Item 1. Business
General
Howard Bancorp, Inc., the parent company of Howard Bank, was incorporated in April 2005 under the laws of the State of Maryland to serve as the bank holding company of Howard Bank. Howard Bank is a Maryland-chartered trust company that was formed in March 2004 and commenced banking operations in August 2004. Howard Bank does not currently exercise trust powers, and our business, powers and regulatory structure are the same as a Maryland-chartered commercial bank. The Bank has nine subsidiaries-six were formed to hold foreclosed real estate (three of which are currently inactive), two own and manage real estate used for corporate purposes, and one holds historic tax credit investments.
In this report, unless the context suggests otherwise, references to the “Company” refer to Howard Bancorp, Inc. and references to “we,” “us,” and “our” mean the combined business of the Company and the Bank and its wholly-owned subsidiaries.
Howard Bank is headquartered in Baltimore City, Maryland. We consider our primary market area to be the Greater Baltimore metropolitan area. We engage in a general commercial banking business, making various types of loans and accepting deposits. We market our financial services to small- and medium-sized businesses and their owners, professionals and executives, and high-net-worth individuals. Our loans are primarily funded by core deposits of customers in our market.
Our core business strategy involves driving organic growth by delivering advice and superior customer service to clients through local decision makers. Our customer focus is small- and medium-sized businesses in our local markets and we compete by providing our customers a broad array of products, new technology and access to seasoned banking professionals. Our experienced executives seek to establish a relationship with each client and bring value to all phases of a client’s business and personal banking needs. To develop this strategy, we have established long-standing relationships with key customers in the community and with local business leaders who can create business opportunities.
Our leadership team is deep and experienced both as it relates to tenure with us and to industry experience. Our Chairman and Chief Executive Officer, Mary Ann Scully, founded the Company and has over 35 years of banking experience, mainly in senior executive roles with larger financial institutions. Our President and Chief Operating Officer, Robert D. Kunisch, Jr., has over 30 years of banking experience. In addition, we employ a strong stable of next level senior leadership, which we believe is critical for the successful implementation of our strategic initiatives. It is this leadership experience that has driven our growth since our founding.
Our strategic plan focuses on enhancing stockholder value through market share growth as reflected in balance sheet growth, related revenue growth and resulting growth in operating profits. During the past several years, we have expanded our branch locations both through opening new branches and acquiring branch offices via acquisition. More recently, we have focused on branch optimization initiatives that have resulted in a reduction in branches. While we may open additional branches in the counties where we now operate and in contiguous counties over the next several years, we currently have no definitive plans or agreements in place with respect to any additional branches. Our long-term vision also includes supplementing our organic growth with strategic acquisitions. As discussed below, we have completed and integrated multiple bank acquisitions and we consider additional acquisitions to be a critical component of furthering our future growth. We believe that acquiring other financial institutions, in whole or in part, through business line spin-offs, branch purchases or the hiring of teams of individuals, will allow us to expand our market, achieve certain operating efficiencies, and grow our stockholder base and thus our share value and liquidity. We believe that our demonstrated expertise in commercial lending and deposit gathering (especially non-interest bearing transactional deposits), our demonstrated ability to attract additional investment and capital, and community leadership, positions us as an attractive acquirer.
Our Market Area
Our headquarters are located in Baltimore City, Maryland. We consider our primary market area to be the Greater Baltimore Metropolitan Area in Maryland. As of December 31, 2020, we had 15 full-service branches and eight commercial lending offices located throughout Maryland; however, we plan to close two of our branches in early 2021. For additional details regarding branch and lending offices, see “Item 2. Properties” below in this report.
Competition
Our primary market area is highly competitive and heavily branched by other financial institutions of all sizes. The principal methods of competition for financial services are price (interest rates paid on deposits, interest rates charged on loans and fees charged for services) and service (convenience and quality of services rendered to customers). In addition to competition from other commercial banks, we face significant competition from non-bank financial institutions, including savings and loan associations, credit unions, finance companies, insurance companies and investment firms. The financial services industry has become more competitive as technology advances have lowered barriers to entry, enabling more companies, including nonbank companies, to provide financial services. Many of our nonbank competitors which are not subject to the same extensive federal regulations that govern bank holding companies and banks, such as the Company and the Bank, may have certain competitive advantages. Technological advances may diminish the importance of depository institutions and other financial institutions. We also compete for deposits with a broad range of other types of investments, including mutual funds and annuities.
Mergers and acquisitions have also led to increased concentration in the banking industry, placing added competitive pressure on our core banking products and services as we see competitors enter some of our markets or offer similar products. While we believe that acquisitions of several local competitors by larger institutions headquartered outside of the State of Maryland during the last several years has enhanced our competitive position as a locally-headquartered and managed community bank, many of these competitors have substantially greater resources and lending limits than we do and offer services, such as extensive and established branch networks and trust services, that we do not expect to provide in the near future or ever.
As a community bank with over $2.5 billion in assets, we believe that we are well positioned to navigate the ongoing market consolidation and heightened regulatory environment. We have the ability to outsource certain activities (internal audit, compliance review, information security monitoring) and to source new products and services in a highly efficient manner, allowing us to avoid the risk of impairment of operating earnings faced by some banks. We believe this offers an advantage over our competitors which may be locked into legacy systems, or which may find the onslaught of new regulations and evolving consumer expectations challenging. Strategic partnerships for these outsourced activities include contractual relationships with some of the largest and strongest providers of item processing, data processing, information monitoring and payment systems alternatives. We believe that this provides us with the best of technology and product selection without sacrificing the more intimate delivery advantages of a community bank. We further believe the current economic and regulatory environment will continue to result in greater consolidation among financial institutions, including community banks. Some of that consolidation will occur with larger banks, thus exacerbating the scarcity of banks able to underwrite and offer advice in interactions with customers as we do, which we believe gives us a wider window of opportunity to extend our brand and value proposition. We believe, however, that to the extent some of that consolidation occurs between and among smaller banks, the resulting combined institutions will be better positioned to differentiate themselves. Areas of our primary market are currently experiencing significant disruption due to industry consolidation, management turnover and de novo banking activities. We believe these disruptions will continue in the short-term and may accelerate, which could create additional opportunities for us.
We believe that “Our Mission to Build our Legacy by Helping Others to Build Theirs” approach to delivering services to small and medium-sized businesses is essential to our competitive position. Through a team of experienced advisors, we provide our customers with access to local policy and decision makers. We also offer an array of competitive credit and cash management services that we feel fills a “white space” in the market. We believe that we fit well between sophisticated, but often distracted large banks and responsive, but less capable small banks. Our relationship managers, team leaders and executive management generally have decades of banking experiences and are well established in the communities that they serve. They are able to interface with clients directly to share that experience and to provide
connections with their own network of other specialized advisors. We believe we also benefit from our committed leadership, at both the executive management and board level, who bring a broad array of skills and experiences and who are able to position us for consistent profitable growth.
Lending Activities
General
Our primary focus is making loans to and gathering deposits from small and medium-sized businesses and their owners, professionals and executives, and high-net-worth individuals in our primary market area. Our loans are made to customers primarily in the Greater Baltimore market and, to a lesser extent, the Greater Washington market. Our lending activities consist generally of short to medium-term commercial lending, commercial mortgage lending for both owner occupied and investment properties, residential mortgage lending, and consumer lending, both secured and unsecured. A substantial portion of our loan portfolio consists of loans to businesses secured by real estate and/or other business assets.
Credit Policies and Administration
We have adopted a comprehensive lending policy that includes stringent underwriting standards for all types of loans. Our lending teams follow pricing guidelines established periodically by our management team. In an effort to manage risk, minimal lending authority is given to individual loan officers. Most loan officers can approve loans up to $100,000 (with a select number of loan officers having the authority to $1,000,000). The Chief Credit Officer, the Chief Commercial Banking Officer, the Chief Executive Officer and the Chief Operating Officer can approve loans up to $2,500,000, or any two together can approve loans up to $5,000,000. Loans above these amounts are reviewed by our Loan Committee. Under the leadership of our executive management team, we believe that we employ experienced lending officers, secure appropriate collateral, and carefully monitor the financial condition of our borrowers and the concentration of loans in our portfolio.
In addition to the normal repayment risks, all loans in the portfolio are subject to the state of the economy and the related effects on the borrower and/or the real estate market. Generally, longer-term loans have periodic interest rate adjustments and/or call provisions. Senior management monitors the loan portfolio closely to ensure that we minimize past due loans and that we swiftly deal with potential problem loans.
We also retain an outside, independent firm to annually perform a detailed review of our loan portfolio. We use the results of the firm’s report primarily to validate the risk ratings applied to loans in the portfolio and identify any systemic weaknesses in underwriting, documentation or management of the portfolio. Results of the annual review are presented to executive management, the Asset Quality Committee of the board of directors of the Bank and the full board of directors of the Bank and are available to and used by regulatory examiners when they review the Bank’s asset quality.
We also use an internal credit administration group that assists us in the underwriting and serves as an additional reviewer of underwriting. In addition, a separately-managed loan administration group oversees documentation, compliance and timeliness of collection activities. Our outsourced internal audit firm also reviews documentation, compliance and file management.
Commercial Lending
Our commercial lending consists of lines of credit, revolving credit facilities, accounts receivable and inventory financing, term loans, equipment loans, equipment leases, small business administration (“SBA”) loans, stand-by letters of credit and unsecured loans. We originate commercial loans for any business purpose, including the financing of leasehold improvements and equipment, the carrying of accounts receivable, general working capital, contract administration and acquisition activities. These loans typically have maturities of seven years or less. We have a diverse client base and we do not have a concentration of these types of loans in any specific industry segment. We generally secure commercial business loans with accounts receivable and inventory, equipment, indemnity deeds of trust and other collateral such as marketable securities, cash value of life insurance, and time deposits at the Bank. Commercial business loans have a higher degree of risk than residential mortgage loans because the availability of funds for repayment generally depends on
the success of the business. To help manage this risk, we establish parameters/covenants at the inception of the loan to provide early warning systems before payment default. We normally seek to obtain appropriate collateral and personal guarantees from the borrower’s principal owners. We are able, given our business model, to proactively monitor the financial condition of the business.
Commercial Mortgage Lending
We finance commercial real estate for our clients, for both owner-occupied properties and non-owner occupied (investment) properties (including residential properties). We generally will finance owner occupied commercial real estate at a maximum loan-to-value of 85% and non-owner occupied at a maximum loan-to-value of 80%. Our underwriting policies and processes focus on the underlying credit of the owner for owner-occupied real estate and on the rental income stream (including rent terms and strength of tenants) for non-owner occupied real estate as well as an assessment of the underlying real estate. Risks inherent in managing a commercial real estate portfolio relate to vacancy rates/absorption rates for surrounding properties, sudden or gradual drops in property values as well as changes in the economic climate. We attempt to mitigate these risks by carefully underwriting loans of this type as well as by following appropriate loan-to-value standards. We are cash flow lenders and we generally do not rely solely on property valuations in reaching a lending decision. Personal guarantees are often required for commercial real estate loans as they are for other commercial loans. Most of our commercial real estate loans carry fixed interest rates and amortize over 20 to 25 years but have five to seven-year maturities. Properties securing our commercial real estate loans primarily include office buildings, office condominiums, distribution facilities and manufacturing plants. Substantially all of our commercial real estate loans are secured by properties located in our market area.
Commercial real estate loans generally carry higher interest rates and have shorter terms than one-to-four family residential mortgage loans. Commercial real estate loans, however, entail significant additional risks as compared with residential mortgage lending, as they typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment of loans secured by income-producing properties typically depends on the successful operation of the property, as repayment of the loan generally is dependent, in large part, on sufficient income from the property to cover operating expenses and debt service. Changes in economic conditions that are not in the control of the borrower or lender could affect the value of the collateral for the loan or the future cash flow of the property. Additionally, any decline in real estate values may be more pronounced for commercial real estate than residential properties.
Construction Lending
Construction lending can cover funding for land acquisition, land development and/or construction of residential or commercial structures. Our construction loans generally bear a variable rate of interest and have terms of one to two years. Funds are advanced on a percentage-of-completion basis. These loans are generally repaid at the end of the development or construction phase, although loans for both residential and commercial construction will often convert into a permanent mortgage loan at the end of the term of the loan. Loan to value parameters range from 65% of the value of land to 75% for developed land, 80% for commercial or multifamily construction and 85% for residential construction. These loan-to-value ratios represent the upper limit of advance rates to remain in compliance with Bank policy. Typically, loan-to-value ratios should be somewhat lower than these upper limits, requiring the borrower to provide significant equity at the inception of the loan. Our underwriting looks not only at the value of the property but the expected cash flows to be generated by sale of the parcels or completed construction. We expect the borrower to demonstrate solid experience in this type of construction and personal guarantees are usually required.
Construction lending entails significant risks compared with residential mortgage lending. These risks involve larger loan balances concentrated with single borrowers with funds advanced upon the security of the land or the project under construction. The value of the project is estimated prior to the completion of construction. Thus, it is more difficult to evaluate accurately the total loan funds required to complete a project and related loan to value ratios. If the estimate of construction or development cost proves to be inaccurate, we may be required to advance additional funds beyond the amount originally committed in order to protect the value of the property. Moreover, if the estimated value of the completed project proves to be inaccurate, the borrower may hold a property with a value that is insufficient to assure full repayment. To mitigate these risks, in addition to the underwriting considerations noted above, we maintain an in-house
construction monitoring unit that has oversight for the projects and we require both site visits and frequent reporting before funds are advanced.
Residential Mortgage Lending
Beginning in early 2020, we ceased originating first lien residential mortgage loans as a result of the exit of our mortgage banking activities. In order to manage loan run-off within the residential mortgage loan portfolio, we now purchase first lien residential mortgage loans, on a servicing released basis, from third-party originators. In addition to ensuring program eligibility and prudent underwriting from our delegated correspondents, we require that all loans meet the ability to repay rules established by the Consumer Financial Protection Bureau (“CFPB”). Correspondents must demonstrate experience, facilities, selling standards, capital requirements, legal standing, licensing and insurance in order to participate.
We originate home equity loans and home equity lines of credit that are primarily secured by a second mortgage on owner occupied one-to-four family residences. Our home equity loans are originated at fixed interest rates and with terms of between five and 30 years for primary residences and between five and 15 years for secondary and rental properties, and are fully amortizing. Our home equity lines allow for the borrower to draw against the line for ten years, after which the line is refinanced into a 20-year fixed-rate loan. Home equity lines of credit carry a variable rate of interest and minimum monthly payments during the draw period, which are the greater of (i) $50.00 or (ii) depending on credit score, loan-to-value and debt-to-income ratios, either the interest due or interest due plus 1% of the outstanding loan balance. Home equity loans and lines of credit are generally underwritten with a maximum loan-to-value ratio of 85% (80% when appraised value is greater than $1 million) for a primary residence when combined with the principal balance of the existing mortgage loan. At the time we close a home equity loan or line of credit, we record a mortgage to perfect our security interest in the underlying collateral.
Home equity loans and lines of credit generally have greater risk than owner-occupied residential loans secured by first mortgages. When customers default on their loans we attempt to foreclose on the property. However, the value of the collateral may not be sufficient to repay the amount of the unpaid loan, and we may be unsuccessful in recovering the remaining balance from these customers. In addition, decreases in property values could adversely affect the value of properties used as collateral for the loans. These second lien loans represent a smaller portion of our portfolio than our first lien residential mortgage loans.
Our home equity loans and lines of credit provide some diversification in our client base. Although most of these loans are in our primary market area, we believe the diversity of the individual loans in the portfolio reduces our potential risk.
Consumer Lending
We offer various types of secured and unsecured consumer loans, including marine loans originated through brokers. Consumer loans may present greater credit risk than residential mortgage loans because many consumer loans are unsecured or are secured by depreciating assets. Repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance because of the greater likelihood of damage, loss or depreciation. Consumer loan collections also depend on the borrower’s continuing financial stability. If a borrower suffers personal financial difficulties, the loan may not be repaid. Also, various federal and state laws, including bankruptcy and insolvency laws, may limit the amount we can recover on such loans.
Loan Originations, Purchases, Sales, Participations and Servicing
All loans that we originate or purchase are underwritten pursuant to our policies and procedures, which incorporate standard underwriting guidelines. We originate both fixed and variable rate loans. Our loan origination activity may be adversely affected by a rising interest rate environment that typically results in decreased loan demand. With the exit of our mortgage banking activities, we now generally retain in our portfolio the majority of loans that we originate. In addition, we now purchase first lien residential mortgage loans, on a servicing released basis, from third-party originators. We do not retain the servicing rights on any loans sold.
We occasionally sell participations in commercial loans to correspondent banks if the amount of the loan exceeds our internal lending limits. In addition, we purchase loan participations from correspondent banks in our local market. Those loans are underwritten in-house with the same care as loans directly originated.
Loan Approval Procedures and Authority
Our lending activities follow written, non-discriminatory underwriting standards and loan origination procedures established by our board of directors. The loan approval process is intended to assess the borrower’s ability to repay the loan, the viability of the loan, and the adequacy of the value of the collateral that will secure the loan, if applicable. To assess a business borrower’s ability to repay, we review and analyze, among other factors, current income, credit history including our prior experience with the borrower, cash flow, any secondary sources of repayment, other debt obligations in regards to the equity/net worth of the borrower and collateral available to us to secure the loan.
We generally require appraisals of all real property securing one- to four-family residential and commercial real estate loans and home equity loans and lines of credit. All appraisers are state-licensed or state-certified appraisers, and our practice is to have local appraisers approved by our board of directors annually.
Mortgage Banking
Although we exited our mortgage banking activities in early 2020 and still have recourse exposure on loans we previously originated and sold. In general, we may be required to repurchase a previously sold mortgage loan or indemnify the purchaser if there is non-compliance with defined loan origination or documentation standards, including fraud, negligence or material misstatement in the loan documents. In addition, we may have an obligation to repurchase a loan if the mortgagor has defaulted early in the loan term. The potential default repurchase period varies by purchaser but can be up to approximately 12 months after sale of the loan to the purchaser. The recourse period for fraud, material misstatement, breach of representations and warranties, noncompliance with law, or similar matters could be as long as the term of the loan. Mortgages subject to recourse are collateralized by single-family residential properties, follow purchaser guidelines, and carry private mortgage insurance, where applicable.
The exit of our mortgage banking activities is discussed in Note 2 to the Consolidated Financial Statements.
Investments and Funding
We utilize both our investment and borrowings portfolios to balance the liquidity needs that result from changes in loan and deposit balances. It is our goal to provide adequate funding in support of loan growth and ample contingent liquidity against unusual funding needs. A significant portion of our investment portfolio is generally kept in highly liquid securities, and a portion of the portfolio is used to generate additional positive earnings. Our primary source of funds is, and will continue to be, core deposits generated from our market area. Additional funding is provided by overnight unsecured master notes, customer repurchase agreements, Federal Home Loan Bank of Atlanta (“FHLB”) advances, Federal Reserve Bank of Richmond Discount Window borrowings, subordinated debentures and other purchased funds. Other purchased funds may include certificates of deposit (“CDs”) over $100,000, federal funds purchased, and institutional or brokered deposits. Collateralized lines of credit and Fed Funds lines of credit are maintained with multiple correspondent banks in order to protect liquidity levels resulting from unexpected deposit withdrawals and natural-market credit demand.
Our investment policy is reviewed annually by our board of directors. Our board of directors has appointed the Board Asset Liability Committee (“Board ALCO”) to serve as the Investment Committee. The Board ALCO meets at regular intervals (not less than quarterly) and provides a report on the investment portfolio performance to our full board of directors. The investment officer is designated by the Chief Executive Officer and is responsible for the day-to-day management of liquidity and the investment portfolio in accordance with the policies approved by our board of directors. We actively monitor our investment portfolio and the majority of the portfolio is classified as “available for sale.” In general, under such a classification, we may sell investment instruments as management deems appropriate.
Other Banking Products
We offer our customers wire transfer services, automated teller machines (“ATMs”) at all of our branch locations, ATM and check cards, safe deposit boxes at selected branches, and credit cards through a third party processor. In addition, we offer our business customers merchant card services, overnight sweep services, ACH origination capabilities, ACH and check positive pay, remote deposit capture devices for those customers who have a high volume of checks to deposit, and through a third-party provider, an insured cash sweep product to provide expanded FDIC coverage beyond the standard $250,000 per depositor.
We also provide digital banking capabilities to our customers. Our Online and Mobile Banking capabilities allow both consumer and business customers to essentially do their banking from anywhere at any time. All customers can open accounts, check balances, view eStatements, pay bills, set real-time account alerts, manage cards, and deposit checks from their desktops, tablets, and/or mobile devices. In addition, our consumer customers have access to send and receive money via Zelle®, mobile payment options including Apple Pay®, Google Pay™ and Samsung Pay™ and can control their debit cards by allowing them to remotely manage, monitor, and proactively control their debit card activity.
Deposit Activities
Deposits are the major source of our funding. We offer a broad array of consumer and business deposit products that include demand, money market, savings, individual retirement accounts, and certificates of deposit. Utilizing key technology partnerships, we offer a competitive array of commercial cash management products that allow us to attract demand deposits. We believe that we pay competitive rates on our interest bearing deposits. As a relationship-oriented organization, we generally seek to obtain deposit relationships with our loan clients.
Employees
We have 235 full-time and eight part-time employees as of December 31, 2020. None of our employees are represented by any collective bargaining unit, and we believe that relations with our employees are good.
Lending Limits
The Bank’s legal lending limit for loans to one borrower was $41.1 million as of December 31, 2020, and we further monitor our exposure to one borrower through an internal policy “in-house” lending limit of $25.0 million as of December 31, 2020, which in-house limit can be exceeded on a limited basis. As part of our risk management strategy, we may participate a portion of larger loans to other financial institutions. This strategy allows us to maintain customer relationships yet observe both the legal and “in house” lending limits and manage credit exposure. However, this strategy may not always be available.
Available Information
The Company is a public company subject to the reporting requirements of the U.S. Securities and Exchange Commission (the “SEC”). We file electronically with the SEC our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We make available on the investor relations page of our website at www.howardbank.com, free of charge, copies of these reports as soon as reasonably practicable after filing or furnishing them to the SEC. The information on our website is not incorporated by reference in this Annual Report on Form 10-K.
SUPERVISION AND REGULATION
As a financial institution, we operate in a highly regulated environment. The regulatory framework under which we operate is intended primarily for the protection of depositors and the Federal Deposit Insurance Corporation’s (the “FDIC’s”) Deposit Insurance Fund and not for the protection of our stockholders and creditors. The following is a general summary of the material aspects of certain statutes and regulations applicable to us. These summary descriptions are not complete,
and you should refer to the full text of the statutes, regulations, and corresponding guidance for more information. These statutes and regulations are subject to change, and additional statutes, regulations, and corresponding guidance may be adopted. We are unable to predict these future changes or the effects, if any, that these changes could have on our business, revenues, and results of operations.
Recent Regulatory Developments
Regulatory developments implemented in response to the COVID-19 pandemic, including the CARES Act and the Consolidated Appropriations Act, 2021, which enhanced and expanded certain provisions of the CARES Act, have had and will continue to have an impact on our operations.
The CARES Act and Initiatives Related to COVID-19
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act, or the CARES Act, was signed into law. The CARES Act provided for approximately $2.2 trillion in direct economic relief in response to the public health and economic impacts of COVID-19. Many of the CARES Act’s programs are, and remain, dependent upon the direct involvement of financial institutions like the Bank. These programs have been implemented through rules and guidance adopted by federal departments and agencies, including the U.S. Department of Treasury, the Federal Reserve and other federal bank regulatory authorities, including those with direct supervisory jurisdiction over the Company and the Bank. Furthermore, as the COVID-19 pandemic evolves, federal regulatory authorities continue to issue additional guidance with respect to the implementation, life cycle, and eligibility requirements for the various CARES Act programs, as well as industry-specific recovery procedures for COVID-19. In addition, it is possible that Congress will enact supplementary COVID-19 response legislation, including amendments to the CARES Act or new bills comparable in scope to the CARES Act. We continue to assess the impact of the CARES Act and other statutes, regulations and supervisory guidance related to the COVID-19 pandemic.
On March 11, 2021, the American Rescue Plan Act of 2021, or ARP, was signed into law. The ARP provides for approximately $1.9 trillion in direct economic relief as well as funding for COVID-19 testing, contact tracing, and vaccine deployment. The ARP builds upon many of the measures from the CARES Act and subsequent COVID-19 related legislation.
Paycheck Protection Program
A principal provision of the CARES Act amended the SBA’s loan program to create a guaranteed, unsecured loan program, the Paycheck Protection Program, or PPP, to fund operational costs of eligible businesses, organizations and self-employed persons impacted by COVID-19. These loans are eligible to be forgiven if certain conditions are satisfied and are fully guaranteed by the SBA. Additionally, loan payments will also be deferred for the first six months of the loan term. The PPP commenced on April 3, 2020 and was available to qualified borrowers through August 8, 2020. No collateral or personal guarantees were required. On December 27, 2020, the President signed into law omnibus federal spending and economic stimulus legislation titled the “Consolidated Appropriations Act, 2021” that included the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (the “HHSB Act”). Among other things, the HHSB Act renewed the PPP, allocating $284.45 billion for both new first time PPP loans under the existing PPP and the expansion of existing PPP loans for certain qualified, existing PPP borrowers. In addition to extending and amending the PPP, the HHSB Act also creates a new grant program for “shuttered venue operators.” As a participating lender in the PPP, we continue to monitor legislative, regulatory, and supervisory developments related thereto, including the most recent changes implemented by the HHSB Act.
Troubled Debt Restructurings and Loan Modifications for Affected Borrowers
The CARES Act, as extended by certain provisions of the Consolidated Appropriations Act, 2021, permits banks to suspend requirements under GAAP for loan modifications to borrowers affected by COVID-19 that may otherwise be characterized as troubled debt restructurings and suspend any determination related thereto if (i) the borrower was not more than 30 days past due as of December 31, 2019, (ii) the modifications are related to COVID-19, and (iii) the modification occurs between March 1, 2020 and the earlier of 60 days after the date of termination of the national
emergency or January 1, 2022. Federal bank regulatory authorities also issued guidance to encourage banks to make loan modifications for borrowers affected by COVID-19.
Howard Bancorp, Inc.
We are a bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). We are subject to regulation and examination by the Board of Governors of the Federal Reserve (the “FRB”) and the Maryland Office of the Commissioner of Financial Regulation (the “Commissioner”) and are required to file periodic reports and any additional information that the FRB and the Commissioner may require. In addition, the FRB and the Commissioner have enforcement authority over the Company, which includes the power to remove officers and directors and the authority to issue cease and desist orders to prevent us from engaging in unsafe or unsound practices or violating laws or regulations governing our business. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities.
The status of Howard Bancorp as a registered bank holding company under the BHC Act and a Maryland-chartered bank holding company does not exempt it from certain federal and state laws and regulations applicable to corporations generally, including, without limitation, certain provisions of the federal securities laws.
Source of Strength
Under FRB regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. Under this requirement, we could, in the future, be required to provide financial assistance to the Bank should the Bank experience financial distress. In addition, in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the FRB to be an unsafe and unsound banking practice, a violation of FRB regulations or both. The FRB may require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the FRB’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any subsidiary depository institution of the bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or nonbank subsidiary if the agency determines that divestiture may aid the depository institution’s financial condition.
Acquisitions
The primary purpose of a bank holding company is to control and manage banks. The BHC Act generally requires the prior approval of the FRB for any merger involving a bank holding company or any acquisition by a bank holding company of another bank or bank holding company. Subject to certain conditions (including deposit concentration limits established by the BHC Act), the FRB may allow a bank holding company to acquire banks located in any state of the United States. In approving interstate acquisitions, the FRB is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its FDIC-insured institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state institutions or their holding companies) and state laws that require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company. Furthermore, in accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), bank holding companies must be well-capitalized and examiners must rate them well-managed in order to effect interstate mergers or acquisitions.
Change in Control
Two statutes, the BHC Act and the Change in Bank Control Act (the “CIBC Act”), together with regulations promulgated under them, require some form of regulatory review before any company may acquire “control” of a bank or a bank holding company. Under the BHC Act, control is deemed to exist if a company acquires 25% or more of any class of voting securities of a bank holding company; controls the election of a majority of the members of the board of directors; or exercises a controlling influence over the management or policies of a bank or bank holding company. On January 30, 2020, the FRB issued a final rule (which became effective September 30, 2020) that clarified and codified the FRB’s standards for determining whether one company has control over another. The final rule established four categories of tiered presumptions of noncontrol that are based on the percentage of voting shares held by the investor (less than 5%, 5-9.9%, 10-14.9% and 15-24.9%) and the presence of other indicia of control. As the percentage of ownership increases, fewer indicia of control are permitted without falling outside of the presumption of noncontrol. These indicia of control include nonvoting equity ownership, director representation, management interlocks, business relationship and restrictive contractual covenants. Under the final rule, investors can hold up to 24.9% of the voting securities and up to 33% of the total equity of a company without necessarily having a controlling influence.
Under the CIBC Act, an investor that owns or controls 10% or more of any class of voting stock of a bank or bank holding company and (i) the institution has registered securities under Section 12 of the Exchange Act and (ii) no other person owns, controls or has the power to vote a greater percentage of that class of voting securities is considered a “control” person and may be required to file a change in control notice with the primary federal regulator of the bank or with the FRB. For the purposes of both the BHC Act and the CIBC Act, ownership by affiliated parties, or parties acting in concert, is typically aggregated.
Activities
Pursuant to provisions of the BHC Act and regulations promulgated by the FRB thereunder, the Company may only engage in or own companies that engage in activities deemed by the FRB to be so closely related to the business of banking or managing or controlling banks as to be a proper incident thereto, and the holding company must obtain permission from the FRB prior to engaging in most new business activities. As a bank holding company, we also can elect to be treated as a “financial holding company,” which would allow us to engage in a broader array of activities. In sum, a financial holding company can engage in activities that are financial in nature or incidental or complementary to financial activities, including insurance underwriting, sales and brokerage activities, providing financial and investment advisory services and underwriting services, and engaging in limited merchant banking activities. We have not sought financial holding company status, but we may elect that status in the future as our business matures. If we were to elect in writing for financial holding company status, we would be required to be well capitalized and well managed, and each insured depository institution we control would also have to be well capitalized, well managed and have at least a satisfactory rating under the Community Reinvestment Act (discussed below).
Capital Requirements
The FRB imposes certain capital requirements on a bank holding company under the BHC Act, including a minimum leverage ratio and a minimum ratio of “qualifying” capital to risk-weighted assets. These requirements are essentially the same as those that apply to the Bank and are described below under “Howard Bank-Capital Requirements.” However, because the Company currently has less than $3.0 billion in consolidated assets, it currently qualifies as a small bank holding company, and these capital requirements do not currently apply to the Company. Subject to certain restrictions, we are able to borrow money to make a capital contribution to the Bank, and these loans may be repaid from dividends paid from the Bank to the Company.
Dividends
The Company is a legal entity separate and distinct from the Bank. The FRB has issued a policy statement regarding the payment of dividends by bank holding companies. In general, the FRB’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital needs, asset quality, and overall financial condition. Under the prompt corrective
action rules discussed below, the ability of a bank holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions.
In addition, funds for cash distributions to our stockholders are derived primarily from dividends received from our Bank. Our Bank is subject to various general regulatory policies and requirements relating to the payment of dividends. Any restriction on the ability of our Bank to pay dividends will indirectly restrict the ability of the Company to pay dividends to our stockholders. See “Howard Bank-Dividends” below.
Federal Securities Regulation
Our common stock is registered with the SEC under the Exchange Act. As such, we are subject to the information, proxy solicitation, insider trading restrictions and other requirements of the Exchange Act.
Further, if we wish to sell common stock or other securities to raise capital in the future, we will be subject to the registration, anti-fraud, and other applicable provisions of state and federal securities laws. For example, we will have to register the sales of such securities under the Securities Act, the Maryland Securities Act, and the applicable securities laws of each state in which we offer or sell the securities, unless an applicable exemption from registration exists with respect to such sales. Such exemptions may, among other things, limit the number and types of persons we could sell such securities to and the manner in which we could market the securities. We would also be subject to federal and state anti-fraud requirements with respect to any statements we make to potential purchasers in connection with the offer and sale of such securities.
Sarbanes-Oxley Act of 2002
The Sarbanes Oxley Act of 2002 addresses, among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. We have adopted policies, procedures and systems designed to ensure compliance with the Sarbanes Oxley Act and related regulations.
Howard Bank
Howard Bank is a Maryland-chartered trust company (with all powers of a commercial bank), and its deposit accounts are insured by the FDIC up to the maximum legal limits. It is subject to regulation, supervision and regular examination by the Commissioner and the FDIC. The regulations of these agencies govern most aspects of the Bank’s business, including required reserves against deposits, loans, investments, mergers and acquisitions, borrowing, dividends and location and number of branch offices.
Financial Institutions Article of the Maryland Annotated Code
The Financial Institutions Article of the Maryland Annotated Code (the “Banking Code”) contains detailed provisions governing the organization, operations, corporate powers, commercial and investment authority, branching rights and responsibilities of directors, officers and employees of Maryland banking institutions. The Banking Code delegates extensive rulemaking power and administrative discretion to the Commissioner in its supervision and regulation of state-chartered banking institutions. The Commissioner may order any banking institution to discontinue any violation of law or unsafe or unsound business practice.
The Economic Growth, Regulatory Relief, and Consumer Protection Act
On May 24, 2018, President Trump signed into law the first major financial services reform bill since the enactment of the Dodd-Frank Act. The Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Reform Law”) modifies
or eliminates certain requirements on community and regional banks and nonbank financial institutions. For instance, under the Reform Act and related rule making:
● banks that have less than $10 billion in total consolidated assets and total trading assets and trading liabilities of less than five percent of total consolidated assets are exempt from Section 619 of the Dodd-Frank Act, known as the “Volcker Rule”, which prohibits “proprietary trading” and the ownership or sponsorship of private equity or hedge funds that are referred to as “covered funds”;
● the asset threshold for bank holding companies to qualify for treatment under the “Small Bank Holding Company and Savings and Loan Holding Company Policy Statement” was raised from $1 billion to $3 billion, which exempts these institutions (including the Company) from certain regulatory requirements including the Basel III capital rules;
● a new “community bank leverage ratio” was adopted, which is applicable to certain banks and bank holding companies with total assets of less than $10 billion (as described below under “Capital Requirements”); and
● banks with up to $3 billion in total consolidated assets may be examined by their federal banking regulator every 18 months (as opposed to every 12 months).
Capital Requirements
Regulatory capital rules adopted in July 2013 and fully phased in as of January 1, 2019, which we refer to as Basel III, impose minimum capital requirements for bank holding companies and banks. The Basel III rules apply to all national and state banks and savings and loan associations regardless of size and bank holding companies and savings and loan holding companies other than “small bank holding companies,” generally holding companies with consolidated assets of less than $3 billion. The Company is currently considered a “small bank holding company.” More stringent requirements are imposed on “advanced approaches” banking organizations-those organizations with $250 billion or more in total consolidated assets, $10 billion or more in total foreign exposures, or that have opted into the Basel II capital regime. Specifically, the following minimum capital requirements apply to the Bank:
● a common equity Tier 1 (“CET1”) risk-based capital ratio of 4.5%;
● a Tier 1 risk-based capital ratio of 6%;
● a total risk-based capital ratio of 8%; and
● a leverage ratio of 4%.
The final rules also established a “capital conservation buffer” above the regulatory minimum capital requirements, which must consist entirely of CET1 risk-based capital, which was phased in over several years. The fully phased-in capital conservation buffer of 2.500%, which became effective on January 1, 2019, resulted in the following effective minimum capital ratios beginning in 2019: (i) a CET1 risk-based capital ratio of 7.0%, (ii) a Tier 1 risk-based capital ratio of 8.5%, and (iii) a total risk-based capital ratio of 10.5%. Under Basel III, institutions are subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if their capital levels fall below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.
