Item 1A. Risk Factors.
The following risk factors and other information included
in this Annual Report on Form 10-K should be carefully considered. The risks and uncertainties described below are not the only ones we
face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may adversely impact our
business operations. If any of the following risks occur, our business, financial condition, operating results, and cash flows could be
materially adversely affected.
Risks Related to Economic Conditions
Our business may be adversely affected by conditions
in the financial markets and economic conditions generally.
Our financial performance generally, and in particular
the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans,
as well as demand for loans and other products and services we offer and whose success we rely on to drive our growth, is highly dependent
upon the business environment in the primary markets where we operate and in the United States as a whole. Unlike larger banks that are
more geographically diversified, we are a regional bank that provides banking and financial services to customers primarily in Greenville,
Columbia, Charleston, and Summerville, South Carolina; Raleigh, Greensboro and Charlotte, North Carolina; and Atlanta, Georgia. The economic
conditions in these local markets may be different from, and in some instances worse than, the economic conditions in the United States
as a whole.
Some elements of the business environment that affect
our financial performance include short-term and long-term interest rates, the prevailing yield curve, inflation and price levels, monetary
and trade policy, unemployment and the strength of the domestic economy and the local economy in the markets in which we operate. Unfavorable
market conditions can result in a deterioration in the credit quality of our borrowers and the demand for our products and services, an
increase in the number of loan delinquencies, defaults, charge-offs, foreclosures, additional provisions for credit losses, adverse asset
values of the collateral securing our loans and an overall material adverse effect on the quality of our loan portfolio. Unfavorable or
uncertain economic and market conditions can be caused by declines in economic growth, business activity or investor or business confidence;
limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; high
unemployment; natural disasters; epidemics and pandemics (such as COVID-19); or a combination of these or other factors.
As economic conditions relating to the COVID-19 pandemic
have improved, the Federal Reserve has shifted its focus to limiting inflationary and other potentially adverse effects of the extensive
pandemic-related government stimulus, which signals the potential for a continued period of economic uncertainty even though the pandemic
has subsided. In addition, there are continuing concerns related to, among other things, the level of U.S. government debt and fiscal
actions that may be taken to address that debt, a potential resurgence of economic and political tensions with China, the Russian invasion
of Ukraine, and the Middle East conflict, all of which may have a destabilizing effect on financial markets and economic activity. Economic
pressure on consumers and overall economic uncertainty may result in changes in consumer and business spending, borrowing and saving habits.
These economic conditions and/or other negative developments in the domestic or international credit markets or economies may significantly
affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability.
Declines in real estate values and sales volumes and high unemployment or underemployment may also result in higher than expected loan
delinquencies, increases in our levels of nonperforming and classified assets and a decline in demand for our products and services. These
negative events may cause us to incur losses and may adversely affect our capital, liquidity and financial condition.
A significant portion of our loan portfolio is
secured by real estate, and events that negatively affect the real estate market could hurt our business.
As of December 31, 2023, approximately 85% of our loans
had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source
of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. A weakening
of the real estate market in our primary market areas could result in an increase in the number of borrowers who default on their loans
and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and
asset quality. Deterioration in the real estate market could cause us to adjust our opinion of the level of credit quality in our loan
portfolio. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values,
our earnings and capital could be adversely affected. Acts of nature, including hurricanes, tornados, earthquakes, fires and floods, which
may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively affect our financial condition.
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Risks Related to Lending Activities
Our loan portfolio contains a number of real
estate loans with relatively large balances.
Because our loan portfolio contains a number of real
estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in nonperforming
loans, which could result in a net loss of earnings, an increase in the provision for credit losses and an increase in loan charge-offs,
all of which could have a material adverse effect on our financial condition and results of operations.
Commercial real estate loans increase our exposure
to credit risk.
At December 31, 2023, 47.9% of our loan portfolio was
secured by commercial real estate. Loans secured by commercial real estate are generally viewed as having more risk of default than loans
secured by residential real estate or consumer loans because repayment of the loans often depends on the successful operation of the property,
the income stream of the borrowers, the accuracy of the estimate of the property’s value at completion of construction, and the
estimated cost of construction. Such loans are generally riskier than loans secured by residential real estate or consumer loans because
those loans are typically not secured by real estate collateral. An adverse development with respect to one lending relationship can expose
us to a significantly greater risk of loss compared with a single-family residential mortgage loan because we typically have more than
one loan with such borrowers. Additionally, these loans typically involve larger loan balances to single borrowers or groups of related
borrowers compared with single-family residential mortgage loans. Therefore, the deterioration of one or a few of these loans could cause
a significant decline in the related asset quality. A return of recessionary conditions could result in a sharp increase in loans charged-off
and could require us to significantly increase our allowance for credit losses, which could have a material adverse impact on our business,
financial condition, results of operations, and cash flows.
Imposition of limits by the bank regulators on
commercial and multi-family real estate lending activities could curtail our growth and adversely affect our earnings.
In 2006, the FDIC, the Federal Reserve and the OCC
issued joint guidance entitled “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” (the “CRE
Guidance”). Although the CRE Guidance did not establish specific lending limits, it provides that a bank’s commercial real
estate lending exposure could receive increased supervisory scrutiny where total non-owner occupied commercial real estate loans, including
loans secured by apartment buildings, investor commercial real estate, and construction and land loans, represent 300% or more of an institution’s
total risk-based capital, and the outstanding balance of the commercial real estate loan portfolio has increased by 50% or more during
the preceding 36 months. Our level of commercial real estate and multi-family loans represents 271.4% of the Bank’s total risk-based
capital at December 31, 2023.
