# Capital Bancorp Inc (CBNK) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Capital Bancorp Inc's 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1419536/000141953622000057/cbnk-20211231.htm
Accession: 0001419536-22-000057
Filing date: 2022-03-15
Report date: 2021-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/CBNK/
All MD&A years: /company/CBNK/mda/
Next year: /company/CBNK/mda/fy2022/ (FY 2022)

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis is intended as a review of significant factors affecting the Company’s financial condition and results of operations for the periods indicated. This discussion and analysis should be read in conjunction with the accompanying consolidated financial statements and the related notes.

Executive Summary

The following summary should be read in conjunction with the Management’s Discussion and Analysis of Financial Condition and Results of Operations section in its entirety.

Net income for the year ended December 31, 2021 increased $14.2 million, or 54.8% when compared to the prior year, due primarily to an increase in average balances in the loan portfolio, an increase in credit card revenue, a reduction in rates for all interest bearing liabilities, and a reduction in the provision for loan losses. These positive factors were offset by a decrease in mortgage banking revenue, increases in salaries and employee benefits, data processing and advertising. During the year ended December 31, 2021, primarily as a result of bringing on new lending teams to focus on growing the Company’s commercial real estate portfolio, specifically owner occupied properties, the Bank’s commercial real estate loan portfolio grew by $163.8 million, of which $102.2 million was owner occupied. The growth in our credit card portfolio of $38.9 million was due in part to targeted advertising as well as the normalization of consumer behavior across a larger customer base. The increase in credit card activity was mainly responsible for the increase in data processing expenses.

The net interest margin was 5.86% for the year ended December 31, 2021 compared to 5.14% for the prior year. Primarily driving this margin expansion were increases in average portfolio loan balances of $155.9 million, a 90 basis point increase in the loan yield on the portfolio loans, and the overall rate reduction for the interest bearing deposit portfolio. Leading the increase in average portfolio balances were the commercial real estate and credit card portfolios with average balance increases of $90.5 million and $51.4 million, respectively, when comparing the year ended December 31, 2021 to December 31, 2020. Management’s concerted effort in reducing the cost of funds associated with our interest bearing deposit portfolio resulted in a 63 basis point reduction between 2020 and 2021. The reduction in rates for the money market and time deposit portfolios provided the greatest benefit in reducing the cost of funds for the overall interest bearing deposit portfolio.

Total assets grew by $178.7 million while total liabilities grew by $140.1 million when comparing year end 2021 to 2020. Liquidity provided by the net SBA-PPP run off and the reduction in our mortgage loans held for sale balances coupled with our increase in core deposits enabled the Company to redeploy excess liquidity to growth in our loan and investment portfolios as well as acquiring $35.0 million in bank-

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owned life insurance. Total liability growth was due to the growth in total core deposits with noninterest bearing deposits growing by 29.4% when comparing December 31, 2021 to December 31, 2020.

The Bank’s OpenSky® division continued to exceed management’s expectations during 2021. Active customer accounts grew by 92 thousand when comparing the year end balance 2021 to 2020, driving a $38.9 million growth in credit card loans, net of reserves. The noninterest bearing deposits associated with the secured credit card loans grew by $37.0 million, to $229.5 million at December 31, 2021 in comparison to December 31, 2020. Management is beginning to see the impact of COVID-19 dissipate as customer behaviors begin to return to more seasonal norms. Prior to COVID-19, the majority of growth came in the first and second quarters of the year tapering off in quarters three and four. Beginning in the second quarter of 2020, management saw unprecedented growth through the end of the year and into the first quarter of 2021 due mainly to the COVID-19 stimulus monies being received by OpenSky’s® target market. The second quarter of 2021 saw a return to more normalized quarterly trends which continued throughout the year.

The Bank’s Capital Bank Home Loans division saw a decline in mortgage originations during the year ended December 31, 2021 when compared to the prior year. The steepening of the yield curve in 2021 slowed originations from the year earlier when low interest rates fueled refinance volumes. Gain on sale margins, down slightly from 3.02% for the twelve months ended December 31, 2020, remained strong at 2.79% for the twelve months ended December 31, 2021. Historically-low housing inventory, shortages in new home building materials, and fluctuating interest rates are likely to continue suppressing origination volumes into 2022.

Critical Accounting Estimates

The accounting and reporting policies of the Company are in accordance with U.S. GAAP and conform to general practices within the banking industry. The Company’s financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions, and judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues, expenses, and related disclosures. Different assumptions in the application of these policies could result in material changes in the Company’s consolidated financial position and/or results of operations. The Company evaluates its critical accounting estimates and assumptions on an ongoing basis and updates them, as needed. Management has discussed the Company’s critical accounting policies and estimates with the Audit Committee of the Board of Directors of the Company.

The Company’s accounting policies are fundamental to understanding the Company’s consolidated financial position and consolidated results of operations. Accordingly, the Company’s significant accounting policies are discussed in detail in “Note 1 - Nature of Business and Basis of Presentation” in the “Notes to the Consolidated Financial Statements” contained in Part II, Item 8 "Financial Statements and Supplementary Data".

The critical accounting and reporting policies include the Company’s accounting for the allowance for loan losses. The Company provides additional information on its allowance for loan losses in “Note 1 - Nature of Business and Basis of Presentation” in the “Notes to the Consolidated Financial Statements” contained in Part II, Item 8 "Financial Statements and Supplementary Data".

Recent Accounting Pronouncements

For a discussion of Recent Accounting Pronouncements, see “Part II, Item 8. Financial Statements and Supplementary Data - Notes to Financial Statements - Note 1. Summary of Significant Accounting Policies.”

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[["","31"]]
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Results of Operations for the Years Ended December 31, 2021 and 2020

Net Income

The following table sets forth the principal components of net income for the periods indicated.

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["(in thousands)","2021","","2020","","% Change"],["Interest income","$","123,243","","","$","97,251","","","26.7","%"],["Interest expense","6,550","","","13,182","","","(50.3)","%"],["Net interest income","116,693","","","84,069","","","38.8","%"],["Provision for loan losses","3,359","","","11,242","","","(70.1)","%"],["Net interest income after provision","113,334","","","72,827","","","55.6","%"],["Noninterest income","50,636","","","50,144","","","1.0","%"],["Noninterest expense","110,094","","","87,834","","","25.3","%"],["Net income before income taxes","53,876","","","35,137","","","53.3","%"],["Income tax expense","13,898","","","9,314","","","49.2","%"],["Net income","$","39,978","","","$","25,823","","","54.8","%"]]
[[/GREPCENT_TABLE]]

Net income for the year ended December 31, 2021 was $40.0 million, up from net income for the year ended December 31, 2020 of $25.8 million. The increase in net interest income was primarily due to the increase in average loans outstanding in the loan portfolio year over year, an increase in credit card fees, and a reduction in rates for all interest bearing liabilities. Year over year growth in portfolio loan volumes attributed $26.8 million to the increase in net interest income with $22.1 million attributable to the growth in the credit card portfolio. An additional $10.9 million in credit card fees were generated in 2021 when compared to 2020. Year over year rate reductions for all interest bearing liabilities contributed an additional $6.1 million to the net interest income growth. The provision for loan losses decreased $7.9 million when comparing the years ended December 31, 2020 to 2021. Management’s focus on reducing nonperforming assets as well as the improved economy during 2021 resulted in a reduced need for additional provisioning. Offsetting factors included a decline in mortgage banking revenue of $11.4 million when comparing 2021 to 2020 as well as increases in noninterest expenses. Data processing and advertising increased $12.3 million and $2.3 million, respectively, when comparing the annual 2021 expenses to 2020 due primarily to increases in credit card portfolio activity and targeted marketing campaigns for the unveiling of OpenSky’s new offerings. Salaries and employee benefits increased $4.4 million for the year ended December 31, 2021 in comparison to 2020 as the Company increased its overall full-time positions by 18, hiring commercial lending teams as well as senior management officials and staff at the Bank.

