Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of the consolidated financial condition and results of operations of the Company and its subsidiary should be read in conjunction with the consolidated financial statements and related notes presented in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K. Historical results of operations and the percentage relationships among any amounts included, and any trends that may appear, may not be indicative of results of operations or trends in operations for any future periods.
Use of Non-GAAP Financial Measures
This discussion and analysis contains financial information determined by methods other than in accordance with GAAP. Management believes that the supplemental non-GAAP information provides a better comparison of period-to-period operating performance. Additionally, the Company believes this information is utilized by regulators and market analysts to evaluate a company’s financial condition and therefore, such information is useful to investors. Non-GAAP measures used in this report consist of tax-equivalent net interest income, core non-interest income, core net income, core earnings per share (diluted), core return on average assets and core return on average equity excluding the impact of losses recognized in July 2023 on the sale of available-for-sale securities and taxes paid on the early surrender of bank owned life insurance policies.
These disclosures should not be viewed as a substitute for financial results in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures which may be presented by other companies. Where the non-
44
Table of Contents
GAAP financial measure is used, the comparable GAAP financial measure, as well as reconciliation to that comparable GAAP financial measure, as well as a statement of the company’s reasons for utilizing the non-GAAP financial measure, can be found within this discussion and analysis.
Overview
We are a bank holding company headquartered in Reston, Virginia primarily serving the Washington, D.C. metropolitan area. The material business operations of our organization are performed through the Bank. As a result, the discussion and analysis within this section primarily relate to activities conducted at the Bank.
As with most community banks, the Bank derives a significant portion of its income from interest received on loans and investments. The Bank’s primary source of funding is deposits, both interest-bearing and non-interest-bearing. To account for credit risk inherent in all loans, the Bank maintains an allowance for loan credit losses to absorb lifetime losses on existing loans. The Bank establishes and maintains this allowance by recording a provision for loan credit losses against earnings. In addition to net interest income, the Bank also generates income through service charges on deposits, insurance commission income, merchant services fee income, swap fee income and gain on sale of the guaranteed portion of U.S. Small Business Administration (“SBA”) 7(a) loans. In order to maintain its operations, the Bank incurs various operating expenses which are further described within the “Results of Operations” later in this section.
As of December 31, 2023, the Company had total consolidated assets of $2.24 billion, total loans net of unearned income of $1.86 billion, total deposits of $1.91 billion and total shareholders’ equity of $229.9 million.
Critical Accounting Policies and Estimates
The Company’s accounting and reporting policies conform to GAAP, as well as general practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements may reflect different estimates, assumptions, and judgments. Certain policies inherently rely more extensively on the use of estimates, assumptions, and judgments and as such may have a greater possibility of producing results that could be materially different than originally reported.
The following is a discussion of the critical accounting policy and significant estimate that require us to make complex and subjective judgments. Additional information about this policy can be found in Note 1 of our consolidated financial statements included in Item 8 of this Form 10-K.
Allowance for Loan Credit Losses
The allowance for loan credit losses represents an amount which, in management's judgment, is adequate to absorb the lifetime expected losses that may be sustained on outstanding loans at the balance sheet date based on the evaluation of the size and current risk characteristics of the loan portfolio, past events, current conditions, reasonable and supportable forecasts of future economic conditions, and prepayment experience. The allowance for loan credit losses is measured and recorded upon the initial recognition of a financial asset. The allowance for loan credit losses is reduced by charge-offs, net of recoveries of previous losses, and is increased or decreased by a provision for (or recovery of) credit losses, which is recorded in the Consolidated Statements of Income.
The Company is utilizing a discounted cash flow model to estimate its current expected credit losses. For the purposes of calculating its quantitative reserves, the Company has segmented its loan portfolio based on loans which share similar risk characteristics. Within the quantitative portion of the calculation, the Company utilizes at least one or a combination of loss drivers, which may include unemployment rates, home price indices, and/or gross domestic product, to adjust its loss rates over a reasonable and supportable forecast period of one year. A straight-line reversion technique is used for the following four quarters, at which time the Company reverts to historical averages. To further adjust the allowance for credit losses for expected losses not already included within the quantitative component of the calculation, the Company may consider qualitative factors, including but not limited to: variability in the economic forecast, changes in volume and
45
Table of Contents
severity of adversely classified loans, changes in concentrations of credit, changes in the nature and volume of the loan segments, factors related to credit administration, and other idiosyncratic risks not embedded in the data used in the model.
Loans that do not share risk characteristics are evaluated on an individual basis. The Company designates individually evaluated loans on nonaccrual status as collateral dependent loans, as well as other loans that management of the Company designates as having higher risk and loans for which the repayment is expected to be provided substantially through the operation or sale of the collateral. These loans do not share common risk characteristics and are not included within the collectively evaluated loans for determining the allowance for credit losses. Under CECL, for collateral dependent loans, the Company has adopted the practical expedient to measure the allowance for credit losses based on the fair value of collateral. The allowance for credit losses is calculated on an individual loan basis based on the shortfall between the fair value of the loan's collateral, which is adjusted for liquidation costs/discounts, and amortized cost. If the fair value of the collateral exceeds the amortized cost, no allowance is required.
The adoption of CECL did not result in a significant change to any other credit risk management and monitoring processes, including identification of past due or delinquent borrowers, nonaccrual practices or charge-off policy.
46
Table of Contents
Selected Financial Data
The following table contains selected historical consolidated financial data as of the dates and for the periods shown. The selected balance sheet data as of December 31, 2023 and 2022 and the selected income statement data for the years ended December 31, 2023 and 2022 have been derived from our audited consolidated financial statements included elsewhere in this Form 10-K and should be read in conjunction with the other information contained in this Form 10-K, including the information contained within this “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8 – Financial Statements and Supplementary Data.”
As of or for the Years Ended
Balance Sheet Data:
Allowance for loan credit losses 19,543 20,208
Asset Quality Data:
Allowance for loan credit losses to nonperforming loans NM NM
Non-performing assets to total assets 0.00 % 0.00 %
Non-performing loans to total loans 0.00 % 0.00 %
Capital Ratios (Bank level):
Equity-to-total assets ratio 11.1 % 10.0 %
Total risk-based capital ratio 15.7 % 15.6 %
Tier 1 risk-based capital ratio 14.7 % 14.4 %
Common equity tier 1 ratio 14.7 % 14.4 %
Income Statement Data:
Provision for (recovery of) credit losses (3,252) 175
Non-interest income (loss) (14,940) 1,691
Per Share Data and Shares Outstanding:
Earnings per share, basic $ 0.37 $ 2.27
Earnings per share, diluted $ 0.36 $ 2.25
Book value per share $ 16.25 $ 15.09
Performance Ratios:
Return on average assets ("ROAA")(1) 0.22 % 1.40 %
Return on average equity ("ROAE")(2) 2.32 % 15.18 %
Net interest margin(3) 2.22 % 3.16 %
Non-interest expense to average assets (4) 1.33 % 1.40 %
47
Table of Contents
NM – Not meaningful
(1) ROAA is calculated by dividing net income by year-to-date average assets.
(2) ROAE is calculated by dividing net income by year-to-date average equity.
