FVCBankcorp, Inc. (FVCB) FY 2021 MD&A

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following presents management's discussion and analysis of our consolidated financial condition at December 31, 2021 and 2020 and the results of our operations for the years ended December 31, 2021 and 2020. This discussion should be read in conjunction with our consolidated financial statements and the notes thereto appearing elsewhere in this report.

In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause results to differ materially from management's expectations.

Overview

We are a bank holding company headquartered in Fairfax County, Virginia. Our sole subsidiary, FVCbank, was formed in November 2007 as a community-oriented, locally-owned and managed commercial bank under the laws of the Commonwealth of Virginia. The Bank offers a wide range of traditional bank loan and deposit products and services to both our commercial and retail customers. Our commercial relationship officers focus on attracting small and medium sized businesses, commercial real estate developers and builders, including government contractors, non-profit organizations, and professionals. Our approach to our market features competitive customized financial services offered to customers and prospects in a personal relationship context by seasoned professionals.

On August 31, 2021, we announced that the Bank made an investment in ACM for $20.4 million to obtain a 28.7% ownership interest in ACM. This ownership interest is subject to an earnback option of up to 3.7% over the next three years. In addition, the Bank provides a warehouse lending facility to ACM, which includes a construction-to-permanent financing line, and has developed portfolio mortgage products to diversify our held to investment loan portfolio.

On October 12, 2018, we completed our acquisition of Colombo Bank ("Colombo"). Colombo, which was headquartered in Rockville, Maryland, merged into FVCbank effective October 12, 2018, adding five banking locations in Washington, D.C., and Montgomery County and the City of Baltimore in Maryland.

Net interest income is our primary source of revenue. We define revenue as net interest income plus noninterest income. As discussed further in "Quantitative and Qualitative Disclosures About Market Risk" below, we manage our balance sheet and interest rate risk exposure to maximize, and concurrently stabilize, net interest income. We do this by monitoring our liquidity position and the spread between the interest rates earned on interest-earning assets and the interest rates paid on interest-bearing liabilities. We attempt to minimize our exposure to interest rate risk, but are unable to eliminate it entirely. In addition to managing interest rate risk, we also analyze our loan portfolio for exposure to credit risk. Loan defaults and foreclosures are inherent risks in the banking industry, and we attempt to limit our exposure to these risks by carefully underwriting and then monitoring our extensions of credit. In addition to net interest income, noninterest income is a complementary source of revenue for us and includes, among other things, service charges on deposits and loans, income from minority membership interest in ACM, merchant services fee income, insurance commission income, income from bank owned life insurance ("BOLI"), and gains and losses on sales of investment securities available-for-sale.

On October 13, 2020, we completed our private placement of $20.0 million of our 4.875% fixed-to-floating subordinated notes due 2030 (the "Notes") to certain qualified institutional buyers and accredited investors. The Notes have a maturity date of October 15, 2030 and carry a fixed rate of interest of 4.875% for the first five years. Thereafter, the Notes will pay interest at 3-month SOFR plus 471 basis points, resetting quarterly. The Notes include a right of prepayment without penalty on or after October 15, 2025. The Notes have been structured to qualify as Tier 2 capital for regulatory purposes. The proceeds from the placement of the Notes have been used for general corporate purposes, including to support the capital ratios at the Bank, and the repayment of the $25.0 million outstanding subordinated debt which was called in full on September 30, 2021.

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Critical Accounting Policies

General

The accounting principles we apply under GAAP are complex and require management to apply significant judgment to various accounting, reporting and disclosure matters. Management must use assumptions, judgments and estimates when applying these principles where precise measurements are not possible or practical. These policies are critical because they are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such judgments, assumptions and estimates may have a significant impact on the consolidated financial statements. Actual results, in fact, could differ from initial estimates.

The accounting policies we view as critical are those relating to judgments, assumptions and estimates regarding the determination of the allowance for loan losses, accounting for purchase credit-impaired loans, and fair value measurements.

Allowance for Loan Losses

We maintain the allowance for loan losses at a level that represents management's best estimate of known and inherent losses in our loan portfolio. We are not required to implement the provisions of the CECL until January 1, 2023, and are continuing to account for the allowance for loan losses under the incurred loss model. Both the amount of the provision expense and the level of the allowance for loan losses are impacted by many factors, including general and industry-specific economic conditions, actual and expected credit losses, historical trends and specific conditions of individual borrowers. Unusual and infrequently occurring events, such as weather-related disasters and health related events, such as COVID-19 pandemic and associated efforts to restrict the spread of the disease, may impact our assessment of possible credit losses. As a part of our analysis, we use comparative peer group data and qualitative factors such as levels of and trends in delinquencies, nonaccrual loans, charged-off loans, changes in volume and terms of loans, effects of changes in lending policy, experience and ability and depth of management, national and local economic trends and conditions and concentrations of credit, competition, and loan review results to support estimates.

The allowance for loan losses is based first on a segmentation of the loan portfolio by general loan type, or portfolio segments. For originated loans, certain portfolio segments are further disaggregated and evaluated collectively for impairment based on loan segments, which are largely based on the type of collateral underlying each loan. For purposes of this analysis, we categorize loans into one of five categories: commercial and industrial, commercial real estate, commercial construction, consumer residential, and consumer nonresidential loans. Typically, financial institutions use their historical loss experience and trends in losses for each loan category which are then adjusted for portfolio trends and economic and environmental factors in determining their allowance for loan losses. Since the Bank's inception in 2007, we have experienced minimal loss history within our loan portfolio. Because of this, our allowance model uses the average loss rates of similar institutions (our custom peer group) as a baseline which is then adjusted based on our particular qualitative loan portfolio characteristics and environmental factors. The indicated loss factors resulting from this analysis are applied for each of the five categories of loans.

Our peer group is defined by selecting commercial banking institutions of similar size within Virginia, Maryland and the District of Columbia. This is known as our custom peer group. The commercial banking institutions comprising the custom peer group can change based on certain factors including but not limited to the characteristics, size, and geographic footprint of the institution. We have identified 22 banks for our custom peer group which are within $1 billion to $3 billion in total assets, the majority of whom are geographically concentrated in the Washington, D.C. metropolitan area in which we operate, as this area has experienced more stable economic conditions than many other areas of the country. These baseline peer group loss rates are then adjusted based on an analysis of our loan portfolio characteristics, trends, economic considerations and other conditions that should be considered in assessing our credit risk. Our peer loss rates are updated on a quarterly basis.

The allowance for loan losses consists of specific and general components. The specific component relates to loans that are determined to be impaired and, therefore, individually evaluated for impairment. We individually assign loss factors to all loans that have been identified as having loss attributes, as indicated by deterioration in the financial condition of the borrower or a decline in underlying collateral value if the loan is collateral dependent. We evaluate the impairment of certain loans on a loan by loan basis for those loans that are adversely risk rated. Measurement of impairment is based on the expected future cash flows of an impaired loan, which are discounted at the loan's effective interest rate, or measured on an observable market value, if one exists, or the fair value of the collateral underlying the loan, discounted to consider estimated costs to sell the collateral for collateral-dependent loans. If the net collateral value is less than the loan

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balance (including accrued interest and any unamortized premium or discount associated with the loan) we recognize an impairment and establish a specific reserve for the impaired loan.

