FINWISE BANCORP The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and related notes thereto and other financial information included elsewhere in this Report. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions that could cause actual results to differ materially from our expectations. Factors that could cause such differences are discussed in the sections entitled "Risk Factors," "Cautionary Note Regarding Forward-Looking Statements" and elsewhere in this Report. We assume no obligation to update any of these forward-looking statements except to the extent required by law. The following discussion pertains to our historical results, on a consolidated basis. However, because we conduct all our material business operations through our wholly owned subsidiary,FinWise Bank , the discussion and analysis relates to activities primarily conducted at the subsidiary level. For a discussion of trends, uncertainties and risks that will or could impact the Company's businesses, results of operations and financial condition during 2022, see "Principal Factors Affecting Our Results of Operations," and "Principal Factors Affecting Our Financial Condition." All dollar amounts in the tables in this section are in thousands of dollars, except per share data or where otherwise specifically noted. Unless otherwise stated, all information in this Report gives effect to a six-for-one stock split of our common stock completed effectiveJuly 26, 2021 . The effect of the stock split on outstanding shares and per share figures has been retroactively applied to all periods presented in this Report.
Overview
The Company is aUtah corporation and the parent company ofFinWise Bank . The Company's assets consist primarily of its investment in the Bank and all of its material business activities are conducted through the Bank. The Company is a registered bank holding company that is subject to supervision by the UDFI and theFederal Reserve . As aUtah state-chartered bank that is not a member of theFederal Reserve System , the Bank is separately subject to regulations and supervision by both the UDFI and theFDIC . The Bank's deposits are federally insured up to the maximum legal limits. See "Supervision and Regulation." Our banking business is our only business line. Our banking business offers a diverse range of commercial and retail banking products and services, and consists primarily of originating loans in a variety of sectors. Attracting nationwide deposits from the general public, businesses and other financial institutions, and investing those deposits, together with borrowings and other sources of funds, is also critical to our banking business. While our commercial and residential real estate lending and other products and services offered from our branch continue to be concentrated in and around theSalt Lake City, Utah MSA, our third-party loan origination relationships have allowed us to expand into new markets acrossthe United States . These relationships were developed to support our ability to generate significant loan volume across diverse consumer and commercial markets and have been the primary source of our significant growth and superior profitability. Our analytics platform, FinView™, enhances our ability to gather and interpret performance data for our originations and provides management with an ability to identify attractive, risk-adjusted sectors for growth. These insights coupled with the billions of dollars in originations funded annually and our ability to sell loans or retain for investment enhance our unique position. Our track record has demonstrated that these qualities deliver superior growth and profitability and that the flexibility inherent in our model enhances our ability to manage credit risk. Our financial condition and results of operations depend primarily on our ability to (i) originate loans using our strategic relationships with third-party loan origination platforms to earn interest and noninterest income, (ii) utilize FinView™ to identify attractive risk-adjusted lending opportunities and inform the selection of loans for investment while limiting credit losses, (iii) attract and retain low cost, stable deposits, and (iv) efficiently operate in compliance with applicable regulations.
Our lending focuses on four main lending areas: (i) SBA 7(a) loans, (ii) Strategic Programs, (iii) residential and commercial real estate and (iv) consumer lending. For a description and analysis of the Company's loan categories, see "-Principal Factors Affecting Our Financial Condition".
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Covid 19 Pandemic
SinceMarch 2020 , our nation has experienced a massive health and economic crisis as a result of the Covid-19 pandemic, which continues to negatively impact the health and finances of millions of people and businesses and have a pronounced impact on the global and national economy. To control the spread of the Covid-19 virus, governments around the world instituted widespread shutdowns of the economy which resulted in record unemployment in a matter of weeks. The economic turbulence spawned by the Covid-19 pandemic left many banks with potential credit quality and income issues. These issues are further compounded by uncertainties regarding the length, depth and possible resurgence of the pandemic and its ultimate long-term effects on the economy. In an effort to reduce the impact of economic shutdowns, theUnited States Congress has passed the CARES Act, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act, the Consolidated Appropriations Act, 2021, and recently the American Rescue Plan Act of 2021. These relief measures have provided stimulus payments to individuals, expanded unemployment benefits, and created programs that provided critical financing to small businesses through products such as the EIDL and the PPP, both of which are being administered by the SBA. Additionally,the United States government agreed to make six months of payments on SBA loans and increase the SBA guaranty on SBA 7(a) loans to 90% for loans originated fromFebruary 1, 2020 throughSeptember 30, 2021 . The SBA has made the full monthly P&I payments with respect to our qualifying SBA 7(a) customers in "regular servicing" status for six months. For most of our SBA portfolio (the legacy loans), the SBA made borrowers' principal and interest payments fromApril 2020 throughSeptember 2020 . These were officially referred to as First Round Section 1112 Payments, as they derived from Section 1112 of the CARES Act. To be eligible for the full six months of First Round Section 1112 Payments, the SBA loans were required to be: (i) in "regular servicing" status; (ii) approved by the SBA beforeMarch 27, 2020 ; and (iii) fully disbursed bySeptember 27, 2020 . Under the Economic Aid Act, the SBA will make an additional two payments for eligible SBA customers, capped at$9,000 per month per loan. Borrowers with loan payments above$9,000 per month are responsible for paying the difference. For our legacy portfolio, the SBA will make payment on the lesser of a borrower's monthly principal and interest payment or$9,000 per month fromFebruary 2021 throughMarch 2021 . These are referred to as Second Round Section 1112 Payments. The SBA released a list of NAICS codes deemed to have been particularly affected by the Covid-19 pandemic. SBA customers who met all other Section 1112 qualifying criteria and operated within certain NAICS codes, are entitled to an additional three months of payments. As ofDecember 31, 2020 , the Bank had 35 qualifying SBA loans totaling approximately$4.9 million in SBA 7(a) unguaranteed balance that received an additional three months of Second Round Section 1112 Payments, which were capped at$9,000 per month and per loan. As ofDecember 31, 2021 , 5 of the 35 qualifying SBA loans have been paid in full. The remaining 30 loans are all performing and total approximately$4.5 million in SBA 7(a) unguaranteed balance. As ofDecember 31, 2021 , none of the remaining 30 loans are entitled to additional Section 1112 payments. We participated in the first round of PPP lending and provided PPP loans to approximately 700 businesses totaling approximately$126.6 million during the year endedDecember 31, 2020 . No PPP loans were originated by the Company during the year endedDecember 31, 2021 . We believe the Bank's diversified loan portfolio and associated revenue streams have enabled the Bank to sustain and grow its business despite the adverse conditions relating to the Covid-19 pandemic. During the first and second quarters of 2020, we recorded higher than normal provisions to position ourselves for the possibility of elevated losses on loans resulting from the pandemic. The provision amounts reflected our early uncertainty surrounding the impact of the pandemic. Provisions ceased in the third and fourth quarters when we determined that our loan portfolios were not materially impacted at that time. For the year endedDecember 31, 2020 , the provision for loan losses amounted to$5.2 million . For the year endedDecember 31, 2021 the provision for loan losses amounted to$8.0 million . While some of the adverse conditions relating to the Covid-19 pandemic reversed in 2021, and have continued such reversal in the beginning of 2022, sustained improvements are highly dependent upon strengthening economic conditions. The Covid-19 pandemic continues to cause economic uncertainties which may again result in these and other adverse impacts to our financial condition and results of operations. We believe our SBA 7(a) underwriting program has remained strong throughout the Covid-19 pandemic and our SBA 7(a) loans are well collateralized when compared to the SBA industry in general. The dollar amount of short-term modifications of loans held-for-investment not classified as troubled debt restructurings was$0.5 million and$1.2 million as ofDecember 31, 2021 and 2020, respectively.
Principal Factors Affecting Our Results of Operations
Net Income. Net income is calculated by taking interest and noninterest income and subtracting our costs to do business, such as provision for loan losses, interest expense, salaries, taxes and other operational expenses. Net Interest Income. Net interest income represents interest income, less interest expense. We generate interest income from interest and fees received on interest earning assets, including loans, interest earning deposits in other banks, theFederal Reserve and investment securities we own. We incur interest expense from interest paid on interest bearing liabilities, including interest bearing deposits, borrowings and other forms of indebtedness. Net interest income was the most significant contributor to our net income in 2020 and 2021. To evaluate net interest income, we measure and monitor: (i) yields on our loans and other interest earning assets; (ii) the costs of our deposits and other funding sources; (iii) our net interest spread; and (iv) our net interest margin. Net interest spread is the difference between rates earned on interest earning assets and rates paid on interest bearing liabilities. Net interest margin is a ratio calculated as net interest income divided by average interest earning assets for the same period. Because noninterest bearing sources of funds, such as noninterest bearing deposits and shareholders' equity, also fund interest earning assets, net interest margin includes the benefit of these noninterest bearing sources. 51
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Decreases in interest rates, as well as the ongoing economic uncertainty, may decrease our net interest income and net interest margin in future periods, while increases in interest rates are expected to increase our net interest income and net interest margin in future periods. We expect increases in the federal funds rate in 2022 which is anticipated to be beneficial to our net interest income and net interest margin. In its statement released onJanuary 26, 2022 , theFederal Open Market Committee stated that it would soon be appropriate to raise the target range for the federal funds rate above the range of 0.0% to 0.25% in response to inflation that is above their 2.0% target and a strong labor market. As ofDecember 31, 2021 , approximately 79.9% of our loans held for investment were indexed to a market rate that is expected to reprice along with the federal funds rate. Changes in market interest rates and interest we earn on interest earning assets or pay on interest bearing liabilities, as well as the volume and types of our interest earning assets, liabilities and shareholders' equity, have the largest impact on our net interest spread, net interest margin and net interest income. We measure net interest income before and after our provision for loan losses. Provision for Loan Losses. Provision for loan losses is the amount of expense that, based on our judgment at that time, is required to maintain our ALL at an adequate level to absorb probable losses inherent in our loan portfolio and that, in our management's judgment, is appropriate under relevant accounting guidance. Determination of the ALL is complex and involves a high degree of judgment and subjectivity. For a description of the factors we considered in determining the ALL see "-Principal Factors Affecting Our Financial Condition-Allowance for Loan Losses." Noninterest Income. Noninterest income consists of, among other things: (i) Strategic Program fees; (ii) loan servicing fees; (iii) deposit related fees; (iv) gain on sale of loans; and (v) other noninterest income. Strategic Program fees are paid to us by loan origination platforms and include monthly minimum fees, fees based on the volume of loan originations in each month, testing and oversight fees, wire transfer fees, ACH fees, and program set up fees. Deposit related fees include checking fees, account maintenance fees, insufficient funds fees, overdraft fees, stop payment fees, domestic and foreign wire interchange and card processing fee income. Noninterest Expense. Noninterest expense includes, among other things: (i) salaries and employee benefits; (ii) occupancy and equipment expense; (iii) communications and data processing fees (iv) professional services fees; (v) federal deposit insurance assessments; (vi) correspondent bank charges; (vii) marketing costs; and (viii) other general and administrative expenses. Salaries and employee benefits include compensation (including employee-related stock compensation), employee benefits and tax expenses for our personnel. Occupancy expense includes depreciation expense, lease expense on our leased properties and other occupancy-related expenses. Equipment expense includes expenses related to our furniture, fixtures, equipment and software. Data processing fees include expenses paid to our third-party data processing system provider and other data service providers. Communications expense includes costs for telephone and internet. Professional fees include legal, accounting, consulting and other outsourcing arrangements. Federal deposit insurance expense relates toFDIC assessments based on the level of our deposits. Correspondent bank charges include wire transfer fees, transaction fees and service charges related to transactions settled with correspondent relationships. Marketing expense includes marketing material production, trade show participation, marketing fees related to Strategic Programs, website enhancement, outsourced marketing and branding services. Other general and administrative expenses include expenses associated with travel, meals, advertising, promotions, training, supplies and postage. Regulatory Environment. We are subject to federal and state regulation and supervision, which continue to evolve as the legal and regulatory framework governing our operations continues to change. The current operating environment includes extensive regulation and supervision in areas such as consumer compliance, the BSA and anti-money laundering compliance, risk management and internal audit. We anticipate that this environment of extensive regulation and supervision will continue for the industry. As a result, changes in the regulatory environment may result in additional costs for additional compliance, risk management and audit personnel or professional fees associated with advisors and consultants. Results of Operations Net Income Overview The following table sets forth the principal components of net income for the periods indicated. For the Years Ended December 31, ($ in thousands) 2021 2020 Interest income$ 49,243 $ 29,506 Interest expense (1,265 ) (1,756 ) Provision for loan losses (8,039 ) (5,234 ) Non-interest income 31,844 14,373 Non-interest expense (29,511 ) (21,749 ) Provision for income taxes (10,689 ) (3,942 ) Net income 31,583 11,198 52
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Net income for the year endedDecember 31, 2021 was$31.6 million , an increase of$20.4 million or 182.0% from net income of$11.2 million for the year endedDecember 31, 2020 . The increase was primarily due to an increase of$19.7 million or 66.9% in interest income and an increase of$17.5 million or 121.6% in non-interest income, offset by an increase of$7.8 million or 35.7% in non-interest expense and an increase of$6.7 million or 171.1% in provision for income taxes, as described below.
