securities analysts, the price of our common stock could decline substantially.
Our stock price can fluctuate significantly in response to a variety of factors including, among other things:
•volatility of stock market prices and volumes in general;
•changes in market valuations of similar companies;
•changes in the conditions of credit markets;
•changes in accounting policies or procedures as required by the Financial Accounting Standards Board, or other regulatory agencies;
•legislative and regulatory actions, including the impact of the Dodd-Frank Act and related regulations, that may subject us to additional regulatory oversight which may result in increased compliance costs and/or require us to change our business model;
•government intervention in the U.S. financial system and the effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the FRB;
•additions or departures of key members of management;
•fluctuations in our quarterly or annual operating results; and
•changes in analysts’ estimates of financial performance.
Future issuances of the Company’s common stock could adversely affect the market price of the common stock and could be dilutive.
The Company is not restricted from issuing additional shares of common stock, and may issue securities that are convertible into or exchangeable for, or that represent the right to receive, shares of common stock. Issuances of a substantial number of shares of common stock, or the expectation that such issuances might occur, including in connection with acquisitions by the Company, could materially adversely affect the market price of the shares of common stock and could be dilutive to shareholders. Because the Company’s decision to issue equity securities in the future will depend on market conditions and other factors, it cannot predict or estimate the amount, timing, or nature of possible future stock issuances. Accordingly, the Company’s shareholders bear the risk that future stock issuances will reduce market prices and dilute their stock holdings in the Company.
Common stock is equity and is subordinate to the Company’s existing and future indebtedness and effectively subordinated to all the indebtedness and other non-equity claims against the Bank.
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Shares of the Company’s common stock are equity interests and do not constitute indebtedness. As such, shares of the common stock will rank junior to all of the Company’s indebtedness and to other non-equity claims against the Company and its assets available to satisfy claims against it, including in the event of the Company’s liquidation. The Company is permitted to incur additional debt. Upon liquidation, lenders and holders of the Company’s debt securities would receive distributions of the Company’s available assets prior to holders of the Company’s common stock. Furthermore, the Company’s right to participate in a distribution of assets upon the Bank’s liquidation or reorganization is subject to the prior claims of the Bank’s creditors, including holders of any depositors of the Bank or any debt issued by the Bank.
Risks Related to Our Business Strategy
Our profitability depends significantly on economic conditions.
Our success depends primarily on the general economic conditions of the geographic markets in which we operate, primarily in Virginia and North Carolina. The local economic conditions in the areas where we operate have a significant impact on our commercial, real estate and construction loans, the ability of our borrowers to repay their loans and the value of the collateral securing these loans and on customer demand for loans, deposits and other bank products. A significant decline in general economic conditions, including a decline caused by the COVID-19 pandemic, inflation, recession, acts of terrorism, outbreak of hostilities (including the military conflict between Russia and Ukraine) or other international or domestic calamities, unemployment or other factors, all of which are beyond our control, could impact economic conditions and negatively affect our financial results.
We face strong competition from financial services companies and other companies that offer banking services which could negatively affect our business.
We conduct our banking operations primarily in Virginia and North Carolina, including Fredericksburg, Charlottesville, Lynchburg, Roanoke, Blacksburg, Martinsville, and Danville in Virginia, and Greensboro, Charlotte, Raleigh and Mooresville in North Carolina. Increased competition in these markets may result in reduced loans and deposits. Ultimately, we may not be able to compete successfully against current and future competitors. Many competitors offer the same banking services that we offer in our service area. These competitors include national banks, regional banks and other community banks. We also face competition from many other types of financial institutions, including without limitation, savings and loan institutions, finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. In particular, our competitors include several major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and ATMs, conduct extensive promotional and advertising campaigns and offer a wider range of products, services and technologies.
Additionally, banks and other financial institutions with larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the credit needs of larger customers. Areas of competition include interest rates for loans and deposits, efforts to obtain deposits, and range and quality of products and services provided, including new technology-driven products and services. Technological innovation continues to contribute to greater competition in domestic and international financial services markets as technological advances enable more companies to provide financial services, products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. We also face competition from out-of-state financial intermediaries that have opened loan production offices or that solicit deposits in our market areas. If we are unable to attract and retain banking customers, we may be unable to continue to grow our loan and deposit portfolios or may be required to increase the rates we pay on deposits or lower the rates we offer on loans and results of operations and financial condition may otherwise be adversely affected.
Our customers may increasingly decide not to use the Bank to complete their financial transactions, which would have a material adverse impact on our financial condition and operations.
Technology and other changes are allowing parties to complete financial transactions through alternative methods that have historically involved banks. For example, customers can now maintain funds that would have historically been held as bank deposits in brokerage accounts, mutual funds, or general-purpose reloadable prepaid cards. Customers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. We face increasing competition from fintech companies, as trends toward digital financial transactions have accelerated during the COVID-19 pandemic. 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
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ITEM 1A. RISK FACTORS - (continued)
revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.
Risks Related to Regulatory Compliance and Legal Matters
We are subject to extensive government regulation and supervision.
Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not security holders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. For example, we currently derive a portion of our noninterest income from consumer overdraft fees, which have recently come under scrutiny by banking regulators and politicians. Such regulators or politicians could act to impose additional restrictions on overdraft fee programs which could reduce our noninterest income, increase our compliance costs, or increase our exposure to regulatory and legal claims related to our overdraft program.Moreover, on August 16, 2022, the Inflation Reduction Act of 2022 was signed into law and it imposes a 1% excise tax on net repurchases of stock by certain publicly traded corporations. The excise tax is imposed on the value of net stock repurchased or treated as repurchased and will apply to stock repurchases occurring after December 31, 2022. Failure to comply with laws, regulations, policies or supervisory guidance could result in enforcement and other legal actions by Federal or state authorities, including criminal and civil penalties, the loss of FDIC insurance, the revocation of a banking charter, other sanctions by regulatory agencies, civil money penalties and/or reputational damage. In this regard, government authorities, including the bank regulatory agencies, are pursuing aggressive enforcement actions with respect to compliance and other legal matters involving financial activities, which heightens the risks associated with actual and perceived compliance failures. See “Supervision and Regulation” included in Item 1, Business, of this Annual Report on Form 10-K for a more detailed description of the certain regulatory requirements applicable to the Bank.
The Company is subject to more stringent capital and liquidity requirements as a result of the Basel III regulatory capital reforms and the Dodd-Frank Act, which could adversely affect its return on equity and otherwise affect its business.
The Company and the Bank are each subject to capital adequacy guidelines and other regulatory requirements specifying minimum amounts and types of capital, which each must maintain. From time to time, regulators implement changes to these regulatory capital adequacy guidelines. In addition, regulators may require the Company to maintain higher levels of regulatory capital based on the Company’s condition, risk profile, or growth plans or conditions in the banking industry or economy. The capital adequacy standards applicable to the Company and the Bank impose stricter capital requirements and leverage limits than the requirements to which the Company and the Bank were subject in the past.
The application of more stringent capital requirements could, among other things, result in lower returns on equity, require the raising of additional capital, and result in regulatory actions if the Company were to be unable to comply with such requirements. Furthermore, the imposition of liquidity requirements in connection with the implementation of Basel III could result in the Company having to lengthen the term of its funding, restructure its business models, and/or increase its holdings of liquid assets. Implementation of changes to asset risk weightings for risk-based capital calculations, items included or deducted in calculating regulatory capital and/or additional capital conservation buffers could result in management modifying its business strategy, and could limit the Company’s ability to make distributions, including paying out dividends or buying back shares. If the Company and the Bank fail to meet these minimum capital guidelines and/or other regulatory requirements, the Company’s financial condition would be materially and adversely affected.
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ITEM 1A. RISK FACTORS - (continued)
Failure to maintain effective systems of internal control over financial reporting and disclosure controls and procedures could have a material adverse effect on our results of operation and financial condition.
Effective internal controls over financial reporting and disclosure controls and procedures are necessary for us to provide reliable financial reports and effectively prevent fraud and to operate successfully as a public company. We are required to establish and maintain an adequate internal control structure over financial reporting. If we cannot provide reliable financial reports or prevent fraud, our reputation and operating results would be harmed. As part of our ongoing monitoring of internal control, we may discover material weaknesses or significant deficiencies in our internal control that require remediation. A “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis.
Our inability to maintain the operating effectiveness of the controls described above could result in a material misstatement to our financial statements or other disclosures, which could have an adverse effect on our business, financial condition or results of operations. In addition, any failure to maintain effective controls or to timely effect any necessary improvement of our internal and disclosure controls could, among other things, require significant investments of management time, funds and other resources in remediation efforts, result in losses from fraud or error or harm to our reputation, or cause investors to lose confidence in our reported financial information, all of which could have a material adverse effect on our results of operation and financial condition.
The Company may be involved in a variety of litigation and other actions, which may have a material adverse effect on its financial condition, results of operation or business.
The Company operates in a business, legal and regulatory environment that exposes the Company to potential significant litigation risk, and the Company may be involved from time to time in a variety of litigation arising out of its business. Litigation and claims against the Company can arise from the Company’s lending activities, commercial agreements, compliance programs, and other general business matters. Such litigation and claims could involve large amounts in controversy and substantial legal costs necessary for the Company’s defense or to recover amounts owed to the Company, and substantial legal liability, which may or may not be insured, against the Company could materially and adversely impact the Company’s financial condition and results of operations. Even if the Company has insurance coverage for certain claims or legal or administrative actions against it, the Company’s insurance may not cover all claims that may be asserted against it in legal or administrative actions or costs that it may incur defending such actions, and any claims asserted against it, regardless of merit or eventual outcome, may harm the Company’s reputation. Should the ultimate judgments or settlements and/or costs incurred in any litigation exceed any applicable insurance coverage, they could have a material adverse effect on the Company’s financial condition and results of operation for any period.
Our risk management framework may not be effective in mitigating risk and loss.