Credit losses are an inherent part of our business and, although we believe the methodologies for determining the allowance for loan losses and the current level of the allowance are appropriate, it is possible that there may be unidentified losses in the portfolio at any particular time that may become evident at a future date pursuant to additional internal analysis or regulatory comment. Additional provisions for such losses, if necessary, would be recorded, and would negatively impact earnings.

Allowance for Loan Losses — Acquired Loans

Acquired loans accounted for under Accounting Standards Codification ("ASC") 310-30

For our acquired loans, to the extent that we experience a deterioration in borrower credit quality resulting in a decrease in our expected cash flows subsequent to the acquisition of the loans, an allowance for loan losses would be established based on our estimate of future credit losses over the remaining life of the loans through provision for loan loss expense.

Acquired loans accounted for under ASC 310-20

Subsequent to the acquisition date, we establish our allowance for loan losses through a provision for loan losses based upon an evaluation process that is similar to our evaluation process used for originated loans. This evaluation, which includes a review of loans on which full collectability may not be reasonably assured, considers, among other factors, the estimated fair value of the underlying collateral, economic conditions, historical net loan loss experience, carrying value of the loans, which includes the remaining net purchase discount or premium, and other factors that warrant recognition in determining our allowance for loan losses.

Purchased Credit-Impaired Loans

Purchased credit-impaired ("PCI") loans, which are the loans acquired in our acquisition of Colombo, are loans acquired at a discount (that is due, in part, to credit quality). These loans are initially recorded at fair value (as determined by the present value of expected future cash flows) with no allowance for loan losses. We account for interest income on all loans acquired at a discount (that is due, in part, to credit quality) based on the acquired loans' expected cash flows. The acquired loans may be aggregated and accounted for as a pool of loans if the loans being aggregated have common risk characteristics. A pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flow. The difference between the cash flows expected at acquisition and the investment in the loans, or the "accretable yield," is recognized as interest income utilizing the level-yield method over the life of each pool. Increases in expected cash flows subsequent to the acquisition are recognized prospectively through adjustment of the yield on the pool over its remaining life, while decreases in expected cash flows are recognized as impairment through a loss provision and an increase in the allowance for loan losses. Therefore, the allowance for loan losses on these impaired pools reflect only losses incurred after the acquisition (representing the present value of all cash flows that were expected at acquisition but currently are not expected to be received). At December 31, 2021, we had no specific reserves for any acquired loan within our allowance for loan losses that had further deteriorated post acquisition.

We periodically evaluate the remaining contractual required payments due and estimates of cash flows expected to be collected. These evaluations, performed quarterly, require the continued use of key assumptions and estimates, similar to the initial estimate of fair value. Changes in the contractual required payments due and estimated cash flows expected to be collected may result in changes in the accretable yield and non-accretable difference or reclassifications between accretable yield and the non-accretable difference. On an aggregate basis, if the acquired pools of PCI loans perform better than originally expected, we would expect to receive more future cash flows than originally modeled at the acquisition date. For the pools with better than expected cash flows, the forecasted increase would be recorded as an additional accretable yield that is recognized as a prospective increase to our interest income on loans.

Fair Value Measurements

We determine the fair values of financial instruments based on the fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value. Our investment securities available-for-

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sale are recorded at fair value using reliable and unbiased evaluations by an industry-wide valuation service. This service uses evaluated pricing models that vary based on asset class and include available trade, bid, and other market information. Generally, the methodology includes broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs. Depending on the availability of observable inputs and prices, different valuation models could produce materially different fair value estimates. The values presented may not represent future fair values and may not be realizable.

LIBOR and Other Benchmark Rates

We have certain loans, interest rate swap agreements, investment securities, and debt obligations whose interest rate is indexed to LIBOR. In 2017, the Financial Conduct Authority (the authority that regulates LIBOR) announced its intention to stop compelling banks to submit rates for the calculation of LIBOR after 2021. In December 2020, the administrator of LIBOR announced its intention to (i) cease the publication of the one-week and two-month U.S. dollar LIBOR after December 31, 2021, and (ii) cease the publication of all other tenors of U.S. dollar LIBOR (one, three, six and 12 month LIBOR) after June 30, 2023. In October 2021, the federal bank regulatory agencies issued a Joint Statement on Managing the LIBOR Transition. In that guidance, the agencies offered their regulatory expectations and outlined potential supervisory and enforcement consequences for banks that fail to adequately plan for and implement the transition away from LIBOR. The failure to properly transition away from LIBOR may result in increased supervisory scrutiny.

Central banks and regulators around the world have commissioned working groups to find suitable replacements for Interbank Offered Rates ("IBOR") and other benchmark rates and to implement financial benchmark reforms more generally. These actions have resulted in uncertainty regarding the use of alternative reference rates ("ARRs") and could cause disruptions in a variety of markets, as well as adversely impact our business, operations and financial results.

To facilitate an orderly transition from IBORs and other benchmark rates to ARRs, we have established an enterprise-wide initiative led by senior management. The objective of this initiative is to identify, assess and monitor risks associated with the expected discontinuation or unavailability of benchmarks, including LIBOR, achieve operational readiness and engage impacted clients in connection with the transition to ARRs.To mitigate the risks associated with the expected discontinuation of LIBOR, we have ceased originating LIBOR-linked loans, implemented fallback language for LIBOR-linked commercial loans, adhered to the International Swaps and Derivatives Association 2020 Fallbacks Protocol for interest rate swap agreements, and have updated our systems to accommodate loans linked to the Secured Overnight Financing Rate ("SOFR"). In accordance with regulatory guidance, we ceased entering into new LIBOR transactions at the end of 2021 and have selected SOFR, as the rate that best represents an alternative to LIBOR. Uncertainty as to the adoption, market acceptance or availability of SOFR or other alternative reference rates may adversely affect the value of LIBOR-based loans and securities in our portfolio and may impact the availability and cost of hedging instruments and borrowings.

Financial Overview

For the years ended December 31, 2021 and 2020, we expanded our market area through continued organic growth, capitalizing on new customer relationships we obtained through our participation in the 2020 and 2021 PPP assistance.

•Total assets increased to $2.20 billion compared to $1.82 billion at December 31, 2021 and 2020, respectively, an increase of $381.4 million, or 20.9%. The increase in total assets is primarily attributable to our increase in deposits, which increased $351.3 million during 2021.

