What changed in this filing

/stocks — the workspaceLOADING

Item 2. Management’s Discussion and Analysis

2023-05-15 compared with 2022-11-14 · 114 added, 242 removed, 201 unchanged (64% of the section changed)

19 unchanged sentences

It is the parent company of Shore United Bank, N.A.

The Bank operates 30 full-service branches in Baltimore City, Baltimore County, Howard County, Kent County, Queen Anne’s County, Caroline County, Talbot County, Dorchester County, Anne Arundel County and Worcester County in Maryland, Kent County, Delaware and in Accomack County, Virginia.

The Bank operates 31 full-service branches in Baltimore County, Howard County, Kent County, Queen Anne’s County, Caroline County, Talbot County, Dorchester County, Anne Arundel County and Worcester County in Maryland, Kent County and Sussex County in Delaware and in Accomack County, Virginia.

The Company engages in trust and wealth management services through Wye Financial Partners, a division of Shore United Bank, N.A.

10 unchanged sentences

Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported.

The most significant accounting policies that the Company follows are presented in Note 1 of the 2021 Annual Report.

The most significant accounting policies that the Company follows are presented in Note 1 of the 2022 Annual Report along with Note 2 of the current period interim financial information.

These policies, along with the disclosures presented in the notes to the financial statements and in this discussion, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined.

Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has determined that the accounting policies with respect to the loans acquired in a business combination, the allowance for credit losses and goodwill are critical accounting policies.

Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has determined that the accounting policies the allowance for credit losses on loans and goodwill are critical accounting policies.

These policies are considered critical because they relate to accounting areas that require the most subjective or complex judgments, and, as such, could be most subject to revision as new information becomes available.

Loans Acquired in a Business Combination

Acquired loans are classified as either (i) purchase credit-impaired (“PCI”) loans or (ii) purchased performing loans and are recorded at fair value on the date of acquisition.

PCI loans are those for which there is evidence of credit deterioration since origination and for which it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments.

When determining fair value, PCI loans are aggregated into pools of loans based on common risk characteristics as of the date of acquisition such as loan type, date of origination, and evidence of credit quality deterioration such as internal risk grades and past due and nonaccrual status.

The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the “nonaccretable difference.” Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the “accretable yield” and is recognized as interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows.

On a quarterly basis, we evaluate our estimate of cash flows expected to be collected on PCI loans.

Estimates of cash flows for PCI loans require significant judgment.

Subsequent decreases to the expected cash flows will generally result in a provision for loan losses resulting in an increase to the allowance for loan losses.

Subsequent significant increases in cash flows may result in a reversal of post-acquisition provision for loan losses or a transfer from nonaccretable difference to accretable yield that increases interest income over the remaining life of the loan, or pool(s) of loans.

Disposals of loans, which may include sale of loans to third parties, receipt of payments in full or in part from the borrower or foreclosure of the collateral, result in removal of the loan from the PCI loan portfolio at its carrying amount.

PCI loans are not classified as nonperforming by the Company at the time they are acquired, regardless of whether they had been classified as nonperforming by the previous holder of such loans, and they will not be classified as nonperforming so long as, at quarterly re-estimation periods, we believe we will fully collect the new carrying value of the pools of loans.

The Company accounts for purchased performing loans using the contractual cash flows method of recognizing discount accretion based on the acquired loans’ contractual cash flows.

Purchased performing loans are recorded at fair value, including a credit discount.

The fair value discount is accreted as an adjustment to yield over the estimated lives of the

There is no allowance for loan losses established at the acquisition date for purchased performing loans.

A provision for loan losses may be required for any deterioration in these loans in future periods.

Allowance for Credit Losses

The allowance for credit losses represents management’s estimate of credit losses inherent in the loan portfolio as of the balance sheet date.

Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of similar loans based on historical loss experience, and consideration of current economic trends and conditions and other factors, all of which may be susceptible to significant change.

The loan portfolio also represents the largest asset type on the consolidated balance sheets.

Note 1 to the 2021 Annual Report describes the methodology used to determine the allowance for credit losses.

A discussion of the allowance determination and factors driving changes in the amount of the allowance for credit losses is included in the Provision for Credit Losses and Allowance for Credit Losses sections below.

Allowance for Credit Losses on Losses

The Company adopted ASU No.

2026-13, “Financial Instruments – Credit Losses (Topic 326)”, as amended, on January 1, 2023 and in accordance with ASC 326, has recorded an allowance for credit losses (“ACL”) on loans carried at amortized cost.

The ACL represents management’s best estimate of expected lifetime credit losses within the Company's loan portfolio as of the balance sheet date.

The allowance for credit losses is established through a provision for credit losses and is increased by recoveries of loans previously charged off.

Loan losses are charged against the allowance when management's assessments confirm that the Company will not collect the full amortized cost basis of a loan.

The calculation of expected credit losses is determined using cash flow methodology, and includes considerations of historical experience, current conditions, and reasonable and supportable economic forecasts that may affect collection of the recorded balances.

The Company assesses an ACL to groups of loans which share similar risk characteristics or on an individual basis, as deemed appropriate.

Changes in the ACL on loans, and as a result, the related provision for credit losses, can materially affect financial results.

Although the overall balance is determined based on specific portfolio segments and individually assessed assets, the entire balance is available to absorb credit losses for loans in the portfolio.

The determination of the appropriate level of ACL on loans inherently involves a high degree of subjectivity and requires the Company to make significant judgments concerning credit risks and trends using quantitative and qualitative information, as well as reasonable and supportable forecasts of future economic conditions, all of which may undergo frequent and significant changes.

Changes in conditions, including unforeseen events, changes in asset-specific risk characteristics, and other economic factors, both within and outside the Company's control, may indicate the need for an increase or decrease in the ACL on loans.

While management makes every effort to utilize the best information available in making its assessment of the ACL estimate, the estimation process is inherently challenging as potential changes in any one factor or input may occur at different rates and/or impact pools of loans in different ways.

Further, changes in factors and inputs may also be directionally inconsistent, such that improvement in one factor may offset deterioration in others.

The Company’s management reviews the adequacy of the ACL on loans on at least a quarterly basis.