We maintain an enterprise risk management program that is designed to identify, quantify, monitor, report and control the risks we face. These risks include, but are not limited to, interest rate, credit, liquidity, operational, reputation, legal, compliance, economic and litigation risk. Although we assess our risk management program on an ongoing basis and make identified improvements to it, we can offer no assurances that this approach and risk management framework (including related controls) will effectively mitigate the risks listed above or limit losses that we may incur. If our risk management program has flaws or gaps, or if our risk management controls do not function effectively, our results of operations, financial condition or business may be adversely affected.
Our earnings are significantly affected by the fiscal and monetary policies of the federal government and its agencies.
The policies of the FRB affect us significantly. The FRB regulates the supply of money and credit in the United States. Its policies directly and indirectly influence the rate of interest earned on loans and paid on borrowings and interest-bearing deposits and can also affect the value of financial instruments we hold. Those policies determine, to a significant extent, our cost of funds for lending and investing, and can significantly impact the levels of inflation in the United States. Changes in those policies are beyond our control and are difficult to predict. FRB policies can also affect our borrowers, potentially increasing the risk that they may fail to repay their loans. For example, a tightening of the money supply by the FRB could reduce the demand for a borrower's products and services. This could adversely affect the borrower’s earnings and ability to repay a loan, which could have a material adverse effect on our financial condition and results of operations.
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ITEM 1A. RISK FACTORS - (continued)
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, we are facing increasing scrutiny from customers, regulators, investors, and other stakeholders related to ESG practices and disclosure. Investor advocacy groups, investment funds, and influential investors are 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 expanding 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.
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ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
The Company’s principal executive office is located at 1300 Kings Mountain Road in Martinsville, Virginia. There are also two other corporate administrative locations that house its operations center and various other corporate functions. We offer our community banking services through 66 combined depository locations in Virginia and North Carolina at December 31, 2022, 53 offices are located in Virginia and 13 are located in North Carolina. Three of these depository banking locations are held under lease contracts. In addition, the Bank leases a loan production office, a commercial banking office and another office housing various Bank functions. Management believes the terms of the various leases are consistent with market standards and were arrived at through arm’s length bargaining. The leases are described in Note 8, Premises and Equipment, of the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, the Company is subject to various legal and administrative proceedings and claims. Legal and administrative proceedings are subject to inherent uncertainties and unfavorable rulings could occur, and the timing and outcome of any legal or administrative proceeding cannot be predicted with certainty. As of December 31, 2022, the Company is not involved in any material pending or threatened legal proceedings other than proceedings occurring in the ordinary course of business.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
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ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
PART II
Market for Common Stock and Dividends
The Company’s common stock trades on NASDAQ, under the ticker symbol “CARE.” As of the close of business on March 7, 2023, we had 2,309 shareholders of record.
Dividends
On October 14, 2016, prior to the Reorganization, the board of directors of the Bank (the "Bank Board") determined that it was prudent not to declare a quarterly cash dividend on the Bank's common stock beginning in the fourth quarter of 2016. Notwithstanding the Bank’s prior practice of paying a quarterly cash dividend on its common stock, the Bank Board believed this decision was necessary and appropriate as the Bank committed, and now the Company commits, additional resources to assist with regulatory compliance, preserve capital during the COVID-19 pandemic, and make significant investments in new technology and human resources.
The Bank Board paid a special one-time cash dividend of $0.14 per share on March 3, 2020. The amount and timing of future dividends, if any, remains subject to the discretion of the Board and will depend upon a number of factors, including future earnings, financial condition, liquidity and capital requirements of the Company, applicable governmental regulations and other factors deemed relevant by the Board.
Repurchases of Shares of Common Stock
On June 28, 2022, the Company announced that its Board authorized, effective August 1, 2022, a common share repurchase program to purchase up to 750,000 shares of the Company’s common stock in the aggregate over a period of twelve months, subject to non-objection from the Federal Reserve Bank of Richmond, which was received in July 2022 (the “Current Program”). The Current Program authorizes the purchase of the Company’s common stock in open market transactions or privately negotiated transactions, including pursuant to a trading plan in accordance with Rule 10b-18 promulgated under the Exchange Act. The authorization permits management to repurchase shares of the Company’s common stock from time to time at management’s discretion. The actual means and timing of any shares purchased under the Current Program will depend on a variety of factors, including the market price of the Company’s common stock, general market and economic conditions, and applicable legal and regulatory requirements. The Current Program is authorized through August 1, 2023, although it may be modified or terminated by the Board at any time. The Current Program does not obligate the Company to purchase any particular number of shares.
Previously on December 13, 2021, the Company announced that its Board authorized, effective December 10, 2021, a common share repurchase program to purchase up to 2,000,000 shares of the Company’s common stock in the aggregate over a period of twelve months (the “Prior Program”). The Prior Program authorized the purchase of the Company’s common stock in open market transactions or privately negotiated transactions, including pursuant to a trading plan in accordance with Rule 10b5-1 and/or Rule 10b-18 promulgated under the Exchange Act. The Prior Program permitted management to repurchase shares of the Company’s common stock from time to time at management’s discretion. The Prior Program was originally authorized through December 9, 2022, did not obligate the Company to purchase any particular number of shares, and was exhausted as of April 28, 2022.
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ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES - (continued)
The following table provides information regarding the Company’s purchases of our common stock during the quarter ended December 31, 2022:
(1) The number shown represents, as of the end of each period, the approximate number of Common Stock shares that may yet be purchased under publicly-announced share repurchase plan authorizations. The shares may be purchased, from time-to-time, depending on market conditions.
Five-Year Cumulative Total Return
The following chart compares the cumulative total shareholder return on our common stock with the cumulative total return of the NASDAQ Composite Index and S&P U.S. BMI Banks Index, which includes the stocks of banks, thrifts and bank and financial holding companies listed on all major exchanges (NYSE, AMEX, NASDAQ) in the S&P Global Market Intelligence’s coverage universe.
Period Ending
(1)An investment in Carter Bankshares, Inc. prior to November 2020 represents an investment in Carter Bank & Trust.
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ITEM 6. [RESERVED]
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand Carter Bankshares, Inc., our operations, and our present business environment. The MD&A is provided as a supplement to, and should be read in conjunction with, our Consolidated Financial Statements and the accompanying notes thereto contained in Item 8 of this Annual Report on Form 10-K. The MD&A includes the following sections:
•Explanation of Use of Non-GAAP Financial Measures
•Critical Accounting Policies and Estimates
•Our Business
•Results of Operations and Financial Condition
•Capital Resources
•Contractual Obligations
•Off-Balance Sheet Arrangements
•Liquidity
•Inflation
•Stock Repurchase Program
This section reviews our financial condition for each of the past two years and results of operations for each of the past three years. Certain reclassifications have been made to prior periods to place them on a basis comparable with the current period presentation. Some tables may include additional time periods to illustrate trends within our Consolidated Financial Statements and notes thereto. The results of operations reported in the accompanying Consolidated Financial Statements are not necessarily indicative of results to be expected in future periods.
Explanation of Use of Non-GAAP Financial Measures
In addition to the results of operations presented in accordance with generally accepted accounting principles in the United States (“GAAP”), management uses, and this annual report references, interest and dividend income, yield on interest earnings assets, net interest income and net interest margin on a fully taxable equivalent, (“FTE”) basis, which are non-GAAP financial measures. Management believes these measures provide information useful to investors in understanding our underlying business, operational performance and performance trends as it facilitates comparisons with the performance of other companies in the financial services industry. The Company believes the presentation of interest and dividend income, yield on interest earnings assets, net interest income and net interest margin on an FTE basis ensures the comparability of interest and dividend income, yield on interest earning assets, net interest income and net interest margin arising from both taxable and tax-exempt sources and is consistent with industry practice. Interest and dividend income (GAAP) per the Consolidated Statements of Income is reconciled to interest and dividend income adjusted on an FTE basis, yield on interest earning assets (GAAP) is reconciled to yield on interest earning assets adjusted on an FTE basis, net interest income (GAAP) is reconciled to net interest income adjusted on an FTE basis and net interest margin (GAAP) is reconciled to net interest margin adjusted on an FTE basis in the "Results of Operations and Financial Condition - Net Interest Income" section of this MD&A for the years ended 2022, 2021 and 2020.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Although management believes that this non-GAAP financial measure enhances investors’ understanding of our business and performance, this non-GAAP financial measure should not be considered an alternative to GAAP or considered to be more relevant than financial results determined in accordance with GAAP, nor is it necessarily comparable with similar non-GAAP measures which may be presented by other companies.
Critical Accounting Estimates
The Company’s preparation of financial statements in accordance with GAAP requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. Over time, these estimates, assumptions and judgments may prove to be inaccurate or vary from actual results and may significantly affect our reported results and financial position for the periods presented or in future periods. We currently view the determination of the allowance for credit losses to be critical, because it is made in accordance with GAAP, is highly dependent on subjective or complex judgments, assumptions and estimates made by management and have had or is reasonably likely to have a material impact on the Company’s financial condition and results of operations.
We have identified the following critical accounting estimate:
Allowance for Credit Losses (“ACL”)
The ACL represents an amount which, in management's judgment, is adequate to absorb expected credit losses over the life of outstanding loans as of the balance sheet date based on the evaluation of current risk characteristics of the loan portfolio, past events, current conditions, reasonable and supportable forecasts of future economic conditions and prepayment experience. The ACL is measured and recorded upon the initial recognition of a financial asset. The ACL is reduced by charge-offs, net of recoveries of previous losses, and is increased by a provision or decreased by a recovery for credit losses, which is recorded as a current period operating expense.
Determination of an appropriate ACL is inherently complex and requires the use of significant and highly subjective estimates. The reasonableness of the ACL is reviewed quarterly by management.
Management believes it uses relevant information available to make determinations about the ACL and that it has established the existing allowance in accordance with GAAP. However, the determination of the ACL requires significant judgment, and estimates of expected credit losses in the loan portfolio can vary from the amounts actually observed. While management uses available information to recognize expected credit losses, future additions to the ACL may be necessary based on changes in the loans comprising the portfolio, changes in the current and forecasted economic conditions, changes to the interest rate environment which may directly impact prepayment and curtailment rate assumptions, and changes in the financial condition of borrowers.
