Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion provides information about the results of operations, financial condition, liquidity, and capital resources of the Company. The Company’s primary subsidiary is the Bank, and the Company’s other direct and indirect active subsidiaries are Bethesda Leasing, LLC, Eagle Insurance Services, LLC and Landroval Municipal Finance, Inc.
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This discussion and analysis should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto, appearing elsewhere in this report.
Caution About Forward Looking Statements . This report contains forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act. 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,” “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. Actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward looking statements.
The following factors, among others, could cause our financial performance to differ materially from that expressed in such forward looking statements:
• Changes in the general economic, political, social and health conditions, including the macroeconomic and other challenges and uncertainties resulting from the effects of the 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;
• Our management of liquidity risks in our operations, including, but not limited to, risks related to customer deposits, deposits in excess of the FDIC insurance coverage limits, access to capital markets and securities and market values;
• 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;
• 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;
• Our decision to cease originating residential mortgages (See Note 26 of the Consolidated Financial Statements for further details);
• The growth and profitability of noninterest or fee income being less than expected;
• Changes in the level of our nonperforming assets and charge-offs;
• Changes in consumer spending and savings habits;
• The impact of climate change or government action and societal responses to climate change;
• Difficulty recruiting or retaining successful bankers, executive officers or other key personnel;
• 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 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 SEC, the Public Company Accounting Oversight Board ("PCAOB") or the FASB;
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• Cybersecurity breaches, threats, and cyber-fraud that cause the Bank to sustain financial losses;
• Technological and social media changes;
• Our management of risks inherent in the use of statistical and quantitative data and modeling;
• 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; and
• The factors discussed under the caption “Risk Factors” in this report.
If one or more of the factors affecting our forward looking information and statements proves incorrect, then our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward looking information and statements contained in this report. You should not place undue reliance on our forward looking information and statements. We will not update the forward looking statements to reflect actual results or changes in the factors affecting the forward looking statements.
GENERAL
The Company is a growth-oriented, one-bank holding company headquartered in Bethesda, Maryland, which is currently celebrating twenty-four 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. 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. The Company’s philosophy is to provide superior, personalized service to its customers. The Company focuses on relationship banking, providing each customer with a number of services and becoming familiar with and addressing customer needs in a proactive, personalized fashion. The Bank currently has a total of sixteen branch offices (six in Suburban Maryland, five in Washington, D.C. and five in Northern Virginia), a principal corporate office, five lending centers (two are co-located with branches and one co-located in the principal corporate office) and one operations center. Refer to the Business Section above, which describes in detail the various banking services offered.
Although the global economy has largely adapted operations to a world with COVID-19, certain adverse residual consequences of the pandemic continue to impact the macroeconomic environment and they may continue to persist. The growth in economic activity and demand for goods and services, alongside labor shortages and supply chain complications and/or disruptions, has contributed greatly to rising inflationary pressures. In 2022, the Federal Reserve Open Market Committee ("FOMC"), began a series of rate increases thereby discontinuing the generally accommodative monetary policy it had pursued when the COVID-19 pandemic began in early 2020. In late 2022, the Federal Reserve begun tapering purchases of securities and is no longer expanding its balance sheet as aggressively. Actual real U.S. GDP growth for 2022 was 2.1%, in contrast to 5.7% growth in 2021 as the economy re-opened, and was adversely impacted by the effects of the COVID-19 pandemic. Employment climbed throughout 2022 as the U.S. unemployment rate ended the year at 3.4%, down from 3.9% at the end of 2021.
Longer-term U.S. interest rates increased in 2022, with the ten year U.S. Treasury rate averaging 2.95% in 2022 as compared to 1.45% in 2021. The yield curve in 2022 was inverted as rates increased sharply on the short end of the curve and remained anchored on the longer end versus a more normal shape in 2021.
As the ten year U.S. Treasury rate continued to increase in 2022, the volume of residential mortgage lending continued to decrease in 2022. Overall, real estate values in most of the Company's markets decreased moderately in 2022 as the FOMC increased interest rates in 2022 to stave off inflationary pressures. Political gridlock continued in Washington, D.C. over concerns of public debt and deficits, as well as tax policy and spending levels.
The Company’s primary market, the Washington, D.C. metropolitan area, has continued to perform well relative to other parts of the country notwithstanding the adverse effects of the COVID-19 pandemic, due to a stable public sector along with increased government spending. The private sector, in particular, the Leisure and Hospitality sector has seen some recovery in recent years following the adverse effects of the pandemic. The multi-family commercial real estate leasing sector, notwithstanding increased supply of units in the Bank’s market area, has held up relatively well, particularly for well-located close-in projects. 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 therefore, we are being careful with valuations.
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In spite of recent 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 the financial resources to meet, and has remained committed to meeting, the credit needs of its community. The decline in the Company's loan balances in 2021 was a result of PPP loans paying off, competition refinancing at lower rates with longer amortization periods, and excess liquidity at competing banks as well as many companies and construction project sponsors. Loan balances increased in 2022 as rising rates led to deposit disintermediation reducing our liquidity levels and earning assets. However, rates on interest earning assets increased which ultimately had a net positive impact on the net interest margin and resulted in a higher net interest income in 2022 despite the decrease in liquidity and earning assets.
The Company’s capital position remained strong in 2022 as a result of good earnings, improved economic conditions and strong asset quality. As a result of the Company’s strong capital position and earnings, we were able to continue our quarterly dividend in 2022. Additionally, the Company was active in share repurchase activity as we repurchased 738,300 shares at an average price of $44.82 per share during 2022.
On December 13, 2022, the Company's Board of Directors authorized a new share repurchase program to take effect starting January 2, 2023, after the expiration of the previous repurchase program on December 31, 2022. The Board of Directors authorized the repurchase of 1,600,000 shares of common stock, or approximately 5% of the Company's outstanding shares of common stock, under the 2023 Repurchase Program, which will expire on December 31, 2023, subject to earlier termination of the program by the Board of Directors.
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. Additionally, the Company believes such focus and strategy of relationship building has fostered future growth opportunities, as the Company’s reputation in the marketplace remains strong. At December 31, 2022, the Company had total assets of approximately $11.2 billion, total loans of $7.6 billion, total deposits of $8.7 billion and sixteen branches in the Washington, D.C. metropolitan area.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company’s Consolidated Financial Statements are prepared in accordance with GAAP and follow general practices within the banking industry. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the Consolidated Financial Statements; accordingly, as this information changes, the Consolidated Financial Statements could reflect different estimates, assumptions and judgments. Certain policies, including those identified below for the year ended December 31, 2022, 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. Carrying assets and liabilities at fair value inherently results in more financial statement volatility.
Allowance for Credit Losses and Provision for Unfunded Commitments
A consequence of lending activities is that we may incur credit losses, so we record an 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 years prior to 2020. The 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
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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 ACL represents the expected credit losses arising from the Company's loan and available-for-sale ("AFS") securities portfolios. The ACL is determined as follows:
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.
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 PD and LGD. This analysis also determines how expected PD 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 18 months, and reverts back to a historical loss rate over the following twelve months on a straight-line basis. While the COVID-19 pandemic negatively impacted unemployment projections for 2021, which informed our CECL economic forecast and increased our loss reserve for that year, there were positive signs in 2022 as the unemployment rate and economic forecast continued to improve and suggested that the effects of the COVID-19 pandemic on credit would not be as significant as previously considered in 2021. 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 effects of the COVID-19 pandemic and related hybrid or fully remote working environment had negatively impacted the performance outlook in the central business district office commercial real estate segment of our loan portfolio, which informed our CECL economic forecast and continued to adversely impact our loss reserve as of December 31, 2022. See Notes 1, 3 and 4 to the Consolidated Financial Statements, the “Provision for Credit Losses” section in Management’s Discussion and Analysis and the risk factors related to our business and economic conditions in Item 1A for more information on the provision for credit losses.
SELECTED FINANCIAL DATA
The following discussion is intended to assist in understanding the financial condition and results of operations of the Company as of and for the year ended December 31, 2022. The information contained in this section should be read together with the December 31, 2022 audited Consolidated Financial Statements and the accompanying Notes included in Item 8 Financial Statements And Supplementary Data of this Form 10-K.
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This section of this Form 10-K generally discusses 2022 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Form 10-K for the fiscal year ended December 31, 2021.
Use of Non-GAAP Financial Measures
The information set forth below contains certain financial information determined by methods other than in accordance with GAAP. These non-GAAP financial measures are “tangible common equity,” “tangible book value per common share,” “efficiency ratio” and “return on average common equity.” Management uses these non-GAAP measures in its analysis of our performance because it believes these measures are used as a measure of our performance by investors.
These disclosures should not be considered in isolation or as a substitute for results determined in accordance with GAAP and are not necessarily comparable to non-GAAP performance measures which may be presented by other bank holding companies. Management compensates for these limitations by providing detailed reconciliations between GAAP information and the non-GAAP financial measures. A reconciliation table is set forth below following the selected historical consolidated financial data.
Years Ended December 31,
2022
2021 2020
Balance Sheets - Period End
Securities - available for sale $ 1,598,666 $ 2,623,408 $ 1,151,083
Securities - held to maturity 1,093,374 — —
Loans held for sale 6,734 47,218 88,205
Loans 7,635,632 7,065,598 7,760,212
Allowance for credit losses (74,444) (74,965) (109,579)
Intangible assets, net 104,233 104,255 104,307
Total assets 11,150,854 11,847,310 11,117,802
Deposits 8,713,182 9,981,540 9,189,203
Borrowings 1,044,795 369,670 568,077
Total liabilities 9,922,533 10,496,535 9,876,910
Total shareholders’ equity 1,228,321 1,350,775 1,240,892
Tangible common equity (1)
1,124,088 1,246,520 1,135,778
Statements of Income
Interest income $ 424,613 $ 364,496 $ 389,986
Interest expense 91,746 39,982 68,424
Provision (reversal) for credit losses 266 (20,821) 45,571
Noninterest income 23,654 40,385 45,696
Noninterest expense 165,098 149,165 144,162
Income before taxes 189,680 237,674 176,145
Income tax expense 48,750 60,983 43,928
Net income
140,930 176,691 132,217
Cash dividends declared 55,776 44,691 28,330
Total revenue (2)
356,521 364,899 367,258
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Years Ended December 31,
(dollars in thousands except per share data) 2022
2021 2020
Per Common Share Data
Net income, basic $ 4.40 $ 5.53 $ 4.09
Net income, diluted 4.39 5.52 4.09
Dividends declared 1.75 1.40 0.88
Book value 39.18 42.28 39.05
Tangible book value (3)
35.86 38.97 35.74
Common shares outstanding 31,346,903 31,950,092 31,779,663
Weighted average common shares outstanding, basic 32,004,251 31,935,824 32,334,201
Weighted average common shares outstanding, diluted 32,078,070 32,003,090 32,362,556
Ratios
Net interest margin 2.93 % 2.81 % 3.19 %
Efficiency ratio (4)
46.31 % 40.88 % 39.25 %
Return on average assets 1.20 % 1.49 % 1.28 %
Return on average common equity 10.99 % 13.54 % 10.98 %
Return on average tangible common equity (1)
11.97 % 14.73 % 12.03 %
CET1 capital (to risk weighted assets) 14.03 % 14.63 % 13.49 %
Total capital (to risk weighted assets) 14.94 % 15.74 % 17.04 %
Tier 1 capital (to risk weighted assets) 14.03 % 14.63 % 13.49 %
Tier 1 capital (to average assets) 11.63 % 10.19 % 10.31 %
Tangible common equity ratio 10.18 % 10.60 % 10.31 %
Dividend payout ratio 39.58 % 25.29 % 21.59 %
Asset Quality
Nonperforming assets and loans 90+ past due $ 8,430 $ 30,843 $ 65,930
Nonperforming assets and loans 90+ past due to total assets 0.08 % 0.26 % 0.59 %
Nonperforming loans to total loans 0.08 % 0.41 % 0.79 %
Allowance for credit losses to loans 0.97 % 1.06 % 1.41 %
Allowance for credit losses to nonperforming loans 1,150.96 % 256.66 % 179.80 %
Net charge-offs $ 624 $ 13,339 $ 20,097
Net charge-offs to average loans 0.01 % 0.18 % 0.26 %
(1) Tangible common equity and return on average tangible common equity are non-GAAP financial measures. Tangible common equity is defined as total common shareholders’ equity reduced by goodwill and other intangible assets.