Refer to Note 2, “Adoption of Accounting Standards”, of the interim consolidated financial information for additional detail concerning the determination of the ACL on loans.

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

3 unchanged sentences

If the fair value of a reporting unit is less than book value, an expense may be required to write down the related goodwill to record an impairment loss.

As of September 30, 2022, the Company had a banking and mortgage reporting unit.

The Company reported net income of $9.7 million for the third quarter of 2022, or diluted income per common share of $0.49, compared to net income of $4.6 million, or diluted income per common share of $0.39, for the third quarter of 2021.

For the second quarter of 2022, the Company reported net income of $7.5 million, or diluted income per common share of $0.38.

Net income, excluding merger related expenses, for the third quarter of 2022 was $9.8 million or $0.49 per diluted common share, compared to net income, excluding merger related expenses, of $7.7 million or $0.39 per diluted common share for the second quarter of 2022.

When comparing net income, excluding merger related expenses, for the third quarter of 2022 to the third quarter of 2021, net income increased $4.7 million, primarily due to increases in net interest income of $11.7 million and noninterest income of $2.4 million, partially offset by an increase in noninterest expenses of $7.3 million primarily resulting from the acquisition of Severn Bank (“Severn”) in November 2021.

When comparing the third quarter of 2022 to the second quarter of 2022, net income, excluding merger related expenses, increased $2.1 million, due to increases in net interest income of $2.7 million and a decrease in noninterest expense of $1.1 million partially offset by a decrease in in noninterest income of $489 thousand.

Merger-related expenses recorded for the third quarter of 2022 and the second quarter of 2022 were $159 thousand and $241 thousand, respectively.

For the first nine months of 2022, the Company reported net income of $22.8 million, or diluted income per common share of $1.15, compared to net income of $12.6 million, or diluted income per common share of $1.08, for the first nine months of 2021.

When comparing net income for the first nine months of 2022 to the first nine months of 2021, the increase in net income was primarily due to an increase in net interest income of $30.9 million and noninterest income of $8.9 million.

These improvements to income were partially offset by an increase in noninterest expense of $26.0 million resulting primarily from the Severn merger.

The Company reported net income of $6.5 million for the first quarter of 2023, or diluted income per common share of $0.32, compared to net income of $5.6 million, or diluted income per common share of $0.28, for the first quarter of 2022.

For the fourth quarter of 2022, the Company reported net income of $8.4 million, or diluted income per common share of $0.42.

Net income, excluding merger related expenses, for the first quarter of 2023 was $7.0 million or $0.35 per diluted common share, compared to net income, excluding merger related expenses, of $9.1 million or $0.46 per diluted common share for the fourth quarter of 2022 and net income, excluding merger-related expenses, of $6.2 million or $0.31per diluted common share for the first quarter of 2022.

When comparing net income, excluding merger related expenses, for the first quarter of 2023 to the first quarter of 2022, net income increased $803 thousand, primarily due to increases in net interest income of $3.2 million, partially offset by a decrease in noninterest income of $712 thousand, coupled with increases in both noninterest expense of $600 thousand and provision for credit losses of $613 thousand.

When comparing the first quarter of 2023 to the fourth quarter of 2022, net income, excluding merger related expenses, decreased $2.2 million, due to decreases in net interest income of $1.3 million and noninterest income of $528 thousand, coupled with increases in in noninterest expense of $169 thousand and provision for credit losses of $763 thousand.

Merger-related expenses recorded for the first quarter of 2023 and the fourth quarter of 2022 were $691 thousand and $967 thousand, respectively.

RESULTS OF OPERATIONS

1 unchanged sentence

Tax-equivalent net interest income is net interest income adjusted for the tax-favored status of income from certain loans and investments.

As shown in the table below, tax-equivalent net interest income was $27.4 million for the third quarter

of 2022 and $15.6 million for the third quarter of 2021.

Tax-equivalent net interest income was $24.7 million for the second quarter of 2022.

The increase in net interest income when comparing the third quarter of 2022 to the third quarter of 2021 and the second quarter of 2022, was due to increases in interest and fees on loans and income from taxable investment securities, partially offset by increases in interest expense on interest-bearing deposits and subordinated debt primarily due to the acquisition of Severn.

As shown in the table below, tax-equivalent net interest income was $25.7 million for the first quarter of 2023 and $22.5 million for the first quarter of 2022.

Tax-equivalent net interest income was $26.9 million for the fourth quarter of 2022.

The increase in net interest income when comparing the first quarter of 2023 to the first quarter of 2022 due to increases in interest and fees on loans and income from taxable investment securities, partially offset by increases in interest expense on interest-bearing deposits and FHLB short-term borrowings.

Net interest margin is tax-equivalent net interest income (annualized) divided by average earning assets.

The net interest margin for the third quarter of 2022 was 3.38% which was an increase of 39bps when compared to 2.99% for the third quarter of 2021 and an increase of 28bps when compared to 3.10% for the second quarter of 2022.

The improvement in net interest margin in the third quarter of 2022 when compared to the third quarter of 2021 and the second quarter of 2022 was due to higher average loan balances, accretion income from purchased loans and higher rates paid on lower yielding assets.

The net interest margin for the first quarter of 2023 was 3.18% which was an increase of 42bps when compared to 2.76% for the first quarter of 2022 and a decrease of 17bps when compared to 3.35% for the fourth quarter of 2022.

The improvement in net interest margin in the first quarter of 2023 when compared to the first quarter of 2022 was primarily due to significantly higher volume of interest earning assets as well as improved yields on such interest earning assets.

The decrease in net interest margin when compared to the fourth quarter of 2022 was primarily due to the increase in the average balance of FHLB short-term borrowings of $106.6 million and an increases rate of 98bps, resulting in $1.3 million in interest expense.

Interest Income

On a tax-equivalent basis, interest income increased $13.7 million, or 80.8%, for the third quarter of 2022 when compared to the third quarter of 2021.

The improvement to interest income was the result of increases in interest and fees on loans, income from investment securities and higher yields on interest-bearing deposits with other banks.

