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
The effective management of market risk is essential to achieving the Company’s strategic financial objectives. As a financial institution, the Company’s most significant market risk exposure is interest rate risk in its balance sheet; however, market risk also includes product liquidity risk, price risk and volatility risk in the Company’s lines of business. The primary objectives of market risk management are to minimize any adverse effect that changes in market risk factors may have on net interest income, and to offset the risk of price changes for certain assets recorded at fair value.
Interest Rate Market Risk
The Company’s net interest income and the fair value of its financial instruments are influenced by changes in the level of interest rates. The Company manages its exposure to fluctuations in interest rates through policies established by its Asset/Liability Committee. The Asset/Liability Committee meets regularly and has responsibility for approving asset/liability management policies, formulating strategies to improve balance sheet positioning and/or earnings and reviewing the interest rate sensitivity of the Company.
We estimate what our net interest income would be for a 12-month period. We then calculate what the net interest income would be for the same period under different interest rate assumptions. These estimates require certain assumptions to be made, including loan and mortgage-related investment prepayment speeds, reinvestment rates, and deposit maturity and decay rates. These assumptions are inherently uncertain. As a result, no simulation model can precisely predict the impact of changes in interest rates on our net interest income.
The table below sets forth, as of December 31, 2021, the calculation of the estimated changes in our net interest income that would result from changes in market interest rates over one year if we take no action from our current plan.
Basis Point Change in Net Interest Income Year 1 Change
Interest Rates Year 1 Forecast From Level
(Dollars in thousands)
Economic Value of Equity (“EVE”). We analyze the sensitivity of our financial condition to changes in interest rates through our economic value of equity model. This analysis measures the difference between predicted changes in the fair value of our assets and predicted changes in the present value of our liabilities assuming various changes in current interest rates. The table below represents an analysis of our interest rate risk as measured by the estimated changes in our economic value of equity, resulting from an instantaneous and sustained parallel shift in the yield curve at December 31, 2021.
Estimated Increase EVE as a Percentage of Fair
(Decrease) EVE Value of Assets(3)
Basis Point Increase
Change in Estimated EVE (Decrease)
Interest Rates(1) EVE(2) Amount Percent Ratio(4) Basis Points
(Dollars in thousands)
(1) Assumes an immediate uniform change in interest rates at all maturities.
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(4) EVE Ratio represents EVE divided by the fair value of assets.
Market Interest Rate Shift
The financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles in the United States of America which require the measurement of financial position and operating results in terms of historical dollars without considering changes in relative purchasing power of money over time due to inflation.
The majority of assets and liabilities of a financial institution are monetary in nature; therefore, a financial institution differs greatly from most commercial and industrial companies, which have significant investments in fixed assets or inventories that are greatly impacted by inflation. However, inflation does have an important impact on the growth of total assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity-to-assets ratio. Inflation also affects other expenses that tend to rise during periods of general inflation.
Management believes the most significant potential impact of inflation on financial results is a direct result of the Company’s ability to manage the impact of changes in interest rates. Management attempts to maintain a balanced position between rate-sensitive assets and liabilities in order to minimize the impact of interest rate fluctuations on net interest income. However, this goal can be difficult to completely achieve in times of rapidly changing interest rates and is one of many factors considered in determining the Company’s interest rate positioning. The Company is asset sensitive as of December 31, 2021. Refer to the Net Interest Income Sensitivity table for additional details on the Company’s interest rate sensitivity.
The Bank also uses derivative financial instruments to manage risk to the Bank associated with changing interest rates, and to assist customers with their risk management objectives. The Bank enters into interest rate swaps with certain qualifying commercial loan customers to meet their interest rate risk management needs. The net result of these interest rate swaps is that the customer pays a fixed rate of interest and the Bank receives a floating rate thus allowing the Bank another tool to further manage the interest rate risk for certain products. These back-to-back loan swaps qualify as financial derivatives with fair values reported in “Other assets” and “Other liabilities” in the Consolidated Balance Sheet.