(2) Total revenue calculated as net interest income plus noninterest income.
(3) Tangible book value per common share, a non-GAAP financial measure, is defined as tangible common shareholders’ equity divided by total common shares outstanding.
(4) Computed by dividing noninterest expense by the sum of net interest income and noninterest income.
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The following table details our Non-GAAP to GAAP reconciliation for the years 2020 through 2022.
Non-GAAP Reconciliation Years Ended December 31,
(dollars in thousands except per share data) 2022
2021 2020
Common shareholders’ equity $ 1,228,321 $ 1,350,775 $ 1,240,891
Less: Intangible assets (104,233) (104,255) (104,307)
Tangible common equity $ 1,124,088 $ 1,246,520 $ 1,136,584
Book value per common share $ 39.18 $ 42.28 $ 39.05
Less: Intangible book value per common share (3.32) (3.31) (3.31)
Tangible book value per common share $ 35.86 $ 38.97 $ 35.74
Total assets $ 11,150,854 $ 11,847,310 $ 11,117,802
Less: Intangible assets (104,233) (104,255) (104,307)
Tangible assets $ 11,046,621 $ 11,743,055 $ 11,013,495
Tangible common equity ratio 10.18 % 10.61 % 10.32 %
Average common shareholders’ equity $ 1,281,921 $ 1,304,902 $ 1,204,341
Less: Average intangible assets (104,248) (104,265) (104,361)
Average tangible common equity $ 1,177,673 $ 1,200,637 $ 1,099,980
Net Income $ 140,930 $ 176,691 $ 132,217
Average tangible common equity $ 1,177,673 $ 1,200,637 $ 1,099,438
Return on average tangible common equity 11.97 % 14.72 % 12.03 %
Total noninterest expense $ 165,098 $ 149,165 $ 144,162
Net interest income $ 332,867 $ 324,514 $ 321,562
Total noninterest income 23,654 40,385 45,696
Total of net interest and noninterest income $ 356,521 $ 364,899 $ 367,258
Efficiency ratio 46.31 % 40.88 % 39.25 %
RESULTS OF OPERATIONS
Twelve Months Ended December 31, 2022 Compared with Twelve Months Ended December 31, 2021
Overview
Net income for the years ended December 31, 2022 and 2021 was $140.9 million and $176.7 million, respectively. Net income per basic and diluted common share for 2022 was $4.40 and $4.39, respectively, compared to $5.53 and $5.52 per basic and diluted common share, respectively for 2021, a 20% decrease.
Net income decreased in 2022 relative to 2021 primarily due to the provision reversals in the allowance for credit losses in 2021 that did not recur in 2022, increases in interest expense, lower noninterest income and higher noninterest expense which was partially offset by an increase in interest income.
The most significant portion of revenue (i.e., net interest income plus noninterest income) is net interest income, which increased to $332.9 million for 2022 compared to $324.5 million for 2021. The increase was due to an increase in the yield on average earning assets from 3.16% to 3.74%, or 58 basis points, which was partially offset by an increase in cost of funds of 46 basis points in net interest margin due to increased rates on interest bearing deposits and other borrowings.
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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 2.93% for 2022 and 2.81% for 2021, an increase of 12 basis points. The drivers of the change are detailed in the "Net Interest Income and Net Interest Margin" section below.
The provision for credit losses in 2022 was $266 thousand as compared to a reversal of $20.8 million in 2021. For information on the components and drivers of these changes see "Provision for Credit Losses" section below.
Total noninterest income in 2022 was $23.7 million, as compared to $40.4 million in 2021, a 41% decrease.
Noninterest expenses in 2022 totaled $165.1 million, as compared to $149.2 million in 2021, an 11% increase. The efficiency ratio, which measures the ratio of noninterest expense to total revenue, was 46.31% for 2022 as compared to 40.88% for 2021. The adverse change in the efficiency ratio was driven by the $22.9 million settlement expenses, which increased noninterest expense and was partially offset by the $5.0 million accrual reduction related to share-based compensation awards and deferred compensation associated with our former CEO and Chairman, which reduced noninterest expense. Refer to the “Use of Non-GAAP Financial Measures” section for additional detail and a reconciliation of GAAP to non-GAAP financial measures.
At December 31, 2022, total loan balances (including PPP loans) were 8% higher than they were at December 31, 2021, and average loans were 1% lower in 2022 as compared to 2021. PPP loans represented just $3.3 million of total loans at the end of 2022, as compared to $51.1 million at the end of 2021. Excluding PPP loans, adjusted loan balances, increased 9% in 2022, driven by originations and advances which outpaced payoffs and paydowns. The decline in PPP loans was the result of the forgiveness process.
Total deposits at December 31, 2022 declined by $1.3 billion as compared to December 31, 2021. The decline consists of $127.2 million in noninterest bearing deposits and $1.1 billion in interest bearing deposits. This was primarily driven by a significant increase in short term interest rates and the related deposit disintermediation.
In terms of the average asset composition or mix, loans, which generally have higher yields than securities and other earning assets, represented 63.4% and 63.0% of average earning assets for 2022 and 2021, respectively. For 2022, as compared to 2021, average loans, excluding loans held for sale, decreased $54.7 million, or 1%, driven by slightly higher payoffs and paydowns, which just outpaced originations and advances as well as PPP loan forgiveness.
Average investment securities for 2022 were 25% of average earning assets compared to 14% for 2021. The combination of federal funds sold, interest bearing deposits with other banks and loans held for sale represented 11% and 23% of average earning assets for 2022 and 2021, respectively, as lower levels of on-balance sheet liquidity existed throughout 2022. The decrease was driven by the decline in deposits due to a significant increase in short term interest rates.
The ratio of common equity to total assets decreased to 11.02% at December 31, 2022 from 11.40% at December 31, 2021, due to the significant impact of higher rates on the unrealized loss position of the investment portfolio and resulting impact to accumulated other comprehensive income. The impact resulted in a reduction of common equity of $185.5 million related to investment securities in addition to the $55.8 million of cash dividends declared and $33.1 million in share repurchase activity during 2022.
For 2022, the return on average assets (“ROAA”) was 1.20%, as compared to 1.49% for 2021. Total shareholders’ equity was $1.23 billion at December 31, 2022 as compared to $1.35 billion at December 31, 2021, a decrease of 9%. The return on average common equity (“ROACE”) for 2022 was 10.99% as compared to 13.54% for 2021. The return on average tangible common equity (“ROATCE”) for 2022, a non-GAAP financial measure, was 11.97% as compared to 14.73% for 2021. Refer to the “Use of Non-GAAP Financial Measures” section for additional detail and a reconciliation of GAAP to non-GAAP financial measures. The decreases in these returns was primarily due to lower noninterest income, higher noninterest expense, the SEC and FRB settlements and, to a lesser extent, the non recurrence of provision reversals in the allowance for credit losses and net interest income on a lower asset base.
Net Interest Income and Net Interest Margin
Net interest income is the difference between interest income on earning assets and the cost of funds supporting those assets. Earning assets are composed primarily of loans, loans held for sale, investment securities and interest bearing deposits with other banks. 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. Noninterest bearing
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deposits and capital are other components representing funding sources. Changes in the volume and mix of assets and funding sources, along with the changes in yields earned and rates paid, determine changes in net interest income.
The Bank's earnings are significantly dependent upon net interest income, which is the difference between interest earned on earning assets and interest expense on interest bearing liabilities. Net interest income represented 93% and 89% of the Company’s revenue for the years ended December 31, 2022 and December 31, 2021, respectively. Net interest income in 2022 was $332.9 million compared to $324.5 million in 2021. The 3% increase resulted from an increase in rates on earning assets, which was partially offset by increased rates on lower average balances of interest bearing deposits, as compared to 2021.
Net interest margin increased by 12 basis points to 2.93% in 2022 from 2.81% in 2021. The increase reflects the impact of an increase in yields which more than offset the increase in the cost of funds and decrease in average earning assets. The yield on earning assets increased by 58 basis points from 3.16% in 2021 to 3.74% in 2022 while cost of funds increased 46 basis points from 0.35% in 2021 to 0.81% in 2022. Average interest bearing deposits with other banks and other short term investments were $1.2 billion for 2022 compared to $2.5 billion for 2021. As a result of FRB actions related to Fed Funds interest rate increases, overall yields and rates increased in 2022 as compared to 2021, as variable rate loans adjusted upwards and an increased number of loans moved off their rate floors.
Loans, the largest component of interest income on earnings assets, had a yield of 4.97% in 2022, compared to 4.62% in 2021, an increase of 35 basis points (includes PPP loans).
Although deposits declined in 2022 due to disintermediation, the deposit mix continued to be favorable at year end, with average noninterest deposits being 38% of average total deposits, up from 34% in 2021. In 2022, average loans, the primary source of the Bank’s revenue, decreased by 1% between 2021 and 2022.
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, 2022, 2021 and 2020. Included in the table are measurements of interest rate spread and margin. Interest rate spread is the difference (expressed as a percentage) between the interest rate earned on earning assets less the interest rate paid on interest bearing liabilities. While the interest rate spread provides a quick comparison of earnings rates versus cost of funds, management believes that margin, together with net interest income, provides a better measurement of performance. The net interest margin (as compared to net interest spread) includes the effect of noninterest bearing sources in its calculation. Net interest margin is net interest income expressed as a percentage of average earning assets.
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Eagle Bancorp, Inc.