The primary driver for the increase in interest income on loans was the higher average volume of loans of $840.0 million, significantly impacted by the acquisition of Severn in the fourth quarter of 2021 coupled with a higher average yield of 29bps.

On a tax-equivalent basis, interest income increased $10.7 million, or 44.1%, for the first quarter of 2023 when compared to the first quarter of 2022.

The improvement to interest income was the result of increases in interest and fees on loans and income from investment securities.

The primary driver for the increase in interest income on loans was the higher average volume of loans of $475.9 million coupled with an increase in the average yield of 59bps.

The average balance of taxable investment securities increased $122.5 million, providing $2.1 million of additional income.

On a tax-equivalent basis, interest income increased $3.9 million, or 14.6%, for the third quarter of 2022 when compared to the second quarter of 2022.

The increase was primarily a result of growth in the average balance in loans of $110.1 million, or 5.0%.

In addition, the average balance of taxable investment securities increased $72.1 million, or 13.2%, and the average yield increased 31bps, which provided $793 thousand of additional income.

On a tax-equivalent basis, interest income increased $2.8 million, or 8.6%, for the first quarter of 2023 when compared to the fourth quarter of 2022.

The primary driver for the increase in interest income growth in the average balance of $144.3 million, or 5.8% coupled with a higher average yield of 34bps.

Interest Expense

Interest expense increased $2.0 million, or 148.9%, when comparing the third quarter of 2022 to the third quarter of 2021.

The increase in interest expense from the third quarter of 2021 was the result of increases in expenses on interest-bearing deposits of $1.6 million and both long-term advances from FHLB and subordinated debt for a combined $341 thousand, all of which were significantly impacted by the acquisition of Severn in the 4 th quarter of 2021.

Interest expense increased $1.2 million, or 58.8%, when comparing the third quarter of 2022 to the second quarter of 2022 primarily due to an increase in interest expense on deposits.

The increase in the interest expense comparing the third quarter of 2022 to the second quarter of 2022 was primarily due to increases in average balances of money market and savings accounts and interest-bearing checking accounts.

The rates paid on interest-bearing deposits increased to 48bps in the third quarter of 2022 from 29 bps in the second quarter of 2022.

The following tables present the distribution of the average consolidated balance sheets, interest income/expense, and annualized yields earned and rates paid for the three months ended September 30, 2022 and 2021.

Interest expense increased $7.5 million, or 396.1%, when comparing the first quarter of 2023 to the first quarter of 2022.

The increase in interest expense from the first quarter of 2022 was the result of increases in expenses on interest-bearing deposits of $5.9 million and FHLB short-term borrowings of $1.4 million, primarily a result of an increase in the average balance of FHLB short term borrowings of $114.0 million.

Interest expense increased $4.1 million, or 76.1%, when comparing the first quarter of 2023 to the fourth quarter of 2022 primarily due to increases in rates paid on interest-bearing liabilities.

These interest-bearing liabilities included increases in interest bearing deposits of 52bps and FHLB short-term borrowings of 98bps.

For Three Months Ended

September 30, 2022

September 30, 2021

(Dollars in thousands)

Earning assets

Loans (2), (3)

Investment securities:

Interest-bearing deposits

Total earning assets

Cash and due from banks

Allowance for credit losses

Interest-bearing liabilities

Demand deposits

Money market and savings deposits

Certificates of deposit $100,000 or more

Other time deposits

Interest-bearing deposits

Securities sold under retail repurchase agreements and short-term FHLB advances

Advances from FHLB - long-term

Subordinated debt

Total interest-bearing liabilities

Noninterest-bearing deposits

Other liabilities

Stockholders’ equity

Total liabilities and stockholders’ equity

Net interest spread

Net interest margin

Tax-equivalent adjustment

(1) All amounts are reported on a tax-equivalent basis computed using the statutory federal income tax rate of 21.0%,

exclusive of nondeductible interest expense.

(2) Average loan balances include nonaccrual loans.

(3) Interest income on loans includes accreted loan fees, net of costs and accretion of discounts on acquired loans, which are included in the yield calculations.

Net Interest Income

Tax-equivalent net interest income increased $30.9 million, or 70.8%, during the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021.

The higher net interest income was due to an increase in interest income of $33.8 million, or 70.6%, specifically increased interest and fees on loans of $27.2 million, or 61.4%, primarily due to an increase in the average loan balance of $774.0 million, or 53.0%, coupled with accretion income from acquired loans of $2.1 million for the nine months of 2022.

Taxable investment securities and interest on deposits with other banks increased $4.2 million and $2.3 million, respectively.

The increase in interest expense was the result of an increase in the average balance on interest bearing deposits of $819.8 million, or 62.8%.

Interest on long term borrowings increased by $688 thousand due to the acquisition of long-term advances from the FHLB and junior subordinated debt acquired as part of the Severn acquisition.

This resulted in a net interest margin of 3.09% for the nine months ended September 30, 2022 compared to 2.97% for the nine months ended September 30, 2021.

Interest Income

On a tax-equivalent basis, interest income increased $33.8 million, or 70.6%, for the nine months ended September 30, 2022 when compared to the nine months ended September 30, 2021.

The increase was primarily due to higher interest and fees on loans of $27.2 million, or 61.4%, and taxable investment securities of $4.2 million, or 126.2%.

The increase in interest and fees on loans was due to a higher average balance of loans of $774.0 million, or 53.0%, primarily due to the acquisition of Severn in the 4 th quarter of 2021 as well as organic growth during the year.

The increase in interest on taxable investment securities was due to a higher average balance in these securities of $282.4 million, or 99.8%.

Interest Expense

Interest expense increased $2.9 million, or 68.3%, when comparing the nine months ended September 30, 2022 to the nine months ended September 30, 2021.

The increase in interest expense was the result of an increase in average interest-bearing deposits of $819.8 million, or 62.8%.

Interest on long-term borrowings increased by $688 thousand due to the acquisition of long-term advances with the FHLB and junior subordinated debt acquired as part of the Severn acquisition.

The following tables present the distribution of the average consolidated balance sheets, interest income/expense, and annualized yields earned and rates paid for the nine months ended September 30, 2022 and 2021.

