Item 1A. Risk Factors
This section highlights the material risks that the Company currently faces. Any of the risks described below could materially adversely affect our business, financial condition, and results of operations.
Risks Related to Our Business
Pandemic Risks
Pandemic risks, such as the one we are currently experiencing due to COVID-19, can have an impact on every risk outlined in the paragraphs below. We have learned that pandemic risks can, in-and-of-themselves, cause serious national and even global financial and economic distress. The results of that financial distress and the associated health concerns can and will impact businesses as ongoing concerns, the health and well-being of a population, and the financial capabilities of consumers, businesses and government entities. Pandemic risks can and will impact our business and financial results.
The COVID-19 pandemic has created, and may continue to create, significant disruption of the global economy and financial markets. Governments, businesses, and the public are taking actions to contain the spread of COVID-19 and to mitigate its effects, including quarantines, travel bans, “stay at home” orders, cancellation of events and travel, closures of businesses and schools, fiscal stimulus, and legislation intended to provide monetary aid and other relief. While the scope, duration, and full effect of COVID-19 continue to evolve and are not fully known, the pandemic and related efforts to contain it have disrupted global economic activity, adversely affected the functioning of financial markets, impacted interest rates, increased economic and market uncertainty, and disrupted trade and supply chains.
Credit and Lending Risks
Our business, like that of most banking organizations, is highly susceptible to credit risk.
As a lender, the Bank is exposed to the risk that customers will be unable to repay their loans according to terms of the loan agreements and that the collateral securing payment of the loans (if any) may not be sufficient to assure repayment. Credit losses could have a material adverse effect on our operating results and financial condition.
We have significant exposure to risks associated with commercial and residential real estate.
A substantial portion of our loan portfolio consists of commercial and residential real estate-related loans, including construction and residential and commercial mortgage loans. As of December 31, 2021, we had approximately $173.1 million of owner-occupied and $361.1million of investment commercial real estate loans outstanding, which represented approximately 12.7% and 26.6%, respectively, of our loan portfolio as of December 31, 2021. As of that same date, we had approximately $337.2 million of construction real estate loans and $300.4 million of residential real estate loans, which represent 24.8% and 22.1% respectively.
The adverse consequences from real estate-related credit risks tend to be cyclical and are often driven by local and national economic developments that are not controllable or entirely foreseeable by us or our borrowers. As a result:
Since we engage in lending secured by real estate and may be forced to foreclose on the collateral property and own the underlying real estate, we may be subject to the increased costs and risks associated with the ownership of real property, which could have an adverse effect on our business and results of operations.
A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans, in which event we become exposed to the risks inherent in the ownership of real estate. The amount that we, as a mortgagee, may realize after a default is dependent upon factors outside of our control, including:
• general or local economic conditions;
• environmental clean-up liabilities;
• neighbourhood values;
• interest rates;
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• real estate tax rates;
• operating expenses of the foreclosed properties;
• supply of and demand for rental units or properties;
• ability to obtain and maintain adequate occupancy of the properties;
• zoning laws;
• governmental rules, regulations and fiscal policies; and
• extreme weather conditions or other natural or man-made disasters.
Certain expenditures associated with the ownership of real estate, principally real estate taxes and maintenance costs, may also adversely affect our operatingexpenses.
Commercial and industrial loans may expose us to greater financial and credit risk than other loans.
Commercial and industrial loans generally carry larger loan balances and can involve a greater degree of financial and credit risk than other loans, including less collateral at liquidation. Any significant failure to pay on time by our customers would hurt our earnings. The increased financial and credit risks associated with these types of loans result from several factors, including the concentration of principal in a limited number of loans and borrowers, the size of loan balances, the effects of general economic conditions on income-producing properties and the increased difficulty of evaluating and monitoring these types of loans. In addition, when underwriting a commercial or industrial loan, we may take a security interest in commercial real estate, and, in some instances upon a default by the borrower, we may foreclose on and take title to the property, which may lead to additional risks for us under applicable environmental laws.
The small-to-midsized businesses that we lend to may have fewer resources to weather adverse business developments, which may impair a borrower’s ability to repay a loan, and such impairment could have a material adverse effect on our business, financial condition and results of operations.
We focus our business development and marketing strategy primarily on small-to-midsized businesses. These businesses frequently have smaller market shares than their competition, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete and may experience substantial volatility in operating results, any of which may impair a borrower’s ability to repay a loan. In addition, the success of a small-to-midsized business often depends on the management skills, talents and efforts of one or two people or a small group of people, and the death, disability or resignation of one or more of these people could have an adverse impact on the business and its ability to repay its loan. If general economic conditions negatively impact the markets in which we operate and small-to-midsized businesses are adversely affected or our borrowers are otherwise harmed by adverse business developments, this, in turn, could have a material adverse effect on our business, financial condition and results of operations.
The borrowing needs of our customers may increase, especially during a challenging economic environment, which could result in increased borrowing against our contractual obligations to extend credit.
A commitment to extend credit is a formal agreement to lend funds to a customer as long as there is no violation of any condition established under the agreement. The actual borrowing needs of our customers under these credit commitments have historically been lower than the contractual amount of the commitments. A significant portion of these commitments expire without being drawn upon. Because of the credit profile of our customers, we typically have a substantial amount of total unfunded credit commitments, which is not reflected on our balance sheet. As of December 31, 2021 we had $304.3 million in unfunded credit commitments to our customers. Actual borrowing needs of our customers may exceed our expectations, especially during a challenging economic environment when our customers’ companies may be more dependent on our credit commitments due to the lack of available credit elsewhere, the increasing costs of credit, or the limited availability of financings from venture firms. This could adversely affect our liquidity, which could impair our ability to fund operations and meet obligations as they become due and could have a material adverse effect on our business, financial condition and results of operations.
Our allowance for loan losses may not be adequate to cover actual future losses.
We maintain an allowance for loan losses to cover estimable and observable loan losses inherent in our portfolio. Every loan we make carries a certain risk of non-repayment, and we make various assumptions and judgments about the collectability of our loan portfolio including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of loans. Through a periodic review of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of customers relative to their financial obligations with us. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and these losses may exceed current estimates. We cannot fully predict the amount or timing of losses or whether the loss allowance will be adequate in the future. If our assumptions prove to be incorrect, our allowance for loan losses may not
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be sufficient to cover losses inherent in our loan portfolio, resulting in additions to the allowance. Excessive loan losses could have a material adverse impact on our financial condition and results of operations.
We may be required to increase our provisions for loan losses and to charge off loans in the future, which increases and charges could materially adversely affect us.
There is no precise method of predicting the timing of loan losses. We can give no assurance that our allowance for loan losses is or will be sufficient to absorb actual loan losses. We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, that represents management’s estimable and observable losses within the existing portfolio of loans. The level of the allowance reflects management’s evaluation of, among other factors, the status of specific impaired loans, trends in historical loss experience, delinquency trends, credit concentrations and economic conditions within our market area. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and judgment and requires us to make significant estimates of current credit risks and future trends, all of which may undergo subsequent material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require us to increase our allowance for loan losses. Increases in nonperforming loans have a significant impact on our allowance for loan losses.
In addition, bank regulatory agencies periodically review our allowance for loan losses and may require us to increase the provision for loan losses or to recognize further loan charge-offs, based on judgments that differ from those of management. If loan charge-offs in future periods exceed our allowance for loan losses, we will need to record additional provisions to increase our allowance for loan losses. Furthermore, growth in our loan portfolio would generally lead to an increase in the provision for loan losses. Generally, increases in our allowance for loan losses will result in a decrease in net income and shareholders’ equity, and may have a material adverse effect on our financial condition, results of operations and cash flows. Material additions to our allowance could also materially decrease our net income.
The implementation of the Current Expected Credit Loss accounting standard could require the Company to increase its allowance for credit losses.
In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which replaces the incurred loss model with an expected loss model, which is referred to as the current expected credit loss model, or “CECL.” This standard requires earlier recognition of expected credit losses on loans and certain other instruments, compared to the incurred loss model. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration.
The revised methodology required by ASU 2016-13, which will be effective for the Company in the fiscal year beginning after December 15, 2022, represents a significant change from existing GAAP and may result in material changes to the Company’s accounting for financial instruments. For most debt securities, the transition approach requires a cumulative-effect adjustment to the statement of financial position as of the beginning of the first reporting period the guidance is effective. For other-than-temporarily impaired debt securities, the guidance will be applied prospectively. The Company will record a one-time adjustment to its credit loss allowance, as of the beginning of the first quarter of 2023, equal to the difference between the amounts of its credit loss allowance under the incurred loss methodology and under CECL. The Company cannot yet determine the magnitude of any such one-time cumulative adjustment or of the overall impact of the new standard on its financial condition or results of operations. In anticipation of the implementation of CECL, the Company is working with a third party to compile data and develop an estimate using historical and qualitative data based on the requirements of ASU 2016-13.
A significant portion of our loan portfolio is unseasoned.
Since December 31, 2016, our loan portfolio has increased approximately 191.6%, from $464 million at December 31, 2016 to $1.4 billion at December 31, 2021. While we believe our underwriting standards are designed to manage normal lending risks, it is difficult to assess the future performance of our loan portfolio due to the recent origination of many of our loans. As a result, it is difficult to determine whether these loans will become non-performing or delinquent, or whether we will hold non-performing or delinquent loans that may adversely affect our future performance.
We extend credit to a variety of customers based on internally established standards and judgment. We manage credit risk through a program of underwriting standards, the review of certain credit decisions and an on-going process of assessment of the quality of the credit already extended. Our credit standards and ongoing process of credit assessment might not protect us from significant credit losses.
We take credit risk by virtue of making loans, extending loan commitments and letters of credit and, to a lesser degree, purchasing non-governmental securities. Our exposure to credit risk is managed through the use of consistent underwriting standards, and we avoid highly leveraged transactions as well as excessive industry and other concentrations. Our credit administration function employs risk management techniques to ensure that loans adhere to corporate policy and problem loans are promptly identified. While these procedures are designed to provide us with the information needed to implement policy adjustments where necessary, and to take proactive corrective actions, there can be no assurance that such measures will be effective in avoiding undue credit risk.
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We are subject to environmental liability risk associated with our lending activities.
In the course of our business, we may purchase real estate, or we may foreclose on and take title to real estate. Although we exercise prudent due diligence when making loans, we could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination or may be required to investigate or clean up hazardous or toxic substances or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. Any significant environmental liabilities could cause an adverse effect on our business, financial condition and results of operations.
Interest Rate Risks
Changes in interest rates may negatively affect our earnings, income and financial condition as well as the value of our assets.
Our earnings and cash flows depend substantially upon our net interest income. Net interest income is the difference between interest income earned on interest-earning assets, such as loans and investment securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are sensitive to many factors that are beyond our control, including general economic conditions, competition and policies of various governmental and regulatory agencies and, in particular, the policies of the Federal Reserve.
In an attempt to help the overall economy, the Federal Reserve has kept interest rates low through its targeted Fed Funds rate. During 2020, the Federal Reserve decreased the targeted Fed Funds rate to 0 - 25 basis points. The Federal Reserve has indicated that further changes would be subject to economic conditions. As the Federal Reserve increases and decreases the targeted Fed Funds rate, overall interest rates will likely be impacted.
Changes in monetary policy, including changes in interest rates, not only could influence the interest we receive on loans and investment securities and theamountofinterestwepayondepositsandborrowings,butsuchchangescouldalsoaffect:(1)ourabilitytooriginateloansand obtain deposits; (2) the fair value of our financial assets and liabilities, including our securities portfolio; and (3) the average duration of our interest-earning assets. Interest-earning assets may be more responsive to changes in interest rates than interest-bearing liabilities, or vice versa (repricing risk), individual interest rates or rate indices underlying various interest-earning assets and interest-bearing liabilities may not change in the same degree over a given time period (basis risk), and interest rate relationships may change across the spectrum of interest-earning asset and interest-bearing liability maturities (yield curve risk), including a prolonged flat or inverted yield curve environment. Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition and results ofoperations.
Our business may be adversely affected by the transition from the London InterBank Offered Rate (LIBOR) as a reference rate..