Net Interest Income and Net Margin Analysis

Net interest income is the difference between interest income on earning assets and the cost of funds supporting those assets. Earning assets are composed primarily of loans, loans held for sale, investment securities, and interest bearing deposits with banks. The cost of funds represents interest expense on deposits and borrowings, which consist of federal funds purchased, advances from the FHLB, and subordinated notes. Noninterest bearing deposits and capital also provide sources of funding.

We analyze our ability to maximize income generated from interest earning assets and control the interest expenses of our liabilities, measured as net interest income, through our net interest margin and net interest spread. Net interest margin is a ratio calculated as net interest income annualized divided by average interest earning assets for the same period. Net interest spread is the difference between average interest rates earned on interest earning assets and average interest rates paid on interest bearing liabilities.

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Changes in market interest rates and the interest rates we earn on interest earning assets or pay on interest bearing liabilities, as well as in the volume and mix of interest earning assets, interest bearing and noninterest bearing liabilities and stockholders’ equity, are usually the largest drivers of periodic changes in net interest income, net interest margin and net interest spread. Fluctuations in market interest rates are driven by many factors, including governmental monetary policies, inflation, deflation, macroeconomic developments, changes in unemployment, the money supply, political and international conditions and conditions in domestic and foreign financial markets. Periodic changes in the volume and types of loans in our loan portfolio are affected by, among other factors, economic and competitive conditions in the Washington, D.C. and Baltimore metropolitan areas, as well as developments affecting the real estate, technology, government services, hospitality and tourism and financial services sectors within our target markets and throughout the Washington, D.C. and Baltimore metropolitan areas. Our ability to respond to changes in these factors by using effective asset-liability management techniques is critical to maintaining the stability of our net interest income and net interest margin as our primary sources of earnings.

The table below presents the average balances and weighted average rates of the major categories of the Company’s assets, liabilities, and stockholders’ equity for the years ended December 31, 2021 and 2020. Weighted average yields are derived by dividing annual income by the average balance of the related assets, and weighted average rates are derived by dividing annual expense by the average balance of the related liabilities, for the periods shown. Average outstanding balances are derived by utilizing average daily balances for the time period shown. The weighted average yields and rates include amortization of fees, costs, premiums and discounts, which are considered adjustments to yield/rates. Weighted average yields on tax-exempt securities are not calculated on a fully taxable equivalent basis.

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AVERAGE BALANCE SHEET AND NET INTEREST ANALYSIS

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["","2021","","2020"],["(in thousands)","Average Outstanding Balance","","Interest Income/ Expense","","Average Yield/ Rate","","Average Outstanding Balance","","Interest Income/ Expense","","Average Yield/ Rate"],["Assets"],["Interest earning assets:"],["Interest bearing deposits","$","228,420","","","$","283","","","0.12","%","","$","112,249","","","$","343","","","0.31","%"],["Federal funds sold","2,850","","","\u2014","","","\u2014","","","3,128","","","4","","","0.12"],["Investment securities","151,479","","","2,010","","","1.33","","","58,071","","","1,292","","","2.22"],["Restricted investments","3,774","","","166","","","4.40","","","4,025","","","244","","","6.07"],["Loans held for sale","43,126","","","1,224","","","2.84","","","84,928","","","2,610","","","3.07"],["SBA-PPP loans receivable","190,588","","","7,613","","","3.99","","","157,630","","","4,479","","","2.84"],["Portfolio Loans(1)(2)","1,370,988","","","111,947","","","8.17","","","1,215,049","","","88,279","","","7.27"],["Total interest earning assets","1,991,225","","","123,243","","","6.19","","","1,635,080","","","97,251","","","5.95"],["Noninterest earning assets","44,619","","","","","","","24,923"],["Total assets","$","2,035,844","","","","","","","$","1,660,003"],["Liabilities and Stockholders\u2019 Equity"],["Interest bearing liabilities:"],["Interest bearing demand accounts","$","289,285","","","$","202","","","0.07","","","$","195,794","","","$","656","","","0.34"],["Savings","6,470","","","3","","","0.05","","","4,722","","","5","","","0.11"],["Money market accounts","482,225","","","1,484","","","0.31","","","480,218","","","4,786","","","1.00"],["Time deposits","269,262","","","4,119","","","1.53","","","297,997","","","6,077","","","2.04"],["Borrowed funds","34,214","","","742","","","2.17","","","42,471","","","1,658","","","3.90"],["Total interest bearing liabilities","1,081,456","","","6,550","","","0.61","","","1,021,202","","","13,182","","","1.29"],["Noninterest bearing liabilities:"],["Noninterest bearing liabilities","24,128","","","","","","","22,007"],["Noninterest bearing deposits","750,760","","","","","","","473,301"],["Stockholders\u2019 equity","179,500","","","","","","","143,493"],["Total liabilities and stockholders\u2019 equity","$","2,035,844","","","","","","","$","1,660,003"],["Net interest spread","","","","","5.58","%","","","","","","4.66","%"],["Net interest income","","","$","116,693","","","","","","","$","84,069"],["Net interest margin (3)","","","","","5.86","%","","","","","","5.14","%"]]
[[/GREPCENT_TABLE]]

_______________

(1)Includes nonaccrual loans.

(2)Interest income includes amortization of deferred loan fees, net of deferred loan costs.

(3)For the twelve months ended December 31, 2021 and 2020, SBA-PPP loans and credit card loans accounted for 226 and 125 basis points of the reported net interest margin, respectively.

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[[/GREPCENT_TABLE]]

Rate/Volume Analysis of Net Interest Income

The rate/volume table below presents the composition of the change in net interest income for the periods indicated, as allocated between the change in net interest income due to changes in the volume of average earning assets and interest bearing liabilities, and the changes in net interest income due to changes in interest rates.

[[GREPCENT_TABLE]]
[["","Year Ended December 31, 2021"],["","Compared to the"],["","Year Ended December 31, 2020"],["","Change Due To","","Interest Variance"],["(In thousands)","Volume","","Rate"],["Interest Income:"],["Interest bearing deposits","$","144","","","$","(205)","","","$","(61)"],["Federal funds sold","\u2014","","","(4)","","","(4)"],["Investment securities","1,239","","","(521)","","","718"],["Restricted investments","(11)","","","(67)","","","(78)"],["Loans held for sale","(1,186)","","","(200)","","","(1,386)"],["SBA-PPP loans","1,316","","","1,818","","","3,134"],["Portfolio loans excluding credit card loans","4,752","","","(4,806)","","","(54)"],["Credit card loans","22,064","","","1,659","","","23,723"],["Total interest income","28,318","","","(2,326)","","","25,992"],["Interest Expense:"],["Interest bearing demand accounts","65","","","(519)","","","(454)"],["Savings","1","","","(3)","","","(2)"],["Money market accounts","6","","","(3,308)","","","(3,302)"],["Time deposits","(440)","","","(1,518)","","","(1,958)"],["Borrowed funds","(179)","","","(737)","","","(916)"],["Total interest expense","(547)","","","(6,085)","","","(6,632)"],["Net interest income","$","28,865","","","$","3,759","","","$","32,624"]]
[[/GREPCENT_TABLE]]

When comparing the years ended December 31, 2021 to 2020, the greatest positive impact to total interest income was associated with the credit card portfolio. On a stand-alone basis, the credit card portfolio contributed an increase of $23.7 million due to volume and rate increases when comparing the year over year 2021 to 2020 figures. The origination of SBA-PPP loans in 2021 as well as the SBA-PPP loan forgiveness in 2021 contributed an additional $3.1 million to interest income. Volume increases in the portfolio loans excluding credit cards accounted for an additional increase $4.8 million in interest income for the year ended December 31, 2021. Management’s efforts to reduce the cost of funds associated with the deposit portfolio contributed $5.3 million to the increase in net interest income between the years ended December 31, 2021 and 2020.

