FARMERS AND MERCHANTS BANCSHARES, INC. The following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto for the years endedDecember 31, 2022 and 2021, which are presented elsewhere in this annual report. The Company was incorporated onAugust 8, 2016 for the purpose of becoming the bank holding company of the Bank in a share exchange transaction that was intended to constitute a tax-free exchange under Section 351 of the IRC. This reorganization was consummated onNovember 1, 2016 , at which time the Bank became a wholly-owned subsidiary of the Company and all of the Bank's stockholders became stockholders of the Company by virtue of the conversion of their shares of common stock of the Bank into an equal number of shares of common stock of the Company.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
The consolidated financial statements of the Company are prepared in accordance with accounting principles generally accepted inthe United States of America ("GAAP") and follow general practices within the industry in which the Company operates. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the consolidated 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 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 followed by the Company are presented in Note 1 to the consolidated financial statements presented elsewhere in the annual report. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, 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 identified the determination of the allowance for loan losses as the accounting area that requires the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available. The allowance for loan losses represents management's estimate of probable loan losses inherent in the loan portfolio. Determining the amount of the allowance for loan 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 homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the balance sheet. Note 1 to the consolidated financial statements describes the methodology used to determine the allowance for loan losses. Management applies various valuation methodologies to assets and liabilities which often involve a significant degree of judgment, particularly when liquid markets do not exist for the particular items being valued. Quoted market prices are referred to when estimating fair values for certain assets, such as most investment securities. However, for those items for which an observable liquid market does not exist, management utilizes significant estimates and assumptions to value such items. Examples of these items include loans, deposits, borrowings, goodwill, core deposit and other intangible assets, other assets and liabilities obtained or assumed in business combinations. These valuations require the use of various assumptions, including, among others, discount rates, rates of return on assets, repayment rates, cash flows, default rates, and liquidation values. The use of different assumptions could produce significantly different results, which could have material positive or negative effects on our results of operations, financial condition or disclosures of fair value information. In addition to valuation, we must assess whether there are any declines in value below the carrying value of assets that should be considered other than temporary or otherwise require an adjustment in carrying value and recognition of a loss in the consolidated statements of income. Examples include investment securities, goodwill and core deposit intangible, among others. - 23 - --------------------------------------------------------------------------------
PAYCHECK PROTECTION PROGRAM TheU.S. Government's Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") established theSmall Business Administration ("SBA") Paycheck Protection Program ("PPP"), which provided small businesses in 2020 and 2021 with resources to maintain payroll, hire back employees who may have been laid off, and to cover applicable overhead expenses. During 2021, we made$22 million of PPP loans. All PPP loans are 100% guaranteed by the SBA. AtDecember 31, 2022 ,$0.7 million of PPP loans are outstanding compared to$9.7 million atDecember 31, 2021 . FINANCIAL CONDITION Total assets were$718,210,672 atDecember 31, 2022 , an increase of$1,533,417 , or 0.2%, over the$716,677,255 recorded atDecember 31, 2021 . The increase was due primarily to an increase of$34,909,206 in loans, an increase of$6,215,208 in deferred taxes, and an increase of$3,029,179 in bank owned life insurance, offset by a decrease of$24,266,665 in securities available for sale and held to maturity and a decrease of$19,198,569 in cash and cash equivalents. Total liabilities were$670,435,709 atDecember 31, 2022 , an increase of$10,379,912 , or 1.6%, over the$660,055,797 recorded atDecember 31, 2021 . The increase was due primarily to an increase of$15,000,000 inFederal Home Loan Bank of Atlanta ("FHLB") advances, offset by a decrease of$2,803,546 in deposits and a decrease of$1,883,263 in long term debt.
Stockholders' equity was
Loans
Major categories of loans at
2022 2021
Real estate:
Commercial $ 351,794,702 67 % $ 319,185,116 66 %
Construction/Land development 23,978,373 5 % 28,221,854 6 %
Residential 114,683,149 22 % 107,436,033 22 %
Commercial 31,066,497 6 % 31,182,206 6 %
Consumer 156,422 0 % 355,958 0 %
521,679,143 100 % 486,381,167 100 %
Less: Allowance for loan losses 4,150,198 3,650,268
Deferred origination fees net of costs 608,405 719,565
$ 516,920,540 $ 482,011,334 The Company had no foreign loans for any of the years presented.
- 24 -
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Loans increased by $34,909,206 , or 7.2%, to $516,920,540 at December 31, 2022
from $482,011,334 at December 31, 2021 . The increase was due primarily to
increases in commercial real estate loans of $32,609,586 and residential real
estate loans of $7,247,116 , offset by a decrease in construction/land
development loans of $4,243,481 . With several new loan officers on staff in
2022, total loan production increased by $18 million in 2022 as compared to
2021. In addition, line of credit usage increased by $4 million . Also, loan
payoffs decreased by $22 million since rising rates made it more difficult for
borrowers to refinance. Finally, $9 million of PPP loans were forgiven. For
construction/land development loans the decrease was due primarily to several
loans moving to permanent status after the construction completion. The
allowance for loan losses increased by $499,930 to $4,150,198 at December 31,
2022 as compared to $3,650,268 at December 31, 2021 .
Commercial loans in the table above include $0.7 million and $9.7 million of PPP
loans as of December 31, 2022 and December 31, 2021 , respectively, which are
100% guaranteed by the SBA. None of these loans were originated during 2022
compared to $22 million originated in 2021.
The Company has adopted policies and procedures that seek to mitigate credit
risk and to maintain the quality of the loan portfolio. These policies include
underwriting standards for new credits as well as the continuous monitoring
including annual external loan reviews and monthly review at loan committee, and
reporting of asset quality and the adequacy of the allowance for loan losses.
These policies, coupled with continuous training efforts, have provided
effective checks and balances for the risk associated with the lending process.
Lending authority is based on the level of risk, size of the loan, and the
experience of the lending officer. The Company's policy is to make the majority
of its loan commitments in the market area it serves. Management believes that
this tends to reduce risk because management is familiar with the credit
histories of loan applicants and has in-depth knowledge of the risk to which a
given credit is subject. Although the loan portfolio is diversified, its
performance will be influenced by the economy of the region.
The maturities and interest rate sensitivity of the loan portfolio at December
31, 2022 is as follows:
Maturing after Maturing after Maturing
Maturing within one but within five but within after fifteen
one year five years fifteen years years Total
Real estate:
Commercial $ 26,472,724 $ 178,967,907
12,965,681 7,499,058 1,809,743 1,703,891 23,978,373
Residential 10,117,341 61,768,382 24,383,092 18,414,334 114,683,149
Commercial 9,405,381 14,984,162 6,581,007 95,947 31,066,497
Consumer 34,202 112,990 9,230 - 156,422
$ 58,995,329 $ 263,332,499 $ 154,137,611 $ 45,213,704 $ 521,679,143
Rate terms:
Fixed-interest rate loans $ 42,703,907 $ 228,449,144
16,291,422 34,883,355 57,315,912 34,695,129 143,185,818
$ 58,995,329 $ 263,332,499 $ 154,137,611 $ 45,213,704 $ 521,679,143
It is the Company's policy to place a loan in nonaccrual status when any portion
of the principal or interest is 90 days past due unless there are mitigating
factors. Management closely monitors nonaccrual loans. The Company returns a
nonaccrual loan to accruing status when (i) the loan is brought current with the
full payment of all principal and interest arrearages, (ii) all contractual
payments are thereafter made on a timely basis for at least six months, and
(iii) management determines, based on a credit review, that it is reasonable to
expect that future payments will be made as and when required by the contract.
- 25 ---------------------------------------------------------------------------------
Year-end non-accrual loans, segregated by class of loans, were as follows:
2022 2021
Non-accrual loans
Commercial real estate $ 502,961 $ 4,810,965
Residential real estate - 31,500
Commercial 152,449 152,449
Total non-accrual loans $ 655,410 $ 4,994,914
At December 31, 2022 , the Company had one non-accrual commercial real estate
loan totaling $502,961 and one non-accrual commercial loan totaling $152,449 .
The commercial loan was secured by business assets and was personally
guaranteed. Gross interest income of $45,856 would have been recorded in 2022 if
these non-accrual loans had been current and performing in accordance with the
original terms. The Company allocated $281,910 of its allowance for loan losses
to these non-accrual loans. The decrease of $4.3 million from December 31, 2021
to December 31, 2022 is due to a loan of the same balance that began making full
principal and interest payments again in July 2022 .
At December 31, 2021 , the Company had two non-accrual commercial real estate
loan totaling $4,810,965 , one non-accrual residential real estate loan totaling
$31,500 , and one non-accrual commercial loan totaling $152,449 . The real estate
loan was secured by real estate and business assets and was personally
guaranteed. The commercial loan was secured by business assets and was
personally guaranteed. Gross interest income of $219,734 would have been
recorded in 2021 if these non-accrual loans had been current and performing in
accordance with the original terms. The Company allocated $281,910 of its
allowance for loan losses to these non-accrual loans. The balance of the
nonaccrual loans was net of charge-offs and a nonaccretable discount totaling
$27,146 at December 31, 2021 .
At December 31, 2022 , the Company had no loans that were delinquent 90 days or
greater other than the non-accrual loans listed above. At December 31, 2021 , the
Company had one residential real estate loan with a carrying value of $217,661
and two commercial loans with a carrying value of $263,241 that were delinquent
90 days or greater in addition to the non-accrual loans listed above. The
residential loan is a chronic delinquent loan that the borrower brings current
at least several times a year. The two commercial loans were PPP loans that were
fully guaranteed and were paid in full in January 2022 .
Year-end impaired loans are set forth in the following table:
2022 2021
Impaired loans no valuation allowance $ 6,772,804 $ 6,357,199
Impaired loans with a valuation allowance 655,410 655,410
Total impaired loans $ 7,428,214 $ 7,012,609 Valuation allowance related to impaired loans
Impaired loans include certain loans that have been modified in troubled debt
restructurings ("TDRs") where economic concessions have been granted to
borrowers who have experienced or are expected to experience financial
difficulties. These concessions typically result from the Company's loss
mitigation activities and could include reductions in the interest rate, payment
extensions, forgiveness of principal, forbearance, or other actions. Certain
TDRs are classified as nonperforming at the time of restructure and may only be
returned to performing status after considering the borrower's sustained
repayment performance for a reasonable period, generally six months.
- 26 -
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At December 31, 2022 , the Company had two commercial real estate loans totaling
$6,516,454 and two residential loans totaling $256,350 that were classified as
TDRs. All four loans are included in impaired loans above. Each loan is paying
as agreed. None of the borrowers have defaulted nor have there been charge-offs
or allowances associated with the four loans. One of the commercial real estate
loans with a principal balance of $4,542,896 and one of the residential loans
with a principal balance of $222,767 were restructured as TDRs during 2022.
At December 31, 2021 , the Company had one commercial real estate loan totaling
$2,009,967 and one residential loan totaling $39,228 classified as TDRs. Both
loans are included in impaired loans above. Each loan is paying as agreed. There
have been no charge-offs or allowances associated with these two loans.
Year-end TDRs are set forth in the following table:
2022 2021
Restructured loans (TDRs):
Total - all performing as agreed $ 6,772,804 $ 2,049,195
As part of our portfolio risk management, the Company assigns a risk grade to
each loan. The factors used to determine the grade are the payment history of
the loan and the borrower, the value of the collateral and net worth of any
guarantor, and cash flow projections of the borrower. Special mention,
Substandard, and Doubtful grades are assigned to loans with a higher frequency
of delinquent payments and/or the collateral and/or cash flow are insufficient
to support the loan and such loans are included on the Company's watch list. The
Special mention grade is intended to be a temporary grade.
Year-end loans graded special mention, substandard and doubtful are set forth in the following table:
2022 2021
Special mention $ 5,530,925 $ 5,288,153
Substandard 12,070,750 15,109,965
Doubtful 35,381 20,627
Total $ 17,637,056 $ 20,418,745
The allowance for loan losses is a reserve established through a provision for
loan losses and is charged to expense. The allowance for loan losses represents
an amount which, in management's judgment, will be adequate to absorb probable
losses on existing loans and other extensions of credit that may become
uncollectible. The Company's allowance for loan loss methodology includes
allowance allocations calculated in accordance with ASC Topic 310, "Receivables"
and allowance allocations calculated in accordance with ASC Topic 450,
"Contingencies." Accordingly, the methodology is based on historical loss
experience by type of credit and internal risk grade, specific homogeneous risk
pools and specific loss allocations, with adjustments for current events and
conditions.
The Company's process for determining the appropriate level of the allowance for
loan losses is designed to account for credit deterioration as it occurs. The
provision for loan losses reflects loan quality trends, including the levels of
and trends related to non-accrual loans, past due loans, potential problem
loans, classified and criticized loans and net charge-offs or recoveries, among
other factors.
Although management believes, based on currently available information, that the
Company's allowance for loan losses is sufficient to cover losses probable and
estimable inherent in its loan portfolio at this time, no assurances can be
given that the Company's level of allowance for loan losses will be sufficient
to cover future loan losses incurred by the Company or that future adjustments
to the allowance for loan losses will not be necessary if economic or other
conditions differ substantially from the economic and other conditions at the
time management determined the current level of the allowance for loan losses.
- 27 ---------------------------------------------------------------------------------
The following tables detail activity in the allowance for loan losses by
portfolio for the years ended
Allowance for loan losses ending Outstanding loan balances
Provision Loan balance evaluated for impairment: evaluated for impairment:
Beginning for loan Charge Ending Segment Purchase Credit Purchase Credit
December 31, 2022 balance losses offs Recoveries balance Percentage Individually Impaired Collectively Individually Impaired Collectively
Real estate:
Commercial $ 2,482,930 $ 343,424 $ (7,772 ) $ - $ 2,818,582 67 % $ 129,461 $ - $ 2,689,121 $ 7,019,415 $ - $ 344,775,287
Construction and land
development 214,547 (66,151 ) - 16,200 164,596 5 % - - 164,596 - 369,622 23,608,751
Residential 603,558 173,859 (2,468 ) 18,970 793,919 22 % - - 793,919 256,350 209,583 114,217,216
Commercial 255,413 81,890 - - 337,303 6 % 152,449 - 184,854 152,449 - 30,914,048
Consumer 4,370 336 - - 4,706 0 % - - 4,706 - - 156,422
Unallocated 89,450 (58,358 ) - - 31,092 0 % - - 31,092 - - -
$ 3,650,268 $ 475,000 $ (10,240 ) $ 35,170 $ 4,150,198 100 % $ 281,910 $ - $ 3,868,288 $ 7,428,214 $ 579,205 $ 513,671,724
Allowance for loan losses ending Outstanding loan balances
Provision Loan balance evaluated for impairment: evaluated for impairment:
Beginning for loan Charge Ending Segment Purchase Credit Purchase Credit
December 31, 2021 balance losses offs Recoveries balance Percentage Individually Impaired Collectively Individually Impaired Collectively
Real estate:
Commercial $ 2,230,129 $ 241,301 $ - $ 11,500 $ 2,482,930 66 % $ 129,461 $ - $ 2,353,469 $ 6,820,932 $ 56,825 $ 312,307,359
Construction and land
development 201,692 (3,345 ) - 16,200 214,547 6 % - - 214,547 - 383,666 27,838,188
Residential 644,639 (22,111 ) (18,970 ) - 603,558 22 % - - 603,558 39,228 568,151 106,828,654
Commercial 111,390 129,023 - 15,000 255,413 6 % 152,449 - 102,964 152,449 - 31,029,757
Consumer 2,138 2,232 - - 4,370 0 % - - 4,370 - - 355,958
Unallocated 106,550 (17,100 ) - - 89,450 0 % - - 89,450 - - -
$ 3,296,538 $ 330,000 $ (18,970 ) $ 42,700 $ 3,650,268 100 % $ 281,910 $ - $ 3,368,358 $ 7,012,609 $ 1,008,642 $ 478,359,916
2022 2021
Allowance for loan losses to total loans
outstanding 0.80 % 0.75 %
Ratio of net charge-offs to average loans outstanding during the period 0.00 %
0.00 %
Nonaccrual loans to total loans outstanding at period end 0.13 %
1.03 %
Allowance for loan losses to nonaccrual loans at
period end 633.22 % 73.08 %
- 28 ---------------------------------------------------------------------------------
Net recovery (charge-offs) during the period to average loans outstanding:
2022
Real estate:
Commercial 0.00 %
Construction and land development 0.06 %
Residential 0.02 %
Commercial -0.01 %
Consumer 0.00 %
Total 0.01 %
The Company recorded net recoveries of $24,930 and $23,730 for 2022 and 2021,
respectively. The provision for loan losses was $475,000 in 2022 and $330,000 in
2021.
Management believes that the $4.2 million reserve at December 31, 2022 and the
$475,000 provision for the year ended December 31, 2022 are appropriate to
adequately cover the probable and estimable losses inherent in the loan
portfolio. The reserve increased by $499,930 or 14% from December 31, 2021 .
Excluding PPP loans, the Company's loan portfolio grew by $44 million during the
2022. An increasing portfolio typically requires a commensurate increase in the
provision. In addition, several qualitative factors were increased to reflect
the potential impact of rising interest rates on loan losses.
Other Real Estate Owned
Other real estate owned ("OREO") at December 31, 2022 included two properties
with an aggregate carrying value of $1,242,365 . The first property is an
apartment building in Baltimore, Maryland with a carrying value of $1,242,365
that was acquired in the Merger. The property is being marketed for sale. The
other property is land in Cecil County, Maryland with a carrying value of $0 . It
was acquired through foreclosure in 2007. The latter property consists of 10.43
acres and is currently under contract for a gross sales price of $295,000 with
closing expected in 2023. Due to the length of time that the latter property has
been held, Maryland banking law required a write-down of the value to $0 in
2019.
2022 2021
Other Real Estate Owned $ 1,242,365 $ 1,242,365
Investment Securities
Investment securities decreased by $24,266,445 , or 14.2%, to $146,823,446 at
December 31, 2022 from $171,089,891 at December 31, 2021 . The decrease was due
primarily to a $21,675,430 increase in the unrealized loss of the available for
sale securities as a result of the significant increase in interest rates during
2022. At December 31, 2022 and 2021, the Company had classified 86% and 87%,
respectively, of the investment portfolio as available for sale. The remaining
balance of the portfolio was classified as held to maturity.
Securities classified as available for sale are held for an indefinite period of
time and may be sold in response to changing market and interest rate conditions
as part of the Company's asset/liability management strategy. Available for sale
securities are carried at fair value, with unrealized gains and losses excluded
from earnings and reported as a separate component of stockholders' equity, net
of income taxes. Securities classified as held to maturity, which management has
both the positive intent and ability to hold to maturity, are reported at
amortized cost. The Company does not currently follow a strategy of making
security purchases with a view to near-term sales, and, therefore, does not own
trading securities. The Company manages the investment portfolio within policies
that seek to achieve desired levels of liquidity, manage interest rate
sensitivity, meet earnings objectives, and provide required collateral for
deposit and borrowing activities.
- 29 -
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The following table sets forth the carrying value of investment securities at
December 31 :
2022 2021
Available for sale
State and municipal $ 552,281 $ 763,498
SBA pools 1,019,797 1,397,762
Corporate bonds 9,389,896 9,234,207
Mortgage-backed securities 115,352,475 137,842,449
$ 126,314,449 $ 149,237,916
Held to maturity
State and municipal $ 20,508,997 $ 21,851,975
The following table sets forth the scheduled maturities of investment securities
at December 31, 2022 :
Available for Sale Held to Maturity
Amortized Cost Fair Value Yield (1) Amortized Cost Fair Value Yield (1)
Within 1 year $ 580,522 $ 564,841 1.39 % $ 330,000 $ 330,175 4.00 %
Over 1 to 5 years 3,079,483 2,937,072 2.12 % 474,937 469,235 2.77 %
Over 5 to 10 years 7,324,263 6,440,264 4.62 % 3,308,340 3,162,389 2.78 %
Over 10 years - - - 16,395,720 14,917,996 3.02 %
10,984,268 9,942,177 3.75 % 20,508,997 18,879,795 2.99 %
SBA Pools 1,033,606 1,019,797 4.12 % - - -
Mortgage-backed securities 137,896,519 115,352,475 1.97 % - - -
$ 149,914,393 $ 126,314,449 2.12 % $ 20,508,997 $ 18,879,795 2.99 %
(1) - the yields indicated are based upon the amortized cost and have not been tax effected for tax exempt securities.
SBA pools and mortgage-backed securities are due in monthly installments.
Deposits Total deposits were$623,611,124 atDecember 31, 2022 compared to$626,414,670 atDecember 31, 2021 , a decrease of$2,803,546 , or 0.4%. The decrease was due to a$22,080,938 decrease in certificates of deposit, offset by a$3,348,466 increase in savings accounts, a$5,229,891 increase in interest bearing checking accounts, a$8,179,301 increase in money market accounts and a$2,519,734 increase in noninterest-bearing accounts. The following table shows the average balances and average costs of deposits for the years endedDecember 31 : - 30 - --------------------------------------------------------------------------------
2022 2021
Average Average
Balance Cost Balance Cost
Noninterest bearing demand deposits $ 129,642,652 0.00 % $ 120,935,434 0.00 %
Interest bearing demand deposits 134,141,125 0.17 % 118,795,136 0.18 %
Savings and money market deposits 199,407,223 0.13 % 183,453,217 0.15 %
Certificates of deposit 168,618,943 0.53 % 187,568,107 0.81 %
$ 631,809,943 0.22 % $ 610,751,894 0.33 %
As of December 31, 2022 , certificates of deposit greater than $250,000 mature as
follows:
Period Balance
3 months or less $ 13,376,259
Over 3 months to 6 months 6,248,186
Over 6 months to 12 months 8,358,449
Over 12 months 9,993,344
Total $ 37,976,238 Uninsured deposits totaled
Off-Balance Sheet Arrangements
The Company is a 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, lines of credit, including home-equity lines and commercial lines, and letters of credit. Loan commitments generally have interest rates at current market values, fixed expiration dates, and may require a fee. Lines of credit generally have variable interest rates and do not necessarily represent future cash flow requirements because it is unlikely that all customers will draw upon their lines in full at any one time. Letters of credit are commitments issued to guarantee the performance of a customer to a third party. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. For commitments to extend credit, lines of credit, and letters of credit, the Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument is represented by the contractual notional amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. AtDecember 31, 2022 , the Company's off-balance sheet financial instruments were as follows: Loan commitments$ 13,975,917 Unused lines of credit$ 37,550,783 Letters of credit$ 1,403,956
Management does not believe that any of the foregoing arrangements are reasonably likely to have a material adverse effect on the Company's financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.
Borrowings and Other Contractual Obligations
The Company's contractual obligations consist primarily of borrowings and operating leases for various facilities.
- 31 -
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Securities sold under agreements to repurchase represent overnight borrowings
from customers. Securities owned by the Company which are used as collateral for
these borrowings are primarily U.S. government agency securities.
On September 30, 2020 , Farmers and Merchants Bancshares, Inc. borrowed
$17,000,000 from First Horizon Bank ("FHN") to be used, on October 1, 2020 , to
fund a portion of the merger consideration paid in the Merger. Net of issuance
costs of $28,126 , the proceeds of the net long-term debt was $16,971,874 . The
loan matures on September 30, 2025 . The interest rate on the loan is fixed at
4.10%. The Company made quarterly interest-only payments through October 1,
2021 . During the remaining term of the loan, the Company is required to make
quarterly interest and principal payments of approximately $646,472 , which is
based on a nine-year straight-line amortization schedule. The remaining balance
of approximately $9,916,667 will be due at maturity. To secure its obligations
under this loan, the Company pledged all of its shares of common stock of the
Bank to the lender.
Specific information about the Company's borrowings and contractual obligations is set forth in the following table:
At December 31,
2022 2021
Amount outstanding at year-end:
Securities sold under repurchase agreements $ 5,175,303 $ 5,414,026
Federal Home Loan Bank advances 20,000,000
5,000,000
2023 $ 15,000,000 $ -
2025 $ 5,000,000 $ 5,000,000
Long-term debt (net of issuance costs) matures in 2025 15,095,642 16,978,905
Weighted average rate paid atDecember 31 : Securities sold under repurchase agreements 0.30 % 0.31 % Federal Home Loan Bank advances 3.68 % 1.00 % Long-term debt 4.10 % 4.10 % For years ended December 31, 2022 2021 Average rate paid for the year: Securities sold under repurchase agreements 0.30 % 0.43 % Federal Home Loan Bank advances 1.55 % 1.01 % Long-term debt 4.10 % 4.10 %
The terms of the Company's operating leases, including the future minimum payments under those leases, are disclosed in Note 9 to the consolidated financial statements.
RESULTS OF OPERATIONS Overview The Company reported net income of$8,090,127 for the year endedDecember 31, 2022 compared to$8,149,606 for the year endedDecember 31, 2021 . The decrease of$59,479 from 2021 was due to an increase in noninterest expense of$1,238,681 , an increase in the provision for loan losses of$145,000 , and an increase in income taxes of$52,213 , offset by an increase in net interest income of$1,248,391 and an increase in noninterest income of$128,024 . - 32 - --------------------------------------------------------------------------------
Net Interest Income
The primary source of income for the Company is net interest income, which is the difference between interest income on interest-earning assets, such as investment securities and loans, and interest expense incurred on interest-bearing sources of funds, such as deposits and borrowings.
For the year endedDecember 31, 2022 , the Company recorded net interest income of$24,123,495 compared to$22,875,104 for 2021, an increase of$1,248,391 . The increase was attributable to an increase in the average balance of interest-earning assets of$22,011,503 to$686,760,420 in 2022 from$664,748,917 in 2021, and an increase in the net yield on interest-earning assets of 7 basis points to 3.54% in 2022 from 3.47% in 2021. Total interest income for the year endedDecember 31, 2022 increased by$589,250 to$26,269,653 , from$25,680,403 for 2021. The increase was due primarily to the aforementioned increase in average interest earning assets, offset by a decrease of 4 basis points in the tax equivalent yield on interest earning assets to 3.85% in 2022 from 3.89% in 2021. Interest income from loans was$22,565,034 in 2022 compared to$23,491,614 in 2021, a decrease of$926,580 . This decrease was attributable to a$16,740,010 decrease in the average balance of loans to$498,427,308 in 2022 from$515,167,318 in 2021, and a 3 basis point decrease in the average yield on loans to 4.53% in 2022 from 4.56% in 2021. PPP revenue recognized declined by approximately$659,000 in 2022 compared to 2021 which contributed to a 13 basis point decline in the yield. For the year endedDecember 31, 2022 , the Company recorded interest income on securities of$3,551,955 compared to$2,123,293 for the same period in 2021. The$1,428,662 increase in 2022 was attributable to a$54,871,003 increase in the average balance of securities to$174,776,879 in 2022 from$119,905,876 in 2021, and a 21 basis point increase in the average tax equivalent yield on securities to 2.13% in 2022 from 1.92% in 2021. Interest income on federal funds sold and other interest-earning assets (FHLB stock and certificates of deposit) increased$87,168 to$152,664 in 2022 compared to$65,496 in 2021. The increase was due to a 97 basis point decrease in the average tax equivalent yield to 1.20% in 2022 from 0.23% in 2021, offset by a$16,119,490 decrease in the average balance of federal funds sold and other interest-earning assets to$13,556,233 in 2022 from$29,675,723 in 2021. Total interest expense decreased by$659,141 to$2,146,158 in 2022 compared to$2,805,299 in 2021. The decrease was due to a 13 basis point decrease in the cost of interest-bearing liabilities to 0.41% in 2022 from 0.54% in 2021, offset by an increase of$5,994,959 in the average balance of interest-bearing liabilities to$528,210,165 in 2022 from$522,215,206 in 2021. Interest paid on NOW, savings, and money market deposit accounts decreased by$9,330 to$476,213 in 2022 compared to$485,543 in 2021. The decrease was due to a 2 basis point decrease in the cost of funds to 0.14% in 2022 from 0.16% in 2021 offset by a$31,299,995 increase in the average balance of these deposits to$333,548,348 in 2022 from$302,248,353 in 2021.
Interest paid on time deposits decreased by
Interest paid on securities sold under repurchase agreements decreased by$31,860 to$12,768 in 2022 compared to$44,628 in 2021. The decrease was attributable to a decrease of 13 basis points in the average rate paid to 0.30% in 2022 from 0.43% in 2021, and a$6,167,187 increase in the average balance of securities sold under repurchase agreements to$4,255,436 in 2022 from$10,422,623 in 2021. Interest paid on long-term debt was$664,620 in 2022 compared to$712,306 in 2021. This debt relates to the$17 million term loan obtained onSeptember 30, 2021 to finance a portion of the cash paid to the former stockholders ofCarroll Bancorp, Inc. in the Merger. The average balance, net of issuance costs, decreased$1,059,888 to 15,916,205 in 2022 from$16,976,093 in 2021 due to scheduled principal payments. Interest paid on FHLB advances and other borrowings increased$42,587 to$93,079 in 2022 from$50,492 in 2021. The increase was attributable to an increase of 58 basis points in the average rate paid to 1.59% in 2022 from 1.01% in 2021, and a$871,203 increase in the average balance of FHLB advances and other borrowings to$5,871,233 in 2022 from$5,000,030 in 2021. - 33 - -------------------------------------------------------------------------------- The following table sets forth certain information relating to the Company's average interest-earning assets and interest-bearing liabilities for the periods indicated. The yields and rates are calculated by dividing interest income or expense by the average daily balance of assets or liabilities, respectively. Non-accruing loans are included in the average balance.
Average Balance Sheet, Interest and Yields
For the Years Ended December 31,
2022 2021
Average Balance Interest Yield Average Balance Interest Yield
Assets:
Loans $ 498,427,308 $ 22,565,034 4.53 % $ 515,167,318 $ 23,491,614 4.56 %
Securities, taxable (1) 156,008,736 2,986,225 1.91 % 99,668,430 1,516,487 1.52 %
Securities, tax exempt
(1) 18,768,143 736,696 3.93 % 20,237,446 787,818 3.89 %
Federal funds sold and
other interest earning
assets (1) 13,556,233 162,410 1.20 % 29,675,723 69,098 0.23 %
Total interest-earning
assets 686,760,420 26,450,365 3.85 % 664,748,917 25,865,017 3.89 %
Noninterest-earning
assets 27,355,077 38,706,505
Total assets $ 714,115,497 $ 703,455,422
Liabilities and
Stockholders' Equity: Rate Rate
NOW, savings, and money
market $ 333,548,348 476,213 0.14 % $ 302,248,353 485,543 0.16 %
Certificates of deposit 168,618,943 899,478 0.53 % 187,568,107 1,512,330 0.81 %
Securities sold under
repurchase agreements 4,255,436 12,768 0.30 % 10,422,623 44,628 0.43 %
Long-term debt 15,916,205 664,620 4.18 % 16,976,093 712,306 4.20 %
FHLB advances and other
borrowings 5,871,233 93,079 1.59 % 5,000,030 50,492 1.01 %
Total interest-bearing
deposits 528,210,165 2,146,158 0.41 % 522,215,206 2,805,299 0.54 %
Noninterest-bearing
deposits 129,642,652 120,935,434
Noninterest-bearing
liabilities 5,804,686 5,419,526
Total liabilities 663,657,503 648,570,166
Stockholders' equity 50,457,994 54,885,256
Total liabilities and
stockholders' equity $ 714,115,497 $ 703,455,422
Net interest income $ 24,304,207 $ 23,059,718
Interest rate spread 3.44 % 3.35 %
Net yield on
interest-earning assets 3.54 % 3.47 %
Ratio of average
interest-earning assets
to average
interest-bearing
liabilities 130.02 % 127.29 %
(1) - Interest on tax-exempt
investments are reported on a
fully taxable equivalent
basis. The federal, state, and
combined tax rates used were
21.00%, 8.25%, and 27.5175%
respectively.
- 34 -
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The following table sets forth the dollar amount of changes in interest income
and interest expense for the major categories of the Company's interest-earning
assets and interest-bearing liabilities. The table distinguishes between (i)
changes in net interest income attributed to volume (change in volume multiplied
by the prior year's interest rate), and (ii) changes in net interest income
attributed to rate (change in rate multiplied by the prior year's volume). The
change in interest due to the combined rate and volume changes is allocated
proportionally to the change in volume and rate.
RATE/VOLUME ANALYSIS
Year ended December 31, 2022 Year ended December 31, 2021
compared to 2021 compared to 2020
Change due to variance in Change due to variance in
Volume Rate Total Volume Rate Total
Interest income:
Loans $ (758,854 ) $ (167,726 ) $ (926,580 ) $ 4,293,991 $ (93,539 ) $ 4,200,452
Securities, taxable 1,009,107 460,631 1,469,738 856,005 (114,100 ) 741,905
Securities, tax exempt (57,625 ) 6,503 (51,122 ) (43,603 ) 31,580 (12,023 )
Federal funds sold and
other interest-earning
assets (55,105 ) 148,417 93,312 56,920 (67,668 ) (10,748 )
Total interest-earning
assets 137,523 447,825 585,348 5,163,313 (243,727 ) 4,919,586
Interest expense:
NOW, savings, and money
market 47,585 (56,915 ) (9,330 ) 199,146 (232,621 ) (33,475 )
Certificates of deposit (140,897 ) (471,955 ) (612,852 ) 303,198 (1,400,844 ) (1,097,646 )
Securities sold under
repurchase agreements (21,159 ) (10,701 ) (31,860 ) 11,269 (73,959 ) (62,690 )
Long-term debt (44,274 ) (3,412 ) (47,686 ) 526,496 4,345 530,841
FHLB advances and other
borrowings 9,972 32,615 42,587 1,055 8,537 9,592
Total interest-bearing
liabilities (148,773 ) (510,368 ) (659,141 ) 1,041,164 (1,694,542 ) (653,378 )
Change in net interest income$ 286,296 $ 958,193 $ 1,244,489 $ 4,122,149 $ 1,450,815 $ 5,572,964 Noninterest Income Noninterest income was$2,293,938 in 2022 compared to$2,165,914 in 2021, an increase of$128,024 . The increase was due primarily to a$673,483 gain on insurance proceeds from the storm damage to the Bank'sUpperco, Maryland location and a$151,206 increase in the gain on sale of SBA loans, offset by a$696,470 decrease in mortgage banking revenue as a result of the significant increase in interest rates in 2022 which reduced residential loan activity. Noninterest Expense Total noninterest expense increased by$1,238,681 to$15,367,280 in 2022 from$14,128,599 in 2021. The increase was due primarily to increases in salaries and benefits of$730,088 as a result of the addition of several new positions as well as normal salary increases, and an increase in professional fees of$475,872 as a result of third party fees paid in connection with the hiring of new employees.
Other noninterest expenses include the following:
2022 2021
Directors fees 212,436 221,239
Insurance claims 205,000 145,000
Telephone 202,854 219,418
Correspondent bank services 195,223 185,081
Internet banking fees 177,164 168,424
Stationery, printing, and supplies 176,467 225,266
Liability insurance 137,885 106,938
Other 550,754 516,268
$ 1,857,783 $ 1,787,634
- 35 ---------------------------------------------------------------------------------
Income Taxes
Income taxes increased by
The Company's effective tax rate increased to 23.5% in 2022, from 23.0% in 2021. The increase was due to a lower percentage of tax-exempt revenue. Note 14 to the consolidated financial statements provides additional information about the Company's taxes, including a reconciliation of the Company's effective tax rate to the Federal statutory rate of 21%.
Quarterly Results of Operations
Three Months Ended
Unaudited
2022 December 31 September 30 June 30 March 31
Interest income $ 6,918,716 $ 6,586,065 $ 6,275,147 $ 6,489,725
Interest expense 623,247 494,313 502,962 525,636
Net interest income 6,295,469 6,091,752 5,772,185 5,964,089
Provision for loan losses 380,000 95,000 - -
Net income 2,014,282 1,974,310 2,050,733 2,050,802
Earnings per share - basic and diluted $ 0.66 $ 0.65 $ 0.67 $ 0.68
2021 December 31 September 30 June 30 March 31
Interest income $ 6,374,432 $ 6,654,268 $ 6,281,111 $ 6,370,592
Interest expense 607,293 662,279 738,590 797,137
Net interest income 5,767,139 5,991,989 5,542,521 5,573,455
Provision for loan losses (100,000 ) 330,000 (20,000 ) 120,000
Net income 1,965,265 2,122,547 2,032,219 2,029,575
Earnings per share - basic
and diluted $ 0.65 $ 0.70 $ 0.67 $ 0.67
INTEREST RATE RISK
The Company's principal market risk is exposure to the risk that the interest
rates associated with our interest-bearing liabilities and interest-earning
assets will fluctuate. This risk arises from the Company's lending, investing
and deposit-taking activities, and is affected by many factors, including
economic and financial conditions, movements in interest rates and consumer
preferences. Interest rate fluctuation has a direct impact on the Company's net
interest income. Net interest income is susceptible to interest rate risk when
deposits and other short-term liabilities have different repricing intervals
than do loans, investments and other interest-earning assets. When
interest-earning assets mature or reprice faster than interest-bearing
liabilities, a decline in interest rates may cause a decline in net interest
income. Conversely, when interest-bearing liabilities mature or reprice faster
than interest-earning assets, an increase in interest rates may cause a decline
in net interest income.
The Company recognizes that there are many types of interest rate risk. Management believes that the three types that pose the greatest potential threat to current and long-term earnings are:
• Repricing risk - the difference in the timing of the scheduled maturity and
re-pricing dates of assets and liabilities within a certain time frame;
• Option risk - interest rate related options embedded in the Company's assets
and liabilities which change the cash flow characteristics of the assets and
liabilities; and
- 36 ---------------------------------------------------------------------------------
• Yield curve / basis risk - changes in the relationship between different
interest rates with the same maturity or interest rates across a maturity
spectrum which create compression or expansion of our net interest margin.
The Company uses earnings at risk and economic value at risk measures to
quantify our exposure to these types of interest rate risk. We believe that
using simulations that measure all three types of risks in combination is a more
efficient tool for measurement, and we therefore do not routinely process models
to isolate each risk. Rather, we combine the three types of analyses, which we
believe provides a better overall result than a simulation based on a single
system and a more economical use of resources than targeted models. Following is
a description of the analyses to be utilized:
Earnings at Risk
Earnings at Risk ("EAR") measures exposure to net changes in net interest income
("NII"), and is considered the Company's best source of managing short-term
interest rate risk (one-year and two-year time frames). EAR is a dynamic
analysis, which can capture all the different forms of interest rate risk under
many different interest rate scenarios, and using various assumptions for
growth, optionality, and yield curve structure.
Economic Value of Equity
Economic Value of Equity ("EVE") is management's primary analytical tool for
measuring long-term interest rate risk, and helps to measure if the long-term
safety and soundness of the Company is being compromised for the sake of
short-term results. However, the Company also recognizes the inherent
difficulties of calculating a definitive value for many sections of the balance
sheet as well as the weakness that EVE ignores future events (e.g., growth,
etc.). These difficulties, coupled with the nature of our core business, allow
the Company to adopt wide limits for this measure.
In order to mitigate the impact of changing interest rates, the Board of
Directors has established policies and procedures that include acceptable
parameters for the relationship between rate sensitive assets to rate sensitive
liabilities as measured by earnings at risk and economic value at risk. The
Asset/Liability Committee reviews rate sensitivity measures on a quarterly
basis. Material deviations from policy parameters are reported to the Board of
Directors and corrective action is initiated and monitored.
Measures of NII at risk produced by simulation analysis are indicators of an
institution's short-term performance in alternative rate environments. These
measures are typically based upon a relatively brief period, usually one year.
They do not necessarily indicate the long-term prospects or economic value of
the institution.
Based upon the simulation analysis performed at December 31, 2022 and 2021,
management estimated the following changes in NII, assuming the indicated rate
changes:
Change in Rate 2022 2021
400 basis point increase $ (2,282,000 ) $ (1,844,000 )
300 basis point increase (1,610,000 ) (1,191,000 )
200 basis point increase (958,000 ) (677,000 )
100 basis point increase (424,000 ) (278,000 )
100 basis point decrease 417,000 (878,000 )
200 basis point decrease 375,000 (1,131,000 )
300 basis point decrease 216,000 (1,201,000 )
- 37 ---------------------------------------------------------------------------------
LIQUIDITY MANAGEMENT Liquidity describes our ability to meet financial obligations that arise out of the ordinary course of business. Liquidity is primarily needed to meet depositor withdrawal requirements, to fund loans, and to fund our other debts and obligations as they come due in the normal course of business. We maintain our asset liquidity position internally through short-term investments, the maturity distribution of the investment portfolio, loan repayments, and income from earning assets. On the liability side of the balance sheet, liquidity is affected by the timing of maturing liabilities and the ability to generate new deposits or borrowings as needed. The Bank is approved to borrow 75% of eligible pledged single family residential loans and 50% of eligible pledged commercial loans as well as investment securities, or approximately$60.5 million under a secured line of credit with the FHLB. The Bank also has a facility with theFederal Reserve Bank of Richmond (the "Reserve Bank ") under which the Bank could borrow approximately$25.4 million . Finally, the Bank has$23,500,000 ($14,500,000 unsecured and$9,000,000 secured) overnight federal funds lines of credit available from commercial banks. FHLB advances of$20,000,000 and$5,000,000 were outstanding as ofDecember 31, 2022 and 2021, respectively. There were no borrowings from theReserve Bank or from the commercial banks' lines of credit atDecember 31, 2022 and 2021. OnSeptember 30, 2020 , the Company borrowed$17,000,000 from a commercial bank, which was used onOctober 1, 2020 to fund a portion of the cash consideration paid to the former stockholders ofCarroll Bancorp, Inc. in the Merger. The outstanding balance atDecember 31, 2022 , net of unamortized issuance costs, was$15,095,642 . Management believes that we have adequate liquidity sources to meet all anticipated liquidity needs over the next 12 months. Management knows of no trend or event which is likely to have a material impact on our ability to maintain liquidity at satisfactory levels. Cash provided by operating activities decreased by$4,548,768 to$7,155,962 in 2022 from$11,704,730 in 2021. Cash used in investing activities decreased by$23,626,325 to$35,358,568 in 2022 from$58,984,893 in 2021 due primarily to a$110,483,756 decrease in the net cash outflow from the debt securities portfolio, offset by a$75,821,469 increase in the net cash outflow from the loan portfolio. Cash provided by financing activities decreased by$23,762,562 to$9,004,037 in 2022 from$32,766,599 in 2021 due primarily to a$55,905,586 decrease in the net cash inflow from deposits, offset by a$19,101,224 decrease in the net cash outflow from securities sold under repurchase agreements and a$15,000,000 increase in the net cash inflow from FHLB advances.
Information about the various financial obligations, including contractual obligations and commitments that may require future cash payments, to which we are subject is set forth above under the captions "Off-Balance Sheet Transactions" and "Borrowings and Other Contractual Obligations".
CAPITAL RESOURCES AND ADEQUACY
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possible additional, discretionary actions by the regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain offbalance sheet items as calculated under regulatory accounting practices. The Basel III Capital Rules became effective for the Bank onJanuary 1, 2015 (subject to a phase-in period for certain provisions). Quantitative measures established by the Basel III Capital Rules to ensure capital adequacy require the maintenance of minimum amounts and ratios (set forth in the table below) of Common Equity Tier 1 capital, Tier 1 capital, and Total capital (as defined in the regulations) to riskweighted assets (as defined), and of Tier 1 capital to adjusted quarterly average assets (as defined). OnSeptember 17, 2019 , theFDIC finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio ("CBLR") framework), as required by the Economic Growth, Regulatory Relief and Consumer Protection Act. The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework. OnApril 6, 2020 , in a joint statement, theFDIC ,Federal Reserve and theOffice of Comptroller of the Currency ("OCC"), issued two interim final rules regarding temporary changes to the CBLR framework to implement provisions of the CARES Act. Under the interim final rules, the community bank leverage ratio was reduced to 8% beginning in the second quarter and for the remainder of calendar year 2020, 8.5% for calendar year 2021, and 9% thereafter. In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of greater than 8%, less than$10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations and will not be required to report or calculate risk-based capital. The Company has not opted-in to the CBLR framework. - 38 - -------------------------------------------------------------------------------- Additional information regarding the capital requirements that apply to us can be found in Note 14 of the consolidated financial statements and notes thereto included in the Annual Report. The following table presents actual and required capital ratios as ofDecember 31, 2022 and 2021, for the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as ofDecember 31, 2022 and 2021, based on the phase-in provisions of the Basel III Capital Rules. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. Minimum To Be Well (Dollars in thousands) Actual Capital Adequacy Capitalized
Total capital (to risk-weighted assets)$ 75,826 12.96 %$ 61,410 10.50 %$ 58,486 10.00 % Tier 1 capital (to risk-weighted assets) 71,676 12.26 % 49,713 8.50 % 46,789 8.00 % Common equity tier 1 (to risk- weighted assets) 71,676 12.26 % 40,940 7.00 % 38,016 6.50 % Tier 1 leverage (to average assets) 71,676 9.83 % 29,167 4.00 % 36,459 5.00 %December 31, 2021 Total capital (to risk-weighted assets)$ 69,957 13.24 %$ 55,471 10.50 %$ 52,830 10.00 % Tier 1 capital (to risk-weighted assets) 66,307 12.55 % 44,905 8.50 % 42,267 8.00 % Common equity tier 1 (to risk- weighted assets) 66,307 12.55 % 36,981 7.00 % 34,339 6.50 % Tier 1 leverage (to average assets) 66,307 9.27 % 28,614 4.00 % 35,797 5.00 % The Company intends to fund future growth primarily with cash, federal funds, maturities of investment securities and deposit growth. Management knows of no other trend or event that will have a material impact on capital. - 39 -
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