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Item 7. Management’s Discussion and Analysis

2021-03-01 compared with 2020-03-02 · 581 added, 394 removed, 523 unchanged (65% of the section changed)

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These forward looking statements represent plans, estimates, objectives, goals, guidelines, expectations, intentions, projections and statements of our beliefs concerning future events, business plans, objectives, expected operating results and the assumptions upon which those statements are based.

Forward looking statements include without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and are typically identified with words such as “may,” “could,” “should,” “will,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” or words or phases of similar meaning.

Forward looking statements include without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and are typically identified with words such as “may,” “will,” “can,” “anticipates,” “believes,” “expects,” “plans,” “estimates,” “potential,” “assume," "probable," "possible," "continue,” “should,” “could,” “would,” “strive," "seeks,” "deem," "projections," "forecast," "consider," "indicative," "uncertainty," "likely," "unlikely," ""likelihood," "unknown," "attributable," "depends," "intends," "generally," "feel" "typically," "judgment," "subjective" and similar words or phrases.

These forward looking statements are based largely on our expectations and are subject to a number of known and unknown risks and uncertainties that are subject to change based on factors which are, in many instances, beyond our control.

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The following factors, among others, could cause our financial performance to differ materially from that expressed in such forward looking statements:

● The strength of the United States economy, in general, and the strength of the local economies in which we conduct operations;

● Geopolitical conditions, including acts or threats of terrorism, actions taken by the United States or other governments in response to acts or threats of terrorism and/or military conflicts, which could impact business and economic conditions in the United States and abroad;

● The effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board, inflation, interest rate, market and monetary fluctuations;

● Results of examinations of us by our regulators, including the possibility that our regulators may, among other things, require us to increase our allowance for credit losses, to write-down assets or to hold more capital;

● Our management of risks inherent in our real estate loan portfolio, and the risk of a prolonged downturn in the real estate market, which could impair the value of, and our ability to sell, properties which stand as collateral for loans we make;

● Changing bank regulatory conditions, policies or programs, whether arising as new legislation or regulatory initiatives, that could lead to restrictions on activities of banks generally, or our subsidiary bank in particular, more restrictive regulatory capital requirements, increased costs, including deposit insurance premiums, regulation or prohibition of certain income producing activities or changes in the secondary market for loans and other products;

● The effects or impact of any litigation, regulatory proceeding, including enforcement proceedings, and any possibly resulting fines, judgments, expenses or restrictions on our business activities;

• The macroeconomic and other challenges and uncertainties resulting from the coronavirus (“COVID-19”) pandemic;

• The timely development of competitive new products and services and the acceptance of these products and services by new and existing customers;

• The willingness of customers to substitute competitors’ products and services for our products and services;

● The impact of changes in financial services policies, laws and regulations, including laws, regulations and policies concerning taxes, banking, securities and insurance, and the application thereof by regulatory bodies;

● The effect of changes in accounting policies and practices, as may be adopted from time-to-time by bank regulatory agencies, the Securities and Exchange Commission, the Public Company Accounting Oversight Board or the Financial Accounting Standards Board;

● Technological and social media changes;

● Cybersecurity breaches, threats, and cyber-fraud that cause the Bank to sustain financial losses;

• Our management of risks inherent in our real estate loan portfolio, and the risk of a prolonged downturn in the real estate market, which could impair the value of, and our ability to sell, properties which stand as collateral for loans we make;

• The effect of acquisitions we may make, including, without limitation, the failure to achieve the expected revenue growth and/or expense savings from such acquisitions;

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• Changes in consumer spending and savings habits;

• Changing bank regulatory conditions, policies or programs, whether arising as new legislation or regulatory initiatives, that could lead to restrictions on activities of banks generally, or our subsidiary bank in particular, more restrictive regulatory capital requirements, increased costs, including deposit insurance premiums, regulation or prohibition of certain income producing activities or changes in the secondary market for loans and other products;

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• The impact of changes in financial services policies, laws and regulations, including laws, regulations and policies concerning taxes, banking, securities and insurance, and the application thereof by regulatory bodies;

• The effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board, inflation, interest rate, market and monetary fluctuations;

• Results of examinations of us by our regulators, including the possibility that our regulators may, among other things, require us to increase our allowance for credit losses, to write-down assets or to hold more capital;

• The effects or impact of any litigation, regulatory proceeding, including enforcement proceedings, and any possibly resulting fines, judgments, expenses or restrictions on our business activities;

• Unanticipated regulatory or judicial proceedings;

• The effect of changes in accounting policies and practices, as may be adopted from time-to-time by bank regulatory agencies, the Securities and Exchange Commission, the Public Company Accounting Oversight Board or the Financial Accounting Standards Board;

• Technological and social media changes;

• Cybersecurity breaches, threats, and cyber-fraud that cause the Bank to sustain financial losses;

• The strength of the United States economy, in general, and the strength of the local economies in which we conduct operations;

• Geopolitical conditions, including acts or threats of terrorism, actions taken by the United States or other governments in response to acts or threats of terrorism and/or military conflicts, which could impact business and economic conditions in the United States and abroad;

• The factors discussed under the caption “Risk Factors” in this report.

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We will not update the forward looking statements to reflect actual results or changes in the factors affecting the forward looking statements.

The Company is a growth-oriented, one-bank holding company headquartered in Bethesda, Maryland, which is currently celebrating twenty-one years of successful operations.

The Company is a growth-oriented, one-bank holding company headquartered in Bethesda, Maryland, which is currently celebratin g twenty-two years of successful operations.

The Company provides general commercial and consumer banking services through the Bank, its wholly owned banking subsidiary, a Maryland chartered bank which is a member of the Federal Reserve System.

The Company was organized in October 1997, to be the holding company for the Bank.

The Company was organized in October 1997 and to be the holding company for the Bank.

The Bank was organized in 1998 as an independent, community oriented, full service banking alternative to the super regional financial institutions, which dominate the Company’s primary market area.

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The Bank currently has a total of twenty branch offices, including nine in Northern Virginia, six in Suburban Maryland, and five in Washington, D.C.

The Bank offers a broad range of commercial banking services to its business and professional clients as well as full service consumer banking services to individuals living and/or working primarily in the Bank's market area.

The Bank emphasizes providing commercial banking services to sole proprietors, small and medium-sized businesses, non-profit organizations and associations, and investors living and working in and near the primary service area.

These services include the usual deposit functions of commercial banks, including business and personal checking accounts, "NOW"

accounts and money market and savings accounts, business, construction, and commercial loans, residential mortgages and consumer loans, and cash management services.

The Bank is also active in the origination and sale of residential mortgage loans and the origination of SBA loans.

The residential mortgage loans are originated for sale to third-party investors, generally large mortgage and banking companies, under best efforts and mandatory delivery commitments with the investors to purchase the loans subject to compliance with pre-established criteria.

The Bank generally sells the guaranteed portion of the SBA loans in a transaction apart from the loan origination generating noninterest income from the gains on sale, as well as servicing income on the portion participated.

The Company originates multifamily FHA loans through HUD's MAP.

The Company securitizes these loans through the Ginnie Mae MBS I program, and sells the resulting securities in the open market to authorized dealers in the normal course of business and periodically bundles and sells the servicing rights.

Bethesda Leasing, LLC, a subsidiary of the Bank, holds title to and manages other real estate owned ("OREO") assets.

Eagle Insurance Services, LLC, a subsidiary of the Bank, offers access to insurance products and services through a referral program with a third party insurance broker.

Additionally, the Bank offers investment advisory services through referral programs with third parties.

Landroval Municipal Finance, Inc., a subsidiary of the Bank, focuses on lending to municipalities by buying debt on the public market as well as direct purchase issuance.

As 2019 began, expectations were high that the Federal Reserve Open Market Committee, or FOMC, would continue moving short-term interest rates higher after they adjusted the Federal Funds Target rate up by 25 bps four times over the course of 2018.

They also continued their plans for reducing the Federal Reserve's balance sheet as U.S.

Treasuries and mortgage backed securities mature and that cash flow was not reinvested.

Refer to the Business Section above which describes in detail the various banking services offered.

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As 2020 began, expectations were high that the Federal Reserve Open Market Committee, or FOMC, would continue generally accommodative monetary policy, in support of strong GDP, low levels of unemployment and lower than expected inflation.

The Federal Reserve had purchases of securities expanding their balance sheet as late as year-end 2019.

Actual GDP growth for 2020 in the U.S.

was expected to be slightly below 2018 and after considerable negative market sentiment occurred, the FOMC reversed course and lowered short term rates three times in 2019.

It also began increasing its balance sheet to support liquidity in the Federal Funds market.

was expected to be slightly below 2019 and before a global pandemic occurred in the first quarter of 2020 (termed COVID-19), which severely impacted business activity and person to person interactions.

The 2020 U.S.

official unemployment rate declined to 3.53% by year end.

2019 saw steady job growth, above average wage growth, an increase in the labor force participation rate, and improved consumer confidence levels.

These fundamentals were factored into the Federal Reserve Board's monetary policy, but the slowing growth and the lack of inflation led to the three 25 basis point rate cuts in the year.

The Federal Reserve Board is currently indicating that this level of monetary policy is appropriate and any changes from here will be data dependent.

official unemployment rate increased to 6.7% by year-end 2020 from a record low level of 3.6% pre-pandemic.

and world economies were turned upside down with the health care community placed on high alert in March and April 2020, which continued throughout the remainder of the year.

In 2020 there was volatile job markets across the country and Washington D.C.

metropolitan region with transitions to work from home and different degrees of economic lockdowns at different times as State Governors adopted different responses.

These fundamentals were factored into the Federal Reserve Board's monetary policy, as the situation led to 200 basis points of rate cuts in the overnight federal fund rate back to near 0% and massive expansion in liquidity support in the form of U.S.

Treasury and mortgage backed security ("MBS") bond purchases.

Additionally, fiscal policy accommodation was provided with the U.S.

Congress passing three stimulus measures approaching $2.6 trillion in 2020, adding to an already high level of total National Debt.

The Federal Reserve Board is currently indicating that a continued high level of monetary policy support is appropriate and that extraordinary support will continue through 2021, including continued very low interest rates.

Longer-term U.S.

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Treasury rate averaging 0.88% in 2020 as compared to 2.15% in 2019.

The yield curve continued to flatten (two year as compared to ten year U.S.

Treasury rates) during 2019 as the long end of the yield curve fell more sharply than the short end.

The relative volatility of long-term interest rates was partly a function of attractive yields in U.S.

Treasury securities relative to non U.S.

bonds, as there remained some perceived weaknesses in European Central Bank economies generally, along with geopolitical risks, and expectations of slowing global growth.

Energy prices (oil and natural gas), after a period of low prices in 2016, and a steady climb over the course of 2017 and early 2018 came back down

below 2017 prices by the end of 2018.

In 2019, energy prices remained relatively stable at 2018's average price.

Inflationary factors remained close to, but still below, the FOMC's target rate of 2.00% throughout 2019.

The yield curve in 2020 was steeper than in 2019 (two year as compared to ten year U.S.

Treasury rates) as the short end of the yield curve fell more sharply than the long end although the long end also fell dramatically.

As the ten year U.S.

Treasury rate dropped back to 2016 levels in the summer of 2020, the volume of residential mortgage lending began to increase.

Overall, real estate values in most of the Company's markets were stable to increasing in 2019 as interest rates remained historically low and job growth and personal income levels rose modestly.

Overall, real estate values in most of the Company's markets were stable to increasing in 2020 as interest rates remained historically low.

Political gridlock continued in Washington, D.C.

over concerns of Presidential impeachment, immigration and health care policy, public debt and deficits, as well as tax policy and spending levels.

Major corporate and personal tax reform was passed late in 2017, which benefited business earnings and consumer spending, while deficit spending continued and remains a point of serious concern.

over concerns of pandemic policy, public debt and deficits, as well as tax policy and spending levels, and the November elections.

The Company’s primary market, the Washington, D.C.

metropolitan area, has continued to perform well relative to other parts of the country, due to good growth in the private sector along with increased government spending, and this was no different in 2019.

Private sector growth was attributable in part to a diverse economy including a large healthcare component, substantial business services, and a highly educated work force.

During 2019, the Company enhanced its marketplace positioning by remaining proactive in growing client relationships.

The Company has had the financial resources to meet, and has remained committed to meeting, the credit needs of its community, resulting in continued growth in the Bank’s loan portfolio during 2019.

Furthermore, the Company’s capital position remained strong in 2019 as a result of very strong and consistent earnings despite higher legal expenses.

As a result of the Company’s strong capital position and earnings, it was able to initiate a quarterly dividend and to implement a share repurchase program.

metropolitan area, has continued to perform well relative to other parts of the country notwithstanding the impact of the COVID-19 pandemic, due to a stable public sector along with increased government spending.

The private sector lost jobs which was attributable in large part to the difficulties in the Leisure and Hospitality sector brought on by challenges associated with the pandemic.

In spite of these challenges, the Washington, D.C.

metropolitan area maintains a diverse economy including a large healthcare component, substantial business services, and a highly educated work force.

The Company has had the financial resources to meet, and has remained committed to meeting, the credit needs of its community, which resulted in modest growth in the Bank’s loan portfolio during 2020, as COVID-19 related factors slowed new lending opportunities while loan payoffs continued on schedule demonstrating successful projects and financings.

Liquidity levels grew ever higher as we moved through 2020, which negatively impacted net interest margins and resulted in a much lower loan to deposit ratio.

Furthermore, the Company’s capital position remained strong in 2020 as a result of good earnings despite higher legal expenses.

Additionally, with longer term interest rates very low, residential lending and refinance activity was very strong which resulted in favorable noninterest income growth, largely from gain on sale of residential loans.

As a result of the Company’s strong capital position and earnings, it was able to sustain a quarterly dividend in 2020 and to execute a share repurchase program amounting to about 5% of shares outstanding.

The Company believes its strategy of remaining growth-oriented, retaining talented staff and maintaining focus on seeking quality lending and deposit relationships has proven successful and is evidenced in its financial and performance ratios.

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metropolitan area.

Operating in the more competitive economic environment of 2019, the Bank was able to produce solid growth in loans.

Additionally, the Bank was able to grow its net interest spread earnings, maintain an above average net interest margin in spite of margin compression, retain a strong position regarding asset quality, and generate continued favorable enhanced operating leverage due to its seasoned and professional staff.

Operating in the weaker economic environment of 2020, the Bank was able to produce growth in average loans of 3.1%, excluding PPP loans.

Additionally, the Bank was able to grow its net interest spread earnings, as a result of very strong average deposit growth, retain a solid position regarding asset quality, and generate continued favorable operating leverage due to its seasoned and professional staff.

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Impact of COVID-19

In March 2020, the outbreak of COVID-19 was recognized as a pandemic by the World Health Organization.

The spread of COVID-19 has created a global public health crisis that has resulted in unprecedented uncertainty, volatility and disruption in financial markets and in governmental, commercial and consumer activity in the U.S.

and globally, including the markets that we serve.

Governmental responses to the pandemic have included orders closing nonessential businesses, directing individuals to restrict their movements, observe social distancing, and shelter in place.

These actions, together with responses to the pandemic by businesses and individuals, have resulted in rapid decreases in commercial and consumer activity, temporary closures of many businesses that have led to a loss of revenues and a rapid increase in unemployment, material decreases in oil and gas prices and in business valuations, disrupted global supply chains, market downturns and volatility, changes in consumer behavior related to COVID-19 pandemic fears, related emergency response legislation and an expectation that Federal Reserve policy will maintain a low interest rate environment for the foreseeable future.

Our business and consumer customers are experiencing varying degrees of financial distress.

In order to protect the health of our customers and employees, and to comply with applicable government directives, we have modified our business practices, including directing employees to work from home insofar as is possible, implementing our business continuity plans and protocols to the extent necessary, and our branches have modified hours and advanced safety measures.

We have established general guidelines for returning that include having employees maintain safe distances, staggered work schedules to limit the number of employees in a single location, more frequent cleaning of our facilities and other practices encouraging a safe working environment during this challenging time, including required COVID-19 training programs.

On March 27, 2020, the CARES Act was signed into law.

It contains substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic.

The CARES Act created the PPP, a program designed to aid small- and medium-sized businesses through federally guaranteed loans distributed through banks.

These loans are intended to guarantee payroll and other costs to help those businesses remain viable and allow their workers to pay their bills.

On December 27, 2020, The Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act was enacted, which includes additional funding for the PPP.

As an SBA preferred lender, the Bank is participating in the PPP, and at December 31, 2020, had an outstanding balance of PPP loans of $454.8 million to just over 1,400 businesses.

The statutory interest rate on these loans is 1.00% and the average yield, which includes fee amortization, was 2.55% for 2020.

There have also been various governmental actions taken or proposed to provide forms of relief, such as streamlining the application process for forgiveness of all PPP loans under $150,000, limiting debt collections efforts, including foreclosures, and encouraging or requiring extensions, modifications or forbearance, with respect to certain loans and fees.

Governmental actions taken in response to the COVID-19 pandemic have not always been coordinated or consistent across jurisdictions but, in general, have been expanding in scope and intensity.

The efficacy and ultimate effect of these actions is not known.

In response to the COVID-19 pandemic, we have also implemented a short-term loan modification program to provide temporary payment relief to certain borrowers who meet the program's qualifications.

Initial modifications under the program have predominantly been for 90 days, with a second 90 day modification, if warranted.

The deferred payments along with interest accrued during the deferral period are due and payable on the existing maturity date of the existing loan.

As of December 31, 2020, we had ongoing temporary modifications on approximately 36 loans representing $72 million (approximately 1% of total loans) in outstanding balances.