Provision for Loan Losses

The provision for loan losses represents the amount of expense charged to current earnings to fund the allowance for loan losses. The amount of the allowance for loan losses is based on many factors which reflect management’s assessment of the risk in the loan portfolio. Those factors include historical losses, economic conditions and trends, the value and adequacy of collateral, volume and mix of the portfolio, performance of the portfolio, and internal loan processes of the Company and Bank. For a detailed description of the factors taken into account by our management in determining the allowance for loan losses see “Financial Condition— Allowance for Loan Losses.”

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For the year ended December 31, 2021, the Company recorded a provision for loan losses of $3.4 million, compared to $11.2 million for the previous year. The decrease in the provision for 2021 compared to 2020 was primarily due to an improving economy. See additional discussion regarding the Company’s allowance for loan losses and reserve for off-balance sheet credit exposures at December 31, 2021 in “Financial Condition— Allowance for Loan Losses.”

The maintenance of a high quality loan portfolio, with an adequate allowance for possible credit losses, will continue to be a primary management objective for the Company.

Noninterest Income

Our primary sources of recurring noninterest income are credit card fees, such as interchange fees and statement fees, and mortgage banking revenue. Noninterest income does not include (i) loan origination fees to the extent they exceed the direct loan origination costs, which are generally recognized over the life of the related loan as an adjustment to yield using the interest method or (ii) annual, renewal and late fees related to our credit card portfolio, which are generally recognized over the twelve month life of the related loan as an adjustment to yield using the interest method.

The following table presents, for the periods indicated, the major categories of noninterest income:

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["(in thousands)","2021","","2020","","% Change"],["Noninterest income:"],["Service charges on deposit accounts","$","609","","","$","520","","","17.1","%"],["Credit card fees","27,884","","","16,966","","","64.4"],["Mortgage banking revenue","20,843","","","32,273","","","(35.4)"],["Gain on sale of investment securities available for sale, net","153","","","20","","","665.0"],["Other income","1,147","","","365","","","214.2"],["Total noninterest income","$","50,636","","","$","50,144","","","1.0","%"]]
[[/GREPCENT_TABLE]]

The Bank’s OpenSky® Division continued to exceed management’s expectations in 2021. Active customer accounts grew by 92 thousand when comparing the year-end balance 2021 to 2020. The increase in accounts led to increased fees totaling $10.9 million during 2021. Management anticipates the impact of COVID-19 will wane as consumer patterns return to more normalized seasonal trends.

The Bank’s Capital Bank Home Loans division saw a decline in mortgage originations during the year ended December 31, 2021 when compared to the prior year. The steepening of the yield curve in 2021 slowed originations from the year earlier when low interest rates fueled refinance volumes. Gain on sale margins, down slightly from 3.02% for the twelve months ended December 31, 2020, remained strong at 2.79% for the twelve months ended December 31, 2021. Historically-low housing inventory, shortages in new home building materials, and fluctuating interest rates are likely to continue suppressing origination volumes into 2022.

Mortgage loans sold are subject to repurchase in circumstances where documentation is deficient or the underlying loan becomes delinquent or pays off within a specified period following loan funding and sale. The Bank considers these potential recourse provisions to be a risk and has established a reserve under generally accepted accounting principles for possible repurchases. The reserve was $1.2 million at December 31, 2021 and 2020. The Bank repurchased one loan for $205 thousand during 2021 while no loans were repurchased during 2020. The Bank does not originate “sub-prime” loans and has no exposure to this market segment

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Noninterest Expense

Generally, noninterest expense is composed of all employee expenses and costs associated with operating our facilities, obtaining and retaining customer relationships and providing bank services. The largest component of noninterest expense is salaries and employee benefits. Noninterest expense also includes operational expenses, such as occupancy and equipment expenses, professional fees, advertising expenses, loan processing expenses and other general and administrative expenses, including FDIC assessments, communications, travel, meals, training, supplies and postage.

The following table presents, for the periods indicated, the major categories of noninterest expense:

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["(in thousands)","2021","","2020","","% Change"],["Noninterest expense:"],["Salaries and employee benefits","$","37,843","","","$","33,442","","","13.2","%"],["Occupancy and equipment","4,327","","","5,170","","","(16.3)"],["Professional fees","6,996","","","4,900","","","42.8"],["Data processing","39,237","","","26,917","","","45.8"],["Advertising","4,803","","","2,530","","","89.8"],["Loan processing","3,527","","","3,811","","","(7.5)"],["Other real estate expense, net","368","","","69","","","433.3"],["Other operating","12,993","","","10,995","","","18.2"],["Total noninterest expense","$","110,094","","","$","87,834","","","25.3","%"]]
[[/GREPCENT_TABLE]]

During 2021, salaries and employee benefits increased due to the addition of new employees in our commercial and commercial real estate lending groups as well as additional positions in executive management as the Company continues to put in place the requisite human capital for its continued growth. Contributions to the long-term incentive plan during 2021 was responsible for an additional $1.2 million in salaries and employee benefits expense when compared to the year ended December 31, 2020. The increase in data processing expense as well as other operating expense was primarily related to the increase in the number of active OpenSky® accounts at year end 2021, while the increase in advertising expense was attributable to enhanced marketing for the commercial bank segment as well as OpenSky® during 2021. Professional fees associated with the commercial bank segment increased as the Company continued to build out its regulatory and compliance infrastructure in anticipation of the budgeted growth for 2022.

Income Tax Expense

The amount of income tax expense we incur is influenced by our pre-tax income and our nondeductible expenses. Deferred tax assets and liabilities are reflected at current income tax rates in effect for the period in which the deferred tax assets and liabilities are expected to be realized or settled. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized.

Income tax expense was $13.9 million for 2021 compared to $9.3 million for 2020. Our effective tax rates for those periods were 25.8% and 26.5%, respectively.

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

Financial Condition

The following table summarizes the Company’s financial condition at the dates indicated.

[[GREPCENT_TABLE]]
[["","December 31,","","Change expressed in:"],["(in thousands)","2021","","2020","","Dollars","","Percent"],["Total assets","$","2,055,300","","","$","1,876,593","","","$","178,707","","","9.5","%"],["AFS securities","184,455","","","99,787","","","84,668","","","84.8"],["Portfolio loans receivable, net","1,523,982","","","1,315,502","","","208,480","","","15.8"],["Deposits","1,797,137","","","1,652,128","","","145,009","","","8.8"],["Borrowings","34,062","","","36,016","","","(1,954)","","","(5.4)"],["Stockholders\u2019 equity","197,903","","","159,311","","","38,592","","","24.2"],["Equity to total assets at end of period","9.6","%","","8.5","%","","","","12.9"],["Average number of basic shares outstanding","13,799","","13,793","","","","","0.0"],["Average number of diluted shares outstanding","14,081","","13,800","","","","","2.0","%"]]
[[/GREPCENT_TABLE]]

Total assets at December 31, 2021 reflected an increase from its December 31, 2020 balance due to growth in the commercial real estate loan portfolio and credit card portfolios, the addition of bank-owned life insurance, and the deployment of excess liquidity into the investment portfolio. Offsetting these increases were decreases in the loans held for sale portfolio during 2021 when compared to 2020, as well as a reduction in SBA-PPP loans.

Securities

The Company uses its securities portfolio to provide a source of liquidity, provide an appropriate return on funds invested, manage interest rate risk, meet collateral requirements and meet regulatory capital requirements.