Under Basel III, Tier 1 capital includes two components: CET1 capital and additional Tier 1 capital. The highest form of capital, CET1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, otherwise referred to as AOCI, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital is primarily comprised of noncumulative perpetual preferred stock, Tier 1 minority interests and grandfathered trust preferred securities (as discussed below). Tier 2 capital generally includes the allowance for loan and lease losses up to 1.25% of risk-weighted assets, qualifying preferred stock, subordinated debt and qualifying tier 2 minority interests, less any deductions in Tier 2 instruments of an unconsolidated financial institution. Cumulative perpetual preferred stock is included only in Tier 2 capital, except that the Basel III rules permit bank holding companies with less than $15 billion in total consolidated assets to continue to include trust preferred securities and cumulative perpetual preferred stock issued before May 19, 2010 in Tier 1 Capital (but not in CET1 capital), subject to certain restrictions. The regulations also require unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital unless the Bank elected to opt-out from this treatment, which it did.
On December 21, 2018, the federal banking agencies issued a joint final rule to revise their regulatory capital rules to (i) address the upcoming implementation of a new credit impairment model, the Current Expected Credit Loss, or CECL model, an accounting standard under GAAP; (ii) provide an optional three-year phase-in period for the day-one adverse regulatory capital effects that banking organizations are expected to experience upon adopting CECL; and (iii) require the use of CECL in stress tests beginning with the 2020 capital planning and stress testing cycle for certain banking organizations that are subject to stress testing. We are currently evaluating the impact the CECL model will have on our accounting, and expect to recognize a one-time cumulative-effect adjustment to our allowance for loan and lease losses as of the beginning of the first quarter of 2023, the first reporting period in which the new standard is effective for us. At this time, we cannot yet reasonably determine the magnitude of such one-time cumulative adjustment, if any, or of the overall impact of the new standard on our business, financial condition or results of operations.
In November 2019, the federal banking regulators published final rules implementing a simplified measure of capital adequacy for certain banking organizations that have less than $10 billion in total consolidated assets. Under the final rules, which went into effect on January 1, 2020, depository institutions and depository institution holding companies that have less than $10 billion in total consolidated assets and meet other qualifying criteria, including a leverage ratio of greater than 9%, off-balance-sheet exposures of 25% or less of total consolidated assets and trading assets plus trading liabilities of 5% or less of total consolidated assets, are deemed “qualifying community banking organizations” and are eligible to opt into the “community bank leverage ratio framework.” A qualifying community banking organization that elects to use the community bank leverage ratio framework and that maintains a leverage ratio of greater than 9% is considered to have satisfied the generally applicable risk-based and leverage capital requirements under the Basel III rules and, if applicable, is considered to have met the “well capitalized” ratio requirements for purposes of its primary federal regulator’s prompt corrective action rules, discussed below. The final rules include a two-quarter grace period during which a qualifying community banking organization that temporarily fails to meet any of the qualifying criteria, including the greater-than-9% leverage capital ratio requirement, is generally still deemed “well capitalized” so long as the banking organization maintains a leverage capital ratio greater than 8%. A banking organization that fails to maintain a leverage capital ratio greater than 8% is not permitted to use the grace period and must comply with the generally applicable requirements under the Basel III rules and file the appropriate regulatory reports. We do not have any immediate plans to elect to use the community bank leverage ratio framework but may make such an election in the future.
Prompt Corrective Action
Under federal prompt corrective action regulations, the bank regulatory agencies are authorized and, under certain circumstances, required, to take various “prompt corrective actions” to resolve the problems of any bank subject to their jurisdiction that is not adequately capitalized. Depending on their capital levels, every insured depository institution is in one of five capital tiers: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Under the prompt corrective action regulations, a bank is considered “well capitalized” if it: (i) has a total risk-based capital ratio of 10.0% or greater; (ii) a Tier 1 risk-based capital ratio of 8.0% or greater; (iii) a CET1 ratio of 6.5% or greater; (iv) a leverage capital ratio of 5.0% or greater; and (iv) is not subject to any written agreement, order, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. Well capitalized status is a prerequisite for certain types of favorable regulatory treatment, including expedited processing of applications by the FDIC and the ability to rely on brokered deposits.
The Bank has been “well capitalized” since it commenced its business operations.
Effective with the March 31, 2020 Call Report, qualifying community banking organizations that elect to use the new community bank leverage ratio framework and that maintain a leverage ratio of greater than 9.0% will be considered to have satisfied the risk-based and leverage capital requirements to be deemed well-capitalized. We do not have any immediate plans to elect to use the community bank leverage ratio framework but may make such an election in the future.
The bank regulatory agencies may impose higher capital requirements on certain banks, and future regulatory change could impose higher capital standards as a routine matter. The regulators may also set higher capital requirements for holding companies whose circumstances warrant it. For example, holding companies experiencing internal growth or making acquisitions are expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets.
As an additional means to identify problems in the financial management of depository institutions, the Federal Deposit Insurance Act requires federal bank regulatory agencies to establish certain non-capital safety and soundness standards for institutions for which they are the primary federal regulator. The standards relate generally to operations and management, asset quality, interest rate exposure and executive compensation. The agencies are authorized to take action against institutions that fail to meet such standards.
Dividends
The Company is a legal entity separate and distinct from the Bank. Virtually all of the Company’s revenue available for the payment of dividends on its common stock results from dividends paid to the Company by the Bank. Under Maryland law, the Bank may declare a cash dividend, after providing for due or accrued expenses, losses, interest and taxes, from its undivided profits or, with the prior approval of the Commissioner, from its surplus in excess of 100% of its required capital stock. Also, if the Bank’s surplus is less than 100% of its required capital stock, then, until its surplus is 100% of its capital stock, the Bank must transfer to its surplus annually at least 10% of its net earnings and may not declare or pay any cash dividends that exceed 90% of its net earnings. In addition, federal bank regulators have stated that paying dividends that deplete a banking organization’s capital base to an inadequate level would be an unsafe and unsound banking practice and that banking organizations should generally only pay dividends out of current earnings. The Bank must also maintain the CET1 capital conservation buffer of 2.5% to avoid becoming subject to restrictions on capital distributions, including dividends, as described above.
Deposit Insurance Assessments
The Bank’s deposit accounts are insured by the FDIC generally up to a maximum of $250,000 per separately insured depositor. FDIC-insured depository institutions are required to pay deposit insurance assessments to the FDIC. The amount of a particular institution’s deposit insurance assessment is determined by an FDIC risk-based assessment system. The assessment is a function of a financial ratios method that takes into account seven financial ratios and the institution’s weighted average CAMELS component ratings. The assessment must be within a range that depends on the institution’s composite CAMELS rating, and the assessment will be adjusted up or down to come within the range. Assessment rates (inclusive of possible adjustments) for institutions with less than $10 billion in consolidated assets currently range from 1.5 to 30 basis points of each institution’s total assets less tangible capital. The FDIC may increase or decrease the range of assessments uniformly, except that no adjustment can deviate more than two basis points from the base assessment rate without notice and comment rulemaking. The FDIC may terminate insurance of deposits upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
In addition to the ordinary assessments described above, the FDIC has the ability to impose special assessments in certain instances. For example, under the Dodd-Frank Act, the minimum designated reserve ratio for the Deposit Insurance Fund (“DIF”) was increased to 1.35% of the estimated total amount of insured deposits. On September 30, 2018, the DIF reached 1.36%, exceeding the statutorily required minimum reserve ratio of 1.35%. On reaching the minimum reserve ratio of 1.35%, FDIC regulations provided for two changes to deposit insurance assessments: (i) surcharges on insured depository institutions with total consolidated assets of $10 billion or more (large institutions) ceased; and (ii) small banks were to receive assessment credits for the portion of their assessments that contributed to the growth in the reserve ratio from between 1.15% and 1.35%, to be applied when the reserve ratio is at or above 1.38%. The Bank subsequently received such assessment credits in 2019.
Maryland Regulatory Assessment
The Commissioner annually assesses state banking institutions to cover the expense of regulating banking institutions. The Bank’s asset size determines the amount of the assessment.
Liquidity
The Bank is subject to the uniform reserve requirements of the FRB’s Regulation D, which applies to all insured depository institutions with transaction accounts or non-personal time deposits. Effective March 26, 2020, the FRB reduced reserve
requirement ratios to zero percent, thus eliminating reserve requirements for depository institutions to support lending to households and businesses. The FRB may change its reserve requirements in the future and the Bank may be subject to new reserve requirements for 2021.
Loans-to-One-Borrower Limitation
With certain limited exceptions, a Maryland banking institution may lend to a single or related group of borrowers an aggregate amount not more than 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if such loan is secured by readily marketable collateral, which is defined to include certain securities and bullion, but generally does not include real estate. The Bank is in compliance with the loans-to-one borrower limitations.
Commercial Real Estate Loans
Commercial real estate (“CRE”) loans are subject to two types of regulatory oversight. If total reported loans for construction, land development, and other land represent more than 100% of a bank’s total capital or if total CRE loans represent 300% or more of total capital and have grown by 50% or more in the last 36 months, the bank is expected to have enhanced risk management and will be subject to greater regulatory scrutiny. In addition, the risk-based capital rules (so long as they are applicable) presumptively risk weight CRE loans at 100% but impose a 150% risk weight on loans deemed to be high volatility. Among other things, the capital rules required that a borrower contribute 15% of the equity of a financed project in order for the loan to qualify for the lower risk weight. The Reform Act narrowed the types of loans potentially subject to the higher risk weight but did not eliminate that risk weight.
Community Reinvestment Act and Fair Lending Laws
Under the Community Reinvestment Act of 1977 (“CRA”), the FDIC is required to assess the record of all financial institutions regulated by it to determine if such institutions are meeting the credit needs of the communities (including low and moderate income neighborhoods) that they serve. CRA performance evaluations are based on a four-tiered rating system: Outstanding, Satisfactory, Needs to Improve and Substantial Noncompliance. CRA performance evaluations are considered in evaluating applications for such things as mergers, acquisitions and new branches. The Bank has a CRA rating of “Satisfactory.”
In December 2019, the FDIC and the Office of the Comptroller of the Currency (“OCC”) proposed changes to the regulations implementing the CRA. The FRB did not join the proposal. On May 20, 2020, the OCC issued a final rule to strengthen and modernize its existing CRA framework, but the FDIC was not prepared to finalize its CRA proposal at that time.
In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics, such as ethnicity, gender, and race, as specified in each statute. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the FDIC, the Department of Housing and Urban Development, and the Department of Justice, and in private civil actions by borrowers.
Transactions with Related Parties
Transactions between banks and their related parties or affiliates are limited by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a bank is any company or entity that controls, is controlled by or is under common control with the bank. In a holding company context, the parent bank holding company and any companies which are controlled by such parent holding company are affiliates of the bank.
Generally, Section 23A of the Federal Reserve Act and the FRB’s Regulation W limit the “covered transactions” in which a bank or its subsidiaries may engage with any one affiliate to an amount equal to 10% of such bank’s capital stock and surplus, and limit such covered transactions with all affiliates to an amount equal to 20% of such bank’s capital stock and surplus. The term ‘‘covered transaction’’ includes loans, asset purchases, issuances of guarantees, and other similar
transactions that expose the bank to the credit risk of an affiliate. In addition, loans or other extensions of credit by the bank to an affiliate must be collateralized in accordance with regulatory requirements. The Bank’s transactions with affiliates must be consistent with safe and sound banking practices and may not involve the purchase by the Bank of any low-quality asset. Section 23B applies to covered transactions as well as certain other transactions and requires that all such transactions be on terms substantially the same, or at least as favorable, to the bank or subsidiary as those provided to non-affiliates.
Section 22(h) of the Federal Reserve Act and the FRB’s Regulation O govern extensions of credit made by a bank to its directors, executive officers, and principal stockholders (‘‘insiders’’). Among other things, these provisions require that extensions of credit to insiders be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features. Further, such extensions may not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Howard Bank’s capital. Extensions of credit in excess of certain limits must also be approved by the board of directors.
On December 22, 2020, the federal banking agencies issued an interagency statement extending the temporary relief from enforcement action against banks or asset managers, which become principal stockholders of banks, with respect to certain extensions of credit by banks that otherwise would violate Regulation O, provided the asset managers and banks satisfy certain conditions designed to ensure that there is a lack of control by the asset manager over the bank. This temporary relief will apply until January 1, 2022, unless amended or extended, while the FRB, in consultation with the other federal banking agencies, considers whether to amend Regulation O.
Standards for Safety and Soundness
Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. Interagency guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard.
Enforcement Powers
The Bank and its “institution-affiliated parties,” including its management, employees, agents, independent contractors, and consultants such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs, are subject to potential civil and criminal penalties for violations of law, regulations or written orders of a government agency. These practices can include the failure of an institution to timely file required reports or the filing of false or misleading information or the submission of inaccurate reports. Potential civil penalties have been substantially increased. Criminal penalties for some financial institution crimes have been increased to 20 years.
In addition, regulators are provided with considerable flexibility to commence enforcement actions against institutions and institution-affiliated parties. Possible enforcement actions include the termination of deposit insurance. Furthermore, banking agencies’ have expansive power to issue cease-and-desist orders. These orders may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnifications or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts or take other actions as determined by the ordering agency to be appropriate.
Further, state attorneys general may bring civil actions or other proceedings under the Dodd-Frank Act or regulations against state-chartered banks, including the Bank.
Anti-Money Laundering and Office of Foreign Assets Control
Under federal law, financial institutions must maintain programs to prevent money laundering and the financing of terrorism that include established internal policies, procedures and controls; a designated compliance officer; an ongoing employee training program; testing of the program by an independent audit function; and a “know your customer” program with enhanced due diligence of certain customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering; they must file currency transaction reports for deposits and withdrawals of large amounts of currency and suspicious activity reports of possible criminal activity. Financial institutions also must assess their money laundering risk with respect to private banking and foreign correspondent banking relationships. Law enforcement authorities have been granted increased access to financial information maintained by financial institutions. Bank regulators routinely examine institutions for compliance with these obligations, and they must consider an institution’s compliance in connection with the regulatory review of applications, including applications for banking mergers and acquisitions. The regulatory authorities have imposed “cease and desist” orders and civil money penalty sanctions against institutions found to be violating these obligations.
Bank Secrecy Act and anti-money laundering compliance has been a special focus of the Federal banking agencies in recent years. Any non-compliance is likely to result in an enforcement action, often with substantial monetary penalties and reputation damage. A savings association or bank that is required to strengthen its compliance program often must put on hold any initiatives that require banking agency approval.
The Office of Foreign Assets Control, (“OFAC”) is responsible for helping to ensure that U.S. entities do not engage in transactions with certain prohibited parties, as defined by various Executive Orders and Acts of Congress. OFAC sends bank regulatory agencies lists of persons and organizations suspected of aiding, harboring or engaging in terrorist acts, known as Specially Designated Nationals and Blocked Persons. If we find a name on any transaction, account or wire transfer that is on an OFAC list, we must freeze such account, file a suspicious activity report and notify the appropriate authorities.
USA PATRIOT Act
The Patriot Act became effective on October 26, 2001 and amended the Bank Secrecy Act. The Patriot Act provides, in part, for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering by enhancing anti-money laundering and financial transparency laws, as well as enhanced information collection tools and enforcement mechanics for the U.S. government, including:
● requiring standards for verifying customer identification at account opening;
● rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering;
● reports by nonfinancial trades and businesses filed with the Treasury Department’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and
● filing suspicious activities reports by brokers and dealers if they believe a customer may be violating U.S. laws and regulations.
The Patriot Act requires financial institutions to undertake enhanced due diligence of private bank accounts or correspondent accounts for non-U.S. persons that they administer, maintain, or manage. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.
Under the Patriot Act, the Financial Crimes Enforcement Network (“FinCEN”) can send the Bank a list of the names of persons suspected of involvement in terrorist activities or money laundering. The Bank may be requested to search its records for any relationships or transactions with persons on the list. If the Bank finds any relationships or transactions, it must report those relationships or transactions to FinCEN.
Consumer Protection Laws
We are subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the economy. These laws include the Equal Credit Opportunity Act, the Fair Housing Act, the Fair Credit Reporting Act, the Fair and Accurate Credit Transactions Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, and the Real Estate Settlement Procedures Act, and various state law counterparts. Further, the Dodd-Frank Act established the CFPB, which has the responsibility for making rules and regulations under the federal consumer protection laws relating to financial products and services. The CFPB has the authority to supervise and examine depository institutions with more than $10 billion in assets for compliance with federal consumer laws. The authority to supervise and examine depository institutions with $10 billion or less in assets, such as the Bank, for compliance with federal consumer laws remains largely with those institutions’ primary regulators. However, the CFPB may participate in examinations of these smaller institutions on a “sampling basis” and may refer potential enforcement actions against such institutions to their primary regulators. As such, the CFPB may participate in examinations of the Bank. The CFPB also has a broad mandate to prohibit unfair, deceptive or abusive acts and practices and is specifically empowered to require certain disclosures to consumers and draft model disclosure forms. Failure to comply with consumer protection laws and regulations can subject financial institutions to enforcement actions, fines and other penalties.
In addition, federal law currently contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, at the inception of the customer relationship and annually thereafter, the institution’s policies and practices regarding the handling of customers’ nonpublic personal financial information. These provisions also provide that, except for certain limited exceptions, a financial institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. Further, under the ‘‘Interagency Guidelines Establishing Information Security Standards,’’ banks must implement a comprehensive information security program that includes administrative, technical, and physical safeguards to ensure the security and confidentiality of customer information. Federal law makes it a criminal offense, except in limited circumstances, to obtain or attempt to obtain customer information of a financial nature by fraudulent or deceptive means.
Effect of Governmental Monetary Policies
Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The FRB’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through the FRB’s power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the FRB affect the levels of bank loans, investments and deposits through the FRB’s control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in monetary and fiscal policies. On August 1, 2019, September 19, 2019 and October 31, 2019, the Federal Open Market Committee (the “FMOC”) decreased the federal funds target rate by 25 basis points, which resulted in a total reduction of 75 basis points during 2019. On March 4, 2020, the FMOC decreased the federal funds target rate by 50 basis points to a target range of 1.00% to 1.25%; and on March 16, 2020, the FMOC decreased the federal funds target rate by 100 basis points to a target range of 0.00% to 0.25%. Further changes may occur in 2021.
Item 1A.
Item 1A. Risk Factors
You should consider carefully the following risks, along with the other information contained in and incorporated into this report. The risks and uncertainties described below are not the only ones that may affect us. Additional risks and uncertainties also may adversely affect our business and operations. If any of the following events actually occur, our business and financial results could be materially adversely affected.
Economic and Geographic-Related Risks
The global COVID-19 pandemic has adversely affected our business, financial condition and results of operations, and the ultimate effect of the pandemic on our business, financial condition and results of operations will depend on future developments and other factors that are highly uncertain.
The global COVID-19 pandemic and related government-imposed and other measures intended to control the spread of the disease, including restrictions on travel and the conduct of business, such as stay-at-home orders, quarantines, travel bans, border closings, business and school closures and other similar measures, have had a significant impact on global economic conditions and have negatively impacted certain aspects of our business, financial condition and results of operations, and may continue to do so in the future. The governmental and social response to the COVID-19 pandemic has resulted in an unprecedented slow-down in economic activity and a related increase in unemployment. The COVID-19 pandemic, and related efforts to contain it, have also caused significant disruptions in the functioning of the financial markets and have increased economic and market uncertainty and volatility.
Given the ongoing, dynamic and unprecedented nature of the COVID-19 pandemic, it is difficult to predict the full impact the pandemic will have on our business. While certain factors point to improving economic conditions, uncertainty remains regarding the path of the economic recovery, the mitigating impacts of government interventions, the success of vaccine distribution and the efficacy of administered vaccines, as well as the effects of the change in leadership resulting from the recent elections. The COVID-19 pandemic may subject us to any of the following risks, any of which could have a material adverse effect on our business, financial condition, liquidity, results of operations, risk-weighted assets and regulatory capital:
● because the incidence of reported COVID-19 cases and related hospitalizations and deaths varies significantly by state and locality, the economic downturn caused by the pandemic may be deeper and more sustained in certain areas, including those in which we do business, relative to other areas of the country;
● our ability to market our products and services may be impaired by a variety of external factors, including a prolonged reduction in economic activity and continued economic and financial market volatility, which could cause demand for our products and services to decline, in turn making it difficult for us to grow assets and income;
● if the economy is unable to substantially reopen and high levels of unemployment continue for an extended period of time, loan delinquencies, problem assets, and foreclosures may increase, resulting in increased charges and reduced income;
● collateral for loans, especially real estate, may decline in value, which may reduce our ability to liquidate such collateral and could cause loan losses to increase and impair our ability over the long run to maintain our targeted loan origination volume;
● our allowance for loan and lease losses may have to be increased if borrowers experience financial difficulties beyond forbearance periods, which will adversely affect our net income;
● an increase in non-performing loans due to the COVID-19 pandemic would result in a corresponding increase in the risk-weighting of assets and therefore an increase in required regulatory capital;
● the net worth and liquidity of borrowers and loan guarantors may decline, impairing their ability to honor commitments to us;
● as the result of the reduction of the FRB’s target federal funds rate to near 0%, the yield on our assets may decline to a greater extent than the decline in our cost of interest-bearing liabilities, reducing our net interest margin and spread and reducing net income;
● deposits could decline if customers need to draw on available balances as a result of the economic downturn;
● the borrowing needs of our clients may increase, especially during this challenging economic environment, which could result in increased borrowing against our contractual obligations to extend credit;
● we face heightened cybersecurity risk in connection with our operation of a remote working environment, which risks include, among others, greater phishing, malware, and other cybersecurity attacks, vulnerability to disruptions of our information technology infrastructure and telecommunications systems, increased risk of unauthorized dissemination of confidential information, limited ability to restore our systems in the event of a systems failure or interruption, greater risk of a security breach resulting in destruction or misuse of valuable information, and potential impairment of our ability to perform critical functions-all of which could expose us
to risks of data or financial loss, litigation and liability and could seriously disrupt our operations and the operations of any impacted customers;
● we rely on third party vendors for certain services and the unavailability of a critical service or limitations on the business capacities of our vendors for extended periods of time due to the COVID-19 pandemic could have an adverse effect on our operations; and
● as a result of the COVID-19 pandemic, there may be unexpected developments in financial markets, legislation, regulations and consumer and customer behavior.
Even after the COVID-19 outbreak has subsided, we may continue to experience materially adverse impacts to our business as a result of the virus’ global economic impact, including the availability of credit, adverse impacts on our liquidity and any recession that has occurred or may occur in the future. There are no comparable recent events that provide guidance as to the effect the spread of COVID-19 as a global pandemic may have, and, as a result, the ultimate impact of the outbreak is highly uncertain and subject to change. We do not yet know the full extent of the impacts on our business, our operations or the global economy as a whole. However, the effects could have a material impact on our results of operations and heighten many of our known risks described herein.
Our business may be adversely affected by economic conditions.
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 the Great Baltimore Metropolitan area. The economic conditions in this local market may be different from, and in some instances worse than, the economic conditions in the United States as a whole. In addition, due to the proximity of our primary market area to Washington, D.C., decreases in spending by the Federal government or cuts to Federal government employment could impact us to a greater degree than banks that serve a larger or a different geographical area. Such risks are beyond our control and may have a material adverse effect on our financial condition and results of operations and, in turn, the value of our common stock. 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 and charge-offs, additional provisions for loan 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 or pandemics (including COVID-19); or a combination of these or other factors.
The impact of the COVID-19 pandemic is fluid and continues to evolve and there is pervasive uncertainty surrounding the future economic conditions that will emerge in the months and years following the onset of the pandemic. Even after the COVID-19 pandemic subsides, the U.S. economy will likely require some time to recover from its effects, the length of which is unknown, and during which we may experience a recession. 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, depressed oil prices and a potential resurgence of economic and political tensions with China that 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.
Credit, Lending and Interest Rate Risks
Because our loan portfolio consists largely of commercial business and commercial real estate loans, our portfolio carries a higher degree of risk than would a portfolio composed primarily of residential mortgage loans.
Our loan portfolio is made up largely of commercial business loans and commercial real estate loans, most of which is collateralized by real estate. These types of loans generally expose a lender to a higher degree of risk of non-payment and loss than do residential mortgage loans because of several factors, including dependence on the successful operation of a business or a project for repayment, the collateral securing these loans may not be sold as easily as residential real estate, and loan terms with a balloon payment rather than full amortization over the loan term. In addition, commercial real estate and commercial loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one- to four-family residential mortgage loans. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one- to four-family residential mortgage loan. Underwriting and portfolio management activities cannot completely eliminate all risks related to these loans. Any significant failure to pay on time by our customers or a significant default by our customers would materially and adversely affect us.
We make both secured and some unsecured commercial and industrial loans. Unsecured loans generally involve a higher degree of risk of loss than do secured loans because, without collateral, repayment is wholly dependent upon the success of the borrowers’ businesses. Secured commercial and industrial loans are generally collateralized by accounts receivable, inventory, equipment or other assets owned by the borrower and include a personal guaranty of the business owner. Compared to real estate, that type of collateral is more difficult to monitor, its value is harder to ascertain, it may depreciate more rapidly and it may not be as readily saleable if repossessed. Further, commercial and industrial loans generally will be serviced primarily from the operation of the business, which may not be successful, and commercial real estate loans generally will be serviced from income on the properties securing the loans.
While any declines in the value of our real estate collateral securing loans have been reflected in existing reserves, the discounts and reserves we have taken against our loan portfolio based on our internal review of economic conditions and their impact on real estate values in our market areas may be insufficient. Deterioration in the real estate market or the economy could adversely affect the value of the properties securing the loans or revenues from borrowers’ businesses, thereby increasing the risk of non-performing loans and increased portfolio losses that could materially and adversely affect us.
The small businesses that make up the majority of our commercial borrowers generally do not have the cash reserves to help cushion them from an economic slowdown to the same extent that large borrowers do and thus may be more heavily impacted by an economic downturn, including the downturn related to the COVID-19 pandemic. Any recession that has occurred due to the COVID-19 pandemic or that may occur and/or other negative developments in the domestic or international credit markets or economies may have a negative effect on the ability of our commercial borrowers to make timely repayments of their loans, which could have an adverse impact on our earnings.
Construction loans are subject to risks during the construction phase that are not present in standard residential real estate and commercial real estate loans. These risks include:
● the viability of the contractor;
● the value of the project being subject to successful completion;
● the contractor’s ability to complete the project, to meet deadlines and time schedules and to stay within cost estimates; and
● concentrations of such loans with a single contractor and its affiliates.
Real estate construction and land loans also present risks of default in the event of declines in property values or volatility in the real estate market during the construction phase. If we are forced to foreclose on a project prior to completion, we may not be able to recover the entire unpaid portion of the loan, may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminate amount of time. If any of these risks were to occur, it could adversely affect our financial condition, results of operations and cash flows.
As of December 31, 2020, our commercial real estate loans were equal to 271% of our total regulatory capital. The federal banking agencies have issued guidance regarding high concentrations of commercial real estate loans within bank loan portfolios. The guidance requires financial institutions that exceed certain levels of commercial real estate lending compared with their total capital to maintain heightened risk management practices that address the following key elements: board and management oversight and strategic planning, portfolio management, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing, and maintenance of increased capital levels as needed to support the level of commercial real estate lending. If there is any deterioration in our commercial real estate or real estate construction and land portfolios or if our regulators conclude that we have not implemented appropriate risk management practices, it could adversely affect our business and result in a requirement that we increase our capital levels, and such capital may not be available to us on acceptable terms or at all.
Because our loan portfolio includes residential real estate loans, our earnings are sensitive to the credit risks associated with these types of loans.
While we ceased originating residential first lien mortgage loans in early 2020, we will continue to originate home equity loans and home equity lines of credit within our local market area. We will also purchase residential first lien mortgage loans in order to offset portfolio runoff. While residential real estate loans are more diversified than loans to commercial borrowers, and our local real estate market and economy have historically performed better than many other markets, a prolonged downturn related to the COVID-19 pandemic could cause higher unemployment, more delinquencies, and could adversely affect the value of properties securing loans in our portfolio. In addition, should values begin to decline again, the real estate market may take longer to recover or not recover to previous levels. These risks increase the probability of an adverse impact on our financial results as fewer borrowers would be eligible to borrow and property values could be below necessary levels required for adequate coverage on the requested loan.
If our allowance for loan and lease losses is not sufficient to cover actual loan losses, our earnings would decrease.
We are exposed to the risk that our customers will be unable to repay their loans according to their terms and that any collateral securing the payment of their loans will not be sufficient to ensure full repayment. Credit losses are inherent in the lending business and could have a material adverse effect on our operating results and ability to meet our obligations. Volatility and deterioration in domestic markets may also increase our risk for credit losses. We maintain an allowance for loan and lease losses that we believe is adequate for absorbing any potential losses in our loan portfolio. Management, through a periodic review and consideration of our loan portfolio, determines the amount of the allowance for loan and lease losses. We cannot, however, predict with certainty the amount of probable losses in our portfolio or be sure that our allowance will be adequate in the future. If management’s assumptions and judgments prove to be incorrect and the allowance for loan and lease losses is inadequate to absorb future losses, our losses will increase and our earnings will suffer.
We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan and lease losses, we review our loans and our loss and delinquency experience, and we evaluate economic conditions. If our assumptions are incorrect, our allowance for loan and lease losses may not be sufficient to cover probable incurred losses in our loan portfolio, resulting in additions to the allowance and a corresponding decrease to earnings. We expect economic uncertainty to continue in 2021, and further deterioration in economic conditions may result in a significant increase to our allowance for loan losses in future periods. Material additions to the allowance could materially decrease our net income. If delinquencies and defaults should increase, we may be required to further increase our provision for loan losses.
In addition, bank regulators periodically review our allowance for loan and lease losses and may require us to increase our provision for credit losses or recognize further loan charge-offs to the allowance for loan and lease losses. Any increase in the allowance for loan and lease losses or loan charge-offs might have a material adverse effect on our financial condition and results of operations.
Our financial condition, earnings and asset quality could be adversely affected if we are required to repurchase loans originated for sale by our former mortgage banking division.
As discussed in “Item 1. Business - Mortgage Banking,” most loans that we sold in the secondary market are with recourse. Therefore, we may be required to repurchase a previously sold mortgage loan or indemnify the purchaser if there is non-compliance with defined loan origination or documentation standards, including fraud, negligence or material misstatement in the loan documents, if the mortgagor has defaulted early in the loan term, or noncompliance with applicable law. While to date we have only had to repurchase a minimal amount of loans previously sold, should repurchases become a material issue, our earnings and asset quality could be adversely impacted, which could adversely impact the market price of our common stock.
Certain of our estimates related to accounting for acquired loans may differ from actual results.
The application of the purchase method of accounting in our prior mergers and any future mergers or acquisitions will impact our allowance for loan and lease losses. Under the purchase method of accounting, all acquired loans were recorded in our Consolidated Financial Statements at their estimated fair value at the time of acquisition and any related allowance for loan and lease loss was eliminated because credit quality, among other factors, was considered in the determination of fair value. To the extent that our estimates of fair value are too high, we will incur losses associated with the acquired loans. The allowance associated with our acquired credit impaired loans reflects deterioration in cash flows since acquisition resulting from our quarterly re-estimation of cash flows which involves complex cash flow projections and significant judgment on timing of loan resolution.
If the estimates we have made regarding the performance of loans we have acquired are inaccurate, the fair value estimates may exceed the actual collectability of the balances, and this may result in the related loans being considered by us as impaired, which would result in a reduction in interest income. The tangible book value we measure is based in part on these estimates, and if fair value estimates differ from actual collectability, then subsequent earnings may also differ from original estimates. Measures of tangible book value and earnings impact of business combinations are frequently used in evaluating the merits and value of business combinations. Numerous assumptions and estimates are integral to purchased loan accounting, and actual results could be different from prior estimates.
The small and medium-sized businesses that we lend to may have fewer resources to weather a downturn in the economy, which may impair a borrower’s ability to repay a loan to the Bank that could materially harm our operating results.
We target our business development and marketing strategy primarily to serve the banking and financial services needs of small and medium-sized businesses. These small and medium-sized businesses frequently have a smaller market share than their competition, may be more vulnerable to economic downturns, may need substantial additional capital to expand or compete and may experience significant volatility in operating results. Any one or more of these factors may impair their ability to repay a loan. In addition, the success of a small and medium-sized business often depends on the management talents and efforts of one or two persons or a small group of persons, and the death, disability or resignation of one or more of these persons could have a material adverse impact on its business and its ability to repay a loan. As a result, economic downturns and other events that negatively impact our market areas and the businesses we serve could cause us to incur substantial credit losses that could negatively affect our results of operations and financial condition.
Our profitability depends on interest rates, and changes in interest rates could have an adverse impact on our results of operations and financial condition.
Our results of operations depends to a large extent on our “net interest income,” which is the difference between the interest income received from our interest-earning assets, such as loans and investment securities, and the interest expense incurred in connection with our interest-bearing liabilities, such as interest on deposit accounts. Changes in interest rates can increase or decrease our net interest income, because different types of assets and liabilities may react differently, and at different times, to market interest rate changes. When interest bearing liabilities mature or reprice more quickly than interest earning assets in a period, an increase in interest rates could reduce net interest income. Similarly, when interest earning assets mature or reprice more quickly than interest bearing liabilities, falling interest rates could reduce net interest
income. Additionally, an increase in interest rates may, among other things, reduce loan demand and our ability to originate loans (which would also decrease our ability to generate noninterest income through the sale of loans into the secondary market), and make it more difficult for borrowers to repay adjustable-rate loans or otherwise decrease loan repayment rates. A decrease in the general level of interest rates may affect us through, among other things, increased prepayments on our loan and mortgage-backed securities portfolios and increased competition for deposits. Accordingly, changes in the level of market interest rates affect our net yield on interest earning assets, loan origination volume, loan and mortgage-backed securities portfolios, and our overall results. Fluctuations in interest rates are highly sensitive to many factors that are not predictable or controllable. Therefore, while we attempt to manage our risk from changes in market interest rates by adjusting the rates, maturity, repricing, and balances of the different types of interest-earning assets and interest bearing liabilities, we might not be able to maintain a consistent positive spread between the interest that we receive and the interest that we pay. As a result, a rapid increase or decrease in interest rates could have an adverse effect on our net interest margin and results of operations.
In addition, as market interest rates rise, we will have competitive pressures to increase the rates we pay on deposits. Because interest rates we pay on our deposits could be expected to increase more quickly than the increase in the yields we earn on our interest-earning assets, our net interest income would be adversely affected.
Governmental economic and monetary policy will influence our results of operations. The rates of interest payable on deposits and chargeable on loans are affected by monetary policy as determined by various governmental and regulatory authorities, in particular the FRB, as well as by national, state and local economic conditions. In response to the COVID-19 pandemic, the Federal Open Market Committee cut short-term interest rates to a record low range of 0% to 0.25%, and the FRB has indicated it expects rates to remain within this range through 2023 and possibly longer. If short-term interest rates continue to remain at their historically low levels 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. If rates remain relatively low it could create deflationary pressures, which while possibly lowering our operating costs, could have a negative impact on our borrowers, especially our commercial borrowers, and the values of collateral securing our loans, which could negatively affect our financial performance. If the FRB increases the federal funds rate, overall interest rates will likely rise, which may negatively impact the housing markets and U.S. economic growth.
We also are subject to reinvestment risk associated with changes in interest rates. Changes in interest rates may affect the average life of loans and mortgage-related securities. Decreases in interest rates can result in increased prepayments of loans and mortgage-related securities, as borrowers refinance to reduce borrowing costs. Under these circumstances, we are subject to reinvestment risk to the extent that we are unable to reinvest the cash received from such prepayments at rates that are comparable to the interest rates on existing loans and securities.