Results of Operations – Years Ended December 31, 2023 and December 31, 2022
Overview
The Company reported net income of $5.2 million for the year ended December 31, 2023, a decrease of $26.6 million when compared to the same period in 2022. As disclosed in our second quarter Form 10-Q filed August 9, 2023, during July, the Company sold certain lower-yielding available-for-sale investment securities with a total par value of $161.2 million and agreed to surrender $21.4 million of bank owned life insurance (“BOLI”) contracts, resulting in a non-recurring, after-tax loss of $14.6 million that was recorded during the third quarter of 2023 (the “Restructuring”). Core net income (Non-GAAP) defined as reported net income excluding the non-recurring after-tax loss on securities sale and taxes paid in conjunction with the surrender of the Bank’s BOLI policies resulting from the Restructuring, was $19.8 million for the year ended December 31, 2023, a decrease of $12.0 million when compared to the same period in 2022. The following table reconciles net income to core net income, which is a non-GAAP measure, and outlines reported (GAAP) and core (Non-GAAP) diluted earnings per share, ROAA and ROAE as follows:
For the Years Ended
Add: Loss on securities sale, net of tax 13,520 -
Earnings per share - diluted (GAAP) $ 0.36 $ 2.25
Core earnings per share - diluted (Non-GAAP) (2) $ 1.39 $ 2.25
Return on average assets (GAAP) 0.22 % 1.40 %
Core return on average assets (Non-GAAP) (3) 0.85 % 1.40 %
Return on average equity (GAAP) 2.32 % 15.18 %
Core return on average equity (Non-GAAP) (4) 8.91 % 15.18 %
Net Interest Income and Net Interest Margin
Net interest income is the excess of interest earned on loans and investments over the interest paid on deposits and borrowings, and is the Company’s primary revenue source. Net interest income is affected by overall balance sheet growth, changes in interest rates and changes in the mix of investments, loans, deposits and borrowings. The Company’s interest-earning assets include loans, investment securities and interest-bearing deposits in other banks, while our interest-bearing liabilities include interest-bearing deposits and borrowings. Net interest margin represents the difference between interest received and interest paid as a percentage of average total interest-earning assets. Management seeks to maximize net interest income without exposing the Company to an excessive level of interest rate risk through management’s asset and liability management policies. Interest rate risk is managed by monitoring the pricing, maturity, and repricing options of all classes of interest-bearing assets and liabilities. Management expects net interest income and net interest margin to fluctuate based on changes in interest rates and changes in the amount and composition of the Company’s interest-earning assets and interest-bearing liabilities.
48
Table of Contents
The following table presents the average balance for each principal balance sheet category, and the amount of interest income or expense associated with that category, as well as corresponding average yields earned and rates paid for the years ended December 31, 2023 and 2022.
Average Balance Sheets and Interest Rates on Interest-Earning Assets and Interest-Bearing Liabilities
Interest Income / Average Interest Income / Average
Assets:
Securities:
Loans, net of unearned income(2):
Total non-interest earning assets 32,430 36,624
Liabilities & Shareholders’ Equity:
Interest-bearing deposits:
Net interest spread 1.33 % 2.88 %
49
Table of Contents
Net interest margin as presented above is calculated by dividing tax-equivalent net interest income by total average earning assets. Net interest income, on a tax equivalent basis, is a financial measure that the Company believes provides a more accurate picture of the interest margin for comparative purposes. Tax-equivalent net interest income is calculated by adding the tax benefit on certain securities and loans, whose interest is tax-exempt, to total interest income then subtracting total interest expense. The following table, “Tax-Equivalent Net Interest Income,” reconciles net interest income to tax-equivalent net interest income, which is a non-GAAP measure.
Tax-Equivalent Net Interest Income
Year ended
December 31,
GAAP Financial Measurements:
Interest Income - Securities and Other Interest-Earning Assets 14,335 9,785
Interest Expense - Borrowings 3,118 1,867
Total Net Interest Income (GAAP) $ 50,484 $ 70,421
Non-GAAP Financial Measurements:
Add: Tax Benefit on Tax-Exempt Interest Income - Loans 244 209
Add: Tax Benefit on Tax-Exempt Interest Income - Securities 15 32
Total Tax Benefit on Tax-Exempt Interest Income (1) $ 259 $ 241
Tax-Equivalent Net Interest Income (Non-GAAP) $ 50,743 $ 70,662
(1) Tax benefit was calculated using the federal statutory tax rate of 21%.
Net interest income decreased $19.9 million or 28.3% on a fully tax-equivalent basis for the year ended December 31, 2023. The decrease in net interest income was driven by the increase in the costs of interest-bearing liabilities outpacing the increase in yield on interest-earning assets.
On a fully tax-equivalent basis, the net interest margin was 2.22% for the year ended December 31, 2023, compared to 3.16% for the same period in 2022. The decrease in net interest margin was primarily due to increases in the cost of interest-bearing deposits, which was partially offset by an increase in yields on the Company’s interest-earning assets.
The cost of interest-bearing liabilities increased 2.19% from 0.89% for the year ended December 31, 2022 to 3.08% for the year ended December 31, 2023. The increase in the cost of interest-bearing liabilities was primarily due to higher interest expense on deposits and other borrowings. The increase in the cost of interest-bearing liabilities was primarily due to a 2.21% increase in the cost of interest-bearing deposits as a result of the repricing of the Company’s time deposits coupled with an increase in rates offered on money market, NOW and savings deposit accounts since the fourth quarter of 2022.
The loan portfolio’s yield for the year ended December 31, 2023 was 4.84% compared to 4.44% for the year ended December 31, 2022. The increase in yield on the Company’s loan portfolio was primarily attributable to an increase in yield on the Company’s variable rate loans as a result of an increase in interest rates since 2022, coupled with a higher weighted average yield on loans originated since December 31, 2022.
The investment securities portfolio’s yield for the year ended December 31, 2023 was 2.04% compared to 1.87% for the year ended December 31, 2022. The increase was primarily due to the Company realizing the full benefit of higher yields on investment securities purchased during the latter part of the second quarter of 2022.
The yield on interest-bearing deposits due from banks for the year ended December 31, 2023 was 5.35% compared to 1.28% for the year ended December 31, 2022. The increase was primarily due to higher federal funds rate during the year ended December 31, 2023 when compared to same period in 2022.
50
Table of Contents
The following table presents the effects of changing rates and volumes on net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated to volume.
Rate/Volume Analysis
For the Year Ended December 31,
Increase
(Decrease) Due to
(Dollars in thousands) Volume Rate Total Increase (Decrease)
Interest-earning Assets:
Securities:
Tax-exempt(1) (76) (8) (84)
Loans, net of unearned income:
Interest-bearing deposits in other banks $ 744 $ 4,550 $ 5,294
Interest-bearing Liabilities:
Interest-bearing deposits:
Federal funds purchased — — —
(2)The Company did not have any loans on non-accrual as of December 31, 2023 or December 31, 2022.
Interest Income
Interest income increased by $16.7 million or 19.8% to $101.0 million on a fully tax-equivalent basis for the year ended December 31, 2023 compared to $84.3 million for the year ended December 31, 2022, driven by both an increase in rates and volume on interest-earning assets. The increase in rate on interest-earning assets was primarily attributable to the Company’s loan portfolio and interest-bearing deposits due from banks. The increase in volume of average interest-earning assets was primarily attributable to the Company’s loan portfolio.