The London Interbank Offered Rate (LIBOR) is used extensively in the United States and globally as a reference rate for various commercial and financial contracts, including adjustable rate mortgages, corporate debt, interest rate swaps and other derivatives. LIBOR is set based on interest rate information reported by certain banks, which may stop reporting such information after 2021. In 2017, the United Kingdom’s Financial Conduct Authority (FCA) announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. On November 30, 2020, to facilitate an orderly LIBOR transition, the United States financial institution regulatory agencies jointly announced that entering into new contracts using LIBOR as a reference rate after December 31, 2021, would create a safety and soundness risk. On March 5, 2021, the FCA announced that all LIBOR settings will either cease to be provided by any administrator or no longer be representative immediately after December 31, 2021, in the case of 1-week and 2-month LIBOR, and immediately after June 30, 2023, in the case of the remaining LIBOR settings.
In the United States, while there is no consensus on what rate or rates will become the accepted alternatives to LIBOR, a group of market participants convened by the Federal Reserve, the Alternative Reference Rate Committee (ARRC), has selected the Secured Overnight Financing Rate (SOFR) as its recommended alternative to LIBOR. SOFR is different from LIBOR in that it is a backward-looking secured rate rather than a forward-looking unsecured rate. These differences could lead to a greater disconnect between our costs to raise funds for SOFR as compared to LIBOR. For cash products and loans, ARRC has also recommended Term SOFR, which is a forward-looking rate based on SOFR futures and may in part reduce differences between SOFR and LIBOR. There are operational issues that may create a delay in the transition to SOFR or other substitute indices, leading to uncertainty across the industry.
Until replacement rates are established and all agreements have been addressed, we will continue to have a number of loans, derivative contracts, and other financial instruments with attributes that are directly or indirectly dependent on LIBOR.
Liquidity Risk
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Liquidity risk could impair our ability to fund operations and jeopardize our financial condition.
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities, or on terms that are acceptable to us, could be impaired by factors that affect us specifically or the financial services industry or the economy in general. Factors that could detrimentally affect our access to liquidity sources include, among other things, a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated and an adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry.
Among other sources of funds, we rely heavily on deposits for funds to make loans and provide for our other liquidity needs. However, our loan demand has historically exceeded the rate at which we have been able to build core deposits for which there is substantial competition from a variety of different competitors, so we have relied on interest-sensitive deposits, including wholesale deposits, as sources of funds. Those deposits may not be as stable as other types of deposits and, in the future, depositors may not renew those deposits when they mature, or we may have to pay a higher rate of interest to attract or retain them or to replace them with other deposits or with funds from other sources. Not being able to attract deposits, or to retain or replace them as they mature, would adversely affect our liquidity. Paying higher deposit rates to attract, retain or replace those deposits could have a negative effect on our interest margin and operating results.
Operational Risks
New lines of business, products, product enhancements or services may subject us to additional risks.
From time to time, we implement new lines of business, or offer new products and product enhancements as well as new services within our existing lines of business and we will continue to do so in the future. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In implementing, developing or marketing new lines of business, products, product enhancements or services, we may invest significant time and resources, although we may not assign the appropriate level of resources or expertise necessary to make these new lines of business, products, product enhancements or services successful or to realize their expected benefits. Further, initial timetables for the introduction and development of new lines of business, products, product enhancements or services may not be achieved, and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives and shifting market preferences, may also impact the ultimate implementation of a new line of business or offerings of new products, product enhancements or services. Furthermore, any new line of business, product, product enhancement or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or offerings of new products, product enhancements or services could have an adverse impact on our business, financial condition or results of operations.
In 2016, we added a new funding source by way of facilitating payment services. We are continuing to identify and solicit new customers in need of these specialized services. The primary reasons for expanding into payment services are to secure an additional source of low-cost deposits and to capture additional fee income. A bank’s risks when dealing with a processor account are similar to risks from other activities in which customers conduct transactions through the bank on behalf of the customers’ clients. It is necessary for a bank to implement an adequate processor approval, monitoring and auditing program that extends beyond credit risk management and is conducted on an ongoing basis. When a bank is not able to identify and understand the nature and source of transactions processed through accounts, the bank’s risks and the likelihood of suspicious activity can increase. Without these precautions, a bank could be vulnerable to processing illicit or sanctioned transactions.
We face risks related to our operational, technological and organizational infrastructure.
Our ability to grow and compete is dependent on the Bank’s ability to build or acquire the necessary operational and technological infrastructure and to manage the cost of that infrastructure as we expand. In our case, operational risk can manifest itself in many ways, such as errors related to failed or inadequate processes, faulty or disabled computer systems, fraud by employees or outside persons and exposure to external events. As discussed below, we are dependent on our operational infrastructure to help manage these risks. In addition, we are heavily dependent on the strength and capability of our technology systems that the Bank uses both to interface with customers and to manage internal financial and other systems. Our ability to develop and deliver new products that meet the needs of our existing customers and attract new ones depends on the functionality of our technology systems. Additionally, our ability to run our business in compliance with applicable laws and regulations is dependent on these infrastructures.
We continuously monitor our operational and technological capabilities and make modifications and improvements as circumstances warrant. In some instances, the Bank may build and maintain these capabilities itself. We outsource many of these functions to third parties. These third parties may experience errors or disruptions that could adversely impact the Bank and over which it may have limited control. We also face risk from the integration of new infrastructure platforms and/or new third-party providers of such platforms into the Bank’s existing businesses.
Many of our larger competitors have substantially greater resources to invest in technological improvements. As a result, they may be able to offer additional or superior technologies compared to those that we will be able to provide, which could put us at a competitive
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disadvantage. Accordingly, we may lose customers seeking new technology-driven products and services to the extent we are unable to compete effectively.
A failure in our operational systems or infrastructure, or those of third parties, could impair our liquidity, disrupt our business, result in the unauthorized disclosure of confidential information, damage our reputation and cause financial losses.
Our business is dependent on our ability to process and monitor, on a daily basis, a number of transactions. These transactions, as well as the information technology services we provide to clients, often must adhere to client-specific guidelines, as well as legal and regulatory standards. Developing and maintaining our operational systems and infrastructure is challenging, particularly as a result of rapidly evolving legal and regulatory requirements and technological shifts. Our financial, accounting, data processing or other operating systems and facilities may fail to operate properly or become disabled as a result of events that are wholly or partially beyond the Bank’s control, such as a spike in transaction volume, cyber-attack or other unforeseen catastrophic events, which may adversely affect our ability to process these transactions or provide services.
In addition, our operations rely on the secure processing, storage and transmission of confidential and other information on our computer systems and networks. Although we take protective measures to maintain the confidentiality, integrity and availability of our and our clients’ information across all geographic and product lines, and endeavor to modify these protective measures as circumstances warrant, the nature of the threats continues to evolve. As a result, our computer systems, software and networks may be vulnerable to unauthorized access, loss or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses or other malicious code, cyber-attacks and other events that could have an adverse security impact. Despite the defensive measures we take to manage our internal technological and operational infrastructure, these threats may originate externally from third parties such as foreign governments, organized crime and other hackers, and outsource or infrastructure-support providers and application developers, or may originate internally from within our organization. Given the increasingly high volume of our transactions, certain errors may be repeated or compounded before they can be discovered and rectified.
We also face the risk of operational disruption, failure, termination or capacity constraints of any of the third parties that facilitate our business activities, including exchanges, clearing agents, clearing houses or other financial intermediaries. Such parties could also be the source of an attack on, or breach of, our operational systems, data or infrastructure. In addition, as interconnectivity with our clients grows, we increasingly face the risk of operational failure with respect to our clients’ systems.
We rely on vendors to support our operations. We also rely on vendors to provide part of our services we deliver to customers. While we have a vendor management program policy in place and believe we have selected our vendors appropriately, we cannot directly control their employees or their operating environments. A breach or failure of a chosen vendor could have a material impact on our operating environment.
Our services and technology solutions rely on the internet more and more. Computers connected to the internet are vulnerable to many types of threats by cyber criminals. Although none of these types of attacks have had a material impact on our business to date, we anticipate that the efforts to attack our systems, and those of our customers and vendors, will grow in complexity and volume. As such, we have developed an incident response plan to coordinate the efforts following the identification of an attack.
Failure to maintain a secure computing environment, stay up to date on security vulnerabilities or deploy adequate technologies to protect against attacks, may subject our information and systems to security breaches that could compromise confidential information and damage our reputation and business. We rely on industry-standard encryption and authentication security systems to provide the security required to protect our data. Periodically our systems are subjected to scans, exploitations and audits by a qualified independent third party to evaluate the effectiveness of our security controls and system configurations.
Cyber criminals may attempt to trick employees, customers or vendors through phishing schemes or other methods to disclose sensitive information. Employees receive annual security training and are periodically assessed through simulated attack tools to assist with behavior shaping and coaching against social engineering threats.
If one or more of these events occurs, it could potentially jeopardize the confidential, proprietary and other information processed and stored in, and transmitted through, the Bank’s computer systems and networks, or otherwise cause interruptions or malfunctions in our, as well as our clients’ or other third parties’ operations, which could result in damage to our reputation, substantial costs, regulatory penalties and/or client dissatisfaction or loss.
Potential costs of a cyber incident may include, but would not be limited to, remediation costs, increased protection costs, lost revenue from the unauthorized use of proprietary information or the loss of current and/or future customers, and litigation.
We maintain an insurance policy through the Bank’s blanket bond at the maximum of currently available limits. However, we cannot assure you that this policy would be sufficient to cover all financial losses, damages, penalties, including lost revenues, should the Bank experience any one or more of our or a third party’s systems failing or experiencing attack.
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We rely on third parties to provide key components of our business infrastructure, and a failure of these parties to perform for any reason could disrupt our operations.
Third parties provide key components of our business infrastructure such as data processing, internet connections, network access, core application processing, statement production and account analysis. Our business depends on the successful and uninterrupted functioning of our information technology and telecommunications systems and third-party servicers. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. Replacing vendors or addressing other issues with our third-party service providers could entail significant delay and expense. If we are unable to efficiently replace ineffective service providers, or if we experience a significant, sustained or repeated system failure or service denial, it could compromise our ability to operate effectively, damage our reputation, result in a loss of customer business, and subject us to additional regulatory scrutiny and possible financial liability, any of which could have an adverse effect on our business, financial condition and results of operations.
Reputational risk and social factors may impact our results.
Our ability to originate and maintain accounts is highly dependent upon consumer and other external perceptions of our business practices and/or our financial health. Adverse perceptions could damage our reputation in both the customer and funding markets, leading to difficulties in generating and maintaining accounts as well as in financing them. Adverse developments with respect to the consumer or other external perceptions regarding the practices of our competitors, or our industry as a whole, may also adversely impact our reputation. In addition, adverse reputational impacts on third parties with whom we have important relationships may also adversely impact our reputation. Adverse impacts on our reputation, or the reputation of our industry, may also result in greater regulatory and/or legislative scrutiny, which may lead to laws or regulations that may change or constrain the manner in which the Bank engages with its customers and the products the Bank offers. Adverse reputational impacts or events may also increase our litigation risk. We carefully monitor internal and external developments for areas of potential reputational risk and have established governance structures to assist in evaluating such risks in our business practices and decisions.
We could be subject to losses, regulatory action or reputational harm due to fraudulent and negligent acts on the part of loan applicants, our employees and vendors.
In deciding whether to extend credit or enter into other transactions with clients and counterparties, and the terms of any such transaction, we may rely on information furnished by or on behalf of clients and counterparties, including financial statements, property appraisals, title information, employment and income documentation, account information and other financial information. We may also rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. Any such misrepresentation or incorrect or incomplete information, whether fraudulent or inadvertent, may not be detected prior to funding. In addition, one or more of our employees or vendors could cause a significant operational breakdown or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates our loan documentation, operations or systems. Whether a misrepresentation is made by the applicant or another third party, we generally bear the risk of loss associated with the misrepresentation. A loan subject to a material misrepresentation is typically unsellable or subject to repurchase if it is sold prior to detection of the misrepresentation. The sources of the misrepresentations may also be difficult to locate, and we may be unable to recover any of the monetary losses we may suffer as a result of the misrepresentations. Any of these developments could have an adverse effect on our business, financial condition and results of operations.
We are subject to claims and litigation pertaining to intellectual property.
Banking and other financial services companies, such as ours, rely on technology companies to provide information technology products and services necessary to support their day-to-day operations. Technology companies frequently enter into litigation based on allegations of patent infringement or other violations of intellectual property rights. In addition, patent holding companies seek to monetize patents they have purchased or otherwise obtained. Competitors of our vendors, or other individuals or companies, may from time to time claim to hold intellectual property sold to us by our vendors. Such claims may increase in the future as the financial services sector becomes more reliant on information technology vendors. The plaintiffs in these actions frequently seek injunctions and substantial damages.