Consolidated Average Balances, Interest Yields And Rates (Unaudited)
(dollars in thousands)
Years Ended December 31,
2022
2021 2020
Average
Balance Interest Average
Yield /
Rate Average
Balance Interest Average
Yield /
Rate Average
Balance Interest Average
Yield /
Rate
Assets
Interest earning assets:
Interest bearing deposits with other banks and other short-term investments $ 1,235,768 $ 13,304 1.08 % $ 2,499,377 $ 3,511 0.14 % $ 1,181,591 $ 2,601 0.22 %
Loans held for sale 15,356 650 4.23 % 71,043 2,278 3.21 % 67,361 2,125 3.15 %
Loans (1) (2) 7,206,158 358,317 4.97 % 7,260,886 335,471 4.62 % 7,868,523 366,729 4.66 %
Investment securities available-for-sale (2) 2,003,475 33,641 1.68 % 1,653,522 23,205 1.40 % 929,983 18,440 1.98 %
Investment securities held-to-maturity 857,584 17,840 2.08 % — — — % — — — %
Federal funds sold 48,402 861 1.78 % 31,667 31 0.10 % 32,781 91 0.28 %
Total interest earning assets 11,366,743 424,613 3.74 % 11,516,495 364,496 3.16 % 10,080,239 389,986 3.87 %
Noninterest earning assets 475,563 416,492 371,345
Less: allowance for credit losses 74,726 96,252 101,621
Total noninterest earning assets 400,837 320,240 269,724
Total Assets $ 11,767,580 $ 11,836,735 $ 10,349,963
Liabilities and Shareholders’ Equity
Interest bearing liabilities:
Interest bearing transaction $ 893,137 $ 6,721 0.75 % $ 814,999 $ 1,609 0.20 % $ 783,568 $ 3,190 0.41 %
Savings and money market 4,683,850 65,777 1.40 % 4,947,198 15,000 0.30 % 3,925,413 26,271 0.67 %
Time deposits 669,824 10,763 1.61 % 803,718 11,163 1.39 % 1,149,185 24,105 2.10 %
Total interest bearing deposits 6,246,811 83,261 1.33 % 6,565,915 27,772 0.42 % 5,858,166 53,566 0.91 %
Customer repurchase agreements and federal funds purchased 30,745 356 1.16 % 24,884 51 0.20 % 29,345 293 1.00 %
Other short-term borrowings 172,717 3,980 2.30 % 300,003 2,008 0.67 % 280,126 1,870 0.66 %
Long-term borrowings 69,737 4,149 5.95 % 164,970 10,151 6.15 % 259,975 12,696 4.80 %
Total interest bearing liabilities 6,520,010 91,746 1.41 % 7,055,772 39,982 0.57 % 6,427,612 68,425 1.06 %
Noninterest bearing liabilities:
Noninterest bearing demand 3,871,773 3,374,662 2,643,856
Other liabilities 93,876 101,399 74,154
Total noninterest bearing liabilities 3,965,649 3,476,061 2,718,010
Shareholders’ equity 1,281,921 1,304,902 1,204,341
Total Liabilities and Shareholders’ Equity $ 11,767,580 $ 11,836,735 $ 10,349,963
Net interest income $ 332,867 $ 324,514 $ 321,561
Net interest spread 2.33 % 2.59 % 2.81 %
Net interest margin 2.93 % 2.81 % 3.19 %
Cost of funds 0.81 % 0.35 % 0.68 %
(1) Loans placed on nonaccrual status are included in average balances. Net loan fees and late charges included in interest income on loans totaled $15.3 million, $30.6 million and $22.3 million for the years ended December 31, 2022, 2021 and 2020, res pectively.
(2) Interest and fees on loans and investments exclude tax equivalent adjustments.
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The rate/volume table below presents the composition of the change in net interest income for the periods indicated, as allocated between the change in net interest income due to changes in the volume of average earning assets and interest bearing liabilities and the changes in net interest income due to changes in interest rates. As the table shows, the increase in net interest income in 2022 as compared to 2021 was due to an increase in volume of earning assets and a decrease in the volume of borrowings, which were partially offset by a change in mix along with the impact of higher deposit rates. The increase in net interest income in 2021 as compared to 2020 was due to a decrease in the volume of earning assets, which was more than offset by lower deposit rates.
2022 compared with 2021
2021 compared with 2020
(dollars in thousands) Change
Due to
Volume Change
Due to
Rate Total
Increase
(Decrease) Change
Due to
Volume Change
Due to
Rate Total
Increase
(Decrease)
Interest earned on
Loans $ (2,529) $ 25,375 $ 22,846 $ (28,320) $ (2,938) $ (31,258)
Loans held for sale (1,786) 158 (1,628) 116 37 153
Investment securities available-for sale 4,911 5,525 10,436 14,354 (9,589) 4,765
Investment securities held-to-maturity 12,035 5,805 17,840 — — —
Interest bearing bank deposits (1,775) 11,568 9,793 2,901 (1,991) 910
Federal funds sold 16 814 830 (3) (57) (60)
Total interest income 10,872 49,245 60,117 (10,952) (14,538) (25,490)
Interest paid on
Interest bearing transaction 154 4,958 5,112 128 (1,709) (1,581)
Savings and money market (798) 51,575 50,777 6,838 (18,109) (11,271)
Time deposits (1,860) 1,460 (400) (7,246) (5,696) (12,942)
Customer repurchase agreements 12 293 305 (45) (197) (242)
Other borrowings (6,712) 2,682 (4,030) (4,506) 2,100 (2,406)
Total interest expense (9,204) 60,968 51,764 (4,831) (23,611) (28,442)
Net interest income $ 20,076 $ (11,723) $ 8,353 $ (6,121) $ 9,073 $ 2,952
Provision for Credit Losses
The provision for credit losses represents the amount of expense charged to current earnings to fund the ACL on loans and the ACL on AFS investment securities and HTM 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 $266 thousand in 2022, as compared to a reversal of $20.8 million in 2021. The provisions were primarily driven by adjustments to the qualitative components of the CECL model owing to the high inflationary environment and the related uncertainty and impacts on the broader economy, offset by improvements in asset quality. The reversal in 2021 was driven by the improved macroeconomic outlook, improvement of credits in the loan portfolio and a reduction in total loans.
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 $1.5 million in 2022, as compared to a reversal of $1.1 million in 2021.
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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. The process is being continually enhanced and refined based on periodic review and challenge. 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 and Estimates” 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 for loans at year-end 2022 decreased by $521 thousand as compared to year-end 2021, reflecting a provision for credit losses of $103 thousand and $624 thousand in net charge-offs. The $266 thousand charge to the provision for credit losses includes $163 thousand for securities and $103 thousand for loans. Net charge-offs of $624 thousand during 2022 represented 0.01% of average loans, excluding loans held for sale, a decline from net charge-offs of $13.3 million during 2021, which represented 0.18% of average loans, excluding loans held for sale. Net charge-offs during 2022 were attributable primarily to commercial loans net charge-offs of $848 thousand and consumer net charge-offs of $73 thousand, which was partially offset by commercial real estate recoveries of $297 thousand (net of charge-offs).
At December 31, 2022, the ACL represented 0.97% of loans outstanding, as compared to 1.06% at December 31, 2021. The ACL represented 1151% of nonperforming loans at December 31, 2022, as compared to 257% at December 31, 2021.
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 90 days past-due, unless they are well secured and in the process of collection. Additionally, the Credit Administration department 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 ACL, will continue to be a primary management objective for the Company.
Noninterest Income
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, 2022 was $23.7 million as compared to $40.4 million for the year ended December 31, 2021. The 41% decrease was substantially due to lower gains on sale of residential mortgage loans of $10.3 million and lower net gains on sales of securities of $3.1 million. The Bank recently announced that it plans to cease originating residential mortgages for sale in the first quarter of 2023 (See Note 26 of the Consolidated Financial Statements for further details).
At December 31, 2022, locked commitments for residential mortgage loans were $323.7 million, as compared to $994.5 million at December 31, 2021, a 67.45% decrease. The rise in interest rates for residential mortgages in 2022 had a substantial negative impact on the volume of mortgage originations and in turn the sale of residential mortgages declined.
For the year ended December 31, 2022, service charges on deposits increased by $837 thousand to $5.4 million from $4.6 million for the same period in 2021, an increase of 18%. While total deposits decreased in 2022, deposit fees increased significantly since those fees are no longer waived due to the pandemic, as they had been in 2021.
Gain on sale of loans consists of gains on the sale of residential mortgage and SBA loans. For the year ended December 31, 2022, gain on sale of loans was $3.7 million, compared to $14.0 million in 2021, a decrease of 74%. The decrease was driven by higher residential mortgage rates in 2022, which reduced mortgage origination volume.
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The Company has historically originated residential mortgage loans and utilized both “mandatory delivery” and “best efforts” forward loan sale commitments to sell those loans with servicing released. 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 GAAP for possible repurchases. There were no repurchases due to fraud by the borrower during the year ended December 31, 2022. The reserve is included in other liabilities on the Consolidated Balance Sheets. The Bank does not originate “sub-prime” loans and has no exposure to this market segment.
Residential mortgage Years Ended December 31,
(dollars in thousands) 2022
2021 % Change
Gain on sale $ 3,211 $ 13,585 (76.4) %
Closed loans 295,567 1,140,408 (74.1) %
Locked loans 323,735 994,452 (67.4) %
Reserve 25 125 (80.0) %
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.
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 $491 thousand for the year ended December 31, 2022, compared to $460 thousand for the same period in 2021. Activity in SBA loan sales to secondary markets can vary widely from year to year.
Loss on the sale of investment securities was $169 thousand for the year ended December 31, 2022, compared to a gain of $3.0 million for the year ended December 31, 2021.
Other income totaled $12.2 million for the year ended December 31, 2022 as compared to $16.8 million for 2021, a decrease of 27%. The FHA business unit generated income on the sale of FHA multifamily-backed Ginnie Mae securities of $790 thousand for 2022 compared to $4.2 million for 2021.
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. The Company will generally recover funds advanced pursuant to these arrangements under the FHA insurance and guarantee program. However, in the interim, the Company must absorb the cost of the funds it advances during the time the advance is outstanding. The Company must also bear the costs of attempting to collect on delinquent and defaulted mortgage loans. 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, 2022, the Company did not have any funds advanced outstanding under FHA mortgage loan servicing agreements.
Noninterest Expense
Total noninterest expense includes salaries and employee benefits, premises and equipment expenses, marketing and advertising, data processing, legal, accounting and professional fees, FDIC insurance premiums and other expenses.
Total noninterest expense totaled $165.1 million for 2022, as compared to $149.2 million for 2021, an 11% increase. For 2022, the efficiency ratio (ratio of noninterest expenses to total revenue) was 46.31% as compared to 40.88% for 2021. Refer to the “Use of Non-GAAP Financial Measures” section for additional detail and a reconciliation of GAAP to non-GAAP financial measures. The increase in 2022 as compared to 2021 was primarily associated with the $22.9 million of settlement expenses in the second quarter of 2022, which were partially offset by the salary accrual reduction of $5.0 million related to stock-based compensation awards and deferred compensation for our former CEO and Chairman in the first quarter of 2022.
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Salaries and employee benefits were $84.1 million for 2022, as compared to $88.4 million for 2021, a decrease of 5%. The primary reason for the decrease in 2022 was the reduction of the $5.0 million accrual related to stock-based compensation awards and deferred compensation for our former CEO and Chairman in the first quarter of 2022. The accrual was originally recorded in the first quarter of 2019. Additionally, at December 31, 2022, the Company’s full time equivalent staff numbered 496, as compared to 507 at December 31, 2021.