We believe that our current interest rate exposure is manageable and does not indicate any significant exposure to interest rate changes.
Item 8. Financial Statements and Supplementary Data
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Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors
MainStreet Bancshares, Inc.
Fairfax, Virginia
Opinion on the Financial Statements
We have audited the accompanying consolidated statements of financial condition of MainStreet Bancshares, Inc. and Subsidiaries (the Company) as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for the years then ended, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Yount, Hyde & Barbour, P.C.
We have served as the Company's auditor since 2008.
Winchester, Virginia
March 23, 2022
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Item 8 – Financial Statements and Supplementary Data
Consolidated Financial Statements
Consolidated Statements of Financial Condition as of December 31, 2021 and December 31, 2020 (Dollars in thousands, except per share data)
Assets
Investment securities available-for-sale, at fair value 99,913 147,414
Investment securities held-to-maturity, at amortized cost 20,349 22,520
Loans held for sale — 57,006
Other real estate owned, net 775 1,180
Accrued interest and other receivables 7,701 9,604
Computer software, net of amortization 2,493 —
Liabilities and Stockholders’ Equity
Liabilities
Commitments and contingencies (Note 13)
Stockholders’ Equity
Accumulated other comprehensive income 197 977
See Notes to the Consolidated Financial Statements
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Consolidated Statements of Income for the Years Ended December 31, 2021 and 2020 (Dollars in thousands, except per share data).
For the Year Ended December 31,
Interest Income
Interest and dividends on investment securities
Interest on federal funds sold 134 431
Interest Expense
Interest on interest bearing DDA deposits 229 317
Interest on savings and NOW deposits 165 221
Interest on money market deposits 772 2,162
Interest on Federal Home Loan Bank advances — 107
Interest on subordinated debt 1,884 966
Provision for (recovery of) loan losses (1,175 ) 3,610
Net interest income after provision for (recovery of) loan losses 54,711 42,367
Non-Interest Income
Deposit account service charges 2,426 1,916
Bank owned life insurance income 900 779
Net gain on held-to-maturity securities 6 —
Net gain on sale of loans 847 33
Non-Interest Expense
Furniture and equipment expenses 2,468 2,128
Administrative expenses 685 674
Other real estate expenses, net 84 459
Net Income available to Common Shareholders $ 20,015 $ 15,082
Net Income per common share:
See Notes to the Consolidated Financial Statements
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Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2021 and 2020 (Dollars in thousands)
For the Year Ended December 31,
Comprehensive Income, net of taxes
Other comprehensive income (loss), net of tax expense (benefit):
Other comprehensive income (loss) (780 ) 554
See Notes to the Consolidated Financial Statements
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2021 and 2020 (Dollars in thousands).
Accumulated Other
Preferred Common Capital Retained Comprehensive
Stock Stock Surplus Earnings Income Total
Vesting of restricted stock — 316 (316 ) — — —
Stock based compensation expense — — 1,529 — — 1,529
Dividends on preferred stock — — — (635 ) — (635 )
Other comprehensive income — — — — 554 554
Accumulated Other
Preferred Common Capital Retained Comprehensive
Stock Stock Surplus Earnings Income (Loss) Total
Vesting of restricted stock — 336 (336 ) — — —
Stock based compensation expense — — 1,888 — — 1,888
Dividends on preferred stock — — — (2,156 ) — (2,156 )
Other comprehensive loss — — — — (780 ) (780 )
See Notes to the Consolidated Financial Statements
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Consolidated Statements of Cash Flows (Dollars in thousands)
Cash Flows from Operating Activities
Depreciation, amortization, and accretion, net 1,893 1,746
Amortization of right-of-use assets 472 390
Deferred income tax (benefit) 336 (1,752 )
Writedown of other real estate owned 22 432
Loss (gain) on transfer or sale of other real estate owned 40 (43 )
Provision for (recovery of) loan losses (1,175 ) 3,610
Stock based compensation expense 1,888 1,529
Income from bank owned life insurance (900 ) (779 )
Subordinated debt amortization expense 223 29
