What changed in this filing

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Item 7. Management’s Discussion and Analysis

2023-03-15 compared with 2022-03-15 · 156 added, 161 removed, 476 unchanged (40% of the section changed)

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The following summary should be read in conjunction with the Management’s Discussion and Analysis of Financial Condition and Results of Operations section in its entirety.

Net income for the year ended December 31, 2021 increased $14.2 million, or 54.8% when compared to the prior year, due primarily to an increase in average balances in the loan portfolio, an increase in credit card revenue, a reduction in rates for all interest bearing liabilities, and a reduction in the provision for loan losses.

These positive factors were offset by a decrease in mortgage banking revenue, increases in salaries and employee benefits, data processing and advertising.

During the year ended December 31, 2021, primarily as a result of bringing on new lending teams to focus on growing the Company’s commercial real estate portfolio, specifically owner occupied properties, the Bank’s commercial real estate loan portfolio grew by $163.8 million, of which $102.2 million was owner occupied.

The growth in our credit card portfolio of $38.9 million was due in part to targeted advertising as well as the normalization of consumer behavior across a larger customer base.

The increase in credit card activity was mainly responsible for the increase in data processing expenses.

Net income for the year ended December 31, 2022 increased $1.8 million, or 4.6% when compared to the prior year, due primarily to an increase in average balances in the loan portfolio, an increase in credit card interest, and a decrease in data processing.

These positive factors were offset by an increase in rates for all interest-bearing liabilities, a decrease in mortgage banking revenue, a decrease in credit card fees, an increase in the provision for loan losses, and increases in salaries and employee benefits and advertising.

During the year ended December 31, 2022, continued focus on growing the Company’s commercial real estate loan portfolio, specifically owner-occupied properties, led to growth of the Bank’s commercial real estate loan portfolio by $108.2 million, of which $87.6 million was owner-occupied.

Our credit card portfolio declined by $12.7 million in comparison to December 31, 2021;

however, increases in interest rates helped to offset the impact of the declining balance and corresponding credit card fees.

The decrease in data processing expenses was primarily due to a contract renegotiation entered into in the first quarter of 2022.

The net interest margin was 6.92% for the year ended December 31, 2022 compared to 5.86% for the prior year.

Primarily driving this margin expansion were increases in average portfolio loan balances of $155.9 million, a 90 basis point increase in the loan yield on the portfolio loans, and the overall rate reduction for the interest bearing deposit portfolio.

Leading the increase in average portfolio balances were the commercial real estate and credit card portfolios with average balance increases of $90.5 million and $51.4 million, respectively, when comparing the year ended December 31, 2021 to December 31, 2020.

Management’s concerted effort in reducing the cost of funds associated with our interest bearing deposit portfolio resulted in a 63 basis point reduction between 2020 and 2021.

The reduction in rates for the money market and time deposit portfolios provided the greatest benefit in reducing the cost of funds for the overall interest bearing deposit portfolio.

Primarily driving this margin expansion were increases in average portfolio loan balances of $208.7 million and a 73 basis point increase in the loan yield on the portfolio loans, while the average interest rates across all interest-bearing liabilities only increased 35 basis points.

Leading the increase in average portfolio balances was commercial real estate with an average balance increase of $156.9 million when comparing the year ended December 31, 2022 to December 31, 2021.

Increasing interest rates contributed to sharp increases in the cost of funds associated with our interest-bearing deposit portfolio and resulted in a 22 basis point increase between 2021 and 2022.

The increase in rates for money market accounts was the most significant contributor to the over-all increase in our cost of funds.

Total assets grew by $68.4 million while total liabilities grew by $42.2 million when comparing year end 2022 to 2021.

Liquidity provided by the net SBA-PPP run off and the reduction in our mortgage loans held for sale balances coupled with our increase in core deposits enabled the Company to redeploy excess liquidity to growth in our loan and investment portfolios as well as acquiring $35.0 million in bank-

owned life insurance.

Total liability growth was due to the growth in total core deposits with noninterest bearing deposits growing by 29.4% when comparing December 31, 2021 to December 31, 2020.

The Bank’s OpenSky ® division continued to exceed management’s expectations during 2021.

Active customer accounts grew by 92 thousand when comparing the year end balance 2021 to 2020, driving a $38.9 million growth in credit card loans, net of reserves.

The noninterest bearing deposits associated with the secured credit card loans grew by $37.0 million, to $229.5 million at December 31, 2021 in comparison to December 31, 2020.

Management is beginning to see the impact of COVID-19 dissipate as customer behaviors begin to return to more seasonal norms.

Prior to COVID-19, the majority of growth came in the first and second quarters of the year tapering off in quarters three and four.

Beginning in the second quarter of 2020, management saw unprecedented growth through the end of the year and into the first quarter of 2021 due mainly to the COVID-19 stimulus monies being received by OpenSky’s ® target market.

The second quarter of 2021 saw a return to more normalized quarterly trends which continued throughout the year.

Total asset growth was primarily due to an increase in portfolio loans held for investment of $203.4 million and investment securities available for sale of $68.0 million, offset by net

SBA-PPP run off of $106.1 million.

Total liability growth was due, in part, to an increase in Federal Home Loan Bank advances of $85.0 million when comparing December 31, 2022 to December 31, 2021.

The Bank’s OpenSky ® Division continued to exceed management’s expectations during 2022 despite headwinds brought on by significant interest rate increases and economic uncertainty.

OpenSky ® had a record year of profitability in 2022, resulting in an increase of $8.4 million in net income for the segment.

Average credit card loan balances increased in 2022 compared to 2021, and that increase, coupled with the increase in interest rates, accounted for $15.1 million growth in interest income compared to the year ended December 31, 2021.

Normal customer attrition and aggressive marketing and product strategies by fintech and credit card companies offering unsecured subprime credit cards have contributed to the continued decline in the total number of OpenSky ® accounts, particularly in late 2022.

Active customer accounts decreased by 127 thousand when comparing the year end balance 2022 to 2021, leading to a decline in revenues earned from interchange and other fees.