Regardless of the scope or validity of such patents or other intellectual property rights, or the merits of any claims by potential or actual litigants, we may have to engage in protracted litigation. Such litigation is often expensive, time-consuming, disruptive to our operations and distracting to management. If we are found to infringe one or more patents or other intellectual property rights, we may be required to pay substantial damages or royalties to a third party. In certain cases, we may consider entering into licensing agreements for disputed intellectual property, although no assurance can be given that such licenses can be obtained on acceptable terms or that litigation will not occur. These licenses may also significantly increase our operating expenses. If legal matters related to intellectual property claims were resolved against us or settled, we could be required to make payments in amounts that could have an adverse effect on our business, financial condition and results of operations.
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The decreased soundness of other financial institutions could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led in the past to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral that we hold cannot be realized upon or is liquidated at prices insufficient to recover the full amount of the loan. We cannot assure you that any such losses would not materially and adversely affect our business, financial condition or results ofoperations.
Strategic Risks
Strong competition within our market area could reduce our profits and slow growth.
We face competition in making loans, attracting deposits and hiring and retaining experienced employees. Price competition for loans and deposits may result in our charging lower interest rates on loans and paying higher interest rates on deposits, thereby reducing our net interest income. Price competition also may limit our ability to originate loans. Competition makes it more difficult and costly to attract and retain qualified employees.
Our financial performance will be negatively affected if we are unable to execute our growth strategy.
Our stated growth strategy is to grow organically and supplement that growth with select acquisitions, if available. Our success depends primarily on generating loans and deposits of acceptable risk and expense. There can be no assurance that we will be successful in continuing our organic, or internal, growth strategy. Our ability to identify appropriate markets for expansion, recruit and retain qualified personnel, and fund growth at reasonable cost, depends upon prevailing economic conditions, maintenance of sufficient capital, competitive factors, changes in banking laws, and other factors.
We cannot be certain as to our ability to manage increased levels of assets and liabilities without increased expenses and higher levels of nonperforming assets. We may be required to make additional investments in equipment and personnel to manage higher asset levels and loan balances, which may adversely affect earnings, shareholder returns, and our efficiency ratio. Increases in operating expenses or nonperforming assets may decrease our earnings and the value of the Company’s capital stock.
We may face increasing deposit-pricing pressures, which may, among other things, reduce our profitability.
Deposit pricing pressures may result from competition as well as changes to the interest rate environment. Current economic conditions have intensified competition for deposits. The competition has had an impact on interest rates paid to attract deposits as well as fees charged on deposit products. In addition to the competitive pressures from other depository institutions, we face heightened competition from non-depository financial products such as securities and other alternative investments.
Furthermore, technology and other market changes have made it more convenient for bank customers to transfer funds for investing purposes. Bank customers also have greater access to deposit vehicles that facilitate spreading deposit balances among different depository institutions to maximize FDIC insurance coverage. In addition to competitive forces, we also are at risk from market forces as they affect interest rates. It is not uncommon when interest rates transition from a low interest rate environment to a rising rate environment, for deposit and other funding costs to rise in advance of yields on earning assets. In order to keep deposits required for funding purposes, it may be necessary to raise deposit rates without commensurate increases in asset pricing in the short term.
Historically low interest rates may adversely affect our net interest income and profitability.
In recent years it has been the policy of the Federal Reserve to maintain interest rates at historically low levels through its targeted federal funds rate and the purchase of mortgage-backed securities. As a result, market rates on the loans we have originated and the yields on securities we have purchased have been at historically low levels. As discussed above, rates are fluctuating, and due to a number of factors including changes in monetary policies of the Federal Reserve, will likely continue to fluctuate.
External and Market-Related Risks
Changes in general business, economic and political conditions, especially in Northern Virginia, could adversely affect our earnings.
Our success depends, to a certain extent, upon economic and political conditions, local and national, as well as governmental monetary policies. Conditions such as inflation, recession, unemployment, changes in interest rates, money supply and other factors beyond our control may adversely affect our asset quality, deposit levels and loan demand and, therefore our earnings. In addition, there are continuing ocncerns
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related to, among other things, the level of U.S. government debt and fiscal actions that may be taken to address that debt, a potential resurgence of economic and political tensions with China or an escalation of tensions between Russia and Ukraine, all of which may have a destabilizing effect on financial markets and economic activity. Economic pressure on consumers, businesses and overall economic uncertainty may result in changes in spending, borrowing, and saving habits. These economic conditions and other negative developments in the domestic or international credit markets and economies may significantly affect the markets in which we do business. Because we have a significant amount of real estate loans, decreases in real estate values could adversely affect the value of property used as collateral and our ability to sell the collateral upon foreclosure. Adverse changes in the economy may also have a negative effect on the ability of our borrowers to make timely repayments of their loans, which would have an adverse impact on our earnings. If during a period of reduced real estate values we are required to liquidate the collateral securing a loan to satisfy the debt or to increase our allowance for loan losses, it could materially reduce our profitability and adversely affect our financialcondition.Thesubstantialmajorityofourloansaretoindividualsandbusinessesin the NorthernVirginia and Washington D.C metropolitan area.Consequently, significant declines in the economy in the Northern Virginia and Washington D.C. metropolitan area could have a materially adverse effect on our financial condition and results of operations.
Additionally, the emergence of widespread health emergencies or pandemics, such as coronavirus (“COVID-19”), could lead to quarantines, business shutdowns, increases in unemployment, labor shortages, disruptions to supply chains, and overall economic instability. Events such as these may become more common in the future and could cause significant damage such as disrupt power and communication services, impact the stability of our facilities and result in additional expenses, impair the ability of our borrowers to repay their loans, reduce the value of collateral securing the repayment of our loans, which could result in the loss of revenue. While we have established and regularly test disaster recovery procedures, the occurrence of any such event could have a material adverse effect on our business, operations and financial condition.
If we do not adjust to rapid changes in the financial services industry, our financial performance may suffer.
We face substantial competition for customer relationships, as well as other sources of funding in the communities it serves. Competing providers include other banks, savings institutions and trust companies, insurance companies, mortgage banking operations, credit unions, finance companies, title companies, money market funds and other financial and nonfinancial companies which may offer products functionally equivalent to those offered by the Bank. Many competing providers have greater financial resources than we do and offer services within and outside the market areas we serve. In addition to this challenge of attracting and retaining customers for traditional banking services, our competitors include securities dealers, brokers, mortgage bankers, investment advisors and finance and insurance companies who seek to offer one-stop financial services to their customers that may include services that financial institutions have not been able or allowed to offer to their customers in the past. The increasingly competitive environment is primarily a result of changes in regulation, changes in technology and product delivery systems and the accelerating pace of consolidation among financial service providers. If we are unable to adjust both to increased competition for traditional banking services and changing customer needs and preferences, our financial performance and your investment in our capital stock could be adverselyaffected.
Additional required capital may not be available.
We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. In addition, we may elect to raise additional capital to support our business or to finance acquisitions, if any, or we may otherwise elect or be required to raise additional capital. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets, economic conditions and a number of other factors, many of which are outside of our control, and on our financial performance. Accordingly, there can be no assurance that we can raise additional capital if needed or on terms acceptable to us. If we cannot raise additional capital when needed, it may have a material adverse effect on our financial condition, results of operations and prospects.
Compliance and Regulatory Risks
We operate in a highly regulated environment, and we may be adversely affected by changes in laws and regulations.
We are subject to extensive regulation, supervision and examination by the Federal Reserve, our primary federal regulator, the Virginia Bureau of Financial Institutions, our chartering authority and the FDIC, as insurer of our deposits. Such regulation and supervision govern the activities in which we and the Bank may engage, and are intended primarily for the protection of the insurance fund and the depositors and borrowers of the Bank rather than for holders of our common stock. Various consumers and compliance laws also affect our operations.
Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations. The earnings of the Bank, and therefore the earnings of the Company, are affected by changes in federal and state legislation and actions of various regulatory authorities.
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The Bank has become subject to more stringent regulatory capital requirements.
The Bank is subject to the comprehensive, consolidated supervision and regulation of the FRB and the Bureau of Financial Institutions, including risk-based and leverage capital requirements. The Bank must maintain certain risk-based and leverage capital ratios as required by our banking regulators, which can change depending on general economic conditions and on the Bank’s particular condition, risk profile and growth plans. If at any time we fail to meet minimum regulatory capital standards or other regulatory requirements, our financial condition would be materially and adversely affected.
In addition, the capital requirements implemented by the federal banking regulators under Basel III could, among other things, result in lower returns on invested capital, adversely affect our ability to pay dividends or repurchase shares, require the raising of additional capital, and result in regulatory actions if we were to be unable to comply with such requirements. Compliance with current or new capital requirements may limit operations that require the intensive use of capital and could adversely affect our ability to expand or maintain present business levels. Additional information, including the Bank’s compliance with applicable capital requirements at December 31, 2021, is provided in Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations.
The Tax Cuts and Jobs Act may have an unanticipated impact on our business.
The Tax Cuts and Jobs Act (the “Act”), enacted in 2017, contains the most extensive amendments to the Internal Revenue Code in over 30 years. The primary change for the Company was the Act’s reduction of the federal corporate tax rate from a maximum of 35% to a flat 21%. Among other sweeping changes for individual taxpayers, the Act doubles the standard deduction for individuals, limits the deductibility of state and local income, property and sales taxes by individuals to $10,000 per year, eliminates the deductibility of interest on home equity loans, and eliminates the deductibility of interest on new home mortgages in excess of $750,000 (down from $1.0 million previously). The Act also eliminates loss carrybacks and limits the deductibility of loss carryforwards to 80% of current-year taxable income. The Act allows 100% expensing for all non-real property capital expenditures for five years but limits the deductibility of net interest expense (interest expense minus interest income) to 30% of taxable income for businesses with average annual gross receipts of more than $25 million.
While we expect to benefit from the lower federal tax rate in the future, the lower tax rate reduced the value of existing other deferred tax assets, which we were required to revalue during the 2017 fiscal year. Lower tax rates will also reduce the attractiveness of certain tax-advantaged bank investments such as municipal bonds and bank-owned life insurance. Various other provisions of the Act could have unanticipated effects on the business of the Bank. By reducing the tax advantages of home ownership through its limits on the deductibility of mortgage interest and property taxes and the elimination of the deductibility of interest on certain home equity loans, the Act could affect demand for housing and residential mortgages in the future. The value of the properties securing loans in our loan portfolio may be adversely impacted as a result of the changing economics of home ownership, as such an impact could require an increase in our provision for loan losses, which would reduce our profitability and could materially adversely affect our business, financial condition and results of operations. The higher standard deduction could also affect mortgage financing by reducing the number of taxpayers who itemize deductions and therefore benefit from these deductions. Furthermore, the lower corporate tax rates and new limits on the deductibility of net interest expense may reduce demand for loans from larger business borrowers and increase competition for lending to smaller business borrowers.
Risks Associated with Our Common Stock
The market price for the Company’s common stock price may be volatile.
The market price of our common stock may be highly volatile, which may make it difficult for you to resell your shares at the volume, prices and times desired. There are many factors that may impact the market price and trading volume of our common stock, including, without limitation:
• changes in expectations as to our future financial performance;
• future issuances of our common stock or other securities;
• changes in general economic or business conditions;
• proposed or adopted changes in laws, regulations or policies affecting us;
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There is not an active or consistent trading market in our common stock, and we cannot assure you that a more active or consistent trading market in the common stock will develop. As a result, relatively small trades could have a significant impact on the price of our common stock.
Our common stock is subordinate to our existing and future preferred stock and to our subordinated notes.
The Company has outstanding preferred stock that is senior to the common stock and could adversely affect the ability of the Company to declare or pay dividends or distributions of common stock. In addition, the terms of the Company’s outstanding fixed-to-floating rate subordinated notes prohibit it from declaring or paying any dividends, or purchasing, acquiring, or making a liquidation payment with respect to, its capital stock, during an event of default under the subordinated note purchase agreement. Furthermore, if the Company experiences a material deterioration in its financial condition, liquidity, capital, results of operations or risk profile, the Company’s regulators may not permit it to make future payments on its preferred stock, thereby preventing the payment of dividends on the common stock.
We are an emerging growth company, and any decision on our part to comply only with certain reduced reporting and disclosure requirements applicable to emerging growth companies could make our common stock less attractive to investors.