Gain on disposal of premises and equipment (57 ) (36 )
Gain on loans held for sale (847 ) —
Gain on called held-to-maturity securities (6 ) —
Proceeds from sale of loans 31,264 —
Change in:
Accrued interest receivable and other receivables 1,903 (4,184 )
Net cash provided by operating activities 60,388 17,016
Cash Flows from Investing Activities
Activity in available-for-sale securities:
Activity in held-to-maturity securities:
Purchases of equity securities (10,651 ) —
Purchases of restricted investment in bank stock (758 ) (1,222 )
Redemption of restricted investment in bank stock 332 2,763
Proceeds from sale of other real estate owned 343 —
Purchases of bank owned life insurance (10,000 ) —
Proceeds from sale of premises and equipment 79 53
Purchases of premises and equipment (1,806 ) (1,282 )
Computer software developed (2,493 ) —
Net cash used in investing activities (60,515 ) (313,786 )
Cash Flows from Financing Activities
Net decrease in Federal Home Loan Bank advances and other borrowings — (40,000 )
Net increase in subordinated debt 14,237 —
Issuance of preferred stock, net — 27,263
Cash dividends paid on preferred stock (2,156 ) (635 )
Repurchase of common stock — (13,797 )
Net cash provided by (used in) financing activities (14,202 ) 339,454
Increase (decrease) in Cash and Cash Equivalents (14,329 ) 42,684
Cash and Cash Equivalents, beginning of period 107,528 64,844
Cash and Cash Equivalents, end of period $ 93,199 $ 107,528
Supplementary Disclosure of Cash Flow Information
Cash paid during the period for interest $ 10,165 $ 16,358
Cash paid during the period for income taxes $ 6,838 $ 4,618
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Transfers from loans to other real estate owned $ — $ 362
Transfers from loans held for sale to loans receivable $ 26,046 $ —
Net unrealized gain (loss) on securities available-for-sale $ (1,023 ) $ 678
See Notes to the Consolidated Financial Statements
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MAINSTREET BANCSHARES, INC. AND SUBSIDIARY
Notes to Unaudited Consolidated Financial Statements
Note 1. Organization, Basis of Presentation and Impact of Recently Issued Accounting Pronouncements
Organization
MainStreet Bancshares Inc. (the “Company”) is a bank holding company incorporated under the laws of the Commonwealth of Virginia whose principal activity is the ownership and management of MainStreet Bank. On May 18, 2016, the stockholders of MainStreet Bank (the “Bank”) approved a Reorganization Agreement and Plan of Share Exchange (“Reorganization”) whereby the Bank would reorganize into a holding company structure. The Plan of Share Exchange called for each outstanding share of Bank common stock to be automatically converted into and exchanged for one share of the Company’s common stock, and the common stockholders of the Bank would become the common stockholders of the Company on the effective date of the Reorganization. On October 12, 2021, the Company filed an election with the Federal Reserve Board to be a financial holding company in order to engage in a broader range of financial activities than are permitted for bank holding companies generally. The Company is authorized to issue 10,000,000 shares of common stock with a par value of $4.00 per share. Additionally, the Company is authorized to issue 2,000,000 shares of preferred stock at a par value $1.00 per share. There are currently 28,750 shares of preferred stock outstanding.
On July 15, 2016, the Reorganization became effective, and the Bank became a wholly-owned subsidiary of the Company. The holding company is regulated under the Bank Holding Company Act of 1956, as amended, and is subject to inspection, examination, and supervision by the Federal Reserve Board.
On April 18, 2019, the Company completed the registration of its common stock with the Securities Exchange Commission through its filing of a General Form for Registration of Securities on Form 10 (“Form 10”), pursuant to Section 12(b) of the Securities Exchange Act of 1934. The Company is considered an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012, or the “JOBS Act,” and as defined in Section 2(a) of the Securities Act of 1933, as amended, or the “Securities Act.” We are also a “smaller reporting company” as defined in Exchange Act Rule 12b-2. As such, we may elect to comply with certain reduced public company reporting requirements in future reports that we file with the Securities and Exchange Commission, or the “SEC.”