Fully tax-equivalent interest income on loans increased by approximately $12.2 million as a result of volume growth and an increase in rate. Average loans increased approximately $115.4 million between the years ended December 31, 2023 and December 31, 2022, which was primarily attributable to growth in the investor real estate and residential mortgage portfolios.
Fully tax-equivalent interest income on investment securities decreased by approximately $0.8 million as a result of volume decreases due the Restructuring that took place in July 2023, and to a lesser extent, the amortization of securities,
51
Table of Contents
partially offset by rate increases. Average investment securities decreased approximately $74.6 million between the years ended December 31, 2023 and December 31, 2022.
The increase in rates on loans, investment securities, and interest-bearing deposits in other banks was primarily attributable to an increase in benchmark interest rates since 2022.
Interest Expense
Interest expense increased by $36.6 million to $50.3 million for the year ended December 31, 2023 compared to $13.6 million for the year ended December 31, 2022, primarily due to an increase in rates and, to a lesser extent, volume of deposits and other borrowed funds. The increase in rates was primarily a result of the repricing of the Company’s time deposits coupled with an increase in rates offered on deposit accounts during the year ended December 31, 2023 as a result of an increase in benchmark interest rates.
Provision Expense
The Company recorded a $3.3 million recovery of provision for credit losses for the year ended December 31, 2023 compared to a $175 thousand provision for the year ended December 31, 2022. The recovery of provision for credit losses during 2023 was primarily a result of changes in the Company’s loss driver analysis, resulting from a periodic review of our assumptions and improved economic forecasts used in the quantitative portion of the model and assessment of management’s considerations of existing economic versus historical conditions combined with the continued strong credit performance of our loan portfolio segments.
Non-interest Income
The Company’s recurring sources of non-interest income consist primarily of interchange income, bank owned life insurance income, service charges on deposit accounts and insurance commissions. Generally speaking, loan fees are included in interest income on the loan portfolio and not reported as non-interest income.
The following table summarizes non-interest income for the years ended December 31, 2023 and December 31, 2022.
Year ended
December 31,
Service charges on deposit accounts
Overdrawn account fees $ 82 $ 88
Account service fees 248 236
Other service charges and fees
Other charges and fees 435 247
Bank owned life insurance 224 544
Losses on sale of available-for-sale securities (17,316) —
Net gains on premises and equipment 16 —
Insurance commissions 386 382
Gain on sale of government guaranteed loans 131 —
Other operating income 134 139
Total non-interest income (loss) $ (14,940) $ 1,691
Non-interest income decreased $16.6 million during the year ended December 31, 2023 compared to the same period in 2022. The decrease in non-interest income was primarily due to the Restructuring that resulted in a loss on sale of available-for-sale securities of $17.1 million. Core non-interest income (Non-GAAP) increased $483 thousand primarily due to favorable variances of $671 thousand as a result of mark-to-market adjustments on investments related to the Company’s nonqualified deferred compensation plan, as well as increases in other charges and fees of $188 thousand primarily as a result of penalty fee income recognized on the early withdrawal of certificates of deposit, and gains recorded on the sale
52
Table of Contents
of the guaranteed portion of SBA 7(a) loans totaling $131 thousand. These increases were partially offset by a decrease in BOLI income of $320 thousand due to the surrender of all BOLI policies as part of the Restructuring.
Non-interest Expense
Generally, non-interest expense is composed of all employee expenses and costs associated with operating our facilities, obtaining and retaining customer relationships and providing banking services. The largest component of non-interest expense is salaries and employee benefits. Non-interest expense also includes operational expenses, such as occupancy and equipment expenses, data processing expenses, professional fees, advertising expenses and other general and administrative expenses, including FDIC assessments, and Virginia state franchise taxes.
The following table summarizes non-interest expense for the years ended December 31, 2023 and December 31, 2022.
Year ended
December 31,
Salaries and employee benefits expense $ 19,436 $ 20,190
Occupancy expense of premises 1,811 1,893
Furniture and equipment expenses 1,178 1,325
Advertising expense 288 193
Supplies, printing, and postage 103 133
Other operating expenses 847 664
Non-interest expense decreased $1.1 million or 3.3% during the year ended December 31, 2023 compared to the same period in 2022 primarily due to decreases in salaries and employee benefits expense. The decrease in salaries and employee benefits was primarily due to a reduction in incentive related compensation accruals year-over-year. The decrease in professional fees was the result of a favorable verdict received by the Company on a multi-year legal matter that was resolved during the year and lower legal and consulting expenses. The increase in FDIC insurance expense resulted from the FDIC increasing the base assessment rate for all insured depository institutions. The increase in franchise tax expense was due to an increase in the Bank’s equity as that is the basis the Commonwealth of Virginia uses to assess taxes on banking institutions. The increase in advertising expense was due to increased marketing and promotional activity. The decrease in occupancy expense of premises was due to a decrease in office rent as a result of the renegotiation of certain leases. The decrease in furniture and equipment expense was due to lower depreciation expense on fixed assets and lower software and equipment service expense due to contract renegotiation efforts.
Income Taxes
Income tax expense decreased $5.4 million or 65.8% to $2.8 million for the year ended December 31, 2023 compared to $8.3 million for the year ended December 31, 2022. Excluding the impact of the Restructuring, the effective tax rate for the year ended December 31, 2023 was 21.2% compared to 20.6% for the same period in 2022. The increase in effective tax rate between the comparative periods was due to changes in temporary differences.
53
Table of Contents
Discussion and Analysis of Financial Condition – Years Ended December 31, 2023 and December 31, 2022
Assets, Liabilities, and Shareholders’ Equity
The Company’s total assets decreased $105.7 million or 4.5% to $2.24 billion at December 31, 2023 compared to $2.35 billion at December 31, 2022. The decrease in total assets is primarily attributable to a decrease in available-for-sale securities and BOLI of $187.6 million and $21.2 million, respectively, partially offset by increases in loans, net of unearned income and interest-bearing deposits in banks of $70.5 million and $36.6 million, respectively.
The Company’s total liabilities decreased $122.8 million or 5.8% to $2.01 billion at December 31, 2023 compared to $2.14 billion at December 31, 2022. The decrease in total liabilities was attributable to an $161.1 million decrease in deposits, primarily driven by a $44.0 million decrease in wholesale deposits (Brokered and QwickRate CDs), and $15.5 million decrease in federal funds purchased, partially offset by an increase in borrowings as a result of the Bank Term Funding Program (“BTFP”) advance obtained during the second quarter of 2023. The Company reduced wholesale deposits by $65.6 million since March 31, 2023.
Shareholders’ equity increased $17.1 million or 8.0% to $229.9 million at December 31, 2023 compared to $212.8 million at December 31, 2022. The increase in shareholders’ equity was primarily attributable to a decrease in accumulated other comprehensive loss as a result of the realization of losses on the sale of certain low-yielding investment securities as part of the Restructuring and improvements in market values, net income recorded for the year, and increase in additional paid-in capital as a result of option exercises during the year ended December 31, 2023. These increases were partially offset by a decrease to retained earnings as a result of the Company’s adoption of ASC 326 on January 1, 2023 and dividends declared. Book value per share was $16.25 as of December 31, 2023 compared to $15.09 as of December 31, 2022.