Net Interest Income and Net Interest Margin Analysis
Net interest income was the primary contributor to our earnings in 2021 and 2020. We believe our net interest income results were enhanced by using FinView™ to identify attractive risk-adjusted lending opportunities and assist in the selection of Strategic Program loans that we chose to hold for investment. Net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as "volume changes." It is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds, referred to as "rate changes." For the year endedDecember 31, 2021 , our net interest income increased$20.2 million , or 72.9%, to$48.0 million compared to the year endedDecember 31, 2020 . This increase was primarily due to an increase in asset yields, growth in average interest earning assets, and a decrease in our cost of funds. Average interest earning assets increased by$64.8 million , or 25.6%, to$317.8 million for the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 , while the related yield on average interest earning assets increased by 380 basis points to 15.5%, resulting in increased interest income for the year endedDecember 31, 2021 of$19.7 million . A substantial decrease in comparatively low yielding PPP loans during the year endedDecember 31, 2021 contributed to the increase in yield on average interest earning assets for the year. While the corresponding cost of funds on interest bearing liabilities for the year endedDecember 31, 2021 declined by 40 basis points to 0.9%, the average balance in interest bearing liabilities increased by$12.3 million , or 9.3%. The general decline of interest rates in theU.S. financial markets in 2021 is the primary cause for the decline in the cost of funds. As indicated in the rate/volume table set forth below, the decline in the cost of funds partially offset by the effect of increased volumes of interest-bearing liabilities, resulting in decreased interest expense for the year endedDecember 31, 2021 of$0.5 million . We gather deposits in theSalt Lake City, Utah MSA through our one branch and nationwide from our Strategic Program service providers, SBA 7(a) borrowers, Institutional Deposit exchanges, and brokered deposit arrangements. For the year endedDecember 31, 2021 , deposits sourced through our branch, Strategic Programs, SBA 7(a) borrowers, national Institutional Deposit exchanges and brokered deposit arrangements increased compared to the year endedDecember 31, 2020 . Our net interest margin increased from 11.0% atDecember 31, 2020 to 15.1% atDecember 31, 2021 . 53
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Average Balances and Yields. The following table presents average balances for assets and liabilities, the total dollar amounts of interest income from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting average yields and costs. The yields and costs for the periods indicated are derived by dividing the income or expense by the average balances for assets or liabilities, respectively, for the periods presented. Loan fees are included in interest income on loans and represent approximately$3.6 million (including approximately$1.8 million in SBA fees related to PPP loans) and$1.4 million (including approximately$1.2 million in SBA fees related to PPP loans), for the years endedDecember 31, 2021 andDecember 31, 2020 , respectively. Average balances have been calculated using daily averages. Years Ended December 31, 2021 2020 Average Average Average Average ($ in thousands) Balance Interest Yield/Rate Balance Interest Yield/Rate Interest earning assets: Interest-bearing deposits with the Federal Reserve, non U.S. central banks and other banks$ 55,960 $ 61 0.1 %$ 43,892 $ 201 0.5 % Investment securities 3,298 47 1.4 % 1,622 34 2.1 % Loans held for sale 59,524 22,461 37.7 % 20,154 10,560 52.4 % Loans held for investment 198,992 26,674 13.4 % 187,314 18,711 10.0 % Total interest earning assets 317,774 49,243 15.5 % 252,982 29,506 11.7 % Less: ALL (7,548 ) (6,706 ) Non-interest earning assets 17,002 8,130 Total assets$ 327,228 $ 254,406 Interest bearing liabilities: Demand$ 6,060 $ 53 0.9 %$ 3,237 $ 62 1.9 % Savings 7,897 10 0.1 % 6,234 16 0.3 % Money market accounts 21,964 75 0.3 % 16,327 104 0.6 % Certificates of deposit 72,311 1,000 1.4 % 57,496 1,401 2.4 % Total deposits 108,232 1,138 1.1 % 83,294 1,583 1.9 % Other borrowings 36,363 127 0.3 % 49,044 173 0.4 % Total interest bearing liabilities 144,595 1,265 0.9 % 132,338 1,756 1.3 % Non-interest bearing deposits 107,481 80,537 Non-interest bearing liabilities 11,392 3,941 Shareholders' equity 63,760 37,590 Total liabilities and shareholders' equity$ 327,228 $ 254,406 Net interest income and interest rate spread$ 47,978 14.6 %$ 27,750 10.3 % Net interest margin 15.1 % 11.0 % Ratio of average interest-earning assets to average interest- bearing liabilities 219.8 % 191.2 % 54
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Rate/Volume Analysis. The following table sets forth the effects of changing
rates and volumes on our net interest income. The rate column shows the effects
attributable to changes in rate. The volume column shows the effects
attributable to changes in volume. For purposes of this table, changes
attributable to changes in both rate and volume that cannot be segregated have
been allocated proportionally based on the changes due to rate and the changes
due to volume.
Years Ended December 31,
2021 2020
Increase (Decrease) Due to Increase (Decrease) Due to
($ in thousands) Rate Volume Total Rate Volume Total
Interest income:
Interest-bearing
deposits with the
Federal Reserve,
non-U.S. central banks
and other banks $ (219 ) $ 79 $ (140 ) $ (790 ) $ 327 $ (463 )
Investment securities (6 ) 19 13 (3 ) 21 18
Loans held-for-sale (1,990 ) 13,891 11,901 (1,036 ) 3,814 2,778
Loans held for
investment 6,735 1,228 7,963 (2,185 ) 7,950 5,765
Total interest income 4,520 15,217 19,737 (4,014 ) 12,112 8,098
Interest expense:
Demand 15 (24 ) (9 ) 30 32 62
Savings (13 ) 7 (6 ) - 4 4
Money market accounts (113 ) 84 (29 ) (18 ) 13 (5 )Certificates of deposit (992 ) 591 (401 ) (52 ) 112 60 Other borrowings
(2 ) (44 ) (46 ) 87 86 173
Total interest bearing
liabilities (1,105 ) 614 (491 ) 47
247 294
Net interest income
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Provision for Loan Losses
The provision for loan losses is a charge to income to bring our ALL to a level deemed appropriate by management and approved by of board of directors. We determine the provision for loan losses monthly in connection with our monthly evaluation of the adequacy of our ALL. For a description of the factors we considered in determining the ALL see "-Principal Factors Affecting Our Financial Condition-Allowance for Loan Losses" and "-Critical Accounting Policies and Estimates-Allowance for Loan Losses." Our provision for loan losses was$8.0 million and$5.2 million for the years endedDecember 31, 2021 and 2020, respectively. The increase of$2.8 million was primarily due to an overall increase in our provision attributable to Strategic Program lending, which was the result of our decision to increase certain retained Strategic Program loan balances during the period, and an overall increase in our provision attributable to SBA lending, which was the result of our decision to increase SBA 7(a) loan balances during the period.
Noninterest Income
The largest portion of our noninterest income is associated with our Strategic
Program fees. Other sources of noninterest income include gain on sale of loans,
SBA loan servicing fees, change in fair value on investment in BFG and other
miscellaneous fees.
The following table presents, for the periods indicated, the major categories of
noninterest income:
For the Years Ended
December 31, Change
($ in thousands) 2021 2020 $ %
Noninterest income:
Strategic Program fees $ 17,959 $ 9,591 $ 8,368 87.3 %
Gain on sale of loans 9,689 2,849 6,840 240.1 %
SBA loan servicing fees 1,156 1,028 128 12.5 %
Change in fair value on investment in BFG 2,991 856 2,135 249.4 %
Other miscellaneous income 49 49 - 0.0 %
Total noninterest income $ 31,844 $ 14,373 $ 17,471 121.6 %
For the year ended December 31, 2021 , total noninterest income increased $17.5
million , or 121.6%, to $31.8 million compared to the year ended December 31,
2020 . This increase was primarily due to the increase in Strategic Program fees,
gain on sale of loans, the change in fair value on investment in BFG, and SBA
loan servicing fees. The increase in Strategic Program fees was primarily due to
the increase in loan origination volume in the Strategic Program. Strategic
Program fees were also positively impacted by the launch of three origination
platforms during the year ended December 31, 2021 . The increase in gain on sale
of loans was primarily due to the increase in the number of SBA 7(a) loans sold
during the year ended December 31, 2021 . The increase in fair value on
investment in BFG was primarily due to BFG's increased profitability and cash
position during and for the year ended December 31, 2021 and the appreciation of
its peer companies under the Guideline Public Company valuation method during
the same period. The increase in SBA loan servicing fees was primarily due to
the increase in SBA 7(a) loans serviced for others during the year.