•Total loans, net of deferred fees, increased $37.8 million, or 2.6%, from December 31, 2020 to December 31, 2021. Excluding PPP loans, which decreased $124.8 million as a result of loan forgiveness, net loan growth was $162.6 million for the year ended December 31, 2021. Asset quality remains sound with nonperforming loans and loans past due 90 days or more as a percentage of total assets being 0.16% at December 31, 2021, compared to 0.31% at December 31, 2020.

•Total deposits increased $351.3 million, or 22.9%, from December 31, 2020 to December 31, 2021, the increase attributable to a combination of deposits from new customer relationships (many acquired through PPP originations) as well as growth in existing customer deposits.

•Tangible book value per share at December 31, 2021 was $14.70, an increase from $13.41 at December 31, 2020.

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•Net income was $21.9 million for the year ended December 31, 2021 compared to $15.5 million for the same period of 2020. Our 2021 results were impacted by merger-related expenses totaling $1.4 million, which were associated with our previously announced proposed merger with Blue Ridge Bankshares, Inc. ("Blue Ridge"), which was mutually terminated by us and Blue Ridge on January 20, 2022. We also recorded one-time accelerated debt issuance costs of $380 thousand associated with the redemption of our 2016 subordinated debt issuance during the third quarter of 2021 and a gain on the sale of other real estate owned ("OREO") of $236 thousand during the fourth quarter of 2021. Excluding the merger-related expenses, accelerated debt issuance costs and gain on OREO, we would have recorded net income of $23.2 million for the year ended December 31, 2021. Our 2020 results were impacted by branch closure charges totaling $676 thousand, and excluding these charges, we would have recorded $16.0 million in net income for the year ended December 31, 2020. For a reconciliation of this non-GAAP information which excludes the effect of merger-related expenses, accelerated debt issuance costs, gain on sale of OREO and the impairment from branch closures, please refer to the table below.

Reconciliation of Net Income (GAAP) to Operating Earnings (Non-GAAP)

Years Ended December 31, 2021 and 2020

(Dollars in thousands, except per share data)

Below shows selected financial data for the periods ended December 31, 2021 and 2020.

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Selected Financial Data

(Dollars and shares in thousands, except per share data)

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(1)Tangible book value is calculated as total stockholders' equity, less goodwill and other intangible assets, divided by common shares outstanding.

(2)Net interest margin is calculated as net interest income divided by total average earning assets.

(3)Efficiency ratio is calculated as total non-interest expense divided by the total of net interest income and non-interest income.

Results of Operations—Years Ended December 31, 2021 and December 31, 2020

Overview

We recorded net income of $21.9 million, or $1.50 per diluted common share, for the year ended December 31, 2021, compared to net income of $15.5 million, or $1.10 per diluted common share for the year ended December 31, 2020. Our 2021 results were impacted by merger-related expenses totaling $1.4 million. We also recorded one-time accelerated debt issuance costs of $380 thousand associated with our redemption of our 2016 subordinated debt issuance during the third quarter of 2021 and a gain on the sale of OREO of $236 thousand. Excluding the merger-related expenses, accelerated debt issuance costs and gain on OREO and their related tax effects, we would have recorded net income of $23.2 million, or $1.59 per diluted common share, for the year ended December 31, 2021. Our 2020 results were impacted by one-time branch closure costs of $676 thousand and increased provision for loan losses. Excluding the branch closure costs, we would have recorded income of $16.0 million, or $1.13 per diluted common share, for the year ended December 31, 2020. See above table for a reconciliation of GAAP net income to operating earnings (non-GAAP).

Net interest income increased $5.3 million to $57.9 million for the year ended December 31, 2021, compared to $52.6 million for the year ended December 31, 2020, primarily as a result of decreases in the costs of interest-bearing deposits. For the year ended December 31, 2021, we released provision for loan losses totaling $500 thousand, compared to recording provision expense of $5.0 million for the same period of 2020 which was elevated primarily as a result of qualitative factors related to the COVID-19 pandemic. Noninterest income increased $1.4 million to $4.3 million for the year ended December 31, 2021 as compared to $2.9 million for 2020, primarily attributable to the Bank's income associated with its investment in ACM, recording $1.5 million during the year ended December 31, 2021. Noninterest expense was $34.5 million for the year ended December 31, 2021 compared to $30.8 million for the same period of 2020. Noninterest expense increased during 2021 primarily as a result of merger-related expenses totaling $1.4 million and additions to business development staffing and associated increases in incentive accruals.

The return on average assets for the years ended December 31, 2021 and 2020 was 1.11% and 0.91%, respectively. The return on average equity for the years ended December 31, 2021 and 2020 was 10.92% and 8.48%, respectively. Excluding merger-related expenses, accelerated debt issuance costs, and gain on sale of OREO recorded during 2021, return on average assets and return on average equity would have been 1.17% and 11.53%, respectively. Excluding branch closure costs and the associated taxes recorded during 2020, return on average assets and return on average equity for the year ended December 31, 2020 would have been 0.94% and 8.77%, respectively. See above table for a reconciliation of GAAP net income to operating earnings (non-GAAP).

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Net Interest Income/Margin

The following table presents average balance sheet information, interest income, interest expense and the corresponding average yields earned and rates paid for the years ended December 31, 2021 and 2020.

Average Balance Sheets and Interest Rates on Interest-Earning Assets and Interest-Bearing Liabilities

Years Ended December 31, 2021 and 2020

(Dollars in thousands)

________________________

(1)Non-accrual loans are included in average balances and do not have a material effect on the average yield. Interest income on non-accruing loans was not material for the years presented.

(2)The average yields for investment securities are reported on a fully taxable-equivalent basis at a rate of 21% for 2021 and 2020.

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The level of net interest income is affected primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates. See "Quantitative and Qualitative Disclosures About Market Risk" below for further information. The following table shows the effect that these factors had on the interest earned from our interest-earning assets and interest incurred on our interest-bearing liabilities.

Rate and Volume Analysis

Years Ended December 31, 2021 and 2020

(Dollars in thousands)

_________________________

(1)Non-accrual loans are included in average balances and do not have a material effect on the average yield. Interest income on non-accruing loans was not material for the years presented.

(2)The average yields for investment securities are reported on a fully taxable-equivalent basis at a rate of 21% for 2021 and 2020.

(3)Changes attributable to rate/volume have been allocated to volume.

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Net interest income, on a tax equivalent basis, is a financial measure that we believe provides a more accurate picture of the interest margin for comparative purposes. To derive our net interest margin on a tax equivalent basis, net interest income is adjusted to reflect tax-exempt income on an equivalent before tax basis with a corresponding increase in income tax expense. For purposes of this calculation, we use our federal and state statutory tax rates for the periods presented. This measure ensures comparability of net interest income arising from taxable and tax-exempt sources.

The following table provides a reconciliation of our GAAP net interest income to our tax equivalent net interest income.