Capital and Liquidity Risks
We may be subject to more stringent capital requirements in the future.
We are subject to regulatory requirements specifying minimum amounts and types of capital that we must maintain. From time to time, the regulators change these regulatory capital adequacy guidelines. If we fail to meet these minimum capital guidelines and other regulatory requirements, we may be restricted in the types of activities we may conduct and we may be prohibited from taking certain capital actions, such as paying dividends and repurchasing or redeeming capital securities.
In particular, the capital requirements applicable to the Bank under the Basel III rules become fully phased-in on January 1, 2019. The Bank is now required to satisfy additional, more stringent, capital adequacy standards than it had in the past. While we expect to meet the requirements of the Basel III rules, we may fail to do so. Failure to meet minimum capital requirements could result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have an adverse material effect on our financial condition and results of operations. In addition, these requirements could have a negative impact on our ability to lend, grow deposit balances, make acquisitions or make capital distributions in the form of dividends or share repurchases. Higher capital levels could also lower our return on equity.
Our investment securities portfolio is subject to credit risk, market risk, and liquidity risk.
Our investment securities portfolio is subject to risks beyond our control that may significantly influence its fair value. These include, but are not limited to, rating agency downgrades of the securities, defaults of the issuers of the securities, lack of market pricing of the securities, and instability in the credit markets. Lack of market activity with respect to some securities has, in certain circumstances, required us to base their fair market valuation on unobservable inputs. Any changes in these risk factors, in current accounting principles or interpretations of these principles could impact our assessment of fair value and thus the determination of other-than-temporary impairment of the securities in the investment securities portfolio. Investment securities that previously were determined to be other-than-temporarily impaired could require further write-downs due to continued erosion of the creditworthiness of the issuer. Write-downs of investment securities would negatively affect our earnings and regulatory capital ratios.
Further, most of our securities investment portfolio as of December 31, 2020 has been designated as available for sale pursuant to Accounting Standards Codification (“ASC”) Topic 320 - “Investments.” ASC Topic 320 requires that unrealized gains and losses in the estimated value of the available for sale portfolio be “marked to market” and reflected as a separate item in stockholders’ equity, net of tax. If the market value of the investment portfolio declines, this could cause a corresponding decline in stockholders’ equity.
We are subject to liquidity risks.
Market conditions could negatively affect the level or cost of available liquidity, which would affect our ongoing ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations, and fund asset growth and new business transactions at a reasonable cost, in a timely manner, and without adverse consequences. Core deposits are our primary source of funding, but this is supplemented by overnight unsecured master notes, customer repurchase agreements, FHLB advances, the FRB Discount Window, subordinated debentures and other purchased funds. A significant decrease in our core deposits, an inability to renew FHLB advances or access the Discount Window, an inability to obtain alternative funding to core deposits or our other traditional sources of funds, or a substantial, unexpected, or prolonged change in the level or cost of liquidity could have a negative effect on our business, financial condition and results of operations.
We may be required to raise additional capital in the future, but that capital may not be available when it is needed on attractive terms, or at all.
We are required by regulatory authorities to maintain adequate levels of capital to support our operations. Our capital requirements for the foreseeable future are currently satisfied. We may at some point, however, need to raise additional capital to support our continued growth or if our liquidity is adversely affected by external factors such as a return of recessionary conditions and/or other negative developments in the domestic or international credit markets. Our ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control. Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations could be materially impaired, or the failure to raise additional capital could have a material adverse effect on our liquidity, financial condition or results of operations. In addition, if we decide to raise additional equity capital, your interest in the Company could be diluted. Furthermore, if we raise additional capital through the issuance of debt securities, there can be no assurance that sufficient revenues or cash flow will exist to service such debt.
Risks Related to Our Industry
The phase-out of LIBOR could negatively impact our net interest income and require significant operational work.
The United Kingdom’s Financial Conduct Authority, which regulates the London Interbank Offered Rate (“LIBOR”), has announced that it will not compel panel banks to contribute to LIBOR after 2021. The discontinuance of LIBOR has resulted in significant uncertainty regarding the transition to suitable alternative reference rates and could adversely impact our business, operations, and financial results.
The FRB, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, has endorsed replacing the U.S. dollar LIBOR with a new index calculated by short-term repurchase agreements, backed by Treasury securities (“SOFR”). SOFR is observed and backward looking, which stands in contrast with LIBOR under the current methodology, which is an estimated forward-looking rate and relies, to some degree, on the expert judgment of submitting panel members. Given that SOFR is a secured rate backed by government securities, it will be a rate that does not take into account bank credit risk (as is the case with LIBOR). In November 2020, the federal banking agencies issued a statement that says that banks may use any reference rate for its loans that the bank determines to be appropriate for its funding model and customer needs.
We have substantial exposure to LIBOR-based products, including loans, securities, derivatives and hedges, and we are preparing to transition away from the widespread use of LIBOR to alternative rates. We continue to monitor the market's progress toward an alternative to LIBOR, but are not yet comfortable that there is an efficient instrument with sufficient liquidity to begin a meaningful transition. At this time, we anticipate that a transition may occur in late 2021 or early 2022. We continue to monitor market developments and regulatory updates, including recent announcements from the ICE Benchmark Administrator to extend the cessation date for several USD LIBOR tenors to June 30, 2023, as well as collaborate with regulators and industry groups on the transition. The manner and impact of this transition, as well as the effect of these developments on our funding costs, loan and investment and trading securities portfolios, asset-liability management, and business, is uncertain.
Consumers may decide not to use banks to complete their financial transactions.
Technology and other changes are allowing consumers 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 transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, which may increase as consumers become more comfortable with these new technologies and offerings, 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.
Strong competition within our market area may limit our growth and profitability.
Competition in the banking and financial services industry within our market area is intense. In our market area, we compete with, among others, commercial banks, savings institutions, mortgage brokerage firms, credit unions, mutual funds, insurance companies and brokerage and investment banking firms operating locally and elsewhere. There are also a number of smaller community-based banks that pursue similar operating strategies as the Bank. In addition, some of our competitors may offer loans with lower fixed rates and on more attractive terms than we are willing to offer. Our continued profitability depends on our continued ability to successfully compete in our market area. The greater resources and broader range of deposit and loan products offered by our competition may limit our ability to increase our interest earning assets and profitability. See “Item 1. Business-Competition” for more information about competition in our market area.
We expect competition to remain intense in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Banks, securities firms and insurance companies can merge under the umbrella 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. Increased competition among financial services companies due to the recent consolidation of certain competing financial institutions may adversely affect our ability to market our products and services. Also, technological advances have lowered barriers to entry and made it possible for banks to compete in our market without a retail footprint by offering competitive rates and for non-banks to offer products and services that have traditionally been provided by banks. Additionally, due to their size, many of our competitors may offer a broader range of products and services as well as better pricing for certain products and services than we can, which could affect our ability to grow and remain profitable on a long-term basis. Our profitability depends on our ability to successfully compete in our market area, and competition for deposits and the origination of loans could limit our ability to successfully implement our business plan, and could adversely affect our
results of operations in the future. Further, if we must raise interest rates paid on deposits or lower interest rates charged on our loans, our net interest margin and profitability could be adversely affected.
Furthermore, competition in the banking and financial services industry is coming not only from traditional competitors but from technology-oriented financial services (“FinTech”) companies, which are subject to limited regulation. They offer user friendly front-end, quick turnaround times for loans and other benefits. While we are considering the possibility of developing relationships with FinTech companies for efficiency in processing and/or as a source of loans and other benefits, we cannot limit the possibility that our customers or future prospects will work directly with a FinTech company instead. This could impact our growth and profitability going forward.
Our lending limit may limit our growth.
We are limited in the amount we can loan to a single borrower by the amount of our capital. Generally, under current law, we may lend up to 15% of our unimpaired capital and surplus to any one borrower. Based upon our current capital levels, such amount is significantly less than that of many of our competitors and may discourage potential borrowers who have credit needs in excess of our lending limit from doing business with us. We accommodate larger loans by selling participations in those loans to other financial institutions, but this strategy may not always be available.
The failure to maintain our reputation may materially adversely affect our ability to grow and generate revenue.
Our reputation is one of the most valuable components of our business. Damage to our reputation could undermines the confidence of clients and prospects in our ability to serve them and therefore could negatively affect our earnings. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, mergers and acquisitions and cybersecurity incidents, and from actions taken by government regulators and community organizations in response to those activities. Damage to our reputation could affect the confidence of rating agencies, regulators, stockholders and other parties in a wide range of transactions that are important to our business. Failure to maintain our reputation ultimately would have an adverse effect on our ability to maintain and grow our business. Actions by the financial services industry generally or by other members of or individuals in the financial services industry also could impact our reputation negatively. The considerable expansion in the use of social media over recent years has increased the risk that our reputation could be negatively impacted in a short amount of time. If we are unable to quickly and effectively respond to any incidents negatively impacting our reputation, it could have a material and long-term negative impact on our business and, therefore, our operating results.
Risks Related to Our Strategy
Our growth strategy may not be successful, may be dilutive and may have other adverse consequences.
A key component of our growth strategy is to pursue acquisitions of other financial institutions or branches of other financial institutions, and we routinely evaluate opportunities to acquire additional financial institutions or branches or to open new branches. As consolidation of the banking industry continues, the competition for suitable acquisition candidates may increase. We compete with other banking companies for acquisition opportunities, and there are a limited number of candidates that meet our acquisition criteria. Consequently, we may not be able to identify suitable candidates for acquisitions. If we are unable to locate suitable acquisition candidates willing to sell on terms acceptable to us, our net income could decline and we would be required to find other methods to grow our business. We may also open additional branches organically and expand into new markets or offer new products and services.
Our merger and acquisition activities could be material and could require us to use a substantial amount of common stock and dilute our existing stockholders, cash, other liquid assets, and/or incur debt. In addition, if goodwill recorded in connection with our prior or potential future acquisitions were determined to be impaired, then we would be required to recognize a charge against our earnings, which could materially and adversely affect our results of operations during the period in which the impairment was recognized.
Our expansion activities could involve a number of additional risks, including:
● the time and expense associated with identifying and evaluating potential acquisition and merger partners;
● using inaccurate estimates and judgments to evaluate credit, operations, management and market risks with respect to the target institution or its branches or assets;
● the time and expense associated with evaluating new markets for expansion, hiring experienced local management and opening new offices or branches as there may be a substantial time lag between these activities before we generate sufficient assets and deposits to support the costs of the expansion;
● operating in markets in which we have had no or only limited experience;
● taking a significant amount of time negotiating a transaction or working on expansion plans, resulting in management’s time and attention being diverted from the operation of our existing business;
● we may not be able to correctly identify profitable or growing markets for new branches;
● difficulty or unanticipated expense associated with converting the operating systems of the acquired or merged company into ours;
● the possibility that we will be unable to successfully implement integration strategies, due to challenges associated with integrating complex systems, technology, banking centers, and other assets of the acquired bank in a manner that minimizes any adverse effect on customers, suppliers, employees, and other constituencies;
● the possibility that the expected benefits of a transaction may not materialize in the timeframe expected or at all, or may be costlier to achieve;
● the ability to realize the anticipated benefits of the merger or acquisition;
● creating an adverse short-term effect on our results of operations;
● losing key employees and customers as a result of a merger or acquisition that is poorly received;
● the possibility of regulatory approval being delayed, impeded, conditioned or denied due to existing or new regulatory issues surrounding the Company, the target institution or the proposed combined entity as a result of, among other things, issues related to anti-money laundering/Bank Secrecy Act compliance, fair lending laws, fair housing laws, consumer protection laws, unfair, deceptive or abusive acts or practices regulations, or the CRA;
● delay in completing a merger or acquisition due to litigation;
● inability to obtain additional financing (including by issuing additional common equity), if necessary, on favorable terms or at all; and
● unforeseen adjustments, write-downs, write-offs or restructuring or other impairment charges.
Also, the costs to lease and start up new branch facilities or to acquire existing financial institutions or branches, and the additional costs to operate these facilities, may increase our noninterest expense. It also may be difficult to adequately and profitably manage the anticipated growth from the new branches. We can provide no assurance that any new branch sites will successfully attract a sufficient level of deposits and other banking business to offset their operating expenses.
Further, we plan to continue to make investments in our infrastructure in the future. We may in the future open additional branches in the areas where we now operate and in other markets. We anticipate that this will have the short-term effect of, at least temporarily, increasing our expenses at a faster rate than revenue growth, which will have an adverse effect on net income.
If we grow too quickly and are not able to control costs and maintain asset quality, growth could materially and adversely affect our financial condition and results of operations. Further, we may not be successful in our growth strategy, which would negatively impact our financial condition and results of operations.
Operational Risks
A failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and other service providers or other third parties, including as a result of cyber-attacks, could disrupt our businesses, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and cause losses.
We rely heavily on communications and information systems to conduct our business. Information security risks for financial institutions such as ours have generally increased in recent years in part because of the proliferation of new technologies, the use of the internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists, activists, and other external parties. As client, public, and regulatory expectations regarding operational and information security have increased, our operational systems and infrastructure must continue to be safeguarded and monitored for potential failures, disruptions, and breakdowns. Our business, financial, accounting and data processing systems, or other operating systems and facilities may stop operating properly or become disabled or damaged as a result of a number of factors, including events that are wholly or partially beyond our control. For example, there could be electrical or telecommunications outages; natural disasters such as earthquakes, tornadoes, and hurricanes; disease pandemics; events arising from local or larger scale political or social matters, including terrorist acts; and, as described below, cyber-attacks.
As noted above, our business relies on our digital technologies, computer and email systems, software, and networks to conduct its operations. Although we have information security procedures and controls in place, our technologies, systems, networks, and our clients’ devices may become the target of cyberattacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our clients’ confidential, proprietary and other information, or otherwise disrupt our or our clients’ or other third parties’ business operations. Third parties with whom we do business or that facilitate our business activities, including financial intermediaries, or vendors that provide services or security solutions for our operations, and other third parties, could also be sources of operational and information security risk to us, including from breakdowns or failures of their own systems or capacity constraints.
While we have disaster recovery and other 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. Our risk and exposure to these matters remains heightened because of the evolving nature of these threats. As a result, cybersecurity and the continued development and enhancement of our controls, processes and practices designed to protect our systems, computers, software, data and networks from attack, damage or unauthorized access remain a focus for us. As threats continue to evolve, we may be required to expend additional resources to continue to modify or enhance our protective measures or to investigate and remediate information security vulnerabilities. Disruptions or failures in the physical infrastructure or operating systems that support our businesses and clients, or cyber-attacks or security breaches of the networks, systems or devices that our clients use to access our products and services could result in client attrition, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially adversely affect our results of operations or financial condition.
We depend on information technology and telecommunications systems of third-party servicers, and systems failures, interruptions or breaches of security involving these systems could have an adverse effect on our operations, financial condition and results of operations.
Our business is highly dependent on the successful and uninterrupted functioning of our information technology and telecommunications systems, third-party servicers accounting systems and mobile and online banking platforms. We outsource many of our major systems, such as data processing, deposit processing systems and online banking platforms. While we have selected these vendors carefully, we do not control their actions. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Financial or operational difficulties of a vendor could also hurt our operations if those difficulties interfere with the vendor’s ability to serve us. Furthermore, our vendors could also be sources of operational and information security risk to us, including from breakdowns or failures of their own systems or capacity constraints. Replacing these third-party vendors could also create significant delay and expense. Because our information technology and
telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. If sustained or repeated, a system failure or service denial could result in a deterioration of our ability to process new and renewal loans, gather deposits and provide customer service, compromise our ability to operate effectively, damage our reputation, result in a loss of customer business and/or subject us to additional regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
We continually encounter technological change.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology driven by new or modified 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, on 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 effect on our business and, in turn, our financial condition and results of operations.
Our business may be adversely affected by increasing prevalence of fraud and other financial crimes.
As a financial institution, we are subject to risk of loss due to fraud and other financial crimes. Nationally, reported incidents of fraud and other financial crimes have increased. We believe we have controls in place to detect and prevent such losses, but in some cases multi-party collusion or other sophisticated methods of hiding fraud may not be readily detected or detectable, and could result in losses that affect our financial condition and results of operations.
Financial crime is not limited to the financial services industry. Our customers could experience fraud in their businesses, which could materially impact their ability to repay their loans, and deposit customers in all financial institutions are constantly and unwittingly solicited by others in fraud schemes that vary from easily detectable and obvious attempts to high-level and very complex international schemes that could drain an account of millions of dollars and require detailed financial forensics to unravel. While we have controls in place, contractual agreements with our customers partitioning liability, and insurance to help mitigate the risk, none of these are guarantees that we will not experience a loss, potentially a loss that could have a material adverse effect on our financial condition, reputation and results of operations.
Legal, Accounting, Regulatory and Compliance Risks
We must comply with extensive and complex governmental regulation, which could have an adverse effect on our business and our growth strategy, and we may be adversely affected by changes in laws and regulations.
We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various federal and state regulatory agencies. The Company is subject to FRB regulation, and the Bank is subject to extensive regulation, supervision and examination by the FDIC and the Commissioner.
Many of these regulations are intended to protect depositors, the public or the FDIC insurance funds, not stockholders. Regulatory requirements affect our lending practices, capital structure, investment practices, dividend policy and many other aspects of our business. These requirements may constrain our operations, and changes in regulations could adversely affect us. The burden imposed by these federal and state regulations may place banks in general, and the Bank specifically, at a competitive disadvantage compared to less regulated competitors. In addition, the cost of compliance with regulatory requirements could adversely affect our ability to operate profitably or increase profitability. See “Supervision and Regulation” for more information about applicable banking laws and regulations.
Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, classification of our assets and determination of the level of our allowance for loan and lease losses. In addition, changes to statutes, regulations or regulatory policies or supervisory guidance, including changes
in interpretation or implementation of statutes, regulations, policies or supervisory guidance, could affect us in substantial and unpredictable ways, including, among other things, subjecting us to increased capital, liquidity and risk management requirements, creating additional costs, limiting the types of financial services and products we may offer and/or increasing the ability of non-banks to offer competing financial services and products. 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 stockholders 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.
Further, as a public company, we incur significant legal, accounting, insurance and other expenses in connection with compliance with rules of the SEC and The Nasdaq Stock Market LLC.
We face risks related to the adoption of future legislation and potential changes in federal regulatory agency leadership, policies, and priorities.
With a new Congress taking office in January 2021, Democrats have retained control of the U.S. House of Representatives, and have gained control of the U.S. Senate, albeit with a majority found only in the tie-breaking vote of Vice President Harris. However slim the majorities, though, the net result is unified Democratic control of the White House and both chambers of Congress, and consequently Democrats will be able to set the agenda both legislatively and in the Administration. We expect that Democratic-led Congressional committees will pursue greater oversight and will also pay increased attention to the banking sector’s role in providing COVID-19-related assistance. The prospects for the enactment of major banking reform legislation under the new Congress are unclear at this time.
Moreover, the turnover of the presidential administration has produced, and likely will continue to produce, certain changes in the leadership and senior staffs of the federal banking agencies, the CFPB, SEC, and the U.S. Treasury Department. These changes could impact the rulemaking, supervision, examination and enforcement priorities and policies of the agencies. The potential impact of any changes in agency personnel, policies and priorities on the financial services sector, including 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 Patriot Act, the Bank Secrecy Act and other anti-money laundering statutes and regulations.
Financial institutions are required under the PATRIOT Act, Bank Secrecy Act and other laws and regulations to, among other duties, institute and maintain effective anti-money laundering programs and file suspicious activity and currency transaction reports as appropriate. These rules also require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. The federal Financial Crimes Enforcement Network, established by the U.S. Treasury Department 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 the 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 impact 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.
New accounting standards could require us to increase our allowance for loan and lease losses and may have a material adverse effect on our financial condition and results of operations.
The measure of our allowance for loan and lease losses is dependent on the adoption and interpretation of accounting standards. The Financial Accounting Standards Board, or FASB, has issued a new credit impairment model, the Current Expected Credit Loss, or CECL model, which will become applicable to us in 2023. Under the CECL model, we will be 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 to be 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 currently required under GAAP, which delays recognition until it is probable a loss has been incurred. Accordingly, we expect that the adoption of the CECL model will materially affect how we determine our allowance for loan and lease losses and could require us to significantly increase our allowance. Moreover, the CECL model may create more volatility in the level of our allowance for loan and lease losses. If we are required to materially increase our level of allowance for loan and lease losses for any reason, such increase could adversely affect our business, financial condition and results of operations.
We could be adversely affected by changes in tax laws and regulations or the interpretations of such laws and regulations.
We are subject to the income tax laws of the U.S., and its states and municipalities in which we do business. These tax laws are complex and may be subject to different interpretations. We must make judgments and interpretations about the application of these inherently complex tax laws when determining our provision for income taxes, our deferred tax assets and liabilities, and our valuation allowance. Changes to the tax laws, administrative rulings or court decisions could increase our provision for income taxes and reduce our net income.
In addition, our ability to continue to record our deferred tax assets is dependent on our ability to realize their value through future projected earnings. Future changes in tax laws or regulations could adversely affect our ability to record our deferred tax assets. Loss of part or all of our deferred tax assets would have a material adverse effect on our financial condition and results of operations.
We are party to various claims and lawsuits incidental to our business. Litigation is subject to many uncertainties such that the expenses and ultimate exposure with respect to many of these matters cannot be ascertained.
From time to time, we are the subject of various claims and legal actions by customers, employees, stockholders and others. Whether such claims and legal actions are legitimate or unfounded, if such claims and legal actions are not resolved in our favor, they may result in significant financial liability and/or adversely affect the market perception of us and our products and services as well as impact customer demand for those products and services. In light of the potential cost and uncertainty involved in litigation, we have in the past and may in the future settle matters even when we believe we have a meritorious defense. Certain claims may seek injunctive relief, which could disrupt the ordinary conduct of our business and operations or increase our cost of doing business. Our insurance or indemnities may not cover all claims that may be asserted against us. Any judgments or settlements in any pending litigation or future claims, litigation or investigation could have a material adverse effect on our business, reputation, financial condition and results of operations.
From time to time we are, or may become, involved in suits, legal proceedings, information-gatherings, investigations and proceedings by governmental and self-regulatory agencies that may lead to adverse consequences.
Many aspects of the banking business involve a substantial risk of legal liability. From time to time, we are, or may become, the subject of information-gathering requests, reviews, investigations and proceedings, and other forms of regulatory inquiry, including by bank regulatory agencies, self-regulatory agencies, the SEC and law enforcement authorities. The results of such proceedings could lead to significant civil or criminal penalties, including monetary penalties, damages, adverse judgements, settlements, fines, injunctions, restrictions on the way we conduct our business or reputational harm.
As a participating lender in the SBA Paycheck Protection Program (“PPP”), we are subject to additional risks of litigation from our customers or other parties regarding our processing of loans for the PPP and risks that the SBA may not fund some or all PPP loan guaranties.
On March 27, 2020, President Trump signed the CARES Act, which created a guaranteed, unsecured loan program, the Paycheck Protection Program, or PPP, to fund operational costs of eligible businesses, organizations and self-employed persons during COVID-19. Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The Bank is participating as a lender in the PPP. The PPP commenced on April 3, 2020 and was available to qualified borrowers through August 8, 2020, and an additional stimulus package was approved on December 28, 2020, authorizing an additional $284.5 billion of PPP funds. Since the opening of the PPP, several other larger banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP. We may be exposed to the risk of litigation, from both customers and non-customers that approached us regarding PPP loans, regarding our process and procedures used in processing applications for the PPP. If any such litigation is filed against us and is not resolved in a manner favorable to us, it may result in significant financial liability or adversely affect our reputation. In addition, litigation can be costly, regardless of outcome. 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.
We also have credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by us, such as an issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules and guidance regarding the operation of the PPP. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded, or serviced by us, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from us.
Risks Related to Our Human Capital
We depend heavily on key employees, including Mary Ann Scully and Robert D. Kunisch, Jr., to continue the implementation of our long-term business strategy, and the loss of one or more of these key employees could curtail our growth, disrupt our operations and result in reduced earnings.
Ms. Scully is our Chairman and Chief Executive Officer, and Mr. Kunisch is our President and Chief Operating Officer. We believe that our continued growth and future success will depend in large part on the skills of our senior management team. We believe these two executive officers possess valuable knowledge about and experience in the banking industry and that their knowledge and relationships would be difficult to replicate. We have entered into an employment agreement with each of Ms. Scully and Mr. Kunisch and acquired key-person life insurance on each, but the existence of such agreements and insurance does not assure that we will be able to retain their services or recover losses associated with the loss of their services. The unexpected loss of the services of Ms. Scully or Mr. Kunisch could have a material adverse effect on our business, operations, financial condition and operating results, as well as the value of our common stock.
Our success also depends, in part, on our continued ability to attract and retain experienced loan originators, as well as other management personnel. Competition for personnel is intense, and we may not be successful in attracting or retaining qualified personnel. Our failure to compete for these personnel, or the loss of the services of several of such key personnel, could adversely affect our business strategy and materially and adversely affect our business, results of operations, and financial condition.
Risks Related to an Investment in Our Common Stock
Anti-takeover provisions in our corporate documents and in federal and state law may make it difficult and expensive to remove current management.
Anti-takeover provisions in our articles of incorporation and bylaws and federal and state banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire us, even if doing so would be perceived to be beneficial to our stockholders. For example, we have a classified board of directors with three-year staggered terms, which may delay the ability of stockholders to change the membership of a majority of our board. In addition, directors may only be removed from office by the affirmative vote of at least 80% of all of the votes of our stockholders entitled to be cast. Our articles of incorporation also authorize our board to classify or reclassify shares of our stock in one or more classes or series, to cause the issuance of additional shares of our stock, and to amend our articles without stockholder approval to increase or decrease the number of shares of stock that we have authority to issue. The combination of these provisions may inhibit a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock. These provisions could also discourage proxy contests and make it more difficult and expensive for holders of our common stock to elect directors other than the candidates nominated by our board of directors or otherwise remove existing directors and management, even if current management is not performing adequately.
Maryland law and our articles of incorporation limit the liability of our directors and officers and the rights of us and our stockholders to take action against our directors and officers.
Maryland law provides that a director will not have any liability as a director as long as he or she performs his or her duties in accordance with the applicable standard of conduct. In addition, our articles of incorporation eliminate our directors’ and officers’ liability to us and our stockholders for money damages to the fullest extent permitted by Maryland law. Our articles of incorporation and bylaws also require us to indemnify our directors and officers for liability resulting from actions taken by them in those capacities to the maximum extent permitted by Maryland law. As a result, we and our stockholders may have more limited rights against our directors and officers than might otherwise exist under common law. In addition, we may be obligated to fund the defense costs incurred by our directors and officers.
The market price for our common stock may be volatile.
The market price of our common stock could be subject to significant fluctuations due to changes in sentiment in the market regarding our operations or business prospects. Factors that may affect market sentiment include:
● operating results that vary from the expectations of our management or of securities analysts and investors;
● developments in our business or in the financial service sector generally;
● regulatory or legislative changes affecting our industry generally or our business and operations in particular;
● operating and securities price performance of companies that investors consider to be comparable to us;
● changes in estimates or recommendations by securities analysts;
● announcements of strategic developments, acquisitions, dispositions, financings and other material events by us or our competitors; and
● changes in financial markets and national and local economies and general market conditions, such as interest rates and stock, commodity, credit or asset valuations or volatility.
While the U.S. and other governments continue efforts to restore confidence in financial markets and promote economic growth, market and economic turmoil could still occur in the near- or long-term, negatively affecting our business, financial condition and results of operations, as well as the price, trading volume and volatility of our common stock.
We may be unable to, or may continue to choose not to, pay dividends on our common stock.
We have never paid cash dividends to holders of our common stock. Although we may pay cash dividends in the future, we currently intend to retain a large majority of any earnings to help fund our growth. Our ability to pay cash dividends
may be limited by regulatory restrictions, by our Bank’s ability to pay cash dividends to the Company and by our need to maintain sufficient capital to support our operations. The FRB has issued a policy statement regarding the payment of dividends by bank holding companies. In general, the FRB’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. The FRB’s policies also require that a bank holding company serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. Under the prompt corrective action regulations, the ability of a bank holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions.
Since the Company is a legal entity separate and distinct from the Bank and does not conduct stand-alone operations, its ability to pay dividends depends on the ability of the Bank to pay dividends to it. As a Maryland-chartered trust company, the Bank is subject to limitations on the amount of dividends that it is permitted to pay. The federal banking agencies have also issued policy statements which provide that bank holding companies and insured banks should generally only pay dividends out of current earnings.
If our Bank is not permitted to pay cash dividends to the Company, it is unlikely that we would be able to pay cash dividends on our common stock. Moreover, holders of our common stock are entitled to receive dividends only when, and if declared by our board of directors. If we fail to pay dividends in the future, capital appreciation, if any, of our common stock may be the sole opportunity for gains on an investment in our common stock. In addition, in the event the Bank becomes unable to pay dividends to the Company, we may not be able to service our debt or pay our other obligations. Accordingly, the Company’s inability to receive dividends from the Bank could also have a material adverse effect on our business, financial condition and results of operations.
We can sell additional shares of common stock without consulting stockholders and without offering shares to existing stockholders, which would result in dilution of our stockholders’ interests and could depress our stock price.
Our articles of incorporation currently authorize an aggregate of 20,000,000 shares of common stock, 18,782,399 of which are outstanding as of March 15, 2021. As permitted by Maryland law, our articles of incorporation provide that our board of directors can amend our articles of incorporation, without stockholder approval, to increase or decrease the aggregate number of shares of stock or the number of shares of any class of stock that we have the authority to issue. Our board of directors is further authorized to issue additional shares of common stock and preferred stock, at such times and for such consideration as it may determine, without stockholder action. Because our common stockholders do not have preemptive rights to purchase shares of our capital stock (that is, the right to purchase a stockholder’s pro rata share of any securities issued by us), any future offering of capital stock could have a dilutive effect on holders of our common stock.
Item 1B.
Item 1B. Unresolved Staff Comments
None
Item 2.
Item 2. Properties
Our headquarters are located at 3301 Boston Street, Baltimore, Maryland in a building that we own, which also includes a full-service branch office. Including the headquarters building, at December 31, 2020, we owned ten of our fifteen full-service branches and leased the remaining five branches, all of which are located in our Greater Baltimore Metropolitan market area. In addition, we lease five regional commercial lending offices (four in Maryland and one in Delaware) and lease one former branch location. Of the five regional offices and one former branch not occupied, we sublease four of the five locations. We also own one former branch facility that is classified as long-lived assets within “Interest receivable and other assets” on our Consolidated Balance Sheet. See Notes to the Consolidated Financial Statements, “Premises and Equipment,” and “Operating Leases” for information with respect to the amount at which our premises and equipment are recorded as well as our commitments under long-term leases.
Item 3.
Item 3. Legal Proceedings
From time to time, we may be involved in litigation relating to claims arising out of our normal course of business. As of the date of this report, we are not aware of any material pending litigation matters.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable
Part II
Item 5.
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities
Our common stock is listed on The Nasdaq Stock Market under the symbol “HBMD.” At March 15, 2021, we had 369 stockholders of record.
Dividends
We have not declared or paid any dividends on our common stock. We currently intend to retain all of our future earnings, if any, for use in our business and do not anticipate paying cash dividends on our common stock in the foreseeable future; however, our board of directors may decide to declare dividends in the future. Payments of future dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including our business, operating results and financial condition, current and anticipated cash needs, plans for expansion, tax considerations, general economic conditions and other factors deemed relevant to our board. We are not obligated to pay dividends on our common stock.
As a Maryland corporation, we are subject to certain restrictions on dividends under the Maryland General Corporation Law. Generally, Maryland law limits cash dividends if the corporation would not be able to pay its debts in the usual course of business after giving effect to the cash dividend or if the corporation’s total assets would be less than the corporation’s total liabilities plus the amount needed to satisfy the preferential rights upon dissolution of stockholders whose preferential rights on dissolution are superior to those receiving the distribution. We are also subject to certain restrictions on the payment of cash dividends as a result of banking laws, regulations and policies. See “Supervision and Regulation-Howard Bancorp, Inc.-Dividends.”
Because we are a bank holding company and do not engage directly in business activities of a material nature, our ability to pay dividends to our stockholders depends, in large part, upon our receipt of dividends from the Bank, which is also subject to numerous limitations on the payment of dividends under federal and state banking laws, regulations and policies. See “Supervision and Regulation-Howard Bank-Dividends.”
Issuer Purchases of Equity Securities
We did not engage in any share repurchases in the fourth quarter of 2020. On April 24, 2019, our Board of Directors authorized a stock repurchase program under which we were authorized, from time to time, to purchase up to $7.0 million of our outstanding common shares. We completed our $7.0 million stock repurchase program on February 24, 2020, and no shares remain available for repurchase.
Item 6.
Item 6. Selected Financial Data
(1)Represents a non-GAAP financial measure. Refer to “Use of Non-GAAP Financial Measures and Related Reconciliations” Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion provides additional information regarding our operations for the twelve-month periods ending December 31, 2020, 2019 and 2018, and financial condition at December 31, 2020 and 2019, and should be read in conjunction with our Consolidated Financial Statements and related notes that appear elsewhere in this report. Historical results of operations and the percentage relationships among any amounts included, and any trends that may appear, may not indicate trends in operations or results of operations for any future periods.
We have made, and will continue to make, various forward-looking statements with respect to financial, business and economic matters. Comments regarding our business that are not historical facts are considered forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in these forward-looking statements. For additional information regarding our cautionary disclosures, see the “Cautionary Note Regarding Forward-Looking Statements” at the beginning of this report.
Overview
Howard Bancorp, Inc. is the holding company for Howard Bank. Howard Bank was formed in 2004. Howard Bank’s business has consisted primarily of originating both commercial and real estate loans secured by property in our market area. We are headquartered in Baltimore, Maryland. We consider our primary market area to be the Greater Baltimore Metropolitan Area. We engage in a general commercial banking business, making various types of loans and accepting deposits. We market our financial services primarily to small- and medium-sized businesses and their owners, professionals and executives, and high-net-worth individuals. Our loans are primarily funded by core deposits of customers in our market.
Recent Business Developments
We completed the exit of our mortgage banking activities in early 2020. On December 18, 2019, we entered into an agreement to release certain management members of our mortgage division from their employment contracts and allow those individuals to create a limited liability company (“LLC”) for the purpose of hiring our remaining mortgage employees. We also agreed to transfer ownership of the domain name “VAmortgage.com” to the newly created LLC. In consideration of the release of the employment agreements, the transfer of our mortgage employees, and the sale of the domain name, the LLC paid us $750 thousand. Under the agreement, we agreed to cease originating residential first lien mortgage loans and exit all our mortgage banking activities in 2020. Accordingly, all of our residential first lien mortgage pipeline loans were processed by the end of the first quarter of 2020 and our remaining mortgage loans held for sale were sold in the second quarter of 2020. In order to manage future loan run-off within our residential mortgage loan portfolio, we began (and plan to continue) buying first lien residential mortgage loans, on a servicing released basis, from third-party originators. The exit of our mortgage banking activities is discussed in Note 2 to the Consolidated Financial Statements.
COVID-19 Pandemic
Our business, financial condition and results of operations generally rely upon the ability of our borrowers to repay their loans, the value of collateral underlying our secured loans, and demand for loans and other products and services we offer, which are highly dependent on the business environment in our primary market and in the United States as a whole. The COVID-19 pandemic continues to create extensive disruptions to the global economy and financial markets and to businesses and the lives of individuals throughout the world. Federal and state governments have taken, and may continue to take, unprecedented actions to contain the spread of the disease, including quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal stimulus, and legislation designed to deliver monetary aid and other relief to businesses and individuals impacted by the pandemic. Although in various locations certain activity restrictions have been relaxed and businesses and schools have reopened with some level of success, in many states and localities the number of individuals diagnosed with COVID-19 has increased significantly, which may cause a freezing or, in certain cases, a reversal of previously announced relaxation of activity restrictions and may prompt the need for additional aid and other forms of relief.