Noninterest Expense
Noninterest expense has increased as we have grown and as we have expanded and
modernized our operational infrastructure and implemented our plan to build an
efficient, technology-driven banking operation with significant capacity for
growth.
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The following table presents, for the periods indicated, the major categories of
noninterest expense:
For the Years Ended
($ in thousands) December 31, Change
2021 2020 $ %
Noninterest expense:
Salaries and employee benefits $ 22,365 $ 16,835 $ 5,530 32.9 %
Occupancy and equipment expenses 810 694 116 16.7 %
Impairment of SBA servicing asset 800 - 800 100.0 %
Loss on investment in BFG - 50 (50 ) -100.0 %
Other operating expenses 5,536 4,170 1,366 32.8 %
Total noninterest expense $ 29,511 $ 21,749 $ 7,762 35.7 %
For the year ended December 31, 2021 , total noninterest expense increased $7.8
million , or 35.7%, to $29.5 million compared to the year ended December 31,
2020 . This increase was primarily due to the increase in salaries and employee
benefits and other operating expenses. For the year ended December 31, 2021 ,
salaries and employee benefits increased $5.5 million , or 32.9%, to $22.4
million compared to the year ended December 31, 2020 . This increase was
primarily due to the increase in the number of employees during the year ended
December 31, 2021 . The increase in employees during this timeframe coincided
with an increase in Strategic Program loan volume and the expansion of our
information technology and security division to support enhancements in our
infrastructure, and an increase in contractual bonuses paid relating to the
expansion of the Strategic Programs in 2021. For the year ended December 31,
2021 , other operating expense increased $1.4 million , or 32.8%, to $5.5 million
compared to the year ended December 31, 2020 . This increase was primarily due to
our initiative to develop new and upgrade existing technology, increased third
party financial and business process reviews, increased marketing costs, and
increased legal and professional fees, all with the intent of supporting of our
growth. For the year ended December 31, 2021 , an impairment of SBA servicing
asset was recognized for $0.8 million due to a softening of the secondary market
for SBA 7(a) loans.
Principal Factors Affecting Our Financial Condition
The primary factors we use to evaluate and manage our financial condition include asset quality, capital and liquidity.
Asset Quality. We manage the diversification and quality of our assets based on factors that include the level, distribution, severity and trend of problem, classified, delinquent, nonaccrual, nonperforming and restructured assets, the adequacy of our ALL, the diversification and quality of our loan and investment portfolios, the extent of counterparty risks, credit risk concentrations and other factors. Capital. Financial institution regulators have established guidelines for minimum capital ratios for banks. As a small bank holding company, we are expected to be a capital resource to our subsidiary, which is required to be well capitalized. We, however, are not subject to specific capital ratios as a small bank holding company. We manage capital based upon factors that include: (i) the level and quality of capital and our overall financial condition; (ii) the trend and volume of problem assets; (iii) the adequacy of reserves; (iv) the level and quality of earnings; (v) the risk exposures in our balance sheet; (vi) the Community Bank Leverage Ratio; (viii) the state of local and national economic conditions; and (ix) other factors including our asset growth rate, as well as certain liquidity ratios. Liquidity. We manage liquidity based on factors that include the amount of core deposits as a percentage of total deposits, the level of Strategic Program held-for-sale loan balances compared to Strategic Program reserve deposit balances, the level of diversification of our funding sources, the allocation and amount of our deposits among deposit types, the short-term funding sources, the amount of non-deposit funding, the availability of unused funding sources, off-balance sheet obligations, the availability of assets to be readily converted into cash without undue loss, the amount of cash, interest earning deposits in other banks and liquid securities we hold, the re-pricing characteristics and maturities of our assets and other factors.
Loan Portfolio
We manage our loan portfolio based on factors that include concentrations per
loan program and aggregated portfolio, industry selection and geographies. We
also monitor the impact of identified and estimated losses on capital as well as
the pricing characteristics of each product. The following provides a general
description and the risk characteristics relevant to each of the business lines.
Each loan is assigned a risk grade during the origination and closing process by
credit administration personnel based on criteria described later in this
section. We analyze the resulting ratings, as well as other external statistics
and factors such as delinquency, to track the migration performance of the
portfolio balances. This ratings analysis is performed at least quarterly.
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SBA 7(a) Loans
We originate and service loans partially guaranteed by the SBA under its Section 7(a) loan program. SBA 7(a) loans are made to small businesses and professionals throughout theUSA . As ofDecember 31, 2021 and 2020, we had total SBA 7(a) loans of$141.3 million and$96.2 million , respectively, representing 53.2% and 36.7% of our total loans, respectively. Loans are sourced primarily through our referral relationship with BFG. Although BFG actively markets throughout theUSA , because of its physical location in theNew York area we have developed a lending presence in theNew York andNew Jersey geographies. The maximum SBA 7(a) loan amount is$5 million . Underwriting is generally based on commercial credit metrics where the primary repayment source is borrower cash flow, secondary is personal guarantor cash flow and tertiary is the sale of collateral pledged. These loans may be secured by commercial and residential mortgages as well as liens on business assets. In addition to typical underwriting metrics, we review the nature of the business, use of proceeds, length of time in business and management experience to help us target loans that we believe have lower credit risk. The SBA 7(a) program generally provides 50%, 75%, 85% and 90% guarantees for eligible SBA 7(a) loans. The guaranty is conditional and covers a portion of the risk of payment default by the borrower, but not the risk of improper underwriting, closing or servicing by the lender. As such, prudent underwriting, closing and servicing processes are essential to effective utilization of the SBA 7(a) program. Historically, we have generally sold the SBA-guaranteed portion (typically 75% of the principal balance) of a majority of the loans we originate at a premium in the secondary market while retaining all servicing rights and the unguaranteed portion; however, beginning in 2020, we made the decision to drive interest income by temporarily retaining a larger amount of the guaranteed portion of these loans.
SBA Paycheck Protection Program Loans
As an experienced SBA 7(a) lender, we were an active participant in the first round of the PPP, which began in April of 2020 and expired onAugust 8, 2020 . As a result of our efforts, we provided PPP loans to approximately 700 businesses, totaling approximately$126.6 million , for the year endedDecember 31, 2020 . As ofDecember 31, 2021 and 2020, we had total PPP loans of$1.1 million and$107.1 million , respectively, representing 0.4% and 40.9% of our total loans, respectively. The PPP loans also resulted in fees paid by the SBA to the originating bank for processing PPP loans, which fees are accreted into interest income over the life of the applicable loans. If a PPP loan is forgiven or paid off before maturity, the remaining unearned fee is recognized into income at that time. For the year endedDecember 31, 2020 , the Company recognized$0.4 million in PPP-related SBA accelerated deferred loan fees through interest income as a result of PPP loan forgiveness. For the year endedDecember 31 . 2021, the Company recognized a total of$1.8 million in PPP-related accreted fees ($1.5 million of which were accelerated due to loan forgiveness). A de minimis amount of deferred fees remained as ofDecember 31, 2021 .
Commercial, non-real estate
Commercial non-real estate loans consist of loans and leases made to commercial enterprises that are not secured by real estate. As ofDecember 31, 2021 andDecember 31, 2020 , we had total commercial non-real estate loans of$3.4 million and$4.0 million , respectively, representing 1.3% and 1.5% of our total loans, respectively. Any loan, line of credit, or letter of credit (including any unfunded commitments) and any interest obtained in such loans made by another lender to individuals, sole proprietorships, partnerships, corporations, or other business enterprises for commercial, industrial, agricultural, or professional purposes, not secured by real estate, but not for personal expenditure purposes are included in this category. For example, commercial vehicle term loans and commercial working capital term loans. Underwriting is generally based on commercial credit metrics where the primary repayment source is borrower cash flow, secondary is personal guarantor cash flow (when applicable) and tertiary is the sale of collateral pledged. The nature of the business, use of proceeds, length of time in business, management experience, repayment ability, credit history, ratio calculations and assessment of collateral adequacy are all considerations. These loans are generally secured by liens on business assets. Historically, we have retained these loans on our balance sheet for investment.
Residential real estate
Residential real estate loans include construction, lot and land development loans that are for the purpose of acquisition and development of property to be improved through the construction of residential buildings, and loans secured by other residential real estate. As ofDecember 31, 2021 andDecember 31, 2020 , we had total residential real estate loans of$27.1 million and$17.7 million , respectively, representing 10.2% and 6.8% of our total loans, respectively. Construction loans are usually paid off through the conversion to permanent financing from third-party lending institutions. Lot loans may be paid off as the borrower converts to a construction loan. At the completion of the construction project, if the loan is converted to permanent financing by us or if scheduled loan amortization begins, it is then reclassified from construction to single-family dwelling. Underwriting of construction and development loans typically includes analysis of not only the borrower's financial condition and ability to meet the required debt obligations, but also the general market conditions associated with the area and type of project being funded. These loans are generally secured by mortgages for residential property located primarily in theSalt Lake City, Utah MSA, and we obtain guarantees from responsible parties. Historically, we have retained these loans on our balance sheet for investment. Strategic Program loans We, through our Strategic Program service providers, issue, on a nationwide basis, unsecured consumer and secured or unsecured business loans to borrowers within certain approved credit profiles. As ofDecember 31, 2021 andDecember 31, 2020 , we had total Strategic Program loans of$85.9 million and$28.3 million , respectively, representing 32.3% and 10.8% of our total loans, respectively. Loans originated through these programs are limited to predetermined Bank underwriting criterion, which has been approved by our board of directors. The primary form of repayment on these loans is from personal or business cash flow. Business loans may be secured by liens on business assets, as applicable. We have generally sold most of these loans, but as our capital grows and FinView™ evolves, we may choose to hold more of the funded loans and/or receivables. We reserve the right to sell any portion of funded loans and/or receivables directly to the Strategic Program service providers or other investors. We retain the legal right to service all these loans, but contract with the Strategic Program service provider or another approved sub-servicer to service these loans on our behalf. 58
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Commercial real estate
Commercial real estate loans include loans to individuals, sole proprietorships, partnerships, corporations, or other business enterprises for commercial, industrial, agricultural, or professional purposes, secured by real estate primarily located in theSalt Lake City, Utah MSA, but not for personal expenditure purposes. As ofDecember 31, 2021 andDecember 31, 2020 , we had total commercial real estate loans of$2.4 million and$2.9 million , respectively, representing 0.9% and 1.1% of our total loans, respectively. Underwriting is generally based on commercial credit metrics where the primary repayment source is borrower cash flow, secondary is personal guarantor cash flow (when applicable) and tertiary is the sale of collateral pledged. The nature of the business, use of proceeds, length of time in business, management experience, repayment ability, credit history, ratio calculations and assessment of collateral adequacy are all considerations. In addition to real estate, these loans may also be secured by liens on business assets. Historically, we have retained these loans on our balance sheet for investment.