Overall, throughout 2020, the Bank's COVID-19 modification program granted temporary modifications on approximately 750 loans representing approximately $1.6 billion in outstanding balances, including 714 temporary modifications representing $1.5 billion that have or are expected to return to pre-modification terms.

None of the deferrals are reflected in the Company's asset quality measures (i.e., non-performing loans) due to the provision of the CARES Act that permits U.S.

financial institutions to temporarily suspend the U.S.

GAAP requirements to treat such short-term loan modifications as TDRs.

Similar provisions have also been confirmed by interagency guidance issued by the federal banking agencies and confirmed with staff members of the Financial Accounting Standards Board.

Significant uncertainties as to future economic conditions exist, and we have taken deliberate actions in response, including maintaining record levels of on and off-balance sheet liquidity and have maintained regulatory capital ratios significantly above the well capitalized.

Furthermore, we suspended our share repurchase program during the first quarter of 2020.

Accordingly, we made no share repurchases in the second quarter of 2020.

The Company’s Board of Directors approved lifting the suspension of the Company’s share repurchase program in the third quarter of 2020 and commenced repurchasing the balance of the 458,069 shares available for repurchase under that program.

Subsequently on December 16, 2020, the Board of Directors authorized the repurchase of 1,588,848 shares of common stock, or approximately 5% of the Company’s outstanding

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shares of common stock, under a new repurchase program (effective January 1, 2021), which will expire on December 31, 2021, subject to earlier termination of the program by the Board of Directors.

Additionally, the economic pressures, coupled with the implementation of the expected loss methodology for determining our provision for credit losses as required by the CECL standard described below, have contributed to an increased provision for credit losses for the full year 2020.

We continue to monitor the impact of COVID-19 closely, as well as any effects that may result from the CARES Act and other legislative and regulatory developments related to COVID-19;

however, the extent to which the COVID-19 pandemic will impact our operations and financial results during 2021 is highly uncertain.

CRITICAL ACCOUNTING POLICIES

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accordingly, as this information changes, the Consolidated Financial Statements could reflect different estimates, assumptions, and judgments.

Certain policies, including for the year ended December 31, 2019 those identified below, inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported.

Certain policies, including those identified below for the year ended December 31, 2020, inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported.

Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or a valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event.

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The fair values and the information used to record valuation adjustments for investment securities available-for-sale are based either on quoted market prices or are provided by other third-party sources, when available.

The Company’s investment portfolio is categorized as available-for-sale with unrealized gains and losses net of income tax being a component of shareholders’ equity and accumulated other comprehensive income (loss).

Allowance for Credit Losses

The allowance for credit losses is an estimate of the losses that may be sustained in our loan portfolio.

The allowance is based on two principles of accounting:

(a) ASC Topic 450, “Contingencies,” which requires that losses be accrued when they are probable of occurring and are estimable and (b) ASC Topic 310, “Receivables,” which requires that losses be accrued when it is probable that the Company will not collect all principal and interest payments according to the contractual terms of the loan.

The loss, if any, can be determined by the difference between the loan balance and the value of collateral, the present value of expected future cash flows, or values observable in the secondary markets.

Three components comprise our allowance for credit losses:

a specific allowance, a formula allowance and a nonspecific or environmental factors allowance.

Each component is determined based on estimates that can and do change when actual events occur.

The specific allowance allocates a reserve to identified impaired loans.

Impaired loans are assigned specific reserves based on an impairment analysis.

Under ASC Topic 310, “Receivables,” a loan for which reserves are individually allocated may show deficiencies in the borrower’s overall financial condition, payment record, support available from financial guarantors and for the fair market value of collateral.

When a loan is identified as impaired, a specific reserve is established based on the Company’s assessment of the loss that may be associated with the individual loan.

The formula allowance is used to estimate the loss on internally risk rated loans, exclusive of those identified as requiring specific reserves.

The portfolio of unimpaired loans is stratified by loan type and risk assessment.

Allowance factors relate to the type of loan and level of the internal risk rating, with loans exhibiting higher risk and loss experience receiving a higher allowance factor.

The environmental factors allowance is also used to estimate the loss associated with pools of non-classified loans.

These non-classified loans are also stratified by loan type, and environmental allowance factors are assigned by management based upon a number of conditions, including delinquencies, loss history, changes in lending policy and procedures, changes in business and economic conditions, changes in the nature and volume of the portfolio, management expertise, concentrations within the portfolio, quality of internal and external loan review systems, competition, and legal and regulatory requirements.

The allowance captures losses inherent in the loan portfolio, which have not yet been recognized.

Allowance factors and the overall size of the allowance may change from period to period based upon management’s assessment of the above described factors, the relative weights given to each factor, and portfolio composition.

Management has significant discretion in making the judgments inherent in the determination of the provision and allowance for credit losses, including in connection with the valuation of collateral, a borrower’s prospects of repayment, and in establishing allowance factors on the formula and environmental components of the allowance.

The establishment of allowance factors involves a continuing evaluation, based on management’s ongoing assessment of the global factors discussed above and their impact on the portfolio.

The allowance factors may change from period to period, resulting in an increase or decrease in the amount of the provision or allowance, based upon the same volume and classification of loans.

Changes in allowance factors can have a direct impact on the amount of the provision, and a related after tax effect on net income.

Errors in management’s perception and assessment of the global factors and their impact on the portfolio could result in the allowance not being adequate to cover losses in the portfolio, and may result in additional provisions or charge-offs.

Alternatively, errors in management’s perception and assessment of the global factors and their impact on the portfolio could result in the allowance being in excess of amounts necessary to cover losses in the portfolio, and may result in lower provisions in the future.

For additional information regarding the provision for credit losses, refer to the discussion under the caption “Provision for Credit Losses” below.

Provision for Credit Losses and Provision for Unfunded Commitments

A consequence of lending activities is that we may incur credit losses, so we record an allowance for credit losses ("ACL") with respect to loan receivables and a reserve for unfunded commitments (“RUC”) as estimates of those losses.

The amount of such losses will vary depending upon the risk characteristics of the loan portfolio as affected by economic conditions such as changes in interest rates, the financial performance of borrowers and regional unemployment rates, which management estimates by using a national forecast and estimating a regional adjustment based on historical differences between the two.

As a result of our January 1, 2020 adoption of FASB's Accounting Standard Codification ("ASC") 326, Measurement of Credit Losses on Financial Instruments , and its related amendments, our methodology for estimating these credit losses changed significantly from prior years.

The new standard replaced the “incurred loss” approach with a “current expected credit loss” approach known as CECL, which requires an estimate of the credit losses expected over the life of an exposure (or pool of exposures).

CECL removes the incurred loss approach’s threshold that delayed the recognition of a credit loss until it was “probable” a loss event was “incurred.”

The Provision for Unfunded Commitments represents the expected credit losses on off-balance sheet commitments such as unfunded commitments to extend credit and standby letters of credit.

The RUC is determined by estimating future draws and applying the expected loss rates on those draws.

Management has significant discretion in making the judgments inherent in the determination of the provisions for credit loss, ACL, and the RUC.

Our determination of these amounts requires significant reliance on estimates and significant judgment as to the amount and timing of expected future cash flows on loans, significant reliance on historical loss rates on homogenous portfolios, consideration of our quantitative and qualitative evaluation of economic factors, and the reliance on our reasonable and supportable forecasts.

The Provision for Credit Losses ("PCL") represents the expected credit losses arising from the Company's loan and AFS securities portfolios.

The PCL is determined by following:

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The Company uses a loan-level probability of default ("PD")/ loss given default ("LGD") cash flow method with an exposure at default ("EAD") model to estimate expected credit losses for the commercial, income producing – commercial real estate, owner occupied – commercial real estate, real estate mortgage - residential, construction – commercial and residential, construction – C&I (owner occupied), home equity, and other consumer loan pools.

For each of these loan segments, the Company generates cash flow projections at the instrument level wherein payment expectations are adjusted for estimated prepayment speed, probability of default, and loss given default.

The modeling of expected prepayment speeds is based on historical internal data.

PPP loans are included in the model but do not carry a reserve, as these loans are fully guaranteed by the SBA, whose guarantee is backed by the full faith and credit of the U.S.

The Company uses regression analysis of historical internal and peer data (as Company loss data is insufficient) to determine suitable loss drivers to utilize when modeling lifetime probability of default and loss given default.

This analysis also determines how expected probability of default will react to forecasted levels of the loss drivers.

For our cash flow model, management utilizes and forecasts regional unemployment by using a national forecast and estimating a regional adjustment based on historical differences between the two as a loss driver over our reasonable and supportable period of two years, and reverts back to a historical loss rate over the following twelve months on a straight-line basis.

COVID-19 has negatively impacted unemployment projections, which inform our CECL economic forecast and increased our loss reserve during 2020.

Management leverages economic projections from reputable and independent third parties to inform its loss driver forecasts over the forecast period.

The ACL also includes an amount for inherent risks not reflected in the historical analyses.

Relevant factors include, but are not limited to, concentrations of credit risk, changes in underwriting standards, experience and depth of lending staff, and trends in delinquencies.

While our methodology in establishing the reserve for credit losses attributes portions of the ACL and RUC to the commercial and consumer portfolio segments, the entire ACL and RUC is available to absorb credit losses expected in the total loan portfolio and total amount of unfunded credit commitments, respectively.

Going forward, the impact of utilizing the CECL approach to calculate the reserve for credit losses will be significantly

influenced by the composition, characteristics and quality of our loan portfolio, as well as the prevailing economic conditions and forecasts utilized.

Material changes to these and other relevant factors may result in greater volatility to the reserve for credit losses, and therefore, greater volatility to our reported earnings.

For example, the COVID-19 pandemic has negatively impacted the performance outlook in the Accommodation & Food Service segment of our loan portfolio, which informs our CECL economic forecast and increased our loss reserve as of December 31, 2020.

See Notes 1 and 4 to the Consolidated Financial Statements, the “Provision for Credit Losses” section in Management’s Discussion and Analysis, and the COVID-19 risk factors in Item 1A for more information on the provision for credit losses.

Goodwill and Other Intangibles

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired.

Other intangible assets represent purchased assets and MSRs that lack physical substance but can be distinguished from goodwill because of contractual or other legal rights.

Other intangible assets represent purchased assets and mortgage servicing rights ("MSRs") that lack physical substance but can be distinguished from goodwill because of contractual or other legal rights.

Intangible assets that have finite lives, such as core deposit intangibles, are amortized over their estimated useful lives and subject to periodic impairment testing.

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Goodwill is subject to impairment testing at the reporting unit level, which must be conducted at least annually.

The Company performs impairment testing during the fourth quarter of each year or when events or changes in circumstances indicate the assets might be impaired.

The Company performs impairment testing during the fourth quarter of each year (as of December 31) or when events or changes in circumstances indicate the assets might be impaired.

The Company performs a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount.

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These approaches use significant estimates and assumptions including projected future cash flows, discount rates reflecting the market rate of return, projected growth rates and determination and evaluation of appropriate market comparables.

Based on the results of qualitative assessments of all reporting units, the Company concluded that no impairment existed at December 31, 2019.

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As of June 30, 2020, COVID-19 caused the occurrence of what management deemed to be a triggering event that caused us to perform a goodwill impairment test to determine if an impairment charge was required for that period.

Based on the results of the assessment of the reporting unit, the Company concluded that no goodwill impairment existed as of June 30, 2020.

However, future events could cause the Company to conclude that goodwill or other intangibles have become impaired, which would result in recording an impairment loss.

Any resulting impairment loss could have a material adverse impact on the Company's financial condition and results of operations.

Management did not consider a triggering event to have occurred during the fourth quarter of 2020.

Management did, however, perform its annual assessment of goodwill as of December 31, 2020.

Based on the results of qualitative assessments of the reporting unit as part of its annual goodwill impairment testing, the Company concluded that no impairment existed at December 31, 2020.

However, future events could cause the Company to conclude that goodwill or other intangibles have become impaired, which would result in recording an impairment loss.

Any resulting impairment loss could have a material adverse impact on the Company’s financial condition and results of operations.

See “Item 1A Risk Factors—Changes in the value of goodwill and intangible assets could reduce our earnings” for more information.

Accounting for Income Taxes

The Company accounts for income taxes by recording deferred income taxes that reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.

Management exercises significant judgment in the evaluation of the amount and timing of the recognition of the resulting tax assets and liabilities.

The judgments and estimates required for the evaluation are updated based upon changes in business factors and the tax laws.

If actual results differ from the assumptions and other considerations used in estimating the amount and timing of tax recognized, there can be no assurance that additional expenses will not be required in future periods.

If actual results differ from the assumptions and other considerations used in estimating the amount and timing of tax recognized, there might be additional expenses required in future periods.

The Company’s accounting policy follows the prescribed authoritative guidance that a minimal probability threshold of a tax position must be met before a financial statement benefit is recognized.

The Company recognized, when applicable, interest and penalties related to unrecognized tax benefits in other non-interest expenses in the Consolidated Statements of Operations.

Assessment of uncertain tax positions requires careful consideration of the technical merits of a position based on management’s analysis of tax regulations and interpretations.

The Company recognizes, when applicable, interest and penalties related to unrecognized tax benefits in other noninterest expenses in the Consolidated Statements of Income.

Assessment of uncertain tax positions requires careful consideration of the technical merits of a position based on management’s analysis of tax laws, regulations and other procedural guidance.

Significant judgment may be involved in applying the applicable reporting and accounting requirements.

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Factors that could impact management’s judgment include changes in income, tax laws and regulations, and tax planning strategies.

See “Item 1A Risk Factors—Changes in tax laws could have an adverse effect on us, the banking industry, our customers, the value of collateral securing our loans and demand for loans” for more information.

Stock Based Compensation

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The Company’s practice is to utilize reasonable and supportable assumptions.

FASB ASC 815, Derivatives and Hedging (“ASC 815”), provides the disclosure requirements for derivatives and hedging activities with the intent to provide users of financial statements with an enhanced understanding of:

FASB ASC Topic 815, Derivatives and Hedging , provides the disclosure requirements for derivatives and hedging activities with the intent to provide users of financial statements with an enhanced understanding of:

(a) how and why an entity uses derivative instruments, (b) how the entity accounts for derivative instruments and related hedged items, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows.

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RESULTS OF OPERATIONS

For the year ended December 31, 2019, the Company’s net income was $142.9 million, a 6% decrease as compared to $152.3 million for the year ended December 31, 2018.

Where appropriate, parenthetical references refer to operating earnings, which the Company believes are more relevant comparisons to current and historical period results of operations.

Reconciliations of 2017 GAAP earnings to operating earnings are contained in the tables under “Selected Financial Data”.

For the year ended December 31, 2019, net income was $4.18 per basic and diluted common share as compared to $4.44 per basic common share and $4.42 per diluted common share for 2018, a 6% decrease in basic and 5% decrease in diluted earnings per share for the full year of 2019 as compared to 2018.

For the year ended December 31, 2019, the Company reported a return on average assets, or ROAA, of 1.61% as compared to 1.91% for the year ended December 31, 2018.

The return on average common equity, or ROACE, for the year ended December 31, 2019 was 12.20%, as compared to 14.89% for the year ended December 31, 2018.

The return on average tangible common equity, or ROATCE, for the year ended December 31, 2019 was 13.40%, as compared to 16.63% for the year ended December 31, 2018.

The Company’s earnings are largely dependent on net interest income, the difference between interest income and interest expense, which represented 92% and 93% of total revenue (defined as net interest income plus noninterest income) for the full year of 2019 and 2018, respectively.

The net interest margin, which measures the difference between interest income and interest expense (i.e., net interest income) as a percentage of average earning assets, decreased 33 basis points from 4.10% for the year ended December 31, 2018 to 3.77% for the year ended December 31, 2019.

Average earning asset yields decreased by 9 basis points (5.09% to 5.00%) for the year ended December 31, 2019 compared to the same period in 2018, while the cost of interest bearing liabilities increased by 34 basis points (to 1.95% from 1.61%).

For 2019, in spite of competitive factors, the Company has been able to maintain its loan portfolio yields relatively close to 2018 levels (5.45% as compared to 5.54%) due to disciplined loan pricing practices.

For the year ended December 31, 2019, the net interest spread decreased by 43 basis points (to 3.05% from 3.48%) as compared to 2018, due primarily to an increase in the average cost of interest bearing liabilities.

The cost of interest bearing liabilities increased in 2019 largely as a result of interest rate increases by the FOMC in mid to late 2018 and increased competition for deposits within our market area, though funding costs started to moderate in the second half of 2019, as the market rate cuts passed through to the liability base.

Overall, the Company believes its deposit mix and cost of funds remain favorable.

The benefit of noninterest sources funding earning assets increased by 10 basis points to 72 basis points for the year ended December 31, 2019 as compared to 62 basis points for the year ended December 31, 2018 as a result of a favorable mix of noninterest bearing deposits.

The percentage of average noninterest deposits relative to average total deposits was 31% for the full year 2019 compared to 33% for the same period in 2018.

The combination of a 43 basis point decrease in the net interest spread and a 10 basis point increase in the value of noninterest sources resulted in the 33 basis point decrease in the net interest margin for the year ended December 31, 2019 as compared to the same period in 2018.

The Company believes it has effectively managed its net interest margin and net interest income during 2019 as market interest rates (on average) have remained quite low.

This factor has been significant to overall earnings performance during the past year as net interest income represented 92% of the Company’s total revenue for the year ended December 31, 2019.

The provision for credit losses was $13.1 million for the year ended December 31, 2019 as compared to $8.7 million for the year ended December 31, 2018.