In December 2015, the regulatory agencies released
a new statement on prudent risk management for commercial real estate lending (the “2015 Statement”). In the 2015 Statement,
the regulatory agencies, among other things, indicate the intent to continue “to pay special attention” to commercial real
estate lending activities and concentrations going forward. If the FDIC, our primary federal regulator, were to impose restrictions on
the amount of commercial real estate loans we can hold in our portfolio, for reasons noted above or otherwise, our earnings would be adversely
affected.
Repayment of our commercial business loans is
often dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in
value.
At December 31, 2023, commercial business loans comprised
13.9% of our total loan portfolio. Our commercial business loans are originated primarily based on the identified cash flow and general
liquidity of the borrower and secondarily on the underlying collateral provided by the borrower and/or repayment capacity of any guarantor.
The borrower’s cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Although commercial business
loans are often collateralized by equipment, inventory, accounts receivable, or other business assets, the liquidation of collateral in
the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories may
be obsolete or of limited use. In addition, business assets may depreciate over time, may be difficult to appraise, and may fluctuate
in value based on the success of the business. Accordingly, the repayment of commercial business loans depends primarily on the cash flow
and credit worthiness of the borrower and secondarily on the underlying collateral value provided by the borrower and liquidity of the
guarantor. If these borrowers do not have sufficient cash flows or resources to pay these loans as they come due or the value of the underlying
collateral is insufficient to fully secure these loans, we may suffer losses on these loans that exceed our allowance for credit losses.
We may have higher credit losses than we have
allowed for in our allowance for credit losses.
Our actual loans losses could exceed our allowance
for credit losses and therefore our historic allowance for credit losses may not be adequate. As of December 31, 2023, 47.9% of our loan
portfolio was secured by commercial real estate. Repayment of such loans is generally considered more subject to market risk than residential
mortgage loans. Industry experience shows that a portion of loans will
become delinquent and a portion of loans will require partial or entire charge-
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off. Regardless of the underwriting criteria utilized,
losses may be experienced as a result of various factors beyond our control, including among other things, changes in market conditions
affecting the value of loan collateral, the cash flows of our borrowers and problems affecting borrower credit. If we suffer credit losses
that exceed our allowance for credit losses, our financial condition, liquidity or results of operations could be materially and adversely
affected.
Our decisions regarding allowance for credit
losses and credit risk may materially and adversely affect our business.
Making loans and other extensions of credit is an essential
element of our business. Although we seek to mitigate risks inherent in lending by adhering to specific underwriting practices, our loans
and other extensions of credit may not be repaid. The risk of nonpayment is affected by a number of factors, including:
● the duration of the credit;
● credit risks of a particular client;
● changes in economic and industry conditions; and
We attempt to maintain an appropriate allowance for
credit losses to provide for probable losses in our loan portfolio. We periodically determine the amount of the allowance based on consideration
of several factors, including but not limited to:
● an ongoing review of the quality, mix, and size of our overall loan portfolio;
● our historical loan loss experience;
● evaluation of economic conditions;
● regular reviews of loan delinquencies and loan portfolio quality;
● ongoing review of financial information provided by borrowers; and
The determination of the appropriate level of the allowance
for credit losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks
and future trends, all of which may undergo material changes. A deterioration in economic conditions affecting borrowers, new information
regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require
an increase in the allowance for credit losses. In addition, regulatory agencies periodically review our allowance for credit losses and
may require an increase in the provision for credit losses or the recognition of further loan charge-offs, based on judgments different
than those of management. In addition, if charge-offs in future periods exceed the allowance for credit losses, we will need additional
provisions to increase the allowance for credit losses. Any increases in the allowance for credit losses will result in a decrease in
net income and, possibly, capital, and may have a material adverse effect on our financial condition and results of operations.
A percentage of the loans in our portfolio currently
include exceptions to our loan policies and supervisory guidelines.
All of the loans that we make are subject to written
loan policies adopted by our board of directors and to supervisory guidelines imposed by our regulators. Our loan policies are designed
to reduce the risks associated with the loans that we make by requiring our loan officers to take certain steps that vary depending on
the type and amount of the loan, prior to closing a loan. These steps include, among other things, making sure the proper liens are documented
and perfected on property securing a loan, and requiring proof of adequate insurance coverage on property securing loans. Loans that do
not fully comply with our loan policies are known as “exceptions.” We categorize exceptions as policy exceptions, financial
statement exceptions and document exceptions. As a result of these exceptions, such loans may have a higher risk of loan loss than the
other loans in our portfolio that fully comply with our loan policies. In addition, we may be subject to regulatory action by federal
or state banking authorities if they believe the number of exceptions in our loan portfolio represents an unsafe banking practice.
Risks Related to Capital and Liquidity
Liquidity needs could adversely affect our financial
condition and results of operations.
Dividends from the Bank provide the primary source
of funds for the Company. The primary sources of funds of the Bank are client deposits and loan repayments. While scheduled loan repayments
are a relatively stable source of funds, they are subject to the ability of borrowers to repay the loans. The ability of borrowers to
repay loans can be adversely affected by a number of factors, including changes in economic conditions, adverse trends or events affecting
business industry groups, reductions in real estate values or markets, business closings or lay-offs, inclement weather, natural disasters
and international instability.