Consumer
Consumer lending provides financing for personal, family, or household purposes on a nationwide basis. Most of these loans are originated through our POS platform and come from a variety of sources, including other approved merchant or dealer relationships and lending platforms. As ofDecember 31, 2021 andDecember 31, 2020 , we had total consumer loans of$4.6 million , and$5.5 million , respectively, representing 1.7% and 2.1% of our total loans, respectively. We use a debt-to-income ("DTI") ratio to determine whether an applicant will be able to service the debt. The DTI ratio compares the applicant's anticipated monthly expenses and total monthly obligations to the applicant's monthly gross income. Our policy is to limit the DTI ratio to 45% after calculating interest payments related to the new loan. Loan officers, at their discretion, may make exceptions to this ratio if the loan is within their authorized lending limit. DTI ratios of no more than 50% may be approved subject to an increase in interest rate. Strong offsetting factors such as higher discretionary income or large down payments are used to justify exceptions to these guidelines. All exceptions are documented and reported. While the loans are generally for the purchase of goods which may afford us a purchase money security interest, they are underwritten as if they were unsecured. On larger loans, we may file a Uniform Commercial Code financing form. Historically, we have retained these loans on our balance sheet for investment.
Loan Portfolio Program Summary
Through our diversification efforts and FinView™, we have built a portfolio that
we believe positions us to withstand economic shifts. For example, we focus on
industries and loan types that have historically lower loss rates such as
professional, scientific and technical services (including law firms), non-store
retailers (e-commerce), and ambulatory healthcare services. We believe that
these efforts helped minimize our exposure to industries severely impacted by
the Covid-19 pandemic.
The following table summarizes our loan portfolio by loan program as of the
dates indicated:
As of December 31,
2021 2020
% of % of
total total
Amount loans Amount loans
SBA(1) $ 142,392 53.6 % $ 203,317 77.7 %
Commercial, non real estate 3,428 1.3 % 4,020 1.5 %
Residential real estate 27,108 10.2 % 17,740 6.8 %
Strategic Program loans 85,850 32.3 % 28,265 10.8 %
Commercial real estate 2,436 0.9 % 2,892 1.1 %
Consumer 4,574 1.7 % 5,543 2.1 %
Total $ 265,788 100.0 % $ 261,777 100.0 %
(1) The amount of SBA loans as of
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Index
Loan Maturity and Sensitivity to Changes in Interest Rates
As ofDecember 31, 2021 , including the impact of PPP loans,$103.1 million , or 50.3%, of the total held for investment loan balance matures in less than five years. Loans maturing in greater than five years totaled$101.9 million as ofDecember 31, 2021 . The variable rate portion of our total held for investment loan portfolio atDecember 31, 2021 was$163.8 million , or 79.9%. As ofDecember 31, 2020 , including the impact of PPP loans,$173.5 million , or 72.1%, of the total held for investment loan balance matures in less than five years. Loans maturing in greater than five years totaled$67.3 million as ofDecember 31, 2020 . The variable rate portion of our total held for investment loan portfolio atDecember 31, 2020 was$107.7 million , or 44.7%. The variable rate portion of the total held for investment loans reflects our strategy to minimize interest rate risk through the use of variable rate products.
The following tables detail maturities and sensitivity to interest rate changes
for our loan portfolio at
At December 31, 2021 Remaining Contractual Maturity Held for Investment
After Five
After One Years and
Year and Through After
One Year Through Fifteen Fifteen
($ in thousands) or Less Five Years Years Years Total
Fixed rate loans:
SBA(1) $ 644 $ 732 $ 259 $ 114 $ 1,749
Commercial, non-real estate 1,168 2,112 142 6 3,428
Residential real estate 2,876 1,519 - - 4,395
Strategic Program loans 18,121 6,981 - - 25,102
Commercial real estate 1,565 639 7 1 2,212
Consumer 1,500 2,793 66 - 4,359
Variable rate loans:
SBA 7,920 31,598 58,493 42,632 140,643
Commercial, non-real estate - - - - -
Residential real estate 22,234 291 188 - 22,713
Strategic Program loans - - - - -
Commercial real estate 224 - - - 224
Consumer 62 153 - - 215
Total $ 56,314 $ 46,818 $ 59,155 $ 42,753 $ 205,040
(1) The amount of SBA fixed rate loans includes approximately $1.1 million of
PPP loans. PPP loans originated prior to June 5, 2020 , have a two year term. PPP
loans originated on or after June 5, 2020 , have a five year term. For PPP
borrowers who submit completed applications for forgiveness, loan payments are
automatically deferred until the SBA renders a decision on the forgiveness
request. PPP borrowers who fail to submit timely forgiveness applications are
required to make monthly payments beginning ten months from the end of the
chosen "covered period". The "covered period" is a maximum of 24 weeks from the
origination date. Assuming a 24 week covered period, PPP borrowers are not
required to begin making payments until 16 months after the origination date. At
the time payments begin, if the borrower and lender of a two year PPP loan
mutually agree to extend the term of the loan it can be extended to a five year
term. As of December 31, 2021 , three PPP loans have been granted maturity date
extensions.
At December 31, 2020 Remaining Contractual Maturity Held for Investment
After Five
After One Years and
Year and Through After
One Year Through Fifteen Fifteen
($ in thousands) or Less Five Years Years Years Total
Fixed rate loans:
SBA(1) $ 53,093 $ 54,376 $ 339 $ 158 $ 107,966
Commercial, non-real estate 1,746 2,203 70 1 4,020
Residential real estate 4,788 1,392 - - 6,180
Strategic Program loans 6,547 770 - - 7,317
Commercial real estate 1,902 766 17 - 2,685
Consumer 1,737 3,226 20 - 4,983
Variable rate loans:
SBA 5,762 23,009 39,866 26,714 95,351
Commercial, non-real estate - - - - -
Residential real estate 10,696 747 117 - 11,560
Strategic Program loans - - - - -
Commercial real estate 207 - - - 207
Consumer 191 369 - - 560
Total $ 86,669 $ 86,858 $ 40,429 $ 26,873 $ 240,829 (1) The amount of SBA fixed rate loans includes approximately
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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 contractually 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 such loans are actually past due. In general, we place loans on nonaccrual status when they become 90 days past due. We also generally 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 recoveries received (either from payments received from the customer, derived from the disposition of collateral or from legal action, such as judgment enforcement) exceed liquidation expenses incurred and outstanding principal.
A non-accrual asset may be restored to accrual status when (1) none of its principal and interest is due and unpaid, and we expect repayment of the remaining contractual principal and interest, or (2) when asset otherwise becomes well secured and is not in the process of collection.
Any loan which we deem to be uncollectible, in whole or in part, is charged off
to the extent of the anticipated loss. In general, loans that are past due for
90 days or more are charged off unless the loan is both well secured and in the
process of collection. We believe our disciplined lending approach and focused
management of nonperforming assets has resulted in sound asset quality and
timely resolution of problem assets. We have several procedures in place to
assist us in maintaining the overall quality of our loan portfolio. We have
established underwriting guidelines to be followed by our loan officers, and we
also monitor our 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 due to general economic
conditions.
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The following table provides information with respect to our nonperforming assets and troubled debt restructurings at the dates indicated:
As of December 31,
($ in thousands) 2021 2020
Nonaccrual loans:
SBA $ 657 $ 816
Commercial, non real estate - -
Residential real estate - -
Strategic Program loans - 15
Total nonperforming loans $ 657 $ 831
Total accruing loans past due 90
days or more $ 54 $ 1
Nonaccrual troubled debt
restructuring $ 25 $ 53
Total troubled debt restructurings 106 870
Other Real Estate Owned - -
Less nonaccrual troubled debt
restructurings (25 ) (53 )
Total nonperforming assets and
troubled debt restructurings $ 763 $ 1,701
Total nonperforming loans to total
loans 0.2 % 0.3 %
Total nonperforming loans to total
assets 0.2 % 0.3 %
Total nonperforming assets and
troubled debt restructurings to
total loans 0.3 % 0.6 %
Total nonperforming assets and
troubled debt restructurings to
total assets 0.2 % 0.5 %
Total nonperforming assets and
troubled debt restructurings to
total assets (less PPP loans) (1) 0.2 % 0.8 %
(1) See "GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures" for a reconciliation of this measure to its most comparable GAAP measure.
Our total nonperforming assets and troubled debt restructurings atDecember 31 . 2021 were$0.8 million , which represented a reduction of$0.9 million fromDecember 31, 2020 . The largest troubled debt restructuring attributable to a single borrower atDecember 31, 2020 with balance of$0.8 million paid in full including interest inMay 2021 . Total nonperforming assets atDecember 31, 2021 were composed of$0.7 million in nonaccrual loans and$0.1 million of troubled debt restructurings. Total nonperforming assets atDecember 31, 2020 were composed of$0.8 million in nonaccrual loans and$0.9 million of troubled debt restructurings. We do not classify loans that experience insignificant payment delays and payment shortfalls as impaired. We consider an "insignificant period of time" from payment delays to be a period of 90 days or less, or 180 days or less in certain Strategic Programs. We will customarily attempt to provide a modification for a customer experiencing what we consider to be a short-term event that has temporarily impacted cash flow. In those cases, we will review the request to determine if the customer is experiencing cash flow strain and how the event has impacted the ability of the customer to repay in the long term. Short-term modifications are not classified as troubled debt restructurings because they do not meet the definition set by theFDIC or our accounting policy for identifying troubled debt restructurings. TheFDIC issued statements in March and April of 2020 that encouraged banks to work with all borrowers, especially those from industry sectors particularly vulnerable to economic volatility. TheFDIC clarified that prudent efforts to modify the terms on existing loans for affected customers will not be subject to examiner criticism, and that certain loan modifications made in response to Covid-19 are not troubled debt restructurings. The dollar amount of short-term modifications of loans held for investment as ofDecember 31, 2021 was$0.5 million , substantially all of which are attributable to our Strategic Program loans. The dollar amount of short-term modifications of loans held for investment as ofDecember 31, 2020 was$1.2 million . Of this, approximately$0.6 million , or 46.7%, is attributable to our Strategic Program loans,$0.5 million , or 46.5%, is attributable to our SBA 7(a) portfolio, and$0.1 million , or 6.8%, is attributable to our Commercial, non-real estate portfolio. Interest income that would have been recorded for the years endedDecember 31, 2021 and 2020 had nonaccrual loans been current throughout the period amounted to$0.1 million and$0.1 million , respectively. 62
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Credit Risk Profile
We believe that we underwrite loans carefully and thoroughly, limiting our
lending activities to those products and services where we have the resources
and expertise to lend profitably without undue credit risk. We require all loans
to conform to policy (or otherwise be identified as exceptions to policy and
monitored and reported on, at minimum, quarterly) and be granted on a sound and
collectable basis. Loans are made with a primary emphasis on loan profitability,
credit risk and concentration exposures.