Net charge-offs of $9.4 million during 2019 represented 0.13% of average loans, excluding loans held for sale, as compared to $3.5 million or 0.05% of average loans, excluding loans held for sale, in 2018.

At December 31, 2019, the allowance for credit losses represented 0.98% of loans outstanding, as compared to 1.00% at December 31, 2018.

The allowance for credit losses represented 151% of nonperforming loans at December 31, 2019, as compared to 430% at December 31, 2018.

Total noninterest income for the year ended December 31, 2019 increased to $25.7 million from $22.6 million for the year ended December 31, 2018, a 14% increase.

The efficiency ratio, which measures the ratio of noninterest expense to total revenue, remained favorable at 39.99% for the year ended December 31, 2019 as compared to 37.31% for the same period in 2018.

Total noninterest expenses totaled $139.9 million for the year ended December 31, 2019, as compared to $126.7 million for the year ended December 31, 2018, a 10% increase.

As a percentage of average assets, total noninterest expense was 1.58% for the year of 2019 as compared to 1.59% for the same period in 2018.

The ratio of common equity to total assets increased from 13.22% at December 31, 2018 to 13.25% at December 31, 2019 due to growth from retained earnings.

As discussed under “Capital Resources and Adequacy”, the regulatory capital ratios of the Bank and Company remain above well capitalized levels.

Net income for the years ending December 31, 2020, 2019, and 2018 was $132.2 million, $142.9 million, and $152.3 million, respectively.

Net income per basic and diluted common share for 2020 was $4.09 compared to $4.18 per basic and diluted common share for 2019, a 2% decrease.

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Net income decreased for 2020 relative to 2019 primarily due to a decline in the net interest margin, and increased provisioning for credit losses (see "Provision for Credit Losses" section below, and Notes 1 - " Summary of Significant Accounting Policies " and Note 4 - " Loans and Allowance for Credit Losses " to the consolidated financials statements for further detail on CECL ), partially off set by higher noninterest income (as discussed in the "Noninterest Income" section below).

The most significant portion of revenue (i.e., net interest income plus noninterest income) is net interest income, which decreased to $321.6 million for 2020 compared to $324.0 million for 2019.

The decrease resulted from a decline in the net interest margin substantially offset by growth in average earning assets of 17%.

The net interest margin, which measures the difference between interest income and interest expense (i.e., net interest income) as a percentage of earning assets, was 3.19% for 2020 and 3.77% for 2019.

The drivers of the change are detailed in the "Net Interest Income and Net Interest Margin" section below.

The benefit of noninterest sources funding earning assets decreased by 34 basis points to 38 basis points for 2020 as compared to 72 basis points for 2019, due to significantly lower market interest rates.

The combination of a 58 basis point decrease in the net interest spread and a 34 basis point decrease in the value of noninterest sources resulted in a 92 basis point decrease in the net interest margin for 2020 as compared to 2019.

Despite currently having lesser value resulting from lower interest rates, the Company continues to consider the value of its noninterest sources of funds as very significant to its business model and its overall profitability over the longer term.

The provision for credit losses in 2020 was $45.6 million as compared to $13.1 million for the year ended December 31, 2019.

The higher provisioning for 2020, as compared 2019, is primarily due to the implementation of the CECL accounting standard and the impact of COVID-19 on our actual and expected future credit losses.

F or information on the components and drivers of these changes see "Provision for Credit Losses" section below.

Total noninterest income for 2020 increased to $45.7 million from $25.7 million for 2019, a 78% increase.

F or further information on the components and drivers of these changes see "Noninterest Income" section below.

Noninterest expenses totaled $144.2 million for 2020, as compared to $139.9 million for 2019, a 3% increase.

See the "Noninterest Expense" section for further detail on the components and drivers of the change.

The efficiency ratio, which measures the ratio of noninterest expense to total revenue, was 39.25% for 2020 as compared to 39.99% for 2019.

Income tax expense was $43.9 million for 2020, a decrease of $9.9 million or 18% compared to the same period in 2019.

The components and drivers of the change are discussed in the "Income Tax Expense" section below.

At December 31, 2020, total loan balances (including PPP loans) were 3% higher than they were at December 31, 2019, and average loans were 7% higher in 2020 as compared to 2019.

PPP loans represented $454.8 million of total loans at the end of 2020.

Excluding PPP loans, average loans increased 3% in 2020.

The slower loan growth in 2020 (excluding PPP loans) is mostly attributable to the successful completion of construction projects and the related construction loan payoff, coupled with the Company’s de-emphasizing new construction lending.

Average deposit growth was strong throughout 2020, and resulted in well above average overnight liquidity.

Deposit funding during 2020 was primarily from noninterest bearing and money market accounts.

In order to fund such loan increases and sustain significant liquidity, the Company has relied on funding from interest bearing accounts primarily as a result of inflows from certain financial intermediary relationships.

In large part due to those inflows, total deposits at December 31, 2020 were 27% higher than deposits at December 31, 2019, while average deposits were 18% higher for 2020 compared with 2019.

This increase in deposits allowed the Company to sustain strong primary and secondary sources of liquidity in the fourth quarter of 2020.

In terms of the average asset composition or mix, loans, which generally have higher yields than securities and other earning assets, represented 76% and 83% of average earning assets for 2020 and 2019, respectively.

For 2020, as compared to 2019, average loans, excluding loans held for sale, increased $535.6 million, or 7%, due primarily to growth in PPP, income producing commercial real estate, and commercial loans.

Average investment securities for 2020 and 2019 both amounted to 9% average earning assets.

The combination of federal funds sold, interest bearing deposits with other banks and loans held for sale represented 12% and 5% of average earning assets for 2020 and 2019, respectively, as much higher levels of on-balance sheet liquidity existed throughout 2020.

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The ratio of common equity to total assets decreased to 11.16% at December 31, 2020 from 13.25% at December 31, 2019, due to total assets growing faster than common equity, including common equity reductions due to $61 million in share repurchase activity, the approximate $10.9 million charge to common equity due to implementation of CECL on January 1, 2020, and $28.3 million of cash dividends declared.

As discussed later in “ Capital Resources and Adequacy,” the regulatory capital ratios of the Bank and Company remain above well capitalized levels.

For 2020, the Company reported an annualized return on average assets (“ROAA”) of 1.28%, as compared to 1.61% for 2019.

Total shareholders’ equity was $1.24 billion at December 31, 2020 and $1.19 billion and 2019, an increase of 4%.

The annualized return on average common equity (“ROACE”) for 2020 was 10.98% as compared to 12.20% for 2019.

The annualized return on average tangible common equity (“ROATCE”) for 2020 was 12.03% as compared to 13.40% for 2019.

Refer to the “Use of Non-GAAP Financial Measures” section for additional detail and a reconciliation of GAAP to non-GAAP financial measures.

The decline in these ratios was primarily due to the implementation of CECL and COVID-19 impacts on loan loss provisioning, as well as a lower net interest margin.

Net Interest Income and Net Interest Margin

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The cost of funds represents interest expense on deposits, customer repurchase agreements and other borrowings, which consist of federal funds purchased, advances from the FHLB and subordinated notes.

For additional information on the Company’s subordinated notes, please refer to Note 13 to the Consolidated Financial Statements, as well as the “Capital Resources and Adequacy” section below.

Noninterest bearing deposits and capital are other components representing funding sources.

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Net interest income in 2020 was $321.6 million compared to $324.0 million in 2019 and $317.0 million in 2018.

For the year ended December 31, 2019, net interest income increased 2% over the same period for 2018.

Average loans increased $694.8 million (10%) and average deposits increased by $787.1 million (12%).

For the year ended December 31, 2020, net interest income decreased 0.8% over the same period for 2019.

Average loans increased $535.6 million (7%) and average deposits increased by $1.3 billion (18%).

The net interest margin was 3.19% for the year ended December 31, 2020, as compared to 3.77% for the same period in 2019.

The Company has been able to maintain its loan yields in 2019 relatively close to 2018 levels due to disciplined loan pricing practices, and has managed its funding costs while maintaining a favorable deposit mix;

much of which has occurred from sales efforts to increase and deepen client relationships.

In spite of margin compression, the Company believes its net interest margin remains favorable as compared to its peer banking companies.

Excluding PPP loans, average loans increased 3% in 2020.

The yield on PPP loans was lower than other loans, which depressed loan yields and the net interest margin for 2020.

Excluding PPP loans, the yield on loans for 2020 was 4.87%, and the net interest margin was 3.28%.

The Company has maintained its disciplined loan pricing practices in 2020, and the Company has also managed its funding costs lower in 2020 while maintaining a favorable deposit mix, wherein noninterest deposits averaged 31% of average total deposits.

Higher levels of on-balance sheet liquidity contributed to margin compression in 2020.

The table below presents the average balances and rates of the major categories of the Company’s assets and liabilities for the years ended December 31, 2020, 2019 and 2018.

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The net interest margin (as compared to the net interest spread) includes the effect of noninterest bearing sources in its calculation and is net interest income expressed as a percentage of average earning assets.

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Eagle Bancorp, Inc.

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Years Ended December 31,

2020 2019 2018

Balance Interest Average

Interest earning assets:

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Loans (1) (2)

7,868,523 366,729 4.66 % 7,332,886 399,358 5.45 % 6,638,136 367,511 5.54 %

Investment securities available-for-sale (2) 929,983 18,440 1.98 % 796,608 21,037 2.64 % 692,753 17,907 2.58 %

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Total noninterest earning assets 269,724 267,882 232,540

Total Assets $ 10,349,963 $ 8,853,066 $ 7,958,941

Liabilities and Shareholders’ Equity

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(2) Interest and fees on loans and investments exclude tax equivalent adjustments.

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Rate/Volume Analysis of Net Interest Income

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

As the table shows, the increase in net interest income in both 2019 as compared to 2018, and 2018 as compared to 2017 was a function of an increase in the volume of earning assets.

2019 compared with 2018

2018 compared with 2017

(dollars in thousands)

As the table shows, the decrease in net interest income in 2020, as compared to 2019 was a function of an increase in the volume of earning assets more than offset by a decline in the net interest margin.

The increase in net interest income in 2019 as compared to 2018 was a function of an increase in the volume of earning assets more than offsetting a decline in the net interest margin.

2020 compared with 2019 2019 compared with 2018

(dollars in thousands) Change

Volume Change

(Decrease) Change

Volume Change

Interest earned on

Loans $ 29,171 $ (61,799) $ (32,628) $ 38,464 $ (6,617) $ 31,847

Loans held for sale 1,058 (498) 560 748 (278) 470

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Provision for Credit Losses

The provision for credit losses represents the amount of expense charged to current earnings to fund the allowance for credit losses.

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

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

Management has developed a comprehensive analytical process to monitor the adequacy of the allowance for credit losses.

The process and guidelines were developed utilizing, among other factors, the guidance from federal banking regulatory agencies.

The results of this process, in combination with conclusions of the Bank’s outside loan review consultant, support management’s assessment as to the adequacy of the allowance at the balance sheet date.

Please refer to the discussion under the caption “Critical Accounting Policies” for an overview of the methodology management employs on a quarterly basis to assess the adequacy of the allowance and the provisions charged to expense.

Also, refer to the table in the “Allowance for Credit Losses” section that reflects activity in the allowance for credit losses.

The allowance for credit losses increased $3.7 million at December 31, 2019 as compared to December 31, 2018, reflecting $13.1 million in provision for credit losses and $9.4 million in net charge-offs during 2019.

The provision for credit losses in 2019 compared to $8.7 million for the year ended December 31, 2018.

The higher provisioning during 2019, as compared to 2018, is due to higher net charge-offs.

The provision for credit losses represents the amount of expense charged to current earnings to fund the ACL on loans and the ACL on available for sale investment securities.

The amount of the ACL on loans is based on many factors that reflect management’s assessment of the risk in the loan portfolio.

Those factors include historical losses based on internal and peer data (as Company loss data is insufficient), economic conditions and trends, the value and adequacy of collateral, volume and mix of the portfolio, performance of the portfolio, and internal loan processes of the Company and Bank.

The ACL under CECL (adopted January 1, 2020) utilizes an economic forecast that is updated quarterly with the significant measure being the expected regional unemployment rate, which management estimates by using a national forecast and estimating a regional adjustment based on historical differences between the two.

The provision for credit losses was $45.6 million in 2020, as compared to $13.1 million in 2019.

The increase was due substantially to the implementation of the CECL methodology and the related impact of the COVID-19 pandemic.

The provision for unfunded commitments is presented separately on the Statement of Income.

This provision considers the probability that unfunded commitments will fund.

The provision was $1.4 million in 2020, as compared to no provision expense in 2019 (prior to CECL).

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Management has developed a comprehensive analytical process to monitor the adequacy of the ACL.

The process and guidelines were developed utilizing, among other factors, the guidance from federal banking regulatory agencies, relevant available information, from internal and external sources, relating to past events, current conditions and reasonable and supportable forecasts.

Historical credit loss experience provides the basis for the estimation of expected credit losses.

Adjustments to historical loss information are made for differences in current loan-specific risk characteristics such as differences in underwriting standards, portfolio mix, loan concentrations, credit quality, or term as well as for changes in environmental conditions, such as changes in unemployment rates, property values or other relevant factors.

Refer to additional detail regarding these forecasts in the “Cash Flow Method" section of Note 1 to the Consolidated Financial Statements.

The results of this process, in combination with conclusions of the Bank’s outside consultants’ review of the risk inherent in the loan portfolio, support management’s assessment as to the adequacy of the allowance at the balance sheet date.

Please refer to the discussion under “Critical Accounting Policies” above and in Note 1 to the Consolidated Financial Statements for an overview of the methodology management employs on a quarterly basis to assess the adequacy of the allowance and the provisions charged to expense.

Also, refer to the table in the "Allowance for Credit Losses" section which reflects activity in the ACL.

The ACL increased $35.9 million at December 31, 2020 as compared to December 31, 2019, reflecting $45.6 million in provision for credit losses, day one CECL impact of $10.6 million charged to retained earnings, and $20.1 million in net charge-offs during 2020.

Net charge-offs of $20.1 million during 2020 represented 0.26% of average loans, excluding loans held for sale, as compared to $9.4 million or 0.13% of average loans, excluding loans held for sale, in 2019.

Net charge-offs during 2019 were attributable primarily to commercial real estate ($5.0 million) and commercial loans ($4.5 million).

At December 31, 2019 the allowance for credit losses represented 0.98% of loans outstanding, as compared to 1.00% at December 31, 2018.

The allowance for credit losses represented 151% of nonperforming loans at December 31, 2019, as compared to 430% at December 31, 2018.

As part of its comprehensive loan review process, the Bank’s Board of Directors and Loan Committee or Credit Review Committee carefully evaluate loans which are past-due 30 days or more.

The Committees make a thorough assessment of the conditions

and circumstances surrounding each delinquent loan.

Net charge-offs during 2020 were attributable primarily to commercial real estate ($7.2 million), commercial loans ($12 million), and residential mortgages ($815 thousand).

At December 31, 2020 the ACL represented 1.41% of loans outstanding (1.50% excluding PPP loans), as compared to 0.98% at December 31, 2019.

The ACL represented 180% of nonperforming loans at December 31, 2020, as compared to 151% at December 31, 2019.

As part of its comprehensive loan review process, internal loan and credit committees carefully evaluate loans that are past-due 30 days or more.

The committees make a thorough assessment of the conditions and circumstances surrounding each delinquent loan.

The Bank’s loan policy requires that loans be placed on nonaccrual if they are ninety days past-due, unless they are well secured and in the process of collection.

Additionally, Credit Administration specifically analyzes the status of development and construction projects, sales activities and utilization of interest reserves in order to carefully and prudently assess potential increased levels of risk requiring additional reserves.

The maintenance of a high quality loan portfolio, with an adequate allowance for possible credit losses, will continue to be a primary management objective for the Company.

The maintenance of a high quality loan portfolio, with an adequate ACL, will continue to be a primary management objective for the Company.

Noninterest Income

Total noninterest income includes service charges on deposits, gain on sale of loans, gain on sale of investment securities, income from bank owned life insurance (“BOLI”) and other income.

Total noninterest income for the year ended December 31, 2019 was $25.7 million as compared to $22.6 million for the year ended December 31, 2018, a 14% increase due to $2.7 million higher gains on sale of residential mortgage loans, $1.4 million higher gain on sale of investment securities, partially offset by $767 thousand lower service charges on deposits.

For the year ended December 31, 2019, service charges on deposit accounts decreased $767 thousand to $6.2 million from $7.0 million for the same period in 2018, a decrease of 11%, due primarily to a lower volume of insufficient funds charges.

Total noninterest income for the year ended December 31, 2020 was $45.7 million as compared to $25.7 million for the year ended December 31, 2019, a 78% increase due substantially to $13.7 million higher gains on sale of residential mortgage loans, $2.9 million higher gains associated with the origination, securitization, sale and servicing of FHA loans, $1.2 million gain on the sale of OREO, and $1.1 million on swap fee income, partially offset by $1.8 million lower service charges on deposits.

For the year ended December 31, 2020, service charges on deposit accounts decreased $1.8 million to $4.4 million from $6.2 million for the same period in 2019, a decrease of 29%, due primarily to waived fees due to the pandemic.

Gain on sale of loans consists of gains on the sale of SBA and residential mortgage loans.

For the year ended December 31, 2020, gain on sale of loans increased from $8.5 million to $22.1 million, an increase of 161%, compared to the same period in 2019.

The Company originates residential mortgage loans and utilizes both “mandatory delivery” and “best efforts” forward loan sale commitments to sell those loans, servicing released.