We were approved to list shares of our common stock on the Nasdaq Capital Market under our current symbol “MNSB” as of April 22, 2019. We were approved to list depositary shares of preferred stock on the Nasdaq Capital Market on the symbol “MNSBP” as of September 16, 2020. Each depositary share represents a 140th interest in a share of 7.50% Series A Fixed-Rate Non-Cumulative Perpetual Preferred Stock.
In August 2021, the Company created a community development entity (“CDE”) subsidiary, MainStreet Community Capital, LLC, a Virginia limited liability company to promote development in economically distressed areas. This CDE will be an intermediary vehicle for the provision of loans and investments in Low-Income Communities (“LICs”). In January 2022, the Community Development Financial Institutions Fund (“CDFI”) of the United States Department of the Treasury certified MainStreet Community Capital, LLC as a registered CDE.
MainStreet Bank is headquartered in Fairfax, Virginia where it also operates a branch. The Bank was incorporated on March 28, 2003 and received its charter from the Bureau of Financial Institutions of the Commonwealth of Virginia (the “Bureau”) on March 16, 2004. The Bank commenced regular operations on May 26, 2004 and is supervised by the Bureau and the Federal Reserve Bank of Richmond. The Bank is a member of the Federal Reserve System and the Federal Deposit Insurance Corporation. The Bank places special emphasis on serving the needs of individuals, and small and medium-sized business and professional concerns in the Washington, D.C. metropolitan area.
Basis of Presentation
The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“US GAAP”) as applicable to a smaller reporting company.
Principles of Consolidation – The consolidated financial statements include accounts of the Company and its wholly-owned subsidiaries, the Bank and MainStreet Community Capital, LLC. All significant intercompany transactions and balances have been eliminated in consolidation.
Cash and cash equivalents – For the purpose of presentation in the Statements of Cash Flows, the Bank has defined cash and cash equivalents as those amounts included in the balance sheet captions “Cash and due from banks” and “Federal funds sold.”
Investment securities – The Bank’s investment debt securities are classified as either held to maturity, available for sale or trading. At December 31, 2021 and December 31, 2020, the Bank held approximately $20.3 million and $22.5 million, respectively, in securities classified as held to maturity. The Bank held no securities classified as trading.
Debt securities which are not classified as held to maturity or trading are classified as securities available for sale. Debt securities available for sale are reported at fair value. Any unrealized gain or loss, net of applicable income taxes, is reported as a separate addition to or reduction
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from stockholders’ equity. Gains and losses arising from the sale of debt securities available for sale are recognized based on the specific identification method on a trade-date basis and included in results of operations.
Debt securities held to maturity includes securities purchased with the ability and positive intent to hold to maturity. Debt securities are stated at historical cost adjusted for amortization of premiums and accretion of discount. Any investment security, for which there has been a value impairment deemed by management to be other than temporary, is written down to its estimated fair value with a charge to current operations.
Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held to maturity and available for sale debt securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In determining whether other-than-temporary impairment exists, management considers many factors, including (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether the Bank intends to sell the security, whether it is more likely than not that the Bank will be required to sell the security before recovery of its amortized cost basis, and whether the Bank expects to recover the security’s entire amortized cost basis. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
Restricted equity securities consist of the Federal Reserve Bank and Federal Home Loan Bank of Atlanta (“FHLB”) stock in the amount of $4.1 million and $826,000 respectively, as of December 31, 2021, compared to $3.3 million and $1.1 million, respectively, as of December 31, 2020. Restricted equity securities also consisted of $126,800 in Community Bankers Bank stock at December 31, 2021 and December 31, 2020. This restricted stock is recorded at cost because its ownership is restricted and it lacks a market for resale. The Bank is required to maintain Federal Reserve Bank stock at a level of 6% of capital and surplus. The FHLB requires the Bank to maintain stock, at a minimum, in an amount equal to 4.5% of outstanding borrowings and 0.20% of total assets. When evaluating restricted stock for impairment, its value is based on ultimate recoverability of the par value rather than by recognizing temporary declines in value. The Bank does not consider these investments to be impaired at December 31, 2021 or December 31, 2020 and no previous impairment has been recognized. Restricted equities include $4.9 million in Low-Income Housing Tax Credits (“LIHTC”) that are carried at amortized cost through the proportional amortization method. Restricted equities also include $5.7 million of nonmarketable securities as of December 31, 2021 that do not qualify for equity method accounting. These investments are recorded at cost because the ownership is restricted and lacks a market for resale. There were no nonmarketable equities as of December 31, 2020.