We are proactive in our approach to identifying and resolving problem loans and
are focused on working with the borrowers and guarantors of problem loans to
provide loan modifications when warranted. When considering how to best
diversify our loan portfolio, we consider several factors including our
aggregate and product-line specific concentration risks, our business line
expertise, and the ability of our infrastructure to appropriately support the
product. While certain product lines generate higher net charge-offs, our
exposure is carefully monitored and mitigated by our concentration policies and
reserved for by the loan loss allowance we maintain. Specifically, retention of
certain Strategic Program loans with higher default rates account for a
disproportionate amount of our charge-offs. In addition to our oversight of the
credit policies and processes associated with these programs, we limit within
our concentration policies the aggregate exposure of these loans as a percentage
of the total loan portfolio, carefully monitor certain vintage loss-indicative
factors such as first payment default and marketing channels, and appropriately
provision for these balances so that the cumulative charge-off rates remain
consistent with management expectations. While the level of nonperforming assets
fluctuates in response to changing economic and market conditions, the relative
size and composition of the loan portfolio, and our management's degree of
success in resolving problem assets, we believe our proactive stance to early
identification and intervention is the key to successfully managing our loan
portfolio. As an example, at the beginning of the Covid-19 pandemic we analyzed
our portfolio to identify loans that were more likely to be vulnerable to the
pandemic's impact. We then proactively opened a dialogue with potentially
affected borrowers to assess their needs and provide assistance. Through this
process we were able to not only better understand our portfolio risks but were
able to intercede with borrowers if needed.
Accurate and timely loan risk grading is considered a critical component of an
effective credit risk management system. Loan grades take into consideration the
borrower's financial condition, industry trends, and the economic environment.
Loan risk grades are changed as necessary to reflect the risk inherent in the
loan. Among other things, we use loan risk grading information for loan pricing,
risk and collection management and determining monthly loan loss reserve
adequacy. Further, on a quarterly basis, the Loan Committee holds a Loan Risk
Grade meeting, wherein all loans in our portfolio are reviewed for accurate risk
grading. Any changes are made after the Loan Risk Grade meeting to provide for
accurate reporting. Reporting is achieved in Loan Committee minutes, which
minutes are reviewed by the Board. We supplement credit department supervision
of the loan underwriting, approval, closing, servicing and risk grading process
with periodic loan reviews by risk department personnel specific to the testing
of controls.
We use a grading system to rank the quality of each loan. The grade is
periodically evaluated and adjusted as performance dictates. Loan grades 1
through 4 are passing grades, grade 5 is special mention. Collectively, grades 6
(substandard), 7 (doubtful) and 8 (loss) represent classified loans within the
portfolio. The following guidelines govern the assignment of these risk grades.
We do not currently grade Strategic Program loans held for investment due to
their small balances and homogenous nature. As credit quality for Strategic
Program loans have been highly correlated with delinquency levels, the Strategic
Program loans are evaluated collectively for impairment.
Grade 1: Pass - Loans fully secured by deposit accounts. Loans where the
borrower has strong sources of repayment, generally 5 years or more of
consistent employment (or related field) and income history. Debt of the
borrower is modest relative to the borrower's financial strength and ability to
pay with a DTI ratio of less than 25%. Cash flow is very strong as evidenced by
significant discretionary income amounts. Borrower will consistently maintain
30% of the outstanding debts in deposit accounts with us, often with the right
of offset, holds, etc. Loan to value ratios (LTV) will be 60% or less. Loans in
this category require very minimal monitoring.
Grade 2: Pass - The borrower has good sources of repayment, generally 3 years or
more of consistent employment (or related field) and income history. The debt of
the borrower is reasonable relative to the borrower's financial strength with a
DTI ratio of less than 35%. Cash flow is strong as evidenced by exceptional
discretionary income amounts. Borrowers will consistently maintain 20% of the
outstanding debts in deposit accounts with us. LTV ratios will be 70% or less.
These loans require minimal monitoring.
Grade 3: Pass - There is a comfortable primary source of repayment, generally 2
years or more of consistent employment (or related field) and income history.
Borrowers may exhibit a mix of strengths and weaknesses. For example, they have
either adequate cash flow with higher than desired leverage, or marginal cash
flow with strong collateral and liquidity. Borrowers will have DTIs less than
45%. Borrowers will generally maintain deposit accounts with us, but the
consistency and amount of the deposits are not as strong as Grades 1 and 2. LTV
ratios will be within our guidelines. These loans will be monitored on a
quarterly basis.
Grade 4: Pass Watch - There is adequate primary source of repayment, generally
employment time or time in a related field is less than 2 years. Borrowers' debt
to income ratios may fall outside of our guidelines or there is minimal excess
cash flow. There may be heavy reliance on collateral, or the loan is large,
relative to the financial strength of the borrower. The loans may be maintenance
intensive requiring closer monitoring.
Grade 5: Special Mention - A loan in this category has a specific weakness or
problem but does not currently present a significant risk of loss or default as
to any material terms of the loan or financing agreement. A typical problem
could include a documentation deficiency. If the deficiency is corrected the
account will be re-graded.
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Grade 6: Classified Substandard - A substandard loan has a developing or current weakness or weaknesses that could result in loss or default if deficiencies are not corrected, or adverse conditions arise.
Grade 7: Classified Doubtful - A doubtful loan has an existing weakness or weaknesses that make collection or liquidation in full, on the basis of currently existing facts and conditions, highly questionable and improbable.
Grade 8: Classified Loss - A loss loan has an existing weakness or weaknesses
that render the loan uncollectible and of such little value that continuing to
carry as an asset on our book is not warranted. This classification does not
mean that the loan has absolutely no recovery or salvage value, but rather it is
not practical nor desirable to defer writing off this basically worthless asset,
even though partial recovery may be affected in the future.
The following table presents, as of the period presented, the loan balances by
loan program as well as risk rating. No loans were classified as 'Loss' grade
during the periods presented.
As of December 31, 2021
Special Classified/
Pass Mention Doubtful Loss
($ in thousands) Grade 1-4 Grade 5 Grade 6-7 Grade 8 Total
SBA $ 139,985 $ 1,435 $ 972 $ - $ 142,392
Commercial, non real estate 3,382 46 - - 3,428
Residential real estate 27,108 - - - 27,108
Commercial real estate 2,436 - - - 2,436
Consumer 4,574 - - - 4,574
Not Risk Graded
Strategic Program(1) loans - - - - 85,850
Total $ 177,485 $ 1,481 $ 972 $ - $ 265,788
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As of December 31, 2020
Special Classified/
Pass Mention Doubtful Loss
($ in thousands) Grade 1-4 Grade 5 Grade 6-7 Grade 8 Total
SBA $ 200,360 $ 2,040 $ 917 - $ 203,317
Commercial, non real estate 3,960 60 - - 4,020
Residential real estate 16,984 - 756 - 17,740
Commercial real estate 2,892 - - - 2,892
Consumer 5,543 - - - 5,543
Not Risk Graded
Strategic Program(1) loans - - - - 28,265
Total $ 229,739 $ 2,100 $ 1,673 - $ 261,777
(1) The Strategic Program loan balance includes $60.7 million and $21.0 million
of loans classified as held-for-sale as of December 31, 2021 and December 31,
2020 , respectively.
Allowance for Loan Losses
We have not adopted Financial Accounting Standards Board Accounting Standards
Update No. 2016-13, Financial Instruments - Credit Losses (Topic 326), commonly
referred to as the "CECL model," but plan to adopt the CECL model in the 2023
calendar year.
The ALL, a material estimate which could change significantly in the near-term
in the event of rapidly shifting credit quality, is established through a
provision for loan losses charged to earnings to account for losses that are
inherent in the loan portfolio and estimated to occur, and is maintained at a
level that we consider adequate to absorb potential losses in the loan
portfolio. Loan losses are charged against the ALL when we believe that the
collectability of the principal loan balance is unlikely. Subsequent recoveries,
if any, are credited to the ALL when received.
Our judgment in determining the adequacy of the allowance is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available and as situations and information change.
We evaluate the ALL on a monthly basis and take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans and current economic conditions and trends that may affect the borrower's ability to repay. The quality of the loan portfolio and the adequacy of the ALL is reviewed by regulatory examinations and the Company's auditors.
The ALL consists of the following two elements:
• Specific allowance for identified impaired loans. For such loans that are
identified as impaired, an allowance is established when the discounted cash
flows (or collateral value if the loan is collateral dependent) or observable
market price of the impaired loan are lower than the carrying value of that
loan. Independent appraisals are obtained for all collateral dependent loans deemed impaired when collateral value is expected to exceed$5 thousand net of actual and/or anticipated liquidation-related expenses. After initially measured for impairment, new appraisals are ordered on at least an annual basis for all real estate secured loans deemed impaired. Non-real estate secured loan appraisal values are reevaluated and assessed throughout the year based upon interim changes in collateral and market conditions.
• General valuation allowance. This component represents a valuation allowance on
the remainder of the loan portfolio, after excluding impaired loans. For this
portion of the allowance, loans are reviewed based on industry, stage and
structure and are assigned allowance percentages based on historical loan loss
experience for similar loans with similar characteristics and trends adjusted
for qualitative factors. Qualitative factors that, in management's judgment,
affect the collectability of the portfolio as of the evaluation date, may
include changes in lending policies and procedures; changes in national and
local economic and business conditions, including the condition of various
market sectors; changes in the nature and volume of the portfolio; changes in
the experience, ability and depth of lending management and staff; changes in
the volume and severity of past due and classified loans and in the volume of
nonaccruals, troubled debt restructurings, and other loan modifications; the
existence and effect of any concentrations of credit and changes in the level
of such concentrations; and the effect of external factors, such as competition
and legal and regulatory requirements, on the level of estimated and inherent
credit losses in our current portfolio.
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The ALL was
The following table presents a summary of changes in the ALL for the periods and
dates indicated:
For the Year Ended
December 31,
($ in thousands) 2021 2020
ALL:
Beginning balance $ 6,199 $ 4,531
Provision for loan losses 8,039 5,234
Charge offs
SBA (154 ) (197 )
Commercial, non-real estate (63 ) (332 )
Residential real estate - -
Strategic Program loans (4,684 ) (3,262 )
Commercial real estate - -
Consumer (4 ) (17 )
Recoveries
SBA 46 -
Commercial, non-real estate 103 -
Residential real estate - -
Strategic Program loans 372 236
Commercial real estate - 5
Consumer 1 1
Ending balance $ 9,855 $ 6,199
Although we believe that we have established our ALL in accordance with GAAP and
that the ALL 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.