Management classifies investment securities as either held to maturity or available for sale based on our intentions and the Company’s ability to hold such securities until maturity. In determining such classifications, securities that management has the positive intent and the Company has the ability to hold until maturity are classified as held to maturity and carried at amortized cost. All other securities are designated as available for sale and carried at estimated fair value with unrealized gains and losses included in stockholders’ equity on an after-tax basis. For the years presented, all securities were classified as available for sale.

To supplement interest income earned on our loan portfolio, the Company invests in high quality mortgage-backed securities, government agency bonds, asset-backed securities and high quality municipal and corporate bonds. During 2021, management invested a portion of its excess liquidity into U.S. Treasuries as the spread between treasuries and other investment portfolios continued to contract.

The following tables summarize the contractual maturities, without consideration of call features or pre-refunding dates, and weighted-average yields of investment securities at December 31, 2021 and the amortized cost and carrying value of those securities as of the indicated dates. The weighted average yields were calculated by multiplying the book value of each individual security by its yield, dividing that figure by the portfolio total, and then summing the value of these results to arrive at the weighted average yield. Yields on tax-exempt investments are not calculated on a fully tax equivalent basis.

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[[GREPCENT_TABLE]]
[["","","","","More Than One Year Through Five Years","","More Than Five Years Through Ten Years","","More Than Ten Years","","Total"],["At December 31, 2021","","","","","","Book Value","","Weighted Average Yield","","Book Value","","Weighted Average Yield","","Book Value","","Weighted Average Yield","","Book Value","","Fair Value","","Weighted Average Yield"],["(dollars in thousands)"],["Securities Available for Sale:"],["U.S Treasuries","","","","","","$","58,602","","","0.56","%","","$","73,850","","","1.27","%","","$","\u2014","","","\u2014","%","","$","132,452","","","$","131,001","","","0.96","%"],["Asset-backed securities","","","","","","\u2014","","","\u2014","","","\u2014","","","\u2014","","","10,093","","","0.98","","","10,093","","","10,140","","","0.98"],["Municipal","","","","","","\u2014","","","\u2014","","","\u2014","","","\u2014","","","10,825","","","1.94","","","10,825","","","10,474","","","1.94"],["Corporate bonds","","","","","","\u2014","","","\u2014","","","5,000","","","4.31","","","\u2014","","","\u2014","","","5,000","","","4,934","","","4.31"],["Mortgage-backed securities","","","","","","\u2014","","","\u2014","","","10,172","","","2.34","","","17,417","","","0.57","","","27,589","","","27,906","","","1.23"],["Total","","","","","","$","58,602","","","0.56","%","","$","89,022","","","1.56","%","","$","38,335","","","1.06","%","","$","185,959","","","$","184,455","","","1.15","%"]]
[[/GREPCENT_TABLE]]

Portfolio Loans

Our primary source of income is derived from interest earned on loans. Our loan portfolio consists of loans secured by real estate, commercial business loans and credit card loans, substantially all of which are secured by corresponding deposits at the Bank and, to a very limited extent, other consumer loans. Our loan customers primarily consist of small to medium-sized businesses, professionals, real estate investors, small residential builders and individuals. Our owner-occupied and investment commercial real estate loans, residential construction loans and commercial business loans provide us with higher risk-adjusted returns, shorter maturities and more sensitivity to interest rate fluctuations, and are complemented by our relatively lower risk residential real estate loans to individuals. Our credit card portfolio supplements our traditional lending products with enhanced yields. Outside of credit cards, our lending activities are principally directed to our market area consisting of the Washington, D.C. and Baltimore metropolitan areas.

Residential Real Estate Loans. We offer one-to-four family mortgage loans primarily on owner-occupied primary residences and, to a lesser extent, investor owned residences. Residential loans are originated through our commercial sales teams and our Capital Bank Home Loan division. Our residential loans also include home equity lines of credit. Our owner-occupied residential real estate loans usually have fixed rates for five to seven years and adjust on an annual basis after the initial term based on a typical maturity of 30 years. Our investor residential real estate loans are generally based on 25-year terms with a balloon payment due after five years. In general, the required minimum debt service coverage ratio is 1.15. Residential real estate loans have represented a growing portion of our loan portfolio.

Commercial Real Estate Loans. The Company originates both owner-occupied and non-owner-occupied commercial real estate loans. These loans may be adversely affected by conditions in the real estate markets or in the general economy. Commercial loans that are secured by owner-occupied commercial real estate and primarily collateralized by operating cash flows are also included in this category of loans. Commercial real estate loan terms are generally extended for 10 years or less and amortize generally over 25 years or less. The interest rates on our commercial real estate loans generally have an initial fixed rate terms that adjust typically at 5 years. Origination fees are routinely charged for our services. The Company generally requires personal guarantees from the principal owners of the business, supported by a review of the principal owners’ personal financial statements and global debt service obligations. The properties securing the portfolio are diverse in terms of type. This diversity helps reduce the exposure to adverse economic events that affect any single industry.

Construction Loans. Our construction loans are offered within our Washington, D.C. and Baltimore, Maryland metropolitan operating areas to builders primarily for the construction of single-family homes, condominium and townhouse conversions or renovations and, to a lesser extent, to individuals. Our construction loans typically have terms of 12 to 18 months with the goal of transitioning the borrowers to

[[GREPCENT_TABLE]]
[["","39"]]
[[/GREPCENT_TABLE]]

permanent financing or re-underwriting and selling into the secondary market through Capital Bank Home Loan. According to our underwriting standards, the ratio of loan principal to collateral value, as established by an independent appraisal, should not exceed 75% for investor-owned and 80% for owner-occupied properties. We conduct semi-annual stress testing of our construction loan portfolio and closely monitor underlying real estate conditions as well as our borrower’s trends of sales valuations as compared to underwriting valuations as part of our ongoing risk management efforts. Borrowers’ progress is monitored during the course of construction buildout, including for adherence to construction milestones and completion timelines.

Commercial Business Loans. In addition to our other loan products, the Company provides general commercial loans, including commercial lines of credit, working capital loans, term loans, equipment financing, letters of credit and other loan products, primarily in our target markets, and underwritten based on each borrower’s ability to service debt from income. These loans are primarily made based on the identified cash flows of the borrower and, secondarily, on the underlying collateral provided by the borrower. Most commercial business loans are secured by a lien on general business assets including, among other things, available real estate, accounts receivable, promissory notes, inventory and equipment, and we generally obtain a personal guaranty from the borrower or other principal.

Credit Cards. Through our OpenSky® credit card division, the Company provides credit cards on a nationwide basis to under-banked populations and those looking to rebuild their credit scores through a fully digital and mobile platform. Substantially all of the lines of credit are secured by a noninterest bearing demand account at the Bank in an amount equal to the full credit limit of the credit card. In addition, using our proprietary scoring model, which considers credit score and repayment history (typically a minimum of six months of on-time repayments, but ultimately determined on a case-by-case basis), the Bank offers certain customers an unsecured line in excess of their secured line of credit.

Other Consumer Loans. To a very limited extent and typically as an accommodation to existing customers, we offer personal consumer loans such as term loans, car loans or boat loans.

[[GREPCENT_TABLE]]
[["","40"]]
[[/GREPCENT_TABLE]]

The repayment of loans is a source of additional liquidity for us. The following table details contractual maturities of our portfolio loans, along with associated weighted average yields and an analysis of loans maturing after one year categorized by rate characteristic. Loans with adjustable interest rates are shown as maturing in the period during which the contract is due. The table does not reflect the effects of possible prepayments.