Investment Securities
The Company maintains a primarily fixed income investment securities portfolio that had a total carrying value of $265.5 million at December 31, 2023 and $457.0 million at December 31, 2022. The investment portfolio is used as a source of liquidity, interest income, and credit risk diversification, as well as to manage rate sensitivity and provide collateral for secured public funds and secured credit lines. Investment securities are classified as available-for-sale or held-to-maturity based on management’s investment strategy and management’s assessment of the intent and ability to hold the securities until maturity. Investment securities that we may sell prior to maturity in response to changes in management’s investment strategy, liquidity needs, interest rate risk profile or for other reasons are classified as available-for-sale. The Company also had restricted stock and equity securities within its investment securities portfolio with total carrying values of $5.0 million and $2.8 million, respectively, as of December 31, 2023 and $4.4 million and $2.1 million, respectively, as of December 31, 2022.
The Company did not purchase investment securities during the year ended December 31, 2023. During the year ended December 31, 2023, the Company sold available-for-sale securities with a total par value of $173.2 million, which were comprised of $124.7 million of mortgage-backed securities, $25.1 million of U.S. government and federal agencies, $19.3 million of U.S. Treasuries, $3.5 million of municipal bonds and $0.6 million of collateralized mortgage obligations. The sale resulted in a pre-tax loss of $17.3 million. The Company had $39.3 million in maturities and principal repayments on securities during the year ended December 31, 2023, which was comprised of $34.1 million of mortgage-backed securities and $5.2 million of collateralized mortgage obligation securities.
54
Table of Contents
The following table summarizes the amortized cost and fair value of the Company’s fixed income investment portfolio as of December 31, 2023 and December 31, 2022, respectively.
Amortized Fair Amortized Fair
(Dollars in thousands) Cost Value Cost Value
Held-to-maturity
Available-for-sale
In the prevailing rate environments as of both December 31, 2023 and December 31, 2022, the Company’s investment portfolio had an estimated weighted average remaining life of approximately 4.2 years and 4.5 years, respectively. The Company’s available-for-sale investment portfolio had an estimated weighted average remaining life of approximately 3.0 years and 3.8 years in the prevailing rate environments as of December 31, 2023 and December 31, 2022, respectively. The held-to-maturity investment portfolio had an estimated weighted average remaining life of approximately 6.7 years and 7.3 years as of December 31, 2023 and December 31, 2022, respectively.
The following table summarizes the maturity composition of our investment securities as of December 31, 2023, including the weighted average yield of each maturity band. Maturities are based on the final contractual payment date, and do not reflect the effect of scheduled principal repayments, prepayments, or early redemptions that may occur. The weighted-average yield below represents the effective yield for the investment securities and is calculated based on the amortized cost of each security.
Amortized Fair Weighted-Average
(Dollars in thousands) Cost Value Yield
Held-to-maturity
Due in one year or less $ — $ — —
Available-for-sale
55
Table of Contents
Loan Portfolio
Gross loans net of unearned income increased $70.5 million or 3.9% to $1.86 billion as of December 31, 2023 compared to $1.79 billion as of December 31, 2022. The Company continues to maintain its disciplined underwriting standards while prudently pursuing loan growth opportunities that provide acceptable risk-adjusted returns.
The following table presents the Company’s composition of loans held for investment, net of deferred fees and costs, in dollar amounts and as a percentage of total gross loans as of December 31, 2023 and December 31, 2022.
(Dollars in thousands) Amount Percent Amount Percent
Real Estate Loans:
Commercial - Non Real Estate:
Consumer - Non-Real Estate:
Allowance for loan credit losses (19,543) (20,208)
Net deferred loan costs 4,983 4,060
The following table summarizes the contractual maturities of the loans as of December 31, 2023 by loan type. Maturities are based on the final contractual payment date, and do not reflect the effect of scheduled principal repayments, prepayments, or early redemptions that may occur. The table also summarizes the fixed and floating rate composition of loans held for investment for contractual maturities greater than one year.
After 1 After 5
Year years Maturing
Within 1 Within 5 Within 15 After 15
(Dollars in thousands) Year Years Years Years Total
Real Estate Loans:
Commercial - Non-Real Estate:
Consumer - Non-Real Estate:
For Maturities Over One Year:
Asset Quality
The Company maintains policies and procedures to promote sound underwriting and mitigate credit risk. The Chief Credit Officer is responsible for establishing credit risk policies and procedures, including underwriting and hold guidelines and credit approval authority, and monitoring credit exposure and performance of the Company’s lending-related transactions.
56
Table of Contents
The Company’s asset quality remained strong during the year ended December 31, 2023. The Company did not have any nonperforming assets, which includes nonperforming loans and OREO, as of December 31, 2023 or December 31, 2022. As a result, the Company did not have any nonperforming loans, which consists of loans that are 90 days or more past due or loans placed on nonaccrual as of December 31, 2023 or December 31, 2022.
The Company did not have any nonaccrual loans as of December 31, 2023 or December 31, 2022 nor were there any loans placed on nonaccrual during those periods. A loan is placed on nonaccrual status when (i) the Company is advised by the borrower that scheduled principal or interest payments cannot be met, (ii) when management’s best judgment indicates that payment in full of principal and interest can no longer be expected, or (iii) when any such loan or obligation becomes delinquent for 90 days, unless it is both well-secured and in the process of collection. As a result, the Company did not have any interest income that would have been recognized on nonaccrual loans for the years ended December 31, 2023 or December 31, 2022.
The Company did not make any loan modifications to borrowers experiencing financial difficulty during the year ended December 31, 2023. The Company had a recorded investment in troubled debt restructurings (“TDRs”) of $418 thousand as of December 31, 2022, all of which were in compliance with their modified terms at December 31, 2022. The Company adopted ASU 2022-02 on January 1, 2023, which eliminated the accounting guidance for TDRs.
The following table summarizes the Company’s asset quality as of December 31, 2023 and December 31, 2022.
Nonaccrual loans $ — $ —
Loans past due 90 days and accruing interest — —
Other real estate owned and repossessed assets — —
Total nonperforming assets $ — $ —
Allowance for loan credit losses to nonperforming assets NM NM
Nonaccrual loans to gross loans 0.00 % 0.00 %
Nonperforming assets to period end loans and OREO 0.00 % 0.00 %
NM – Not meaningful
Allowance for Loan Credit Losses
Refer to the discussion in the “Critical Accounting Policies and Estimates” section above for management’s approach to estimating the allowance for loan credit losses.
The Company recorded net recoveries of $2 thousand during the year ended December 31, 2023 compared to net recoveries of $1 thousand during the year ended December 31, 2022. At December 31, 2023, the allowance for loan credit losses was $19.5 million, or 1.05% of outstanding loans, net of unearned income, compared to $20.2 million, or 1.13% of outstanding loans, net of unearned income, at December 31, 2022. The decrease in the allowance as a percentage of outstanding loans, net of unearned income, was primarily a result of improved economic forecasts used in the quantitative portion of the model and an assessment of management’s considerations of existing economic versus historical conditions combined with the continued strong credit performance of our loan portfolio segments.
The following table summarizes the Company’s loan credit loss experience by loan portfolio for the years ended December 31, 2023 and December 31, 2022.