Supplemental Financial Data and Reconciliations to GAAP Financial Measures

Years Ended December 31, 2021 and 2020

(Dollars in thousands)

Net interest income for the year ended December 31, 2021 was $58.0 million on a fully taxable-equivalent basis, compared to $52.6 million for the year ended December 31, 2020, an increase of $5.3 million, or 10.1%. The increase in net interest income was primarily a result of a decrease in the cost of interest-bearing deposits, reflecting our efforts to decrease deposit rates in light of the current rate environment. During March 2020, in response to market conditions as the economy was impacted by COVID-19, the Federal Open Market Committee of the Federal Reserve reduced its targeted fed funds rate an unprecedented 150 basis points. We responded quickly by reducing deposit rates substantially to offset the repricing of the variable rate portion of our loan portfolio. During 2021, we continued to review interest rates on deposits and other borrowed funds and reduced rates where possible.

Our net interest margin, on a tax equivalent basis, for the years ended December 31, 2021 and 2020 was 3.09% and 3.28%, respectively. The decrease in our net interest margin was primarily a result of the decreased rate environment during 2021, which decreased the yields on interest-earning assets, partially offset by our decrease in the cost of our interest-bearing liabilities.

The yield on interest-earning assets decreased 53 basis points to 3.65% for the year ended December 31, 2021, compared to 4.18% for the same period of 2020, a result of the decreased rate environment during 2021. In addition, our excess liquidity, which was caused by the increase in our deposits and PPP forgiveness, contributed to the reduction of our net interest margin an additional 12 basis points for 2021. Offsetting this decrease in yields on earning assets was a 45 basis point decrease in the cost of interest-bearing liabilities, reflecting the decreases in rates we made to help offset the decreased yields on our earning assets during 2021.

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Average interest-earning assets increased by 16.6% to $1.87 billion at December 31, 2021 compared to $1.61 billion at December 31, 2020, which resulted in an increase in total interest income on a tax equivalent basis of $1.3 million, to $68.4 million for the year ended December 31, 2021 compared to $67.1 million for the year ended December 31, 2020. While volume increased during 2021, contributing $4.8 million in additional interest income, the decreases in average rate significantly impacted interest income earned, decreasing interest income by $3.5 million.

Average loans receivable increased $47.4 million to $1.46 billion for the year ended December 31, 2021, compared to $1.42 billion for the year ended December 31, 2020. The yield on average loans decreased 9 basis points to 4.37% for the year ended December 31, 2021. The increase in average volume of loans receivable contributed $2.4 million to interest income. However, the increase in interest income on loans was impacted by a decrease in yields earned on the loan portfolio, which decreased interest income $1.7 million. Average balances of nonperforming loans, which consist of nonaccrual loans, are included in the net interest margin calculation and did not have a material impact on our net interest margin in 2021 and 2020.

Average investment securities increased $84.9 million to $205.0 million for the year ended December 31, 2021, compared to $120.1 million for the year ended December 31, 2020. The significant increase in average investment securities was primarily a result of the increase in liquidity at the Bank as a result of PPP loan forgiveness and an increase in deposits during 2021. This excess liquidity was invested in fixed income securities which increased interest income $693 thousand on a tax equivalent basis for the year ended December 31, 2021. The yield on average investment securities decreased 76 basis points to 1.89% for the year ended December 31, 2021, primarily as a result of purchasing securities at lower average yields relative to the average yield of the portfolio.

Average interest-earning deposits at other financial institutions, consisting primarily of excess cash reserves maintained at the FRB, increased $137.4 million to $198.0 million for the year ended December 31, 2021, compared to $60.6 million for the year ended December 31, 2020. The significant increase in average was primarily a result of our deposit growth during 2021. The yield on average interest-earning deposits decreased 12 basis points to 0.13% for the year ended December 31, 2021.

Total average interest-bearing deposits increased $111.7 million to $1.16 billion at December 31, 2021 compared to $1.05 billion at December 31, 2020. Average noninterest-bearing deposits increased $137.0 million, or 35.1%, to $527.7 million at December 31, 2021, compared to $390.7 million at December 31, 2020. The increase in total deposits, and specifically noninterest-bearing deposits, reflects a combination of new customer relationships (primarily from PPP originations) as well as growth in average deposit balances from existing customers. The largest increase in average interest-bearing deposit balances was in our interest checking accounts, which increased $223.7 million compared to 2020. Average time deposits decreased $87.2 million to $230.7 million as of December 31, 2021 compared to $317.9 million at December 31, 2020, as customers now prefer short-term deposit options such as interest checking accounts as a result of the low interest rate environment. Average wholesale deposits decreased $63.2 million to $37.7 million as of December 31, 2021 compared to $100.9 million as of December 31, 2020, as we have been able to reduce our reliance on wholesale funding due to other core sources of liquidity. This change in the mix of our interest-bearing liabilities, in addition to the action taken by the Bank to reduce deposit rates during 2020 and 2021, have contributed to the decrease in our cost of interest-bearing deposits to 0.66% in 2021 from 1.18% in 2020.

The cost of other borrowed funds, which include federal funds purchased, FHLB advances, and our subordinated notes, increased 87 basis points to 4.58% for the year ended December 31, 2021, from 3.71% for the same period in 2020, a result of the subordinated debt we issued during the fourth quarter of 2020 at 4.88% and the recognition of accelerated debt issuance costs of $380 thousand recorded during 2021.

Provision Expense and Allowance for Loan Losses

Our policy is to maintain the allowance for loan losses at a level that represents our best estimate of inherent losses in the loan portfolio. Both the amount of the provision and the level of the allowance for loan losses are impacted by many factors, including general and industry-specific economic conditions, actual credit losses, historical trends and specific conditions of individual borrowers. We are not required to implement the provisions of CECL until January 1, 2023, and we are continuing to account for the allowance for losses under the incurred loss model.

We recorded a release of provision for loan losses of $500 thousand for the year ended December 31, 2021 compared to a provision for loan losses of $5.0 million for the same period of 2020. The allowance for loan losses at December 31, 2021 was $13.8 million compared to $15.0 million at December 31, 2020. Our allowance for loan loss ratio as a percent of

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total loans, net of deferred fees and costs, for December 31, 2021 and 2020 was 0.92% and 1.02%, respectively. The decrease in provision for loan losses during 2021 as compared to 2020 primarily reflects changes in certain qualitative factors as a result of the improvement in local economic conditions and the credit quality metrics of our loan portfolio during 2021 as well as a reduction in specific reserves on impaired loans. During 2021, we continued to evaluate our exposure to certain credit risks within industry segments in our loan portfolio that are most impacted by the pandemic and for those loans that have deferred payments. Industry subgroups such as retail, hotels, churches, and other commercial real estate loans were isolated within our allowance model, in addition to those loans deferring payments, and qualitative factors were adjusted to increase reserves for these loans as a result of their risk profiles during 2020. As a result of the improvement in the performance of these pandemic impacted loans, we eliminated the additional reserves recorded for these loans during 2021. Specific reserves decreased $1.9 million to $186 thousand for the year ended December 31, 2021, compared to $2.1 million at December 31, 2020, as a result of the impairment analysis completed for impaired loans during 2021.

See "Asset Quality" section below for additional information on the credit quality of the loan portfolio.

Noninterest Income

The following table provides detail for non-interest income for the years ended December 31, 2021 and 2020.

Non-Interest Income

Years Ended December 31, 2021 and 2020

(Dollars in thousands)

Noninterest income includes service charges on deposits and loans, loan swap fee income, income from our membership interest in ACM, income from our BOLI policies, and other fee income, and continues to supplement our operating results. Noninterest income for the years ended December 31, 2021 and 2020 was $4.3 million and $2.9 million, respectively, an increase of $1.4 million, or 48.8%. The increase in noninterest income for the year ended December 31, 2021 was primarily attributable to the Bank's income associated with its investment in ACM, recording $1.5 million during 2021. Fee income from service charges on deposits and other fee income was $1.7 million for the year ended December 31, 2021, an increase of 9.7%, as compared $1.6 million for the same period of 2020, primarily a result of an increase in customer deposit relationships over the past year. There were no loan swap fees for the year ended December 31, 2021 compared to $378 thousand for the year ended December 31, 2020. Income from BOLI decreased 10.4% to $994 thousand for the year ended December 31, 2021 as compared to $1.1 million for the year ended December 31, 2020. Noninterest income for the year ended December 31, 2020 included gains on the sale of securities available-for-sale totaling $141 thousand. These securities were sold as they had larger premiums susceptible to prepayment risk, decreasing future interest income. There were no gains on security sales during 2021. Noninterest income for 2020 were impacted by losses on loans held for sale totaling $451 thousand. Loans held for sale were comprised of consumer unsecured loans which were transferred to held for sale at the end of 2019. On April 1, 2020, we transferred these loans back to held for investment at the lower of cost or market as the market for these types of loans receded due to market volatility as a result of the COVID-19 pandemic.

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Noninterest Expense

The following table reflects the components of non-interest expense for the years ended December 31, 2021 and 2020.

Non-Interest Expense

Years Ended December 31, 2021 and 2020

(Dollars in thousands)

Noninterest expense includes, among other things, salaries and benefits, occupancy and equipment costs, professional fees, data processing, insurance and miscellaneous expenses. Noninterest expense was $34.5 million and $30.8 million for the years ended December 31, 2021 and 2020, respectively, an increase of $3.7 million, or 12.0%.

Salaries and benefits expense increased $2.2 million to $19.0 million for the year ended December 31, 2021 compared to $16.8 million for the same period in 2020, which was primarily related to additions to business development staff and associated accruals for incentive compensation during 2021. Merger-related expenses associated with our proposed merger totaled $1.4 million for the year ended December 31, 2021. Audit, legal and consulting fees increased $503 thousand to $1.5 million for the year ended December 31, 2021 as compared to the same period of 2020, primarily as a result of expenses incurred as a result of our membership interest purchase of ACM. Offsetting a portion of these increases is recorded gains of $236 thousand related to our sale of our OREO property during the fourth quarter of 2021.

During the third quarter of 2020, we closed two branch office locations. Because of the COVID-19 pandemic, more clients have transitioned to our electronic banking products, reducing the need to have physical branch locations to serve our customers. The right-of-use assets and leasehold improvements written off as a result of closing these locations totaled $676 thousand. Annual costs savings for the closure of these locations related to occupancy expense is expected to be approximately $350 thousand, of which, we began to see a portion of those cost savings during the fourth quarter of 2020, which contributed to the decrease in occupancy expense year-over-year. Other savings of approximately $250 thousand

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include salaries and benefits expense as the employees for each of these locations filled other vacant positions with the Bank, reducing the need to hire additional personnel.

Income Taxes

We recorded a provision for income tax expense of $6.3 million for the year ended December 31, 2021, an increase of $2.1 million, or 51.0%, compared to $4.2 million for the year ended December 31, 2020. Our effective tax rate for December 31, 2021 was 22.2%, compared to 21.1% for 2020. Our effective tax rate for 2021 is more than the statutory rate of 21% as a result of nondeductible merger expenses recorded during 2021.

Discussion and Analysis of Financial Condition

Overview

At December 31, 2021, total assets were $2.20 billion, an increase of 20.9%, or $381.4 million, from $1.82 billion at December 31, 2020. Total loans receivable, net of deferred fees and costs, increased 2.6%, or $37.8 million, to $1.50 billion at December 31, 2021, from $1.47 billion at December 31, 2020. Total investment securities increased by $231.6 million, or 183.2%, to $358.0 million at December 31, 2021, from $126.4 million at December 31, 2020. Total deposits increased 22.9%, or $351.3 million, to $1.88 billion at December 31, 2021, from $1.53 billion at December 31, 2020. From time to time, we may utilize other borrowed funds such as federal funds purchased and FHLB advances as an additional funding source for the Bank. The Bank had FHLB advances outstanding of $25.0 million at each of December 31, 2021 and 2020. At December 31, 2021, we had $19.5 million in subordinated notes, a decrease of $24.6 million, as we redeemed in full our 2016 issuance of subordinated debt totaling $25.0 million on September 30, 2021.

Loans Receivable, Net

Total loans receivable, net of deferred fees and costs, were $1.50 billion at December 31, 2021, an increase of $37.8 million, or 2.6%, compared to $1.47 billion at December 31, 2020. Excluding PPP loans, which decreased $124.8 million as a result of loan forgiveness, net loan growth was $162.6 million for the year ended December 31, 2021. During the second quarter of 2021, we began originating loans under a warehouse lending facility to ACM, which contributed $72.0 million to our loan growth during 2021.

PPP loans, net of deferred fees and costs, totaled $28.1 million at December 31, 2021, a decrease from $153.0 million at December 31, 2020. Loans forgiven during 2021 totaled $193.3 million. Net deferred fees associated with PPP loans totaled $568 thousand at December 31, 2021.

Commercial real estate loans totaled $906.1 million at December 31, 2021, or 60.1% of total loan receivable, compared to $790.0 million at December 31, 2020, an increase of $116.1 million, or 14.7%. Owner-occupied commercial real estate loans were $191.8 million at December 31, 2021 compared to $182.9 million at December 31, 2020. Nonowner-occupied commercial real estate loans were $714.3 million at December 31, 2021 compared to $607.5 million at December 31, 2020. Construction loans totaled $187.6 million at December 31, 2021, or 12.5% of total loans receivable. Of the $187.6 million in construction loans, $47.6 million are collateralized by land, and lot acquisition and development loans (which have a higher degree of credit risk than the remaining portion of the construction portfolio) totaled $5.0 million at December 31, 2021. Our commercial real estate portfolio, including construction loans, is diversified by asset type and geographic concentration. We plan to manage this portion of our portfolio in a disciplined manner. We have comprehensive policies to monitor, measure, and mitigate our loan concentrations within this portfolio segment, including rigorous credit approval, monitoring and administrative practices.