Ultimately, outstanding year end credit card balances decreased $12.7 million, net of reserves, while the noninterest-bearing deposits associated therewith decreased by $42.1 million to $187.4 million at December 31, 2022 from $229.5 million at December 31, 2021.

The Bank’s Capital Bank Home Loans division saw a decline in mortgage originations during the year ended December 31, 2022 when compared to the prior year.

The steepening of the yield curve in 2021 slowed originations from the year earlier when low interest rates fueled refinance volumes.

The steepening of the yield curve in 2022 resulted in continued decline in home loan sales and home loan refinances.

Gain on sale margins, down slightly from 2.79% for the twelve months ended December 31, 2021, remained strong at 2.34% for the twelve months ended December 31, 2022.

Historically-low housing inventory, shortages in new home building materials, and fluctuating interest rates are likely to continue suppressing origination volumes into 2023.

Critical Accounting Estimates

Critical Accounting Policies

The accounting and reporting policies of the Company are in accordance with U.S.

GAAP and conform to general practices within the banking industry.

The Company’s financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions, and judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues, expenses, and related disclosures.

Different assumptions in the application of these policies could result in material changes in the Company’s consolidated financial position and/or results of operations.

The Company evaluates its critical accounting estimates and assumptions on an ongoing basis and updates them, as needed.

The Company evaluates its critical accounting estimates and assumptions on an ongoing basis and updates them, as deemed necessary.

Management has discussed the Company’s critical accounting policies and estimates with the Audit Committee of the Board of Directors of the Company.

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Net income $ 41,804 $ 39,978 4.6 %

Net income for the year ended December 31, 2021 was $40.0 million, up from net income for the year ended December 31, 2020 of $25.8 million.

The increase in net interest income was primarily due to the increase in average loans outstanding in the loan portfolio year over year, an increase in credit card fees, and a reduction in rates for all interest bearing liabilities.

Year over year growth in portfolio loan volumes attributed $26.8 million to the increase in net interest income with $22.1 million attributable to the growth in the credit card portfolio.

An additional $10.9 million in credit card fees were generated in 2021 when compared to 2020.

Year over year rate reductions for all interest bearing liabilities contributed an additional $6.1 million to the net interest income growth.

The provision for loan losses decreased $7.9 million when comparing the years ended December 31, 2020 to 2021.

Management’s focus on reducing nonperforming assets as well as the improved economy during 2021 resulted in a reduced need for additional provisioning.

Offsetting factors included a decline in mortgage banking revenue of $11.4 million when comparing 2021 to 2020 as well as increases in noninterest expenses.

Data processing and advertising increased $12.3 million and $2.3 million, respectively, when comparing the annual 2021 expenses to 2020 due primarily to increases in credit card portfolio activity and targeted marketing campaigns for the unveiling of OpenSky’s new offerings.

Salaries and employee benefits increased $4.4 million for the year ended December 31, 2021 in comparison to 2020 as the Company increased its overall full-time positions by 18, hiring commercial lending teams as well as senior management officials and staff at the Bank.

Net income for the year ended December 31, 2022 was $41.8 million, compared to net income for the year ended December 31, 2021 of $40.0 million.

The increase in net interest income was primarily due to the increase in average loans outstanding in the loan portfolio year over year, an increase in credit card interest income, and a reduction in data processing expenses.

Year over year growth in portfolio loan volumes contributed $24.4 million to the increase in net interest income, with $15.1 million attributable to the credit card portfolio, which benefited from increased interest rates and an increase in average credit card balances.

Data processing expenses decreased $9.8 million primarily due to contract renegotiations completed in the first quarter of 2022.

Offsetting factors included a decrease in mortgage banking revenue of $16.0 million and an increase in the cost of interest-bearing liabilities of $3.5 million when comparing 2022 to 2021.

The increased cost of interest-bearing liabilities was the result of the increase in market interest rates.

The provision for loan losses increased $3.3 million due to economic uncertainty, particularly in respect of the credit card portfolio.

A decrease in overall credit card accounts led to the reduction in credit card fees of $5.9 million for the year ended December 31, 2022 in comparison to 2021.

Advertising increased $1.4 million due primarily to increased competition for credit card customers.

Salaries and employee benefits increased $5.1 million for the year ended December 31, 2022 in comparison to 2021 as the Company increased its overall headcount by 60, hiring commercial lending teams as well as senior management officials and staff at the Bank.

Professional fees increased $4.0 million, primarily in consequence of efforts to enhance the Bank’s regulatory compliance function and its technology infrastructure.

Net Interest Income and Net Margin Analysis

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and Baltimore metropolitan areas.

Our ability to respond to changes in these factors by using effective asset-liability management techniques is critical to maintaining the stability of our net interest income and net interest margin as our primary sources of earnings.

Our ability to respond to changes in these factors by using effective asset-liability management techniques is critical to maintaining the stability of net interest income and net interest margin.

The table below presents the average balances and weighted average rates of the major categories of the Company’s assets, liabilities and stockholders’ equity for the years ended December 31, 2022 and 2021.

Weighted average yields are derived by dividing annual income by the average balance of the related assets, and weighted average rates are derived by dividing annual expense by the average balance of the related liabilities, for the periods shown.

Average outstanding balances are derived by utilizing average daily balances for the time period shown.

Weighted average yields are derived by dividing annualized income by the average balance of the related assets, and weighted average rates are derived by dividing annualized expense by the average balance of the related liabilities, for the periods shown.

Average outstanding balances are derived by utilizing average daily balances for the time periods shown.

The weighted average yields and rates include amortization of fees, costs, premiums and discounts, which are considered adjustments to yield/rates.

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The rate/volume table below presents the composition of the change in net interest income for the periods indicated, as allocated between the change in net interest income due to changes in the volume of average earning assets and interest-bearing liabilities, and the changes in net interest income due to changes in interest rates.