The impact of the COVID-19 pandemic is fluid and continues to evolve. The unprecedented and rapid spread of COVID-19 and its associated impacts on trade (including supply chains and export levels), travel, employee productivity, unemployment, consumer spending, and other economic activities has resulted in less economic activity, lower equity market valuations and significant volatility and disruption in financial markets. In addition, due to the COVID-19 pandemic, market interest rates have declined significantly, with the 10-year Treasury bond falling below 1.00% on March 3, 2020 for the first time, then declining further to a low of 0.52% in early August. Since that time, intermediate and long-term bond yields have risen, with a sharper rise in 2021; the yield on the 10-year Treasury bond is now nearing where it was before the start of the pandemic in February 2020. On March 3, 2020, the Federal Open Market Committee reduced the targeted federal funds interest rate range by 50 basis points to 1.00% to 1.25%. This range was further reduced to 0% to 0.25% percent on March 16, 2020 and remained at that level throughout the remainder of 2020. These reductions in interest rates and the other effects of the COVID-19 pandemic have had, and are expected to continue to have, possibly materially, an adverse effect on our business, financial condition, and results of operations. The ultimate extent of the impact of the COVID-19 pandemic on our business, financial condition and results of operations is currently uncertain and will depend on various developments and other factors, including the effect of governmental, regulatory and private sector initiatives, the effect of the recent rollout of vaccinations for the virus, whether such vaccinations will be effective against any resurgence of the virus, including any new strain, and the ability for customers and businesses to return to their pre-pandemic routine.
Our COVID-19 Operational Response
In response to the pandemic, we have taken a number of steps to protect our employees, customers and communities. Our response has continued to evolve since the first confirmed case of COVID-19 was reported in Maryland on March 5, 2020. We have implemented the following measures in an effort to ensure the safety of both our customers and employees while continuing to serve our customers during this challenging period:
● Twelve of the Bank’s fifteen branches remain accessible to customers - nine through drive thru capabilities and all twelve through pre-scheduled meetings.
● Encouraged utilization of our mobile, online, ATM, and other banking channels to limit personal contact.
● Implemented a work-from-home policy for substantially all employees other than branch personnel.
● Added one week of paid time off to all full-time employees to be used in either 2020 or 2021, to acknowledge long hours devoted to providing extraordinary customer service.
● Implemented deep cleaning procedures at all branch locations and other bank facilities.
● Instituted mandatory social distancing policies and wearing of masks for employees working in bank facilities.
Lending Operations and Accommodations to Borrowers
We actively participated in the Small Business Administration’s (“SBA”) Paycheck Protection Program (“PPP”) established under the Coronavirus Aid, Relief and Economic Security Act (“CARES” Act), as amended and extended. Lending under the PPP commenced on April 3, 2020 and the SBA notified lenders that PPP funds were exhausted on or around April 16, 2020. On April 24, 2020, additional funds were allocated to the PPP and were available through August 8, 2020. An additional stimulus package, approved on December 27, 2020, authorized additional PPP funds. We are continuing to monitor the potential development of additional legislation and further actions taken by the U.S. government with respect to the PPP.
The Paycheck Protection Program Flexibility Act of 2020 (the “PPPF Act”) was enacted in June 2020 and modified the PPP as follows: (i) established a minimum maturity of five years for all loans made after the enactment of the PPPF Act and permits an extension of the maturity of existing loans to five years if the borrower and lender agree; (ii) extended the “covered period” of the CARES Act from June 30, 2020, to December 31, 2020; (iii) extended the eight-week “covered period” for expenditures that qualify for forgiveness to the earlier of 24 weeks following loan origination or December 31, 2020; (iv) extended the deferral period for payment of principal, interest and fees to the date on which the forgiveness amount is remitted to the lender by the SBA; (v) requires the borrower to use at least 60% (down from 75%) of the proceeds of the loan for payroll costs, and up to 40% (up from 25%), for other permitted purposes, as a condition to obtaining forgiveness of the loan; (vi) delayed from June 30, 2020 to December 31, 2020 the date by which employees must be rehired to avoid a reduction in the amount of forgiveness of a loan, and created a “rehiring safe harbor” that allows
businesses to remain eligible for loan forgiveness if they make a good-faith attempt to rehire employees or hire similarly qualified employees, but are unable to do so, or are able to document an inability to return to pre-COVID-19 levels of business activity due to compliance with social distancing measures; and (vii) allows borrowers to receive both loan forgiveness under the PPP and the payroll tax deferral permitted under the CARES Act, rather than having to choose which of the two would be more advantageous.
In July 2020, the CARES Act was amended to extend, through August 8, 2020, the SBA’s authority to make commitments under the PPP. The SBA’s existing authority had previously expired on June 30, 2020. We are continuing to monitor the potential development of additional legislation and further actions taken by the U.S. government.
At December 31, 2020, we had originated $201.0 million of loans under the PPP. During the first phase of the program, which commenced on April 3, we funded 777 loans totaling $178.7 million. During the second phase, which commenced on April 24 and ended with applications submitted to the SBA by August 8, 2020, we funded an additional 285 loans totaling $22.5 million. The average loan size under the first and second phase of the PPP program was $230 thousand and $78 thousand, respectively. We will continue to support our customers throughout the forgiveness process. We received processing fees from the SBA for the originated PPP loans totaling $6.7 million, which were deferred. In addition, we deferred $782 thousand of origination costs. The net deferred fees are being accreted as a yield adjustment over the contractual term of the underlying PPP loans. PPP lending generated pretax income of $3.8 million, or $0.16 after tax per share in 2020. PPP loans, net of unearned income, totaled $167.6 million at December 31, 2020. A total of $30.1 million of PPP loans were forgiven during 2020.
During this unprecedented situation, we have also established client assistance programs, including offering loan modifications, on a case by case basis, in the form of payment deferrals for periods up to six months, to both commercial and retail customers as discussed in the “Nonperforming and Problem Assets” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”). We have also temporarily ceased making collection calls, are temporarily waiving a higher proportion of late fees assessed for consumer loans, and have paused new foreclosure and repossession actions. We will continue to re-evaluate these temporary actions based on the ongoing COVID-19 pandemic. These programs may negatively impact our revenue and other results of operations in the near term and, if not effective in mitigating the effect of COVID-19 on our customers, may adversely affect our business and results of operations more substantially over a longer period of time. Current and future governmental actions may require these and other types of customer-related responses.
The CARES Act also permits financial institutions to suspend requirements under GAAP for certain loan modifications to borrowers affected by COVID-19 that would otherwise be characterized as TDRs, as discussed in the “Nonperforming and Problem Assets” section of this MD&A.
Impact on Our Results of Operation and Financial Condition
We continue to monitor the impact of the COVID-19 pandemic on our results of operation and financial condition. While the pandemic did not have a significant impact on our financial condition as of December 31, 2020, in the form of significant incurred losses or any communications from our borrowers that significant losses were imminent, we nevertheless determined it prudent to increase our allowance for loan and lease losses (the “allowance”) by $8.8 million in 2020, related to changes in qualitative factors, primarily as a result of the abrupt slowdown in commercial economic activity related to COVID-19, as well as the dramatic rise in the unemployment rate in our market area. Our allowance may also be materially impacted in future periods by the COVID-19 pandemic.
In addition, due to the pandemic and the related economic fallout, including most specifically, declining stock prices at both the Company and peer banks, the Federal Reserve’s significant reduction in interest rates, and other business and market considerations, we performed an interim goodwill impairment analysis as of June 30, 2020. Based on this analysis, the estimated fair value of the Company was less than book value, resulting in a $34.5 million impairment charge, recorded in noninterest expense, in the second quarter of 2020. This was a non-cash charge to earnings and had no impact on our regulatory capital ratios, cash flows, or liquidity position.
Capital and Liquidity
As of December 31, 2020, all of our capital ratios were in excess of all regulatory requirements. While we believe that we have sufficient capital to withstand an extended economic recession brought about by the COVID-19 pandemic, our reported and regulatory capital ratios could be adversely impacted by loan and lease losses.
We anticipated potential stresses on liquidity management as a result of the COVID-19 pandemic and our participation in the PPP. We built on-balance sheet liquidity during the first quarter of 2020 in anticipation of a possible increase in the utilization of existing lines of credit or decreases in customer deposits. Since these events didn’t materialize, in part due to the various actions initiated by the Federal Reserve to provide market liquidity, we reduced this on-balance sheet liquidity to pre-COVID-19 levels during the second quarter of 2020 while continuing to build our contingent funding availability during 2020.
The Federal Reserve created the Paycheck Protection Program Lending Facility (“PPPLF”), a lending facility that allows us to obtain funding specifically for loans that we make under the PPP, and allows us to retain existing sources of liquidity for our traditional operations. While we had originally planned to use the PPPLF as the funding source for all PPP loans, strong customer deposit growth and the availability of alternative short-term funding sources at a lower cost resulted in our limited usage of the PPPLF and no borrowings outstanding at December 31, 2020.
Use of Non-GAAP Financial Measures and Related Reconciliations
This report contains references to financial measures that are not defined in GAAP. Such non-GAAP financial measures include the presentation of our tangible book value per share, portfolio loans, and portfolio loan-related asset quality ratios.
Management believes that the presentation of these non-GAAP financial measures (a) provides important supplemental information that contributes to a proper understanding of our operating performance and provides a meaningful comparison to our peers, (b) enables a more complete understanding of factors and trends affecting our business, and (c) allows investors to evaluate our performance in a manner similar to management, the financial services industry, bank stock analysts, and bank regulators. Management uses non-GAAP measures as follows: in the preparation of our operating budgets, monthly financial performance reporting, and in our presentation to investors of our performance. However, non-GAAP financial measures have a number of limitations. Limitations associated with non-GAAP financial measures include the risk that persons might disagree as to the appropriateness of items comprising these measures and that different companies might calculate these measures differently. These disclosures should not be considered in isolation or as an alternative to our GAAP results. A reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measures is presented below.
Certain information in this report is presented with respect to “portfolio loans,” a non-GAAP financial measure defined as total loans and leases, but excluding PPP loans. Portfolio loans is calculated by subtracting PPP loans (net of unamortized deferred fees and origination costs) from total loans and leases. We also provide certain asset quality ratios such as nonperforming loans and the allowance for loan and lease losses as a percentage of portfolio loans. We believe that the presentation of portfolio loans and the related asset quality measures provide additional useful information for purposes of evaluating our results of operations and financial condition with respect to the year 2020 when comparing to other periods, since the PPP loans are 100% guaranteed, were not subject to traditional loan underwriting standards, and a substantial portion of these loans are expected to be forgiven and repaid by the SBA within the next 12-18 months.
We also present “tangible book value per common share.” We believe that this measure is consistent with the treatment by bank regulatory agencies, which exclude intangible assets from the calculation of risk-based capital ratios. Accordingly, we believe that this non-GAAP financial measure provides information that is important to investors and that is useful in understanding our capital position and ratios. In addition, tangible book value per share is the key metric used by bank analysts in evaluating bank stock price performance. Tangible book value per common share is calculated by dividing tangible common stockholders' equity by total common shares outstanding. Tangible common stockholders' equity is calculated by subtracting goodwill and our net core deposit intangible from total stockholders' equity.
The tables below provide a reconciliation of these non-GAAP financial measures with financial measures defined under GAAP.
Tangible Book Value per Common Share
Portfolio Loans and Related Asset Quality Ratios
Financial Highlights
Financial highlights for 2020 are as follows:
● We reported a net loss of $17.0 million, or a loss of $0.91 per diluted common share for the year ended December 31, 2020 compared to net income of $16.9 million, or $0.89 per diluted common share for the year ended December 31, 2019.
● We recorded a goodwill impairment charge of $34.5 million (or a loss of $1.84 per share) in the second quarter of 2020, which was a non-cash charge that did not affect regulatory capital ratios, liquidity, or our overall financial strength.
● We recorded a provision for credit losses of $9.8 million in 2020, a $5.7 million increase from the $4.2 million we recorded in 2019.
● The allowance for loan and lease losses (the “allowance”) was $19.2 million at December 31, 2020, an increase of $8.8 million from $10.4 million at December 31 2019.
● The allowance was 1.03% of total loans and leases and 1.13% of portfolio loans (a non-GAAP financial measure - refer to the section “Use of Non-GAAP Financial Measures and Related Reconciliations” for additional detail) at December 31, 2020, compared to 0.60% of total loans and leases at December 31, 2019.
● Our net interest margin was 3.27% in 2020, a decrease of 23 basis points (“bp”) from 2019; due primarily to a 78 bp decrease in the average yield on our earning assets, partially offset by a 66 bp decrease in the average rate paid on interest-bearing liabilities.
● Total assets were $2.54 billion at December 31, 2020, up $163.4 million from year end 2019 with this asset growth primarily attributable to securities available for sale, up $159.9 million, and loans and leases, net of unearned income, up $120.4 million. Offsetting this growth were decreases in interest bearing deposits with banks, down $31.8 million, loans held for sale, down $30.7 million, and goodwill, down $34.5 million.
● Total loans and leases, net of unearned income, were $1.87 billion at December 31, 2020, up $120.4 million from December 31, 2019. Portfolio loans were $1.70 billion at December 31, 2020, a decrease of $47.0 million from December 31, 2019.
● Total deposits were $1.98 billion at December 31, 2020, up $261.0 million from year end 2019, with customer deposits up $221.9 million from year end 2019.
● Our borrowings of $242.1 million at December 31, 2020 decreased by $77.3 million since year end 2019 as strong customer and institutional deposit growth reduced our utilization of this source of funds.
● We completed our $7.0 million stock repurchase program on February 24, 2020; a total of 372,801 shares were repurchased during the first quarter for $6.7 million.
● We remained “well capitalized” by all regulatory measures in 2020.
● Our book value per common share was $15.72 at December 31, 2020, down $0.73 per share from December 31, 2019. The decrease in book value per share was driven by the goodwill impairment charge in 2020 of $1.84 per common share.
● Our tangible book value per common share (a non-GAAP financial measure - refer to the “Use of Non-GAAP Financial Measures” for additional detail) was $13.81 per share at December 31, 2020, an increase of 8.8%, or $1.13 per share since at December 31, 2019. The goodwill impairment charge did not impact tangible book value per share.
Critical Accounting Policies
Our accounting and financial reporting policies conform to the accounting principles generally accepted in the United States of America (“GAAP”) and general practice within the banking industry. Application of these principles requires management to make estimates, assumptions and complex judgements that affect the amounts reported in our Consolidated Financial Statements and accompanying notes. These estimates, assumptions and judgments are based on historical experience and various assumptions that we believe to be reasonable as of the date of the financial statements; accordingly, as this information changes, our Consolidated Financial Statements could reflect different estimates, assumptions and judgments. Actual results could differ significantly from those estimates.
Certain accounting measurements 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. The accounting policies we view as critical accounting policies are those relating to the allowance for loan and lease losses, the valuation of goodwill and other intangible assets, and income taxes.
In reviewing and understanding our financial information, we also encourage you to review our significant accounting policies used in preparing our financial statements. See Note 1 to our Consolidated Financial Statements for further discussion of our significant accounting policies.
Allowance for Loan and Lease Losses
Our allowance for loan and lease losses (the “allowance”) is established through a provision for credit losses charged against income. Loans are charged against the allowance when we believe that the collectability of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that represents the amount of probable and reasonably estimable known and inherent incurred losses in the loan portfolio, based on evaluations of the collectability of loans. The evaluations take into consideration such factors as changes in the types and amount of loans in the loan portfolio, historical loss experience, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, estimated losses relating to specifically identified loans, and current economic conditions. Based on our estimate of the level of allowance required, we record a provision for loan losses to maintain the allowance at an appropriate level.
Our evaluation of the allowance is inherently subjective as it requires material estimates including, among others, exposure at default, the amount and timing of expected future cash flows on impaired loans, value of collateral, and estimated losses on our loan portfolios as well as consideration of general loss experience. The allowance is also influenced by factors outside of our control such as such as industry and business trends, geopolitical events and the effects of laws and regulations as well as economic conditions such as trends in housing prices, interest rates, GDP, inflation, energy prices and unemployment.
We cannot predict with certainty the amount of loan charge-offs that we will incur. We do not currently determine a range of loss with respect to the allowance. In addition, our regulatory agencies, as an integral part of their examination processes, periodically review our allowance. Such agencies may require that we recognize additions to the allowance based on their judgments about information available to them at the time of their examination. To the extent that actual outcomes differ from management’s estimates, additional provisions to the allowance may be required that would adversely impact earnings in future periods. Note 7 to our Consolidated Financial Statements describes the methodology used to determine the allowance.
Goodwill, Other Intangible Assets and Long-Lived Assets
Goodwill represents the excess of the purchase price over the sum of the estimated fair values of tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed. Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in a business combination. The core deposit intangible is amortized over the estimated useful lives of the long-term deposits acquired, and the remaining amounts of the core deposit intangible are periodically reviewed for impairment. Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. Long-lived assets are those that provide the Company with a future economic benefit beyond the current year or operating period. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset is greater than the fair value of the asset. Assets to be disposed of are reported at the lower of the cost or the fair value, less costs to sell.
Effective April 1, 2020, the Company adopted ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. The goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit's fair value, to the extent that the loss recognized does not exceed the amount of goodwill allocated to that reporting unit.
Management has determined that we have one reporting unit. The sudden and continuing decline in economic conditions triggered by the pandemic included a significant decline in stock market valuations and the stock price of both the Company and our peer banks. These events indicated that goodwill may be impaired and resulted in us performing a goodwill impairment assessment. Based on this assessment, the Company's estimated fair value was less than its book value, resulting in a goodwill impairment charge of $34.5 million recorded in the second quarter of 2020.
Based on the results of our annual impairment analysis, performed in the fourth quarter of 2020, we determined that there was no additional impairment of the carrying value of either the goodwill or core deposit intangible at December 31, 2020.
Income Taxes
We account for income taxes under the asset/liability method. We recognize deferred tax assets and liabilities for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as operating loss and tax credit carry-forwards. We measure deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We recognize the effect on deferred tax assets and liabilities of a change in tax rates in income in the period indicated by the enactment date. We establish a valuation allowance for deferred tax assets when, in the judgment of management, it is more likely than not that such deferred tax assets will not become realizable. The judgment about the level of future taxable income is dependent to a great extent on matters that may, at least in part, be beyond our control. It is at least reasonably possible that management’s judgment about the need for a valuation allowance for deferred tax assets could change in the near term.
Balance Sheet Analysis and Comparison of Financial Condition
A comparison between December 31, 2020 and December 31, 2019 balance sheets is presented below.
General
Total assets increased $163.4 million, or 6.9%, to $2.54 billion at December 31, 2020 compared to $2.37 billion at December 31, 2019. Our asset growth consisted primarily of increases in our total loans of $120.4 million, which included $167.6 million of PPP loans, and investment securities available for sale of $159.9 million. The growth in these assets was partially offset by decreases in interest-bearing deposits with banks of $31.8 million, goodwill of $34.5 million, and loans held for sale of $30.7 million as we exited our mortgage banking activities. The primary source of funding our net asset growth was deposits. Total deposits increased by $261.0 million, including an increase in customer deposits of $221.9 million. Borrowings decreased by $77.3 million, primarily as a result of a decrease of $85.0 million in Federal Home Loan Bank of Atlanta (“FHLB”) borrowings. Total stockholders’ equity decreased by $19.5 million due primarily to the goodwill impairment charge to earnings.
Investment Securities
The following table sets forth the composition of our investment securities portfolio at the dates indicated.
Available for sale
Our available for sale securities are reported at fair value. At December 31, 2020 and 2019, we held U.S. agency debentures, mortgage backed securities, and corporate debentures. This portfolio is used primarily to provide sufficient liquidity to fund our loans and provide funds for withdrawals of deposits. In addition, this portfolio is used as collateral
for borrowings such as commercial customer overnight securities sold under agreements to repurchase (“repurchase agreements”) and as a source of earnings. At December 31, 2020 and 2019, $226.2 million and $11.6 million in fair value of available for sale securities, respectively, were pledged as collateral. These securities were pledged at the FRB Discount Window as well as for repurchase agreements and deposits of local government entities that require pledged collateral as a condition of maintaining these deposit accounts.
During 2020, we embarked on a strategy to monetize certain unrealized gains in our mortgage-backed securities (“MBS”) portfolio by selling $105 million of MBS with high prepayment speeds, resulting in net gains of $3.0 million. We then purchased $125 million of lower coupon MBS in order to replace both the MBS sold as well as other available for sale securities runoff. We also executed a leveraging strategy that increased the MBS portfolio by $102.4 million from the prior-year level. The leveraging strategy was designed to replace the decrease in the MBS portfolio’s net interest income that resulted from the completion of the strategy to monetize certain unrealized gains in the MBS portfolio. Our portfolio growth, consisting primarily of MBS, was part of our overall earnings and interest rate risk management strategies.
Our available for sale securities portfolio contained eight securities with unrealized losses of $58 thousand at December 31, 2020, and 16 securities with unrealized losses of $166 thousand at December 31, 2019. Changes in the fair value of these securities resulted primarily from interest rate fluctuations. We neither intend to sell these securities nor is it more likely than not that we would be required to sell these securities before their anticipated recovery. Furthermore, we believe the collection of the investment and related interest is probable. Based on this analysis, we do not consider any of the unrealized losses to be other-than-temporary impairment.
Average investment securities available for sale were $309.5 million for the year 2020, an increase of $127.1 million, or 69.7%, from the year 2019 average balance.
Held to maturity
Held to maturity securities are reported at amortized cost. The only investments that we have classified as held to maturity are certain corporate debentures. These investments are intended to be held until maturity. Our held to maturity securities balances were $7.3 million at December 31, 2020 and $7.8 million at December 31, 2019.
There were three held to maturity securities in an unrealized loss position totaling $32 thousand at December 31, 2020, and none at December 31, 2019. Based on our analysis of these securities, we do not consider the unrealized losses to be other-than-temporary impairment. Note 4 to our Consolidated Financial Statements provides more detail concerning the composition of our portfolio and our process for evaluating the portfolio for other-than-temporary impairment.
Portfolio Maturities and Yields
The composition and maturities of the investment securities portfolio (with respect to those securities that have a fixed maturity date) at December 31, 2020 is summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur.
Nonmarketable Equity Securities
At December 31, 2020 and 2019, we held an investment in stock of the Federal Home Loan Bank of Atlanta (“FHLB”) of $10.6 million and $14.2 million, respectively. This investment is required for continued FHLB membership and is based partially upon the amount of borrowings outstanding from the FHLB. This FHLB stock is carried at cost which approximates fair value.
Loan and Lease Portfolio
Total loans and leases (hereinafter referred to as “loans”) increased $120.4 million, or 6.9%, to $1.87 billion at December 31, 2020 from $1.75 billion at December 31, 2019. We originated $196.4 million of PPP loans, net of unamortized deferred fees and origination costs, during the second and third quarters of 2020. At December 31, 2020, PPP loans totaled $167.6 million. Our portfolio loans, which exclude PPP loans (a non-GAAP financial measure - refer to the “Use of Non-GAAP Financial Measures” section for additional detail), decreased by $47.0 million, or 2.7%, to $1.70 billion at December 31, 2020 from $1.75 billion at December 31, 2019.
The $47.0 million decrease in portfolio loans was primarily driven by residential real estate loans, which decreased by $70.7 million, or 13.8%. Despite $42.1 million of loan originations and purchases in 2020 ($11.4 million of portfolio originations prior to our exit of mortgage banking activities and $30.7 million of secondary market loan purchases), the net decrease in residential real estate loans was the result of a continued substantially higher level of prepayments due to lower interest rates that led to strong mortgage refinancing. The commercial lending portfolio modestly increased with commercial real estate loans up $56.8 million, or 8.3%, commercial and industrial (“C&I”) loans down $38.8 million, or 10.4%, primarily due to lower line utilization, and construction and land loans down $11.6 million, or 9.1% due primarily to transfers to other loan portfolios. Consumer loans were up $17.1 million, or 36.4%, primarily driven by growth in our marine lending portfolio.
Average loans were $1.85 billion for the year 2020, an increase of $166.8 million, or 9.9%, over average loans for the year 2019. Average portfolio loans were $1.72 billion for the year 2020, an increase of $35.3 million, or 2.1%, from average loans for the year 2019. The year over year growth was primarily in commercial real estate loans, partially offset by decreased residential real estate loans.
The following table sets forth the composition of our loan portfolio at the dates indicated.
(1)
Includes equipment financing leases of $3,597, $6,382, $7,607, $8,759, and $2,847 at December 31, 2020, 2019, 2018, 2017, and 2016, respectively.
Loan Portfolio Maturities
The following table summarizes the scheduled repayments of our loan portfolio and sets forth the scheduled repayments of fixed and adjustable rate loans in our portfolio at December 31, 2020.
1.
Includes equipment financing leases of $3,597 at December 31, 2020
Loans Held for Sale
In connection with exiting of our mortgage banking activities, we completed the processing of our remaining residential first lien mortgage loan pipeline during the first quarter of 2020 and sold the remaining loans held for sale during the second quarter of 2020. As a result, we did not have any loans held for sale at December 31, 2020 compared to $30.7 million at December 31, 2019.
Interest-Bearing Deposits with Banks
Interest-bearing deposits with banks, primarily with the Federal Reserve Bank of Richmond, were $65.2 million at December 31, 2020, a decrease of $31.8 million from the December 31, 2019 balance of $97.0 million. On March 15, 2020, the Board of Governors of the Federal Reserve System reduced the reserve requirement to zero percent due to the COVID-19 pandemic; this action and our active management of cash levels were the primary drivers of the lower balance.
Goodwill, Other Intangible Assets and Long-Lived Assets
Goodwill represents the excess of the purchase price over the sum of the estimated fair value of tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed. Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired.
Due to the pandemic and the related economic fallout, including most specifically, declining stock prices at both the Company and peer banks, the Federal Reserve’s significant reduction in interest rates, and other business and market considerations, we performed an interim goodwill impairment analysis as of June 30, 2020. Based on this analysis, the estimated fair value of the Company was less than book value, resulting in a $34.5 million goodwill impairment charge,
recorded in noninterest expense, in the second quarter of 2020. This was a non-cash charge to earnings and had no impact on our regulatory capital ratios, cash flows, or liquidity position. As a result, goodwill decreased to $31.4 million at December 31, 2020 compared to $65.9 million at December 31, 2019.
Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in a business combination. The core deposit intangible is amortized over the estimated useful lives of the long-term deposits acquired, and the remaining amounts of the core deposit intangible are periodically reviewed for impairment. The unamortized balance of our core deposit intangible was $5.8 million at December 31, 2020, compared to $8.5 million at December 31, 2019. Amortization expense reflected in noninterest expense totaled $2.7 million, $3.0 million and $2.9 million for the years ended December 31, 2020, 2019 and 2018, respectively.
Deposits
We accept deposits primarily from the areas in which our branches and offices are located. We have consistently focused on building broader customer relationships and targeting small business customers to increase our core deposits. We also rely on our customer service to attract and retain deposits. We offer a variety of deposit accounts with a range of interest rates and terms. Our deposit accounts consist of commercial and retail checking accounts, savings accounts, certificates of deposit, money market accounts, and individual retirement accounts. In addition, we utilize brokered deposits, primarily through IntraFi Network’s certificate of deposit account registry service (“CDARS”) program. Customer deposits, which exclude brokered deposits and other non-customer deposits, have historically provided us with a sizeable source of relatively stable and low-cost funds to support asset growth.
We review and update interest rates paid, maturity terms, service fees and withdrawal penalties on a periodic basis. Deposit rates and terms are based primarily on current operating strategies and market interest rates, liquidity requirements, anticipated short term loan demand and our deposit growth goals.
Total deposits were $1.98 billion at December 31, 2020, an increase of $261.0 million, or 15.2%, from $1.71 billion at December 31, 2019. Customer deposits were $1.70 billion at December 31, 2020, an increase of $221.9 million, or 15.0%, from $1.47 billion at December 31, 2019. The increase in customer deposits was primarily the result of strong growth in low-cost, non-maturity deposits, which increased by $317.7 million, or 27.8%. $239.1 million of this non-maturity deposit growth was in transaction accounts, with $207.8 million of the transaction account growth in noninterest-bearing deposits. Offsetting this growth was a decline of $86.6 million, or 15.2%, in customer certificates of deposit. Brokered and other non-customer deposits were $279.2 million at December 31, 2020, compared to $240.0 million at December 31, 2019. Non-customer deposits are currently our lowest-cost incremental funding source.
Average customer deposits for the year 2020 were $1.60 billion, an increase of $124.2 million, or 8.4%, from the year 2019 average balance. Customer non-maturity deposit balances increased by $193.6 million, or 17.2%, with transaction accounts up $161.5 million; $170.4 million of the transaction account growth was in noninterest-bearing deposits.
The following table sets forth the distribution of total deposits, by account type, at the dates indicated:
The following table sets forth the maturity of certificates of deposit of $100,000 or more at December 31, 2020.
FHLB Advances
Our primary source of non-deposit funding is FHLB advances. We use a variety of term structures in order to manage liquidity and interest rate risk. FHLB advances were $200.0 million at December 31, 2020, a decrease of $85.0 million from December 31, 2019. As of December 31, 2020, all FHLB advances have maturities beyond one year. In the second quarter of 2020, we repaid $5.0 million of long-term FHLB borrowings, recording a prepayment penalty of $224 thousand in other operating expenses. The early repayment of these advances were primarily for asset/liability management purposes and a result of the current rate environment.
Additional information regarding FHLB borrowings with final maturities of less than one year are presented in the following table:
Stockholders’ Equity
Total stockholders’ equity was $294.6 million at December 31, 2020, a $19.5 million decrease from $314.1 million at December 31, 2019. Our decrease in stockholders’ equity was primarily the result of our $17.0 million net loss in 2020, which included the $34.5 million goodwill impairment charge. On February 24, 2020, we completed our stock repurchase program authorized by the Board of Directors on April 24, 2019. A cumulative total of 392,565 shares, at an average price
paid per share of $17.83, for an aggregate amount of $7.0 million, were repurchased under the program. A total of 372,801 shares were repurchased during the first quarter of 2020 for an aggregate amount of $6.7 million.
Our book value per common share was $15.72 at December 31, 2020, down $0.73 per share from December 31, 2019. The decrease in book value per share was driven by the goodwill impairment charge in 2020 of $1.84 per common share.
Our tangible book value per common share (a non-GAAP financial measure - refer to the “Use of Non-GAAP Financial Measures” section for additional detail) was $13.81 per share at December 31, 2020, an increase of 8.8%, or $1.13 per share since December 31, 2019. The goodwill impairment charge had no impact on our tangible book value per common share.
Comparison of Results of Operations
General
Our results of operations depend mainly on our net interest income, which is the difference between the interest income we earn on our loan and investment portfolios, as well as accretion income on acquired loans, and the interest expense we pay on deposits and borrowings. Our net interest income can be significantly influenced by a variety of factors, including overall loan demand, economic conditions, credit risk, the amount of nonearning assets including nonperforming loans and acquired credit impaired loans, the amounts of and rates at which assets and liabilities reprice, variances in prepayment of loans and securities, early withdrawal of deposits, exercise of call options on borrowings or securities, a general rise or decline in interest rates, changes in the slope of the yield-curve, and balance sheet growth or contraction.
Our results of operations are also affected by provisions for credit losses, noninterest income and noninterest expense. Our noninterest expense consists primarily of compensation and employee benefits, as well as office occupancy, data processing, deposit insurance, and general administrative expenses.
A discussion of our results of operations for the years ended December 31, 2020, 2019 and 2018 follows.
Average Balance and Yields
The following tables set forth average balances, average yields and costs, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, and have been
reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.
(1)
Loan fee income is included in the interest income calculation, and non-accrual loans are included in the average loan balance; they have been reflected as loans carrying a zero yield.
(2)
Available for sale securities are presented at fair value; held to maturity securities are presented at amortized cost.
(3)
Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.
(4)
Net interest margin represents net interest income divided by average total interest-earning assets.
Rate/Volume Analysis
The following table presents the effects of changing rates and volumes on our 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) as well as any impact of number of days and mix.
The total of the changes set forth in the rate and volume columns are presented in the total column.
The Federal Reserve’s Federal Open Market Committee’s target for federal funds increased 125 bp in 2017 and 100 bp in 2018 to a range of 2.25% to 2.50% for the year ended December 31, 2018. During 2019, the federal funds target rate remained at the 2.25% to 2.50% range until July 2019 when the Federal Reserve began to drop the federal funds target rate. In the last half of 2019, the Federal Reserve dropped the federal funds target rate 75 bp to the range of 1.50% to 1.75% at December 31, 2019. In March 2020, in response to the COVID19 pandemic, the Federal Reserve then dropped the federal funds target rate 150 bp to a range of 0.00% to 0.25% where it remained at December 31, 2020.
Comparison of the years ended December 31, 2020 and December 31, 2019
General
We reported a net loss of $17.0 million, or a loss of $0.91 per both basic and diluted common share for the year ended December 31, 2020, compared to net income of $16.9 million, or $0.89 per both basic and diluted common share for the year ended December 31, 2019. The $33.9 million, or $1.80 per diluted common share, decrease in net income for 2020 compared to 2019, was driven primarily by the $34.5 million goodwill impairment charge ($1.84 per diluted common share) in 2020, which was not tax deductible. Outside of the goodwill impairment, net income increased by $628 thousand, or $0.03 per diluted common share, in 2020 compared to 2019, primarily as a result of the following:
(a)
Increase in securities gains of $2.4 million ($0.10 after tax per diluted common share) in 2020;
(b)
Income tax benefit of $1.3 million ($0.07 per diluted common share) in 2020 resulting from a net operating loss carryback provision in the CARES Act;
(c)
Decrease in prepayment penalties on FHLB advances of $427 thousand ($0.02 after tax per diluted common share) in 2020;
(d)
Decrease in branch optimization charges of $2.7 million ($0.11 after tax per diluted common share) in 2020;
(e)
PPP loan pretax income of $3.8 million ($0.16 after tax per diluted common share) in 2020; and
(f)
Litigation settlement charge of $700 thousand ($0.03 after tax per diluted common share) in 2019 stemming from certain mortgages originated by First Mariner Bank before its merger with Howard Bank.
These items were partially offset by:
(a)
Higher provision for credit losses in 2020 when compared to 2019 of $5.7 million (or $0.23 after tax per diluted common share) as we increased our allowance for loan and lease losses due to the current economic environment;
(b)
Decrease in pretax income from our now exited mortgage banking activities of $2.1 million (or $0.08 after tax per diluted common share) in 2020;
(c)
Litigation settlement charge of $2.0 million (or $0.08 after tax per diluted common share) in 2020 stemming from certain mortgages originated by First Mariner Bank before its merger with Howard Bank. This settlement was not related to the litigation accrual recorded in 2019; and
(d)
Expenses attributable to the departure of our former CFO of $788 thousand (or $0.03 after tax per diluted common share) in 2020.
Net Interest Income
Net interest income is our largest source of operating revenue. Net interest income is affected by various factors including changes in interest rates and the composition of interest-earning assets and interest-bearing liabilities and maturities. Net interest income is determined by the interest rate spread (i.e., the difference between the yields earned on interest-earning assets and the rates paid on interest-bearing liabilities) and the relative amounts of interest-earning assets and interest-bearing liabilities.
Net interest income for 2020 was $73.6 million, an increase of $4.3 million, or 6.2%, from 2019. Our net interest margin was 3.27% in 2020, a decrease of 23 bp from the net interest margin of 3.50% in 2019. We continue to experience compression in our net interest margin as market interest rates, after falling to historically low levels as a result of the COVID-19 pandemic through the second quarter of 2020, have generally stabilized. Average earning assets for 2020 of $2.25 billion increased by $267.3 million, or 13.5%, while total interest income decreased by $5.1 million when compared to 2019, as the impact of the 78 bp decrease in the average yield on our earning assets more than offset the interest income
benefit attributable to the growth in earning assets. Our average interest-bearing liabilities for 2020 increased by $62.6 million while interest expense decreased by $9.4 million compared 2019, as the impact of the 66 bp decrease in the average rate paid on our interest-bearing liabilities more than offset the increase in interest expense attributable to the growth in interest-bearing liabilities.