Additionally, deposit levels may be affected by a number
of factors, including rates paid by competitors, general interest rate levels, regulatory capital requirements, returns available to clients
on alternative investments and general economic
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conditions. Accordingly, we may be required from time to time to rely on secondary sources
of liquidity to meet withdrawal demands or otherwise fund operations. Such sources include proceeds from FHLB advances, sales of investment
securities and loans, and federal funds lines of credit from correspondent banks, as well as out-of-market time deposits. While we believe
that these sources are currently adequate, there can be no assurance they will be sufficient to meet future liquidity demands, particularly
if we continue to grow and experience increasing loan demand. We may be required to slow or discontinue loan growth, capital expenditures
or other investments or liquidate assets should such sources not be adequate.
The Company is a stand-alone entity with its own liquidity
needs to service its debt or other obligations. Other than dividends from the Bank, the Company does not have additional means of generating
liquidity without obtaining additional debt or equity funding. If we are unable to receive dividends from the Bank or obtain additional
funding, we may be unable to pay our debt or other obligations.
Legal, Accounting, Regulatory and Compliance
Risks
We are subject to extensive regulation that has
limited the conduct of our business, and could impose financial requirements, each of which could have an adverse impact on our operations.
We operate in a highly regulated industry and are subject
to examination, supervision, and comprehensive regulation by various regulatory agencies. We are subject to regulation by the Federal
Reserve. The Bank is subject to extensive regulation, supervision, and examination by our primary federal regulator, the FDIC, the regulating
authority that insures client deposits, and by our primary state regulator, the S.C. Board. Also, as a member of the Federal Home Loan
Bank, the Bank must comply with applicable regulations of the Federal Housing Finance Board and the Federal Home Loan Bank. Regulation
by these agencies is intended primarily for the protection of our depositors and the deposit insurance fund and not for the benefit of
our shareholders. The Bank’s activities are also regulated under consumer protection laws applicable to our lending, deposit, and
other activities. A sufficient claim against us under these laws could have a material adverse effect on our results of operations.
Failure to comply with laws, regulations or policies
could also result in heightened regulatory scrutiny and in sanctions by regulatory agencies (such as a memorandum of understanding, a
written supervisory agreement or a cease and desist order), civil money penalties and/or reputation damage. Any of these consequences
could restrict our ability to expand our business or could require us to raise additional capital or sell assets on terms that are not
advantageous to us or our shareholders and could have a material adverse effect on our business, financial condition and results of operations.
While we have policies and procedures designed to prevent any such violations, such violations may occur despite our best efforts.
We are subject to federal and state fair lending
laws, and failure to comply with these laws could lead to material penalties.
Federal and state fair lending laws and regulations,
such as the Equal Credit Opportunity Act and the Fair Housing Act, impose nondiscriminatory lending requirements on financial institutions.
The Department of Justice, CFPB and other federal and state agencies are responsible for enforcing these laws and regulations. A finding
by these regulators of noncompliance with these laws could result in a wide variety of sanctions, including the required payment of damages
and civil money penalties, injunctive relief, and imposition of restrictions on expansion activity. Private parties may also have the
ability to challenge an institution’s performance under fair lending laws in private class action litigation, which if successful could
adversely impact our rating under the CRA.
As of our most recent examination report, the Bank
received a “Needs to Improve” CRA rating, which results in restrictions on certain expansionary activities, including certain
mergers and acquisitions and the establishment and relocation of bank branches. This rating will also result in a loss of expedited processing
of applications to undertake certain activities, and requires the Bank to receive prior regulatory approval for certain activities, including
to issue or prepay certain subordinated debt obligations, and open or relocate bank branches. A “Needs to Improve” rating
could have an impact on our relationships with certain states, counties, municipalities or other public agencies to the extent applicable
law, regulation or policy limits, restricts or influences whether such entity may do business with a company that has a below “Satisfactory”
rating and, in general, could negatively affect our reputation, business, financial condition and results of operations. These restrictions,
among others, will remain in place at least until the Bank’s next CRA rating is publicly released by the FDIC. The FDIC may take
additional enforcement action, including a possible informal or formal enforcement action and/or civil monetary penalties. As a result
of these limitations and conditions, we may be unable or may fail to pursue, evaluate or complete
transactions that might have been strategically or competitively significant.
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We face risks related to the adoption of future
legislation and potential changes in federal regulatory agency leadership, policies, and priorities.
In 2023, Republicans gained control of the U.S. House
of Representatives, while Democrats retained control of the U.S. Senate. However slim the majorities, though, the net result was a split
Congress, which in the past leads to less sweeping policy changes. However, Congressional committees with jurisdiction over the banking
sector have pursued oversight and legislative initiatives in a variety of areas, including addressing climate-related risks, promoting
diversity and equality within the banking industry and addressing other Environmental, Social, and Governance matters, improving competition
in the banking sector and enhancing oversight of bank mergers and acquisitions, establishing a regulatory framework for digital assets
and markets, and oversight of pandemic responses and economic recovery. The prospects for the enactment of major banking reform legislation
remain unclear at this time.
