FVCBankcorp, Inc. (FVCB) FY 2023 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, 2023 and 2022 and the results of our operations for the years ended December 31, 2023 and 2022. 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. 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 December 15, 2022, the Company announced that the Board of Directors approved a five-for-four split of the Company's common stock in the form of a 25% stock dividend for shareholders of record on January 9, 2023, payable on January 31, 2023. Earnings per share and all other per share information reflected herein have been adjusted for the five-for-four split of the Company's common stock for comparative purposes.

Net interest income is our primary source of revenue. We define revenue as net interest income plus non-interest income. 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, non-interest 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.

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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 credit losses - loans & reserve for unfunded commitments, allowance for credit losses - securities, and fair value measurements.

Allowance for Credit Losses - Loans & Unfunded Commitments

We maintain the allowance for credit losses ("ACL") at a level that represents management’s best estimate of expected losses in our loan portfolio. We adopted the provisions of the CECL accounting standard as of January 1, 2023 in accordance with the required implementation date and recorded the impact of the adoption to retained earnings, net of deferred income taxes, as required by the standard. Prior to the adoption of CECL, we utilized an incurred loss model to derive our best estimate of the ACL.

Accounting Standards Codification ("ASC") 326 requires that an estimate of CECL be immediately recognized and reevaluated over the contractual life of the financial asset. The ACL is a valuation account that is deducted from the amortized cost basis of loans to present the net amount expected to be collected on the loan portfolio. Loans, or portions thereof, are charged off against the ACL when they are deemed uncollectible. Expected recoveries are recorded to the extent they do not exceed the aggregate of amounts previously and expected to be charged-off.

Reserves on loans that do not share risk characteristics are evaluated on an individual basis. Nonaccrual loans are specifically reviewed for loss potential and when deemed appropriate are assigned a reserve based on an individual evaluation. The remainder of the portfolio, representing all loans not evaluated individually for impairment, is segmented based on call report code and processed through a cash flow valuation model. In particular, loan-level probability of default ("PD") and severity (also referred to as loss given default ("LGD")) is applied to derive a baseline expected loss as of the valuation date. These expected default and severity rates, which are regression-derived and based on peer historical loan-level performance data, are calibrated to incorporate our reasonable and supportable forecast of future losses as well as any necessary qualitative adjustments.

Typically, financial institutions use their historical loss experience and trends in losses for each loan segment which are then adjusted for portfolio trends and economic and environmental factors in determining the ACL. Since the Bank’s inception in 2007, we have experienced minimal loss history within our loan portfolio. Due to the fact that limited internal loss history exists to generate statistical significance, we determined it was most prudent to rely on peer data when deriving our best estimate of PD and LGD. As part of our estimation process, we will continue to assess the reasonableness of the data, assumptions, and model methodology utilized to derive our allowance for credit losses.

For each of the modeled loan segments, we generate cash flow projections at the instrument level wherein payment expectations are adjusted for estimated prepayment speeds, PD rates, and LGD rates. The modeling of expected prepayment speeds is based on internal loan-level historical data. For our cash flow model, we utilize national unemployment for reasonable and supportable forecasting of expected default. To further adjust the ACL for expected losses not already within the quantitative component of the calculation, we may consider qualitative factors as prescribed in ASC 326.

Financial instruments include off-balance sheet credit instruments such as commitments to make loans and commercial letters of credit issued to meet customer financing needs. Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the contractual amount of those instruments. Such financial instruments are recorded when they are funded. We record a reserve for unfunded commitments on off-balance sheet credit exposures through a charge to provision for credit loss expense in our Consolidated Statement of Income. The reserve for unfunded commitments is estimated by call report code segmentation as of the valuation date under the CECL model using the same methodologies as portfolio loans taking utilization rates into consideration. The reserve for unfunded commitments is reflected as a liability on our Consolidated Statement of Condition.

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While our methodology in establishing the ACL attributes portions of a combined reserve to multiple elements, we believe that the combined allowance of credit losses (which is inclusive of the reserve for unfunded commitments) represents the most appropriate coverage metric for loss absorption purposes.

Our methodology utilized in the estimation of the ACL, which is performed at least quarterly, is designed to be dynamic and responsive to changes in our loan portfolio credit quality, composition, and forecasted economic conditions. The review of the reasonableness and appropriateness of the ACL is reviewed by the ACL Committee for approval as of the valuation date. Additionally, information is provided to the Board of Directors on a quarterly basis along with our consolidated financial statements.

Credit losses are an inherent part of our business and, although we believe the methodologies for determining the ACL and the current level of the allowance and reserve on unfunded commitments 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.

Collateral Dependent Financial Assets

Loans that do not share risk characteristics are evaluated on an individual basis. For collateral dependent financial assets where we have determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and we expect repayment of the financial asset to be provided substantially through the sale of the collateral, the ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the asset as of the measurement date. When repayment is expected to be from the operation of the collateral, expected credit losses are calculated as the amount by which the amortized cost basis of the financial asset exceeds the net present value from the operation of the collateral. When repayment is expected to be from the sale of the collateral, expected credit losses are calculated as the amount by which the amortized cost basis of the financial asset exceeds the fair value of the underlying collateral less estimated cost to sell. The ACL may be zero if the fair value of the collateral at the measurement date exceeds the amortized cost basis of the financial asset.