Sales of residential mortgage loans yielded gains of $8.2 million for the year ended December 31, 2019 compared to $5.4 million in the same period in 2018, due to higher origination volume ($665.7 million for 2019 as compared to $415.8 million for 2018) and higher sales volume ($628.2 million for 2019 as compared to $421.6 million in 2018).

The Company is an originator of SBA loans and its practice is to sell the guaranteed portion of those loans at a premium.

Income from this source was $269 thousand for the year ended December 31, 2020 compared to $309 thousand for the same period in 2019.

Activity in SBA loan sales to secondary markets can vary widely from year to year.

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The Company originates residential mortgage loans and utilizes both “mandatory delivery” and “best efforts” forward loan sale commitments to sell those loans with servicing released.

Sales of residential mortgage loans yielded gains of $21.8 million for the year ended December 31, 2020 compared to $8.2 million in the same period in 2019, due to higher loan locked volume ($367.7 million for 2020 as compared to $49.9 million for 2019).

Loans sold are subject to repurchase in circumstances where documentation is deficient or the underlying loan becomes delinquent or pays off within a specified period following loan funding and sale.

The Bank considers these potential recourse provisions to be a minimal risk, but has established a reserve under generally accepted accounting principles for possible repurchases.

The Bank considers these potential recourse provisions to be a minimal risk, but has established a reserve under generally accepted accounting principles ("GAAP") for possible repurchases.

There were no repurchases due to fraud by the borrower during the year ended December 31, 2020.

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

The Company is an originator of SBA loans and its practice is to sell the guaranteed portion of those loans at a premium.

Income from this source was $309 thousand for the year ended December 31, 2019 compared to $540 thousand for the same period in 2018.

Activity in SBA loan sales to secondary markets can vary widely from year to year.

Other income totaled $7.8 million for the year ended December 31, 2019 as compared to $8.0 million for the same period in 2018, a decrease of 3%.

Net investment gains amounted to $1.5 million for the year ended December 31, 2019 compared to $97 thousand for the year ended December 31, 2018.

The FHA business unit generated income of $501 thousand on the origination, securitization, servicing and sale of FHA Multifamily-Backed GNMA securities for the full year 2019 compared to $357 thousand for the same period in 2018.

Servicing agreements relating to the Ginnie Mae mortgage backed securities program require the Company to advance funds to make scheduled payments of principal, interest, taxes and insurance, if such payments have not been received from the borrowers.

As a result of elevated origination volumes and market dislocations associated with the current COVID-19 pandemic, beginning in the second quarter of 2020, and continuing through the fourth quarter of 2020, the Company began to shift its pipeline strategy towards a best efforts lock basis.

The decision whether to sell residential mortgage loans on a mandatory or best efforts lock basis is a function of multiple factors, including but not limited to overall market volumes of mortgage loan originations, forecasted “pull-through” rates of origination, loan underwriting and closing operational considerations, pricing differentials between the two methods, and availability and pricing of various interest rate hedging strategies associated with the mortgage origination pipeline.

The Company continually monitors these factors to maximize profitability and minimize operational and interest rate risks.

Gain on the sale of investments amounted to $1.8 million for the year ended December 31, 2020 compared to $1.5 million for the year ended December 31, 2019.

Other income totaled $15.3 million for the year ended December 31, 2020 as compared to $7.8 million for 2019, a increase of 97%.

The FHA business unit generated income of $3.4 million on the origination, securitization, servicing and sale of FHA Multifamily-Backed GNMA securities for the full year 2020 compared to $501 thousand for the same period in 2019.

There was also a $1.2 million gain on OREO and $1.1 million gain on swaps.

Servicing agreements relating to the Ginnie Mae ("GNMA") mortgage backed securities program require the Company to advance funds to make scheduled payments of principal, interest, taxes and insurance, if such payments have not been received from the borrowers.

The Company will generally recover funds advanced pursuant to these arrangements under the FHA insurance and guarantee program.

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In addition, if a defaulted loan is not cured, the mortgage loan would be canceled as part of the foreclosure proceedings and the Company would not receive any future servicing income with respect to that loan.

At December 31, 2019, the Company had no funds advanced outstanding under FHA mortgage loan servicing agreements.

To the extent the mortgage loans underlying the Company’s servicing portfolio experience delinquencies, the Company would be required to dedicate cash resources to comply with its obligation to advance funds as well as incur additional administrative costs related to increases in collection efforts.

At December 31, 2020, the Company did not have any funds advanced outstanding under FHA mortgage loan servicing agreements.

The funds advanced were in conjunction with a single loan of $90 thousand that suffered financial hardship due to COVID-19 and was granted forbearance by the Company on November 25th, 2020 for the period from December 1, 2020 to December 31, 2021.

Under the Forbearance Agreement, the borrower has the option to extend the Forbearance Period through February 28, 2021.

During this time, the Company will advance principal and interest on the borrower’s behalf and will be repaid in 12 monthly installments beginning on March 1, 2021 and ending on February 1, 2022.

To the extent the loan currently in forbearance or other mortgage loans underlying the Company’s servicing portfolio experience delinquencies, the Company would be required to dedicate cash resources to comply with its obligation to advance funds as well as incur additional administrative costs related to increases in collection efforts.

Noninterest Expense

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Total noninterest expenses totaled $144.2 million for the year ended December 31, 2020, as compared to $139.9 million for the year ended December 31, 2018, a 3% increase.

For 2019, the efficiency ratio was 39.99% as compared to 37.31% for the same period in 2018.

Salaries and employee benefits were $79.8 million for the year ended December 31, 2019, as compared to $67.7 million for the same period in 2018, an increase of 18%.

Cost increases for salaries and benefits were due primarily to $8.2 million of nonrecurring charges related to acceleration of share based compensation expenses associated with the retirement of our former Chairman and Chief Executive Officer and the resignation of certain directors.

In addition, $4.0 million of the increase resulted from additional staffing, merit increases, and incentives.

For the year 2020, the efficiency ratio (ratio of noninterest expenses to total revenue) was 39.25% as compared to 39.99% for the same period in 2019.

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Salaries and employee benefits were $74.4 million for the year ended December 31, 2020, as compared to $79.8 million for the same period in 2018, a decrease of 7%.

Cost decreased as result of 2019 having $8.2 million of nonrecurring charges related to acceleration of share based compensation expenses associated with the retirement of our former Chairman and Chief Executive Officer and the resignation of certain directors.

The decrease was partially offset by higher salaries attributable to merit increases and increased headcount in 2020.

At December 31, 2020, the Company’s full time equivalent staff numbered 519, as compared to 492 at December 31, 2019.

Premises and equipment expenses amounted to $14.4 million for the year ended December 31, 2019 as compared to $15.7 million for the same period in 2018, a decrease of 8%.

Premises and equipment expenses amounted to $15.7 million for the year ended December 31, 2020 as compared to $14.4 million for the same period in 2019, an increase of 9%.

The largest increase related to adjustments for lease extensions not previously recorded.

For the year ended December 31, 2020, the Company recognized $469 thousand of sublease revenue as compared to $527 thousand for the same period in 2019.

The sublease revenue is accounted for as a reduction to premises and equipment expenses.

Marketing and advertising expenses increased to $4.8 million for the year ended December 31, 2019 from $4.6 million for the same period in 2018, an increase of 6%, due primarily to increased digital and print advertising spend.

Data processing expenses decreased from $9.7 million for the year ended December 31, 2018 to $9.4 million for 2019, a decrease of 3%, primarily due to ongoing contract renegotiations.

Marketing and advertising expenses decreased to $4.3 million for the year ended December 31, 2020 from $4.8 million for 2019, a decrease of 11%, due primarily to a reduction in sponsorship fees as several expected conferences did not happen as result of COVID-19 in 2020.

Data processing expenses increased from $9.4 million for the year ended December 31, 2019 to $10.7 million for 2020, an increase of 14%, primarily due to yearly increases in license fee renewals and additional networking capacity needed related to COVID-19.

Legal, accounting and professional fees and expenses for the year ended December 31, 2020 increased to $16.4 million from $12.2 million in 2019, a 35% increase.

The increased expenses were primarily associated with legal fees and expenditures associated with ongoing governmental investigations and related subpoenas and document requests.

The increased expenses were primarily associated with legal fees and expenditures related to ongoing governmental investigations and subpoenas and document requests.

The Company expects to continue to incur elevated levels of legal and professional fees and expenses in 2021 as it continues to cooperate with these investigations.

FDIC insurance decreased $306 thousand to $3.2 million for the year ended December 31, 2019, a decrease of 9% compared to 2018, due to one time premium credits in the second and third quarters of 2019 due to the deposit insurance fund exceeding regulatory levels partially offset by premiums on a larger deposit base.

Other expenses increased to $16.0 million for the year ended December 31, 2019 from $15.8 million for the same period in 2018, an increase of 1%.

Refer to "Item 3- Legal Proceedings" for additional information on the Company’s recent proceedings.

FDIC insurance increased $4.7 million to $7.9 million for the year ended December 31, 2020, an increase of 148% compared to 2019, primarily due to a nonrecurring $1.8 million credit in 2019 and a higher assessment base in 2020 resulting from growth in total assets.

Other expenses decreased to $14.7 million for the year ended December 31, 2020 from $16.0 million for the same period in 2019, a decrease of 8%.

The major components of cost in this category include broker fees, franchise tax, core deposit intangible amortization, insurance expenses, and director compensation.

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The Company recorded income tax expense of $43.9 million in 2020 compared to $53.8 million in 2019, resulting in an effective tax rate of 24.9% and 27.4%, respectively.

The higher effective tax rate for 2019 was due primarily to a decrease in federal tax credits, an increase in nondeductible expenses, and adjustments related to the completion of the 2018 tax returns.

The decrease was due primarily to a decrease in nondeductible expenses related to executive compensation, state taxes and adjustments related to the completion of the 2019 tax returns.

BALANCE SHEET ANALYSIS

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Loans held for sale amounted to $88.2 million at December 31, 2020 as compared to $56.7 million at December 31, 2019, a 56% increase.

The investment portfolio totaled $843.4 million at December 31, 2019, an 8% increase from $784.1 million at December 31, 2018.

Total borrowed funds (excluding customer repurchase agreements) were $467.7 million at December 31, 2019 and $217.3 million at December 31, 2018, a 115% increase due to the $250.0 million in FHLB advances outstanding as of December 31, 2019.

Total shareholders’ equity at December 31, 2019 increased 7%, to $1.19 billion from $1.11 billion at December 31, 2018.

The increase in shareholders’ equity from December 31, 2018 was primarily due to increased retained earnings.

Growth in retained earnings has enhanced the Company’s capital position well in excess of regulatory requirements for well capitalized status.

The investment portfolio totaled $1.2 billion at December 31, 2020, a 36% increase from $843.4 million at December 31, 2019.

Total borrowed funds (excluding customer repurchase agreements) were $568.1 million at December 31, 2020 and $467.7 million at December 31, 2019, a 21% increase.

Total shareholders’ equity at December 31, 2020 increased 4%, remaining at a rounded $1.24 billion from $1.19 billion at December 31, 2019.

The relatively modest increase in shareholders’ equity from December 31, 2019 was due to favorable net income being largely offset by share repurchases, cash dividends and a Day 1 adjustment to the Allowance for Credit Losses for adoption of the CECL accounting methodology.

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The total risk based capital ratio was 17.04% at December 31, 2020, as compared to 16.20% at December 31, 2019.

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The ratio of common equity to total assets was 11.16% at December 31, 2020 as compared to 13.25% at December 31, 2019.

The Company’s capital position remains well in excess of regulatory requirements for well capitalized status.

Investment Securities Available-for-Sale and Short-Term Investments

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This classification requires that investment securities be recorded at their fair value with any difference between the fair value and amortized cost (the purchase price adjusted by any discount accretion or premium amortization) reported as a component of shareholders’ equity (accumulated other comprehensive income), net of deferred income taxes.

At December 31, 2019, the Company had a net unrealized gain in AFS securities of $4.2 million with a deferred tax liability of $757 thousand, as compared to a net unrealized loss in AFS securities of $9.5 million at December 31, 2018, with a deferred tax asset of $2.8 million.

At December 31, 2020, the Company had a net unrealized gain in AFS securities of $22.0 million with a deferred tax liability of $5.5 million as compared to a net unrealized loss in AFS securities of $4.2 million at December 31, 2019, with a deferred tax asset of $757 thousand.

The AFS portfolio is comprised of U.S.

agency securities (13% of AFS securities) with an average duration of 2.9 years, seasoned mortgage backed securities that are 100% agency issued (72% of AFS securities) which have an average expected life of 5.5 years with contractual maturities of the underlying mortgages of up to thirty years, municipal bonds (8% of AFS securities) which have an average duration of 4.0 years, U.S.

Treasuries (4% of AFS securities) which have an average duration of 0.3 years, corporate bonds (1% of AFS securities) which have an average duration of 5 years, and equity investments which comprise less than 1% of AFS securities.

agency securities (16% of AFS securities) with an average duration of 1.9 years, seasoned mortgage backed securities that are 100% agency issued (72% of AFS securities) which have an average expected life of 3.2 years with contractual maturities of the underlying mortgages of up to thirty years, municipal bonds (9% of AFS securities) which have an average duration of seven years, corporate bonds (3% of AFS securities) which have an average duration of four years, and equity investments which comprise less than 1% of AFS securities.

The equity investment consists of common stock of two community banking companies with an estimated fair value of $198 thousand.

Ninety eight percent of the investment securities which are debt instruments are rated AAA or AA or have the implicit guarantee of the U.S.

At December 31, 2019, the investment portfolio amounted to $843.4 million as compared to $784.1 million at December 31, 2018, an increase of 8%.

96 percent of the investment securities which are debt instruments are rated AAA or AA or have the implicit guarantee of the U.S.

At December 31, 2020, the investment portfolio amounted to $1.2 billion as compared to $843.4 million at December 31, 2019, an increase of 36%.

The investment portfolio is managed to achieve goals related to liquidity, income, interest rate risk management and to provide collateral for customer repurchase agreements and other borrowing relationships.

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Amounts are reported at estimated fair value.

The change in composition of the portfolio at December 31, 2019 as compared to 2018 was due principally to ALCO decisions to buy longer-term municipal investments and increase holdings of U.S.

agency securities to better position the Company for the current interest rate environment while maintaining portfolio cash flow and liquidity.

During the year ended December 31, 2019, the investment portfolio balances increased as compared to balances at December 31, 2018, as the Bank’s deposit growth outpaced loan growth.

The change in composition of the portfolio at December 31, 2020 as compared to 2019 was due principally to ALCO decisions to buy longer-term municipal investments and increase holdings of mortgage backed securities to better position the Company for the current interest rate environment while maintaining portfolio cash flow and liquidity.

During the year ended December 31, 2020, the investment portfolio balances at fair value increased as compared to balances at December 31, 2019, as the Bank’s deposit growth outpaced loan growth.

Years Ended December 31,

(dollars in thousands)

Percent of Total

(dollars in thousands) Balance Percent of Total Balance Percent of Total Balance Percent of Total

agency securities $ 181,921 15.8 % $ 179,794 21.3 % $ 256,345 32.7 %

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Corporate bonds 35,850 3.1 % 10,733 1.3 % 9,576 1.2 %

Other equity investments

treasury — — % 34,855 4.1 % — —

$ 1,150,885 $ — $ 843,363 100 % $ 784,139 100 %

At December 31, 2020, there were no issuers, other than the U.S.

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Yields on tax exempt securities have not been calculated on a tax equivalent basis.

After One Year

After Five Years

One Year or Less

Through Five Years

Through Ten Years

After Ten Years

(dollars in thousands)

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One Year or Less After One Year

Through Five Years After Five Years

Through Ten Years After Ten Years Total

(dollars in thousands) Amortized

Cost Weighted

Yield Amortized

Cost Weighted

Yield Amortized

Cost Weighted

Yield Amortized

Cost Weighted

Yield Amortized

Cost Weighted

Government agency securities $ 53,916 0.70 % $ 110,083 1.33 % $ 17,087 1.26 % $ — — $ 181,086 1.14 %

Residential mortgage backed securities 57,278 0.99 % 648,455 0.86 % 105,595 1.36 % — — 811,328 0.93 %

Muncipal bonds

Municipal bonds 4,329 3.86 % 26,622 2.54 % 69,309 2.19 % 2,000 2.67 % 102,260 2.41 %

Corporate bonds 5,218 3.68 % 22,189 3.77 % 6,976 4.72 % — — 34,383 3.95 %

Other equity investments

$ 120,741 1.08 % $ 807,349 0.98 % $ 198,967 1.76 % $ 2,000 2.67 % $ 1,129,057 1.19 %

Federal funds sold amounted to $28.2 million at December 31, 2020 as compared to $39.0 million at December 31, 2019.

These funds represent excess daily liquidity which is invested on an unsecured basis with well capitalized banks, in amounts generally limited both in the aggregate and to any one bank.

Interest bearing deposits with banks and other short-term investments amounted to $195.4 million at December 31, 2019 as compared to $303.2 million at December 31, 2018.

Interest bearing deposits with banks and other short-term investments amounted to $1.8 billion at December 31, 2020 as compared to $195.4 million at December 31, 2019.

These short term investments represent liquid funds held at the Federal Reserve to meet future loan demand, to fund future increases in investment securities and to meet other general liquidity needs of the Company.

The Bank also holds a time deposit amounting to $1.6 million at December 31, 2019 and $1.6 million at December 31, 2018.

The Bank no longer holds any time deposits at December 31, 2020 and held $1.6 million at December 31, 2019.