Moreover, turnover of the presidential administration
in 2020 resulted in certain changes in the leadership and senior staffs of the federal banking agencies, the CFPB, CFTC, SEC, and the
Treasury Department, with certain significant leadership positions yet to be permanently filled, including the Comptroller of the Currency.
These changes have impacted the rulemaking, supervision, examination and enforcement priorities and policies of the agencies and likely
will continue to do so over the next several years. The potential impact of the 2024 election on additional changes in agency personnel,
policies and priorities on the financial services sector, including the Company and the Bank, cannot be predicted at this time. Regulations
and laws may be modified at any time, and new legislation may be enacted that will affect us. Any future changes in federal and state
laws and regulations, as well as the interpretation and implementation of such laws and regulations, could affect us in substantial and
unpredictable ways, including those listed above or other ways that could have a material adverse effect on our business, financial condition
or results of operations.
We face a risk of noncompliance and enforcement
action with the Bank Secrecy Act and other anti-money laundering statutes and regulations.
The federal Bank Secrecy Act, the USA Patriot Act and
other laws and regulations require financial institutions, among other duties, to institute and maintain effective anti-money laundering
programs and file suspicious activity and currency transaction reports as appropriate. The federal Financial Crimes Enforcement Network,
established by the U.S. Treasury to administer the Bank Secrecy Act, is authorized to impose significant civil money penalties for violations
of those requirements and has engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the
U.S. Department of Justice, Drug Enforcement Administration and Internal Revenue Service. There is also increased scrutiny of compliance
with the rules enforced by OFAC. Federal and state bank regulators also focus on compliance with Bank Secrecy Act and anti-money laundering
regulations. If our policies, procedures and systems are deemed deficient or the policies, procedures and systems of the financial institutions
that we have already acquired or may acquire in the future are deficient, we would be subject to liability, including fines and regulatory
actions such as restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain
aspects of our business plan, including our acquisition plans, which would negatively affect our business, financial condition and results
of operations. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have
serious reputational consequences for us.
Federal, state and local consumer lending laws
may restrict our ability to originate certain mortgage loans or increase our risk of liability with respect to such loans and could increase
our cost of doing business.
Federal, state and local laws have been adopted that
are intended to eliminate certain lending practices considered “predatory.” These laws prohibit practices such as steering
borrowers away from more affordable products, selling unnecessary insurance to borrowers, repeatedly refinancing loans and making loans
without a reasonable expectation that the borrowers will be able to repay the loans irrespective of the value of the underlying property.
Loans with certain terms and conditions and that otherwise meet the definition of a “qualified mortgage” may be protected
from liability to a borrower for failing to make the necessary determinations. In either case, we may find it necessary to tighten our
mortgage loan underwriting standards in response to the CFPB rules, which may constrain our ability to make loans consistent with our
business strategies. It is our policy not to make predatory loans and to determine borrowers’ ability to repay, but the law and related
rules create the potential for increased liability with respect to our lending and loan investment activities. They increase our cost
of doing business and, ultimately, may prevent us from making certain loans and cause us to reduce the average percentage rate or the
points and fees on loans that we do make.
The Federal Reserve may require us to commit
capital resources to support the Bank.
The Federal Reserve requires a bank holding company
to act as a source of financial and managerial strength to a subsidiary bank and to commit resources to support such subsidiary bank.
Under the “source of strength” doctrine, the Federal Reserve may require a bank holding company
to make capital injections into a troubled subsidiary bank and may charge the bank holding company with engaging in unsafe and unsound
practices for failure to commit resources to such a subsidiary bank. In addition, the Dodd-Frank Act directs the federal bank regulators
to require that all companies that directly or indirectly control an insured depository institution serve as a source of strength for
the institution. Under these
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requirements, in the future, we could be required to provide financial assistance to the Bank if the Bank
experiences financial distress.
A capital injection may be required at times when we
do not have the resources to provide it, and therefore we may be required to borrow the funds. In the event of a bank holding company’s
bankruptcy, the bankruptcy trustee will assume any commitment by the holding company to a federal bank regulatory agency to maintain the
capital of a subsidiary bank. Moreover, bankruptcy law provides that claims based on any such commitment will be entitled to a priority
of payment over the claims of the holding company’s general unsecured creditors, including the holders of its note obligations. Thus,
any borrowing that must be done by the holding company in order to make the required capital injection becomes more difficult and expensive
and will adversely impact the holding company’s cash flows, financial condition, results of operations and prospects.
The CECL accounting standard
resulted in a significant change in how we recognize credit losses and may continue to have a material impact on our financial condition
or results of operations.
In June 2016, the Financial
Accounting Standards Board (“FASB”) issued an accounting standard update, “Financial Instruments-Credit Losses (Topic
326), Measurement of Credit Losses on Financial Instruments,” which replaces the current “incurred loss” model for recognizing
credit losses with an “expected loss” model referred to as the Current Expected Credit Loss (“CECL”) model. While
the new CECL standard became effective on January 1, 2023 and for interim periods within that year, we early adopted CECL as of January
1, 2022.
Under the CECL model, we are
required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt
securities, at the net amount expected to be collected. The measurement of expected credit losses is based on information about past events,
including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported
amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter.