Allowance for Credit Losses - Securities

We evaluate our available-for-sale and held-to-maturity debt securities portfolios for expected credit losses as of the valuation date under ASC 326. For available-for-sale debt securities in an unrealized loss position, we first assess whether we intend to sell, or if it is more likely than not that we will be required to sell, the security before recovery of our amortized cost basis. If either criterion is met, the security’s amortized cost basis is written down to fair value through income during the current period. For available-for-sale debt securities that do not meet the aforementioned criteria, we evaluate whether the decline in fair value has resulted from credit losses or other driving factors. If our assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security is compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, an ACL is recorded for the credit loss (which represents the difference between the expected cash flows and amortized cost basis), limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an ACL is recognized in other comprehensive income.

The entire amount of an impairment loss is recognized in earnings only when: (1) we intend to sell the security; or (2) it is more likely than not that we will have to sell the security before recovery of our amortized cost basis; or (3) we do not expect to recover the entire amortized cost basis of the security. In all other situations, only the portion of the impairment loss representing the credit loss must be recognized in earnings, with the remaining portion being recognized in shareholders' equity as comprehensive income, net of deferred taxes.

Changes in the ACL are recorded as a provision for (or reversal of) credit losses. Losses are charged against the ACL when we believe the uncollectibility of an available-for-sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met. Any impairment not recorded through an ACL is recognized in other comprehensive income as a noncredit-related impairment.

As part of our estimation process, we have made a policy election to exclude accrued interest from the amortized cost basis of available-for-sale debt securities and report accrued interest separately in other assets in the Consolidated Statement of Condition. Available-for-sale debt securities are placed on nonaccrual status when we no longer expect to receive all contractual amounts due, which is generally at 90 days past due. Accrued interest receivable is reversed against interest income when a security is placed on nonaccrual status. Accordingly, we do not recognize an ACL against accrued interest receivable. This approach is consistent with our nonaccrual policy implemented for our loan portfolio.

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We separately evaluate our held-to-maturity investment securities for any credit losses. If we determine that a security indicates evidence of deteriorated credit quality, the security is individually-evaluated and a discounted cash flow analysis is performed and compared to the amortized cost basis. As of December 31, 2023, we had one security classified as held-to-maturity with an amortized cost basis of $264 thousand with the remainder of the securities portfolio held as available-for-sale.

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-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.

Financial Overview

For the years ended December 31, 2023 and 2022, we focused on organic growth, capitalizing on new customer relationships we obtained through centers of influence and portfolio cultivation.

•Total assets decreased to $2.19 billion compared to $2.34 billion at December 31, 2023 and 2022, respectively, a decrease of $153.8 million, or 7%. The decrease in total assets is primarily attributable to our strategic balance sheet management which focused on repositioning the balance sheet through two investment securities restructurings and reducing our reliance on wholesale funding to limit funding costs.

•Total loans, net of deferred fees, decreased $11.9 million, or 1%, from December 31, 2022 to December 31, 2023. Asset quality remains sound with nonperforming loans and loans past due 90 days or more as a percentage of total assets of 0.08% at December 31, 2023, compared to 0.19% at December 31, 2022.

•Total deposits increased $15.1 million or 1%, from December 31, 2022 to December 31, 2023. Noninterest-bearing deposits were $396.7 million at December 31, 2023, or 21.5% of total deposits. At December 31, 2023, core deposits, which exclude wholesale deposits, increased $17.9 million from December 31, 2022, or 1%.

•Net income totaling $3.8 million was recorded for the year ended December 31, 2023 compared to $25.0 million for 2022. The year ended December 31, 2023 results include after-tax losses of $12.2 million for the first quarter 2023 and fourth quarter 2023 securities repositionings. Core bank operating earnings, which excludes the securities sales and other nonrecurring items discussed more fully below under "Results of Operations", for the year ended December 31, 2023 was $16.3 million. For a reconciliation of this non-GAAP information which excludes the effect of these non-recurring items, please refer to the table below.

•Net interest income decreased $10.8 million, or 17%, to $54.4 million for the year ended December 31, 2023 compared to the year ended December 31, 2022. Interest income on loans increased $24.7 million and interest expense on deposits increased $34.9 million for 2023, compared to 2022. Net interest margin for 2023 was 2.49% compared to 3.19% for 2022.

•The provision for credit losses for 2023 totaled $0.1 million compared to a provision for credit losses totaling $2.6 million in 2022. The provision for credit losses for 2023 was a reflection of the credit quality of the loan portfolio and the decrease in total loans for the 2023 period.

•Noninterest income for 2023 decreased to a loss of $13.4 million compared to income of $2.8 million for 2022. This decrease was primarily driven by the loss related to the sales of available-for-sale securities during 2023.