57
Table of Contents
Net Net Net Net
(charge-offs) (charge-off) (charge-offs) (charge-off)
(Dollars in thousands) recoveries recovery rate (1) recoveries recovery rate (1)
Real estate loans:
Commercial $ — — $ (1) (0.00) %
Construction and land development — — — —
Residential — — — —
Consumer loans — — — —
Total $ 2 $ 1
Average loans outstanding during the period $ 1,792,505 $ 1,677,151
Allowance coverage ratio (2) 1.05 % 1.13 %
Total net (charge-off) recovery rate 0.00 % (0.00) %
Allowance to nonaccrual loans ratio(3) NM NM
NM – Not meaningful
The following table summarizes the allowance for loan credit losses by portfolio with a comparison of the percentage composition in relation to total allowance for loan credit losses and total loans as of December 31, 2023 and December 31, 2022.
Allowance Percent of Allowance Percent of Loans in
for Loan Credit in Each Category to Each Category to Total
(Dollars in thousands) Losses Total Allocated Allowance Loans
Real Estate Loans:
Construction and land development 1,787 9.14 % 9.75 %
Commercial - Non-Real Estate:
Consumer - Non-Real Estate:
58
Table of Contents
Allowance Percent of Allowance Percent of Loans in
for Loan in Each Category to Each Category to Total
(Dollars in thousands) Losses Total Allocated Allowance Loans
Real Estate Loans:
Commercial - Non-Real Estate:
Consumer - Non-Real Estate:
Unallocated 638 — —
Management believes that the allowance for loan credit losses is adequate to absorb lifetime credit losses inherent in the portfolio as of December 31, 2023. There can be no assurance, however, that adjustments to the provision for (recovery of) credit losses will not be required in the future. Changes in the economic assumptions underlying management’s estimates and judgments; adverse developments in the economy, on a national basis or in the Company’s market area; or changes in the circumstances of particular borrowers are criteria that could change and make adjustments to the provision for (recovery of) credit losses necessary.
Deposits
Total deposits decreased $161.1 million or 7.8% to $1.91 billion as of December 31, 2023 compared to $2.07 billion as of December 31, 2022.
Non-interest bearing demand deposits decreased $65.3 million or 13.7% to $411.4 million as of December 31, 2023 compared to $476.7 million at December 31, 2022. Non-interest bearing demand deposits represented 21.6% and 23.1% of total deposits at December 31, 2023 and December 31, 2022, respectively.
Interest-bearing deposits, which include NOW accounts, regular savings accounts, money market accounts, and time deposits, decreased $95.8 million or 6.0% to $1.50 billion as of December 31, 2023 compared to $1.59 billion as of December 31, 2022. Interest-bearing deposits represented 78.4% and 76.9% of total deposits at December 31, 2023 and December 31, 2022, respectively.
The Company focuses on funding asset growth with deposit accounts, with an emphasis on core deposit growth, as its primary source of deposits. Core deposits consist of checking accounts, NOW accounts, money market accounts, regular savings accounts, time deposits, reciprocal IntraFi Demand® deposits, IntraFi Money Market® deposits and IntraFi CD® deposits. Core deposits totaled $1.58 billion or 82.7% of total deposits and $1.69 billion or 81.9% of total deposits at December 31, 2023 and December 31, 2022, respectively.
59
Table of Contents
The following table sets forth the average balances of deposits and the average interest rates paid for the years ended December 31, 2023 and 2022.
Average Average
(Dollars in thousands) Amount Rate Amount Rate
Interest bearing:
The following table sets forth the maturity ranges of certificates of deposit with balances of $250,000 or more as of December 31, 2023.
(Dollars in thousands) Total Uninsured
The total amount of our uninsured deposits (deposits in excess of $250,000, as calculated in accordance with FDIC regulations) was estimated at $802.8 million at December 31, 2023 and $963.9 million at December 31, 2022. Included in these amounts were $168.7 million and $162.2 million of public fund deposits that are collateralized by securities as of December 31, 2023 and December 31, 2022, respectively. Deposits that were not insured or not collateralized by securities represented 33% and 39% of total deposits, respectively, as of December 31, 2023 and December 31, 2022.
Capital Resources
The Company is a bank holding company with less than $3 billion in assets and does not (i) have significant off balance sheet exposure, (ii) engage in significant non-banking activities, or (iii) have a material amount of securities registered under the Exchange Act. As a result, the Company qualifies as a small bank holding company under the Federal Reserve’s Small Bank Holding Company Policy Statement and is currently not subject to consolidated regulatory requirements.
The Bank is subject to capital adequacy standards adopted by the Federal Reserve, including the capital rules that implemented the Basel III regulatory capital reforms developed by the Basel Committee on Banking Supervision.
Note 16 to the Consolidated Financial Statements, included in Item 8 of this Form 10-K, contains additional discussion and analysis regarding the Company and Bank’s regulatory capital requirements.
Shareholders’ equity increased $17.1 million or 8.0% to $229.9 million at December 31, 2023 compared to $212.8 million at December 31, 2022. The increase in shareholders’ equity was primarily attributable to a decrease in accumulated other comprehensive loss as a result of the realization of losses on the sale of certain low-yielding investment securities as part of the Restructuring and improvements in market values, net income recorded for the year, and increase in additional paid-in capital as a result of option exercises during the year ended December 31, 2023. These increases were partially offset by a decrease to retained earnings as a result of the Company’s adoption of ASC 326 on January 1, 2023 and dividends declared.
In August of 2023, the Company’s Board of Directors authorized the extension of the Company’s stock repurchase program that was originally adopted in August of 2021. Under the stock repurchase program, the Company may repurchase
60
Table of Contents
up to 700,000 shares of its outstanding common stock, or 5.0% of outstanding shares as of December 31, 2023. The stock repurchase program will expire on August 31, 2024 or earlier if all the authorized shares have been repurchased. The Company had not repurchased any of its outstanding common stock under the program as of December 31, 2023.
Liquidity
Liquidity reflects a financial institution’s ability to fund assets and meet current and future financial obligations. Liquidity is essential in all banks to meet customer withdrawals, compensate for balance sheet fluctuations, and provide funds for growth. Monitoring and managing both liquidity measurements is critical in developing prudent and effective balance sheet management. Management conducts liquidity stress testing on a quarterly basis to prepare for unexpected adverse scenarios and contemporaneously develops mitigating strategies to reduce losses in the event of an economic downturn.
The Company’s principal source of liquidity and funding is its deposit base. The level of deposits necessary to support the Company’s lending and investment activities is determined through monitoring loan demand.
In addition to the liquidity provided by balance sheet cash flows, the Company supplements its liquidity with additional sources such as secured borrowing credit lines with the FHLB and the Reserve Bank. Specifically, the Company has pledged a portion of its commercial real estate and residential real estate loan portfolios to the FHLB and the Reserve Bank. Based on collateral pledged as of December 31, 2023, the total FHLB available borrowing capacity was $436.9 million. Additional borrowing capacity with the Reserve Bank was approximately $22.8 million as of December 31, 2023.
On March 12, 2023, the Reserve Bank made available the BTFP, which enhances the ability of banks to borrow against the par value of certain high-quality, unencumbered investments. On May 15, 2023, the Company obtained a $54.0 million BTFP advance to secure lower funding costs relative to wholesale deposits. The BTFP advance has a term of one year, bears interest at a fixed rate of 4.80% and can be prepaid at any time without penalty.