[[GREPCENT_TABLE]]
[["","As of December 31, 2021"],["(in thousands)","One Year or Less","","One to Five Years","","Over Five Years to Fifteen Years","","After Fifteen Years","","Total"],["","Amount","","Yield","","Amount","","Yield","","Amount","","Yield","","Amount","","Yield"],["Real estate:"],["Residential","$","74,282","","","5.58","%","","$","152,875","","","4.88","%","","$","97,229","","","4.38","%","","$","77,221","","","4.19","%","","$","401,607"],["Commercial","114,801","","","4.98","","","212,592","","","4.54","","","223,468","","","4.14","","","5,478","","","3.23","","","556,339"],["Construction","240,587","","","5.86","","","14,560","","","5.75","","","\u2014","","","\u2014","","","\u2014","","","\u2014","","","255,147"],["Commercial","74,002","","","5.25","","","57,822","","","4.61","","","39,863","","","5.50","","","4,269","","","4.53","","","175,956"],["Credit card","141,120","","","42.96","","","\u2014","","","\u2014","","","\u2014","","","\u2014","","","\u2014","","","\u2014","","","141,120"],["Other consumer","306","","","5.60","","","296","","","5.30","","","431","","","4.89","","","\u2014","","","\u2014","","","1,033"],["Total portfolio loans, gross","$","645,098","","","13.69","%","","$","438,145","","","4.71","%","","$","360,991","","","4.36","%","","$","86,968","","","4.14","%","","$","1,531,202"],["Loans above maturing after one year categorized by rate characteristic:","","","","Predetermined Interest Rates","","Floating or Variable Rates","","Total"],["Real estate:"],["Residential","","","","","","","","","$","154,928","","","$","172,397","","","$","327,325"],["Commercial","","","","","","","","","297,753","","","143,785","","","441,538"],["Construction","","","","","","","","","488","","","14,072","","","14,560"],["Commercial","","","","","","","","","69,682","","","32,272","","","101,954"],["Other consumer","","","","","","","","","677","","","50","","","727"],["Total portfolio loans, gross","","","","","","","","$","523,528","","","$","362,576","","","$","886,104"]]
[[/GREPCENT_TABLE]]

Nonperforming Assets

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on nonaccrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on nonaccrual status regardless of whether or not such loans are considered past due. In general, we place loans on nonaccrual status when they become 90 days past due. We also place loans on nonaccrual status if they are less than 90 days past due if the collection of principal or interest is in doubt. When interest accrual is discontinued, all unpaid accrued interest is reversed from income. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are, in management’s opinion, reasonably assured. Any loan which the Bank deems to be uncollectible, in whole or in part, is charged off to the extent of the anticipated loss. Consumer credit card balances are moved into the charge off queue after they become more than 90 days past due and are charged off not later than 120 days after they become past due. Loans that are past due for 180 days or more are charged off unless the loan is well secured and in the process of collection.

The Company believes its disciplined lending approach and focused management of nonperforming assets has resulted in sound asset quality and timely resolution of problem assets. There are several procedures in place to assist the Company in maintaining the overall quality of our loan portfolio. The Company has established underwriting guidelines to be followed by our bankers, and monitor our

[[GREPCENT_TABLE]]
[["","41"]]
[[/GREPCENT_TABLE]]

delinquency levels for any negative or adverse trends. There can be no assurance, however, that our loan portfolio will not become subject to increasing pressures from deteriorating borrower credit.

Potential Problem Loans

From a credit risk standpoint, we grade watchlist and problem loans into one of five categories: pass/watch, special mention, substandard, doubtful or loss. The classifications of loans reflect a judgment about the risks of default and loss associated with the loan. Credits ratings are reviewed regularly. Ratings are adjusted regularly to reflect the degree of risk and loss that our management believes to be appropriate for each credit. Our methodology is structured so that specific reserve allocations are increased in accordance with deterioration in credit quality (and a corresponding increase in risk and loss) or decreased in accordance with improvement in credit quality (and a corresponding decrease in risk and loss). Our lending policy requires the routine monitoring of weekly past due reports, daily overdraft reports, monthly maturing loans, monthly risk rating reports and internal loan review reports. The lending and credit management of the Bank meet periodically to review loans rated pass/watch. The focus of each meeting is to identify and promptly determine any necessary required action with this loan population, which consists of loans that, although considered satisfactory and performing to terms, may exhibit special risk features that warrant management’s attention.

Loans that are deemed special mention, substandard, doubtful or loss are listed in the Bank’s Problem Loan Status Report. The Problem Loan Status Report provides a detailed summary of the borrower and guarantor status, loan accrual status, collateral evaluation and includes a description of the planned collection and administration program designed to mitigate the Bank’s risk of loss and remove the loan from problem status. The Special Asset Committee reviews the Problem Loan Status Report on a quarterly basis for borrowers with an overall loan exposure in excess of $250,000.

The Bank uses the following definitions for watch list risk ratings:

•Pass/Watch. Borrowers who are considered satisfactory and performing to terms, however exhibiting special risk features such as declining earnings, strained cash flow, increasing leverage, and/or weakening fundamentals that indicate above average risk.

•Special Mention. A special mention loan has potential weaknesses deserving of management’s attention. If uncorrected, such weaknesses may result in deterioration of the repayment prospects for the asset or in our credit position at some future date.

•Substandard. A substandard loan is inadequately protected by the current financial condition and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that we will sustain some loss if deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets that are classified as substandard.

•Doubtful. A doubtful loan has all weaknesses inherent in one classified as substandard, with the added characteristic that weaknesses make collection or liquidation in full, on the basis of existing facts, conditions, and values, highly questionable and improbable. The probability of loss is extremely high, but certain important and reasonably specific factors that may work to the advantage and strengthening of the asset exist. Therefore, its classification as an estimated loss is deferred until a more precise status may be determined by management. Pending factors include proposed merger, acquisition or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans.

•Loss. Credits rated as loss are charged-off. We have no expectation of the recovery of any payments in respect of credits rated as loss.

[[GREPCENT_TABLE]]
[["","42"]]
[[/GREPCENT_TABLE]]

Loans not meeting the criteria above are considered to be pass-rated loans. The following tables present the portfolio loan balances by category as well as risk rating. No assets were classified as loss during the periods presented.

At December 31, 2021, the recorded investment in impaired loans was $11.3 million, $336 thousand of which required a specific reserve of $218 thousand compared to a recorded investment in impaired loans of $9.2 million including $391 thousand requiring a specific reserve of $253 thousand at December 31, 2020. Of the $11.3 million of impaired loans, $5.0 million was related to one well-collateralized construction loan relationship.

Impaired loans also include certain loans that have been modified as troubled debt restructurings (“TDRs”). At December 31, 2021, the Company had five loans amounting to $534 thousand that were considered to be TDRs, compared to five loans amounting to $440 thousand at December 31, 2020.

Allowance for Loan Losses

We maintain an allowance for loan losses that represents management’s best estimate of the loan losses and risks inherent in our loan portfolio. The amount of the allowance for loan losses should not be interpreted as an indication that charge-offs in future periods will necessarily occur in those amounts, or at all. In determining the allowance for loan losses, we estimate losses on specific loans, or groups of loans, where the probable loss can be identified and reasonably determined. The balance of the allowance for loan losses is based on internally assigned risk classifications of loans, historical loan loss rates, changes in the nature of our loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, current economic factors and the estimated impact of current economic conditions on certain historical loan loss rates.

The following table presents key ratios for the allowance for loan losses and nonaccrual loans for the periods indicated:

[[GREPCENT_TABLE]]
[["","","For the Years Ended December 31,"],["(in thousands)","","Allowance for loan losses to period end portfolio loans (1)","","Nonaccrual loans to total portfolio loans","","Allowance for loan losses to nonaccrual loans (1)"],["","","2021","","2020","","2021","","2020","","2021","","2020"],["Real estate:"],["Residential","","1.40","%","","1.63","%","","0.71","%","","0.82","%","","198","%","","200","%"],["Commercial","","1.54","","","1.73","","","\u2014","","","0.60","","","34,606","","","288"],["Construction","","1.84","","","2.04","","","3.06","","","0.84","","","60","","","244"],["Commercial","","1.50","","","1.54","","","0.38","","","0.75","","","390","","","205"],["Credit card","","2.59","","","2.41","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Other consumer","","1.13","","","1.28","","","\u2014","","","\u2014","","","\u2014","","","\u2014"],["Total","","1.65","%","","1.78","%","","0.70","%","","0.61","%","","220","%","","254","%"]]
[[/GREPCENT_TABLE]]
_____________

(1)Allowance calculation excludes SBA-PPP loans.