Year Ended December 31, 2021

Compared to the

Year Ended December 31, 2020

Year Ended December 31, 2022 Year Ended December 31, 2021

December 31, 2021 December 31, 2020

Change Due To

Interest Variance

Change Due To

Interest Variance

(In thousands) Volume

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Net interest income $ (2,215) $ 26,129 $ 23,914 $ 28,865 $ 3,759 $ 32,624

When comparing the years ended December 31, 2021 to 2020, the greatest positive impact to total interest income was associated with the credit card portfolio.

On a stand-alone basis, the credit card portfolio contributed an increase of $23.7 million due to volume and rate increases when comparing the year over year 2021 to 2020 figures.

The origination of SBA-PPP loans in 2021 as well as the SBA-PPP loan forgiveness in 2021 contributed an additional $3.1 million to interest income.

Volume increases in the portfolio loans excluding credit cards accounted for an additional increase $4.8 million in interest income for the year ended December 31, 2021.

Management’s efforts to reduce the cost of funds associated with the deposit portfolio contributed $5.3 million to the increase in net interest income between the years ended December 31, 2021 and 2020.

When comparing the years ended December 31, 2022 to 2021, the greatest positive impact to total interest income was the increased market interest rate affecting all interest earning assets.

On a stand-alone basis, the credit card portfolio contributed an increase of $15.1 million due to market interest rate increases and increased average credit card balances when comparing the year over year 2022 to 2021 figures.

While credit card balances declined as of December 31, 2022 compared to 2021, average credit card loan balances maintained a consistent balance until late 2022, when credit card balances declined, likely due to the lapse of certain government stimulus programs.

SBA-PPP loans continued to be forgiven in 2022 resulting in reduced interest income of $4.1 million when compared to 2021.

Volume increases in portfolio loans excluding credit cards accounted for an increase of $10.3 million in interest income for the year ended December 31, 2022, while interest rates accounted for an increase of $3.1 million for the same period.

The increase in rates paid on the deposit portfolio increased interest expense by $3.1 million due to the increase in market interest rates between the years ended December 31, 2022 and 2021.

Provision for Loan Losses

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The amount of the allowance for loan losses is based on many factors which reflect management’s assessment of the risk in the loan portfolio.

Those factors include historical losses, economic conditions and trends, the value and adequacy of collateral, volume and mix of the portfolio, performance of the portfolio, and internal loan processes of the Company and Bank.

Those factors include historical losses, economic conditions and trends, the value and adequacy of collateral, volume and mix of the

portfolio, performance of the portfolio, and internal loan processes of the Company and Bank.

For a detailed description of the factors taken into account by our management in determining the allowance for loan losses see “Financial Condition— Allowance for Loan Losses.”

For the year ended December 31, 2022, the Company recorded a provision for loan losses of $6.6 million, compared to $3.4 million for the previous year.

The decrease in the provision for 2021 compared to 2020 was primarily due to an improving economy.

The increase in the provision for 2022 compared to 2021 was primarily associated with the credit card portfolio.

See additional discussion regarding the Company’s allowance for loan losses and reserve for off-balance sheet credit exposures at December 31, 2022 in “Financial Condition— Allowance for Loan Losses.”

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Our primary sources of recurring noninterest income are credit card fees, such as interchange fees and statement fees, and mortgage banking revenue.

Noninterest income does not include (i) loan origination fees to the extent they exceed the direct loan origination costs, which are generally recognized over the life of the related loan as an adjustment to yield using the interest method or (ii) annual, renewal and late fees related to our credit card portfolio, which are generally recognized over the twelve month life of the related loan as an adjustment to yield using the interest method.

Noninterest income does not include (i) loan origination fees to the extent they exceed the direct loan origination costs and annual renewal fees, which are generally recognized over the life of the related loan as an adjustment to yield using the interest method or (ii) late fees assessed on delinquent accounts.

The following table presents, for the periods indicated, the major categories of noninterest income:

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$ 29,372 $ 50,636 (42.0) %

The Bank’s OpenSky ® Division continued to exceed management’s expectations in 2021.

Active customer accounts grew by 92 thousand when comparing the year-end balance 2021 to 2020.

The increase in accounts led to increased fees totaling $10.9 million during 2021.

Management anticipates the impact of COVID-19 will wane as consumer patterns return to more normalized seasonal trends.

The Bank’s OpenSky ® Division active customer accounts decreased by 127 thousand when comparing the 2022 year end levels to 2021 year end levels.

The decrease in accounts was due to waning COVID-19 consumer patterns, a return to more normalized seasonal trends in 2022 and aggressive marketing by competitors.

These headwinds led to decreased fees of $5.9 million during 2022.

The Bank’s Capital Bank Home Loans division saw a decline in mortgage originations during the year ended December 31, 2022 when compared to the prior year.

The steepening of the yield curve in 2021 slowed originations from the year earlier when low interest rates fueled refinance volumes.

A rising interest rate environment dampened home loan sales and home loan refinances.

Gain on sale margins, down slightly from 2.79% for the twelve months ended December 31, 2021, remained strong at 2.34% for the twelve months ended December 31, 2022.

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The reserve was $1.2 million at December 31, 2022 and 2021.

The Bank repurchased one loan for $205 thousand during 2021 while no loans were repurchased during 2020.

The Bank does not originate “sub-prime” loans and has no exposure to this market segment

The Bank repurchased one loan in December 2022 for $463 thousand and one loan for $205 thousand during 2021.

The Bank does not originate “sub-prime” mortgage loans and has no exposure to this market segment

Noninterest Expense

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4,865 4,327 12.4

Professional fees

6,996 4,900 42.8

Professional services 11,012 6,996 57.4

Data processing

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Other real estate expense, net

(183) 368 (149.7)

Other operating

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$ 109,114 $ 110,094 (0.9) %

During 2021, salaries and employee benefits increased due to the addition of new employees in our commercial and commercial real estate lending groups as well as additional positions in executive management as the Company continues to put in place the requisite human capital for its continued growth.

Contributions to the long-term incentive plan during 2021 was responsible for an additional $1.2 million in salaries and employee benefits expense when compared to the year ended December 31, 2020.

The increase in data processing expense as well as other operating expense was primarily related to the increase in the number of active OpenSky ® accounts at year end 2021, while the increase in advertising expense was attributable to enhanced marketing for the commercial bank segment as well as OpenSky ® during 2021.