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The following table shows the allocation of the ALL among loan categories and certain other information as of the dates indicated. The ALL related to Strategic Programs constitutes 66.5% and 66.3% of the total ALL while comprising 32.3% and 10.8% of total loans as ofDecember 31, 2021 andDecember 31, 2020 , respectively. This reflects the increased credit risks associated with certain retained Strategic Program loans. December 31, 2021 % of % of Loans in Total Category of ($ in thousands) Amount Total Loans Allowance Total Loans SBA$ 2,739 $ 142,392 27.8 % 53.6 % Commercial, non real estate 132 3,428 1.3 % 1.3 % Residential real estate 352 27,108 3.6 % 10.2 % Strategic Program loans 6,549 85,850 66.5 % 32.3 % Commercial real estate 21 2,436 0.2 % 0.9 % Consumer 62 4,574 0.6 % 1.7 % Total$ 9,855 $ 265,788 100.0 % 100.0 % December 31, 2020 % of % of Loans in Total Category of ($ in thousands) Amount Total Loans Allowance Total Loans SBA$ 920 $ 203,317 14.8 % 77.7 % Commercial, non real estate 232 4,020 3.8 % 1.5 % Residential real estate 855 17,740 13.8 % 6.8 % Strategic Program loans 4,111 28,265 66.3 % 10.8 % Commercial real estate 19 2,892 0.3 % 1.1 % Consumer 62 5,543 1.0 % 2.1 % Total$ 6,199 $ 261,777 100.0 % 100.0 % The following table reflects the ratio of the ALL to nonperforming loan balances, as well as net charge-offs to average loans outstanding by loan category, as of the dates presented. The ratio of net charge-offs to average loans outstanding generally decreased or remained consistent for loan categories in the year endedDecember 31, 2021 from the year endedDecember 31, 2020 . The decrease in the ratio for Strategic Programs loans was primarily due to increases in average loan balances in the year endedDecember 31,2021 while the decreases in Commercial, non-real estate and Consumer were primarily due to lower charge-off amounts in the year endedDecember 31, 2021 . As of December 31, 2021 2020 ALL to nonperforming loans 1,499.1 % 745.7 % Net charge-offs to average loans outstanding by loan category SBA 0.1 % 0.1 % Commercial, non-real estate (1.0 %) 5.9 % Residential real estate 0.0 % 0.0 % Strategic Program loans 5.7 % 9.6 % Commercial real estate 0.0 % (0.1 %) Consumer 0.1 % 0.3 % 67
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Interest-Bearing Deposits in Other Banks
Our interest-bearing deposits in other banks increased to$85.3 million atDecember 31, 2021 from$47.0 million atDecember 31, 2020 , an increase of$38.3 million , or 81.7%. This increase was primarily due to the net proceeds of$35.6 million from our initial public offering and an increase in loan originations. Interest-bearing deposits in other banks have generally been the primary repository of the liquidity we use to fund our operations. Aside from minimal balances held with our correspondent banks, the majority of our interest-bearing deposits in other banks was held directly with theFederal Reserve .
Securities
We use our securities portfolio to provide a source of liquidity, provide an appropriate return on funds invested, manage interest rate risk, meet collateral requirements and meet regulatory capital requirements. We classify investment securities as either held-to-maturity or available-for-sale based on our intentions and the Company's ability to hold such securities until maturity. In determining such classifications, securities that we have the positive intent and the ability to hold until maturity are classified as held-to-maturity and carried at amortized cost. All other securities are designated as available-for-sale and carried at estimated fair value with unrealized gains and losses included in shareholders' equity on an after-tax basis. For the year presented, all securities were classified as held-to-maturity. The following tables summarize the contractual maturities and weighted average yields of investment securities atDecember 31, 2021 andDecember 31, 2020 , and the amortized cost of those securities as of the indicated dates. AtDecember 31 . 2021 One Year or Less After
One to Five Years
Amortized Weighted Amortized Weighted
($ in thousands) Cost Average Yield Cost Average Yield
Mortgage-backed
securities $ - - $ - -
At December 31, 2021
After Five to Ten Years Weighted After Ten Years Weighted
Total
Amortized Weighted Amortized Weighted Amortized
($ in thousands) Cost Average Yield Cost Average Yield Cost
Mortgage-backed
securities $ 1,541 1.3 % $ 9,882 1.5 % $ 11,423 The weighted average yield of investment securities is the sum of all interest that the investments generate, divided by the sum of the book value.
There were no calls, sales or maturities of securities during the years ended
AtDecember 31, 2021 , there were 13 securities, consisting of five collateralized mortgage obligations and eight mortgage-backed securities. Four of these securities were in gain positions for greater than 12 months and nine of these securities were in an unrealized loss position as ofDecember 31, 2021 . There were no unrealized losses as ofDecember 31, 2020 .
Deposits
Deposits are the major source of funding for the Company, with the exception of
the Company's participation in the PPPLF, which added a significant amount of
funding in 2020 (see discussion below in Liquidity and Capital Resources -
Liquidity Management). We offer a variety of deposit products including interest
and noninterest bearing demand accounts, money market and savings accounts and
certificates of deposit, all of which we market at competitive pricing. We
generate deposits from our customers on a relationship basis and through access
to national Institutional and brokered deposit sources. We also generate
deposits in relation to our Strategic Programs in the form of reserve accounts
as discussed above. These deposits add an element of flexibility in that they
tend to increase or decrease in relation to the size of or Strategic Program
loan portfolio. In addition to the reserve account, some Strategic Program loan
originators maintain operating deposit accounts with us.
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The following table presents the end of period and average balances and for the
periods indicated (average balances have been calculated using daily averages):
For the Years Ended December 31,
2021 2020
($ in thousands) Total Percent Total Percent
Period end:
Noninterest-bearing demand deposits $ 110,548 43.9 % $ 88,067 53.5 %
Interest-bearing deposits:
Demand 5,399 2.1 % 6,095 3.7 %
Savings 6,685 2.7 % 7,435 4.5 %
Money markets 31,076 12.3 % 17,567 10.7 %
Time certificates of deposit 98,184 39.0 % 45,312 27.6 %
Total period end deposits $ 251,892 100.0 % $ 164,476 100.0 %
Average:
Noninterest-bearing demand deposits $ 107,481 49.8 % $ 80,537 49.2 %
Interest-bearing deposits:
Demand 6,060 2.8 % 3,237 2.0 %
Savings 7,897 3.7 % 6,234 3.8 %
Money market 21,964 10.2 % 16,327 9.9 %
Time certificates of deposit 72,311 33.5 % 57,496 35.1 %
Total average deposits $ 215,713 100.0 % $ 163,831 100.0 %
Our deposits increased to
As anFDIC -insured institution, our deposits are insured up to applicable limits by the DIF of theFDIC . The Dodd-Frank Act raised the limit for federal deposit insurance to$250,000 for most deposit accounts and increased the cash limit ofSecurities Investor Protection Corporation protection from$100,000 to$250,000 . Our total uninsured deposits were$163.7 million and$92.2 million for the years endedDecember 31, 2021 and 2020, respectively. The maturity profile of our uninsured time deposits, those amounts that exceed theFDIC insurance limit, atDecember 31, 2021 is as follows: More than Three More than six months More than months three months to twelve twelve ($ in thousands) or less to six months months months Total
Time deposits, uninsured $ - $ 128$ 501 $ 155 $ 784 69
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Liquidity and Capital Resources
Liquidity Management
Liquidity management is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, the sale of loans, repayment of loans and net profits. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows, loan prepayments, loan sales and security sales are greatly influenced by general interest rates, economic conditions, and competition. OnNovember 23, 2021 , we completed our IPO at a price of$10.50 per share. We raised approximately$36.1 million in net proceeds after deducting underwriting discounts and commissions of approximately$3.0 million and certain estimated offering expenses payable by us of approximately of$3.2 million . The net proceeds less$0.5 million in other related expenses, including legal fees totaled$35.6 million . Our primary source of funds to originate new loans (other than the PPPLF program used to fund PPP loans in 2020) is derived from deposits. Deposits are comprised of core and noncore deposits. We use brokered deposits and a rate listing service to advertise rates to banks, credit unions, and other institutional entities. We designate deposits obtained from this source as Institutional Deposits. To date, depositors of brokered and Institutional Deposits have been willing to place deposits with us at rates near the middle of the market. To attract deposits from local and nationwide consumer and commercial markets, we historically paid rates at the higher end of the market, which we have been able to pay due to our high margin and technology oriented business model. We utilize rate listing services and website advertising to attract deposits from consumer and commercial sources. We regularly evaluate new, core deposit products and in 2020, we launched a deposit product targeted to the needs of our PPP borrowers. We intend to have various term offerings to match our funding needs. Plans for 2022 include marketing commercial checking accounts to selected business customers and expanded roll out of our deposit product targeted to the needs of our SBA borrowers. These accounts offer small business cash management tools including ACH and wire capabilities, competitive interest rates, and personalized customer support. The commercial checking account is expected to be a no-fee based account with emphasis on electronic banking. With no current plans to expand our brick-and-mortar branch network, online and mobile banking offers a means to meet customer needs and better efficiency through technology compared to traditional branch networks. We believe that the rise of mobile and online banking provides us the opportunity to further leverage the technological competency we have demonstrated in recent years. We regularly adjust our investment in liquid assets based upon our assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities and (4) the objectives of our asset/liability management, funds management and liquidity policies. The objective of the liquidity policy is to reduce the risk to our earnings and capital arising from the inability to meet obligations in a timely manner. This entails ensuring sufficient funds are available at a reasonable cost to meet potential demands from both fund providers and borrowers. Liquid assets, defined as cash and due from banks and interest bearing deposits, were 22.6% of total assets atDecember 31, 2021 . We primarily utilize short-term and long-term borrowings to supplement deposits to fund our lending and investment activities, each of which is discussed below. AtDecember 31, 2021 , we had the ability to access$10.9 million from theFederal Reserve Bank's Discount Window on a collateralized basis. ThroughZions Bank , the Bank had an available unsecured line available of$1.0 million . The Bank had an available unsecured line of credit withBankers' Bank of the West to borrow up to$1.05 million in overnight funds. We also maintain a$4.1 million line of credit withFederal Home Loan Bank , secured by specific pledged loans. We had no outstanding balances on the unsecured or secured lines of credit as ofDecember 31, 2021 . In long term borrowings, we had$1.1 million outstanding atDecember 31, 2021 related to the PPPLF. The PPPLF is secured by pledged PPP loans. Our most liquid assets are cash and cash equivalents. The levels of these assets depend on our operating, financing, lending and investing activities during any given period. AtDecember 31, 2021 , liquid assets (defined as cash and due from banks and interest bearing deposits), consisting of cash and due from banks, totaled$85.8 million . We believe that our liquid assets combined with the available lines of credit provide adequate liquidity to meet our current financial obligations for at least the next 12 months.