The ACL “base case” model is derived from various economic forecasts provided by widely recognized sources. Management evaluates the variability of market conditions by examining the peak and trough of economic cycles. These peaks and troughs are used to stress the base case model to develop a range of potential outcomes. Management then determines the appropriate reserve through an evaluation of these various outcomes relative to current economic conditions and known risks in the portfolio. For the year ended December 31, 2022 the range of outcomes would produce a 17% reduction or a 27% increase in reserves based on the best and worst case scenarios, respectively.
Refer to Note 1, Summary of Significant Accounting Policies, for further detailed descriptions of our estimation process and methodology related to the ACL and Note 6, Allowance for Credit Losses, of this Annual Report on Form 10-K.
Our Business and Strategy
Carter Bankshares, Inc. (the “Company”) is a bank holding company headquartered in Martinsville, Virginia with assets of $4.2 billion at December 31, 2022. The Company conducts its business solely through the Bank, an insured, Virginia state-chartered bank. The Company provides a full range of financial services with retail, and commercial banking products and insurance. Our common stock trades on the Nasdaq Global Select Market under the ticker symbol “CARE.”
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
The Company earns revenue primarily from interest on loans and securities and fees charged for financial services provided to our customers. The Company incurs expenses for the cost of deposits, provision for credit losses and other operating costs such as salaries and employee benefits, data processing, occupancy and tax expense.
For the 2023-2025 fiscal year periods, the Company will be focusing on refining and enhancing the Bank’s guiding principles to better align with the future of the Company. A new mission, vision, and set of core values are in development and the Company expects to rollout this plan in 2023. The Company’s current mission is to strive to be the preferred lifetime financial partner for its customers and shareholders, and the employer of choice in the communities the Company is privileged to serve. The vision and purpose of the Company is to enrich lives and enhance communities today, to build a better tomorrow, with values of loyalty, care, optimism, trustworthiness and innovation.
The Company’s Board of Directors and management believe that the Bank is at a turning point in its evolution and transformation. The Company’s focus will shift from restructuring the balance sheet to pursuing a growth strategy that focuses on organic growth. Another area of focus will be to consider opportunistic acquisitions that the Company believes will fit with its strategic vision.
Our focus continues to be on loan and deposit growth, as well as, implementing opportunities to increase fee income while closely monitoring our operating expenses. The Company is focused on executing this strategy to successfully build our new brand and grow our business in our current markets as well as new markets.
Results of Operations and Financial Condition
Earnings Summary
2022 Highlights
•Net interest income increased $28.7 million, or 25.9%, to $139.9 million for the full year 2022 compared to $111.2 million for the full year 2021 primarily due an increase of 61 basis points in the yield on earning assets due to the rising interest rate environment and by a reduction of nine basis points in funding costs;
•The provision for credit losses decreased $0.9 million to $2.4 million for the year ended December 31, 2022, compared to the full year ended December 31, 2021;
•Total noninterest income decreased $7.2 million to $21.7 million for the full year 2022 compared to $28.9 million for the full year 2021 due primarily to a reduction in gains on sales of securities;
•Total noninterest expense decreased $5.3 million to $97.0 million for the full year 2022 compared to $102.3 million for the full year 2021 primarily resulting from our retail branch optimization project and the reversal of tax credit amortization due to an in-service date extension to 2023; and
•Provision for income taxes increased $7.5 million to $11.6 million for the full year 2022 compared to $4.1 million for the full year 2021.
Balance Sheet Highlights (period-end balances, December 31, 2022 compared to December 31, 2021)
•The securities portfolio decreased $86.1 million and is currently 19.9% of total assets compared to 22.3% of total assets. The decrease is due to the Company’s strategy of redeploying securities maturities into higher yielding loan growth and the continued decline in fair value due to rising market interest rates;
•Total portfolio loans increased $336.8 million, or 12.0%, primarily due to consistent loan growth in 2022;
•The portfolio loans to deposit ratio was 86.7%, compared to 76.0%, since deposits decreased;
•Total deposits decreased $68.2 million to $3.6 billion at December 31, 2022 compared to December 31, 2021;
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
•The ACL to total portfolio loans ratio was 2.98% compared to 3.41%. The ACL on portfolio loans totaled $93.9 million at December 31, 2022, compared to $95.9 million with the decrease driven by declines in the other segment due to principal pay-downs, offset by loan growth and increased qualitative reserves;
•During 2022, the Company repurchased 2,587,361 shares totaling $42.9 million under its stock repurchase program at a weighted average cost of $16.59. There were 132,232 shares available for repurchase at December 31, 2022 under the current repurchase program.
The Company reported net income of $50.1 million, or $2.03 diluted earnings per share for the year ended December 31, 2022 compared to net income of $31.6 million, or $1.19 diluted earnings per share, for the year ended December 31, 2021.
Years Ended December 31,
Return on Average Assets 1.21 % 0.76 % (1.12) %
Return on Average Shareholders' Equity 14.30 % 7.92 % (9.78) %
Allowance for Credit Losses to Total Portfolio Loans 2.98 % 3.41 % 1.83 %
Net Interest Income
Our principal source of revenue is net interest income. Net interest income represents the difference between the interest and fees earned on interest-earning assets and the interest paid on interest-bearing liabilities. Net interest income is affected by changes in the average balance of interest-earning assets, interest-bearing liabilities, as well as changes in interest rates and spreads. The level and mix of interest-earning assets and interest-bearing liabilities is managed by our Asset and Liability Committee (“ALCO”), in order to mitigate interest rate and liquidity risks of the balance sheet. A variety of ALCO strategies were implemented, within prescribed ALCO risk parameters, to produce what the Company believes is an acceptable level of net interest income.
Net interest income and the net interest margin are presented on an FTE basis. The FTE basis (non-GAAP) adjusts net interest income and net interest margin for the tax benefit of income on certain tax-exempt loans and securities using the applicable federal statutory tax rate for each period (which was 21% for the periods presented) and the dividend-received deduction for equity securities. The Company believes this FTE basis presentation provides a relevant comparison between taxable and non-taxable sources of interest income. Refer to the “Explanation of Use of Non-GAAP Financial Measures” above for additional discussion regarding the non-GAAP measures used in this Annual Report on Form 10-K.
The following table reconciles interest and dividend income (GAAP), yield on interest-earning assets (GAAP), net interest margin (GAAP) and net interest income per the Consolidated Statements of Income (Loss) to interest and dividend income on an FTE basis (non-GAAP), yield on interest-earning assets on an FTE basis (non-GAAP), net interest margin on an FTE basis (non-GAAP) and net interest income on an FTE basis (non-GAAP), respectively, for the periods presented:
(Dollars in Thousands) Years Ended December 31,
Yield on Interest-earning Assets (GAAP) 3.98 % 3.37 % 3.68 %
Yield on Interest-earning Assets (FTE) (Non-GAAP) 4.01 % 3.41 % 3.74 %
Net Interest Margin (GAAP) 3.48 % 2.80 % 2.74 %
Net Interest Margin (FTE) (Non-GAAP) 3.51 % 2.84 % 2.80 %
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Average Balance Sheet and Net Interest Income Analysis (FTE)
Total net interest income increased $28.7 million, or 25.9% to $139.9 million for the year ended December 31, 2022 compared to the same period in 2021. The increase for the year ended December 31, 2022 compared to the same period in 2021 was primarily due to an increase in average interest-earning assets of $52.0 million and higher interest rate yields on interest-earning assets of 61 basis points due to the rising interest rate environment during fiscal year 2022. Net interest income, on an FTE basis (non-GAAP), increased $28.4 million, or 25.2%, to $141.1 million for the year ended December 31, 2022 compared to $112.7 million for the same period in 2021. The increases in net interest income, on an FTE basis (non-GAAP), was driven by an increase in interest income of $25.9 million and lower interest expense of $2.5 million for the year ended December 31, 2022 when compared to the same period in 2021. Net interest margin increased 68 basis points to 3.48% for the year ended December 31, 2022 compared to 2.80% for the same period in 2021. Net interest margin, on an FTE basis (non-GAAP), increased 67 basis points to 3.51% for the year ended December 31, 2022 compared to 2.84% for the same period in 2021.
The Company continues to focus on the expansion of net interest income and net interest margin. The full year of 2022 was positively impacted by an increase in the yield on loans and investment securities due to the rising interest rate environment as well as the continued decline in funding costs. The full year of 2022 was also positively impacted by enhanced pricing on loans related to one large credit relationship. Certain of these loans may not be renewed at maturity and/or may not otherwise impact the net interest income and net interest margin as significantly in future periods. In addition, rising market interest rates may begin to increase the Company’s funding costs in future periods.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
The following table provides information regarding the average balances, interest and rates earned on interest-earning assets and the average balances, interest and rates paid on interest-bearing liabilities for the years ended December 31:
ASSETS
LIABILITIES AND SHAREHOLDERS' EQUITY
(1)Nonaccruing loans are included in the daily average loan amounts outstanding.
(2)Tax-exempt income is on an FTE basis using the statutory federal corporate income tax rate of 21 percent.
(3)Loan and deposit balances include held-for-sale transactions in connection with sale of Bank branches.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Interest income increased $26.3 million, or 19.6% for 2022 compared to 2021. Interest income, on an FTE basis (non-GAAP), increased $25.9 million, or 19.2%, for 2022 compared to 2021. The change was primarily due to increases in average interest-earning assets of $52.0 million for 2022, and higher interest rate yields on interest-earning assets of 60 basis points compared to 2021 due to the rising interest rate environment in fiscal year 2022. Average interest-bearing deposits with banks decreased $143.7 million in 2022, and the average rate paid increased 53 basis points for 2022 compared to 2021 as funds were deployed into higher yielding loans and securities.