We are an emerging growth company, and, for as long as we continue to be an emerging growth company, we may choose to take advantage of exemptions from various reporting requirements applicable to other public companies but not to emerging growth companies, including, but not limited to, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. As an emerging growth company, we also will not be subject to Section 404(b) of the Sarbanes Oxley Act of 2002, which would require that our independent auditors review and attest as to the effectiveness of our internal control over financial reporting. In this Form 10-K, we have elected to take advantage of the reduced disclosure requirements relating to executive compensation, and in the future we may take advantage of any or all of these exemptions for so long as we remain an emerging growth company. In addition to the relief described above, the JOBS Act permits us an extended transition period for complying with new or revised accounting standards affecting public companies. We have elected not to take advantage of this extended transition period, which means that the financial statements included in this Form 10-K, as well as any financial statements that we file in the future, will be subject to all new or revised accounting standards generally applicable to public companies.
We will cease to be an emerging growth company upon the earliest of: (i)the first fiscal year after our annual gross revenues are $1.07 billion or more; (i)the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt securities; or (i)the end of any fiscal year in which the market value of our common stock held by non-affiliates exceeded $700 million as of the end of the second quarter of that fiscal year, or five years after completing our initial public offering. Investors may find our common stock less attractive if we choose to rely on these exemptions. If some investors find our common stock less attractive as a result of any choices to reduce future disclosure, there may be a less active trading market for our common stock and the price of our common stock may be more volatile.
General Risk Factors
We will depend on our management team to implement our business strategy and execute successful operations, and we could be harmed by the loss of their services.
We are dependent upon the services of the members of our senior management team who direct our strategy and operations. Members of our senior management team, as well as commercial lending specialists who possess expertise in our markets and key business relationships, could be difficult to replace. The loss of these persons, or our inability to hire additional qualified personnel, could impact our ability to implement our business strategy and could have a material adverse effect on our results of operations and our ability to compete in our markets.
We may not be able to attract and retain skilled people.
Our success depends, in large part, on our ability to attract and retain key people. Competition for the best people in most activities in which we engage can be intense, and we may not be able to retain or hire the people we want or need. In order to attract and retain qualified employees, we must compensate our employees at market levels. If we are unable to continue to attract and retain qualified employees, or do so at rates necessary to maintain our competitive position, our performance, including our competitive position, could suffer, and, in turn, adversely affect our business, financial condition and results of operations. The number of experienced banking professionals in our markets may not be the same as in certain other markets.
We may be subject to increased litigation which could result in legal liability and damage to our reputation.
We may be named from time to time as a defendant in litigation relating to its business and activities. Litigation may include claims for substantial compensatory or punitive damages or claims for indeterminate amounts of damages. We are also involved from time to time in other reviews, investigations and proceedings (both formal and informal) by governmental and self- regulatory agencies regarding its business. These matters also could result in adverse judgments, settlements, fines, penalties, injunctions or other relief.
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In addition, in recent years, a number of judicial decisions have upheld the right of borrowers to sue lending institutions on the basis of various evolving legal theories, collectively termed “lender liability.” Generally, lender liability is founded on the premise that a lender has either violated a duty, whether implied or contractual, of good faith and fair dealing owed to the borrower or has assumed a degree of control over the borrower resulting in the creation of a fiduciary duty owed to the borrower or its other creditors or shareholders.
Substantial legal liability or significant regulatory action against the Company could materially adversely affect its business, financial condition or results of operations, or cause significant harm to our reputation.
Our reported financial results depend on management’s selection of accounting methods and certain assumptions and estimates.
Our accounting policies and assumptions are fundamental to the Company’s reported financial condition and results of operations. Management must exercise judgment in selecting and applying many of these accounting policies and methods so that they comply with generally accepted accounting principles and reflect management’s judgment of the most appropriate manner to report our financial condition and results. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which may be reasonable under the circumstances, yet may result in the Company’s reporting materially different results than would have been reported under an alternativemethod.
The obligations associated with being a public company require significant resources and management attention.
As a public company, we face increased legal, accounting, administrative and other costs and expenses that we have not previously incurred, particularly after we are no longer an emerging growth company. We are subject to the reporting requirements of the Exchange Act, which requires that we file annual, quarterly and current reports with respect to our business and financial condition and proxy and other information statements, and the applicable rules and regulations implemented by the SEC, the Sarbanes-Oxley Act, the Dodd-Frank Act, the PCAOB and the Nasdaq Stock Market, each of which imposes additional reporting and other obligations on public companies.
As a public company, we are required to:
• expand the roles and duties of our board of directors and committees thereof;
• enhance our investor relations function;
• retain additional personnel;
• comply with Nasdaq Stock Market listing standards; and
• comply with applicable requirements of the Sarbanes-Oxley Act.
We expect these rules and regulations and changes in laws, regulations and standards relating to corporate governance and public disclosure, which have created uncertainty for public companies, to increase legal and financial compliance costs and make some activities more time consuming and costly. These laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. Our investment in compliance with existing and evolving regulatory requirements will result in increased administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities, which could have an adverse effect on our business, financial condition and results of operations. These increased costs could require us to divert a significant amount of money that we could otherwise use to expand our business and achieve our strategic objectives.
Item 1B. Unresolved Staff Comments
None.
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Item 2. Properties
As of December 31, 2021, the net book value of our office properties was $9.1 million, and the net book value of our furniture, fixtures and equipment was $1.6 million. The following table sets forth information regarding our offices.
Net Book Value
Leased or Year Acquired of Real
Location Owned or Leased Property
(In thousands)
Headquarters:
Other Properties:
Herndon Branch
Operations Center
McLean Branch
Clarendon Branch
Leesburg Branch
Washington D.C. Branch
1130 Connecticut Avenue, N.W. Leased 2019 —
We believe that current facilities are adequate to meet our present and foreseeable needs, subject to possible future expansion. See Note 7 of Notes to the December 31, 2021, Consolidated Financial Statements, for additional disclosures related to the Company’s properties.
Item 3. Legal Proceedings
From time to time, we are a party to various litigation matters incidental to our ordinary conduct of our business. Management believes that none of these legal proceedings, individually or in the aggregate, will have a material adverse impact on the results of operations or financial condition of the Company.
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
Common Stock
Our common stock is traded on the Nasdaq Capital Market under the symbol “MNSB.” At December 31, 2021 the Company had approximately 245 shareholders of record. This total does not reflect shares held in nominee or “street name” accounts through various firms.
Dividends
Holders of our common stock are only entitled to receive dividends when, as and if declared by the Board of Directors out of funds legally available for dividends. As the Company is a financial holding company and does not engage directly in business activities of a material nature, its ability to pay dividends on our common stock will depend, in large part, upon the receipt of dividends from the Bank. Any future determination relating to our dividend policy will be made by the Board of Directors and will depend on a number of factors, including general and economic conditions, industry standards, our financial condition and operating results, our available cash and current and anticipated cash needs, capital requirements, our ability to service debt obligations senior to our common stock, banking regulations, contractual, legal, tax and regulatory restrictions, and limitations on the payment of dividends by the Company to its shareholders or by the Bank, and such other factors as the Board of Directors may deem relevant. On January 19, 2022, the Company declared its first cash dividend to be paid to common shareholders on February 10, 2022.
Holders of the common stock are subject to priority dividend rights of any holders of preferred stock then outstanding. There were 28,750 shares of preferred stock outstanding at December 31, 2021.
A discussion of applicable regulatory restrictions on dividends by the Company and the Bank is provided in Item 1 (“Business”) under “Supervision, Regulation and Other Factors – Payment of Dividends.”
Securities Authorized For Issuance Under Equity Compensation Plans
The following table provides information concerning securities authorized for issuance under equity compensation plans, the weighted average price of such securities and the number of securities remaining available for future issuance, as of December 31, 2021.
Plans not approved by shareholders — — —
Unregistered Sales and Issuer Repurchases of Common Stock
Unregistered Sales of Common Stock
Set forth below is information concerning sales of common stock by the Company during the past 3 years that were not registered under the Securities Act.
On August 24, 2018, the Company issued and sold 2,368,421 shares of common stock at $19.00 per share, for a total of $49,999,999, to accredited investors. The Company relied upon the exemption from registration under Section 4(a)(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder. Sales commissions of $1,899,212 were paid to FIG Partners, LLC, the sole placement agent. See Note 23 of Notes to Consolidated Financial Statements.
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In 2016, the Board of Directors of the Bank and the Bank’s shareholders approved the MainStreet Bank 2016 Equity Incentive Plan (the “2016 Plan”), to provide officers, other selected employees and directors with additional incentives to promote growth and performance. The terms and conditions of the 2016 Plan were subsequently converted into and deemed to be the terms and conditions of a substantially identical Company incentive compensation plan. A total of204,971 shares of restricted common stock were awarded under the 2016 Plan.The Bank relied on the exemption from registration under Section 3(a)(2) of the Securities Act. The Company relied upon the exemption from registration under Rule 701 promulgated under the Securities Act. See Note 18 of Notes to Consolidated Financial Statements.
In 2019, the Board of Directors of the Bank and the Bank’s shareholders approved the MainStreet Bank 2019 Equity Incentive Plan (the “2019 Plan”), to provide officers, other selected employees and directors with additional incentives to promote growth and performance. The terms and conditions of the 2019 Plan were subsequently converted into and deemed to be the terms and conditions of a substantially identical Company incentive compensation plan. To date, a total of 245,566 shares of restricted common stock have been awarded under the 2019 Plan. During 2021, 84,117 shares of restricted common stock vested from shares issued under both the 2016 and 2019 Plans. See Note 18 of Notes to Consolidated Financial Statements. In August 2019, the Company registered with the SEC, on Form S-8, the shares of common stock that would then be issuable under the 2019 Plan.As a result of the stockholders’ approval of the 2019 Plan, no additional awards have been or will be made under the Bank’s 2016 Plan, although all awards that were outstanding under the 2016 Plan as of July 17, 2019 remained outstanding in accordance with their terms.
Repurchases of Common Stock
On October 22, 2020, the Company announced that the Board of Directors had authorized a new plan to repurchase up to $17.0 million of the Company’s outstanding common stock in open market transactions or privately negotiated transactions, including pursuant to a trading plan in accordance with Rule 10b-18 under the Securities Exchange Act of 1934. The new stock repurchase program replaces the Company’s previous program. During the year ended December 31, 2020, the Company repurchased 895,785 shares. The Company did not repurchase any common shares during the year ended December 31, 2021.
Preferred Stock and Depositary Shares
On September 15, 2020, the Company closed its underwritten public offering of 1,000,000 depositary shares, each representing 1/40th of a share of 7.50% Series A Fixed-Rate Non-Cumulative Perpetual Preferred Stock, par value $1.00 per share (the “Series A Preferred Stock”). On September 25, 2020, the Company completed the sale of an additional 150,000 depositary shares pursuant to the underwriters’ full exercise of their over-allotment option to purchase additional depositary shares.
Trading the depositary shares on the Nasdaq Capital Market commenced on September 16, 2020, under the symbol “MNSBP.”
The Board of Directors declared a quarterly cash dividend on the outstanding shares of the Series A Preferred Stock each quarter in agreement with the depositary share offering. Each declared cash dividend equated to approximately $0.47 per depositary share, or $18.75 per share of Series A Preferred Stock outstanding.
Item 6. [Reserved]
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The purpose of this discussion is to focus on significant changes in the financial condition and results of operations of the Company during the years ended December 31, 2021 and 2020. The following discussion supplements and provides information about the major components of the results of operations, financial condition, liquidity and capital resources of the Company. This discussion and analysis should be read in conjunction with the accompanying consolidated financial statements.
Forward-Looking Statements
This Annual Report on Form 10-K contains certain forward-looking statements and information relating to the Company within the meaning of the Private Securities Litigation Reform Act of 1995 that are based on the beliefs of management as well as assumptions made by and information currently available to management. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words like “believe,” “expect,” “anticipate,” “estimate,” and “intend” or future or conditional verbs such as “will,” “should,” “could,” or “may” and similar expressions or the negative thereof. Important factors that could cause actual results to differ materially from those in the forward–looking statements included herein include, but are not limited to:
• adverse changes in the securities markets;
• our ability to successfully integrate acquired entities;
• changes in consumer spending, borrowing and savings habits;
• changes in accounting policies and practices;
• changes in our organization, compensation and benefit plans;
• our ability to attract and retain key employees;
• adequacy of our allowance for loan losses;
• deterioration of our asset quality;
• cyber threats, attacks or events
• reliance on third parties for key services
• liquidity, interest rate and operational risks associated with our business;
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Should one or more of these risks or uncertainties materialize or should underlying assumptions prove incorrect, actual results may vary materially from those described herein. We caution readers not to place undue reliance on forward-looking statements. The Company disclaims any obligation to revise or update any forward-looking statements contained in this Form 10-K to reflect future events or developments. The discussion of the critical accounting policies and analysis set forth below is intended to supplement and highlight information contained in the accompanying Consolidated Financial Statements and the selected financial data presented elsewhere in this Form 10-K.