•Noninterest expense was $36.7 million and $34.5 million for the years ended December 31, 2023 and 2022, respectively. The increase of $2.2 million, or 6%, was primarily a result of increases in internet banking, software expense and state franchise taxes, which are more fully discussed below under "Results of Operations".

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

Years Ended December 31, 2023 and 2022

(Dollars in thousands, except per share data)

Below shows selected financial data for the periods ended December 31, 2023 and 2022.

Selected Financial Data

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

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______________________

(1)Amounts for all periods include the effect of a 5-for-4 stock split declared on December 15, 2022.

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

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

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

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Results of Operations—Years Ended December 31, 2023 and December 31, 2022

Overview

We recorded net income of $3.8 million, or $0.21 per diluted common share, for the year ended December 31, 2023, compared to net income of $25.0 million, or $1.35 per diluted common share for the year ended December 31, 2022. Our 2023 results were impacted by a decrease in net interest income, primarily due to the increase in our funding costs during 2023. In addition, we completed two balance sheet repositionings where we sold $102.5 million in book value available-for-sale investment securities, which resulted in after-tax losses of $12.2 million. Commercial bank operating earnings (non-GAAP), which exclude these securities losses and other nonrecurring expense items that were recorded during 2023 and 2022, were $16.3 million and $25.1 million, respectively. Diluted commercial bank operating earnings per share (non-GAAP) for the year ended December 31, 2023 and 2022 were $0.90 and $1.36, respectively.

Net interest income decreased $10.8 million to $54.4 million for the year ended December 31, 2023, compared to $65.2 million for the year ended December 31, 2022. For the year ended December 31, 2023, we recorded a provision for credit losses of $132 thousand compared to $2.6 million for the year ended December 31, 2022. The provision for credit losses was primarily impacted by net loan growth for both 2023 and 2022. We reported noninterest income as a loss of $13.4 million for the year ended December 31, 2023, compared to noninterest income of $2.8 million for 2022, a decrease of $16.2 million, which was primarily driven by the losses recorded on the sale of available-for-sale securities totaling $15.6 million for the year ended December 31, 2023.

Noninterest expense was $36.7 million and $34.5 million for the years ended December 31, 2023 and 2022, respectively, an increase of $2.2 million, or 6%. The increase in noninterest expense was primarily a result of an increases in internet banking and software expense and FDIC insurance fees. Included in noninterest expense for the year ended December 31, 2023 was $457 thousand related to office space reductions and severance costs. Excluding these nonrecurring expenses, noninterest expense for the year ended December 31, 2023 increased $1.7 million, or 5%, year-over year.

The return on average assets for the years ended December 31, 2023 and 2022 was 0.17% and 1.18%, respectively. The return on average equity for the years ended December 31, 2023 and 2022 was 1.82% and 12.34%, respectively. The return on average assets for the years ended December 31, 2023 and 2022 based on operating earnings (a non-GAAP metric) was 0.72% and 1.18%, respectively. The return on average equity for the years ended December 31, 2023 and 2022 based on core bank operating earnings (non-GAAP) was 7.78% and 12.39%, respectively. See the above table for a reconciliation of GAAP net income to core bank 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, 2023 and 2022.

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

Years Ended December 31, 2023 and 2022

(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. Net loan fees and late charges included in interest income on loans totaled $2.1 million and $3.0 million for the years ended December 31, 2023 and 2022, respectively.

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(2)The average yields for investment securities are reported on a fully taxable-equivalent basis at a rate of 22% for 2023 and 21% for 2022.

(3)The average balances for investment securities includes restricted stock.

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. 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 for the years ended December 31, 2023 and 2022.

Rate and Volume Analysis

Years Ended December 31, 2023 and 2022

(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 22% for 2023 and 21% for 2022.

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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, 2023 and 2022

(Dollars in thousands)

Net interest income for the year ended December 31, 2023 was $54.4 million on a fully taxable-equivalent basis, compared to $65.3 million for the year ended December 31, 2022, a decrease of $10.9 million, or 17%. The decrease in net interest income is primarily due to an increase in funding costs, which have increased precipitously as a result of Federal Reserve monetary policy, coupled with the need to meet intense competition from market area banks, brokerages, other financial institutions and the U.S. Treasury. We have been disciplined in our approach to rising interest rates, which has resulted in a cycle-to-date beta (calculated comparing the change in deposit interest rates from March 31, 2022 to December 31, 2023, including non-interest bearing deposits and excluding wholesale deposits) of approximately 42% since the Federal Reserve enacted its contractionary monetary policy through the increase of short-term interest rates to combat inflation.

Our net interest margin, on a tax equivalent basis, for the years ended December 31, 2023 and 2022 was 2.49% and 3.19%, respectively. The decrease in our net interest margin was primarily a result of the previously mentioned increased rate environment during 2023, as our cost of funds increased more than our yield on earning assets during the year. The yield on interest-earning assets increased 93 basis points to 4.88% for the year ended December 31, 2023, compared to 3.95% for the same period of 2022, a result of the increased rate environment during 2023. Offsetting the increase in yields on earning assets was a 213 basis point increase in the cost of interest-bearing liabilities, which was primarily attributable to the repricing of our interest-bearing deposits to higher interest rates during 2023. Cost of deposits (which includes noninterest-bearing deposits) was 2.47% for the year ended December 31, 2023 compared to 0.69% for the same period of 2022. Cost of other borrowed funds increased 101 basis points to 3.77% for the year ended December 31, 2023 compared to 2.76% for the year ended December 31, 2022.