Average loan balances increased $48.0 million primarily influenced by the consistent loan growth in 2022 as compared to 2021. The average rate earned on loans increased 54 basis points for 2022 compared to 2021 primarily due to increased short-term interest rates during 2022. At December 31, 2022, the loan portfolio was comprised of 26.8% floating rate loans which reprice monthly, 41.2% variable rate loans that reprice at least once during the life of the loan and 32.0% fixed rate loans that do not reprice during the life of the loan.
Average investment securities increased $147.8 million and the average rate earned increased 53 basis points for 2022 compared to 2021. The change in investment securities is the result of active balance sheet management to deploy excess cash combined with the continued decline in fair value. The portfolio has been diversified as to bond types, maturities, and interest rate structures. As of December 31, 2022, the securities portfolio was comprised of 47.3% variable rate securities with approximately 45.8% that will reprice at least once over the next 12 months. Having a significant percentage of variable rate securities is an important strategy during times of rising interest rates because fixed-rate bond prices generally fall when interest rates increase, which can result in unrealized losses. However, variable rate securities do not carry as much interest rate risk so there is much less price volatility. This variable rate structure is expected to limit the impact of rising rates on the Company’s unrealized losses on debt securities.
Interest expense decreased $2.5 million for 2022 compared to 2021. The decrease was primarily due to the intentional runoff of higher cost certificates of deposits (“CDs”) in 2021 and the first half of 2022. Interest expense on deposits decreased $3.6 million for 2022 compared to 2021 primarily due to the decline in the average balance of CDs and the reduction in average rates paid on CDs. The decrease of $212.9 million or 14.3% in the average balance of CDs for 2022 compared to 2021 was primarily due to the aforementioned intentional runoff of these higher cost CDs. The average balances on our interest-bearing core deposits, including money market accounts, interest-bearing demand accounts and savings accounts increased by $137.9 million, $75.6 million and $57.3 million, respectively, for the year ended December 31, 2022, compared to the same period in 2021. The average rates paid on interest-bearing demand accounts increased eight basis points for the year ended December 31, 2022 and the average rate paid on money market accounts increased six basis points for the year ended December 31, 2022, when compared to the same period in 2021. The average rates paid on savings accounts for the year ended December 31, 2022 compared to the same period in 2021 remained unchanged. Overall, the cost of interest-bearing liabilities decreased nine basis points for 2022 compared to 2021. Due to historically low market interest rates during 2021 and the first half of 2022, the Company was able to migrate away from higher rate CDs and grow lower yielding, more liquid products. During the second half of 2022 market interest rates increased quickly providing new incentives for customers to seek out higher yielding CDs.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
The following table sets forth for the periods presented a summary of the changes in interest earned and interest paid resulting from changes in volume and changes in rates:
Interest Earned on:
Interest Paid on:
Federal Funds Purchased 188 — 188 — (1) (1)
(1) Nonaccruing loans are included in the daily average loan amounts outstanding.
(2) Tax-exempt income is on an FTE basis (non-GAAP) using the statutory federal corporate income tax rate of 21 percent.
(3) Changes to rate/volume are allocated to both rate and volume on a proportionate dollar basis.
Provision (Recovery) for Credit Losses
The Company recognizes provision (recovery) for the ACL based on the difference between the existing balance of ACL reserves and the ACL reserve balance necessary to adequately absorb expected credit losses associated with the Company’s financial instruments. Similarly, the Company recognizes provision (recovery) expense for unfunded commitments based on the difference between the existing balance of reserves for unfunded commitments and the reserve balance for unfunded commitments necessary to adequately absorb expected credit losses associated with those commitments. The Company adopted ASU 2016-03 on January 1, 2021, and increased the ACL by $64.5 million, for the Day 1 adjustment which included $61.6 million to the ACL and $2.9 million related to the life-of-loan reserve on unfunded loan commitments.
The ACL as a percentage of total portfolio loans was 2.98% at December 31, 2022 and 3.41% at December 31, 2021. The provision (recovery) for credit losses decreased $0.9 million to $2.4 million for the year ended 2022 compared to year ended 2021. The decrease for the full year of 2022 was primarily driven by the release of $7.0 million of reserves that were allocated to the other segment due to principal pay-downs, partially offset by strong loan growth, increased qualitative reserves of $3.0 million, and net charge-offs of $4.5 million. The increase in qualitative reserves were factors attributable to the residential mortgage and commercial construction portfolios. Project costs continue to escalate due to supply chain and labor disruptions as well as increased material costs. Supply chain and labor disruptions cause the overall construction duration to increase, increasing interest costs to the borrower. The Bank has observed a handful of significant cost overruns on Commercial Real Estate, (“CRE”) projects. To date, these cost overruns have either been funded by the borrower and/or project sponsors or
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
partially funded by the Bank within acceptable underwriting guidelines. The Company continues to monitor these trends by diligently collecting data on commercial construction projects and analyzing risk presented to the Company’s loan portfolio.
A provision of $0.5 million was recorded in 2022 related to the provision for unfunded commitments primarily related to increases in construction commitments.
Net charge-offs were $4.5 million for the full year 2022 compared to $23.1 million for the full year 2021. During 2022, net charge-offs were primarily included in the commercial and industrial, (“C&I”), and other consumer segments. Net charge-offs of $23.1 million during the full year 2021 was primarily attributable to the resolution of five problem relationships, in which the majority of losses were anticipated and previously reserved. As a percentage of average portfolio loans, on an annualized basis, net charge-offs were 0.15% and 0.79% for the years ended 2022 and 2021, respectively. See the “Allowance for Credit Losses” section of this MD&A for additional details regarding our charge-offs.
Nonperforming loans (“NPLs”) decreased at December 31, 2022 by $0.8 million, or 10.2% to $6.6 million compared to $7.4 million at December 31, 2021. The decrease was primarily due to a significant reduction of our largest NPL relationship in addition to pay-downs on other existing NPLs, all offset by a new NPL in the amount of $1.2 million. NPLs as a percentage of total portfolio loans were 0.21% at December 31, 2022 compared to 0.26% at December 31, 2021. See the “Credit Quality” section of this MD&A for more detail on our NPLs.
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 Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the SEC on March 11, 2022, and is incorporated herein by reference.
Noninterest Income
Years Ended December 31,
(Dollars in Thousands) 2022 2021 $ Change % Change
Gains on Sales and Write-downs of Bank Premises, net 73 — 73 NM
Other Real Estate Owned Income 50 90 (40) (44.4) %
Total noninterest income decreased $7.2 million, or 24.8%, to $21.7 million for the year ended December 31, 2022 when compared to December 31, 2021. The decrease was primarily related to declines of $6.8 million in net security gains for the year ended December 31, 2022 when compared to December 31, 2021. The decline in security gains during 2022 was due to the rising interest rate environment resulting in lower securities prices in the market that discouraged sales.
Changes in total noninterest income for the year ended December 31, 2022 also included a decrease of $1.6 million in commercial loan swap fee income due to the timing and demand for this product in the current rising interest rate environment. Offsetting the decreases were increases of $0.5 million in other noninterest income related to the unwind of two completed historic tax credit partnerships, a $0.5 million increase in service charges on deposit accounts primarily driven by volume, and $0.2 million in debit card interchange fees driven by higher customer activity.
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 Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the SEC on March 11, 2022, and is incorporated herein by reference.
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Noninterest Expense
(Dollars in Thousands) Years Ended December 31,
Losses on Sales and Write-downs of Bank Premises, net — 231 (231) (100.0) %
Total noninterest expense decreased $5.3 million to $97.0 million for the full year 2022, when compared to the full year 2021. For the full year 2022 the most significant decrease for the period was a decline of $3.2 million in losses on sales and write-downs of other real estate owned (“OREO”), net, due to nonrecurring write-downs related to closed bank branches in 2021. Also impacting the decrease was a $1.8 million decrease in salaries and employee benefits, $1.1 million decrease in tax credit amortization, $0.4 million decrease in telephone expenses and $0.2 million decrease in losses on sales and write-downs of bank premises, net. Offsetting these decreases were increases of $0.6 million in professional and legal fees, $0.5 million in advertising expenses and $0.3 million in data processing expenses.
The decrease in salaries and employee benefits related to lower salaries of $1.3 million, lower medical expenses of $1.7 million, the impact from our retail branch optimization project, offset by a $1.0 million one-time inflationary bonus for associates in 2022. The decrease in tax credit amortization was primarily due to reversing amortization expense as a result of updated information from the developer which extended the in-service date to 2023 for one of the Company’s historic tax credit partnerships during the third quarter of 2022. The $0.4 million decline in telephone expenses is due to the implementation of a new telephone system during 2022. The increases for the full year 2022 compared to the same period of 2021 included $0.6 million in professional and legal fees which was due to increased consulting fees in our retail and operations areas, the increase of $0.5 million in advertising expenses due to marketing efforts and timing of various promotions, as well as an increase of $0.3 million in data processing expenses related to our online banking platform.
Discussion of noninterest expense 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” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the SEC on March 11, 2022, and is incorporated herein by reference.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Provision for Income Taxes
The provision for income taxes increased $7.5 million to $11.6 million for the year ended December 31, 2022 compared to $4.1 million for December 31, 2021. Pre-tax income increased $26.0 million for the year ended 2022 compared to 2021. Our effective tax rate was 18.8% for the year ended December 31, 2022 compared to 11.5% for December 31, 2021. The increase in the effective tax rate is primarily due to a higher level of pre-tax income and lower level of tax-exempt interest income and updated information from the developer extending the in-service date on a new tax credit from 2022 to 2023. The Company ordinarily generates an annual effective tax rate that is less than the statutory rate of 21% due to benefits resulting from tax-exempt interest income, tax credit projects and Bank Owned Life Insurance (“BOLI”).
Discussion of provision for 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 “Provision for Income Taxes” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, which was filed with the SEC on March 11, 2022, and is incorporated herein by reference.
Financial Condition
December 31, 2022
Total assets increased $70.8 million, or 1.7%, to $4.2 billion at December 31, 2022 compared to December 31, 2021. Federal Reserve Bank excess reserves decreased $170.9 million to $5.3 million at December 31, 2022 from $176.2 million at December 31, 2021 due to redeploying excess cash into higher yielding loans and securities.