Loan Portfolio

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Loan growth over the past year has been favorable, with loans outstanding reaching $7.8 billion at December 31, 2020, an increase of $214.5 million or 3% as compared to $7.5 billion at December 31, 2019.

Loan growth over the last twelve months was due in part to the Bank’s enhanced marketing efforts and continued focus on our Relationships FIRST strategy.

Loan growth in 2019 was predominantly in the income producing - commercial real estate and owner occupied – commercial real estate loan categories.

Despite an increased level of in-market competition for business, the Bank continued to experience strong organic loan production and portfolio growth.

Loan production in 2020 was predominantly in the income producing - commercial real estate and owner occupied – commercial real estate loan categories, while construction loans have been de-emphasized.

That said, the Company continues to be active as a construction lender and we expect to continue to see construction commitments funded up over time.

Despite an increased level of in-market competition for business, the Bank continued to experience organic loan production, having originated more than $1 billion in new CRE loan commitments during 2020.

This production was offset by the continued successful completion of projects and subsequent paydowns.

Notwithstanding increased supply of units, multi-family commercial real estate leasing in the Bank’s market area has held up well, particularly for well-located close-in projects.

While as a general comment there has been some softening in the Suburban Maryland office leasing market, in certain well located pockets and submarkets, the sector has evidenced some positive absorption.

Overall, commercial real estate values have generally held up well with price escalation in prime pockets, but we continue to be cautious of the cap rates at which some assets are trading and we are being careful with valuations as a result.

While the ultra high-end real estate market has softened, the moderately priced housing market has remained stable to increasing, with well-located, Metro accessible properties garnering a premium.

While as a general comment there has been softening in the office leasing market, in certain well-located pockets and submarkets, the sector has evidenced some resilience.

Overall, commercial real estate values have generally held up well, but we continue to be cautious of the cap rates at which some assets are trading and we are being careful with valuations as a result.

Owner occupied commercial real estate and construction – C&I (owner occupied) loans represent 15% of the loan portfolio.

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Real estate also serves as collateral for loans made for other purposes, resulting in 85% of loans being secured or partially secured by real estate.

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The following table shows the trends in the composition of the loan portfolio over the past five years.

Years Ended December 31,

(dollars in thousands)

2020 2019 2018 2017 2016

(dollars in thousands) Amount % Amount % Amount % Amount % Amount %

Commercial $ 1,437,433 19 % $ 1,545,906 20 % $ 1,553,112 22 % $ 1,375,939 21 % $ 1,200,728 21 %

PPP loans 454,771 6 % — — % — — % — — % — — %

Income producing - commercial real estate 3,687,000 47 % 3,702,747 50 % 3,256,900 46 % 3,047,094 48 % 2,509,517 44 %

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Construction - C&I (owner occupied) 158,905 2 % 89,490 1 % 57,797 1 % 58,691 1 % 126,038 2 %

Home equity 73,167 1 % 80,061 1 % 86,603 1 % 93,264 1 % 105,096 2 %

Other consumer 1,389 — % 2,160 — 2,988 — 3,598 — 10,365 —

Total loans 7,760,212 100 % 7,545,748 100 % 6,991,447 100 % 6,411,528 100 % 5,677,893 100 %

Allowance for credit losses (109,579) (73,658) (69,944) (64,758) (59,074)

Net loans $ 7,650,633 $ 7,472,090 $ 6,921,503 $ 6,346,770 $ 5,618,819

As noted above, a significant portion of the loan portfolio consists of commercial, construction and commercial real estate loans, primarily made in the Washington, D.C.

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While our basic market area is the Washington, D.C.

metropolitan area, the Bank has made loans outside that market area where the nature and quality of such loans was consistent with the Bank’s lending policies.

metropolitan area, the Bank has made loans outside that market area where the applicant is an existing customer and the nature and quality of such loans was consistent with the Bank’s lending policies.

At present, the Company believes that commercial real estate values are stable to improving in those sub-markets of the Washington, D.C.

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As of December 31, 2020, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represent 321% of consolidated risk based capital;

however, growth in that segment over the past 36 months at 46% does not exceed the 50% threshold laid out in the regulatory guidance.

however, growth in that segment over the past 36 months a t 18% do es not exceed the 50% threshold laid out in the regulatory guidance.

Construction, land and land development loans represent 122% of consolidated risk based capital.

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Nevertheless, we may be required to maintain higher levels of capital as a result of our commercial real estate concentrations, which could require us to obtain additional capital, and may adversely affect shareholder returns.

The Company has an extensive Capital Plan and Policy, which includes pro-forma projections including stress testing within which the Board of Directors has established internal minimum targets for regulatory capital ratios that are in excess of well capitalized ratios.

The Company has an extensive Capital Policy and Capital Plan, which includes pro-forma projections including stress testing within which the Board of Directors has established internal minimum targets for regulatory capital ratios that are in excess of well capitalized ratios.

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As of December 31, 2020, loans to the Accommodation and Food Service industry represent 10% of the loan portfolio compared to 9% as of December 31, 2019.

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Refer to Note 4 to the Consolidated Financial Statements for further detail regarding related party loans.

Loan Portfolio Exposures- COVID-19:

Industry areas of potential concern within the Loan Portfolio are presented below as of December 31, 2020

Industry Principal Balance

(in 000's) % of Loan Portfolio

Accommodation & Food Services $ 768,568 (1 )

Retail Trade $ 98,882 (2 )

(1) Includes $81,832 of PPP loans.

(2) Includes $13,512 of PPP loans.

Concerns over exposures to the Accommodation and Food Service industry and Retail Trade are the most immediate at this time.

Accommodation and Food Service exposure represents 10% of the Bank’s loan portfolio as of December 31, 2020 among 311 customers.

Retail Trade exposure represents 1% of the Bank’s loan portfolio and represented 111 customers.

The Bank has ongoing extensive outreach to these customers and is assisting where necessary with PPP loans and payment deferrals or interest-only periods in the short term while customers work with the Bank to develop longer term stabilization strategies as the landscape of the COVID-19 pandemic evolves.

The uncertain duration and severity of the pandemic will likely impact future credit challenges in these areas.

The table below is collateral-based and shows exposures on loans secured by CRE by tenant type as of December 31, 2020.

This table excludes loans disclosed in the industry table above.

Property Type Principal Balance (in 000’s) % of Loan

Restaurant $ 44,541 0.6 %

Hotel 35,741 0.5 %

Retail 377,269 4.9 %

Although not evidenced at December 31, 2020, it is anticipated that some portion of the CRE loans secured by the above property types could be impacted by the tenancies associated with impacted industries.

The Bank is working with CRE borrowers and monitoring rent collections as part of our portfolio management oversight.

Loan Maturity

The following table sets forth the time to contractual maturity of the loan portfolio as of December 31, 2020.

(dollars in thousands)

One Year or Less

Over One to Five Years

Over Five to Ten Years

Over Ten Years

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(dollars in thousands) Total One Year or Less Over One to Five Years Over Five to Ten Years Over Ten Years

Commercial $ 1,437,432 $ 543,070 $ 726,409 $ 133,838 $ 34,115

PPP loans 454,771 — 454,771 — —

Income producing - commercial real estate 3,687,000 1,014,785 1,942,146 730,069 —

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Construction - C&I (owner occupied) 158,905 8,508 44,007 75,346 31,044

Home equity 73,167 6,867 17,031 2,739 46,530

Other consumer 1,390 733 171 — 486

Total loans $ 7,760,212 $ 2,321,671 $ 3,739,848 $ 1,475,602 $ 223,091

Predetermined fixed interest rate $ 3,523,055 $ 481,868 $ 2,062,449 $ 867,641 $ 111,097

Floating or Adjustable interest rate 4,237,157 1,839,803 1,677,399 607,961 111,994

Total loans $ 7,760,212 $ 2,321,671 $ 3,739,848 $ 1,475,602 $ 223,091

Loans are shown in the period based on final contractual maturity.

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Allowance for Credit Losses

The provision for credit losses represents the amount of expense charged to current earnings to fund the allowance for credit losses.

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

The provision for credit losses represents the amount of expense charged to current earnings to fund the ACL.

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

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

Management has developed a comprehensive analytical process to monitor the adequacy of the allowance for credit losses.

Management has developed a comprehensive analytical process to monitor the adequacy of the ACL.

This process and guidelines were developed utilizing, among other factors, the guidance from federal banking regulatory agencies.

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During 2020, a provision for credit losses was made in the amount of $45.6 million and net charge-offs amounted to $20.1 million.

A full discussion of the accounting for allowance for credit losses is contained in Note 1 to the Consolidated Financial Statements and activity in the allowance for credit losses is contained in Note 4 to the Consolidated Financial Statements.

Also, please refer to the discussion under the caption “Critical Accounting Policies” within Management’s Discussion and Analysis of Financial Condition and Results of Operation for further discussion of the methodology which management employs to maintain an adequate allowance for credit losses, as well as the discussion under the caption “Provision for Credit Losses.”

The allowance for credit losses represented 0.98% of total loans at December 31, 2019 as compared to 1.00% at December 31, 2018.

A full discussion of the accounting for ACL is contained in Note 1 to the Consolidated Financial Statements and activity in the ACL is contained in Note 4 to the Consolidated Financial Statements.

Also, please refer to the discussion under the caption “Critical Accounting Policies” within Management’s Discussion and Analysis of Financial Condition and Results of Operation for further discussion of the methodology which management employs to maintain an adequate ACL, as well as the discussion under the caption “Provision for Credit Losses.”

The ACL represented 1.41% of total loans at December 31, 2020 as compared to 0.98% at December 31, 2019.

At December 31, 2020, the allowance represented 180% of nonperforming loans as compared to 151% at December 31, 2019 .

The decline in the ratio of the allowance for loan losses to total loans was due to a higher percentage increase in loans outstanding as compared to the allowance growth.

The decrease in the allowance coverage ratio was due to a higher percentage increase in nonperforming loans as compared to the allowance growth.

The majority of nonperforming loans are believed to be adequately secured by real estate.

Please refer to the “Nonperforming Assets” section for a discussion of non performing loans.

As part of its comprehensive loan review process, the Bank’s Board of Directors, Directors’ Loan Committee and Credit Review Committee carefully evaluate loans which are past due 30 days or more.

The increase in the ratio of the allowance for loan losses to total loans was partially due to the adoption of CECL, as well as changes in the economic conditions and forecasts due to COVID-19 in 2020.

The increase in the allowance coverage ratio was also due to the same factors.

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As part of its comprehensive lo an review process, the Bank’s Board of Directors, Directors’ Loan Committee and Credit Review Committee carefully evaluate loans which are past due 30 days or more.

The Committees make a thorough assessment of the conditions and circumstances surrounding delinquent and potential problem loans.

The Bank’s loan policy requires that loans be placed on nonaccrual if they are 90 days past due, unless they are well secured and in the process of collection.

Additionally, Credit Administration specifically analyzes the status of development and construction projects, including sales activities and utilization of interest reserves in order to carefully and prudently assess potential increased levels of risk which may require additional reserves.

The Credit Administration department specifically analyzes the status of development and construction projects, including sales activities and utilization of interest reserves in order to carefully and prudently assess potential increased levels of risk which may require additional reserves.

Additionally, for COVID-19 impacted relationships, a Task Force comprised of senior executives has been formed to evaluate each request for deferral or modification, along with a remediation plan, before any modification to any loan is made.

At December 31, 2020, the Company had $60.9 million of loans classified as nonperforming, and $91.2 million of additional loans considered potential problem loans, as compared to $48.7 million of nonperforming loans and $20.0 million of potential problem loans at December 31, 2019.

The $20.0 million in potential problem loans at December 31, 2019, decreased from $102.7 million at December 31, 2018 due primarily to two commercial real estate secured relationships.

The $91.2 million in potential problem loans at December 31, 2020, increased from $20.0 million at Decembe r 31, 2019 due primarily to one commercial real estate loan and one assisted living property.

Please refer to Note 1 to the Consolidated Financial Statements under the caption “Loans” for a discussion of the Company’s policy regarding impairment of loans.

Please refer to the “Nonperforming Assets” section for a discussion of problem and potential problem assets.

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

The Company has taken a conservative posture with respect to risk rating its loan portfolio.

Based upon their status as potential problem loans, these loans receive heightened scrutiny and ongoing intensive risk management.

Additionally, the Company's loan loss allowance methodology incorporates increased reserve factors for certain loans considered potential problem loans as compared to the general portfolio.

See the “Allowance for Credit Losses” section for a description of the allowance methodology.

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

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

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The Bank provides analysis of credit requests and the management of problem credits.

The Bank has developed and implemented analytical procedures for evaluating credit requests, has refined the Company’s risk rating system, and has adopted enhanced monitoring of the loan portfolio (in particular the construction loan portfolio) and the adequacy of the allowance for credit losses, including stress test analyses.

Additionally, fair value assessments of loans acquired is made as part of analytical procedures.

The loan portfolio analysis process is ongoing and proactive in order to maintain a portfolio of quality credits and to quickly identify any weaknesses before they become more severe.

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The following table sets forth activity in the allowance for credit losses for the past five years.

2 unchanged sentences

Balance at beginning of year $ 73,658 $ 69,944 $ 64,758 $ 59,074 $ 52,687

Impact of adopting CECL 10,614 — — — —

Commercial 12,082 4,868 3,491 747 3,745

Income producing - commercial real estate 4,300 1,847 121 1,470 2,341

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Construction - commercial and residential 2,947 3,496 1,160 2,158 —

Construction - C&I (owner occupied)

Home equity 92 — — 100 217

Other consumer 3 8 81 100 37

Total charge-offs 20,259 10,219 4,985 4,575 6,340

Commercial 130 405 340 681 220

Income producing - commercial real estate — 26 2 80 908

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Construction - commercial and residential 4 354 1,009 492 215

Construction - C&I (owner occupied)

Home equity — — 133 5 12

Other consumer 28 51 18 21 31

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Net charge-offs 20,097 9,377 3,474 3,287 4,944

Provision for Credit Losses

Provision for Credit Losses- Loans $ 45,404 13,091 8,660 8,971 11,331

Balance at end of year $ 109,579 $ 73,658 $ 69,944 $ 64,758 $ 59,074

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Ratio of net charge-offs during the year to average loans outstanding during the year 0.26 % 0.13 % 0.05 % 0.06 % 0.09 %

The following table presents the allocation of the allowance for credit losses by loan category and the percent of loans each category bears to total loans.

The allocation of the allowance at December 31, 2019 includes specific reserves of $10.0 million against impaired loans of $54.9 million as compared to specific reserves of $11.4 million against impaired loans of $40.3 million at December 31, 2019.

The following table presents the allocation of the ACL by loan category and the percent of loans each category bears to total loans.

The allocation of the allowance at December 31, 2020 includes specific reserves of $15.4 million against individually assessed loans of $71.2 million as compared to specific reserves of $10.0 million against impaired loans of $54.9 million at December 31, 2019.

The allocation of the allowance to each category is not necessarily indicative of future losses or charge-offs and does not restrict the usage of the allowance for any specific loan or category.

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Years Ended December 31,

(dollars in thousands)

2020 2019 2018 2017 2016

(dollars in thousands) Amount % (1)

Commercial $ 26,569 24 % $ 18,832 20 % $ 15,857 22 % $ 13,102 21 % $ 14,700 21 %

Income producing - commercial real estate 55,385 51 % 29,265 50 % 28,034 46 % 25,376 48 % 21,105 44 %

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Construction - C&I (owner occupied) 2,437 2 % 1,113 1 % 691 1 % 687 1 % 1,485 2 %

Home equity 1,039 1 % 656 1 % 599 1 % 770 1 % 1,328 2 %

Other consumer 37 — % 25 — 72 — 140 — 160 —

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Nonperforming Assets

As shown in the table below, the Company’s level of nonperforming assets, which is comprised of loans delinquent 90 days or more, nonaccrual loans, which includes the nonperforming portion of troubled debt restructurings, or TDR, and OREO, totaled $50.2 million at December 31, 2019, representing 0.56% of total assets, as compared to $17.7 million of nonperforming assets at December 31, 2018, representing 0.21% of total assets.

As shown in the table below, the Company’s level of nonperforming assets, which is comprised of loans delinquent 90 days or more, nonaccrual loans, which includes the nonperforming portion of troubled debt restructurings, or TDR, and other real estate owned ("OREO"), totaled $65.9 million at December 31, 2020, representing 0.59% of total assets, as compared to $50.2 million of nonperforming assets at December 31, 2019, representing 0.56% of total assets.

The Company had no accruing loans 90 days or more past due at December 31, 2020 or December 31, 2019.

Management remains attentive to early signs of deterioration in borrowers’ financial conditions and to taking the appropriate action to mitigate risk.

Furthermore, the Company is diligent in placing loans on nonaccrual status and believes, based on its loan portfolio risk analysis, that its allowance for credit losses at 0.98% of total loans at December 31, 2019, is adequate to absorb potential credit losses within the loan portfolio at that date.

Furthermore, the Company is diligent in placing loans on nonaccrual status and believes, based on its loan portfolio risk analysis, that its ACL at 1.41% of total loans at December 31, 2020, is adequate to absorb potential credit losses within the loan portfolio at that date.

Total nonperforming loans amounted to $60.9 million at December 31, 2020, representing 0.79% of total loans, compared to $48.7 million at December 31, 2019, representing 0.65% of total loans.

The majority of nonperforming loans are believed to be adequately secured by real estate.

Included in nonperforming assets are loans that the Company considers to be impaired.

Impaired loans are defined as those as to which we believe it is probable that we will not collect all amounts due according to the contractual terms of the loan agreement, as well as those loans whose terms have been modified in a TDR that have not shown a period of performance as required under applicable accounting standards.