Premises and equipment expenses were $13.2 million for 2022 as compared to $14.9 million for 2021, a decrease of 11%. The decrease was due to the reduction in rent expense from the closure of one location and was partially offset by normal lease increases and acceleration of leasehold amortization.
Marketing and advertising expenses were $4.7 million for 2022 as compared to $4.2 million for 2021, an increase of 13%. Marketing and advertising expenses increased due to additional advertising, promotions and sponsorships.
Data processing expenses were $12.2 million for 2022 as compared to $11.7 million for 2021, an increase of 4%.
Legal, accounting and professional fees and expenses were $8.6 million for 2022 as compared to $11.5 million for 2021, a 25% decrease. Legal expenses were greater in 2021 primarily due to the previously disclosed governmental investigations and related subpoenas and document requests, as well as our defense of the previously disclosed class action lawsuit. The amount of legal fees and expenditures reported for 2022 are net of expected insurance coverage where we believe we have a high likelihood of recovery pursuant to our D&O insurance policies, but does not include any offset for potential claims we may have in the future as to which recovery is impossible to predict at this time. Refer to Note 21 – Commitments and Contingent Liabilities to the Consolidated Financial Statements for additional information on the Company’s recent proceedings.
FDIC insurance expense was $5.0 million for 2022 as compared to $5.9 million for 2021, a decrease of 16%. The decreases in 2022 compared to 2021 were due to a change in the institution's size, which improved metrics used in the calculation of fees.
In 2022, the Company incurred a penalty of $22.9 million in connection with the settlements with the SEC and FRB. The amount of penalty fees was reported as noninterest expense for 2022. No such penalty fees were incurred in 2021.
The major components of other expenses include broker fees, franchise tax, insurance expenses and director compensation. Other expenses were $14.4 million for 2022 as compared to $12.6 million for 2021, an increase of 14%. The increase in 2022, as compared to 2021, was primarily due to director compensation and insurance expenses.
Income Tax Expense
Income tax expense was $48.8 million for 2022 as compared to $61.0 million for 2021, resulting in an effective tax rate of 25.70% and 25.66%, respectively. The overall reduction in tax expense for 2022 versus 2021 was primarily attributable to lower pre-tax earnings, a lower state effective tax rate and to higher levels of tax-exempt income earned during 2022. The reductions in tax expense were partially offset by the non-deductible SEC and FRB settlements in 2022. The effective tax rate was essentially flat for 2022 compared to 2021 because the benefits from the lower effective state tax rate and the higher tax-exempt income were offset by the impact of the non-deductible expenses. The impact of the change in mix of the components noted above can be seen in the reconciliation of statutory federal income tax rate table in Note 14 to the Consolidated Financial Statements.
The Inflation Reduction Act of 2022 ("Inflation Reduction Act") was signed into law by president Biden on August 16, 2022. The Inflation Reduction Act makes significant changes to the U.S. tax law, including the introduction of a corporate alternative minimum tax of 15% of the “adjusted financial statement income” of certain domestic corporations as well as a 1% excise tax on the fair market value of stock repurchases by certain domestic corporations, effective for tax years beginning in 2023. The Company currently does not expect the tax-related provision of the Inflation Reduction Act to have a material impact on our financial results.
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Twelve Months Ended December 31, 2021 Compared with Twelve Months Ended December 31, 2020
Overview
Net income for the years ended December 31, 2021 and 2020 were $176.7 million and $132.2 million, respectively. Net income per basic and diluted common share for 2021 was $5.53 and $5.52, respectively, compared to $4.09 per basic and diluted common share for 2020, a 35% increase.
Net income increased in 2021 relative to 2020 primarily due to reversals from the allowance for credit losses and, to a lesser extent, net interest income on a higher asset base, partially off set by lower noninterest income and higher noninterest expense.
The most significant portion of revenue (i.e., net interest income plus noninterest income) is net interest income, which increased to $324.5 million in 2021 compared to $321.6 million for 2020. The increase resulted from an increase in average earning assets of 14%, which offset a decline of 38 basis points in net interest margin.
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 2.81% for 2021 and 3.19% for 2020, a decline of 38 basis points. The drivers of the change are detailed in the "Net Interest Income and Net Interest Margin" section below.
The provision for credit losses in 2021 was a reversal of $20.8 million as compared to a provision of $45.6 million in 2020. The reversal of the provision was primarily driven by the improved economic environment, adjustments to the quantitative components of the CECL model and improvements in asset quality. F or information on the components and drivers of these changes see "Provision for Credit Losses" section below.
Total noninterest income in 2021 was $40.4 million, as compared to $45.7 million in 2020, a 12% decrease.
Noninterest expenses in 2021 totaled $149.2 million, as compared to $144.2 million in 2020, a 3% increase.
The efficiency ratio, which measures the ratio of noninterest expense to total revenue, was 40.88% for 2021 as compared to 39.25% for 2020. Refer to the “Use of Non-GAAP Financial Measures” section for additional detail and a reconciliation of GAAP to non-GAAP financial measures.
Income tax expense in 2021 was $61.0 million, as compared to $43.9 million in 2020, a 39% increase.
At December 31, 2021, total loan balances (including PPP loans) were 9% lower than they were at December 31, 2020, and average loans were 8% lower in 2021 as compared to 2020. PPP loans represented $51.1 million of total loans at the end of 2021, as compared to $454.8 million at the end of 2020. Excluding PPP loans, loans decreased 4% in 2021, driven by higher payoffs and paydowns, which outpaced originations and advances. The decline in PPP loans was the result of the forgiveness process and, in the second quarter of 2021, the Company's sale of a portion of the PPP loan portfolio.
Deposit growth was strong throughout 2021, and resulted in well above historical average overnight liquidity for the Company. Deposit funding during 2021 was primarily from noninterest bearing and money market accounts. In large part due to those inflows, total deposits at December 31, 2021 were 9% higher than deposits at December 31, 2020, while average deposits were 17% higher for 2021 compared with 2020. This increase in deposits allowed the Company to sustain strong primary and secondary sources of liquidity and increase the size of the investment securities portfolio.
In terms of the average asset composition or mix, loans, which generally have higher yields than securities and other earning assets, represented 63% and 76% of average earning assets for 2021 and 2020, respectively. For 2021, as compared to 2020, average loans, excluding loans held for sale, decreased $607.6 million, or 8%, driven by higher payoffs and paydowns, which outpaced originations and advances, and PPP loan forgiveness and sale.
Average investment securities for 2021 were 14% of average earning assets compared to 9% for 2020. The combination of federal funds sold, interest bearing deposits with other banks and loans held for sale represented 23% and 12% of average earning assets for 2021 and 2020, respectively, as much higher levels of on-balance sheet liquidity existed throughout 2021. These increases were driven by the decline in loans coupled with the inflow of deposits.
The ratio of common equity to total assets increased to 11.40% at December 31, 2021 from 11.16% at December 31, 2020, due to common equity growing faster rate than total assets, even with common equity reductions due to $682 thousand in share repurchase activity and $44.7 million of cash dividends declared.
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For 2021, the return on average assets (“ROAA”) was 1.49%, as compared to 1.28% for 2020. Total shareholders’ equity was $1.35 billion at December 31, 2021 and $1.24 billion and 2020, an increase of 9%. The return on average common equity (“ROACE”) for 2021 was 13.54% as compared to 10.98% for 2020. The return on average tangible common equity (“ROATCE”) for 2021 was 14.73% as compared to 12.03% for 2020. Refer to the “Use of Non-GAAP Financial Measures” section for additional detail and a reconciliation of GAAP to non-GAAP financial measures. The increase in these returns was primarily due to reversals from the allowance for credit losses and to a lesser extent net interest income on a higher asset base, partially off set by lower noninterest income and higher noninterest expense.
Net Interest Income and Net Interest Margin
Net interest income in 2021 was $324.5 million compared to $321.6 million in 2020. For 2021, net interest income increased 1% over the same period for 2020. The increase resulted from an increase in average earning assets of 14%, which offset a decline of 38 basis points in net interest margin.
The net interest margin was 2.81% for 2021, as compared to 3.19% for 2020, a decline of 38 basis points. This decline was led by a lower rate environment and the decline in loans, which generally have higher yields than securities. Additionally, the increase in deposits, led to an increase in low yielding assets such as securities or interest bearing deposits at other banks, which contributed to net income and liquidity, but lowered net interest margin. In 2021, average loans decreased $607.6 million or 8% and average deposits increased by $1.4 billion or 17%.
Loans, the largest component of interest income on earnings assets, had a yield of 4.62% in 2021, compared to 4.66% in 2020, a decline of 4 basis points (includes PPP loans). The decline in yield was minimized due to disciplined loan pricing practices and the sale or forgiveness of PPP loans, which accelerated net deferred fees and cost into interest income. Additionally, the deposit mix remained favorable, with average noninterest deposits being 34% of average total deposits, up from 31% in 2020. In 2021, total net loans, the primary source of the Bank’s revenue, declined, although total assets increased over the same period. Further, loan pricing pressures in the highly competitive market for high-quality commercial loans, and the costs and implementation risks associated with pursuing loan growth, put pressure on loan portfolio yields and consequently the Bank’s net interest margin and net income.
Provision for Credit Losses
The provision for credit losses was a reversal of $20.8 million in 2021, as compared to a provision of $45.6 million in 2020. The reversal in 2021 was largely due to the improvement of the economy as the COVID-19 vaccines and treatments became widely available and the improvement in credit quality, whereas the provision in 2020 was due to a reserve build associated with the onset 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 a reversal of $1.1 million in 2021, as compared to a provision of $1.4 million in 2020.
For 2021, the ACL decreased by $34.6 million, reflecting a reversal of $20.8 million to provision for credit losses and $13.3 million in net charge-offs. Net charge-offs of $13.3 million during 2021 represented 0.18% of average loans, excluding loans held for sale, as compared to $20.1 million or 0.26% of average loans, excluding loans held for sale, in 2020. Net charge-offs during 2021 were attributable primarily to commercial real estate ($5.1 million) and commercial loans ($8.3 million).
At December 31, 2021 the ACL represented 1.06% of loans outstanding, as compared to 1.41% at December 31, 2020. The ACL represented 257% of nonperforming loans at December 31, 2021, as compared to 180% at December 31, 2020.
Noninterest Income
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, 2021 was $40.4 million as compared to $45.7 million for the year ended December 31, 2020. The 12% decrease was due substantially to $8.0 million lower gains on sa le of residential mortgage loans which was partially offset by $1.1 million higher gains on sales of securities and $1.6 million higher fees associated with the origination, securitization, sale and servicing of FHA loans.
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The Bank recently announced that it plans to cease originating residential mortgages for sale in the first quarter of 2023 (See Note 26 of the Consolidated Financial Statements for further details).
For the year ended December 31, 2021, service charges on deposit accounts slightly increased $146 thousand to $4.6 million from $4.4 million for the same period in 2020, an increase of 3%. While deposits increased significantly in 2021, deposit fees continue to be waived due to the pandemic.