The net accretion of fair value adjustments on acquired loans added ten bp to our net interest margin in 2020, unchanged from 2019. We expect the impact of this net accretion to continue declining in future periods. PPP loans, with an average yield of 3.06% and an interest spread (net of an assumed funding cost at 0.35%) of 2.71%, reduced our net interest margin by four bp in 2020. The PPP program commenced in the second quarter of 2020; therefore, we had no PPP loans in 2019.
Interest Income
Interest income decreased by $5.1 million, or 5.6%, to $86.4 million in 2020, compared to $91.4 million in 2019. Interest income on loans and leases decreased by $3.7 million, or 4.5%, in 2020 compared to 2019, while average loans and leases increased by 9.9% to $1.85 billion in 2020 when compared to 2019. The average yield on loans and leases of 4.25% for 2020 was down 64 bp from 2019, primarily driven by the lower interest rate environment and, to a lesser extent, the impact of the lower-yielding PPP loans. PPP loans reduced the average loan yield by nine bp in 2020. The net accretion of fair value adjustments on acquired loans added 13 bp to our average yield on loans in 2020, unchanged from 2019.
The average yield on available for sale securities decreased by 104 bp to 1.99%, in 2020 compared to 2019, with the yield on the MBS portfolio, which represents 74.5% and 51.3% of the average available for sale securities portfolio in 2020 and 2019, respectively, down 143 bp to 1.66% in 2020 compared to 2019. Average MBS were up $137.3 million in 2020 (refer to the “Balance Sheet Analysis and Comparison of Financial Condition, Investment Securities” section for additional detail), with net purchases in 2020 at lower yields. In addition, higher prepayment speeds within this portfolio adversely impacted the portfolio yield in 2020. Reflective of the significant decline in the federal funds target rate, the average yield on our interest-bearing deposits in banks fell 128 bp to 0.43% in 2020 compared to 2019.
Interest Expense
Interest expense decreased $9.4 million, or 42.3%, to $12.8 million, in 2020, compared to $22.1 million in 2019. The average rate on interest-bearing liabilities decreased by 66 bp to 0.82% in 2020 compared to 2019. Driving this decrease was a $5.0 million decrease in average interest-bearing deposits which included a 56 bp reduction in the average rate paid on total interest-bearing deposits. We lowered the interest rates paid on interest-bearing deposits in response to the lower prevailing competitive market rates starting in late February 2020, with the full impact of those rate reductions expected as maturing time deposits reprice at lower market interest rates. In addition, our interest expense on FHLB advances decreased $2.3 million in 2020 compared to 2019, while the average balance increased by $54.4 million. The average rate paid on FHLB advances of 0.94% for 2020 decreased by 135 bp when compared to 2019.
Provision for Credit Losses
We recorded a provision for credit losses of $9.8 million in 2020, compared to $4.2 million in 2019, an increase of $5.7 million. The higher provision for credit losses reflects the changing economic environment driven by COVID-19. The provision for credit losses included $320 thousand attributable to our reserve for unfunded commitments, with the remaining $9.5 million attributable to loan and lease losses. For 2020, the portion of the provision for credit losses attributable to loan and lease losses, less net charge-offs of $764 thousand, resulted in an increase in the allowance for loan and lease losses of $8.8 million. For 2019, the provision for credit losses, less net charge-offs of $3.7 million, resulted in an increase in the allowance of $528 thousand. The increase in our allowance is more fully discussed below under the sections of this MD&A entitled “Nonperforming and Problem Assets; COVID-Related Loan Deferrals” and “Allowance for Loan and Lease Losses.”
Noninterest Income
The following table presents the major categories of noninterest income for the years ended December 31, 2020 and 2019:
Noninterest income for the year 2020 was $12.4 million, a decrease of $8.7 million, or 41.2%, compared to $21.0 million for 2019. The primary drivers of this decrease were the $9.2 million decrease in noninterest income attributable to exiting our mortgage banking activities, which was partially offset by a $3.0 million increase in gains on the sale of investment securities. Noninterest income other than from mortgage banking activities and securities gains, decreased by $1.9 million, or 19.1%, in 2020 compared to 2019.
Noninterest income from our mortgage banking activities consisted of realized and unrealized gains on mortgage banking activity as well as a portion of the line item “loan related fees and service charges.” Noninterest income attributable to our mortgage banking activities was $1.4 million in 2020, compared to $10.6 million in 2019. We completed the exit of our mortgage banking activities during the second quarter of 2020.
During the second quarter of 2020, we embarked on a strategy to monetize certain unrealized gains in our MBS portfolio. We identified and sold $105 million of MBS with high prepayment speeds, resulting in net gains on the sale of securities of $3.0 million in 2020.
Service charges on deposit accounts, which consisted of account activity fees such as nonsufficient funds (”NSF”) and overdraft fees in addition to other traditional banking fees, decreased by $631 thousand in 2020 when compared to 2019. While the traditional banking fee component was up $150 thousand, NSF and overdraft fees were down $781 thousand in 2020 from 2019 levels, with a portion of this reduction representing accommodations to COVID-19 impacted customers.
Loan related fees and service charges decreased by $2.6 million in 2020 when compared to 2019, which included $389 thousand and $2.8 million attributable to our now exited mortgage banking activities in 2020 and 2019, respectively. Outside of our mortgage banking activities, loan related fees and service charges were down $126 thousand in 2020. 2019 included an early payoff fee of $308 thousand while 2020 included an interest rate swap arrangement fee of $217 thousand.
Other operating income, which consisted mainly of non-depository account fees such as wire, merchant card and ATM services, decreased by $1.1 million in 2020 when compared to 2019. Interchange income declined by $238 thousand in 2020, with a portion of the decline in transaction volumes attributable to the COVID-19 related drop in economic activity. Additionally, 2019 included $750 thousand in revenue associated with the exit of our mortgage banking activities.
Noninterest Expenses
The following table presents the major categories of noninterest expense for the years ended December 31, 2020 and 2019:
N/M - not meaningful
Noninterest expenses increased by $25.4 million to $89.5 million in 2020, compared to $64.1 million in 2019. The increase in noninterest expenses was primarily driven by a $34.5 million goodwill impairment charge in 2020. Partially offsetting this increase was a reduction in noninterest expenses attributable to our now exited mortgage banking activities, which were $1.4 million in 2020, down $7.6 million from 2019. Noninterest expenses other than from our goodwill impairment charge and mortgage banking activities, were down $1.5 million, or 2.8%, in 2020 compared to 2019.
Compensation and benefits expense is the largest component of our noninterest expenses, and decreased by $3.5 million in 2020, compared to 2019. Compensation and benefits expense attributable to our now exited mortgage banking activities was $928 thousand in 2020, compared to $6.4 million 2019, a $5.5 million decrease. Compensation and benefits expense other than from our mortgage banking activities increased $2.0 million, or 7.7%, in 2020 compared to 2019. Included within this increase was $698 thousand of compensation expense attributable to the departure of our former CFO in the first quarter of 2020, $214 thousand related to higher claims experience in our self-insured healthcare plan, an increase of $171 thousand resulting from a lower level of loan origination cost deferrals driven by a decline in lending activities, $360 thousand attributable to an accrual for compensated absences related to additional PTO with a carryover provision granted in light of COVID-19, and $527 thousand attributable to increased staff costs.
Occupancy and equipment expense decreased by $3.6 million in 2020 compared to 2019. In 2020, we continued to evaluate our branch delivery system and further optimized our branch locations, resulting in a $1.1 million branch optimization charge in the fourth quarter of 2020 associated with our decision to close two branches in early 2021. Both of these branches have been temporarily closed since March 2020 due to the pandemic. This $1.1 million charge was partially offset by the partial reversal of a $538 thousand branch closing liability, initially recorded in 2019, as a result of securing a sublease on the former branch location. In 2019, we reported a branch optimization charge of $3.6 million, as we closed three branch locations in 2019 and consolidated two other existing branch locations into a new smaller branch location in 2020. The projected cost savings from our 2019 branch optimization initiative have been realized. Occupancy and equipment expense also decreased by $334 thousand in 2020 due to the exit of our mortgage banking activities.
Marketing and business development expenses decreased by $940 thousand, to $1.4 million in 2020. Lower marketing and business development expenses were driven primarily by the impact of COVID-19 and non-customer direct contact, although our corporate sponsorships were up $195 thousand in 2020 as we increased our level of community support in response to the pandemic.
Data processing fees consist of core system processors and banking network costs. These expenses decreased by $935 thousand to $4.0 million in 2020, from $4.9 million in 2019, as we realize the benefits from our renegotiated core processing contract.
Loan production expenses decreased by $1.6 million in 2020 compared to 2019, with $1.2 million attributable to our now exited mortgage banking activities.
Our FDIC insurance expense increased by $657 thousand in 2020 compared to 2019. Our second and third quarter 2020 FDIC assessment rate increased due to the impact of the goodwill impairment charge on the assessment calculation. We received small bank assessment credits from the FDIC of $522 thousand in 2019 that did not reoccur in 2020.
Other operating expenses increased by $1.2 million in 2020 compared to 2019. Other operating expenses consisted mainly of a variety of general expenses such as telephone and data lines, supplies and postage, courier services, general insurance, director fees, and miscellaneous losses. Also included in other operating expenses in 2020 was a $2.0 million litigation settlement charge associated with potential litigation claims stemming from certain mortgages originated by First Mariner Bank before its merger with Howard Bank. The settlement agreement was executed in January 2021. Prepayment penalties on FHLB advances were $224 thousand in 2020, a decrease of $427 thousand from 2019. Included in other operating expenses in 2019 was a $700 thousand litigation settlement charge stemming from certain mortgages originated by First Mariner Bank before its merger with Howard Bank. That settlement was not related to the $2.0 million litigation settlement charge recorded in 2020.
Income Tax Expense
Income tax expense for 2020 was $3.6 million compared to $5.2 million in 2019. Our effective tax rate (income tax expense as a percentage of pretax income) was -27.3% in 2020 and 23.5% in 2019. The effective tax rate is influenced by sources of non-taxable income, such as the income from Bank Owned Life Insurance (“BOLI”) as well as certain non-deductible expense items. The $34.5 million goodwill impairment charge in 2020 was not tax deductible. Income tax expense for 2020 was favorably impacted by certain provisions of the CARES Act. The CARES Act permits corporate taxpayers to recover prior period taxes paid by carrying back net operating losses incurred in tax years ending after December 31, 2017 to tax years ending up to five years earlier. As a result, we will be able to carryback the 2018 tax net operating loss of $9.8 million to tax years 2013-2017. The $1.3 million tax benefit represents the difference between the current federal statutory tax rate of 21% and the 34% statutory federal tax rate applicable during the carryback years. Excluding the impact of the goodwill impairment charge and the $1.3 million benefit from the CARES Act, the effective tax rate for 2020 would have been 23.2%.
Income tax expense for 2019 was favorably impacted by a 2019 U.S. Treasury Department change in tax regulations that provided for retroactive application to the taxability of income from BOLI contracts that were acquired in certain tax-free merger transactions. As a result of the change in tax regulations, we recognized a $232 thousand net reduction of tax expense in 2019 pertaining to BOLI income that was earned, and initially treated as subject to income tax, in 2018. Excluding the impact of the $232 thousand of BOLI income, the effective tax rate for 2019 would have been 24.5%.
Comparison of the years ended December 31, 2019 and December 31, 2018
General
Our net income increased $20.7 million to $16.9 million in 2019, compared to a net loss of $3.8 million in 2018. The net loss in 2018 was primarily driven by $15.5 million of merger and restructuring expenses related to our March 1, 2018 merger with First Mariner, which were not repeated in 2019. The increase in net income in 2019 was also driven by an $11.0 million increase in interest income, compared to 2018, primarily from an increase in interest and fees earned on loans and leases as a result of organic growth and a full-year impact of our merger with First Mariner, partially offset by an $8.4 million increase in interest expense. In 2019, net income was also partially offset by $3.6 million of expense, included within occupancy and equipment expense, related to our branch optimization initiative that resulted in three branch closures in 2019, and the expected consolidation of two additional branches in the first quarter of 2020. Our results
for 2019 also included the proceeds from our agreement to exit our mortgage banking activities (net of expenses recorded) of $462 thousand.
Both our basic and diluted earnings per common share were $0.89 in 2019, compared to both a basic and diluted loss per common share of $0.22 in 2018.
Net Interest Income
Net interest income increased $2.7 million in 2019, compared to 2018. The increase in net interest income, while up $7.3 million due to favorable volume variances, was offset by unfavorable rate variances of $4.6 million. Our net interest margin was 3.50% in 2019, a decline of 28 bp, compared to 3.78% in 2018. This decrease was primarily driven by a 44 bp increase in the average rate paid on interest bearing liabilities, which more than offset the six bp increase in the average yield on interest earning assets. The net accretion of fair value adjustments added eight bp to our net interest margin in 2019, compared to 18 bp in 2018.
Interest Income
Interest income increased $11.0 million, or 13.7%, to $91.4 million in 2019, compared to $80.4 million in 2018. $8.9 million of this increase was attributable to interest and fees on loans and leases (excluding loans held for sale) and was primarily attributable to organic loan growth with the average balance of our loans and leases up $170.6 million, or 11.3%, in 2019. Interest income was further aided by a four bp increase in the average yield on our loans and leases, with increases in yields in all categories of loans other than consumer loans. The accretion of fair value adjustments in our loan portfolio added ten bp to the average yield on loans in 2019, compared to 15 bp in 2018. Interest and dividends on investment securities increased $2.5 million in 2019 as a result of both an increase in average balances of $59.1 million and a 36 bp increase in the average yield.
Interest Expense
Interest expense increased $8.4 million, or 60.7%, to $22.1 million, in 2019, compared to $13.8 million in 2018. Interest expense on deposits increased by $6.9 million in 2019, compared to 2018, with $3.9 million of the increase resulting from increases in average volumes and $3.0 million resulting from increases in rates paid on interest-bearing deposits. These increases were influenced by a $129.4 million increase in the average balance of time deposits and a corresponding 75 bp increase in the rate paid on such deposits. Average non-maturity interest bearing deposits increased $43.7 million with a 12 bp increase in the average rate paid on such deposits. We increased the interest rates on our interest-bearing deposits in response to the prevailing competitive rates in our market. The amortization of fair value adjustments in our interest-bearing liabilities, primarily in time deposits, reduced the rate on interest bearing liabilities by one bp in 2019, compared to six bp in 2018. Overall, the average interest rate paid on interest bearing deposits increased 45 bp in 2019. In addition, interest expense on short- and long-term borrowings increased an aggregate of $1.4 million in 2019, compared to 2018, resulting from a 148 bp increase in the average rate paid on such borrowings. The increase in average rates paid on borrowings more than offset the $4.9 million decrease in our average balance of short- and long-term borrowings in 2019, compared to 2018.
Provision for Credit Losses
We recorded a provision for credit losses of $4.2 million for 2019, compared to $6.1 million for 2018, a decrease of $1.9 million. The decrease included the impact of a decrease in specific reserves from $2.4 million at December 31, 2018 to $500 thousand at December 31, 2019. The trend in our asset quality metrics indicate year over year improvement. Our nonperforming loans, as a percentage of gross loans, declined to 1.10% at 2019, from 1.50% at 2018, and nonperforming assets, as a percentage of total assets, declined to 0.94% at 2019 from 1.28% at 2018.
Noninterest Income
The following table presents the major categories of noninterest income for the years ended December 31, 2019 and 2018:
Noninterest income was $21.0 million for 2019, compared to $17.9 million for 2018. This increase was primarily driven by a $2.6 million increase in realized and unrealized gains on mortgage banking activity and the net $1.0 million increase in gain (loss) on the sale of securities. While our mortgage loans originated for sale were down 2.2% in 2019, compared to 2018, our increase in realized and unrealized gains was up 48.7%. This represents an average gain on loans originated for sale of 1.36% in 2019, compared to 0.89% in 2018. The improvement in our average gain on loans originated for sale was the result of a stronger management focus on originating a more profitable product mix. The gain/(loss) on the sale of securities in 2019 and 2018, respectively, were both due to our interest rate positioning strategies at the time of the respective sales.
Service charges on deposit accounts, which consisted of account activity fees such as overdraft fees and other traditional banking fees, increased $531 thousand in 2019, compared to 2018, primarily as a result of increased overdraft activities resulting from deposit growth during 2019.
Other operating income, which consisted mainly of non-depository account fees such as wire, merchant card and ATM services increased $252 thousand in 2019, compared to 2018. Reflected in 2019 other operating income was $750 thousand in revenue associated with the previously disclosed exit of our mortgage banking activities. In 2018, other operating income included a $750 thousand insurance refund.
Partially offsetting the above increases was a $1.7 million decrease in loan related fees and service charges. This decrease was primarily due to a $2.0 million reduction in underwriting and processing fees in 2019. Underwriting and processing fees from our mortgage banking activities decreased $2.3 million in 2019, compared to 2018. This reduction resulted from our decision to discontinue our national consumer direct origination channel in mid-2018. The loans originated from this channel generated substantially higher underwriting and processing fees per loan than comparable fees on loans originated from our retail origination channel.
Our mortgage banking activities generated total noninterest income of $10.6 million in 2019 and $10.2 million in 2018.
Noninterest Expenses
The following table presents the major categories of noninterest expense for the years ended December 31, 2019 and 2018:
Noninterest expenses decreased $19.0 million, or 22.9%, to $64.1 million for 2019, compared to $83.1 million for 2018. This decrease was primarily driven by $15.5 million of merger and restructuring expenses related to our merger with First Mariner in 2018, which were not repeated in 2019.
Compensation and benefits expense decreased $1.6 million in 2019, compared to 2018. The primary driver of this decrease was decreases in staff related to our branch optimization initiative in 2019.
Occupancy and equipment expense decreased $1.6 million in 2019, compared to 2018. Following our merger with First Mariner in 2018, we evaluated our retail branch network, which resulted in the closing of several acquired and existing locations that we deemed to be redundant. In 2019, we continued to evaluate our branch delivery system and further optimized our branch locations. Because of our branch optimization efforts, we incurred $3.6 million and $2.7 million in lease termination and location closing costs in 2019 and 2018, respectively, partially offset by a reduction in lease liability expense on one branch location closed in 2019. These efficiencies also reduced general operating expenses (rent, janitorial, utilities, and depreciation) by $2.0 million in 2019, and equipment expenses (hardware and maintenance contracts and real estate taxes) by $281 thousand in 2019.
Marketing and business development expenses decreased by $1.0 million, or 29.9%, to $2.3 million in 2019. The 2018 expense level included $1.1 million of costs associated with mortgage lead generation from our former national leads-based consumer direct residential first lien mortgage origination channel that we discontinued in mid-2018. Data processing costs increased by $877 thousand to $4.9 million in 2019, from $4.0 million in 2018, resulting from the large growth in loan and deposit accounts primarily resulting from our merger with First Mariner, which increased our core processing cost, as well as improved technology to enhance product deliveries. Our FDIC insurance expense was down $601 thousand in 2019. We received small bank assessment credits from the FDIC of $522 thousand in 2019, resulting from the Deposit Insurance Fund ratio exceeding 1.38%.
Other operating expenses increased $268 thousand in 2019, compared to 2018, primarily as a result of a $700 thousand charge related to the settlement of a litigation claim related to mortgages originated by First Mariner before our acquisition of the bank and $692 thousand of prepayment penalties resulting from our early redemption of FHLB advances. Partially offsetting these increases was a $1.4 million reduction in various categories of other expense, due primarily to merger integration and branch optimization efficiencies.
Income Tax Expense
Income tax expense for 2019 was $5.2 million, compared to an income tax benefit in 2018 of $897 thousand. Our effective tax rate (income tax expense as a percentage of pretax income) was 23.5% in 2019 and 19.0% in 2018. The effective tax rate is influenced by sources of non-taxable income, such as the income from Bank Owned Life Insurance (“BOLI”) as
well as certain non-deductible expense items. Certain merger and acquisition costs are deemed not deductible for income tax purposes, which impacted the effective tax rate for 2018. Income tax expense for 2019 was favorably impacted by a 2019 U.S. Treasury Department change in tax regulations that provided for retroactive application to the taxability of income from BOLI contracts that were acquired in certain tax-free merger transactions. As a result of the change in tax regulations, we recognized a $232 thousand net reduction of tax expense in 2019 pertained to BOLI income that was earned, and initially treated as subject to income tax, in 2018. Excluding the impact of the $232 thousand of BOLI income, the effective tax rate for 2019 would have been 24.5%.
Nonperforming and Problem Assets; COVID-Related Loan Deferrals
We perform reviews of all delinquent loans and our loan officers contact customers to attempt to resolve potential credit issues in a timely manner. Loans are placed on non-accrual status when payment of principal or interest is 90 days or more past due and the value of the collateral securing the loan, if any, is less than the outstanding balance of the loan. Loans are also placed on non-accrual status if we have serious doubt about further collectability of principal or interest on the loan, even though the loan is currently performing. When loans are placed on non-accrual status, unpaid accrued interest is fully reversed, and subsequent income, if any, is recognized only to the extent received. The loan may be returned to accrual status if the loan is brought current, has performed in accordance with the contractual terms for a reasonable period of time and ultimate collectability of the total contractual principal and interest is no longer in doubt.
Under GAAP we are required to account for certain loan modifications or restructurings as troubled debt restructurings (“TDRs”). In general, the modification or restructuring of a debt constitutes a TDR if we, for economic or legal reasons related to the borrower’s financial difficulties, grant a concession, such as a reduction in the effective interest rate, to the borrower that we would not otherwise consider. However, all debt restructurings or loan modifications for a borrower do not necessarily constitute TDRs. We believe loan modifications will potentially result in a lower level of loan losses and loan collection costs than if we proceeded immediately through the foreclosure process with these borrowers.
The CARES Act, as extended by certain provisions of the Consolidated Appropriations Act, 2021, permits banks to suspend requirements under GAAP for loan modifications to borrowers affected by COVID-19 that may otherwise be characterized as TDRs and suspend any determination related thereto if (i) the borrower was not more than 30 days past due as of December 31, 2019, (ii) the modifications are related to COVID-19, and (iii) the modification occurs between March 1, 2020 and the earlier of 60 days after the date of termination of the national emergency or January 1, 2022. Federal bank regulatory authorities also issued guidance to encourage banks to make loan modifications for borrowers affected by COVID-19 and confirmed in working with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs.
Our level of COVID-19-related loan deferrals has generally continued to trend favorably. As of December 31, 2020, a total of $56.1 million of loans, representing 3.0% of total loans and 3.3% of portfolio loans, were performing under some form of deferral or other payment relief. By comparison, $291.4 million of loans, representing 15.3% of total loans and 17.1% of portfolio loans, were performing under some form of deferral or other payment relief as of June 30, 2020; June 30, 2020 represented our highest level of loan deferrals at any quarter-end in 2020. As of March 12, 2021, loan deferrals were $55.8 million, representing 3.0% of total loans and 3.3% of portfolio loans. We expect that some requests for payment deferral extensions will continue while other borrowers currently on payment deferral will resume payments.
The table below sets forth the amounts and categories of our nonperforming assets, which consist of non-accrual loans, TDRs and OREO (which includes real estate acquired through, or in lieu of, foreclosure), at the dates indicated.
(1)
Denotes a non-GAAP measure; refer to the section “Use of Non-GAAP Financial Measures and Related Reconciliations” for additional detail.
Nonperforming Loans
The government fiscal stimulus and relief programs appear to have delayed any materially adverse financial impact to our loan portfolio. Once these stimulus programs have been exhausted, however, we believe our credit metrics could worsen and loan losses could ultimately materialize. Any potential loan losses will be contingent upon a number of factors beyond our control, such as the resurgence of the virus, including any new strains, offset by the potency of the vaccine along with its extensive distribution, and the ability for customers and businesses to return to their pre-pandemic routines.
Nonperforming loans were $19.4 million, or 1.04% of total loans and leases and 1.14% of portfolio loans, at December 31, 2020. Nonperforming loans were up $288 thousand from the December 31, 2019 level, which represented 1.10% of total loans. The $288 thousand increase in 2020 was due primarily to $6.9 million in new nonaccrual loans offset by $5.2 million in payoffs, $1.0 million of charge-offs and $369 thousand of returns to accruing status. $564 thousand of the 2020 nonperforming loan charge-offs were attributable to the full charge-off of loans to one borrower during the first quarter of 2020 where we had recorded a specific allocation of the allowance for loan and lease losses of $500 thousand at December 31, 2019.
Included in non-accrual loans at December 31, 2020 are three troubled debt restructured loans (“TDRs”) with a new carrying balance totaling $498 thousand that were not performing in accordance with their modified terms, and the accrual of interest has ceased. In addition, there were five TDRs totaling $1.5 million that were performing in accordance with their modified terms. There were no additional TDRs in 2020.
The composition of our nonperforming loans at December 31, 2020 is further described below:
Non-Accrual Loans
● Two construction and land loans
● 55 residential first lien loans, three with a combined fair value of $2.5 million in the process of foreclosure
● 22 residential junior lien loans, one with a fair value of $25 thousand in the process of foreclosure
● Two commercial real estate owner-occupied loans, one with a fair value of $294 thousand in the process of foreclosure
● Four commercial real estate non-owner-occupied loans
● Nine commercial loans representing five separate relationships, one with an SBA guarantee, and two loans to one relationship with specific reserves totaling $894 thousand
Accruing Troubled Debt Restructured Loans
● Three residential real estate loans
● Two commercial loans
Nonperforming Assets
Nonperforming assets consist of nonperforming loans and other real estate owned (“OREO”). Our nonperforming assets were $20.2 million, or 0.79% of total assets, at December 31, 2020 compared to $22.2 million, or 0.94% of total assets, at December 31, 2019. Nonperforming assets decreased by $2.1 million at December 31, 2020, compared to December 31, 2019, with OREO down $2.4 million, partially offset by a $288 thousand increase in nonperforming loans.
Other Real Estate Owned
Real estate we acquire as a result of foreclosure is classified as OREO. When a property is acquired as a result of foreclosure, it is recorded at fair value less the anticipated cost to sell at the date of foreclosure. If there is a subsequent change in the value of OREO, we record a valuation allowance to adjust the carrying value of the real estate to its current fair value less estimated disposal costs. Costs relating to holding such real estate are expensed in the current period while
costs relating to improving such real estate are capitalized up to the property’s net realizable value until a saleable condition is reached. Costs in excess of the property’s net realizable value would be expensed in the current period.
Our OREO totaled $743 thousand at December 31, 2020, a $2.4 million decrease from $3.1 million at December 31, 2019. Included in noninterest expenses were $257 thousand, $473 thousand and $352 thousand for 2020, 2019 and 2018, respectively, attributable to net increases in valuation allowances as the current appraised value of OREO properties, less estimated cost to sell, was insufficient to cover the recorded OREO amount. In addition, we sold several parcels of land, one commercial real estate property, and three residential real estate properties with a combined net carrying balance of $2.1 million in 2020, which resulted in a $98 thousand net loss on the disposition of OREO in 2020. We added one new residential real estate property with a carrying balance of $51 thousand in 2020.
OREO at December 31, 2020 consisted of:
● Several parcels of unimproved land.
● Two residential 1-4 family properties.
Classification of Loans
Our policies, consistent with regulatory guidelines, provide for the classification of loans and other assets that are considered to be of lesser quality as Substandard, Doubtful, or Loss assets. An asset is considered Substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or by the collateral pledged, if any. Substandard assets include those assets characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Assets classified as Doubtful have all of the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable or improbable. Assets (or portions of assets) classified as Loss are those considered uncollectible and of such little value that their continuance as assets is not warranted. Assets that do not expose us to risk sufficient to warrant classification in one of the aforementioned categories, but which possess potential weaknesses that deserve our close attention, are required to be designated as Special Mention.
We maintain an allowance for loan and lease losses at an amount estimated to equal all loan losses incurred in our loan portfolio that are both probable and reasonable to estimate at a balance sheet date. Our determination as to the classification of our assets is subject to review by the Commissioner and the FDIC. We regularly review our asset portfolio to determine whether any assets require classification in accordance with applicable regulations.
The $22.2 million increase in special mention loans at December 31, 2020, is primarily due to COVID-related downgrades. The following table sets forth our amounts of classified loans and criticized loans (classified loans plus loans designated as Special Mention) at the dates indicated.
Allowance for Loan and Lease Losses
Our allowance for loan and lease losses (the “allowance”) at December 31, 2020 was $19.2 million, up $8.8 million or 84.2% from $10.4 million at December 31, 2019. Net charge-offs in 2020 were $764 thousand and we recorded a $9.5 million provision for credit losses attributable to loan and lease losses. The allowance was 1.03% of total loans and leases and 1.13% of portfolio loans (a non-GAAP financial measure - refer to the “Use of Non-GAAP Financial Measures” section for additional detail) at December 31, 2020, compared to 0.60% of total loans and leases at December 31, 2019.
The allowance was also 98.62% of nonperforming loans at December 31, 2020, an increase of 44.28% from 54.34% of nonperforming loans at December 31, 2019. The $8.8 million increase in our allowance was primarily the result of management’s response to the COVID-19 pandemic and changes in the qualitative factors discussed below.
COVID-19 and Our Evaluation of the Allowance
The December 31, 2020 allowance reflects our assessment of the impact of COVID-19 on the national and local economies and the impact on various categories of our loan portfolio. Management’s evaluation of COVID-19’s impact on the allowance identified the following qualitative factors for further review:
● Changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments;
● The existence and effect of any concentrations of credit, and changes in the level of such concentrations;
● Changes in the value of underlying collateral for collateral-dependent loans; and
● Changes in the volume and severity of past due, nonaccrual, and adversely classified loans.
Our evaluation of changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments, considered the abrupt slowdown in commercial economic activity and the dramatic rise in the unemployment rate in our market area. Initially, stay-at-home orders, travel restrictions and closure of non-essential businesses resulted in significant business and operational disruptions, including business closures, supply chain disruptions, mass layoffs, and furloughs. Although many of those restrictions have been lifted or eased, continuing capacity restrictions and health and safety recommendations that discourage travel and encourage continued physical distancing and teleworking have limited the ability of businesses to return to pre-pandemic levels of activity and employment. Therefore, this qualitative factor was increased during 2020 in response to this potential risk, and represents $6.0 million, or 0.35%, of the increase in the allowance.
We also evaluated the existence and effect of any concentrations of credit, and changes in the level of such concentrations, with a focus on the identification of our exposure to industry segments that may potentially be the most highly impacted by COVID-19. The following table identifies those industry segments within our loan portfolio that we believe may potentially be most highly impacted by COVID-19. All balances are as of December 31, 2020; note that the column “Initial SBA PPP Loan Relief” indicates the original balance of PPP loans received by our borrowers in each of the identified loan segments. The potentially highly impacted loan segments total $352.0 million, or 18.9% of total loans and leases, at December 31, 2020. However, the table presents each of these loan segments as a percentage of portfolio loans, which we believe is a more meaningful measure of our potentially highly impacted loan concentration. The definition of our potentially highly impacted (“PHI”) loan segments has remained unchanged through December 31, 2020.
(1)
A non-GAAP financial measure - refer to the section “Use of Non-GAAP Financial Measures and Related Reconciliation” for additional detail
(2)
Includes unused lines of credit, unfunded commitments, and letters of credit
The PHI breakdown by loan portfolio segment is as follows:
(1)
A non-GAAP financial measure - refer to the section “Use of Non-GAAP Financial Measures and Related Reconciliation” for additional detail
PHI loan exposures at December 31, 2020 were concentrated in non-owner-occupied commercial real estate (62.1% of total PHI), owner-occupied commercial real estate (19.4% of total PHI), construction and land (9.6% of total PHI), and C&I loans (8.4% of total PHI). Therefore, this qualitative factor within these PHI loan portfolio segments was increased during 2020 in response to this potential risk, and represents $1.3 million, or 0.08%, of the increase in the allowance.
Our evaluation of potential changes in the value of underlying collateral for collateral-dependent loans considered the potential impact of the economic fallout from COVID-19 on commercial property values due to rent relief and possible business failures resulting in vacancies. In addition, the need for office space may diminish in the future as work from home policies have allowed much office-oriented business activity to continue. We concluded that 53% of our non-owner-occupied commercial real estate portfolio at December 31, 2020 was not included in a PHI loan segment. Therefore, this qualitative factor was increased during 2020 in response to this potential risk, and represents $1.0 million, or 0.06%, of the increase in the allowance.
Our evaluation of changes in the volume and severity of past due, nonaccrual, and adversely classified loans identified three loan portfolio segments where adverse risk rating migration warranted an upward revision to this qualitative factor during 2020; these portfolio segments were both non-owner-occupied and owner-occupied commercial real estate loans as well as C&I loans. The increase in this qualitative factor represents $1.3 million, or 0.08%, of the increase in the allowance.
Credit Risk Management and Allowance Methodology
We provide for loan and lease losses (hereinafter referred to as “loan losses”) based upon the consistent application of our documented allowance methodology. All loan losses are charged to the allowance and all recoveries are credited to it. Additions to the allowance are provided by charges to income based on various factors that, in our judgment, deserve current recognition in estimating probable losses. We regularly review the loan portfolio and make provisions for credit losses in order to maintain the allowance in accordance with GAAP.
In accordance with accounting guidance for business combinations, there was no allowance brought forward on any acquired loans in our acquisitions. For acquired performing loans, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value and the discount is accreted to interest income over the life of the loan. Subsequent to the purchase date, the method used to evaluate the sufficiency of the credit discount is similar to originated loans, and if necessary, additional reserves are recognized in the allowance.
We recorded acquired credit impaired loans in our acquisitions net of purchase accounting adjustments. Subsequent to the acquisition date, management continues to monitor cash flows on a quarterly basis, to determine the performance of each acquired credit impaired loan in comparison to management’s initial performance expectations. Subsequent decreases in the present value of expected cash flows will be recorded as an increase in the allowance through a provision for credit losses. Subsequent significant increases in cash flows result in a reversal of the provision for credit losses to the extent of prior provisions or a reclassification of amount from non-accretable difference to accretable yield, with a positive impact on the accretion of interest income in future periods.
The allowance consists of two components - specific and general allowances:
1)
Specific allowances are established for loans classified as Substandard or Doubtful. For loans classified as impaired, the allowance is established when the net realizable value (collateral value less costs to sell) of the impaired loan is lower than the carrying amount of the loan. The amount of impairment provided for as a specific allowance is represented by the deficiency, if any, between the underlying collateral value and the carrying value of the loan. Impaired loans for which the estimated fair value of the loan, or the loan’s observable market price or the fair value of the underlying collateral, if the loan is collateral dependent, exceeds the carrying value of the loan are not considered in establishing specific allowances; and
2)
General allowances established for loan losses on a portfolio basis for loans that do not meet the definition of impaired loans. The portfolio is grouped into similar risk characteristics, primarily loan type and regulatory classification. We apply an estimated loss rate to each loan group. The loss rates applied are based upon our loss experience adjusted, as appropriate, for the qualitative factors discussed below. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revisions based upon changes in economic and real estate market conditions.
The allowance is maintained at a level to provide for loan losses that are probable and can be reasonably estimated. Our periodic evaluation of the adequacy of the allowance is based on past credit loss experience, known and inherent losses in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans.
A loan is considered past due or delinquent when a contractual payment is not paid on the day it is due. A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. We determine the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. The impairment of a loan may be measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if repayment is expected to be provided by the collateral. Generally, our impairment on such loans is measured by reference to the fair value of the collateral. Interest income on impaired loans is recognized on the cash basis.