Total portfolio loans increased $336.8 million, or 12.0%, to $3.1 billion at December 31, 2022 compared to December 31, 2021 primarily due to consistent loan growth during the year. The variances in loan segments for portfolio loans related to increases of $200.0 million in residential mortgages, $147.3 million in CRE loans, and $70.6 million in construction loans, offset by decreases of $45.4 million in the other category, $35.6 million in C&I loans and $0.1 million in other consumer loans. At January 1, 2021, the initial break-out of Other loans related to the adoption of Topic 326 totaled $379.9 million consisting of $140.8 million of CRE, $78.1 million of C&I, $50.8 million of Residential Mortgages and $110.2 million of Construction. This segment of loans has unique risk attributes considered inconsistent with current underwriting standards. The analysis applied to this segment resulted in an expected credit loss of $51.3 million at adoption. The Company had no loans held-for-sale at December 31, 2022 and $0.2 million at December 31, 2021.
Other real estate owned, (“OREO”), decreased $2.5 million at December 31, 2022 compared to December 31, 2021 due to sales and payments of OREO. Closed retail bank office carrying values increased $0.1 million and have a remaining book value of $1.1 million at December 31, 2022 compared to $1.0 million at December 31, 2021. During 2022, $1.9 million in properties were sold and two properties totaling $0.9 million were closed and moved to OREO, but remain to be sold. OREO related to foreclosed assets decreased $2.6 million at December 31, 2022 compared to December 31, 2021.
The securities portfolio decreased $86.1 million and is currently 19.9% of total assets at December 31, 2022 compared to 22.3% of total assets at December 31, 2021. The decrease is due to the Company’s strategy of redeploying securities maturities into higher yielding loan growth, as well as the continued decline in fair value due to rising interest rates. At December 31, 2022, total gross unrealized gains in the available-for-sale portfolio were $0.3 million, offset by $109.7 million of gross unrealized losses. Refer to the “Securities” section below for further discussion of unrealized losses in the available-for-sale securities portfolio.
Total deposits decreased $68.2 million to $3.6 billion at December 31, 2022 compared to December 31, 2021. The decreases included $82.8 million decrease in CDs due to the intentional runoff of higher cost CDs, a decline of $44.6 million in noninterest-bearing demand accounts and a decrease of $6.3 million in savings accounts. These decreases were offset by an increase of $44.3 million in interest-bearing demand accounts and an increase of $21.2 million in money market accounts. At December 31, 2022, noninterest-bearing deposits comprised 19.4% of total deposits compared to 20.2% at December 31, 2021. CDs comprised 34.7% of total deposits at December 31, 2022 and 36.3% at December 31, 2021. The decline in deposit balances can be attributed to the competitive market given the rising interest rate environment.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Total capital decreased by $79.0 million or 19.4% to $328.6 million at December 31, 2022 compared to $407.6 million at December 31, 2021. The decrease in equity was primarily due to a $87.3 million, net of tax, decrease in other comprehensive loss due to declines in the fair value of available-for-sale securities, a $42.9 million decrease related to the repurchase of common stock through December 31, 2022, partially offset by net income of $50.1 million for the year ended December 31, 2022 that was retained by the Company. The remaining difference of $1.1 million is related to stock-based compensation expense during 2022.
The ACL was 2.98% of total portfolio loans at December 31, 2022 compared to 3.41% as of December 31, 2021. General reserves as a percentage of total portfolio loans were 2.96% at December 31, 2022 compared to 3.38% at December 31, 2021. The decrease in the general reserves as a percentage of total portfolio loans was primarily driven by the release of $7.0 million of reserves that were allocated to the other segment due to principal pay-downs, throughout 2022, partially offset by strong loan growth, increased qualitative reserves of $3.0 million, and net charge-offs of $4.5 million. Management believes, the ACL is adequate to absorb expected losses inherent in the loan portfolio.
The Company remains well capitalized. Our Tier 1 capital ratio decreased to 12.61% at December 31, 2022 compared to 14.21% at December 31, 2021. Our leverage ratio was 10.29% at December 31, 2022, compared to 10.62% at December 31, 2021 and total risk-based capital ratio was 13.86% at December 31, 2022 compared to 15.46% at December 31, 2021.The decrease is primarily related to the aforementioned repurchase of common stock of $42.9 million through December 31, 2022. We adopted Current Expected Credit Losses (“CECL”) effective January 1, 2021 and elected to implement the regulatory agencies’ capital transition relief over the permissible three-year period.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Securities
The following table presents the composition of available-for-sale securities for the periods presented:
(Dollars in Thousands) 2022 2021 $ Change
The balances and average rates of our securities portfolio are presented below as of December 31:
Balance Weighted-AverageYield Balance Weighted-AverageYield
The Company invests in various securities in order to maintain a source of liquidity, to satisfy various pledging requirements, to increase net interest income and as a tool of the ALCO to diversify and reposition the balance sheet for interest rate risk purposes. Securities are subject to market risks that could negatively affect the level of liquidity available to the Company. Security purchases are subject to the Company’s Investment Policy approved annually by the Board and administered through ALCO and the Company’s treasury function.
The securities portfolio decreased $86.1 million at December 31, 2022 compared to December 31, 2021. Securities comprise 19.9% of total assets at December 31, 2022 compared to 22.3% at December 31, 2021. The decrease is due to the Company’s strategy of redeploying securities maturities into higher yielding loan growth, as well as the continued decline in fair value due to rising interest rates. We have further diversified the securities portfolio as to bond types, maturities and interest rate structures.
At December 31, 2022, total gross unrealized gains in the available-for-sale portfolio were $0.3 million offset by $109.7 million of gross unrealized losses. At December 31, 2021, total gross unrealized gains in the available-for-sale portfolio were $10.0 million offset by $7.8 million of gross unrealized losses.
The unrealized losses on debt securities are believed to be temporary primarily because these unrealized losses are due to reductions in market value caused by upward movement in interest rates, and not related to the credit quality of these securities. Our portfolio consists of 49.2% of securities issued by United States government sponsored entities and carry an implicit government guarantee. States and political subdivisions comprise 29.8% of the portfolio and largely general obligation or
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
essential purpose revenue bonds, which have performed very well historically over all business cycles, and are rated AA and AAA. We have the intent and ability to hold these securities to maturity and expect full recovery of the amortized cost.
The Company’s investment securities with intermediate and long-term maturities were the largest driver of these gross unrealized losses, as the market values of these securities are significantly impacted by the Treasury yield curve for similar durations (i.e., 5-year and 10-year Treasury securities). This portion of the Treasury yield curve has moved significantly upward over the past year, driving unrealized losses on these securities higher. Although the Federal Reserve continues its aggressive effort to raise short-term interest rates to combat inflation, the Company does not expect higher short-term rates to adversely impact the fair values of the Company’s investment securities to the same extent as increases in longer-term rates. The Company expects that higher short-term rates may improve yields on certain of the Company’s variable rate securities within the next six to twelve months.
At December 31, 2021, the 5-year and 10-year U.S. Treasury yields were 1.26% and 1.52%, respectively. At December 31, 2022, those same bond yields were 3.99% and 3.88%, respectively. Therefore, this increase of 273 and 236 basis points, respectively in the intermediate part of the yield curve largely caused the reduction in bond prices for fixed rate bonds in that maturity range. The effects were generally greater for longer maturity bonds, such as municipal bonds. On the other hand, floating rate bonds largely held consistent values, as those interest rates adjust in line with Federal Reserve interest rate hikes.
Should the impairment of any of these securities become credit related, the cost basis of the investment will be reduced and the resulting loss will be recognized in net income in the period the credit related impairment is identified, while any non-credit loss will be recognized in other comprehensive loss. At December 31, 2022 and December 31, 2021, the Company had no credit related net investment impairment losses.
The following table sets forth the maturities of securities at December 31, 2022 and the weighted average yields of such securities.
Available-for-Sale Securities
(Dollars in Thousands) Maturing
Amount Yield Amount Yield Amount Yield Amount Yield
Residential Mortgage-Backed Securities(2) — — % — — % — — % 103,685 2.90 %
Other Commercial Mortgage-Backed Securities(2) — — % — — % — — % 22,399 2.65 %
Corporate Notes — — % — — % 61,733 3.87 % — — %
(1)Weighted -average yields are calculated on a taxable-equivalent basis using the federal statutory tax rate of 21 percent.
(2) Securities not due at a single maturity date
At December 31, 2022 the Company had no held-to-maturity securities; however, if at a future date we classify securities as held-to-maturity, our disclosures will show the weighted average yield for each range of maturities.
At December 31, 2022, the Company held 54.2% fixed rate and 45.8% floating rate securities.The floating rate securities may have a stated maturity greater than ten years, but the interest rate generally adjusts monthly.Therefore, the duration on these securities is short, generally less than one year, and will therefore not be as sensitive to interest rate changes.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Refer to Note 4, Investment Securities, in the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for additional information related to our securities.
Loan Composition
The following table summarizes our loan portfolio as of the periods presented:
December 31,
Commercial
Consumer
Our loan portfolio represents our most significant source of interest income. The risk that borrowers are unable to pay such obligations is inherent in the loan portfolio. Other conditions such as downturns in the borrower's industry or the overall economic climate can significantly impact the borrower’s ability to pay. For a discussion of the risk factors relevant to our business and operations, please refer to Part I, Item 1A, “Risk Factors,” contained in this Annual Report on Form 10-K for the year ended December 31, 2022.
Total portfolio loans increased $336.8 million, or 12.0% to $3.1 billion at December 31, 2022 compared to $2.8 billion at December 31, 2021 with strong production in our CRE, residential mortgage and construction portfolios. We experienced a decline in total loans during 2021 primarily due to large commercial loan payoffs, $62.2 million of loan sales and mortgage refinancing sold in the secondary markets.