Commercial and industrial loans, excluding PPP loans, increased $54.5 million to $174.1 million at December 31, 2021, from $119.5 million at December 31, 2020. Consumer residential loans increased $32.7 million to $200.6 million at December 31, 2021, from $167.9 million at December 31, 2020, the increase primarily a result of ACM warehouse lending facility activity, which is secured by individual real estate loans. These loans are repurchased by ACM if not sold to ultimate investor within 60 days of settlement.

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The following table sets forth the repricing characteristics and sensitivity to interest rate changes of our loan portfolio at December 31, 2021.

Loan Maturities and Interest Rate Sensitivity

At December 31, 2021

(Dollars in thousands)

________________________

*Payments due by period are based on the repricing characteristics and not contractual maturities.

Asset Quality

Nonperforming assets, defined as nonaccrual loans, loans contractually past due 90 days or more as to principal or interest and still accruing, and OREO at December 31, 2021 were $3.5 million compared to $9.5 million at December 31, 2020. Our ratio of nonperforming assets to total assets was 0.16% at December 31, 2021 compared to 0.52% at December 31, 2020. TDRs, as of December 31, 2021 and 2020 totaled $92 thousand and $97 thousand, respectively.

Nonperforming loans, which are primarily commercial real estate and commercial and industrial loans, decreased $2.1 million during 2021 as compared to 2020. Loans that we have classified as nonperforming are a result of customer specific deterioration, mostly financial in nature, and not a result of economic, industry, or environmental causes that we might see as a pattern for possible future losses within our loan portfolio. For each of our criticized assets, we conduct an impairment analysis to determine the level of additional or specific reserves required for any portion of the loan that may result in a loss. As a result of the analysis completed, we have specific reserves totaling $186 thousand and $2.1 million at December 31, 2021 and 2020, respectively. Because these loans are individually evaluated for impairment, nonperforming loans are excluded from the general reserve allocation.

We categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, collateral adequacy, credit documentation, and current economic trends, among other factors. We analyze loans individually by classifying the loans as to credit risk. This analysis includes, larger non-homogeneous loans such as commercial real estate and commercial and industrial loans. This analysis is performed on an ongoing basis as new information is obtained. At December 31, 2021, we had $3.0 million in loans identified as special mention within the originated loan portfolio, a decrease of $9.1 million from December 31, 2020. Special mention rated loans are loans that have a potential weakness that deserves management's close attention; however, the borrower continues to pay in accordance with their contract. The decrease from December 31, 2020 is a result of a significant number of loans being either upgraded or having been paid off during 2021. These loans do not have a specific reserve and are considered well-secured.

At December 31, 2021, we had $19.0 million in loans identified as substandard within the originated loan portfolio, an increase of $1.9 million from December 31, 2020. Substandard rated loans are loans that are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. For each of these substandard loans, a liquidation analysis is completed. At December 31, 2021, specific reserves on originated and acquired loans totaling $186 thousand, have been allocated within the allowance for loan losses to supplement any shortfall of collateral.

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We recorded annualized net charge-offs of 0.04% and 0.02% for the years ended December 31, 2021 and 2020, respectively. The following tables provide additional information on our asset quality for the periods presented.

Nonperforming Assets

At December 31, 2021 and 2020

(Dollars in thousands)

At December 31, 2021 and 2020, there were no performing loans considered a potential problem loan. Potential problem loans are defined as loans that are not included in the 90 day past due, nonaccrual or adversely classified or restructured categories, but for which known information about possible credit problems causes management to be uncertain as to the ability of the borrowers to comply with the present loan repayment terms which may in the future result in disclosure in the past due, nonaccrual or restructured loan categories. We take a conservative approach with respect to risk rating loans in our portfolio. Based upon the status as a potential problem loan, these loans receive heightened scrutiny and ongoing intensive risk management. Additionally, our loan loss allowance methodology incorporates increased reserve factors for certain loans that are adversely rated but not impaired as compared to the general portfolio.

We have evaluated our exposure to credit risks directly related to the COVID-19 pandemic. During 2020, as a result of the COVID-19 pandemic, we implemented loan payment deferral programs to allow customers who were required to close or reduce business operations to defer loan principal and interest payments primarily for 90 days. During the first and second quarters of 2020, we modified 277 loans for a total outstanding principal balance of $360.2 million, or 24.4% of the total loan portfolio. At December 31, 2021, remaining payment deferred loans totaled $10.6 million, or 0.71% of the total loan portfolio, comprising two loans. One loan is a hotel participation loan totaling $9.7 million and the second is a commercial real estate mixed use loan totaling $955 thousand.

We believe that as a result of our conservative underwriting discipline at loan origination coupled with the active dialogue we have had with our borrowers, we have the ability and necessary flexibility to assist our customers through this pandemic.

At December 31, 2020, we had one OREO property with a fair value of $3.9 million. In 2021, we sold this property and recognized a gain of approximately $236,000.

While our loan growth has continued to be strong, unexpected changes in economic growth could adversely affect our loan portfolio, including causing increases in delinquencies and default rates, which would adversely impact our charge-offs and provision for loan losses. Deterioration in real estate values, employment data and household incomes may also result in higher credit losses for us. Also, in the ordinary course of business, we may also be subject to a concentration of credit risk to a particular industry, counterparty, borrower or issuer. At December 31, 2021, our commercial real estate portfolio (including construction lending) was 72.6% of our total loan portfolio. A deterioration in the financial condition or prospects of a particular industry or a failure or downgrade of, or default by, any particular entity or group of entities could negatively impact our business, perhaps materially, and the systems by which we set limits and monitor the level of our credit exposure to individual entities and industries, may not function as we have anticipated.

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See "Critical Accounting Policies" above for more information on our allowance for loan losses methodology.

The following tables present additional information pertaining to the activity in and allocation of the allowance for loan losses by loan type and the percentage of the loan type to the total loan portfolio. The allocation of the allowance for loan losses to a category of loans is not necessarily indicative of future losses or charge-offs, and does not restrict the use of the allowance to any specific category of loans.

Allowance for Loan Losses

Years Ended December 31, 2021 and 2020

(Dollars in thousands)

Allocation of the Allowance for Loan Losses

At December 31, 2021 and 2020

(Dollars in thousands)

___________________

*Percentage of loan type to the total loan portfolio.

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Investment Securities

Our investment securities portfolio is used as a source of income and liquidity. The investment portfolio consists of investment securities available-for-sale and investment securities held-to-maturity. Investment securities available-for-sale are those securities that we intend to hold for an indefinite period of time, but not necessarily until maturity. These securities are carried at fair value and may be sold as part of an asset/liability strategy, liquidity management or regulatory capital management. Investment securities held-to-maturity were $264 thousand at each of December 31, 2021 and 2020, and are those securities that we have the intent and ability to hold to maturity and are carried at amortized cost. The fair value of our investment securities available-for-sale was $357.8 million at December 31, 2021, an increase of $231.6 million, or 183.6%, from $126.2 million at December 31, 2020. During 2021, we purchased $245.7 million in available-for-sale investment securities to invest excess liquidity and reinvest cashflows received from the investment portfolio and PPP forgiveness.