This differs significantly from the “incurred loss” model required under current generally accepted accounting principles
(“GAAP”), which delays recognition until it is probable a loss has been incurred. Accordingly, the adoption of the CECL model
materially affected how we determine our allowance for credit losses and required us to increase our allowance. Moreover, the CECL model
may create more volatility in the level of our allowance for credit losses. If we are required to materially increase our level of allowance
for credit losses for any reason, such increase could adversely affect our business, financial condition and results of operations.
Risks Related to Our Operations
Competition with other financial institutions
may have an adverse effect on our ability to retain and grow our client base, which could have a negative effect on our financial condition
or results of operations.
The banking and financial services industry is very
competitive and includes services offered from other banks, savings and loan associations, credit unions, mortgage companies, other lenders,
and institutions offering uninsured investment alternatives. Legal and regulatory developments have made it easier for new and sometimes
unregulated competitors to compete with us. The financial services industry has and is experiencing an ongoing trend towards consolidation
in which fewer large national and regional banks and other financial institutions are replacing many smaller and more local banks. These
larger banks and other financial institutions hold a large accumulation of assets and have significantly greater resources and a wider
geographic presence or greater accessibility. In some instances, these larger entities operate without the traditional brick and mortar
facilities that restrict geographic presence. Some competitors have more aggressive marketing campaigns and better brand recognition,
and are able to offer more services, more favorable pricing or greater customer convenience than the Bank. In addition, competition has
increased from new banks and other financial services providers that target our existing or potential clients. As consolidation continues
among large banks, we expect other smaller institutions to try to compete in the markets we serve. This competition could reduce our net
income by decreasing the number and size of the loans that we originate and the interest rates we charge on these loans. Additionally,
these competitors may offer higher interest rates, which could decrease the deposits we attract or require us to increase rates to retain
existing deposits or attract new deposits. Increased deposit competition could adversely affect our ability to generate the funds necessary
for lending operations which could increase our cost of funds.
The financial services industry could become even more
competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and
insurance companies can merge as part of a financial holding company, which can offer virtually any type of financial service, including
banking, securities underwriting, insurance (both agency and underwriting)
and merchant banking. Technological developments have allowed competitors, including some non-depository institutions, to compete more
effectively in local markets and have expanded the range of financial products, services and capital available to our target clients.
If we are unable to implement, maintain and use such technologies effectively, we may not be able to offer products or achieve cost-efficiencies
necessary to compete in the industry. In addition, some of these competitors have fewer regulatory constraints and lower cost structures.
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We are subject to environmental risks that could
result in losses.
In the course of business, the Bank may acquire, through
foreclosure, or deed in lieu of foreclosure, properties securing loans it has originated or purchased which are in default. Particularly
in commercial real estate lending, there is a risk that hazardous substances could be discovered on these properties. In this event, the
Bank may be required to remove these substances from the affected properties at our sole cost and expense. The cost of this removal could
substantially exceed the value of affected properties. We may not have adequate remedies against the prior owner or other responsible
parties and could find it difficult or impossible to sell the affected properties. These events could have a material adverse effect on
our business, results of operations and financial condition.
In addition, we are subject to the growing risk of
climate change. Among the risks associated with climate change are more frequent severe weather events. Severe weather events such as
hurricanes, tropical storms, tornados, winter storms, freezes, flooding and other large-scale weather catastrophes in our markets subject
us to significant risks and more frequent severe weather events magnify those risks. Large-scale weather catastrophes or other significant
climate change effects that either damage or destroy residential or multifamily real estate underlying mortgage loans or real estate collateral,
or negatively affects the value of real estate collateral or the ability of borrowers to continue to make payments on loans, could decrease
the value of our real estate collateral or increase our delinquency rates in the affected areas and thus diminish the value of our loan
portfolio. Such events could also cause downturns in economic and market conditions generally, which could have an adverse effect on our
business and financial results. The potential losses and costs associated with climate change related risks are difficult to predict and
could have a material adverse effect on our business, financial condition and results of operation.
We rely on other companies to provide key components
of our business infrastructure.
Third parties provide key components of our business
operations such as data processing, recording and monitoring transactions, online banking interfaces and services, internet connections
and network access. While we have selected these third-party vendors carefully, we do not control their actions. Any problem caused by
these third parties, including poor performance of services, data breaches, failure to provide services, disruptions in communication
services provided by a vendor and failure to handle current or higher volumes, could adversely affect our ability to deliver products
and services to our clients and otherwise conduct our business, and may harm our reputation. Financial or operational difficulties of
a third-party vendor could also hurt our operations if those difficulties interfere with the vendor’s ability to serve us. Replacing
these third-party vendors could also create significant delay and expense. Accordingly, use of such third parties creates an unavoidable
inherent risk to our business operations.
We may be adversely affected by the soundness
of other financial institutions.
Financial services institutions are interrelated as
a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties,
and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers,
investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a
counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by the Bank cannot be realized upon or
is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to the Bank. Any such losses
could have a material adverse effect on our financial condition and results of operations.
We are subject to losses due to errors, omissions
or fraudulent behavior by our employees, clients, counterparties or other third parties.
We are exposed to many types of operational risk, including
the risk of fraud by employees and third parties, clerical recordkeeping errors and transactional errors. Our business is dependent on
our employees as well as third-party service providers to process a large number of increasingly complex transactions. We could be materially
and adversely affected if employees, clients, counterparties or other third parties caused an operational breakdown or failure, either
as a result of human error, fraudulent manipulation or purposeful damage to any of our operations or systems.