The commercial portfolio is monitored for potential concentrations of credit risk by market, property type and tenant concentrations. The Bank experienced strong growth in the residential mortgage loan portfolio during 2022. However, given the expectation of continued higher mortgage rates next year, we expect more modest growth during future periods. At December 31, 2022, the loan portfolio was comprised of 26.8% floating rate loans which reprice monthly, 41.2% variable rate loans that reprice at least once during the life of the loan, of which a majority of this loan population has one or more repricing events remaining before maturity, and 32.0% fixed rate loans. The Company carefully monitors the loan portfolio, including the potential impact on repayment capacity that our borrowers may experience given the interest rate environment.
Our exposure to the hospitality industry at December 31, 2022 equated to approximately $360.4 million, or 11.4%, of total portfolio loans. These were mostly loans secured by upscale or top tier flagged hotels, which have historically exhibited low leverage and strong operating cash flows. Beginning in the second quarter of 2021, we observed improvements in occupancy and the average daily rates for our hotel clients following sharp declines as a result of the pandemic. However, our clients continue to face challenges with respect to labor, which we believe impedes their ability to turnover rooms resulting in occupancy constraints. This has caused, or may cause, them to operate with lower levels of liquidity and an inability to reserve for capital improvements and could adversely affect their ability to pay property expenses, capital improvements and/or repay existing indebtedness. Contractual payments have been restored since the expiration of our deferral program on June 30, 2021. These developments, together with the current economic conditions, generally, may adversely impact the value of real estate
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collateral in hospitality and other commercial real estate exposure. As a result, our financial condition, capital levels and results of operations could be adversely affected.
Aggregate commitments to our top 10 credit relationships were $652.5 million at December 31, 2022. The largest relationship of the top 10 represents 47.4% of the aggregate commitments of our top 10 credit relationships.
The following table summarizes our top 10 relationships and a description of industries represented for the periods presented:
Dollars in Thousands For the Periods Ending
Unfunded commitments on lines of credit were $512.7 million at December 31, 2022 as compared to $433.1 million at December 31, 2021. The majority of unused commitments are for construction projects that will be drawn as the construction completes. Total utilization was 50.3% at December 31, 2022 and 52.2% at December 31, 2021. Unfunded commitments on commercial operating lines of credit was 49.7% at December 31, 2022 and 51.7% at December 31, 2021.
We attempt to limit our exposure to credit risk by diversifying our loan portfolio by segment, geography, collateral and industry while actively managing concentrations. When concentrations exist in certain segments, this risk is mitigated by reviewing the relevant economic indicators and internal risk rating trends of the loans in these segments. The Company established transaction, relationship and specific loan segment limits in its loan policy. Total commercial real estate balances should not exceed the combination of 300% of total risk-based capital and growth in excess of 50% over the previous thirty-six months and construction loan balances should not exceed 100% of total risk-based capital. Investment real estate property types and purchased loan programs have individual dollar limits that should not be exceeded in the portfolio and are based on management’s risk tolerance relative to capital. In addition, there are specific limits in place for various categories of real estate loans with regards to loan-to-value ratios, loan terms, and amortization periods. We also have policy limits on loan-to-cost for construction projects. Although leverage is important, the Company is also focused on cash flow generation and uses multiple metrics to calculate a supportable loan amount. Supportable loan amounts have generally been more challenging given the increases in commodities pricing.
Unsecured loans pose higher risk for the Company due to the lack of a well-defined secondary source of repayment. Commercial unsecured loans are reserved for the best quality customers with well-established businesses that operate with low financial and operating leverage. The repayment capacity of the borrower should exceed the policy and guidelines for secured loans. The Company significantly increased the standards for consumer unsecured lending by adjusting upward the required qualifying Fair Isaac Corporation (“FICO”) scores and restricting loan amounts at lower FICO scores.
Deferred costs and fees included in the portfolio balances above were $8.2 million and $4.5 million at December 31, 2022 and December 31, 2021, respectively. Discounts on purchased 1-4 family loans included in the portfolio balances above were $161.2 thousand and $190.6 thousand at December 31, 2022 and December 31, 2021, respectively.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
From time to time, we have mortgage loans held-for-sale derived from two sources. First, we purchase mortgage loans on a short-term basis from a partner financial institution that has fully executed sales contracts to end investors. Second, we originate and close mortgages with fully executed contracts with investors to purchase shortly after closing. We then hold these mortgage loans from both sources until funded by the investor, typically a two-week period. There were no mortgage loans held-for-sale at December 31, 2022 and $0.2 million at December 31, 2021.
The following tables present the maturity schedule of portfolio loan types at December 31, 2022:
Maturity
Fixed interest rates
Other — — — — —
Variable interest rates
Refer to Note 5, Loans and Loans Held-For-Sale, in the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for additional information related to our loans.
Credit Quality
On a monthly basis, a Criticized Asset Committee meets to review certain watch, special mention and substandard risk rated loans within prescribed policy thresholds. These loans typically represent the highest risk of loss to the Company. Action plans are established and these loans are monitored through regular contact with the borrower and loan officer, review of current financial information and other documentation, review of all loan or potential loan restructures or modifications and the regular re-evaluation of assets held as collateral.
On a quarterly basis, the Credit Risk Committee of the Board meets to review our loan portfolio metrics, approve segment limits, approve the adequacy of ACL, and findings from Loan Review identified in the previous quarter. Annually, this same committee approves credit related policies and policy enhancements as they become available.
Additional credit risk management practices include continuous reviews of trends in our lending footprint and our lending policies and procedures to support sound underwriting practices, concentrations, delinquencies and annual portfolio stress testing. Our Loan Review department serves as a mechanism to independently monitor credit quality and assess the effectiveness of credit risk management practices to provide oversight of all lending activities. The loan review function has the primary responsibility for assessing commercial credit administration and credit decision functions of consumer and mortgage underwriting, as well as providing input to the loan risk rating process. Our policy is to place loans in all categories in nonaccrual status when collection of interest or principal is doubtful, or generally when interest or principal payments are 90 days or more past due based on contractual terms. Consumer unsecured loans and secured loans are evaluated for charge-off
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after the loan becomes 90 days past due. Unsecured loans are fully charged-off and secured loans are charged-off to the estimated fair value of the collateral less the cost to sell.
The ability of borrowers to repay commercial loans is dependent upon the success of their business and general economic conditions. Due to the greater potential for loss within our commercial portfolio, we monitor the commercial loan portfolio through an internal risk rating system. Loan risk ratings are assigned based upon the creditworthiness of the borrower and are reviewed on an ongoing basis according to our internal policies. Loans rated special mention or substandard have potential or well-defined weaknesses not generally found in high quality, performing loans, and require attention from management to limit loss.
The following tables represent credit exposures by internally assigned risk ratings as of December 31, 2022 and 2021:
At December 31, 2022 and December 31, 2021, the Company had no loans that were risk rated as doubtful. Special mention and substandard loans at December 31, 2022 decreased $38.4 million to $156.9 million compared to $195.3 million at December 31, 2021, with an increase of $5.0 million in special mention and a decrease of $43.4 million in substandard. The largest variance in special mention was primarily related to a CRE project totaling $9.9 million that was downgraded, offset by the payment in full on two CRE projects totaling $6.0 million and an upgraded credit to pass status in the amount of $1.5 million. In addition to CRE, the Company downgraded a syndicated C&I loan totaling $2.9 million. The decrease in substandard loans primarily related to the Other loan segment due to principal paydowns during 2022.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Nonperforming assets consist of nonaccrual loans and OREO. The following table summarizes nonperforming assets for the dates presented:
(Dollars in Thousands) December 31,
Nonperforming Loans
Commercial and Industrial 204 451
Other Consumer 8 73
Other — —
Nonperforming Loans to Total Portfolio Loans 0.21 % 0.26 %
Nonperforming assets decreased $3.3 million, or 17.9% to $15.0 million at December 31, 2022 compared to December 31, 2021. The decrease was primarily due to a $2.5 million decrease in OREO, driven primarily by sales and payments. Closed retail bank offices have a remaining book value of $1.1 million at December 31, 2022 compared to $1.0 million at December 31, 2021. During 2022, six branch closures were completed and moved to OREO as part of our branch network optimization project that aligns with our strategic goals to enhance franchise value and improve operating efficiency. Nine properties were sold totaling $1.9 million sold and two properties totaling $0.9 million were closed, but remain to be sold. Organic OREO decreased $2.6 million at December 31, 2022 compared to December 31, 2021.
NPLs decreased by $0.8 million at December 31, 2022 compared to December 31, 2021. NPLs as a percentage of total portfolio loans were 0.21% at December 31, 2022 compared to 0.26% at December 31, 2021.
Past Company legacy underwriting standards relied heavily on loan to value and did not necessarily consider the income characteristics of the borrower. An overreliance on value as a primary repayment source can become compromised during real estate cycles. As a result, management has worked through these legacy credits and has installed a number of underwriting guardrails that consider the proportion of speculation, transaction limits and introduced sensitivity analysis in order to determine supportable loan amounts. While these guardrails do not insulate the Company from credit cycles, it should reduce the experience of defaults. Despite economic uncertainty, increased costs and interest rates, credit quality remains favorable.
There were no nonaccrual loans related to loans held-for-sale at December 31, 2022 and December 31, 2021, respectively.
Refer to Note 6, Allowance for Credit Losses, in the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for additional information related to our nonperforming loans and OREO.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
The following table summarizes past due loans for the dates presented:
(Dollars in Thousands) December 31,
Loans 30 to 89 Days Past Due
Commercial
Commercial Real Estate $ 104 $ 229
Commercial and Industrial 283 297
Consumer
Other — —
Portfolio loans past due 30 to 89 days and still accruing increased $3.2 million to $4.8 million at December 31, 2022 compared to December 31, 2021, primarily in the construction segment due to two relationships with an aggregate principal balance of $2.9 million at December 31, 2022. There were no loans during the year ended December 31, 2022 and December 31, 2021 that were past due more than 90 days and still accruing.