COVID-19 Pandemic
The effects of the COVID-19 pandemic and resulting economic conditions have impacted our business and financial results and could continue to impact our business and results of operations in a number of ways in the future, including without limitation in areas related to credit, collateral, customer demand, operations, interest rate risk, liquidity and litigation, as described in more detail below. The extent to which the Company’s business will continue to be negatively affected by the pandemic will depend on future developments, which are highly uncertain and cannot be reasonably predicted.
Credit Risk. The risk of timely loan repayment and the value of collateral supporting our loans are affected by the strength of our borrowers’ businesses. Concern about the spread of COVID-19 has caused, and is likely to continue to cause, business shutdowns, limitations on commercial activity and financial transactions, labor shortages, supply chain interruptions, increased unemployment and commercial property vacancy rates, reduced profitability and ability for property owners to make mortgage payments, and overall economic and financial market instability, all of which may cause our customers to be unable to make scheduled loan payments. If the effects of COVID-19 result in widespread and sustained repayment shortfalls on loans in our portfolio, we could incur significant delinquencies, foreclosures and credit losses, particularly if the available collateral is not sufficient to cover our exposure. The future effects of COVID-19 on economic activity could negatively affect the collateral values associated with our existing loans, our ability to liquidate real estate collateral securing our residential and commercial real estate loans, our ability to maintain loan origination volume and to obtain additional financing, the future demand for, or profitability of, our lending and services, and the financial condition and credit risk of our customers. Further, in the event of delinquencies, regulatory changes and policies designed to protect borrowers may slow or prevent us from making business decisions or may delay our taking certain remediation actions. In addition, we have unfunded commitments to extend credit to customers. Increased borrowings under these commitments could adversely impact our liquidity.
In an effort to support our communities during the pandemic, we participated in the Paycheck Protection Program (“PPP”), a program established by the CARES Act to provide loans to small businesses for payroll and other basic expenses during the COVID-19 pandemic.PPP loans are fully guaranteed by the Small Business Administration (“SBA”) and provide for full forgiveness of the loans during a specified forgiveness period that meet specific guidelines provided by the SBA. The deadline to apply for PPP loans was initially June 30, 2020 and was later extended to August 8, 2020; the Consolidated Appropriations Act of 2021 (the “CAA”), enacted in December 2020, reopened and expanded the PPP. Small businesses and other entities and individuals could have applied for PPP loans from existing SBA lenders and other approved regulated lenders that enrolled in the program, subject to numerous limitations and eligibility criteria.
PPP loans are subject to regulatory requirements that would require forbearance of loan payments for a specified time or that could limit our ability to pursue all available remedies in the event of a loan default. If the borrower under the PPP loan fails to qualify for loan forgiveness, or if the borrower defaults and the SBA determines there is a deficiency in the manner in which any PPP loans were originated, funded or serviced by the Bank, we would be subject to repayment risk as well as the heightened risk of holding these loans at unfavorable interest rates as compared to loans that we would have otherwise made.
Business Continuity Planning Risk. Our financial condition and results of operations may be affected by a variety of external factors that may affect the price or marketability of our products and services, changes in interest rates that may increase our funding costs, reduced demand for our financial products due to economic conditions and the various responses of governmental and nongovernmental authorities. The COVID-19 pandemic has significantly increased economic and demand uncertainty and has led to severe disruption and volatility in capital markets. Furthermore, many of the governmental actions in response to the pandemic have been directed toward curtailing household and business activity to contain COVID-19. These actions have been rapidly changing. Future effects of COVID-19 on economic activity could negatively affect the future banking products we provide and could result in a decline in loan originations.
Operational Risk. Current and future restrictions on our workforce’s access to our facilities could limit our ability to meet customer servicing expectations and have a material adverse effect on our operations. We rely on business processes and branch activity that largely depend on people and technology, including access to information technology systems as well as information, applications, payment systems and other services provided by third parties. In response to COVID-19, we have modified our business practices with a portion of our employees working remotely from their homes to minimize interruptions of our operations. Technology in employees’ homes may be more limited or less reliable than in our offices. The continuation of these work-from-home measures also introduces additional operational risk, including increased cybersecurity risk.
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We rely on many third parties in our business operations. Many of these parties may limit the availability and access of their services. If third-party service providers continue to have limited capacities for a prolonged period or if additional limitations or potential disruptions in these services materialize, it may negatively affect our operations.
Interest Rate Risk. Our net interest income, lending activities, deposits, investment portfolio, cash flows and profitability are and are likely to continue to be negatively affected by volatility in interest rates caused by uncertainties stemming from COVID-19. On March 15, 2020 the Federal Reserve lowered its target range for the federal funds rate to a range from 0 to 0.25 percent, and has since maintained that range, citing concerns about the impact of COVID-19 on markets and stress in the energy sector. A prolonged period of extremely volatile and unstable market conditions would likely increase our funding costs and negatively affect market risk mitigation strategies. Higher income volatility from changes in interest rates and spreads to benchmark indices will likely cause a loss of future net interest income and a decrease in current fair market values of our investment portfolio and other assets. Fluctuations in interest rates will impact both the level of income and expense recorded on most of our assets and liabilities and the market value of all interest-earning assets and interest-bearing liabilities, which in turn could have a material adverse effect on our net income, operating results, or financial condition.
Liquidity. Federal, state and local governments have mandated or encouraged financial institutions to accommodate borrowers and other customers affected by the COVID-19 pandemic. Legal and regulatory responses to concerns about the COVID-19 pandemic could result in additional regulation or restrictions affecting the conduct of our business in the future. In addition to our measures to address the potential effects from negative economic conditions noted above, the Company has instituted a program to help COVID-19 impacted customers. This program includes waiving certain fees and charges and offering payment deferment and other loan relief, as appropriate, for customers impacted by COVID-19. The Company’s liquidity could be negatively impacted if a significant number of customers apply and are approved for the deferral of payments or request additional deferrals. In addition, if these deferrals are not effective in mitigating the effect of COVID-19 on our customers, the negative effects on our business and results of operations may be more substantial and may continue over a longer period of time.
Litigation Risk. Although the Company has taken and continues to take precautions to protect the safety and well-being of its employees, no assurance can be given that the steps being taken will be adequate or appropriate. Concerns have been expressed regarding possible employee lawsuits for tort claims related to the COVID-19 pandemic, including class action lawsuits alleging that unsafe workplaces have caused employees to contract COVID-19 or subjected them to the risk of exposure. Possible statutory defenses may mitigate the risk of liability in any such lawsuits; however, the availability of such defenses is uncertain and cannot be predicted at this time.
The PPP has also attracted interest from federal and state enforcement authorities, oversight agencies, regulators and Congressional committees. Offices of state attorneys general and other federal and state agencies may assert that they are not subject to the provisions of the CARES Act and the PPP regulations that entitle the Bank to rely on borrower certifications, and they may take more aggressive actions against the Bank for alleged violations of the provisions governing the Bank’s participation in the PPP. Federal and state regulators can impose or request that we consent to substantial sanctions, restrictions and requirements if they determine there are violations of laws, rules or regulations or weaknesses or failures with respect to general standards of safety and soundness, which could adversely affect our business, reputation, results of operation and financial condition.
Since the opening of the PPP, several larger banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP. The Company and the Bank may be exposed to the risk of litigation, from both clients and non-clients that solicited the Bank for PPP loans, regarding its process and procedures used to process applications for the PPP. If any such litigation is filed against the Company or the Bank and is not resolved in a manner favorable to the Company or the Bank, it may result in significant financial liability or adversely affect the Company’s reputation. Any financial liability, litigation costs or reputational damage caused by PPP-related litigation could have a material adverse impact on our business, financial condition and results of operations.
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Critical Accounting Policies
The accounting and financial reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Accordingly, the financial statements require certain estimates, judgments, and assumptions, which are believed to be reasonable, based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the periods presented. Critical accounting policies comprise those that management believes are the most critical to aid in fully understanding and evaluating our reported financial results. These policies require numerous estimates or economic assumptions that may prove inaccurate or may be subject to variations which may significantly affect our reported results and financial condition for the current period or in future periods.
The accounting principles followed by the Company and the methods of applying these principles conform with accounting principles generally accepted in the United States of America and with general practices within the banking industry. The Company’s critical accounting policies relate to (1) the allowance for loan losses, (2) fair value of financial instruments, (3) income taxes, (4) computer software, and (5) derivative financial instruments. These critical accounting policies require the use of estimates, assumptions and judgments which are based on information available as of the date of the financial statements. Accordingly, as this information changes, future financial statements could reflect the use of different estimates, assumptions and judgments. Certain determinations inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported.
Allowance for Loan Losses: Management’s policy is to maintain the allowance for loan losses at a level sufficient to absorb estimated probable incurred losses inherent in the loan portfolio. Management performs periodic and systematic detailed reviews of its loan portfolio to identify trends and to assess the overall collectability of the loan portfolio. Accounting standards require that loan losses be recorded when management determines it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated.
The allowance consists of a specific component and a general component. The specific component relates to loans that are classified as impaired, and is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. For impaired collateral dependent loans, an updated appraisal will typically be ordered if a current one is not on file. Appraisals are performed by independent third-party appraisers with relevant industry experience. Adjustments to the appraised value may be made based on recent sales of like properties or general market conditions when appropriate. The general component covers non-classified or performing loans and those loans classified as substandard or special mention that are not impaired. The general component is based on historical loss experience adjusted for qualitative factors, such as current economic conditions, including current home sales and foreclosures, unemployment rates and retail sales. Non-impaired classified loans are assigned a higher allowance factor based on an internal migration analysis, which increases with the severity of classification, than non-classified loans.
Estimates for the allowance for loan losses are determined by analyzing historical losses, historical migration to charge-off experience, current trends in delinquencies and charge-offs, the results of regulatory examinations and changes in the size, composition and risk assessment of the loan portfolio. Also included in management’s estimate for the allowance for loan losses are considerations with respect to the impact of current economic events. These events may include, but are not limited to, fluctuations in overall interest rates, political conditions, legislation that may directly or indirectly affect the banking industry and economic conditions affecting specific geographical areas and industries in which the Company conducts business.
While management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses and methodology may be necessary if economic or other conditions differ substantially from the assumptions used in making the estimates. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels vary from previous estimates. A detailed discussion of the methodology used in determining the allowance for loan losses is included in Note 1, Basis of Presentation, in Notes to Consolidated Financial Statements.
Fair Value of Financial Instruments: A portion of the Company’s assets and liabilities is carried at fair value, with changes in fair value recorded either in earnings or accumulated other comprehensive income (loss). These include investment securities available for sale and interest rate loan swaps on qualifying commercial loans. Periodically, the estimation of fair value also affects investment securities held to maturity when it is determined that an impairment write-down is other than temporary. Fair value determination is also relevant for certain other assets such as other real estate owned, which is recorded at the lower of the recorded balance or fair value, less estimated costs to sell. The determination of fair value also impacts certain other assets that are periodically evaluated for impairment using fair value estimates, including impaired loans.
Fair value is generally based upon quoted market prices, when available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use observable market-based parameters as inputs. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the Company’s creditworthiness, among other things, as well as other unobservable parameters. Any such valuation adjustments are applied consistently over time. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
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See Note 20, Fair Value Presentation, in Notes to Consolidated Financial Statements for a detailed discussion of determining fair value, including pricing validation processes.
Income Taxes: The Company’s income tax expense, deferred tax assets and liabilities, and reserves for unrecognized tax benefits reflect management’s best assessment of estimated taxes due. The calculation of each component of the Company’s income tax provision is complex and requires the use of estimates and judgments in its determination. As part of the Company’s evaluation and implementation of business strategies, consideration is given to the regulations and tax laws that apply to the specific facts and circumstances for any tax positions under evaluation. Management closely monitors tax developments on both the federal and state level in order to evaluate the effect they may have on the Company’s overall tax position and the estimates and judgments used in determining the income tax provision and records adjustments as necessary.