In deciding whether to extend credit or to enter into
other transactions with clients and counterparties, we may rely on information furnished to us by or on behalf of clients and counterparties,
including financial statements and other financial information, which we do not independently verify. We also may rely on representations
of clients and counterparties as to the accuracy and completeness
of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to
extend credit to clients, we may assume that a client’s audited financial statements conform with GAAP and present fairly, in all
material respects, the financial condition, results of operations and cash flows of the client. Our financial condition and results of
operations could be negatively affected to the extent we rely on financial statements that do not comply with GAAP or are materially misleading,
any of which could be caused by errors, omissions, or fraudulent behavior by our employees, clients, counterparties, or other third parties.
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In addition, criminals committing fraud increasingly
are using more sophisticated techniques and in some cases are part of larger criminal rings, which allow them to be more effective. This
type of fraudulent activity has taken many forms, ranging from check fraud, mechanical devices attached to ATM machines, social engineering
and phishing attacks to obtain personal information or impersonation of our clients through the use of falsified or stolen credentials.
Additionally, an individual or business entity may properly identify themselves, particularly when banking online, yet seek to establish
a business relationship for the purpose of perpetrating fraud. Further, in addition to fraud committed against us, we may suffer losses
as a result of fraudulent activity committed against third parties. Increased deployment of technologies, such as chip card technology,
defray and reduce aspects of fraud; however, criminals are turning to other sources to steal personally identifiable information, such
as unaffiliated healthcare providers and government entities, in order to impersonate the consumer to commit fraud. Many of these data
compromises are widely reported in the media.
As a result of the increased sophistication of fraud
activity, we have increased our spending on systems and controls to detect and prevent fraud. This will result in continued ongoing investments
in the future. Nevertheless, these investments may prove insufficient and fraudulent activity could result in losses to us or our customers;
loss of business and/or customers; damage to our reputation; the incurrence of additional expenses (including the cost of notification
to consumers, credit monitoring and forensics, and fees and fines imposed by the card networks); disruption to our business; our inability
to grow our online services or other businesses; additional regulatory scrutiny or penalties; or our exposure to civil litigation and
possible financial liability any of which could have a material adverse effect on our business, financial condition and results of operations.
Our operational or security systems may experience
an interruption or breach in security, including as a result of cyber-attacks.
We rely heavily on communications and information systems
to conduct our business. Any failure, interruption or breach in security of these systems, including as a result of cyber-attacks, could
result in failures or disruptions in our client relationship management, deposit, loan, and other systems and also the disclosure or misuse
of confidential or proprietary information. While we have systems, policies and procedures designed to prevent or limit the effect of
the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions
or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions
or security breaches of our information systems could damage our reputation, result in a loss of client business, subject us to additional
regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect
on our business, financial condition and results of operations.
Furthermore, information security risks for financial
institutions have increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications
technologies to conduct financial transactions, and the increasing sophistication and activities of organized crime, hackers, terrorists,
activists, and other external parties. Our technologies, systems, networks, and our customers’ devices may become the target of
cyber-attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction
of our or our customers’ confidential, proprietary and other information, or otherwise disrupt our or our customers’ or other
third parties’ business operations. As cyber threats continue to evolve, we may also be required to expend significant additional
resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities.
While we have not experienced any material losses relating
to cyber-attacks or other information security breaches to date, we may suffer such losses in the future and any information security
breach could result in significant costs to us, which may include fines and penalties, potential liabilities from governmental or third
party investigations, proceedings or litigation, legal, forensic and consulting fees and expenses, costs and diversion of management attention
required for investigation and remediation actions, and the negative impact on our reputation and loss of confidence of our customers
and others, any of which could have a material adverse impact on our business, financial condition and operating results.
Our enterprise risk management framework may
not be effective in mitigating risk and reducing the potential for losses.
Our enterprise risk management framework seeks to mitigate
risk and loss to us. We have established comprehensive policies and procedures and an internal control framework designed to provide a
sound operational environment for the types of risk to which we are subject, including credit risk, market risk (interest rate and price
risks), liquidity risk, operational risk, compliance risk, legal risk, strategic risk, and reputational risk. However, as with any risk
management framework, there are inherent limitations to our current and future risk management strategies, including risks that we have
not appropriately anticipated or identified. In addition, our businesses and the markets in which we operate are continuously evolving.
We may fail to adequately or timely enhance our enterprise risk framework to address those changes. If our enterprise risk framework is
ineffective, either because it fails to keep pace with changes in the financial markets, regulatory requirements, our businesses, our
counterparties, clients or service providers or for other reasons,
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we could incur losses, suffer reputational damage or find ourselves
out of compliance with applicable regulatory or contractual mandates. In addition to our executive committee, the Risk Committee of the
Board, the Audit Committee of the Board, as well as the Company’s Chief Risk Officer are all responsible for the “risk management
framework” of the Company. These committees each meet regularly, with the authority to convene additional meetings, as circumstances
require.
Our interest rate risk is overseen by the Risk Committee
which monitors our compliance with regulatory guidance in the formulation and implementation of our interest rate risk program. The Risk
Committee reviews the results of our interest rate risk modeling quarterly to assess whether we have appropriately measured our interest
rate risk, mitigated our exposures appropriately and any residual risk is acceptable. In addition to our annual review of this policy,
our Board of Directors reviews the interest rate risk policy limits at least annually.