Our loan policies state that after all collection efforts have been exhausted, and the loan is deemed to be a loss, then the remaining loan balance will be charged off against the allowance. All loans are evaluated for loss potential once it has been determined by our Watch Committee that the likelihood of repayment is in doubt. When a loan is past due for at least 90 days or a deterioration in debt service coverage ratio, guarantor liquidity, or loan-to-value ratio has occurred that would cause concern regarding the likelihood of the full repayment of principal and interest, and the loan is deemed not to be well secured, the loan is moved to non-accrual status and a specific reserve is established if the net realizable value is less than the principal value of the loan balance(s). Once the actual loss value has been determined, this amount is charged off against the allowance. Each loss is evaluated on its specific facts regarding the appropriate timing to recognize the loss.
The adjustments to historical loss experience are based on our evaluation of several qualitative factors, including:
● changes in lending policies, procedures, and practices;
● changes in international, national, state and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments;
● changes in the nature and volume of the loan portfolio;
● changes in the experience, ability and depth of the lending staff;
● changes in the volume and severity of past due, nonaccrual, and adversely classified loans;
● changes in the quality of our loan review system;
● changes in the value of underlying collateral for collateral-dependent loans;
● the existence of any concentrations of credit, and changes in the level of such concentrations;
● the effect of other external factors such as competition and legal and regulatory requirements; and
● any other factors that management considers relevant to the quality or performance of the loan portfolio.
We evaluate the allowance based upon the combined total of the specific and general components. Generally when the loan portfolio increases, absent other factors, the allowance methodology results in a higher dollar amount of estimated probable losses than would be the case without the increase. Generally when the loan portfolio decreases, absent other factors, the allowance methodology results in a lower dollar amount of estimated probable losses than would be the case without the decrease.
Commercial and commercial real estate loans generally have greater credit risks compared to the one- to four-family residential mortgage loans in our loan portfolio, as they typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties typically depends on the successful operation of the related business and thus may be subject to a greater extent to adverse conditions in the real estate market and in the general economy. Actual loan and lease losses may be significantly more than the allowance we have established, which could have a material negative effect on our financial results.
Generally, we underwrite commercial loans based on cash flow and business history and receive personal guarantees from the borrowers where appropriate. We generally underwrite commercial real estate loans and residential real estate loans at a loan-to-value ratio of 85% or less at origination. In the event that a loan becomes significantly past due, we will conduct visual inspections of collateral properties and/or review publicly available information, such as online databases, to ascertain property values. We will also obtain formal appraisals on a regular basis even if we are not considering liquidation of the property to repay a loan. It is our practice to obtain updated appraisals if there is a material change in market conditions or if we become aware of new or additional facts that indicate a potential material reduction in the value of any individual property collateral.
For impaired loans, we utilize the appraised value or present value of expected cash flows in determining the appropriate specific allowance attributable to the loan. In addition, changes in the appraised value of multiple properties securing our loans may result in an increase or decrease in our general allowance as an adjustment to our historical loss experience due to qualitative and environmental factors, as described above.
Nonperforming loans are evaluated and valued at the time the loan is identified as impaired on a case by case basis, at the lower of cost or market value. Market value is measured based on the value of the collateral securing the loan. The value of real estate collateral is determined based on an appraisal by qualified licensed appraisers hired by us. Appraised values may be discounted based on management’s historical experience, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. The difference between the appraised value and the principal balance of the loan will determine the specific allowance valuation required for the loan, if any. Nonperforming loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly.
We evaluate the loan portfolio on at least a quarterly basis, more frequently if conditions warrant, and the allowance is adjusted accordingly. While we use the best information available to make evaluations, future adjustments to the
allowance may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of their examination process, the Commissioner and the FDIC will periodically review the allowance. The Commissioner and the FDIC may require us to recognize additions to the allowance based on their analysis of information available to them at the time of their examination.
The following table sets forth activity in our allowance for loan and lease losses for the periods ended:
(1)
Portion attributable to loan and lease losses
(2)
Denotes a non-GAAP measure - refer to the section “Use of Non-GAAP Financial Measures and Related Reconciliations” for additional detail
Allocation of Allowance for Loan and Lease Losses
The following table sets forth the allocation of the allowance by loan category and the percent of loans in each category to total loans at the dates indicated. The allowance 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. Loans funded through the PPP program are fully guaranteed by the U.S. government and we anticipate that the majority of these loans
will ultimately be forgiven by the SBA in accordance with the terms of the program. Therefore, no allowance for loan and lease losses is attributable to this loan portfolio segment.
(1)
Represents the percent of loans in each category to total loans and leases.
Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial obligations. Our primary sources of funds consist of deposit inflows, loan repayments, advances from the FHLB, and the sale of securities available for sale. 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 Asset/Liability Committee (“ALCO”) is 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 had enough sources of liquidity to satisfy our short- and long-term liquidity needs as of December 31, 2020 and December 31, 2019.
We regularly monitor and adjust our investments in liquid assets based upon our assessment of:
● Expected loan demand;
● Expected deposit flows and borrowing maturities;
● Yields available on interest-earning deposits and securities; and
● The objectives of our asset/liability management program.
The most liquid of all assets are cash and cash equivalents. The level of these assets is dependent on our operating, financing, lending and investing activities during any given period. At December 31, 2020 and 2019, cash and cash equivalents totaled $74.6 million and $110.0 million, respectively. Our excess liquid assets were invested in interest-bearing deposits in banks (primarily the Federal Reserve Bank of Richmond). The level of these assets is dependent on our operating, financing, lending and investing activities during any given period.
Our cash flows are derived from operating activities, investing activities and financing activities as reported in our statements of cash flows included in our financial statements.
Our total commitments to extend credit and available credit lines are discussed in the “Commitments and Off-Balance Sheet Arrangements” section of this MD&A, including a table presenting our comparative exposure at December 31, 2020 and 2019.
CDs due within one year totaled $416.1 million, or 21.1% of total deposits, and $458.9 million, or 26.8% of total deposits, at December 31, 2020 and 2019, respectively. If we do not retain these deposits, we may be required to seek other sources of funds, including loan and securities sales and FHLB advances. Based on current market conditions, a substantial portion of our customer CDs with maturities of one year or less are at significantly higher rates than current market rates for both customer CDs and other funding sources. As a result, we do not expect to retain some portion of our customer CDs with maturities of one year or less as of December 31, 2020.
Our primary investing activity is originating loans. During the years ended December 31, 2020 and December 31, 2019, cash used to fund net loan growth was $119.5 million and $99.2 million, respectively. PPP loans accounted for $167.6 million of the net loan growth in 2020. During 2020, we purchased $340.4 million of securities which partially offset $80.1 million of securities maturities / calls / paydowns and $105.0 million of securities sales. In 2019, we purchased $102.7 million of securities which partially offset $80.4 million of securities maturities / calls / paydowns and $35.4 million of securities sales.
Financing activities consist primarily of activity in deposit accounts and FHLB advances. We experienced a net increase in cash provided from deposits of $261.0 million and $28.6 million, respectively, during the years ended December 31, 2020 and 2019. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors, and by other factors, including the pandemic which caused significant growth in deposit balances held by both households and businesses.
Liquidity management is both a daily and long-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLB, which provide an additional source of funds. FHLB advances decreased to $200.0 million at December 31, 2020 compared to $285.0 million at December 31, 2019. At December 31, 2020, we had an available line of credit for $639.7 million at the FHLB, with borrowings limited to a total of $475.0 million based on pledged collateral. At December 31, 2019, this available line of credit at the FHLB was $573.3 million, with borrowings limited to a total of $435.4 million based on pledged collateral. Additionally, we participated in and continue to have access to borrowing availability under the FRB’s PPPLF. At December 31, 2020 there were no outstanding PPPLF advances.
The Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At December 31, 2020 and 2019, we exceeded all regulatory capital requirements and are considered “well capitalized” under regulatory guidelines. See “Item 1. Business-Supervision and Regulation-Howard Bank-Capital Requirements” and Note 20 of our Consolidated Financial Statements.
Commitments and Off-Balance Sheet Arrangements
We are party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our customers. These financial instruments are limited to commitments to originate loans and involve, to varying degrees, elements of credit, interest rate, and liquidity risk. These do not represent unusual risks, and management does not anticipate any losses that would have a material effect on us.
Outstanding loan commitments and lines of credit at December 31, 2020 and December 31, 2019 are as follows:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. We generally require collateral to support financial instruments with credit risk on the same basis as we do for balance sheet instruments. Management generally bases the collateral required on the credit evaluation of the counterparty. Commitments generally have interest rates at current market rates, expiration dates or other termination clauses and may require payment of a fee. Available credit lines represent the unused portion of lines of credit previously extended and available to the customer so long as there is no violation of any contractual condition. These lines generally have variable interest rates. Since we expect many of the commitments to expire without being drawn upon, and since it is unlikely that all customers will draw upon their lines of credit in full at any one time, the total commitment amount or line of credit amount does not necessarily represent future cash requirements. We evaluate each
customer’s credit-worthiness on a case-by-case basis. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party.
The credit risk involved in these financial instruments is essentially the same as that involved in extending loan facilities to customers. At December 31, 2020 we had a $320 thousand reserve for potential credit losses related to these commitments, recorded in other liabilities on the consolidated balance sheet. We did not have a reserve for potential credit losses related to these commitments at December 31, 2019.
We have contractual obligations to make future payments on debt and lease agreements. In the normal course of business, we enter into contractual arrangements whereby we commit to future purchases of products or services from unaffiliated parties. These purchase obligations are legally binding agreements whereby we agree to purchase products or services with a specific minimum quantity at a fixed, minimum or variable price over a specified period of time. Purchase obligations may include vendor contracts, communication services, processing services and software contracts. We also have contractual obligations under real property leases for certain facilities we utilize.
Payments due by period for our contractual obligations at December 31, 2020 are as follows:
Impact of Inflation and Changing Prices
Our financial statements and related notes have been prepared in accordance with GAAP. GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration of changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Liquidity and Funding
The objective of effective liquidity management is to ensure that we can meet customer loan requests, customer deposit maturities/withdrawals, and other cash commitments efficiently under both normal operating conditions as well as under unforeseen and unpredictable circumstances of industry or market stress. To achieve this objective, the Asset Liability Committee of the Board (“Board ALCO”) establishes and monitors liquidity guidelines; these guidelines generally include maintaining sufficient asset based liquidity to cover potential funding requirements and avoiding an over-dependence on volatile, less reliable funding markets. We manage liquidity at both the parent and subsidiary levels through active management of the balance sheet.
The additional information called for by this item is incorporated herein by reference to the “Liquidity and Capital Resources” section of the MD&A.
Interest Rate Risk
Interest rate risk, one of the more prominent risks in terms of potential earnings impact, is an inevitable part of being a financial intermediary. It can occur for any one or more of the following reasons: (a) assets and liabilities may mature or
reprice at different times (for example, if assets reprice faster than liabilities and interest rates are generally falling, our earnings will initially decline); (b) assets and liabilities may re-price at the same time but by different amounts (when the general level of interest rates is falling, we may choose for customer management, competitive, or other reasons to reduce the rates paid on checking and savings deposit accounts by an amount that is less than the general decline in market interest rates); (c) short-term and long-term market interest rates may change by different amounts (i.e. the shape of the yield curve may impact new loan yields and funding costs differently); or (d) the remaining maturity of various assets or liabilities may shorten or lengthen as interest rates change (for example, mortgage-backed securities held in the securities available for sale portfolio may prepay significantly earlier than anticipated - with an associated reduction in portfolio yield and income - if long-term mortgage rates decline sharply). In addition to the direct impact of interest rate changes on net interest income through these categories, interest rates indirectly impact earnings through their effect on loan demand, credit losses, mortgage origination fees, and other sources of our earnings.
In determining the appropriate level of interest rate risk, we consider the impact on earnings and capital of the current outlook on interest rates, potential changes in interest rates, regional economies, liquidity, business strategies and other factors. We believe that short term interest rate risk is best measured by simulation modeling. We prepare a current base case and standard alternative scenarios at least once quarterly and report the analysis to ALCO, Board ALCO, and the Board of Directors.
The balance sheet is subject to quarterly testing for the standard alternative interest rate shock possibilities to indicate the inherent interest rate risk. Current and forward rates are shocked by +/- 100, + 200, +300, and +400 bp. Certain scenarios may be impractical under different economic circumstances. We seek to structure the balance sheet so that net interest income at risk over a twelve month period does not exceed policy guidelines at the various interest rate shock levels.
Measures of the net interest income at risk produced by the simulation analysis are indicators of an institution’s short-term performance in alternative rate environments. The measures are typically based upon a relatively brief period, usually one year, and do not provide meaningful insight into the institution’s long-term performance. Our net interest income exposure to these rate shocks at both December 31, 2020 and 2019 are presented in the following table. Due to low current market interest rates, it was not possible to calculate a market rate decrease of 200 bp because many of the market interest rates would fall below zero in that scenario. All measures were in compliance with our policy limits.
Estimated Change in Net Interest Income
Part II
Item 8.
Item 8. Financial Statements and Supplementary Data
Report Of Independent Registered Public Accounting Firm
Stockholders and the Board of Directors
Howard Bancorp, Inc.
Baltimore, Maryland
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Howard Bancorp, Inc. and Subsidiary (the "Company") as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive income, changes in stockholders’ equity, and cash flows, for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) ("PCAOB"), the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 16, 2021, expressed an unqualified opinion.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated 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 consolidated 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 consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Allowance for Loan and Lease Losses
As described in Notes 1 and 7 to the consolidated financial statements, the Company’s allowance for loan and lease losses (“the allowance”) was $19.2 million on gross loans of $1.9 billion as of December 31, 2020. The allowance is maintained at a level believed adequate by management to absorb probable losses inherent in the loan and lease portfolio and is based on the size and current risk characteristics of the loan and lease portfolio, an assessment of individual problem loans and leases, actual loss experience, current economic events in specific industries and geographic areas including unemployment levels and other pertinent factors including general economic conditions. The determination of the allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans and leases, estimated losses on pools of homogenous loans and leases based on historical loss experience and consideration of economic trends and qualitative factors, all of which may be susceptible to significant change.
We have determined that the allowance is a critical audit matter. The principal consideration for that determination is the amount of auditor judgement required to audit management’s subjective identification, evaluation and application of the qualitative factors in the allowance model.
The primary procedures we performed to address this critical audit matter included, among others:
●We evaluated the design and tested the operating effectiveness of key controls relating to the Company’s allowance, including controls over the credit monitoring function related to loan performance, the completeness and accuracy of data inputs and management’s determination of the assumptions used to develop and adjust the qualitative factors, and the precision of management’s review and approval of the allowance model and resulting estimate.
●We tested the accuracy of the mathematical application of qualitative factors by loan segment and the resulting allocation to the allowance to adjust the historical loss factors.
●We evaluated the reasonableness of the qualitative factors by comparing the information utilized by management to internal and external evidence and assessed the appropriateness and completeness and accuracy of data utilized by management in developing the assumptions, including the consideration of potentially new or contradictory information.
●We analyzed the qualitative factors over a historical period and evaluated the appropriateness and level of the allowance component resulting from the qualitative factors.
●We performed analytical procedures on the level of the overall allowance as well as its various components, including historical reserves, qualitative reserves and specific reserves, as well as credit quality to ensure movement in a directionally consistent manner relative to credit quality indicators and changes in the Company’s loan portfolio and the economy.
Goodwill Impairment Assessment
As described in Notes 1 and 9 to the consolidated financial statements, the Company’s goodwill balance was $31.4 million at December 31, 2020, which is allocated to the Company’s single reporting unit. The Company’s annual evaluation of goodwill for impairment involves the comparison of the fair value of the reporting unit to its carrying value. Goodwill is tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. Based on an interim assessment, the Company recorded a goodwill impairment charge of $34.5 million in the quarter ended June 30, 2020. The Company utilized a market approach to estimate the fair value of the reporting unit. The determination of fair value in an assessment requires the Company to make significant assumptions and estimates. These assumptions primarily include the selection of appropriate peer group companies and an appropriate market multiple and selection of comparable transactions and related control premiums. Changes in these assumptions could have a significant impact on the fair value of the reporting unit and the amount, if any, of a goodwill impairment charge.
We have determined that the Company’s goodwill impairment assessment is a critical audit matter. The principal considerations for that determination are management’s subjective judgments regarding the valuation methods, assumptions and significant estimates required for the estimate of the fair value of the reporting unit. In turn, auditing the
reasonableness of management’s methods, assumptions and estimates involves a higher degree of judgment and subjectivity.
The primary procedures we performed to address this critical audit matter included, among others:
●We evaluated the design and operating effectiveness of controls relating to management’s goodwill impairment tests, including controls over management's review of the significant inputs and assumptions utilized by the client-engaged specialist.
●With the assistance of our valuation specialists, we evaluated the reasonableness of the goodwill impairment estimate by performing the following procedures:
oWe evaluated the qualifications of the client-engaged specialist
oWe tested the methods and assumptions utilized by the client-engaged specialist for reasonableness
oWe tested the reasonableness of the overall conclusion of the client-engaged specialist
/s/ DIXON HUGHES GOODMAN LLP
We have served as the Company's auditor since 2016.
Atlanta, Georgia
March 16, 2021
Report Of Independent Registered Public Accounting Firm
Stockholders and the Board of Directors
Howard Bancorp, Inc.
Baltimore, Maryland
Opinion on Internal Control Over Financial Reporting
We have audited Howard Bancorp, Inc. and Subsidiary’s (the “Company”) internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated financial statements of the Company as of December 31, 2020 and 2019, and for each of the three years in the period ended December 31, 2020, and our report dated March 16, 2021, expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company's management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ DIXON HUGHES GOODMAN LLP
Atlanta, Georgia
March 16, 2021
Howard Bancorp, Inc. and Subsidiary
Consolidated Balance Sheets
The accompanying notes are an integral part of these Consolidated Financial Statements.
Consolidated Statements of Operations
The accompanying notes are an integral part of these Consolidated Financial Statements.
Consolidated Statements of Comprehensive Income
The accompanying notes are an integral part of these Consolidated Financial Statements.
Consolidated Statements of Changes in Stockholders’ Equity
The accompanying notes are an integral part of these Consolidated Financial Statements.
Consolidated Statements of Cash Flows
The accompanying notes are an integral part of these Consolidated Financial Statements.
Notes to Consolidated Financial Statements
Note 1: Summary of Significant Accounting Policies
Nature of Operations
Howard Bancorp, Inc. (“Bancorp” or the “Company”) was incorporated in April 2005 under the laws of the State of Maryland. On December 15, 2005, Bancorp acquired all of the stock of Howard Bank (the “Bank”) pursuant to the Plan of Reorganization approved by the stockholders of the Bank and by federal and state regulatory agencies. Each share of the Bank’s common stock was converted into two shares of Bancorp common stock effected by the filing of Articles of Exchange on that date, and the stockholders of the Bank became the stockholders of Bancorp. Bancorp is now a bank holding company registered under the Bank Holding Company Act of 1956, with a single bank subsidiary, Howard Bank, which operates as a state trust company with commercial banking powers regulated by the Maryland Office of the Commissioner of Financial Regulation (the “Commissioner”).
The Bank has nine subsidiaries-six were formed to hold foreclosed real estate (three of which are currently inactive), two own and manage real estate used for corporate purposes, and one holds historic tax credit investments.
The Company is a diversified financial services company providing commercial banking, mortgage banking and consumer finance through banking branches, the internet and other distribution channels to businesses, business owners, professionals and other consumers located primarily in the Greater Baltimore Metropolitan Area.
Basis of Presentation
The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America (“GAAP”) and prevailing practices within the financial services industry for financial information.
Principles of Consolidation
The Consolidated Financial Statements include the accounts of Bancorp, the Bank and the Bank’s subsidiaries. All significant intercompany accounts and transactions have been eliminated. The parent company only condensed financial statements in Note 24 report Bancorp’s investments in the Bank under the equity method.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant changes in the near-term relate to the determination of the allowance for loan and lease losses, the valuation of goodwill and deferred tax assets, other-than-temporary impairment of investment securities and the fair value of loans held for sale.
Segment Information
The Company has one reportable segment, “Community Banking.” All of the Company’s activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company supports the others. For example, lending is dependent upon the ability of the Bank to fund itself with deposits and other borrowings and manage interest rate and credit risk. Accordingly, all significant operating decisions are based upon analysis of the Company as one segment or unit.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, amounts due from banks, cash items in the process of clearing, federal funds sold, and interest-bearing deposits with banks with original maturities of less than 90 days. Generally, federal funds are sold as overnight investments.
Investment Securities
Debt securities not classified as held-to-maturity are classified as available-for-sale. Investments held-to-maturity represents securities that the Company has both the intent and ability to hold until maturity. Securities available-for-sale are acquired as part of the Bank's asset/liability management strategy and may be sold in response to changes in interest rates, loan demand, changes in prepayment risk and other factors. Securities available-for-sale are carried at estimated fair value, with unrealized gains or losses based on the difference between amortized cost and fair value reported as accumulated other comprehensive income (loss), net of deferred taxes, a separate component of stockholders’ equity, when appropriate. Realized gains and losses, using the specific identification method, are included as a separate component of noninterest income. Related interest and dividends are included in interest income. Premiums and discounts on held-to-maturity investments are amortized to interest income using the effective interest method. Declines in the fair value of individual securities below their amortized cost that are other-than-temporary result in write-downs of the individual securities to their fair value. Factors affecting the determination of whether an other-than-temporary impairment has occurred include a downgrading of the security by a rating agency, a significant deterioration in the financial condition of the issuer, or a change in management’s intent and ability to hold a security for a period of time sufficient to allow for any anticipated recovery in fair value.
Nonmarketable Equity Securities
Nonmarketable equity securities include equity securities that are not publicly traded or are held to meet regulatory requirements. The Company’s only security in this category is Federal Home Loan Bank of Atlanta (“FHLB”) stock, which is accounted for at cost and evaluated for impairment each reporting period. Due to redemptive provisions of the FHLB, cost approximates fair value.
Marketable Equity Securities
Marketable equity securities are carried at estimated fair value based on quoted prices. Changes in fair value of marketable equity securities are recognized in net income. At both December 31, 2020 and 2019, marketable equity securities totaled $4.0 million and are included in the interest receivable and other assets caption of the consolidated balance sheet.
Derivative Instruments and Hedging Activity
Interest Rate Swaps
The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. These interest rate swaps are simultaneously economically hedged by offsetting interest rate swaps that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this activity do not meet the strict hedge accounting requirements, changes in fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings.
By using derivative instruments, the Company is exposed to credit and market risk. If the counterparty fails to perform, credit risk is equal to the fair value gain in a derivative. When the fair value of a derivative contract is positive, this situation generally indicates that the counterparty is obligated to pay the Company, and, therefore, creates a repayment risk for the Company. When the fair value of a derivative contract is negative, the Company is obligated to pay the counterparty and therefore, has no repayment risk. The Company minimizes the credit risk in derivative instruments by entering into transactions with high-quality counterparties that are reviewed periodically by the Company.
The Company recognizes the fair value of derivatives as assets or liabilities in the Consolidated Financial Statements. The accounting for the changes in the fair value of a derivative depends on the intended use of the derivative instrument at inception. The change in fair value of the effective portion of cash flow hedges is accounted for in other comprehensive income rather than net income. Changes in fair value of derivative instruments that are not intended as a hedge are accounted for in the net income in the period of the change (see Derivatives and Hedging Activities footnote for further disclosure).
Interest Rate Lock Commitments
In connection with its mortgage banking activities that were exited in early 2020, the Company entered into commitments to originate residential mortgage loans whereby the interest rate on the loan was determined prior to funding (i.e. rate lock commitment). Such rate lock commitments on mortgage loans to be sold in the secondary market were considered to be derivatives. The period of time between issuance of a loan commitment and closing and sale of the loan generally ranged from 15 to 60 days. The Company protected itself from changes in interest rates through the use of best efforts forward delivery commitments, whereby the Company committed to sell a loan at a premium at the time the borrower committed to an interest rate with the intent that the buyer had assumed interest rate risk on the loan.
For purposes of calculating fair value of rate lock commitments, the Bank estimated loan closing and investor delivery rate based on historical experience. The measurement of the estimated fair value of the rate lock commitments is presented as realized and unrealized gains on mortgage banking activities with the corresponding balance sheet amount presented within other assets in the Consolidated Financial Statements.
Loans Held For Sale
The Company completed the processing of the remaining residential first lien mortgage pipeline during the first quarter of 2020 and sold the remaining loans held for sale during the second quarter of 2020, each in connection with exiting our mortgage banking activities. As a result, we did not have any loans held for sale at December 31, 2020 compared to $30.7 million at December 31, 2019.
Prior to the Company’s exit from mortgage banking activities, loans held for sale were carried at fair value. Fair value was based on outstanding investor commitments or, in the absence of such commitments, on current investor yield requirements based on third party models. The Company elected to measure loans held for sale under the fair value option to better align reported results with the underlying economic changes in value of the loans on the Company’s Consolidated Balance Sheets. Changes in the fair value of these loans were recorded in earnings as a component of realized and unrealized gains from mortgage banking activities in noninterest income in the Consolidated Statements of Operations. Prior to the Company’s exit from mortgage banking activities, it sold residential mortgage loans on a servicing released basis, and, therefore, it had no intangible asset recorded for the value of such servicing. Interest on loans held for sale was credited to income based on the principal amounts outstanding.
Loans held for sale that were not ultimately sold, but instead were placed into the Bank’s portfolio, were reclassified to loans held for investment and continue to be recorded at fair value.
Loans and Leases
Loans and leases are stated at their principal balance outstanding, plus deferred origination costs, less unearned discounts and deferred origination fees. Interest on loans and leases is credited to income based on the principal amounts outstanding. Origination fees and costs are amortized to income over the contractual life of the related loans and leases. Generally, accrual of interest on a loan or lease is discontinued when the loan or lease is delinquent more than 90 days unless the collateral securing the loan or lease is sufficient to liquidate the loan. All interest accrued but not collected for loans and leases that are placed on non-accrual or charged-off is reversed against interest income. Interest on these loans and leases is accounted for on the cash basis, until qualifying for return to accrual. Loans and leases are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Management considers loans and leases impaired when, based on current information, it is probable that the Company will not collect all principal and interest payments according to contractual terms. Loans and leases are tested for impairment no later than when principal or interest payments become 90 days or more past due and they are placed on non-accrual. Management also considers the financial condition of the borrower, cash flows of the loan or lease and the value of the related collateral. Impaired loans and leases do not include large groups of smaller balance homogeneous loans and leases such as residential real estate and consumer installment loans which are evaluated collectively for impairment. Loans and leases specifically reviewed for impairment are not considered impaired during periods of “minimal delay” in payment (90 days or less) provided eventual collection of all amounts due is expected. The impairment of a loan or lease may be measured based on the present value of expected future cash flows discounted at the loan or lease’s effective interest rate,
or the fair value of the collateral if repayment is expected to be provided by the collateral. Generally, the Company’s impairment on such loans and leases is measured by reference to the fair value of the collateral. Interest income on impaired loans and leases is recognized on the cash basis.
The segments of the Company’s loan and lease portfolio are disaggregated to a level that allows management to monitor risk and performance. The commercial real estate (“CRE”) loan segment is further disaggregated into two classes; owner occupied loans and non-owner occupied loans. Non-owner occupied CRE loans, which include loans secured by non-owner occupied nonfarm nonresidential properties, generally have a greater risk profile than owner occupied CRE loans. The residential mortgage loan segment is further disaggregated into two classes: first lien mortgages and second or junior lien mortgages. Loans originated under the Small Business Administration's ("SBA") Paycheck Protection Program ("PPP") established under the Coronavirus Aid, Relief and Economic Security Act ("CARES" Act) which was signed into law on March 27, 2020, hereafter referred to as PPP loans, are segregated from the Company's commercial business loans and leases ("C&I") loan segment.
Acquired Loans
Acquired loans are recorded at fair value at the date of acquisition, and accordingly, no allowance for loan losses is transferred to the acquiring entity under the acquisition method. The fair values of loans with evidence of credit deterioration (acquired credit impaired loans) are initially recorded at fair value, but thereafter accounted for differently than purchased, non-credit-impaired loans. For acquired credit impaired loans, the excess of all cash flows estimated to be collectable at the date of acquisition over the initial investment in the acquired credit impaired loan is recognized as interest income, using a level-yield basis over the life of the loan. This amount is referred to as the accretable yield. The acquired credit impaired loan’s contractually-required payments receivable estimated to be in excess of the amount of its future cash flows expected at the date of acquisition is referred to as the non-accretable difference, and is not reflected as an adjustment to the yield, but in the form of a loss accrual or a valuation allowance.
Subsequent to the acquisition date, management continues to monitor cash flows on a quarterly basis, to determine the performance of each acquired credit impaired loan in comparison to management’s initial performance expectations. Subsequent decreases in the present value of expected cash flows will be recorded as an increase in the allowance for loan and lease losses through a provision for loan losses. Subsequent significant increases in cash flows result in a reversal of the provision for loan losses to the extent of prior provisions or a reclassification of amount from non-accretable difference to accretable yield, with a positive impact on the accretion of interest income in future periods.
Allowance for Loan and Lease Losses
The allowance for loan and lease losses (the “allowance”) is maintained at a level believed adequate by management to absorb probable incurred losses inherent in the loan and lease portfolio and is based on the size and current risk characteristics of the loan and lease portfolio, an assessment of individual problem loans and leases, actual loss experience, current economic events in specific industries and geographic areas including unemployment levels and other pertinent factors including general economic conditions. Determination of the allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans and leases, estimated losses on pools of homogenous loans and leases based on historical loss experience and consideration of economic trends, all of which may be susceptible to significant change. Loan and lease losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for credit losses is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors. Evaluations are conducted at least quarterly and more often if deemed necessary.
The allowance consists of a specific component and a nonspecific component. The components of the allowance represent an estimation done pursuant to either the Financial Accounting Standards Board’s (the “FASB”) Accounting Standards Codification (“ASC”) Topic 450 Contingencies or ASC Topic 310 Receivables. The specific component of the allowance reflects estimated incurred losses resulting from analysis developed through credit allocations for individual loans and leases. The credit allocations are based on a regular analysis of all loans and leases over a fixed-dollar amount where the internal credit rating is at or below a predetermined classification.
The nonspecific portion of the allowance is determined based on management’s assessment of general economic conditions, as well as economic factors in the individual markets in which the Company operates including the strength and timing of economic cycles and concerns over the effects of a prolonged economic downturn in the current cycle. This determination inherently involves a higher risk of uncertainty and considers current risk factors that may not have yet manifested themselves in the Bank’s historical loss factors used to determine the nonspecific component of the allowance, and it recognizes that knowledge of the portfolio may be incomplete. The Bank’s historic loss factors are based upon actual losses incurred by portfolio segment over the preceding 24-month period. In portfolio segments where no actual losses have been incurred within the most recent 24-month period, industry loss data for that portfolio segment, as provided by the Federal Deposit Insurance Corporation (“FDIC”), are utilized. In addition to historic loss factors, the Bank’s methodology for the allowance incorporates other risk factors that may be inherent within the portfolio segments. For each portfolio segment, in addition to the historic loss experience, the qualitative factors that are measured and monitored in the overall determination of the allowance include:
● changes in lending policies, procedures, and practices;
● changes in international, national, state and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments;
● changes in the nature and volume of the loan portfolio;
● changes in the experience, ability and depth of the lending staff;
● changes in the volume and severity of past due, nonaccrual, and adversely classified loans;
● changes in the quality of our loan review system;
● changes in the value of underlying collateral for collateral-dependent loans;
● the existence of any concentrations of credit, and changes in the level of such concentrations;
● the effect of other external factors such as competition and legal and regulatory requirements; and
● any other factors that management considers relevant to the quality or performance of the loan portfolio.
Each of these qualitative risk factors is measured based upon data generated either internally, or in the case of economic conditions utilizing independently provided data on items such as unemployment rates, commercial real estate vacancy rates, or other market data deemed relevant to the business conditions within the markets served.
The Company’s credit policies state that after all collection efforts have been exhausted, and the loan or lease is deemed to be a loss, then the remaining loan or lease balance will be charged to the Company’s established allowance. All loans and leases are evaluated for loss potential once it has been determined by the Watch Committee that the likelihood of repayment is in doubt. When a loan is past due for at least 90 days or a deterioration in debt service coverage ratio, guarantor liquidity, or loan-to-value ratio has occurred that would cause concern regarding the likelihood of the full repayment of principal and interest, and the loan or lease is deemed not to be well secured, the loan or lease would be moved to non-accrual status and a specific reserve is established if the net realizable value is less than the principal value of the loan balance(s). Once the actual loss value has been determined, a charge-off against the allowance for the amount of the loss is taken. Each loss is evaluated on its specific facts regarding the appropriate timing to recognize the loss.
Goodwill, Other Intangible Assets and Long-Lived Assets
Goodwill represents the excess of the purchase price over the sum of the estimated fair values of tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed. Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in a business combination. The core deposit intangible is amortized over the estimated useful lives of the long-term deposits acquired, and the remaining amounts of the core deposit intangible are periodically reviewed for impairment. Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. Long-lived assets are those that provide the Company with a future economic benefit beyond the current year or operating period. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset is greater than the fair value of the asset. Assets to be disposed of are reported at the lower of the cost or the fair value, less costs to sell.
Effective April 1, 2020, the Company adopted the FASB’s Accounting Standards Update (“ASU”) 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which simplifies the subsequent
measurement of goodwill by eliminating Step 2 from the goodwill impairment test. The goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit's fair value, to the extent that the loss recognized does not exceed the amount of goodwill allocated to that reporting unit.
Management has determined that the Company has one reporting unit. The sudden and continuing decline in economic conditions triggered by the Coronavirus ("COVID-19") pandemic included a significant decline in stock market valuations and the stock price of the Company and peer banks. These events indicated that goodwill may be impaired and resulted in the Company performing a goodwill impairment assessment. Based on this assessment, the Company's estimated fair value was less than its book value, resulting in a goodwill impairment charge of $34.5 million recorded in the quarter ended June 30, 2020. Based on the annual impairment analysis, the Company determined that there was not an impairment of the carrying value of either the goodwill or core deposit intangible at December 31, 2020. The Company is not aware of any issues that have arisen since the annual impairment analysis was performed in the fourth quarter of 2020.
Business Combinations
GAAP requires that the acquisition method of accounting be used for all business combinations and that an acquirer be identified for each business combination. Under GAAP, the acquirer is the entity that obtains control of one or more businesses in the business combination, and the acquisition date is the date the acquirer achieves control. GAAP requires that the acquirer recognize the fair value of assets acquired, liabilities assumed, and any non-controlling interest in the acquired entity at the acquisition date.
Other Real Estate Owned
Other real estate acquired through, or in lieu of, foreclosure is initially recorded at fair value less estimated cost to sell at the date of acquisition, establishing a new cost basis. Gains or losses arising at the date of acquisition of such properties are charged against the allowance for loan and lease losses. Subsequent to foreclosure, valuations are periodically performed by management and a valuation allowance is established, if necessary, by a charge to noninterest expense if the carrying value of a property exceeds its estimated fair value less estimated costs to sell. Gains and losses realized from the sale of OREO as well as expenses of operation are recorded in noninterest expense.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and amortization computed using the straight-line method. Premises and equipment are depreciated over the useful lives of the assets, which generally range from three to 10 years for furniture, fixtures and equipment and three to five years for computer software and hardware. Bank owned premises are depreciated over a range of 20 to 30 years. Leasehold improvements are amortized over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter. The costs of major renewals and betterments are capitalized, while the costs of ordinary maintenance and repairs are included in noninterest expense.
Operating Leases
The Company determines if an arrangement is a lease at inception. All of the Company’s leases are currently classified as operating leases and are included in other assets and other liabilities on the Company’s Consolidated Balance Sheet.