[[GREPCENT_TABLE]]
[["","43"]]
[[/GREPCENT_TABLE]]

The following table presents a summary of the net charge-off (recovery) of loans as a percentage of average loans for the periods indicated:

[[GREPCENT_TABLE]]
[["","","For the Years Ended December 31,"],["(in thousands)","","Net Charge-offs (Recoveries)","","Average Loans","","Percent of average portfolio loans","","Net Charge-offs","","Average Loans","","Percent of average portfolio loans"],["","","2021","","2020"],["Real estate:"],["Residential","","$","\u2014","","","$","421,856","","","\u2014","%","","$","\u2014","","","$","426,868","","","\u2014","%"],["Commercial","","161","","","456,972","","","0.04","","","\u2014","","","366,490","","","\u2014"],["Construction","","(1)","","","233,964","","","\u2014","","","289","","","218,787","","","0.13"],["Commercial","","33","","","143,434","","","0.02","","","233","","","139,432","","","0.17"],["Credit card","","1,419","","","112,313","","","1.26","","","587","","","60,958","","","0.96"],["Other consumer","","\u2014","","","2,449","","","\u2014","","","\u2014","","","2,512","","","\u2014"],["Total","","$","1,612","","","$","1,370,988","","","0.12","%","","$","1,109","","","$","1,215,047","","","0.09","%"]]
[[/GREPCENT_TABLE]]

The allowance for loan losses at December 31, 2021 included specific reserves of $218 thousand set aside for impaired loans. The allowance for loan losses at December 31, 2020 included specific reserves of $253 thousand set aside for impaired loans. Total charge-offs for the years ended December 31, 2021 and 2020 were primarily due to credit card charge-offs resulting from growth in our credit card portfolio and certain charges in excess of credit limits.

As the loan portfolio and allowance for loan losses review processes continue to evolve, there may be changes to elements of the allowance and this may have an effect on the overall level of the allowance maintained. Historically, the Bank has enjoyed a high quality loan portfolio with relatively low levels of net charge-offs and low delinquency rates. The maintenance of a high quality portfolio will continue to be a high priority.

Management is intent on maintaining a strong credit review function and risk rating process. The Company has an experienced Credit Administration function, which provides independent analysis of credit requests and the management of problem credits. The Credit Department has developed and implemented analytical procedures for evaluating credit requests, has refined the Company’s risk rating system, and continues to adapt and enhance the monitoring of the loan portfolio. The loan portfolio analysis process is intended to contribute to the identification of weaknesses before they become more severe.

Although we believe we have established our allowance for loan losses in accordance with GAAP and that the allowance for loan losses was adequate to provide for known and inherent losses in the portfolio at all times shown above, future provisions for loan losses will be subject to ongoing evaluations of the risks in our loan portfolio.

The following table sets forth activity in the allowance for loan losses for the past two years for the categories shown below as of the dates indicated. The total allowance is available to absorb losses from any loan category.

[[GREPCENT_TABLE]]
[["","44"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","December 31,"],["","2021","","2020"],["(in thousands)","Amount","","Percent(1)","","Amount","","Percent(1)"],["Real estate:"],["Residential","$","5,612","","","22","%","","$","7,153","","","31","%"],["Commercial","8,566","","","34","","","6,786","","","29"],["Construction","4,699","","","19","","","4,595","","","20"],["Commercial","2,637","","","10","","","2,417","","","10"],["Credit card","3,655","","","15","","","2,462","","","10"],["Other consumer","12","","","\u2014","","","21","","","\u2014"],["Total allowance for loan losses","$","25,181","","","100","%","","$","23,434","","","100","%"]]
[[/GREPCENT_TABLE]]

_______________

(1) Loan category as a percentage of total portfolio loans which excludes SBA-PPP loans.

Total Liabilities

Total liabilities at December 31, 2021 saw an increase from its December 31, 2020 balance due to growth in the deposit portfolio. Offsetting this increase were decreases in borrowed funds as well as other liabilities.

Deposits

Deposits are the major source of funding for the Company. We offer a variety of deposit products including interest bearing demand, savings, money market and time accounts all of which we actively market at competitive pricing. We generate deposits from our customers on a relationship basis and through the efforts of our commercial lending officers and our business banking officers. The Company continues to execute on its strategic initiative to improve the deposit portfolio mix by reducing reliance on wholesale time deposits. At December 31, 2021, the Company had no balances pertaining to wholesale time deposits compared to $107.7 million at December 31, 2020. Our credit card customers are also a significant source of low cost deposits. As of December 31, 2021 and 2020, our credit card customers accounted for $229.5 million and $192.5 million, or 29.1% and 31.6%, respectively, of our total noninterest bearing deposit balances.

The following table presents the average balances and average rates paid on deposits for the periods indicated:

[[GREPCENT_TABLE]]
[["","December 31,"],["","2021","","2020"],["(in thousands)","Average Balance","","Average Rate","","Average Balance","","Average Rate"],["Interest bearing demand accounts","$","289,285","","","0.07","%","","$","195,794","","","0.34","%"],["Money market accounts","482,225","","","0.31","","","480,218","","","1.00"],["Savings accounts","6,470","","","0.05","","","4,722","","","0.11"],["Certificates of deposit","269,262","","","1.53","","","297,997","","","2.04"],["Total interest bearing deposits","1,047,242","","","0.55","%","","978,731","","","1.18","%"],["Noninterest bearing demand accounts","750,760","","","","","473,301"],["Total deposits","$","1,798,002","","","0.32","%","","$","1,452,032","","","0.79","%"]]
[[/GREPCENT_TABLE]]

Management was actively focused on reducing its cost of funds on its deposits during 2021 as evidenced by the overall reduction in average rates from 0.79% during 2020 to 0.32% in 2021.

[[GREPCENT_TABLE]]
[["","45"]]
[[/GREPCENT_TABLE]]

The following table presents the maturities of our certificates of deposit as of December 31, 2021.

[[GREPCENT_TABLE]]
[["(in thousands)","Three Months or Less","","Over Three Through Six Months","","Over Six Through Twelve Months","","Over Twelve Months","","Total"],["$250,000 or more","$","9,353","","","$","6,057","","","$","90,355","","","$","3,062","","","$","108,827"],["Less than $250,000","23,043","","","14,432","","","24,082","","","7,266","","","68,823"],["Total","$","32,396","","","$","20,489","","","$","114,437","","","$","10,328","","","$","177,650"]]
[[/GREPCENT_TABLE]]

As of December 31, 2021 and 2020, approximately $972.4 million and $934.6 million, respectively, of our deposit portfolio was uninsured. The uninsured amounts are estimates based on the methodologies and assumptions used for the Bank’s regulatory reporting requirements.

Borrowings

We utilize short-term and long-term borrowings to supplement deposits to fund our lending and investment activities, each of which is discussed below.

FHLB Advances. The FHLB allows us to borrow up to 25% of our assets on a blanket floating lien status collateralized by certain securities and loans. As of December 31, 2021, approximately $296.1 million in real estate loans were pledged as collateral for our FHLB borrowings. Of the $296.1 million in loans pledged to the FHLB, our total borrowing capacity at December 31, 2021 was $205.3 million. None of our investment securities were pledged with the FHLB as of December 31, 2021. We utilize these borrowings to meet liquidity needs and to fund certain fixed rate loans in our portfolio. As of December 31, 2021, we had $22.0 million in outstanding advances and $183.3 million in available borrowing capacity from the FHLB.