Valuation allowances for those loans determined to be impaired are evaluated in accordance with ASC Topic 310—“ Receivables, ” and updated quarterly.

For collateral dependent impaired loans, the carrying amount of the loan is determined by current appraised value less estimated costs to sell the underlying collateral, which may be adjusted downward under certain circumstances for actual events and/or changes in market conditions.

For example, current average actual selling prices less average actual closing costs on an impaired multi-unit real estate project may indicate the need for an adjustment in the appraised valuation of the project, which in turn could increase the associated ASC Topic 310 specific reserve for the loan.

Generally, all appraisals associated with impaired loans are updated on a not less than annual basis.

The CECL standard allows for institutions to evaluate individual loans in the event that the asset does not share similar risk characteristics with its original segmentation.

This can occur due to credit deterioration, increased collateral dependency or other factors leading to impairment.

In particular, the Company individually evaluates loans on nonaccrual and those identified as TDRs, though it may individually evaluate other loans or groups of loans as well if it determines they no longer share similar risk with their assigned segment.

Reserves on individually assessed loans are determined by one of two methods:

the fair value of collateral or the discounted cash flow.

Fair value of collateral is used for loans determined to be collateral dependent, and the fair value represents the net realizable value of the collateral, adjusted for sales costs, commissions, senior liens, etc.

Discounted cash flow is used on loans that are not collateral dependent where structural concessions have been made and continuing payments are expected.

The continuing payments are discounted over the expected life at the loan’s original contract rate and include adjustments for risk of default.

Under the incurred loss methodology that the Company applied as of December 31, 2020, nonperforming assets included loans that the Company considered to be individually assessed.

Individually assessed loans were defined as those as to which we believed it was probable that we would not collect all amounts due according to the contractual terms of the loan agreement, as well as those loans whose terms had been modified in a TDR that had not shown a period of performance as required under applicable accounting standards.

For collateral dependent individually assessed loans, the carrying amount of the loan was determined by current appraised value less estimated costs to sell the underlying collateral, which may have been adjusted downward under certain circumstances for actual events and/or changes in market conditions.

For example, current average actual selling prices less average actual closing costs on an impaired multi-unit real estate project may have indicated the need for an adjustment in the appraised valuation of the project, which in turn could increase the associated ASC Topic 310 specific reserve for the loan.

Generally, all appraisals associated with individually assessed loans were updated on a not less than annual basis.

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Loans are considered to have been modified in a TDR when, due to a borrower's financial difficulties, the Company makes unilateral concessions to the borrower that it would not otherwise consider.

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Such modifications are not considered to be TDRs as the accommodation of a borrower's request does not rise to the level of a concession if the modified transaction is at market rates and terms and/or the borrower is not experiencing financial difficulty.

(1) adverse weather conditions may create a short term cash flow issue for an otherwise profitable retail business

which suggests a temporary interest only period on an amortizing loan;

(1) adverse weather conditions may create a short term cash flow issue for an otherwise profitable retail business which suggests a temporary interest only period on an amortizing loan;

(2) there may be delays in absorption on a real estate project which reasonably suggests extension of the loan maturity at market terms;

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The determination of whether a restructured loan is a TDR requires consideration of all of the facts and circumstances surrounding the change in terms, and the exercise of prudent business judgment.

The Company had nine TDRs at December 31, 2019, totaling approximately $19.1 million, as compared to twelve TDRs totaling approximately $24.6 million at December 31, 2018.

At December 31, 2019, seven of these TDR loans, totaling approximately $16.6 million, are performing under their modified terms, as compared to the same period in 2018, there were nine performing TDR loans totaling approximately $24.0 million.

During 2019, there were three performing TDRs totaling $9.5 million that defaulted on their modified terms which were reclassified to nonperforming loans, as compared to the same period in 2018, there were two performing TDR loans totaling approximately $460 thousand that defaulted on their modified terms and were reclassified to nonperforming loans.

The Company had 10 TDRs at December 31, 2020, totaling approximately $19.2 million, as compared to nine TDRs totaling approximately $19.1 million at December 31, 2019.

At December 31, 2020, six of these TDR loans, totaling approximately $10.5 million, are performing under their modified terms, as compared to the same period in 2019, there were seven performing TDR loans totaling approximately $16.6 million.

During 2020, there were two performing TDRs totaling $6.3 million that defaulted on their modified terms which were reclassified to nonperforming loans, as compared to the same period in 2019, there were three performing TDR loans totaling approximately $9.5 million that defaulted on their modified terms and were reclassified to nonperforming loans.

A default is considered to have occurred once the TDR is past due 90 days or more, or it has been placed on nonaccrual.

During 2020, there were two restructured loans totaling approximately $572 thousand, and one TDR loan totaling $138 thousand defaulted on its modified terms and was charged off.

During 2019, there were three restructured loans totaling approximately $9.5 million, one loan totaling $4.8 million had its collateral property sold for approximately $3 million and the remaining $1.8 million was charged-off during the year, the second loan totaling $2.3 million defaulted on its modified terms and was charged off, the third loan totaling $2.4 million defaulted on its modified terms and migrated to nonperforming.

During 2018, there were four defaulted loans totaling approximately $1.4 million that were charged off during the year.

During 2019 there was one loan totaling $10.4 million that was re-underwritten into two new loans which provided better collateral for the Bank, and there was one restructured loan totaling approximately $309 thousand that was paid off from the sale proceeds of the collateral property, as compared to 2018, there were two loan payoffs on performing loans totaling approximately $3.9 million that were modified during the year.

During 2018, there was a pay down of approximately $176 thousand on one nonperforming loan totaling approximately $183 thousand at December 31, 2017.

During 2020 there were no TDR loans that were re-underwritten, and there were two restructured loans totaling approximately $870 thousand that were paid off from the sale proceeds of the collateral property.

During 2019 there was one TDR totaling $10.4 million that was re-underwritten into two new loans which provided better collateral for the Bank.

During 2019 there was also one restructured loan totaling approximately $309 thousand that was paid off from the sale proceeds of the collateral property.

Commercial and consumer loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future default.

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The allowance may be increased, adjustments may be made in the allocation of the allowance, or partial charge-offs may be taken to further write-down the carrying value of the loan.

During 2019, there was one loan modified in a TDR totaling approximately $2.3 million, as compared to the same period in 2018, there were two loans totaling approximately $12.8 million modified in a TDR.

Refer to Note 4 to the Consolidated Financial Statements for additional detail.Included in nonperforming assets at December 31, 2019 is OREO of $1.5 million, consisting of three foreclosed property.

Included in nonperforming assets at December 31, 2018 was OREO of $1.4 million, consisting of one foreclosed property.

During 2020, there were two loan modified in a TDR totaling approximately $572 thousand, as compared to the same period in 2019, there was one loan modified in a TDR totaling approximately $2.3 million.

Refer to Note 4 - " Loans and Allowance for Credit Losses" to the Consolidated Financial Statements for additional detail.

Included in nonperforming assets at December 31, 2020 is OREO of $5.0 million, consisting of three foreclosed properties .

Included in nonperforming assets at December 31, 2019 was OREO of $1.5 million, consisting of three foreclosed properties.

OREO properties are carried at fair value less estimated costs to sell.

It is the Company's policy to obtain third party appraisals prior to foreclosure, and to obtain updated third party appraisals on OREO properties generally not less frequently than annually.

The increase was due to a foreclosure involving an ultra high-end residential property located in Washington, D.C.

The Company is continuing to see softness in the market for ultra high-end residential properties.

This is particularly true in light of COVID-19 and the related limitations in marketing residential properties.

It is the Company's policy to generally obtain third party appraisals prior to foreclosure, and to obtain updated third party appraisals on OREO properties generally not less frequently than annually.

Generally, the Company would obtain updated appraisals or evaluations where it has reason to believe, based upon market indications (such as comparable sales, legitimate offers below carrying value, broker indications and similar factors), that the current appraisal does not accurately reflect current value.

During 2019 and 2018, there were no OREO sales.

During 2020, there was one OREO sale compared to no sales in 2019.

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There is uncertainty regarding the region’s overall economic outlook given lack of clarity over how long COVID-19 will continue to impact our region.

Management has been working with customers on payment deferrals to assist companies in managing through this crisis.

Through December 31, 2020, we granted approximately 750 temporary modifications representing approximately $1.6 billion in outstanding balances, including 714 temporary modifications representing $1.5 billion that have or are expected to return to pre-modification terms.

We have also granted second deferrals totaling $67 million on 33 notes as of December 31, 2020.

Of all the deferrals granted only 36 notes amounting to $72 million were outstanding as of December 31, 2020 (approximately 1% of total loans).

All loans that received a second deferral were automatically downgraded and added to our watch list to raise visibility within the loan portfolio.

Additionally, none of the deferrals are reflected in the Company’s asset quality measures (i.e.

non-performing loans) due to the provision of the CARES Act that permits U.S.

financial institutions to temporarily suspend the GAAP requirements to treat such short-term loan modifications as TDRs.

Similar provisions have also been confirmed by interagency guidance issued by the federal banking agencies and confirmed with staff members of the Financial Accounting Standards Board.

Other loan portfolio areas of concern and additional COVID-19 loan related matters are discussed below.

The following table details the deferrals discussed above as of December 31, 2020:

Industry/Collateral Type Number of Notes Total Outstanding (in millions) Deferred Note Count Total Deferred Outstanding (in millions) Percentage Outstanding Deferred Weighted Avg LTV of RE Collateral Average Loan Size (in millions)

Hotels 43 $ 529 — $ — — % N/A N/A

Transportation & Warehousing 60 171 29 38 22 % 70 % $ 1.3

Restaurants 393 238 2 5 2 % 75 % 2.5

Retail 139 276 1 4 1 % 75 % 4

Other Real Estate 911 3,688 2 6 >0.5% 44 % 3

Healthcare 197 274 1 19 7 % 87 % 19

Art/Entertainment/Recreation 66 139 0 — — % N/A N/A

Other 3,138 2,445 1 0.4 >0.5% 68 % 0.5

Total 4,947 $ 7,760 36 $ 72.4 1 % N/A N/A

The following table shows the amounts and relevant ratios of nonperforming assets at the dates indicated:

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Nonaccrual Loans:

Commercial $ 15,352 $ 14,928 $ 7,115 $ 3,493 $ 2,521

Income producing - commercial real estate 18,879 9,711 1,766 832 10,508

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Construction - C&I (owner occupied) — — — — —

Home equity 416 487 487 494 —

Other consumer — — — 91 126

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Total nonperforming loans (1)(2)

60,943 48,729 16,277 13,238 17,875

Other real estate owned 4,987 1,487 1,394 1,394 2,694

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Ratio of nonperforming assets to total assets 0.59 % 0.56 % 0.21 % 0.20 % 0.30 %

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(1) At December 31, 2020, nonaccrual loans reported in the table above included two loans totaling approximately $6.3 million which migrated from performing troubled debt restructuring.

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Significant variation in the amount of nonperforming loans may occur from period to period because the amount of nonperforming loans depends largely on the condition of a relatively small number of individual credits and borrowers relative to the total loan portfolio.

At December 31, 2019, there were $20.0 million of performing loans considered potential problem loans, defined as loans that are not included in the 90 days past due, nonaccrual or restructured categories, but for which known information about possible credit problems causes management to be uncertain as to the ability of the borrowers to comply with the present loan repayment terms which may in the future result in disclosure in the past due, nonaccrual or restructured loan categories.

The $20.0 million in potential problem loans at December 31, 2019, decreased from $102.7 million at December 31, 2018 due primarily to two commercial real estate secured relationships.

The balance of potential problem loans at December 31, 2019 included $11.9 million of loans that were considered potential problem loans at December 31, 2018.

The Company has taken a conservative posture with respect to risk rating its loan portfolio.

Based upon their status as potential problem loans, these loans receive heightened scrutiny and ongoing intensive risk management.

Additionally, the Company's loan loss allowance methodology incorporates increased reserve factors for certain loans considered potential problem loans as compared to the general portfolio.

See the “Allowance for Credit Losses” section for a description of the allowance methodology.

Other Earning Assets

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BOLI is utilized by the Company in accordance with income tax regulations as part of the Company’s financing of its benefit programs.

At December 31, 2019, this asset amounted to $75.7 million as compared to $73.4 million at December 31, 2018, which reflected the purchase of $580 thousand in additional policies during 2019 and an increase in cash surrender values.

At December 31, 2020, this asset amounted to $76.7 million as compared to $75.7 million at December 31, 2019, which reflected the increase in cash surrender value of the policies during 2020.

Refer to Note 19 to Consolidated Financial Statements for further detail.

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At December 31, 2020, the balance of excess servicing fees was $946 thousand.

For 2018, excess servicing fees of $1.8 million were recorded, $672 thousand of the FHA mortgage servicing was sold, and $1.1 million was amortized as a reduction of actual service fees collected, which is a component of other income.

For 2019, excess servicing fees of $175 thousand were recorded and $246 thousand was amortized as a reduction of actual service fees collected, which is a component of other income.

At December 31, 2019, the balance of excess servicing fees was $507 thousand.

In connection with the acquisitions of Fidelity in 2008 and Virginia Heritage in 2014, the Company allocated a portion of the purchase price to core deposit intangibles, based upon an independent evaluation, and which is included in intangible assets, on the Consolidated Balance Sheets.

Refer to Note 7 to the Consolidated Financial Statements for information on the initial and current carrying values as well as additions and amortization.

The core deposit intangible is being amortized over its remaining economic life as a component of other noninterest expense.

The amount of the core deposit intangible relating to the Fidelity and Virginia Heritage acquisitions was fully amortized at December 31, 2020, as a component of other noninterest expense.

In 2008, the Company recorded an unidentified intangible asset (goodwill) incident to the acquisition of Fidelity of $2.2 million.

In 2014, the Company recorded an initial amount of unidentified intangible (goodwill) incident to the acquisition of Virginia Heritage

of approximately $102 million.

The Company’s testing of potential goodwill impairment (which is performed annually), has resulted in no impairment being recorded.

In 2014, the Company recorded an initial amount of unidentified intangible (goodwill) incident to the acquisition of Virginia Heritage of approximately $102 million.

As of June 30, 2020, the Company performed a qualitative assessment to determine whether it was more likely than not that the fair value of the reporting unit was less than its carrying amount.

As of June 30, 2020, a triggering event was deemed to have occurred as a result of COVID-19 and, accordingly, a step one assessment was performed by comparing the fair value of the reporting unit with its carrying amount (including goodwill).

Determining the fair value of a reporting unit under the goodwill impairment test is subjective and often involves the use of significant estimates and assumptions.

Estimates of fair value are primarily determined using discounted cash flows, market comparisons and recent transactions.

Based on the results of the assessment of the reporting unit, the Company concluded that no impairment existed as of June 30, 2020.

The Company determined that there were no triggering events and an impairment analysis was not performed as of September 30, 2020.

An impairment analysis was performed during the fourth quarter as part of our regularly scheduled annual impairment testing and again found no impairment existed.

Future events could cause the Company to conclude that goodwill or other intangibles have become impaired, which would result in recording an impairment loss.

Any resulting impairment loss could have a material adverse impact on the Company’s financial condition and results of operations.

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Refer to Note 7 to the Consolidated Financial Statements for information on the initial and current carrying values as well as additions and amortization.

Deposits and Other Borrowings

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The deposit base includes transaction accounts, time and savings accounts and accounts which customers use for cash management and which provide the Bank with a source of fee income and cross-marketing opportunities, as well as an attractive source of lower cost funds.

To meet funding needs during periods of high loan demand and seasonal variations in core deposits, the Bank utilizes alternative funding sources such as secured borrowings from the FHLB, federal funds purchased lines of credit from correspondent banks and brokered deposits from regional and national brokerage firms and Promontory.

For the year ended December 31, 2019, total deposits increased by $250.1 million or 4% compared to the same period in 2018.

Noninterest bearing deposits decreased $39.9 million or 2% to $2.06 billion at December 31, 2019 as compared to $2.10 billion at December 31, 2018, while interest bearing deposits increased by $290.0 million, or 6%.

Within interest bearing deposits, money market and savings accounts collectively amounted to $3.01 billion at December 31, 2019, or 42% of total deposits, as compared to $2.95 billion, or 42% of total deposits, at December 31, 2018, an increase of $63.6 million, or 2%.

Average total deposits for the year ended December 31, 2019 were $7.23 billion, as compared to $6.44 billion for the same period in 2018, a 12% increase.

Approximately 18% of the Bank’s deposits at December 31, 2019 ($1.28 billion) were time deposits, which are generally the most expensive form of deposit because of their fixed rate and term, as compared to 19% at December 31, 2018 ($1.33 billion).

The following table sets forth the maturities of time deposits with balances of $250 thousand or more, which represent 5% and 6% of total deposits as of December 31, 2019 and 2018, respectively.

For the year ended December 31, 2020, total deposits increased by $2.0 billion or 27% compared to the same period in 2019.

Noninterest bearing deposits increased $745.0 million or 36% to $2.8 billion at December 31, 2020 as compared to $2.1 billion at December 31, 2019, while interest bearing deposits increased by $1.4 billion, or 31%.

Within interest bearing deposits, money market and savings accounts collectively amounted to $4.6 billion at December 31, 2020, or 51% of total deposits, as compared to $3.0 billion, or 42% of total deposits, at December 31, 2019, an increase of $1.6 billion, or 54%.

Average total deposits for the year ended December 31, 2020 were $8.5 billion, as compared to $7.2 billion for the same period in 2019, an 18% increase.