Loans held for sale - Loans intended for sale are recorded at the lower aggregate cost or fair value as of the balance sheet date. Gains and losses on loan sales are determined by the specific-identification method.
Loans - The Bank makes commercial and consumer loans to customers. Our recorded investment in loans that management has the intent and ability to hold for the foreseeable future, or until maturity or pay-off, generally are reported at their unpaid principal balances adjusted for charge-offs, unearned discounts, any deferred fees or costs on originated loans, and the allowance for loan losses. Interest on loans is credited to operations based on the principal amount outstanding. Loan fees and origination costs are deferred and the net amount is amortized as an adjustment of the related loan’s yield using the effective interest method. The Bank is amortizing these amounts over the contractual life of the related loans.
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. It is Bank policy to charge-off loans whose collectability is sufficiently questionable and can no longer be justified as an asset on the balance sheet. To determine if a loan should be charged-off, all possible sources of repayment are analysed, including: (1) the potential for future cash flow, (2) the value of the Bank’s collateral, and (3) the strength of co-makers or guarantors. All principal and previously accrued interest is charged to the allowance for loan losses. All future payments received on the loan are credited to the allowance for loan losses as a recovery. These policies are applied consistently across our loan portfolio.
Impairment of a loan - The Bank considers a loan impaired when it is probable that the Bank will be unable to collect all interest and principal payments as scheduled in the loan agreement when due. A loan is not considered impaired during a period of an insignificant delay in payment if the ultimate collectability of all amounts due is expected. Impairment is measured on a loan by loan basis for all commercial, construction and residential loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent. Consistent with the Bank’s method for nonaccrual loans, payments on impaired loans are first applied to principal outstanding. Smaller balance consumer loans are not individually evaluated for impairment.
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Troubled Debt Restructuring (TDR) occurs when the Bank agrees to modify the original terms of a loan due to the deterioration in the financial condition of the borrower. TDRs are considered impaired loans. Upon designation as a TDR, the Bank evaluates the borrower’s payment history, past due status and ability to make payments based on the revised terms of the loan. If a loan was accruing prior to being modified as a TDR and if the Bank concludes that the borrower is able to continue making such payments, and there are no other factors or circumstances that would cause it to conclude otherwise, the loan will remain on an accruing status. If a loan was on nonaccrual status at the time of the TDR, the loan will remain on nonaccrual status following the modification and may be returned to accrual status based on the policy for returning loans to accrual status as noted above. Restructured loans for which there was no rate concession, and therefore made at a market rate of interest, may be eligible to be removed from TDR status in periods subsequent to the restructuring depending on the performance of the loan. As of December 31, 2021, and December 31, 2020, the Bank had zero loans classified as TDR.
Allowance for Loan Losses - The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. Loan losses are charged against the allowance for loan losses for the difference between the carrying value of the loan and the estimated net realizable value or fair value of the collateral, if collateral dependent, when:
• The loan is a consumer loan and is 120 days past due.
Subsequent recoveries, if any, are credited to the allowance.