Professional fees associated with the commercial bank segment increased as the Company continued to build out its regulatory and compliance infrastructure in anticipation of the budgeted growth for 2022.

During 2022, data processing expenses decreased $9.8 million primarily due to a contract renegotiation entered into in the first quarter of 2022.

When compared to the year ended December 31, 2021, salaries and employee benefits increased due to the addition of new employees in our commercial and commercial real estate lending groups as well as additional positions in executive management as the Company continues to put in place the requisite human capital for its continued growth.

An increase in advertising expense was attributable to enhanced marketing for the commercial bank segment as well as OpenSky ® during 2022 as the Company focused on retaining high-quality customers and faced increasing competition in the credit card market.

Professional fees associated with the commercial bank segment increased as the Company continued to build out its regulatory compliance function and its technology infrastructure.

Income Tax Expense

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Total assets $ 2,123,655 $ 2,055,300 $ 68,355 3.3 %

AFS securities 184,455 99,787 84,668 84.8

Portfolio loans receivable, net 1,523,982 1,315,502 208,480 15.8

Deposits 1,797,137 1,652,128 145,009 8.8

Investment securities available for sale 252,481 184,455 68,026 36.9

Portfolio loans receivable, net of deferred fees and costs 1,728,592 1,523,982 204,610 13.4

Total deposits 1,758,072 1,797,137 (39,065) (2.2)

Borrowings 119,062 34,062 85,000 249.5

Stockholders’ equity 197,903 159,311 38,592 24.2

Total stockholders’ equity 224,015 197,903 26,112 13.2

Equity to total assets at end of period 10.5 % 9.6 % 9.4

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Average number of diluted shares outstanding 14,362 14,081 2.0

Total assets at December 31, 2021 reflected an increase from its December 31, 2020 balance due to growth in the commercial real estate loan portfolio and credit card portfolios, the addition of bank-owned life insurance, and the deployment of excess liquidity into the investment portfolio.

Offsetting these increases were decreases in the loans held for sale portfolio during 2021 when compared to 2020, as well as a reduction in SBA-PPP loans.

Total assets at December 31, 2022 reflected an increase from the December 31, 2021 balance due primarily to growth in the commercial real estate loan portfolio, which was accompanied by decreases in the credit card portfolio, increases in borrowings, and decreases in deposits during 2022 when compared to 2021, as well as a reduction in SBA-PPP loans as a result of payoffs during 2022.

The Company uses its securities portfolio to provide a source of liquidity, provide an appropriate return on funds invested, manage interest rate risk, meet collateral requirements and meet regulatory capital requirements.

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To supplement interest income earned on our loan portfolio, the Company invests in high-quality mortgage-backed securities, government agency bonds, asset-backed securities and high-quality municipal and corporate bonds.

During 2021, management invested a portion of its excess liquidity into U.S.

During early 2022, management invested a portion of its excess liquidity into U.S.

Treasuries as the spread between treasuries and other investment portfolios continued to contract.

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Yields on tax-exempt investments are not calculated on a fully tax equivalent basis.

More Than One Year Through Five Years More Than Five Years Through Ten Years More Than Ten Years Total

At December 31, 2021 Book Value Weighted Average Yield Book Value Weighted Average Yield Book Value Weighted Average Yield Book Value Fair Value Weighted Average Yield

(dollars in thousands)

One Year or Less More Than One Year Through Five Years More Than Five Years Through Ten Years More Than Ten Years Total

At December 31, 2022 Book Value Weighted Average Yield Book Value Weighted Average Yield Book Value Weighted Average Yield Book Value Weighted Average Yield Book Value Fair Value Weighted Average Yield

(in thousands)

Securities Available for Sale:

U.S Treasuries $ 53,739 2.60 % $ 88,165 1.25 % $ 73,582 1.27 % $ — — % $ 215,486 $ 199,449 1.59 %

Asset-backed securities — — — — 10,093 0.98 10,093 10,140 0.98

Municipal — — — — 508 2.53 10,307 1.91 10,815 8,012 1.94

Corporate bonds — — — — 5,000 4.31 — — 5,000 4,600 4.31

Asset-backed securities — — — — — — 7,970 2.89 7,970 7,711 2.89

Mortgage-backed securities

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Our primary source of income is derived from interest earned on loans.

Our loan portfolio consists of loans secured by real estate, commercial business loans and credit card loans, substantially all of which are secured by corresponding deposits at the Bank and, to a very limited extent, other consumer loans.

Our portfolio loans consist of loans secured by real estate as well as commercial business loans, credit card loans, substantially all of which are secured by corresponding deposits at the Bank and, to a limited extent, other consumer loans.

Our loan customers primarily consist of small- to medium-sized businesses, professionals, real estate investors, small residential builders and individuals.

Our owner-occupied and investment commercial real estate loans, residential construction loans and commercial business loans provide us with higher risk-adjusted returns, shorter maturities and more sensitivity to interest rate fluctuations, and are complemented by our relatively lower risk residential real estate loans to individuals.

Our owner-occupied commercial real estate loans, residential construction loans and commercial business and investment loans provide us with higher risk-adjusted returns, shorter maturities and more sensitivity to interest rate fluctuations, and are complemented by our relatively lower risk residential real estate loans to individuals.

Our credit card portfolio supplements our traditional lending products with enhanced yields.

Outside of credit cards, our lending activities are principally directed to our market area consisting of the Washington, D.C.

and Baltimore metropolitan areas.

Our lending activities, outside of credit cards, are principally directed to our market area consisting of the Washington, D.C.

and Baltimore, Maryland metropolitan areas.

Residential Real Estate Loans .

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The Company generally requires personal guarantees from the principal owners of the business, supported by a review of the principal owners’ personal financial statements and global debt service obligations.

The properties securing the portfolio are diverse in terms of type.

The properties securing the portfolio are diverse in type.

This diversity helps reduce the exposure to adverse economic events that affect any single industry.