For Nine Months Ended

September 30, 2022

September 30, 2021

March 31, 2023

March 31, 2022

(Dollars in thousands)

13 unchanged sentences

Securities sold under retail repurchase agreements and federal funds purchased

Advances from FHLB - short-term

Advances from FHLB - long-term

8 unchanged sentences

Tax-equivalent adjustment

Investment securities

(1) All amounts are reported on a tax-equivalent basis computed using the statutory federal income tax rate of 21.0%, exclusive of nondeductible interest expense.

2 unchanged sentences

Noninterest Income

Total noninterest income for the third quarter of 2022 increased $2.4 million, or 83.7%, when compared to the third quarter of 2021.

The increase from the third quarter of 2021 was largely the result of the addition of Severn in the fourth quarter of 2021 which contributed in part to increases in service charges on deposit accounts of $704 thousand and added mortgage-banking revenue of $680 thousand and title revenue from Mid-Maryland Title Company of $397 in the third quarter of 2022.

Noninterest income decreased $489 thousand, or 8.4%, when compared to the second quarter of 2022 primarily due to a decrease in revenue associated with the mortgage division of $416 thousand and other bank fee income of $132 thousand, partially offset by increases in service charges on deposit accounts $71 thousand.

Total noninterest income for the nine months ended September 30, 2022, increased $8.9 million, or 105.8%, when compared to the same period in 2021.

The increase in noninterest income primarily consisted of revenue associated with the mortgage division, service charges on deposit related fees, title company revenue and other noninterest income.

increases in other noninterest income were primarily due to increases in rental income and other loan fee income as a result of the Severn acquisition.

Total noninterest income for the first quarter of 2023 decreased $712 thousand, or 11.8%, when compared to the first quarter of 2022.

The decrease from the first quarter of 2022 was primarily due to decreases in revenue associated with the mortgage division of $890 thousand, revenue from Mid-Maryland Title Company, Inc.

of $186 thousand and service charges on deposit accounts of $146 thousand partially offset by increases in interchange credits of $174 thousand, and other fees on bank services of $336 thousand.

Noninterest income decreased $528 thousand, or 9.0%, when compared to the fourth quarter of 2022 primarily due to a decrease in revenue associated with the mortgage division of $590 thousand and in service charges on deposit accounts $133 thousand.

Declines in noninterest income from the mortgage division are primarily attributable to the general rise in interest rates that continue to put pressure on the mortgage market, resulting in declines in home loan sales and home loan refinances.

Noninterest Expense

Total noninterest expense for the third quarter of 2022, excluding merger-related expenses, increased $7.3 million, or 64.4%, when compared to the third quarter of 2021 and decreased $1.1 million, or 5.5%, when compared to the second quarter of 2022.

The increase in noninterest expense when compared to the third quarter of 2021 was primarily due to increases in salaries and wages, employee related benefits, occupancy expense, data processing, amortization of intangible assets and legal and professional fees, which were all significantly impacted by adding Severn branches and its operations.

The decrease in noninterest expense when compared to the second quarter of 2022 was primarily due to increased deferrals of direct loan origination costs for salaries and employee benefits associated with the elevated level of loan originations during the quarter, as well as various cost savings related to the merger with Severn.

Total noninterest expense for the nine months ended September 30, 2022, excluding merger-related expenses, increased $25.8 million, or 79.6%, when compared to the same period in 2021.

The increase was primarily a result of higher salaries, employee benefits, occupancy expense, other intangibles, data processing costs, other noninterest expenses, and FDIC insurance premiums due to significant increases in new and existing customers and the acquisition of Severn.

Total noninterest expense for the first quarter of 2023, excluding merger-related expenses, increased $600 thousand, or 3.1%, when compared to the first quarter of 2022 and increased $169 thousand, or less than 1.0%, when compared to the fourth quarter of 2022.

The increase in noninterest expense when compared to the first quarter of 2022 was primarily due to other noninterest expenses, employee related benefits, data processing, legal and professional fees and furniture and equipment expense partially offset by decreases in salary expense due to deferred salaries based on loan originations in the first quarter of 2023.

The increase in noninterest expense when compared to the fourth quarter of 2022 was primarily due to increases in employee benefits and legal and professional fees offset by decreases in salaries due to an increase in deferred salaries based on loan originations in the fourth quarter of 2022.

Provision for Credit Losses

The provision for credit losses was $675 thousand for the third quarter of 2022, $290 thousand for the third quarter of 2021 and $200 thousand for the second quarter of 2022.

The increase in the provision for credit losses during the third quarter of 2022 as compared to the prior quarters was primarily attributable to significant loan growth.

The ratio of the allowance for credit losses to period-end loans was 0.68% at September 30, 2022, 0.68% at June 30, 2022 and 1.04% at September 30, 2021.

Excluding PPP loans and acquired loans, the ratio of the allowance for credit losses to period-end loans was 0.84% at September 30, 2022, slightly lower than the 0.89% at June 30, 2022 and lower than the 1.07% at September 30, 2021.

The decline in the percentage of the allowance from the third quarter of 2021 was primarily the result of lower historical loss experience as well as lower pandemic related qualitative reserves.

The Company reported net recoveries in the third quarter of 2022 of $119 thousand, compared to net recoveries of $147 thousand for the third quarter of 2021 and net recoveries of $573 thousand for the second quarter of 2022.

Management continually evaluates the adequacy of the allowance for credit losses as changes in the environment and within the portfolio become known.

The provision for credit losses for the nine months ended September 30, 2022 and 2021 was $1.5 million and $1.4 million, respectively, while net recoveries were $858 thousand and $272 thousand, respectively.

The increase in provision for credit losses was the result of an increase in loans held for investment in the first nine months of 2022 of $283 million compared to $41 million for the first nine months of 2021.

The ratio of allowance to total loans increased from 0.66% at December 31, 2021, to 0.68% at September 30, 2022.

Excluding PPP and acquired loans, the ratio of the allowance for credit losses to period-end loans was 0.84% at September 30, 2022, lower than the 0.93% at December 31, 2021.

The primary drivers for the decrease in the percentage of allowance for credit losses to total loans were due to lower historical loss experience and reduced pandemic relative qualitative factors.

The ratio of annualized net recoveries to average loans was (0.05%) for the first nine months of 2022, compared to annualized net recoveries to average loans of (0.02%) for the first nine months of 2021.

Management will continue to evaluate the adequacy of the allowance for credit losses as more economic data becomes available and as changes within the Company’s portfolio are known.

The Company reported income tax expense of $3.4 million for the third quarter of 2022, $1.7 million for the third quarter of 2021 and $2.7 million for the second quarter of 2022.

Income tax expense increased when compared to both the third quarter of 2021 and second quarter of 2022 due to higher pre-tax earnings.

The effective tax rate for the third quarter of 2022 was 26.2%, 26.2% for the second quarter of 2022, and 26.4% for the third quarter of 2021.

Income tax expense was $8.0 million for the nine months ended September 30, 2022, and $4.5 million for the nine months ended September 30,

The effective tax rate was 26.0% for the nine months ended September 30, 2022, and 26.4% for the nine months ended September 30, 2021.

The provision for credit losses was $1.2 million for the first quarter of 2023, $600 thousand for the first quarter of 2022 and $450 thousand for the fourth quarter of 2022.

The increase in the provision for credit losses during the first quarter of 2022 as compared to the prior quarters was primarily a result of new loan growth of $112.6 million.

The ratio of the allowance for credit losses to period-end loans was 1.07% at March 31, 2023, 0.65% at December 31, 2022 and 0.67% at March 31, 2022.

The Company reported net charge offs in the first quarter of 2023 of $20 thousand, compared to net recoveries of $166 thousand for the first quarter of 2022 and net charge offs of $84 thousand for the fourth quarter of 2022.

Management continually evaluates the adequacy of the allowance for credit losses as changes in the economic environment and within the portfolio become known.

The provision for the three months ended March 31, 2023 was comprised of $1.05 million related to the allowance for credit losses on loans and $163 thousand for the allowance for credit losses on held to maturity securities.

The Company reported income tax expense of $2.4 million for the first quarter of 2023, $1.9 million for the first quarter of 2022 and $2.9 million for the fourth quarter of 2022.

Income tax expense increased when compared to the first quarter of 2022 due to higher pre-tax earnings and decreased compared to the fourth quarter of 2022 due to lower pre-tax earnings.

The effective tax rate for the first quarter of 2023 was 27.4%, 26.0% for the fourth quarter of 2022, and 25.6% for the first quarter of 2022.

The higher effective tax rate in the first quarter of 2023 was the result of non-deductible merger related expenses.

ANALYSIS OF FINANCIAL CONDITION

1 unchanged sentence

We originate residential mortgage loans for sale on the secondary market, which we have elected to carry at fair value.

At September 30, 2022 and December 31, 2021, the fair value of loans held for sale amounted to $8.3 million and $37.7 million, respectively.

At March 31, 2023 and December 31, 2022, the fair value of loans held for sale amounted to $3.5 million and $4.2 million, respectively.

When we sell mortgage loans we make certain representations to the purchaser related to loan ownership, loan compliance and legality, and accurate documentation, among other things.

1 unchanged sentence

Loans Held for Investment

The following tables represent the composition of the Company’s loan portfolio at September 30, 2022 and December 31, 2021.

September 30, 2022

The following tables represent the composition of the Company’s loan portfolio at March 31, 2023 and December 31, 2022.

March 31, 2023

Loans acquired from

15 unchanged sentences

Total loans, net

The acquisition of Severn added $584.6 million in total loans as of October 31, 2021, of which $407.8 million in total loans remained outstanding as of September 30, 2022.

The acquisition of Severn added $584.6 million in total loans as of October 31, 2021, of which $342.8 million in total loans remained outstanding as of March 31, 2023.

Excluding these loans and legacy PPP loans, total legacy loans increased $142.0 million, or 6.5%, when compared to December 31, 2022.

At September 30, 2022 and December 31, 2021, PPP loans accounted for $250 thousand and $18.4 million of total legacy loans, respectively.

At March 31, 2023 and December 31, 2022, PPP loans accounted for $167 thousand and $187 thousand of total legacy loans, respectively.

Most of our loans, excluding PPP loans, are secured by real estate and are classified as construction, residential or commercial real estate loans.

The increase in legacy loans, excluding PPP loans, was comprised of increases in consumer loans of $104.8

million, or 84.2%, construction loans of $56.4 million, or 38.9%, residential real estate loans of $140.8 million, or 30.0%, and commercial real estate loans of $150.6 million, or 22.2%, partially offset by a decrease in commercial loans of $6.7

million, or 5.2%, at September 30, 2022 compared to December 31, 2021.

At September 30, 2022, the legacy loan portfolio, excluding PPP loans, was comprised of 41.7% commercial real estate, 30.6% residential real estate, 11.5% consumer, 10.1% construction and 6.1% commercial.

The increase in legacy loans, excluding PPP loans, was comprised of increases in residential real estate loans of $68.5 million, or 10.1%, consumer loans of $28.8 million, or 10.1%, commercial real estate loans of $40.7 million or 4.6%, construction loans of $10.5 million, or 4.6%, partially offset by a decrease in commercial loans of $6.4 million, or 5.7%, at March 31, 2023 compared to December 31, 2022.

At March 31, 2023, the legacy loan portfolio, excluding PPP loans, was comprised of 39.6% commercial real estate, 32.2% residential real estate, 13.5% consumer, 10.2% construction and 4.5% commercial.

That compares to 40.3%, 31.2%, 13.1%, 10.4% and 5.1%, respectively, at December 31, 2022.

Outstanding PPP loans totaled $291 thousand at September 30, 2022 and $27.6 million at December 31, 2021, a decrease of $27.3 million or 98.9%.

The decrease was primarily due to forgiveness on first and second round PPP loans originated in 2020 and 2021.

We do not engage in foreign or subprime lending activities.

1 unchanged sentence

Our loan portfolio has a commercial real estate loan concentration, which is generally defined as a combination of certain construction and commercial real estate loans.

Construction loans were $230.1 million, or 9.6% of total loans, at September 30, 2022 and $239.4 million, or 11.3% of total loans, at December 31, 2021.

Commercial real estate loans were $1.02 billion, or 42.6% of total loans, at September 30, 2022, compared to $896.2 million, or 42.3% of total loans, at December 31, 2021.

Construction loans were $250.4 million, or 9.4% of total loans, at March 31, 2023 and $246.3 million, or 9.6% of total loans, at December 31, 2022.

Commercial real estate loans were $1.10 billion, or 41.1% of total loans, at March 31, 2023, compared to $1.07 billion, or 41.7% of total loans, at December 31, 2022.

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;

land development, and other land acquisitions which represent 100% or more of an institution’s total risk-based capital;

or (2) total non-owner occupied commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the institution’s non-owner occupied commercial real estate loan portfolio (including construction) has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk.

1 unchanged sentence

The Company, like many community banks, has a concentration in commercial real estate loans, and the Company has experienced significant growth in its commercial real estate portfolio in recent years.

At September 30, 2022, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represented 288.8% of total risk-based capital.

At March 31, 2023, non-owner-occupied commercial real estate loans (including construction, land and land development loans) represented 290.9% of total risk-based capital.

At such time, construction, land and land development loans represented 69.3% of total risk-based capital.

3 unchanged sentences

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 or be required to sell/participate portions of loans, which may adversely affect shareholder returns.

Allowance for Credit Losses

We have established an allowance for credit losses, which is increased by provisions charged against earnings and recoveries of previously charged-off loans and is decreased by current period charge-offs of uncollectible loans.

Management evaluates the adequacy of the allowance for credit losses at least quarterly and adjusts the provision for credit losses based on this analysis.

The evaluation of the adequacy of the allowance for credit losses is based primarily on a risk rating system of individual loans, as well as on a collective evaluation of smaller balance homogenous loans, each grouped by loan type.

Each loan type is assigned allowance factors based on criteria such as past credit loss experience, local economic and industry trends, and other measures which may impact collectability.

Please refer to the discussion above under the caption “Critical Accounting Policies” for an overview of the underlying methodology management employs to maintain the allowance.

The allowance for credit losses was $16.3 million at September 30, 2022, $13.9 million at December 31, 2021 and $15.5 million at September 30, 2021.

There were net recoveries of $119 thousand for the third quarter of 2022, compared to net recoveries of $573 thousand for the second quarter of 2022 and net recoveries of $147 thousand for the third quarter of 2021.

The ratio of annualized net recoveries to average loans was 0.02% for the third quarter of 2022, compared to

annualized net recoveries of 0.10% for the second quarter of 2022 and annualized net recoveries of 0.04% for the third quarter of 2021.

Allowance for Credit Losses on Loans

The allowance for credit losses was $28.5 million at March 31, 2023, $16.6 million at December 31, 2022 and $14.7 million at March 31, 2022.

There were net charge-offs of $20 thousand for the first quarter of 2022, compared to net charge-offs of $84 thousand for the fourth quarter of 2022 and net recoveries of $166 thousand for the first quarter of 2022.

The ratio of annualized net charge-offs to average loans was 0.00% for the first quarter of 2023, compared to annualized net charge-offs of 0.01% for the fourth quarter of 2022 and annualized net recoveries of 0.03% for the first quarter of 2022.

Management remains focused on its efforts to dispose of problem loans and to prudently charge-off nonperforming loans to enable the Company to continue to improve its overall credit quality.

The allowance for credit losses as a percentage of period-end loans was 0.68% at September 30, 2022 and 0.66% at December 31, 2021.

Excluding PPP loans and acquired loans from Severn and Northwest, the ratio of the allowance for credit losses to period-end loans was 0.84% at September 30, 2022, lower than the 0.93% at December 31, 2021.

The decrease in the percentage of the allowance to total loans, excluding PPP loans and acquired loans, at September 30, 2022 compared to December 31, 2021, was primarily the result of improved credit quality, including lower historical loss experience as well as lower pandemic related qualitative factors.

Management currently believes that the provision for credit losses and the resulting allowance were adequate to provide for probable losses inherent in our loan portfolio at September 30, 2022.

The following tables present a summary of the activity in the allowance for credit losses at or for the three and nine months ended September 30, 2022 and 2021.

For the Three Months Ended

September 30, 2022

September 30, 2021

Percentage of net

charge-offs (recoveries)

(annualized) to

average loans

Net (charge-offs)

(Dollars in thousands)

Average balances

during the year

Average balances

during the year

Residential real estate

Commercial real estate

Allowance for credit losses at period end as a percentage of total period end loans (1)

Allowance for credit losses at period end as a percentage of total period end loans (2)

Allowance for credit losses at period end as a percentage of average loans (3)

Allowance for credit losses at period end as a percentage of period end nonaccrual loans

(1) At September 30, 2022 and September 30, 2021, these ratios included all loans held for investment, including PPP loans of $291 thousand and $41.5 million, respectively.

(2) At September 30, 2022 and September 30, 2021, these ratios exclude PPP loans, acquired loans and the associated purchase discount mark on the acquired loans from both Severn and Northwest.

(3) At September 30, 2022 and September 30, 2021, these ratios included all loans held for investment, including average PPP loans of $749 thousand and $63.9 million, respectively.

For the Nine Months Ended

September 30, 2022

September 30, 2021

The allowance for credit losses as a percentage of period-end loans was 1.07% at March 31, 2023 and 0.65% at December 31, 2022.

The following tables present a summary of the activity in the allowance for credit losses at or for the three months ended March 31, 2023 and 2022.

March 31, 2023

March 31, 2022

Percentage of net

19 unchanged sentences

Allowance for credit losses at period end as a percentage of period end nonaccrual loans

(1) At September 30, 2022 and September 30, 2021, these ratios included all loans held for investment, including PPP loans of $291 thousand and $41.5 million, respectively.

(2) At September 30, 2022 and September 30, 2021, these ratios exclude PPP loans, acquired loans and the associated purchase discount mark on the acquired loans from both Severn and Northwest.

(3) At September 30, 2022 and September 30, 2021, these ratios included all loans held for investment, including average PPP loans of $8.9 million and $103.9 million, respectively.

Nonperforming Assets and Accruing TDRs

As shown in the following table, nonperforming assets were $3.0 million at both September 30, 2022 and December 31, 2021.

The balance of nonperforming asset changes from September 30, 2022 to December 31, 2021 were an increase in total loans 90 days or more past due and still accruing of $323 thousand offset by a decrease in other real estate owned of $335 thousand and nonaccrual assets of $52 thousand.

Accruing troubled debt restructurings (“TDRs”) decreased $1.2 million, or 21.3%, over the same time period.

Other real estate owned properties decreased to $197 thousand at September 30, 2022 from $532 thousand at December 31, 2021.

The ratio of nonaccrual loans and accruing TDRs to total loans ratio at September 30, 2022 was 0.27% compared to 0.36% at December 31, 2021.

(1) At March 31, 2023 and March 31, 2022, these ratios included all loans held for investment, including PPP loans of $167 thousand and $14.9 million, respectively.

(2) For 2023, this ratio excludes only PPP loans given the Company’s adoption of the CECL standard.

For periods in 2022, this ratio excludes PPP loans and loans acquired in the Severn and Northwest acquisition.

(3) At March 31, 2023 and March 31, 2022, these ratios included all loans held for investment, including average PPP loans of $176 thousand and $18.9 million, respectively.

Nonperforming Assets

As shown in the following table, nonperforming assets were $2.7 million at March 31, 2023 and $3.9 million at December 31, 2022.

The balance of nonperforming asset decreased primarily due to a decrease in total loans 90 days or more past due and still accruing of $1.2 million, or 66.8%.

The Company continues to focus on the resolution of its nonperforming and problem assets.

6 unchanged sentences

The reduction of nonperforming and problem assets is and will continue to be a high priority for the Company.

The following table summarizes our nonperforming assets and accruing TDRs at September 30, 2022 and December 31, 2021.

The following table summarizes our nonperforming assets at March 31, 2023 and December 31, 2022.

(Dollars in thousands)

September 30, 2022

March 31, 2023

December 31, 2022

4 unchanged sentences

Total nonperforming assets

Total accruing TDRs

As a percent of total loans:

Nonaccrual loans

Accruing TDRs

Nonaccrual loans and accruing TDRs

As a percent of total loans and other real estate owned:

Nonperforming assets

Nonperforming assets and accruing TDRs

As a percent of total assets:

1 unchanged sentence

Nonperforming assets

Accruing TDRs

Nonperforming assets and accruing TDRs

Investment Securities

4 unchanged sentences

Net unrealized holding gains and losses on these securities are reported net of related income taxes as accumulated other comprehensive income (loss), a separate component of stockholders’ equity.

Investment securities in the held to maturity category are stated at cost adjusted for amortization of premiums and accretion of discounts.

Investment securities in the held to maturity category are stated at cost adjusted for amortization of premiums and accretion of discounts and the allowance for credit losses.

We have the intent and ability to hold such securities until maturity.

At September 30, 2022, 14.7% of the portfolio of debt securities was classified as available for sale and 85.3% was classified as held to maturity, compared to 22.6% and 77.4% respectively, at December 31, 2021.

At March 31, 2023, 14.2% of the portfolio of debt securities was classified as available for sale and 85.8% was classified as held to maturity, compared to 14.5% and 85.5% respectively, at December 31, 2022.

See Note 3 – “Investment Securities”, in the Notes to Consolidated Financial Statements for additional details on the composition of our investment portfolio.

Investment securities, including restricted stock, totaled $668.2 million at September 30, 2022, a $141.1 million, or 26.8%, increase since December 31, 2021.

The increase was primarily due to purchases of held to maturity securities of $207.5 million, purchases of restricted securities of $5.7 million and purchases of equity securities of $12 thousand partially offset by proceeds from maturities and principal repayments of available for sale securities of $16.7 million and held to maturity securities of $40.6 million.

At September 30, 2022, 76.6% of the securities available for sale were mortgage-backed, 21.2% were U.S.

Investment securities, including restricted stock, totaled $647.0 million at March 31, 2023, an $8.5 million, or 1.3%, decrease since December 31, 2022.

At March 31, 2023, 75.3% of the securities available for sale were mortgage-backed, 22.5% were U.S.

Government agencies and 2.3% were corporate bonds, compared to 76.0%, 21.7% and 2.3%, respectively, at year-end 2022.

At September 30, 2022, 71.0% of the securities held to maturity were mortgage-backed, 26.8% were U.S.

At March 31, 2023, 70.2% of the securities held to maturity were mortgage-backed, 27.5% were U.S.

Government agencies, 2.1% were subordinated debt instruments and less than 1% were community reinvestment bonds, compared to 70.4%, 27.2%, 2.1% and less than 1%, respectively, at year-end 2022.

1 unchanged sentence

Government agencies or government-sponsored agencies.

The decline in fair values on available for sale securities in the third quarter of 2022 was the result of the recent increases in interest rates and are not indicative of any credit concerns due to the Company holding high quality securities.

Total deposits at September 30, 2022 amounted to $3.02 billion, a decrease of $10.9 million, or less than 1%, when compared to the level at December 31, 2021.

The decrease in total deposits consisted of a decrease in money market and savings accounts of $72.5 million, $33.7 million in noninterest bearing deposits and $30.6 million in time deposits partially offset by an increase in interest bearing checking accounts of $125.8 million.

Total deposits at March 31, 2023 amounted to $2.99 billion, a decrease of $15.2 million, or less than 1%, when compared to the level at December 31, 2022.

The decrease in total deposits consisted of a decrease in money market and savings accounts of $58.2 million and $53.3 million in noninterest bearing deposits partially offset by an increase in time deposits of $64.2 million and an increase in interest bearing checking accounts of $32.0 million.

Total estimated uninsured deposits amounted to $839.4 million and $871.5 million at March 31, 2023 and December 31, 2022, respectively.

Short-Term Borrowings

The Company had no short-term borrowings as of September 30, 2022, compared to short-term borrowings consisting of securities sold under agreements to repurchase of $4.1 million at December 31, 2021.

Securities sold under agreements to repurchase are issued in conjunction with cash management services for commercial depositors.

Other short-term borrowings may consist of overnight borrowing from correspondent banks or advances from the FHLB.

The Company had $131.5 million of short-term borrowings consisting of short-term advances with the FHLB as of March 31, 2023, compared to short-term borrowings consisting of advances with the FHLB of $40.0 million at December 31, 2022.

This increase was due to funding needs as a result of the decrease in deposits and the increase in loans.

Other short-term borrowings may consist of overnight borrowing from correspondent banks or securities sold under agreements to repurchase, primarily with commercial depositors.

Short-term advances are defined as those with original maturities of one year or less.

At September 30, 2022 and December 31, 2021, the Company had no outstanding short-term advances with the FHLB.

At March 31, 2023 and December 31, 2022, the Company had no securities sold under agreements to repurchase or overnight borrowings from correspondent banks.

Long-Term Debt

The Company occasionally borrows from the FHLB to meet longer term liquidity needs, specifically to fund loan growth when liquidity from deposit growth is not sufficient.

The acquisition of Severn added $10.1 million in long-term FHLB borrowings, which carried an interest rate of 2.19%.

The balance of this debt was $10.0 million and $10.1 million at September 30, 2022 and December 31, 2021 respectively.

The long-term FHLB borrowings were paid off in October of 2022.

There were no long-term borrowings from the FHLB outstanding at March 31, 2023 and December 31, 2022.

On August 25, 2020, the Company entered into Subordinated Note Purchase Agreements with certain purchasers pursuant to which the Company issued and sold $25.0 million in aggregate principal amount with an initial interest rate of 5.375% of Fixed-to-Floating Rate Subordinated Notes due September 1, 2030.

As a result of the Severn merger, the Company acquired Junior Subordinated Debt Securities due in 2035 (“2035 Debentures”) which had an outstanding principal balance of $20.6 million.

The debt balance of $18.4 million at September 30, 2022 and $18.2 million at December 31, 2021 wasthe presented net of a fair value adjustment of $2.2 million and $2.4 million, respectively.

As a result of the Severn merger, the Company acquired Junior Subordinated Debt Securities due in 2035 which had an outstanding principal balance of $20.6 million.

The debt balance of $18.4 million at March 31, 2023 and December 31, 2022 was presented net of a fair value adjustment of $2.2 million.

Liquidity and Capital Resources

We derive liquidity through increased customer deposits, non-reinvestment of the cash flow from the investment portfolio, loan repayments, borrowings and income from earning assets.

As seen in the Consolidated Statements of Cash Flows in the Financial Statements, the net decrease in cash and cash equivalents was $420.3 million for the first nine months of 2022 compared to an increase of $123.9 million for the first nine months of 2021.

The decrease in cash and cash equivalents in 2022 was mainly due to funding net loan growth of $280.9 million and purchases of securities held to maturity of $207.5 million.

As seen in the Consolidated Statements of Cash Flows in the Financial Statements, the net decrease in cash and cash equivalents was $17.8 million for the first three months of 2023 compared to a decrease of $12.6 million for the first three months of 2022.

The decrease in cash and cash equivalents in 2023 was mainly due to funding net loan growth of $111.8 million.

To the extent that deposits are not adequate to fund customer loan demand, liquidity needs can be met in the short-term fund markets.

1 unchanged sentence

The Bank is also a member of the FHLB, which provides another source of liquidity.

Through the FHLB, the Bank had collateral pledged of approximately $298.7 million and $363.7 million at September 30, 2022 and December 31, 2021, respectively.

Through the FHLB, the Bank had collateral pledged of approximately $283.5 million and $298.9 million at March 31, 2023 and December 31, 2022, respectively.

The Bank has pledged, under a blanket lien, all qualifying residential and commercial real estate loans under borrowing agreements with the FHLB.

Total stockholders’ equity increased $6.5 million, or 1.9%, to $357.2 million at September 30, 2022 when compared to December 31, 2021 primarily due to the current year’s retained earnings, partially offset by an increase in unrealized losses

of $9.8 million (net of tax) on available for sale securities and dividends paid which are recorded in accumulated other comprehensive income (loss).

Total stockholders’ equity decreased $2.6 million, or less than 1%, to $361.6 million at March 31, 2023 when compared to December 31, 2022 primarily due to a Day 1 CECL adjustment of ($7.8) million, partially offset by current year earnings of $6.5 million and a decrease in unrealized losses on available for sale securities of $860 thousand.

The Bank and the Company are subject to various regulatory capital requirements administered by the federal banking agencies.

2 unchanged sentences

The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

In July 2013, federal bank regulatory agencies issued a final rule that revised their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with certain standards that were developed by Basel III and certain provisions of the Dodd-Frank Act.

The final rule currently applies to all depository institutions and bank holding companies and savings and loan holding companies with total consolidated assets of more than $3 billion.

The Company had total consolidated assets of more than $3 billion as of December 31, 2021, due to the acquisition of Severn in the fourth quarter of 2021.

As such, the Company was required to comply with the consolidated capital requirements for the first quarterly report date following the effective date of the business combination as its total assets exceeded $3 billion.

Quantitative measures established by regulation to ensure capital adequacy require the Bank and the Company to maintain minimum ratios of common equity Tier 1, Tier 1, and total capital as a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 1,250%.

The Bank and Company are also required to maintain capital at a minimum level based on quarterly average assets, which is known as the leverage ratio.

The Bank and the Company were well capitalized at September 30, 222.

The following tables present the applicable capital ratios for the Company and the Bank as of September 30, 2022 and December 31, 2021.

The Bank and the Company were deemed “well capitalized” under applicable regulatory capital requirements at March 31, 2023.

The following tables present the applicable capital ratios for the Company and the Bank as of March 31, 2023 and December 31, 2022.

Common Equity

September 30, 2022

March 31, 2023

capital ratio

9 unchanged sentences

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

What changed 10-Q

Item 2. Management’s Discussion and Analysis