The allowance represents an amount that, in management’s judgment, will be adequate to absorb probable and estimable losses inherent in the loan portfolio. Management’s judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. The evaluation also considers the following risk characteristics of each loan portfolio segment:
The allowance consists of specific and general components. 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 collateral dependent loans, an updated appraisal will be ordered if a current one is not on file. Appraisals are performed by independent third-party appraisers with the 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. The characteristics of the loan ratings are as follows:
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Other Real Estate Owned (“OREO”) - Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less costs to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, management periodically performs valuations of the foreclosed assets based on updated appraisals, general market conditions, and recent sales of like properties, length of time the properties have been held and our ability and intention with regard to continued ownership of the properties. The Bank may incur additional write-downs of foreclosed assets to fair value less costs to sell if valuations indicate a further deterioration in market values. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets and improvements are capitalized.
Interest income on loans – Interest on loans is accrued and credited to income on daily balances of the principal amount outstanding. The accrual of interest on loans is discontinued when, in the opinion of management, there is an indication that the borrower may be unable to meet payments as they become due. Upon such discontinuance, all unpaid accrued interest is reversed.
Generally, the Bank will return a loan to accrual status when all delinquent interest and principal becomes current and remains current for six consecutive months under the terms of the loan agreement or the loan is well-secured or in process of collection. Upon returning to accrual status, interest payments applied to the principal balance of a loan while in nonaccrual status are recognized as a yield adjustment over the remaining life.
Loan origination and commitment fees and certain related direct costs- Loan origination and commitment fees charged by the Bank and certain direct loan origination costs are deferred and the net amount is amortized as a yield adjustment. The Bank amortizes these net amounts over the life of the related loans or, in the case of demand loans, over the estimated life. Net fees related to standby letters of credit are recognized over the commitment period.
Premises and equipment – Land is carried at cost. Premises and equipment are stated at cost, less accumulated depreciation and amortization computed principally on the straight-line basis over the estimated useful life of each asset, which ranges from 3 to 39 years. Leasehold improvements are amortized over the shorter of the related lease term or the estimated useful lives of the improvements. Construction in progress includes assets which will be reclassified and depreciated once placed into service.
Computer softwaredevelopment - The Company capitalizes new product development costs incurred for software to be sold from the point at which technological feasibility has been established through the point at which the product is ready for general availability. Software development costs that are capitalized are evaluated annually for impairment and are assigned an estimated economic life based on the type of product, market characteristics, and maturity of the market for that particular product. These costs are amortized on a straight-line basis. All of this amortization expense is included within components of operating income.
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Income taxes– The Bank uses an asset and liability approach in financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future. The principal items relate primarily to differences between the allowance for loan losses, deferred loan fees, and accumulated depreciation and amortization. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense (benefit) is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. As of December 31, 2021, and December 31, 2020, there were no such liabilities recorded.
Interest and penalties associated with unrecognized tax benefits, if any, would be classified as additional income taxes in the statement of income.
Comprehensive income – Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although, certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.
Stock compensation plans– Stock compensation accounting guidance (FASB ASC 718, “Compensation – Stock Compensation”) requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the grant date fair value of the equity or liability instruments issued.
The stock compensation accounting guidance requires that compensation cost for all stock awards be calculated and recognized over the employees’ service period, generally defined as the vesting period. For awards with graded-vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. A Black-Sholes model is used to estimate the fair value of stock options, while the market price of the Bank’s common stock at the date of grant is used for restricted stock awards. No stock options were granted during 2021 and 2020.
Earnings per common share– Net income per common share has been determined under the provisions of FASB ASC 260, “Earnings Per Share” and has been computed based on the weighted average common shares outstanding during the year ended December 31, (7,559,310 for 2021 and 8,131,334 for 2020). Diluted earnings per share reflect additional potential common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance.
The only potential dilutive stock of the Bank as defined in FASB ASC 260 would be stock options granted to various directors, officers, and employees of the Bank. There were no such options outstanding at December 31, 2021 or December 31, 2020. Restricted stock is included in the computation of basic earnings per share as the holder is entitled to full benefits of a stockholder during the vesting period.