Deferred income taxes arise from temporary differences between the tax and financial statement recognition of revenue and expenses. In evaluating the Company’s ability to recover its deferred tax assets within the jurisdiction from which they arise, the Company must consider all available evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and the results of recent operations. A valuation allowance is recognized for a deferred tax asset if, based on the available evidence, it is more likely than not that some portion or all of a deferred tax asset will not be realized. See Note 11, Income Taxes, in Notes to Consolidated Financial Statements for additional information.
Computer Software:The Company incurs certain costs to develop commercial software. For software that is to be sold, significant areas of judgment include: establishing when technological feasibility has been met and costs should be capitalized, determining the appropriate period over which to amortize the capitalized costs based on the estimated useful lives, estimating the marketability of the commercial software product and related future revenues, and assessing the unamortized cost balances for impairment. Costs incurred prior to establishing technological feasibility are expensed as incurred. Amortization begins on the date of general release and the appropriate amortization period is based on estimates of future revenues from sales of the products. We consider various factors to project marketability and future revenues, including an assessment of alternative solutions or products, current demand for the product, and anticipated changes in technology that may make the product obsolete.
The Bank’s computer software developments are described more fully in Note 8 in the December 31, 2021, Consolidated Financial Statements.
Derivative Financial Instruments:The Bank recognizes derivative financial instruments at fair value as either other assets or other liabilities in the consolidated balance sheet. The Bank’s derivative financial instruments include interest rate swaps with certain qualifying commercial loan customers and dealer counterparties. Because the interest rate swaps with loan customers and dealer counterparties are not designated as hedging instruments, adjustments to reflect unrealized gains and losses resulting from changes in fair value of these instruments are reported as noninterest income or noninterest expense, as applicable. The Bank’s interest rate swaps with loan customers and dealer counterparties are described more fully in Note 19 in the December 31, 2021, Consolidated Financial Statements.
Selected Financial Data
The following table sets forth summarized historical consolidated financial information for each of the periods indicated. This information should be read together with the accompanying consolidated financial statements included in this Form 10-K. The historical information indicated as of and for the years ended December 31, 2021 2020 and 2019, has been derived from the Company's audited consolidated financial statements for the years ended December 31, 2021, 2020 and 2019. Historical results set forth below and elsewhere in this Form 10-K are not necessarily indicative of future performance
At December 31,
(In thousands)
Selected Financial Condition Data:
Loans held for sale — 57,006
Computer software, net of amortization 2,493 —
FHLB advances and other borrowings — —
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For the year ended December 31,
(In thousands)
Selected Operating Data:
Provision for (recovery of) loan losses (1,175 ) 3,610
Net interest income after provision for (recovery of) loan losses 54,711 42,367
Less: Preferred stock dividends 2,156 635
Net income available to common shareholders $ 20,015 $ 15,082
Basic and diluted net income per common share $ 2.65 $ 1.85
At or For the Years Ended December 31,
Performance Ratios:
Return on average assets 1.32 % 1.05 %
Interest rate spread 2.94 % 2.69 %
Net interest margin 3.33 % 3.21 %
Non-interest expense to average assets 1.95 % 2.02 %
Per share Data and Shares Outstanding
Earnings per common share (basic and diluted) $ 2.65 $ 1.85
Book value per common share $ 21.27 $ 18.86
Market value per common share $ 24.59 $ 16.91
Capital Ratios (Bank)
Common equity tier 1(CET1) capital to risk-weighted assets 15.23 % 13.61 %
Total risk-based capital to risk-weighted assets 16.06 % 14.60 %
Tier 1 capital to risk-weighted assets 15.23 % 13.61 %
Tier 1 capital to average assets 12.90 % 10.78 %
Asset Quality Ratios
Allowance for loan losses as a percentage of total loans 0.86 % 1.03 %
Allowance for loan losses to non-performing assets 15.09 9.68
Net charge-offs to average outstanding loans during the period 0.00 % 0.03 %
Non-performing loans as a percentage of total loans 0.00 % 0.01 %
Non-performing assets as a percentage of total assets 0.05 % 0.08 %
Other Data:
Common equity / total assets 9.80 % 8.54 %
Total equity / total assets 11.46 % 10.20 %
Average equity to average assets 10.63 % 9.96 %
Number of offices 6 7
Number of full-time equivalent employees 138 126
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Analysis of Results of Operations for the Years Ended December 31, 2021 and 2020
Net Income
The following table sets forth the principal components of net income for the periods indicated.
For the Year Ended December 31,
(In thousands)
Net income for the year ended December 31, 2021, was $22.2 million, an increase of $6.5 million, or 41.1% compared to $15.7 million earned during the year ended December 31, 2020. The increase in net income was due to $7.6 million of additional net interest income, primarily driven by increased volume of loans and decrease in interest rates on interest-bearing deposits, as well as a recovery of loan loss provision of $1.2 million. The increase in non-interest expenses was due to a $1.4 million increase in salaries and employee benefits and increases in general operating expenses.
Net Interest Income and Net Interest Margin
Net interest income is the principal component of the Company’s income stream and represents the difference, or spread, between interest and fee income generated from earning assets and the interest expense paid on deposits and borrowed funds. Net interest margin, stated as a percentage, is the yield obtained by dividing the difference between interest income generated on earning assets and the interest expense paid on all funding sources by average earning assets. Fluctuations in interest rates as well as changes in the volume and mix of earning assets and interest-bearing liabilities can impact net interest income and net interest margin.
Net interest income before provision for or recovery of loan losses totaled $53.5 million for the year ended December 31, 2021, compared to $46.0 million for the year ended December 31, 2020. The increase in net interest income was driven by an increase in loan production and decrease in interest rates on interest-bearing deposits during the year for the year ended December 31, 2021.
The net interest margin was 3.33% for the year ended December 31, 2021, compared to 3.21% for the year ended December 31, 2020. The increase in net interest margin primarily resulted from a decrease in average rates on our cost of funds, primarily in wholesale deposits, money market deposits and other borrowings. The increase from lower cost deposits were offset by set continued margin pressure on our loan portfolio and other interest earning assets. In addition, loans associated with the Paycheck Protection Program (“PPP”) carried a below market rate of 1.00%.
The yield for the year ended December 31, 2021 for the loan portfolio was 4.79% compared to 4.89% for the year ended December 31, 2020. The decrease primarily reflects the maturity of higher yielding loans and lower yields on new loans based on lower interest rates originated during the year. The Federal Reserve decreased its targeted benchmark interest rate to 0-25 basis points in the prior year, which impacted yields obtained on new loans.
For the year ended December 31, 2021, the yield on the total investment securities portfolio was 2.32% compared to 2.63% for the year ended December 31, 2020. The decrease of 31 basis points was primarily due to rates on variable securities decreasing with the current rate environment and lower yields on investment securities purchased during the period.
The rate paid on interest bearing deposits decreased to 0.90% during the year ended December 31, 2021, from 1.58% during the year ended December 31, 2020. This decrease was a result of lower rates paid on all outstanding deposits in conjunction with the decreasing rate environment throughout the year.
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The rate paid on FHLB borrowings for the year ended December 31, 2021 was negligible compared to 1.73% for the corresponding period in 2020. This decrease was due to no outstanding balances for these types of borrowings.
The following table sets forth the major components of net interest income and the related yields and rates for the year ended December 31, 2021, compared to the year ended December 31, 2020.
Average Balances, Net Interest Income, Yields Earned and Rates Paid
The following table shows for the periods indicated the total dollar amount of interest from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. All average balances are based on daily balances.
For the Year Ended December 31,
(Dollars in thousands)
Interest-earning assets:
Interest-bearing liabilities:
Non-interest-bearing liabilities:
Interest rate spread (2) 2.94 % 2.69 %
Net interest margin (4) 3.33 % 3.21 %
Net interest margin, excluding PPP loans(5) 3.19 % 3.21 %
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Rate/ Volume Analysis
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 proportionately, based on the changes due to rate and the changes due to volume.
For the Twelve Months Ended
Increase (Decrease) Due to Total Increase
Volume Rate (Decrease)
(In thousands)
Interest-earning assets:
Federal funds and interest-bearing deposits 173 (470 ) (297 )
Interest-bearing liabilities:
Interest-bearing demand deposits $ 169 $ (257 ) $ (88 )
Savings and NOW deposits 26 (82 ) (56 )
Federal Home Loan Bank advances (107 ) — (107 )
Total interest-bearing liabilities 484 (5,916 ) (5,432 )
Provision for Loan Losses
We establish a provision for loan losses, which is charged to operations, in order to maintain the allowance for loan losses at a level we consider necessary to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimated at the balance sheet date. In determining the level of the allowance for loan losses, we consider past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan and the levels of non-performing loans. The amount of the allowance is based on estimates, and actual losses may vary from such estimates as more information becomes available or economic conditions change.
This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as circumstances change as more information becomes available. The allowance for loan losses is assessed on a monthly basis and provisions are made for loan losses as required in order to maintain the allowance.
The provision for loan losses decreased to a recovery of loan loss provision of $1.2 million for the year ended. The decrease is as a direct result of recovering the special COVID-19 pandemic provision that was provisioned for in 2020. After assessing the impact that the COVID-19 pandemic had our loan portfolio and analyzing the credit strength we have been able to maintain, management believes we no longer needed the special COVID-19 provision we assessed in 2020. The portfolio continues to consistently perform well as management monitors key economic indicators that could have an impact on our loan profile. Offsetting this decrease were increases in loan loss provision due to normal loan growth. Loan originations increased $166.2 million, which totalled $409.4 million for the year ended December 31, 2020 compared to loan originations of $575.6 million for the year ended December 31, 2021. Loan originations included $52.0 million in PPP loans during the year ended December 31, 2021. Non-performing loans were $149,000 at December 31, 2020 and $0 at December 31, 2021. During the year ended December 31, 2021, substandard loans increased $3.2 million for a balance of $5.3 million. During the year ended December 31, 2021, special mention loans increased $15.5 million, however this increase is attributable to one relationship in the hospitality industry and is being actively managed. Management does not believe any loss currently exists in these loans but due to the disproportionate impact COVID-19 has had on the hospitality industry, the Bank is managing these credits closely. During the year ended December 31, 2021, there were $32,000 in charge-offs and recoveries of $27,000 were received. During the year ended December 31, 2020, there were $1.9 million in charge-offs recorded and recoveries received of $1.5 million.
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Non-Interest Income
Our primary sources of non-interest income are service charges on deposit accounts, such as interchange fees and statement fees, income earned on bank owned life insurance, fees earned from executing interest rate swaps on commercial loans, and gains realized on the sale of the guaranteed portion of Small Business Administration (“SBA”) loans.
The following table presents, for the period indicated, the major categories of non-interest income:
For the Year Ended December 31,
(In thousands)
Non-interest income
Net gain on called held-to-maturity securities 6 — -100.00 %
Non-interest income decreased $1.3 million, or 18.0%, to $6.1 million for the year ended December 31, 2021 from $7.5 million for the year ended December 31, 2020. The decrease in non-interest income was primarily due to a decrease in fees earned from executing interest rate swaps on commercial loans for the year ended December 31, 2021. Fees earned on interest rate swaps for commercial loans decreased $3.4 million, or 97.6%, to $83,000 for the year ended December 31, 2021 from $3.5 million for the year ended December 31, 2020. This increase was purely related to the volume of interest rate swaps entered into during 2020 compared to 2021. This decrease was offset by an increase in service fees on our business accounts of $510,000 for the year ended December 31, 2021. Gains on sale of loans increased $814,000 compared the same period in 2020, this increase was attributed to the sale of loans held for sale and the guaranteed portion of SBA loans. Bank owned life insurance income increased $121,000 for the year ended December 31, 2021 compared to the year ended December 31, 2020, due to additional policies purchased later in the prior year and being able to realize the income for a full year.