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Average interest-earning assets increased by 7% to $2.19 billion at December 31, 2023 compared to $2.04 billion at December 31, 2022, which resulted in an increase in total interest income on a tax equivalent basis of $25.9 million, to $106.6 million for the year ended December 31, 2023 compared to $80.7 million for the year ended December 31, 2022. Both average volume and rate significantly impacted interest income during 2023, with volume contributing an additional $8.7 million in interest income and rate contributing an additional $17.3 million in interest income when compared to the prior year.

Average loans receivable increased $230.2 million to $1.85 billion for the year ended December 31, 2023, compared to $1.62 billion for the year ended December 31, 2022. The yield on average loans increased 77 basis points to 5.32% for the year ended December 31, 2023. The increase in average rate of loans receivable contributed $14.7 million to interest income while the increase in average loan volume contributed $10.1 million to interest income. 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 2023 and 2022.

Average investment securities decreased $64.6 million to $287.5 million for the year ended December 31, 2023, compared to $352.1 million for the year ended December 31, 2022. The decrease in average investment securities was primarily a result of repositioning the investment portfolio with the sale of $102.5 million in book value available-for-sale investment securities during 2023. The yield on average investment securities increased 14 basis points to 1.95% for the year ended December 31, 2023, primarily as a result of the sale of lower yielding securities relative to the average yield of the securities portfolio.

Average interest-earning deposits at other financial institutions, consisting primarily of excess cash reserves maintained at the Federal Reserve, decreased $23.8 million to $50.7 million for the year ended December 31, 2023, compared to $74.5 million for the year ended December 31, 2022. The decrease in average interest-earning deposits at other financial institutions was primarily a result of our deployment of excess liquidity during 2023 to reduce the Bank's reliance on wholesale funding. The yield on average interest-earning deposits increased 429 basis points to 5.21% for the year ended December 31, 2023.

Total average interest-bearing liabilities increased $215.2 million to $1.61 billion at December 31, 2023 compared to $1.40 billion at December 31, 2022, which resulted in an increase in interest expense of $36.8 million to $52.2 million for the year ended December 31, 2023 compared to $15.4 million for the year ended December 31, 2022. Average rate significantly impacted interest expense during 2023, as average volume only contributed an additional $4.9 million in interest expense while average rate increases contributed an additional $31.9 million in interest expense compared to the prior year.

Total average interest-bearing deposits increased $183.4 million to $1.49 billion at December 31, 2023 compared to $1.31 billion at December 31, 2022, which resulted in an increase in interest expense on deposits of $34.9 million to $47.3 million for the year ended December 31, 2023 compared to $12.5 million for the year ended December 31, 2022. Average noninterest-bearing deposits decreased $76.0 million, or 15%, to $425.9 million at December 31, 2023, compared to $502.0 million at December 31, 2022. During 2023, competition for deposits along with higher interest rates resulted in customers' movement of excess funds from noninterest-bearing into interest-bearing deposit products. Average interest checking deposits decreased $143.2 million to $581.7 million as of December 31, 2023 compared to $724.9 million as of December 31, 2022. Average time deposits increased $145.6 million to $349.3 million as of December 31, 2023 compared to $203.7 million at December 31, 2022, as customers preferred to fix a portion of their funds at higher interest rates. Average wholesale deposits increased $242.0 million to $303.5 million as of December 31, 2023 compared to $61.5 million as of December 31, 2022.

Average other borrowed funds increased $31.8 million to $102.1 million for the year ended December 31, 2023, compared to $70.3 million for the year ended December 31, 2022. Interest expense on other borrowed funds increased $1.9 million for the year ended December 31, 2023 to $3.8 million compared to $1.9 million for the same period of 2022.

Provision Expense and Allowance for Credit Losses

Our policy is to maintain the ACL at a level that represents our best estimate of expected losses in the loan portfolio as of the valuation date. Both the amount of the provision and the level of the allowance for credit 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. We adopted CECL as of January 1, 2023 in accordance with the required implementation date and recorded the impact of the adoption to retained earnings, net of deferred income

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taxes, as required by the standard. Note that prior to the adoption of CECL, we utilized an incurred loss model to derive our best estimate of the ACL.

As a result of the adoption of CECL, reserves for credit losses increased $3.7 million and consisted of increases to the allowance for credit losses on loans as well as an increase in reserves for unfunded commitments (referred to as combined ACL herein). For the year ended December 31, 2023, subsequent to the aforementioned adoption, we recorded a provision for credit losses of $132 thousand for the year ended December 31, 2023 compared to $2.6 million for the year ended December 31, 2022. The allowance for credit losses at December 31, 2023 was $18.9 million compared to $16.0 million at December 31, 2022. Our allowance for credit loss ratio as a percent of total loans, net of deferred fees and costs, for December 31, 2023 and 2022 was 1.03% and 1.02%, respectively.