Capital Resources
Shareholders' equity increased$69.5 million to$115.4 million atDecember 31, 2021 compared to$45.9 million atDecember 31, 2020 . The increase in shareholders' equity was primarily attributable to the net proceeds of$35.6 million from the issuance of 4,025,000 shares of common stock in our IPO and net income recognized of$31.6 million . Stock options exercised, and stock-based compensation increased additional paid-in capital aggregately by approximately$2.4 million . We use several indicators of capital strength. The most commonly used measure is average common equity to average assets, which was 23.1% and 16.0% atDecember 31, 2021 and 2020, respectively. 70
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Our return on average equity was 39.2% and 28.4% for the years endedDecember 31, 2021 and 2020, respectively. Our return on average assets was 9.1% and 4.5% for the years endedDecember 31, 2021 and 2020, respectively. We seek to maintain adequate capital to support anticipated asset growth, operating needs and unexpected risks, and to ensure that we are in compliance with all current and anticipated regulatory capital guidelines. Our primary sources of new capital include retained earnings and proceeds from the sale and issuance of capital stock or other securities. Expected future use or activities for which capital may be set aside include balance sheet growth and associated relative increases in market or credit exposure, investment activity, potential product and business expansions, acquisitions and strategic or infrastructure investments. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate 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 about components, risk weightings, and other factors. Under the prompt corrective action rules, an institution is deemed "well capitalized" if its Tier 1 leverage ratio, Common Equity Tier 1 ratio, Tier 1 Capital ratio, and Total Capital ratio meet or exceed 5%, 6.5%, 8%, and 10%, respectively. OnSeptember 17, 2019 , the federal banking agencies jointly finalized a rule intending to simplify the regulatory capital requirements described above for qualifying community banking organizations that opt into the Community Bank Leverage Ratio framework, as required by Section 201 of the Regulatory Relief Act. The Bank has elected to opt into theCommunity Bank Leverage Ratio framework starting in 2020. Under these new capital requirements, as temporarily amended by Section 4012 of the CARES Act, the Bank must maintain a leverage ratio greater than 8% for 2020 and 8.5% for 2021. As ofDecember 31, 2021 and 2020, the most recent notification from theFDIC categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action (there are no conditions or events since that notification we believe have changed the Bank's category). The following table sets forth the actual capital amounts and ratios for the Bank and the amount of capital required to be categorized as well-capitalized as of the dates indicated. The following table presents the regulatory capital ratios for the Bank as of the dates indicated: December 31, Well- Capitalized Capital Ratios 2021 2020 Requirement Leverage Ratio (under CBLR) 17.7 % 16.6 % 8.5 %(1)
(1) The Well-Capitalized Requirement for 2020 was 8.0%.
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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 ofDecember 31, 2021 . One to More Less than Three Three to Than Five ($ in thousands) Total One Year Years Five Years Years Contractual Obligations Deposits without stated maturity$ 115,947 $ 115,947 $ - $ - $ - Time deposits 98,184 41,567 37,023 19,594 - Long term borrowings(1) 1,050 573 - 477 - Operating lease obligations 8,717 946 2,212 2,204 3,355 Total$ 223,898 $ 159,033 $ 39,235 $ 22,275 $ 3,355
(1) Balances in this category pertain to the PPPLF and are fully-collateralized with PPP loans
Off-Balance Sheet Items In the normal course of business, we enter into various transactions, which, in accordance with GAAP, are not included in our consolidated statements of financial condition. We enter into these transactions to meet the financing needs of our customers. These transactions include commitments to extend credit, which involves, to varying degrees, elements of credit risk and interest rate risk exceeding the amounts recognized in our consolidated statements of financial condition. 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; if required, we would maintain an allowance for off-balance sheet credit risk which would be recorded in other liabilities on the consolidated balance sheets.
Our commitments to extend credit as of the dates indicated are summarized below. Since commitments associated with commitments to extend credit may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements.
As of December 31,
($ in thousands) 2021 2020
Revolving, open-end lines of credit $ 1,259 $ 757
Commercial real estate 15,402 14,468
Other unused commitments 377 928
Total commitments $ 17,038 $ 16,153 Critical Accounting Policies and Estimates
The preparation of our consolidated financial statements in accordance with GAAP
requires us to make estimates and judgments that affect our reported amounts of
assets, liabilities, revenues and expenses and related disclosures of contingent
assets and liabilities. We base our estimates on historical experience and on
various other assumptions that are believed to be reasonable under current
circumstances, results of which form the basis for making judgments about the
carrying value of certain assets and liabilities that are not readily available
from other sources. We evaluate our estimates on an ongoing basis. Actual
results may differ from these estimates under different assumptions or
conditions.
Accounting policies, as described in detail in the notes to our consolidated
financial statements, included elsewhere in this Report, are an integral part of
our financial statements. A thorough understanding of these accounting policies
is essential when reviewing our reported results of operations and our financial
position. We believe that the critical accounting policies and estimates
discussed below require us to make difficult, subjective or complex judgments
about matters that are inherently uncertain. Changes in these estimates, which
are likely to occur from period to period, or use of different estimates that we
could have reasonably used in the current period, would have a material impact
on our financial position, results of operations or liquidity.
The JOBS Act permits us an extended transition period for complying with new or
revised accounting standards affecting public companies. We have elected to take
advantage of this extended transition period, which means that the financial
statements included in this Report, as well as any financial statements that we
file in the future, will not be subject to all new or revised accounting
standards generally applicable to public companies for the transition period for
so long as we remain an emerging growth company or until we affirmatively and
irrevocably opt out of the extended transition period under the JOBS Act.
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The following is a discussion of the critical accounting policies and significant estimates that we believe require us to make the most complex or subjective decisions or assessments.
Allowance for Loan Losses. The ALL is a valuation allowance for probable incurred credit losses. Loans that are deemed to be uncollectible are charged off and deducted from the ALL. The provision for loan losses and recoveries on loans previously charged off are credited to the ALL. The ALL consists of specific and general components subject to significant judgment and short-term change. The specific component relates to loans that are individually classified as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered TDRs and classified as impaired. The general component covers loans that are collectively evaluated for impairment and loans that are not individually identified for impairment evaluation. The general component is based on historical loss experience adjusted for current factors and includes actual loss history experienced for the preceding three fiscal years and the interim period for the current fiscal year. This actual loss experience is supplemented with other qualitative economic factors based on the risks present for each portfolio type. These economic factors include consideration of the following: levels and trends in delinquencies and impaired loans (including TDRs); levels and trends in charge-offs and recoveries, trends in volumes and terms of loans; migration of loans to the classification of special mention, substandard, or doubtful; effects of any change in risk selection and underwriting standards; other changes in lending policies and procedures; national and local economic trends and conditions; and effects of changes in credit concentrations. Generally, our estimate for the ALL does not have significant sensitivity to the changes in the qualitative factors. For a 0.20% increase in the qualitative economic factors assigned by us to each loan category the ALL atDecember 31, 2021 would have increased by approximately$0.3 million . The Company considered COVID-19 to be the most significant factor the Company uses in the qualitative economic factors estimate of the ALL. The ALL increase associated with the COVID-19 pandemic was$0.7 million as ofDecember 31, 2021 andDecember 31, 2020 . These sensitivity analyses do not represent management's expectations of the deterioration in risk ratings or the increases in loss rates but are provided as hypothetical scenarios to assess the sensitivity of the allowance for loan and lease losses to changes in key inputs. We believe the risk ratings and loss severities currently in use are appropriate. We estimate the allowance balance required using past loan loss experience, current economic conditions, the nature and volume of the portfolio, information about specific borrower situations, estimated collateral values and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged off. Amounts are charged off when available information confirms that specific loans, or portions thereof, are uncollectible. This methodology for determining charge-offs is consistently applied to each group of loans. We group loans into different categories based on loan type to determine the appropriate allowance for each loan group. The Company generally places loans on a nonaccrual status when: (1) payment is in default for 90 days or more unless the loan is well secured and in the process of collection; or (2) full repayment of principal and interest is not foreseen. When a loan is placed on nonaccrual status, all accrued and uncollected interest on that loan is reversed. Past-due interest received on nonaccrual loans is not recognized in interest income but is applied as a reduction of the outstanding principal of the loan consistent with the accounting for impaired loans. A loan is relieved of its nonaccrual status when all principal and interest payments are brought current, the loan is well secured, and an analysis of the borrower's financial condition provides reasonable assurance that the borrower can repay the loan as scheduled. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due in accordance with the contractual terms of the loan agreement, including scheduled interest payments. Impairment is evaluated in total for smaller-balance loans of similar nature, such as Strategic Program loans, and on an individual loan basis for commercial real estate secured and SBA and commercial non-real estate and consumer loans. If a loan or pool of loans is impaired, a portion of the allowance is allocated so that the loan or pool of loans is reported, net of the present value of estimated future cash flows using the loan's original effective rate or at the fair value of collateral less estimated costs to sell if repayment is expected solely from the collateral. Factors considered in determining impairment include payment status, collateral value and the probability of collecting all amounts when due. Loans that experience insignificant payment delays and payment shortfalls are generally not classified as impaired. We considered the significance of payment delays on a case by case basis, taking into consideration all the circumstances of the loan and borrower, including the length of delay, the reasons for the delay, the borrower's prior payment record, the amount of the shortfall in relation to principal and interest owed. See our consolidated financial statements included elsewhere in this Report and "-Principal Factors Affecting Our Financial Condition-Allowance for Loan Losses" for more information.
Stock-based Compensation. Our historical and outstanding stock-based compensation awards are described in Note 10 in our annual consolidated financial statements included elsewhere in this Report.
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We record stock-based compensation in accordance with ASC 718, Compensation -
Stock Compensation ("ASC 718") and recognize stock-based compensation expense in
the period in which an employee or non-employee is required to provide service,
which is generally over the vesting period of the individual stock-based payment
award. Compensation expense for awards is recognized over the requisite service
period on a straight-line basis and we account for forfeitures as they occur. We
classify our awards as equity awards and these awards are valued as of the grant
date based upon the underlying stock price and a number of assumptions,
including volatility, performance period, risk-free interest rate and expected
dividends.