Total liquidity, defined as cash and cash equivalents, unencumbered securities at fair value, and available secured borrowing capacity, was $638.9 million at December 31, 2023 compared to $763.5 million at December 31, 2022. The Company’s liquidity position represented 101% of uninsured, non-collateralized deposits at December 31, 2023.
In addition to available secured borrowing capacity, the Company had available federal funds lines with correspondent banks of $100.0 million at December 31, 2023.
Liquidity is a core pillar of the Company’s operations. Conditions may arise in the future that could negatively impact the Company’s future liquidity position resulting in funding mismatches. These include market constraints on the ability to convert assets into cash or accessing sources of funds (i.e., market liquidity) and contingent liquidity events. Changes in economic conditions or exposure to credit, market, operational, legal, and reputation risks also can affect a bank’s liquidity. Management maintains that the Company has a strong liquidity position, but any of the factors referenced above could materially impact that in the future.
The Company has various contractual obligations that affect its cash flows and liquidity. For information regarding material contractual obligations, please see Note 7, Note 8 and Note 11 to the Consolidated Financial Statements, included in Item 8 of this Form 10-K.
Off-Balance Sheet Arrangements
The Company enters into certain off-balance sheet arrangements in the normal course of business to meet the financing needs of its customers. These off-balance sheet arrangements include commitments to extend credit, standby letters of credit and financial guarantees which would impact the Company’s liquidity and capital resources to the extent customers accept and or use these commitments. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. With the exception of these off-balance sheet arrangements, the Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources, that is material to investors. For further information, see Note 11 to the Consolidated Financial Statements, included in Item 8 of this Form 10-K, for further discussion of the nature, business purpose and elements of risk involved with these off-balance sheet arrangements.
61
Table of Contents
Item 7A.Quantitative and Qualitative Disclosures About Market Risk
Not required for small reporting companies.
Item 8.Financial Statements and Supplementary Data
John Marshall Bancorp, Inc. Audited Consolidated Financial Statements:
Page
Report of Independent Registered Public Accounting Firm 63
Consolidated Balance Sheets as of December 31, 2023 and December 31, 2022 64
Notes to the Consolidated Financial Statements 69
62
Table of Contents
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors
John Marshall Bancorp, Inc.
Reston, Virginia
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of John Marshall Bancorp, Inc. and its subsidiary (the Company) as of December 31, 2023 and 2022, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for the years then ended, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2023 and 2022, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Adoption of New Accounting Standard
As discussed in Notes 1 and 4 to the financial statements, the Company changed its method of accounting for credit losses in 2023 due to the adoption of Accounting Standards Update 2016-13, Financial Instruments – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Yount, Hyde & Barbour, P.C.
We have served as the Company's auditor since 2008.
Richmond, Virginia
March 20, 2024
63
Table of Contents
John Marshall Bancorp, Inc. and Subsidiary
Consolidated Balance Sheets
December 31, 2023 and 2022
(In thousands, except share data)
Assets
Cash and due from banks $ 7,424 $ 6,583
Interest-bearing deposits in other banks 91,581 55,016
Securities available-for-sale, at fair value 169,993 357,576
Less: Allowance for investment credit losses — —
Securities held-to-maturity, net 95,505 99,415
Restricted securities, at cost 5,012 4,425
Equity securities, at fair value 2,792 2,115
Less: Allowance for loan credit losses (19,543) (20,208)
Bank premises and equipment, net 1,281 1,219
Accrued interest receivable 6,110 5,531
Bank owned life insurance - 21,170
Liabilities and Shareholders’ Equity
Liabilities
Deposits:
Federal Reserve Bank borrowings 54,000 —
Commitments and contingencies
Shareholders’ Equity
Accumulated other comprehensive loss (12,251) (28,697)
See Notes to Consolidated Financial Statements.
64
Table of Contents
John Marshall Bancorp, Inc. and Subsidiary
Consolidated Statements of Income
Years Ended December 31, 2023 and 2022
(In thousands, except per share data)
Interest and Dividend Income
Interest on investment securities, taxable 7,206 7,934
Interest on investment securities, tax-exempt 53 120
Interest on deposits in banks 6,776 1,482
Total interest and dividend income $ 100,770 $ 84,066
Interest Expense
Federal funds purchased 15 15
Federal Home Loan Bank advances 67 42
Federal Reserve Bank borrowings 1,640 —
Provision for (recovery of) credit losses (3,252) 175
Non-interest Income
Service charges on deposit accounts $ 330 $ 324
Bank owned life insurance 224 544
Other service charges and fees 838 656
Losses on sale of available-for-sale securities (17,316) —
Insurance commissions 386 382
Gain on sale of government guaranteed loans 131 —
Total non-interest income (loss) $ (14,940) $ 1,691
Non-interest Expenses
Salaries and employee benefits $ 19,436 $ 20,190
Occupancy expense of premises 1,811 1,893
Furniture and equipment expenses 1,178 1,325
Other operating expenses 8,390 8,466
Total non-interest expenses $ 30,815 $ 31,874
Income before income taxes $ 7,981 $ 40,063
Earnings per share, basic $ 0.37 $ 2.27
Earnings per share, diluted $ 0.36 $ 2.25
See Notes to Consolidated Financial Statements.
65
Table of Contents
John Marshall Bancorp, Inc. and Subsidiary
Consolidated Statements of Comprehensive Income
Years Ended December 31, 2023 and 2022
(In thousands)
Other comprehensive income:
Total other comprehensive income (loss) $ 16,446 $ (28,297)
Total comprehensive income $ 21,604 $ 3,506
See Notes to Consolidated Financial Statements.
66
Table of Contents
John Marshall Bancorp, Inc. and Subsidiary
Consolidated Statements of Changes in Shareholders’ Equity
Years Ended December 31, 2023 and December 31, 2022
(In thousands, except share data)
Accumulated
Other Total
Additional Paid- In Retained Comprehensive Shareholders’
Shares Common Stock Capital Earnings (Loss) Equity
Other comprehensive loss — — — — (28,297) (28,297)
Share-based compensation — — 573 — — 573
Other comprehensive income — — — — 16,446 16,446
Exercise of stock options 27,375 — 320 — — 320
Share-based compensation — — 596 — — 596
See Notes to Consolidated Financial Statements.