Approximately 11% of the Bank’s deposits at December 31, 2020 ($977.8 million) were time deposits, whi ch are generally the most expensive form of deposit because of their fixed rate and term, as compared to 18% at December 31, 2019 ($1.3 billion).

The following table sets forth the maturities of time deposits with balances of $250 thousand or more, which represents 11% and 5% of total deposits as of December 31, 2020 and 2019, respectively.

See Note 11 to the Consolidated Financial Statements for additional information regarding the maturities of time deposits and the Average Balances Table in the “Net Interest Income and Net Interest Margin” section for the average rates paid on interest-bearing deposits.

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Over twelve months 451,119 90,361

From time to time, when appropriate in order to fund strong loan demand, the Bank accepts brokered time deposits, generally in denominations of less than $250 thousand, from a regional brokerage firm, and other national brokerage networks, including Promontory.

Additionally, the Bank participates in the CDARS and the ICS products, which provides for reciprocal (“two-way”) transactions among banks facilitated by Promontory for the purpose of maximizing FDIC insurance.

Total $ 977,760 $ 350,601

Additionally, the Bank participates in the CDARS and the ICS products, which provides for reciprocal (“two-way”) transactions among banks facilitated by IntraFi for the purpose of maximizing FDIC insurance.

The total of reciprocal deposits at December 31, 2020 was $790.0 million (9% of total deposits) as compared to $502.9 million at December 31, 2019 (7% of total deposits).

These sources are believed by the Company to represent a reliable and cost efficient alternative funding source for the Bank.

The Bank also is able to obtain one way CDARS deposits and participates in Promontory’s Insured Network Deposit, (“IND”).

The Bank had $533.1 million and $544.5 million of “IND” brokered deposits as of December 31, 2019 and 2018, respectively.

The Bank also is able to obtain one way CDARS deposits and participates in IntraFi’s Insured Network Deposit, (“IND”).

The Bank had $1.3 billion and $533.1 million of “IND” brokered deposits as of December 31, 2020 and 2019, respectively.

However, to the extent that the condition or reputation of the Company or Bank deteriorates, or to the extent that there are significant changes in market interest rates which the Company and Bank do not elect to match, we may experience an outflow of brokered deposits.

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At December 31, 2019, total brokered deposits (excluding the CDARS and ICS two-way) were $1.8 billion, or 25% of total deposits.

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At December 31, 2020, the Company had $2.8 billion in noninterest bearing demand deposits, representing 31% of total deposits.

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The Company had no outstanding balances under its federal funds lines of credit provided by correspondent banks (which are unsecured) at December 31, 2020 and 2019.

At December 31, 2019, the Company had $250.0 million of FHLB advances borrowed as part of the overall asset liability strategy and to support loan growth.

The Company did not have FHLB advances outstanding as of December 31, 2018.

At December 31, 2020, the Company had $300.0 million of FHLB advances borrowed as part of the overall asset liability strategy.

The Company had $250.0 million FHLB advances outstanding as of December 31, 2019.

Outstanding FHLB advances are secured by collateral consisting of a blanket lien on qualifying loans in the Bank’s commercial mortgage, residential mortgage and home equity loan portfolios.

Long-term borrowings outstanding at December 31, 2019 and December 31, 2018 include the Company’s August 5, 2014 issuance of $70.0 million of subordinated notes, due September 1, 2024 and the Company’s July 26, 2016 issuance of $150.0 million of subordinated notes, due August 1, 2026.

Long-term borrowings outstanding at December 31, 2020 and December 31, 2019 consisted of the Company’s August 5, 2014 issuance of $70.0 million of subordinated notes, due September 1, 2024 and the Company’s July 26, 2016 issuance of $150.0 million of subordinated notes, due August 1, 2026.

For additional information on the Company’s subordinated notes, please refer to Note 13 to the Consolidated Financial Statements, as well as the “Capital Resources and Adequacy” section below.

Additionally, long-term borrowings consisted of FHLB advances with maturities over one year, which amounted to $50 million at December 31, 2020 and $0 at December 31, 2019.

COMPARISON OF THE YEARS ENDED DECEMBER 31, 2019 AND 2018

For the year ended December 31, 2018, the Company’s net income was $152.3 million, a 52% increase as compared to the $100.2 million for the year ended December 31, 2017.

Net income per basic and diluted common share for the year ended December 31, 2018 was $4.44 and $4.42, respectively as compared to $2.94 per basic common share and $2.92 per diluted common share for 2017, an increase of 51% per basic and diluted common share.

For the year ended December 31, 2019, the Company’s net income was $142.9 million, a 6% decrease as compared to $152.3 million.

For the year ended December 31, 2019, the Company reported a return on average assets, or ROAA, of 1.61% as compared to 1.91% for the year ended December 31, 2018.

The return on average common equity, or ROACE, for the year ended December 31, 2019 was 12.20%, as compared to 14.89% for the year ended December 31, 2018.

The return on average tangible common equity for the year ended December 31, 2018 was 16.63%, as compared to 12.54% for the year ended December 31, 2017.

The Company’s earnings are largely dependent on net interest income, the difference between interest income and interest expense, which represented 93% and 91% of total revenue for the full year of 2018 and 2017, respectively.

The return on average tangible common equity, or ROATCE, for the year ended December 31, 2019 was 13.40%, as compared to 16.63% for the year ended December 31, 2018.

The Company’s earnings were largely dependent on net interest income, the difference between interest income and interest expense, which represented 93%% of total revenue (defined as net interest income plus noninterest income) for both the full year of 2019 and 2018, respectively.

Average earning asset yields increased by 36 basis points (4.73% to 5.09%) for the year ended December 31, 2018 compared to the same period in 2017, while the cost of interest bearing liabilities increased by 67 basis points (to 1.61% from 0.94%).

For 2018, in spite of competitive factors, the Company has been able to increase its loan portfolio yields relative to 2017 levels (5.54% as compared to 5.17%) due to disciplined loan pricing practices.

For 2019, in spite of competitive factors, the Company was able to maintain its loan portfolio yields relatively close to 2018 levels (5.45% as compared to 5.54%) due to disciplined loan pricing practices.

The cost of interest bearing liabilities increased in 2018 largely as a result of interest rate increases by the FOMC and increased competition for deposits within our market area.

Overall, the Company believes its deposit mix and cost of funds remain favorable.

though funding costs started to moderate in the second half of 2019, as the market rate cuts passed through to the liability base.

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Overall, the Company believed its deposit mix and cost of funds remained favorable across 2018 and 2019.

The percentage of average noninterest deposits relative to average total deposits increased to 33% for the full year 2018 from 32% for the same period in 2017.

The percentage of average noninterest deposits relative to average total deposits was 31% for the full year 2019 compared to 33% for the same period in 2018.

The provision for credit losses was $8.7 million for the year ended December 31, 2018 as compared to $9.0 million for the year ended December 31, 2017.

Net charge-offs of $3.5 million during 2018 represented 0.05% of average loans, excluding loans held for sale, as compared to $3.3 million or 0.06% of average loans, excluding loans held for sale, in 2017.

Total noninterest income for the year ended December 31, 2018 decreased to $22.6 million from $29.4 million for the year ended December 31, 2017, a 23% decrease.

The efficiency ratio, which measures the ratio of noninterest expense to total revenue, remained favorable at 37.31% for the year ended December 31, 2018 as compared to 37.84% for the same period in 2017.

Total noninterest expenses totaled $126.7 million for the year ended December 31, 2018, as compared to $118.6 million for the year ended December 31, 2017, a 7% increase.

As a percentage of average assets, total noninterest expense was 1.59% for the year of 2018 as compared to 1.67% for the same period in 2017.

The ratio of common equity to total assets increased from 12.71% at December 31, 2017 to 13.22% at December 31, 2018 due to growth from earnings.

Net interest income in 2018 was $317.0 million as compared to $283.9 million in 2017.

Net interest income in 2019 was $324.0 million compared to $317.0 million in 2018.

For the year ended December 31, 2019, net interest income increased 2% over the same period for 2018.

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The net interest margin was 3.77% for the year ended December 31, 2019, as compared to 4.10% for the same period in 2018.

The Company has been able to improve its loan yields in 2018 as compared to 2017 levels due to disciplined loan pricing practices, and has managed its funding costs while maintaining a favorable deposit mix;

The Company was able to maintain its loan yields in 2019 relatively close to 2018 levels due to disciplined loan pricing practices, and was able to manage its funding costs while maintaining a favorable deposit mix;

much of which has occurred from sales efforts to increase and deepen client relationships.

The allowance for credit losses increased $5.2 million at December 31, 2018 as compared to December 31, 2017, reflecting $8.7 million in provision for credit losses and $3.5 million in net charge-offs during 2018.

In spite of margin compression, the Company believed its net interest margin remains were favorable as compared to its peer banking companies across 2018 and 2019.

The provision for credit losses was $13.1 million for the year ended December 31, 2019 as compared to $8.7 million for the year ended December 31, 2018.

The lower provisioning during 2018, as compared to 2017, is due to lower loan growth ($579.9 million as compared to $733.6 million) due to higher loan payoffs.

Net charge-offs during 2018 were attributable primarily to commercial loans ($3.2 million).

At December 31, 2018 the allowance for credit losses represented 1.00% of loans outstanding, as compared to 1.01% at December 31, 2017.

The allowance for credit losses represented 430% of nonperforming loans at December 31, 2018, as compared to 489% at December 31, 2017.

Total noninterest income for the year ended December 31, 2018 was $22.6 million as compared to $29.4 million for the year ended December 31, 2017, a 23% decrease.

This decrease was primarily due to $2.1 million lower revenue on the origination, securitization, servicing, and sale of FHA Multifamily-Backed GNMA securities, a $1.2 million nonrecurring adjustment to a tax credit investment recorded in the fourth quarter of 2017, a $354 thousand prepayment penalty associated with a single credit that was recorded during the fourth quarter of 2017, $269 thousand of premium and servicing income recorded during 2017 resulting from the portfolio sale of $44.3 million in residential mortgages and HELOC’s out of the loan portfolio, $3.3 million lower gains on sale of loans, and $445 thousand lower gain on sale of investment securities.

The FHA business unit generated income of $357 thousand on the origination, securitization, servicing and sale of FHA Multifamily-Backed GNMA securities for the full year 2018 compared to $2.5 million for the same period in 2017.

The residential mortgage unit had $5.4 million of gains on the sale of loans for the full year of 2018 as compared to $7.8 million for the same period in 2017 resulting from fewer loan originations and subsequent loan sales.

Net charge-offs during 2019 were attributable primarily to commercial real estate ($5.0 million) and commercial loans ($4.5 million).

At December 31, 2019, the ACL represented 0.98% of loans outstanding, as compared to 1.00% at December 31, 2018.

The ACL represented 151% of nonperforming loans at December 31, 2019, as compared to 430% at December 31, 2018.

Total noninterest expenses totaled $139.9 million for the year ended December 31, 2019, as compared to $126.7 million for the year ended December 31, 2018, a 10% increase.

Salaries and employee benefits were $67.7 million for the year ended December 31, 2018, as compared to $67.1 million for the same period in 2017, an increase of less than 1%.

Cost increases for salaries and benefits were due to new hires and merit increases, higher stock-based compensation expense, and higher health insurance costs partially offset by lower incentive compensation accruals.

As a percentage of average assets, total noninterest expense was 1.58% for the year of 2019 as compared to 1.59% for the same period in 2018.

Total noninterest income for the year ended December 31, 2019 was $25.7 million as compared to $22.6 million for the year ended December 31, 2019, a 14% increase due to $2.7 million higher gains on sale of residential mortgage loans, $1.4 million higher gain on sale of investment securities, partially offset by $767 thousand lower service charges on deposits.

Gain on sale of loans consisted of gains on the sale of SBA and residential mortgage loans.

For the year ended December 31, 2019, gain on sale of loans increased from $6.0 million to $8.5 million, an increase of 42%, compared to the same period in 2018.

The Company is an originator of SBA loans and its practice is to sell the guaranteed portion of those loans at a premium.

Income from this source was $309 thousand for the year ended December 31, 2019 compared to $540 thousand for the same period in 2018.

Activity in SBA loan sales to secondary markets can vary widely from year to year as seen in 2019 and 2018.

Other income totaled $7.8 million for the year ended December 31, 2019 as compared to $8.0 million for the same period in 2018, a decrease of 3%.

Gain on sale of investments amounted to $1.5 million for the year ended December 31, 2019 compared to $97 thousand for the year ended December 31, 2018.

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Total noninterest expenses totaled $139.9 million for the year ended December 31, 2019, as compared to $126.7 million for the year ended December 31, 2018, a 10% increase.

For 2019, the efficiency ratio was 39.99% as compared to 37.31% for the same period in 2018.

Salaries and employee benefits were $79.8 million for the year ended December 31, 2019, as compared to $67.7 million for the same period in 2018, an increase of 18%.

In addition, $4.0 million of the increase resulted from additional staffing, merit increases, and incentives.

At December 31, 2019, the Company’s full time equivalent staff numbered 492, as compared to 470 at December 31, 2018.

Premises and equipment expenses amounted to $15.7 million for the year ended December 31, 2018 as compared to $15.6 million for the same period in 2017, an increase of less than 1%.

Premises and equipment expenses amounted to $14.4 million for the year ended December 31, 2019 as compared to $15.7 million for the same period in 2018, a decrease of 8%.

For the year ended December 31, 2019, the Company recognized $527 thousand of sublease revenue as compared to $501 thousand for the same period in 2018.

The sublease revenue is accounted for as a reduction to premises and equipment expenses.

Marketing and advertising increased from $4.1 million to $4.6 million, an increase of 12%, due primarily to increase digital and print advertising spend.

Data processing increased from $8.2 million for the year ended December 31, 2017 to $9.7 million for 2018, an increase of 18%, and due primarily to the costs of software and infrastructure investments.

Legal, accounting and professional fees increased from $5.1 million to $9.7 million, an increase of 93% due primarily to due diligence costs from independent consultants associated with the internet event, related to the short seller claims, late in 2017 as well as costs to enhance risk management systems, including corporate governance as the Company approaches $10 billion in assets.

FDIC insurance increased $958 thousand to $3.5 million for the year ended December 31, 2018, an increase of 38% compared to 2017, primarily due to higher assessment rates and growth in total assets.

Other expenses decreased to $15.8 million for the year ended December 31, 2018 from $15.9 million for the same period in 2017, a decrease of less than 1%.

The major components of cost in this category include broker fees, Virginia franchise tax, core deposit intangible amortization, insurance expenses, and director compensation.

Cost control remains a significant operating objective of the Company.

The Company recorded income tax expense of $51.9 million in 2018 compared to $85.5 million in 2017 ($70.9 million on an operating basis), resulting in an effective tax rate of 25.4% and 46.0% (38.2% on an operating basis), respectively.

The lower effective tax rate for 2018 was due to a $14.6 million deferred tax asset adjustment charged through tax expense during the fourth quarter of 2017 as a result of the 2017 Tax Act, and tax credits taken in the fourth quarter of 2018 resulting from new tax credit equity investments.

While the Company’s earnings beginning in 2018 benefitted from the lower corporate federal income tax statutory rates (from 35% to 21%) resulting from the 2017 Tax Act, companies were required to revalue their deferred tax positions as of December 31, 2017 based upon the reduced federal income tax rates.

This adjustment increased income tax expense for the year ended December 31, 2017 by $14.6 million ($0.43 per basic and $0.42 per diluted share).

As a result of reduced income tax rates, the Company incurred substantially reduced income tax expense in 2018.

Data processing expenses decreased from $9.7 million for the year ended December 31, 2018 to $9.4 million for 2019, a decrease of 3%, primarily due to ongoing contract renegotiations.

Legal, accounting and professional fees and expenses for the year ended December 31, 2019 increased to $12.2 million from $9.7 million in 2018, a 25% increase.

The increased expenses were primarily associated with legal fees and expenditures associated with governmental investigations and related subpoenas and document requests.

Other expenses increased to $16.0 million for the year ended December 31, 2019 from $15.8 million for the same period in 2018, an increase of 1%.

The major components of cost in this category included broker fees, franchise tax, core deposit intangible amortization, insurance expenses, and director compensation.

Cost control was and remains a significant operating objective of the Company, which helped to contribute to the minimal increase year-over-year between 2019 and 2018.

The Company recorded income tax expense of $53.8 million in 2019 compared to $51.9 million in 2018, resulting in an effective tax rate of 27.4% and 25.4%, respectively.

Total assets at December 31, 2019 were $9.0 billion a 7% increase as compared to $8.39 billion at December 31, 2018.

Total loans (excluding loans held for sale) were $6.99 billion at December 31, 2018, a 9% increase as compared to $6.41 billion at December 31, 2017.

Loans held for sale amounted to $19.3 million at December 31, 2018 as compared to $25.1 million at December 31, 2017, a 23% decrease.

The investment portfolio totaled $784.1 million at December 31, 2018, a 33% increase from $589.3 million at December 31, 2017.

Total borrowed funds (excluding customer repurchase agreements) were $217.3 million at December 31, 2018 and $541.9 million at December 31, 2017, a 60% decrease due to the $325.0 million in FHLB advances outstanding as of December 31, 2017 being paid off during 2018.

Total shareholders’ equity at December 31, 2018 increased 17%, to $1.11 billion, from $950.4 million at December 31, 2017.

Total loans (excluding loans held for sale) were $7.5 billion at December 31, 2019, an 8% increase as compared to $6.99 billion at December 31, 2018.

Loans held for sale amounted to $56.7 million at December 31, 2019 as compared to $19.3 million at December 31, 2018, a 195% increase.