Gain on sale of loans consists of gains on the sale of residential mortgage and SBA loans. For the year ended December 31, 2021, gain on sale of loans was $14.0 million, compared to $22.1 million for the year ended December 31, 2020, a decrease of 36%. The decrease was driven by higher residential mortgage rates in the latter part of the year, which reduced mortgage origination volume.
Residential mortgage Years Ended December 31,
(dollars in thousands) 2021 2020 % Change
Gain on sale $ 13,585 $ 22,368 (39.3) %
Closed loans 1,140,408 1,260,615 (9.5) %
Locked loans 994,452 1,860,813 (46.6) %
Reserve 125 205 (39.2) %
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 $460 thousand for the year ended December 31, 2021 compared to $269 thousand for the same period in 2020. Activity in SBA loan sales to secondary markets can vary widely from year to year.
Gain on the sale of investments were $3.0 million for the year ended December 31, 2021 compared to $1.8 million for the year ended December 31, 2020.
Other income totaled $16.8 million for the year ended December 31, 2021 as compared to $15.3 million for 2020, an increase of 9%. The FHA business unit generated income on the sale of FHA multifamily-backed GNMA securities of $5.0 million for 2021 compared to $3.4 million for 2020.
Noninterest Expense
Total noninterest expenses totaled $149.2 million for 2021, as compared to $144.2 million for 2020, a 3% increase. For 2021, the efficiency ratio (ratio of noninterest expenses to total revenue) was 40.88% as compared to 39.25% for 2020. Refer to the “Use of Non-GAAP Financial Measures” section for additional detail and a reconciliation of GAAP to non-GAAP financial measures.
Salaries and employee benefits were $88.4 million for 2021, as compared to $74.4 million for 2020, an increase of 19%. The increase was a result of higher incentive bonus accruals based on Company performance and increased share based compensation. At December 31, 2021, the Company’s full time equivalent staff numbered 507, as compared to 519 at December 31, 2020.
Premises and equipment expenses were $14.9 million for 2021 as compared to $15.7 million for 2020, a decrease of 5%. The reduction in rent expense from the closure of several locations and was partially offset by normal lease increases and acceleration of leasehold amortization; and the third quarter of 2020 included a $1.7 million adjustment which increased rent expense in accordance with ASC 842 on leases.
Marketing and advertising expenses were $4.2 million for 2021 as compared to $4.3 million for 2020, a decrease of 3%. Marketing and advertising expenses remained low in 2021 as events and conferences remained on hold as a result of COVID-19.
Data processing expenses were $11.7 million for 2021 as compared to $10.7 million for 2020, an increase of 9%, primarily due to increased customer activity and annual increases in license fee renewals.
Legal, accounting and professional fees and expenses were $11.5 million for 2021 as compared to $16.4 million for 2020, a 30% decrease. The decrease was primarily associated with reduced legal fees as the Company incurred significant legal expenses in 2020 due to ongoing governmental investigations and subpoenas and document requests. Refer to Note 21 – Commitments and Contingent Liabilities to the Consolidated Financial Statements for additional information on the Company’s recent proceedings.
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FDIC insurance expense was $5.9 million for 2021 as compared to $7.9 million for 2020, a decrease of 26%. The decrease was primarily due to adoption of the large bank assessment methodology.
Other expenses were $12.6 million for 2021 as compared to $14.7 million for 2020, a decrease of 14%. The decrease was associated with reductions in OREO expense, franchise tax, other loan expenses, telephone and travel expense. The major components of cost in this category include broker fees, franchise tax, insurance expenses, and director compensation. Cost control remains a significant operating objective of the Company.
Income Tax Expense
Income tax expense was $61.0 million for 2021 as compared to $43.9 million for 2020, resulting in an effective tax rate of 25.7% and 24.9%, respectively. The increase in rates was due to an increase in state income taxes and nondeductible stock-based compensation awarded to execu tiv e officers.
BALANCE SHEET ANALYSIS
Overview
Total assets at December 31, 2022 were $11.2 billion as compared to $11.8 billion at December 31, 2021, a 6% decrease. The decrease in total assets in 2022 was primarily due to the decrease in total interest-bearing deposits with banks and other short-term investments, partially offset by the increase in total loans. The largest component of assets, total loans (excluding loans held for sale), were $7.6 billion at December 31, 2022, as compared to $7.1 billion at December 31, 2021 an 8% increase. The increase in loans in 2022, was driven by growth from CRE loans. Additionally, the Bank reduced its PPP loans from $51.1 million at December 31, 2021 to $3.3 million at December 31, 2022 through the forgiveness process. Loans held for sale were $6.7 million at December 31, 2022, compared to $47.2 million at December 31, 2021, an 86% decrease due to a decline in production.
The investment securities portfolio totaled $2.7 billion at December 31, 2022 as compared to $2.6 billion at December 31, 2021, a $68.6 million increase. For the year ended December 31, 2022, total deposits were $8.7 billion as compared to $10.0 billion at December 31, 2021, a decrease of 13%, due primarily to deposit disintermediation as a result of the higher interest rate environment.
Total shareholders’ equity at December 31, 2022 was $1.23 billion as compared to $1.35 billion at December 31, 2021, a 9% decrease. The decrease in shareholders’ equity in 2022 was from unrealized losses on the AFS investments included in other comprehensive income (loss), cash dividends and common stock repurchased, offset by net income.
The Company's capital ratios remain substantially in excess of regulatory minimum and buffer requirements. Regulatory ratios based on risk-weighted assets declined in 2022 as non-risk weighted cash was moved into risk-weighted securities and loans.
The total risk based capital ratio was 14.94% at December 31, 2022, as compared to 15.74% at December 31, 2021. In addition, the tangible common equity ratio was 10.18% at December 31, 2022, compared to 10.60% at December 31, 2021. The ratio of common equity to total assets was 11.02% at December 31, 2022 as compared to 11.40% at December 31, 2021. The CET1 risk based capital ratio was 14.03% at December 31, 2022, as compared to 14.63% at December 31, 2021. The tier 1 leverage ratio was 11.63% at December 31, 2022, as compared to 10.19% at December 31, 2021.
Investment Securities and Short-Term Investments
The tables below and Note 3 to the Consolidated Financial Statements provide additional information regarding the Company’s investment securities categorized as “available-for-sale” or AFS and as "held-to-maturity" or HTM. The Company classifies its investment securities as either AFS or HTM. The AFS classification requires that investment securities be recorded at 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, while securities classified as HTM are recorded and presented at their amortized cost. At December 31, 2022, the Company had a net unrealized loss in AFS securities of $205.2 million with a deferred tax asset of
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$50.4 million, as compared to December 31, 2021 where there was a net unrealized loss in AFS securities of $18.6 million with a deferred tax asset of $5.0 million.
The AFS portfolio is comprised of U.S. treasury bonds (2.9% of AFS securities), U.S. agency securities (41.9% of AFS securities) with an average duration of 3.8 years, seasoned mortgage-backed securities that are 100% agency issued (51.3% of AFS securities for residential mortgage-backed and 3.1% for commercial mortgage-backed) which have an average expected life of 4.6 years with contractual maturities of the underlying mortgages of up to thirty years, municipal bonds (0.6% of AFS securities) which have an average duration of 6.6 years and corporate bonds (0.1% of AFS securities) which have an average duration of 0 years. Investment securities which are debt instruments are 95 percent of the portfolio and are generally rated AAA or AA or have the implicit guarantee of the U.S. Treasury.
At December 31, 2022, the AFS investment portfolio was $1.6 billion as compared to $2.6 billion at December 31, 2021, a decrease of 39%. 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. The decrease in AFS in 2022 was primarily due to securities being transferred into HTM. During the first quarter of 2022, we evaluated our securities portfolio and determined that certain securities will be maintained for the life of the instrument and made a decision to transfer $1.1 billion of securities designated as AFS to HTM, including $237.0 million of securities acquired in the first quarter of 2022 for which the intention to hold to maturity was finalized. The transferred securities had unrealized losses of $66.2 million, and, as of December 31, 2022, $59.1 million remains in accumulated other comprehensive loss and will be amortized ratably over the remaining lives of the securities through accumulated other comprehensive loss. The securities transferred were generally municipal bonds, corporate bonds, bonds that qualify for Community Reinvestment Act credit and mortgage-backed securities with longer final maturity dates. At December 31, 2022, $1.1 billion, or 40.6% of the securities portfolio, was classified as securities HTM.
The following table provides information regarding the composition of the investment securities portfolio at the dates indicated. AFS securities are reported at estimated fair value and HTM securities are reported at amortized cost. At December 31, 2022, the investment portfolio balances at fair value decreased and amortized cost increased as compared to December 31, 2021, and the composition of portfolio changed, as follows:
Years Ended December 31,
Available-for-sale 2022
2021
(dollars in thousands) Fair Value Percent of Total Fair Value Percent of Total
U.S. treasury bonds $ 46,327 2.9 % $ 49,458 1.9 %
U.S. agency securities 669,728 41.9 % 622,387 23.7 %
Residential mortgage-backed securities 820,503 51.3 % 1,618,027 61.7 %
Commercial mortgage-backed securities 50,213 3.1 % 59,646 2.3 %
Municipal bonds 10,087 0.6 % 145,431 5.5 %
Corporate bonds 1,808 0.1 % 128,459 4.9 %
$ 1,598,666 100 % $ 2,623,408 100 %
Years Ended December 31,
Held-to-maturity 2022
2021
(dollars in thousands) Amortized Cost Percent of Total Amortized Cost Percent of Total
Residential mortgage-backed securities $ 741,057 67.8 % — — %
Commercial mortgage-backed securities 92,557 8.4 % — — %
Municipal bonds 128,273 11.7 % — — %
Corporate bonds 132,253 12.1 % — — %
1,094,140 100 % — — %
Allowance for credit losses (766) — % — — %
Total held-to-maturity securities, net of ACL $ 1,093,374 100 % $ — — %
At December 31, 2022, there were no issuers, other than the U.S. Government and its agencies, whose securities owned by the Company had a book or fair value exceeding 10% of the Company’s shareholders’ equity.
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The following tables provides information, on an amortized cost basis, for AFS and HTM portfolios regarding the expected maturity and weighted-average yield of the investment portfolio at December 31, 2022. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Yields on tax exempt securities have not been calculated on a tax equivalent basis.
Available-for-sale 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
Average
Yield Amortized
Cost Weighted
Average
Yield Amortized
Cost Weighted
Average
Yield Amortized
Cost Weighted
Average
Yield Amortized
Cost Weighted
Average
Yield
U.S. treasury bonds $ — — % $ 49,793 0.83 % $ — — % $ — — $ 49,793 0.83 %
U.S. agency securities 549,137 1.50 % 111,742 0.81 % 73,886 2.90 % 13,012 1.25 % 747,777 1.53 %
Residential mortgage-backed securities 3,994 4.95 % 7,043 1.64 % 186,813 1.43 % 739,707 1.89 % 937,557 1.81 %
Commercial mortgage-backed securities 475 1.25 % 24,938 2.10 % 20,001 2.54 % 10,657 3.67 % 56,071 2.55 %
Municipal bonds 300 5.96 % 1,444 5.20 % 8,956 2.44 % — — % 10,700 2.91 %
Corporate bonds — — % 2,000 5.50 % — — % — — 2,000 5.50 %
Total available-for-sale securities $ 553,906 1.53 % $ 196,960 1.09 % $ 289,656 1.91 % $ 763,376 1.90 % $ 1,803,898 1.68 %
Held-to-maturity 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
Average
Yield Amortized
Cost Weighted
Average
Yield Amortized
Cost Weighted
Average
Yield Amortized
Cost Weighted
Average
Yield Amortized
Cost Weighted
Average
Yield
Residential mortgage-backed securities — — % 1,904 2.62 % 21,865 2.15 % 717,288 2.65 % 741,057 2.64 %
Commercial mortgage-backed securities — — % 1,865 2.63 % 36,709 2.63 % 53,983 2.59 % 92,557 2.61 %
Municipal bonds 3,156 2.50 % 35,579 3.04 % 77,262 3.06 % 12,276 3.12 % 128,273 3.05 %
Corporate bonds 23,954 3.44 % 84,953 4.26 % 23,346 3.81 % — — % 132,253 4.03 %
$ 27,110 1.58 % $ 124,301 1.99 % $ 159,182 2.08 % $ 783,547 2.80 % 1,094,140 2.85 %
Allowance for credit losses (766)
Total held-to-maturity securities, net of ACL $ 1,093,374
Federal funds sold were $33.9 million at December 31, 2022, as compared to $20.4 million at December 31, 2021. 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 represent liquid funds held at the Federal Reserve to meet general liquidity needs of the Company, such as future loan demand and future increases in investment securities, among others. Interest bearing deposits with banks and other short-term investments were $265.3 million at December 31, 2022, as compared to $1.68 billion at December 31, 2021, a decrease of $1.4 billion, or 84%. In 2022, as rising rates led to deposit disintermediation reducing our liquidity levels, and loan balances increased, the Company reduced these short-term investments to rebalance the earning assets mix.
The Bank did not hold any time deposits at December 31, 2022 or December 31, 2021.
Loan Portfolio
In its lending activities, the Company seeks to develop and expand relationships with clients whose business and individual banking needs will grow with the Bank. Superior customer service, local decision making and accelerated turnaround time from application to closing have been significant factors in growing the loan portfolio and meeting the lending needs in the markets served, while maintaining sound asset quality.
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Loans increased over the past year as loans outstanding were $7.6 billion at December 31, 2022, as compared to $7.1 billion at December 31, 2021, an increase of $570.0 million or 8% .
Loan production in 2022 was predominantly in the commercial, income producing - commercial real estate and owner occupied – commercial real estate loan categories. 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, we have experienced net loan growth for 2022 over 2021; the Bank continued to experience organic gross loan production, having originated more than $2.3 billion in new CRE loan commitments and more than $1.3 billion in CRE Construction commitment during 2022. 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 relatively well, particularly for well-located close-in projects. 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 therefore, we are being careful with valuations.
"Owner occupied-commercial real estate" and "construction–C&I (owner occupied)" loans represent 16% of the loan portfolio. The Bank has a large portion of its loan portfolio related to real estate, with 79% consisting of commercial real estate and real estate construction loans. When "owner occupied commercial real estate" and "construction–C&I (owner occupied)" are excluded, the percentage of total loans represented by commercial real estate decreases to 63%. Real estate also serves as collateral for loans made for other purposes, resulting in 81% of loans being secured or partially secured by real estate.
The following table shows the trends in the composition of the loan portfolio over the past three years.
Years Ended December 31,
2022
2021 2020
(dollars in thousands) Amount % Amount % Amount %
Commercial $ 1,487,349 19 % $ 1,354,317 19 % $ 1,437,433 19 %
PPP loans 3,256 — % 51,105 1 % 454,771 6 %
Income producing - commercial real estate 3,919,941 51 % 3,385,298 48 % 3,687,000 47 %
Owner occupied - commercial real estate 1,110,325 15 % 1,087,776 15 % 997,694 13 %
Real estate mortgage - residential 73,001 1 % 73,966 1 % 76,592 1 %
Construction - commercial and residential 877,755 12 % 896,319 13 % 873,261 11 %
Construction - C&I (owner occupied) 110,479 1 % 159,579 2 % 158,905 2 %
Home equity 51,782 1 % 55,811 1 % 73,167 1 %
Other consumer 1,744 — % 1,427 — % 1,389 — %
Total loans 7,635,632 100 % 7,065,598 100 % 7,760,212 100 %
Less: Allowance for credit losses (74,444) (74,965) (109,579)
Net loans $ 7,561,188 $ 6,990,633 $ 7,650,633
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. metropolitan area and secured by real estate or other collateral in that market. Although these loans are made to a diversified pool of unrelated borrowers across numerous businesses, adverse developments in the Washington, D.C. metropolitan real estate market could have an adverse impact on this portfolio of loans and the Company’s income and financial position. While our basic market area is the Washington, D.C. 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.
The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending. Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions which have (1) total reported loans for construction, land development and other land acquisitions which represent 100% or more of an institution’s total risk-based capital; or (2) total commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the institution’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. 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 growth in its commercial real estate portfolio in recent years. As of
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December 31, 2022, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represented 347.9% of consolidated risk based capital; however, growth in that segment over the past 36 months at 1.2% did not exceed the 50% threshold laid out in the regulatory guidance. Construction, land and land development loans represented 62% 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. 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. 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 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.
At December 31, 2022, the Company had no concentrations of loans in any one industry exceeding 10% of its total loan portfolio. An industry for this purpose is defined as a group of businesses that are engaged in similar activities and have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions.
Certain directors and executive officers have had loan transactions with the Company. Such loans were made in the ordinary course of the Company’s lending business; were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable loans with third parties; and, in the opinion of management, did not involve more than the normal risk of collectability or present other unfavorable features. Refer to Note 4 to the Consolidated Financial Statements for further detail regarding related party loans.
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Loan Maturity
The following table sets forth the time to contractual maturity of the loan portfolio as of December 31, 2022.
Due In
(dollars in thousands) Total One Year or Less Over One to Five Years Over Five to Ten Years Over Ten Years
Commercial $ 1,487,349 $ 600,252 $ 736,058 $ 146,857 $ 4,182
PPP loans 3,256 2,477 779 — —
Income producing - commercial real estate 3,919,941 1,467,208 1,980,772 470,779 1,182
Owner occupied - commercial real estate 1,110,325 52,642 422,667 489,123 145,893
Real estate mortgage - residential 73,001 15,880 42,467 3,309 11,345
Construction - commercial and residential 877,755 424,117 396,998 36,634 20,006
Construction - C&I (owner occupied) 110,479 12,308 10,141 34,712 53,318
Home equity 51,782 4,667 4,845 1,028 41,242
Other consumer 1,744 971 211 — 562
Total loans $ 7,635,632 $ 2,580,522 $ 3,594,938 $ 1,182,442 $ 277,730
Loans with:
Predetermined fixed interest rate
Commercial 426,932 107,215 229,695 90,022 —
PPP loans 3,256 2,477 779 — —
Income producing - commercial real estate 1,729,753 455,687 973,078 300,988 —
Owner occupied - commercial real estate 621,172 36,150 239,317 280,936 64,769
Real estate mortgage - residential 67,195 12,328 41,894 2,956 10,017
Construction - commercial and residential 28,184 25,724 2,460 — —
Construction - C&I (owner occupied) 64,627 8,408 8,748 21,092 26,379
Home equity 998 174 228 596 —
Other consumer 152 8 127 — 17
$ 2,942,269 $ 648,171 $ 1,496,326 $ 696,590 $ 101,182
Floating or adjustable interest rate
Commercial 1,060,417 493,037 506,363 56,835 4,182
Income producing - commercial real estate 2,190,188 1,011,521 1,007,694 169,791 1,182
Owner occupied - commercial real estate 489,153 16,492 183,350 208,187 81,124
Real estate mortgage - residential 5,806 3,552 573 353 1,328
Construction - commercial and residential 849,571 398,393 394,538 36,634 20,006
Construction - C&I (owner occupied) 45,852 3,900 1,393 13,620 26,939
Home equity 50,784 4,493 4,617 432 41,242
Other consumer 1,592 963 84 — 545
$ 4,693,363 $ 1,932,351 $ 2,098,612 $ 485,852 $ 176,548
Total loans $ 7,635,632 $ 2,580,522 $ 3,594,938 $ 1,182,442 $ 277,730
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Loans are shown in the period based on final contractual maturity. Demand loans, having no contractual maturity, and overdrafts are reported as due in one year or less.
Allowance for Credit Losses
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. The provision for credit losses represents the amount of expense charged to current earnings to fund the ACL.
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. The ACL represented 0.97% of total loans at December 31, 2022 as compared to 1.06% at December 31, 2021. At December 31, 2022, the allowance represented 1,151% of nonperforming loans as compared to 257% at December 31, 2021. As the loan portfolio balances increased, the ACL decreased driven by the improved macroeconomic outlook and improvement of the quality of the loan portfolio.
In 2022, the decrease in the ratio of the allowance for loan losses to total loans was also driven by net charge offs of $624 thousand, which had a greater impact on the ratio than the increase in loans. The decreases were offset by the increase in the provision of $103 thousand due to the increase in loan balances.
In 2021, the decrease in the ratio of the allowance for loan losses to total loans was due to the provision reversal of $20.8 million and net charge offs of $13.3 million, which had a greater impact on the ratio than the decline in loans. The increase in the coverage ratio is due to the improvement in asset quality, which also contributed to the decision to reverse provisions to the ACL.
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 and Estimates” 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.”
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 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. 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.
At December 31, 2022 and 2021, the Company had $6.5 million and $29.2 million, respectively, of loans classified as nonperforming. At each of December 31, 2022 and 2021, the Company also had $88.6 million of additional loans rated substandard or worse. 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.
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. Management did conduct sensitivity analysis on the CECL model. This was tested by shocking the unemployment forecast up by 2% across the forecast period. This stress test resulted in an increased expected loss and resulting increase to ACL of $11.2 million versus the current balance.
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Historically, the Bank has enjoyed a high quality loan portfolio with relatively low levels of net charge-offs and low delinquency rates. In 2022, the Company experienced an improvement in the reduced level of net charge-offs as a percentage of average loans (0.01%) as compared to 2021 (0.18%) and to 2020 (0.26%). The maintenance of a high quality portfolio will continue to be a high priority for both management and the Board of Directors.
Bank management, being aware of the loan growth experienced by the Bank, is intent on maintaining strong portfolio management and a strong risk rating process. 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 ACL, 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.
The following table sets forth activity in the allowance for credit losses for the past three years.
Years Ended December 31,
(dollars in thousands) 2022
2021 2020
Balance at beginning of year $ 74,965 $ 109,579 $ 73,658
Impact of adopting CECL — — 10,614
Charge-offs:
Commercial 1,561 8,788 12,082
Income producing - commercial real estate — — 4,300
Owner occupied - commercial real estate 1,355 5,445 20
Real estate mortgage - residential — — 815
Construction - commercial and residential — 206 2,947
Home equity — — 92
Other consumer 79 1 3
Total charge-offs 2,995 14,440 20,259
Recoveries:
Commercial 713 486 130
Income producing - commercial real estate — — —
Owner occupied - commercial real estate 25 97 —
Real estate mortgage - residential — — —
Construction - commercial and residential 1,627 499 4
Home equity — — —
Other consumer 6 18 28
Total recoveries 2,371 1,100 162
Net charge-offs 624 13,340 20,097
(Reversal) Provision for Credit Losses- Loans 103 (21,274) 45,404
Balance at end of year $ 74,444 $ 74,965 $ 109,579
Ratio of allowance for credit losses to total loans outstanding at year end 0.97 % 1.06 % 1.41 %
Ratio of net charge-offs during the year to average loans outstanding during the year 0.01 % 0.18 % 0.26 %
The following table presents the allocation of the ACL by loan category and the percentage of allowance in each category. The allocation of the allowance at December 31, 2022 includes specific reserves of $5.2 million against individually assessed loans of $30.7 million, as compared to specific reserves of $7.0 million against individually assessed of $39.1 million at December 31, 2021. 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,
2022
2021
Years Ended December 31,
2022 2021
(dollars in thousands) Amount % of Total ACL % of Total Loans Amount % of Total ACL % of Total Loans
Commercial $ 15,655 21 % 19 % $ 14,475 19 % 20 %
Income producing - commercial real estate 35,688 48 % 51 % 38,287 51 % 48 %
Owner occupied - commercial real estate 12,702 17 % 15 % 12,146 16 % 15 %
Real estate mortgage - residential 969 1 % 1 % 449 1 % 1 %
Construction - commercial and residential 8,801 12 % 12 % 9,099 12 % 15 %
Home equity 555 1 % 1 % 474 1 % 1 %
Other consumer 74 0 1 % 35 — % — %
Total allowance $ 74,444 100 % 100 % $ 74,965 100 % 100 %
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 ("TDR"), and other real estate owned ("OREO") totaled $8.4 million at December 31, 2022, representing 0.08% of total assets, as compared to $30.8 million at December 31, 2021, representing 0.26% of total assets. The Company had no accruing loans 90 days or more past due at December 31, 2022 or December 31, 2021. 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 ACL at 0.97% of total loans at December 31, 2022, is adequate to absorb expected credit losses.
Total nonperforming loans amounted to $6.5 million at December 31, 2022, representing 0.08% of total loans, compared to $29.2 million at December 31, 2021, representing 0.41% of total loans. The majority of nonperforming loans are believed to be adequately secured by real estate.
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.
Nonperforming assets include loans that the Company considers to be individually assessed. Individually assessed 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 has not shown a period of performance as required under applicable accounting standards. Loans that do not share risk characteristics are evaluated on an individual basis. For collateral dependent financial assets where the Company has determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and the Company expects repayment of the financial asset to be provided substantially through the sale of the collateral, the ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the asset as of the measurement date. When repayment is expected to be from the operation of the collateral, expected credit losses are calculated as the amount by which the amortized cost basis of the financial asset exceeds the NPV from the operation of the collateral. When repayment is expected to be from the sale of the collateral, expected credit losses are calculated as the amount by which the amortized cost basis of the financial asset exceeds the fair value of the underlying collateral less estimated cost to sell. The ACL may be zero if the fair value of the
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collateral at the measurement date exceeds the amortized cost basis of the financial asset. Generally, all appraisals associated with individually assessed loans are updated on a not less than annual basis.
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. Concessions could include interest rate reductions, principal or interest forgiveness, forbearance and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Alternatively, management, from time-to-time and in the ordinary course of business, implements renewals, modifications, extensions and/or changes in terms of loans to borrowers who have the ability to repay on reasonable market-based terms, as circumstances may warrant. 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. For example: (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; or (3) there may be maturing loans to borrowers with demonstrated repayment ability who are not in a position at the time of maturity to obtain alternate long-term financing.
The most common change in terms provided by the Company is an extension of an interest only term. 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 5 TDRs at December 31, 2022, totaling approximately $24.4 million, as compared to 7 TDRs totaling approximately $16.5 million at December 31, 2021. Refer to Note 4 – Loan Modifications for more detail on TDRs.
Commercial and consumer loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future default. If loans modified in a TDR subsequently default, the Company evaluates the loan for possible further impairment. 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 2022 and 2021, there was one loan modified in a TDR.
Included in nonperforming assets at December 31, 2022 is OREO of $2.0 million, consisting of 4 foreclosed properties. Included in nonperforming assets at December 31, 2021 was OREO of $1.6 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 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. There was one OREO sale in 2022 and one in 2021.
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The following table shows the amounts and relevant ratios of nonperforming assets at the dates indicated:
(dollars in thousands) 2022
2021 2020
Nonaccrual Loans:
Commercial $ 2,488 $ 8,876 $ 15,352
PPP — 1,365 —
Income producing - commercial real estate 2,000 13,456 18,879
Owner occupied - commercial real estate 17 42 23,158
Real estate mortgage - residential 1,913 2,010 2,932
Construction - commercial and residential — 3,093 206
Construction - C&I (owner occupied) — — —
Home equity — 366 416
Other consumer 50 — —
Accrual loans-past due 90 days — — —
Total nonperforming loans (1)(2)
6,468 29,208 60,943
Other real estate owned 1,962 1,635 4,987
Total nonperforming assets $ 8,430 $ 30,843 $ 65,930
Coverage ratio, allowance for credit losses to total nonperforming loans 1,151 % 257 % 180 %
Ratio of nonperforming loans to total loans 0.08 % 0.41 % 0.79 %
Ratio of nonperforming assets to total assets 0.08 % 0.26 % 0.59 %
(1) At December 31, 2022, nonaccrual loans reported in the table above do not include any loans that were migrated from TDR and as of December 31, 2021 there was one loan totaling $101 thousand which migrated from performing troubled debt restructuring.
(2) Gross interest income of $558 thousand, $1.7 million and $3.7 million would have been recorded for 2022, 2021 and 2020, respectively, if nonaccrual loans shown above had been current and in accordance with their original terms, while interest actually recorded on such loans were $17 thousand, $101 thousand and $679 thousand at December 31, 2022, 2021 and 2020, respectively. See Note 1 to the Consolidated Financial Statements for a description of the Company’s policy for placing loans on nonaccrual status.
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.
Other Earning Assets
Due to the higher interest rate environment in 2022, residential mortgage loans held for sale declined to $6.7 million at December 31, 2022 from $47.2 million at December 31, 2021. The Company’s general practice was to originate and sell such loans only on a “servicing released” basis in order to enhance noninterest income. The Bank plans to cease originating residential mortgages for sale in the first quarter of 2023 (See Note 26 of the Consolidated Financial Statements for further details). See the “Business” section for a additional details on the Bank’s residential mortgage lending and sales activities.
Bank owned life insurance at December 31, 2022 amounted to $111.0 million, as compared to $108.8 million at December 31, 2021 . Refer to Note 19 to Consolidated Financial Statements for further detail.
Intangible Assets
The Company recognizes a servicing asset for the computed value of servicing fees on the sales of multifamily FHA loans, the guaranteed portion of SBA loans and other loans sold with retained servicing which is in excess of the normal servicing fees. Assumptions related to loan term and amortization are made to arrive at the initial recorded value, which is included in intangible assets, net, on the Consolidated Balance Sheet.
For 2022, excess servicing fees of $67 thousand were recorded and $89 thousand was amortized as a reduction of actual service fees collected, which is a component of other income. At December 31, 2022, the balance of excess servicing fees was $65 thousand. For 2021, excess servicing fees of $130 thousand were recorded and $182 thousand was amortized as a
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reduction of actual service fees collected, which is a component of other income. At December 31, 2021, the balance of excess servicing fees was $87 thousand.
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.
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. 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 comparable factors. Impairment analyses were performed as of December 31, 2022 and 2021 as part of our regularly scheduled annual impairment testing and 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.
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
The principal sources of funds for the Bank are core deposits, consisting of demand deposits, money market accounts, NOW accounts and savings accounts. Additionally, the Bank obtains certificates of deposits from the Washington, D.C. metropolitan area. 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 regularly 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.
For the year ended December 31, 2022, deposits were $8.7 billion as compared to $10.0 billion at December 31, 2021, a decrease of 13%. Noninterest bearing deposits decreased $127.2 million or 4% to $3.2 billion at December 31, 2022 as compared to $3.3 billion at December 31, 2021, while interest bearing deposits decreased by $1.1 billion, or 17%. Within interest bearing deposits, money market and savings accounts collectively amounted to $3.6 billion at December 31, 2022, or 42% of total deposits, as compared to $5.2 billion, or 52% of total deposits, at December 31, 2021, a decrease of $1.6 billion, or 30%.
Average total deposits for the year ended December 31, 2022 were $10.1 billion, as compared to $9.9 billion for the same period in 2021, a 2% increase.
Time deposits were $783.5 million at December 31, 2022, which was 9% of deposits. This was an increase from $729.1 million at December 31, 2021, which was 7% of deposits. The increase in time deposits was driven by an increase in interest rates.
Time deposits $250,000 or more
(dollars in thousands) 2022
2021
Three months or less $ 87,959 $ 16,663
More than three months through six months 51,746 56,619
More than three months through twelve months 108,877 48,271
Over twelve months 269,200 30,907
Total $ 517,782 $ 152,460
Maturities of time deposits with balances of $250 thousand or more represented 6% and 2% of total deposits as of December 31, 2022 and 2021, 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. Time deposits of $250 thousand or more can be more volatile and more expensive than time deposits of less than $250 thousand. However, because the Bank focuses on relationship banking, and
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its marketplace demographics are favorable, its historical experience has been that large time deposits have not been more volatile or significantly more expensive than smaller denomination certificates.
From time to time, when appropriate in order to fund strong loan demand or account for increased deposit outflow, 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 IntraFi. 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, 2022 was $782.2 million (9% of total deposits) as compared to $701.5 million (7% of total deposits) at December 31, 2021. These sources are believed by the Company to represent a reliable and cost efficient alternative funding source for the Bank, but there can be no assurance that they will continue to be adequate or appropriate to meet our liquidity needs. The Bank also is able to obtain one way CDARS deposits and participates in IntraFi’s Insured Network Deposit, (“IND”). The Bank had $979.5 million and $1.7 billion of IND brokered deposits as of December 31, 2022 and 2021, 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 or a difficulty with obtaining them in the future. In that event we would be required to obtain alternate sources for funding, which may increase our cost of funds and negatively impact our net interest margin.
At December 31, 2022 and 2021, total deposits included $2.3 billion and $2.6 billion of brokered deposits (excluding the CDARS and ICS two-way), which represented 26.5% and 26.5% of total deposits, respectively.
At December 31, 2022, the Company had $3.2 billion in noninterest bearing demand deposits, representing 36% of total deposits. This compared to $3.3 billion of noninterest bearing demand deposits at December 31, 2021, or 33% of total deposits. The Bank also offers business NOW accounts and business savings accounts to accommodate those customers who may have excess short term cash to deploy in interest earning assets.
As an enhancement to the basic noninterest bearing demand deposit account, the Company offers a sweep account, or “customer repurchase agreement,” allowing qualifying businesses to earn interest on short-term excess funds, which are not suited for either a certificate of deposit or a money market account. The balances in these accounts were $35.1 million at December 31, 2022 compared to $23.9 million at December 31, 2021. Customer repurchase agreements are not deposits and are not insured by the FDIC, but are collateralized by U.S. agency securities and or U.S. agency backed mortgage-backed securities. These accounts are particularly suitable to businesses with significant fluctuation in the levels of cash flows. Attorney and title company escrow accounts are examples of accounts which can benefit from this product, as are customers who may require collateral for deposits in excess of FDIC insurance limits but do not qualify for other pledging arrangements. This program requires the Company to maintain a sufficient investment securities level to accommodate the fluctuations in balances which may occur in these accounts.
The Company had no outstanding balances under its federal funds lines of credit provided by correspondent banks (which are unsecured) at December 31, 2022 and 2021. At December 31, 2022, the Company had $975.0 million of FHLB advances borrowed as part of the overall asset liability strategy. The Company had $300.0 million FHLB advances outstanding as of December 31, 2021. 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, 2022 and 2021 consisted of the Company’s August 5, 2014 issuance of $70.0 million of subordinated notes, due September 1, 2024. 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, there were no long-term borrowings that consist of FHLB advances (maturities over one year) at December 31, 2022 and December 31, 2021.
CONTRACTUAL OBLIGATIONS
The Company has various financial obligations, including contractual obligations and commitments that may require future cash payments 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, 2022, in the time period indicated.
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(dollars in thousands) Within One
Year One to
Three Years Three to
Five Years Over Five
Years Total
Deposits without a stated maturity (1)
$ 7,929,683 $ — $ — $ — $ 7,929,683
Time deposits (1)
463,393 310,218 6,758 3,130 783,499
Borrowed funds (2)
1,010,101 69,794 — — 1,079,895
Operating lease obligations 6,916 12,198 4,717 5,436 29,267
Outside data processing (3)
3,600 1,625 — — 5,225
George Mason sponsorship (4)
675 1,363 1,400 5,375 8,813
LIHTC investments (5)
6,363 5,660 768 931 13,722
Other (6)
2,000 — — — 2,000
Total $ 9,422,731 $ 400,858 $ 13,643 $ 14,872 $ 9,852,104
(1) Excludes accrued interest payable at December 31, 2022.
(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 one other vendor arrangement that relates to network infrastructure and data center services that expires in December 2024.
(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). Should the Bank elect to exercise its right to terminate the George Mason contract, contractual obligations would decrease $3.5 million and $3.6 million for the first option period (years 11-15) and the second option period (16-20), respectively.
(5) Low Income Housing Tax Credits (“LIHTC”) expected payments for unfunded affordable housing commitments.
(6) 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. These financial instruments include commitments to extend credit and standby letters of credit. They involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheets. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.
Various commitments to extend credit are made in the normal course of banking business. Letters of credit are also issued for the benefit of customers. These commitments are subject to loan underwriting standards and geographic boundaries consistent with the Company’s loans outstanding.
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. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Loan commitments outstanding and lines and letters of credit at December 31, 2022 and 2021 were as follows:
(dollars in thousands) 2022 2021
Unfunded loan commitments $ 2,335,735 $ 1,763,247
Unfunded lines of credit 107,919 108,209
Letters of credit 100,196 112,509
Interest rate lock commitments 6,963 56,331
Total $ 2,550,813 $ 2,040,296
Included in the unfunded loan commitments are interest rate lock commitments on residential mortgage loans which are short-term in nature. These interest rate lock commitments were $7.0 million as of December 31, 2022 and $53.3 million as of December 31, 2021.
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. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. See Note 20 to the Consolidated Financial Statements for a summary list of loan commitments at December 31, 2022 and 2021.
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Loan commitments represent agreements to lend to a customer as long as there is no violation of any condition established in the contract and which have been accepted in writing by the borrower. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained is based on management’s credit evaluation of the borrower. Collateral obtained varies and may include certificates of deposit, accounts receivable, inventory, property and equipment, residential and commercial real estate.
Standby letters of credit are conditional commitments issued by the Company which guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies as specified above and is required in instances which the Company deems necessary. At December 31, 2022, approximately 60.8% of the dollar amount of standby letters of credit was collateralized.
In connection with deposit guarantees, the Bank collateralizes certain public funds using qualified investment securities.
With the exception of these off-balance sheet arrangements, the Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, capital expenditures or capital resources, that is material to investors.
LIQUIDITY MANAGEMENT
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. The Bank’s primary sources of liquidity consist of cash and cash balances due from correspondent banks, excess reserves at the Federal Reserve, loan repayments, federal funds sold and other short-term investments, maturities and sales of available-for-sale investment securities, income from operations and new core deposits into the Bank. The majority of the Bank’s investment portfolio of debt securities is held in an available-for-sale status which allows for flexibility, subject to holdings held as collateral for customer repurchase agreements and public funds, to generate cash from sales as needed to meet ongoing loan demand. Investment securities that are classified as held-to-maturity can also be used as collateral to pledge against additional borrowings. 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 $155.0 million in federal funds on an unsecured basis from its correspondents, against which there were no amounts outstanding at December 31, 2022 and can borrow unsecured funds under one-way CDARS and ICS brokered deposits in the amount of $1.8 billion, against which there was $67 million outstanding at December 31, 2022. The Bank also has a commitment at December 31, 2022 from IntraFi to place up to $1.8 billion of brokered deposits from its IND program in amounts requested by the Bank, as compared to an actual balance of $1.1 billion at December 31, 2022. At December 31, 2022, the Bank was also eligible to make advances from the FHLB up to $1.1 billion based on collateral at the FHLB, of which there were $975.0 million outstanding as of December 31, 2022. The Bank has posted additional collateral to the FHLB in the first quarter of 2023 to increase its eligibility for advances up to $1.5 billion to meet its ongoing liquidity needs and expects to continue to utilize and expand this source of funding in the future. 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. The Bank also has a back-up borrowing facility through the Discount Window at the Federal Reserve Bank of Richmond (“Federal Reserve Bank”). This facility, which amounts to approximately $607.0 million, is collateralized with specific loan assets identified to the Federal Reserve Bank. It is anticipated that, except for periodic testing, this facility would be utilized for contingency funding only. There can be no assurance, however, that these alternative sources of liquidity will continue to be available or will be sufficient to meet our ongoing liquidity needs.
The loss of deposits, through disintermediation, is one of the greater risks to liquidity. Disintermediation occurs most commonly when rates rise and depositors withdraw deposits seeking higher rates in alternative savings and investment sources than the Bank may offer. The Bank was founded under a philosophy of relationship banking and, therefore, believes that it has less of an exposure to disintermediation and resultant liquidity concerns than do many banks. The Bank makes competitive deposit interest rate comparisons weekly and makes adjustments from time to time to ensure its interest rate offerings are competitive. There is, however, a risk that the cost of funds will increase significantly as the Bank competes for deposits or that some deposits would be lost if rates were to increase and the Bank elected not to remain competitive with its deposit rates. Under those conditions, the Bank believes that it is well positioned to use other sources of funds such as FHLB borrowings, brokered deposits, repurchase agreements and correspondent banks’ lines of credit to offset a decline in deposits in the short run, but the use of such sources may negatively impact our net interest margin and our earnings and there can be no assurance that they will be adequate to meet our liquidity needs. However, the market for customer and brokered deposits is highly
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competitive and the risk of disintermediation is high, particularly in a high interest rate environment. Most of our noninterest bearing deposits are operating deposits or compensating balances that are held in connection with lending relationships, and are less likely to disintermediate. The potential outflow of such deposits is a risk unless we pay a more competitive rate of interest on them, which could significantly and negatively impact the Bank’s interest expense and net interest margin. Over the long-term, an adjustment in assets and change in business emphasis could compensate for a potential loss of deposits. The Bank also maintains a marketable investment portfolio to provide flexibility in the event of significant liquidity needs. The ALCO has adopted policy guidelines, which emphasize the importance of core deposits, adequate asset liquidity and a contingency funding plan.
At December 31, 2022, under the Bank’s liquidity formula, it had $4.4 billion of primary and secondary liquidity sources. Management believes the amount is deemed adequate to meet current and projected funding needs.
CAPITAL RESOURCES AND ADEQUACY
The assessment of capital adequacy depends on a number of factors such as asset quality and mix, liquidity, earnings performance, changing competitive conditions and economic forces, stress testing, regulatory measures and policy, as well as the overall level of growth and complexity of the balance sheet. The adequacy of the Company’s current and future capital needs is monitored by management on an ongoing basis. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses.
The federal banking regulators have issued guidance for those institutions, which are deemed to have concentrations in commercial real estate lending. Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions which have (1) total reported loans for construction, land development and other land acquisitions which represent 100% or more of an institution’s total risk-based capital; or (2) total commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the institution’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. 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 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. 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 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. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings and other factors and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements.
The prompt corrective action regulations provide five categories, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If a bank is only adequately capitalized, regulatory approval is required to, among other things, accept, renew or roll-over brokered deposits. If a bank is undercapitalized, capital distributions and growth and expansion are limited, and plans for capital restoration are required.
At December 31, 2022, 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: Tier 1 risk-based capital ratio, Total risk-based capital ratio, the Leverage ratio and the CET1 ratio. 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 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
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of Tier 1 capital to average assets for the prior quarter is often referred to as the leverage ratio. The CET1 ratio is the Tier 1 capital ratio but excluding preferred stock.
The FRB and the other federal banking agencies have adopted the Basel III Rules to implement the Basel III capital guidelines for U.S. banks. 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; a minimum total capital to risk-weighted assets ratio of 10.5% with the fully phased-in capital conservation buffer; and a minimum leverage ratio of 4.0%. The Basel III Rules also increased risk weights for certain assets and off-balance-sheet exposures. See the “Regulation” section for additional information regarding regulatory capital requirements.
The Company’s capital ratios were all well in excess of guidelines established by the Federal Reserve Board and the Bank’s capital ratios were in excess of those required to be classified as a “well capitalized” institution under the prompt corrective action provisions of the Federal Deposit Insurance Act. The Company’s and Bank’s capital ratios at December 31, 2022 and December 31, 2021 are shown in Note 22 to the Consolidated Financial Statements.
The ability of the Company to continue to grow is dependent on its earnings and those of the Bank, the ability to obtain additional funds for contribution to the Bank’s capital, through additional borrowings, through the sale of additional common stock or preferred stock or through the issuance of additional qualifying capital instruments, such as subordinated debt. The capital levels required to be maintained by the Company and Bank may be impacted as a result of the Bank’s concentrations in commercial real estate loans. See further detail at the “Regulation” and “Risk Factors” sections.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and Notes thereto have been prepared in accordance with GAAP in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of operations. Unlike most industrial companies, nearly all of our assets and liabilities are monetary in nature. As a result, interest rates have a greater impact on our performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods or services.
NEW AUTHORITATIVE ACCOUNTING GUIDANCE
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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