We lend to well-established and relationship-driven borrowers which has contributed to our track record of low historical credit losses. We continue to maintain our disciplined credit guidelines during the current rate environment. We proactively monitor the impact of interest rates on our adjustable loans as the industry navigates through this economic cycle of increased inflation and higher interest rates. Credit quality metrics improved for the year ended December 31, 2023 as nonperforming loans and loans 90 days or more past due totaled $1.8 million, or 0.08% of total assets, compared to $4.5 million, or 0.19%, of total assets at December 31, 2022. Watchlist credits increased to $28.8 million at December 31, 2023, an increase of $14.3 million from December 31, 2022, as we proactively manage the credit quality of our loan portfolio, including reducing our commercial real estate concentrations, which has resulted in limited credit losses over our history. We had no other real estate owned at December 31, 2023. We recorded net charge-offs of $375 thousand during the year ended December 31, 2023 and net charge-offs of $418 thousand for same period of 2022.

See “Asset Quality” 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, 2023 and 2022.

Noninterest Income

Years Ended December 31, 2023 and 2022

(Dollars in thousands)

Noninterest income includes service charges on deposits and loans, loan swap fee income, income from our membership interest in ACM and other investments, income from our BOLI policies, and other fee income, and continues to supplement our operating results. Noninterest income was recorded as a loss for the year ended December 31, 2023 totaling $13.4 million compared to income of $2.8 million for same period in 2022. During 2023, we recorded $15.6 million in losses for the sale of $102.5 million in book value available-for-sale investment securities. We also recorded a loss from minority membership interest, primarily from our investment in ACM, totaling $1.1 million for the year ended December 31, 2023, compared a loss of $33 thousand for the year ended December 31, 2022.

Fee income from loans was $388 thousand for the year ended December 31, 2023, compared to $232 thousand for the same period of 2022. Service charges on deposits and other fee income was $1.5 million for the year ended December 31, 2023, compared to $1.4 million for the same period of 2022. Loan swap fees for the year ended December 31, 2023 totaled $187 thousand compared to none for the same period of December 31, 2022. Income from BOLI increased 21% to $1.5 million for the year ended December 31, 2023 as compared to $1.2 million for the year ended December 31, 2022, primarily due to the purchase of $15 million in additional BOLI during the second quarter of 2022.

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Noninterest Expense

The following table reflects the components of noninterest expense for the years ended December 31, 2023 and 2022.

Noninterest Expense

Years Ended December 31, 2023 and 2022

(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 $36.7 million and $34.5 million for the years ended December 31, 2023 and 2022.

Salaries and benefits expense increased $327 thousand to $20.6 million for the year ended December 31, 2023 compared to $20.3 million for the same period in 2022, which was primarily related to a decrease in salaries deferred associated with loan origination activity. Internet banking and software expense increased $798 thousand for the year ended December 31, 2023 to $2.5 million, compared to $1.7 million for the same period in 2022, primarily as a result of the implementation of enhanced customer software solutions. FDIC insurance premium expense increased $813 thousand for the year ended December 31, 2023 compared to the same period in 2022, a result of the FDIC increasing the assessment rate to replenish its deposit insurance fund. Marketing expenses increased $241 thousand to $724 thousand for the year ended December 31, 2023 compared to the same period in 2022, which was primarily related to expenses associated with low cost deposit gathering and branding efforts. Audit, legal and consulting fees decreased $352 thousand to $858 thousand for the year ended December 31, 2023 as compared to the same period of 2022, primarily as a result of expense management. Lastly, loan related expenses decreased $565 thousand during 2023 compared to the prior year, as we received a recovery of legal expenses in 2023 associated with a previous watchlist credit.

During the fourth quarter of 2023, we reduced our future occupancy expense through a reduction in office space. We wrote-off two leases totaling $273 thousand to reduce excess office space and to consolidate two branch locations in

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Montgomery County, Maryland. We also reduced staffing which resulted in severance costs of $184 thousand for the year ended December 31, 2023. These initiatives reduce operating expenses in 2024 by over $1.0 million.

Income Taxes

We recorded a provision for income tax expense of $410 thousand for the year ended December 31, 2023, compared to $6.0 million for the year ended December 31, 2022. Our effective tax rate for December 31, 2023 was 9.7%, compared to 19.4% for 2022. Our effective tax rates for 2023 and 2022 are less than our combined federal and state statutory rate of 22.5% because of discrete tax benefits recorded as a result of nonqualified option exercises during the aforementioned periods.