Our controls and procedures may fail or be circumvented.
We regularly review and update our internal controls,
disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and
operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the
system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls
and procedures could have a material adverse effect on our business, results of operations and financial condition.
Failure to keep pace with technological change
could adversely affect our business.
The financial services industry is continually undergoing
rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology
increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in
part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer
demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources
to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be
successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting
the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results
of operations.
Our profitability is dependent on our banking
activities.
Because we are a bank holding company, our profitability
is directly attributable to the success of the Bank. Our banking activities compete with other banking institutions on the basis of products,
service, convenience and price, among others. Due in part to both regulatory changes and consumer demands, banks have experienced increased
competition from other entities offering similar products and services. We rely on the profitability of the Bank and dividends received
from the Bank for payment of our operating expenses and satisfaction of our obligations. As is the case with other similarly situated
financial institutions, our profitability will be subject to the fluctuating cost and availability of funds, changes in the prime lending
rate and other interest rates, changes in economic conditions in general, and other factors.
Risks Related to Our Industry
We are subject to interest rate risk, which could
adversely affect our financial condition and profitability.
A significant portion of our banking assets
are subject to changes in interest rates. As of December 31, 2023, approximately 84% of our loan portfolio was in fixed rate loans,
while only 16% was in variable rate loans. Like most financial institutions, our earnings significantly depend on our net interest
income, the principal component of our earnings, which is the difference between interest earned by us from our interest-earning
assets, such as loans and investment securities, and interest paid by us on our interest-bearing liabilities, such as deposits and
borrowings. We expect that we will periodically experience “gaps” in the interest rate sensitivities of our assets and
liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than
our interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to our position, this
“gap” will negatively impact our earnings. Many factors beyond our control impact interest rates, including economic
conditions, governmental monetary policies, inflation, recession, changes in unemployment, the money supply, and disorder and
instability in domestic and foreign financial markets. Changes in monetary policies of the various government agencies could
influence not only the interest we receive on loans and securities and the interest we pay on deposits and borrowings, but such
changes could also affect our ability to originate loans and obtain deposits, the fair value of our financial assets and
liabilities, and the average duration of our assets and liabilities.
In a declining interest rate environment, there may
be an increase in prepayments on loans as borrowers refinance their loans at lower rates. In a rising interest rate environment, the interest
rate increases often result in larger payment requirements for our floating interest rate borrowers, which increases the potential for
default. At the same time, the
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marketability of the property securing a loan may be adversely affected by any reduced demand resulting
from higher interest rates. An increase (or decrease) in interest rates also requires us to increase (or decrease) the interest rates
that we pay on our deposits. Changes in interest rates also can affect the value of loans, securities and other assets. An increase in
interest rates that adversely affects the ability of borrowers to pay the principal or interest on loans may lead to increases in nonperforming
assets, charge-offs and delinquencies, further increases to the allowance for credit losses, and a reduction of income recognized, among
others, which could have a material adverse effect on our results of operations and cash flows. Further, when we place a loan on non-accrual
status, we reverse any accrued but unpaid interest receivable, which decreases interest income. At the same time, we continue to have
a cost to fund the loan, which is reflected as interest expense, without any interest income to offset the associated funding expense.
Thus, an increase in the amount of nonperforming assets could have a material adverse impact on our net interest income.
In March 2020, in response to the COVID-19 pandemic,
the Federal Reserve reduced the target Federal Funds rate to between zero and 0.25%; however, due in part to rising inflation, throughout
2022 the target Federal Funds rate increased to between 4.25% and 4.50%. Throughout 2023, the target Federal Funds rate increased to between
5.25% and 5.50%. Rapid changes in interest rates make it difficult for us to balance our loan and deposit portfolios, which may adversely
affect our results of operations by, for example, reducing asset yields or spreads, creating operating and system issues, or having other
adverse impacts on our business. When short-term interest rates are low for a prolonged period and assuming longer-term interest rates
fall further, we could experience net interest margin compression as our interest-earning assets would continue to reprice downward while
our interest-bearing liability rates could fail to decline in tandem, which would have an adverse effect on our net interest income and
could have an adverse effect on our business, financial condition and results of operations. When interest-earning assets mature or reprice
more quickly, or to a greater degree than interest-bearing liabilities, falling interest rates could reduce net interest income. When
interest-bearing liabilities mature or reprice more quickly, or to a greater degree than interest-earning assets in a period, an increase
in interest rates could reduce net interest income.
In addition, our mortgage operations provide a portion
of our noninterest income. We generate mortgage revenues primarily from gains on the sale of residential mortgage loans pursuant to programs
currently offered by Fannie Mae, Ginnie Mae or Freddie Mac. In this rising or higher interest rate environment, our originations of mortgage
loans have decreased, resulting in fewer loans that are available to be sold to investors, which has decreased mortgage revenues in noninterest
income. In addition, our results of operations are affected by the amount of noninterest expenses associated with mortgage activities,
such as salaries and employee benefits, other loan expense, and other costs. During periods of reduced loan demand, our results of operations
may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in loan originations.
Inflationary pressures and rising prices may
affect our results of operations and financial condition.