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 bank 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, professional fees, advertising expenses and other general and administrative expenses, including FDIC assessments, communications, travel, meals, training, supplies and postage. The following table presents, for the periods indicated, the major categories of non-interest expense:
For the Year Ended December 31,
(In thousands)
Non-interest expense
Other real estate expenses, net 84 459 -81.70 %
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Non-interest expense increased $2.6 million or 8.6% to $32.9 million for the year ended December 31, 2021 from $30.3 million for the year ended December 31, 2020 primarily as a result of increases in salary and employee benefits of $1.4 million, advertising and marketing expenses of $562,000 and outside services of $435,000. Salaries and employee benefits expense increased by $1.4 million to $19.3 million for the year ended December 31, 2021 from $17.9 million for the year ended December 31, 2020 primarily as a result of increasing our personnel team members by 12 employees. Advertising and marketing increased $562,000, or 56.0%, to $1.5 million for the year ended December 31, 2021 from $1.0 million for the year ended December 31, 2021. Outside service expenses increased $435,000, or 45.4%, to $1.4 million for the year ended December 31, 2021, due to investments in the Company’s payments division and other technological infrastructure. Offsetting these increases, our FDIC insurance decreased approximately $278,000 to $1.1 million for the year ended December 31, 2021 from $1.3 million for the year ended December 31, 2020. This decrease was attributed to continued financial strength that resulted in a reduction of FDIC assessments.
Income Tax Expense
Income tax expense increased $1.9 million, or 50.5%, to $5.8 million for the year ended December 31, 2021 from $3.8 million for the year ended December 31, 2020. The increase in federal income tax expense for the year ended December 31, 2021 compared to the same period a year ago was driven by the increase in income before income taxes of $8.4 million, or 42.9%, to $28.0 million as of December 31, 2021 compared to $19.6 million for the same period in the prior year. As a result of tax regulation, the Company has included assessments in income tax expense for state tax liabilities during 2021. For the year ended December 31, 2021, the Bank had an effective tax rate of 20.7%, compared to effective federal tax rate of 19.6% for the year ended December 31, 2020.
a division of MainStreet Bank
Analysis of Results of Operations for the Year Ended December 31, 2021
Net Income
The following table sets forth the principal components of net income for Avenu for the period indicated. All amounts set forth are included in the Results of Operations for the Year Ended December 31, 2021 for MainStreet Bancshares, Inc.
For the Year Ended December 31,
(In thousands)
Income Statement
Service charge income $ 904
Other income 46
Total income 950
Salaries and employee benefits 521
Outside services 235
Data processing 60
Other operating expenses 53
Total expense 869
Net income before taxes $ 81
Net income for the year ended December 31, 2021, was $81,000 and serves as a “value-add” to MainStreet Bank. Net income of $81,000 does not include transfer pricing on the $68.7 million in non-interest bearing deposits that greatly enhances the overall value Avenu brings to the Company. Avenu is developing a comprehensive hosted BaaS software platform that will provide Fintechs with a subledger integrated within a regulatory compliant framework, easily connectable APIs, and access to banking payment networks. Avenu expects to deploy this platform in 2022.
Comparison of Statements of Financial Condition at December 31, 2021 and at December 31, 2020
Total Assets
Total assets increased $4.2 million, or 0.3%, to $1.6 billion at December 31, 2021 from $1.6 billion at December 31, 2020. The increase was primarily the result of increases of $109.5 million in gross loans receivable, $11.0 million restricted securities, and $10.9 million in bank owned life insurance. These increases were offset by decreases in cash equivalents and other assets of $14.3 million and $8.8 million, respectively.
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Investment Securities
We use our securities portfolio to provide a source of liquidity, provide an appropriate return on funds invested, manage interest rate risk, meet collateral requirements and meet regulatory capital and liquidity requirements. Our investment policy is established and reviewed annually by the Board of Directors. We are permitted under federal law to invest in various types of liquid assets, including United States Government obligations, securities of various federal agencies and of state and municipal governments, mortgage-backed securities, time deposits of federally insured institutions, subordinated debt of other financial institutions, certain bankers’ acceptances and federal funds.
Our investment objectives are to maintain high asset quality, to provide and maintain liquidity, to establish an acceptable level of interest rate and credit risk, to provide an alternate source of low-risk investments when demand for loans is weak and to generate a favorable return. The Board of Directors has the overall responsibility for the investment portfolio, including approval of our investment policy. The Board of Directors is also responsible for implementation of the investment policy and monitoring investment performance. The Board of Directors reviews the status of the investment portfolio on a quarterly basis, or more frequently if warranted.
Generally accepted accounting principles require that, at the time of purchase, we designate a security as held to maturity, available-for-sale, or trading, depending on our ability and intent to hold such security. Debt securities available for sale are reported at fair value, while debt securities held to maturity are reported at amortized cost. We do not maintain a trading portfolio. Establishing a trading portfolio would require specific authorization by the Board of Directors.
The total investment securities portfolio, including both investment securities available for sale and investment securities held to maturity, was $120.3 million at December 31, 2021, a decrease of $49.7 million compared with December 31, 2020. At December 31, 2021, the investment securities portfolio includes $99.9 million of investment securities available for sale and $20.3 million of investment securities held to maturity compared to $147.4 million of investment securities available for sale and $22.5 million of investment securities held to maturity at December 31, 2020.
The Company did not sell any securities within the investment portfolio for the year ended December 31, 2021 or 2020.
While all securities are reviewed by the Company for other-than-temporary impairments (“OTTI”), the securities that typically are impacted by credit impairment are non-agency collateralized mortgage obligations and asset-backed securities. Refer to Note 3, in Notes to Consolidated Financial Statements for further details. To date, we have had no OTTI.
Portfolio Maturities and Yields. The composition and maturities of the investment securities portfolio at December 31, 2021, are summarized in the following table. 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. Adjustable-rate mortgage-backed securities are included in the period in which interest rates are next scheduled to adjust. The Company does invest in both taxable and non-taxable municipal securities. No material changes occurred in the non-taxable security portfolio for the year ended December 31, 2021.
More than One Year More than Five Years More than
One Year or Less through Five Years through Ten Years Ten Years Total
Weighted Weighted Weighted Weighted Weighted
Cost Yield (1) Cost Yield (1) Cost Yield (1) Cost Yield (1) Cost Value Yield (1)
(Dollars in thousands)
Securities available for sale:
Municipal Securities
Securities held to maturity:
Municipal Securities
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Loan Portfolio
Our primary source of income is derived from interest earned on loans. Our loan portfolio consists of loans secured by real estate as well as commercial business loans and consumer loans, substantially all of which are secured by corresponding deposits at the Bank. Our loan customers primarily consist of small- to medium-sized businesses, professionals, real estate investors, small residential builders and individuals. Our owner occupied and investment commercial real estate loans, residential construction loans and commercial business loans provide us with higher risk-adjusted returns, shorter maturities and more sensitivity to interest rate fluctuations, and are complemented by our relatively lower risk residential real estate loans to individuals. Our lending activities are principally directed to our market area consisting of the Washington, D.C. and Northern Virginia metropolitan areas.
Loan Portfolio Maturities and Yields.The following table summarizes the scheduled repayments of our loan portfolio at December 31, 2021. Demand loans, having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less. Maturities are based on the final contractual payment date and do not reflect the impact of prepayments and scheduled principal amortization.
Single-Family Multi-Family Farmland Owner Occupied Non-owner Occupied
(In thousands)
Amounts due in:
Construction and Land Development Commercial and Industrial Consumer Total
Amounts due in: (In thousands)
After fifteen years — — — 24,656
The following table sets forth our fixed and adjustable-rate loans at December 31, 2021 that are contractually due after December 31, 2021.
Fixed Adjustable
Rates Rates Total
(In thousands)
Residential real estate:
Commercial real estate:
Commercial – non-real estate:
Consumer – non-real estate:
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The following table shows our loan originations, participations, purchases, sales and repayment activities for the periods indicated.
Years Ended December 31,
(In thousands)
Loans originated:
Real estate loans:
Residential real estate:
Commercial real estate:
Commercial – non-real estate:
Consumer – non-real estate:
Loan principal repayments:
Loans transferred to other real estate owned:
Transfers to other real estate owned — 362
Loans transferred to (from) loans held for sale:
Transfers to (from) loans held for sale (26,046 ) 57,006
Loans, net of unearned income, totaled $1.4 billion at December 31, 2021, an increase of $109.5 million from December 31, 2020. The increase in total loans was primarily driven by growth in the overall loan portfolio, with significant increases in multifamily residential real estate, as well as the non-owner occupied commercial real estate portfolio.
Asset Quality
The Company’s asset quality remained strong during the year ended December 31, 2021. Nonperforming assets, which includes nonaccrual loans, accruing loans 90 days past due, accruing troubled debt restructured (“TDR”) loans 90 days past due, and other real estate owned totaled $775,000 at December 31, 2021 and $1.3 million at December 31, 2020.
A loan’s past due status is based on the contractual due date of the most delinquent payment due. All loans which are 30 or more days past due at the end of the month are reported to the Board of Directors. Commercial loans are generally placed on nonaccrual status when the collection of principal or interest is 90 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value of the collateral and the financial strength of the borrower. Consumer loans are generally placed on nonaccrual status when the collection of principal or interest is 120 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value of the collateral and the financial strength of the borrower. Loans greater than 90 days past due may remain on accrual status if management determines it has adequate collateral to cover the principal and interest. For those loans that are carried on nonaccrual status, payments are first applied to principal outstanding. A loan may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed.
The Company may identify loans for potential restructure primarily through direct communication with the borrower and evaluation of the borrower’s financial statements, revenue projections, tax returns, and credit reports. Even if the borrower is not presently in default,
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management will consider the likelihood that cash flow shortages, adverse economic conditions and negative trends may result in a payment default in the near future.
As a percentage of total assets, nonperforming assets were 0.05% at December 31, 2021 compared with 0.08% at December 31, 2020. As of December 31, 2021, the Company had no loans placed on nonaccrual status.
See Note 1, Organization, Basis of Presentation, and Impact of Recently Issued Accounting Pronouncements and Note 5, Allowance for Loan Losses, in Notes to Consolidated Financial Statements for further information on the Company’s credit grade categories, which are derived from standard regulatory rating definitions.
The following table summarizes asset quality information at December 31, 2021 and December 31, 2020.
December 31, December 31,
(Dollars in thousands)
Non-accrual loans:
Residential real estate
Single family $ — $ 149
Total non-accrual loans — 149
Total non-performing loans — 149
Total non-performing assets $ 775 $ 1,329
Ratios:
Total non-performing loans to gross loans receivable 0.00 % 0.01 %
Total non-performing loans to total assets 0.00 % 0.01 %
Total non-performing assets to total assets 0.05 % 0.08 %
Interest income that would have been recorded for the years ended December 31, 2021 and 2020 had non-accruing loans been current according to their original terms amounted to $0 and $45 respectively. We did not recognize any interest income for these loans for the years ended December 31, 2021 and 2020, respectively.
According to United States generally accepted accounting principles, restructuring a debt constitutes a TDR if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The CARES Act states that from March 1, 2020, until the end of the year (unless the President terminates the COVID-19 emergency declaration sooner), financial institutions may elect to suspend the TDR accounting principles for loan modifications related to COVID-19. The Consolidated Appropriations Act of 2021, enacted in December 2020, extended this relief to the earlier of January 1, 2022 or the first day of a bank’s fiscal year that begins after the national emergency ends.
The suspension applies during the modification. A modification can be a forbearance agreement, a new repayment plan, interest rate modification, or any other arrangement that defers or delays the payment of principal or interest. This provision applies only to loans that were current or less than 30 days past due on payments as of December 31, 2019.
The agencies are to defer to the financial institutions to suspend the TDR requirements. Financial institutions may presume that borrowers current on payments are not experiencing financial difficulties at modification to determine TDR status, and no further TDR analysis is required for each loan modification in the program. Examiners will exercise judgment in reviewing loan modifications, including TDRs, will not automatically adversely risk rate credits affected by COVID-19, and will not criticize prudent efforts to modify the terms on existing loans to affected customers.
As of December 31, 2021, there were no loans not disclosed in the above table, where known information about possible credit problems of borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms.
Analysis and Determination of the Allowance for Loan Losses.The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb probable and estimable credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. Because of uncertainties associated with regional economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that management’s estimate of probable credit losses inherent in the loan portfolio and the related allowance may change materially in the near-term. The allowance is increased by a provision for loans losses which is charged to expense and reduced by full and partial charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Management’s periodic evaluation of the adequacy of the allowance is
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based on various factors, including, but not limited to, management’s ongoing review and grading of loans, facts and issues related to specific loans, historical loan loss or loan pools, the fair value of the underlying collateral, current economic conditions and other qualitative and quantitative factors which could affect potential credit losses. An integral part of their examination process, the Federal Reserve Board will periodically review our allowance for loan losses, and as a result of such reviews, we may have to adjust our allowance for loan losses.
The following table sets forth activity in our allowance for loan losses for the periods indicated.