Discussion and Analysis of Financial Condition

Overview

At December 31, 2023, total assets were $2.2 billion, a decrease of 7%, or $153.8 million, from $2.34 billion at December 31, 2022. Total loans receivable, net of deferred fees and costs, decreased 1%, or $11.9 million, to $1.83 billion at December 31, 2023, from $1.84 billion at December 31, 2022. Total investment securities decreased by $106.5 million, or 38%, to $171.9 million at December 31, 2023, from $278.3 million at December 31, 2022. Total deposits increased 1%, or $15.1 million, to $1.85 billion at December 31, 2023, from $1.83 billion at December 31, 2022. 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. For December 31, 2023, we had no federal funds purchased compared to $30 million at December 31, 2022. The Bank had FHLB advances outstanding of $85.0 million and $235.0 million for the years ended December 31, 2023 and 2022, respectively. Subordinated debt, net of unamortized issuance costs, totaled $19.6 million at each of December 31, 2023 and 2022.

We review our balance sheet and interest rate sensitivity on an ongoing basis as part of our asset/liability risk management process. During 2023, with the expectation that short-term interest rates would continue to increase during year, we modeled various scenarios to improve balance sheet efficiency, reduce our cost of funds, improve margin and our capital ratios. As a result, we sold $102.5 million in book value available-for-sale investment securities. The proceeds were utilized to paydown high cost short-term FHLB advances and assist in the funding of higher yielding newly originated commercial loans through out 2023. The sale of these investment securities generated an after-tax loss of $12.2 million. These transactions were neutral to shareholders’ equity and tangible book value, as the loss recorded was already reflected in our accumulated other comprehensive loss.

Additionally, during the first quarter of 2023, we fixed $150 million of our wholesale funding through the execution of pay-fixed/receive-floating interest rate swaps. The interest rate swaps have a weighted average rate of 3.50%, have a maturity of five years, and are designated against a mix of FHLB advances and brokered certificates of deposits. Classified as cash flow hedges, the market value fluctuations will not impact future earnings, but will impact accumulated other comprehensive income.

Loans Receivable, Net

Total loans receivable, net of deferred fees, were $1.83 billion at December 31, 2023, a decrease of $11.9 million, or 1%, compared to $1.84 billion at December 31, 2022.

Commercial real estate loans totaled $1.10 billion at each of December 31, 2023 and December 31, 2022, comprising 60% of total loans for each period. Owner-occupied commercial real estate loans were $212.4 million at December 31, 2023 compared to $206.8 million at December 31, 2022. Nonowner-occupied commercial real estate loans were $879.3 million at December 31, 2023 compared to $893.2 million at December 31, 2022. Commercial construction loans totaled $148.0 million at December 31, 2023, compared to $147.3 million at December 31, 2022 and comprised 8% of total loans receivable. Of the $148.0 million in construction loans at December 31, 2023, $26.3 million are collateralized by land and only $1.4 million are lot acquisition and development loans (which have a higher degree of credit risk than the remaining portion of the construction portfolio). Our regulatory commercial real estate concentration (which includes nonowner-occupied real estate and construction loans) was 399% of our total risk based capital at December 31, 2023. 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,

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measure, and mitigate our loan concentrations within this portfolio segment, including rigorous credit approval, monitoring and administrative practices.

Commercial and industrial loans increased $1.5 million to $216.4 million at December 31, 2023, from $214.9 million at December 31, 2022. Consumer residential loans increased $32.7 million to $363.3 million at December 31, 2023, from $330.6 million at December 31, 2022. The increase in residential loans was primarily a result of purchasing ACM construction-to-permanent mortgages originated during 2022, a portfolio product offered by the Bank which met our underwriting criteria.

The following table sets forth the repricing characteristics and sensitivity to interest rate changes to the outstanding principal balance of our loan portfolio at December 31, 2023.

Loan Maturities and Interest Rate Sensitivity

At December 31, 2023

(Dollars in thousands)

________________________

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

Asset Quality

Nonperforming loans, defined as nonaccrual loans and loans contractually past due 90 days or more as to principal or interest and still accruing, were $1.8 million and $4.5 million at December 31, 2023 and 2022, respectively, a decrease of $2.7 million, or 60%. Loans that we have classified as nonperforming are a result of customer specific deterioration, mostly financial in nature, that are 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 had specific reserves totaling $676 thousand and $86 thousand at December 31, 2023 and 2022, respectively. Our ratio of nonperforming loans to total assets was 0.08% and 0.19% at December 31, 2023 and 2022, respectively. We had no other real estate owned and there were $3.5 million in loan modifications for borrowers who were experiencing financial difficulty during the year ended December 31, 2023.

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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, 2023, we had $6.2 million in loans identified as special mention, a decrease of $4.2 million from December 31, 2022. Special mention rated loans have a potential weakness that deserves our close attention; however, the borrower continues to pay in accordance with their contractual terms, unless modified and disclosed. The decrease from December 31, 2022 was driven by $9.3 million of loans being upgraded or paid off, offset by three additional loans identified as special mention. Loans rated as special mention do not have a specific reserve and are considered well-secured.

At December 31, 2023, we had $22.5 million in loans identified as substandard, an increase of $18.4 million from December 31, 2022. Substandard rated loans 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. The increase from December 31, 2022 was primarily related to one owner-occupied commercial loan totaling $20.0 million, which was downgraded due to concerns regarding the financial condition of this borrower's parent company. This loan is current and paying as agreed to with no modifications in terms since its origination. No impairment was indicated as a result of the liquidation analysis completed as the loan was and continues to be well-collateralized. At December 31, 2023, specific reserves totaling $676 thousand were allocated within the allowance for credit losses to supplement any shortfall of collateral for the additional $2.5 million in substandard loans.