Right-of-use (“ROU”) assets represent the Company’s right to use an underlying asset for the lease term, and lease liabilities represent the Company’s obligation to make lease payments arising from the lease arrangements. Operating lease ROU assets and liabilities are recognized at the lease commencement date based on the present value of the expected future lease payments over the remaining lease term. In determining the present value of future lease payments, the Company uses its incremental borrowing rate based on the information available at the lease commencement date. The operating ROU assets are adjusted for any lease payments made at or before lease commencement date, initial direct costs and any lease incentives received. The Company’s lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise such options. Lease expense is recognized on a straight line basis over the expected lease term. Lease agreements that include lease and non-lease components, such as common area maintenance charges, are accounted for separately.
Income Taxes
The Company uses the asset/liability method of accounting for income taxes. Under the asset/liability method, deferred tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities (i.e., temporary differences) and are measured at the enacted rates that will be in effect when these differences reverse. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. In addition, deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or the entire deferred tax asset will not be realized. The Company does not have uncertain tax positions that are deemed material, and did not recognize any adjustments for unrecognized tax benefits. The Company’s policy is to recognize interest and penalties on income taxes in other noninterest expenses. The Company remains subject to examination by federal and state taxing authorities for income tax returns for the years ending after December 31, 2016.
Net Income per Common Share
Basic net income per common share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the year. Diluted net income per common share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the year including any potential dilutive effects of common stock equivalents. Dilutive common stock equivalents consist of stock options and restricted stock units, calculated under the treasury stock method.
Share-Based Compensation
Compensation cost is recognized for stock options issued to directors and employees. Compensation cost is measured as the fair value of these awards on their date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options. Compensation cost is recognized over the required service period, generally defined as the vesting period for stock option awards. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.
Compensation expense for non-vested common stock awards is based on the fair value of the awards, which is generally the market price of the common stock on the measurement date, which, for the Company, is the date of grant, and is recognized ratably over the service period of the award. Compensation expense for performance-based grants is recognized based on the probability of achievement of the goals underlying the grant.
Off-Balance Sheet Financial Instruments
In the ordinary course of business, the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit. Such financial instruments are recorded in the consolidated balance sheet when they are funded. Potential exposure to loss on commitments to extend credit, if deemed necessary, is recorded in other liabilities.
As noted under Loans Held for Sale, prior to the Company’s exit from mortgage banking activities the Company originated and sold residential mortgage loans to a variety of investors. Mortgage loans sold were subject to representations and warranties made to the third party purchasers regarding certain attributes. Subsequent to the sale, if a material underwriting deficiency or documentation defect was determined, the Company would be obligated to repurchase the mortgage loan or reimburse the investor for losses incurred if the deficiency or defect could not be rectified within a specific period subsequent to discovery.
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on securities available for sale, are reported as a separate component of the equity section of the consolidated balance sheets, and such items, along with net income, are components of comprehensive income. The Company’s sole component of accumulated other comprehensive income (loss) is realized and unrealized gains and losses on available for sale securities.
Transfer 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 Company, (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 Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. In certain cases, the recourse to the Bank to repurchase assets may exist but is deemed immaterial based on the specific facts and circumstances.
Reclassifications
Certain reclassifications to 2019 and 2018 financial presentation were made to conform to the 2020 presentation. These reclassifications did not affect previously reported net income or total stockholders’ equity.
Recent Accounting Pronouncements
The FASB has issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform, on financial reporting. The risk of termination of the London Interbank Offered Rate (LIBOR), has caused regulators to undertake reference rate reform initiatives to identify alternative reference rates that are more observable or transaction based that are less susceptible to manipulation. ASU 2020-04 is effective between March 12, 2020 and December 31, 2022. The Company has identified its products that utilize LIBOR and has begun efforts to transition to an alternative reference rate. The Company continues to evaluate systems to assist in the transition to a new rate.
The FASB has issued ASU 2019-10, Financial Instruments - Credit losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). This ASU amends the effective date of the credit loss standard (ASU 2016-13) for smaller reporting companies, as defined by the SEC. The one-time determination of whether an entity is eligible to be a smaller reporting company is based on an entity’s most recent determination as of November 15, 2019, in accordance with SEC regulations. The Company met this definition of smaller reporting company based on its most recent determination as of November 15, 2019. As a result, the effective date of this ASU for the Company has been amended from fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, to fiscal years beginning after December 31, 2022, and interim periods within those fiscal years. In addition, this ASU amended the mandatory effective date for the elimination of Step 2 from the goodwill impairment test (ASU 2017-04 discussed below). As a smaller reporting company, the effective date of the goodwill impairment standard for the Company has been amended from fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, to fiscal years beginning after December 31, 2022, and interim periods within those fiscal years.
The FASB has issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The amendments in this Update simplify the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. The Company should perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. Impairment charges should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value, however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The impairment charge is limited to the amount of goodwill allocated to that reporting unit. As discussed above, this ASU, as amended by ASU 2019-10, was to be effective for the Company on January 1, 2023. However, the Company adopted ASU 2017-04 on April 1, 2020.
The FASB has issued ASU 2016-13, Financial Instruments-Loan Losses (Topic 326). The main objective of this update is to provide financial statement users with more decision-useful information about the expected loan losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the guidance in this update replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected loan losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The measurement of expected loan losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity must use judgment in determining the relevant information and
estimation methods that are appropriate in its circumstances. As discussed above, this ASU, as amended by ASU 2019-10, will be effective for the Company on January 1, 2023. The Company has licensed and implemented third party software to gather historical data and review the methodologies and assumptions utilized to determine the impact of this update on the Company’s Consolidated Financial Statements.
COVID-19 Risks and Uncertainties
The coronavirus (COVID-19) pandemic, which was declared a national emergency in the United States in March 2020, continues to create extensive disruptions to the global economy and financial markets and to businesses and the lives of individuals throughout the world. Federal and state governments have taken, and may continue to take, unprecedented actions to contain the spread of the disease, including quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal stimulus, and legislation designed to deliver monetary aid and other relief to businesses and individuals impacted by the pandemic. Although in various locations certain activity restrictions have been relaxed and businesses and schools have reopened with some level of success, in many states and localities the number of individuals diagnosed with COVID-19 has increased significantly, which may cause a freezing or, in certain cases, a reversal of previously announced relaxation of activity restrictions and may prompt the need for additional aid and other forms of relief.
The impact of the COVID-19 pandemic is fluid and continues to evolve. The unprecedented and rapid spread of COVID-19 and its associated impacts on trade (including supply chains and export levels), travel, employee productivity, unemployment, consumer spending, and other economic activities has resulted in less economic activity, lower equity market valuations and significant volatility and disruption in financial markets. In addition, due to the COVID-19 pandemic, market interest rates have declined significantly, with the 10-year Treasury bond falling below 1.00% on March 3, 2020 for the first time, then declining further to a low of 0.52% in early August. Since that time, intermediate and long-term bond yields have risen, with a sharper rise in 2021; the yield on the 10-year Treasury bond is now nearing where it was before the start of the pandemic in February 2020. On March 3, 2020, the Federal Open Market Committee reduced the targeted federal funds interest rate range by 50 basis points to 1.00% to 1.25%. This range was further reduced to 0% to 0.25% percent on March 16, 2020 and remained at that level throughout the remainder of 2020. These reductions in interest rates and the other effects of the COVID-19 pandemic have had, and are expected to continue to have, possibly materially, an adverse effect on the Company’s business, financial condition, and results of operations. The ultimate extent of the impact of the COVID-19 pandemic on the Company’s business, financial condition and results of operations is currently uncertain and will depend on various developments and other factors, including the effect of governmental, regulatory and private sector initiatives, the effect of the recent rollout of vaccinations for the virus, whether such vaccinations will be effective against any resurgence of the virus, including any new strain, and the ability for customers and businesses to return to their pre-pandemic routine.
Note 2: Exit of Mortgage Banking Activities
On December 18, 2019, the Company entered into an agreement to release certain management members of the mortgage division from their employment contracts and allow those individuals to create a limited liability company (“LLC”) for the purpose of hiring all remaining mortgage employees. The Company also agreed to transfer ownership of the domain name “VAmortgage.com” to the newly created LLC. In consideration of the release of the employment agreements, the transfer of the mortgage employees, and the sale of the domain name, the LLC paid the Company $750 thousand. Under the agreement, there was a transition period of approximately 45 days, after which the Company agreed to cease originating residential first lien mortgage loans and exit all mortgage banking activities. Accordingly, all of the residential first lien mortgage pipeline loans were processed by the end of the first quarter of 2020 and the remaining loans held for sale were sold during the second quarter of 2020. In order to manage loan run-off within the residential mortgage loan portfolio, the Company commenced purchasing first lien residential mortgage loans, on a servicing released basis, from both the LLC and other third-party originators.
The following table presents a roll-forward of loans held for sale, showing loans originated for sale and loans sold into the secondary market, for the years ended December 31, 2020, 2019, and 2018. In addition, the volume of loans originated for the Company’s loan portfolio as well as a statement of operations for the mortgage banking activities for the years ended December 31, 2020, 2019, and 2018 is presented. Since the mortgage banking activities were conducted within a division
of the Bank, formal financial statements were not prepared. The statement of operations presented below reflects only the direct costs associated with the Company’s mortgage banking activities and is thus representative of the incremental after tax impact of exiting this activity.
Since the Bank’s 91 employees that were engaged in mortgage banking activities were hired by the LLC under the terms of the agreement, no severance costs were recorded. However, the Company recorded $288 thousand of exit costs in 2019, associated with change in control and retention agreements. Since the LLC has subleased the office space that was used by these employees, no exit costs associated with lease terminations were recorded.
Note 3: Cash and Due from Banks
Regulation D of the Federal Reserve Act requires that banks maintain reserve balances with the Federal Reserve Bank based principally on the type and amount of their deposits. During 2020 and 2019, the Company maintained balances at the Federal Reserve (in addition to vault cash) to meet the reserve requirements as well as balances to partially compensate for services. On March 15, 2020, the Board of Governors of the Federal Reserve System reduced the reserve requirement to zero percent due to the COVID-19 pandemic, effective March 26, 2020. Additionally, the Company maintained balances with the Federal Home Loan Bank and other domestic correspondent financial institutions as partial compensation for services they provided to the Company.
Note 4: Investment Securities
The Company holds securities classified as available for sale and held to maturity.
The amortized cost and estimated fair values of investments are as follows:
Gross unrealized losses and fair value by investment category and length of time the individual securities have been in a continuous unrealized loss position at December 31, 2020 and December 31, 2019 are presented below:
The unrealized losses that existed were a result of market changes in interest rates since the original purchase. Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include (1) the duration and magnitude of the decline in value, (2) the financial condition of the issuer or issuers and (3) the structure of the security. The number of securities in the portfolio with unrealized losses totaled 11 and 16 at December 31, 2020 and 2019, respectively.
An impairment loss is recognized in earnings if any of the following are true: (1) the Company intends to sell the debt security; (2) it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis; or (3) the Company does not expect to recover the entire amortized cost basis of the security. In situations where the Company intends to sell or when it is more likely than not that the Company will be required to sell the security, the entire impairment loss must be recognized in earnings. In all other situations, only the portion of the impairment loss representing the credit loss must be recognized in earnings, with the remaining portion being recognized in stockholders’ equity as a component of other comprehensive income, net of deferred tax.
The amortized cost and estimated fair values of investments by contractual maturity are shown below:
At December 31, 2020 and December 31, 2019, securities with a fair value of $226.2 million and $11.6 million, respectively, were pledged as collateral. These securities were pledged at the Federal Reserve Bank of Richmond ("FRB") Discount Window as well as for repurchase agreements and deposits of local government entities that require pledged collateral as a condition of maintaining these deposit accounts. No single issuer of securities, except for government agency and mortgage backed securities, had outstanding balances that exceeded ten percent of stockholders’ equity at December 31, 2020.
Note 5: Nonmarketable Equity Securities
At December 31, 2020 and December 31, 2019, the Company’s investment in nonmarketable equity securities consisted of FHLB stock, which is required for continued membership, of $10.6 million and $14.2 million, respectively. This investment is carried at cost.
Note 6: Loans and Leases
The Company makes loans and leases to customers primarily in the Greater Baltimore Maryland metropolitan area, and surrounding communities. A substantial portion of the Company’s loan portfolio consists of loans to businesses secured by real estate and/or other business assets.
The loan and lease portfolio segment balances at December 31, 2020 and December 31, 2019 are presented in the following table:
Includes equipment financing leases of $3,597 and $6,382 at December 31, 2020 and 2019, respectively.
The PPP program provided financial relief and funding opportunities for small businesses from approved SBA lenders. In response to the COVID-19 pandemic, as an SBA lender, the Bank actively assisted its qualified customers with applications and lending through this program, as amended by subsequent legislation. During 2020, the Bank funded PPP loans totaling $201.0 million of which $170.8 million in principal balances were still outstanding at December 31, 2020. Loans funded through the PPP program are fully guaranteed by the U.S. government and the Company anticipates that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program.
Total loan and lease balances at December 31, 2020 and 2019 include net deferred loan fees or costs, including premiums on purchased loans. Net deferred loan fees, including premiums on purchased loans, were $913 thousand at December 31, 2020. Net deferred loan fees at December 31, 2020 included $3.2 million in net deferred loan fees attributable to PPP loans. Net deferred loan costs, including premiums on purchased loans, totaled $2.0 million at December 31, 2019.
Portfolio Segments
The Company currently manages its credit products and the respective exposure to credit losses (credit risk) by the following specific portfolio segments (classes) which are levels at which the Company develops and documents its systematic methodology to determine the allowance for loan and lease losses attributable to each respective portfolio segment. These segments are:
● Commercial business loans & leases (“C&I”) - C&I loans are made to provide funds for equipment and general corporate needs. Repayment of a loan primarily uses the funds obtained from the operation of the borrower’s business. C&I loans also include lines of credit that are utilized to finance a borrower’s short-term credit needs and/or to finance a percentage of eligible receivables and inventory. The Company’s loan portfolio also includes a small portfolio of equipment leases, which consists of leases for essential commercial equipment used by small- and medium-sized businesses.
● Construction and land loans - Commercial acquisition, development and construction loans are intended to finance the construction of commercial and residential properties and include loans for the acquisition and development of land. Construction loans represent a higher degree of risk than permanent real estate loans and may be affected by a variety of factors such as the borrower’s ability to control costs and adhere to time schedules and the risk that constructed units may not be absorbed by the market within the anticipated time frame or at the anticipated price. The loan commitment on these loans often includes an interest reserve that allows the lender to periodically advance loan funds to pay interest charges on the outstanding balance of the loan.
● Commercial owner occupied real estate loans - Commercial owner-occupied real estate loans consist of commercial mortgage loans secured by owner occupied properties where an established banking relationship exists and involves a variety of property types to conduct the borrower’s operations. The primary source of repayment for this type of loan is the cash flow from the business and is based upon the borrower’s financial health and the ability of the borrower and the business to repay.
● Commercial non-owner occupied real estate loans - Commercial non-owner occupied loans consist of properties where an established banking relationship exists and involves investment properties for warehouse, retail, and office space with a history of occupancy and cash flow. This commercial real estate category contains mortgage loans to the developers and owners of commercial real estate where the borrower intends to operate or sell the property at a profit and use the income stream or proceeds from the sale(s) to repay the loan.
● Consumer loans - This category of loans includes primarily installment loans and personal lines of credit. Consumer loans include installment loans used by customers to purchase boats, automobiles, and recreational vehicles.
● Residential first lien mortgage loans - The residential real estate category contains permanent mortgage loans principally to consumers secured by residential real estate. Residential real estate loans are evaluated for the adequacy of repayment sources at the time of approval, based upon measures including credit scores, debt-to-income ratios, and collateral values. Loans may be either conforming or non-conforming.
● Residential junior lien mortgage loans - This category of loans includes primarily home equity loans and lines. The home equity category consists mainly of revolving lines of credit to consumers which are secured by residential real estate. These loans are typically secured with second mortgages on the homes.
● PPP loans - Loans funded through the PPP program are fully guaranteed by the U.S. government and the Company anticipates that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program. Therefore, no allowance is attributable to this loan portfolio segment.
Acquired Credit Impaired Loans
The following table documents changes in the accretable discount on acquired credit impaired loans for the years ended December 31, 2020, 2019 and 2018:
The table below presents the outstanding balances and related carrying amounts for all acquired credit impaired loans at the end of the respective periods:
Note 7: Credit Quality Assessment
Allowance for Loan and Lease Losses
Credit risk can vary significantly as losses, as a percentage of outstanding loans and leases, can vary widely during economic cycles and are sensitive to changing economic conditions. The amount of loss in any particular type of loan or lease can vary depending on the purpose of the loan or lease and the underlying collateral securing the loan or lease. Collateral securing commercial loans and leases can range from accounts receivable to equipment to improved or unimproved real estate depending on the purpose of the loan or lease. Home mortgage and home equity loans and lines are typically secured by first or second liens on residential real estate. Consumer loans may be secured by personal property, such as marine loans or they may be unsecured loan products.
To control and manage credit risk, the Company has an internal credit process in place to determine whether credit standards are maintained along with an in-house loan and lease administration accompanied by oversight and review procedures. The primary purpose of loan and lease underwriting is the evaluation of specific lending risks that involves the analysis of the borrower’s ability to service the debt as well as the assessment of the value of the underlying collateral. Oversight and review procedures include the monitoring of the portfolio credit quality, early identification of potential problem credits and the management of the problem credits. As part of the oversight and review process, the Company maintains an allowance for loan and lease losses (the “allowance”) to absorb estimated and probable losses in the loan and lease portfolio. The allowance is based on consistent, continuous review and evaluation of the loan and lease portfolio, along with ongoing assessments of the probable losses and problem credits in each portfolio. While portions of the allowance are attributed to specific portfolio segments, the entire allowance is available for credit losses inherent in the total loan and lease portfolio.
Summary information on activity in the allowance for the years ended December 31, 2020, 2019, and 2018 is presented in the following table:
1 Portion attributable to loan and lease losses.
The December 31, 2020 allowance reflects the Company’s assessment of the impact of COVID-19 on the national and local economies and the impact on various categories of our loan portfolio. Management’s evaluation of COVID-19’s impact on the allowance identified the following qualitative factors for further review:
● Changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments;
● The existence and effect of any concentrations of credit, and changes in the level of such concentrations;
● Changes in the value of underlying collateral for collateral-dependent loans; and
● Changes in the volume and severity of past due, nonaccrual, and adversely classified loans.
The Company’s evaluation of changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments, considered the abrupt slowdown in commercial economic activity and the dramatic rise in the unemployment rate in the Company’s market area. Initially, stay-at-home orders, travel restrictions and closure of non-essential businesses resulted in significant business and operational disruptions, including business closures, supply chain disruptions, mass layoffs, and furloughs. Although many of those restrictions have been lifted or eased, continuing capacity restrictions and health and safety recommendations that discourage travel and encourage continued physical distancing and teleworking have limited the ability of businesses to return to pre-pandemic levels of activity and employment. Therefore, this qualitative factor was increased during 2020 in response to this potential risk, and represents $6.0 million, or 0.35%, of the increase in the allowance.
The Company’s evaluation of the existence and effect of any concentrations of credit, and changes in the level of such concentrations focused on the identification of its exposure to industry segments that may potentially be the most highly impacted by COVID-19. Based on this evaluation, the Company identified the following industry segments as potentially highly impacted: commercial real estate (“CRE”) - retail; CRE - residential rental; hotels; restaurants and caterers; nursing and residential care; retail trade; religious and similar organizations; and arts, entertainment, and recreation. The definition of our potentially highly impacted (“PHI”) loan segments has remained unchanged through December 31, 2020.
The PHI loan exposures at December 31, 2020 were concentrated in non-owner-occupied commercial real estate (62.1% of total PHI), owner-occupied commercial real estate (19.4% of total PHI), construction and land (9.6% of total PHI), and C&I loans (8.4% of total PHI). Therefore, this qualitative factor within these PHI loan portfolio segments was increased during 2020 in response to this potential risk, and represents $1.3 million, or 0.08%, of the increase in the allowance.
The Company’s evaluation of potential changes in the value of underlying collateral for collateral-dependent loans considered the potential impact of the economic fallout from COVID-19 on commercial property values due to rent relief and possible business failures resulting in vacancies. In addition, the need for office space may diminish in the future as work from home policies have allowed much office-oriented business activity to continue. Excluding the PHI portfolios, management concluded that 53% of the Company’s non-owner-occupied commercial real estate portfolio at December 31, 2020 was not included in the PHI exposure. Therefore, this qualitative factor was increased during 2020 in response to this potential risk, and represents $1.0 million, or 0.06%, of the increase in the allowance.
The Company’s evaluation of changes in the volume and severity of past due, nonaccrual, and adversely classified loans identified three loan portfolio segments where adverse risk rating migration warranted an upward revision to this qualitative factor during 2020; these portfolio segments were both non-owner-occupied and owner-occupied commercial real estate loans as well as C&I loans. The increase in this qualitative factor represents $1.3 million, or 0.08%, of the increase in the allowance.
The following table provides information on the activity in the allowance, by the respective loan and lease portfolio segments, for the years ended December 31, 2020, 2019 and 2018:
1 portion attributable to loan and lease losses.
Integral to the assessment of the allowance process is an evaluation that is performed to determine whether a specific reserve on an impaired credit is warranted. At such time an action plan is agreed upon for the particular loan or lease, an appraisal will be ordered (for real estate based collateral) depending on the time elapsed since the prior appraisal, the loan or lease balance and/or the result of the internal evaluation. The Company’s policy is to strictly adhere to regulatory appraisal standards. If an appraisal is ordered, no more than a 45 day turnaround is requested from the appraiser, who is selected from an approved appraiser list. After receipt of the updated appraisal, the Company’s Watch Committee will determine whether a specific reserve or a charge-off should be taken based upon an impairment analysis. When potential losses are identified, a specific provision and/or charge-off may be taken, based on the then current likelihood of repayment, that is at least in the amount of the collateral deficiency, and any potential collection costs, as determined by the independent third party appraisal. Any further collateral deterioration may result in either further specific reserves being established or additional charge-offs. The President and the Chief Lending Officer have the authority to approve a specific reserve or charge-off between Watch Committee meetings to ensure that there are no significant time lapses during this process.
The Company’s systematic methodology for evaluating whether a loan or lease is impaired begins with risk-rating credits on an individual basis and includes consideration of the borrower’s overall financial condition, resources and payment record, the sufficiency of collateral and, in a select few cases, support from financial guarantors. In measuring impairment, the Company looks to the discounted cash flows of the project itself or the value of the collateral as the primary sources of repayment of the loan or lease. The Company will consider the existence of guarantees and the financial strength and wherewithal of the guarantors involved in any loan or lease relationship as both a secondary source of repayment and for the potential as the primary repayment of the loan or lease.
The Company typically relies on recent third party appraisals of the collateral to assist in measuring impairment.
Management has established a credit process that dictates that structured procedures be performed to monitor these loans or leases between the receipt of an original appraisal and the updated appraisal. These procedures include the following:
● An internal evaluation is updated quarterly to include borrower financial statements and/or cash flow projections.
● The borrower may be contacted for a meeting to discuss an update or revised action plan which may include a request for additional collateral.
● Re-verification of the documentation supporting the Company’s position with respect to the collateral securing the loan or lease.
● At the Watch Committee meeting the loan may be downgraded and a specific reserve may be decided upon in advance of the receipt of the appraisal if it is determined that the likelihood of repayment is in doubt.
The Company generally follows a policy of not extending maturities on non-performing loans and leases under existing terms. The Company may extend the maturity of a performing or current loan or lease that may have some inherent weakness associated with the loan or lease. Maturity date extensions only occur under terms that clearly place the Company in a position to assure full collection of the loan or lease under the contractual terms and/or terms at the time of the extension that may eliminate or mitigate the inherent weakness in the loan or lease. These terms may incorporate, but are not limited to additional assignment of collateral, significant balance curtailments/liquidations and assignments of additional project cash flows. Guarantees may be a consideration in the extension of loan or lease maturities, but the Company does not extend loans or leases based solely on guarantees. As a general matter, the Company does not view extension of a loan or lease to be a satisfactory approach to resolving non-performing credits. On an exception basis, certain performing loans and leases that have displayed some inherent weakness in the underlying collateral values, an inability to comply with certain loan or lease covenants which are not affecting the performance of the credit or other identified weakness may be extended.
Collateral values or estimates of discounted cash flows (inclusive of any potential cash flow from guarantees) are evaluated to estimate the probability and severity of potential losses. A specific amount of impairment is established based on the Company’s calculation of the probable loss inherent in the individual loan or lease. The actual occurrence and severity of losses involving impaired credits can differ substantially from estimates.
Credit risk profile by portfolio segment based upon internally assigned risk assignments are presented below:
● Special Mention - A Special Mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Special Mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.
● Substandard - Substandard loans and leases are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans and leases so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
● Doubtful - Loans and leases classified Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable.
Loans and leases classified Special Mention, Substandard, and Doubtful are reviewed at least quarterly to determine their appropriate classification. All commercial credit relationships are reviewed annually. Non-classified residential mortgage loans and consumer loans are not evaluated unless a specific event occurs to raise the awareness of a possible credit deterioration.
Credit risk profile by portfolio segment based upon internally assigned credit quality indicators are presented below:
Included are acquired credit impaired loans where the Company amortizes the accretable discount into interest income, however these loans do not accrue interest based on the terms of the loan.
Total loans and leases either in non-accrual status or in excess of 90 days delinquent totaled $18.3 million or 1.0% of total loans and leases outstanding at December 31, 2020, which represents a $432 thousand increase from $17.9 million at December 31, 2019.
The Company had no impaired leases or impaired PPP loans for the years ended December 31, 2020 and 2019. The impaired loans for the years ended December 31, 2020 and 2019 are as follows:
1 Included are acquired credit impaired loans where the Company amortizes the accretable discount into interest income, however these loans do not accrue interest based on the terms of the loan.
Included in the total impaired loans above were non-accrual loans of $17.9 million and $17.8 million at December 31, 2020 and 2019, respectively. Interest income that would have been recorded if non-accrual loans had been current and in accordance with their original terms, was $630 thousand and $748 thousand for the years ended December 31, 2020 and 2019, respectively.
Loans may have their terms restructured (e.g., interest rates, loan maturity date, payment and amortization period, etc.) in circumstances that provide payment relief to a borrower experiencing financial difficulty. Such restructured loans are considered impaired loans that may either be in accruing status or non-accruing status. Non-accruing restructured loans may return to accruing status provided there is a sufficient period of payment performance in accordance with the restructure terms. Loans may be removed from the restructured category in the year subsequent to the restructuring if they have performed based on all of the restructured loan terms.
The Company had no troubled debt restructured (“TDR”) leases or PPP loans at December 31, 2020 and December 31, 2019. The TDR loans at December 31, 2020 and 2019 are as follows:
A summary of TDR loan modifications outstanding and performance under modified terms is as follows:
The CARES Act provides financial institutions with relief from certain accounting and disclosure requirements under GAAP for certain loan modifications to borrowers affected by COVID-19 that would otherwise be characterized as TDRs. In addition, before the CARES Act was enacted, federal banking regulators issued an interagency statement that included guidance on their approach for the accounting of loan modifications in light of the economic impact of the COVID-19 pandemic. The guidance interprets current accounting standards and indicates that a lender can conclude that a borrower is not experiencing financial difficulty if short-term modifications are made in response to COVID-19, such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant related to the loans in which the borrower is less than 30 days past due on its contractual payments at the time a modification program is implemented. The agencies confirmed in working with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs. As of December 31, 2020, a total of $56.1 million of loans, representing 3.0% of total loans, were performing under some form of deferral or other payment relief.
In 2020 there were no new loans classified as TDR, there was one construction and land loan for $125 thousand that paid off, and one residential real estate loan for $197 thousand that was upgraded from non-performing to performing. During 2019, there were two new commercial loans with terms extended and their payments modified totaling $367 thousand that are currently performing in accordance with their modified terms.
During 2020 and 2019, there were no TDRs that subsequently defaulted within twelve months of their modification dates.
At December 31, 2020 there were three loans secured by residential real estate first liens totaling $2.5 million, one loan secured by a residential real estate junior lien of $25 thousand, and one commercial real estate loan of $294 thousand in the process of foreclosure.
Note 8: Derivatives and Hedging Activities
Non-designated Hedges of Interest Rate Risk
The Company maintains interest rate swap contracts with customers that are classified as non-designated hedges and are not speculative in nature. These agreements are designed to effectively convert certain customers’ variable rate loans with the Company to fixed rate. These interest rate swaps are executed with loan customers to facilitate their respective risk management strategy and allow the customer to pay a fixed rate of interest to the Company. These interest rate swaps are simultaneously economically hedged by executing offsetting interest rate swaps with unrelated market counterparties to minimize the net risk exposure to the Company resulting from the transactions and allow the Company to receive a variable rate interest. The interest rate swaps pay and receive interest based on a floating rate indexed to one month LIBOR plus a credit spread with payment being calculated on the notional amount. The interest rate swaps are settled with varying maturities.
As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. The fair value of the interest rate swap derivatives are recorded in other assets and other liabilities. All changes in fair value are recorded through earnings as noninterest income. For both 2020 and 2019, the Company recorded a net loss of $5 thousand related to the change in fair value of these interest rate swap derivatives.
The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Consolidated Balance Sheet at December 31, 2020 and December 31, 2019:
Note 9: Goodwill and Other Intangible Assets
Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The Bank has one reporting unit, which is community banking. The Company performs its annual impairment evaluation in the fourth quarter.
Due to the COVID-19 pandemic and the related economic fallout, including most specifically, declining stock prices at both the Company and peer banks, the Federal Reserve’s significant reduction in interest rates, and other business and market considerations, the Company performed an interim goodwill impairment analysis as of June 30, 2020. Based on this analysis, the estimated fair value of the Company was less than book value, resulting in a $34.5 million impairment charge, recorded in noninterest expense, in the second quarter of 2020. This was a non-cash charge to earnings and had no impact on the Company’s regulatory capital ratios, cash flows, or liquidity position.
The table below presents a roll forward of goodwill for the years ended December 31, 2020 and 2019:
Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in either business combinations or other purchases of deposits and are amortized based upon the estimated economic benefits received. The gross carrying amount and accumulated amortization of other intangible assets are as follows:
Estimated future amortization expense for amortizing intangibles are as follows:
Based upon an annual impairment analysis performed during the fourth quarter of 2020, it was determined that there was not an impairment of the carrying value of either the goodwill or core deposit intangible.
Note 10: Bank Premises and Equipment
Premises and equipment include the following at:
Depreciation and amortization expense for premises and equipment were $2.3 million, $2.3 million and $2.1 million for the years ended December 31, 2020, 2019 and 2018, respectively.
Note 11: Operating Leases
The Company has operating leases on land and buildings with remaining lease terms ranging from 2021 to 2030. Many of the leases include renewal options, with renewal terms generally extending up to 10 years.
On January 1, 2019, the Company adopted the requirements of ASU 2016-02, Leases (Topic 842). The objective of this ASU, along with several related ASUs subsequently issued, is to increase transparency and comparability between organizations that enter into lease agreements. The most significant change is the requirement to recognize right of use (“ROU”) assets and lease liabilities for leases classified as operating leases. The standard requires disclosures to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. As part of the transition to the new standard, the Company was required to measure and recognize leases that existed at January 1, 2019, and the Company elected a modified retrospective approach. For leases existing at the effective date, the Company elected the package of three transition practical expedients and therefore did not reassess whether an arrangement is or contains a lease, did not reassess lease classification, and did not reassess what qualifies as an initial direct cost.
The adoption of Topic 842 resulted in the initial recognition of operating ROU assets and related lease liabilities of $18.0 million on January 1, 2019, which were recorded in other assets and other liabilities, respectively. As of the adoption date, there were no lease incentives that would have impacted the ROU asset balance.
The Company completed the consolidation of two branch locations into a single new location during the first quarter of 2020; the opening of the new location increased ROU assets by $2.0 million. During the fourth quarter of 2020, the Company communicated its plan to close two additional branches in early 2021. Both of the branches to be permanently closed have been temporarily closed since March 2020 due to the pandemic. A partial write-down of the ROU assets attributable to the two branches to be closed totaled $554 thousand. The opening of the new location, the pending closure of the two branches, and the amortization of the ROU asset reduced the ROU asset to $13.2 million at December 31, 2020.
Operating lease ROU assets and lease liabilities are as follows:
The components of lease expense were as follows:
Lease liability maturities are as follows:
The Company from time to time subleases its vacant locations. Operating sublease income is recognized as a component of noninterest expense on a straight-line basis over the sublease term. Lease terms range from one to six years.
The following table details the future minimum operating sublease payments to be received at December 31, 2020:
Note 12: Deposits
The following table details the composition of deposits and the related percentage mix of total deposits, respectively, at the dates indicated:
The following table presents the maturity schedule for time deposits maturing within years ending December 31:
Interest expense on deposits for the years ended December 31, 2020, December 31, 2019 and December 31, 2018 was as follows:
Note 13: Borrowings
Federal Home Loan Bank Advances
FHLB advances, by maturity year, at December 31, 2020 and 2019 consisted of the following:
(1)
Fixed rate credit
(2)
Fixed rate hybrid advance
(3)
Convertible rate advances
(4)
Borrowing was prepaid in June 2020 resulting in a prepayment penalty of $224 thousand
(5)
$35.0 million of the outstanding balance at December 31, 2019 was called in January 2020
Additional information regarding FHLB borrowings with final maturities of less than one year are presented in the following table:
At December 31, 2020, the Company had an available line of credit for $639.7 million with the FHLB under which its borrowings are limited to $475.0 million based on pledged collateral with $200.0 million borrowed against the line. At December 31, 2019, the Company had an available line of credit for $573.3 million with the FHLB under which its borrowings are limited to $435.4 million based on pledged collateral with $285.0 million borrowed against the line. Under a blanket lien, the Company has pledged qualifying residential mortgage loans, home equity lines of credit, and commercial real estate loans as collateral for this borrowing arrangement in the aggregate amount of $702.0 million and $615.6 million at December 31, 2020 and 2019, respectively.
Customer Repurchase Agreements and Other Borrowings
Customer Repurchase Agreements and Other Borrowings (“Other Borrowings”) consist of overnight securities sold under agreement to repurchase, overnight unsecured master notes, federal funds purchased, overnight borrowings from the FRB Discount Window, and borrowings under the FRB Paycheck Protection Program Lending Facility (“PPPLF”), a lending facility that provides a source of liquidity for PPP loans. At December 31, 2020 there were no outstanding PPPLF advances. Additional information relating to Other Borrowings is presented below:
1 includes overnight unsecured master notes
The Company pledges mortgage-backed securities, based upon their fair value, as collateral for 100% of the principal and accrued interest of its repurchase agreements. At December 31, 2020 and 2019 there were $13.6 million and $6.6 million, respectively, in investment securities pledged under these agreements.
In addition, the Company has unsecured lines of credit with correspondent banks of $65.0 million at both December 31, 2020 and 2019. There were no outstanding borrowings against these lines of credit at either December 31, 2020 or 2019.
Subordinated Debentures
Information relating to subordinated debt is presented below:
Subordinated debt acquired in 2015. Carrying value after purchase accounting adjustments of $3.8 million at December 31, 2020. Interest adjusts quarterly at the rate of three month LIBOR plus 1.48%
Subordinated debt issued in 2018. Carrying value net of issuance costs of $24.6 million at December 31, 2020. Initial rate of 6.00% per annum for five years. Subsequently, the rate adjusts quarterly at the rate of three month LIBOR plus 3.02%
On December 6, 2018, the Company entered into Subordinated Note Purchase Agreements with certain Purchasers pursuant to which the Company sold and issued $25,000,000 in aggregate principal amount of 6.00% Fixed-to-Floating Rate Subordinated Notes due December 6, 2028. The Notes were issued by the Company to the Purchasers at a price equal to 100% of their face amount in reliance on the exemptions from registration available under Section 4(a)(2) of the Securities Act and the provisions of Regulation D thereunder. The Company used the net proceeds of this offering for general corporate purposes, to provide for continued growth and to supplement its regulatory capital ratios.