As of December 31, 2021 and 2020, the majority of the investment securities portfolio consisted of securities rated AAA by a leading rating agency. Investment securities that carry a AAA rating are judged to be of the best quality and carry the smallest degree of investment risk. All of our mortgage-backed securities are guaranteed by either the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, or the Government National Mortgage Association. Investment securities that were pledged to secure public deposits totaled $85.6 million and $9.2 million at December 31, 2021 and December 31, 2020, respectively.

We complete reviews for other-than-temporary impairment at least quarterly. At December 31, 2021 and December 31, 2020, only investment grade securities were in an unrealized loss position. Investment securities with unrealized losses are a result of pricing changes due to recent and negative conditions in the current market environment and not as a result of permanent credit impairment. Contractual cash flows for the agency mortgage-backed securities are guaranteed and/or funded by the U.S. government. Municipal securities have third party protective elements and there are no negative indications that the contractual cash flows will not be received when due. We do not intend to sell nor do we believe we will be required to sell any of our temporarily impaired securities prior to the recovery of the amortized cost.

No other-than-temporary impairment has been recognized for the securities in our investment portfolio as of December 31, 2021, and December 31, 2020.

We hold restricted investments in equities of the FRB and FHLB. At December 31, 2021, we owned $1.8 million in FHLB stock and $4.4 million in FRB stock. At December 31, 2020, we owned $2.4 million in FHLB stock and $4.0 million in FRB stock.

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The following table presents the weighted average yields of our investment portfolio for each of the maturity ranges at December 31, 2021 and 2020.

Investment Securities by Stated Maturity

At December 31, 2021 and 2020

(Dollars in thousands)

Deposits and Other Borrowed Funds

The following table sets forth the average balances of deposits and the percentage of each category to total average deposits for the years ended December 31, 2021 and 2020:

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Total deposits were $1.88 billion at December 31, 2021, an increase of $351.3 million, or 22.9%, from $1.53 billion at December 31, 2020. Noninterest-bearing deposits totaled $581.3 million at December 31, 2021, comprising 30.9% of total deposits and increased $182.2 million, or 45.7%, compared to December 31, 2020. The increase in total deposits during 2021 reflects a combination of new customer relationships (including those new customers we assisted in their PPP loan originations) as well as growth in deposit balances from existing customers.

Wholesale deposits decreased to $35.0 million at December 31, 2021, from $50.0 million at December 31, 2020. In addition, we are a member of the IntraFi Network ("IntraFi"), which gives us the ability to offer Certificates of Deposit Account Registry Service ("CDARS"), and Insured Cash Sweep ("ICS"), products to our customers who seek to maximize FDIC insurance protection. When a customer places a large deposit with us for IntraFi, funds are placed into certificates of deposit or other deposit products with other banks in the CDARS and ICS networks in increments of less than $250 thousand so that principal and interest are eligible for FDIC insurance protection. These deposits are part of our core deposit base. At December 31, 2021 and December 31, 2020, we had $186.0 million and $138.9 million, respectively, in either CDARS reciprocal or ICS reciprocal products. The increase from December 31, 2020 is a result of certain customers wanting additional FDIC insurance protection as a result of the pandemic in addition to increases in customer deposit activity in these products.

As of December 31, 2021 and 2020, the estimated amount of total uninsured deposits were $901.1 million and $653.2 million, respectively. The estimate of uninsured deposits generally represents the portion of deposit accounts that exceed the FDIC insurance limit of $250,000 and is calculated based on the same methodologies and assumptions used for purposes of the Bank's regulatory reporting requirements. The following table reports maturities of the estimated amount of uninsured certificates of deposit at December 31, 2021.

Certificates of Deposit Greater than $250,000

At December 31, 2021

(Dollars in thousands)

Other borrowed funds, which include federal funds purchased, FHLB advances, and our subordinated notes, were $44.5 million at December 31, 2021, and $69.1 million at December 31, 2020. For each of December 31, 2021 and 2020, we had $25.0 million in FHLB advances. Subordinated debt, net of unamortized issuance costs, totaled $19.5 million and $44.1 million at December 31, 2021 and 2020, respectively. For each of December 31, 2021 and 2020, we had no federal funds purchased.

At September 30, 2021, we redeemed our 2016 subordinated debt which totaled $25.0 million. As such, our subordinated debt at December 31, 2021 decreased to $19.5 million from $44.1 million at December 31, 2020.

On October 13, 2020, we completed our private placement of $20 million of our 4.875% fixed-to-floating rate subordinated notes due 2030 to certain qualified institutional buyers and accredited investors. The Notes have a maturity date of October 15, 2030 and carry a fixed rate of interest of 4.875% for the first five years. Thereafter, the Notes will pay interest at 3-month SOFR plus 471 basis points, resetting quarterly. The Notes include a right of prepayment without penalty on or after October 15, 2025. The Notes have been structured to qualify as Tier 2 capital for regulatory purposes. We have used the proceeds from the placement of the Notes for general corporate purposes, including to support our capital ratios at the Bank, and the repayment of our $25.0 million outstanding subordinated debt which was called on September 30, 2021.

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Capital Resources

Capital adequacy is an important measure of financial stability and performance. Our objectives are to maintain a level of capitalization that is sufficient to sustain asset growth and promote depositor and investor confidence.

Regulatory agencies measure capital adequacy utilizing a formula that takes into account the individual risk profile of the financial institution. The minimum capital requirements are: (i) CET1 capital ratio of 4.5%; (ii) a Tier 1 to risk-based assets capital ratio of 6%; (iii) a total risk based capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. Additionally, a capital conservation buffer requirement of 2.5% of risk-weighted assets is designed to absorb losses during periods of economic stress and is applicable to our CET1 capital, Tier 1 capital and total capital ratios. Including the conservation buffer, we currently consider our minimum capital ratios to be as follows: 7.00% for CET1; 8.50% for Tier 1 capital; and 10.50% for Total capital. Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the minimum plus the conservation buffer will face constraints on dividends, equity repurchases, and compensation.

On January 1, 2020, the federal banking agencies adopted a CBLR, which is calculated by dividing tangible equity capital by average consolidated total assets. If a "qualified community bank," generally a depository institution or depository institution holding company with consolidated assets of less than $10 billion, opts into the CBLR framework and has a leverage ratio that exceeds the CBLR threshold, which was initially set at 9%, then such bank will be considered to have met all generally applicable leverage and risk based capital requirements under Basel III, the capital ratio requirements for "well capitalized" status under Section 38 of the FDIA, and any other leverage or capital requirements to which it is subject. A bank or holding company may be excluded from qualifying community bank status base on its risk profile, including consideration of its off-balance sheet exposures; trading assets and liabilities; total notional derivatives exposures and such other facts as the appropriate federal banking agencies determine to be appropriate.

At January 1, 2020, we qualified for and adopted this simplified capital structure, however, there can be no assurance that satisfaction of the CBLR will provide adequate capital for our operations and growth, or an adequate cushion against increased levels of nonperforming assets or weakened economic conditions.

Stockholders' equity at December 31, 2021 was $209.8 million, an increase of $20.3 million, compared to $189.5 million at December 31, 2020. The increase in stockholders' equity was primarily attributable to the recognition of net income of $21.9 million for the year ended December 31, 2021. Common stock issued as a result of option exercises increased stockholders' equity by $1.2 million for the year ended December 31, 2021. Accumulated other comprehensive income (loss) decreased $3.9 million during 2021, primarily as a result of a decrease in the market value of our available-for-sale investment securities portfolio.

Total stockholders' equity to total assets for December 31, 2021 was 9.52% and for December 31, 2020 was 10.4%. Tangible book value per shares (a non-GAAP financial measure which is defined in the table below) at December 31, 2021 and December 31, 2020 was $14.70 and $13.41, respectively. The Bank's CBLR at December 31, 2021 and 2020 was 10.53% and 11.65%, respectively. Accordingly, we were considered "well capitalized" for regulatory purposes at December 31, 2021 and December 31, 2020.

As noted above, regulatory capital levels for the bank meets those established for "well capitalized" institutions. While we are currently considered "well capitalized," we may from time to time find it necessary to access the capital markets to meet our growth objectives or capitalize on specific business opportunities.

As the Company is a bank holding company with less than $3 billion in assets, and which does not (i) conduct significant off balance sheet activities, (ii) engage in significant non-banking activities, and (iii) have a material amount of securities registered under the Securities Exchange Act of 1934 (the "Exchange Act"), it is not currently subject to risk-based capital requirements adopted by the Federal Reserve, pursuant to the small bank holding company policy statement. The Federal Reserve has not historically deemed a bank holding company ineligible for application of the small bank holding company policy statement solely because its common stock is registered under the Exchange Act. There can be no assurance that the Federal Reserve will continue this practice.

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The following tables shows the minimum capital requirement and our capital position at December 31, 2021 and December 31, 2020 for the Bank.

Capital Components

At December 31, 2021 and 2020

(Dollars in thousands)

Reconciliation of Book Value (GAAP) to Tangible Book Value (non-GAAP)

At December 31, 2021 and 2020

(Dollars in thousands, except per share data)

Liquidity

Liquidity in the banking industry is defined as the ability to meet the demand for funds of both depositors and borrowers. We must be able to meet these needs by obtaining funding from depositors or other lenders or by converting non-cash items into cash. The objective of our liquidity management program is to ensure that we always have sufficient resources to meet the demands of our depositors and borrowers. Stable core deposits and a strong capital position provide the base for our liquidity position. We believe we have demonstrated our ability to attract deposits because of our convenient branch locations, personal service, technology and pricing.

In addition to deposits, we have access to the different wholesale funding markets. These markets include the brokered certificate of deposit market and the federal funds market. We are a member of the IntraFi Network, which allows banking customers to access FDIC insurance protection on deposits through our Bank which exceed FDIC insurance limits. We also have one-way authority with IntraFi for both their CDARs and ICS products which provides the Bank the ability to access additional wholesale funding as needed. We also maintain secured lines of credit with the FRB and the FHLB for which we can borrow up to the allowable amount for the collateral pledged. Having diverse funding alternatives reduces our reliance on any one source for funding.

Cash flow from amortizing assets or maturing assets also provides funding to meet the needs of depositors and borrowers.

We have established a formal liquidity contingency plan which establishes a liquidity management team and provides guidelines for liquidity management. For our liquidity management program, we first determine our current liquidity position and then forecast liquidity based on anticipated changes in the balance sheet. In this forecast, we expect to maintain a liquidity cushion. We also stress test our liquidity position under several different stress scenarios, from moderate to severe. Guidelines for the forecasted liquidity cushion and for liquidity cushions for each stress scenario have been established. We believe that we have sufficient resources to meet our liquidity needs.

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Our primary and secondary sources of liquidity remain strong. Liquid assets, which include cash and due from banks, federal funds sold and investment securities available for sale, totaled $598.7 million at December 31, 2021, or 27.2% of total assets, an increase from $267.2 million, or 14.7%, at December 31, 2020. To maintain ready access to the Bank's secured lines of credit, the Bank has pledged a portion of its commercial real estate and residential real estate loan portfolios to the FHLB and FRB. Additional borrowing capacity at the FHLB at December 31, 2021 was approximately $127.6 million. Borrowing capacity with the FRB was approximately $77.4 million at December 31, 2021. These facilities are subject to the FHLB and the FRB approving disbursement to us. We also have unsecured federal funds purchased lines of $265.0 million available to us. We anticipate maintaining liquidity at a level sufficient to protect depositors as we endure through this pandemic, provide for reasonable growth, and fully comply with all regulatory requirements.

Liquidity is essential to our business. Our liquidity could be impaired by an inability to access the capital markets or by unforeseen outflows of cash, including deposits. This situation may arise due to circumstances that we may be unable to control, such as general market disruption, negative views about the financial services industry generally, or an operational problem that affects a third party or us. Our ability to borrow from other financial institutions on favorable terms or at all could be adversely affected by disruptions in the capital markets or other events. While we believe we have a healthy liquidity position and do not anticipate the loss of deposits of any of the significant deposit customers, any of the factors discussed above could materially impact our liquidity position in the future.

Financial Instruments with Off-Balance-Sheet Risk and Credit Risk

We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet.

The Bank's maximum exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. We evaluate each customer's credit worthiness on a case-by-case basis and require collateral to support financial instruments when deemed necessary. The amount of collateral obtained upon extension of credit is based on management's evaluation of the counterparty. Collateral held varies but may include deposits held by us, marketable securities, accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates up to one year or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. These instruments represent obligations to extend credit or guarantee borrowings and are not recorded on the consolidated statements of financial condition. The rates and terms of these instruments are competitive with others in the market in which we do business.

Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. Those lines of credit may not be drawn upon to the total extent to which we have committed.

Standby letters of credit are conditional commitments we issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. We hold certificates of deposit, deposit accounts, and real estate as collateral supporting those commitments for which collateral is deemed necessary.

With the exception of these off-balance sheet arrangements, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, results of operations, changes in financial condition, revenue, expenses, capital expenditures, or capital resources, that is material to the business of the Company.

At December 31, 2021 and December 31, 2020, unused commitments to fund loans and lines of credit totaled $183.1 million and $166.3 million, respectively. Commercial and standby letters of credit totaled $8.9 million and $5.5 million at December 31, 2021 and December 31, 2020, respectively.

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