We recorded annualized net charge-offs (recoveries) of 0.02% and 0.03% for the years ended December 31, 2023 and 2022, respectively. The following tables provide additional information on our asset quality for the periods presented.

Nonperforming Assets

At December 31, 2023 and 2022

(Dollars in thousands)

We are closely and proactively monitoring the effects of recent market activity. As mentioned above, our commercial real estate loan portfolio totaled $1.10 billion, or 60% of total, at both December 31, 2023 and at December 31, 2022. The commercial real estate portfolio, including construction loans, is diversified by asset type and geographic concentration. We manage this portion of the portfolio in a disciplined manner, and have comprehensive policies to monitor, measure and mitigate our loan concentrations within this portfolio segment, including rigorous credit approval, monitoring and administrative practices. Included in commercial real estate are loans secured by office buildings totaling $92.9 million, or 5% of total loans, and retail shopping centers totaling $264.0 million, or 14% of total loans, at December 31, 2023. Multi-family commercial properties totaled $178.6 million, or 10% of total loans, at December 31, 2023. The following table provides further stratification of these asset classes as of December 31, 2023 (dollars in thousands).

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_________________________

(1).Loan-to-value is determined at origination date against current bank owned principal.

(2).Minimum debt service coverage policy is 1.30x for owner occupied and 1.25x for non-owner occupied at origination.

The loans shown in the above table exhibit strong credit quality, reflecting only one classified delinquency at December 31, 2023. During our assessment of the allowance for credit losses on loans, we addressed the credit risks associated with these portfolio segments and believe that as a result of our conservative underwriting discipline at loan origination and our ongoing loan monitoring procedures, we have appropriately reserved for possible credit concerns in the event of a downturn in economic activity.

At December 31, 2023 and 2022, there were no performing loans considered potential problem loans. Potential problem loans are defined as loans that are not included in the 90 days or more past due, nonaccrual or restructured categories, but for which known information about possible credit problems causes us 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 allowance for credit losses on loans estimation methodology adjusts expected losses to calibrate the likelihood of a default event to occur through the use of risk ratings.

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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, allowance for credit losses, and provision for credit 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 be subject to a concentration of credit risk to a particular industry, counterparty, borrower or issuer. 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.

See “Critical Accounting Policies” above for more information on our allowance for credit losses methodology.

The following tables present additional information pertaining to the activity in and allocation of the allowance for credit losses on loans by loan type and the percentage of the loan type to the total loan portfolio. The allocation of the allowance for credit losses on loans 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 Credit Losses on Loans

Years Ended December 31, 2023 and 2022

(Dollars in thousands)

Allocation of the Allowance for Credit Losses on Loans

At December 31, 2023 and 2022

(Dollars in thousands)

___________________

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*Percentage of loan type to the total loan portfolio.

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 at each of December 31, 2023 and 2022 totaled $264 thousand, 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 $171.6 million at December 31, 2023, a decrease of $106.5 million, or 38%, from $278.1 million at December 31, 2022, primarily as a result of the $102.5 million of book value available-for-sale investment securities sold during the year.

As of December 31, 2023 and 2022, the majority of the investment securities portfolio consisted of securities rated AAA by a leading rating agency. Investment securities which 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. The effective duration of the investment securities portfolio continues to be slightly over five years, which is within the industry average. Investment securities that were pledged to secure public deposits totaled $7.2 million and $104.6 million at December 31, 2023 and 2022, respectively.

In accordance with ASC 326, we complete periodic assessments on at least a quarterly basis to determine if credit deterioration exists within our investment securities portfolio and if an allowance for credit losses would be required as of a valuation date. For additional details related to management's assessment process, see the “Critical Accounting Policies” section above. As a result of the assessment performed as of December 31, 2023, the investment securities with unrealized losses are a result of pricing changes due to recent rising interest rate conditions in the current market environment and not as a result of credit deterioration. Contractual cash flows for agency-backed portfolios are guaranteed and 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 investment securities portfolio prior to the recovery of the amortized cost as of the valuation date. As such, no impairment was recognized in our investment securities portfolio as of December 31, 2023.

We hold restricted investments in equities of the FRB and FHLB. At December 31, 2023, we owned $3.6 million in FRB stock and $5.8 million in FHLB stock. At December 31, 2022, we owned $4.4 million in FRB stock and $11.1 million in FHLB 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, 2023 and 2022.

Investment Securities by Stated Yields

At December 31, 2023 and 2022

(Dollars in thousands)

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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, 2023 and 2022:

Average Deposit Balance

Years Ended December 31, 2023 and 2022

Total deposits increased $15.1 million, or 1%, to $1.85 billion at December 31, 2023 from $1.83 billion at December 31, 2022. Noninterest-bearing deposits were $396.7 million at December 31, 2023, or 21% of total deposits. At December 31, 2023, core deposits, which exclude wholesale deposits, increased $17.9 million from December 31, 2022, or 1%. Time deposits (which exclude wholesale deposits) increased $45.9 million, or 18%, to $306.3 million at December 31, 2023 from December 31, 2022, and were 19% of core deposits, representing new and existing customer deposits as customers were looking to fix interest rates on their deposit balances.