Off-balance sheet instruments – In the ordinary course of business, the Bank has entered into off-balance sheet financial instruments consisting of commitments to extend credit, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded, or related fees are incurred or received.
Advertising and marketing expense – Advertising and marketing costs are expensed as incurred.
Use of estimates – The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that 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 reporting period. Actual results could differ from the estimates.
The Company’s critical accounting policies relate to (1) the allowance for loan losses, (2) fair value of financial instruments, (3) derivative financial instruments, and (4) income taxes. 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
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than originally reported. In connection with the determination of the allowances for losses on loans, management obtains independent appraisals for significant properties.
Fair value of financial instruments – Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 20. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.
Derivative Financial Instruments – The Bank recognizes derivative financial instruments at fair value as either an other asset or other liability 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.
Transfers of financial assets – Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Bank – put presumptively beyond reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.
Risks and uncertainties - The outbreak of COVID-19 has adversely impacted a broad range of industries in which the Company’s customers operate and could impair their ability to fulfil their financial obligations to the Company. The World Health Organization has declared COVID-19 to be a global pandemic indicating that almost all public commerce and related business activities must be, to varying degrees, curtailed with the goal of decreasing the rate of new infections. The spread of the outbreak has caused disruptions in the U.S. economy and has disrupted banking and other financial activity in the areas in which the Company operates. While there has been no material impact to the Company’s employees to date, COVID-19 could also potentially create widespread business continuity issues for the Company. The Company’s business is dependent upon the willingness and ability of its employees and customers to conduct banking and other financial transactions. If the global response to contain COVID-19 escalates further or is unsuccessful, the Company could experience a material adverse effect on its business, financial condition, results of operations and cash flows. While it is not possible to know the full universe or extent that the impact of COVID-19, and resulting measures to curtail its spread, will have on the Company’s operations, the Company is disclosing potentially material items of which it is aware.
Revenue Recognition
Most revenue associated with the Company’s financial instruments, including interest income and gains/losses on investment securities, derivatives and sales of financial instruments are outside the scope of ASC Topic 606. The Company’s services that fall within the scope of ASC Topic 606 are presented within noninterest income and are recognized as revenue. A description of the primary revenue streams accounted for under ASC Topic 606 follows:
Service Charges on Deposit Accounts. The Company earns fees from its deposit customers for overdraft and account maintenance services. Overdraft fees are recognized when the overdraft occurs. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the company satisfies the performance obligation.
Other Service Charges and Fees. The Company earns fees from its customers for transaction-based services. Such services include safe deposit box, ATM, stop payment, wire transfer, mortgage origination and interest rate swap fees. In each case, these service charges and fees are recognized in income at the time or within the same period that the Company’s performance obligation is satisfied.
Interchange Income. The Company earns interchange fees from debit and credit cardholder transactions conducted through various payment networks. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services.
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Impact of Recently Issued Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. 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 FASB has issued multiple updates to ASU 2016-13 as codified in Topic 326, including ASU’s 2019-04, 2019-05, 2019-10, 2019-11, 2020-02, and 2020-03. These ASU’s have provided for various minor technical corrections and improvements to the codification as well as other transition matters. Smaller reporting companies who file with the U.S. Securities and Exchange Commission (SEC) and all other entities who do not file with the SEC are required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements. The Company has formed a Committee to oversee the accounting impact of this ASU. In anticipation of the ASU, the Company is running parallel calculations simultaneously and preliminary analysis indicates there will not be a significant adjustment upon implementation.
Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin (SAB) 119. SAB 119 updated portions of SEC interpretative guidance to align with FASB ASC 326, “Financial Instruments – Credit Losses.” It covers topics including (1) measuring current expected credit losses; (2) development, governance, and documentation of a systematic methodology; (3) documenting the results of a systematic methodology; and (4) validating a systematic methodology.