In 2021 through 2022, inflation rose to levels not
seen for over 40 years, reaching 7% and 6.5%, respectively. In 2023, the annual inflation rate decreased to 3.4% but inflationary pressures
are currently expected to remain elevated throughout 2024. Inflation could lead to increased costs to our customers, making it more difficult
for them to repay their loans or other obligations increasing our credit risk. Sustained higher interest rates by the Federal Reserve
may be needed to tame persistent inflationary price pressures, which could push down asset prices and weaken economic activity. A deterioration
in economic conditions in the United States and our markets could result in an increase in loan delinquencies and non-performing assets,
decreases in loan collateral values and a decrease in demand for our products and services, all of which, in turn, would adversely affect
our business, financial condition and results of operations.
The Federal Reserve has implemented significant
economic strategies that have affected interest rates, inflation, asset values, and the shape of the yield curve.
In 2020, in response to economic disruption
associated with the COVID-19 pandemic, the Federal Reserve quickly reduced short-term rates to extremely low levels and acted to
influence the markets to reduce long-term rates as well. During 2021, the Federal Reserve significantly reduced such
“easing” actions that held down long-term rates. During 2022, the Federal Reserve switched to a tightening policy. It
raised short-term rates significantly and rapidly throughout the year. Those actions triggered a significant decline in the values
of most categories of U.S. stocks and bonds; significantly raised recessionary expectations for the U.S.; and inverted the yield
curve in the U.S. for much of the last two quarters of 2022.
Effects on the yield curve often are most pronounced
at the short end of the curve, which is of particular importance to us and other banks. Among other things, easing strategies are intended
to lower interest rates, expand the money supply, and stimulate economic activity, while tightening strategies are intended to increase
interest rates, discourage borrowing, tighten the money supply, and restrain economic activity. However, in 2022, short term rates rose
faster than long term rates to the point that the yield curve inverted for much of the final two quarters of 2022. This sort of phenomenon—where
short term rates rise more strongly and rapidly than long-term rates can follow—is relatively uncommon.
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It is unclear how long it will take for long-term rates
to catch up. Many external factors may interfere with the effects of these plans or cause them to be changed, sometimes quickly. Such
factors include significant economic trends or events as well as significant international monetary policies and events. These economic
strategies have had, and will continue to have, a significant impact on our business and on many of our clients. As exemplified by the
2023 bank failures in the U.S., such strategies also can affect the U.S. and world-wide financial systems in ways that may be difficult
to predict.
Negative public opinion surrounding the Company
and the financial institutions industry generally could damage our reputation and adversely impact our earnings.
Reputation risk, or the risk to our business, earnings
and capital from negative public opinion surrounding the Company and the financial institutions industry generally, is inherent in our
business. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending practices,
corporate governance and acquisitions, and from actions taken by government regulators and community organizations in response to those
activities. Negative public opinion can adversely affect our ability to keep and attract clients and employees and can expose us to litigation
and regulatory action. Although we take steps to minimize reputation risk in dealing with our clients and communities, this risk will
always be present given the nature of our business.
Adverse developments affecting the financial
services industry, such as recent bank failures or concerns involving liquidity, may have a material adverse effect on the Company’s
operations.
The high-profile bank failures in 2023 involving Silicon
Valley Bank, Signature Bank, and First Republic Bank caused general uncertainty and concern regarding the liquidity adequacy of the banking
sector. Although we were not directly affected by these bank failures, the resulting speed and ease in which news, including social media
commentary, led depositors to withdraw or attempt to withdraw their funds from these and other financial institutions, which then caused
the stock prices of many financial institutions to become volatile. Additional bank failures could have an adverse effect on our financial
condition and results of operations, either directly or through an adverse impact on certain of our customers.
In response to these bank failures and the resulting
market reaction, the Secretary of the Treasury approved actions enabling the FDIC to complete its resolutions of the failed banks in a
manner that fully protects depositors by utilizing the Deposit Insurance Fund, including the use of Bridge Banks to assume all of the
deposit obligations of the failed banks, while leaving unsecured lenders and equity holders of such institutions exposed to losses.. With
the risk of any additional bank failures, we may face the potential for reputational risk, deposit outflows, increased costs and competition
for liquidity, and increased credit risk which, individually or in the aggregate, could have a material adverse effect on our business,
financial condition and results of operations.
Consumers may decide not to use banks to complete
their financial transactions.
Technology and other changes are allowing parties to
complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain
funds that would have historically been held as bank deposits in brokerage accounts, mutual funds or general-purpose reloadable prepaid
cards. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks.
The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income,
as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the
lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.
Our reliance on brokered deposits could adversely
affect our liquidity and operating results.
Among other sources of funds, in 2023, we
relied on brokered deposits to provide funds with which to make loans and provide other liquidity needed. Our brokered deposits were
$379.4 million, representing 11.2% of our total deposits at December 31, 2023 and included fixed-rate time deposits with maturities
through October 2028. Brokered deposits are utilized, along with other wholesale funding sources, to fund loan growth and offset
core deposit outflows. Generally, these deposits may not be as stable as other types of deposits. In the future, these depositors
may not replace their deposits with us as they mature, or we may have to pay a higher rate of interest to keep those deposits or to
replace them with other deposits or sources of funds. Not being able to maintain or replace these deposits as they mature could
affect our liquidity. Paying higher deposit rates to maintain or replace these types of deposits could adversely affect our net