Wholesale deposits were $245.3 million at December 31, 2023 compared to $248.0 million at December 31, 2022, a decrease of $2.7 million, or 1%. Wholesale deposits are partially fixed at a weighted average rate of 3.77% as we have executed $165.0 million in pay-fixed/receive-floating interest rate swaps to reduce funding costs. 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, 2023 and 2022, we had $254.1 million and $117.6 million, respectively, in either CDARS reciprocal or ICS reciprocal products.

As of December 31, 2023 and 2022, the estimated amount of total uninsured deposits (excluding collateralized deposits) was $574.6 million, or 31.1%, and $727.3 million, or 39.7%, of total deposits, 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.

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The following table reports maturities of the estimated amount of uninsured certificates of deposit at December 31, 2023.

Certificates of Deposit Greater than $250,000

At December 31, 2023

(Dollars in thousands)

Other borrowed funds, which include federal funds purchased, FHLB advances, and our subordinated notes, were $104.6 million at December 31, 2023, and $284.6 million at December 31, 2022. For December 31, 2023 and 2022, we had $85.0 million and $235.0 million, respectively, in FHLB advances. The decrease in FHLB advances was primarily a result of the aforementioned paydown from the proceeds of the sale of available-for-sale investment securities during 2023. These FHLB advances are fixed at a weighted average rate of 3.21% as we have executed $85.0 million in pay-fixed/receive-floating interest rate swaps to reduce funding costs. Subordinated debt, net of unamortized issuance costs, totaled $19.6 million at each of December 31, 2023 and 2022. For December 31, 2023 and 2022, we had $0 and $30.0 million federal funds purchased, respectively.

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 for the Bank are: (i) a 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 the Bank’s CET1 capital, Tier 1 capital and total capital ratios. Including the conservation buffer, we currently consider the Bank’s 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 “Community Bank Leverage Ratio", 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 $10.00 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 Federal Deposit Insurance Act, 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 based 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 and adopted this simplified capital structure. Effective September 30, 2022, we opted out of the CBLR framework. A banking organization that opts out of the CBLR framework can subsequently opt back into the CBLR framework if it meets the criteria listed above. We believe that the Bank met all capital adequacy requirements to which it was subject as of December 31, 2023 and 2022.

Stockholders' equity at December 31, 2023 was $217.1 million, an increase of $14.7 million, compared to $202.4 million at December 31, 2022. The increase in stockholders' equity was attributable to a decrease in accumulated other comprehensive loss of $12.4 million, which was primarily related to the sale of available-for-sale investment securities and an improvement in the market value of the investment securities portfolio, and net income recorded for the year ended

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December 31, 2023 totaling $3.8 million. Retained earnings decreased $2.8 million primarily as a result of the adoption of CECL on January 1, 2023.

Total stockholders' equity to total assets for December 31, 2023 and 2022 was 9.9% and 8.6%, respectively. Tangible book value per share (a non-GAAP financial measure which is defined in the table below) at December 31, 2023 and 2022 was $11.77 and $11.14, respectively.

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 $3.00 billion in assets, and which does not (i) conduct significant off balance sheet activities, (ii) engage in significant non-banking activities, or (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.

The following tables shows the minimum capital requirement and our capital position at December 31, 2023 and 2022 for the Bank.

Bank Capital Components

At December 31, 2023 and 2022

(Dollars in thousands)

________________________

(1).Includes capital conservation buffer.

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

At December 31, 2023 and 2022

(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. As of December 31, 2023, estimated uninsured deposits (excluding collateralized deposits) for the Bank improved to 31.1% of total deposits from 39.7% at December 31, 2022.

In addition to deposits, we have access to the various 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. As part of our membership with the IntraFi Network, we have one-way authority 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.

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 $232.1 million at December 31, 2023, or 11% of total assets, a decrease from $359.6 million, or 15%, at December 31, 2022. As of December 31, 2023 and 2022, $9.4 million and $104.6 million, respectively, in investment securities available for sale were pledged as collateral for municipal deposits. 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, 2023 was approximately $401.6 million. Borrowing capacity with the FRB was approximately $118.5 million at December 31, 2023. We also have unsecured federal funds purchased lines of $185.0 million available to us, of which none were used at December 31, 2023. We anticipate maintaining liquidity at a level sufficient to protect depositors, provide for reasonable growth and fully comply with all regulatory requirements. As of December 31, 2023, our liquidity position was significantly in excess of our estimated uninsured deposits of 31.1% of total deposits.

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

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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 our 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 our business.

At December 31, 2023 and 2022, unused commitments to fund loans and lines of credit totaled $215.9 million and $235.6 million, respectively. Commercial and standby letters of credit totaled $26.0 million and $6.5 million at December 31, 2023 and 2022, respectively.