The investment portfolio totaled $843.4 million at December 31, 2019, an 8% increase from $784.1 million at December 31, 2018.

Total shareholders’ equity at December 31, 2019 increased 7%, to $1.2 billion from $1.1 billion at December 31, 2018.

The increase in shareholders’ equity from December 31, 2018 was primarily due to increased retained earnings.

Growth in retained earnings has enhanced the Company’s capital position well in excess of regulatory requirements for well capitalized status.

During 2019 and 2018, growth in retained earnings has enhanced the Company’s capital position well in excess of regulatory requirements.

The total risk based capital ratio was 16.20% at December 31, 2019, as compared to 16.08% at December 31, 2018.

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The ratio of common equity to total assets was 13.25% at December 31, 2019 as compared to 13.22% at December 31, 2018.

Federal funds sold amounted to $11.9 million at December 31, 2018 as compared to $15.8 million at December 31, 2017.

These funds represent excess daily liquidity which is invested on an unsecured basis with well capitalized banks, in amounts generally limited both in the aggregate and to any one bank.

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Interest bearing deposits with banks and other short-term investments amounted to $195.4 million at December 31, 2019 as compared to $303.2 million at December 31, 2018.

The Bank also holds a time deposit amounting to $1.6 million.

These short term investments represented liquid funds that were held at the Federal Reserve to meet future loan demand, to fund future increases in investment securities and to meet other general liquidity needs of the Company.

The Bank also holds a time deposit amounting to $1.6 million at both December 31, 2019 and 2018.

Loan growth over the past year has been favorable, with loans outstanding reaching $7.5 billion at December 31, 2019, an increase of $554 million or 8% as compared to $6.99 billion at December 31, 2018.

Loan growth over the last twelve months was due in part to the Bank’s enhanced marketing efforts and continued focus on our Relationships FIRST strategy.

Residential mortgage loans held for sale amounted to $19.3 million at December 31, 2018 compared to $25.1 million at December 31, 2017.

The bank's continued strong financial performance over the last twelve months has remained relatively flat due to the Bank's dedication to our relationship-first strategy of supporting the needs of the markets we serve and working with our existing clients.

The ACL represented 0.98% of total loans at December 31, 2019 as compared to 1.00% at December 31, 2018.

At December 31, 2019, the allowance represented 151% of nonperforming loans as compared to 430% at December 31, 2018.

The decline in the ratio of the allowance for loan losses to total loans was due to a higher percentage increase in loans outstanding as compared to the allowance growth.

The decrease in the allowance coverage ratio was due to a higher percentage increase in nonperforming loans as compared to the allowance growth.

The majority of nonperforming loans are believed to be adequately secured by real estate.

At December 31, 2019, the Company had $48.7 million of loans classified as nonperforming, and $20.0 million of additional loans considered potential problem loans, as compared to $16.3 million of nonperforming loans and $102.7 million of potential problem loans at December 31, 2018.

The $20.0 million in potential problem loans at December 31, 2019, decreased from $102.7 million at December 31, 2018 due primarily to two commercial real estate secured relationships.

The Company had no accruing loans 90 days or more past due at December 31, 2019 or December 31, 2018.

During both 2019 and 2018, management was attentive to early signs of deterioration in borrowers’ financial conditions and to taking the appropriate action to mitigate risk.

Furthermore, the Company is diligent in placing loans on nonaccrual status and believed, based on its loan portfolio risk analysis, that its ACL at 0.98% of total loans at December 31, 2019, was adequate to absorb potential credit losses within the loan portfolio at that date.

Total nonperforming loans amounted to $48.7 million at December 31, 2019, representing 0.65% of total loans, compared to $16.3 million at December 31, 2018, representing 0.23% of total loans.

The majority of nonperforming loans were believed to be adequately secured by real estate.

The $20.0 million in potential problem loans at December 31, 2019, decreased from $102.7 million at December 31, 2018 due primarily to two commercial real estate secured relationships.

The balance of potential problem loans at December 31, 2019 included $11.9 million of loans that were considered potential problem loans at December 31, 2018.

BOLI is utilized by the Company in accordance with income tax regulations as part of the Company’s financing of its benefit programs.

At December 31, 2018, this asset amounted to $73.4 million as compared to $60.9 million at December 31, 2017, which reflected the purchase of $10.0 million in additional policies during 2018 and an increase in cash surrender values.

For the year ended December 31, 2018, total deposits increased by $1.12 billion or 19% compared to the same period in 2017.

Noninterest bearing deposits increased $121.3 million or 6% to $2.10 billion at December 31, 2018 as compared to $1.98 billion at December 31, 2017, while interest bearing deposits increased by $999.0 million, or 26%.

For 2019, excess servicing fees of $175 thousand were recorded and $246 thousand was amortized as a reduction of actual service fees collected, which is a component of other income.

At December 31, 2019, the balance of excess servicing fees was $507 thousand.

For the year ended December 31, 2019, total deposits increased by $250.1 million or 4% compared to the same period in 2018.

Within interest bearing deposits, money market and savings accounts collectively amounted to $3.0 billion at December 31, 2019, or 42% of total deposits, as compared to $2.95 billion, or 42% of total deposits, at December 31, 2018, an increase of $63.6 million, or 2%.

Approximately 18% of the Bank’s deposits at December 31, 2019 ($3.0 billion) were time deposits, which are generally the most expensive form of deposit because of their fixed rate and term, as compared to 19% at December 31, 2018 ($1.33 billion).

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At December 31, 2019, total deposits included $1.80 billion of brokered deposits (excluding the CDARS and ICS two-way), which represented 25% of total deposits.

At December 31, 2017, total brokered deposits (excluding the CDARS and ICS two-way) were $935.9 million, or 16% of total deposits.

At December 31, 2018, the Company had $2.10 billion in noninterest bearing demand deposits, representing 30% of total deposits.

This compared to $1.98 billion of noninterest bearing demand deposits at December 31, 2017 or 34% of total deposits.

At December 31, 2018, total brokered deposits (excluding the CDARS and ICS two-way) were $1.36 billion, or 19% of total deposits.

The Company had no outstanding balances under its federal funds lines of credit provided by correspondent banks (which are unsecured) at December 31, 2019 and 2018.

The Company did not have FHLB advances outstanding as of December 31, 2018.

At December 31, 2019, the Company had $350.0 million of FHLB advances borrowed as part of the overall asset liability strategy and to support loan growth.

Outstanding FHLB advances are secured by collateral consisting of a blanket lien on qualifying loans in the Bank’s commercial mortgage, residential mortgage and home equity loan portfolios.

The Company did not have FHLB advances outstanding as of December 31, 2018.

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Except for its loan commitments, as shown in Note 21 to the Consolidated Financial Statements, the following table shows details on these fixed and determinable obligations as of December 31, 2020 in the time period indicated.

(dollars in thousands)

(dollars in thousands) Within One

Three Years Three to

Five Years Over Five

Deposits without a stated maturity (1)

$ 8,211,443 $ — $ — $ — $ 8,211,443

Time deposits (1)

526,641 376,825 74,294 — $ 977,760

Borrowed funds (2)

326,726 — 70,000 200,000 $ 596,726

Operating lease obligations 8,342 12,741 9,283 9,500 $ 39,866

Outside data processing (3)

4,592 8,190 1,677 — $ 14,459

George Mason sponsorship (4)

675 1,350 1,363 6,775 $ 10,163

820 844 — — $ 1,664

LIHTC investments (6)

5,343 2,070 672 676 $ 8,761

$ — $ 2,000 $ — $ — $ 2,000

Total $ 9,084,582 $ 404,020 $ 157,289 $ 216,951 $ 9,862,842

(1) Excludes accrued interest payable at December 31, 2020.

(2) Borrowed funds include customer repurchase agreements, and other short-term and long-term borrowings.

(3) The Bank has outstanding obligations under its current core data processing contract that expire in June 2024 and two other vendor arrangements that relate to network infrastructure and data center services, one expires in December 2021 and the other expires in December 2020.

(3) The Bank has outstanding obligations under its current core data processing contract that expire in June 2024 and one other vendor arrangement that relates to network infrastructure and data center services that expires in December 2021.

(4) The Bank has the option of terminating the George Mason agreement at the end of contract years 10 and 15 (that is, effective June 30, 2025 or June 30, 2030).

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(6) Low Income Housing Tax Credits (“LIHTC”) expected payments for unfunded affordable housing commitments.

FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

(7) As disclosed in the 8-K dated January 25, 2021, pursuant to the executed stipulation of settlement of the demand litigation, the Company has agreed to invest an additional $2 million incremental spend above 2020 levels by the end of 2023 to enhance its corporate governance, and risk and compliance controls and infrastructure.

The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates.

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

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

Commitments generally have fixed expiration dates or other termination clauses and may require

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payment of a fee.

Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

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Letters of credit 70,779 69,723

Unfunded loan commitments of $50 million as of December 31, 2019 were related to interest rate lock commitments on residential mortgage loans and were of a short-term nature.

Total $ 2,353,733 $ 2,332,790

Additionally, unfunded loan commitments of $367.7 million as of December 31, 2020 and $49.9 million as of December 31, 2019 were related to interest rate lock commitments on residential mortgage loans and were of a short-term nature.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments.

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At December 31, 2020, approximately 63% of the dollar amount of standby letters of credit was collateralized.

The Company enters into interest rate lock commitments, which are commitments to originate residential mortgage loans whereby the interest rate on the loan is determined prior to funding and the customers have locked into that interest rate.

The Bank either locks in the loan and rate with an investor and commits to deliver the loan if settlement occurs under best efforts or commits to deliver the locked loan in a binding mandatory delivery program with an investor.

Certain loans under rate lock commitments are covered under forward sales contracts of mortgage backed securities.

Forward sales contracts of mortgage backed securities are recorded at fair value with changes in fair value recorded in noninterest income.

Interest rate lock commitments and commitments to deliver loans to investors are considered 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 and delivery contracts by measuring the fair value of the underlying asset, which is impacted by current interest rates and taking into consideration the probability that the rate lock commitments will close or will be funded.

The Company enters into interest rate swap derivative financial instruments to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to certain variable rate deposits.

Such instruments are designated as cash flow hedges.

For a cash flow hedge, the gain or loss on the derivative is reported in other comprehensive income (a Consolidated Balance Sheet component of shareholders’ equity) and is reclassified into earnings in the same period(s) during which the hedged transaction affects earnings (i.e.

the period when cash flows are exchanged between counterparties).

Changes in the fair value of derivatives that are not highly effective in hedging the changes in the expected cash flows of the hedged item are recognized immediately in current earnings.

Please refer to Note 10 to the Consolidated Financial Statements for further detail.

During the third quarter of 2018, the Company entered into credit risk participation agreements (“RPAs”) with institutional counterparties, under which the Company assumes its pro-rata share of the credit exposure associated with a borrower’s performance related to interest rate derivative contracts.

The fair value of RPAs is calculated by determining the total expected asset or liability exposure of the derivatives to the borrowers and applying the borrowers’ credit spread to that exposure.

Total expected exposure incorporates both the current and potential future exposure of the derivatives, derived from using observable inputs, such as yield curves and volatilities.

These derivatives are not designated as hedges, are not speculative, and have a notional value of $27.4 million as of December 31.

The changes in fair value for these contracts are recognized directly in earnings.

Please refer to Note 10 to the Consolidated Financial Statements for further detail.

Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain customers.

The Company executes interest rate caps and swaps with commercial banking customers to facilitate their respective risk management strategies.

Those interest rate swaps are simultaneously hedged by offsetting derivatives that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions.

As the interest rate derivatives associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting derivatives are recognized directly in earnings.

Please refer to Note 10 to the Consolidated Financial Statements for further detail.

In connection with deposit guarantees, the Bank collateralizes certain public funds using qualified investment securities.

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LIQUIDITY MANAGEMENT

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Liquidity is a measure of the Company’s and Bank’s ability to meet loan demand and to satisfy depositor withdrawal requirements in an orderly manner.

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These sources of liquidity are considered primary and are supplemented by the ability of the Company and Bank to borrow funds or issue brokered deposits, which are termed secondary sources of liquidity and which are substantial.

Additionally, the Bank can purchase up to $172.5 million in federal funds on an unsecured basis from its correspondents, against which there were no amounts outstanding at December 31, 2019 and can borrow unsecured funds under one-way CDARS and ICS brokered deposits in the amount of $1.34 billion, against which there was $82.4 million outstanding at December 31, 2019.

The Bank also has a commitment at December 31, 2019 from Promontory to place up

to $700.0 million of brokered deposits from its IND program in amounts requested by the Bank, as compared to an actual balance of $533.1 million at December 31, 2019.

At December 31, 2019, the Bank was also eligible to make advances from the FHLB up to $1.54 billion based on collateral at the FHLB, of which there was $250 million outstanding as of December 31, 2019.

Additionally, the Bank can purchase up to $142.5 million in federal funds on an unsecured basis from its correspondents, against which there were no amounts outstanding at December 31, 2020 and can borrow unsecured funds under one-way CDARS and ICS brokered deposits in the amount of $1.34 billion, against which there was $682 thousand outstanding at December 31, 2020.

The Bank also has a commitment at December 31, 2020 from IntraFi to place up to 2.0 billion of brokered deposits from its IND program in amounts requested by the Bank, as compared to an actual balance of $1.3 billion at December 31, 2020.

At December 31, 2020, the Bank was also eligible to make advances from the FHLB up to $1.64 billion based on collateral at the FHLB, of which there were $350 million outstanding as of December 31, 2020.

The Bank may enter into repurchase agreements as well as obtain additional borrowing capabilities from the FHLB provided adequate collateral exists to secure these lending relationships.

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At December 31, 2020, under the Bank’s liquidity formula, it had $3.5 billion of primary and secondary liquidity sources.

The amount is deemed adequate to meet current and projected funding needs.

Management believes the amount is deemed adequate to meet current and projected funding needs.

CAPITAL RESOURCES AND ADEQUACY

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Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital.

The Company, like many community banks, has a concentration in commercial real estate loans, and the Company has experienced significant growth in its commercial real estate portfolio in recent years.

As of December 31, 2019, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represent 347% of consolidated risk based capital;

however, growth in that segment over the past 36 months at 46% does not exceed the 50% threshold laid out in the regulatory guidance.

Construction, land and land development loans represent 118% of consolidated risk based capital.

Management has extensive experience in commercial real estate lending, and has implemented and continues to maintain heightened risk management procedures, and strong underwriting criteria with respect to its commercial real estate portfolio.

The Company, like many community banks, has a concentration in commercial real estate loans, and the Company continues to pursue lending opportunities in its commercial real estate portfolio.

Loan monitoring practices include but are not limited to periodic stress testing analysis to evaluate changes to cash flows, owing to interest rate increases and declines in net operating income.

The Company has an extensive Capital Plan and Policy, which includes pro-forma projections including stress testing within which the Board of Directors has established internal policy limits for regulatory capital ratios that are in excess of well capitalized ratios (as defined in the section “Regulation” above).

Nevertheless, we may be required to maintain higher levels of capital as a result of our commercial real estate concentrations, which could require us to obtain additional

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capital, and may adversely affect shareholder returns.

The Company has an extensive Capital Policy and Capital Plan, which includes pro-forma projections including stress testing within which the Board of Directors has established internal policy limits for regulatory capital ratios that are in excess of well capitalized ratios (as defined in the section “Regulation” above).

The Company and the Bank are subject to regulatory capital requirements administered by federal banking agencies.

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If a bank is undercapitalized, capital distributions and growth and expansion are limited, and plans for capital restoration are required.

At December 31, 2019, the capital position of the Company and its wholly owned subsidiary, the Bank, continue to exceed regulatory requirements and guidelines.

At December 31, 2020, the capital position of the Company and its wholly owned subsidiary, the Bank, continue to exceed regulatory requirements and well-capitalized guidelines.

The primary indicators relied on by bank regulators in measuring the capital position are four ratios as follows:

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Tier 1 capital consists of common and qualifying preferred shareholders’ equity less goodwill and other intangibles.

Total risk-based capital consists of Tier 1 capital, plus qualifying subordinated debt, and the qualifying portion of the allowance for credit losses, and for the Company to a limited extent, excess amounts of restricted core capital elements.

Total risk-based capital consists of Tier 1 capital, plus qualifying subordinated debt, and the qualifying portion of the ACL, and for the Company to a limited extent, excess amounts of restricted core capital elements.

Risk-based capital ratios are calculated with reference to risk-weighted assets, which are prescribed by regulation.

The measure of Tier 1 capital to average assets for the prior quarter is often referred to as the leverage ratio.

The Common Equity Tier 1 ratio is the Tier 1 capital ratio but excluding preferred stock.

The CET 1 ratio is the Tier 1 capital ratio but excluding preferred stock.

The Federal Reserve Board and the other federal banking agencies have adopted the Basel III Rules to implement the Basel III capital guidelines for U.S.

The capital rules require a CET1 ratio) of 4.5% and a capital conservation buffer of 2.5% of risk-weighted assets, which when fully phased-in, effectively resulting in a minimum CET1 ratio of 7.0%;

The capital rules require a CET1 ratio of 4.5% and a capital conservation buffer of 2.5% of risk-weighted assets, effectively resulting in a minimum CET1 ratio of 7.0%;

a minimum ratio of Tier 1 capital to risk-weighted assets of 6.0%, or 8.5% with the fully phased in capital conservation buffer;

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Refer to Note 1 to the Consolidated Financial Statements for New Authoritative Accounting Guidance and their expected impact on the Company’s Financial Statements.

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

What changed 10-K

Item 7. Management’s Discussion and Analysis