67
Table of Contents
John Marshall Bancorp, Inc. and Subsidiary
Consolidated Statements of Cash Flows
Years Ended December 31, 2023 and 2022
(In thousands)
Year ended
December 31,
Cash Flows from Operating Activities
Right of use asset amortization 1,231 1,360
Provision for (recovery of) credit losses (3,252) 175
Share-based compensation expense 596 573
Net accretion of securities (270) (25)
Fair value adjustment on equity securities (317) 354
Amortization of debt issuance costs 84 317
Net gains on premises and equipment (16) —
Losses on available-for-sale securities 17,316 —
Deferred tax expense 921 594
Net increase in cash surrender value of life insurance (224) (544)
Gain on sale of government guaranteed loans (131) —
Changes in assets and liabilities:
Increase in accrued interest receivable (579) (588)
Increase in other assets (1,659) (1,376)
Increase in accrued interest payable 3,524 192
Decrease in other liabilities (4,862) (237)
Net cash provided by operating activities $ 18,004 $ 33,155
Cash Flows from Investing Activities
Purchase of available-for-sale securities — (206,890)
Purchase of held-to-maturity securities — (1,003)
Proceeds from sale of available-for-sale securities 156,011 —
Net (purchases) redemptions of restricted securities (587) 526
Net purchases of equity securities (360) (600)
Proceeds from bank owned life insurance contracts 21,394 371
Proceeds from sale of premises and equipment 82 —
Purchases of bank premises and equipment (612) (156)
Net cash provided by (used in) investing activities $ 144,836 $ (270,872)
Cash Flows from Financing Activities
Net (decrease) increase in deposits $ (161,140) $ 186,187
Net repayment of Federal Home Loan Bank advances — (18,000)
Proceeds from Federal Reserve Bank borrowings 54,000 —
Issuance of subordinated debt — 24,579
Repayment of subordinated debt — (25,000)
Cash dividends paid (3,108) (2,799)
Net proceeds (repayment) of federal funds purchased (15,500) 25,500
Issuance of common stock for share options exercised 320 3,058
Net cash (used in) provided by financing activities $ (125,434) $ 193,517
Net increase in cash and cash equivalents $ 37,406 $ (44,200)
Cash and cash equivalents, beginning of period 61,599 105,799
Cash and cash equivalents, end of period $ 99,005 $ 61,599
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Supplemental Disclosures of Noncash Transactions
Unrealized gain (loss) on securities available-for-sale $ 20,939 $ (35,637)
See Notes to Consolidated Financial Statements.
68
Table of Contents
Note 1— Nature of Business and Summary of Significant Accounting Policy
Nature of Banking Activities
John Marshall Bancorp, Inc. (the “Company”), headquartered in Reston, Virginia, became the registered bank holding company under the Bank Holding Company Act of 1956 for its wholly-owned subsidiary, John Marshall Bank (the “Bank”), on March 1, 2017. This reorganization was completed through a one-for-one share exchange in which the Bank’s shareholders received one share of voting common stock of the Company in exchange for each share of the Bank’s voting common stock.
The Company was formed on April 21, 2016 under the laws of the Commonwealth Virginia. The Bank formed on April 5, 2005 under the laws of the Commonwealth of Virginia and was chartered as a bank on February 9, 2006, by the Virginia Bureau of Financial Institutions. The Bank is a member of the Federal Reserve System and is subject to the rules and regulations of the Virginia Bureau of Financial Institutions, the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and the Federal Deposit Insurance Corporation (“FDIC”). The Bank opened for business on April 17, 2006 and provides banking services to its customers primarily in the Washington, D.C. metropolitan area.
The accounting and reporting policies of John Marshall Bancorp, Inc. conform to generally accepted accounting principles in the United States of America and reflect practices of the banking industry. The significant accounting policies are summarized below.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. All significant intercompany accounts and transactions between the Company and the Bank have been eliminated.
Restriction on Dividends
The Bank is subject to certain restrictions on the amount of dividends that it may pay to the Company without prior regulatory approval. At December 31, 2023, the Bank had $58.1 million available to distribute in the form of dividends to the Company.
Significant Accounting Policies
Use of Estimates
In preparing financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”), management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan credit losses.
Reclassifications
Certain items in the prior year financial statements were reclassified to conform to the current presentation. Reclassifications had no effect on prior year net income or shareholders’ equity.
Concentration of Credit Risk
Most of the Company’s activities are with customers located in the Washington, D.C. metropolitan area. Real estate loans, including commercial, construction and land development, and residential loans, represented 98% of the total loan portfolio at December 31, 2023 and 97% of the total loan portfolio at December 31, 2022. The Company does not have any significant concentrations to any one industry or customer.
69
Table of Contents
Cash and Cash Equivalents
For the purposes of the statements of cash flows, cash and cash equivalents include cash and balances due from banks and interest-bearing deposits in banks (items with an original maturity of three months or less).
Securities
Certain debt securities that management has the positive intent and ability to hold-to-maturity are classified as “held-to-maturity” and recorded at amortized cost. Debt securities not classified as held-to-maturity or trading, are classified as “available-for-sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported net of deferred tax in accumulated other comprehensive income (loss) within shareholders’ equity. Purchase premiums and discounts on debt securities are recognized in interest income using the interest method over the terms of the securities.
Transfers of debt securities into the held-to-maturity classification from the available-for-sale classification are made at fair value on the date of transfer. The unrealized holding gain or loss on the date of the transfer is reported in accumulated other comprehensive income (loss) and in the carrying value of the held-to-maturity securities. Such amounts are amortized over the remaining contractual lives of the securities.
Equity securities with readily determinable fair values are carried at fair value, with changes in fair value reported in net income. Any equity securities without readily determinable fair values are carried at cost, minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments. Restricted equity securities are carried at cost and are periodically evaluated for impairment based on the ultimate recovery of par value. The entirety of any impairment on the equity securities is recognized in earnings.
Gains and losses on sales of securities are recorded on the trade date and determined using the specific identification method.
Allowance for Credit Losses - Held-to-Maturity Securities
The Company estimates expected credit losses on held-to-maturity securities on an individual basis based on a Probability of Default/Loss Given Default (“PD/LGD”) methodology primarily using security-level credit ratings. The primary indicators of credit quality for the Company’s held-to-maturity portfolio are security type and credit rating, which are influenced by a number of factors including obligor cash flow, geography, seniority, among other factors. The Company’s held-to-maturity securities with credit risk are municipal bonds, which had a credit rating of AA or better as of December 31, 2023. All other held-to-maturity securities are covered by the explicit or implied guarantee of the United States government or one of its agencies.
Changes in the allowance for credit loss are recorded as provision for (or recovery of) credit losses in the Consolidated Statements of Income.
Allowance for Credit Losses - Available-for-Sale Securities
Management evaluates all available-for-sale securities in an unrealized loss position on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. If the Company has the intent to sell the security or it is more likely than not that the Company will be required to sell the security, the security is written down to fair value and the entire loss is recorded in earnings.
If either of the above criteria is not met, the Company evaluates whether the decline in fair value is the result of credit losses or other factors. In making the assessment, the Company may consider various factors including the extent to which fair value is less than amortized cost, downgrades in the ratings of the security by a rating agency, the failure of the issuer to make scheduled interest or principal payments and adverse conditions specific to the security. If the assessment indicates that a credit loss exists, the present value of cash flows expected to be collected are compared to the amortized cost basis of the security and any deficiency is recorded as an allowance for credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any amount of unrealized loss that has not been recorded through an allowance for credit loss is recognized in other comprehensive income (loss).
70
Table of Contents
Changes in the allowance for credit loss are recorded as a provision for (or recovery of) credit losses in the Consolidated Statements of Income. Losses are charged against the allowance for credit loss when management believes an available-for-sale security is confirmed to be uncollectible or when either of the criteria regarding intent or requirement to sell is met.
Accrued interest receivable on available-for-sale securities totaled $518 thousand at December 31, 2023 and was excluded from the estimate of credit losses.
Loans
The Company grants real estate, commercial and consumer loans to customers (representing the Company’s loan segments). A substantial portion of the loan portfolio is represented by commercial real estate loans in the Washington, D.C. metropolitan area. Within the real estate segment, the Company has also identified the residential, commercial and construction classes. The ability of the Company’s debtors to honor their real estate loan contracts is dependent upon the real estate market and general economic conditions in this area, among other factors.
Underwriting and risk characteristics of each loan class are summarized as follows:
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for the allowance for loan credit losses and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.
The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days past due unless the credit is well secured and in the process of collection. Other personal loans are typically charged off no later than 180 days past due. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful. The determination of days past due or delinquency status uses the first contractual payment date that has not been paid-in-full by the borrower.
All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
71
Table of Contents
Allowance for Credit Losses - Loans
The allowance for loan credit losses represents an amount which, in management's judgment, is adequate to absorb the lifetime expected losses that may be sustained on outstanding loans at the balance sheet date based on the evaluation of the size and current risk characteristics of the loan portfolio, past events, current conditions, reasonable and supportable forecasts of future economic conditions, and prepayment experience. The allowance for loan credit losses is measured and recorded upon the initial recognition of a financial asset. The allowance for loan credit losses is reduced by charge-offs, net of recoveries of previous losses, and is increased or decreased by a provision for (or recovery of) credit losses, which is recorded in the Consolidated Statements of Income.
The Company is utilizing a discounted cash flow model to estimate its current expected credit losses. For the purposes of calculating its quantitative reserves, the Company has segmented its loan portfolio based on loans which share similar risk characteristics. Within the quantitative portion of the calculation, the Company utilizes at least one or a combination of loss drivers, which may include unemployment rates, home price indices, and/or gross domestic product, to adjust its loss rates over a reasonable and supportable forecast period of one year. A straight-line reversion technique is used for the following four quarters, at which time the Company reverts to historical averages. To further adjust the allowance for credit losses for expected losses not already included within the quantitative component of the calculation, the Company may consider qualitative factors, including but not limited to: variability in the economic forecast, changes in volume and severity of adversely classified loans, changes in concentrations of credit, changes in the nature and volume of the loan segments, factors related to credit administration, and other idiosyncratic risks not embedded in the data used in the model.
Loans that do not share risk characteristics are evaluated on an individual basis. The Company designates individually evaluated loans on nonaccrual status as collateral dependent loans, as well as other loans that management of the Company designates as having higher risk and loans for which the repayment is expected to be provided substantially through the operation or sale of the collateral. These loans do not share common risk characteristics and are not included within the collectively evaluated loans for determining the allowance for credit losses. The Company has adopted the practical expedient to measure the allowance for credit losses for collateral dependent loans based on the fair value of collateral. The allowance for credit losses is calculated on an individual loan basis based on the shortfall between the fair value of the loan's collateral, which is adjusted for liquidation costs/discounts, and amortized cost. If the fair value of the collateral exceeds the amortized cost, no allowance is required.
Allowance for Credit Losses – Unfunded Commitments
Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit issued to meet customer financing needs. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the contractual amount of those instruments. Such financial instruments are recorded when they are funded.
The Company records an allowance for credit losses on off-balance sheet credit exposures, unless the commitments to extend credit are unconditionally cancelable, through a charge to provision for (or recovery of) credit losses in the Consolidated Statements of Income. The allowance for credit losses on off-balance sheet credit exposures is estimated by loan segment at each balance sheet date using the same methodology as the loan portfolio, taking into consideration the likelihood that funding will occur as well as any third-party guarantees. The allowance for unfunded commitments is included in other liabilities on the Company’s consolidated balance sheets.
Accrued Interest Receivable
The Company has elected to exclude accrued interest from the amortized cost basis in its determination of the allowance for credit losses for both loans and held-to-maturity securities, as well as elected the policy to write-off accrued interest receivable directly through the reversal of interest income. Accrued interest receivable totaled $5.3 million on loans and $255 thousand on held-to-maturity securities at December 31, 2023, and is included in “Accrued Interest Receivable” on the Company’s Consolidated Balance Sheets.
72
Table of Contents
Bank Premises and Equipment
Bank premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation of property and equipment is computed on the straight-line method over the useful lives of the assets, ranging from three to fifteen years, or the expected term of leases, if shorter. Expected terms include lease option periods to the extent that the exercise of such options is reasonably certain. Maintenance and repairs of property and equipment are expensed as incurred, while major improvements are capitalized and amortized over their respective useful life.
Bank Owned Life Insurance
The Company has purchased life insurance on certain key executives and officers. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or amounts due that are probable at settlement. Changes in cash surrender value are reflected in non-interest income in the Consolidated Statements of Income. During the third quarter of 2023, the Company surrendered all outstanding Bank Owned Life Insurance policies.
Other Real Estate Owned
Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Operating costs after acquisition are expensed as incurred. The Company had no other real estate owned as of December 31, 2023 and 2022. At December 31, 2023 and 2022, there were no consumer mortgage loans secured by residential real estate for which formal foreclosure proceedings were in progress.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (a) the assets have been isolated from the Company – put presumptively beyond the reach of the transferor and its creditors, even in the event of bankruptcy or other receivership, (b) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (c) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.
Loan Servicing Rights
The Company holds rights to service the guaranteed portion of U.S. Small Business Administration loans sold in the secondary market. Loan servicing rights are capitalized at estimated fair value when acquired through the origination of loans that are subsequently sold with the servicing rights retained. Loan servicing rights are amortized to servicing income on loans sold approximately in proportion to and over the period of estimated net servicing income. The value of loan servicing rights at the date of the sale of loans is estimated based on the discounted present value of expected future cash flows using key assumptions for servicing income and costs and expected prepayment rates on the underlying loans. The estimated fair value is periodically evaluated for impairment by comparing actual cash flows and estimated future cash flows from the loan servicing assets to those estimated at the time that the loan servicing assets were originated. Fair values are estimated using expected future discounted cash flows based on current market rates of interest. For purposes of measuring impairment, the loan servicing rights must be stratified by one or more predominant risk characteristics of the underlying loans. The Company stratifies its capitalized loan servicing rights based on product type and term of the underlying loans. The amount of impairment recognized is the amount, if any, by which the amortized cost of the loan servicing rights exceeds their fair value. Impairment, if deemed temporary, is recognized through a valuation allowance to the extent that fair value is less than the recorded amount. The Company had $22 thousand in loan servicing rights recorded within Other Assets on the Consolidated Balance Sheets as of December 31, 2023. The Company did not have any loan servicing rights as of December 31, 2022.
73
Table of Contents
Income Taxes
Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences, operating loss carryforwards, and tax credit carryforwards. Deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. The Company recorded no liability for unrecognized tax benefits at December 31, 2023 or 2022.
Earnings Per Common Share
Earnings per common share is calculated in accordance with Accounting Standard Codification (“ASC”) 260 - Earnings Per Share, which provides that unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method.
Under the two-class method, basic earnings per common share is computed by dividing net earnings allocated to common stock by the weighted-average number of common shares outstanding during the applicable period, excluding outstanding participating securities. Diluted earnings per common share is computed using the weighted-average number of shares determined for the basic earnings per common share computation plus the dilutive effect of stock compensation using the treasury stock method. Earnings per share are restated for all stock splits and dividends through the date the financial statements are issued.
Advertising Costs
The Company follows the policy of charging the production costs of advertising to expense as incurred. Advertising expense was $288 thousand and $193 thousand for the years ended December 31, 2023 and 2022, respectively.