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and Baltimore, Maryland metropolitan operating areas to builders primarily for the construction of single-family homes, condominium and townhouse conversions or renovations and, to a lesser extent, to individuals.

Our construction loans typically have terms of 12 to 18 months with the goal of transitioning the borrowers to

permanent financing or re-underwriting and selling into the secondary market through Capital Bank Home Loan.

construction loans typically have terms of 12 to 18 months with the goal of transitioning the borrowers to permanent financing or re-underwriting and selling into the secondary market through Capital Bank Home Loan.

According to our underwriting standards, the ratio of loan principal to collateral value, as established by an independent appraisal, should not exceed 75% for investor-owned and 80% for owner-occupied properties.

Exceptions are sometimes made.

We conduct semi-annual stress testing of our construction loan portfolio and closely monitor underlying real estate conditions as well as our borrower’s trends of sales valuations as compared to underwriting valuations as part of our ongoing risk management efforts.

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Through our OpenSky ® credit card division, the Company provides credit cards on a nationwide basis to under-banked populations and those looking to rebuild their credit scores through a fully digital and mobile platform.

Substantially all of the lines of credit are secured by a noninterest bearing demand account at the Bank in an amount equal to the full credit limit of the credit card.

In addition, using our proprietary scoring model, which considers credit score and repayment history (typically a minimum of six months of on-time repayments, but ultimately determined on a case-by-case basis), the Bank offers certain customers an unsecured line in excess of their secured line of credit.

The majority of the lines of credit are secured by a noninterest-bearing demand account at the Bank in an amount equal to the full credit limit of the credit card.

Other Consumer Loans .

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The repayment of loans is a source of additional liquidity for us.

The following table details contractual maturities of our portfolio loans, along with associated weighted average yields and an analysis of loans maturing after one year categorized by rate characteristic.

The following table details contractual maturities of our portfolio loans, along with an analysis of loans maturing after one year categorized by rate characteristic.

Loans with adjustable interest rates are shown as maturing in the period during which the contract is due.

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As of December 31, 2022

(in thousands) One Year

or Less One to

Five Years Over

Five Years to Fifteen Years After Fifteen Years Total

Amount Yield Amount Yield Amount Yield Amount Yield

Five Years to Fifteen Years After Fifteen Years

(in thousands) Amount Amount Amount Amount Total

Residential $ 106,486 $ 169,516 $ 104,389 $ 104,344 $ 484,735

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Loans that are past due for 180 days or more are charged off unless the loan is well secured and in the process of collection.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments.

ASU 2016-13 introduces guidance to change the accounting for loan losses and modifies the impairment model for certain debt securities.

This ASU introduced a new model known as CECL.

CECL changes the impairment model for most financial assets, and requires the use of an “expected credit loss” model for financial instruments measured at amortized

cost and certain other instruments, such as off-balance sheet credit exposures, loan commitments, standby letters of credit, net investments in leases recognized by a lessor and HTM debt securities.

The Company adopted this guidance on January 1, 2023 using the modified retrospective approach, which has impacted our loan loss policies and will have an impact on the Company’s provision for credit losses in the periods after adoption, which could differ materially from historical trends.

For additional information on ASU 2016-13, refer to “Note 1 – Nature of Business and Basis of Presentation” in the “Notes to the Consolidated Financial Statements” contained in Part II, Item 8 “Financial Statements and Supplementary Data”.

The Company believes its disciplined lending approach and focused management of nonperforming assets has resulted in sound asset quality and timely resolution of problem assets.

There are several procedures in place to assist the Company in maintaining the overall quality of our loan portfolio.

The Company has established underwriting guidelines to be followed by our bankers, and monitor our

delinquency levels for any negative or adverse trends.

The Company has established underwriting guidelines to be followed by our bankers, and monitor our delinquency levels for any negative or adverse trends.

There can be no assurance, however, that our loan portfolio will not become subject to increasing pressures from deteriorating borrower credit.

Potential Problem Loans

From a credit risk standpoint, we grade watchlist and problem loans into one of five categories:

pass/watch, special mention, substandard, doubtful or loss.

The classifications of loans reflect a judgment about the risks of default and loss associated with the loan.

The classifications of loans reflect a judgment about the risks of default and loss associated with each loan.

Credits ratings are reviewed regularly.

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Our methodology is structured so that specific reserve allocations are increased in accordance with deterioration in credit quality (and a corresponding increase in risk and loss) or decreased in accordance with improvement in credit quality (and a corresponding decrease in risk and loss).

Our lending policy requires the routine monitoring of weekly past due reports, daily overdraft reports, monthly maturing loans, monthly risk rating reports and internal loan review reports.

The lending and credit management of the Bank meet periodically to review loans rated pass/watch.

The focus of each meeting is to identify and promptly determine any necessary required action with this loan population, which consists of loans that, although considered satisfactory and performing to terms, may exhibit special risk features that warrant management’s attention.

Loans that are deemed special mention, substandard, doubtful or loss are listed in the Bank’s Problem Loan Status Report.

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The Special Asset Committee reviews the Problem Loan Status Report on a quarterly basis for borrowers with an overall loan exposure in excess of $250,000.

The Bank uses the following definitions for watch list risk ratings:

• Pass/Watch.

Borrowers who are considered satisfactory and performing to terms, however exhibiting special risk features such as declining earnings, strained cash flow, increasing leverage, and/or weakening fundamentals that indicate above average risk.

• Special Mention.

A special mention loan has potential weaknesses deserving of management’s attention.

If uncorrected, such weaknesses may result in deterioration of the repayment prospects for the asset or in our credit position at some future date.

• Substandard.

A substandard loan is inadequately protected by the current financial condition and paying capacity of the obligor or of the collateral pledged, if any.

Assets so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.

They are characterized by the distinct possibility that we will sustain some loss if deficiencies are not corrected.

Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets that are classified as substandard.

A doubtful loan has all weaknesses inherent in one classified as substandard, with the added characteristic that weaknesses make collection or liquidation in full, on the basis of existing facts, conditions, and values, highly questionable and improbable.

The probability of loss is extremely high, but certain important and reasonably specific factors that may work to the advantage and strengthening of the asset exist.

Therefore, its classification as an estimated loss is deferred until a more precise status may be determined by management.

Pending factors include proposed merger, acquisition or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans.

Credits rated as loss are charged-off.

We have no expectation of the recovery of any payments in respect of credits rated as loss.

Loans not meeting the criteria above are considered to be pass-rated loans.

The following tables present the portfolio loan balances by category as well as risk rating.

No assets were classified as loss during the periods presented.

Special mention loans at December 31, 2022 increased by $13.5 million compared to December 31, 2021.

The increase is attributable, in part, to the reclassification of the Bank’s $18.4 million participation interest in two commercial loans that are secured by the same collateral.

The borrowers, an individual and a related entity, breached a negative covenant and thereafter agreed, in consideration of a forbearance agreement and an extension of the maturity date of each loan, to increase the applicable interest rate and to provide enhanced reporting to the lead bank.

Interest payments are current on both loans.

The lead bank is in discussions with the borrowers regarding a plan for full repayment of the loans.

At December 31, 2022, the recorded investment in impaired loans was $9.4 million, $458 thousand of which required a specific reserve of $372 thousand compared to a recorded investment in impaired loans of $11.3 million including $336 thousand requiring a specific reserve of $218 thousand at December 31, 2021.

Of the $11.3 million of impaired loans, $5.0 million was related to one well-collateralized construction loan relationship.

Impaired loans also include certain loans that have been modified as troubled debt restructurings (“TDRs”).

At December 31, 2021, the Company had five loans amounting to $534 thousand that were considered to be TDRs, compared to five loans amounting to $440 thousand at December 31, 2020.

At December 31, 2022, the Company had one loan amounting to $288 thousand that was considered to be a TDR, compared to five loans amounting to $534 thousand at December 31, 2021.

Allowance for Loan Losses

We maintain an allowance for loan losses that represents management’s best estimate of the loan losses and risks inherent in our loan portfolio.

We maintain an allowance for loan losses that represents management’s estimate of the loan losses and risks inherent in our loan portfolio.

The amount of the allowance for loan losses should not be interpreted as an indication that charge-offs in future periods will necessarily occur in those amounts, or at all.

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For the Years Ended December 31,

(in thousands) Allowance for loan losses to period end portfolio loans (1)

Allowance for loan losses to period end portfolio loans (1)

Nonaccrual loans to total portfolio loans Allowance for loan losses to nonaccrual loans (1)

2021 2020 2021 2020 2021 2020

(in thousands) 2022 2021 2022 2021 2022 2021

Residential 1.13 % 1.40 % 0.88 % 0.71 % 128 % 198 %

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Construction 1.59 1.84 1.19 3.06 133 60

Commercial 1.50 1.54 0.38 0.75 390 205

Commercial and Industrial 1.33 1.50 0.32 0.38 417 390

Credit card 4.73 2.59 — — — —

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For the Years Ended December 31,

(in thousands) Net Charge-offs (Recoveries) Average Loans Percent of average portfolio loans Net Charge-offs Average Loans Percent of average portfolio loans

Net Charge-offs Average Loans Percent of average portfolio loans Net Charge-offs Average Loans Percent of average portfolio loans

(in thousands) 2022 2021

Residential $ — $ 434,714 — % $ — $ 421,856 — %

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Construction 17 243,921 0.01 (1) 233,964 —

Commercial 33 143,434 0.02 233 139,432 0.17

Commercial and Industrial — 179,757 — 33 143,434 0.02

Credit card 5,410 126,473 4.28 1,419 112,313 1.26

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The allowance for loan losses at December 31, 2021 included specific reserves of $218 thousand set aside for impaired loans.

Total charge-offs for the years ended December 31, 2021 and 2020 were primarily due to credit card charge-offs resulting from growth in our credit card portfolio and certain charges in excess of credit limits.

As the loan portfolio and allowance for loan losses review processes continue to evolve, there may be changes to elements of the allowance and this may have an effect on the overall level of the allowance maintained.

Total charge-offs for the years ended December 31, 2022 and 2021 were primarily due to credit card charge-offs resulting primarily from the aging of the portfolio

and partially from the shift from an almost exclusively secured card portfolio to a partially secured card portfolio as we launched an unsecured card available only to existing qualifying customers.

Additionally, there are economic challenges facing the overall industry that have also impacted the provisioning for our credit card portfolio.

Historically, the Bank has enjoyed a high-quality loan portfolio with relatively low levels of net charge-offs and low delinquency rates.

The maintenance of a high quality portfolio will continue to be a high priority.

Management is intent on maintaining a strong credit review function and risk rating process.

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Although we believe we have established our allowance for loan losses in accordance with GAAP and that the allowance for loan losses was adequate to provide for known and inherent losses in the portfolio at all times shown above, future provisions for loan losses will be subject to ongoing evaluations of the risks in our loan portfolio.

The following table sets forth activity in the allowance for loan losses for the past two years for the categories shown below as of the dates indicated.

The following table shows the allocation of the allowance for loan losses among loan categories as of the dates indicated.

The total allowance is available to absorb losses from any loan category.

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Construction 3,782 14 4,699 19

Commercial 2,637 10 2,417 10

Commercial and Industrial 2,935 11 2,637 10

Credit card 6,078 23 3,655 15

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Total Liabilities

Total liabilities at December 31, 2021 saw an increase from its December 31, 2020 balance due to growth in the deposit portfolio.

Offsetting this increase were decreases in borrowed funds as well as other liabilities.

Total liabilities at December 31, 2022 saw an increase from its December 31, 2021 balance due to growth in borrowed funds.

Offsetting this increase were decreases in the deposits portfolio as well as other liabilities.

Deposits are the major source of funding for the Company.

We offer a variety of deposit products including interest bearing demand, savings, money market and time accounts all of which we actively market at competitive pricing.

We offer a variety of deposit products including interest-bearing and noninterest-bearing demand, savings, money market and time accounts, all of which we actively market at competitive pricing.

We generate deposits from our customers on a relationship basis and through the efforts of our commercial lending officers and our business banking officers.

The Company continues to execute on its strategic initiative to improve the deposit portfolio mix by reducing reliance on wholesale time deposits.

At December 31, 2021, the Company had no balances pertaining to wholesale time deposits compared to $107.7 million at December 31, 2020.

Our credit card customers are also a significant source of low cost deposits.

During the year ended December 31, 2022, competition and a challenging deposit environment

have driven a reduction in low cost interest-bearing deposits and an increase in money market accounts as customers reallocate balances to take advantage of higher rates on those accounts.

Our credit card customers are a significant source of noninterest-bearing deposits.

As of December 31, 2022 and 2021, our credit card customers accounted for $187.4 million and $229.5 million, or 27.8% and 29.1%, respectively, of our total noninterest-bearing deposit balances.

In addition to retail deposits, the Company had $131.8 million of wholesale time deposits at December 31, 2022 compared to no balance at December 31, 2021.

The following table presents the average balances and average rates paid on deposits for the periods indicated:

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Total Interest-bearing deposits 982,082 0.77 % 1,047,242 0.55 %

1,047,242 0.55 % 978,731 1.18 %

Noninterest-bearing demand accounts 781,971 750,760

750,760 473,301

Total deposits

$ 1,764,053 0.43 % $ 1,798,002 0.32 %

Management was actively focused on reducing its cost of funds on its deposits during 2021 as evidenced by the overall reduction in average rates from 0.79% during 2020 to 0.32% in 2021.

Deposit costs increased materially during 2022.

Average rates were 0.32% during 2021 and 0.43% in 2022.

The increase in noninterest-bearing deposits partially offset the increase in rates.

The following table presents the maturities of our certificates of deposit as of December 31, 2022.

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The principal amount of the debentures has not changed since issuance, and they accrue interest at a floating rate equal to the three-month LIBOR plus 1.87%.

On November 30, 2020, the Company issued $10.0 million in subordinated notes due in 2030 to replace the outstanding higher yielding $13.5 million, reducing interest expense.

The notes have a ten year term and have a fixed rated of 5.00% for the first five years;

On November 30, 2020, the Company issued $10.0 million in subordinated notes due in 2030 to replace the outstanding higher yielding $13.5 million issuance.

The notes have a ten-year term and have a fixed rate of 5.00% for the first five years;

thereafter, the rate resets quarterly to a benchmark rate, being the three-month term SOFR, plus 490 basis points.

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Liquidity is defined as the Bank’s capacity to meet its cash and collateral obligations at a reasonable cost.

Maintaining an adequate level of liquidity depends on the Bank’s ability to meet both expected and unexpected cash flows and collateral needs efficiently without adversely affecting either daily operations or the financial condition of the Bank.

Maintaining an adequate level of liquidity depends on the Bank’s ability to meet both expected and unexpected cash flows and collateral needs efficiently and without adversely affecting either daily operations or the financial condition of the Bank.

Liquidity risk is the risk that we will be unable to meet our obligations as they become due because of an inability to liquidate assets or obtain adequate funding.

The Bank’s obligations, and the funding sources used to meet them, depend significantly on our business mix, balance sheet structure and the cash flow profiles of our on- and off-balance sheet obligations.

In managing our cash flows, management regularly confronts situations that can give rise to increased liquidity risk.

In managing our cash flows, management regularly addresses situations that can give rise to increased liquidity risk.

These include funding mismatches, market constraints on the ability to convert assets into cash or in accessing sources of funds (i.e., market liquidity) and contingent liquidity events.

Changes in economic conditions or exposure to credit, market, operating, legal and reputational risks also could affect the Bank’s liquidity risk profile and are considered in the assessment of liquidity and asset/liability management.

Management has established a comprehensive management process for identifying, measuring, monitoring and controlling liquidity risk.

Changes in economic conditions or exposure to credit, market, operational, legal and reputational risks also could affect the Bank’s liquidity risk profile and are considered in the assessment of liquidity and asset/liability management.

Management has established a risk management process for identifying, measuring, monitoring and controlling liquidity risk.

Because of its critical importance to the viability of the Bank, liquidity risk management is integrated into our risk management processes.

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corporate governance consisting of oversight by the board of directors and active involvement by management;

the application of strategies, policies, procedures, and limits used to manage and mitigate liquidity risk;

strategies, policies, procedures, and limits used to manage and mitigate liquidity risk;

liquidity risk measurement and monitoring systems (including assessments of the current and prospective cash flows or sources and uses of funds) that are believed to be commensurate with the complexity and business activities of the Bank;

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a diverse mix of existing and potential future funding sources;

highly liquid marketable securities free of legal, regulatory or operational impediments that can be used to meet liquidity needs in stressful situations;

comprehensive contingency funding plans that are believed to be adequate to address potential adverse liquidity events and emergency cash flow requirements;

and internal controls and internal audit processes that are believed to be appropriate to assure the adequacy of the institution’s liquidity risk management process.

holding liquid marketable securities, free of legal, regulatory or operational impediments, that can be used to meet liquidity needs in situations of stress;

contingency funding plans that address potential adverse liquidity events and emergency cash

flow requirements;

and internal controls and internal audit processes believed to be sufficient to determine the adequacy of the institution’s liquidity risk management process.

We expect funds to be available from a number of basic banking activity sources, including the core deposit base, the repayment and maturity of loans and investment security cash flows.

Other potential funding sources include brokered certificates of deposit, deposit listing services, CDARS, borrowings from the FHLB and other lines of credit.

We participated in the Federal Reserve Bank of Richmond’s Paycheck Protection Program Liquidity Facility (“PPPLF”).

The PPPLF extended credit to eligible financial institutions that originated SBA-PPP loans, using the loans as collateral.

No new extensions of credit were made under the PPPLF after July 30, 2021.

In addition, we have an available borrower custody arrangement with the Federal Reserve Bank of Richmond which allows us to borrow on an eligible collateralized basis.

Deposits securing our OpenSky ® card lines of credit and deposits from title companies represent the largest concentrations in the deposit portfolio.

As of December 31, 2022, these concentrations represent 11% and 13% of deposits, respectively.

As of December 31, 2021, these deposits represented 13% and 18% of deposits, respectively.

We have an available borrower custody arrangement with the Federal Reserve Bank of Richmond which allows us to borrow on an eligible collateralized basis.

As of December 31, 2022, we had $223.8 million of available borrowing capacity from the FHLB, $21.4 million of available borrowing capacity from the Federal Reserve Bank of Richmond and available lines of credit of $76.0 million with other correspondent banks.

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Stockholders’ equity increased $26.1 million for the year ended December 31, 2022 largely due to net income of $41.8 million for the year.

Stock options exercised, shares issued as compensation, shares sold and stock-based compensation increased common stock and additional paid-in capital aggregately by $2.8 million.

These increases were offset by net unrealized losses on available for sale securities of $1.1 million.

Stock options exercised, shares issued as compensation, shares sold and stock-based compensation increased common stock and additional paid-in capital by $3.1 million.

These increases were more than offset by net unrealized losses on available for sale securities of $15.7 million.

The Company uses several indicators of capital strength.

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The Bank is subject to various regulatory capital requirements administered by the federal banking agencies.

Failure to meet minimum capital requirements can precipitate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on the Company’s financial statements.

Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices.

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The Bank was required to implement the new Basel III capital standards (subject to the phase-in for certain parts of the new rules) as of January 1, 2015.

In August of 2018 the Regulatory Relief Act directed the Federal Reserve Board to revise the Small BHC Policy Statement to raise the total consolidated asset limit in the Small BHC Policy Statement from $1 billion to $3 billion.

In August of 2018 the Regulatory Relief Act directed the Federal Reserve Board to revise the Small BHC

Policy Statement to raise the total consolidated asset limit in the Small BHC Policy Statement from $1 billion to $3 billion.

The Company is currently exempt from the consolidated capital requirements.

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See “Risks Related to the Regulation of Our Industry” in Part I, Item 1A - Risk Factors.

As of December 31, 2021, the Bank was in compliance with all applicable regulatory capital requirements to which it was subject and was classified as “well capitalized” for purposes of the prompt corrective action regulations.

As of December 31, 2022, the Bank was in compliance with all applicable regulatory capital requirements to which it was subject, and the Bank was classified as “well capitalized” for purposes of the prompt corrective action regulations.

As we deploy our capital and continue to grow our operations, our regulatory capital levels may decrease depending on our level of earnings.

However, we intend to monitor and control our growth in order to remain in compliance with all regulatory capital standards applicable to us.

However, we intend to monitor and control our growth relative to our earnings in order to remain in compliance with all regulatory capital standards applicable to us.

The following table presents the regulatory capital ratios for the Company (as if such requirements applied to the Company) and the Bank as of the dates indicated.

(dollars in thousands) Actual Minimum Capital

(in thousands) Actual Minimum Capital

Adequacy To Be Well

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We have contractual obligations to make future payments on debt and lease agreements.

While our liquidity monitoring and management consider both present and future demands for and sources of liquidity, the following table of contractual commitments focuses only on future obligations and summarizes our contractual obligations as of December 31, 2021.

Our liquidity monitoring and management consider both present and future demands for and sources of liquidity.

The following table of contractual commitments focuses only on future obligations and summarizes our contractual obligations as of December 31, 2022.

(in thousands) Due in One Year or Less Due After One Through Three Years Due After Three Through Five Years Due After 5 Years Total

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Our exposure to credit loss is represented by the contractual amounts of these commitments.

The same credit policies and procedures are used in making these commitments as for on-balance sheet instruments.

The same credit policies and procedures are generally used in making these commitments as for on-balance sheet instruments.

We are not aware of any accounting loss to be incurred by funding these commitments;

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Our commitments associated with outstanding letters of credit and commitments to extend credit expiring by period as of the date indicated are summarized below.

Since commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements.

Since commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts shown do not necessarily reflect actual future cash funding requirements.

(in thousands) 2022 2021

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Our policies generally require that letter of credit arrangements contain security and debt covenants similar to those contained in loan agreements.

The credit risk associated with issuing letters of credit is substantially the same as the risk involved in extending loan facilities to our customers.

We minimize our exposure to loss under letters of credit and credit commitments by subjecting them to the same credit approval and monitoring procedures as we do for on-balance sheet instruments.

The effect on our revenue, expenses, cash flows and liquidity of the unused portions of these lines of credit commitments cannot be precisely predicted because there is no guarantee that the lines of credit will be used.

Commitments to extend credit are agreements to lend funds to a customer, as long as there is no violation of any condition established in the contract, for a specific purpose.

We believe the credit risk associated with issuing letters of credit is substantially the same as the risk involved in extending loan facilities to our customers.

We seek to minimize our exposure to loss under letters of credit and credit commitments by subjecting them to the same credit approval and monitoring procedures as we do for on-balance sheet instruments.

The effect on our revenue, expenses, cash flows and liquidity of the unused portions of these letters of credit commitments cannot be precisely predicted because we do not control the extent to which the lines of credit may be used.

Commitments to extend credit are agreements to lend funds to a customer, as long as there is no violation of any condition established in the contract.

Commitments generally have variable interest rates, fixed expiration dates or other termination clauses and may require payment of a fee.

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Interest rate lock commitments are entered into in order to economically hedge the effect of changes in interest rates resulting from our commitments to fund the loans.

These commitments to fund mortgage loans, to be sold into the secondary market (interest rate lock commitments), and forward commitments for the future delivery of mortgage loans to third party investors are considered derivatives.

These commitments to fund mortgage loans to be sold into the secondary market, along with the interest rate lock commitments and forward commitments for the future delivery of mortgage loans to third party investors, are considered derivatives.

The commitment to fund other investments reflects an obligation to make an investment in a Small Business Investment Company.

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Interest rates may not necessarily move in the same direction or in the same magnitude as the prices of goods and services.

However, other operating expenses do reflect general levels of inflation.

However, most other operating expenses are sensitive to changes in levels of inflation.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis