Harford Bank : Form 10-K~Annual Report

FEDERAL DEPOSIT INSURANCE CORPORATION

WASHINGTON, DC 20429

FORM 10-K

• ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2023

• TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from

to

.

FDIC file number 19101

HARFORD BANK

(Exact name of registrant as specified in its charter)

Maryland	52-0799113
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
8 West Bel Air Avenue, Aberdeen, Maryland	21001
(Address of principal executive offices)	(Zip Code)

[phone]

(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $10.00 per share

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days Yes  No 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes  No  (Not Applicable)

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of "large accelerated filer", "accelerated filer", "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer 	Accelerated filer 
Non-accelerated filer 	Smaller reporting company 
	Emerging growth company 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 

Indicate by check mark whether the registrant has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. 

If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. 

Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant's executive officers during the relevant recovery period pursuant to § 240.10D-1(b).

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act)  Yes  No

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant's most recently completed second fiscal quarter: $43,711,503.

The number of shares outstanding of the registrant's common stock as of February 29, 2024 was 1,477,995.

Documents Incorporated by Reference

Portions of the registrant's definitive proxy statement for the 2024 annual meeting of stockholders are incorporated by reference into Part III of this Form 10-K.

	HARFORD BANK
	FORM 10-K
	INDEX
	PART I
Item 1.	Business
Item 1A.	Risk Factors
Item 1B.	Unresolved FDIC Comments
Item 1C.	Cybersecurity
Item 2.	Properties
Item 3.	Legal Proceedings
Item 4.	Mine Safety Disclosures
	PART II
Item 5.	Market for Registrant's Common Equity, Related Stockholder Matters and
	Issuer Purchases of Equity Securities
Item 6.	[Reserved]
Item 7.	Management's Discussion and Analysis of Financial Condition
	and Results of Operations
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk
Item 8.	Financial Statements and Supplementary Data
Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Item 9A.	Controls and Procedures
Item 9B.	Other Information
Item 9C.	Disclosure Regarding Foreign Jurisdiction that Prevent Inspections
	PART III
Item 10.	Directors, Executive Officers and Corporate Governance
Item 11.	Executive Compensation
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13.	Certain Relationships and Related Transactions, and Director Independence
Item 14.	Principal Accountant Fees and Services
	PART IV
Item 15.	Exhibits and Financial Statement Schedules
Item 16.	Form 10-K Summary
SIGNATURES

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As used in this Annual Report of Harford Bank on Form 10-K for the year ended December 31, 2023, the terms "the Bank", "we", "us" and "our" refer to Harford Bank and, unless the context clearly requires otherwise, its consolidated subsidiary, HB Trust.

This annual report contains forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. Readers of this report should be aware of the speculative nature of "forward-looking statements." Statements that are not historical in nature, including those that include the words "anticipate," "estimate," "should," "expect," "believe," "intend," and similar expressions, are based on current expectations, estimates and projections about, among other things, the industry and the markets in which the Bank operates, and they are not guarantees of future performance. Whether actual results will conform to expectations and predictions is subject to known and unknown risks and uncertainties, including risks and uncertainties discussed in this report; general economic, market, or business conditions, including those impacted and/or driven by current and/or future pandemics; changes in interest rates, deposit flow, the cost of funds, and demand for loan products and financial services; changes in the Bank's competitive position or competitive actions by other companies; changes in the quality or composition of loan and investment portfolios; the ability to manage growth; changes in laws or regulations or policies of federal and state regulators and agencies; and other circumstances beyond the Bank's control. Consequently, all of the forward-looking statements made in this document are qualified by these cautionary statements, and there can be no assurance that the actual results anticipated will be realized, or if substantially realized, will have the expected consequences on the Bank's business or operations. Forward-looking statements speak only as of the date on which they are made, and, except to the extent required by federal securities laws, the Bank undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. In addition, the Bank cannot assess the impact of each factor on the Bank's business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

You should also consider carefully the Risk Factors contained in Item 1A of Part I of this annual report, which address additional factors that could cause the Bank's actual results to differ from those set forth in the forward-looking statements and could materially and adversely affect the Bank's business, operating results and financial condition. The risks discussed in this annual report are factors that, individually or in the aggregate, management believes could cause the Bank's actual results to differ materially from expected and historical results. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider such disclosures to be a complete discussion of all potential risks or uncertainties.

PART I

Item 1. BUSINESS.

General

The Bank was chartered as a national banking association on April 27, 1964 under the name of Aberdeen National Bank. On December 8, 1980, desiring to expand into other municipalities in Harford County, Maryland, Aberdeen National Bank legally changed its name to Harford National Bank. On July 2, 2001, Harford National Bank converted to a Maryland-chartered bank and changed its name to Harford Bank. The Bank operates seven banking offices in Harford County, Maryland, and two banking offices in Cecil County, Maryland, with the Bank's main office located in Aberdeen, Maryland. The Bank closed the Marketplace banking office in Harford County in the third quarter of 2023 and sold the land and building to the State of Maryland in the fourth quarter of 2023, retaining occupancy until the second quarter of 2024. The Bank is engaged in a general commercial and retail banking business serving individuals, businesses, and governmental units in Harford County, Maryland and neighboring counties. The Bank has one subsidiary, HB Trust, which is a Maryland statutory trust formed for the purposes of servicing and disposing of the real estate that the Bank acquires through foreclosure or by deed in lieu of foreclosure.

Information about the Bank's revenues, net income and assets derived from its operations for the years ended December 31, 2023 and 2022 may be found in the audited consolidated financial statements and notes thereto, which are contained in Item 8 of Part II of this annual report.

Location and Market Area

The Bank conducts general commercial banking in its primary service areas, emphasizing the banking needs of individuals and small to medium sized businesses and professional concerns. The Bank operates from seven branches located throughout Harford County, Maryland and two branch offices in Cecil County, Maryland. The Bank draws most of its customer deposits and conducts most of its lending transactions from within its primary service area.

Deposit and Related Services

The Bank offers deposit services to consumers and commercial entities customary for a state-chartered community bank, including checking accounts, savings accounts, money market accounts, and time deposits consisting of certificates of deposit of various types. The transaction accounts and certificates of deposit are tailored to the Bank's principal market areas at rates competitive to

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those offered in the area. In addition, the Bank offers certain retirement account services, such as Individual Retirement Accounts ("IRAs"). All deposits are insured by the Federal Deposit Insurance Corporation (the "FDIC") up to the maximum allowed by law. The Bank solicits these accounts from individuals, businesses, associations and organizations, and governmental authorities.

Other banking services include, but are not limited to, mobile banking, drive-through banking services, automated teller machine ("ATM") services, on-line banking with bill payment, cash management services, commercial account remote deposit capture, safe deposit boxes, direct deposit of payroll and social security checks, and ACH origination. The Bank is associated with the NYCE and Money Pass networks of ATMs that may be used by Bank customers throughout Maryland and other regions. The Bank also offers Visa check (debit) cards, as well as Visa gift cards and Visa credit cards issued through a third-party provider.

Lending Activities

The Bank also offers a full range of commercial and consumer loans. Commercial loans include secured and unsecured loans for working capital, business expansion (including acquisition and real estate improvements), purchase of equipment and machinery, as well as commercial mortgages secured by real estate, real estate construction loans and real estate acquisition loans. It is typical for commercial loans to be secured by real estate, accounts receivable, inventory, equipment or other assets of the business. Commercial loans generally involve a greater degree of credit risk than one-to-four family residential consumer mortgage loans. Repayment is often dependent on the successful operation of the business and may be affected by adverse conditions in the local economy or real estate market. The financial condition and cash flow of commercial borrowers is therefore carefully analyzed during the loan approval process, and continues to be monitored by obtaining business financial statements, personal financial statements and income tax returns. Personal guarantees of the borrowers are generally required. The frequency of this ongoing analysis depends upon the size and complexity of the credit and collateral that secures the loan.

Consumer loans include secured and unsecured loans for financing automobiles, boats, mobile homes, education, bill consolidation and home improvements. The Bank also originates secured fixed-rate consumer mortgage loans, variable rate home equity lines of credit and fixed rate home equity loans, as well as real estate construction loans and real estate acquisition loans. These lending activities are subject to a variety of lending limits imposed on state-chartered banks. Careful analysis of an applicant's creditworthiness is performed before granting credit, and on-going monitoring of loans outstanding is performed in an effort to minimize risk of loss by identifying problem loans early. The risk of loss associated with real estate construction lending is controlled through conservative underwriting policies and procedures such as loan-to-value ratios of 80% or less, obtaining additional collateral when prudent, and closely monitoring construction projects to control disbursement of funds on loans. The Bank's underwriting standards for residential mortgage loans recommend loan to value ratios not to exceed 80%, without private mortgage insurance, based on appraisals performed by approved independent appraisers of the Bank. Title insurance protecting the Bank's lien priority, as well as fire and casualty insurance, for all mortgage loans is generally required. Repayment of these loans is dependent on the borrower's continuing financial stability, which can be adversely impacted by job loss, divorce, illness, or personal bankruptcy.

Seasonality

Management does not believe that the business activities of the Bank are seasonal in nature.

Employees

At December 31, 2023, the Bank had 89 full- and part-time employees, which equated to 88 full-time equivalent employees.

COMPETITION

The banking business, in all of its phases, is highly competitive. Within its market area, the Bank competes with commercial banks (including local banks and branches or affiliates of other larger banks), savings institutions and credit unions for loans and deposits, with consumer finance companies for loans, and with other financial institutions for various types of financial products and services. There is also competition for commercial and retail banking business from banks and financial institutions located outside the Bank's market area. The competition for deposits depends primarily on interest rates, personalized services, the quality and range of financial services, convenience of office locations and office hours. Factors that impact competition for loans include the general availability of lendable funds and credit, the number and amount of associated fees and charges, general and local economic conditions, current interest rates, and other factors, which are not readily predictable. Additionally, many of the financial institutions operating in the Bank's market area may offer certain services, such as investment brokerage, that the Bank does not offer and have greater financial resources or have substantially higher lending limits than does the Bank.

To compete with other financial services providers, the Bank relies principally upon local promotional activities, personal relationships established by officers, directors and employees with its customers and specialized services tailored to meet its customers' needs.

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For further information about competition in our market areas, see the Risk Factor entitled "The Bank Operates in a Competitive Market" in Item 1A of Part I of this annual report.

SUPERVISION AND REGULATION

The following is a summary of the material regulations and policies applicable to the Bank and is not intended to be a comprehensive discussion. Changes in applicable laws and regulations may have a material effect on the business of the Bank.

Banking Regulation

The Bank is a Maryland-chartered commercial bank with the FDIC as its primary federal regulator. The Bank is subject to the banking laws of Maryland and to regulation by the Office of the Maryland Commissioner of Financial Regulation (the "Maryland Commissioner"), who is required by statute to make at least one examination in each calendar year (or at 18-month intervals if the Maryland Commissioner determines that an examination is unnecessary in a particular calendar year). In addition, the Bank is subject to supervision and examination by the FDIC and to the federal laws and regulations that the FDIC is tasked with enforcing, such as the Federal Deposit Insurance Act (the "FDI Act"). Further, there are a myriad of other federal and state laws and regulations that affect and govern the business of banking, including consumer lending and deposit-taking. The Maryland Commissioner and the FDIC have extensive enforcement authority over the institutions they regulate to prohibit or correct activities that violate law, regulations or written agreements with the regulator, or which are deemed to constitute unsafe or unsound practices. Enforcement actions may include the appointment of a conservator or receiver, the issuance of a cease and desist order, the termination of deposit insurance, the imposition of civil money penalties on the institution, its directors, officers, employees and institution-affiliated parties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the removal of, or restrictions on directors, officers, employees and institution-affiliated parties, and the enforcement of any such mechanisms through restraining orders or other court actions.

Loan operations are subject to certain federal laws applicable to credit transactions, such as the federal Truth-In-Lending Act governing disclosures of credit terms to consumer borrowers, the Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves, the Equal Credit Opportunity Act prohibiting discrimination on the basis of race, creed, or other prohibited factors in extending credit, the Fair Credit Reporting Act of 1978, governing the use and provision of information to credit report agencies, and the rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws. The operations of the Bank are also subject to the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records, and the Electronic Funds Transfer Act and Regulation E of the Board of Governors of the Federal Reserve System (the "FRB") that implements that act, which govern automatic deposits to and withdrawals from deposit accounts and customers' rights and liabilities arising from the use of automated teller machines and other electronic banking services Additionally, the Bank is subject to certain restrictions on extensions of credit to executive officers, directors, and principal stockholders or any related interest of such persons. These restrictions generally require that such credit extensions be made on substantially the same terms as are available to third parties dealing with the Bank and not involve more than the normal risk of repayment. Other laws tie the maximum amount that may be loaned to any one customer and its related interests to the Bank's capital levels.

The Community Reinvestment Act ("CRA") requires the FDIC, in connection with the examination of financial institutions within its jurisdictions, to evaluate the record of the financial institutions in meeting the credit needs of their local communities, including low and moderate-income neighborhoods, consistent with the safe and sound operation of those banks. These factors are also considered by all regulatory agencies in evaluating mergers, acquisitions and applications to open a branch or facility. As of the date of its most recent examination report, the Bank has a CRA rating of "Satisfactory."

Under the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), each federal banking agency is required to prescribe, by regulation, non-capital safety and soundness standards for institutions under its authority. The standards adopted by federal regulators under this law include standards for internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation, fees and benefits. An institution that fails to meet those standards may be required by the agency to develop a plan acceptable to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions. Management believes that the Bank meets substantially all applicable standards. FDICIA also imposes capital standards on insured depository institutions, which are described below under the caption "Capital Requirements."

The Dodd-Frank Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), which was enacted in July 2010, significantly restructured the financial regulatory regime in the United States. The Dodd-Frank Act established the Consumer Financial Protection Bureau (the "CFPB"), and contains a wide variety of provisions affecting the regulation of depository institutions, including fair lending, fair debt collection practices, mortgage loan origination and servicing obligations, bankruptcy, military service member protections, use of credit reports, privacy matters, and disclosure of credit terms and correction of billing

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errors. In addition, the Dodd-Frank Act permits states to adopt stricter consumer protection laws and each state attorney general may enforce consumer protection rules issued by the CFPB. Since the enactment of the Dodd-Frank Act, the CFPB, and to some extent, some state attorney generals, have used provisions of the Dodd-Frank Act to bring enforcement actions seeking to curb "unfair, deceptive or abusive acts or practices" ("UDAAP") in the financial services sector. With a change of leadership at the CFPB, and continued enforcement and regulatory actions at the state level, enforcement and regulatory priorities could change, resulting in increased regulatory compliance burdens and costs and restrictions on the financial products and services that we offer to our customers in the future.

Deposit Insurance

The Bank is a member of the FDIC and pays an insurance premium to the FDIC based upon its average total assets minus average tangible equity on a quarterly basis. Deposits are insured by the FDIC through the Deposit Insurance Fund (the "DIF") and such insurance is backed by the full faith and credit of the United States Government. Under the Dodd-Frank Act, a permanent increase in deposit insurance to $250,000 was authorized. The coverage limit is per depositor, per insured depository institution for each account ownership category.

The Federal Deposit Insurance Reform Act of 2005, which created the DIF, gave the FDIC greater latitude in setting the assessment rates for insured depository institutions which could be used to impose minimum assessments. The FDIC has the flexibility to adopt actual rates that are higher or lower than the total base assessment rates adopted without notice and comment, if certain conditions are met.

The Dodd-Frank Act also set a new minimum DIF reserve ratio at 1.35% of estimated insured deposits. The FDIC was required to attain this ratio by September 30, 2020. The Dodd-Frank Act required the FDIC to redefine the deposit insurance assessment base for an insured depository institution. As redefined pursuant to the Dodd-Frank Act, an institution's assessment base is now an amount equal to the institution's average consolidated total assets during the assessment period minus average tangible equity. Institutions with less than $1.0 billion in assets at the end of a fiscal quarter, like the Bank, are permitted to report their average consolidated total assets on a weekly basis (rather than on a daily basis) and to report their average tangible equity on an end-of- quarter balance (rather than on an end-of-month balance). Beginning in the third quarter of 2016, the range of initial assessment ranges for all institutions was adjusted downward such that the initial base deposit insurance assessment rate ranges from 3 to 30 basis points on an annualized basis. After the effect of potential base-rate adjustments, the total base assessment rate could range from 1.5 to 40 basis points on an annualized basis. The rule imposed a surcharge on the assessments of depository institutions with $10 billion or more in assets, beginning with the third quarter of 2016 and continuing through the earlier of the quarter that the reserve ratio first reaches or exceeds 1.35% and December 31, 2018. These surcharges ended in 2019. With the Bank's assets well below the $10 billion threshold, the surcharges on larger banks resulted in decreased costs for the Bank in 2020. Small banks were awarded assessment credits for the portion of their assessments that contributed to the growth in the reserve ratio from 1.15% to 1.35% to be applied when the reserve ratio is at least 1.35%. The FDIC began applying the small bank credits with the Bank's September 30, 2019 deposit insurance assessment invoice, and the Bank received the final credit on the June 30, 2020 deposit insurance assessment.

The Bank expensed $392,000 and $299,404 in FDIC deposit insurance premiums in 2023 and 2022, respectively.

The FDIC is authorized to conduct examinations of and require reporting by FDIC-insured institutions. It is also authorized to terminate a depository bank's deposit insurance upon a finding by the FDIC that the Bank's financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the bank's regulatory agency. The termination of deposit insurance would have a material adverse effect on the Bank's earnings, operations and financial condition.

Capital Requirements

Federal and state banking laws require the Bank to meet certain minimum capital stock and surplus requirements before establishing a new branch. With each new branch located outside the municipal area of the Bank's principal banking office, these minimal levels are subject to upward adjustment based on the population size of the municipal area in which the branch will be located. Prior to establishment of the branch, the Bank must obtain approvals from the Maryland Commissioner and the FDIC. If establishment of the branch involves the purchase of a bank building or furnishings, then the total investment in bank buildings and furnishings cannot exceed, with certain exceptions, 50% of the Bank's unimpaired capital and surplus.

The Bank is subject to other regulatory capital requirements administered by the FDIC. Capital guidelines are intended to ensure that banking organizations have adequate capital given the risk levels of assets and off-balance sheet financial instruments. Under the requirements, banking organizations are required to maintain minimum ratios for Tier 1 capital and total capital to risk-weighted assets (including certain off-balance sheet items, such as letters of credit). For purposes of calculating the ratios, a banking organization's assets and some of its specified off-balance sheet commitments and obligations are assigned to various risk categories. A depository institution's capital, in turn, is classified in one of two tiers, depending on type:

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• Core Capital (Tier 1). Tier 1 capital includes common equity, retained earnings, qualifying non-cumulative perpetual preferred stock, minority interests in equity accounts of consolidated subsidiaries (and, under existing standards, a limited amount of qualifying trust preferred securities and qualifying cumulative perpetual preferred stock at the holding company level), less goodwill, most intangible assets and certain other assets.
• Supplementary Capital (Tier 2). Tier 2 capital includes, among other things, perpetual preferred stock and trust preferred securities not meeting the Tier 1 definition, qualifying mandatory convertible debt securities, qualifying subordinated debt, and allowances for credit losses on loans and credit losses on off-balance sheet items, subject to limitations.

The Basel Committee on Banking Supervision (the "Basel Committee") is a committee of central banks and bank supervisors/regulators from the major industrialized countries that develops broad policy guidelines for use by each country's supervisors in determining the supervisory policies they apply. In 2013, the FRB and the FDIC approved amendments to the regulatory risk-based capital rules that were intended to implement the "Basel III" regulatory capital reforms and changes required by the Dodd-Frank Act. Basel III refers to two consultative documents released by the Basel Committee in December 2009 and the federal banking authorities' related proposals in December 2010 and January 2011, which include significant changes to bank capital, leverage and liquidity requirements.

Some of the most significant aspects of the amended rules are as follows:

• Banks must meet certain risk-based capital and leverage ratios under a revised definition of what constitutes "capital" for purposes of calculating those ratios. The minimum capital level requirements applicable to the Bank are: (i) a common equity Tier 1 capital ("CET1") ratio of 4.5%; (ii) a Tier 1 capital ratio of 6%; (iii) a total capital ratio of 8%; and (iv) a
  Tier 1 leverage ratio of 4% for all institutions.
• Banks must maintain a "capital conservation buffer" above the revised regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital. The capital conservation buffer began for the Bank January 1, 2016 and was phased-in over four years. In 2019, the minimum buffer was permanently set at 2.5%. This resulted in the following minimum ratios beginning in 2019: (i) a common equity Tier 1 capital ratio of 7.0%, (i) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. Under the final rules, institutions are subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.
• Consistent with Basel III, revisions and clarifications were made to the various components of Tier 1 capital, including common equity, unrealized gains and losses, as well as certain instruments that no longer qualify as Tier 1 capital, some of which will be phased out over time. Under the amendments, the effects of certain accumulated other comprehensive items are not excluded; however, banking organizations like the Bank that are not considered "advanced approaches" banking organizations may make a one-time permanent election to continue to exclude these items.
• A revised prompt corrective action framework was established. This framework is designed to place restrictions on insured depository institutions if their capital levels begin to show signs of weakness and is designed to complement the capital conservation buffer. Under the prompt corrective action requirements, insured depository institutions are required to meet the following capital level requirements in order to qualify as "well capitalized": (i) a common equity Tier 1 capital ratio of 6.5%; (ii) a Tier 1 capital ratio of 8%; (iii) a total capital ratio of 10%; and (iv) a Tier 1 leverage ratio of 5%.
• Certain changes were made to the manner in which risk-weighted assets are calculated. The rules utilize an increased number of credit risk exposure categories and risk weights and also address: (i) an alternative standard of creditworthiness consistent with Section 939A of the Dodd-Frank Act; (ii) revisions to recognition of credit risk mitigation; (iii) rules for risk weighting of equity exposures and past due loans; and (iv) revised capital treatment for derivatives and repo-style transactions.

The Bank, like other depository institutions, is required to maintain Tier 1 capital and "total capital" (the sum of Tier 1 and Tier 2 capital) equal to at least 4.0% and 8.0%, respectively, of its total risk-weighted assets (including various off-balance-sheet items, such as letters of credit). In addition, for a depository institution to be considered "well capitalized" under the regulatory framework for prompt corrective action, its Tier 1 and total capital ratios must be at least 6.0% and 10.0% on a risk-adjusted basis, respectively.

The Bank is also required to comply with minimum leverage ratio requirements. The leverage ratio is the ratio of a banking organization's Tier 1 capital to its total adjusted quarterly average assets (as defined for regulatory purposes). The requirements necessitate a minimum leverage ratio of 3.0% for banks that either have the highest supervisory rating or have implemented the appropriate federal regulatory authority's risk-adjusted measure for market risk. All other banks are required to maintain a minimum leverage ratio of 4.0%, unless a different minimum is specified by an appropriate regulatory authority. In addition, for

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a depository institution to be considered "well capitalized" under the regulatory framework for prompt corrective action, its leverage ratio must be at least 5.0%.

On September 17, 2019, the FDIC 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.

On April 6, 2020, in a joint statement, the FDIC, FRB and the Office of Comptroller of the Currency 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 Bank has not opted-in to the CBLR framework.

Prompt Corrective Action

The FDI Act requires, among other things, the federal banking agencies to take "prompt corrective action" in respect of depository institutions that do not meet minimum capital requirements. The FDI Act includes the following five capital tiers: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." A depository institution's capital tier will depend upon how its capital levels compare with various relevant capital measures and certain other factors, as established by regulation. The relevant capital measures are the total capital ratio, the Tier 1 capital ratio and the leverage ratio.

A bank will be (i) "well capitalized" if the institution has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, and a leverage ratio of 5.0% or greater, and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure, (ii) "adequately capitalized" if the institution has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, and a leverage ratio of 4.0% or greater and is not "well capitalized", (iii) "undercapitalized" if the institution has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio of less than 6.0% or a leverage ratio of less than 4.0%, (iv) "significantly undercapitalized" if the institution has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 4.0% or a leverage ratio of less than 3.0%, and (v) "critically undercapitalized" if the institution's tangible equity is equal to or less than 2.0% of average quarterly tangible assets. An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. A bank's capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the bank's overall financial condition or prospects for other purposes.

The Basel III Capital Rules revised the prompt corrective action requirements by (i) introducing the CET1 ratio requirement at each level (other than critically undercapitalized), with the required CET1 ratio being a minimum of 6.5% or greater for well- capitalized status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category (other than critically undercapitalized), with the minimum Tier 1 capital ratio for well-capitalized status being 8%; and (iii) eliminating the provision that permitted a bank with a composite supervisory rating of 1 but a leverage ratio of at least 3% to be deemed adequately capitalized.

The FDI Act generally prohibits a depository institution from making any capital distributions (including payment of a dividend) if the depository institution would thereafter be "undercapitalized." "Undercapitalized" institutions are subject to growth limitations and are required to submit a capital restoration plan. The agencies may not accept such a plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. If a depository institution fails to submit an acceptable plan, it is treated as if it is "significantly undercapitalized." Significantly undercapitalized" depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become "adequately capitalized," requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. "Critically undercapitalized" institutions are subject to the appointment of a receiver or conservator.

The appropriate federal banking agency may, under certain circumstances, reclassify a well capitalized insured depository institution as adequately capitalized. The FDI Act provides that an institution may be reclassified if the appropriate federal banking

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agency determines (after notice and opportunity for hearing) that the institution is in an unsafe or unsound condition or deems the institution to be engaging in an unsafe or unsound practice.

The appropriate agency is also permitted to require an adequately capitalized or undercapitalized institution to comply with the supervisory provisions as if the institution were in the next lower category (but not treat a significantly undercapitalized institution as critically undercapitalized) based on supervisory information other than the capital levels of the institution.

The Bank believes that, as of December 31, 2023, it is "well capitalized" based on the aforementioned ratios. Further information about the Bank's capital resources is provided in Item 7 of Part II of this annual report under the heading "FINANCIAL CONDITION - Capital Management" and Note 14 to the Bank's audited consolidated financial statements, which are included in Item 8 of Part II of this annual report.

Liquidity Requirements

The Bank requires cash to fund loans, satisfy obligations under letters of credit, meet the deposit withdrawal demands of customers, and satisfy other monetary obligations. To the extent that deposits are not adequate to fund these requirements, the Bank can rely on the funding sources identified in Item 7 of Part II of this report under the heading, "FINANCIAL CONDITION - Liquidity Management; Contractual Obligations and Off-Balance Sheet Transactions".

Historically, the regulation and monitoring of bank liquidity has been addressed as a supervisory matter, without required formulaic measures. The Basel III liquidity framework requires large and internationally active banking organizations to measure their liquidity against specific liquidity tests that, although similar in some respects to liquidity measures historically applied by banks and regulators for management and supervisory purposes, going forward would be required by regulation. One test, referred to as the liquidity coverage ratio ("LCR"), is designed to ensure that the banking entity maintains an adequate level of unencumbered high-quality liquid assets equal to the entity's expected net cash outflow for a 30-day time horizon (or, if greater, 25% of its expected total cash outflow) under an acute liquidity stress scenario. The other test, referred to as the net stable funding ratio ("NSFR"), is designed to promote more medium- and long-term funding of the assets and activities of banking entities over a one- year time horizon. These requirements will incent banking entities to increase their holdings of U.S. Treasury securities and other sovereign debt as a component of assets and increase the use of long-term debt as a funding source.

Bank Secrecy Act/Anti-Money Laundering

The Bank Secrecy Act ("BSA"), requires financial institutions to develop policies, procedures, and practices which are intended to prevent and deter money laundering, mandates that insured financial institutions have a written, board-approved program that is reasonably designed to assure and monitor compliance with the BSA.

The program must, at a minimum: (i) provide for a system of internal controls to assure ongoing compliance; (ii) provide for independent testing for compliance; (iii) designate an individual responsible for coordinating and monitoring day-to-day compliance; and (iv) provide training for appropriate personnel. In addition, banks are required to adopt a customer identification program as part of its BSA compliance program. Banks are also required to file Suspicious Activity Reports when they detect certain known or suspected violations of federal law or suspicious transactions related to a money laundering activity or a violation of the BSA.

In addition to complying with the BSA, the Bank is subject to the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the "USA Patriot Act"). The USA Patriot Act is designed to deny terrorists and criminals the ability to obtain access to the United States' financial system and has significant implications for depository institutions, brokers, dealers, and other businesses involved in the transfer of money. The USA Patriot Act mandates that financial service companies implement additional policies and procedures and take heightened measures designed to address any or all of the following matters: customer identification programs, money laundering, terrorist financing, identifying and reporting suspicious activities and currency transactions, currency crimes, and cooperation between financial institutions and law enforcement authorities.

Mortgage Lending and Servicing

The Bank's mortgage lending and servicing activities are subject to various laws and regulations that are enforced by the federal banking regulators and the CFPB, such as the Truth in Lending Act, the Real Estate Settlement Procedures Act, and various rules adopted thereunder, including those relating to consumer disclosures, appraisal requirements, mortgage originator compensation, prohibitions on mandatory arbitration provisions under certain circumstances, and the obligation to credit payments and provide payoff statements within certain time periods and provide certain notices prior to interest rate and payment adjustments.

The Bank is required to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms. Qualified mortgages that

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