The determination of the grant date fair value using an option pricing model is
affected principally by our estimated fair value of our common stock and
requires us to make a number of other assumptions, including the expected term
of the award, the expected volatility of the underlying shares, the risk-free
interest rate and the expected dividend yield. The assumptions used in our
Black-Scholes option-pricing model represent management's best estimates at the
time of measurement. These estimates are complex, involve a number of variables,
uncertainties and assumptions and the application of management's judgment, as
they are inherently subjective. We will continue to use judgment in evaluating
the expected volatility, expected terms and interest rates utilized for our
stock-based compensation expense calculations on a prospective basis. If any
assumptions change, our stock-based compensation expense could be materially
different in the future. These assumptions are estimated as follows:
• Expected Term. The expected term represents the period that our awards are
expected to be outstanding. We calculated the expected term using a permitted
simplified method, which is based on the vesting period and contractual term
for each tranche of awards.
• Expected Volatility. The expected volatility was based on the historical share
volatility of several comparable publicly traded companies over a period of
time equal to the expected term of the awards, as we do not have any trading
history to use the volatility of our own common shares. The comparable
companies were chosen based on their size, stage in life cycle and area of
specialty. We will continue to apply this process until a sufficient amount of
historical information regarding the volatility of our own share price becomes
available.
• Risk-Free Interest Rate. The risk-free rate is based on the
curve in effect at the time of grant for periods corresponding with the expected life.
• Expected Dividend Yield. We have not paid dividends on our common shares nor do
we expect to pay dividends in the foreseeable future. Therefore, we used an
expected dividend yield of zero.
For the years endedDecember 31, 2021 and 2020, stock-based compensation expense was$2.1 million and$1.8 million , respectively. As ofDecember 31, 2021 , we had$0.3 million of total unrecognized stock-based compensation costs, which we expect to recognize over an estimated weighted-average period of 2.33 years. We expect to continue to grant options and other stock-based awards in the future, and to the extent that we do, our stock-based compensation expense recognized in future periods will likely increase. Fair Value of Common Stock. There was no public market for our common shares prior to the completion of our initial public offering onNovember 23, 2021 . As such, the estimated fair value of our common shares has previously been determined at each grant date by our board of directors, with input from management, based on the information known to us on the grant date and upon a review of any recent events and their potential impact on the estimated per share fair value of our common shares. As part of these fair value determinations, our board of directors obtained and considered valuation reports prepared by a third-party valuation firm in accordance with the guidance outlined in theAmerican Institute of Certified Public Accountants Accounting and Valuation Guide , Valuation ofPrivately-Held-Company Equity Securities Issued as Compensation. In estimating the fair value of our common shares prior to the offering completed onNovember 23, 2021 , multiple factors were considered in selecting an appropriate valuation approach, including, without limitation: (i) does the valuation method reflect our going-concern and/or expected time to liquidity status; (ii) does the valuation method assign value to the junior instruments, unless a future exit scenario is being analyzed whereby no cash is being distributed to the junior instruments based on equity class-specific rights; and (iii) is the method appropriate based on our stage of development at the date of the valuation. The valuation method evaluated and utilized, as appropriate, was the Option Pricing Method, or OPM. The OPM is a forward-looking method that considers our current equity value and was used to allocate our total equity value between common stock and stock options granted considering a continuous distribution of outcomes, rather than focusing on distinct future scenarios. We estimated fair value of our common shares using the OPM given the uncertainty associated with both the timing and type of any future exit scenario and applied an Income Approach and Market Approach. The Income Approach attempts to value an asset or security by estimating the present value of the future economic benefits it is expected to produce. These benefits can include earnings, cost savings, tax deductions, and disposition proceeds from the asset. An indication of value may be developed in this approach by discounting expected cash flows to their present value at a rate of return that incorporates the risk-free rate for the use of funds, the expected rate of inflation over the holding period, and the risks associated with realizing the cash flows in the amounts and at the times projected. The discount rate selected is typically based on rates of return available from alternative investments of similar type and quality as of the valuation date. The most commonly employed income approach to valuation is the discounted cash flow analysis. The Market Approach estimates the value of an asset or security by examining observable market values for similar assets or securities. Sales and offering prices for comparable assets are adjusted to reflect differences between the asset being valued and the comparable assets, such as, location, time and terms of sale, utility, and physical characteristics. When applied to the valuation of equity, the analysis may include consideration of the financial condition and operating performance of the company being valued relative to those of publicly traded companies or to those of companies acquired in a single transaction, which operate in the same or similar lines of business. 74
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The OPM uses option theory to value securities in light of their respective claims to the enterprise value. Total equity value is allocated based upon a series of call options with strike prices at various value levels depending upon the rights and preferences of type of outstanding share. While the OPM is capable of allocating value across distinct share classes, because we have only a single class of stock, the OPM applied was utilized only to estimate the value allocable between common stock and stock options granted. A Black-Scholes closed form option pricing model is typically employed in this analysis, with an option term assumption that is consistent with expected time to a liquidity event and a volatility assumption based on the estimated stock price volatility of a peer group of comparable public companies over a similar term. When estimating our total equity value, we applied both an Income Approach and Market Approach and weighted the results evenly. The Income Approach utilized discounted cash flows using forecasted assumptions of operating income and a discount rate based on the cost of equity. The Market Approach was applied considering a set of guideline comparable companies, known as the Guideline Publicly-Traded Companies Method, or GPTCM. Under the GPTCM, valuation multiples were calculated from the market data and operating metrics of the guideline companies. The selected multiples were evaluated and adjusted based on the characteristics of the Company relative to the comparable companies being analyzed. The selected multiples were ultimately applied to our operating metrics to calculate indications of value. A discount for lack of marketability, or DLOM, was also then applied. We considered various objective and subjective factors to estimate the fair value of the Company's equity price per share of each grant date, including the value estimated by a third-party valuation firm. The factors considered by the third-party valuation firm and our board of directors included the following:
• Our financial performance, capital structure and stage of development;
• Our management team and business strategy;
• External market conditions affecting our industry, including competition and
regulatory landscape;
• Our financial position and forecasted operating results;
• The lack of an active public or private market for our equity shares;
• Historical discussions we have had with potential private investors;
• The likelihood of achieving a liquidity event, such as a sale of the Company or
an initial public offering of our equity shares; and
• Market performance analyses, including with respect to share price valuation,
of similar companies in our industry.
Application of these approaches involves the use of estimates, judgment and assumptions that are highly complex and subjective, such as those regarding our expected future revenue, expenses and future cash flows, discount rates, market multiples, the selection of comparable companies and the probability of possible future events. Changes in any or all of these estimates and assumptions or the relationships between the assumptions impact our valuations as of each valuation date and may have a material impact on the valuation of our common shares. After the completion of our initial public offering onNovember 23, 2021 , it is no longer be necessary for our board of directors to estimate the fair value of our common stock in connection with our accounting for stock-based awards we may grant, as the fair value of our common stock will be determined based on the closing price of our common stock as reported on the date of grant. Income Taxes. We account for income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statement carrying amounts and tax bases of assets and liabilities using enacted tax rates expected to be in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts more likely than not to be realized. Realization of the future tax benefits is dependent on our ability to generate sufficient taxable income within the carryforward period. Because of our recent history of operating losses, management believes that recognition of the deferred tax assets arising from the above-mentioned future tax benefits is not likely to be realized and, accordingly, has provided a full valuation allowance. 75
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We assess all material positions taken in any income tax return, including all significant uncertain positions, in all tax years that are still subject to assessment or challenge by relevant taxing authorities. Assessing an uncertain tax position begins with the initial determination of the position's sustainability and is measured at the largest amount of benefit that is more likely than not of being realized upon ultimate settlement. As of each balance sheet date, unresolved uncertain tax positions must be reassessed, and we will determine whether (i) the factors underlying the sustainability assertion have changed and (ii) the amount of the recognized tax benefit is still appropriate. The recognition and measurement of tax benefits requires significant judgment. Judgments concerning the recognition and measurement of a tax benefit might change as new information becomes available. Our unrecognized tax benefits, if recognized, would not have an impact on our effective tax rate assuming we continue to maintain a full valuation allowance position. We do not expect our unrecognized tax benefits to change significantly over the next 12 months. Our policy is to recognize interest and penalties related to the underpayment of income taxes as a component of income tax expense or benefit. During the years endedDecember 31, 2021 and 2020, the Company recognized de minimis interest and penalties.
GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures
Some of the financial measures included in this Report are not measures of financial performance recognized by GAAP. These non-GAAP financial measures are "tangible book value per share," and "total nonperforming assets and troubled debt restructurings to total assets (less PPP loans)." Our management uses these non-GAAP financial measures in its analysis of our performance.
• "Tangible book value per share" is defined as book value per share less
goodwill and other intangible assets, divided by the outstanding number of
common shares at the end of each period. The most directly comparable GAAP
financial measure is book value per share. We had no goodwill or other
intangible assets as of any of the dates indicated. We have not considered loan
servicing rights as an intangible asset for purposes of this calculation. As a
result, tangible book value per share is the same as book value per share as of
each of the dates indicated.
• "Total nonperforming assets and troubled debt restructurings to total assets
(less PPP loans)" is defined as the sum of nonperforming assets and troubled
debt restructurings divided by total assets minus PPP loans. The most directly
comparable GAAP financial measure is the sum of nonperforming assets and
troubled debt restructurings to total assets. We believe this measure is
important because we believe that PPP loans will not be included in
nonperforming assets or troubled debt restructurings since PPP loans are 100%
guaranteed by the SBA. We believe that the non-GAAP measure more accurately
discloses the proportion of nonperforming assets and troubled debt
restructurings to total assets consistently with periods prior to the presence
of PPP loans.
We believe these non-GAAP financial measures provide useful information to
management and investors that is supplementary to our financial condition,
results of operations and cash flows computed in accordance with GAAP; however,
we acknowledge that our non-GAAP financial measures have a number of
limitations. As such, you should not view these measures as a substitute for
results determined in accordance with GAAP, and they are not necessarily
comparable to non-GAAP financial measures that other companies use. The
following table provides a reconciliation of these non-GAAP financial measures
to the most closely related GAAP measure.
Total nonperforming assets and troubled debt restructurings to total assets
(less PPP loans)
Year Ended
December 31,
($ in thousands) 2021 2020
Total nonperforming assets
and troubled debt
restructuring $ 763 $ 1,701
Total assets $ 380,214 $ 317,515
PPP loans $ 1,091 $ 107,145
Total assets less PPP loans $ 379,123 $ 210,370
Total nonperforming assets
and troubled debt
restructurings to total
assets (less PPP loans) 0.2 % 0.8 %
76--------------------------------------------------------------------------------
Index
Recently Issued Accounting Pronouncements
See our consolidated financial statements included elsewhere in this Report for a full description of recent accounting pronouncements, including the respective expected dates of adoption and anticipated effects on our results of operations and financial condition.
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