Closed-end installment loans, amortizing loans secured by real estate and any other loans with payments scheduled monthly are reported past due when the borrower is in arrears two or more monthly payments. Other multi-payment obligations with payments scheduled other than monthly are reported past due when one scheduled payment is due and unpaid for 30 days or more. We monitor delinquency on a monthly basis, including loans that are at risk for becoming delinquent and early stage delinquencies in order to identify emerging patterns and potential problem loans.
Troubled Debt Restructuring Disclosures Prior to Our Adoption of ASU No. 2022-02
Prior to our adoption of ASU No. 2022-02, the Company accounted for Troubled Debt Restructuring (“TDR”) as a loan which, for economic or legal reasons related to a borrower’s financial difficulties, granted a concession to the borrower that we would not otherwise grant. The Company strives to identify borrowers in financial difficulty early and work with them to modify terms and conditions before their loan defaults and/or is transferred to nonaccrual status. Modified terms that might have been considered a TDR generally included extension of maturity dates at a stated interest rate lower than the current market rate for a new loan with similar characteristics, reductions in contractual interest rates or principal deferment. While unusual, there may have been instances of principal forgiveness. Short-term modifications that were considered insignificant were generally not considered a TDR unless there were other concessions granted. On April 1, 2022, the Company adopted ASU 2022-02, which eliminated TDR accounting prospectively for all restructurings occurring on or after January 1, 2022. Refer to Note 1, Summary of Significant Accounting Polices, in the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for additional information related to ASU No. 2022-02.
Generally, the Company individually evaluates all loans experiencing financial difficulty, with a commitment greater than or equal to $1.0 million for individually evaluated loan reserves. In addition, the Company may individually evaluate credits that have complex loan structures, even if the commitment is less than $1.0 million. Nonaccrual loans can be returned to accruing status if the ultimate collectability of all contractual amounts due, according to the restructured agreement, is not in doubt and there is a period of a minimum of six months of satisfactory payment performance by the borrower either immediately before or after the restructuring.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Allowance for Credit Losses
The following summarizes our allowance for credit loss experience at December 31 for each of the years presented:
Impact of CECL Adoption — 61,642 —
Charge-offs:
Construction — 1,859 —
Other — — —
Recoveries:
Commercial Real Estate — 159 707
Commercial and Industrial 1 291 2
Other — — —
Net Charge-offs to Average Portfolio Loans 0.15% 0.79% 0.09%
Allowance for Credit Losses to Total Portfolio Loans 2.98% 3.41% 1.83%
Total net charge-offs decreased to $4.5 million for the year ended December 31, 2022 compared to $23.1 million for the year ended December 31, 2021 primarily in the CRE segment. The largest charge-off in 2022 was $3.4 million on a purchased syndicated C&I loan in the amount of $4.9 million, which was previously reserved for $2.6 million, transferred to held-for-sale in the third quarter of 2022 in the amount of $1.5 million and then sold in the fourth quarter of 2022. The net charge-offs of $23.1 million for the full year 2021 was primarily attributable to the resolution of five problem relationships during 2021, in which the majority of losses were anticipated and previously reserved.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
The following is the allocation of the ACL balance by segment as of December 31 for the years presented below:
(Dollars in Thousands) Amount % of Loans Amount % of Loans
The declines in the other segment were primarily due to principal pay-downs during 2022. The ACL was $93.9 million, or 2.98%, of total portfolio loans at December 31, 2022 compared to $95.9 million, or 3.41% of total portfolio loans at December 31, 2021.
The following table summarizes the credit quality ratios and their components as of December 31 for the years presented below:
Allowance for Credit Losses to Total Portfolio Loans
Allowance for Credit Losses to Total Portfolio Loans 2.98 % 3.41 %
Nonperforming Loans to Total Portfolio Loans
Nonperforming Loans to Total Portfolio Loans 0.21 % 0.26 %
Allowance for Credit Losses to Nonperforming Loans
Allowance for Credit Losses to Nonperforming Loans 1,412.37 % 1,297.00 %
Net Charge-offs to Average Portfolio Loans
Net Charge-offs to Average Portfolio Loans 0.15 % 0.79 %
The provision (recovery) for credit losses, which includes a provision (recovery) for losses on loans and on unfunded commitments, is a charge to earnings to maintain the ACL at a level consistent with management's assessment of expected losses over the life of loans as of the balance sheet date. The provision for credit losses decreased $0.9 million to $2.4 million for the year ended 2022 compared to the same period in 2021. The reductions in the Other segment reserves due to principal paydowns were partially offset by charge-offs in 2022 and reserves associated with loan growth.
The provision (recovery) for unfunded commitments increased $1.8 million to $0.5 million for the year ended 2022 when compared to a recovery of $1.3 million for the year ended 2021 due to the level of construction commitments as well as changes in reserve rates. The reserve for unfunded commitments is largely comprised of unfunded commitments related to real estate construction loans. There are three basic factors that influence the reserve rates associated with unfunded commitments for construction loans. First, the reserve rate is extrapolated from the reserve rates calculated for certain commercial real estate funded loans within the ACL model. These reserve rates are influenced by the same factors cited in the ACL model such as economic forecasts, average portfolio life, etc. Refer to Note 1, Summary of Significant Accounting Policies, in the Notes to
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for additional information related to the ACL Policy and the discussion of these factors. Second, since the category of construction is generic, management applies a weighting of the reserve rates associated with certain CRE loans. The proportion of these segments affect the weighting. Third, volume changes impact the total reserve calculation.
As a percentage of average total portfolio loans, net charge-offs were 0.15% for the year ended December 31, 2022 compared to 0.79% for the same period in 2021. At December 31, 2022 NPLs decreased $0.8 million at December 31, 2022 since December 31, 2021. NPLs as a percentage of total portfolio loans were 0.21% and 0.26% as of December 31, 2022 and December 31, 2021, respectively.
Refer to Note 6, Allowance for Credit Losses, in the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for additional information related to our ACL.
Deposits
The daily average balance of deposits and rates paid on deposits are summarized in the following table for the years ended December 31:
(Dollars in Thousands) AverageBalance Rate AverageBalance Rate
For the year ended December 31, 2022, total average deposits grew $37.5 million, including an increase in average money market accounts of $137.9 million, or 36.0%, an increase in average interest-bearing deposits of $75.5 million, or 18.3%, and an increase in average savings accounts of $57.3 million, or 8.6%. The increases were partially offset by a managed decrease in average CDs of $212.9 million, or 14.3% due to the intentional runoff of higher cost CDs, through the first half of the year, and a decline in average noninterest-bearing demand deposits of $20.3 million. Due to historically low market interest rates during 2021 and the first half of 2022, the Company was able to migrate away from higher rate CDs and grow lower yielding, more liquid products. During the second half of 2022, market interest rates increased quickly providing new incentives for customers to seek out higher yielding CDs.
The following table presents additional information about our year-end deposits:
Noninterest-Bearing Public Funds Deposits 27,086 58,393
Total Deposits not Covered by Deposit Insurance(1) 378,175 396,626
Certificates of Deposits not Covered by Deposit Insurance 159,030 147,134
(1) These deposits are presented on an estimated basis. This estimate was determined based on the same methodologies and assumptions used for regulatory reporting requirements.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Maturities of CDs over $250,000 or more not covered by deposit insurance at December 31, 2022 are summarized as follows:
(Dollars in Thousands) Amount Percent
Over Three Months Through Twelve Months 72,505 45.6 %
Over Twelve Months Through Three Years 62,836 39.5 %
Refer to Note 11, Deposits, in the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for additional information related to our deposits.
Federal Home Loan Bank (“FHLB”) Borrowings and Federal Funds Purchased
Information pertaining to FHLB borrowings and federal funds purchased at December 31 is summarized in the table below:
Balance at Period End
Federal Funds Purchased 17,870 — —
Average Balance during Period
Federal Funds Purchased 5,711 — 55
Average Interest Rate during the Period
Federal Home Loan Bank Borrowings 3.90 % 1.20 % 1.18 %
Federal Funds Purchased 3.29 % — % 1.82 %
Maximum Month-end Balance during the Period
Federal Funds Purchased 23,020 — —
Average Interest Rate at Period End
Federal Home Loan Bank Borrowings 4.48 % 1.61 % 1.13 %
Federal Funds Purchased 4.65 % — % — %
The Company had $180.6 million FHLB borrowings at December 31, 2022 and $7.0 million at December 31, 2021 an increase of $173.6 million. The Company had $17.9 million in overnight federal funds purchased at December 31, 2022 and had no outstanding overnight federal funds purchased at December 31, 2021. The level and composition of borrowed funds fluctuates over time based on many factors including market conditions, loan growth, investment securities, deposit growth and capital considerations. We manage our borrowed funds to provide a reliable source of liquidity.
The Company held FHLB of Atlanta stock of $9.7 million and $2.4 million at December 31, 2022 and December 31, 2021, respectively. Dividends recorded on this restricted stock were $154 thousand and $121 thousand for the years ended December 31, 2022 and December 31, 2021, respectively. The investment is carried at cost and evaluated for impairment based on the ultimate recoverability of the par value. We hold FHLB stock because we are a member of the FHLB of Atlanta. The FHLB requires members to purchase and hold a specified level of FHLB stock based upon the members’ asset values, level of borrowings and participation in other programs offered. Stock in the FHLB is non-marketable and is redeemable at the discretion of the FHLB. Members do not purchase stock in the FHLB for the same reasons that traditional equity investors acquire stock in an investor-owned enterprise. Rather, members purchase stock to obtain access to the products and services offered by the FHLB. Unlike equity securities of traditional for-profit enterprises, the stock of the FHLB does not provide its holders with an opportunity for capital appreciation because, by regulation, FHLB stock can only be purchased, redeemed and transferred at par value.
Refer to Note 12, Federal Home Loan Bank Borrowings and Federal Funds Purchased, in the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for additional information related to our borrowings.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Capital Resources
The following table summarizes ratios for the Company and Bank for December 31:
Common Equity Tier 1
Tier 1 Ratio
Total Risk-Based Capital Ratio
Leverage Ratio
Total shareholders’ equity decreased by $79.0 million to $328.6 million at December 31, 2022 compared to $407.6 million at December 31, 2021. The decrease was primarily due to $87.3 million, net of tax, decrease in other comprehensive loss due to changes in the fair value of available-for-sale securities and $42.9 million related to the repurchase of common stock, partially offset by net income of $50.1 million. The remaining difference of $1.1 million is related to stock-based compensation during the year ended December 31, 2022.
The Company and the Bank are subject to various capital requirements administered by the federal banking regulators. Failure to meet the minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulations to ensure capital adequacy require us to maintain minimum amounts and ratios.
Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At December 31, 2022 and December 31, 2021, the most recent regulatory notifications categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution’s category.
The Company continues to maintain its capital position with a leverage ratio of 10.29% as compared to the regulatory guideline of 5.00% to be well-capitalized and a risk-based Common Equity Tier 1 ratio of 12.61% compared to the regulatory guideline of 6.50% to be well-capitalized. Our risk-based Tier 1 and Total Capital ratios were 12.61% and 13.86%, respectively, which places the Company above the federal bank regulatory agencies’ well-capitalized guidelines of 8.00% and 10.00%, respectively. We believe that we have the ability to raise additional capital, if necessary.
The Basel rules also permit banking organizations with less than $15.0 billion in assets to retain, through a one-time election, existing treatment for accumulated other comprehensive income, which currently does not affect regulatory capital. The Company elected to retain this treatment which reduces the volatility of regulatory capital levels.
The Basel III Capital Rules require the Company and the Bank to maintain minimum Common Equity Tier 1, Tier 1 and Total Capital ratios, along with a capital conservation buffer, effectively resulting in new minimum capital ratios. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of Common
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
Equity Tier 1 capital to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall. The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and does not have any current applicability to the Company or the Bank.
In December 2018, the Office of the Comptroller of the Currency, (the “OCC”), the Federal Reserve System, (“FRB”), and the Federal Deposit Insurance Corporation, (“FDIC”), approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations’ implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the Day 1 adverse effects on regulatory capital that may result from the adoption of the new accounting standard. On March 27, 2020, the regulators issued interim final rule (“IFR”), “Regulatory Capital Rule: Revised Transition of the Current Expected Credit Losses Methodology for Allowances” in response to the disrupted economic activity from the spread of COVID-19. The IFR maintains the three-year transition option in the previous rule and provides banks the option to delay for two years an estimate of CECL’s effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-year transition period (five-year transition option). We adopted CECL effective January 1, 2021 and elected to implement the capital transition relief over the permissible three-year period.
Refer to Note 20, Capital Adequacy, in the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for additional information related to our capital.
Contractual Obligations
Contractual obligations represent future cash commitments and liabilities under agreements with third parties and exclude contingent contractual liabilities for which we cannot reasonably predict future payments. The Company has various financial obligations, including contractual obligations and commitments that may require future cash payments. The following table presents, as of December 31, 2022, significant fixed and determinable contractual obligations to third parties by payment date:
Payments Due In
(1)Excludes Interest
Lease contracts are described in Note 8, Premises and Equipment, of the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Purchase obligations primarily represent obligations under agreement with a third-party data processing vendor and communications charges.
Off-Balance Sheet Arrangements
In the normal course of business, the Company offers our customers lines of credit and letters of credit to meet their financing objectives. The undrawn or unfunded portion of these facilities do not represent outstanding balances and therefore are not reflected in our financial statements as loans receivable. The Company provides lines of credit to our clients to memorialize the commitment to finance the completion of construction projects and revolving lines of credit to operating companies to finance their working capital needs. Lines of credit for construction projects represent $373.2 million, or 59.2% and $283.9 million, or 55.3% of the commitments to extend credit identified in the table below at December 31, 2022 and December 31, 2021, respectively. The Company provides letters of credit, generally, for the benefit or our customers to provide assurance to various municipalities that construction projects will be completed according to approved plans and specifications. These instruments involve elements of credit and interest rate risk and our exposure to credit loss, in the event the customer does not satisfy the
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
terms of the agreement, could be equal to the contractual amount of the obligation less the value of any collateral. The Company analyzes this risk and calculates a reserve for unfunded commitments. The same credit policies are applied in granting these facilities as those used for underwriting loans. Lines of credit to finance construction projects include a construction end date, at which time the loan is expected to convert to a mini-perm loan. A department independent of our lending group monitors construction commitments of $1.0 million or more. Lines of credit to operating companies to finance working capital include a maturity date and may include various financial covenants. Letters of credit include an expiration date unless it is a standby letter of credit which automatically renews but generally provide for a termination clause on an annual basis given sufficient notice to the beneficiary. The Company typically charges an annual fee for the issuance of letters of credit. Because letters of credit are expected to expire without being drawn upon, these commitments do not necessarily represent future cash requirements of the Company.
The following table sets forth the commitments and letters of credit as of December 31:
Estimates of the fair value of these off-balance sheet items were not made because of the short-term nature of these arrangements and the credit standing of the counterparties.
For more details, see Note 17 - Commitments and Contingencies, in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
Liquidity
Liquidity is defined as a financial institution’s ability to meet its cash and collateral obligations at a reasonable cost. This includes the ability to satisfy the financial needs of depositors who want to withdraw funds or borrowers needing to access funds to meet their credit needs. In order to manage liquidity risk the Company’s Board has delegated authority to the ALCO for formulation, implementation and oversight of liquidity risk management for the Company. The ALCO’s goal is to maintain adequate levels of liquidity at a reasonable cost to meet funding needs in both a normal operating environment and for potential liquidity stress events. The ALCO monitors and manages liquidity through various ratios, reviewing cash flow projections, performing stress tests and by having a detailed contingency funding plan. The ALCO policy guidelines define graduated risk tolerance levels. If our liquidity position moves to a level that has been defined as high risk, specific actions are required, such as increased monitoring or the development of an action plan to reduce the risk position.
The Company’s primary funding and liquidity source is a stable customer deposit base. Management believes that we have the ability to retain existing deposits and attract new deposits, mitigating any funding dependency on other more volatile sources. Although deposits are the primary source of funds, the Company has identified various other funding sources that can be used as part of our normal funding program when either a structure or cost efficiency has been identified. Additional funding sources accessible to the Company include borrowing availability at the FHLB, equal to 25% of the Company’s assets approximating $1.0 billion, subject to the amount of eligible collateral pledged, unsecured federal funds lines with six other correspondent financial institutions in the amount of $145.0 million, access to the institutional CD market, and the brokered deposit market. In addition to the lines referenced above, the Company also has $611.8 million of unpledged available-for-sale investment securities as an additional source of liquidity. Please refer to the Liquidity Sources table below for available funding with the FHLB and our unsecured lines of credit with correspondent banks.
An important component of our ability to effectively respond to potential liquidity stress events is maintaining a cushion of highly liquid assets. Highly liquid assets are those that can be converted to cash quickly, with little or no loss in value, to meet financial obligations. ALCO policy guidelines define a ratio of highly liquid assets to total assets by graduated risk tolerance levels of minimal, moderate and high. At December 31, 2022, the Bank had $616.3 million in highly liquid assets, which consisted of FRB Excess Reserves and interest-bearing deposits in other financial institutions of $4.5 million, and $611.8 million in unpledged securities. This resulted in highly liquid assets to total assets ratio of 14.7% at December 31, 2022.
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (continued)
If an extended recession caused large numbers of our deposit customers to withdraw their funds, we might become more reliant on volatile or more expensive sources of funding.
The following table provides detail of liquidity sources as of December 31:
Cash and Due From Banks, including Interest-bearing Deposits $ 46,869 $ 277,799
Inflation
Management is aware of the significant effect inflation has on interest rates and can have on financial performance. The Company’s ability to cope with this is best determined by analyzing its capability to respond to changing interest rates and its ability to manage noninterest income and expense. The mix of interest-rate sensitive assets and liabilities is monitored through ALCO in order to reduce the impact of inflation on net interest income. The effects of inflation are controlled by reviewing the prices of our products and services, by introducing new products and services and by controlling overhead expenses. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation.
Stock Repurchase Plan
On June 28, 2022, the Company’s Board authorized the adoption of a new common stock repurchase program for the purchase of up to an additional 750,000 shares of the Company’s common stock from time-to-time on the open market (“2022 program”), at management’s discretion, which was in addition to the existing plan approved by the Board on December 10, 2021 (“prior program”, and together with the 2022 program, the “Company Stock Repurchase Programs.”) The prior program was completed on April 28, 2022. The Company purchased 2,587,361 shares of its outstanding common stock on the open market at a total cost of $42.9 million, or $16.59 per share during the year ended December 31, 2022 under the Company Stock Repurchase Programs. The remaining shares authorized to be purchased under the 2022 program totaled 132,232 shares at December 31, 2022.
The Company Stock Repurchase Programs are described in Item 5, Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities, of this Annual Report on Form 10-K.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk
Market risk is defined as the degree to which changes in interest rates, foreign exchange rates, commodity prices, or equity prices can adversely affect a financial institution’s earnings or capital. For financial institutions, market risk primarily reflects exposures to changes in interest rates. Interest rate fluctuations affect earnings by changing net interest income and other interest-sensitive income and expense levels. Interest rate changes affect capital by changing the net present value of a financial institution’s future cash flows, and the cash flows themselves, as rates change. Accepting this risk is a normal part of banking and can be an important source of profitability and enhancement of shareholder value. However, excessive interest rate risk can threaten a financial institution’s earnings, capital, liquidity, and solvency. Our sensitivity to changes in interest rate movements is continually monitored by the ALCO.
The ALCO utilizes an asset liability model (“ALM”) to monitor and manage market risk by simulating various rate shock scenarios and analyzing the results of the rate shocks on the Company’s projected net interest income (“NII”) and economic value of equity (“EVE”). The rate shock scenarios used in the ALM span over multiple time horizons and yield curve shapes and include parallel and non-parallel shifts to ensure the ALCO can mitigate future earnings and market value fluctuations due to changes in market interest rates.