For the Year Ended December 31, For the Year Ended December 31,
(Dollars in thousands)
Charge-offs:
Commercial real estate — (1 )
Commercial industrial — (1,792 )
Total charge-offs (32 ) (1,853 )
Recoveries:
Residential real estate — 2
Commercial and industrial 11 1,526
Net charge-offs (5 ) (317 )
Provision for (recovery of) loan losses (1,175 ) 3,610
Ratios:
Net charge offs to average loans outstanding (annualized) 0.00 % 0.03 %
Allowance for loan losses to non-performing loans at end of period N/A 8,642.28
Allowance for loan losses to gross loans at end of period 0.86 % 1.03 %
At December 31, 2021, our allowance for loan losses represented 0.86 % of total loans and had no non-performing loans. The allowance for loan losses decreased to $11.7 million at December 31, 2021 from $12.9 million at December 31, 2020 primarily as a direct result of recovering provisions for loan losses in response to the COVID-19 pandemic that were assessed as no longer necessary. These provision recoveries were offset by provision expense on newly originated loans. There were $5,000 and $317,000 in net loan charge-offs during the years ended December 31, 2021 and December 31, 2020, respectively.
Allocation of Allowance for Loan Losses.The following table sets forth the allowance for loan losses allocated by loan category and the percent of the allowance in each category to the total allocated allowance at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.
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At December 31,
Residential Real Estate:
Commercial Real Estate:
Commercial – Non Real Estate:
Consumer – Non Real Estate:
(1) No allowance assigned to $58.3 million in PPP loans due to SBA guarantee
Funding Activities
Deposits are the primary source of funds for lending and investing activities and their cost is the largest category of interest expense. The Company also utilizes brokered deposits as a funding source in addition to customer deposits. Scheduled payments, as well as prepayments, and maturities from portfolios of loans and investment securities also provide a stable source of funds. FHLB advances, other secured borrowings, federal funds purchased, and other short-term borrowed funds, as well as longer-term debt issued through the capital markets, all provide supplemental liquidity sources. The Company’s funding activities are monitored and governed through the Company’s asset/liability management process
Deposits
Total deposits increased by $146.2 million from December 31, 2020 to December 31, 2021. Brokered deposits, which are included in the table below, totaled $245.5 million and $279.9 million at December 31, 2021 and December 31, 2020, respectively. The following table presents the Company’s average deposits segregated by major category for the year ended December 31, 2021:
At December 31,
(Dollars in thousands)
Deposit type:
The overall increase in total deposits was primarily driven by an increase in non-interest bearing demand deposits and money market deposits largely due to our deposit gather strategies as well as balances related to the PPP initiative. The increase was partially offset by a
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decrease in time deposits. Time deposits decreased from December31, 2021 compared to December 31, 2020 primarily as a result of decreasing our more expensive wholesale deposits and replacing them with low cost and non-interest bearing deposits.
The Company had $682.2 million in total deposits in excess of the FDIC insurance limit of $250,000.
Certificates of deposit in amounts in excess of the FDIC insurance limit of $250,000 totaled approximately $249.9 million. The following table sets forth the maturity of these certificates as of December 31, 2021.
(In thousands)
Maturity period:
Three months or less $ 9,916
Over three through six months 37,662
Over six through twelve months 17,708
Over twelve months through three years 184,004
Over three years 604
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The following table sets forth all of our time deposits classified by interest rate as of the dates indicated.
At December 31,
(In thousands)
Interest Rate Range:
The following table sets forth by interest rate ranges information concerning the maturities of our certificates of deposit as of December 31, 2021.
Period to Maturity
(Dollars in thousands)
Interest Rate Range:
Borrowed Funds
We may obtain advances from the Federal Home Loan Bank of Richmond upon the security of the common stock we own in that bank and certain of our residential mortgage loans, provided certain standards related to creditworthiness have been met. These advances are made pursuant to several credit programs, each of which has its own interest rate and range of maturities. Federal Home Loan Bank advances are generally available to meet seasonal and other withdrawals of deposit accounts and to permit increased lending.
At December 31, 2021 and 2020, we were permitted to borrow up to an aggregate total of $414.0 million and $407.7 million, respectively, from the Federal Home Loan Bank of Richmond. There were Federal Home Loan Bank borrowings outstanding of $0 at December 31, 2021 and December 31, 2020. Additionally, we had credit availability of $104.0 million with correspondent banks for short-term liquidity needs, if necessary. No borrowings were outstanding at December 31, 2021 and 2020, under this facility.
Liquidity and Capital Resources
Liquidity is the ability of the Company to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management involves maintaining the Company’s ability to meet the day-to-day cash flow requirements of its customers, whether they are depositors wishing to withdraw funds or borrowers requiring funds to meet their credit needs. Without proper liquidity management, the Company would not be able to perform the primary function of a financial intermediary and would, therefore, not be able to meet the needs of the communities it serves.
The Company assesses liquidity needs on a daily basis using a sophisticated monitoring system that identifies daily sources and uses for a rolling 30-day period. The Company also assesses liquidity needs under various scenarios of market conditions, asset growth and changes in credit ratings. The assessment includes liquidity stress testing which measures various sources and uses of funds under the different scenarios. The assessment provides regular monitoring of unused borrowing capacity and available sources of contingent liquidity to prepare for unexpected liquidity needs and to cover unanticipated events that could affect liquidity.
The asset portion of the balance sheet provides liquidity primarily through unencumbered debt securities available for sale, loan principal and interest payments, maturities and prepayments of investment securities held to maturity and, to a lesser extent, sales of investment debt securities available for sale. Other short-term investments such as federal funds sold and maturing interest- bearing deposits with other banks, are additional sources of liquidity.
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The liability portion of the balance sheet provides liquidity through various customers’ interest-bearing and noninterest-bearing deposit accounts and through FHLB and other borrowings. Brokered deposits, federal funds purchased, and other short-term borrowings are additional sources of liquidity and, basically, represent the Company’s incremental borrowing capacity. These sources of liquidity are used as necessary to fund asset growth and meet short-term liquidity needs.
In addition to the Company’s financial performance and condition, liquidity may be impacted by the Company’s structure as a bank holding company that is a separate legal entity from the Bank. The Company requires cash for various operating needs that could include payment of dividends to its stockholder, the servicing of debt, and the payment of general corporate expenses. The primary source of liquidity for the Company is dividends paid by the Bank. Applicable federal and state statutes and regulations impose restrictions on the amount of dividends that may be paid by the Bank. In addition to the formal statutes and regulations, regulatory authorities also consider the adequacy of the Bank’s total capital in relation to its assets, deposits and other such items. Any future dividends must be set forth in the Company's capital plans before any dividends can be paid.
The Company’s ability to raise funding at competitive prices is affected by the rating agencies’ views of the Company’s credit quality, liquidity, capital and earnings. Management meets with the rating agencies on a routine basis to discuss the current outlook for the Company.
The Board of Director and the Asset Liability Committee (ALCO) are responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we have enough sources of liquidity to satisfy our short and long-term liquidity needs as of December 31, 2021.
We monitor and adjust our investments in liquid assets based upon our assessment of: (1) expected loan demand; (2) expected deposit flows; (3) yields available on interest-earning deposits and securities; and (4) the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits and short-and intermediate-term securities.
While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. Our most liquid assets are cash and cash equivalents, which include federal funds sold and interest-earning deposits in other banks. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At December 31, 2021, cash and cash equivalents totaled $93.2 million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $99.9 million at December 31, 2021.
Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities. Net cash provided by operating activities was $60.4 million and $17.0 million for the twelve months ended December 31, 2021 and December 31, 2020, respectively. Net cash used in investing activities, which consists primarily of disbursements for loan originations and the purchase of securities, offset by principal collections on loans and proceeds from maturing securities, was $60.5 million and $313.8 million for the twelve months ended December 31, 2021 and December 31, 2020, respectively. There were no sales of available-for-sale debt securities in 2021 or 2020. Net cash used in financing activities was $14.2 million and provided by financing activities was $339.4 million for the twelve months ended December 31, 2021 and 2020, respectively, which consisted primarily of decreases in interest bearing and increases in non-interest bearing deposits for the twelve months ended December 31, 2021. There were no net repayments from the Federal Home Loan Bank for year ended 2021.
We are committed to maintaining a strong liquidity position. We monitor our liquidity position on a daily basis. We anticipate that we will have sufficient funds to meet our current funding commitments. Certificates of deposit due within one year of December 31, 2021, totaled $207.3 million of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds in the normal course of business, including other deposits and Federal Home Loan Bank advances. Depending on market conditions, we may be required to pay higher rates on such deposits or borrowings than we currently pay. We believe, however, based on past experience that a significant portion of such deposits will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered. Management believes that the current sources of liquidity are adequate to meet the Company’s requirements and plans for continued growth.
Regulatory Capital
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of 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.
The federal regulatory capital rules apply to all depository institutions as well as to bank holding companies with consolidated assets of $3 billion or more. However, the regulatory capital requirements generally do not apply on a consolidated basis to a bank holding company with total consolidated assets of less than $3 billion unless the holding company: (1) is engaged in significant nonbanking activities either
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directly or through a nonbank subsidiary; (2) conducts significant off-balance sheet activities (including securitization and asset management or administration) either directly or through a nonbank subsidiary; or (3) has a material amount of debt or equity securities outstanding (other than trust preferred securities) that are registered with the Securities and Exchange Commission. The Federal Reserve may apply the regulatory capital standards at its discretion to any bank holding company, regardless of asset size, if such action is warranted for supervisory purposes.
Because the Company has total consolidated assets of less than $3 billion and does not engage in activities that would trigger application of the federal regulatory capital rules, it is not at present subject to consolidated capital requirements under the such rules.
The Basel III Capital Rules, a comprehensive capital framework for U.S. banking organizations, became effective for the Company and the Bank on January 1, 2015 (subject to a phase-in period for certain provisions). Under the Basel III rules, the Company must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The capital conservation buffer was phased in from 0.0% for 2015 to 2.50% by 2019. The capital conservation buffer for 2021 and 2020 is 2.50%. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios of Total capital, Common Equity Tier 1 capital, and Tier 1 capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2021, the Company and the Bank meets all capital adequacy requirements to which it is subject.
As of December 31, 2021 and 2020, the most recent notification from the Federal Reserve Bank of Richmond categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Common Equity Tier 1 risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Bank’s category.
The Bank’s actual regulatory capital amounts and ratios as of December 31, 2021 and 2020 are presented in the table below.
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
Non-GAAP Measures
In reporting the results of December 31, 2021, the Company has provided supplemental performance measures on an operating basis. These measures are a supplement to GAAP used to prepare the Company’s financial statements and should not be considered in isolation or as a substitute for comparable measures calculated in accordance with GAAP. In addition, the Company’s non-GAAP measures may not be comparable to non-GAAP measures of other companies. The Company uses the non-GAAP measures discussed herein in its analysis of the Company’s performance.
Net interest margin excluding PPP loans, which is used in computing net interest margin, provides valuable additional insight into the net interest margin and the impact the Paycheck Protection Program has had on our financial metrics. The entire PPP adjustment is attributable to the interest received on PPP loans, which is lower than normal market rates, and fees recognized on PPP loans that are amortized ratably over the life of the loan.
The Company believes that Allowance for loan losses, excluding PPP to total loans is a meaningful supplement to GAAP financial measures and useful to investors because it measures the reserves placed aside to absorb possible credit losses inherent in the loan portfolio. PPP loans are backed by the full faith of the SBA and as such, we have not set aside reserves for this segment of the loan portfolio.
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The following table reconciles these non-GAAP measures from their respective GAAP basis measures for the years ended December 31,
For the year ended December 31,
Paycheck Protection Program adjustment impact
Loans held for investment, excluding PPP (non-GAAP) 1,300,596 1,114,255
Average loans held for investment, excluding PPP (non-GAAP) 1,165,907 1,102,835
Net interest margin adjustment
Less: PPP interest income earned 1,235 1,167
Net interest income, excluding PPP income (non-GAAP) 47,328 42,212
Average interest earning assets, excluding PPP (non-GAAP) 1,482,245 1,314,937
Net interest margin (GAAP) 3.33 % 3.21 %
Net interest margin, excluding PPP (non-GAAP) 3.19 % 3.21 %
Allowance for loan losses, adjusted
Allowance for loan losses to total loans, excluding PPP (non-GAAP) 0.90 % 1.16 %
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Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market Risk Management