The Notes have been structured to qualify initially as Tier 2 capital for regulatory capital purposes. The Note will initially bear interest at a rate of 6.00% per annum from December 6, 2018 to December 5, 2023, with interest during this period payable semi-annually in arrears. From December 6, 2023 to but excluding the maturity date or early redemption date, the interest rate will reset quarterly to an annual floating rate equal to three-month LIBOR plus 302 basis points, with interest during this period payable quarterly in arrears. The Notes are redeemable by the Company at its option, in whole or in part, on or after December 6, 2023.
As a part of the acquisition of Patapsco Bancorp, Inc. (“Patapsco Bancorp”) in 2015, Bancorp assumed debt originally issued by Patapsco Bancorp. In 2005 Patapsco Statutory Trust I, a Connecticut statutory business trust and an unconsolidated wholly-owned subsidiary of Patapsco Bancorp and now of Bancorp (the “Trust”), issued $5 million of capital trust pass-through securities to investors. The interest rate currently adjusts on a quarterly basis at the rate of the three month LIBOR plus 1.48%. The Trust purchased $5,155,000 of junior subordinated deferrable interest debentures from Patapsco Bancorp. The debentures are the sole asset of the Trust. Patapsco Bancorp also fully and unconditionally guaranteed the obligations of the Trust under the capital securities, which guarantee became an obligation of Bancorp upon its acquisition of Patapsco Bancorp. The capital securities are redeemable by Bancorp at par. The capital securities must be redeemed upon final maturity of the subordinated debentures on December 31, 2035.
Note 14: Income Taxes
Federal and state income tax expense (benefit) consists of the following for the years ended:
A reconciliation of the statutory federal income tax expense (benefit) to the Company’s effective tax (benefit) rate for the years ended December 31, 2020, 2019, and 2018 is as follows:
For the year 2020, the Company recorded income tax expense of $3.6 million. The goodwill impairment charge of $34.5 million recorded during the second quarter of 2020 was not tax deductible. The results for the year 2020 were favorably impacted by certain provisions of the CARES Act. The CARES Act permits corporate taxpayers to recover federal income taxes paid in prior years by carrying back net operating losses incurred in tax years ending after December 31, 2017 to tax years ending up to five years earlier. As a result, the Company was able to carry back the 2018 tax net operating loss of $9.8 million to tax years 2013 to 2017. The $1.3 million tax benefit represents the difference between the current federal statutory tax rate of 21% and the 34% statutory federal tax rate applicable during the carryback years. Our effective tax rate for the year 2020 was -27.3%.
Income tax expense for 2019 was favorably impacted by a 2019 U.S. Treasury Department change in tax regulations that provided for retroactive application to the taxability of income from Bank Owned Life Insurance (“BOLI”) contracts that were acquired in certain tax-free merger transactions. At the time of the First Mariner merger, the Company recorded a deferred tax liability of $4.6 million that represented the combined federal and state income tax payable on the acquired balance of BOLI contracts. Based on the increase in the cash surrender value of the BOLI contracts for the remainder of 2018, the balance of the deferred tax liability increased to $4.8 million as of December 31, 2018. As a result of the change in tax regulations during the first quarter of 2019, the Company recognized a $232 thousand reduction of tax expense in
2019 that pertained to BOLI income that was earned, and initially treated as subject to income tax, in 2018. In addition, the associated $4.8 million deferred tax liability was eliminated with a corresponding $4.6 million decrease in goodwill. The effective tax rate for the year 2019 was 23.5%.
The Company’s income tax benefit for 2018 was the result of the loss incurred for the year. The benefit for 2018 was reduced by the impact of various merger related non-deductible costs.
The following table is a summary of the tax effect of temporary differences that give rise to a significant portion of deferred tax assets and liabilities:
Based on management’s assessment that it is more likely than not that all net deferred tax assets will be realized, there was no valuation allowance at either December 31, 2020 or 2019.
As part of the Company’s acquisitions, the Company assumed federal tax net operating loss carryforwards. The remaining balance of acquired net operating loss carryforwards totaled approximately $91.7 million and $103.5 million at December 31, 2020 and 2019, respectively. The acquired loss carryforwards can be deducted annually from future taxable income through 2039, subject to various annual limitations.
Currently, tax years ending after December 31, 2016 are considered as open for examination by federal and state taxing authorities.
Note 15: Related Party Loans and Deposits
In the normal course of business, loans are made to executive officers and directors of the Company, as well as to their related interests. In the opinion of management, these loans are consistent with sound banking practices, are within regulatory lending limitations and do not involve more than the normal risk of collectability.
Total outstanding balances to the Company’s executive officers, directors and their related interests are presented below.
In addition to the outstanding balances above, total unfunded commitments to these parties at December 31, 2020 and December 31, 2019 were $12.0 million and $14.0 million, respectively. The Bank also routinely enters into deposit relationships with its officers and directors in the normal course of business. These deposit accounts bear the same terms and conditions for comparable deposit accounts of unrelated parties and totaled $18.0 million at December 31, 2020 and $21.6 million at December 31, 2019.
Note 16: Financial Instruments with Off-Balance Sheet Risk
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business. These financial instruments may include commitments to extend credit, standby letters of credit and purchase commitments. The Company uses these financial instruments to meet the financing needs of its customers. Financial instruments involve, to varying degrees, elements of credit, interest rate, and liquidity risk. These do not represent unusual risks, and management does not anticipate any losses which would have a material effect on the accompanying Consolidated Financial Statements.
Outstanding loan commitments and lines and letters of credit are as follows:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. The Company generally requires collateral to support financial instruments with credit risk on the same basis as it does for on-balance sheet instruments. Management generally bases the collateral required on the credit evaluation of the counterparty. Commitments generally have interest rates at current market rates, expiration dates or other termination clauses and may require payment of a fee. Available credit lines represent the unused portion of lines of credit previously extended and available to the customer so long as there is no violation of any contractual condition. These lines generally have variable interest rates. Since the Company expects many of the commitments to expire without being drawn upon, and since it is unlikely that all customers will draw upon their lines of credit in full at any one time, the total commitment amount or line of credit amount does not necessarily represent future cash requirements. Each customer’s credit-worthiness is evaluated on a case-by-case basis. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party.
The credit risk involved in these financial instruments is essentially the same as that involved in extending loan facilities to customers. The reserve for potential credit losses related to these commitments, recorded in other liabilities on the consolidated balance sheet, was $320 thousand at December 31, 2020. The Company did not have a reserve for potential credit losses related to these commitments at December 31, 2019.
Note 17: Stock Options and Stock Awards
Bancorp’s equity incentive plan provides for awards of nonqualified and incentive stock options as well as vested and non-vested common stock awards. As of December 31, 2020, 359,544 shares are available for issuance pursuant to future grants under our stock incentive plan. Employee stock options can be granted with exercise prices at the fair market value (as defined within the plan) of the stock at the date of grant and with terms of up to ten years and typically vest over a three
to five year period. Except as otherwise permitted in the plan, upon termination of employment, permanent disability or death, the option exercise period is reduced or the options are canceled.
Stock awards may also be granted to non-employee members of the Company’s board of directors (the “Board of Directors” or “Board”) as compensation for attendance and participation at meetings of the Board of Directors and meetings of the various committees of the Board. In 2020, 2019 and 2018, Bancorp issued 22,895, 9,202 and 11,868 shares of common stock, respectively, to directors as compensation for their service.
Stock Options
The fair value of Bancorp’s stock options granted as compensation is estimated on the measurement date, which, for the Company, is the date of grant. The fair value of stock options is calculated using the Black-Scholes option-pricing model under which the Company estimates expected market price volatility and expected term of the options based on historical data and other factors. There were no stock options granted in either 2020 or 2018, while 25,000 stock options were granted in 2019. The valuation of Bancorp’s restricted stock and restricted stock units is the closing price per share of Bancorp’s common stock on the date of grant.
The following table summarizes Bancorp’s stock option activity and related information for the years ended December 31, 2020, 2019, and 2018:
No cash was received from exercise of options in 2020. The cash received from the exercise of stock options during 2019 and 2018 was $116 thousand and $97 thousand, respectively. The intrinsic value of a stock option is the amount that the market value of the underlying stock exceeds the exercise price of the option. Based upon a fair market value of $11.81 on December 31, 2020 the options outstanding had no aggregate intrinsic value. At December 31, 2019, based upon a fair market value of $16.88, the options outstanding had an aggregate intrinsic value of $59 thousand. At December 31, 2018, based upon a fair market value of $14.30, the options outstanding had an aggregate intrinsic value of $85 thousand. The stock options outstanding as of December 31, 2020 have contractual terms that permit exercise of the options through 2029.
At December 31, 2020, based on stock option awards outstanding at that time, the total unrecognized pre-tax compensation expense related to unvested stock option awards was $53 thousand. Based upon the contractual terms, this expense is expected to be recognized as follows:
Restricted Stock Units (“RSU”)
RSUs are equity awards where the recipient does not receive the stock immediately, but instead receives it according to a vesting plan and distribution schedule after achieving required performance milestones or upon remaining with the employer for a particular length of time. Each RSU that vests entitles the recipient to receive one share of the Company’s common stock on a specified issuance date. The recipient does not have any stockholder rights, including voting, dividend or liquidation rights, with respect to the shares underlying awarded RSUs until the recipient becomes the record holder of those shares. The valuation of the Company’s RSU is the closing price per share of the Company’s common stock on the date of grant.
During 2020, the Company granted a total of 167,716 RSUs, consisting of 140,452 RSUs which are subject to a one, three or five year vesting schedule, and 27,264 RSUs which cliff vest and are subject to a three year performance vesting schedule. The Company granted 26,500 RSUs during 2019 which are subject to a three year vesting schedule. During 2018, 20,732 RSUs were granted, all of which vested immediately.
A summary of the activity for Bancorp’s RSUs for the years ended December 31, 2020, 2019, and 2018 is presented in the following table:
At December 31, 2020, based on RSU awards outstanding at that time, the total unrecognized pre-tax compensation expense related to unvested RSU awards was $1.8 million Based upon the contractual terms, this expense is expected to be recognized as follows:
Stock-Based Compensation Expense
Stock-based compensation expense attributable to stock options and RSUs is based on their fair values on the measurement date, which, for the Company, is the date of the grant. This cost is then recognized in noninterest expense on a straight-line basis over the vesting period of the respective stock options and RSUs. No compensation expense was recognized in 2020 for performance-based awards, as the probability of achievement of the performance metrics was considered unlikely. Compensation expense for performance-based awards could be recognized in future years if the probability of achieving the performance metrics becomes likely before the end of the three year measurement period. The amount that the
Company recognized in stock-based compensation expense related to the issuance of stock options and RSUs as well as director compensation paid in stock is presented in the following table:
Note 18: Benefit Plans
Profit Sharing Plan
The Company sponsors a defined contribution retirement plan through a Section 401(k) profit sharing plan. Employees may contribute up to 15% of their pretax compensation. Participants are eligible for matching Company contributions up to 4% of eligible compensation dependent on the level of voluntary contributions. Company matching contributions totaled $826 thousand, $1.0 million and $1.1 million, respectively, for the years ended December 31, 2020, 2019 and 2018. The Company’s matching contributions vest immediately.
Supplemental Executive Retirement Plan (“SERP”)
In 2014, the Bank created a SERP for the Chief Executive Officer (“CEO”). This plan was amended in 2016. Under the defined benefit SERP, the CEO will receive $150,000 each year for 15 years after attainment of the Normal Retirement Age (as defined in the SERP). The CEO earned vesting on a graduated schedule and she became fully vested on August 25, 2019, which had been established for purposes of the SERP as the commencement date for SERP distributions. Expense related to this SERP totaled $75 thousand, $216 thousand and $279 thousand for 2020, 2019 and 2018, respectively. The accrued liability recorded for this SERP was $1.6 million both at December 31, 2020 and December 31, 2019.
Employee Stock Purchase Plan
The 2017 Employee Stock Purchase Plan (the “Plan”) provides eligible employees of the Company and certain of its subsidiaries with opportunities to purchase shares of the Company’s common stock. An aggregate of 250,000 shares of the Company’s common stock was approved for issuance under the Plan. The Plan is intended to qualify as an “employee stock purchase plan” as defined in Section 423 of the Internal Revenue Code of 1986, as amended, and the regulations promulgated thereunder, and shall be interpreted consistent therewith. Expense related to the Plan totaled $21 thousand, $39 thousand , and $11 thousand in 2020, 2019 and 2018, respectively.
Note 19: Net (Loss) Income per Common Share
The calculation of basic and diluted net (loss) income per common share for the years ended December 31, 2020, 2019, and 2018 are presented in the following table:
Note 20: Regulatory Matters
The Company and the Bank are subject to various regulatory capital requirements administered by the federal bank regulatory agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly 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 Company and the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and The Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
In addition, under revised prompt corrective action requirements, in order to be considered “well-capitalized,” the Bank must have a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, a common equity Tier 1 ratio of 6.5% or greater, a leverage capital ratio of 5.0% or greater, and not be subject to any written agreement, order, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure.
There are three main categories of capital under the regulatory capital guidelines. Common equity tier 1 capital consists of paid-in common stock, retained earnings and certain common equity Tier 1 minority interests. Various items, including certain amounts of goodwill, intangible assets, deferred tax assets, must be deducted from common equity Tier 1 before capital ratios are calculated. Tier 1 capital (which, together with common equity tier 1 capital, makes up Tier 1 capital) generally consists of perpetual preferred stock and, in certain circumstances and subject to certain limitations, minority investments in certain subsidiaries, less goodwill and other non-qualifying intangible assets, and certain other deductions. Tier 2 capital consists of perpetual preferred stock that is not otherwise eligible to be included as Tier 1 capital, hybrid
capital instruments, term subordinated debt and intermediate-term preferred stock and, subject to limitations, general allowances for credit losses. At least half of total capital must consist of Tier 1 capital. Under the guidelines, capital is compared to the relative risk related to the balance sheet. To derive the risk included in the balance sheet, one of several risk weights is applied to the different balance sheet and off-balance sheet assets, primarily based on the relative credit risk of the counterparty. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Bancorp and the Bank met all capital adequacy requirements to which they are subject as of December 31, 2020 and December 31, 2019.
Actual regulatory capital amounts and ratios for Bancorp and the Bank at December 31, 2020 and 2019 are presented in the following table:
(1)
Amounts shown exclude the capital conservation buffer of 2.50%. Under the Federal Reserve’s Small Bank Holding Company Policy Statement, Bancorp is not subject to the minimum capital adequacy and capital conservation buffer capital requirements at the holding company level, unless otherwise advised by the FRB (such capital requirements are applicable only at the Bank level). Although the minimum regulatory capital requirements are not applicable to Bancorp, the Company calculates these ratios for its own planning and monitoring purposes.
Note 21: Litigation
In the ordinary course of business, the Company and its subsidiaries are routinely defendants in or parties to pending and threatened legal and regulatory actions and proceedings. The most significant of these is described below. In view of the inherent difficulty of predicting the outcome of such matters, particularly where the claimants seek very large or indeterminate damages or where the matters present novel legal theories or involve a large number of parties, the Company generally cannot predict what the eventual outcome of the pending matters will be, what the timing of the ultimate resolution of these matters will be, or what the eventual loss, fines or penalties related to each matter may be. The Company establishes an accrued liability when those matters present loss contingencies that are both probable and reasonably estimable. In such cases, there may be an exposure to loss in excess of any amounts accrued. The Company thereafter continues to monitor such matters for further developments that could affect the amount of the accrued liability that has been previously established.
Potential mortgage origination claims
The Bank has been notified of potential claims stemming from certain mortgages originated at First Mariner Bank prior to its merger into the Bank. While no lawsuit has been filed with respect to such potential claims, the Bank has engaged in confidential discussions related to the potential claims. Significant management judgment, which involves a variety of assumptions, estimates and known and unknown uncertainties, is required to assess whether a related loss resulting from such potential claims is probable and estimable, such that an accrued liability should be established. The Company accrued a liability of $1.0 million with respect to these potential claims during the second quarter of 2020. Based on continuing settlement negotiations, the accrued liability was increased to $2.0 million at December 31, 2020. This potential litigation was formally settled for $2.0 million in January 2021.
Note 22: Fair Value
FASB ASC Topic 820 Fair Value Measurements (“Topic 820”) defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Topic 820 also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.
Under Topic 820, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine the fair value. These hierarchy levels are:
Level 1: Valuations for assets and liabilities traded in active exchange markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2: Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party pricing services for identical or comparable assets or liabilities which use observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
A financial instrument's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
Recurring Fair Value Measurements
All classes of investment securities available for sale are recorded at fair value using an industry-wide valuation service. The service uses evaluated pricing models that vary based on asset class and include available trade, bid and other market information. Various methodologies include broker quotes, proprietary models, descriptive terms and conditions databases, and quality control programs. Therefore, these securities fall into Level 2 of the fair value hierarchy.
Due to the exit of mortgage banking activities, there were no loans held for sale at December 31, 2020. The loans held for sale at December 31, 2019 were recorded at fair value based upon outstanding investor commitments or, in the absence of such commitments, based on current investor yield requirements or third party pricing models and were considered Level 2. Gains and losses on loan sales were determined using the specific identification method. Changes in fair value were recognized in the Consolidated Statements of Operations as part of realized and unrealized gains on mortgage banking activities.
Due to the exit of mortgage banking activities, there were no interest rate lock commitments at December 31, 2020. The interest rate lock commitments at December 31, 2019 were recorded at fair value determined as the amount that would be required to settle each of these derivatives at the balance sheet date. In the normal course of business, the Company entered into contractual interest rate lock commitments to extend credit to borrowers with fixed expiration dates. The commitment became effective when the borrowers locked in a specified interest rate within the time frames established by the Company. All borrowers were evaluated for creditworthiness prior to the extension of the commitment. Market risk arose if interest rates moved adversely between the time the interest rate was locked by the borrower and the sale date of the loan to an investor. To mitigate the interest rate risk inherent in providing rate lock commitments to borrowers, the Company entered into best effort forward sales contracts to sell loans to investors. The forward sales contracts locked in an interest rate price for the sale of loans similar to the specific rate lock commitment. Rate lock commitments to the borrowers through the date the loan closed were undesignated derivatives and accordingly, were marked to fair value in earnings. These valuations fell into a Level 3 of the fair value hierarchy. The rate lock commitments were deemed as Level 3 inputs because the Company applied an estimated pull-through rate, which was deemed an unobservable measure.
For loans held for investment that were originally intended to be sold and previously included as loans held for sale, fair value is determined by discounting estimated cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
The following table sets forth the Company's financial assets and liabilities that were accounted for or disclosed at fair value on a recurring basis at December 31, 2020 and December 31, 2019.
The following table presents a reconciliation of the assets that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years presented:
Assets under fair value option are as follows:
The Company elected to measure the loans held for sale and the loans held for investment that were originally intended for sale, but instead were added to the Bank’s portfolio at fair value to better align reported results with the underlying economic changes in value of the loans on the Company’s balance sheet.
Net (loss)/gain from changes in the fair value of loans held for sale was $(741) thousand, $265 thousand, and $(181) thousand in 2020, 2019 and 2018, respectively. Net gain/(loss) from the changes the in fair value of loans held for investment was $13 thousand, $69 thousand and $(71) thousand in 2020, 2019 and 2018, respectively.
Non-recurring Fair Value Measurements
Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions. Valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such evidence, management's best estimate is used.
Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of cost or market value. Market value is measured based on the value of the collateral securing these loans and is classified at a Level 3 in the fair
value hierarchy. Collateral may be real estate and/or business assets including equipment, inventory and/or accounts receivable. The value of real estate collateral is determined based on appraisal by qualified licensed appraisers hired by the Company. The value of business equipment, inventory and accounts receivable collateral is based on the net book value on the business' financial statements and, if necessary, discounted based on management's review and analysis. Appraised and reported values may be discounted based on management's historical knowledge, changes in market conditions from the time of valuation, and/or management's expertise and knowledge of the client and client's business. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.
Other real estate owned acquired through, or in lieu of, foreclosure ("OREO") are held for sale and are initially recorded at fair value, less selling costs. Any write-downs to fair value at the time of transfer to OREO are charged to the allowance for loan and lease losses. Values are derived from appraisals of underlying collateral and discounted cash flow analysis. A valuation loss of $257 thousand and $437 thousand was recognized for the years ended December 31, 2020 and 2019, respectively. Charges were for declines in the value of OREO subsequent to foreclosure. OREO is classified within Level 3 of the hierarchy.
The following table sets forth the Company’s financial assets and liabilities that were accounted for or disclosed at fair value on a nonrecurring basis as of December 31, 2020 and December 31, 2019.
At December 31, 2020, OREO consisted of an outstanding balance of $1.5 million, less a valuation allowance of $731 thousand. At December 31, 2019, OREO consisted of an outstanding balance of $4.6 million, less a valuation allowance of $1.5 million. A specific allocation of the allowance for loan and lease losses attributable to impaired loans at December 31, 2020 was $894 thousand and at December 31, 2019 was $500 thousand.
Various techniques are used to value OREO and impaired loans. All loans for which the underlying collateral is real estate, either construction, land, commercial, or residential, an independent appraisal is used to identify the value of the collateral. The approaches within the appraisal report include sales comparison, income, and replacement cost analysis. The resulting value will be adjusted by a selling cost of 9.5% and the residual value will be used to determine if there is an impairment. Commercial loans and leases and consumer loans utilize a liquidation approach to the impairment analysis.
The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair value estimates are based on quoted market prices where available or calculated using present value techniques. Since quoted market prices are not available on many of our financial instruments, estimates may be based on the present value of estimated future cash flows and estimated discount rates.
The following table presents the estimated fair value of the Company’s financial instruments at the dates indicated:
(1)Carrying amount is net of unearned income and allowance for loan and lease losses. In accordance with the prospective adoption of ASU No. 2016-01, the fair value of loans were measured using an exit price notion.
Note 23: Revenue Recognition
Service Charges on Deposit Accounts
Service charges on deposit accounts consist of account analysis fees, monthly service fees, check orders, and other deposit account related fees. The Banks’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account related fees are largely transaction-based, and therefore, the Banks’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers’ accounts.
Other Operating Income
Other operating income is primarily comprised of debit and credit card income, ATM fees, merchant services income, revenue streams such as safety deposit box rental fees, and other miscellaneous service charges. Debit and credit card income is primarily comprised of interchange fees earned whenever Bank debit and credit cards are processed through card payment networks such as VISA. ATM fees are primarily generated when a Bank cardholder uses a non-Bank ATM or a non-Bank cardholder uses a Bank ATM. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. Safe deposit box rental fees are charged to the customer on an annual basis and recognized upon receipt of payment. The Bank determined that since rentals and renewals occur fairly consistently over time, revenue is recognized on a basis consistent with the duration of the performance obligation. Other service charges include revenue from processing wire transfers, bill pay service, cashier’s checks, and other services. The Bank’s performance obligation for fees, and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion under FASB ASC Topic 606 Revenue from Contracts with Customers (“Topic 606”). Payment is typically received immediately or in the following month.
The following table presents noninterest income, segregated by revenue streams in scope and out of scope of Topic 606, for the years ended December 31, 2020, 2019, and 2018:
Note 24: Parent Company Financial Information
The condensed financial statements for Bancorp (Parent Only) are presented below:
Howard Bancorp, Inc.
Balance Sheets
Statements of Operations
Statements of Cash Flows
Note 25: Quarterly Financial Results (unaudited)
The following table provides a summary of selected consolidated quarterly financial data for the years ended December 31, 2020 and December 31, 2019:
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
None
Item 9A.
Item 9A. Controls and Procedures
As required by SEC rules, the Company’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this annual report on Form 10-K. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective as of December 31, 2020. Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
There were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended December 31, 2020, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act). The Company’s internal control over financial reporting is a process designed to provide reasonable assurance to management and the Board of Directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America, as well as provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements. Management evaluates the effectiveness of internal control over financial reporting and tests for reliability through an internal audit process with actions taken to correct potential deficiencies as they are identified. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management evaluated the effectiveness of the Company’s internal control over financial reporting as of December 31, 2020 using the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework (2013). Based on that evaluation, management concluded that, as of December 31, 2020, the Company’s internal control over financial reporting is effective. Dixon Hughes Goodman LLP, the registered public accounting firm that audited the Company’s financial statements included in this report has issued an attestation report on the Company’s internal control over financial reporting as of December 31, 2020 that is included elsewhere in this report.
Item 9B.
Item 9B. Other Information
None
Part III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The Company has adopted a code of ethics (conduct) that applies to all of its employees and a separate code of ethics (conduct) that applies to its non-employee directors. These codes of conduct are available on the Company’s website at www.howardbank.com.
The remainder of the information required by this Item is incorporated by reference to the information included under the captions “Item 1. Election of Directors,” “Corporate Governance-Committees of the Board of Directors” “Executive Officers” in the Company’s definitive proxy statement for its Annual Meeting of Stockholders to be held on May 26, 2021 (the “Proxy Statement”).
There have been no material changes in the procedures previously disclosed by which stockholders may recommend nominees to the Company’s Board of Directors.
Item 11.
Item 11. Executive Compensation
The information required by this Item is incorporated by reference to the information included under the captions “Director Compensation” and “Executive Compensation” in the Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item is incorporated by reference to the information included under the captions “Securities Authorized for Issuance Under Equity Compensation Plans” and “Security Ownership of Directors, Officers and Certain Beneficial Owners” in the Proxy Statement.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item is incorporated by reference to the information included under the captions “Corporate Governance-Board Independence,” “Election of Directors” and “Certain Relationships and Related Transactions” in the Proxy Statement.
Item 14.
Item 14. Principal Accounting Fees and Services
The information required by this Item is incorporated by reference to the information included under the captions “Fees to Independent Registered Public Accounting Firm” and “Policy on Audit Committee Pre-Approval of Audit and Non-Audit Services of Independent Registered Public Accounting Firm” in the Proxy Statement.
Item 15.
Item 15. Exhibits, Financial Statement Schedules
The following financial statements are included in this report
Consolidated Balance Sheets at December 31, 2020 and 2019
Consolidated Statements of Operations for the years ended December 31, 2020, 2019 and 2018
Consolidated Statements of Comprehensive Income for the years ended December 31, 2020, 2019 and 2018
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2020, 2019 and 2018
Consolidated Statements of Cash Flows for the years ended December 31, 2020, 2019 and 2018
Notes to the Consolidated Financial Statements
Reports of Independent Registered Public Accounting Firms
All financial statement schedules have been omitted as the required information is either inapplicable or included in the consolidated financial statements or related notes.
Exhibit No.
Description
Incorporated by Reference to, or Filed Herewith, as Noted:
2.1
Agreement and Plan of Merger, dated as of March 2, 2015, by and between Howard Bancorp, Inc. and Patapsco Bancorp, Inc. (the schedules and exhibits have been omitted pursuant to Item 601(b)(2) of Regulation S-K. Howard Bancorp undertakes to furnish supplemental copies of any of the omitted schedules or exhibits upon request by the Securities and Exchange Commission.)
Exhibit 2.1 of the Company's Form 8-K filed on March 3, 2015
2.2
Agreement and Plan of Reorganization, dated August 14, 2017 by and among Howard Bancorp, Inc., Howard Bank and First Mariner Bank (the schedules and exhibits have been omitted pursuant to Item 601(b)(2) of Regulation S-K. Howard Bancorp undertakes to furnish supplemental copies of any of the omitted schedules or exhibits upon request by the Securities and Exchange Commission.)
Exhibit 2.1 of the Company's Form 8-K filed on August 18, 2017
3.1
Articles of Incorporation of Howard Bancorp, Inc.
Exhibit 3.1 of the Company's Form S-1 filed November 28, 2011
3.2
Articles of Amendment to Articles of Incorporation of Howard Bancorp, Inc.
Exhibit 3.2 of the Company's Form S-1 filed November 28, 2011
3.3
Amended and Restated Articles Supplementary of Senior Non-Cumulative Perpetual Preferred Stock, Series AA
Exhibit 3.3 of the Company's Form S-1 filed November 28, 2011
3.4
Articles of Amendment to Articles of Incorporation of Howard Bancorp, Inc.
Exhibit 3.3 of the Company's Form 8-K filed January 24, 2017
3.5
Articles of Amendment to Articles of Incorporation of Howard Bancorp, Inc.
Exhibit 3.5 of the Company's Form 10-K filed March 16, 2020
3.6
Amended and Restated Bylaws of Howard Bancorp, Inc.
Exhibit 3.1 of the Company's Form 8-K filed May 23, 2019
4.1
Form of Common Stock Certificate of Howard Bancorp, Inc.
Exhibit 4.1 of the Company's Form S-1 filed November 28, 2011
4.2
Description of the Company's Securities Registered Pursuant to Section 12 of the Securities Exchange Act of 1934
Filed herewith
10.1*
Howard Bancorp 2004 Stock Incentive Plan
Exhibit 4.2 of the Company’s Form S-8 filed April 4, 2013
10.2*
Form of Nonstatutory Stock Option Certificate and Grant Agreement under the 2004 Stock Incentive Plan
Exhibit 10.6 of the Company's Form S-1 filed November 28, 2011
10.3*
Howard Bancorp 2004 Incentive Stock Option Plan
Exhibit 4.5 of the Company’s Form S-8 filed April 4, 2013
10.4*
Form of Incentive Stock Option Certificate and Grant Agreement under the 2004 Incentive Stock Option Plan
Exhibit 10.8 of the Company's Form S-1 filed November 28, 2011
10.5*
Howard Bancorp, Inc. 2013 Equity Incentive Plan
Exhibit 10.20 to the Company’s Form 10-K filed March 27, 2014
10.6*
Form of Restricted Stock Unit Award Agreement under Howard Bancorp, Inc. 2013 Equity Incentive Plan
Exhibit 4.6 to the Company’s Form S-8 filed October 28, 2013
10.7*
Form of Restricted Stock Grant Agreement under Howard Bancorp, Inc. 2013 Equity Incentive Plan
Exhibit 4.3 of the Company’s Form S-8 filed October 28, 2013
10.8*
Form of Nonstatutory Stock Option Grant Agreement under the 2013 Equity Incentive Plan
Exhibit 4.4 of the Company’s Form S-8 filed October 28, 2013
Exhibit No.
Description
Incorporated by Reference to, or Filed Herewith, as Noted:
10.9*
Form of Incentive Stock Option Grant Agreement under the 2013 Equity Incentive Plan
Exhibit 4.5 of the Company’s Form S-8 filed October 28, 2013
10.10*
Form of Restricted Stock Grant Agreement under the 2004 Stock Incentive Plan
Exhibit 4.3 of the Company’s Form S-8 filed April 4, 2013
10.11*
Supplemental Executive Retirement Plan of Howard Bank, effective December 1, 2014
Exhibit 10.27 of the Company’s Form 8-K filed January 6, 2015
10.12*
Supplemental Executive Retirement Plan of Howard Bank, effective December 1, 2014 amended January 19, 2016
Exhibit 10.28 of the Company’s Form 10-K filed March 30, 2016
10.13*
Letter Agreement, dated August 14, 2017, by and between Jack E. Steil and Howard Bank
Exhibit 10.1 of the Company’s Form 8-K filed March 1, 2018
10.14*
Employment Agreement, dated August 14, 2017, by and between Robert Kunisch, Jr. and Howard Bank
Exhibit 10.2 of the Company’s Form 8-K filed March 1, 2018
10.15*
Howard Bank Executive Incentive Plan
Exhibit 10.3 of the Company’s Form 8-K filed March 1, 2018
10.16
Form of Subordinated Note Purchase Agreement, dated December 6, 2018, by and between Howard Bancorp, Inc. and certain institutional accredited investors
Exhibit 10.1 of the Company’s Form 8-K filed December 12, 2018
10.17*
Executive Employment Agreement between Howard Bank and Thomas R. Jones dated as of August 14, 2017
Exhibit 10.1 of the Company's Form 10-Q filed May 10, 2019
10.18*
Second Amended and Restated Executive Employment Agreement between Howard Bank and Howard Bancorp, Inc. and Mary Ann Scully dated as of March 20, 2019
Exhibit 10.2 of the Company's Form 10-Q filed May 10, 2019
10.19*
Second Amended and Restated Executive Employment Agreement between Howard Bank and Howard Bancorp, Inc. and George C. Coffman dated as of March 20, 2019
Exhibit 10.3 of the Company's Form 10-Q filed May 10, 2019
10.20*
Second Amended and Restated Executive Employment Agreement between Howard Bank and Howard Bancorp, Inc. and Charles E. Schwabe dated as of March 20, 2019
Exhibit 10.4 of the Company's Form 10-Q filed May 10, 2019
10.21*
Amended and Restated Executive Employment Agreement between Howard Bank and Steven M. Poynot dated as of March 20, 2019
Exhibit 10.5 of the Company's Form 10-Q filed May 10, 2019
10.22*
Change in Control Agreement between Howard Bank and Frank K. Turner, Jr. dated as of April 18, 2013
Exhibit 10.29 of the Company's Form 10-K filed March 16, 2020
10.23*
Executive Employment Agreement between Howard Bank and Robert L. Carpenter Jr. dated as of May 29, 2020
Exhibit 10.1 of the Company’s Form 8-K filed May 27, 2020
Subsidiaries of the Registrant
Filed herewith
Consent of Dixon Hughes Goodman LLP
Filed herewith
31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Exchange Act pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Filed herewith
31.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Exchange Act pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Filed herewith
Exhibit No.
Description
Incorporated by Reference to, or Filed Herewith, as Noted:
Certifications pursuant to 18 U.S.C. Section 1350, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Filed herewith
Extensible Business Reporting Language (“XBRL”)
Filed herewith
101.INS XBRL Instance File
101.SCH XBRL Schema File
101.CAL XBRL Calculation File
101.DEF XBRL Definition File
101.LAB XBRL Label File
101.PRE XBRL Presentation File
The cover page from the Company’s Annual Report on Form 10-K Report for the year ended December 31, 2020, formatted in inline XBRL and contained in Exhibit 101.
Filed herewith
* Management compensatory plan, contract or arrangement
Item 16. Form 10-K Summary
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Howard Bancorp, Inc.
Date: March 16, 2021
By:
/s/ Mary Ann Scully
Mary Ann Scully
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and dates indicated.
Name
Capacities
Date
/s/ Mary Ann Scully
Chief Executive Officer,
March 16, 2021
Mary Ann Scully
Chairman
(Principal Executive Officer)
/s/ Robert L. Carpenter, Jr.
Chief Financial Officer
March 16, 2021
Robert L. Carpenter, Jr.
(Principal Accounting and
Financial Officer)
/s/ Richard G. Arnold
Director
March 16, 2021
Richard G. Arnold
/s/ W. Gary Dorsch
Director
March 16, 2021
W. Gary Dorsch
/s/ James T, Dresher, Jr.
Director
March 16, 2021
James T, Dresher, Jr.
/s/ Howard P. Feinglass
Director
March 16, 2021
Howard P. Feinglass
/s/ Michael B. High
Director
March 16, 2021
Michael B. High
/s/ John J. Keenan
Director
March 16, 2021
John J. Keenan
/s/ Robert D. Kunisch, Jr.
Director
March 16, 2021
Robert D. Kunisch, Jr.
/s/ Paul I. Latta, Jr.
Director
March 16, 2021
Paul I. Latta, Jr.
/s/ Kenneth C. Lundeen
Director
March 16, 2021
Kenneth C. Lundeen
/s/ Thomas P. O’Neill
Director
March 16, 2021
Thomas P. O’Neill
/s/ Linda L. Singh
Director
March 16, 2021
Linda L. Singh
/s/ Robert W. Smith, Jr.
Director
March 16, 2021
Robert W. Smith, Jr.
/s/ Donna Hill Staton
Director
March 16, 2021
Donna Hill Staton
/s/ Jack E. Steil
Director
March 16, 2021
Jack E. Steil