In March 2020, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. Subsequently, in January 2021, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2021-01 “Reference Rate Reform (Topic 848): Scope.” This ASU clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity may elect to apply ASU No. 2021-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications from any date within the interim period that includes or is subsequent to January 7, 2021, up to the date that financial statements are available to be issued. An entity may elect to apply ASU No. 2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includes March 12, 2020, and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020. The Company has inventoried its exposure to instruments that include a reference to LIBOR and have included amendments to transition to an appropriate comparable rate. The Company has also discontinued using LIBOR as a primary rate reference. The Company is assessing ASU 2020-04 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments.
In August 2021, the FASB issued ASU 2021-06, “'Presentation of Financial Statements (Topic 205), Financial Services—Depository and Lending (Topic 942), and Financial Services—Investment Companies (Topic 946): Amendments to SEC Paragraphs Pursuantto SEC Final Rule Releases No. 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No. 33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants. This ASU incorporates recent SEC rule changes into the FASB Codification, including SEC Final Rule Releases No. 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No. 33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants”. The ASU is effective upon addition to the FASB Codification. The Company does not expect the adoption of ASU 2021-06 to have a material impact on its consolidated financial statements.
Recently Adopted Accounting Developments
In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740) – Simplifying the Accounting for Income Taxes.” The ASU is expected to reduce cost and complexity related to the accounting for income taxes by removing specific exceptions to general principles in Topic 740 (eliminating the need for an organization to analyze whether certain exceptions apply in a given period) and improving financial statement preparers’ application of certain income tax-related guidance. This ASU is part of the FASB’s simplification initiative to make narrow-scope simplifications and improvements to accounting standards through a series of short-term projects. ASU 2019-12 was effective for the Company on January 1, 2021. There was no material impact on the Company’s consolidated financial statements.
In January 2020, the FASB issued ASU 2020-01, “Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions between Topic 321, Topic 323, and Topic 815.”
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The ASU is based on a consensus of the Emerging Issues Task Force and is expected to increase comparability in accounting for these transactions. ASU 2016-01 made targeted improvements to accounting for financial instruments, including providing an entity the ability to measure certain equity securities without a readily determinable fair value at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Among other topics, the amendments clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting. ASU 2020-01 was effective for the Company on January 1, 2021.There was no material impact on the Company’s consolidated financial statements.
In October 2020, the FASB issued ASU 2020-08, “Codification Improvements to Subtopic 310-20, Receivables – Nonrefundable fees and Other Costs.” This ASU clarifies that an entity should re-evaluate whether a callable debt security is within the scope of ASC paragraph 310-20-35-33 for each reporting period. ASU 2020-08 was effective for the Company on January 1, 2021. There was no material impact on the Company’s consolidated financial statements.
In December 2020, the Consolidated Appropriations Act of 2021 (the “CAA”) was passed. Under Section 541 of the CAA, Congress extended or modified many of the relief programs first created by the CARES Act, including the PPP loan program and treatment of certain loan modifications related to the COVID-19 pandemic. There was no material impact on the Company’s consolidated financial statements.
Note 2. Restrictions on Cash
To comply with Federal Reserve regulations, the Bank is required to maintain certain average cash reserve balances. The daily average cash reserve requirements were $0 as of December 31, 2021 and December 31, 2020.
On March 15, 2020, the Federal Reserve reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirements for all depository institutions. Prior to the change, reserve requirement ratios on net transactions accounts differed based on the amount of net transactions accounts at the depository institution.
A certain amount of net transaction accounts, known as the "reserve requirement exemption amount," was subject to a reserve requirement ratio of zero percent. Net transaction account balances above the reserve requirement exemption amount and up to a specified amount, known as the "low reserve tranche," were subject to a reserve requirement ratio of 3 percent. Net transaction account balances above the low reserve tranche were subject to a reserve requirement ratio of 10 percent. The reserve requirement exemption amount and the low reserve tranche are indexed each year pursuant to formulas specified in the Federal Reserve Act
Note 3. Investment Securities
Investment securities available-for-sale was comprised of the following:
Municipal Securities
Investment securities held-to-maturity was comprised of the following:
Municipal Securities
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Investment securities available-for-sale was comprised of the following: