Capital Bancorp Inc 10-K

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 68 Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Capital Bancorp, Inc. and Subsidiaries Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Capital Bancorp, Inc. and Subsidiaries (the “Company”) as of December 31, 2023 and 2022, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the two years in the period ended December 31, 2023, and the related notes to the consolidated financial statements (collectively, the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2023 and 2022, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2023, in conformity with accounting principles generally accepted in the United States of America. We have also 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, 2023, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 15, 2024, expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting. Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 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 financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Change in Accounting Principle As discussed in Note 1 to the financial statements, the Company has changed its method of accounting for credit losses effective January 1, 2023 due to the adoption of Financial Accounting Standards Board Accounting Standards Codification No. 326, Financial Instruments – Credit Losses (“ASC 326”). The Company adopted the new credit loss standard using the modified retrospective method such that prior period amounts are not adjusted and continue to be reported in accordance with previously applicable generally accepted accounting principles. Our opinion is not modified with respect to this matter. The adoption of the new credit loss standard and its subsequent application is also communicated as a critical audit matter below. 69 Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the 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 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 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 Credit Losses As described in Note 5 to the Company’s financial statements, the Company has a gross loan portfolio of $1.9 billion and related allowance for credit losses (“ACL”) of $28.6 million as of December 31, 2023. As described by the Company in Note 1, the Company adopted ASC 326 on January 1, 2023. In order to measure expected credit losses on a collective basis, the Company has elected to utilize a discounted cash flow methodology for all segments, except for the credit card and other consumer portfolio segments, which apply a simplified, non‐discounted cash flow calculation. Loans not sharing similar risk characteristics are evaluated on an individual basis. Within the collectively evaluated component, the Company uses regression analysis of historical internal and peer data to determine suitable loss drivers for modeling lifetime probability of default, loss given default, and lifetime loss rates. For the credit card portfolio, the Company calculates the credit card ACL collectively, applying segmentation based on collateral positions: secured, partially secured, and unsecured. Additionally, a qualitative scorecard is used by management to assess the need for adjustments to expected credit loss estimates for information not already captured in the quantitative loss estimation process. The qualitative scorecard evaluates certain risks such as lending policies and procedures, economic conditions, changes in the nature and volume of portfolios, changes in experience, depth, and ability of lending management, changes in volume and severity of past due loans, quality of loan review system, changes in the value of underlying collateral, concentrations of credit, and other external factors. We identified the Company’s estimate of the allowance for credit losses as a critical audit matter. The principal considerations for our determination of the ACL as a critical audit matter related to the high degree of complexity and judgment in the determination of significant model assumptions, specifically, the qualitative factor adjustments to quantitative loss rates. Auditing these complex judgments and assumptions made by the Company involves challenging auditor judgment due to the nature and extent of audit evidence and effort required to address these matters, including the extent of specialized skill or knowledge needed. 70 The primary procedures we performed to address the critical audit matter include the following: ■ We evaluated the appropriateness of the methodology applied in the adoption of ASC 326. ■ We tested the design and operating effectiveness of controls relating to the Company’s determination of the allowance for credit losses, including controls over the establishment of qualitative factors. ■ We evaluated the relevance and the reasonableness of assumptions related to the evaluation of the loan portfolio, current and forecasted economic conditions, and other risk factors used in the development of the qualitative factors. ■ We tested the completeness and accuracy of significant inputs to the model including the underlying data used to develop the qualitative factors. ■ We validated the mathematical accuracy of the calculation. ■ We evaluated the reasonableness of assumptions and data used by the Company in developing the qualitative factors by comparing these data points to internally developed and third‐party sources, and other audit evidence gathered. ■ We performed analytical procedures to evaluate the directional consistency of changes that occurred in the allowance for credit losses for loans. /s/ Elliott Davis, PLLC We have served as the Company’s auditor since 2017. Raleigh, North Carolina March 15, 2024 71 Report of Independent Registered Public Accounting Firm To the Stockholders and the Board of Directors of Capital Bancorp, Inc. and Subsidiaries Opinion on the Internal Control Over Financial Reporting We have audited Capital Bancorp, Inc. and its subsidiaries’ (the “Company”) internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2023, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2023 and 2022 and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for each of the two years in the period ending December 31, 2023 of the Company and our report dated March 15, 2024 expressed an unqualified opinion. 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 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 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, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included 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 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. 72 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/ Elliott Davis, PLLC Raleigh, North Carolina March 15, 2024 73 Capital Bancorp, Inc. and Subsidiaries Consolidated Balance Sheets As of December 31, 2023 and 2022 (dollars in thousands) 2023 2022 Assets Cash and due from banks $ 14,513 $ 19,963 Interest-bearing deposits at other financial institutions 39,044 39,764 Federal funds sold 407 20,688 Total cash and cash equivalents 53,964 80,415 Investment securities available for sale 208,329 252,481 Restricted investments 4,353 7,362 Loans held for sale 7,481 7,416 U.S. Small Business Administration ("SBA") Payroll Protection Program ("PPP") loans receivable, net of fees and costs 645 2,163 Portfolio loans receivable, net of deferred fees and costs 1,902,643 1,728,592 Less allowance for credit losses ( 28,610 ) ( 26,385 ) Total portfolio loans held for investment, net 1,874,033 1,702,207 Premises and equipment, net 5,069 3,386 Accrued interest receivable 11,494 9,489 Deferred tax asset 12,252 13,777 Bank owned life insurance 37,711 36,524 Other assets 10,845 8,435 Total assets $ 2,226,176 $ 2,123,655 Liabilities Deposits Noninterest-bearing $ 617,373 $ 674,313 Interest-bearing 1,278,623 1,083,759 Total deposits 1,895,996 1,758,072 Federal Home Loan Bank advances 22,000 107,000 Other borrowed funds 27,062 12,062 Accrued interest payable 5,583 1,031 Other liabilities 20,675 21,475 Total liabilities 1,971,316 1,899,640 Stockholders' equity Common stock, $ .01 par value; 49,000,000 shares authorized; 13,922,532 and 14,138,829 issued and outstanding 139 141 Additional paid-in capital 54,473 58,190 Retained earnings 213,345 182,435 Accumulated other comprehensive loss ( 13,097 ) ( 16,751 ) Total stockholders' equity 254,860 224,015 Total liabilities and stockholders' equity $ 2,226,176 $ 2,123,655 See Notes to Consolidated Financial Statements 74 Capital Bancorp, Inc. and Subsidiaries Consolidated Statements of Income For the Years Ended December 31, 2023 and 2022 (dollars in thousands except per share data) 2023 2022 Interest income Loans, including fees $ 174,760 $ 144,408 Investment securities available for sale 4,815 3,912 Federal funds sold and other 3,631 2,326 Total interest income 183,206 150,646 Interest expense Deposits 39,625 7,611 Borrowed funds 2,055 2,428 Total interest expense 41,680 10,039 Net interest income 141,526 140,607 Provision for credit losses 9,610 6,631 Release of credit losses on unfunded commitments ( 101 ) — Net interest income after provision for credit losses 132,017 133,976 Noninterest income Service charges on deposits 964 767 Credit card fees 17,273 21,972 Mortgage banking revenue 4,896 4,866 Other income 1,842 1,767 Total noninterest income 24,975 29,372 Noninterest expenses Salaries and employee benefits 48,754 42,898 Occupancy and equipment 5,673 4,865 Professional fees 9,270 11,012 Data processing 25,686 29,418 Advertising 6,161 6,220 Loan processing 1,633 1,702 Foreclosed real estate expenses (income), net 7 ( 183 ) Operational losses 4,613 4,469 Outside service providers 1,932 3,338 Other operating 7,038 5,375 Total noninterest expenses 110,767 109,114 Income before income taxes 46,225 54,234 Income tax expense 10,354 12,430 Net income $ 35,871 $ 41,804 Basic earnings per share $ 2.56 $ 2.98 Diluted earnings per share $ 2.55 $ 2.91 Weighted average common shares outstanding: Basic 14,002,556 14,024,598 Diluted 14,080,547 14,362,203 See Notes to Consolidated Financial Statements 75 Capital Bancorp, Inc. and Subsidiaries Consolidated Statements of Comprehensive Income For the Years Ended December 31, 2023 and 2022 (in thousands) 2023 2022 Net income $ 35,871 $ 41,804 Other comprehensive income (loss): Unrealized gain (loss) on investment securities available for sale 5,066 ( 20,912 ) Income tax benefit (expense) relating to the items above ( 1,412 ) 5,237 Other comprehensive income (loss) 3,654 ( 15,675 ) Comprehensive income $ 39,525 $ 26,129 See Notes to Consolidated Financial Statements 76 Capital Bancorp, Inc. and Subsidiaries Consolidated Statements of Changes in Stockholders’ Equity For the Years Ended December 31, 2023 and 2022 Common Stock Additional Paid-in Capital Retained Earnings Accumulated Other Comprehensive Income (Loss) Total Stockholders' Equity (dollars in thousands, except per share data) Shares Amount Balance, December 31, 2021 13,962,334 $ 140 $ 54,306 $ 144,533 $ ( 1,076 ) $ 197,903 Net income — — — 41,804 — 41,804 Unrealized loss on investment securities available for sale, net of income taxes — — — — ( 15,675 ) ( 15,675 ) Stock options exercised, net of shares withheld for purchase price 160,590 1 1,999 ( 765 ) — 1,235 Shares issued as compensation 15,905 — 223 ( 52 ) — 171 Stock-based compensation — — 1,662 — — 1,662 Cash dividends to stockholders ($ 0.22 per share) — — — ( 3,085 ) — ( 3,085 ) Balance, December 31, 2022 14,138,829 141 58,190 182,435 ( 16,751 ) 224,015 Cumulative effect adjustment due to adoption of the CECL standard — — — ( 29 ) — ( 29 ) Net income — — — 35,871 — 35,871 Unrealized gain on investment securities available for sale, net of income taxes — — — — 3,654 3,654 Stock options exercised, net of shares withheld for purchase price 228,405 2 2,726 ( 937 ) — 1,791 Shares issued as compensation 30,644 — 622 ( 75 ) — 547 Stock-based compensation — — 1,757 — — 1,757 Cash dividends to stockholders ($ 0.28 per share) — — — ( 3,920 ) — ( 3,920 ) Shares repurchased and retired ( 475,346 ) ( 4 ) ( 8,822 ) — — ( 8,826 ) Balance, December 31, 2023 13,922,532 $ 139 $ 54,473 $ 213,345 $ ( 13,097 ) $ 254,860 See Notes to Consolidated Financial Statements 77 Capital Bancorp, Inc. and Subsidiaries Consolidated Statements of Cash Flows For the Years Ended December 31, 2023 and 2022 (in thousands) 2023 2022 Cash flows from operating activities Net income $ 35,871 $ 41,804 Adjustments to reconcile net income to net cash provided by operating activities: Provision for credit losses 9,610 6,631 Release of credit losses on unfunded commitments ( 101 ) ( 54 ) (Release of) provision for mortgage put-back reserve, net ( 188 ) 9 Net amortization on investments 188 540 Premises and equipment depreciation 324 364 Lease asset amortization 149 1,068 Increase in cash surrender value of BOLI ( 1,187 ) ( 1,018 ) Executive long-term incentive plan expense 148 582 Stock-based compensation expense 1,757 1,662 Director and employee compensation paid in Company stock 547 171 Deferred income tax expense 142 1,240 Valuation allowance on derivatives 8 9 Gain on sale of foreclosed real estate — ( 20 ) Loss on disposal of premises and equipment — 14 Decrease in valuation of loans held for sale carried at fair value 6 — Proceeds from sales of loans held for sale 176,373 308,549 Originations of loans held for sale ( 176,444 ) ( 299,976 ) Changes in assets and liabilities: Accrued interest receivable ( 2,005 ) ( 1,588 ) Taxes payable 179 ( 282 ) Other assets ( 2,448 ) ( 4,382 ) Accrued interest payable 4,552 558 Other liabilities ( 63 ) ( 4,491 ) Net cash provided by operating activities 47,418 51,390 See Notes to Consolidated Financial Statements 78 Capital Bancorp, Inc. and Subsidiaries Consolidated Statements of Cash Flows For the Years Ended December 31, 2023 and 2022 (in thousands) 2023 2022 Cash flows from investing activities Purchases of securities available for sale ( 6,960 ) ( 113,078 ) Proceeds from calls and maturities of securities available for sale 55,991 23,846 Net sales (purchases) of restricted investments 3,009 ( 3,864 ) Net decrease in SBA-PPP loans receivable 1,518 106,122 Net increase in portfolio loans receivable ( 182,240 ) ( 210,037 ) Net purchases of premises and equipment ( 2,156 ) ( 1,550 ) Proceeds from sales of foreclosed real estate — 106 Net cash used in investing activities ( 130,838 ) ( 198,455 ) Cash flows from financing activities Net increase (decrease) in: Noninterest-bearing deposits ( 56,940 ) ( 113,337 ) Interest-bearing deposits 194,864 74,272 Federal Home Loan Bank (repayments) advances, net ( 85,000 ) 85,000 Other borrowed funds 15,000 — Dividends paid ( 3,920 ) ( 3,085 ) Repurchase of common stock ( 8,826 ) — Net proceeds from exercise of stock options 1,791 1,235 Net cash provided by financing activities 56,969 44,085 Net decrease in cash and cash equivalents ( 26,451 ) ( 102,980 ) Cash and cash equivalents, beginning of year 80,415 183,395 Cash and cash equivalents, end of year $ 53,964 $ 80,415 Noncash investing and financing activities: Change in unrealized gains (losses) on investments $ 5,066 $ ( 20,912 ) Cash paid during the period for: Taxes $ 7,704 $ 11,730 Interest $ 37,128 $ 9,481 See Notes to Consolidated Financial Statements 79 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1 - Nature of Business and Basis of Presentation Nature of operations: Capital Bancorp, Inc. is a Maryland corporation and bank holding company (the “Company”) for Capital Bank, N.A. (the “Bank”). The Company's primary operations are conducted by the Bank, which operates branches in Rockville and Columbia, Maryland; Reston, Virginia; and the District of Columbia. The Bank is principally engaged in the business of investing in commercial, real estate, and credit card loans and attracting deposits. The Company originates residential mortgages for sale in the secondary market through Capital Bank Home Loans (“CBHL”), the Bank’s residential mortgage banking arm, and issues credit cards through OpenSky ™ , a digitally-driven, nationwide credit card platform providing secured, partially secured, and unsecured credit solutions. The Company formed Church Street Capital, LLC (“Church Street Capital”) in 2014 to provide short-term secured real estate financing to Washington, D.C. area investors and developers that may not meet all Bank credit criteria. At December 31, 2023, Church Street Capital had loans totaling $ 7.9 million with a collectively assessed allowance for credit losses (“ACL”) of $ 184 thousand. Refer to Note 5 - Portfolio Loans Receivable to the Consolidated Financial Statements for further discussion of the consolidated ACL. In addition, the Company owns all of the stock of Capital Bancorp (MD) Statutory Trust I (the “Trust”). The Trust is a special purpose non-consolidated entity organized for the sole purpose of issuing trust preferred securities. Basis of presentation: The accompanying consolidated financial statements include the activity of the Company and its wholly-owned subsidiaries, the Bank and Church Street Capital. All intercompany transactions have been eliminated in consolidation. The Company reports its activities as four business segments: commercial banking; mortgage lending; credit cards; and corporate activities. In determining the appropriateness of segment definition, the Company considers components of the business about which financial information is available and regularly evaluated relative to resource allocation and performance assessment. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and conform to general practices within the banking industry. Significant accounting policies: The preparation of consolidated financial statements in accordance with GAAP requires estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. The primary reference point for the estimates is on historical experience and assumptions believed to be reasonable regarding the value of certain assets and liabilities that are not readily available from other sources. Estimates are evaluated on an ongoing basis. Actual results may materially differ from these estimates under different assumptions or conditions. Cash and cash equivalents For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from financial institutions, interest-bearing deposits with financial institutions and federal funds sold. Generally, federal funds are sold for one-day periods. 80 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1 - Nature of Business and Basis of Presentation (continued) Investment securities Investment securities are classified as available for sale and carried at fair value with unrealized gains and losses included in stockholders’ equity on an after-tax basis. Premiums and discounts on investment securities are amortized on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated. Changes in the fair value of debt securities available for sale are included in stockholder’s equity as unrealized gains and losses, net of the related tax effect. Management evaluates all investments in an unrealized loss position on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. If the Company has the intent to sell the security or it is more likely than not that the Company will be required to sell the security, the security is written down to fair value and the entire loss is recorded in earnings. If either of the above criteria is not met, the Company evaluates whether the decline in fair value is the result of credit losses or other factors. In making the assessment, the Company may consider various factors including the extent to which fair value is less than amortized cost, performance on any underlying collateral, downgrades in the ratings of the security by a rating agency, the failure of the issuer to make scheduled interest or principal payments and adverse conditions specifically related to the security. If the assessment indicates that a credit loss exists, the present value of cash flows expected to be collected are compared to the amortized cost basis of the security and any excess is recorded as an ACL, limited by the amount that the fair value is less than the amortized cost basis. Any amount of unrealized loss that has not been recorded through an ACL is recognized in other comprehensive income. Changes in the ACL are recorded as provision for (or reversal of) credit loss expense. Losses are charged against the ACL when management believes an AFS security is confirmed to be uncollectible or when either of the criteria regarding intent or requirement to sell is met. At December 31, 2023, there was no ACL related to the AFS portfolio. Loans held for sale Mortgage loans originated and intended for sale are recorded at fair value, determined individually, as of the balance sheet date. Fair value is determined based on outstanding investor commitments, or in the absence of such commitments, based on current investor yield requirements. Gains and losses on loan sales are determined by the specific-identification method. The Company’s current practice is to sell residential mortgage loans on a servicing released basis. Interest on loans held for sale is credited to income based on the principal amounts outstanding. Upon sale and delivery, loans are legally isolated from the Company and the Company has no ability to restrict or constrain the ability of third‑party investors to pledge or exchange the mortgage loans. The Company does not have the entitlement or ability to repurchase the mortgage loans or unilaterally cause third‑party investors to put the mortgage loans back to the Company. Unrealized and realized gains on loan sales are determined using the specific-identification method and are recognized through mortgage banking activity in the Consolidated Statements of Income. The Company elects to measure loans held for sale at fair value to better align reported results with the underlying economic changes in value of the loans on the Company’s balance sheet. 81 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1 - Nature of Business and Basis of Presentation (continued) U.S. Small Business Administration Paycheck Protection Program During the global COVID-19 pandemic, pursuant to the CARES Act and the Consolidated Appropriations Act, 2021, the United States Small Business Administration Payroll Protection Program (“SBA-PPP”) provided forgivable loans to small businesses to enable them to maintain payroll, hire back employees who had been laid off, and cover overhead. SBA-PPP loans have an interest rate of 1%, have two or five year terms, and carry a 100% guarantee of the SBA. The program ended on May 31, 2021. SBA-PPP loans are eligible to be forgiven by the SBA. Due to the unique nature of these provisions, SBA-PPP loans have been disclosed as a separate balance sheet item. Origination fees received by the SBA are capitalized into the carrying amount of the loans. The deferred fee income, net of origination costs, is recognized over the life of the loan as an adjustment to yield using the effective interest method. The remaining net deferred income is recognized upon forgiveness of the loan. Portfolio loans and the ACL Loans are stated at the principal amount outstanding, adjusted for deferred origination fees and costs, discounts on loans acquired, and the ACL. Interest is accrued based on the loan principal balances and stated interest rates. Origination fees and costs are recognized as an adjustment to the related loan yield using approximate interest methods. For credit card loans, loan origination fees and direct loan origination costs are amortized on a straight-line basis over a 12-month period. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. For reporting purposes, the Company discontinues the accrual of interest at the earlier of the date any portion of the principal and/or interest is 90 days past due, or at such time as we determine that it is probable that not all principal and interest payments will be collected, and that collateral is insufficient to discharge the debt in full. When the interest accrual is discontinued, all unpaid accrued interest is reversed from income. Generally, interest payments on nonaccrual loans are recorded as a reduction of the principal balance. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are generally charged-off in part or in full when management determines the loan to be uncollectible. Factors for charge-off that may be considered include: repayments deemed to be extended out beyond reasonable time frames, customer bankruptcy and lack of assets, and/or collateral deficiencies. On January 1, 2023, we adopted Accounting Standards Update (“ASU”) 2016-13 “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”), which replaces the incurred loss methodology for determining our provision for credit losses and ACL with an expected loss methodology that is referred to as the Current Expected Credit Loss model (“CECL”). The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loans receivable and held-to-maturity (“HTM”) debt securities. It also applies to off-balance sheet credit exposures not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees, and other similar instruments) and net investments in leases recognized by a lessor in accordance with ASU 2016-02 “Leases (Topic 842)”. 82 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1 - Nature of Business and Basis of Presentation (continued) In addition, ASU 2016-13 made changes to the accounting for AFS debt securities. One such change is to require credit-related impairments to be recognized as an ACL rather than as a write-down of the security’s amortized cost basis when the Company does not intend to sell or believes that the Company will be required to sell the securities prior to recovery of the security’s amortized cost basis. The Company adopted ASU 2016-13 using the modified retrospective method. Results for reporting periods beginning after January 1, 2023 are presented under ASU 2016-13 while prior period amounts continue to be reported in accordance with previously applicable GAAP. The Company does not own HTM debt securities. There was no ACL on available for sale securities at December 31, 2023. The following table illustrates the impact of the adoption of ASC 326, or the CECL standard. The adoption of the standard required an $ 804 thousand increase in the ACL and a $ 775 thousand reduction to the reserve for unfunded commitments (“RUC”). The improved precision of the calculation of the historical utilization of unfunded commitments gave rise to the reduction. The net impact of the adoption of the CECL standard to retained earnings was $ 29 thousand. January 1, 2023 (in thousands) Pre-adoption of the CECL standard As Reported Under ASC 326 Impact of adoption of the CECL standard Assets: Real estate: Residential $ 484,735 $ 484,735 $ — Commercial 664,551 664,551 — Construction 238,099 238,099 — Commercial and Industrial 220,221 220,221 — Credit card, net of reserve 128,434 128,434 — Other consumer 1,179 1,179 — Portfolio loans receivable, gross $ 1,737,219 $ 1,737,219 $ — Deferred origination fees, net ( 8,627 ) ( 8,627 ) — Allowance for credit losses ( 26,385 ) ( 27,189 ) ( 804 ) Portfolio loans receivable, net $ 1,702,207 $ 1,701,403 $ ( 804 ) Liabilities: Reserve for unfunded commitments $ 1,682 $ 907 $ ( 775 ) We maintain an ACL that represents management’s estimate of the expected credit losses and risks inherent in our loan portfolio. The amount of the ACL should not be interpreted as an indication that charge-offs in future periods will necessarily occur in those amounts, or at all. The allowance immediately recognizes lifetime expected credit losses when a financial asset is originated or purchased. The ACL is a valuation account that is deducted from the amortized cost basis of loans to present the net amount expected to be collected on the loans. Loans, or portions thereof, are charged-off against the allowance when they are deemed uncollectible. Factors for charge-off that may be considered include: repayments deemed to be extended out beyond reasonable time frames, customer bankruptcy and lack of assets, and/or collateral deficiencies. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. In determining the ACL, we estimate losses collectively based on quantitative analysis of historical credit losses adjusted for current conditions and reasonable and supportable forecasts of collectability of future cash flows over the remaining term of each financial instrument. The Company has elected to utilize a discounted cash flow methodology for all segments, except for the credit card and other consumer portfolio segments, which apply a simplified, non-discounted cash flow calculation. See further detail regarding our forecasting methodology in the “Cash Flow Method” section below. 83 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1 - Nature of Business and Basis of Presentation (continued) Quarterly, the Company utilizes a Qualitative Scorecard to consider the need to qualitatively adjust expected credit loss estimates for information not already captured in the quantitative loss estimation process, which may impact expected credit losses. The Qualitative Scorecard evaluates certain risk environments such as economic conditions, changes in the nature and volume of portfolios, changes in experience, depth, and ability of lending management, changes in volume and severity of past due loans and similar conditions, and changes in the value of underlying collateral. The scorecard results help the Company analyze directional consistency to risk conditions and circumstances that should be considered for each loan segment and to refine its estimates of expected credit losses. As of December 31, 2023, there have been no significant changes applied through the Qualitative Scorecard subsequent to implementation on January 1, 2023. Purchased Credit Deterioration Upon adoption of ASU 2016-13, loans which were identified as Purchase Credit Impaired under the incurred loss model are identified as Purchased Credit Deteriorated (“PCD”) loans at January 1, 2023 without reassessment. In future acquisitions, the Company may purchase loans, some of which have experienced more than insignificant credit deterioration since origination. In those cases, the Company will consider certain criteria including days past due, accrual status, risk rating, credit mark, and other relevant factors in assessing whether purchased loans are PCD. PCD loans are recorded at the amount paid and the Company will determine the initial ACL required for PCD assets with no impact to earnings. The loan’s purchase price and ACL is then the initial amortized cost basis for PCD loans. The difference between the initial amortized cost basis and the par value of the loan is a noncredit discount or premium, which is amortized into interest income over the life of the loan. Subsequent to initial recognition, PCD loans are subject to the same interest income recognition and impairment model as non-PCD loans, with changes to the ACL recorded through provision expense. Cash Flow Method The Company uses the discounted cash flow (“DCF”) method to estimate expected credit losses for each portfolio loan segment, with the exception of credit card and other consumer loans, which use a non-discounted cash flow calculation. For each of these loan segments, the Company generates cash flow projections at the instrument level. Payment expectations are adjusted for estimated prepayment speed and for probability and severity of a loss. The expected credit losses derived from the cash flow calculations are estimated over the contractual term of the loans, adjusted for expected prepayments when appropriate. The modeling of expected prepayment speeds is primarily based on historical internal data. Industry benchmark data is utilized when a statistically insufficient history exists. The contractual term excludes expected extensions, renewals and modifications. The Company uses regression analysis of historical internal and peer data to determine suitable portfolio segment level loss drivers to utilize when modeling lifetime probability of default, lifetime loss given default, and lifetime loss rates. This analysis also determines how expected probability of default, loss given default, and lifetime loss rates will react to forecasted levels of the loss drivers. For the credit card portfolio, the Company calculates the credit card ACL collectively, applying segmentation based on collateral positions: secured, partially secured, and unsecured. For all DCF and loss rate models, the Company has elected to use a four quarter forecast period across all portfolio segments. After the forecasted period, the models will revert to a long run average of each economic factor over four quarters. The Company uses economic projections from reputable and independent third parties to inform its loss driver forecast over the forecast period. 84 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1 - Nature of Business and Basis of Presentation (continued) For the non-credit card and consumer portfolios, the combination of adjustments for credit expectations (default and loss) and timing expectations (prepayment, curtailment, and time to recovery) produces an expected cash flow stream at the instrument level. An effective interest rate is calculated by the Company, adjusted for any net deferred fees or costs, premium, or discount existing at the origination or acquisition, to produce an instrument-level net present value of expected cash flows. The ACL reflects the difference between the amortized cost basis and the present value of the expected cash flows. Individual Evaluation The Company will evaluate individual instruments for expected credit losses when those instruments do not share similar risk characteristics with instruments evaluated on a collective basis. Instruments may be evaluated whether or not there is an expectation of collectability in place. Instruments evaluated individually are not included in the Company’s collective analysis. Collateral dependent or secured loans with respect to which the Company expects repayment to be provided substantially through the operation or sale of the collateral utilize a collateral-based methodology in which ACL is measured based on the difference between the net realizable value of the collateral and the amortized cost basis of the asset as of the measurement date. If the collateral valuation is equal to or greater than amortized cost, no reserve is applied. If a loan is not collateral dependent, the loan will be analyzed based on a forecast of future cash flows. Credit Losses on Off-Balance Sheet Credit Exposures The Company’s financial instruments include off-balance sheet credit instruments such as unfunded commitments to make loans, commercial letters of credit issued, and commitments to fund other investments. The Company’s maximum exposure to credit loss in the event of nonperformance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the contractual amount of the credit commitment. Loan commitments and lines of credit are generally made on the same terms, including with regard to collateral, as outstanding loans. The Company maintains a RUC on off-balance sheet credit exposures through a provision reflected in other liabilities. Increases or decreases in the reserve are charged to or released from the provision for credit losses for unfunded commitments in the consolidated statements of income. The provision (credit) for credit losses on off-balance sheet exposures prior to January 1, 2023 was included in other noninterest expense in the consolidated statements of income. The RUC on off-balance credit exposures is estimated by loan segment at each balance sheet date under the current expected credit loss model based on the segment loss factor and the estimated utilization rate of the unfunded commitments. The Company has analyzed its historic funding behavior at the segment level to determine an expected utilization rate. The above methodology for determining an appropriate ACL is based on a comprehensive analysis of the loan portfolio in accordance with ASC 326. The analysis considers all significant factors that affect the expected collectability of the portfolio and supports the expected credit losses estimated by this process. It is important to recognize that the related process, methodology, and underlying assumptions require a substantial degree of judgment. Additional disclosure on the ACL, and qualitative factors can be found in Part II, Item 1A - Risk Factors and Note 5 - Portfolio Loans Receivable. Credit Losses on SBA-PPP loans and interest receivable The ACL for SBA-PPP loans was separately evaluated given the explicit government guarantee. The Company has incorporated historical experience with similar SBA guarantees and underwriting adjusted for reasonable and supportable forecasts and concluded the expected credit loss is zero and, therefore, no allowance has been assigned to these loans. 85 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1 - Nature of Business and Basis of Presentation (continued) The Company does not measure an ACL on accrued interest receivable balances because these balances are written off as a reduction to interest income when loans are placed on nonaccrual status. Loan modifications Effective January 1, 2023, the Company adopted ASU 2022-02 - Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. From time to time, the Company may elect to modify the contractual terms of loans to a borrower experiencing financial difficulties as a way to mitigate loss, to proactively work with borrowers in financial difficulty, or to comply with regulations regarding the treatment of certain bankruptcy filing and discharge situations. These modifications may include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Under ASU 2022-02, modifications to a loan for a borrower experiencing financial difficulty that have occurred in the current reporting period, are disclosed along with the impact of the modifications. During the year ended December 31, 2023, the Company did not have any such modifications. Premises and equipment Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the related property, generally over two to seven years . Leasehold improvements are amortized over the estimated term of the respective leases, which may include renewal options where management has the positive intent to exercise such options, or the estimated useful lives of the improvements, whichever is less. The costs of major renewals and improvements are capitalized with the corresponding costs associated with amortization or depreciation included as a component of occupancy and equipment expenses. Expenditures for maintenance, repairs, and minor replacements are charged to noninterest expenses as incurred. Leases The Company accounts for leases according to ASU 2016-02, Leases (Topic 842), and applies a right-of-use (“ROU”) model that requires a lessee to record, for all leases with a lease term of more than 12 months, an asset representing its right to use the underlying asset and a liability to make lease payments. The Company elected to apply the package of practical expedients permitting entities to not reassess: 1) whether any expired or existing contracts are or contain leases; 2) the lease classification for any expired or existing leases; and 3) initial direct costs for any existing leases. Additionally, as provided by ASU 2016-02, the Company elected not to apply the recognition requirements of ASC 842 to short-term leases, defined as leases with a term of 12 months or less, and to recognize the lease payments in net income on short-term leases on a straight-line basis over the lease term. Derivative financial instruments The Company may enter into commitments to fund residential mortgage loans (interest rate locks) with the intention of selling them in the secondary market. The Company also enters into forward sales agreements for certain funded loans and loan commitments. The Company records unfunded commitments intended for loans held for sale and forward sales agreements at fair value with changes in fair value recorded as a component of mortgage banking revenue. Loans originated and intended for sale in the secondary market are carried at fair value. For pipeline loans which are not pre-sold to an investor, the Company endeavors to manage the interest rate risk on rate lock commitments by entering into forward sale contracts, whereby the Company obtains the right to deliver securities to investors in the future at a specified price. Such contracts are accounted for as derivatives and are recorded at fair value as derivative assets or liabilities, with changes in fair value recorded in mortgage banking revenue. 86 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1 - Nature of Business and Basis of Presentation (continued) The Company accounts for derivative instruments and hedging activities according to guidelines established in ASC 815-10, Accounting for Derivative Instruments and Hedging Activities , as amended. The Company recognizes all derivatives as either assets or liabilities on the balance sheet and measures those instruments at fair value. Changes in fair value of derivatives designated and accounted for as cash flow hedges, to the extent they are effective as hedges, are recorded in other comprehensive income, net of deferred taxes. Any hedge ineffectiveness would be recognized in the income statement line item pertaining to the hedged item. As of December 31, 2023, there were no derivative instruments held which would require recognition by the Company. Fair value measurements Fair value is the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market inputs. For financial instruments that are traded actively and have quoted market prices or observable market inputs, there is minimal subjectivity involved in measuring fair value. However, when quoted market prices or observable market inputs are not fully available, significant management judgment may be necessary to estimate fair value. In developing our fair value estimates, we strive to maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy defines Level 1 valuations as those based on quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 valuations include inputs based on quoted prices for similar assets or liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 3 valuations are based on at least one significant assumption not observable in the market, or significant management judgment or estimation, some of which may be internally developed. Financial assets that are recorded at fair value on a recurring basis include investment securities available for sale, loans held for sale, and derivative financial instruments. Financial liabilities that are recorded at fair value on a recurring basis are comprised of derivative financial instruments. See Note 17 - Fair Value. Revenue Recognition Accounting Standards Codification 606, Revenue from Contracts with Customers (“ASC 606”), establishes a revenue recognition model for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the entity's contracts to provide goods or services to customers. A description of the revenue-generating activities that are within the scope of ASC 606, and included in other income in the Company’s consolidated statements of income are as follows: Interest Income and Fees Interest income and fees on loans and investment securities are recognized based on the contractual provisions of the underlying arrangements. Loan origination fees, direct loan origination costs, premiums and discounts on loans held for investment are deferred and generally amortized into interest income as yield adjustments over the contractual life and/or commitment period using the interest method. For credit card loans, loan origination fees and direct loan origination costs are amortized on a straight-line basis over a 12 or 24 month period. 87 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1 - Nature of Business and Basis of Presentation (continued) The unamortized premiums, discounts and other basis adjustments on investment securities are included as components of the investment securities’ carrying value and are generally recognized in interest income as yield adjustments over the contractual lives of the securities using the interest method. However, premiums for certain callable investment securities are amortized to the earliest call date. Finance charges and fees on credit card loans are recorded in revenue when earned and presented on our consolidated balance sheets within portfolio loans receivable. Annual membership fees are classified as interest income in our consolidated statements of income and are deferred and amortized over 12 months on a straight-line basis. Bank-owned life insurance The Company had $ 37.7 million of bank-owned life insurance at December 31, 2023 and $ 36.5 million at December 31, 2022. The Company recognized income on bank-owned life insurance, which is included in other noninterest income, of $ 1.2 million and $ 1.0 million for the years ended December 31, 2023 and December 31, 2022, respectively. Income taxes The Company employs the asset and liability method of accounting for income taxes as required by ASC Topic 740, “ Income Taxes .” Under this method, deferred tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities (i.e., temporary timing differences) and are measured at the enacted rates that will be in effect when these differences reverse. The Company utilizes statutory requirements for its income tax accounting, and limits risks associated with potentially problematic tax positions that may incur challenge upon audit, where an adverse outcome is more likely than not. Therefore, no provisions are necessary for either uncertain tax positions nor accompanying potential tax penalties and interest for underpayments of income taxes in the Company’s tax reserves. In accordance with ASC Topic 740, the Company may establish a valuation allowance against deferred tax assets in those cases where realization is less than certain. Earnings per share Earnings per share is computed by dividing net income available to common stockholders by the weighted average number of shares outstanding. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares outstanding, adjusted for the dilutive effect of stock options and restricted stock using the treasury stock method. At December 31, 2023 and 2022, there were 277,066 and 139,921 stock options, respectively, excluded from the calculation as their effect would have been anti-dilutive. 88 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1 - Nature of Business and Basis of Presentation (continued) The following is a reconciliation of the numerators and denominators used in computing basic and diluted earnings per common share: For the Years Ended December 31, 2023 2022 (dollars in thousands) Income Weighted Average Shares Per Share Amount Income Weighted Average Shares Per Share Amount Basic EPS Net income available to common stockholders $ 35,871 14,002,556 $ 2.56 $ 41,805 14,024,598 $ 2.98 Effect of dilutive securities — 77,991 — 337,605 Dilutive EPS per common share $ 35,871 14,080,547 $ 2.55 $ 41,805 14,362,203 $ 2.91 Comprehensive loss The Company reports as comprehensive loss all changes in stockholders' equity during the year from non-stockholder sources. Other comprehensive loss refers to all components (income, expenses, gains, and losses) of comprehensive loss that are excluded from net income. The Company's only component of other comprehensive loss is unrealized losses on investment securities available for sale, net of income taxes. Information concerning the Company's accumulated other comprehensive loss as of December 31, 2023 and 2022 are as follows: As of December 31, (in thousands) 2023 2022 Unrealized losses on securities available for sale $ ( 17,350 ) $ ( 22,416 ) Deferred tax benefit 4,253 5,665 Total accumulated comprehensive loss $ ( 13,097 ) $ ( 16,751 ) 89 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 1 - Nature of Business and Basis of Presentation (continued) Recently issued accounting pronouncements: In March 2020, the FASB released ASU 2020-04 - Reference Rate Reform, Topic 848, which provides temporary guidance to ease the potential accounting burden in accounting for, or recognizing the effects from, reference rate reform on financial reporting. The new standard is a result of London Interbank Offered Rate (“LIBOR”) likely being discontinued as an available benchmark rate. The standard is elective and provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, or other transactions that reference LIBOR, or another reference rate expected to be discontinued. The amendments in the update are effective for all entities between March 12, 2020 and an extended sunset date of December 31, 2024 which was extended by ASU 2022-06 issued by FASB in December 2022. The Company has completed the transition from LIBOR with no material impact on the Company’s financial position or results of operations. In December 2023, the FASB issued Accounting Standards Update ("ASU") 2023-07, "Segment Reporting (Topic 280), Improvements to Reportable Segment Disclosures" ("ASU 2023-07"). ASU 2023-07 Requires public entities to disclose significant segment expenses, an amount and description for other segment items, the title and position of the entity’s chief operating decision maker ("CODM") and an explanation of how the CODM uses the reported measures of profit or loss to assess segment performance, and, on an interim basis, certain segment related disclosures that previously were required only on an annual basis. ASU 2023-07 also clarifies that entities with a single reportable segment are subject to both new and existing segment reporting requirements and that an entity is permitted to disclose multiple measures of segment profit or loss, provided that certain criteria are met. ASU 2023-07 is effective for the Company for fiscal years beginning after December 15, 2023 and interim periods within fiscal years beginning after December 15, 2024, with early adoption permitted. The Company will update its segment related disclosures upon adoption. In December 2023, the FASB issued Accounting Standards Update 2023-09, “Income Taxes (Topic 740), Improvements to Income Tax Disclosures" ("ASU 2023-09"). ASU 2023-09 requires public entities to disclose in their rate reconciliation table additional categories of information about federal, state and foreign income taxes and to provide more details about the reconciling items in some categories if items meet a quantitative threshold. ASU 2023-09 also requires all entities to disclose income taxes paid, net of refunds, disaggregated by federal, state and foreign taxes for annual periods and to disaggregate the information by jurisdiction based on a quantitative threshold, among other things. ASU 2023-09 is effective for the Company for fiscal years beginning after December 15, 2024 with early adoption permitted. The Company will update its income tax disclosures upon adoption. Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company's financial position, results of operations or cash flows. Reclassifications: Certain reclassifications have been made to amounts reported in prior periods to conform to the current period presentation. The reclassifications had no material effect on net income or total stockholders' equity. 90 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 2 - Cash and Cash Equivalents Cash and cash equivalents include cash and amounts due from banks, interest-bearing deposits and federal funds sold. The Bank is required by regulations to maintain an average cash reserve balance based on a percentage of deposits; however, on March 15, 2020, the Federal Reserve announced that reserve requirement ratios would be reduced to zero percent effective March 26, 2020, due to economic conditions, which eliminated the reserve requirement for all depository institutions. The reserve requirement is still at zero percent as of December 31, 2023. Note 3 - Investment Securities The following table summarizes the amortized cost, fair value and allowance for credit losses of securities available-for-sale at December 31, 2023 and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss): Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Allowance for Credit Losses Fair Value (in thousands) December 31, 2023 U.S. Treasuries $ 161,420 $ — $ ( 12,192 ) $ — $ 149,228 Municipal 11,699 4 ( 2,331 ) — 9,372 Corporate 5,000 — ( 587 ) — 4,413 Asset-backed securities 7,069 13 ( 37 ) — 7,045 Mortgage-backed securities 40,491 — ( 2,220 ) — 38,271 Total $ 225,679 $ 17 $ ( 17,367 ) $ — $ 208,329 There was no ACL required on available-for-sale debt securities in an unrealized loss position at December 31, 2023. The following table summarizes the amortized cost and fair value of securities available-for-sale at December 31, 2022 and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income (loss): Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (in thousands) December 31, 2022 U.S. Treasuries $ 215,486 $ — $ ( 16,037 ) $ 199,449 Municipal 10,815 — ( 2,803 ) 8,012 Corporate 5,000 — ( 400 ) 4,600 Asset-backed securities 7,970 — ( 259 ) 7,711 Mortgage-backed securities 35,626 — ( 2,917 ) 32,709 Total $ 274,897 $ — $ ( 22,416 ) $ 252,481 There were no securities sold during the year ended December 31, 2023 or December 31, 2022. 91 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 3 - Investment Securities (continued) The amortized cost and fair value of debt securities are shown by contractual maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately. For the Years Ended December 31, 2023 2022 (in thousands) Amortized Cost Fair Value Amortized Cost Fair Value Within one year $ 39,918 $ 39,294 $ 53,739 $ 53,204 One to five years 101,688 93,218 88,165 82,538 Five to ten years 26,215 22,511 79,090 68,805 Beyond ten years 10,298 7,990 10,307 7,514 Asset-backed securities (1) 7,069 7,045 7,970 7,711 Mortgage-backed securities (1) 40,491 38,271 35,626 32,709 $ 225,679 $ 208,329 $ 274,897 $ 252,481 (1) Asset-backed and Mortgage-backed securities are due in monthly installments. There were no securities pledged at December 31, 2023 and 2022 to secure public deposits and repurchase agreements. Pledged securities at the Federal Reserve's Bank Term Funding Program (“BTFP”) totaled $ 170.7 million at par value at December 31, 2023 and $ 0 at December 31, 2022. At December 31, 2023 and 2022, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of shareholders’ equity. The following table summarizes debt securities available-for-sale in an unrealized loss position for which an allowance for credit losses has not been recorded at December 31, 2023 and 2022, aggregated by major security type and length of time in a continuous unrealized loss position: Less than 12 months 12 months or longer Total Fair Value Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses (in thousands) December 31, 2023 U.S. Treasuries $ — $ — $ 149,228 $ ( 12,192 ) $ 149,228 $ ( 12,192 ) Municipal — — 8,473 ( 2,331 ) 8,473 ( 2,331 ) Corporate — — 4,413 ( 587 ) 4,413 ( 587 ) Asset-backed securities — — 5,154 ( 37 ) 5,154 ( 37 ) Mortgage-backed securities 6,057 ( 8 ) 32,214 ( 2,212 ) 38,271 ( 2,220 ) Total $ 6,057 $ ( 8 ) $ 199,482 $ ( 17,359 ) $ 205,539 $ ( 17,367 ) December 31, 2022 U.S. Treasuries $ 82,102 $ ( 1,396 ) $ 117,347 $ ( 14,641 ) $ 199,449 $ ( 16,037 ) Municipal 1,452 ( 207 ) 6,560 ( 2,596 ) 8,012 ( 2,803 ) Corporate — — 4,600 ( 400 ) 4,600 ( 400 ) Asset-backed securities 6,156 ( 237 ) 1,555 ( 22 ) 7,711 ( 259 ) Mortgage-backed securities 22,067 ( 1,884 ) 10,642 ( 1,033 ) 32,709 ( 2,917 ) Total $ 111,777 $ ( 3,724 ) $ 140,704 $ ( 18,692 ) $ 252,481 $ ( 22,416 ) 92 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 3 - Investment Securities (continued) At December 31, 2023 management determined the Company does not have the intent to sell, nor is it more likely than not that it will be required to sell, available-for-sale debt securities in an unrealized loss position at December 31, 2023 before it is able to recover the amortized cost basis. Further, management reviewed the Company’s holdings as of December 31, 2023 and concluded there were no credit-related declines in fair value. Additional information related to the types of securities held at December 31, 2023, other than securities issued or guaranteed by U.S. Government entities or agencies, is as follows: Corporate Securities – There have been no payment defaults on any of the Company’s holdings of corporate debt securities. There are 5 securities all of which are subordinated debt of other financial institutions with face amounts ranging from $ 0.5 million to $ 2 million. Municipal Securities – All of the Company’s holdings of municipal bonds were investment grade and there have been no payment defaults. Summary ratings information at December 31, 2023, based on the amortized cost basis and reflecting the lowest enhanced or underlying rating by Moody’s, Standard & Poors or Fitch, is as follows: AAA – 82 % of the portfolio; AA+ – 8 %; AA – 10 %. Asset-backed Securities – There were 3 investment grade asset-backed securities, and there have been no payment defaults on these securities. As such, it is deemed the above listed securities are not in an unrealized loss position due to credit-related issues and no further analysis is warranted as of December 31, 2023. Note 4 - SBA-PPP Loans SBA-PPP gross loans receivable totaled $ 0.7 million and $ 2.2 million at December 31, 2023 and 2022, respectively and were all rated as pass credits and were not past due, nonaccrual or otherwise impaired. Unearned net fees associated with the SBA-PPP loans amounted to $ 15.3 thousand and $ 31.0 thousand at December 31, 2023 and 2022, respectively. SBA-PPP loans generated income of $ 29.5 thousand for the year ended December 31, 2023 and $ 3.5 million for the year ended December 31, 2022, of which, earned fees, primarily on loans forgiven by the SBA, represented $ 15.7 thousand and $ 3.2 million of the income, respectively. 93 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 5 - Portfolio Loans Receivable and Allowance for Credit Losses The following is a summary of the major categories of total loans outstanding: December 31, 2023 2022 (in thousands) Amount Percent Amount Percent Real estate: Residential $ 573,104 30 % $ 484,735 28 % Commercial 684,229 35 664,551 38 Construction 290,108 15 238,099 14 Commercial and Industrial 238,548 13 220,221 13 Credit card, net of reserve (1) 123,331 7 128,434 7 Other consumer 950 — 1,179 — Portfolio loans receivable, gross 1,910,270 100 % 1,737,219 100 % Deferred origination fees, net ( 7,627 ) ( 8,627 ) Allowance for credit losses ( 28,610 ) ( 26,385 ) Portfolio loans receivable, net $ 1,874,033 $ 1,702,207 (1) Credit card loans are presented net of reserve for interest and fees. During the year ended December 31, 2023 the Company recorded a $ 284 thousand increase to the ACL, reflected in “Other,” from residual non-accretable discounts on acquired loans post CECL adoption. The following tables set forth the changes in the ACL and an allocation of the ACL by loan segment class for the year ended December 31, 2023 and the activity in the allowance for loan losses by loan segment class for the year ended December 31, 2022. Beginning Balance, Prior to Adoption of the CECL Standard Impact of Adopting the CECL Standard Other Provision (Release of Provision) for Credit Losses Charge-Offs Recoveries Ending Balance (in thousands) Year Ended December 31, 2023 Real estate: Residential $ 5,481 $ ( 1,198 ) $ 91 $ 1,814 $ ( 670 ) $ — $ 5,518 Commercial 8,098 3,941 193 ( 1,075 ) ( 943 ) 102 10,316 Construction 3,782 ( 1,973 ) — 462 — — 2,271 Commercial and Industrial 2,935 1,073 — 475 ( 98 ) 21 4,406 Credit card 6,078 ( 1,045 ) — 7,939 ( 7,076 ) 191 6,087 Other consumer 11 6 — ( 5 ) — — 12 Total $ 26,385 $ 804 $ 284 $ 9,610 $ ( 8,787 ) $ 314 $ 28,610 94 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 5 - Portfolio Loans Receivable and Allowance for Credit Losses (continued) (in thousands) Beginning Balance Provision (Release of Provision) for Loan Losses Charge-Offs Recoveries Ending Balance Year Ended December 31, 2022 Real estate: Residential $ 5,612 $ ( 131 ) $ — $ — $ 5,481 Commercial 8,566 ( 468 ) — — 8,098 Construction 4,699 ( 900 ) ( 17 ) — 3,782 Commercial and Industrial 2,637 298 — — 2,935 Credit card 3,655 7,833 ( 5,461 ) 51 6,078 Other consumer 12 ( 1 ) — — 11 Total $ 25,181 $ 6,631 $ ( 5,478 ) $ 51 $ 26,385 The following tables present a summary of loan balances and the related allowance for loan losses summarized by loan category for each impairment method used as of December 31, 2022. (in thousands) Allowance for Loan Losses Ending Balance Evaluated for Impairment: Outstanding Portfolio Loan Balances Evaluated for Impairment: December 31, 2022 Individually Collectively Individually Collectively Real estate: Residential $ — $ 5,481 $ 4,288 $ 480,447 Commercial — 8,098 1,563 662,988 Construction — 3,782 2,837 235,262 Commercial and Industrial 372 2,563 705 219,516 Credit card — 6,078 — 128,434 Other consumer — 11 — 1,179 Total $ 372 $ 26,013 $ 9,393 $ 1,727,826 95 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 5 - Portfolio Loans Receivable and Allowance for Credit Losses (continued) Past due loans, segregated by age and class of loans, as of December 31, 2023 and 2022 were as follows: Portfolio Loans Past Due Loans 90 or More Days Past Due Total Past Due Loans Current Loans Total Portfolio Loans Accruing Loans 90 or More days Past Due Nonaccrual Loans Loans 30-59 Days Past Due Loans 60-89 Days Past Due (in thousands) December 31, 2023 Real estate: Residential $ 2,201 $ 3,096 $ 11,066 $ 16,363 $ 556,741 $ 573,104 $ 17 $ 11,398 Commercial 1,577 322 582 2,481 681,748 684,229 — 582 Construction — 1,165 3,296 4,461 285,647 290,108 — 3,288 Commercial and Industrial 1,356 74 454 1,884 236,664 238,548 — 774 Credit card 7,767 6,877 519 15,163 108,168 123,331 519 — Other consumer — — — — 950 950 — — Total $ 12,901 $ 11,534 $ 15,917 $ 40,352 $ 1,869,918 $ 1,910,270 $ 536 $ 16,042 December 31, 2022 Real estate: Residential $ 4 $ 142 $ 4,284 $ 4,430 $ 480,305 $ 484,735 $ — $ 4,288 Commercial — — 1,563 1,563 662,988 664,551 — 1,563 Construction 1,164 640 2,837 4,641 233,458 238,099 — 2,837 Commercial and Industrial 117 386 569 1,072 219,149 220,221 — 705 Credit card 8,473 7,455 363 16,291 112,143 128,434 363 — Other consumer — — — — 1,179 1,179 — — Total $ 9,758 $ 8,623 $ 9,616 $ 27,997 $ 1,709,222 $ 1,737,219 $ 363 $ 9,393 There were $ 8.1 million and $ 1.3 million, respectively, of loans secured by one-to-four family residential properties in the process of foreclosure as of December 31, 2023 and 2022. The following presents the nonaccrual loans as of December 31, 2023 and December 31, 2022: December 31, 2023 December 31, 2022 Nonaccrual with No Allowance for Credit Loss Nonaccrual with an Allowance for Credit Loss Total Nonaccrual Loans Interest Recognized on Nonaccrual Loans Total Nonaccrual Loans (in thousands) Real estate: Residential $ 11,152 $ 246 $ 11,398 $ 236 $ 4,288 Commercial 582 — 582 46 1,563 Construction 3,288 — 3,288 185 2,837 Commercial and Industrial 598 176 774 71 705 Total $ 15,620 $ 422 $ 16,042 $ 538 $ 9,393 The Company has certain loans for which repayment is dependent upon the operation or sale of collateral, as the borrower is experiencing financial difficulty. The underlying collateral can vary based upon the type of loan. The following provides more detail about the types of collateral that secure collateral dependent loans: • Residential real estate loans are primarily secured by owner-occupied primary residences and, to a lesser extent, investor-owned residences. 96 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 5 - Portfolio Loans Receivable and Allowance for Credit Losses (continued) • Commercial real estate loans can be secured by either owner-occupied commercial real estate or non-owner-occupied investment commercial real estate. Typically, owner-occupied commercial real estate loans are secured by office buildings, warehouses, manufacturing facilities and other commercial and industrial properties occupied by operating companies. Non-owner-occupied commercial real estate loans are generally secured by office buildings and complexes, retail facilities, multifamily complexes, land under development, industrial properties, as well as other commercial or industrial real estate. • Construction loans are typically secured by owner-occupied commercial real estate or non-owner-occupied investment real estate. Typically, owner occupied construction loans are secured by office buildings, warehouses, manufacturing facilities, and other commercial and industrial properties that are in process of construction. Non-owner-occupied commercial construction loans are generally secured by office buildings and complexes, multi-family complexes, land under development, and other commercial and industrial real estate in process of construction. • Commercial and industrial loans are generally secured by equipment, inventory, accounts receivable, and other commercial property. Collateral dependent loans amortized cost (in thousands) December 31, 2023 Real estate: Residential $ 11,152 Commercial 582 Construction 3,288 Commercial and Industrial 657 Total $ 15,679 Of the collateral dependent loans as of December 31, 2023, a specific reserve of $ 115 thousand was assessed for commercial and industrial loans. The Company had no modifications on loans to borrowers experiencing financial difficulty during the year ended December 31, 2023. Prior to the adoption of the CECL standard, loans were considered impaired when, based on current information, management believed the Company would not collect all principal and interest payments according to contractual terms. Generally, loans were reviewed for impairment when the risk grade for a loan was downgraded to a classified asset category. For loans that were classified as impaired, an allowance was established when the collateral value, if the loan was collateral dependent, or the discounted cash flows of the impaired loan was lower than the carrying value of the loan. Loans were generally charged-off in part or in full when management determined the loan to be uncollectible. The following table presents information related to impaired loans by class of loans as of and for the years ended December 31, 2022: Unpaid Contractual Principal Balance Recorded Investment with no Allowance Recorded Investment with Allowance Total Recorded Investment Related Allowance Average Recorded Investment Interest Recognized (in thousands) December 31, 2022 Real estate: Residential $ 4,476 $ 4,288 $ — $ 4,288 $ — $ 4,629 $ 149 Commercial 1,647 1,563 — 1,563 — 1,656 52 Construction 2,939 2,837 — 2,837 — 2,938 75 Commercial and Industrial 899 247 458 705 372 1,199 77 Total $ 9,961 $ 8,935 $ 458 $ 9,393 $ 372 $ 10,422 $ 353 97 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 5 - Portfolio Loans Receivable and Allowance for Credit Losses (continued) Credit quality indicators As part of the ongoing monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends related to the risk grade of loans, the level of classified loans, net charge-offs, nonperforming loans, and general economic conditions in the Company’s market. From a credit risk standpoint, the Company utilizes a risk grading matrix to assign a risk grade to each of its loans. The classifications of loans reflect a judgment about the risk of expected credit loss associated with each loan. Credit quality indicators are reviewed and adjusted regularly to account for the degree of risk and expected credit loss that the Company believes to be appropriate for each financial asset. A description of the general characteristics of loans characterized as classified is as follows: Pass Loans characterized as pass includes loans graded exceptional, very good, good, satisfactory and pass/watch. The Company believes that there is a low likelihood of credit deterioration related to those loans that are considered pass. Special Mention A special mention loan 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 Company’s credit position at some future date. Special mention loans are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification. Borrowers may exhibit poor liquidity and leverage positions resulting from generally negative cash flow or negative trends in earnings. Access to alternative financing may be limited to finance companies for business borrowers and may be unavailable for commercial real estate borrowers. 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. Substandard loans have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Borrowers may exhibit recent or unexpected unprofitable operations, an inadequate debt service coverage ratio, or marginal liquidity and capitalization. These loans require more intense supervision by Company management. Doubtful A doubtful loan has all the weaknesses associated with a substandard loan with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The following table presents the balances of classified loans based on the most recent credit quality indicator analysis. Classified loans include Special Mention, Substandard and Doubtful loans. Pass classified loans include loans graded exceptional, very good, good, satisfactory, and pass/watch. Credit card loans are ungraded as they are not individually graded. Charge-offs presented represent gross charge-offs recognized in the current period: 98 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 5 - Portfolio Loans Receivable and Allowance for Credit Losses (continued) December 31, 2023 Term Loans by Origination Year (in thousands) 2023 2022 2021 2020 2019 Prior Revolving Total Residential – Real estate Pass $ 140,394 $ 137,362 $ 76,556 $ 76,938 $ 36,122 $ 88,055 $ — $ 555,427 Special Mention — — 134 3,670 1,176 288 — 5,268 Substandard — 33 — — 26 12,350 — 12,409 Doubtful — — — — — — — — Total 140,394 137,395 76,690 80,608 37,324 100,693 — 573,104 Commercial – Real estate Pass 62,095 185,776 145,756 68,748 96,238 116,347 — 674,960 Special Mention — 6,897 — — 805 985 — 8,687 Substandard — — — — 582 — — 582 Doubtful — — — — — — — — Total 62,095 192,673 145,756 68,748 97,625 117,332 — 684,229 Construction – Real estate Pass 142,157 72,240 46,180 16,859 6,246 2,517 — 286,199 Special Mention — — — — — 614 — 614 Substandard — — — 1,254 597 1,444 — 3,295 Doubtful — — — — — — — — Total 142,157 72,240 46,180 18,113 6,843 4,575 — 290,108 Commercial and Industrial Pass 70,540 71,689 27,884 8,827 18,036 37,392 — 234,368 Special Mention — 156 — 2,406 47 273 — 2,882 Substandard 30 814 211 — 42 201 — 1,298 Doubtful — — — — — — — — Total 70,570 72,659 28,095 11,233 18,125 37,866 — 238,548 Other consumer Pass 75 278 147 116 — 334 — 950 Special Mention — — — — — — — — Substandard — — — — — — — — Doubtful — — — — — — — — Total 75 278 147 116 — 334 — 950 Credit card Ungraded — — — — — — 123,331 123,331 Portfolio loans receivable, gross $ 415,291 $ 475,245 $ 296,868 $ 178,818 $ 159,917 $ 260,800 $ 123,331 $ 1,910,270 December 31, 2023 (in thousands) 2023 2022 2021 2020 2019 Prior Revolving Total Gross Charge-offs Residential $ — $ — $ — $ — $ — $ 670 $ — $ 670 Commercial — — — — 943 — — 943 Commercial and Industrial — 98 — — — — — 98 Credit card — — — — — — 7,076 7,076 Total $ — $ 98 $ — $ — $ 943 $ 670 $ 7,076 $ 8,787 99 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 5 - Portfolio Loans Receivable and Allowance for Credit Losses (continued) The following table presents the balances of classified loans based on the credit quality indicator: (in thousands) Pass (1) Special Mention Substandard Doubtful Ungraded (2) Total December 31, 2022 Real estate: Residential $ 469,304 $ 9,966 $ 5,465 $ — $ — $ 484,735 Commercial 657,411 5,577 1,563 — — 664,551 Construction 235,262 — 2,837 — — 238,099 Commercial and Industrial 196,381 22,469 1,371 — — 220,221 Credit card — — — — 128,434 128,434 Other consumer 1,179 — — — — 1,179 Portfolio loans receivable, gross $ 1,559,537 $ 38,012 $ 11,236 $ — $ 128,434 $ 1,737,219 ________________________ (1) Pass includes loans graded exceptional, very good, good, satisfactory and pass/watch in addition to credit cards and consumer credits that are not individually graded. (2) Credit card loans are not individually graded. Certain loans have been modified where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties disclosed as troubled debt restructurings (“TDRs”). These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after confirmation of the borrower’s sustained repayment performance for a reasonable period, generally six months . The status of TDRs is as follows: Number of Contracts Recorded Investment (dollars in thousands) Performing Nonperforming Total December 31, 2022 Real estate: Residential 1 $ — $ 288 $ 288 Total 1 $ — $ 288 $ 288 At December 31, 2022 the Company had one defaulted TDR for $ 288 thousand. In the 12 months ending December 31, 2022, four TDRs, totaling $ 215 thousand paid off. 100 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 5 - Portfolio Loans Receivable and Allowance for Credit Losses (continued) Outstanding loan commitments were as follows: December 31, (in thousands) 2023 2022 Unused lines of credit Real Estate: Residential $ 15,436 $ 14,336 Residential - Home Equity 43,892 43,128 Commercial 20,424 36,609 Construction 98,777 93,913 Commercial and Industrial 42,751 45,747 Credit card (1) 114,882 111,227 Other consumer 310 102 Total $ 336,472 $ 345,062 Letters of credit $ 4,641 $ 5,105 _______________ (1) Outstanding loan commitments in the credit card portfolio include $ 98.2 million and $ 106.9 million in secured and partially secured balances as of December 31, 2023 and 2022, respectively. Lines of credit are agreements to lend to a customer as long as there is no violation of any condition of the contract. Lines of credit generally have variable interest rates. Such lines do not represent future cash requirements because it is unlikely that all customers will, at any given time, draw upon their lines in full. Loan commitments generally have variable interest rates, fixed expiration dates, and may require payment of a fee. The Company's maximum exposure to credit loss in the event of nonperformance by the customer is the contractual amount of the credit commitment. Loan commitments and lines of credit are generally made on the same terms, including with regard to collateral, as outstanding loans. Management is not aware of any accounting loss to be incurred by funding these loan commitments. The Company maintains an estimated reserve for unfunded commitments and certain off-balance sheet items such as unfunded lines of credit, which is reflected in other liabilities, with increases or decreases in the reserve being charged to or released from operating expense. Activity for this account is as follows for the periods presented: (in thousands) 2023 2022 Balance at beginning of period $ 1,682 $ 1,736 Impact of adopting the CECL standard on January 1, 2023 ( 775 ) — Release of credit losses on unfunded commitments ( 101 ) ( 54 ) Balance at end of period $ 806 $ 1,682 The Company makes representations and warranties that loans sold to investors meet the investors’ program guidelines and that the information provided by the borrowers is accurate and complete. In the event of a default on a loan sold, the investor may have the right to make a claim for losses due to document deficiencies, program non-compliance, early payment default, and fraud or borrower misrepresentations. 101 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 5 - Portfolio Loans Receivable and Allowance for Credit Losses (continued) The Company maintains a reserve for potential losses on mortgage loans sold, which is reflected in other liabilities, with changes being charged to or released from a provision for credit loss expense. During the year ended December 31, 2022, this increase or decrease in reserve activity was included in other operating expense. Activity in this reserve is as follows for the periods presented: (in thousands) 2023 2022 Balance at beginning of period $ 1,173 $ 1,164 (Release of) provision for mortgage loan put-back reserve ( 188 ) 9 Balance at end of period $ 985 $ 1,173 Note 6 - Premises and Equipment Year end premises and equipment owned and utilized in the operations of the Company and the related depreciation and amortization expense were as follows: (in thousands) 2023 2022 Leasehold improvements $ 2,710 $ 1,683 Furniture and equipment 4,926 4,775 Vehicle 54 54 Software 2,517 2,517 Construction in progress 33 694 10,240 9,723 Less: Accumulated depreciation and amortization ( 8,758 ) ( 8,434 ) Premises and equipment 1,482 1,289 Net lease asset 3,587 2,097 Premises and equipment, net $ 5,069 $ 3,386 Depreciation and amortization expense $ 324 $ 364 Note 7 - Leases The Company’s primary leasing activities relate to certain real estate leases entered into in support of the Company’s branch operations and back office operations. The Company leases four of its full service branches and four other locations for corporate/administration activities, operations, and loan production. All property leases under lease agreements have been designated as operating leases. The Company does not have leases designated as finance leases. 102 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 7 - Leases (continued) The Company determines if an arrangement is a lease at inception. Operating lease right-of-use (“ROU”) assets are included in premises and equipment, and operating lease liabilities are included as other liabilities in the consolidated balance sheets. ROU assets represent the right to use an underlying asset for the lease term and lease liabilities represent the obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As the Company's leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The historical weighted average discount rate used was 3.79 % at December 31, 2023 and 1.94 % at December 31, 2022. The operating lease ROU asset also includes any lease pre-payments. The Company's lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. The Company has lease agreements with lease and non-lease components, which the Company has elected to account for separately as the non-lease component amounts are readily determinable under most leases. As of December 31, 2023, the Company’s net lease ROU assets and related lease liabilities were $ 3.6 million and $ 3.8 million, respectively, and have remaining terms ranging from one to nine years , including extension options that the Company is reasonably certain will be exercised. As of December 31, 2023, the Company had not entered into any material leases that have not yet commenced. The Company’s lease information is summarized as follows: (in thousands) 2023 2022 Lease Right-of-Use Asset Lease asset $ 6,810 $ 5,171 Less: Accumulated amortization ( 3,223 ) ( 3,074 ) Net lease asset $ 3,587 $ 2,097 Lease Liability Lease liability $ 6,892 $ 5,327 Less: Accumulated amortization ( 3,101 ) ( 2,968 ) Net lease liability $ 3,791 $ 2,359 Future minimum payments for operating leases with initial or remaining terms of one year or more are as follows at December 31, 2023: (in thousands) 2023 Amounts due in: 2024 $ 1,161 2025 715 2026 665 2027 396 2028 266 thereafter 1,182 Total future lease payments 4,385 Discount of cash flows ( 594 ) Present value of net future lease payments $ 3,791 Operating lease and rent expense totaled $ 1.3 million for both the years ended December 31, 2023 and 2022. 103 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 8 - Derivative Financial Instruments As part of its mortgage banking activities, the Company enters into interest rate lock commitments, which are commitments to originate loans whereby the interest rate on the loan is determined prior to funding and customers have locked into that interest rate. The Company then locks the loan and rate in with an investor and commits to deliver the loan if settlement occurs (Best Efforts). Certain loans under rate lock commitments are covered under forward sales contracts. Forward sales contracts are recorded at fair value with changes in fair value recorded in mortgage banking revenue. Interest rate lock commitments and commitments to deliver loans to investors are considered to be derivatives. The market value of interest rate lock commitments and best efforts contracts are not readily ascertainable with precision because they are not actively traded in stand-alone markets. The Company determines the fair value of rate lock commitments by estimating the fair value of the underlying asset, which is impacted by current interest rates and takes into consideration the probability that the rate lock commitments will close or will be funded. The following table reports the commitment and fair value amounts on the outstanding derivatives: (in thousands) December 31, 2023 December 31, 2022 Notional amount of open forward sales agreements $ — $ 1,750 Fair value of open forward delivery sales agreements — 9 Notional amount of interest rate lock commitments — 626 Fair value of interest rate lock commitments — 1 Note 9 - Deposits Time deposits that meet or exceed the FDIC Insurance Limit of $250,000 at year-end 2023 and 2022 were $ 124.7 million and $ 96.3 million. Scheduled maturities of time deposits for the next five years were as follows: (in thousands) 2024 $ 350,658 2025 58,400 2026 1,425 2027 402 2028 69 Total $ 410,954 104 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 10 - Borrowed Funds As of December 31, 2023 and 2022, the Company was indebted as follows: 2023 2022 (dollars in thousands) Balance Interest Balance Interest FHLB fixed rate advance due October 16, 2025 $ 22,000 0.93 % $ 22,000 0.93 % FHLB fixed rate advance due March 20, 2023 — — 50,000 4.42 FHLB daily rate advance due September 13, 2023 — — 35,000 4.57 Total - FHLB advances $ 22,000 0.93 % $ 107,000 3.75 % Junior subordinated debentures due June 15, 2036 $ 2,062 7.52 % $ 2,062 6.64 % Other subordinated notes due November 30, 2030 10,000 5.00 10,000 5.00 Bank Term Funding Program borrowings 15,000 4.84 — — Total - Other borrowed funds $ 27,062 5.10 % $ 12,062 5.28 % The FHLB fixed rate advances accrue interest on a daily basis and are paid semi-annually. Junior subordinated debentures In June 2006, the Company formed Capital Bancorp (MD) Statutory Trust I (the “Trust”) and on June 15, 2006, the Trust issued 2,000 floating rate capital securities (the “Capital Securities”) with an aggregate liquidation value of $ 2.0 million to a third party in a private placement. Concurrent with the issuance of the Capital Securities, the Trust issued trust common securities to the Company in the aggregate liquidation value of $ 62 thousand. The proceeds of the issuance of the Capital Securities and trust common securities were invested in the Company’s Floating Rate Junior Subordinated Deferrable Interest Debentures (the “Floating Rate Debentures”). The Floating Rate Debentures for the Trust will mature on June 15, 2036, which may be shortened if certain conditions are met (including the Company having received prior approval of the Board of Governors of the Federal Reserve System and any other required regulatory approvals). These Floating Rate Debentures, which are the only assets of the Trust, are subordinate and junior in right of payment to all present and future senior indebtedness (as defined in the Indenture dated June 15, 2006) of the Company. The Floating Rate Debentures for the Trust accrue interest at a floating rate equal to the three-month CME Term SOFR plus a spread adjustment of 0.26161% (or 26.161 basis points) plus 187 basis points, payable quarterly. As of December 31, 2023 and 2022, the rate for the Trust was 7.52 % and 6.64 %, respectively. The quarterly distributions on the Capital Securities will be paid at the same rate that interest is paid on the Floating Rate Debentures. The Company has fully and unconditionally guaranteed the Trust’s obligation under the Capital Securities. The Trust must redeem the Capital Securities when the Floating Rate Debentures are paid at maturity or upon any earlier prepayment of the Floating Rate Debentures. The Floating Rate Debentures may be prepaid if certain events occur, including a change in the tax status or regulatory capital treatment of the Capital Securities, or a change in existing laws that requires the Trust to register as an investment company. The junior subordinated debentures are treated as Tier 1 capital by the Company, to a limited extent, by the Federal Reserve. 105 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 10 - Borrowed Funds (continued) Other subordinated notes On November 30, 2020, the Company issued $ 10.0 million of subordinated notes (the “Notes”). The Notes mature on November 30, 2030 and are redeemable in whole or part on November 30, 2025. The Notes bear interest at a fixed annual rate of 5.00 % for the first five years , then adjust quarterly to an interest rate per annum equal to a benchmark rate, which is expected to be the three-month SOFR, plus 490 basis points. There were related debt issuance costs incurred totaling $ 50,000 which were fully expensed at the time of issuance. The Company used the proceeds from the Notes to redeem the outstanding $ 13.5 million, 6.95 % fixed-to-floating rate subordinated notes issued in November 2015 and called on December 1, 2020. Federal Reserve’s Bank Term Funding Program On March 12, 2023, in response to liquidity concerns in the banking system, the Federal Deposit Insurance Corporation, Federal Reserve and U.S. Department of Treasury, collaboratively approved certain actions with a stated intention to reduce stress across the financial system, support financial stability and minimize any impact on business, households, taxpayers, and the broader economy. Among other actions, the Federal Reserve Board has created the BTFP to make additional funding available to eligible depository institutions to help assure institutions can meet the needs of their depositors. Eligible institutions may obtain liquidity against a wide range of collateral, at par value. BTFP advances can be requested through at least March 11, 2024. At December 31, 2023, the Company had $ 15.0 million of BTFP borrowings. In January 2024, the Company paid off the $ 15.0 million of BTFP borrowings. Available lines of credit The Company has available lines of credit of $ 76.0 million with other correspondent banks. There were no outstanding line of credit balances at December 31, 2023 and December 31, 2022. The Company may borrow up to 25 % of its assets from the FHLB, based on collateral available to pledge to secure the borrowings. Borrowings from the FHLB are secured by a portion of the Company’s loan and/or investment portfolio. As of December 31, 2023 and 2022, the Company had pledged loans providing borrowing capacity of $ 313.5 million and $ 330.8 million, respectively. The Company did no t have any pledged investment securities to the FHLB at December 31, 2023 or December 31, 2022. As of December 31, 2023 and 2022, the Company had available borrowing capacity, net of advances and amounts pledged for letters of credit, from the FHLB of $ 291.5 million and $ 223.8 million, respectively. As of December 31, 2023 and 2022, the Company had pledged commercial loans to the Federal Reserve Bank of Richmond to secure a borrowing capacity totaling $ 16.6 million and $ 21.4 million, respectively, under its discount window program. The Company limits its certificate of deposit funding through financial networks to 15 % of the Bank’s assets, or approximately $ 326.5 million and $ 310.5 million as of December 31, 2023 and 2022, respectively. The Company had $ 142.4 million outstanding as of December 31, 2023 and $ 131.8 million outstanding as of December 31, 2022. Note 11 - Retirement Plans The Company provides a defined contribution plan qualifying under Section 401(k) of the Internal Revenue Code to eligible employees. The Company contributes 3 % of eligible compensation on behalf of all full‑time employees up to limits prescribed by the Internal Revenue Code. The Company’s contribution to the plan was $ 1.0 million in 2023 and $ 850 thousand in 2022. 106 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 11 - Retirement Plans (continued) The Bank adopted a Long-Term Incentive Plan (“LTIP”) for executive management members in 2021. The LTIP is in the form of a nonqualified deferred compensation plan and complies with Internal Revenue Code Section 409A as well as related guidance and regulations. The LTIP was introduced in order to align long-term interests of the Bank with the Bank’s key executive management members. Under the LTIP, the CEO is eligible to earn an annual contribution of 20 % of salary for achieving targeted performance levels while other executive management members are eligible to earn an annual contribution of 15 % of salary for achieving targeted performance levels. The Compensation Committee may award more for overachievement of the targets, and all targets are set for participants at the beginning of a fiscal year. All participants are subject to the following vesting schedule for any earnings (or losses) on the investment of the contribution: 100 % vesting following completion of either (i) ten years of service by the applicable executive from the later of the effective date of the LTIP or the executive’s hire date or (ii) ten years of continuous, full-time employment with the Bank by the applicable executive (to include continuous employment prior to the effective date of the LTIP) and retirement, which is defined in the LTIP as the later of a participant’s separation from service or the executive attaining 67 years of age. In the event of a change in control, the LTIP will accelerate vesting. Any executive not fulfilling either vesting requirement will forfeit any employer contributions. Note 12 - Related-Party Transactions Certain executive officers and directors of the Company and Bank, and companies with which they are affiliated, are clients of and have banking transactions with the Company in the ordinary course of business. These transactions are conducted on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with persons not related to the Company. Activity in related-party loans during 2023 and 2022 is shown below: (in thousands) 2023 2022 Balance at beginning of year $ 36,305 $ 32,524 Add: New loans — 18,326 Less: Amounts collected ( 4,231 ) ( 14,545 ) Balance at end of year $ 32,074 $ 36,305 Deposits from officers and directors and their related interests were $ 81.3 million at December 31, 2023, and $ 92.0 million at December 31, 2022. A director of the Company owns an interest in an entity from which the Company leases space for one of its Rockville, Maryland locations. Payments made in accordance with the lease were $ 85 thousand and $ 82 thousand in 2023 and 2022, respectively. Company directors, or their related interests, held $ 2.5 million of the subordinated notes outstanding as of December 31, 2023. These notes hold a fixed rate of interest until November 30, 2025, after which it converts to variable rate. 107 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 13 - Income Taxes Income tax expense was as follows: For the Years Ended December 31, (in thousands) 2023 2022 Current expense Federal $ 8,192 $ 9,906 State 2,020 1,284 Total current expense 10,212 11,190 Deferred tax expense (benefit) 142 1,240 Total income tax expense $ 10,354 $ 12,430 The components of the net deferred tax asset at December 31, 2023 and 2022 were: (in thousands) 2023 2022 Deferred tax assets: Allowance for credit losses $ 7,230 $ 7,073 Reserve for recourse on mortgage loans sold 242 297 Deferred loan fees - PPP — 8 Stock-based compensation 309 257 Long-term incentive program 372 428 Unrealized loss on investment securities available for sale 4,253 5,665 Other 61 85 12,467 13,813 Deferred tax liabilities: Accumulated depreciation 214 34 Other 1 2 215 36 Net deferred tax asset $ 12,252 $ 13,777 The differences between the federal income tax rate and the effective tax rate for the Company are reconciled as follows: 2023 2022 Statutory federal income tax rate 21.00 % 21.00 % Increase (decrease) resulting from: State income taxes, net of federal income tax benefit 3.13 2.58 Nondeductible expenses 0.73 0.56 Tax-exempt interest income and dividend income ( 0.55 ) ( 0.41 ) Stock-based compensation expense ( 0.68 ) ( 0.48 ) Bank-owned life insurance ( 0.54 ) ( 0.40 ) Other, net ( 0.69 ) 0.10 Effective Tax Rate 22.40 % 22.95 % Deferred tax assets represent the future tax benefit of deductible differences and, if it is more likely than not that a tax asset will not be realized, a valuation allowance is required to reduce the net deferred tax assets to net realizable value. As of December 31, 2023, management has determined that it is more likely than not that the majority of the deferred tax asset from continuing operations will be realized. At December 31, 2023 and December 31, 2022, no valuation allowance was recognized. 108 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 13 - Income Taxes (continued) The Company does not have material uncertain tax positions and did not recognize any adjustments for unrecognized tax benefits. The Company remains subject to examination of income tax returns for the years ending after December 31, 2019. Note 14 - Regulatory Capital Matters The Company and Bank are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. The net unrealized gain or loss on available for sale securities is not included in computing regulatory capital. Management believes as of December 31, 2023, the Company and Bank meet all capital adequacy requirements to which they are subject. Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If not adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At year-end 2023 and 2022, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution’s category. Based on recent changes to the Federal Reserve’s definition of a “Small Bank Holding Company” that increased the threshold to $3 billion in assets, the Company is not currently subject to separate minimum capital measurements. At such time as the Company reaches the $3 billion asset level, it will again be subject to capital measurements independent of the Bank. For comparison purposes, the Company’s ratios are presented in the following table as well, all of which would have exceeded the “well-capitalized” level had the Company been subject to separate capital minimums. Actual and required capital amounts and ratios are presented below at year-end. 109 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 14 - Regulatory Capital Matters (continued) Regulatory Capital Actual Minimum Capital Adequacy To Be Well Capitalized (dollars in thousands) Amount Ratio Amount Ratio Amount Ratio December 31, 2023 The Company Tier 1 leverage ratio (to average assets) $ 270,019 12.14 % $ 89,004 4.00 % N/A N/A Tier 1 capital (to risk-weighted assets) 270,019 15.55 % 104,175 6.00 % N/A N/A Common equity tier 1 capital ratio (to risk-weighted assets) 267,957 15.43 % $ 78,132 4.50 % N/A N/A Total capital ratio (to risk-weighted assets) 301,817 17.38 % $ 138,900 8.00 % N/A N/A The Bank Tier 1 leverage ratio (to average assets) $ 228,794 10.51 % $ 87,068 4.00 % $ 108,835 5.00 % Tier 1 capital (to risk-weighted assets) 228,794 13.56 % 101,251 6.00 % 135,001 8.00 % Common equity tier 1 capital ratio (to risk-weighted assets) 228,794 13.56 % 75,938 4.50 % 109,688 6.50 % Total capital ratio (to risk-weighted assets) 249,984 14.81 % 135,001 8.00 % 168,751 10.00 % December 31, 2022 The Company Tier 1 leverage ratio (to average assets) $ 242,829 11.24 % $ 86,442 4.00 % N/A N/A Tier 1 capital (to risk-weighted assets) 242,829 15.13 % 96,315 6.00 % N/A N/A Common equity tier 1 capital ratio (to risk-weighted assets) 240,767 15.00 % 72,237 4.50 % N/A N/A Total capital ratio (to risk-weighted assets) 262,217 16.33 % 128,421 8.00 % N/A N/A The Bank Tier 1 leverage ratio (to average assets) $ 199,846 9.47 % $ 84,416 4.00 % $ 105,521 5.00 % Tier 1 capital (to risk-weighted assets) 199,846 12.95 % 92,574 6.00 % 123,432 8.00 % Common equity tier 1 capital ratio (to risk-weighted assets) 199,846 12.95 % 69,431 4.50 % 100,289 6.50 % Total capital ratio (to risk-weighted assets) 219,234 14.21 % 123,432 8.00 % 154,290 10.00 % 110 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 15 - Stock-Based Compensation Compensation cost is recognized for stock options and restricted stock awards issued to 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, while the market price of the Company’s common stock at the date of grant is used as the fair value of restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period for stock option awards and as the restriction period for restricted stock awards. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. The expense recognition of employee stock option and restricted stock awards resulted in net expense of approximately $ 1.8 million and $ 1.8 million during the years ended December 31, 2023 and 2022, respectively. Stock options: The Company currently has two incentive compensation plans with outstanding stock options, the 2002 Stock Option Plan and the 2017 Stock and Incentive Compensation Plan (the “Plan”). Only the Plan, which authorizes the use of stock options, stock appreciation rights, restricted stock and/or restricted stock, is available to grant options and shares to employees and directors. At inception the Plan allowed for up to 1,120,000 shares of common stock to be issued. In 2021, an additional 900,000 shares were authorized for a total of 2,020,000 . As of December 31, 2023, there are 792,846 shares available for future grant. Shares of common stock related to any unexercised or unvested award granted under the Plan that terminate or expire, or are subsequently forfeited or cancelled for any reason, become available for re-grant under the Plan. Option prices are equal to or greater than the estimated fair value of the common stock at the date of grant. Options outstanding vest over a four-year period, whereby 25 % of the options become exercisable on each anniversary of the grant date. Information with respect to options outstanding during the years ended December 31, 2023 and 2022 is as follows: 2023 2022 Shares Weighted Average Exercise Price Shares Weighted Average Exercise Price Outstanding at beginning of year 811,160 $ 15.37 1,060,023 $ 14.77 Add: Granted 168,819 23.34 2,000 24.25 Less: Exercised ( 228,405 ) 11.96 ( 160,590 ) 12.46 Less: Retired on exercise ( 124,939 ) 12.29 ( 63,697 ) 12.52 Less: Expired/cancelled/forfeited ( 75,917 ) 20.49 ( 26,576 ) 12.82 Outstanding at end of year 550,718 $ 19.21 811,160 $ 15.37 Exercisable at end of year 295,450 $ 16.69 538,066 $ 13.63 The weighted average fair value of options granted during the years ended December 31, 2023 and 2022, was $ 10.81 and $ 11.49 , respectively. 111 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 15 - Stock-Based Compensation (continued) A summary of information about stock options outstanding is as follows: Exercise Price Range Weighted Average Exercise Price Average Remaining Life (years) Outstanding Shares Exercisable Shares December 31, 2023 $ 10.70 - 14.63 $ 14.18 1.52 267,527 221,460 14.64 - 18.56 15.27 1.57 24,000 15,000 18.57 - 22.49 20.15 3.98 3,250 1,250 22.50 - 26.41 24.82 3.56 255,941 57,740 Total outstanding options $ 19.21 2.48 550,718 295,450 Intrinsic value on December 31, 2023 $ 2,999,807 $ 2,346,106 December 31, 2022 $ 10.70 - 14.63 $ 13.02 1.73 648,651 492,909 14.64 - 18.56 14.96 2.14 22,750 10,688 18.57 - 22.49 21.86 3.07 2,500 625 22.50 - 26.41 26.38 3.86 137,259 33,844 Total outstanding options $ 15.37 2.11 811,160 538,066 Intrinsic value on December 31, 2022 $ 7,020,560 $ 5,428,713 The aggregate intrinsic value as presented in the preceding tables is the difference between the estimated fair value of the stock as of December 31, 2023 and 2022, and the exercise price of the option multiplied by the number of options outstanding. Stock options with exercise prices greater than the estimated fair value of the stock are not included in this calculation. Total unrecognized compensation expense related to stock options to be recognized over the next five years was $ 1.4 million and $ 1.2 million at December 31, 2023 and 2022, respectively. The intrinsic value of stock options exercised was $ 1.9 million and $ 1.9 million during the years ended December 31, 2023 and 2022, respectively. The weighted average fair value of options granted during 2023 and 2022 were estimated using the Black-Scholes option-pricing model with the following weighted average assumptions: 2023 2022 Dividend yield 1.04 % 0.99 % Risk free interest rate 4.52 % 3.25 % Expected volatility 54.64 % 55.91 % Expected life in years 5 5 112 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 15 - Stock-Based Compensation (continued) Restricted stock: The Company from time-to-time also grants shares of restricted stock to key employees. These awards help align the interests of these employees with the interests of the stockholders of the Company by providing economic value directly related to increases in the value of the Company’s stock. These awards typically hold service requirements over various vesting periods. The value of the stock awarded is established as the fair market value of the stock at the time of the grant. The Company recognizes expense, equal to the total value of such awards, ratably over the vesting period of the stock grants. All restricted stock agreements are conditioned upon continued employment. Termination of employment prior to a vesting date, as described below, would terminate any interest in non-vested shares. All restricted shares will fully vest in the event of change in control of the Company. Nonvested restricted stock for the years ended December 31, 2023 and 2022 is summarized in the following table. 2023 2022 Shares Weighted Average Grant-Date Fair Value Shares Weighted Average Grant-Date Fair Value Nonvested at beginning of year 39,669 $ 17.45 49,047 $ 14.33 Add: Granted 10,714 25.77 11,495 24.66 Less: Vested ( 13,652 ) 15.92 ( 15,905 ) 14.01 Less: Retired on vesting ( 8,555 ) 16.46 ( 4,968 ) 14.44 Nonvested at end of year 28,176 $ 21.66 39,669 $ 17.45 The vesting schedule of restricted shares as of December 31, 2023 is as follows: Year Shares 2024 17,203 2025 7,403 2026 3,570 28,176 There was $ 78 thousand and $ 429 thousand of total unrecognized compensation expense related to nonvested restricted stock at December 31, 2023 and 2022, respectively. 113 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 16 - Parent Company Financial Information The balance sheets as of December 31, 2023 and 2022 and statements of income and cash flows for the years then ended, for Capital Bancorp, Inc. (Parent only) are presented below. Parent Company Only Balance Sheets (in thousands) 2023 2022 Assets Cash and cash equivalents $ 3,499 $ 272 Investment in Bank 215,698 183,095 Investment in Church Street Capital 6,574 5,402 Investment in Trust 62 62 Loans receivable, net of allowance for credit losses of $ 416 and $ 328 at December 31, 2023 and 2022, respectively 41,310 47,517 Accrued interest receivable 370 288 Deferred income taxes 165 100 Other assets 21 45 Total assets $ 267,699 $ 236,781 Liabilities and Stockholders’ Equity Borrowed funds $ 12,062 $ 12,062 Accrued interest payable 299 48 Other liabilities 478 656 Total liabilities 12,839 12,766 Stockholders’ equity Common stock 139 141 Additional paid-in capital 54,473 58,190 Retained earnings 213,345 182,435 Accumulated other comprehensive loss ( 13,097 ) ( 16,751 ) Total stockholders’ equity 254,860 224,015 Total liabilities and stockholders’ equity $ 267,699 $ 236,781 Parent Company Only Statements of Income (in thousands) 2023 2022 Interest and dividend income $ 2,646 $ 2,146 Dividend from Bank 6,500 11,400 Total interest and dividend revenue 9,146 13,546 Interest expense 649 576 Net interest income 8,497 12,970 Provision for credit losses 88 — Net interest income after provision for credit losses 8,409 12,970 Noninterest income 4 2 Noninterest expenses 629 447 Income before income taxes 7,784 12,525 Income tax expense 304 315 Income before undistributed net income of subsidiaries 7,480 12,210 Undistributed net income of subsidiaries 28,391 29,594 Net income $ 35,871 $ 41,804 114 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 16 - Parent Company Financial Information (continued) Parent Company Only Statements of Cash Flows (in thousands) 2023 2022 Cash flows from operating activities Net Income $ 35,871 $ 41,804 Adjustments to reconcile net income to net cash provided by operating activities: Provision for credit losses 88 — Undistributed net income of subsidiaries ( 28,391 ) ( 29,594 ) Stock-based compensation expense 1,757 1,662 Director and employee compensation paid in Company stock 547 171 Deferred income tax benefit ( 65 ) — Changes in assets and liabilities: Accrued interest receivable ( 82 ) ( 71 ) Other assets 24 ( 31 ) Accrued interest payable 251 4 Other liabilities 597 528 Net cash provided by operating activities 10,597 14,473 Cash flows from investing activities Net decrease (increase) in portfolio loans receivable 5,314 ( 11,319 ) Capital contributions to subsidiaries ( 1,729 ) ( 1,662 ) Net cash provided (used) by investing activities 3,585 ( 12,981 ) Cash flows from financing activities Dividends paid ( 3,920 ) ( 3,085 ) Repurchase of common stock ( 8,826 ) — Net proceeds from exercise of stock options 1,791 1,235 Net cash used by financing activities ( 10,955 ) ( 1,850 ) Net increase (decrease) in cash and cash equivalents 3,227 ( 358 ) Cash and cash equivalents, beginning of year 272 630 Cash and cash equivalents, end of year $ 3,499 $ 272 115 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 17 - Fair Value Fair value is the exchange price that would be received for an asset or paid to transfer a liability (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. There are three levels of inputs that may be used to measure fair values: Level 1 - Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. This includes certain U.S. Treasury and other U.S. Government and government agency securities actively traded in over-the-counter markets; Level 2 - Significant other 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. Level 3 - Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability. The Company used the following methods and significant assumptions to estimate fair value on a recurring basis: Investment securities available for sale - The fair values for investment securities available for sale are provided by an independent pricing service and are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2), using matrix pricing. Matrix pricing is a mathematical technique commonly used to price debt securities that are not actively traded, values debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Loans held for sale - The fair value of loans held for sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan (Level 2). Derivative financial instruments - The fair values of derivatives are based on valuation models using observable market data as of the measurement date (Level 2). Our derivatives are traded in an over-the-counter market where quoted market prices are not always available. Therefore, the fair values of derivatives are determined using quantitative models that utilize multiple market inputs. The inputs will vary based on the type of derivative, but could include interest rates, prices and indices to generate continuous yield or pricing curves, prepayment rates, and volatility factors to value the position. The majority of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services. 116 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 17 - Fair Value (continued) The Company has categorized its financial instruments measured at fair value on a recurring basis as of December 31, 2023 and December 31, 2022 as follows: Fair Value Measurements Using: (in thousands) Total Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) December 31, 2023 Investment securities available for sale U.S. Treasuries $ 149,228 $ 149,228 $ — $ — Municipal 9,372 — 9,372 — Corporate 4,413 — 4,413 — Asset-backed securities 7,045 — 7,045 — Mortgage-backed securities 38,271 — 38,271 — Total $ 208,329 $ 149,228 $ 59,101 $ — Loans held for sale $ 7,481 $ — $ 7,481 $ — Derivative assets $ — $ — $ — $ — Derivative liabilities $ — $ — $ — $ — December 31, 2022 Investment securities available for sale U.S. Treasuries $ 199,449 $ 199,449 $ — $ — Municipal 8,012 — 8,012 — Corporate 4,600 — 4,600 — Asset-backed securities 7,711 — 7,711 — Mortgage-backed securities 32,709 — 32,709 — Total $ 252,481 $ 199,449 $ 53,032 $ — Loans held for sale $ 7,416 $ — $ 7,416 $ — Derivative assets $ 10 $ — $ 10 $ — Derivative liabilities $ — $ — $ — $ — Financial instruments recorded using FASB ASC 825-10 Under FASB ASC 825-10, the Company may elect to report most financial instruments and certain other items at fair value on an instrument-by-instrument basis with changes in fair value reported in net income. After the initial adoption, the election is made at the acquisition of an eligible financial asset, financial liability or firm commitment or when certain specified reconsideration events occur. The fair value election, with respect to an item, may not be revoked once an election is made. 117 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 17 - Fair Value (continued) The following table reflects the difference between the fair value carrying amount of loans held for sale, measured at fair value under FASB ASC 825-10, and the aggregate unpaid principal amount the Company is contractually entitled to receive at maturity: Fair Value of Loans Held for Sale (in thousands) December 31, 2023 December 31, 2022 Aggregate fair value $ 7,481 $ 7,416 Contractual principal 5,168 6,808 Difference $ 2,313 $ 608 The Company elects to account for loans held for sale at fair value to eliminate the mismatch that would occur by recording changes in market value on derivative instruments used to hedge loans held for sale while carrying the loans at the lower of cost or market. Fair value measurements on a nonrecurring basis Individually evaluated loans - The Company has measured expected credit losses based on the fair value of the loan's collateral and discounted cash flow analysis, where appropriate. Fair value of the collateral is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values. As of December 31, 2023 and December 31, 2022, the fair values consist of loan balances of $ 16.0 million and $ 9.4 million, with specific reserves of $ 422 thousand and $ 372 thousand, respectively. Foreclosed real estate - The Company's foreclosed real estate is measured at fair value less cost to sell. Fair value is determined based on offers and/or appraisals. Cost to sell the real estate is based on standard market factors. The Company categorizes its foreclosed real estate as Level 3. As of December 31, 2023 and December 31, 2022, there was no foreclosed real estate held by the Company. Fair Value of Individually Evaluated Loans (in thousands) 2023 2022 Individually evaluated loans for credit loss, net Level 3 Inputs 15,620 9,021 Total $ 15,620 $ 9,021 The following table provides information describing the unobservable inputs used in Level 3 fair value measurements at December 31, 2023 and 2022: Unobservable Inputs Valuation Technique Unobservable Inputs General Range of Inputs Individually evaluated loans Appraised Value/Discounted Cash Flows Discounts to appraisals or cash flows for estimated holding and/or selling costs 0 - 25 % 118 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 17 - Fair Value (continued) Fair value of financial instruments Fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practical to estimate the value is based upon the characteristics of the instruments and relevant market information. Financial instruments include cash, evidence of ownership in an entity, or contracts that convey or impose on an entity the contractual right or obligation to either receive or deliver cash for another financial instrument. The information used to determine fair value is highly subjective in nature and, therefore, the results are imprecise. Subjective factors include, among other things, estimates of cash flows, risk characteristics, credit quality, and interest rates, all of which are subject to change. Since the fair value is estimated as of the balance sheet date, the amounts that will actually be realized or paid upon settlement or maturity on these various instruments could be significantly different. As of December 31, 2023, the technique used by the Company to estimate the exit price of the loan portfolio consists of similar procedures to those used as of December 31, 2022, but with added emphasis on both illiquidity risk and credit risk not captured by the previously applied entry price notion. The fair value of the Company’s loan portfolio has always included a credit risk assumption in the determination of the fair value of its loans. This credit risk assumption is intended to approximate the fair value that a market participant would realize in a hypothetical orderly transaction. The Company’s loan portfolio is initially fair valued using a segmented approach. The Company divides its loan portfolio into the following categories: variable rate loans, impaired loans, and all other loans. The results are then adjusted to account for credit risk as described above. However, under the new guidance, the Company believes a further credit risk discount must be applied through the use of a discounted cash flow model to compensate for illiquidity risk, based on certain assumptions included within the discounted cash flow model, primarily the use of discount rates that better capture inherent credit risk over the lifetime of a loan. This consideration of enhanced credit risk provides an estimated exit price for the Company’s loan portfolio. For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values approximate carrying values. Fair values for individually evaluated loans are estimated using discounted cash flow models or based on the fair value of the underlying collateral. The fair value of cash and cash equivalents, interest-bearing deposits at other financial institutions, federal funds sold and restricted investments is the carrying amount. Restricted investments includes equity of the Federal Reserve and other banker’s banks. The fair value of noninterest-bearing deposits and securities sold under agreements to repurchase is the carrying amount. The fair value of checking, savings, and money market deposits is the amount payable on demand at the reporting date. Fair value of fixed maturity term accounts and individual retirement accounts is estimated using rates currently offered for accounts of similar remaining maturities. The fair value of certificates of deposit in other financial institutions is estimated based on interest rates currently offered for deposits of similar remaining maturities. The fair value of borrowings is estimated by discounting the value of contractual cash flows using current market rates for borrowings with similar terms and remaining maturities. 119 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 17 - Fair Value (continued) The fair value of outstanding loan commitments, unused lines of credit, and letters of credit are not included in the table since the carrying value generally approximates fair value. These instruments generate fees that approximate those currently charged to originate similar commitments. The table below presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments (in thousands). Fair Value of Financial Assets and Liabilities December 31, 2023 December 31, 2022 (in thousands) Carrying Amount Fair Value Carrying Amount Fair Value Financial assets Level 1 Cash and due from banks $ 14,513 $ 14,513 $ 19,963 $ 19,963 Interest-bearing deposits at other financial institutions 39,044 39,044 39,764 39,764 Federal funds sold 407 407 20,688 20,688 Level 3 Loans receivable, net $ 1,874,678 $ 1,855,158 $ 1,704,370 $ 1,659,283 Restricted investments 4,353 4,353 7,362 7,362 Financial liabilities Level 1 Noninterest-bearing deposits $ 617,373 $ 617,373 $ 674,313 $ 674,313 Level 3 Interest-bearing deposits $ 1,278,623 $ 1,280,682 $ 1,083,759 $ 1,090,553 FHLB advances and other borrowed funds 49,062 46,634 119,062 116,544 120 Capital Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2023 and 2022 Note 18 - Segments The Company’s reportable segments represent business units with discrete financial information whose results are regularly reviewed by management. The four segments include Commercial Banking, Capital Bank Home Loans (the Company’s mortgage loan division), and OpenSky ™ (the Company’s credit card division) and the Corporate Office. The following schedule presents financial information for each reportable segment at and for the years ended December 31, 2023 and 2022. For the Year Ended December 31, 2023 (in thousands) Commercial Bank CBHL OpenSky ™ Corporate (2) Eliminations Consolidated Interest income $ 116,408 $ 382 $ 62,476 $ 4,238 $ ( 298 ) $ 183,206 Interest expense 40,896 135 — 947 ( 298 ) 41,680 Net interest income 75,512 247 62,476 3,291 — 141,526 Provision for credit losses 1,540 — 7,948 122 — 9,610 Release of credit losses on unfunded commitments ( 101 ) — — — — ( 101 ) Net interest income after provision 74,073 247 54,528 3,169 — 132,017 Noninterest income 2,737 4,909 17,325 4 — 24,975 Noninterest expense (1) 61,836 6,001 42,524 406 — 110,767 Net income (loss) before taxes $ 14,974 $ ( 845 ) $ 29,329 $ 2,767 $ — $ 46,225 Total assets $ 2,051,945 $ 8,589 $ 117,477 $ 277,565 $ ( 229,400 ) $ 2,226,176 For the Year Ended December 31, 2022 (in thousands) Commercial Bank CBHL OpenSky ™ Corporate (2) Eliminations Consolidated Interest income $ 82,182 $ 435 $ 64,859 $ 3,349 $ ( 179 ) $ 150,646 Interest expense 9,245 218 — 755 ( 179 ) 10,039 Net interest income 72,937 217 64,859 2,594 — 140,607 (Reversal of) provision for loan losses ( 980 ) — 7,611 — — 6,631 Net interest income after provision 73,917 217 57,248 2,594 — 133,976 Noninterest income 2,122 5,276 21,972 2 — 29,372 Noninterest expense (1) 52,552 8,450 47,647 465 — 109,114 Net income (loss) before taxes $ 23,487 $ ( 2,957 ) $ 31,573 $ 2,131 $ — $ 54,234 Total assets $ 1,939,601 $ 7,936 $ 122,418 $ 245,399 $ ( 191,699 ) $ 2,123,655 _______________ (1) Noninterest expense includes $ 23.7 million and $ 27.0 million in data processing expenses in OpenSky’s ™ segment for the years ended December 31, 2023 and 2022, respectively. (2) The Corporate segment invests idle cash in revenue-producing assets including interest-bearing cash accounts, loan participations and other appropriate investments for the Company. Beginning in 2024, the Company allocated certain expenses previously recorded directly to the Commercial Bank segment to the other segments. This change in allocation will be reflected in 2024 segment performance reporting. Note 19 - Litigation In accordance with the current accounting standards for loss contingencies, the Company establishes reserves for litigation-related matters that arise in the ordinary course of its business activities when it is probable that a loss associated with a claim or proceeding has been incurred and the amount of the loss can be reasonably estimated. Litigation claims and proceedings of all types are subject to many uncertain factors that generally cannot be predicted with assurance. In addition, the Company's defense of litigation claims may result in legal fees, which it expenses as incurred. None of the amounts the Company currently has recorded individually or in the aggregate are considered to be material to our financial condition as of December 31, 2023. 121 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.