Other borrowed funds. The Company has also issued junior subordinated debentures and other subordinated notes. At December 31, 2021, these other borrowings amounted to $12.1 million.

At December 31, 2021, our junior subordinated debentures amounted to $2.1 million. The junior subordinated debentures were issued in June of 2006, mature on June 15, 2036, and may be redeemed prior to that date under certain circumstances. The principal amount of the debentures has not changed since issuance, and they accrue interest at a floating rate equal to the three-month LIBOR plus 1.87%.

On November 30, 2020, the Company issued $10.0 million in subordinated notes due in 2030 to replace the outstanding higher yielding $13.5 million, reducing interest expense. The notes have a ten year term and have a fixed rated of 5.00% for the first five years; thereafter, the rate resets quarterly to a benchmark rate, being the three-month term SOFR, plus 490 basis points. The notes may be redeemed, in part or whole, upon the occurrence of certain events.

Federal Reserve Bank of Richmond. The Federal Reserve Bank of Richmond has an available borrower in custody arrangement which allows us to borrow on a collateralized basis. The Company’s borrowing capacity under the Federal Reserve’s discount window program was $15.9 million as of December 31, 2021. Certain commercial loans are pledged under this arrangement. We maintain this borrowing arrangement to meet liquidity needs pursuant to our contingency funding plan. No advances were outstanding under this facility as of December 31, 2021.

The Company also has lines of credit of $76.0 million available with other correspondent banks at December 31, 2021, as well as access to certificate of deposit funding through a financial network which the Bank strives to limit to 15% of the Bank’s assets. There were no outstanding balances on the lines of credit from correspondent banks at December 31, 2021.

[[GREPCENT_TABLE]]
[["","46"]]
[[/GREPCENT_TABLE]]

Liquidity

Liquidity is defined as the Bank’s capacity to meet its cash and collateral obligations at a reasonable cost. Maintaining an adequate level of liquidity depends on the Bank’s ability to meet both expected and unexpected cash flows and collateral needs efficiently without adversely affecting either daily operations or the financial condition of the Bank. Liquidity risk is the risk that we will be unable to meet our obligations as they become due because of an inability to liquidate assets or obtain adequate funding. The Bank’s obligations, and the funding sources used to meet them, depend significantly on our business mix, balance sheet structure and the cash flow profiles of our on- and off-balance sheet obligations. In managing our cash flows, management regularly confronts situations that can give rise to increased liquidity risk. These include funding mismatches, market constraints on the ability to convert assets into cash or in accessing sources of funds (i.e., market liquidity) and contingent liquidity events. Changes in economic conditions or exposure to credit, market, operating, legal and reputational risks also could affect the Bank’s liquidity risk profile and are considered in the assessment of liquidity and asset/liability management.

Management has established a comprehensive management process for identifying, measuring, monitoring and controlling liquidity risk. Because of its critical importance to the viability of the Bank, liquidity risk management is integrated into our risk management processes. Critical elements of our liquidity risk management include: corporate governance consisting of oversight by the board of directors and active involvement by management; the application of strategies, policies, procedures, and limits used to manage and mitigate liquidity risk; liquidity risk measurement and monitoring systems (including assessments of the current and prospective cash flows or sources and uses of funds) that are believed to be commensurate with the complexity and business activities of the Bank; active management of intraday liquidity and collateral; a diverse mix of existing and potential future funding sources; highly liquid marketable securities free of legal, regulatory or operational impediments that can be used to meet liquidity needs in stressful situations; comprehensive contingency funding plans that are believed to be adequate to address potential adverse liquidity events and emergency cash flow requirements; and internal controls and internal audit processes that are believed to be appropriate to assure the adequacy of the institution’s liquidity risk management process.

We expect funds to be available from a number of basic banking activity sources, including the core deposit base, the repayment and maturity of loans and investment security cash flows. Other potential funding sources include brokered certificates of deposit, deposit listing services, CDARS, borrowings from the FHLB and other lines of credit.

We participated in the Federal Reserve Bank of Richmond’s Paycheck Protection Program Liquidity Facility (“PPPLF”). The PPPLF extended credit to eligible financial institutions that originated SBA-PPP loans, using the loans as collateral. No new extensions of credit were made under the PPPLF after July 30, 2021. In addition, we have an available borrower custody arrangement with the Federal Reserve Bank of Richmond which allows us to borrow on an eligible collateralized basis. As of December 31, 2021, we had $183.3 million of available borrowing capacity from the FHLB, $15.9 million of available borrowing capacity from the Federal Reserve Bank of Richmond and available lines of credit of $76.0 million with other correspondent banks. Cash and cash equivalents were $183.4 million at December 31, 2021 and $146.9 million at December 31, 2020. Accordingly, at December 31, 2021, our liquidity resources were at sufficient levels to fund loans and meet other cash needs as necessary.

Capital Resources

Stockholders’ equity increased $38.6 million for the year ended December 31, 2021 largely due to net income of $40.0 million for the year. Stock options exercised, shares issued as compensation, shares sold and stock-based compensation increased common stock and additional paid-in capital aggregately by $2.8 million. These increases were offset by net unrealized losses on available for sale securities of $1.1 million.

[[GREPCENT_TABLE]]
[["","47"]]
[[/GREPCENT_TABLE]]

The Company uses several indicators of capital strength. The most commonly used measure is average common equity to average assets (computed as average equity divided by average total assets), which was 8.82% at December 31, 2021 and 8.64% at December 31, 2020.

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can precipitate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum ratios of common equity Tier 1, Tier 1, and total capital as a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 1250%. The Bank is also required to maintain capital at a minimum level based on quarterly average assets, which is known as the leverage ratio.

In July 2013, federal bank regulatory agencies issued a final rule that revised their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with certain standards that were developed by Basel III and certain provisions of the Dodd-Frank Act. The final rule applies to all depository institutions and bank holding companies and savings and loan holding companies with total consolidated assets of more than $1 billion. The Bank was required to implement the new Basel III capital standards (subject to the phase-in for certain parts of the new rules) as of January 1, 2015. In August of 2018 the Regulatory Relief Act directed the Federal Reserve Board to revise the Small BHC Policy Statement to raise the total consolidated asset limit in the Small BHC Policy Statement from $1 billion to $3 billion. The Company is currently exempt from the consolidated capital requirements.

The ability of the Company to continue to grow is dependent on its earnings and those of the Bank, the ability to obtain additional funds for contribution to the Bank’s capital, through additional borrowings, through the sale of additional common stock or preferred stock, or through the issuance of additional qualifying capital instruments, such as subordinated debt. The capital levels required to be maintained by the Company and Bank may be impacted as a result of the Bank’s concentrations in commercial real estate loans. See "”Risks Related to the Regulation of Our Industry” in Part I, Item 1A - Risk Factors.

As of December 31, 2021, the Bank was in compliance with all applicable regulatory capital requirements to which it was subject and was classified as “well capitalized” for purposes of the prompt corrective action regulations. As we deploy our capital and continue to grow our operations, our regulatory capital levels may decrease depending on our level of earnings. However, we intend to monitor and control our growth in order to remain in compliance with all regulatory capital standards applicable to us.

[[GREPCENT_TABLE]]
[["","48"]]
[[/GREPCENT_TABLE]]

The following table presents the regulatory capital ratios for the Company (as if such requirements applied to the Company) and the Bank as of the dates indicated.

[[GREPCENT_TABLE]]
[["(dollars in thousands)","","Actual","","Minimum Capital Adequacy","","To Be Well Capitalized","","Full Phase In of Basel III"],["December 31, 2021","","Amount","","Ratio","","Amount","","Ratio","","Amount","","Ratio","","Amount","","Ratio"],["The Company"],["Tier 1 leverage ratio (to average assets)","","$","201,040","","","9.73","%","","$","82,683","","","4.00","%","","N/A","","N/A","","N/A","","N/A"],["Tier 1 capital (to risk-weighted assets)","","201,040","","","14.43","%","","83,596","","","6.00","%","","N/A","","N/A","","118,428","","","8.50","%"],["Common equity tier 1 capital ratio (to risk-weighted assets)","","198,978","","","14.28","%","","62,697","","","4.50","%","","N/A","","N/A","","97,529","","","7.00","%"],["Total capital ratio (to risk-weighted assets)","","228,574","","","16.41","%","","111,462","","","8.00","%","","N/A","","N/A","","146,294","","","10.50","%"],["The Bank"],["Tier 1 leverage ratio (to average assets)","","$","169,384","","","8.36","%","","$","81,070","","","4.00","%","","$","101,338","","","5.00","%","","N/A","","N/A"],["Tier 1 capital (to risk-weighted assets)","","169,384","","","12.53","%","","81,097","","","6.00","%","","108,130","","","8.00","%","","114,888","","","8.50","%"],["Common equity tier 1 capital ratio (to risk-weighted assets)","","169,384","","","12.53","%","","60,823","","","4.50","%","","87,856","","","6.50","%","","94,614","","","7.00","%"],["Total capital ratio (to risk-weighted assets)","","186,397","","","13.79","%","","108,130","","","8.00","%","","135,162","","","10.00","%","","141,921","","","10.50","%"],["December 31, 2020"],["The Company"],["Tier 1 leverage ratio (to average assets)","","$","159,656","","","8.78","%","","$","72,770","","","4.00","%","","N/A","","N/A","","N/A","","N/A"],["Tier 1 capital (to risk-weighted assets)","","159,656","","","13.10","%","","73,100","","","6.00","%","","N/A","","N/A","","103,559","","","8.50","%"],["Common equity tier 1 capital ratio (to risk-weighted assets)","","157,594","","","12.94","%","","54,825","","","4.50","%","","N/A","","N/A","","85,284","","","7.00","%"],["Total capital ratio (to risk-weighted assets)","","185,008","","","15.19","%","","97,467","","","8.00","%","","N/A","","N/A","","127,926","","","10.50","%"],["The Bank"],["Tier 1 leverage ratio (to average assets)","","$","135,527","","","7.44","%","","$","72,770","","","4.00","%","","$","90,962","","","5.00","%","","N/A","","N/A"],["Tier 1 capital (to risk-weighted assets)","","135,527","","","12.06","%","","71,731","","","6.00","%","","95,642","","","8.00","%","","101,645","","","8.50","%"],["Common equity tier 1 capital ratio (to risk-weighted assets)","","135,527","","","12.06","%","","53,798","","","4.50","%","","77,709","","","6.50","%","","83,708","","","7.00","%"],["Total capital ratio (to risk-weighted assets)","","150,593","","","13.40","%","","95,642","","","8.00","%","","119,552","","","10.00","%","","125,562","","","10.50","%"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","49"]]
[[/GREPCENT_TABLE]]

Contractual Obligations

We have contractual obligations to make future payments on debt and lease agreements. While our liquidity monitoring and management consider both present and future demands for and sources of liquidity, the following table of contractual commitments focuses only on future obligations and summarizes our contractual obligations as of December 31, 2021.

[[GREPCENT_TABLE]]
[["(in thousands)","Due in One Year or Less","","Due After One Through Three Years","","Due After Three Through Five Years","","Due After 5 Years","","Total"],["FHLB advances","$","\u2014","","","$","\u2014","","","$","22,000","","","$","\u2014","","","$","22,000"],["Certificates of deposit $250,000 or more","105,765","","","2,550","","","512","","","\u2014","","","108,827"],["Certificates of deposit less than $250,000","61,557","","","6,240","","","1,006","","","20","","","68,823"],["Lease payments","1,099","","","1,496","","","225","","","\u2014","","","2,820"],["Subordinated debt","\u2014","","","\u2014","","","\u2014","","","12,062","","","12,062"],["Total","$","168,421","","","$","10,286","","","$","23,743","","","$","12,082","","","$","214,532"]]
[[/GREPCENT_TABLE]]

Off-Balance Sheet Items

In the normal course of business, we enter into various transactions that, in accordance with GAAP, are not included in our consolidated balance sheets. We enter into these transactions to meet the financing needs of our customers. These transactions include commitments to extend credit and issue letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in our consolidated balance sheets. Our exposure to credit loss is represented by the contractual amounts of these commitments. The same credit policies and procedures are used in making these commitments as for on-balance sheet instruments. We are not aware of any accounting loss to be incurred by funding these commitments; however, we maintain an allowance for off-balance sheet credit risk which is recorded in other liabilities on the consolidated balance sheet.

Our commitments associated with outstanding letters of credit and commitments to extend credit expiring by period as of the date indicated are summarized below. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements.

[[GREPCENT_TABLE]]
[["","December 31,"],["(in thousands)","2021","","2020"],["Unfunded lines of credit","$","360,386","","","$","331,576"],["Commitments to originate residential loans held for sale","1,385","","","11,444"],["Letters of credit","5,105","","","5,102"],["Commitment to fund other investments","6,352","","","\u2014"],["Total credit extension commitments","$","373,228","","","$","348,122"]]
[[/GREPCENT_TABLE]]

Unfunded lines of credit represent unused credit facilities to our current borrowers. Lines of credit generally have variable interest rates. Letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. In the event of nonperformance by the customer in accordance with the terms of the agreement with the third party, we would be required to fund the commitment. The maximum potential amount of future payments we could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, we would be entitled to seek recovery from the customer from the underlying collateral, which can include commercial real estate, physical plant and property, inventory, receivables, cash and/or marketable securities. Our policies generally require that letter of credit arrangements contain security and debt covenants similar to those contained in loan agreements. The credit risk associated with issuing letters of credit is substantially the same as the risk involved in extending loan facilities to our customers.

[[GREPCENT_TABLE]]
[["","50"]]
[[/GREPCENT_TABLE]]

We minimize our exposure to loss under letters of credit and credit commitments by subjecting them to the same credit approval and monitoring procedures as we do for on-balance sheet instruments. The effect on our revenue, expenses, cash flows and liquidity of the unused portions of these lines of credit commitments cannot be precisely predicted because there is no guarantee that the lines of credit will be used.

Commitments to extend credit are agreements to lend funds to a customer, as long as there is no violation of any condition established in the contract, for a specific purpose. Commitments generally have variable interest rates, fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being fully drawn, the total commitment amounts disclosed above do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if considered necessary by us, upon extension of credit is based on management’s credit evaluation of the customer.

We enter into forward commitments for the delivery of mortgage loans in our current pipeline. Interest rate lock commitments are entered into in order to economically hedge the effect of changes in interest rates resulting from our commitments to fund the loans. These commitments to fund mortgage loans, to be sold into the secondary market (interest rate lock commitments), and forward commitments for the future delivery of mortgage loans to third party investors are considered derivatives.

The commitment to fund other investments reflects an obligation to make an investment in a Small Business Investment Company.

Impact of Inflation

Our consolidated financial statements and related notes included elsewhere in this report have been prepared in accordance with GAAP. GAAP requires the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative value of money over time due to inflation or recession.

Unlike many industrial companies, substantially all of our assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Interest rates may not necessarily move in the same direction or in the same magnitude as the prices of goods and services. However, other operating expenses do reflect general levels of inflation.

[[GREPCENT_TABLE]]
[["","51"]]
[[/GREPCENT_TABLE]]